What Is the Net Investment Income Tax and Is Your Accountant Handling It Correctly?

By Drew Tignanelli, CPA, CFP®

You have a CPA and have worked with them for years. Your return gets filed every April; you get the bill and move on, reasonably confident that someone with credentials and software has handled everything correctly. What many people with significant investment income never find out is that a specific 3.8% federal tax that applies to millions of Americans approaching or already in retirement is routinely misapplied. The money disappears, year after year, and nobody calls to tell you it’s gone. I call it an invisible loss.

I’ve been reviewing tax returns for over 40 years, and the Net Investment Income Tax is near the top of the list of items I consistently find mishandled in outside returns. If your income is above a certain threshold and you have rental income, partnership interests, or proceeds from a business sale, there is a reasonable chance this has affected you. Here’s what you need to know.

The Net Investment Income Tax Defined

The NIIT is a 3.8% federal surtax introduced to help fund Medicare. It applies to certain investment income for individuals whose modified adjusted gross income exceeds $200,000 for single filers, $250,000 for married couples filing jointly, or $125,000 for those married filing separately. What’s important to know is that these thresholds have not been indexed for inflation since the tax was enacted in 2013, which means more people are being pulled into it every year simply because incomes have risen.

The 2025 tax law changes left the NIIT entirely intact, and the rate, thresholds, and rules are unchanged.

The tax is calculated on the lesser of your net investment income or the amount by which your MAGI exceeds those thresholds. Investment income subject to the NIIT includes interest, dividends, capital gains, and income from passive activities, including passive rental income and passive business interests. And that last category of passive income is where most of the errors I see originate.

The Passive/Nonpassive Distinction Software Often Misses

The tax code draws a clear line between passive and nonpassive income, and the NIIT applies only to passive income. A stock investment that appreciates and gets sold is passive. A savings account paying 4% interest is passive. A rental property where you’ve hired a management company and play no active role is generally passive.

But if you own a building and rent it to your own operating business, what the tax code calls a self-rental, that net rental income is treated as nonpassive, provided the business itself is nonpassive for you. If you own a portfolio of rental properties and you handle the leasing, collect the rents, and manage the accounting yourself, that net rental income can qualify as nonpassive through material participation. Nonpassive income is not subject to the NIIT.

Where the problem comes in: tax software, even good tax software, often defaults to flowing capital gains and rental income through the NIIT calculation. It is the preparer’s job to recognize nonpassive situations and manually override that default because the software won’t do it automatically. It’s similar to the misconception people have about TurboTax—that you can plug in the numbers and it figures everything out. You have to understand what the outcome should be, and then make sure the software gets there.

What This Looks Like in Practice

A business owner approached us after selling his business. The sale generated several million dollars in capital gains, which flowed through to Schedule D and from there into the NIIT calculation. When we conducted the Financial Physical®, our comprehensive review of a prospect’s financial situation before they become a client, we caught the error on the 2024 return before it was filed. That alone was $15,000 to $20,000 in incorrectly assessed tax.

Then we looked further back. If the 2024 return had this problem, we wanted to know about prior years. On the 2023 return, we found two to three million dollars in nonpassive capital gains that had been classified as passive and run through the NIIT. The accountant pushed back when we asked them about it. (Professionals usually don’t enjoy being told they’ve made a mistake.) We held our position, provided the analysis, and eventually they agreed to amend the return. The client received a refund of $91,000.

We have a second case currently in process involving a woman who sold a business she ran from a property she owned. The NIIT was applied to income that was clearly nonpassive. The accountant has refused to amend the return, so we filed the amendment ourselves. She is waiting on a $51,000 refund.

These aren’t rare, one-off mistakes. They are the kind of errors that happen when tax preparation and financial planning operate in separate conversations, year after year, with no one connecting the two.

Why the Coordination Gap Exists

Your CPA is working from the documents in front of them, under a deadline, and with a mandate to get the return filed. Your financial advisor is focused on your portfolio. When those two professionals aren’t in regular, detailed communication, nobody asks the question that catches these errors: Is this income actually passive?

