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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 detailed blog posting here 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

Filing Status

Threshold Amount

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

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.

 

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