The new ObamaCare tax, called the Net Investment Income Tax, or NIIT, hits U.S. residents and expats alike with a 38% levy on most forms of investment income. If your taxable income in 2014 was $200,000 (single) or $250,000 (joint), the ObamaCare tax is coming your way.
- These rates are fixed and will not increase with inflation.
The ObamaCare tax applies to the following forms of income:
- capital gains,
- rental and royalty income,
- non-qualified annuities
- businesses classified as passive activities, and
- income from investment and trading businesses.
Assuming you don’t want to pay any more than necessary to the Obamanation, there are a number of ways to amputate the ObamaCare tax. For example, you can get a divorce or cancel the wedding to avoid the marriage penalty. Two single people may earn up to $400,000 before paying in to ObamaCare, compared to a married couple who start contributing to the cause at $250,000.
If you have residency or citizenship outside of the United States, and can qualify to file as a nonresident alien, you will avoid the ObamaCare tax all together, regardless of your income. That’s right, the NIIT doesn’t apply to nonresident aliens.
If your spouse won’t go for a divorce, and you don’t qualify as a nonresident alien, here are a few other suggestions:
One way around the ObamaCare tax is to give appreciated property to your heirs. If their incomes are below the $200,000 and $250,000 thresholds no NIIT will be due. This can also have significant estate planning and asset protection benefits.
As you may know, when you donate property to your children, who are minors or full-time students up to age 24, they must pay capital gains at your higher rate. However, the ObamaCare tax does not apply to this kiddie tax.
Another solution to the NIIT is to form a Family Foundation and donate appreciated property to that Foundation. This allows you to maintain control over the property, take a deduction for the fair market value on this years return, and then transfer small portions each year to a charity. This allows you to maximize your deduction and avoid both the capital gains and NIIT taxes… all while maintaining control over the assets.
- If you don’t need to control the distributions over a number of years, you can achieve the same benefits by donating the appreciated property to a traditional charity.
You can also cut out the ObamaCare tax by lending money to your onshore or offshore business. Interest income from a third party is taxable under the NIIT, but interest coming from your own business is not. This is a rather strange differentiation, but should motivate you to invest in your business.
Along the same lines, if you take an active roll in a business, rather than being a passive partner, dividends and royalties from that company are not subject to the ObamaCare tax.
An active roll, or, more properly, material participation, means that you spend at least 500 hours per year in the business, you are the primary worker, or you can show a consistent work history in the company. Special care should be taken when converting from passive to active, as other taxes might outweigh the NIIT. But, it is quite possible for this to save you money.
If your business is offshore, and you qualify for the Foreign Earned Income Exclusion, then you should be taking out the full exclusion each year to maximize the benefits of being offshore. This means you (and you spouse) should be taking $99,200 in tax free salary from your offshore company in 2014 and holding any excess as retained earnings in the offshore corporation.
The ObamaCare tax doesn’t apply to this salary. As you will be an active participant in the business, which is why you qualify to take the FEIE, you will also avoid the NIIT on interest, dividends and royalties this business generates. When combined, these savings should be major incentives to invest in your offshore company.
- If your offshore company needs cash, take the full FEIE salary and lend back whatever is requires.
- Note that these benefits do not apply to an onshore or offshore company in the business of trading financial instruments or commodities.
Keeping the trend going, you can rent property to your business and avoid the ObamaCare tax on these payments. The NIIT usually applies to rental income, but not if it comes from your onshore or offshore company.
Leaving offshore companies behind, you can also avoid the ObamaCare tax when you sell your real estate by doing an exchange rather than a traditional sale. A Section 1031 exchange allows you to swap one like-kind property for another and defer the capital gain until you sell the acquired property. A 1031 exchange also defers the ObamaCare tax for as long as you hold the property.
“Like-kind” means that the property you swap for must be similar to the one you are giving up. So, you can transfer one business property for another, one rental for another, etc. However, you may not swap a U.S. property for a foreign property. You must swap a U.S. property for another U.S. property… and you may exchange a foreign property for another foreign property. The foreign properties need not be in the same country. The only requirement is that they both be outside of the United States.
My last suggestion on how to eliminate the ObamaCare tax is that you might sell your losing stocks and use these tax losses against your winners. This common tax mitigation strategy works against the NIIT as you may net capital gains against capital losses and calculate the ObamaCare tax on the net. Even better, you can use a carry forward loss against current year gains to keep the NIIT at bay.
I hope you have found this article on cutting out the ObamaCare tax helpful. If you have questions about forming or operating an offshore company, please contact me at firstname.lastname@example.org. I will be happy to work with you to structure your offshore business and keep it in compliance with the Internal Revenue Service.