For people approaching retirement in 2026 with income above those thresholds, this question deserves a direct answer, not an assumption.

Comprehensive tax expertise isn’t standard in this profession, and most clients don’t realize that until a problem lands in their lap. A large share of advisors are focused on investments and markets, which is the scope of what their training and licensing cover. The tax side either gets handed off to a CPA who doesn’t know the investment picture, or it doesn’t get looked at carefully at all.

At Financial Consulate, nearly half our advisors are CPAs, and I am the original. That structure means the tax review and the financial plan are never separate conversations. When we conduct a Financial Physical®, we review the last three years of your tax returns alongside your investment accounts, income sources, and entity structures. We’re specifically looking for the classification errors that preparers working in isolation are most likely to miss.

One more note: When an error on a return we prepared comes to light, we amend it at no cost to the client and do whatever we can to make it right. That standard matters to us, and it shapes how carefully we look.

What to Ask if You’re Above the Thresholds

If your income is above the NIIT thresholds and you have rental income, partnership interests, or capital gains from a business sale, these questions are worth putting to your accountant directly: 

• Has anyone verified whether my rental or business income is passive or nonpassive for NIIT purposes? 
• If there was a business sale in recent years, was that gain reviewed for NIIT classification? 
• Is there a strategy in place to manage my net investment income exposure going forward?

I’ve seen what happens when those questions don’t get asked. If you’re interested in a second review of your returns, you can reach our team at (410) 823-7283, or schedule a time through our website.

Frequently Asked Questions About Net Investment Income Tax

What is the Net Investment Income Tax (NIIT), and who does it apply to?

The NIIT is a 3.8% federal surtax on certain investment income for individuals with modified adjusted gross income above $200,000 for single filers, $250,000 for married couples filing jointly, or $125,000 for those married filing separately. The tax is calculated on the lesser of your net investment income or the amount by which your income exceeds those thresholds. These thresholds are written directly into the statute and have not been adjusted for inflation since 2013.

What types of income are subject to the NIIT?

The NIIT applies to passive income, including interest, dividends, capital gains, net rental income from passive activities, and income from passive business interests. It does not apply to wages, self-employment income, Social Security benefits, or income from activities in which you materially participate. The 2025 tax law changes left these rules entirely unchanged.

Can my accountant make a mistake on the Net Investment Income Tax?

Yes, and it is more common than most realize. The most frequent error involves misclassifying nonpassive income, such as net rental income from a self-rental or an actively managed rental portfolio as passive, which incorrectly triggers the 3.8% surtax. Most tax software requires the preparer to manually override the default NIIT calculation for nonpassive situations. That override requires judgment, not just data entry, and it gets missed even at experienced firms.

How can I reduce my exposure to the Net Investment Income Tax?

Reducing NIIT exposure depends on your specific income sources and how they are classified. For business owners and real estate investors, verifying the passive versus nonpassive treatment of your income is the most commonly overlooked first step. Beyond classification, strategies may include timing capital gains recognition, coordinating Roth conversions with your passive income levels, and reviewing entity structure for rental or partnership income. These decisions are most effective when your tax preparer and financial advisor are reviewing your situation together throughout the year, not just at filing time.

Should I have my tax return reviewed even if I already work with a CPA?

If your CPA and financial advisor aren’t regularly communicating, a coordinated review may surface issues that neither professional would catch working independently. At Financial Consulate, our Financial Physical® includes a review of your last three years of tax returns alongside your financial plan, specifically to identify errors like NIIT misclassification, missed deductions, and planning opportunities that fall between standard advisory and tax services. In some cases, those reviews have produced five-figure refunds on returns that had already been filed and accepted.

About Drew

Drew Tignanelli, CPA, CFP® is Founder & Chairman and a Wealth Advisor at Financial Consulate. He specializes in tax planning, estate planning, investment planning, and retirement planning. On Wednesday evenings at 6:00, he hosts Money, Riches & Wealth, a live radio show covering all areas of personal finance, airing on WCBM AM 680.