Net Investment Income (NII)

What Is Net Investment Income (NII)?

Net investment income (NII) is income received from investment assets (before taxes) such as bonds, stocks, mutual funds, loans, and other investments (less related expenses). The individual tax rate on net investment income depends on whether it is interest income, dividend income, or capital gains.

Understanding Net Investment Income (NII)

When investors sell assets from their portfolios, the proceeds from the transaction results in either a realized gain or loss. The realized gains could be capital gains from selling a stock; interest income received from fixed income products; dividends paid to shareholders of a company; rental income received from property; certain annuity payments; royalty payments; etc. The difference between any realized gains (before taxes are applied) and trade commissions or fees is the net investment income (NII). NII could be either positive or negative depending on whether the asset was sold for a capital gain or loss.

For example, an individual sells 100 shares of AAPL and 50 shares of NFLX for $175/share and $170/share. They also received coupon payments for the year on their corporate bonds in the sum of $2,650, in addition to rental income of $16,600. Their net investment income can be calculated as:

Capital gain from AAPL:
(Sale Price 175 – Cost 140) x 100

$ 3,500

Capital loss from NFLX:
(Sale Price 170 – Cost 200) x 50

 (1,500)

Brokerage commissions

      (35)

Interest income

   2,650

Rental income

 16,600

Tax preparation fees

    (160)

Net Investment Income

$21,055

Taxing Net Investment Income

The net investment income is subject to a 3.8% tax and applies to individuals with an NII and modified adjusted gross income (MAGI) above the thresholds in the table below:

Filing status

MAGI Limit ($)

Head of Household

Married filing separately

Married filing jointly

Qualified widow(er) with dependent

The net investment income tax is applied to the lesser of the net investment income or the MAGI amount in excess of the predetermined limit. For example, a single tax filer with annual gross income of $188,000 and net investment income of $21,055 has a MAGI of $188,000 + $21,055 = $209,055. Since this amount is more than the limit by $209,055 - $200,000 = $9,055, the individual will pay net investment income tax of 3.8% x $9,055 = $344.09. The NII tax does not include capital gains tax or dividends tax, which the investor still has to pay.

Estates and trusts are also subject to the NII tax if they have undistributed net investment income and their annual adjusted gross income exceeds the dollar amount at which the highest tax bracket begins. A nonresident alien is not subject to the tax unless they are married to a U.S. citizen or resident and elects to be treated as a resident of the U.S. for tax purposes.

For investment companies, this is the amount of income left after operating expenses are subtracted from total investment income, and it is typically expressed on a per-share basis. To find the net investment income per share of a company, divide the total investment income by the shares outstanding. This amount is what is available to shareholders as dividends. A publicly traded company must list its net investment income on its balance sheet.

If you can reduce your reported MAGI or net investment income, you can also reduce your NII tax liability. Some ways to do that include contributing to retirement plans, charities, or tax-loss harvesting.

How to Manage Net Investment Income (NII) Tax

Even if you earn significant investment income, you can reduce your tax liabilities by taking steps that reduce your reported MAGI, your net investment income, or both.

One way to reduce your MAGI is to maximize your contributions to IRAs and qualified retirement plans, or participating in deferred compensation plans. If you can reduce your modified adjusted gross income so that it does not exceed the threshold above, you may not need to pay NII tax at all.

You can also reduce your net investment income through tax-loss harvesting. By selling unprofitable investments at the same time as profitable ones, you can reduce your net investment income, and thereby reduce your tax burden. It is also possible to reduce NII through charitable contributions, such as a charitable remainder trust.

Origins of the Net Investment Income (NII) Tax

The net investment income tax was passed as part of the Health Care and Education Reconciliation Act of 2010. Along with the Affordable Care Act, the law required individuals to have health care coverage or face a financial penalty. The net investment income tax was included as a revenue-raising tool in order to offset the additional costs of the Affordable Care Act (ACA).