How to Cope With the NIIT
Figuring out the tax liability
What is the NIIT? It sounds like some sort of federal agency or maybe a new form of artificial intelligence. But actually NIIT stands for “net investment income tax.” This tax generally applies to higher-income taxpayers, but it could easily sneak up on others if they are not careful.
Background: The NIIT is equal to 3.8% of the lesser of your net investment income (NII) or the amount by which your modified adjusted gross income (MAGI) exceeds an annual threshold of $200,000 for single filers and $250,000 for joint filers. Significantly, these figures are not indexed for inflation, so the reach of the NIIT extends as your income increases over time. The tax is also imposed on trusts and estates with income above the threshold based on the dollar amount of the highest tax bracket.
For this purpose, the definition of NII includes interest and dividends; distributions from annuities (other than tax-deferred distributions); rent and royalties; gains from investments in passive activities; trades of financial instruments and commodities; and net capital gain from the sale of property (other than property held in an active trade or business). In other words, much of your regular investment income probably falls into this category.
However, NII does NOT include salary or wages; distributions from IRAs and qualified retirement plans; taxable Social Security income; active trade or business income; self-employment income; gain on the sale of active interests in a partnership, S corporation or limited liability company; income from tax-exempt municipal bonds; and tax-deferred income from nonqualified annuities. So there is some tax relief.
Here are three examples showing when you may or may not owe this stealth tax.
• You are a single filer with NII of $25,000 in 2023. At tax return time, it is determined that your MAGI is $250,000. Because the NII of $25,000 is less than the excess MAGI of $50,000, you owe a tax of $950 (3.8% of $25,000).
• You are a single filer with NII of $40,000 in 2023. At tax return time, it is determined that your MAGI is $220,000. Because the excess MAGI of $20,000 is less than the NII of $40,000, you owe a tax of $760 (3.8% of $20,000)
• You are a joint filer with NII of $100,000 in 2023. At tax return time, it is determined that your MAGI is $225,000. Because the MAGI does not exceed the $250,000 threshold, you do not owe the tax.
If you have already exceeded the NII threshold for 2023, there is not much you can do about it now. However, if you still have some flexibility, consider various strategies for reducing NII and/or MAGI, including postponing large capital gains, selling real estate on the installment basis, investing in tax-free municipal bonds, converting assets in a traditional IRA to a Roth IRA in a low tax year or using a charitable remainder trust (CRT), just to name a few.
Practical advice: Coordinate one or more of these strategies with assistance from your professional advisors. They can help you maximize investment earnings at the lowest tax cost.
More Flexibility for Section 529 Plans
New law authorizes rollover to Roth
A Section 529 plan is a tax-favored way to save for a child’s higher education. Now the new law called SECURE 2.0 provides an option for using 529 account funds for retirement savings.
Background: Named after the tax code section authorizing its use, Section 529 plans are educational savings plans, generally operated by individual states, that encourage families to build up funds for the future education of the younger generation. If certain requirements are met, there is no tax due on the accumulation of earnings or qualified distributions.
There are two main types of Section 529 plans: Prepaid tuition plans and college savings plans.
1. Prepaid tuition plans: Essentially, the plan is guaranteed to keep pace with the rising cost of college tuition. For instance, say that it currently costs $20,000 annually to send a child to a state university. You pay $20,000 now to buy shares plan for a youngster. When the child is ready to go to school, your shares can pay for an entire year of tuition, no matter what it costs at that point.
This type of plan offers some peace of mind. There is no risk of loss of principal and the investment is usually guaranteed by the state.
2. College savings plans: In contrast, there is no guaranteed lock on future tuition costs under a college savings plan. In fact, the savings may not be enough to cover all of the costs. But you have a bigger potential upside as well, since it is possible to generate a better return with this type of plan. (Of course, there are no guarantees.)
Usually, the plan will feature an asset allocation strategy geared to the current age of the child or the year they will enter school. Most college savings plan also offer a wide variety of risk-based asset allocation portfolios managed by professionals.
