investing Audience: high income 3 min read

The Net Investment Income Tax (NIIT): The 3.8% Surcharge

High earners face a hidden tax on their portfolio. Learn what the NIIT is, when it kicks in, and how to minimize it.

If you make over $200k (Single) or $250k (Married), the IRS adds a surcharge to your investment income. This is the Net Investment Income Tax (NIIT), often called the “Medicare Surtax.” It turns a 15% Capital Gains rate into 18.8%. It turns a 20% Capital Gains rate into 23.8%.

Key Takeaways

  • Thresholds are NOT inflation adjusted. They have stuck at $200k/$250k since 2013, trapping more people every year.
  • Applies to: Capital Gains, Dividends, Interest, Rental Income, Royalty Income.
  • Does NOT apply to: IRA withdrawals, Wages, Active Business Income.
  • The Tax Base: It applies to the *lesser* of your Net Investment Income OR the amount your AGI exceeds the threshold.

How It Hits You

  • Scenario: You earn $300,000 W-2 income. You also have $50,000 in Capital Gains.
  • Threshold: $250,000 (Married).
  • Excess AGI: $350k - $250k = $100,000.
  • Investment Income: $50,000.
  • The Math: Tax applies to the lesser ($50,000).
  • The Bill: $50,000 * 3.8% = $1,900 extra tax.

Understanding how capital gains vs ordinary income are treated is critical here, because only investment income is subject to the NIIT---wages are not.

Strategies to Avoid NIIT

  1. Municipal Bonds: Their interest is exempt from NIIT. See our taxable equivalent yield guide for the math.
  2. Roth Conversions: Distributing from a Roth is exempt. (Though the conversion itself raises AGI, potentially triggering NIIT on other assets in that year).
  3. Active Participation: If you run an Airbnb or business, ensure you “Materially Participate.” Active income is exempt. Passive income is hit. For rental owners, see our rental property tax guide. Qualifying for Real Estate Professional Status (REPS) can reclassify rental income from passive to active, exempting it from the NIIT entirely.
  4. Installment Sales: Selling a business? Spread the payments over years to keep your AGI lower in any single year. See multi-year tax planning for timing strategies.
  5. S-Corp Distributions: Active S-Corp income is not subject to NIIT. If you currently have a sole proprietorship generating passive investment income, an S-Corp election may help restructure the income classification.

The Bracket Creep Problem

Because the $200k/$250k thresholds have not been adjusted for inflation since 2013, more taxpayers are caught by the NIIT every year. A household earning $250,000 in 2013 had meaningfully higher purchasing power than one earning $250,000 in 2026. This is a hidden tax increase that requires no legislation---inflation does the work.

It’s a “Success Tax.” Plan accordingly. For a full menu of approaches, see our tax strategies for high-income earners guide.

How sharper.tax Helps

sharper.tax analyzes your uploaded return to calculate whether you are subject to the NIIT, how much it costs you, and which strategies could reduce or eliminate the 3.8% surcharge. We model the impact of timing capital gains, restructuring income, and other approaches specific to your situation. Sophisticated tax planning used to require a high-end CPA --- we make it available for free.

Sources

The information above is educational and not tax advice.