Net Investment Income Tax: The 3.8% Surtax Retirees Overlook

It is a surtax created by section 1411 of the Internal Revenue Code, in effect since 2013, that applies to individuals, estates and trusts with investment income and income above a statutory threshold (IRS Topic 559). For individuals, the tax is 3.8% of the lesser of net investment income or modified adjusted gross income above the threshold amount (26 U.S.C. 1411(a)(1)).

The thresholds are the single most important fact about this tax. The IRS states plainly that they are not indexed for inflation (IRS NIIT Q&A). Tax brackets, the standard deduction and the IRMAA tiers all rise most years; these do not. A couple who were comfortably under $250,000 in 2013 may be well over it today on the same real income, and the gap widens each year.

For most people, modified adjusted gross income for this purpose is simply the adjusted gross income on your Form 1040. The statute only adds back foreign earned income excluded under section 911 (26 U.S.C. 1411(d)). Unlike the MAGI used for IRMAA, it does not add back tax-exempt interest.

It is separate from the Medicare payroll taxes, and the two never fall on the same dollar. The 0.9% Additional Medicare Tax applies to wages and self-employment income above similar thresholds; the NIIT applies to investment income. A working couple with a large salary and a portfolio can owe both, each on its own kind of income (IRS NIIT Q&A).

Net investment income is gross investment income minus the expenses properly allocable to it. The IRS lists interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses that trade financial instruments or commodities, and income from businesses that are passive activities to you (IRS NIIT Q&A). Gains include sales of stocks, bonds and mutual funds, mutual fund capital gain distributions, investment real estate including a second home, and passive interests in partnerships and S corporations.

The exclusions come from the statute and the IRS guidance. Section 1411(c)(5) excludes any distribution from a plan described in sections 401(a), 403(a), 403(b), 408, 408A or 457(b), which covers traditional and Roth IRAs, 401(k) and profit-sharing plans and most employer pensions (26 U.S.C. 1411). The IRS adds wages, Social Security, alimony, tax-exempt interest, self-employment income and operating income from a non-passive business to the list (IRS NIIT Q&A).

Annuities split along the same line. A non-qualified annuity, bought with after-tax money outside a retirement plan, produces net investment income on its taxable portion. An annuity held inside an IRA or paid from an employer plan does not (Form 8960 instructions). If you own a deferred annuity from an insurance company, check which kind it is before you plan a large withdrawal.

Some deductions reduce net investment income on Form 8960: investment interest expense, advisory and brokerage fees where deductible, expenses of rental and royalty property, and the share of state and local income tax that is attributable to investment income (IRS NIIT Q&A). For a retiree in a high-tax state who itemizes, that state tax allocation is worth asking about. A charitable deduction, by contrast, does not reduce net investment income or the MAGI that sets the threshold.

This is where most confusion lies, including in some professional advice. Two statements are both true. First, an IRA withdrawal, an RMD or a Roth conversion is never itself net investment income, so it is never taxed at 3.8%. Second, the taxable part of each of them is in your adjusted gross income, and adjusted gross income is the MAGI the threshold is measured against (26 U.S.C. 1411(d)).

Put together, ordinary retirement income decides whether the tax applies, and investment income decides how much it can be. Take a couple whose pension, IRA withdrawals and $60,000 of dividends add up to exactly $250,000 of MAGI. They owe no NIIT. Add a $100,000 Roth conversion and their MAGI is $350,000, which is $100,000 over. The tax applies to the smaller figure, the $60,000 of dividends, and costs $2,280. The conversion did not become investment income. It pulled the investment income they already had over the line.

The same logic applies to wages in a final working year, a large RMD, a pension lump sum taken in cash, and the taxable part of Social Security. None of them is net investment income. Each of them can make your interest and dividends taxable at 3.8%. When a CPA or adviser tells you a Roth conversion “isn’t subject to the NIIT,” that is correct about the conversion and incomplete about your return.

Compute two numbers and take the smaller: your net investment income, and your MAGI minus the threshold. Multiply that by 3.8%. If MAGI is under the threshold, the second number is zero and there is no tax, however much investment income you have (IRS Topic 559).

Example 1: a gain that crosses the line. Paul, 67, still earns a $140,000 salary; his wife Diane, 64, draws a $60,000 pension. They have $20,000 of interest and $20,000 of dividends, so their AGI is $240,000, under the $250,000 threshold, and they owe no NIIT. In 2026 they sell shares with a $50,000 long-term gain.

