Since last year, the net investment income tax (NIIT) has applied to some or all net investment income of taxpayers with modified adjusted gross income (MAGI) exceeding the applicable threshold:

• $200,000 singles and heads of households
• $250,000 married couples filing jointly and qualifying widow(er) with dependent child
• $125,000 married couples filing separately

For NIIT purposes, investment income may include — but isn’t limited to — interest, dividends and capital gains. If you meet the applicable MAGI threshold, the NIIT equals 3.8% of the lesser of the amount by which your MAGI exceeds the threshold or your net investment income.

Fortunately, there are ways to reduce your NIIT liability:

1. Plan your gains — and losses. Generally speaking, appreciation on investments isn’t included in net investment income until you sell the investment and recognize capital gains. So you can minimize NIIT by waiting to sell an appreciated investment until a year when you have capital losses to absorb the gains. What if you’ve already recognized some large gains this year? Then look for unrealized losses in your portfolio and consider selling those investments by Dec. 31 to offset your gains.
2. Make gifts to loved ones. If you transfer highly appreciated assets to family members who won’t be subject to the NIIT because their incomes are too low, they can sell the assets and your family as a whole will save NIIT. But beware of the “kiddie” tax that may apply on the sale if the recipient will be under age 24 on Dec. 31 (although there would still be some tax savings because there is no NIIT kiddie tax). Also be sure to consider the gift tax consequences.
3. Take advantage of retirement plans. Pretax or deductible contributions to retirement plans reduce your MAGI and, thus, potentially reduce or eliminate your NIIT liability in the contribution year. Alternatively, consider Roth accounts. Contributions aren’t pretax or deductible, but qualified distributions will be excluded from MAGI, and thus could minimize NIIT liability in retirement. In either case, having the assets in retirement plans allows the assets to grow tax deferred (and, in the case of Roths, tax free), so the interest and dividends being generated in the plans are not currently contributing to your MAGI.
4. Buy municipal bonds. Municipal bond income is not part of the calculation in determining MAGI, so they can help to keep you under the threshold before you fall into being subject to NIIT. Further, municipal bond interest isn’t included in the income subject to NIIT. So municipal bonds have two benefits here (in addition to others mentioned in my previous blog).

These are only some of the ways you can keep your NIIT liability to a minimum. For more NIIT-reduction ideas — or information on what is and isn’t subject to the NIIT — please contact us.