Thomson Reuters Tax & Accounting News

Featuring content from Checkpoint

Back to Thomson Reuters Tax & Accounting News

Subscribe below to the Checkpoint Daily Newsstand Email Newsletter

Draft instructions for new net investment income tax form provide form-fill-in and other rules

January 8, 2014

IRS has issued draft instructions for Form 8960, Net Investment Income Tax—Individuals, Estates and Trusts. It had issued the draft form itself back in Aug., 2013. Besides providing detailed instructions for completing the form, the instructions shed additional light on the net investment income tax rules.

Background on the net investment income tax in general. For tax years beginning after Dec. 31, 2012, certain unearned income of individuals, trusts, and estates is subject to a surtax (i.e., it’s payable on top of any other tax payable on that income). The surtax, also called the “unearned income Medicare contribution tax” or the “net investment income tax” (NIIT), is 3.8% of the lesser of (1) net investment income (NII) or (2) the excess of modified adjusted gross income (MAGI) over the threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case). (Code Sec. 1411(a)(1), Code Sec. 1411(b)) MAGI is adjusted gross income (AGI) plus any amount excluded as foreign earned income under Code Sec. 911(a)(1) (net of the deductions and exclusions disallowed with respect to the foreign earned income). (Code Sec. 1411(d))

RIA illustration For 2013, a single taxpayer has net investment income of $100,000 and MAGI of $220,000. He pays the surtax only on the $20,000 amount by which his MAGI exceeds his threshold amount of $200,000, because that is less than his NII of $100,000. Thus, the surtax is $760 ($20,000 × 3.8%).

For an estate or trust, the surtax is 3.8% of the lesser of (1) undistributed NII or (2) the excess of AGI (as defined in Code Sec. 67(e)) over the dollar amount at which the highest income tax bracket applicable to an estate or trust begins. (Code Sec. 1411(a)(2))

For 3.8% surtax purposes, NII is investment income less deductions properly allocable to such income. Investment income is:


…gross income from interest, dividends, annuities, royalties, and rents, unless derived in the ordinary course of a trade or business to which the 3.8% surtax doesn’t apply;
…other gross income derived from a trade or business to which the Medicare contribution tax does apply; and
…net gain (to the extent taken into account in computing taxable income) attributable to the disposition of property other than property held in a trade or business to which the Medicare contribution tax doesn’t apply. (Code Sec. 1411(c))


The 3.8% surtax applies to a trade or business only if it is a Code Sec. 469 passive activity of the taxpayer or a trade or business of trading in Code Sec. 475(e)(2) financial instruments or commodities. (Code Sec. 1411(c)(2)) Investment income doesn’t include amounts subject to self-employment tax (Code Sec. 1411(c)(6)), distributions from tax-favored retirement plans (e.g., qualified employer plans and IRAs) (Code Sec. 1411(c)(5)), or tax-exempt income (e.g. earned on state or local obligations).

The surtax doesn’t apply to trades or businesses conducted by a sole proprietor, partnership, or S corporation (but income, gain, or loss which is attributable to an investment of working capital isn’t treated as derived from a trade or business and thus is subject to the tax). (Code Sec. 1411(c)(3))

In Dec., 2013, IRS issued final regs and separate proposed regs on the NIIT. (See Weekly Alert ¶  29  12/05/2013; Weekly Alert ¶  14  12/05/2013; and Weekly Alert ¶  27  12/05/2013.)

The basic structure of the form. The form has three parts—Part I, Investment Income; Part II, Investment Expenses Allocable to Investment Income and Modifications; and Part III, Tax Computation.

The line-by-line instructions. The line-by-line instructions reflect several areas of significant complexity in the NIIT. Most significant in that regard are the following:

… Line 4. Line 4 is for rental income, royalties, partnership income, S corporation income, etc. Line 4a is for reporting the amounts of that income from Form 1040, Schedule E or the comparable line on Form 1041 for estates and trusts. Line 4b is for NIIT adjustments to the Form 1040, Schedule E, etc. amount; the instructions contain a detailed list of eight such adjustments.

