The Net Investment Income Tax (NIIT) is a 3.8% surtax applied to certain investment income for individuals, estates, and trusts whose Modified Adjusted Gross Income (MAGI) exceeds specific threshold amounts. Part of the Health Care and Education Reconciliation Act of 2010, NIIT was a revenue-generating measure designed to support healthcare reform by taxing investment income as opposed to labour income.
This article will examine the intricacies of the NIIT as it applies to liquidity events in 2025, its mechanisms, and how Harness can help tax advisors manage NIIT more efficiently for their clients.
Table of Contents
- Understanding Net Investment Income Tax in 2025
- What constitutes Net Investment Income (NII)?
- What are the liquidity events that trigger NIIT?
- What are the best ways to manage the 3.8% surtax?
- Investment strategies to mitigate NIIT
- The role of material participation in NIIT
- How Harness can help
Key takeaways
- The 3.8% Net Investment Income Tax applies to the lesser of a client’s net investment income or the amount their Modified Adjusted Gross Income (MAGI) exceeds specific thresholds. For 2025, these are $250,000 for married filing jointly, $200,000 for single/head of household, and $125,000 for married filing separately.
- Major liquidity events like M&A, IPOs, secondary sales, and significant property dispositions often generate substantial capital gains that can push clients over the NIIT thresholds, making proactive planning essential.
- Strategies such as accelerating deductions, deferring income, maximizing contributions to tax-favored accounts, and strategic capital loss harvesting can significantly reduce both NII and MAGI, reducing NIIT liability.
- Advisors should explore options like installment sales, like-kind exchanges (for real estate), and seller financing to spread income recognition over multiple years, potentially keeping annual income below the NIIT thresholds.
Understanding Net Investment Income Tax in 2025
In addition to other taxes owed, such as capital gains tax, a 3.8% surtax is payable on the net investment income of individuals, estates, and trusts that exceed specific MAGI thresholds. For the 2025 tax year, the MAGI thresholds that trigger the NIIT are as follows
Married Filing Jointly or Qualifying Surviving Spouse: $250,000
Single or Head of Household: $200,000
Married Filing Separately: $125,000
Estates and Trusts: The dollar amount at which the highest tax bracket begins for an estate or trust (for 2024, this threshold was $15,200, with the 2025 threshold subject to inflation adjustments).
It’s important to remember that the 3.8% NIIT applies to the lesser of:
The taxpayer’s net investment income (NII), OR
The amount by which their MAGI exceeds the applicable threshold.
What constitutes Net Investment Income (NII)?
Broadly speaking, Net Investment Income includes income from:
- Interest
- Dividends
- Capital Gains (from the sale of stocks, bonds, real estate, and other investment property)
- Rental and Royalty Income
- Non-qualified Annuity Distributions
- Income from businesses that are passive activities to the taxpayer (e.g., certain partnership income)
Certain types of income are generally exempt from NIIT, such as wages, unemployment compensation, Social Security benefits, alimony, tax-exempt interest (e.g., municipal bond interest), and self-employment income.
What are the liquidity events that trigger NIIT?
When a client converts their illiquid equity or ownership stakes into cash or highly liquid assets, these events will often result in substantial capital gains, making them prime triggers for the NIIT. Common liquidity events include:
Mergers & Acquisitions (M&A): When a company is acquired by another, or two companies merge, shareholders typically receive cash or shares in the acquiring entity, leading to realized gains.
Initial Public Offerings (IPOs): A private company going public by offering shares to the general public for the first time on a stock exchange creates a medium for liquidity for existing shareholders.
Secondary sales: In private companies, secondary transactions allow employees and early investors to sell their equity to other private investors, providing liquidity without a full company exit.
Private equity buyouts: A private equity firm purchases a majority or complete stake in a company, often with the intent to restructure and sell for a profit later.
Sale of investment property: Disposing of significant real estate holdings or other investment assets can generate substantial capital gains subject to NIIT.
For each of these events, the capital gains realized will be included in the calculation of Net Investment Income, and if the client’s MAGI exceeds the aforementioned thresholds, the 3.8% surtax will apply to the lesser of their NII or the MAGI overage.
