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Your net investment income is a means for you to solidify your financial situation. However, the net investment income tax can affect how much you benefit from your gains. Higher-income individuals and certain estates and trusts are primarily affected by this specialized part of the tax code. This might leave you wondering how to avoid net investment income tax.
Managing or even avoiding the net investment income tax may appear challenging. Still, with careful planning and professional guidance, you can definitely achieve this. The first thing you need to do is calculate your net investment income.
How to Calculate Your Net Investment Income Tax
To calculate your net investment income, add all your investment earnings and subtract all associated expenses. This includes interest, dividends, capital gains, rental and royalty income, and other investment profits. Ensure to include all relevant sources for an accurate net investment income tax calculation.
This is a straightforward outline on how to calculate your net investment income.
Step 1: Calculate Your Gross Investment Income
Some income sources like your salary avoid net investment income tax. You need to identify and find the sum of your:
- Capital gains: These are the profits you make from selling investments. This will include gains from selling stocks, bonds, or property.
- Interest income: This is the money you earn from your bank accounts, certificates of deposit (CDs), or bonds.
- Dividend income: This is the money you receive from stocks, mutual funds, or other investments.
- Rental income: This is any rent you collect from leasing out property.
- Royalty income: This is your earnings from any natural resources, copyrighted work, or intellectual property like patents.
Step 2: Identify All Associated Investment Expenses
Now, you’ll need to identify the relevant expenses for your investments and find the sum of all of them. This can include expenses such as:
- Investment interest expenses: This is interest on the money you borrowed to purchase securities or securities that produce income.
- Advisory expenses: These are the fees you would have paid to any financial advisors or wealth managers.
- Rental expenses: This can include expenses such as property management fees, repair costs, and mortgage interest payments.
Be sure not to add expenses from investment sources that avoid net investment income taxes.
Step 3: Calculate Your Net Investment Income
For you to calculate your net investment income, you need to do is follow this formula:
- Net Investment Income = Gross Investment Income - Associated Investment Expenses
Step 3: Find Your Modified Adjusted Gross Income (MAGI)
MAGI is sometimes identical to most taxpayers' Adjusted Gross Income (AGI). You can find this value on your tax return. Sometimes, you might need to adjust the AGI for the foreign-earned income exclusion and foreign investments.
Step 4: Determine If Your MAGI Exceeds the Threshold
This is a critical step because if your MAGI doesn’t exceed the thresholds, you can avoid the net investment income tax.
- Single person or Head of household: $200,000
- Married Filing Jointly: $250,000
- Married Filing Separately: $125,000
- Qualified Widow(er): $250,000
If your MAGI exceeds the thresholds above, subtract the threshold amount from your MAGI to calculate the excess.
Step 5: Calculate Your Net Investment Income Tax:
The net investment income tax will be applied to either your net investment income or the amount by which your MAGI exceeds the threshold—whichever is lower.
Then, you need to apply the 3.8% net investment income tax rate.
What Is Excluded from Net Investment Income?
Not all income is considered net investment income, so these sources avoid net investment income tax. This includes:
- Wages, salaries, and bonuses
- Tax-exempt interest from municipal bonds
- Distributions from your IRAs or qualified retirement plans
- Social security benefits
- Veterans' benefits
- Alimony
- Qualified scholarship funds
- Self-employment income from a business or trade you actively participate in
- Income from a business that isn’t a passive activity
- Gains from selling a personal residence
If you are looking to avoid net investment income tax, investing in these sources of income is a good option.
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Choose the Best Financial Partner for Growth
For many, avoiding the net investment income tax is daunting without the help of a tax professional. By trying to avoid the net investment income tax, you could be overlooking other ways you can maximize your earning potential and savings.
This is why you need the experts at Asset Preservation Wealth and Tax. We are fiduciaries who act in our clients’ best interest by looking at their goals and unique situation. Let us help you determine the best way forward for your tax situation.
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Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
The commentary on this blog reflects the personal opinions, viewpoints and analyses of the author, Stewart Willis, providing such comments, and should not be regarded as a description of advisory services provided by Foundations Investment Advisors, LLC (“Foundations”), an SEC registered investment adviser or performance returns of any Foundations client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment, legal or tax advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Personal investment advice can only be rendered after the engagement of Foundations for services, execution of required documentation, including receipt of required disclosures. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Foundations manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Any statistical data or information obtained from or prepared by third party sources that Foundations deems reliable but in no way does Foundations guarantee the accuracy or completeness. Investments in securities involve the risk of loss. Any past performance is no guarantee of future results. Advisory services are only offered to clients or prospective clients where Foundations and its advisors are properly licensed or exempted. For more information, please go to https://adviserinfo.sec.gov and search by our firm name or by our CRD # 175083.
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