Net Investment Income Tax: Who Owes 3.8% and How to Reduce It

If you have looked at a recent tax return and noticed a line for Form 8960, you have already met the net investment income tax. It is a 3.8 percent surtax that has applied since 2013 to interest, dividends, capital gains, rental income, and similar earnings once a household's income passes a fixed threshold. Because that threshold has never been adjusted for inflation, more physicians, attorneys, executives, and business owners cross it every year.

The tax is not enormous on its own. It adds 3.8 percentage points to the rate on investment income, taking the top long-term capital gains rate from 20 percent to 23.8 percent and the top rate on interest from 37 percent to 40.8 percent. But it stacks on top of everything else, it shows up in years with a large sale or a concentrated stock liquidation, and it responds well to planning. This guide explains who owes the net investment income tax, how it is calculated, and what you can do about it. It is educational, not individualized advice.

Who Owes the Net Investment Income Tax

The tax applies to individuals, estates, and trusts. For individuals, the trigger is modified adjusted gross income above $200,000 for single and head of household filers, $250,000 for married couples filing jointly, and $125,000 for married couples filing separately. For most people, modified AGI is simply the adjusted gross income on the front of Form 1040, with an add-back for certain foreign earned income exclusions.

Those figures were set in 2010 and have not changed. A married couple earning $250,000 was comfortably affluent in 2013. In 2026, that is a single mid-career attending physician or two mid-level professionals in Atlanta. The IRS explains the rules on its net investment income tax page.

Estates and trusts face a much lower threshold. The tax applies to undistributed net investment income above the dollar amount where the top trust tax bracket begins, which is only about $16,000 for 2026. A modest irrevocable trust holding a dividend portfolio can owe the surtax on most of its income unless it distributes to beneficiaries who are under their own thresholds.

What Counts as Net Investment Income

Net investment income includes three broad categories. The first is interest, dividends, annuity payments, royalties, and rents. The second is income from a trade or business that is passive with respect to you or that trades financial instruments and commodities. The third is net gain from the sale of property, other than property held in an active business.

• Taxable interest from bonds, CDs, and savings accounts.
• Dividends, both qualified and nonqualified.
• Capital gains from stocks, funds, real estate, and other investments, net of capital losses.
• Rental income from properties you do not manage as a real estate professional.
• Income from partnerships and S corporations in which you do not materially participate.
• Taxable annuity payments, and the taxable portion of gains on a home sale above the exclusion.
• Royalties and certain trust distributions.

What is not investment income

Wages, bonuses, and self-employment income are excluded, as is income from an active business you materially participate in. Distributions from IRAs, 401(k)s, 403(b)s, pensions, and other qualified plans are excluded. Tax-exempt municipal bond interest is excluded. Social Security benefits, life insurance proceeds, and the excluded portion of gain on your primary residence are excluded. Roth conversions are excluded too. Each of these items still counts toward modified AGI, so they can push you over the threshold even though they are not taxed by the surtax directly.

How the 3.8 Percent Surtax Is Calculated

The tax is 3.8 percent of the lesser of your net investment income or the excess of your modified AGI over the threshold. That lesser-of structure produces different results for different households.

Example one: a married couple has $220,000 of wages and $60,000 of dividends and gains, for a total of $280,000. Their excess over the $250,000 threshold is $30,000. Their net investment income is $60,000. They owe 3.8 percent of the smaller number, $30,000, which is $1,140.

Example two: a physician earns $450,000 in wages and has $40,000 of investment income. The excess over the threshold is $240,000, but net investment income is only $40,000. The tax is 3.8 percent of $40,000, or $1,520. For high earners, the surtax almost always equals 3.8 percent of all investment income, because wages alone put them far past the threshold.

Expenses allocable to investment income reduce the base. Those include investment interest expense and the portion of state income tax attributable to investment income. Advisory fees no longer qualify for individuals because miscellaneous itemized deductions were eliminated. The calculation is done on Form 8960 and the tax is added to your regular liability.

Ways to Reduce the Net Investment Income Tax

Because the tax follows investment income, most of the planning tools are the same ones that reduce ordinary capital gains and dividend taxes. The surtax simply raises the payoff of doing them well.

