This has been a quiet year for tax legislation. However, the relatively new Net Investment Income Tax (NIIT), which took effect in 2013, is still a challenge that causes angst for taxpayers.
The NIIT is a 3.8 percent surtax; in other words, another layer of tax. It is calculated based on an alternative tax base, the taxpayer’s net investment income. While the calculation is complex, it does affect a large population of taxpayers due to the following low thresholds:
- $250,000 adjusted gross income (AGI) for married individuals or surviving spouse filing a joint return
- $125,000 AGI for a married individual filing a separate return
- $200,000 AGI for all others
Investment income includes interest, dividends, annuities, certain rents, royalties, income from passive activities, and net capital gain from a sale of property excluding property in a non-passive business. It does not include salaries, wages, distributions from IRAs or qualified plans, income subject to self-employment tax, or income items that are exempt from income tax such as tax-exempt bonds. Taxpayers can deduct certain limited investment-related expenses when calculating their net investment income.
There are a variety of ways to reduce your net investment income subject to NIIT. Some are familiar income tax planning reduction strategies and some are specific to the NIIT.
- Consider investing in municipal bonds, which are not subject to regular income tax or the NIIT. An added bonus is that this strategy may help keep you below the thresholds above and keep the rest of your investment income from being subject to the NIIT.
- Consider contributing to Roth IRAs rather than traditional IRAs. A distribution from either type of IRA is not subject to the NIIT, but the Roth IRA offers the additional benefit of possibly keeping your AGI below the above thresholds. Alternatively, if your traditional IRA contributions are deductible, they may help you stay below the thresholds.
- Make charitable contributions with appreciated long-term securities. In addition to receiving the full charitable deduction, the resulting capital gain is not subject to regular income tax or the NIIT.
- Consider becoming more active in a business that is now considered passive. If you “materially participate” in a trade or business, the income from that activity is not subject to the NIIT.
- If you are selling an appreciated asset, consider installment reporting. This allows you to defer a portion of the income taxes to later years and may also keep your AGI below the NIIT thresholds.
- It should be noted that real estate owned outside of your business but rented to the business, even on a net lease basis, is not considered rent for the NIIT.
- If capital is needed in your business, consider lending personal funds. Interest paid to you is not subject to the NIIT.
These are just a few strategies to help you reduce or avoid the NIIT. Please contact our Tax Strategies group for help in implementing a planning strategy or to discuss others that may apply.
For questions about this topic or to discuss your company's needs, please contact us at Email or 215.441.4600.
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