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Understanding Net Investment Income and How to Minimize Your Tax Bill

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Learn about the net investment income tax, capital gains tax, and tax strategies for investors.

description: a graph showing the growth of net investment income over time, with a line graph showing the trend increasing steadily.

Research The world of investing can be complex, and one aspect that can add to the complexity is taxes. Understanding the different types of taxes that apply to investment income is crucial for investors looking to maximize their profits. One tax that investors should be aware of is the net investment income tax (NIIT), which was created as part of the Health Care and Education Reconciliation Act to fund healthcare reform in 2010.

NIIT is a tax on net investment income, and those who are subject to the tax will pay 3.8 percent on the lesser of the two: their net investment income or the amount by which their modified adjusted gross income (MAGI) exceeds a certain threshold. For individuals, the MAGI threshold is $200,000, and for married couples filing jointly, it is $250,000.

Net investment income includes income from interest, dividends, capital gains, rental and royalty income, and other passive income sources. It is important to note that not all investment income is subject to NIIT. For example, income from tax-exempt bonds and retirement accounts is not included in net investment income.

In addition to NIIT, investors should also be aware of capital gains taxes. Capital gains tax triggers when an investor sells an asset for more than they paid for it. There are two types of capital gains tax: long-term and short-term. Long-term capital gains tax applies to assets held for more than one year, while short-term capital gains tax applies to assets held for less than one year. The tax rates for each vary depending on the investor's income level.

For investors looking to minimize their tax bill, there are a few strategies they can consider. One strategy is to hold onto assets for more than one year to qualify for long-term capital gains tax rates, which are generally lower than short-term rates. Another strategy is to offset capital gains with capital losses. If an investor sells an asset for less than they paid for it, they can use that loss to offset gains from other assets.

Dividend income is another aspect of investment income that is subject to taxes. Like other earnings and realized gains on investments, dividend income is taxable. The tax rate on dividends, however, is dependent on the investor's income level. For investors in the highest tax bracket, the tax rate on dividends is 20 percent.

Every investor should have a thoughtful tax strategy, and for those that exceed certain income thresholds, proactive planning is all the more important. For example, investors subject to NIIT can consider ways to reduce their MAGI, such as contributing to retirement accounts or taking advantage of deductions and credits.

In terms of specific investments, Canadians looking for passive income may want to consider stocks like Timbercreek Financial Corp. (TSX:TF). With a minimum investment of $25,000, investors can earn a monthly dividend of $0.057 per share, which translates to an annual yield of 7.2 percent.

In the world of stocks, Oxford Lane Capital (OXLC) recently reported its fiscal Q3 net investment income, which slipped from the prior quarter while total investment income increased. Investors should keep an eye on the company's performance in the coming quarters. In recent news, President Biden may propose allocating revenue from the 2010 Affordable Care Act's Net Investment Income Tax (NIIT) to maintain solvency of the Medicare Hospital Insurance Trust Fund. This proposal is part of the President's infrastructure plan, which includes several measures to address healthcare costs and expand access to care for Americans. Investors should stay tuned for updates on this proposal and how it may impact their investments.


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