Net Investment Income Tax

The Net Investment Income Tax “NIIT” was added to the Internal Revenue Code on March 30, 2010. It is imposed at a rate of 3.8% of certain net investment income of individuals, estates and trusts that have income above specified thresholds.

While some taxpayers have been impacted by the tax since tax year 2010, most individuals, who are calendar year payers, were not subject to it until 2013.  As incomes rise more people are expected to be subject to the tax.

The threshold amounts below apply to tax years 2016 and later:

Filing StatusThreshold Amounts
Married Filing Jointly$ 250,000
Married Filing Separately$ 125,000
Single$ 200,000
Head of Household$ 200,000
Widow/(er) with dependent child$ 250,000

NIIT is due only when the modified adjusted gross income exceeds the applicable threshold amount.

  • Example 1: Married couple:
    • Wages: $160,000
    • Investment Income: $90,000
    • Modified AGI: $250,000 (threshold = $250,000)
    • NIIT due: None
  • Example 2: Single taxpayer:
    • Wages: $185,000
    • Investment income: $30,000
    • Modified AGI: $215,000 (threshold = $200,000)
    • NIIT due: on $15,000; tax = $570

Definitions:

Investment income includes: (generally)

  • Interest, dividends, capital gains, rental and royalty income, and non- qualified annuities
  • Income from businesses trading financial instruments.
  • Income from businesses that are passive in nature. The key issue is whether the partner, shareholder or member actively participates in the operation of the business.
  • Income from the sale of personal residences above the exemption amounts ($250,000 for single, $500,000 for married)

The following types of income are specifically not considered investment income:

  • Wages, unemployment compensation, operating income from a nonpassive business, social security benefits, tax exempt interest, self-employment income, and distributions from qualified retirement plans, 401(K) plans and IRA’S.

To arrive at net Investment Income, reduce investment income by expenses generally allocable to investment income.

The International Angle:

As usual, the picture is a bit more complicated when it comes to foreign taxpayers and foreign investments:

  • NIIT does not apply to non-resident aliens.
  • However, foreign investment income is subject to NIIT, including:
    • Amounts excluded under the foreign earned income exclusion
    • Actual distributions of previously taxed income (PTI) from a passive foreign investment company (PFIC) that has elected qualified electing treatment from a controlled foreign corporation (CFC).

Estates and Trusts:

Estates and trusts are subject to the net investment income tax if they exceed the threshold amount, with exceptions for:

  • Wholly charitable trusts
  • Trusts exempt from tax under section 501
  • Charitable remainder trusts
  • Trusts statutorily exempt from income taxes
  • Trusts, of portions thereof that are treated as grantor trusts
  • Electing Alaska Native Settlement Trusts
  • Cemetery Perpetual Care Funds
  • Foreign estates and trusts

Practical Considerations:

  • Grouping activities to treat business activities as active: IRS rules allow taxpayers to “group” activities in order to determine whether the overall group represents a passive or non-passive activity.  By grouping multiple business activities as a single “appropriate economic unit,” a taxpayer’s hours of participation in one entity can extend to another entity. This causes the combined income to be considered active business income, not subject to NIIT.
  • Sale of personal residences: Keep in mind that the tax also applies to the gain on the sale of a personal residence after the exemption of $250,000. ($500,000 for a married couple).
  • Trusts and flexibility:  Trusts can either retain income or pass it to beneficiaries.  Since the threshold for trusts is much lower, it may make sense to pass any income along, rather than retaining it.  Beneficiaries would then be liable to pay NIIT if their modified AGI exceeds their particular threshold.
  • Rental property: Single rental properties may not be considered passive businesses and thus are not subject to NIIT.  The IRS acknowledged that “in certain circumstances” the rental of a single property may require regular and continuous involvement so that the rental activity is a trade or business under Code Section 162.

Calculating and Reporting Net Investment Income:

Form 8960 is used to calculate, report, and compute the tax on Net Investment Income. It is a three part form to:

  • Compile investment income
  • Measure investment expenses allocable to the investment income
  • Compute the tax on net investment income.

The Bottom Line:

Taxpayers who have some investment income and are approaching the applicable NIIT threshold should consult with their tax advisors.  The amount that can be saved through planning can be significant.  It may be possible to employ certain strategies – such as grouping activities, controlling how a trust disburses its income and timing of investment related expenses to investment income to offset in the same year to minimize NIIT liability.  Your AKM CPA is available to discuss your questions and concerns.

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