What Is Net Investment Income (NII)?
Net investment income (NII), for tax purposes, is the total amount of money received from assets such as stocks, bonds, and mutual funds, minus related expenses.
NII may include interest income, dividend income, and capital gains. Whether this income, minus the expenses, is taxable is determined by the taxpayer's modified adjusted gross income (MAGI).
- Net investment income is income received from assets (before taxes) including bonds, stocks, mutual funds, loans, and other investments (less related expenses).
- NII is subject to a 3.8% tax for individuals with an NII and MAGI above certain thresholds.
- Estates?and?trusts?are subject to the NII tax if they have undistributed NII and their annual adjusted gross income exceeds the dollar amount at which the highest tax bracket begins.
- For investment companies, this is the amount of income left after?operating expenses?are subtracted from total investment income.
- The net investment income tax went into effect in 2013 as a means of raising revenue to fund the Affordable Care Act.
Understanding Net Investment Income (NII)
Income can be any money or compensation that an individual or a business earns in exchange for labor, the sale of products and services, or from investments. When investors sell assets from their portfolios, the proceeds from the transaction result in either a realized gain or loss. Realized gains may come in the form of:
- Capital gains from the sale of stock
- Interest income received from fixed-income products
- Dividends paid to shareholders of a company
- Rental income received from property
- Certain annuity payments
- Royalty payments
Costs such as trading commissions are subtracted from realized gains before taxes to arrive at net investment income. Other forms of income, such as wages, are not included.
NII has been taxable above certain thresholds since Jan. 1, 2013. Known as the net investment income tax, it was passed as part of the Health Care and Education Reconciliation Act of 2010. The NII tax was included as a revenue-raising tool to offset the costs of the Affordable Care Act (ACA). The rate was set at 3.8% on "certain net investment income of individuals, estates and trusts that have income above the statutory threshold amounts."
Net investment income may be either positive or negative depending on whether the asset was sold for a capital gain or loss.
What Counts as Net Investment Income?
The following table shows what counts and what doesn't count as net investment income.
|Net Investment Income: What Counts and What Doesn't|
|What Counts?||What Doesn't Count?|
|Interest income?||Wages and salaries|
|Dividends||Social Security benefits|
|Passive investment income||Unemployment benefits|
|Rental income||Qualified distributions from 401(k)s or IRAs|
|Royalty income||Life insurance payouts|
|Non-qualified annuity distributions||Income from active business investments|
|Business income (financial trading activities)||Proceeds from tax-exempt organizations and transactions|
Who Pays the NII Tax?
Net investment income is subject to a 3.8% tax if you exceed certain income limits. The tax applies to individuals, estates, and trusts.
The tax is applied to individuals with NII who fall within a certain modified adjusted gross income threshold. These thresholds are listed in the table below, and they are not indexed for inflation.
|Threshold for Net Investment Income Tax|
|Filing status||MAGI Limit ($)|
|Head of Household||$200,000|
|Married filing separately||$125,000|
|Married filing jointly||$250,000|
|Qualified widow(er) with dependent||$250,000|
The net investment income tax is applied to the lesser of the net investment income or the MAGI amount in excess of the predetermined limit.
Estates and Trusts
Estates and trusts are subject to the NII tax if they have undistributed NII and their annual adjusted gross income (AGI) exceeds the dollar amount at which the highest tax bracket begins. That level is $14,450 in 2023 and $15,200 in 2024.
A nonresident alien is not subject to the tax unless they are married to a U.S. citizen or resident and elect to be treated as a resident of the U.S. for tax purposes.
For investment companies, net investment income is the amount of income left after operating expenses are subtracted from total investment income, and is typically expressed on a per-share basis.
To find the net investment income per share of a company, divide the total investment income by the shares outstanding. This amount is what is available to shareholders as dividends. A publicly traded company must list its net investment income on its balance sheet.
How to Calculate the NII Tax
Before you can calculate the NII tax, you must determine the income you earned from every one of your qualified investments. Be sure you account for and subtract any fees and related expenses, such as commissions and brokerage charges. You can refer to the list of what counts in the table above.
Next, you'll need to get your MAGI. This figure is your AGI plus any excluded income and certain deductions like student loan payments. See the table above for your tax filing status. If you fall above any of those thresholds, you will have to pay an NII tax.
If you can reduce your reported MAGI or net investment income, you can also reduce your NII tax liability. Some ways to do that include contributing to retirement plans or charities or tax-loss harvesting.
