Tax planning tips for 2016 investment income

The 3.8% Net Investment Income Tax (3.8% NIIT) is imposed on net investment income of higher-income individuals. This tax applies to individuals with modified adjusted gross income (MAGI) exceeding the following “thresholds,” which are not indexed for inflation:

  • $250,000 for married individuals filing jointly;
  • $200,000 if single; and
  • $125,000 if married filing separately.

The 3.8% NIIT not only applies to traditional types of investment income (i.e., interest, dividends, annuities, royalties, and capital gains), but it also applies to business income that is taxed to a “passive” owner unless the “passive” income is subject to S/E taxes.

This could include income from an S corporation in which you do not “materially participate,” income as a limited partner, and rental income. You will generally be deemed a passive owner if you do not materially participate in the business as determined under the traditional “passive activity loss” rules. For example, you may be a passive owner unless you spend more than 500 hours working in the business during the year or meet one of the other material participation tests.

Rental income is generally deemed to be passive income under the passive activity loss rules, regardless of how many hours you work in the rental activity. In certain situations, real estate rentals may not be treated as passive income and could be exempt from the 3.8% NIIT. For example, if you are a “qualified real estate professional” or you lease property to a business and you materially participate in the business operations of the lessee, the rental income may be exempt from the 3.8% NIIT.

If you believe you may qualify for one of these rental exemptions, or you otherwise believe you may have passive income from non-rental business activities, please contact our firm. We will gladly evaluate your situation to determine whether there are steps you could take before the end of 2016 to avoid passive income classification, and thus, reduce your exposure to the 3.8% NIIT.

Planning with zero percent tax rate for capital gains and dividends

Long-term capital gains and qualified dividends that would be taxed (if ordinary income) in the 15% or lower ordinary income tax bracket, are taxed at a zero percent rate. For 2016, taxable income up to $75,300 for joint returns ($37,650 if single) is taxed at the 15% rate or below.

Taxpayers who have historically been in higher tax brackets but now find themselves between jobs, recently retired, or expecting to report higher-than-normal business deductions in 2016, may temporarily have income low enough to take advantage of the zero percent rate for 2016. If you are experiencing any of these situations, please call us and we will help you take advantage of this zero percent tax rate for long-term capital gains and qualified dividends.

The zero percent rate for long-term capital gains and qualified dividends is particularly important to lower-income retirees who rely largely on investment portfolios that generate dividends and long-term capital gains.

Furthermore, gifts of appreciated securities to lower-income family members who then sell the securities could reduce the tax on all or part of the gain from as high as 23.8% to as low as zero percent. If the donee is subject to the so-called “kiddie tax,” this planning technique will generally not work.

Timing your capital gains and losses

If the value of some of your investments is less than your cost, it may be a good time to harvest some capital losses. For example, if you have already recognized capital gains in 2016, you should consider selling securities prior to January 1, 2017 that would trigger a capital loss.

These losses will be deductible on your 2016 return to the extent of your recognized capital gains, plus $3,000. These losses may have the added benefit of reducing your income to a level that will qualify you for other tax breaks, such as the: $2,500 American Opportunity Tuition Tax Credit, $1,000 Child Credit, $13,460 Adoption Credit, etc.

If, within 30 days before or after the sale of loss securities, you acquire the same securities, the loss will not be allowed currently because of the “wash sale” rules (although the disallowed loss will increase the basis of the acquired stock).

If you are afraid of missing an upswing in the market during this 60-day period, consider buying shares of a different company in the same sector. Also, there is no wash sale rule for gains. Thus, if you decide to sell stock at a gain in order to take advantage of a zero capital gains rate, or to absorb capital losses, you may acquire the same securities within 30 days without impacting the recognition of the gain.

Source: Don Farmer, CPA