The 3.8% Net Investment Income Tax: Overview, Data, and Policy Options

The 3.8% Net Investment Income Tax: Overview, Data, and Policy Options

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Updated June 30, 2023
The 3.8% Net Investment Income Tax: Overview, Data, and
Policy Options
Since 2013, certain higher-income individuals have been
Revenue Raised and Number of
subject to a 3.8% “unearned income Medicare contribution”
Taxpayers Subject to the NIIT
tax, more commonly referred to as the net investment
The most recent aggregate data from the Internal Revenue
income tax (NIIT). The statutory authority for the tax is
Service (IRS) show that the NIIT raised $59.8 billion
included in Internal Revenue Code Section 1411. The tax
(preliminary figure) in tax year 2021. This represents a
was included as a revenue-raising offset in the Health Care
$43.3 billion increase from the $16.5 billion in revenue the
and Education Reconciliation Act of 2010 (HCERA, P.L.
tax raised in its first year, not adjusted for inflation. Over
111-152), shortly after the Patient Protection and
the same time period, the number of taxpayers subject to
Affordable Care Act (P.L. 111-148) was signed into law.
the tax increased from 3.1 million to 7.3 million.
These two laws are commonly referred to as the Affordable
The increase in both the revenue generated by the tax and
Care Act or ACA.
the number of taxpayers subject to the tax can be partly
Policymakers may consider modifications to the NIIT to
explained by the fact that the $200,000/$250,000 income
raise revenue, address income inequality concerns, or both.
thresholds are not indexed for inflation. Additionally,
Repeal of the NIIT is also a policy option. This In Focus
increases in net investment income, including from higher
provides an overview of the tax, presents data on the
nominal and real (inflation-adjusted) returns to investment,
distribution of the tax, and considers several policy options.
have resulted in more taxpayers and more income becoming
Overview of the NIIT
subject to the tax.
The NIIT is equal to 3.8% of the net investment income of
Distribution of NIIT Paid
individuals, estates, and certain trusts. Net investment
By design, the tax is mostly paid by higher-income
income includes interest, dividends, annuities, royalties,
households. Table 1 shows taxpayers with income of $10
certain rents, and certain other passive business income not
million or more paid 31.5% of the total NIIT collected in
subject to the corporate tax. Net investment income also
tax year 2019 (the most recent tax year for which detailed
includes the amount of capital gain resulting from a home
distributional data are available). These individuals paid
sale that exceeds the amount that can be excluded from
$449,642 in NIIT on average in 2019. Table 1 also shows
taxation ($250,000 for single and head of household filers,
those making between $200,000 and $500,000 accounted
$500,000 for married joint filers). Net investment income
for the majority of taxpayers (69.6%) subject to the 3.8%
does not include wages, unemployment compensation,
tax. The average amount of NIIT paid by these taxpayers in
nonpassive business income, Social Security benefits,
2019 was $1,054. Across all taxpayers subject to the NIIT
alimony, tax-exempt interest, and distributions from some
in 2019, the average amount of tax paid was $5,202.
tax-preferred retirement accounts; for example, 401(k)s,
403(b)s, and 457(b)s.
Table 1. Distribution of Net Investment Income Tax,
2019
The tax applies to taxpayers with modified adjusted gross
income (MAGI) in excess of $200,000 if single or head of
Share of
household and $250,000 if married filing jointly ($125,000
Returns
Share of
for married filing separately). The income thresholds are
Adjusted Gross Income
with Tax
NIIT Paid
not adjusted annually for inflation. For taxpayers without
foreign-source income, MAGI generally equals adjusted
Less than $100k
0.2%
0.0%
gross income (AGI). Hence, MAGI includes wages,
$100k under $200k
1.7%
0.1%
salaries, tips, and other compensation; dividend and interest
income; business and farm income; realized capital gains;
$200k under $500k
69.6%
14.1%
retirement distributions; and income from a variety of other
$500k under $1 mil ion
19.0%
15.7%
passive activities and certain foreign-earned income.
$1 mil ion under $2 mil ion
6.1%
13.6%
For those subject to the NIIT, the amount of tax owed is
equal to 3.8% multiplied by the lesser of
$2 mil ion under $5 mil ion
2.5%
15.0%
•
$5 mil ion under $10 mil ion