You can use Internal Revenue Service (IRS) Form 8960 to determine what your tax liability is for net investment income, or you can do so on your own. The 3.8% tax is imposed on your net investment income or the amount by which your MAGI exceeds the listed thresholds, whichever is less. Here are two simple scenarios, assuming you have an NII of $25,000:
- Scenario 1: You exceed the MAGI by $30,000. You owe the 3.8% tax but only on the $25,000 investment income because it is less than the amount that goes over the MAGI threshold.
- Scenario 2: You exceed the MAGI by $10,000. You owe the 3.8% but only on the $10,000 because it is lower than your NII.
How To Manage the NII Tax
Even if you earn significant investment income, you can reduce your tax liabilities by taking steps that reduce your reported adjusted gross income (AGI), your net investment income, or both.
One way to reduce your AGI is to maximize your contributions to IRAs and other qualified retirement plans, or by participating in deferred compensation plans. If you can reduce your AGI so that it does not exceed the threshold above, you may not need to pay NII tax at all.
You can also reduce your net investment income through tax-loss harvesting. By selling unprofitable investments at the same time as profitable ones, you can reduce your net investment income and thereby reduce your tax burden.
It is also possible to reduce NII through charitable contributions, such as a charitable remainder trust.
How to Pay the NII Tax
You must report your NII on IRS Form 8960. This form can help entities that are required to pay the tax to calculate their liability.
The figure on this form is transferred to the appropriate main tax form. For individuals, the NII tax is reported and paid with Form 1040. Estates and trusts that must report NII tax do so with Form 1041: U.S. Income Tax Return for Estates and Trusts.
Example of Net Investment Income
Here's a hypothetical example to show how net investment income works. Let's say an individual sells 100 shares of Apple (AAPL) for $175 per share and 50 shares of Netflix (NFLX) for $170 per share. They also received coupon payments for the year on their corporate bonds in the sum of $2,650 and income from a rental property of $16,600.
Their net investment income can be calculated as:
|Capital gain from AAPL: (Sale Price $175 – Cost $140) x 100||$ 3,500|
|Capital loss from NFLX: (Sale Price $170 – Cost $200) x 50||($1,500)|
|Tax preparation fees||($160)|
|Net Investment Income||$21,055|
What Qualifies as Net Investment Income?
Net investment income is any money earned from an investment vehicle. This includes interest, capital gains, royalties, rent payments, dividends, and certain payments from annuities. It may come from stocks, bonds, investment properties, mutual funds, and other investments.
Taxpayers should be aware that they may incur a tax on their net investment income if their modified gross adjusted income exceeds a certain amount based on their tax filing status.
The tax also applies to estates, trusts, and other entities.
How Do I Calculate My Net Investment Income Tax?
You can use IRS Form 8960 to calculate your net investment income tax. You can also calculate it yourself by adding together all your investment income and subtracting any related fees and expenses.
Then determine your modified adjusted gross income.
You pay 3.8% on whichever is less—either your net investment income or the portion of your MAGI that exceeds your tax filing threshold as set by the Internal Revenue Service.
Can I Avoid Paying the Net Investment Income Tax?
There are ways to avoid qualifying for the NIIT. The key is keeping your modified adjusted gross income under the threshold.
Talk to a tax professional or another financial professional to see what steps you can take to decrease your tax liability when it comes to your investments.
The Bottom Line
Investments can be used to prepare for the future or to help pay for unexpected emergencies such as car repairs or medical care. Although they may give you a cushion when you need it most, that investment income can add to your annual tax bill. This may come in the form of a net investment income tax.
Net investment income is any money you earn from your investments less any related fees and expenses. The tax will be imposed on the amount that your modified adjusted gross income exceeds your tax filing threshold or on the total amount of your NII.
Correction—Nov. 16, 2023:?This article has been corrected to state that you can reduce your adjusted gross income (AGI) and tax liabilities with contributions to qualified retirement plans.
Internal Revenue Service. "Find Out if Net Investment Income Tax Applies to You."
Congressional Research Service. "The 3.8% Net Investment Income Tax: Overview, Data, and Policy Options," Page 1.
Internal Revenue Service. "Questions and Answers on the Net Investment Income Tax."
Internal Revenue Service. "26 CFR 601.602: Tax Forms and Instructions; Rev. Proc. 2022-38," Page 8.
Internal Revenue Service. "26 CFR 601.602: Tax Forms and Instructions; Rev. Proc. 2023-34," Page 7.
Cornell Law School, Legal Information Institute. "26 CFR § 1.1411-4 - Definition of Net Investment Income."
Internal Revenue Service. "About Form 8960, Net Investment Income Tax Individuals, Estates, and Trusts."