How net investment income can affect tax planning

Estate Planning | Aug 10, 2016 | Hook Law Center

There are two ways in which the 3.8 percent net investment income tax (NIIT) can have an impact on your estate plan. It can raise your tax on capital gains, taxable interest and other investment income, thereby lowering the amount of wealth that is accessible to your family. The tax is also especially severe toward specific trusts used in estate planning.

The NIIT is applicable to net investment income that high income people earn. It is also applicable to trusts and estates to the degree to which their adjusted gross income (AGI) is greater than the low threshold amount of $12,300 in 2015.

Investment income includes the following:

  • taxable interest;
  • dividends, both qualified and non-qualified;
  • capital gains, both short and long-term, with the exception of those used in an active trade or business;
  • rental income;
  • royalty income;
  • non-qualified annuity income;
  • income derived from passive business activities;
  • income derived from trading financial instruments or commodities.

Investment income does not include the following:

  • wages, self-employment income, or income earned from non-passive business activities;
  • tax-exempt interest, an example of which is interest on municipal bonds;
  • distributions from IRAs or specific qualified retirement plans;
  • proceeds from life insurance;
  • alimony;
  • Social Security benefits;
  • Veterans’ benefits;
  • gain on the sale of an active interest in a partnership or S corp.;
  • nontaxable gain on the sale of a principal residence.

You can lower or remove NIIT by decreasing your modified adjusted gross income (MAGI) below the threshold or by reducing your NII. Here are some of the strategies you can use:

  • contributing the maximum amount to IRAs and qualified retirement plans;
  • deferring income with the use of an employer’s nonqualified deferred compensation plan;
  • transferring investments into tax-exempt municipal bonds;
  • transferring investments into growth stocks that pay few dividends or none at all;
  • “harvesting” losses through the sale of securities at a loss and the use of them to counterbalance gains;
  • Making investments in life insurance (there is an exemption from NIIT for an accumulation of cash, and proceeds are subject to an exclusion from both MAGI and NII

Be mindful of the fact that mutual funds usually make distributions of capital gains on a yearly basis, close to the end of the calendar year or, in some instances, more frequently than once a year. In order to reduce the effect of the NIIT, it is recommended that you avoid buying fund shares a short time before a fund distributes capital gains.

Upon reviewing your estate plan, it is advisable for you to speak with your attorney about how you can lower or remove your NIIT. This will require a consideration of tax, estate and financial matters.

The elder law attorneys at Hook Law Center assist Virginia families with will preparation, trust & estate administration, guardianships and conservatorships, long-term care planning, special needs planning, veterans benefits, and more. To learn more, visit or call 757-399-7506.

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