*The 3.8% Net Investment Income Tax - More Than Meets the Eye*
There's a lot for taxpayers to know when it comes to the 3.8% net
investment income tax (3.8% NIIT). This new tax is imposed on income from
several sources and its impact is far reaching. Analyzing its impact can
get complicated fast.
Originating as a component of 2010 health care legislation and first
effective in 2013, the 3.8% NIIT is assessed on the lesser of net
investment income (NII) or modified adjusted gross income (MAGI) above
specific thresholds. MAGI is adjusted gross income plus any excluded net
foreign earned income. The MAGI thresholds are $200,000 for single
individuals, $250,000 for joint filers and surviving spouses, and $125,000
for married taxpayers filing separate returns.
Only individuals with some amount of NII, and MAGI above the applicable
threshold amount, will be subject to the 3.8% NIIT. For example, if a
married couple has $200,000 of wage income and $100,000 of interest and
dividend income (i.e., MAGI totaling $300,000), the 3.8% NIIT applies to
the $50,000 that is over the $250,000 MAGI threshold.
Trusts and estates can also be hit with the 3.8% NIIT. But for them, the
tax applies to the lesser of their undistributed net investment income or
AGI in excess of the threshold for the top trust federal income tax
bracket. For 2013, that threshold is only $11,950, so many trusts and
estates will no doubt be affected this year.
The components of NII generally include gross income from interest,
dividends, royalties, and rents; gross income from a trade or business
involving passive activities; and net gain from the disposition of property
(other than property held in a trade or business in which the owner
materially participates). All of these components are reduced by any
allocable deductions. This may sound simple, but as always, the devil is in
the details.
On a positive note, NII does not include tax-exempt bond interest,
veterans' and social security benefits, excluded gain from the sale of a
principal residence, life insurance proceeds received by reason of an
insured's death, lottery winnings, and the tax-free inside buildup of the
cash surrender value of life insurance, among other items.
Fortunately, distributions from retirement plans are generally not included
in NII. However, if included in MAGI, qualified plan distributions may push
the taxpayer over the threshold that would cause other types of investment
income to be subject to the 3.8% NIIT.
Another positive aspect of the 3.8% NIIT is that it does not apply to
income from a trade or business conducted by a sole proprietor,
partnership, or S corporation; but income, gain, or loss on working capital
is not treated as derived from a trade or business and thus is subject to
the tax. The term working capital generally refers to capital set aside for
use in, or the future needs of, a trade or business.
Unfortunately, the 3.8% NIIT does apply to income derived from a trade or
business if it is a passive activity or a trade or business of trading in
financial instruments or commodities.
With regard to property dispositions, a gain from the disposition of
property that is considered held in the ordinary course of a trade or
business is generally exempt from the 3.8% NIIT. Despite the preceding
exception, gains from dispositions of property held in a passive business
activity or in the business of trading in financial instruments or
commodities (whether passive or not) are included in the definition of NII.
For business owners, a gain or loss from the disposition of an interest in
a partnership or S corporation may be subject to the 3.8% NIIT. However, a
complex calculation involving a deemed sale analysis may be required to
make this determination.
Finally, a taxpayer may be subject to both the 3.8% NIIT and the additional
0.9% Medicare tax, but not on the same income. The additional 0.9% Medicare
tax applies to wages and self-employment income over certain thresholds,
but it does not apply to items included in investment income. So, taxpayers
who have both high wages or self-employment income and high investment
income may be hit with both taxes.
Taxpayers face numerous challenges in learning about and dealing with the
3.8% NIIT. Please contact us to discuss the 3.8% NIIT or any other tax
compliance or planning issue.
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*Business Tax Breaks*
Several favorable business tax provisions have a limited term life that may
dictate taking action between now and year-end. They include the following
two provisions.
*Section 179 Deduction.* Your business may be able to take advantage of the
temporarily increased Section 179 deduction. Under the Section 179
deduction privilege, an eligible business can often claim first-year
depreciation write-offs for the entire cost of new and used equipment,
software, and eligible real property costs. For tax years beginning in
2013, the maximum Section 179 deduction is $500,000, including up to
$250,000 for qualifying real property costs. However, you cannot claim a
Section 179 write-off that would create or increase an overall business tax
loss. For tax years beginning in 2014, the maximum deduction is scheduled
to drop back to only $25,000, and most real property costs will be
ineligible.
*50% First-year Bonus Depreciation.* Above and beyond the Section 179
deduction, your business can also claim first-year bonus depreciation equal
to 50% of the cost of most new (not used) equipment and software placed in
service by December 31 of this year. For a new passenger auto or light
truck that's used for business and is subject to the luxury auto
depreciation limitations, the 50% bonus depreciation break increases the
maximum first-year depreciation deduction by $8,000. The 50% bonus
depreciation break will expire at year-end unless Congress extends it.
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