Net Investment Income Tax

by Shahzad A. Malik J.D. LL.M and Ryan C. Gaglio J.D. *

Effective January 1, 2013, IRC Section 1411 imposes a net investment income tax of 3.8 percent on certain investment income of individuals, estates and trusts that have income above the statutory threshold amounts. Proposed Treasury Regulation Sections 1.1411-1 through 1.1411-10  were issued on December 5, 2012. [77 FR 72612.] Taxpayers may rely on the proposed regulations for purposes of compliance with IRC Section 1411 until the effective date of final regulations.

For individuals, the tax will be reported on, and paid with, the Form 1040. For estates and trusts, the tax will be reported on, and paid with, the Form 1041. The IRS has released a draft of Form 8960, which been developed for the purpose of reporting the net investment income tax.

Individuals owe the tax if they have Net Investment Income and also have modified adjusted gross income over [defined] thresholds, which are not indexed for inflation[.]

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Investment income generally includes interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer (within the meaning of IRC Section 469). To calculate net investment income, investment income is reduced by expenses properly allocable to the income. [Prop Treas Reg 1.1411-4(a).] Examples of properly allocable deductions include investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, and state and local income taxes properly allocable to items included in investment income.

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In the case of an individual, the net investment income tax is imposed on the lesser of (1) net investment income and (2) the amount by modified adjusted gross income exceeds the statutory threshold amounts. [Prop Treas Reg § 1.1411-1(b).]  Examples of properly allocable deductions include investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, and state and local income taxes properly allocable to items included in investment income.

Common types of income that are not included in the computation of investment income, including wages, unemployment compensation; operating income from a nonpassive business, Social Security benefits, alimony, tax-exempt interest, self-employment income, Alaska Permanent Fund Dividends and distributions from certain qualified plans (e.g., plans described in IRC Sections 401(a), 403(a), 403(b), 408, 408A, or 457(b)).

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* Shahzad A. Malik, J.D., LL.M and Ryan C. Gaglio, J.D.are the authors of Taxation of Securities Transactions.

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