by Barry L Weller, EA
A new tax is now in effect from the Affordable Care Act (Obama Care). The Net Investment Income Tax is imposed by section 1411 of the Internal Revenue Code applies at a rate of 3.8 percent to certain net investment income of individuals, estates and trusts that have income above the statutory threshold amounts. This new tax went into effect on January 1, 2013 and will affect income tax returns of individuals, estates and trusts for their first tax year beginning on or after 1/1/ 2013.
Individuals will owe the tax if they have Net Investment Income and also have modified adjusted gross income over the following thresholds:
Filing Status -- Threshold Amount
Married filing jointly -- $250,000
Married filing separately -- $125,000
Single -- $200,000
Head of household (with qualifying person) -- $200,000
Qualifying widow(er) with dependent child -- $250,000
These threshold amounts are not indexed for inflation.
If you are an individual that is exempt from Medicare taxes, you still may be subject to the Net Investment Income Tax if you have Net Investment Income and also have modified adjusted gross income over the applicable thresholds.
Net Investment Income includes interest, dividends, capital gains, rental and royalty income, non-qualified annuity income received, income from businesses involved in trading financial instruments or commodities, and businesses that are passive activities to the taxpayer. Some examples of the capital gains included in Net Investment Income:
- Gains from the sale of stocks, bonds, and mutual funds.
- Capital gain distributions from mutual funds.
- Gain from the sale of investment real estate (including gain from the sale of a second home that is not a primary residence).
- Gains from the sale of interest in partnerships and S-corporations to the extent you were a passive owner.
Additionally, the amounts of Net Investment Income that are included on your Form 1040 by reason of Form 8814 (interest, dividends and capital gains of your children) are included in calculating your Net Investment Income. However, the calculation of your Net Investment Income does not include (a) amounts excluded from your Form 1040 due to the threshold amounts on Form 8814 and (b) amounts attributable to Alaska Permanent Fund Dividends.
Regarding the sale of your principal residence, the Net Investment Income Tax will not apply to any amount of gain that is excluded from gross income for regular income tax purposes. The pre-existing statutory exclusion in IRC section 121 exempts the first $250,000 ($500,000 in the case of a married couple) of gain recognized on the sale of a principal residence from gross income for regular income tax purposes and, thus, from the NIIT. However, any gain from the sale of your principal residence that exceeds the exemption amount is subject to regular income tax and, therefore, subject to the NIIT as well.
Investment expenses are deductible in computing Net Investment Income. In order to arrive at NII, gross investment income is reduced by deductions that are properly allocable. Examples of properly allocable deductions include investment interest expense, investment advisory and brokerage fees, expenses.
Most estates and trusts will be subject to the Net Investment Income Tax if they have undistributed Net Investment Income and also have adjusted gross income over 11,650. Trusts that are not subject to NIIT are charitable trusts, charitable remainder trusts, grantor trusts and real estate investment trusts.
The Net Investment Income Tax is subject to the estimated tax provisions. Individuals, estates, and trusts that expect to be subject to the tax in 2013 should adjust their income tax withholding or estimated payments to account for the tax increase in order to avoid underpayment penalties and interest. All taxpayers subject to Net Investment Income Tax will report the tax on their annual income tax return, form 1040 for individuals and form 1041 for estates and trusts.
Barry L Weller, EA is the president of Barry Weller & Associates with offices at 216 E Philadelphia Ave, Boyertown, PA 19512 Phone (610) 367-8280 He is an enrolled agent, licensed to represent taxpayers before the IRS.