Their net investment income is $90,000, but only $40,000 of their MAGI sits above the threshold, so that smaller figure is taxed: $1,520 of NIIT. The same sale raises their regular federal income tax by $7,632, and because their MAGI moves to IRMAA tier 2, it adds $3,473 to their Medicare premiums in 2028, when Diane is also on Medicare. The total cost of the $50,000 gain is $12,625, or 25.2%. The NIIT is the smallest of the three pieces, which is typical for households just over the line.

Notice what the 3.8% did not touch. The first $10,000 of the gain filled the room under the threshold and was taxed only at the capital gains rate. That room is worth knowing before you sell, and our Capital Gains Tax Calculator shows it for your own numbers as “headroom” before each threshold.

Many retirees with substantial savings live under the threshold in an ordinary year, then cross it once or twice in a decade. The usual triggers:

• •A large stock or fund sale. Rebalancing a concentrated position, selling a holding inherited decades ago, or raising cash for a house or a gift. The whole gain is net investment income.
• •A home sale above the exclusion. Gain within the $250,000 or $500,000 section 121 exclusion is excluded from net investment income; gain above it is included and raises MAGI (IRS NIIT Q&A). Long ownership in an expensive market makes this common. See our guide to downsizing in retirement.
• •A rental property sale. Rents are net investment income every year, and the gain on sale, including the part attributable to depreciation, is too. Our guide to rental property in retirement covers keeping versus selling.
• •A big RMD year with a large taxable portfolio. RMDs are not investment income, but at 75 a large IRA can produce an RMD that, with dividends and interest, lifts MAGI past the threshold every year.
• •A pension lump sum. A lump sum from a qualified plan that is taken in cash rather than rolled to an IRA is not investment income but lands entirely in one year’s MAGI.
• •A Roth conversion year. As in Example 2 below, a conversion can make all of a year’s investment income taxable.
• •The year a spouse dies. The survivor files as single from the year after the death (or after the qualifying-surviving-spouse years with a dependent child), and the threshold drops from $250,000 to $200,000 while much of the income continues.

Example 2: a Roth conversion year. Harold, 72, and June, 70, have a $40,000 pension, a $55,000 RMD, $70,000 of Social Security and $60,000 of interest and dividends from a taxable account. Their AGI is $214,500, under $250,000, so they owe no NIIT. They convert $120,000 of a traditional IRA to a Roth.

Their net investment income is unchanged at $60,000; the conversion added nothing to it. But their MAGI is now $84,500 over the threshold, so the smaller figure is all of their investment income, and the NIIT is $2,280. That is the most the tax can ever be for them in a year with this portfolio, whether they convert $120,000 or $360,000. Their regular federal tax rises from $25,067 to $53,356, and their IRMAA tier for 2028 goes from 0 to 2, adding $5,770 in premiums. For them, the IRMAA cost is larger than the NIIT. Our guide to Roth conversions before RMDs covers sizing the conversion itself.

Example 3: a home sale above the exclusion. Margaret, 74 and widowed, files as single. She sells the house she and her late husband owned for 30 years, with a $650,000 gain. She excludes $250,000 under section 121, leaving $400,000 of taxable long-term gain on top of a $50,000 pension, a $40,000 RMD, $45,000 of Social Security and $20,000 of dividends.

Here the other figure is smaller. Her net investment income is $420,000, but MAGI above $200,000 is $348,250, so that is what is taxed, for $13,234 of NIIT. Her regular federal tax on the sale is $60,385 and her 2028 IRMAA surcharge rises by $4,051, for a total of $77,670. Had she sold while her husband was alive, the $500,000 joint exclusion and the $250,000 threshold would both have applied. Section 121 has a rule for surviving spouses who sell within two years of the death; it is worth asking about before choosing a sale date.

The same dollar of income can be charged three ways: by the capital gains rate, by the NIIT, and two years later by the Medicare IRMAA surcharge. Each uses a slightly different measure of income and its own thresholds.

Three things follow. First, IRMAA starts below the NIIT. For a married couple, the first IRMAA tier begins at $218,000 of MAGI and the NIIT at $250,000, so any couple paying the NIIT on Medicare is almost certainly paying IRMAA two years later. Second, the measures differ: municipal bond interest is excluded from NIIT MAGI but added back for IRMAA. Third, between the two capital gains thresholds a long-term gain is taxed at 15%, so for a household above the NIIT line the effective federal rate is 18.8%; above $613,700 of joint taxable income it is 23.8%.

IRMAA is a cliff and the NIIT is a ramp. A dollar over an IRMAA threshold triggers the whole tier’s surcharge for each person on Medicare; a dollar over the NIIT threshold costs 3.8% of a dollar. That is why, in Examples 1 and 2, IRMAA cost more than the NIIT. Our IRMAA Calculator shows your tier and the room to the next one, and the Medicare and IRMAA guide explains the brackets. A one-time gain or conversion is not a life-changing event for a Form SSA-44 appeal; our guide to appealing IRMAA with Form SSA-44 explains which events are.

