Starting in 2013 there is a new tax applied to net investment income (NII). The 3.8% tax is imposed by Section 1411 to certain net income of individuals, estates and trusts that have income above certain statutory levels.
Individuals will owe the tax if they have net investment income and also have modified adjusted gross income above the following thresholds:
- Married filing jointly $250,000
- Married filing separately $125,000
- Single $200,000
If you are exempt from Medicare taxes you may still be subject to the tax if your income is above the applicable thresholds.
Estates and trusts are subject to the tax if they have any undistributed NII and have adjusted gross income over the dollar amount at which the highest tax bracket for an estate begins for the taxable year (for tax year 2013, this amount is $11,950). There are certain trusts such as grantor trusts, charitable trusts, qualified retirement trusts, REITs and others that are not subject to the new tax.
Net Investment Income includes interest, dividends, capital gains, rental income, royalty income, income from businesses involved in trading of financial instruments or commodities and business income that is considered to come from a passive activity under Section 469. This list is not all inclusive. To arrive at net investment income, gross investment income is reduced by the deductions necessary to generate the gross investment income, such as investment interest expense, investment advisory fees, expenses related to rental and royalty income and state and local taxes allocable to the items included in the NII calculation.
Some common gains included in determining NII are:
- Gains from the sale of stocks, bonds and mutual funds
- Capital gain distributions from mutual funds
- Capital gain from the sale of investment real estate
- Capital gain from the sale of second home
- Gains from the sale of passive interests in partnerships and S Corporations
With regard to gains from the sale of your principal residence, any part of the gain excluded under Section 121 is not included in the NII calculation. However, any gain in excess of the exclusion ($500,000 MFJ and $250,000 single) is included the NII calculation.
The tax will be reported on Form 1040 for individuals and Form 1041 for Trusts and Estates. The IRS has released a draft of Form 8960 for purposes of reporting the new tax. This tax is also subject to estimated tax requirements. Taxpayers should take this tax into consideration in order to avoid under payment penalties.
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By Jeff Eischeid