If you’ve been bitten by the net investment income tax (NIIT) in the past three years, you may be ready now to get more serious about exploring strategies to avoid or reduce your exposure to this complicated 3.8% Medicare surtax on investment income. Below are ten strategies to minimize the bite of this surtax in 2016 and succeeding years.
- Sell securities with losses before year-end to offset gains during the year from the sale of securities.
- Donate appreciated securities instead of cash to IRS-approved charities so that gains won’t be included on your return even though you will receive a tax deduction for the donation.
- Use installment sales or Section 1031 like-kind exchanges to either spread the gain recognition over several years or defer the gain on the sale of property. These two strategies work best for investment real estate.
- Invest more taxable investment funds in municipal bonds. Interest income from municipal bonds is federally tax exempt and also state exempt as well, if bonds are issued by your resident state. If you are subject to the NIIT, be sure to include the 3.8% in your municipal bond interest conversion calculation.
- Invest taxable investment funds in growth stocks. Gains won’t be taxed until the stocks are sold, and growth stocks generally do not distribute dividends.
- Consider conversion of traditional IRA accounts to ROTH accounts. This idea is part of a long-term strategy and requires careful coordination with your tax and investment advisors, because the taxable income from the conversion does increase your taxable income and may result in more of your investment income being subject to the NIIT in the year of the ROTH conversion. In the future, though, this strategy could result in tax savings since the earnings and gains inside the ROTH will be exempt from both income tax and the NIIT when distributed.
- Invest in life insurance and tax-deferred annuity products. Earnings from life-insurance contracts and annuity contracts generally aren’t taxed until they are withdrawn. Life-insurance death benefits are generally exempt from federal income tax.
- Invest in rental real estate. Rental income is offset by depreciation deductions, reducing the amount of net investment income.
- Maximize deductible contributions to tax-favored retirement accounts such as 401(k) and self-employed SEP accounts
- If you are a cash basis self-employed individual or sole shareholder of an S-Corporation, consider accelerating business deductions into 2016 and deferral of business income into 2017.
Bottom-line, the NIIT is complex, and all strategies should be discussed with your tax and investment advisors before implementation to avoid other unintended tax consequences. Many of these strategies take time to implement as well, so start planning now. We can help you evaluate which strategies would be best for your particular situation, so give us a call soon to get started on your 2016 planning process.