Plan Ahead for the 3.8% Net Investment Income Tax

net investment income tax

High-income taxpayers face a 3.8% net investment income tax (NIIT) that’s imposed in addition to regular income tax. Fortunately, there are some steps you may be able to take to reduce its impact.

The NIIT applies to you only if modified adjusted gross income (MAGI) exceeds:

  • $250,000 for married taxpayers filing jointly and surviving spouses,
  • $125,000 for married taxpayers filing separately,
  • $200,000 for unmarried taxpayers and heads of household.

The amount subject to the tax is the lesser of your net investment income or the amount by which your MAGI exceeds the threshold ($250,000, $200,000, or $125,000) that applies to you.

Net investment income includes interest, dividend, annuity, royalty, and rental income, unless those items were derived in the ordinary course of an active trade or business. In addition, other gross income from a trade or business that’s a passive activity is subject to the NIIT, as is income from a business trading in financial instruments or commodities.

There are many types of income that are exempt from the NIIT. For example, tax-exempt interest and the excluded gain from the sale of your main home aren’t subject to the tax. Distributions from qualified retirement plans aren’t subject to the NIIT. Wages and self-employment income also aren’t subject to the NIIT, though they may be subject to a different Medicare surtax.

It’s important to remember the NIIT applies only if you have net investment income, and your MAGI exceeds the applicable thresholds above. But by following strategies, you may be able to minimize net investment income.

Investment choices

If your income is high enough to trigger the NIIT, shifting some income investments to tax-exempt bonds could result in less exposure to the tax. Tax-exempt bonds lower your MAGI and avoid the NIIT.

Dividend-paying stocks are taxed more heavily as a result of the NIIT. The maximum income tax rate on qualified dividends is 20%, but the rate becomes 23.8% with the NIIT.

As a result, you may want to consider rebalancing your investment portfolio to emphasize growth stocks over dividend-paying stocks. While the capital gain from these investments will be included in net investment income, there are two potential benefits: 1) the tax will be deferred because the capital gain won’t be subject to the NIIT until the stock is sold and 2) capital gains can be offset by capital losses, which isn’t the case with dividends.

Qualified plans

Because distributions from qualified retirement plans are exempt from the NIIT, upper-income taxpayers with some control over their situations (such as small business owners) might want to make greater use of qualified plans.

These are only a couple of strategies you may be able to employ. You also may be able to make moves related to charitable donations, passive activities and rental income that may allow you to minimize the NIIT. If you’re subject to the tax, you should include it in your tax planning. Consult with us for tax-planning strategies.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Tax-Favored Ways to Build Up A College Fund

build up a college fund

If you’re a parent with a college-bound child, you may be concerned about being able to fund future tuition and other higher education costs. You want to take maximum advantage of tax benefits to minimize your expenses. Here are some possible options.

Savings bonds

Series EE U.S. savings bonds offer two tax-saving opportunities for eligible families when used to finance college:

  • You don’t have to report the interest on the bonds for federal tax purposes until the bonds are cashed in, and
  • Interest on “qualified” Series EE (and Series I) bonds may be exempt from federal tax if the bond proceeds are used for qualified education expenses.

To qualify for the tax exemption for college use, you must purchase the bonds in your name (not the child’s) or jointly with your spouse. The proceeds must be used for tuition, fees and certain other expenses — not room and board. If only part of the proceeds is used for qualified expenses, only that part of the interest is exempt.

The exemption is phased out if your adjusted gross income (AGI) exceeds certain amounts.

529 plans

A qualified tuition program (also known as a 529 plan) allows you to buy tuition credits for a child or make contributions to an account set up to meet a child’s future higher education expenses. Qualified tuition programs are established by state governments or private education institutions.

Contributions aren’t deductible. The contributions are treated as taxable gifts to the child, but they’re eligible for the annual gift tax exclusion ($15,000 for 2021). A donor who contributes more than the annual exclusion limit for the year can elect to treat the gift as if it were spread out over a five-year period.

The earnings on the contributions accumulate tax-free until college costs are paid from the funds. Distributions from 529 plans are tax-free to the extent the funds are used to pay “qualified higher education expenses.” Distributions of earnings that aren’t used for qualified expenses will be subject to income tax plus a 10% penalty tax.

