Why You're Stuck Paying This Hated Tax at Least 1 More Year

This time last year, many investors believed that many unpopular tax provisions would be history by now. The election of President Donald Trump came with the promise of tax reform, with the goal of simplifying the tax laws.

One of the provisions many had expected to disappear was the net investment income tax. This surtax came about as a result of the legislation that started Obamacare, as part of a broader set of revenue-raising measures that included a Medicare surtax on wage income above certain limits. Although the net investment income tax doesn't hit every investor, focusing instead on high-income taxpayers, Republican dislike for the Affordable Care Act quickly put the NIIT on the endangered list. Yet due to ongoing wrangling in Washington, nothing has happened with the NIIT, so investors will almost certainly have to deal with it once again when they file their 2017 tax returns early next year.

What is the net investment income tax?

The net investment income tax is a 3.8% surtax that applies to income from investments. Money you get from interest, dividends, and short-term and long-term capital gains count as investment income subject to the tax. Also included are rental income from real estate, royalty income from intellectual property and property interests in natural resources, and what's known as passive activity business income. Moreover, if you sell your primary residence and the gain is greater than the $250,000 or $500,000 exemption most taxpayers can use, the excess is treated as taxable investment income.

Because the surtax is on net investment income, you're allowed to deduct certain expenses that you incur in generating that income. That's the case even if you typically can't deduct those expenses directly against investment income for regular tax purposes. Interest expense incurred in making investments, brokerage and investment advisory fees, costs of tax preparation, rental expenses, and state and local income taxes on the investment income are typically only allowed as itemized deductions, but they would allow you to reduce the amount subject to the surtax.

More importantly, only certain high-income taxpayers have to pay the tax. If you're single and have adjusted gross income of more than $200,000, then the tax applies to investment income to the extent that it pushes you above that limit. The corresponding limit for joint filers is $250,000. For instance, if you're part of a couple filing jointly and have $240,000 in combined salary income and $20,000 in investment income, then you'll pay net investment income tax only on the $10,000 by which the total income of $260,000 exceeds the $250,000 threshold limit.

How to deal with net investment income tax

Because it looks like the net investment income tax won't be going away in 2017, you'll need to take steps to avoid it. Tax-loss harvesting is one great way you can reduce net investment income, because the losses that you take will offset any capital gain that would be subject to the tax. You can even use up to $3,000 in extra losses to offset other types of income, further reducing your NIIT liability.

Alternatively, if there are measures you can take to defer income into 2018, then you might be able to stay below the income thresholds above which you'd have to pay the NIIT gets imposed. For instance, retirees can temporarily reduce the amount of taxable withdrawals from retirement accounts like IRAs and 401(k)s in order to keep their taxable income lower.

Many had hoped that the net investment income tax would be gone by now, but hopes that the NIIT would disappear by the end of 2017 have thus far been shattered. Still, by taking steps to minimize its impact now, you'll put yourself in a better position to benefit if it does go away in future years.

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