None of these is right for everyone, and several trade one tax for another. They are options to raise with your CPA, ideally in the autumn before the year ends, when there is still time to act.

Spread gains across years. Because the tax applies only above a fixed threshold, the same gain split over several years can fall partly or wholly below it. In Example 4, Ed and Carol, both 69, have $136,750 of AGI from pensions, IRA withdrawals, Social Security and dividends, and $300,000 of gains in a fund they want to sell.

Selling everything at once puts their MAGI at $436,750 and costs $7,097 of NIIT. Selling a third each year keeps MAGI at $236,750, under $250,000, and the NIIT disappears. Regular income tax is slightly higher when spread, because each year’s gain shrinks the 65-and-over deduction again, but the total is still $10,619 lower. The trade-off is market risk: holding a concentrated position for two more years can cost more than the tax saved. Tax rules can also change between now and the later years.

Give appreciated shares instead of cash. If you give to charity anyway, giving long-held shares directly means the gain is never realized, so it adds nothing to net investment income or MAGI. A charitable deduction does not reduce MAGI, so giving cash and selling the shares yourself does not have the same effect. A donor-advised fund lets you give shares in one year and grant the money over several.

Qualified charitable distributions. From 70½, up to $111,000 a year can go from an IRA directly to charity, counts toward an RMD, and is excluded from income. That lowers MAGI dollar for dollar, which can bring the investment income you do have back under the line. See our guide to qualified charitable distributions.

Municipal bonds. Tax-exempt interest is excluded from both net investment income and NIIT MAGI. It is not excluded from the MAGI used for IRMAA, and it counts when figuring how much of your Social Security is taxable. Whether a move toward munis helps depends on your bracket, your state and the yield difference, and it is not a decision to make for the NIIT alone.

Installment sales. Selling real estate or a private business interest for payments over several years generally spreads the gain over the years the payments arrive, with the same effect as Example 4. Installment treatment is generally not available for publicly traded stock, and depreciation recapture on equipment and other business property is taxed in the year of sale. The buyer’s credit becomes your risk.

Time Roth conversions. Because the NIIT in a conversion year is capped at 3.8% of that year’s investment income, conversions cost least in years without large realized gains, and a year with a big sale is usually a poor year to convert as well. Some households convert enough to stay under $250,000; others accept the NIIT as a small, known cost of a larger conversion. See taxes in retirement for how the brackets fit together.

Harvest losses. Realized capital losses offset realized gains first, which lowers both net investment income and MAGI, and up to $3,000 of net loss can offset other income each year with the rest carried forward. Our tax-loss harvesting guide covers the wash-sale rule.

Hold for the step-up. Assets held until death generally receive a new cost basis equal to their value at death, so the gain built up in your lifetime is never taxed as income, NIIT included. For an 85-year-old with a low-basis stock and other money to live on, never selling may be the lowest-tax outcome. For a 66-year-old with a concentrated position, waiting decades for a step-up is a large investment risk to take for a 3.8% tax.

Form 8960. Attach Form 8960 to your return if your MAGI is above the threshold (Form 8960 instructions). Part I collects investment income from the rest of the return, Part II subtracts allocable expenses, and Part III applies the smaller-of test. The result goes on Schedule 2 of Form 1040. Tax software completes it automatically, which makes it easy to miss that it is there; ask your CPA to show you the Form 8960 line on last year’s return.

Estimated taxes. The NIIT is subject to the estimated tax rules (IRS NIIT Q&A). In a year with a large sale, regular tax and NIIT on the gain can both be due well before April. Raising the federal withholding on an IRA distribution or a pension, or making a quarterly payment in the quarter of the sale, avoids a penalty for underpayment. Your CPA can tell you whether you already meet a safe harbor based on last year’s tax.

Trusts and estates. A non-grantor trust or an estate pays 3.8% on the smaller of its undistributed net investment income or its adjusted gross income above the dollar amount at which its highest tax bracket begins (26 U.S.C. 1411(a)(2)). For 2026 that bracket starts at $16,000 of taxable income (Revenue Procedure 2025-32), against $200,000 for a single person. A trust that accumulates $100,000 of dividends can owe the NIIT on most of it, while the same income distributed to beneficiaries is taxed on their returns against their own thresholds. A revocable living trust is a grantor trust whose income is reported on your own return, so the individual thresholds apply. For a bypass trust, an inherited-IRA trust or an estate in administration, the distribution decision affects both the regular tax and the NIIT, and it is a question for the trustee and the CPA each year.