Coverdell education savings accounts (ESAs)

You can establish a Coverdell ESA and make contributions of up to $2,000 annually for each child under age 18.

The right to make contributions begins to phase out once your AGI is over a certain amount. If the income limitation is a problem, a child can contribute to his or her own account.

Although the contributions aren’t deductible, income in the account isn’t taxed, and distributions are tax-free if used on qualified education expenses. If the child doesn’t attend college, the money must be withdrawn when he or she turns 30, and any earnings will be subject to tax and penalty. But unused funds can be transferred tax-free to a Coverdell ESA of another member of the child’s family who hasn’t reached age 30. (Some ESA requirements don’t apply to individuals with special needs.)

Plan ahead

These are just some of the tax-favored ways to build up a college fund for your children. Once your child is in college, you may qualify for tax breaks such as the American Opportunity Tax Credit or the Lifetime Learning Credit. Contact us if you’d like to discuss any of the options.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Home sales: How to determine your home’s basis

How to determine your home’s basis

The housing market in many parts of the country is strong this spring and summer. If you’re buying or selling a home, you should know how to determine your home’s basis.

How it works

You can claim an itemized deduction on your tax return for real estate taxes and home mortgage interest. Most other home ownership costs can’t be deducted currently. However, these costs may increase your home’s “basis” (your cost for tax purposes). And a higher basis can save taxes when you sell.

The law allows an exclusion from income for all or part of the gain realized on the sale of your home. The general exclusion limit is $250,000 ($500,000 for married taxpayers). You may feel the exclusion amount makes keeping track of the basis relatively unimportant. Many homes today sell for less than $500,000. However, that reasoning doesn’t take into account what may happen in the future. If history is any indication, a home that’s owned for 20 or 30 years appreciates greatly. Thus, you want your basis to be as high as possible in order to avoid or reduce the tax that may result when you eventually sell.

Good recordkeeping

To prove the amount of your basis, keep accurate records of your purchase price, closing costs, and other expenses that increase your basis. Save receipts and other records for improvements and additions you make to the home. When you eventually sell, your basis will establish the amount of your gain. Keep the supporting documentation for at least three years after you file your return for the sale year.

Start with the purchase price

The main element in your home’s basis is the purchase price. This includes your down payment and any debt, such as a mortgage. It also includes certain settlement or closing costs. If you had your house built on land you own, your basis is the cost of the land plus certain costs to complete the house.

You add to the cost of your home any expenses that you paid in connection with the purchase, including attorney’s fees, abstract fees, owner’s title insurance, recording fees and transfer taxes. The basis of your home is affected by expenses after a casualty to restore damaged property and depreciation if you used your home for business or rental purposes.

Over time, you may make additions and improvements to your home. Add the cost of these improvements to your basis. Improvements that add to your home’s basis include:

  • A room addition,
  • Finishing the basement,
  • A fence,
  • Storm windows or doors,
  • A new heating or central air conditioning system,
  • Flooring,
  • A new roof, and
  • Driveway paving.

Home expenses that don’t add much to the value or the property’s life are considered repairs, not improvements. Therefore, you can’t add them to the property’s basis. Repairs include painting, fixing gutters, repairing leaks, and replacing broken windows. However, an entire job is considered an improvement if items that would otherwise be considered repairs are done as part of extensive remodeling.

The cost of appliances purchased for your home generally don’t add to your basis unless they are considered attached to the house. Thus, the cost of a built-in oven or range would increase basis. But an appliance that can be easily removed wouldn’t.

Plan for best results

Other rules and requirements may apply. We can help you plan for the best tax results involving your home’s basis.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

How to ensure life insurance isn’t part of your taxable estate

ensure life insurance isn’t part of your taxable estate

If you have a life insurance policy, you may want to ensure that the benefits your family will receive after your death won’t be included in your estate. That way, the benefits won’t be subject to federal estate tax.

Current exemption amounts

For 2021, the federal estate and gift tax exemption is $11.7 million ($23.4 million for married couples). That’s generous by historical standards but in 2026, the exemption is set to fall to about $6 million ($12 million for married couples) after inflation adjustments — unless Congress changes the law.

