The Net Investment Income Tax (NIIT) is a unique tax provision, introduced in 2013 to help pay for the Affordable Care Act (ACA). While the NIIT may be the focus of future congressional action, the best approach is to continue to factor the tax consequences into your investment decisions.
NIIT basics. It's important to understand how the NIIT works. Simply stated, your net investment income could subject you to an additional 3.8% tax when your modified adjusted gross income (MAGI) exceeds $200,000 for single filers and $250,000 for joint filers. The calculation of the tax is based on the lesser of net investment income or the excess MAGI above the annual threshold. The definition of net investment income includes most common investment items — such as capital gains, dividends, interest, rental income, and royalties — but not others like distributions from qualified retirement plans and IRAs. The confusing part of this tax is that while your investment income may be limited, your other income can expose you to NIIT by exceeding the income threshold. For example, while retirement plan withdrawals may not be subject to the NIIT, a large retirement plan distribution could put your income (MAGI) over the $200,000 - $250,000 threshold.
NIIT example: Ima Gonnapay is a joint filer with net investment income of $100,000 and joint wages along with her husband, Whois, of $200,000. This creates a MAGI of $300,000. They will pay NIIT of $1,900 on the excess $50,000 MAGI over their $250,000 NIIT threshold. Conversely, if they had net investment income of $25,000 and the same $300,000 MAGI, the tax on the net investment income is $950 ($25,000 x 3.8%).
Some NIIT tax reduction ideas. The best way to manage your Affordable Care NIIT is to keep your net investment income and MAGI figures down for the year. You might postpone large capital gains from securities transactions or harvest losses to offset prior gains. Consider investing in tax-free municipals or deferring tax on a potential real estate sale by instead exchanging like-kind properties under Section 1031 of the tax code. Also notice the steep marriage penalty in this surtax. Wedding planning might even include understanding the NIIT impact if your combined income will bring you over the NIIT threshold.
Of course, taxes aren't the only consideration in these investment decisions, but they may be a mitigating factor. Keep your eye on the tax reform deliberations in Congress that could affect the NIIT tax. The outcome could change your tax strategies later in the year.
