Friday, December 6, 2013

Final Regs On The 3.8% Net Investment Income Tax

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The Accounting community was waiting for this eagerly, to see which of their recommendations had been adopted. On November 26th, 2013, the Department Of the Treasury issued final regulations governing the Net Investment Income Tax (NIIT). 

If you remember, the 3.8% tax took effect from January 1st, 2013. We talked about this in my post here and here.  It applies to individuals, estates & trusts who have Net Investment Income and Modified Adjusted Gross Income above the following threshold amounts:

  • Married Filing Jointly & Qualifying Widower with Dependent Child- $250,000
  • Single & Head of Household with Qualifying Person - $200,000
  • Married Filing Separately- $125,000

Some Salient Points in the Final Regs & What May Affect You?
The final regulations usually follow proposed regulations but with changes adopted in answer to the recommendations provided. Comments which had been made were for the following: 
  1. Calculation of net investment income;
  2. Treatment of several special types of trusts;
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  3. Interaction between various aspects of the Sec. 469 passive activity rules with the calculation of net investment income;
  4. The method of gain calculation regarding a sale of an interest in a partnership or S corporation; and
  5. Multiple areas where the proposed regulations could be simplified.
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  • The general structure of calculating NIIT have been retained as in the proposed regulations. 
  • The Internal Revenue Service (IRS) did not address the income & expenses excludible from NIIT. 
  • The IRS rejected calls for providing special relief for estimated taxes with regard to NIIT even though many investors do not know till the end of the year if their pass-through investment will generate NIIT. 
  • The IRS clarified that the foreign tax credit may not be used to offset NIIT. 
  • The IRC 1411 final regs follow the proposed regs & provide that foreign trusts & estates are not subject to NIIT. However, this rule does not exempt U.S. beneficiaries from the application of NIIT to distributions from foreign income. 
  • The IRS has issued guidance on capital loss carry-forwards against NIIT. 
  • Certain net operating losses will be allowed against NIIT, the propsed regs had expressly disallowed these. 
  • The IRS has deemed real estate professionals to be conducting "trade or business" thus removing their rental income from net investment income if certain requirements are met. 
  • The final regs did not provide further clarification regarding the term "trade or business". 
  • Regrouping of activities under Reg. Section 1.469-4 may not be elected if taxpayers do not have both net investment income & MAGI in excess of the applicable thresholds. However with the final regs, if a taxpayer has to amend his 2013 or 2014 tax return that causes him to exceed this threshold, he may then elect to regroup. 
  • The special treatment of sale of S corp or partnership interests have been completely overhauled. Please read more here in this excellent article on forbes.com. 
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The final regulations are effective Dec. 2, upon their publication in the Federal Register, and generally apply to tax years beginning after Dec. 31, 2013. 


For tax years beginning before Jan. 1, 2014, taxpayers can rely on the proposed regulations or on the final regulations, but if a taxpayer takes a position in a tax year beginning before Jan. 1, 2014, that is inconsistent with the final regulations, and that position affects the treatment of one or more items in a tax year beginning after Dec. 31, 2013, then the taxpayer must make reasonable adjustments to ensure that the taxpayer’s tax liability under Sec. 1411 is not "inappropriately distorted" in tax years beginning after Dec. 31, 2013.

Bibliography: T.D. 9644REG-130843-13; Journal Of Accountancy; Thomson Reuters-Resources; irs.gov

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