Beyond portfolio management, two areas of planning are significantly important to affluent and high-net-worth clients: tax planning and estate planning. In this post, we will focus on taxes, and more specifically, the Net Investment Income Tax (NIIT). We will discuss what it is, who is affected, what triggers it and, most important, we will list several ways to reduce and/or eliminate it.
The NIIT is part of the Health Care and Education Reconciliation Act of 2010, effective January 1, 2013. The NIIT tax is 3.8% on the lesser of:
a) Net Investment Income; or
b) The amount MAGI exceeds $250,000 (married filing jointly) or $200,000 (all others)
The purpose of the NIIT was to fund approximately 50% of the total cost of Obamacare. Initial projections from the IRS indicated this would affect about three million taxpayers. Because the thresholds are not indexed to inflation, the number of affected taxpayers is expected to rise.
What Is Included?
Net investment income includes, but is not limited to, the following:
- Interest, dividends, and capital gains
- Rental income (unless derived from a trade or business to which the NIIT does not apply)
- Royalty income
- Income from non-qualified annuities
- Gain from the sale of a personal residence to the extent it exceeds IRS Section 121 ($250,000 single; $500,000 married filing jointly)
- Gain from the sale of investment real estate, including a second home that is not a primary residence
- Income from businesses involved in trading of financial instruments or commodities and businesses that are passive activities to the taxpayer per IRS Section 469 (i.e. passive activity losses and credits)
- Gain from the sale of interests in partnerships and S corporations to the extent the partner or shareholder was a passive owner.
What is Modified Adjusted Gross Income (MAGI)?