To help appreciate the planning opportunities individuals may have between now and year end, we…
Our Best Net Investment Income Tax (NIIT) Tax Minimization Planning Strategies
The NIIT is a 3.8 percent Medicare surtax imposed on the lesser of an individual’s (a) net investment income (NII), or (b) the amount of modified adjusted gross income (MAGI) that exceeds $250,000 for MFJ (married filing jointly) or $200,000 (single).
The NIIT generally applies to unearned passive income, not from a business. NII includes income from interest, capital gains, dividends, annuities, royalties, and rents.
With investment income growing for most this year, reducing NIIT is more important than ever. Below are some of our best NIIT planning strategies to minimize the tax:
- Sell securities with losses before year-end to offset gains during the year from the sale of securities.
- Donate appreciated securities instead of cash to IRS-approved charities so that gains won’t be included on your return even though you will receive a tax deduction for the donation.
- Use installment sales to spread the gain recognition over several years on the sale of property.
- Use Section 1031 like-kind exchanges to defer the gain on the sale of property. This strategy works best for sales of real estate.
- Maximize deductible contributions to tax-favored retirement accounts such as 401(k) and self-employed SEP accounts to reduce your MAGI to avoid the NIIT,
- Increasing deductions to reduce your MAGI to avoid the NIIT,
- Donating appreciated securities to a qualified charity, or
- Altering (carefully with legal advice) the tax characteristics of your investment.
- Invest more taxable investment funds in municipal bonds. Interest income from municipal bonds is federally tax-exempt and also state exempt if bonds are issued by your resident state. If you are subject to the NIIT, be sure to include the 3.8% in your municipal bond interest conversion calculation.
- Invest taxable investment funds in growth stocks. Gains won’t be taxed until the stocks are sold. Growth stocks generally do not distribute dividends.
- Consider conversion of traditional IRA accounts to ROTH accounts. This idea is part of a long-term strategy and requires careful coordination with your tax and investment advisors. The taxable income from the conversion will increase your MAGI and may result in more of your investment income being subject to the NIIT in the year of the ROTH conversion. In the future, though, this strategy could result in tax savings since the earnings and gains inside the ROTH will be exempt from both income tax and the NIIT when distributed.
- Invest in life insurance and tax-deferred annuity products. Earnings from life insurance contracts and annuity contracts generally aren’t taxed until they are withdrawn. Life insurance death benefits are generally exempt from federal income tax.
- Invest in rental real estate. Rental income is offset by depreciation deductions, reducing the amount of NII and MAGI.
Of course, every taxpayer’s situation is different, and planning for the NIIT requires a very personalized strategy. Talk to your tax advisor or tax attorney to implement these strategies.
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