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🧮 What the 

NIIT gap

 means

NIIT stands for the Net Investment Income Tax — a 3.8 percent surtax created by the Affordable Care Act (ACA) in 2013.

It was designed to make wealthy taxpayers contribute more toward Medicare-related funding on their investment income.

But because of the way the law was written, a large group of high-income business owners can legally avoid paying it.

That loophole is what’s called the NIIT gap.

⚙️  How the NIIT works

  • Applies a 3.8 % tax on investment income (interest, dividends, capital gains, rents, royalties, and passive business income).
  • Only applies to individuals earning >$200 k (or >$250 k married).
  • Wages and self-employment income are already subject to Medicare payroll tax, so they’re excluded from NIIT to avoid double taxation.

🚪  The loophole (“NIIT gap”)

Many wealthy owners of “pass-through” businesses — such as S-corporations, partnerships, and LLCs — can:

  1. Report their income as “active business income,”
  2. Avoid both the 3.8 % NIIT and the 3.8 % Medicare payroll tax,
  3. Even though that income functions like investment income for tax purposes.

Economists and the Treasury estimate this gap allows billions in untaxed income at the top — sometimes called a “double exemption” on non-wage business income.

💰  How much revenue is lost

  • The Congressional Budget Office (CBO) and Committee for a Responsible Federal Budget (CRFB) estimate that closing the NIIT gap (making it apply to all pass-through income above the threshold) would raise about $440 billion over 10 years, or roughly $44 billion per year. Source: https://www.crfb.org/blogs/cbos-revenue-savings-options

That’s about the same size as eliminating the carried-interest loophole or equalizing capital-gains rates — a major “trickle-down” subsidy reversal.

🧩  Example

Suppose a high-income partner earns $1 million from a law or investment firm via a partnership share.

If structured as “active” business income, none of it faces the NIIT or the Medicare payroll tax.

A regular salaried worker earning the same amount would owe 3.8 % × $1 million = $38 000 more in Medicare-related taxes.

⚖️  Fixing it

The Biden administration and several congressional proposals (including the 2021 Build Back Better Act) proposed to:

  • Apply the 3.8 % NIIT to all pass-through income above the current thresholds;
  • Ensure parity between labor and capital income taxation at the top.

That simple fix would raise roughly $44 B/yr and close one of the last large “trickle-down” loopholes in the individual income tax system.

📄  Printable references (copyable URLs)

  1. IRS overview of Net Investment Income Tax: https://www.irs.gov/individuals/net-investment-income-tax
  2. Congressional Budget Office – Budget Options, Revenue #15 “Expand the Net Investment Income Tax”: https://www.cbo.gov/budget-options
  3. Committee for a Responsible Federal Budget summary of NIIT closure revenue: https://www.crfb.org/blogs/cbos-revenue-savings-options
  4. Tax Policy Center explainer on NIIT and high-income tax burdens: https://www.taxpolicycenter.org/briefing-book/what-net-investment-income-tax

Summary line:

The NIIT gap is a loophole that lets high-income owners of pass-through businesses avoid both the 3.8 % Medicare payroll tax and the 3.8 % investment-income tax. Closing it would raise roughly $44 billion per year and make the tax system fairer.

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