The Net Investment Income Tax (NIIT) is an unusually complicated extra tax of 3.8 percent passed in 2010 to help finance the Affordable Care Act. The tax went into effect on January 1, 2013 and the Internal Revenue Service issued its final regulations in November 2013.
The NIIT applies to individuals, estates, and trusts with modified adjusted gross income above $200,000 for a single taxpayer or $250,000 for married taxpayers. There is no adjustment for inflation. For estates and trusts, the NIIT applies to any undistributed net investment income for the year or any excess of adjusted gross income at which the highest income tax bracket is applicable.
Net investment income is defined as income from interest, dividends, annuities, royalties, and rents unless such income is derived in the ordinary course of business. Note that tax-exempt interest and dividends are excluded. Net investment income also includes gross income from a trade or business that is passive to the taxpayer (i.e. a taxpayer/owner who works less than 500 hours per year in the business). Net gain (long-term or short-term) from the sale of property is also subject to the NIIT. However, the sale of property from an active trade or business is excluded. Also, income involving trading of commodities/financial instruments is subject to the NIIT.
Below are seven planning techniques to reduce or avoid the NIIT:
- Make contributions to charity using appreciated stock. This eliminates the recognition of gain on the appreciation regarding the normal capital gain and the NIIT.
- Make a business loan to your company, since the interest paid is not subject to the NIIT. Normal interest received is subject to the NIIT.
- Increase your participation in your business if you are not working at least 500 hours per year. Passive income from a business is a major target regarding the NIIT. By increasing your hours, the passive income element will be eliminated.
- If you own a property that you rent to your business, consider increasing reasonable rents. These rents are not subject to the NIIT even if you do not materially participate in the operating business.
- Consider like exchanges regarding real estate properties. Instead of selling the real estate, do a like exchange or a swap. This not only defers the NIIT but also defers the normal capital gain on the transaction.
- Consider selling assets on the installment sale method. The proceeds from the installment are only subject to the NIIT and capital gain tax when they are actually received. This can delay the NIIT and may avoid the tax by keeping any yearly income under the $200,000/$250,000 threshold.
- Review your investment portfolio and consider selling stocks that have losses to offset current gains. Also, prior years’ capital loss carryovers can offset current gains. These techniques will also offset the NIIT and capital gains taxes.
To date, there has been no case law reported regarding NIIT. With that in mind, we recommend that any planning techniques you are contemplating to reduce your NIIT be reviewed by your tax advisor before moving forward.
For more information, contact us at Email or 215.441.4600.
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