More Net Investment Income Tax: 3.8% NIIT And The NRA-Spouse

Taxpayers working on their 2013 tax returns are now grappling with the new 3.8% Medicare surcharge imposed on high wage earners. This tax is more commonly called the “Net Investment Income Tax” or (“NIIT”). There is a lot of confusion because the rules governing application of the NIIT contain nuances with regard to Americans working overseas and with regard to so-called nonresident alien individuals (NRA).

See my previous blog posting “NIIT-Picky Nuances For Americans Overseas Or With Offshore Investments” concerning how the NIIT impacts Americans overseas or those with offshore investments.

Broadly speaking, the NIIT is a 3.8% surtax on “net investment income” that applies to certain high-income individuals. Net investment income includes interest, dividends, capital gains, annuities, royalties and passive rents as well as income from businesses, such as trading of financial instruments and commodities and businesses that are considered “passive” with respect to the taxpayer.

Not everyone will be subject to the NIIT. You must meet two basic requirements for the NIIT to apply. You must have both “net investment income” and modified adjusted gross income (“MAGI”) that exceeds certain applicable thresholds (see the chart below). Individuals having (i) MAGI that is over the applicable threshold amount, and (ii) net investment income, must pay 3.8% of the smaller of (i) or (ii) as their NIIT.

The applicable threshold amount is:

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US Taxpayers Married to Nonresident Alien Individuals (NRA)

NRAs are specifically exempt from the 3.8% NIIT. When a US citizen or resident is married to a NRA, the spouses are treated as married filing separately for purposes of the NIIT. The US citizen or resident spouse is subject to the threshold amount for a married taxpayer filing a separate tax return (that is, the $125,000 threshold). The NRA spouse is exempt from the 3.8 % NIIT. In accordance with the rules for married taxpayers who file separate returns, the US spouse must determine his own net investment income and MAGI.

The US tax laws permit a US taxpayer to treat his or her foreign spouse as a US “resident” alien for tax purposes by making what is known as a Section 6013(g) or (h) election. Making the election generally means the couple can file using “married filing joint” (MFJ) status. In certain cases, this can be very advantageous – for example, tax benefits can result because of the lower tax rates and larger deductions that are available when the couple can file using MFJ status.

MFJ Election Possible for NIIT

The IRS issued Proposed Treasury Regulations (See Prop. Reg. §1.1411-2(a)(2)(i)(B)) under the NIIT rules permitting married taxpayers who file a joint income tax return with a NRA spouse pursuant to the Section 6013(g) or (h) election, to also elect to be treated as making a Section 6013(g) or (h) election for purposes of the NIIT. For purposes of calculating the NIIT, the effect of such an election is to include the combined income, gains, losses and deductions of the US spouse and the NRA spouse for purposes of calculating their net investment income and MAGI. Once so calculated, you look at the threshold amounts (i.e., $250,000) for a taxpayer filing a joint return. The NIIT tax Form 8960 makes it very simple to make the MFJ election for NIIT purposes. Simply, check the check-box near the top of Form 8960, Part I.

Where Can I Find Additional Information About the NIIT?

The IRS has issued FAQs about the NIIT which can be accessed HERE.

In accordance with Circular 230 Disclosure

Virginia La Torre Jeker J.D., has been a member of the New York Bar since 1984 and is also admitted to practice before the United States Tax Court. She has 30 years of experience specializing in US and international tax planning as well as international commercial transactions. She has been based in Dubai since 2001; prior to that time she worked in Hong Kong for 15 years as a US tax consultant for international law firms, major banks (including HSBC) international accounting firms (Deloitte) and trust companies. Early in her career she worked in New York with the top-tier international law firm, Willkie Farr & Gallagher.

Virginia is regularly asked to speak at numerous conferences and seminars for various institutes and commercial organizations; publishes a vast array of scholarly works in her area of expertise, been interviewed by CNN and is regularly quoted (or has her articles featured) in local and international publications. She was recently appointed to the Professional Tax Advisory Council, American Citizens Abroad, Geneva, Switzerland. She was a guest lecturer at the University of Hong Kong, LL.M Program (Law Department) and served as an adjunct Business Law professor at the American University of Dubai and at the American University of Sharjah where she also taught the legal / ethical aspects of internet law and internet based transactions.

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