The IRS has issued guidance on the general application of the net investment income tax (NIIT) and the computation of net investment income (NII). This tax, which became effective in 2013, generally affects individuals, estates and trusts with income above certain threshold amounts. The NIIT does not apply to nonresident aliens. This tax is subject to estimated tax rules and is reported on Form 1040 for individuals and Form 1041 for estates and trusts. It is not required to be withheld from wages.
The 3.8 Percent NII Tax
Individuals. The NII tax on individuals equals 3.8 percent of the lesser of:
- net investment income for the tax year, or
- the excess, if any, of
a)the individual’s modified adjusted gross income (MAGI) for the tax year, over
b)the threshold amount.
For purposes of the NII tax computation, MAGI is defined as adjusted gross income before the foreign earned income exclusion.
The threshold amount is equal to:
- $250,000 in the case of a taxpayer filing a joint return or a surviving spouse;
- $125,000 in the case of a married taxpayer filing a separate return; and
- $200,000 in any other case.
These amounts are not indexed for inflation. Consequently, the number of affected taxpayers is expected to increase over time.
NII defined. Final regulations provide guidance on the calculation of NII subject to the 3.8 percent tax. In general, NII is the sum of:
- gross income from interest, dividends, annuities, royalties, and rents, other than such income which is derived in the ordinary course of a trade or business;
- other gross income derived from any trade or business that is a passive activity with respect to the taxpayer, or the trade or business of trading in financial instruments or commodities; and
- net gain attributable to the disposition of property, other than property held in a trade or business.
Less deductions properly allocable to such gross income or net gain.
Trusts and Estates. Trusts and estates are subject to the NIIT on the lesser of:
- undistributed NII, or
- the excess of adjusted gross income over the dollar amount at which the highest tax bracket begins ($12,150 for 2014; $12,300 for 2015; $12,400 for 2016).
The NIIT does not apply to certain tax-exempt trusts and grantor trusts. Special NIIT computational rules apply for electing small business trusts and charitable remainder trusts.
Unlike the individual threshold amounts, the threshold amount used for estates and trusts is adjusted for inflation because the threshold is tied to the highest tax bracket. Nevertheless, the amount is far less than the lowest threshold amount for individuals ($125,000 for married filing separately). Therefore, trusts and estates should consider distributing investment income, especially if one or more beneficiaries would not otherwise be subject to NIIT because of their threshold amount.
The guidance on the computation of NII subject to the NIIT is complex. However, we can assist you in evaluating the impact of this tax on your total tax liability and guide you in a developing a tax saving strategy. Please feel free to contact us with any questions or concerns you may have in this regard at 858-558-9200.