The 3.8 percent net investment income tax (“NIIT”) under the Affordable Care Act (“ACA”) has been in effect since 2013 and remains in effect for tax year 2015 and beyond. The taxpayer is liable for NIIT on the lesser of their net investment income (“NII”), or the amount by which their modified adjusted gross income (“MAGI”) exceeds the threshold based on filing status.
The MAGI threshold amounts are:
- Married filing jointly--$250,00
- Married filing separately--$125,000
- Single of head of household--$200,000, or
- Qualifying widow(er) with a child--$250,000
Example: Taxpayer 1 is a single filer with wage income of $225,000 and also with a NII of $75,000. MAGI is $300,000, thus exceeding the $200,000 MAGI threshold and since Taxpayer 1 has NII, Taxpayer 1 would be subject to the 3.8 percent surtax as follows:
Lesser of NII ($75,000) or amount MAGI exceeds $200,000 ($100,000) times 3.8 percent ($75,000 x 3.8% = $2,850)
Knowing what is and isn’t considered NII is essential to the accuracy of the calculation of this surtax and could also prove beneficial in tax planning strategies surrounding your investments. Let’s take a quick look at NII under the ACA.
Items commonly included as NII:
- Interest and dividends
- Capital gains from sale of stock, bonds and mutual funds
- Gain on sale of investment real estate (sale of second home that is not a primary residence)
- Gain from sale in partnership interest and S corporation to the extent you were passive
- Rental and royalty income
- Nonqualified annuities (including payments under life insurance contracts) and
- Income from businesses involved in the trading of commodities
NII does not include any gains that are otherwise excludable from regular tax purposes. (i.e. the gain excluded from the sale of your principal residence.)
Items excluded from NII:
- Social security benefits
- Operating income and gains attributable to an active trade or business (sole proprietor, partnership or S corporation)
- Distributions from an IRA or qualified retirement plan
- Other wages, compensation and self-employment income
- Rental income for real estate professionals
Investment expenses are deductible in computing NII, thus you are truly reporting the investment income at net. Examples of expense deductions include properly allocated investment interest expense, advisory and brokerage fees, expenses related to rental and royalty income, fiduciary expenses and tax preparation fees.
Keep in mind, if you are subject to NIIT, it is payable regardless of whether or not you pay any regular income tax or are subject to alternate minimum tax on your income. If subject, you will report and pay this tax with Form 1040 and use Form 8960 to calculate the NIIT.
Conclusion: Proper inclusion/exclusion of net investment income in accordance with the definitions under ACA NIIT and offsetting NII with allocable expenses are both important in the accuracy and overall compliance of reporting this tax. In addition, knowledge of both could be beneficial in tax planning strategies that could save you tax dollars on the 3.8 percent NIIT surtax.
Seek the services of a legal or tax adviser before implementing any ideas contained in this blog. To reach a financial advisor at Lane Gorman Trubitt PLLC, call (214) 871.7500 or email firstname.lastname@example.org.