Mo Money, Mo Problems

Dear Clients and Friends,

There are only so many surprises in life that we get to look forward to. Some examples that come to mind include: randomly finding money in your pocket, engagements, surprise parties, and - last but not least - a surprise tax refund. Now to the darker side of surprises hearing from your CPA or Turbo Tax that “you owe more money in taxes.” As the 2025 tax season is nearly complete, one tax in particular that may have been overlooked is the Net Investment Income Tax (NIIT).

If you are unaware of the NIIT, allow me to introduce it to you. Warning: many acronyms are coming your way!

The Net Investment Income Tax was introduced under the Health Care and Education Reconciliation Act in order to help raise revenue to fund the Affordable Care Act, which was passed in March of 2010. After a two-year legal battle over the legality of the legislation, the NIIT went into effect at the beginning of 2013. The NIIT is a 3.8% tax that gets applied to the following types of income:

Net investment income includes:

• Capital gains (short- and long-term)

• Dividends (qualified and non-qualified)

• Taxable interest – i.e. bank accounts

• Rental and royalty income

• Selling a home for an amount in excess of the principal residence exclusion amount

• Passive income from investments you don't actively participate in

It doesn’t include:

• Wages

• Veterans’ or Social Security benefits

• Unemployment

• Tax free interest from municipal bonds

• Qualified retirement plan withdrawals

• Payouts from a traditional defined benefit pension plan

Another way to think of the NIIT is that it’s a surtax on certain types of unearned, or passive, income.

The NIIT applies if your Modified Adjusted Gross Income (MAGI) exceeds certain thresholds. For single and married filing jointly taxpayers, those limits are $200,000 and $250,000 respectively. Now, your MAGI could be the same as your Adjusted Gross Income (AGI) depending on certain deductions you may receive, and if you have any foreign income (la dolce vita anyone?).

The NIIT is applied to the lesser of two income thresholds:

1) Your actual net investment income, or

2) the amount by which your MAGI exceeds the NIIT income threshold

Here’s a brief example. Let’s say you have $50,000 in net investment income between your dividends / capital gains, and your MAGI exceeds the income threshold by $60,000. The 3.8% tax will apply to the smaller of these two figures, so the additional tax would be $50,000 * 3.8% = $1,900. Remember those unpleasant surprises that we mentioned above?

There are several ways to mitigate your NIIT exposure or outright eliminate the burden altogether. First, make sure you’re taking advantage of any retirement plans, such as a 401(k), 403(b) and/or a SEP IRA to help shelter your income. Another retirement-like plan that often gets overlooked is a Health Savings Account (HSA).

Some out-of-the-box strategies include:

Adding Municipal Bonds – Given that the interest from these types of bonds avoids federal income taxes and, in some cases, state and local income taxes, these types of bonds will help ease your tax pain for your non-retirement accounts.

Tax Loss Harvesting (clickable link to prior article) – Although no one enjoys losing money, the IRS allows you to write off losses from any securities you sell during the year. After you compare your losses to any investments you sold for a gain, the balance can be used to offset your income, up to a maximum of $3,000. This strategy can only be utilized in non-retirement accounts.

Let’s Get Charitable – If you’re fortunate enough to have some sizeable gains in your non-retirement accounts, consider giving those assets away to charity as opposed to giving cash. When you donate a highly appreciated investment to a charity, you’re allowed to deduct the full fair market value of that investment. By gifting shares directly to the charity instead of selling your asset first and then gifting the proceeds, you save capital gains taxes, receive a larger tax deduction, and the charity ends up with more money. That’s a win across the board!

Another option is to open a Donor Advised Fund - more on those to come in a future Weekend Reading.

Spread the “Love” – By “love,” I mean any capital gains you have accrued from the sale of a property (such as a business or a piece of real estate). By utilizing an installment sale, you defer any gains over several years as opposed to receiving a lump sum immediately. You can also utilize what’s known as a section 1031 exchange , but that is mainly used for real estate transactions.

Roth Conversions – If you’ve read my previous Weekend Readings, then I’m sure I sound like a broken record by now - I think you get the point!

It’s estimated that over 7.3 million people have paid over $60 billion in NIIT since 2021, according to the Congressional Research Service. While many items associated with the tax code are adjusted for inflation, these thresholds were not modified, which was by design to help capture additional revenue.

At the end of the day, there’s only so much you can do to mitigate your tax exposure, and I think it’s worth saying that this is a good problem to have. This is an example of why we like to update clients’ financial plans at least once a year, along with reviewing your tax returns. The Notorious B.I.G. said it best: “Mo Money, Mo Problems.”

As always, reach out if you have any questions!

Devin