global Tax
February 08, 2024
Wondering how you can reduce your net investment income tax (NIIT) liability? There are several reduction strategies to consider. We explore here.
The net investment income tax (NIIT) ensnares increasingly more taxpayers every year since it was first imposed by the Affordable Care Act in 2013. That’s because it kicks in at lower levels of income than the top ordinary-income and long-term capital gains rates, plus the threshold that applies to NIIT isn’t adjusted annually for inflation.
However, with proactive planning, you may be able to reduce the amount you owe on your 2024 federal income tax return.
The Basics
The 3.8% NIIT is applied to the lesser of:
- The amount by which your modified adjust gross income (MAGI) exceeds the applicable threshold, or
- Your net investment income.
Generally, if your MAGI exceeds $200,000 ($250,000 if you’re married and file jointly or $125,000 if you’re married and file separately), you could be subject to the tax.
Net investment income is computed by deducting certain expenses (such as interest expense and allocable state taxes) from investment income.
Investment income includes:
- Gains from selling investment assets, such as securities held in taxable brokerage accounts,
- Certain real estate gains, including the amount of capital gain from a home sale that exceeds the tax exclusion,
- Dividends, taxable interest and the taxable portion of annuity payments,
- Income and gains from passive business activities (meaning those in which you don’t “materially participate”),
- Income from businesses involved in trading of financial instruments or commodities, and
- Rents and royalties.
Investment income does not include:
- Interest, dividends, annuities, rents and royalties earned from a non-passive business activity,
- Tax-exempt interest, or
- Distributions from certain qualified retirement plans.
Reduction Strategies
To cut your NIIT liability, you’ll need to cut your MAGI, your net investment income — or both. Consider the following options to reduce your NIIT hit:
Harvesting your tax losses. By selling poorly performing investments, you can reduce any realized gains on a dollar-for-dollar basis. Watch out for the wash-sale rule, though — it prohibits a capital loss when you purchase the same or “substantially identical” security 30 days before or after the sale.
Shaking up your stock portfolio. Pay attention to the types of stocks in which you’re invested. Shifting from dividend-paying stocks into growth stocks can help you delay realized capital gains, thereby reducing your net investment income. And, when you do realize those gains, you may have tax losses you can harvest to offset them.
Investing in bonds.Investing in tax-exempt state and municipal bonds pays off in two ways. First, the interest and dividends on these bonds aren’t subject to the NIIT. Second, you can exclude the interest from your MAGI for purposes of the tax.
Contribute more to your retirement accounts. Maxing out your retirement account contributions for the year comes with multiple tax benefits, potentially including a reduced MAGI. The greater your contributions to your tax-advantaged retirement accounts — including 401(k)s, SEP IRAs and traditional IRAs — the lower your MAGI will be.
Increasing your participation in your investment businesses.Income from a non-passive business investment doesn’t count toward net investment income. By materially participating a business, you can convert an otherwise passive business activity into a non-passive activity. The IRS has a variety of tests for material participation, including several based on the number of hours worked for the business in the tax year. Generally, though, you must participate on a regular, continuous and substantial basis during the year in light of all of the facts and circ*mstances.
Defer income, accelerate expenses. Many taxpayers already manage their taxable income by pushing income into the next tax year and accelerating deductible expenses into the current tax year. This strategy that also can help reduce or avoid NIIT liability. You could, for example, pre-pay mortgage or state property tax payments due early the next year.
Plan Now, Save Later
Don’t wait until the end of 2024 to think about your NIIT liability. You can take actions throughout the year to avoid or reduce it. Contact our Private Client Services team to determine which options may be appropriate for your situation.
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