Proposed regulations and frequently asked questions and answers have been issued by the IRS on the Code Sec. 1411 net investment income tax (NIIT). Proposed regs and questions and answers were also released on the Code Sec. 1401 additional hospital insurance tax.
Net Investment Income Tax
Newly proposed regulations address the NIIT, which goes into effect on January 1, 2013, and applies at a rate of 3.8 percent to certain net investment income. The tax applies to individuals, estates, and trusts with income above certain statutory threshold amounts. The NIIT does not apply to nonresident aliens. This tax is subject to estimated tax rules, and is reported on Form 1040 for individuals and Form 1041 for estates and trusts. It is not required to be withheld from wages. Taxpayers may rely on the proposed regulations until the final regs are released, although the proposed regulations are proposed to be effective after 2013.
The NIIT will apply in the case of income tax returns of individuals, estates and trusts for the first tax year beginning on or after January 1, 2013. It will have no effect on returns for the 2012 tax year that are filed in 2013.
Individuals will be subject to the NIIT if their modified adjusted gross income is over certain thresholds, which are not adjusted for inflation:
- Married filing jointly, $250,000
- Married filing separately, $125,000
- Single, $200,000
- Head of household (with qualifying person), $200,000
- Qualifying widow(er) with dependent child, $250,000
Estates and trusts are subject to the NIIT if they have undistributed net investment income and also have adjusted gross income over the dollar amount at which the highest tax bracket for an estate or trust begins for the tax year (for 2012, this amount is $11,650). Trusts that are not subject to the NIIT include exempt trusts (e.g., charitable trusts and qualified retirement plans), grantor trusts, and trusts that are not classified as trusts for tax purposes (such as real estate investment trusts and common trust funds).
Net investment income is gross investment income reduced by certain investment-related expenses, such as investment interest expense, investment brokerage fees, royalty-related expenses, and state and local taxes allocable to items included in net investment income.
Net investment income includes (but is not limited to) interest, dividends, capital gains, rental and royalty income, nonqualified annuities, income from businesses involved in the trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer, under Code Sec. 469 . In addition to these types of income, net investment income includes gains such as those from the sale of stocks, bonds, and mutual funds, capital gain distributions from mutual funds, gain from the sale of investment real estate, and gains from the sale of partnership or S corporation interests. Gain from a personal residence is subject to the NIIT only if the gain is above the exemption amount under Code Sec. 121 ($250,000 or $500,000 for singles and married filing jointly, respectively).
Income that is not classified as net investment income includes operating income from a nonpassive business, Social Security benefits, alimony, tax-exempt interest, self-employment income, Alaska Permanent Fund Dividends, and distributions from most qualified retirement plans.
Additional Medicare Tax
The IRS has also released proposed regulations covering the additional hospital insurance tax, also known as the additional Medicare tax. The IRS has provided questions and answers to questions pertaining to individuals, as well as employer and payroll services.
This tax applies to individuals' wages and compensation, as well as self-employment income, above a threshold amount that is received after December 31, 2012. The tax rate is 0.9 percent. The additional Medicare tax will be calculated and reported on the individual's tax return.
The thresholds for application of the tax are:
- Married filing jointly, $250,000
- Married filing separately, $125,000
- Single, $200,000
- Head of household (with qualifying person), $200,000
- Qualifying widow(er) with dependent child, $250,000
All wages currently subject to Medicare tax will be subject to the additional Medicare tax, if they are paid in excess of the applicable threshold amount. The same is true of Railroad Retirement Tax Act (RRTA) compensation.
No special rules apply for nonresident aliens and U.S. citizens living abroad. Wages, other compensation, and self-employment income that are subject to Medicare tax will also be subject to additional Medicare tax.
The tax goes into effect after 2012, but the final regulations will not be released until a later time. Taxpayers must comply with the law in effect on any particular date, but may rely on the proposed regulations until the final regulations are released.
Employers must withhold additional Medicare tax for wages paid above the threshold. Compensation subject to RRTA taxes also requires withholding.
A taxpayer cannot request additional withholding specifically for the additional Medicare tax but can request that his or her employer withhold an additional amount of income tax. Estimated tax rules apply to the additional Medicare tax, but the individual need not identify the payments as being specifically for that tax.
The proposed regulations also cover calculation of the additional Medicare tax if an individual has wages subject to Federal Insurance Contributions Act (FICA) tax and self-employment income subject to Self-Employment Contributions Act (SECA) tax, wages subject to RRTA and FICA taxes, or income subject to RRTA and SECA tax.
Employers must begin withholding the additional Medicare tax on wages it pays an employee in excess of $200,000 in a calendar year, beginning January 1, 2013. Further information is provided for employers related to employee notifications, employer liability where there is no withholding, married employees, noncash wages, tips, insurance, third-party sick pay, nonqualified deferred compensation plans, mergers, services performed for subsidiaries, common payroll for related corporations, payments by agents, leased employees, electronic filing, forms, and the consequences of overwithholding, among other subjects.
Questions and Answers for Additional Medicare Tax
Questions & Answers on Code Sec. 1411 Net Investment Income Tax
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