In an earlier article entitled “Be aware of new 2013 3.8% Net Investment Income Tax (Medicare Surtax) and plan ahead” AG Tax Professionals covered the basics of the Net Investment Income Tax (NIIT) and Medicare Surtax that is applicable on certain passive income from 2013 onward.
The Internal Revenue Service (IRS) released the final regulations covering the two surtaxes in the last week of November, 2013. These final regulations provide clarity on the applicable taxes and the associated computation for types of income, trusts and estates, real estate income, and estimated taxes.
AG Tax analysts have prepared a brief summary on these final regulations, which may be useful for high income taxpayers.
Background of Medicare Surtax and NIIT
The 3.8% NIIT is applicable on the passive income for taxpayers whose Modified Adjusted Gross Income (MAGI) is beyond certain limits ($200,000 single or head of household; $125,000 married filing separately; $250,000 married filing jointly or qualified widow(er) with dependent child; $11,950 trusts and estates).
Additional Medicare Surtax is applicable to individuals’ wages, compensation and self-employment income over the same threshold limits (with the exception of $200,000 being the limit for qualified widow(er) with a dependent child). The Medicare surtax does not apply to income items which are part of Net Investment Income (NII).
Final Regulations of Medicare Surtax and NIIT
Types of Income
NII consists of any passive income (for example, interest, dividends, annuities, royalties, and rent) that is not the result of a taxpayer’s business efforts (such as wages, salary, or self-employment income which is a payment for an individual’s services).
Rental income that is treated as non-passive under IRC section 469 is deemed to be derived in the ordinary course of a trade or business for purposes of the surtax. Therefore, even though it is non-passive income, the fact that it is rental income qualifies it for NIIT.
Due to the late release of final regulations, taxpayers have the option to choose from the final regulations or the proposed regulations to determine their tax liability for 2013. However, no relief will be provided in case of underpayment of estimated tax.
Trusts and Estates
The proposed regulations exempt only certain trusts from the NIIT. The final regulations extend this exemption to cover estates with beneficiaries fully devoted to charitable purposes and activities only.
Foreign estates are excluded from the surtax; but U.S. beneficiaries have to pay surtax on distributions from foreign estates and trusts. Additionally, surtax is applicable on the U.S. beneficiary who receives distributions of the accumulated NII from a foreign trust instead of the foreign trust.
Surtax on income from disposition of S-Corporation stock by a Qualified Subchapter S Trusts (QSST) is applicable at the trust and not beneficiary level.
The final regulations provide a deduction for items related to income in respect of a decedent (IRD). NII of a decedent (which may include items such as annuities, and life insurance death benefit), may be offset by a deduction (trustees’ fees, paid taxes, etc.) to offset NII.
Deductions and Losses
The 2% miscellaneous itemized deduction is allowed on fiduciary fees and other administration expense amounts related to NII. Net Operating Losses Deduction is allowed as well but only to the extent it is attributable to NII.
Capital losses are allowed to be carried-forward and excluded while calculating the NII for the year of recognition in order to make it available for deduction in the future years.
The increased income tax rate of 39.6%, and increased rates on capital gains and qualified dividends along with the 3.8% NIIT may increase the tax burden for high income taxpayers. Strategic tax planning, to reduce the MAGI and NII to keep it below or close to the threshold limit is vital. We strongly recommend that all taxpayers consult with a professional tax analyst to plan accordingly.
AG Tax LLP Can Help
If you have any tax-related queries, need assistance with tax planning or filing your tax returns please contact us. Our team comprises of highly experienced tax professionals with extensive knowledge of U.S. and Canadian tax laws as well as cross-border compliance
Furthermore, as a full service accounting firm, AG Tax assures complete assistance with even your most complex tax needs.
We can assist with:
- Canadian Personal and corporate tax returns
- Cross Border Taxation and Business Planning
- U.S. Personal and Corporate Taxation
- Disclosure of Foreign Assets and other information filings
- Retirement planning
- Estate Planning, Inheritance tax advice
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