The Medicare tax on unearned income, formally called the Net Investment Income Tax (NIIT), is a flat 3.8% surtax on investment income that applies once your modified adjusted gross income (MAGI) crosses $200,000 as a single filer or $250,000 if married filing jointly.1Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax Congress created it under the Affordable Care Act to help fund Medicare, and it sits on top of your regular income tax. If you have significant dividends, capital gains, rental profits, or other passive earnings, it can add real money to your bill.
Who Owes the Tax
The 3.8% applies to individuals, estates, and trusts whose income exceeds set dollar thresholds. For individuals, the thresholds break down by filing status:
- Married filing jointly or qualifying surviving spouse: $250,000
- Single or head of household: $200,000
- Married filing separately: $125,000
These figures use MAGI, which for most people equals the adjusted gross income (AGI) shown on the tax return. The one common adjustment: if you claimed the foreign earned income exclusion, add that excluded income back to AGI when checking whether you cross the line. The thresholds are fixed by statute and don’t adjust for inflation, so more filers cross them each year as wages and portfolios grow.2Internal Revenue Service. Questions and Answers on the Net Investment Income Tax
Estates and trusts owe the surtax on the lesser of their undistributed net investment income or the amount by which their AGI exceeds where the highest tax bracket begins.1Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax For 2026, the 37% bracket for trusts and estates starts at $16,000, so even modest undistributed investment income inside a trust can trigger the tax. Distributing income to beneficiaries pushes the measurement to their much higher personal thresholds.
What Counts as Unearned Income Here
Net investment income covers most of what your money earns for you:
- Taxable interest from bank accounts and bonds
- Ordinary and qualified dividends from stocks and mutual funds
- Capital gains from selling stocks, bonds, mutual funds, real estate, and other property (to the extent included in taxable income)
- Net rental and royalty income, including mineral rights and licensing
- Non-qualified annuity payments
- Passive business income where you don’t materially participate
Gains from selling a partnership interest or S corporation shares are included to the extent you were a passive owner.2Internal Revenue Service. Questions and Answers on the Net Investment Income Tax Income from a business that trades financial instruments or commodities is included regardless of your participation level.1Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
The 3.8% applies to the net figure. You can subtract expenses properly allocable to your investment income, including investment interest, brokerage and advisory fees, rental property expenses, and the portion of state and local income taxes attributable to investment income.2Internal Revenue Service. Questions and Answers on the Net Investment Income Tax
What Is Excluded
Several categories of income are outside net investment income entirely, though some of them still raise your MAGI:
- Wages, salaries, and self-employment income (earned income never counts here, though it feeds MAGI)3Internal Revenue Service. Topic No. 559, Net Investment Income Tax
- Distributions from 401(k), 403(b), IRA, Roth IRA, and 457(b) accounts4eCFR. 26 CFR 1.1411-8 – Exception for Distributions From Qualified Plans
- Social Security benefits
- Unemployment compensation
- Tax-exempt municipal bond interest
- Alimony
- Veterans Administration benefits3Internal Revenue Service. Topic No. 559, Net Investment Income Tax
The retirement plan exclusion carries a trap. A large 401(k) withdrawal isn’t itself hit by the 3.8%, but it raises your MAGI. A $100,000 distribution can push you over the threshold and expose your dividend and capital gain income to the surtax. Roth conversions work the same way: the converted amount adds to MAGI even though it isn’t net investment income, potentially triggering the tax on investment income that would otherwise sit below the line.
How the Tax Is Calculated
The NIIT equals 3.8% of the smaller of two numbers: your total net investment income, or the amount by which your MAGI exceeds your filing-status threshold.1Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax Two examples show how the “lesser of” rule works.
Example 1. A single filer has $280,000 in MAGI, including $30,000 of net investment income. The MAGI exceeds the $200,000 threshold by $80,000. Because $30,000 is less than $80,000, the tax is 3.8% of $30,000, or $1,140.
Example 2. A single filer has $215,000 in MAGI, again with $30,000 of net investment income. The MAGI exceeds $200,000 by only $15,000. Because $15,000 is less than $30,000, the tax is 3.8% of $15,000, or $570.
