Net Investment Income Tax (NIIT): The 3.8% Surtax and How It Affects Business Owners

By Yarik Yarosh, CPA ·September 5, 2026 ·5 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

The Net Investment Income Tax (NIIT) under IRC 1411 is a 3.8% surtax on investment income that applies to taxpayers whose modified adjusted gross income (MAGI) exceeds $200,000 (single), $250,000 (MFJ), or $125,000 (married filing separately). The tax is calculated on the LESSER of (1) net investment income or (2) the amount by which MAGI exceeds the threshold. Net investment income includes interest, dividends, capital gains, rental income, royalties, and income from passive business activities. It does NOT include wages, self-employment income, active business income from an S-Corp or partnership in which the taxpayer materially participates, Social Security benefits, tax-exempt interest, or distributions from qualified retirement plans.

✓Key takeaway

NIIT basics:

Factor	Details
Tax rate	3.8%
MAGI thresholds	$200,000 (single), $250,000 (MFJ), $125,000 (MFS)
Thresholds inflation-adjusted?	No (fixed since 2013, not indexed)
Reported on	Form 8960
Applies to	Individuals, estates, trusts

What is subject to NIIT:

Income Type	Subject to NIIT?
Interest income	Yes
Dividends (qualified and ordinary)	Yes
Capital gains (short-term and long-term)	Yes
Rental income (passive)	Yes
Rental income (real estate professional, material participation)	No
Royalties	Yes
Income from passive business activities	Yes
Gain on sale of investment property	Yes
Gain on sale of primary residence (above $250K/$500K exclusion)	Yes

What is NOT subject to NIIT:

Income Type	Subject to NIIT?
Wages and salary	No
Self-employment income (Schedule C)	No
Active S-Corp/partnership income (material participation)	No
Social Security benefits	No
Tax-exempt municipal bond interest	No
Retirement plan distributions (401(k), IRA)	No
Active trade or business income	No

Key distinction for business owners:

Business Type	Owner’s Role	NIIT Applies?
S-Corp, owner materially participates	Active	No
S-Corp, owner does NOT materially participate	Passive	Yes
Partnership, partner materially participates	Active	No
Partnership, limited partner (generally passive)	Passive	Yes
Rental real estate (passive investor)	Passive	Yes
Rental real estate (real estate professional, material participation)	Active	No
Sole proprietorship	Active (always)	No

How does the NIIT affect business owners?

Hypothetical example

Round numbers. A married couple. Both work. Combined MAGI: $350,000.

Income breakdown:

Source	Amount	Subject to NIIT?
Wife’s W-2 salary	$150,000	No
Husband’s S-Corp K-1 (materially participates)	$120,000	No
Rental property income (passive)	$30,000	Yes
Stock dividends	$20,000	Yes
Capital gains from stock sales	$30,000	Yes
Total MAGI	$350,000

NIIT calculation:

Step	Calculation
1. Net investment income	$30,000 (rental) + $20,000 (dividends) + $30,000 (capital gains) = $80,000
2. MAGI over threshold	$350,000 - $250,000 (MFJ) = $100,000
3. NIIT base (lesser of Step 1 or Step 2)	$80,000 (lesser)
4. NIIT (3.8%)	$80,000 x 3.8% = $3,040

Strategies to reduce the NIIT:

Strategy 1: Reduce MAGI below threshold

Action	MAGI Reduction
Maximize retirement contributions ($23,500 each)	($47,000)
HSA contribution ($8,550 family)	($8,550)
Revised MAGI	$294,450
MAGI over threshold	$44,450
NIIT base (lesser of $80,000 or $44,450)	$44,450
NIIT	$44,450 x 3.8% = $1,689
Savings	$1,351

Strategy 2: Convert passive rental income to active If the husband qualifies as a real estate professional (750+ hours in real property trades or businesses, more than half of personal services in real property) AND materially participates in the rental activity:

Item	Before	After RE Pro Status
Rental income subject to NIIT	$30,000	$0
Net investment income	$80,000	$50,000
NIIT	$3,040	$50,000 x 3.8% = $1,900
Savings		$1,140/year

Strategy 3: Harvest capital losses Sell losing stock positions to offset the $30,000 in capital gains:

Item	Before	After Loss Harvesting
Capital gains	$30,000	$0 (offset by $30,000 in realized losses)
Net investment income	$80,000	$50,000
NIIT	$3,040	$1,900
Savings		$1,140

Plus: $30,000 x 15% = $4,500 savings on the capital gains tax itself. Total savings from loss harvesting: $5,640.

The S-Corp material participation advantage: If the husband’s S-Corp income were from a business he did NOT materially participate in (passive S-Corp):

Item	Active S-Corp	Passive S-Corp
S-Corp K-1 income	$120,000	$120,000
Subject to NIIT	No	Yes
NIIT on S-Corp income	$0	$100,000 x 3.8% = $3,800 (MAGI over threshold capped)

Material participation in the S-Corp saves $3,800/year in NIIT alone.

The non-indexed threshold problem: The $200,000/$250,000 thresholds have been fixed since 2013. With inflation, more taxpayers hit the threshold every year.

Year	$250,000 in Today’s Dollars	More Taxpayers Subject to NIIT?
2013 (enacted)	$250,000	Baseline
2025 (13 years later)	Approximately $325,000 purchasing power	Yes (threshold hasn’t moved)
2035 (projected)	Approximately $400,000 purchasing power	Even more

The NIIT increasingly functions as a middle-income surtax rather than a high-income tax, catching more business owners who would not have been subject to it when the thresholds were set.

Illustrative numbers only, not a real client and not advice for your facts.

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Cite this page

Yarik Yarosh, CPA. "Net Investment Income Tax (NIIT): The 3.8% Surtax and How It Affects Business Owners." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-net-investment-income-tax-niit-3-8-percent

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.