Reducing the Impact of Obamacare’s Net Investment Income Tax

For the majority of those affected, MAGI will be the same as AGI. Specifically, MAGI is AGI plus:

• The difference between amounts excluded from gross income under section 911(a)(1), and

• The amount of any deductions (taken into account in computing adjusted gross income) or exclusions disallowed under section 911(d)(6) for amounts described in section 911(a)(1).

While the full explanation is beyond the scope of this post, IRS Section 911(a)(1) is foreign income earned abroad and Section 911(d)(6) involves the denial of double benefits. In short, foreign income may be double taxed. 

How Is the NIIT Calculated?

To demonstrate how the NIIT is calculated, let’s assume we have a married couple with a MAGI of $425,000 and net investment income of $150,000. Their NIIT is the lesser of the following:

• Net Investment Income x NIIT Tax Rate or $150,000 x 3.8% = $5,700
• MAGI – Threshold x NIIT Tax Rate or $425,000 – $250,000 = $175,000 x 3.8% = $6,650

Their NIIT tax would be $5,700, since this is the lesser of the two methods. 

How to Minimize the NIIT

As is the case with many tax laws, the government will project a revenue stream, but fail to consider the strategies taxpayers will employ to avoid or reduce their tax burden. The underlying idea is to reduce your MAGI. Here are a few ways to minimize or avoid the NIIT.

1. Maximize contributions to your company’s retirement plan
2. Sell securities at a loss to offset capital gains
3. Gift appreciated securities to charity rather than cash donations. You will get a charitable deduction and avoid the capital gains tax.
4. Become more active in passive activities. Income from a non-passive activity is not subject to the NIIT. This may require over 500 hours of personal involvement or as low as 100 hours in certain situations (ask a qualified tax professional).
5. On gain subject to the NIIT, spread the gain out over several years using an installment sale.
6. Utilize a tax-free IRS Section 1031 like-kind exchange where applicable (e.g., investment real estate).
7. Self-Employed Business Owners: Defer business income into the following year and accelerate business deductions into the current year.

There are additional methods to minimize or eliminate the NIIT. The NIIT is one more tax in a long line of new taxes. I suspect we will see several new taxes moving forward as the national debt continues to expand. As a result, the importance of tax planning should continue to rise for several years.

Until next time, thanks for reading and have a great week!