Anyone can contribute to a Section 529 plan on behalf of a named beneficiary.
Each state is responsible for setting its own limits on the amount of contributions. Check the limits in the applicable state.
In the event a child decides to not attend college or attends school in another state, you may be able to transfer funds to another plan or “roll over” funds to an account for a successor beneficiary (e.g., a younger child). But amounts withdrawn for nonqualified expenses are fully taxable.
New rule: SECURE 2.0 Act provides another option. Beginning in 2024, a 529 plan account owner can roll over up to $35,000 in unused funds to a Roth IRA without paying any tax. To qualify for this tax break, the account must have been open for at least 15 years.
With a Roth IRA in existence at least five years, funds paid out after age 59½ are completely exempt from tax and penalties. So a 529 plan can now help fuel both higher education savings and retirement savings.
Ultimate question: Does a 529 plan or a rollover of unused funds to a Roth IRA make sense for your family? Investigate the possibilities.
Ten Job-Hunting Mistakes to Avoid
Be smart about employment search
Employers are desperately searching for top-quality workers, so it may a good time to make a move. But that does not mean that finding the right job will be easy. What’s more, your job search may be hampered by costly blunders. Here are ten common mistakes that could derail your chances.
1. You do not identify your goals. It is important from the get-go to figure out what you are aiming to accomplish. Start by listing the qualities you are seeking in a job, including compensation, opportunities, responsibilities, scheduling, etc. Concentrate on both short-term and long-term objectives.
2. You ignore the latest techniques. Job-hunting has changed dramatically over the last decade, but you might still be practicing what was preached “back in the day.” Utilize the tools at your disposal like social media, online services and apps that pertain to your industry or profession.
3. You spell out job responsibilities on your resume, but not accomplishments. Focus more on what your achieved than what your duties were. Employers want to know the reason they should hire you instead of someone else.
4. You list everything you have ever done on your resume. There is no need to overload on details. For instance, it is usually not necessary to list a brief job you had between grad school and your first career-related position.
5. You pester the employer for results. Job-seekers are sometimes advised to check in with employers. But this might backfire if the employer, who is often inundated with resumes and hard-pressed to spend time interviewing candidates, becomes peeved. Try to remain patient.
6. You do not prepare for interviews. Practice answers to likely questions and be ready to provide examples to illustrate why you should be hired. If you have not prepared, you could be passed over for the job, even though it might be a perfect fit.
7. You do not do anything to stand out. In a competitive environment, you need to set yourself apart. But that does not mean relying on gimmicks. Show that you are a qualified candidate by pointing out your successes and being responsive, engaging and enthusiastic.
8. You pay little (or no) attention to references. If you are in line for a job, you should not have to scramble to find the boss you worked for years ago or someone else who has retired or moved. Stay in touch with potential references that will be easy to reach if needed—and give them a heads up if they should expect a reference call about you.
9. You fail to spot the “red flags.” Although you may want a particular job, do not insert yourself into an untenable position. Watch out for warning signs like extremely high turnover rates, a rude or abrasive boss or an overly negative workplace.
10. You become bitter and disillusioned. If you run into roadblocks, do not allow your frustrations to boil over. Your body language and attitude in in-person interviews or on Zoom might hinder employment opportunities. Keep a positive outlook that will encourage an employer to bring you on board.
Of course, there are no guarantees, but avoiding these ten common mistakes should help. The rest is up to you.
Beware the Dirty Dozen Tax Scams
IRS releases updated list for 2023
As it has done for more than three decades, the IRS has published its annual list of the “Dirty Dozen” tax scams to watch out for. This year’s list, summarized below, includes some new twists and turns.
1. ERC claims: Under legislation enacted during the pandemic, an employer could claim an Employee Retention Credit (ERC) for retaining workers. Now aggressive promoters are trumpeting falsehoods about claims for ERC refunds and stealing vital information.