Harvest losses and manage gains

Capital losses offset capital gains before the surtax is applied, so tax-loss harvesting reduces both regular capital gains tax and the 3.8 percent. Timing large gains matters too. Spreading the sale of a concentrated position over two tax years, or taking gains in a year when income dips because of a sabbatical, a job change, or retirement, can keep some of the gain below the threshold. Installment sales of real estate or a business spread the gain across years as well.

Change what you hold and where

Municipal bond interest is exempt from the surtax, which raises the after-tax yield of munis relative to taxable bonds for anyone over the threshold. Growth-oriented stock funds that pay little in dividends defer the tax until you sell. Placing high-yield bonds, REITs, and actively managed funds inside IRAs and 401(k)s, where their income is not counted, and keeping tax-efficient index funds in taxable accounts is the asset location strategy that our investment management service applies as a matter of course.

Give appreciated assets instead of cash

Donating appreciated stock to a charity or a donor-advised fund removes the future gain from your return entirely, so the surtax on that gain never arises. The same is true of a qualified charitable distribution from an IRA after age 70 and a half, which keeps the distribution out of AGI. Our overview of charitable giving tax strategies covers both.

Use retirement accounts and Roth conversions carefully

Maximizing pre-tax retirement contributions lowers modified AGI, which can pull a household back under the threshold. Roth conversions are not investment income, but they do raise modified AGI, so a large conversion in a year with significant capital gains can trigger the surtax on those gains. Conversely, a Roth account produces no future taxable investment income at all, which makes conversions a long-term tool for reducing the surtax in retirement.

Rental real estate and business income

Rental income is investment income unless you qualify as a real estate professional and materially participate in the rental activity, which requires more than 750 hours a year in real property trades and more than half of your working time. Most physicians and executives cannot meet that test. Business owners can reduce exposure by ensuring they materially participate in the business, since income from an active trade or business is excluded. Grouping elections that combine related activities can help meet the participation tests, but they should be made with a CPA.

Situations Where the Surtax Bites Hardest

Certain events push a lot of investment income into a single year and deserve planning in advance.

• Selling a business or practice. Gain on the sale of S corporation stock or partnership interests is investment income unless you were active in the business, and even active owners can owe the surtax on the portion attributable to passive assets.
• A concentrated stock liquidation after an IPO, acquisition, or lockup expiration, where spreading the sale across tax years can matter.
• Selling a rental property or a vacation home, where the full gain is subject to the surtax with no exclusion.
• Large mutual fund capital gain distributions in December, which arrive whether or not you sold anything.
• The year of a required minimum distribution or a large Roth conversion, which is not investment income but raises modified AGI past the threshold.
• Trust income that is retained rather than distributed, taxed at the trust's very low threshold.

Reporting and Estimated Taxes

The surtax is reported on Form 8960 and flows to Schedule 2 of Form 1040. It counts as part of your income tax for estimated payment purposes, so a year with a large gain can create an underpayment penalty if withholding and estimates do not cover it. Safe harbor rules, which generally require paying 110 percent of the prior year's tax for high earners, protect you if you plan estimates around them.

Georgia does not impose a separate surtax on investment income. The state taxes capital gains and dividends as ordinary income at its flat rate, which is a little over 5 percent for 2026, so the combined marginal rate on long-term gains for a Georgia resident in the top bracket is roughly 29 percent once the surtax and state tax are included.

The net investment income tax is easy to overlook because it arrives as a single line on a long return, but for households above the threshold it changes the math on every sale, every dividend, and every rental. The right response is not to avoid investment income but to manage it: harvest losses, locate assets well, give appreciated shares, and time large gains with intention. Those habits reduce the surtax as a byproduct of good tax planning generally, which is the approach our tax planning service takes with clients throughout the year.

Tony Colunga · Founder, Attend Wealth

Tony leads Attend Wealth, a fee-based wealth management firm in Atlanta serving professionals, families, physicians, and business owners. Advisory services are held to a fiduciary standard. More about Attend