PHOENIX — Clients may not be so eager to pay the net investment income tax that goes to pay for President Obama's health care law. The additional 3.8% on all or part of a tax payer's net investment income pays for the Medicaid expansion that Obamacare ushered in.
Advisers have a variety of options that can help clients avoid or reduce that tax, says Samuel A. Donaldson, a professor at Georgia State University College of Law in Atlanta, Georgia, at NAPFA's spring conference.
The following strategies can also help reduce clients’ adjusted gross incomes — and lower their standard tax bills:
• Harvest losses
Donaldson suggests offsetting gains in taxable brokerage accounts with investment losses from the same or similar accounts.
• Fulfill charitable pledges with marketable securities
"I can’t believe how many wealthy people give cash. Don’t do that. Give stock!" Donaldson says. If marketable securities go directly to a charity, they don’t appear as part of the donor's gross income, he explains. But if a client sells the securities and donates the cash, that taxpayer has net investment income — exactly what the law is designed to tax, and part of adjusted gross income to boot.
• Become an active investor
If a client has rental income from real estate, getting more involved in running those rentals moves the client from being a passive investor to active investor, according to Donaldson. Income from active investments isn't subject to the 3.8% Medicaid tax.
• Collect on a property sale over time
Receiving the proceeds from a property sale over multiple years can spread out the total tax bill as well, Donaldson says. This approach also may keep the client below the additional tax threshold.
• Max out contributions
Maxing out contributions to tax-deferred retirement accounts such as IRAs and 401(k) plans is another way to stay below the tax surcharge threshold.
• Accelerate business deductions
Clients who own businesses should consider accelerating deductions and deferring income, where they can. “Prepay business insurance and rent,” Donaldson says.
Donaldson also points out that rental real estate, as well as oil and gas properties offer bigger deductions than many other assets, pushing down clients’ overall tax bills.