Net Investment Income Tax: What, Why, and How it Could be Beat

December 11, 2012 — 4 Comments
English: Barack Obama signing the Patient Prot...

Barack Obama signing the Patient Protection and Affordable Care Act at the White House (Photo credit: Wikipedia)

In 2013 some wealthy earners will be subject to a new Net Investment Income Tax (NIIT – see Infographic); no, this isn’t the medicare payroll tax (although that too will increase), rather it is an additional 3.8% tax applied to Net Investment Income for wealthy taxpayers, legally referred to as the Unearned Income Medicare Contribution.  To be subject, US earners must have an Adjusted Gross Income of $200,000 for individuals or $250,000 for couples filing jointly.  Additionally, they must have some form of unearned income from investments in which they are passively involved, such as: property sales, rents, estates and trusts, annuities, stocks, bonds and more.  Anyone who might be subject to the tax (which, by the way, is less than 4% of Americans), should seek a financial advisor immediately to plan for these changes and others for 2013 and beyond.
This new tax is a result of the Patient Protection and Affordable Care Act, “Obamacare,” and an ammendment  – The Healthcare Education and Reconciliation Act, signed into law March 30, 2010 to help pay for healthcare reform.  Despite Fiscal Cliff negotiations on taxes, the NIIT does not appear to be on the chopping-board.  Coupled with the Medicare Part A Tax Increase of 0.9%, the NIIT is expected to generate around $210 billion in government revenue between 2013 and 2019.

The NIIT will effect different high-income earners in different ways.  In general, the 3.8% tax will apply to the lesser of: The difference in an earner’s income from the $200,000/$250,000 AGI thresholds or their net income investment.

There are different rules for different types of investments, but the threshold amounts and 3.8% rate remain constant.

For estates and trusts, the highest tax bracket begins at around $12,000 in 2013, so trustees may be inclined to distribute money to beneficiaries before year-end, especially to individuals who are below the thresholds, to avoid tax consequences.

For property sales, the same rules apply, however any new income is not taxed as a capital gain unless the sale results in a net gain of $250,000 for individuals or $500,000 for couples.

English: Newt Gingrich at a political conferen...

Newt Gingrich (Photo credit: Wikipedia)

For businesses, the line is a little more blurry.  If the “business” is a passive activity where the individual has no material participation (uses less then 50% of their working hours), the investments will be taxed; however, if the taxpayer can prove active participation with detailed documentation of time and involvement then the tax will not apply; this may encourage more active investing in the future.  For Example, an article on Forbes.com explains how Newt Gingrich might beat the tax.  Newt received a salary close to $250,000 from S corporation in 2010, but had about $2.5 million flow through to him.  In 2013, the additional investment income might be taxed by an additional 3.8%, but if he can prove active participation in the investment through S corporation the tax rate would not increase.

When planning capital gains, it may be a good idea for high income earners to accelerate some gains before 2013 and defer losses until later so as to offset the increased tax rate, especially if they expect to have a high adjusted gross income and large gains in the future.

For all high income Americans, the new Medicare tax opens a floodgate of financial/legal planning questions, burdens and opportunities.  They would be wise to seek financial and legal advice sooner rather than later.

 

 

JDKatz, P.C. is a full-service law firm focused on tax law and estate planning. We are dedicated to minimizing your existing liability and risks while providing valuable tax planning to streamline your tax issues in the future. Please call us at 301-913-2948 to schedule an appointment to meet with one of our trusted attorneys.

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