Tax Blog

Net Investment Income Tax -- Part Three: How to Avoid, Limit, and Minimize the NIIT

Net Investment Income Tax -- Part Three: How to Avoid, Limit, and Minimize the NIIT.

Lets discuss some taxpayers and estate planning structures that are NOT subject to the NIIT. The tools of financial planning may be used to avoid the extra 3.8% tax on investment income. The IRS has listed on their website the following exemptions from NIIT:

  • Trusts that are exempt from income taxes imposed by Subtitle A of the Internal Revenue Code (e.g., charitable trusts and qualified retirement plan trusts exempt from tax under section 501, and Charitable Remainder Trusts exempt from tax under section 664).

  • A trust or decedent’s estate in which all of the unexpired interests are devoted to one or more of the purposes described in section 170(c)(2)(B).

  • Trusts that are classified as “grantor trusts” under sections 671-679.

  • Trusts that are not classified as “trusts” for federal income tax purposes (e.g., Real Estate Investment Trusts and Common Trust Funds).

  • Electing Alaska Native Settlement Trusts.

  • Perpetual Care (Cemetery) Trusts.

Although the 3.8% includes an amount for Medicare, not all those that are subject to the NIIT will be subject to the Medicare tax. If an individual is exempt from Medicare taxes, they may still be subject to the NIIT if they have Net Investment Income AND also have modified adjusted gross income over the appropriate statutory thresholds. The 0.9% Additional Medicare Tax applies to individuals’ wages, compensation and self-employment income over certain thresholds, but it does not apply to income items included in Net Investment Income.

How can this tax be minimized or Offset? The NIIT may be offset by applying any available federal tax credit that may be used to offset a tax liability imposed by subtitle A of the US Code. However, tax credits that are only applied against the tax imposed by chapter 1 of the Code (regular income tax), may not be used to reduce the NIIT. For example, foreign income tax credits (sections 27(a) and 901(a)[1]) and the general business credit (section 38) are allowed as credits only against the tax imposed by chapter 1 of the Code. Because they are only allowed against the tax imposed by chapter 1 of the Code, these credits will not reduce a taxpayers NIIT liability.

Please feel free to reach out to the tax planning professional at The Center for Financial, Legal and Tax Planning. Phone: (618) 997-3436 or Email us at: info@taxplanning.com

[1] This may be avoided, by taking a foreign income tax deduction as opposed to a credit, some (or all) of the deduction amount may be deducted against NII.

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