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US Tax Information About Net Investment Income

 

IJ Zemelman

 

While the IRS is consistent in its annual practice of taxing its citizens around the globe, there are generally a few updates to the United States tax code every year. One of the most significant changes for the tax year 2013 (especially for US Expats) involves the NIIT (Net Investment Income Tax) – a byproduct of the 2010 Health Care Reform Act (otherwise known as Obamacare).

Definition of NIIT

The NIIT is a tax of 3.8% that is applied to income which is generated by a wide variety of investments and is assessed on trusts and estates as well as individual taxpayers whose MAGI (Modified Adjusted Gross Income) income is equal to or greater than the following thresholds established by the IRS:

Tax Filing Status MAGI Threshold
Married Filing Jointly $250K
Qualified widow(er) with one or more dependent children $250K
Married Filing Separately $125K
Single $200K
Head of Household and every other filing status $200K

Your MAGI is calculated each year based on your earnings for the previous tax year; so remember:  Just because your regular salary and wages don’t meet the NIIT liability thresholds, your MAGI may still be high enough to qualify if there was a significant occurrence during the taxable through which your earned income was raised enough to place you into a new tax bracket. Some occurrences which would cause this type of increase in MAGI include a large inheritance, a high-dollar gift or bequest, lottery winnings, the sale of a home, or another large influx of cash or assets.

Again, however, simply having a MAGI above the NIIT thresholds will not mean that you are liable for the NIIT.  In order to have NIIT liability, you must earn income from a source which meets the IRS qualifications for NII (Net Investment Income).  The sale of your primary home, for example, may increase your MAGI sufficiently enough to require you to pay the NIIT of 3.8% IF you also had qualifying NII during the taxable year. The sale of your primary home, though, is not considered a source of NII; so if you have a regular job through which you collect standard wages and the sale of your home was your only source of additional income, you wouldn’t be required to pay the NIIT – even if your earnings from the sale of your home placed you in a qualifying MAGI threshold.

What Types of Income Qualify as Net Investment Income?

There is a long list of acquisitions, investments, and financial accounts which would qualify as a generator of Net Investment Income.  We will outline many of them in this article, but it’s important for you to know that you may have assets through which qualifying Net Investment Income is earned and it’s possible that you are liable for the NIIT in addition to all other state and federal taxes. Some of the most common sources of Net Investment Income include:

  • Stocks or other investments which pay regular dividends
  • Stocks or other investments through which you earn long term or short term capital gains
  • Interest-bearing bank accounts
  • Non-qualified annuities
  • Rental property
  • Investment property
  • Royalty payments
  • Income from a business in which the primary source of revenue is trading financial accounts or other financial assets
  • Passive business income – income your business earns through means such as investment accounts, royalty payments, investment property or other assets such as these rather than receiving pay for services or COGS (Cost of Goods Sold).

What Types of Income do not Qualify as Net Investment Income?

Sources of income which are not regarded by the IRS as Net Investment Income generators include:

  • Salaries and wages
  • Self employment income
  • Alimony
  • Unemployment compensation
  • Tax-exempt interest
  • SSI or SSDI payments
  • Sale of primary home or vehicle
  • IRS Qualified Retirement Plans
  • Dividends earned from Alaska Permanent Fund
  • Non-passive business income

More about NIIT Liability

Individual Taxpayers

As indicated earlier, US Citizens or Green Card Holders with a MAGI higher than the established thresholds and assets yielding NII will be required to pay the NIIT. There are situations, though, in which a non-US Citizen will be required to pay this tax, as well. In the case of a US Expat married to a non-resident, for example, if this couple wanted to file a joint return they would have to consider both of their assets and income levels to determine NIIT liability. If the couple meets the NIIT liability qualifications, both will be responsible for paying the tax.

Trusts and Estates

Like individual taxpayers, organized trusts and estates in the US are potentially liable for the NIIT. The difference between trust and estate NIIT liability and individual taxpayer NIIT liability, however, is in the qualification guidelines.  Very much similar to the progressive income tax bracket scale by which the IRS determines tax rates and other tax or documentation requirements is the progressive tax bracket scale for trusts and estates, but the scale for trusts and estates is devised on a lower value scale.

NIIT liability for trusts and estates is gauged by 2 things:  Whether or not there is undistributed Net Investment Income and whether or not the MAGI of the trust or estate in question is above the lowest dollar amount of the highest tax bracket (currently in tax year 2013 at $11,950).  If an estate or trust does have undistributed NII and it also has a MAGI of $11,950 or more, it may be required to pay the NIIT if certain exceptions aren’t applicable.  Most exceptions to NIIT liability are set aside for specific types of trusts which include Electing Small Business Trust, Charitable Remainder Trusts, certain types of Grantor Trusts and a wide variety of REITs (Real Estate Investment Trusts).  These groups are completely exempt from the NIIT.

Although many REITs may not be subject to the NIIT under standard formation, owning or acquiring non-qualified dividends which were generated by investments held by an REIT may lead to NIIT liability.  If you are involved with an REIT in which investment-generated non-qualified dividends are being held to create passive income, check to see if you have acquired NIIT liability by default.

How to Report NIIT Liability and Pay with Your US Expat Tax Return

Individual taxpayers who are responsible for the NIIT should indicate their liability for this tax on IRS Income Tax Form 1040.  Responsible parties for trusts and estates should indicate NIIT liability on Form 1041, US Income Tax Return for Estates and Trusts.  Both trusts/estates and individual taxpayers should pay the NIIT when all other taxes are paid:  No later than April 15 following the year in which NIIT liability was acquired.

If you are required to make quarterly estimated tax payments or your income is subject to regular withholding and you want to avoid additional tax liability (possibly accompanied by penalties and interest) at the end of the year, you should consider adjusting your estimated tax liability accordingly and/or increasing your income withholding amount.

Understand How the Net Investment Income Tax Affects You

Not everybody will be required to pay the Net Investment Income Tax.  At the same time, many who do have legitimate NIIT liability will surely be under the impression they are not affected by these changes to the United States tax code.  Why put your financial future at risk or open the door for a potential criminal record when you can get a quick assessment with an experienced professional at Taxes for Expats?  If you’re not 100% certain of your status as a taxpayer when it comes to the new Net Investment Income Tax, get in touch with one of our international tax experts at your earliest convenience.

Zemelman
Ines Zemelman, EA is the founder of Taxes for Expats
She may be reached at: +1-646-397-2887