0.6%
9.8%
net investment income, or
$10 mil ion or more
0.4%
31.5%
• the amount by which their MAGI exceeds
$200,000/$250,000.
Total
100.0%
100.0%
Source: Internal Revenue Service, Statistics of Income, Table 3.3.
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The 3.8% Net Investment Income Tax: Overview, Data, and Policy Options
Policy Options
to the tax, and hence, less revenue. This would increase
A number of options pertaining to the NIIT are available
progressivity in the tax code, since it would concentrate the
depending on the objective of policymakers. One option is
incidence on the highest-income taxpayers and reduce
to leave the tax in its current form. The following discusses
complexity for those taxpayers now no longer subject to the
possible modifications to the tax.
tax.
Eliminate the Tax
Index for Inflation
One option would be to eliminate the tax. This change
The NIIT income thresholds are not indexed for inflation.
would reduce the tax burden on investment, which, to the
As a result, more taxpayers become subject to the tax over
extent investment is lower than it otherwise would be, could
time regardless of whether their real (inflation-adjusted)
increase investment. Eliminating the tax would also reduce
income has increased, or increased significantly. Indexing
the progressivity of the overall tax system given that it is
the income thresholds would address this issue. Other
mostly paid by higher-income households. Repealing the
components of the tax code, such as the ordinary income
tax would also reduce complexity in the tax code.
tax brackets and the standard deduction, are indexed for
inflation.
Repealing the tax would decrease federal tax revenues. As
previously discussed, IRS data reveals that the NIIT raised
Expand the Measure of Income Subject to Tax
$59.8 billion in tax year 2021. Estimates by the Joint
The owners of limited partnerships and S corporations—
Committee on Taxation for more recent years suggest that
two forms of business known as “pass-throughs” and that
NIIT repeal would reduce revenues by approximately $50.8
are not subject to the corporate income tax—may be able to
billion annually between 2022 and 2026.
avoid the NIIT if they are actively involved in the business.
Such owners may also be able to avoid the additional 0.9%
Adjust the Tax Rate
Medicare tax that applies to wages and self-employment
Adjusting the NIIT rate could help to achieve certain policy
income above $200,000 for single filers and $250,000 for
goals. Lowering the rate would help to address concerns
married individuals filing jointly. These thresholds are the
about the tax’s impact on investment. Raising the tax rate
same ones that apply to the NIIT.
would likely generate greater tax revenue and increase
progressivity in the tax system. Adjusting the tax in either
In its most recent Options for Reducing the Deficit, the
direction would not impact the administrative aspects of the
Congressional Budget Office (CBO) presented the option of
tax, assuming no other changes were made. One issue in
expanding the amount of income subject to the 3.8% tax.
raising the tax rate is that it could increase the lock-in effect
Specifically, the option would subject the active income of
for capital gains (the incentive to hold on to assets rather
high-income partners and S corporation owners that is not
than sell them), although there is disagreement about the
already subject to Federal Insurance Contributions Act
size of the lock-in effect.
(FICA) or Self-Employed Contributions Act (SECA) tax to
the NIIT. The high-income thresholds would be $200,000
Adjust the Income Thresholds
(single) and $250,000 (married filing jointly). The JCT
As with adjusting the tax rate, adjusting the income
estimates provided to the CBO suggest this change could
thresholds could help policymakers achieve particular
raise $248.9 billion over 10 years.
objectives. Lowering the income thresholds would result in
more households being subject to the tax, and hence, more

revenue. This change could also decrease progressivity in
the tax code and increase complexity from the perspective
Mark P. Keightley, Specialist in Economics
of those who would be subject to the tax. Increasing the
income thresholds would result in fewer households subject
IF11820

https://crsreports.congress.gov

The 3.8% Net Investment Income Tax: Overview, Data, and Policy Options

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https://crsreports.congress.gov | IF11820 · VERSION 6 · UPDATED