3.8% Surtax on Net Investment Income

By: Paul H. Glass

PLANNING ON SELLING YOUR REAL ESTATE?

If so, don’t overlook considering the new surtax that will be extracted from your pocket.

Tax provisions within the Affordable Care Act (aka “Obamacare”), put into place a 3.8% surtax on Net Investment Income. This Net Investment Income Tax is imposed by IRC Section 1411, and it applies to certain Net Investment Income of individuals, estates and trusts that have such income above statutory threshold amounts of $250,000 (joint), $200,000 (single) and $12,000 (trusts).

The Net Investment Income Tax went into effect on January 1, 2013, and it affects income tax returns of individuals, estates and trusts, beginning with their first tax year beginning on (or after) January 1, 2013. It does not affect income tax returns for the 2012 taxable year filed in 2013.

Individuals will owe the tax if they have Net Investment Income and also have Modified Adjusted Gross Income over the statutory threshold amounts. Certain individuals are not subject to the Net Investment Income Tax.

Estates and trusts are subject to the Net Investment Income Tax 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 such taxable year. Certain trusts are not subject to the Net Investment Income Tax, such as trusts that are not classified as “trusts” for federal income tax purposes (e.g., Real Estate Investment Trusts and Common Trust Funds).

In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities and businesses that are passive activities to the taxpayer (within the meaning of IRC Section 469). To calculate your Net Investment Income, your investment income is reduced by certain expenses properly allocable to the income.

To the extent that gains are not otherwise offset by capital losses, the following gains are common examples of items taken into account in computing Net Investment Income: (1) Gains from the sale of stocks, bonds, and mutual funds, (2) Capital gain distributions from mutual funds, (3) Gain from the sale of investment real estate (including gain from the sale of a second home that is not a principal residence), and (4) Gains from the sale of interests in partnerships and S corporations (to the extent the partner or shareholder was a passive owner).

The Net Investment Income Tax does not apply to any amount of gain that is excluded from gross income for regular income tax purposes. The pre-existing statutory exclusion in IRC Section 121 exempts the first $250,000 ($500,000 in the case of a married couple) of gain recognized on the sale of a principal residence from gross income for regular income tax purposes and, thus, from the Net Investment Income Tax.

Individuals, estates and trusts will use Form 8960 to compute their Net Investment Income Tax. For individuals, the tax will be reported on, and paid with, Form 1040. For estates and trusts, the tax will be reported on, and paid with, Form 1041.

Paul H. Glass, CPA, is a California licensed certified public accountant and real estate broker. You can reach him at [email protected]

Notice: The author and publisher disclaim all liability for any loss or injury resulting from the use of the information found in this article. Every reader is advised to seek competent independent professional advice with regard to any contemplated use of such information.