I’m a Tax Specialist: The NIIT Rule High Earners Overlook Until It’s Too Late
Written by
J. Arky
Edited by
Rebekah Evans
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According to the IRS, the Net Investment Income Tax (NIIT) applies at a rate of 3.8% to certain net investment income of individuals, estates and trusts with earnings higher than the statutory threshold amounts.
If you are a high-earning individual, you need to be careful not to overlook a certain NIIT rule or it could be a potential issue later. GOBankingRates spoke with tax specialist, Bill Harris, founder and CEO of Evergreen Wealth, about all the in’s and out’s with this NIIT rule that large income earners should pay attention to sooner rather than later. Find what he shared below.
Understanding the NIIT Rule
“The Net Investment Income Tax is a 3.8% surtax that blindsides many high earners,” Harris explained. “It applies to the lesser of your net investment income or to the amount by which your modified adjusted gross income (MAGI) exceeds $250,000 for married couples filing jointly or $200,000 for single filers.”
Because those thresholds have not been adjusted for inflation, Harris commented that more taxpayers are being affected each year.
How the NIIT Rule Works
According to Harris, you may sell a concentrated stock position, exit a business or liquidate real estate. “Then, suddenly your MAGI is $400,000 or more and you’re looking at an extra $15,200 in tax on top of regular capital gains,” he said.
“NIIT isn’t withheld like ordinary income so most people don’t find out they’re getting hit by it until they file,” Harris said and added that some people may even be affected by underpayment penalties on top of it.
Year to Year
According to Harris, this tax drag can erode wealth over time, but the good news is NIIT is manageable if you plan before the taxable event, not after.
“Tax loss harvesting can offset gains and directly reduce your NIIT exposure,” Harris said. “Spreading a large sale across two or three tax years or using an installment sale structure, may keep you from exceeding the MAGI threshold all at once in one taxable year. Maximizing pre tax 401(k) or deductible IRA contributions can help reduce MAGI as well.”
Ways To Strategize
One strategy Harris this is underused involves donating appreciated securities to a donor-advised fund (DAF). “You eliminate capital gain. No gain means no NIIT on that appreciation and you receive the full charitable deduction. It creates two wins at once,” Harris explained.
Asset location is another strong strategy to consider, in Harris’ professional opinion. “REITs, high yield bonds and other income heavy holdings generate exactly the kind of income that feeds NIIT. Move those into tax advantaged accounts and that income doesn’t hit your taxable return. In 20 or 30 years, it will compound into real money,” Harris added.
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