Might Trusts Rebalance Their Portfolios if Congress Gets NIIT Picky?


Section 1411 imposes the unearned income Medicare tax (generally referred to as “net investment income tax” (NIIT)) on an individual’s, estate’s, or trust’s unearned income. The NIIT was enacted as part of the Health Care and Education Reconciliation Act of 2010, which modified the Patient Protection and Affordable Care Act — together, known colloquially as “Obamacare.”  The American Health Care Act (AHCA), a bill introduced by Republicans in the House of Representatives, would repeal and replace Obamacare, and therefore, the NIIT would cease to exist. The House Ways & Means Committee approved a version of the bill that would indeed repeal the NIIT, effective for tax years beginning after 2017 and the bill has moved on to consideration by the House Budget Committee in the next stage of its progress.

However, this week, the Congressional Budget Office (CBO) released its analysis of the AHCA. The report from the CBO does not bode well for the survival of the AHCA.  The CBO’s analysis estimated that the repeal of the NIIT could result in $157.6 billion in lost revenue over a decade, and the total repeal of Obamacare could cause 24 million people to lose health insurance by 2026. It does not seem like many lawmakers are willing to expend their political capital on a bill that could hurt many low-income households, while eliminating a tax on mostly high-income households.

For an estate or trust, the NIIT is 3.8% of the lesser of: (1) the undistributed net investment income for the tax year; or (2) the excess (if any) of (a) §67(e) adjusted gross income (AGI) for the tax year, over (b) the dollar amount at which the highest tax bracket under §1(e) for estates and trusts begins ($12,501 for 2017)

One of the exceptions to the NIIT, is income from municipal bonds. A good strategy for an estate or trust to reduce its AGI and/or net investment income is by investing in tax-exempt municipal bonds. Local governments rely on bonds to fund infrastructure projects.  By eliminating the NIIT, estates or trusts could potentially invest less in municipal bonds, decreasing the investment flowing to local governments.

This combination of factors makes it likely that the AHCA will either fail entirely, or at the very least be altered to the point that the NIIT survives ­— eliminating a tax on high-income households and the possible loss of investment for infrastructure does not sound like a grand plan to a number of lawmakers whose votes would be necessary to pass the bill in its current form. But hey, I’m terrible at gambling, so it is probably prudent to consider planning opportunities for your clients in case the AHCA does succeed, for example, by reducing tax-free government bond investments in favor of higher yielding (but taxable) corporate bonds or even stocks.

For everything necessary to research, plan, and implement strategies for maximizing your clients’ control while minimizing taxes, take a free trial to the Estates, Gifts and Trusts Portfolios Library.