When a Good Investment Year Comes With a Tax Hangover

At some point, health care and investing crossed paths in the tax code, locked eyes, and decided to make everyone mildly irritated forever. The most visible result of that partnership is the 3.8% Net Investment Income Tax (NIIT), a surtax that tends to appear right after you finish celebrating what you thought was a very solid year. Confetti falls, champagne pops, and then—boom—the IRS shows up with a clipboard.

This tax isn’t about how hard you work. It’s not judging your hustle, your overtime, or your caffeine intake. It’s about how efficiently your money works when you’re not watching it. Interest, dividends, capital gains (short-term and long-term), royalties, annuities held outside retirement accounts, and passive income from rentals or businesses all fall under the IRS definition of investment income. If your money made money without breaking a sweat, the NIIT may already be warming up on the sidelines.

Just as important is what doesn’t count. Wages and self-employment income are out, as well as distributions from IRAs, Roth IRAs, and employer retirement plans. Social Security, Municipal bond interest, life insurance proceeds, veterans’ benefits, and most gains from selling your primary residence are also excluded. That distinction matters because many people assume “high income” automatically equals “surtax.” It doesn’t. High investment income is the real trigger.

Whether that investment income actually gets taxed depends on your modified adjusted gross income, better known as MAGI. Once MAGI exceeds $200,000 for single filers or $250,000 for married couples filing jointly, the surtax enters the chat. Trusts and estates, meanwhile, barely get out of bed before the surtax applies, with thresholds hovering around $16,000 in 2026. If you’ve ever wondered why trust tax planning feels so intense, this is a big reason why—it doesn’t take much income at all to trip the wire.

Here’s where the math is slightly less dramatic than the headlines make it sound. The 3.8% surtax applies to the lesser of your net investment income or the amount your MAGI exceeds the threshold. Stay under the limit, and the tax disappears entirely. Cross it, and the IRS starts peeking into your brokerage account like it’s their business.

The NIIT may get the spotlight, but it’s not the only health-care-related tax lurking in the background. There’s also an additional 0.9% Medicare tax on wages and self-employment income once those same income thresholds are exceeded. Different tax, different bucket, same invisible line in the sand. On top of that, medical expenses only become deductible once they exceed 7.5% of adjusted gross income—a percentage that also determines whether medical costs can help you avoid the 10% early withdrawal penalty on certain retirement account distributions. The tax code loves consistency, even when it’s inconvenient.

At this point, most people realize the real issue isn’t the tax itself. It’s the surprise, and surprises in tax planning are rarely fun.

Next time, we’ll talk about how planning decisions—Roth conversions, retirement distributions, salary deferrals, and trusts—can either trigger this tax or quietly keep it from crashing your otherwise good year.

Michelle Kuehner, ChFC®, MCEP®, is the President of Personal Money Planning, LLC, a Wichita Falls retirement planning and investment management firm.