Net Investment Income Tax (NIIT)

Detailed Explanation

The Net Investment Income Tax under IRC Section 1411, enacted as part of the Affordable Care Act in 2013, imposes an additional 3.8% tax on investment income for higher-income taxpayers. The tax is calculated on Form 8960 and applies to the LESSER of (a) net investment income, or (b) modified adjusted gross income above the threshold ($200,000 single, $250,000 married filing jointly, $125,000 married filing separately). Thresholds are NOT indexed for inflation, so over time more taxpayers fall under the rule. Net investment income includes interest, dividends, capital gains, rental and royalty income, non-qualified annuities, and income from passive business activities (where the taxpayer does not materially participate). It excludes wages, self-employment income, distributions from IRAs and retirement plans, Social Security, alimony, active business income, and gain on sale of an active business. Capital gain on the sale of a primary residence above the Section 121 exclusion is subject to NIIT. The NIIT stacks on top of regular tax: a high-income filer paying 20% federal long-term capital gain rate on a stock sale also pays 3.8% NIIT for an effective 23.8% rate, and the same applies to qualified dividends. For active real estate professionals (REPS), rental income/gain is generally excluded from NIIT because the activity is not "passive." For S-Corp shareholders who are active in the business, K-1 ordinary income is excluded as well.