What are the best ways to manage the 3.8% surtax?
Forward planning is central to the effective management of NIIT on liquidity events. Key strategies that tax advisors can explore with their clients include:
Income and MAGI management
Strategically timing the recognition of income or the realization of deductions can help keep MAGI below the NIIT thresholds in the year of a liquidity event. This might involve accelerating deductions into the year of a large capital gain or deferring other income.
Increasing contributions to 401(k)s, IRAs, or self-employed SEP accounts can also reduce MAGI, potentially keeping a client under the NIIT threshold or reducing the portion of their NII subject to the tax.
Additionally, tax loss harvesting can be particularly effective when there are substantial gains, with the clients using capital losses from other investments to offset capital gains generated by the liquidity event.
Structuring the liquidity event
For the sale of a business or property, structuring the transaction as an installment sale can spread the recognition of capital gains over multiple years. This can help keep annual NII and MAGI below the NIIT thresholds, or at least mitigate the impact in any single year.
Similar to installment sales, Seller Financing and Earnouts structures can spread income recognition over time, allowing for more manageable tax liabilities.
For the sale of real estate, a Section 1031 like-kind exchange can defer capital gains by reinvesting the proceeds into similar property. While this doesn’t eliminate the NIIT entirely, it postpones the tax liability until the replacement property is eventually sold.
Investment strategies to mitigate NIIT
There are several effective investment options that tax advisors can recommend to their clients to reduce the impact of NIIT. Each strategy has its own risks that should be evaluated independently of the impact of NIIT.
Municipal bonds: Interest income from municipal bonds is generally exempt from federal income tax and often from state and local taxes if issued by the client’s resident state. This income is also exempt from NIIT, making municipal bonds an attractive option for high-income investors.
Use tax-deferred vehicles: Investments within qualified retirement accounts (e.g., 401(k)s, IRAs) or tax-deferred annuities grow tax-free until withdrawal. Earnings from life insurance contracts also generally aren’t taxed until withdrawn, and death benefits are typically federal income tax-exempt. This defers the recognition of investment income and thus the NIIT.
Roth conversions (as a long-term strategy): While a Roth conversion increases MAGI in the year of conversion and might trigger NIIT, the future qualified distributions from the Roth account (including earnings and gains) are entirely tax-free, including NIIT.
Strategic asset location: Place income-generating investments (e.g., high-dividend stocks, bonds) in tax-advantaged accounts (e.g., IRAs, 401(k)s) and growth-oriented investments (e.g., growth stocks with minimal dividends) in taxable accounts.
Charitable gifting of appreciated securities: Donating appreciated securities directly to IRS-approved charities can provide a tax deduction for the fair market value of the securities while avoiding the recognition of capital gains (and thus NIIT) that would have occurred if the securities were sold first.
The role of material participation in NIIT
For income from businesses, particularly partnerships or S corporations, a key determinant of NIIT applicability is “material participation.” If a client materially participates in the business activity, the income derived from that activity is generally considered active business income and is *not* subject to NIIT. However, if they do not materially participate, the income may be deemed passive and therefore subject to NIIT. A careful review of IRS regulations and the client’s involvement is vital to properly classify such income.
How Harness can help
Handling Net Investment Income Tax efficiently and effectively can be a challenge for even the most seasoned of tax advisors. More than just calculating a percentage, managing NIIT involves a detailed understanding of a client’s income streams, participation rules, and strategies for long-term client outcomes.
Harness offers a number of resources that can help make the process more efficient. Our TaxAssist platform uses advanced AI to extract data from even the most complex K-1s, 1099s, and other investment documents with unparalleled speed and accuracy. This intelligent automation frees your team to concentrate on strategic tax planning for your clients, proactively addressing NIIT implications before they become liabilities.
Beyond the technology we offer, Harness’s community of tax professionals provides a valuable resource for sharing insights, discussing strategies, and offering peer-to-peer advice. Get started with Harness and help your high-net-worth clients manage NIIT more effectively.
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