Posted by: Robert O’Neil, CPA
As you have probably heard, 2013 marks the beginning of the 3.8% Net Investment Income Tax (NIIT).
While 2013 may already be in the books, it is not too early to begin planning for 2014 and considering the options for minimizing next year’s tax before, it’s too late.
The NIIT is an additional tax on most passive types of income (ie: interest, dividends, and rental income), when their modified adjusted gross income (MAGI) exceeds the threshold amount. The threshold varies for individuals based on their filing status of single, married filing joint, or married filing separate. Estates and trusts are also subject to the NIIT. While the threshold for individuals is set at $200,000 or $250,000 if joint, the threshold for estates and trusts sits much lower at $11,950.
The following trusts are exempt from this tax:
- Tax Exempt Trusts
- Trusts in which all of the unexpired interests are devoted to purposes described in 170(c)(2)(B), (religious, charitable, scientific, literary, or educational purposes)
- Charitable Remainder Trusts
- Grantor Trusts, since their income is taxed at the individual level
- Trusts that are not classified as trusts for income tax purposes
- Foreign Estates
While the above estates and trusts are exempt from the NIIT, most will need to use other methods to reduce their additional net investment income tax.
Since the NIIT threshold for an estate or trust is based on its undistributed net investment income, the simplest method to reduce its exposure to the NIIT would be to distribute the income from the trust. This method allows the investment income from the trust to instead be taxed at the individual level. The goal, here, is that, due to the higher income thresholds for individuals, the income distributed from the trust would avoid the 3.8% tax. Other possible alternatives are to move the trusts investments to tax free municipal bonds or take deductions for charitable contributions and reduce the income within the trust or estate.
It is important to keep in mind that not all income can be distributed. Capital gains for example are generally not distributable as they are required to be treated as principal and not income. Also, before making any distributions, the executor or trustee should consider the other implications aside from the potential tax benefit. For this reason, tax planning is essential in determining the best way to minimizing your tax liability for 2014 and the future.
For questions on this or any other tax related issues, please contact one of the tax professionals at Zinner & Co.
