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For retirees, navigating the complexities of taxes can be a delicate task. However, determining your filing status is one of the most important decisions you will need to make. This is because taxable income differs depending on the method of filing. This is especially important when it comes to net investment income tax (NIIT). So what is it, and what considerations should retirees take to minimize its impact?
What is net investment income tax?
Net investment income tax (NIIT) is a tax on certain types of investment income, such as book royalties and capital gains, that affects high-income earners. It went into effect in 2013 as part of the Health Care and Education Reconciliation Act of 2010.
The Congressional Research Service says it will ultimately be included as a revenue-raising measure and apply to people whose modified adjusted gross income (MAGI) exceeds a threshold determined by the IRS based on their filing status. A person who does so will have to pay a tax of 3.8%. But there are steps retirees can take to minimize the impact.
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Understanding and Optimizing NIIT Thresholds
To find the best submission option for your situation, you need to know what your thresholds are. The threshold for single filers is $200,000. For married couples filing jointly, the amount can be up to $250,000. If they are married but file separately, that amount drops significantly to $125,000. Strategically choosing your filing status can help you maximize these criteria while reducing your overall tax burden.
Unlock deductions and exemptions
Once you know your filing status, check what deductions and exemptions you are eligible for. These are determined by several factors, including adjusted gross income and age, so be sure to consult a professional to find the best option for you. You can reduce your NIIT by finding ways to reduce your income.
Timing of income recognition
For retirees whose income fluctuates, the timing of income recognition becomes important. By strategically managing the timing of income recognition, a retiree can control the application of her 3.8% NIIT and smooth out her tax liability over time.
Benefits for head of household
Single retirees who qualify as heads of households may benefit from a higher income threshold before the 3.8% tax applies. This application status is specifically designed for those who provide a home for a qualifying child or relative. The head of household threshold is $200,000.
Real Estate and Trust Strategies
Retirees engaged in trust or estate planning should carefully consider the impact of the 3.8% NIIT. The proper structure of these entities plays a key role in minimizing the tax impact on investment returns.
With these considerations in mind, it is important to note that choosing your filing status is not something you should approach on your own. Rather, view it as an integral part of your broader tax planning and financial strategy. If you haven’t filed yet, be sure to consult a financial advisor or tax professional to help you make the right choices for your financial situation.
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This article was written by and represents the views of our contributing advisors and not of Kiplinger’s editorial staff. To check your advisor’s records, SEC or together finra.
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