… Worksheets. The instructions contain four worksheets, the first three of which are very lengthy and have very detailed instructions. They are the Lines 5a-5d Net Gains and Losses Worksheet, the Line 7 Deduction Recoveries Worksheet, the Lines 9 and 10 Application of Itemized Deduction Limitations on Deductions Properly Allocable to Investment Income Worksheet, and the Line 10 Worksheet for Traders in Financial Instruments That Maintain More Than One Trade or Business.

Additional insight contained in the Form 8960 instructions.

… Election to file jointly with nonresident spouse. As a general rule, the NIIT does not apply to nonresident alien (NRA) individuals. (Reg. § 1.1411-2(a)(2)(iii)(A))

However, if spouses elect to file a joint return under Code Sec. 6013(g) (where an NRA is married to a U.S. citizen or resident at the end of the tax year) or Code Sec. 6013(h) (where a U.S. citizen or resident is married to an NRA spouse at the beginning of the tax year, but the NRA spouse becomes a U.S. citizen or resident at the end of the tax year), they can also elect to apply the joint return election for NIIT purposes. (Reg. § 1.1411-2(a)(2)(iii)(B)) The election must be made in the manner prescribed by forms, instructions, or in other guidance on an original or amended return, for the tax year for which the election is made. (Reg. § 1.1411-2(a)(2)(iii)(B)(2))

The new instructions provide the guidance mentioned above. Spouses make either election for NIIT purposes by using their combined items of income, gain, loss, and deduction from their joint return to figure their NII and MAGI, and using the married filing joint return applicable threshold amount ($250,000). Additionally, if they make the election to file under Code Sec. 6013(g), they must check the box near the top of Form 8960, Part I.

… Net operating loss (NOL) deduction. The “Section 1411 NOL” (defined below) of a net operating loss (NOL) deduction allowed under Code Sec. 172 is allowed as a properly allocable deduction in determining NII for any tax year. (Reg. § 1.1411-4(f)(2)(iv))

The “Section 1411 NOL” of an NOL deduction for a tax year is calculated by first determining the applicable portion of the taxpayer’s NOL for each loss year. Next, the applicable portion (defined below) for each loss year is used to determine the Section 1411 NOL amount for each NOL carried from a loss year and deducted in a tax year. The Section 1411 NOL amounts of each NOL carried from a loss year and deducted in the tax year are then added together. This sum is the Section 1411 NOL amount of the NOL deduction for the tax year that is allowed as a properly allocable deduction in determining NII for the tax year.

In any tax year in which a taxpayer incurs an NOL, the applicable portion of the loss is the lesser of: (a) the amount of the NOL for the loss year that the taxpayer would incur if only items of gross income that are used to determine NII and only properly allocable deductions are taken into account in determining the NOL in accordance with Code Sec. 172(c) and Code Sec. 172(d) (Reg. § 1.1411-4(h)(2)(i)); or (b) the amount of the taxpayer’s NOL for the loss year. (Reg. § 1.1411-4(h)(2)(ii))

The Form 8960 instructions provide that, for purposes of calculating the Section 1411 NOL, one should compute his NOL using Form 1045, Schedule A—NOL, with only items of income, gain, loss, and deduction on Form 8960 for that year. If that amount is less than the NOL computed for regular tax purposes, then that amount is the applicable portion of the NOL. If that amount is equal to, or greater than, the NOL computed for regular tax purposes, then the applicable portion is 100% of the regular tax NOL (which means the entire NOL will be deductible in computing net investment income when the NOL is used for regular tax purposes).

The instructions also provide that if one incurs an NOL in 2013 or 2014, and carries back that NOL to offset income in years preceding the imposition of the NIIT (for example, a carryback to calendar year 2011 and/or 2012), the amount of Section 1411 NOL that is included in the NOL carryback will be used (as an applicable portion) even though the NIIT was not in effect in the carryback year.