The second case is the one people miss. If your MAGI barely crosses the line, you owe the surtax only on the amount above it, not on all your investment income.
Passive vs. Active for Business Owners
Business profits are treated differently depending on how involved you are. If you materially participate in a trade or business, the profits are active income and fall outside the NIIT. If you’re an investor who collects checks without running operations, those profits are passive and the 3.8% applies.
The IRS uses seven material participation tests under the passive activity rules. The most common path is working more than 500 hours in the business during the tax year. Other paths include performing substantially all the work yourself, or materially participating in any five of the last ten tax years. You only need to meet one test, but if you’re audited, the IRS will look for time logs or similar records.
Real Estate
Rental income is normally passive, which puts it inside the NIIT. Two rules matter most for real estate.
First, the home sale exclusion. If you sell your primary residence, the gain excluded under the home sale rules (up to $250,000 single, $500,000 joint) is also excluded from the NIIT. Any gain above the exclusion counts as net investment income.2Internal Revenue Service. Questions and Answers on the Net Investment Income Tax A married couple with $600,000 of gain excludes $500,000, and the remaining $100,000 is investment income subject to the surtax if their MAGI is over the threshold.
Second, real estate professional status. If you spend more than 750 hours during the year in real property businesses, and more than half your total working time in those activities, and you materially participate in each rental activity, your rentals can be treated as non-passive. You can elect to group all rental properties as a single activity to simplify the participation requirement. The standard is demanding and the IRS scrutinizes these claims, but qualifying can pull rental income out of the NIIT entirely.
Ways to Reduce What You Owe
Because the tax depends on both MAGI and net investment income, cutting either number cuts the bill.
- Harvest investment losses to offset capital gains. Losses beyond gains can offset up to $3,000 of ordinary income, with the rest carried forward. Watch the wash-sale rule, which disallows a loss if you buy a substantially identical investment within 30 days before or after the sale.
- Maximize traditional 401(k) or IRA contributions to lower AGI and, in turn, MAGI. Growth inside those accounts is also excluded from net investment income.
- Time large income events. Roth conversions, property sales, and stock option exercises all raise MAGI. Bunching them into a single year can be worse than spreading them, because each dollar above the threshold exposes more investment income to the tax.
- Increase your material participation in a business that generates passive income. Meeting one of the seven tests removes that income from the NIIT calculation.
- Hold tax-exempt investments. Municipal bond interest doesn’t count as net investment income, though it can affect MAGI for other purposes.
These moves interact. A large Roth conversion done to shift future income out of a taxable account can, in the year of conversion, push MAGI up enough to expose your other investment income to the surtax.
How to Report and Pay
You report the NIIT on IRS Form 8960, attached to your annual return.5Internal Revenue Service. Form 8960 – Net Investment Income Tax, Individuals, Estates, and Trusts The form works through each category of investment income, subtracts allowable deductions, and applies the lesser-of calculation. Interest and dividends come from Form 1040, capital gains and losses from Schedule D, and rental and business income from Schedule E.6Internal Revenue Service. Instructions for Form 8960 – Net Investment Income Tax
No employer withholds this surtax for you. If you expect to owe a meaningful amount, raise your quarterly estimated payments to avoid an underpayment penalty,7Internal Revenue Service. Estimated Taxes or ask your employer to increase your regular income tax withholding to cover it.3Internal Revenue Service. Topic No. 559, Net Investment Income Tax Payments can be submitted through the Electronic Federal Tax Payment System.8Internal Revenue Service. EFTPS: The Electronic Federal Tax Payment System
A Note on the Other Medicare Surtax
A different 0.9% Additional Medicare Tax applies to earned income (wages, compensation, and self-employment income) above the same $200,000 single and $250,000 joint thresholds.9Internal Revenue Service. Net Investment Income Tax The two are separate. You can owe both in the same year, but never on the same dollar. Employers withhold the 0.9% from wages once you cross the line; the 3.8% NIIT is calculated only on your return, with no automatic withholding.