The Net Investment Income Tax is a 3.8% federal surtax that applies to investment income once your total income crosses a fixed threshold. Unlike most tax figures, those thresholds haven’t been adjusted for inflation since the tax was enacted in 2013, which means rising salaries and portfolio values push more households into NIIT territory each year without any change in their actual financial position.
Illinois taxpayers with investment income, real estate holdings, or passive business income should understand how this tax may affect their overall tax liability before filing. Our income tax planning team at Lewis.cpa works through NIIT exposure as part of every comprehensive tax review.
What Is the Net Investment Income Tax?
NIIT is a 3.8% surtax on certain investment income, separate from and in addition to regular federal income tax and capital gains tax. It is calculated on IRS Form 8960 and added to your regular tax liability.
The tax applies to the lesser of:
- Your net investment income, or
- The amount your modified adjusted gross income (MAGI) exceeds the applicable threshold
2026 MAGI thresholds:
- $200,000 — single filers and head of household
- $250,000 — married filing jointly
- $125,000 — married filing separately
For estates and trusts, NIIT applies when adjusted gross income exceeds $16,000 in 2026.
Example: A single filer with $220,000 in MAGI, including $40,000 in investment income, owes NIIT on $20,000 — the lesser of $40,000 (net investment income) and $20,000 (MAGI above threshold). NIIT owed: $760.
Why Illinois Taxpayers Should Pay Close Attention
Illinois doesn’t offer a lower tax rate for capital gains. Investment income is taxed at the state’s flat income tax rate, and qualifying taxpayers may also owe the federal Net Investment Income Tax, increasing the total taxes paid on investment earnings.
The fixed NIIT thresholds compound this issue. Because they have not moved since 2013, inflation alone has steadily pulled more Illinois households across the line. A professional earning $210,000 today faces NIIT exposure that someone at the same real purchasing power did not face a decade ago.
Income Subject to NIIT
Not all investment income triggers NIIT, and not all income types are treated the same way. Knowing which categories are included, and which are excluded, is the starting point for any reduction strategy.
Generally included:
- Taxable interest and dividends
- Capital gains from selling stocks, real estate, or other assets
- Rental and royalty income
- Passive income from partnerships and S corporations
- Income from annuities
Generally excluded:
- Wages and self-employment income
- Social Security benefits
- Tax-exempt interest (such as most municipal bond interest)
- Distributions from qualified retirement accounts (401(k), IRA)
- Gains from selling a primary residence, up to $250,000 for single filers and $500,000 for married filing jointly
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Investment Income Taxed at a Higher Rate Than Expected?
Lewis.cpa reviews your income sources, account structure, and timing decisions to find where NIIT exposure can be reduced. Reach out before your next tax year closes.
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Practical Strategies to Reduce NIIT Exposure
No single approach eliminates NIIT exposure, but the right combination of timing, account structure, and income classification can reduce it significantly. The strategies below apply to most Illinois investors — some are straightforward to implement, others require coordination with a broader tax plan for high earners. Start with the ones that match your current income mix and work from there.
1. Manage the Timing of Realized Gains
Spreading capital gains across multiple tax years may keep MAGI below the threshold in any given year. If you’re rebalancing a portfolio or selling appreciated investments, timing matters. Spreading transactions across tax years may help reduce your exposure to the NIIT, depending on your overall income.
2. Maximize Tax-Advantaged Retirement Accounts
Investment income held inside a 401(k), traditional IRA, or Roth IRA does not count as net investment income for NIIT purposes. Shifting taxable investments into these accounts reduces current-year exposure. Traditional retirement account withdrawals are taxed as ordinary income, but the ability to control when those withdrawals occur can create opportunities to better manage NIIT over time.
3. Use Tax-Loss Harvesting
Selling investments at a loss offsets realized capital gains dollar for dollar. If losses exceed gains, up to $3,000 can offset ordinary income annually, with remaining losses carried forward to future years. This approach is most effective in volatile markets and pairs well with broader year-end tax planning to keep MAGI in check before December 31.
4. Consider Municipal Bonds for Investment Income
Interest from most municipal bonds is excluded from federal taxable income and does not count as net investment income for NIIT purposes. For higher-income investors in Illinois, munis can provide a tax-efficient income stream, though they should be evaluated within a broader plan, since they still affect MAGI calculations in other ways.
5. Review Real Estate Participation Status
Rental income is typically subject to NIIT unless the taxpayer qualifies under IRS material participation rules. If you qualify as a real estate professional under the tax rules, some rental income may no longer be treated as passive income, which can affect how the NIIT applies. The IRS standards are strict, documentation requirements are significant, and this strategy should be reviewed carefully with a tax professional before implementation.
6. Use Charitable Giving Strategies
Donating appreciated securities directly to a qualified charity, rather than selling them and donating cash, eliminates the embedded capital gain from taxable income. Donor-advised funds (DAFs) can extend this benefit over multiple years while allowing the donor to make grant decisions over time. Both approaches reduce net investment income while supporting estate tax planning goals simultaneously.
7. Review Passive Business Income Classification
Passive income from partnerships or S corporations may fall under NIIT. Becoming more actively involved in a business or restructuring how income is earned may change whether that income is considered passive, which can affect NIIT depending on the IRS participation rules.
Common Planning Mistakes That Increase NIIT Exposure
Even taxpayers who are aware of NIIT often make avoidable errors.
The most common include:
- Selling large appreciated positions in a single tax year without spreading gains;
- Ignoring MAGI thresholds when planning Roth conversions — the conversion amount adds to MAGI and can push investment income over the threshold;
- Overlooking passive income classification in business investments;
- Failing to coordinate investment sales with retirement account withdrawals in the same year;
- Assuming municipal bond interest has no MAGI impact — it doesn’t count as NII, but it’s still included in MAGI for other calculations.
Lewis.cpa Can Help Reduce Your NIIT Exposure
NIIT isn’t usually triggered by one event. It often builds over the course of the year through investment decisions, passive income, and the way assets and accounts are structured. Lewis.cpa works with Illinois investors, business owners, and high-income households to identify where exposure is building and adjust the plan before it affects the return. Contact us today to review your investment income picture.
