What is the NIIT and How Might it Affect Your Taxes?

January 3, 2024
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Is the net investment income tax (NIIT) relevant to your financial situation? This is an important tax to understand when it comes to your overall financial planning and specific tax planning throughout the year.

NIIT Basics

The NIIT is a 3.8% tax that may be applicable if your modified adjusted gross income (MAGI) is higher than:

  • Single Filer: $200,000
  • Married, Filing Jointly: $250,000
  • Married, Filing Separately: $125,000

If applicable, the NIIT will be based on the lesser of your net investment income or the amount by which your MAGI exceeds the threshold listed above.

Calculating Your Net Investment Income

Net investment income is any qualifying income earned from investments, including interest, dividends, annuities, etc. It will also include net rental income, as well as any income from businesses in which you don’t materially participate.

Net investment income does not include the following:

  • W-2 Wages
  • Self-Employed Income
  • Tax-Exempt Income
  • Qualified Retirement Plan Distributions

How to Minimize the NIIT

If you are looking to reduce or eliminate the net investment income tax, you will first need to understand why you are paying it. What is affecting your net investment income or MAGI, and which strategies can be implemented to reduce/avoid the NIIT? Here are a few issues to consider:

Municipal Bonds—There are certain bonds which are exempt from the NIIT and from federal/state taxes. Look for these bond investments when possible.

Donating Appreciated Assets—A qualifying charitable donation of appreciated assets can help you avoid the NIIT and provide a tax deduction.

Hold Appreciated Stocks—A smart strategy is to purchase growth stocks that don’t pay dividends and then hold onto them rather than selling.

Section 1031—Executing a qualified Section 1031 exchange will enable you to defer capital gains taxes, while also not impacting your investment income or MAGI.

Life Insurance and Annuities—These investments can generally allow you to defer taxes until withdrawal.

Investment Losses—If you harvest your investment losses, you can often offset your gains and reduce your taxable income. 

Rental Real Estate—When structured correctly, rental real estate investments can minimize taxable income.

Business Participation—If you take an active participation in a business you own, you can avoid income earned being classified as net investment income.

Real Estate Professional—If you own short-term real estate rentals or earn status as a “real estate professional” (as classified by the IRS), you can avoid net investment income.

Marriage Status—If you are married filing separately and one spouse is exceeding the MAGI, consider filing jointly to increase your total MAGI threshold.

Retirement Plans—Investing in retirement plans can also reduce your MAGI.

IRA Conversions—Another strategy is to convert traditional IRAs into Roth IRAs. This may trigger the NIIT in the short-term, but could offer better long-term tax benefits.

Installment Sales—These can level out your MAGI over time.

The NIIT can be a complex tax planning issue to navigate. It’s important to understand how it works and which investment strategies can help you minimize your tax liabilities. For help with all your financial planning needs, contact Illumination Wealth today.