High-income taxpayers need to be aware of the Net Investment Income Tax (NIIT). The NIIT is a tax passed in 2010 to help pay for the Affordable Care Act, a.k.a. ObamaCare. Below is a summary of the NIIT, and a few planning opportunities to consider to avoid/minimize NIIT.
The NIIT applies at a rate of 3.8% to certain net investment income of individuals, estates, and trusts that have income above certain thresholds. The NIIT went into effect for tax years beginning on or after January 1, 2013.
Individuals will owe the tax if they have Net Investment Income and also have modified adjusted gross income over the following thresholds:
|Filing Status||Threshold Amount|
|Married filing jointly||$250,000|
|Married filing separately||$125,000|
|Head of household (with qualifying person)||$200,000|
|Qualifying widow(er) with dependent child||$250,000|
At this time, the threshold amounts are not indexed for inflation.
In general, estates and trusts are subject to the NIIT if they have undistributed Net Investment Income and also have adjusted gross income over the dollar amount at which the highest tax bracket for an estate or trust begins (for tax year 2014, this threshold amount is $12,150).
In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer (meaning the taxpayer does not “materially participate” in the business). To calculate your Net Investment Income, your investment income is reduced by certain expenses properly allocable to the income.
To the extent that gains are not otherwise offset by capital losses, the following gains are examples of items taken into account in computing Net Investment Income: (i) gains from the sale of stocks, bonds, and mutual funds; (ii) capital gain distributions from mutual funds; (iii) gain from the sale of investment real estate (including gain from the sale of a second home that is not a primary residence); and (iv) gains from the sale of interests in partnerships and S corporations (to the extent the partner or shareholder was a passive owner).
The NIIT does not apply to any amount of gain on the sale of a personal residence that is excluded from gross income for regular income tax purposes.
In order to arrive at Net Investment Income, Gross Investment Income (items described in items 7-11 above) is reduced by deductions that are properly allocable to items of Gross Investment Income. Examples of deductions, a portion of which may be properly allocable to Gross Investment Income, include investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, tax preparation fees, fiduciary expenses (in the case of an estate or trust) and state and local income taxes.
Some planning opportunities to consider to help avoid/minimize the NIIT include: (i) receiving the purchase price from a sale of your closely held business or real estate over more than one year; (ii) generating losses to offset gains; (iii) renting property to your business; (iv) lending money to your business; and (v) take an active role in your closely held business.