What Is Net Investment Income (NII)?

What Is Net Investment Income (NII)?

Let me explain net investment income, or NII, for tax purposes—it's the total money you get from assets like stocks, bonds, and mutual funds, after subtracting related expenses.

This can include interest income, dividend income, and capital gains. Whether it's taxable depends on your modified adjusted gross income, or MAGI.

Key Takeaways

Net investment income is what you receive from assets before taxes, including bonds, stocks, mutual funds, loans, and other investments, minus related expenses.

It's subject to a 3.8% tax if you're an individual with NII and MAGI above specific thresholds.

Estates and trusts face this tax if they have undistributed NII and their annual adjusted gross income tops the highest tax bracket threshold.

For investment companies, it's the income remaining after subtracting operating expenses from total investment income.

This tax started in 2013 to raise funds for the Affordable Care Act.

Understanding Net Investment Income (NII)

Income is any money or compensation you or a business earns from labor, selling products and services, or investments. When you sell assets from your portfolio, the proceeds give you either a realized gain or loss.

These realized gains can come from capital gains on stock sales, interest from fixed-income products, dividends from companies, rental income from property, certain annuity payments, or royalty payments.

You subtract costs like trading commissions from these gains to get your net investment income before taxes. Wages and similar income aren't included.

NII has been taxable above certain thresholds since January 1, 2013. It's called the net investment income tax, passed in the Health Care and Education Reconciliation Act of 2010 as a way to cover Affordable Care Act costs. The rate is 3.8% on certain net investment income for individuals, estates, and trusts above statutory thresholds.

Remember, net investment income can be positive or negative based on whether you sold assets for a gain or loss.

What Counts as NII?

What counts as net investment income includes interest income, capital gains, dividends, passive investment income, rental income, royalty income, non-qualified annuity distributions, and business income from financial trading activities.

What doesn't count includes wages and salaries, alimony, Social Security benefits, unemployment benefits, qualified distributions from 401(k)s or IRAs, life insurance payouts, income from active business investments, and proceeds from tax-exempt organizations and transactions.

Who Pays the NII Tax?

The NII tax hits at 3.8% if you exceed certain income limits, applying to individuals, estates, and trusts.

Individuals

For individuals, the tax applies if you have NII and your modified adjusted gross income crosses specific thresholds. These aren't adjusted for inflation: $200,000 for single or head of household, $125,000 for married filing separately, $250,000 for married filing jointly or qualified widow(er) with dependent.

The tax is on the lesser of your net investment income or the MAGI excess over the limit.

Estates and Trusts

Estates and trusts pay if they have undistributed NII and their AGI exceeds the highest tax bracket threshold, which is inflation-adjusted.

Nonresident aliens aren't subject unless married to a U.S. citizen or resident and elect U.S. resident treatment for taxes.

Investment Companies

For investment companies, net investment income is what's left after subtracting operating expenses from total investment income, usually per share.

Calculate it by dividing total investment income by outstanding shares—this is what's available for shareholder dividends. Public companies list this on their balance sheets.

How to Calculate the NII Tax

First, figure out income from all your qualified investments, subtracting fees like commissions and brokerage charges. Use the list of what counts to guide you.

Then, get your MAGI— that's your AGI plus excluded income and certain deductions like student loan payments. Check the thresholds for your filing status; if you're over, you pay NII tax.

If you reduce your reported MAGI or NII, you cut your liability—think contributing to retirement plans, charities, or tax-loss harvesting.

Use IRS Form 8960 or calculate manually: 3.8% on the lesser of NII or MAGI excess over threshold. For example, with $25,000 NII and $30,000 MAGI excess, you tax the $25,000; if $10,000 excess, you tax that.

This is on top of capital gains or dividends taxes you already pay.

How to Manage the NII Tax

Even with big investment income, you can cut taxes by lowering your AGI, NII, or both.

Maximize IRA or qualified retirement plan contributions, or use deferred compensation to drop AGI below thresholds and possibly avoid the tax.

Use tax-loss harvesting: sell losing investments alongside winners to lower net investment income and your tax burden.

Charitable contributions, like a charitable remainder trust, can also reduce NII.

How to Pay the NII Tax

Report NII on IRS Form 8960 to calculate liability, then transfer to your main tax form—Form 1040 for individuals, Form 1041 for estates and trusts.

Example of NII

Suppose you sell 100 Apple shares at $175 each (cost $140) for a $3,500 gain, 50 Netflix shares at $170 each (cost $200) for a $1,500 loss, get $2,650 in bond interest, $16,600 rental income, minus $35 brokerage and $160 tax prep fees.

Your NII totals $21,055.

What Qualifies As Net Investment Income?

It's money from investment vehicles like interest, capital gains, royalties, rents, dividends, and certain annuities—from stocks, bonds, properties, mutual funds, etc.

If your MAGI exceeds thresholds based on filing status, you pay tax on it. This applies to estates, trusts, and others too.

How Do I Calculate My Net Investment Income Tax?

Use Form 8960 or add up investment income minus fees and expenses, then find your MAGI.

Pay 3.8% on the lesser of NII or MAGI over your IRS-set threshold.

Can I Avoid Paying the Net Investment Income Tax?

Yes, by keeping MAGI under the threshold. Consult a tax or financial pro for steps to lower your investment tax liability.

The Bottom Line

Investments help prepare for the future or emergencies, but they can increase your tax bill via NII tax.

NII is investment earnings minus fees; tax is on the lesser of NII or MAGI over threshold.

Note: You can reduce AGI and taxes with qualified retirement contributions.