Net Investment Income Tax – Proactive Planning is the Key

 

9869325054_387ed7e692The net investment income tax is a 3.8% federal tax that applies to certain taxpayers with passive income.  It is important that you understand how this new tax works so that you can take steps to minimize your exposure to it.

Overview

The federal net investment income tax (“NII Tax”) is a new 3.8% tax that was implemented as part of the Patient Protection and Affordable Care Act (a/k/a “Obamacare”) and became effective on January 1, 2013.  Despite the name “Unearned Income Medicare Contribution” given the NII Tax in Section 1411 of the Internal Revenue Code, the taxes collected pursuant to the NII Tax will go directly into the general tax fund to support the operations of the federal government.

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Tax Update – IRS Releases Draft Instructions for Net Investment Income Tax Form 8960

Tax Update – IRS Releases Long Awaited Draft Instructions for Net Investment Income Tax Form 8960

7658298768_e4c2c2635e_zThe IRS released draft instructions  (access the draft instructions here) for tax return preparers to use when preparing new Form 8960 (access Form 8960 here), which is the form that tax return preparers will use to report a taxpayer’s net investment income and the corresponding tax, if applicable.  The net investment income tax was implemented as part of the Affordable Care Act (aka “Obamacare”) and is part of the funding mechanism for this legislation. [Read more...]

Tax Update – IRS Issues Taxpayer Friendly Final Regulations Regarding the Application of the Net Investment Income Tax to Self Rentals

Internal Revenue Service SignTax Update – IRS Issues Taxpayer Friendly Final Regulations Regarding the Application of the Net Investment Income Tax to Self Rentals

The IRS recently issued taxpayer friendly final regulations regarding the application of the “net investment income” tax (the “NII tax”) to self rentals.  While in-depth discussions of the NII tax and the self rental rule are beyond the scope of this post, I will provide quick overviews of each of these items.

Background – Overview of the Net Investment Income Tax - First, the NII tax is a new 3.8% tax that was implemented as part of the Affordable Care Act (aka “Obamacare”) and became effective on January 1, 2013.  Generally, the NII tax is imposed on the lower of (1) a taxpayer’s modified adjusted gross income in excess  of a set threshold ($200,000 for single filers and $250,000 for married filing jointly filers), or (2) a taxpayer’s “net investment income.”  Net investment income generally includes capital gains, dividends, rents, royalties, interest, and income received from businesses in which the taxpayer does not materially participate.

Background – The Self Rental Rule - Second, the self rental rule provides that rent received by a taxpayer (or a business entity that is an affiliate of the taxpayer) from a business in which the taxpayer materially participates is per se non-passive.  For example, many closely held businesses are structured using a limited liability company to hold the building where the business is operated and using another entity (usually another LLC or an S corporation) to actually operate the business.  The operating business will then enter into a lease with the LLC to lease the real estate from the LLC.  One of the primary purposes of this structure is to segregate the liabilities related to the real estate from the liabilities related to the operation of the business.

Prior Question – Trade or Business? - Prior to the issuance of these final regulations, tax practitioners were debating whether the NII tax would apply to self rental income where the landlord and tenant had agreed to use a “triple net lease” under which the tenant was responsible for all maintenance/repairs, taxes, and insurance obligations.  The issue here is whether the landlord’s activities with respect to the rental are substantial enough to constitute a trade or business since the landlord would do little more than collect rent from the tenant.  As a result, many tax practitioners were advising their clients to amend these leases to provide more responsibilities for the landlord.

Final Regulations – Self Rental Income is Not Subject to the NII Tax - In an unexpected announcement, the final regulations recently released by the IRS provide that self rental income will not be subject to the NII tax.  As such, taxpayers can continue collecting self rental income even if they use “triple net leases,” and the income will be non-passive and will not be subject to the additional 3.8% tax imposed by the NII tax.