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

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April 28, 2021
The 3.8% Net Investment Income Tax: Overview, Data, and
Policy Options

Since 2013, certain higher-income individuals have been
Who Pays the NIIT?
subject to a 3.8% “unearned income Medicare contribution”
The Joint Committee on Taxation (JCT) estimates that the
tax, more commonly referred to as the net investment
NIIT will raise approximately $27.5 billion of tax revenue
income tax (NIIT). The statutory authority for the tax is
in 2021. According to the most recent data from the Internal
included in Internal Revenue Code Section 1411. The tax
Revenue Service, the majority of the tax is paid by higher-
was included as a revenue-raising offset in the Health Care
income households. This reflects the fact that the tax only
and Education Reconciliation Act of 2010 (HCERA, P.L.
applies to those taxpayers with income (MAGI) above
111-152), shortly after the Patient Protection and
$200,000 if single or head of household and $250,000 if
Affordable Care Act (P.L. 111-148) was signed into law.
married filing jointly.
These two laws are commonly referred to as the Affordable
Care Act or ACA.
Table 1. Distribution of Net Investment Income Tax,
2018
Policymakers may consider modifications to the NIIT to
raise revenue, address income inequality concerns, or both.
Share of
Repeal of the NIIT is also a policy option. This In Focus
Returns
Share of
provides an overview of the tax, presents data on the
Adjusted Gross Income
with Tax
NIIT Paid
distribution of the tax, and considers several policy options.
Less than $100k
0.1%
0.0%
Overview of the NIIT
$100k under $200k
1.7%
0.1%
The NIIT is equal to 3.8% of the net investment income of
$200k under $500k
68.8%
12.8%
individuals, estates, and certain trusts. Net investment
income includes interest, dividends, annuities, royalties,
$500k under $1 mil ion
19.5%
14.9%
certain rents, and certain other passive business income not
subject to the corporate tax. Net investment income also
$1 mil ion under $2 mil ion
6.2%
12.8%
includes the amount of capital gain resulting from a home
$2 mil ion under $5 mil ion
2.6%
14.3%
sale that exceeds the amount that can be excluded from
taxation ($200,000 for single, $500,000 for married filed
$5 mil ion under $10 mil ion
0.6%
9.4%
jointly). Net investment income does not include wages,
$10 mil ion or more
0.4%
35.7%
unemployment compensation, nonpassive business income,
Social Security Benefits, alimony, tax-exempt interest, and
Total
100%
100%
distributions from some tax-preferred retirement accounts;
Source: Internal Revenue Service, Statistics of Income, Table 3.3.
for example, 401(k)s, 403(b)s, and 457(b)s.
Table 1 shows taxpayers with income of $10 million or
The tax applies to taxpayers with modified adjusted gross
more paid over a third (35.7%) of the total NIIT collected in
income (MAGI) in excess of $200,000 if single or head of
2018. These individuals paid $518,845 in NIIT on average
household and $250,000 if married filing jointly ($125,000
in 2018. Table 1 also shows that those making between
for married filing separately). The income thresholds are
$200,000 and $500,000 accounted for the majority of
not adjusted annually for inflation. For taxpayers without
taxpayers (68.8%) subject to the 3.8% tax. The average
foreign-source income, MAGI generally equals adjusted
amount of NIIT paid by these taxpayers was $1,108 in
gross income (AGI). Hence, MAGI includes wages,
2018. Across all taxpayers subject to the NIIT in 2018, the
salaries, tips, and other compensation; dividend and interest
average amount of tax paid was $5,980.
income; business and farm income; realized capital gains ;
retirement distributions; and income from a variety of other
Policy Options
passive activities and certain foreign-earned income.
A number of options pertaining to the NIIT are available
depending on the objective of policymakers. One option is
For those subject to the NIIT, the amount of tax owed is
to leave the tax in its current form. The following discusses
equal to 3.8% multiplied by the lesser of
possible modifications to the tax.
 net investment income, or
Eliminate the Tax

One option would be to eliminate the tax. This change
the amount by which their MAGI exceeds
would reduce the tax burden on investment, which, to the
$200,000/$250,000.
extent investment is lower than it otherwise would be, could
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The 3.8% Net Investment Income Tax: Overview , Data, and Policy Options
increase investment. Eliminating the tax would also reduce
Index for Inflation
complexity in the tax code.
The NIIT income thresholds are not indexed for inflation.
As a result, more taxpayers can be subject to tax over time
Repealing the tax would reduce federal tax revenues.
regardless if their real (inflation-adjusted) income has
According to previously mentioned JCT estimates, repeal of
increased, or increased significantly. Indexing the income
the NITT would reduce revenues by approximately $27.5
thresholds would address this issue. Other components of
billion in 2021. Eliminating the tax would also reduce the
the tax code, such as the ordinary income tax brackets and
progressivity of the overall tax system.
the standard deduction, are indexed for inflation.
Adjust the Tax Rate
Expand the Measure of Income Subject to Tax
Adjusting the NIIT rate could help to achieve certain policy
The owners of limited partnerships and S corporations—
goals. Lowering the rate would help to address concerns
two forms of business known as “pass-throughs” and that
about the tax’s impact on investment. Raising the tax rate
are not subject to the corporate income tax—may be able to
would likely generate greater tax revenue and increase
avoid the NIIT if they are actively involved in the business.
progressivity in the tax system. Adjusting the tax in either
Such owners may also be able to avoid the additional 0.9%
direction would not impact the administrative aspects of the
Medicare tax that applies to wages and self-employment
tax, assuming no other changes were made. One issue in
income above $200,000 for single filers and $250,000 for
raising the tax rate is that it could increase the lock-in effect
married individuals filing jointly. These thresholds are the
for capital gains (the incentive to hold on to assets rather
same ones that apply to the NIIT.
than sell them), although there is disagreement about the
size of the lock-in effect.
In its most recent Options for Reducing the Deficit, the
Congressional Budget Office (CBO) presented the option of
Adjust the Income Thresholds
subjecting the income of active limited partnership and S
As with adjusting the tax rate, adjusting the income
corporation owners that is not already subject to the
thresholds could help policymakers achieve particular
additional 0.9% Medicare tax to the NIIT. The JCT
objectives. Lowering the income thresholds would result in
estimates provided to the CBO suggest this change could
more households being subject to the tax, and hence, more
raise $209.8 billion over 10 years.
revenue. This change could also decrease progressivity in
the tax code and increase complexity from the perspective

of those who would be subject to the tax. Increasing the
income thresholds would result in fewer households subject
Mark P. Keightley, Specialist in Economics
to the tax, and hence, less revenue. This would increase
IF11820
progressivity in the tax code, since it would concentrate the
incidence on the highest-income taxpayers and reduce
complexity for those taxpayers now no longer subject to the
tax.


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


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