NIIT Tax for high earners 

 Net Investment Income Tax (NIIT) is a 3.8% tax

The Net Investment Income Tax (NIIT) is a 3.8% tax on certain types of investment income for high earners. It applies to individuals with Modified Adjusted Gross Income (MAGI) above:

• $200,000 (Single/Head of Household)

• $250,000 (Married Filing Jointly)

• $125,000 (Married Filing Separately)

Ways to Manage & Reduce NIIT:

1. Tax-Advantaged Accounts

• Use IRAs, 401(k)s, and Roth Accounts: Investment income inside these accounts is not subject to NIIT.

• Health Savings Accounts (HSAs) & 529 Plans: These accounts grow tax-free and are exempt from NIIT.

2. Tax-Efficient Investments

• Municipal Bonds: Interest from tax-exempt muni bonds is not subject to NIIT.

• Index Funds & ETFs: These generate lower taxable distributions compared to actively managed funds.

• Growth Stocks vs. Dividend Stocks: Growth stocks defer gains until you sell, while dividend income is subject to NIIT.

3. Capital Gains Management

• Hold Investments for More Than One Year: Long-term capital gains (lower tax rates) are preferable to short-term gains.

• Tax-Loss Harvesting: Offset gains by selling under performing assets.

• Charitable Giving: Donate appreciated stock to avoid capital gains taxes while getting a deduction.

The Preferential Tax Treatment of Municipal Bonds 

Interest earned on most municipal bonds is exempt from federal taxes. For this reason, the higher an investor’s tax bracket, the more beneficial a municipal bond investment will be. The net investment income tax (NIIT) is an additional 3.8% tax that may be imposed on interest, dividends, capital gains, nonqualified annuities, royalties, rents, and income from passive activities. However, interest earned on municipal bonds is exempt from the NIIT.

As a taxpayer’s adjusted gross income (AGI) increases, certain tax benefits begin to phase out. Because interest earned on municipal bonds is not includable in a taxpayer’s AGI, some of these tax benefits may be preserved. However, some calculations will use a modified AGI (MAGI) to determine the treatment of a particular item, deduction, or credit. In some of these cases, tax-exempt interest is added back in to determine your MAGI. A high earner investor will need to understand when MAGI will be used in their tax planning.

Tax-exempt interest from municipal bonds is also excluded from your MAGI calculation**, which can help you stay below the NIIT threshold or reduce the amount of income subject to the tax. In addition, interest from municipal bonds may also be exempt from state and local income taxes, especially if you buy bonds issued within your state of residence. 

**For seniors who are on medicare and pay for Part B and Part D,  MAGI is not simply your Adjusted Gross Income (AGI) as it appears on your tax return. Instead, it's your AGI plus certain items that are normally tax-exempt, including tax-exempt interest from municipal bonds  Even though municipal bond interest is tax-free, it still counts towards your income for the specific calculation of IRMAA (Income-Related Monthly Adjustment Amount), which determines your Medicare Part B and D premium costs. 

For more information on municipal bonds and bonds yield calculator is found under this chapter subpage.