Net Investment Income Tax (3.8% NIIT): What It Applies To and How Business Owners Can Reduce It

By Yarik Yarosh, CPA ·September 5, 2026 ·6 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 that applies to high-income individuals on the lesser of their net investment income or the amount by which their modified adjusted gross income (MAGI) exceeds the statutory threshold ($200,000 for single filers, $250,000 for married filing jointly, $125,000 for married filing separately). The NIIT was enacted as part of the Affordable Care Act (ACA) to help fund Medicare, and it functions as a Medicare tax on investment income, filling the gap left by the fact that FICA applies only to earned income. Unlike the regular Medicare tax (2.9% on all wages and self-employment income) and the Additional Medicare Tax (0.9% on earned income over $200,000/$250,000), the NIIT targets passive and investment income. For business owners, the critical distinction is between active business income (which is exempt from NIIT) and passive business income (which is subject to it). The material participation tests under IRC 469 determine which category applies.

✓Key takeaway

NIIT threshold and computation:

Filing Status	MAGI Threshold	Tax Rate
Single	$200,000	3.8%
Married filing jointly	$250,000	3.8%
Married filing separately	$125,000	3.8%
Head of household	$200,000	3.8%
Estates and trusts	$15,200 (2025, indexed)	3.8%

Formula: NIIT = 3.8% x lesser of (1) Net Investment Income or (2) MAGI minus threshold

What is and is NOT net investment income:

Subject to NIIT (Net Investment Income)	NOT Subject to NIIT
Interest income	Wages and salaries
Dividends (ordinary and qualified)	Self-employment income
Capital gains (short-term and long-term)	Active business income (S-Corp/partnership, material participation)
Rental income (unless real estate professional)	Distributions from IRAs, 401(k)s, pensions
Royalties	Social Security benefits
Passive business income (no material participation)	Tax-exempt bond interest
Annuity income (taxable portion)	Gain on sale of active business (if materially participating)
Income from trading in financial instruments	Self-rental income (if grouped with active business)

How does the NIIT affect mixed-income owners?

Hypothetical example

Round numbers. Married filing jointly. Combined income from multiple sources.

Income Source	Amount	Net Investment Income?
W-2 wages (one spouse)	$180,000	No
S-Corp active business income (other spouse, material participation)	$150,000	No (active)
Rental property income (no material participation)	$30,000	Yes
Dividends and interest	$25,000	Yes
Capital gains (stock sales)	$50,000	Yes
Total MAGI	$435,000
Total net investment income	$105,000

NIIT calculation:

Step	Amount
MAGI	$435,000
Threshold (MFJ)	$250,000
Excess MAGI	$185,000
Net investment income	$105,000
Lesser of $185,000 or $105,000	$105,000
NIIT (3.8%)	$3,990

Reduction strategies:

Strategy 1: Maximize retirement contributions (reduce MAGI)

Contribution	MAGI Reduction	NIIT Savings
401(k) deferral ($23,500)	($23,500)	$893
Defined benefit plan ($100,000)	($100,000)	$3,800
HSA ($8,550 family)	($8,550)	$325
Total MAGI reduction	($132,050)	$5,018 (but NIIT was only $3,990)

Revised MAGI: $435,000 - $132,050 = $302,950. Excess over threshold: $52,950. NIIT: 3.8% x lesser of $105,000 or $52,950 = $2,012. Savings: $1,978.

Strategy 2: Material participation in rental (convert passive to active) If one spouse qualifies as a real estate professional (750 hours, more than half of services) and materially participates in the rental:

Before	After
Rental income = net investment income ($30,000)	Rental income = active (NOT net investment income)
Net investment income = $105,000	Net investment income = $75,000
NIIT = $3,990	NIIT = 3.8% x $75,000 = $2,850
Savings	$1,140

Strategy 3: Harvest capital losses Realize $20,000 in capital losses to offset $20,000 of the $50,000 in capital gains:

Before	After
Capital gains = $50,000	Capital gains = $30,000 (net of $20,000 losses)
Net investment income = $105,000	Net investment income = $85,000
NIIT = $3,990	NIIT = 3.8% x $85,000 = $3,230
Savings	$760

Strategy 4: Invest in tax-exempt municipal bonds Replace $25,000 of taxable bond interest with tax-exempt municipal bond interest:

Before	After
Interest income = $25,000 (taxable)	Interest income = $0 (tax-exempt muni bonds not included in NII)
Net investment income = $105,000	Net investment income = $80,000
NIIT = $3,990	NIIT = 3.8% x $80,000 = $3,040
Savings	$950

Note: tax-exempt interest IS included in MAGI for NIIT threshold purposes, but is NOT included in net investment income.

Strategy 5: Convert S-Corp passive income to active If the S-Corp income were passive (no material participation), it would be subject to NIIT:

Material Participation Status	S-Corp Income Treatment	NIIT Impact
Active (500+ hours)	NOT net investment income	$0 NIIT on $150,000
Passive (<500 hours)	Net investment income	$5,700 additional NIIT (3.8% x $150,000)

The difference between active and passive participation on the S-Corp income alone is $5,700 in NIIT.

The estate and trust NIIT trap: Estates and trusts hit the NIIT threshold at just $15,200 of income (2025). This means virtually all trust investment income is subject to the 3.8% NIIT.

Entity	NIIT Threshold	Effective on Most Income?
Individual (MFJ)	$250,000	Only above $250K
Individual (Single)	$200,000	Only above $200K
Estate or Trust	$15,200	Yes, on nearly all income

This is why distributing income from trusts to beneficiaries (who have higher thresholds) is often the better approach.

Interaction with other Medicare taxes:

Tax	Applies To	Rate	Threshold
Employee Medicare (regular)	Wages	1.45%	All wages
Employee Medicare (additional)	Wages over threshold	0.9%	$200K/$250K
Self-employment Medicare	SE income	2.9%	All SE income
Self-employment Medicare (additional)	SE income over threshold	0.9%	$200K/$250K
NIIT	Net investment income	3.8%	$200K/$250K

The NIIT fills the gap: wages and SE income face the 2.9% (+ 0.9% additional) Medicare tax, while investment income faces the 3.8% NIIT. The combined effect: all high-income taxpayers pay approximately 3.8% on most forms of income above the threshold (active business income from pass-throughs being the notable exception).

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 (3.8% NIIT): What It Applies To and How Business Owners Can Reduce It." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-net-investment-income-tax-niit-3point8

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