2. “Phishing” and “smishing” schemes: More than a cute rhyme, these are two variations of scam emails.
• Phishing: The scammer claims to work for the IRS or another organization and entices victims with phony refunds or threatens them with legal actions.
• Smishing: Using the same principle, smishing is communicated via text message.
Remember that the IRS will never contact you by email or text.
3. Online accounts: A scammer posing as a third party helping the IRS will request sensitive personal information like your address, phone number, Social Security number (SSN) or Taxpayer Identification Number (TIN). But the IRS doesn’t authorize third parties to conduct these services.
4. Fuel tax credit claims: The fuel tax is limited to certain taxpayers engaged in activities like agriculture and transportation. In this scam, taxpayers are convinced they can qualify for refunds and are charged exorbitant fees for the privilege.
5. Fake charities: Following a disaster, scammers may prey on your generosity by soliciting donations for a worthy cause. Except that the cause is not legitimate and the crooks abscond with the funds.
6. Shady tax professionals: Some red flags of unscrupulous practitioners are as follows.
• Charging fees based on refund size;
• Ignoring clients after giving bad advice;
• Refusing to sign returns or provide a Professional Taxpayer Identification Number (PTIN);
• Asking you to sign a blank return; and
• Fraudulently claiming credits or deductions.
7. Social media schemes: Social media can circulate inaccurate or misleading tax information. These schemes encourage people to submit false claims with the goal of getting a refund.
8. Spearphishing: This is a phishing attempt tailored to a specific organization or business. The IRS is warning tax professionals about spearphishing because there’s the potential for great damage if the tax preparer has a data breach.
9. Offer in compromise mills: The Offers in Compromise (OIC) program helps taxpayers settle their federal tax debts. But “mills” can churn out misleading information that can lead to increased tax liabilities and penalties.
10. High-income filer schemes: The IRS urges you to resist questionable tax practitioners and independent promoters selling schemes aimed at wealthy taxpayers. The potentially abusive arrangements involve techniques like Charitable Remainder Annuity Trusts (CRATs) and monetized installment sales.
11. Abusive tax avoidance schemes: These scams take many shapes, ranging from abusive deals involving syndicated conservation easements and micro-captive insurance arrangements.
12. Schemes with international elements: The IRS continues to scrutinize attempts to hide assets in offshore accounts and accounts holding digital assets such as cryptocurrency. It has also cited IRAs misusing treaties with foreign countries like Malta.
Finally, the IRS concluded its list of Dirty Dozen tax scams for 2023 with a reminder to be vigilant throughout the year—not just during tax season. Heed this advice!
Salute to Military Spouse Credit
The new SECURE 2.0 law creates a band-new tax credit for small businesses that encourages retirement saving by spouses of military personnel.
Call to arms: A qualified employer with 100 or fewer employees last year is eligible for a $200 credit if a military spouse participates in a defined contribution plan such as a 401(k). Also, a credit of up to $300 is available for employer contributions to the plan made for a military spouse. Thus, the maximum total annual credit is $500 for each military spouse.
The credit may be claimed the tax year in which the spouse starts participating in the plan and for the following two years. Other rules apply, so seek professional guidance.
Facts and Figures
Timely points of particular interest
New Reporting Rules—After a year’s delay, new reporting rules for third-party networks that facilitate transactions like Venmo, PayPal and E-Bay take effect this year. Under the new rules, third parties must report payments of over $600 on a Form 1099-K for the 2023 tax year. Previously, 1099-Ks were sent only if recipients had over 200 transactions exceeding $20,000. This will affect numerous taxpayers with side gigs. Caveat: The rules could change again, so stay tuned for possible new developments.
Measuring Sticks—How can you tell if your business is a success? There is no absolute formula, but these five measuring sticks should give you a reasonably good indication: (1) Profit; (2) a thriving customer base; (3) customer satisfaction; (4) employee satisfaction; and (5) personal satisfaction. Do not overlook the last one—if you are not happy, are you truly successful?