In or out of your estate

Under the estate tax rules, insurance on your life will be included in your taxable estate if:

  • Your estate is the beneficiary of the insurance proceeds, or
  • You possessed certain economic ownership rights (called “incidents of ownership”) in the policy at your death (or within three years of your death).

It’s easy to avoid the first situation by making sure your estate isn’t designated as the policy beneficiary.

The second rule is more complicated. Just having someone else possess legal title to the policy won’t prevent the proceeds from being included in your estate if you keep “incidents of ownership.” Rights that, if held by you, will cause the proceeds to be taxed in your estate include:

  • The right to change beneficiaries,
  • The right to assign the policy (or revoke an assignment),
  • The right to pledge the policy as security for a loan,
  • The right to borrow against the policy’s cash surrender value, and
  • The right to surrender or cancel the policy.
  • Be aware that merely having any of the above powers will cause the proceeds to be taxed in your estate even if you never exercise them.

Buy-sell agreements and trusts

Life insurance obtained to fund a buy-sell agreement for a business interest under a “cross-purchase” arrangement won’t be taxed in your estate (unless the estate is the beneficiary).

An irrevocable life insurance trust (ILIT) is another effective vehicle that can be set up to keep life insurance proceeds from being taxed in the insured’s estate. Typically, the policy is transferred to the trust along with assets that can be used to pay future premiums. Alternatively, the trust buys the insurance with funds contributed by the insured. As long as the trust agreement doesn’t give the insured the ownership rights described above, the proceeds won’t be included in the insured’s estate.

The three-year rule

If you’re considering setting up a life insurance trust with a policy you own currently or simply assigning away your ownership rights in such a policy, consult with us to ensure you achieve your goals. Unless you live for at least three years after these steps are taken, the proceeds will be taxed in your estate. (For policies in which you never held incidents of ownership, the three-year rule doesn’t apply.)

Contact us if you have questions or would like assistance with estate planning and taxation.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Keep it all in the family: Transferring your vacation home

Transferring your vacation home

If your family owns a vacation home, you know what a relaxing refuge it can be. This is especially true these days due to the limited travel options you may have because of COVID-19 pandemic restrictions. However, without a solid plan and ground rules that all family members agree to, conflict and tension may result in a ruined vacation — or worse yet, selling the home.

Determining ownership

From an estate planning standpoint, it’s important for all family members to understand who actually owns the home. Family members sharing the home will more readily accept decisions about its usage or disposition knowing that they come from those holding legal title.

If the home has multiple owners — several siblings, for example — consider the form of ownership carefully. There may be advantages to holding the title to the home in a family limited partnership (FLP) and using FLP interests to allocate ownership interests among family members. You can even design the partnership — or a separate buy-sell agreement — to help keep the home in the family.

Laying down the rules

Typically, disputes between family members arise because of conflicting assumptions about how and when the home may be used, who’s responsible for cleaning and upkeep, and how the property will ultimately be sold or transferred. To avoid these disputes, it’s important to agree on a clear set of rules that cover using the home (when, by whom), and responsibilities for cleaning, maintenance, and repairs.

If you plan to rent out the home as a source of income, it’s critical to establish rules for such activities. The tax implications of renting out a vacation home depend on several factors, including the number of rental days and the amount of personal use during the year.

Planning for the future

What happens if an owner dies, divorces, or decides to sell his or her interest in the home? It depends on who owns the home and how the legal title is held. If the home is owned by a married couple or an individual, the disposition of the home upon death or divorce will be dictated by the relevant estate plan or divorce settlement.

If family members own the home as tenants-in-common, they’re generally free to sell their interests to whomever they choose, to bequeath their interests to their heirs, or even to force a sale of the entire property under certain circumstances. If they hold the property as joint tenants with rights of survivorship, an owner’s interest automatically passes to the surviving owners at death. If the home is held in an FLP, family members have a great deal of flexibility to determine what happens to an owner’s interest in the event of death, divorce, or sale.

Handle with care

A vacation home that has been in your family for generations needs to be handled carefully. You likely want to do everything possible to hold on to it for future generations. We can assist you in developing a plan to help you achieve this.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.