Net Investment Income Tax

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  • #1926
    wanttoknow
    Participant

    It has never been clear to me what state income tax can be deducted as an investment expense for calculating the N.I.I.T. Specifically, what’s not clear is whether the tax deducted has to have been incurred in the year of the income, or whether it has to have been paid in the year of the income—or both. Reading Reg. 1.1411-4 hasn’t settled this question for me.

    To be on the safe side I calculate the N.I.I.T. based on all state income tax incurred in the year of the income, and set a rule to always pay the remaining amount of state income tax due before Dec. 31. However, this year I forgot, and 38% of my 2018 tax will not be paid until this coming week. This is significant because 76% of my 2018 AGI is Investment Income.

    Does anybody know whether the I.R.S. will disallow 2018 tax paid in 2019 as an expense deducted from 2018 Investment Income?

    Example:

    2018 state income tax paid in 2018: $15,000 – 2018 Sched. A
    2018 state income tax paid in 2019: $ 9,000

    2018 state income tax (hopefully) deductible from Investment Income: $20,000

    #1928
    Kaye Thomas
    Moderator

    It’s worse than you fear. The amount you can use in calculating NIIT is limited to “deductions allowed by subtitle A” (see (a)(2) of the reg). That means the amount you can deduct in calculating regular income tax. You don’t deduct state income tax you pay after the end of the year in calculating regular income tax, so you can’t deduct it in calculating NIIT. What’s worse, you can’t deduct anything paid within the same year to the extent it exceeds the new $10,000 limit on SALT deduction. If you don’t itemize, it doesn’t include anything. The only good news is that if the amount that would be allocable to net investment income without regard to the $10,000 limit is $10,000 or more, the entire $10,000 you deduct for regular tax purposes (assuming you do so) can be deducted for NIIT purposes. In other words, you don’t have to allocate the deductible portion between investment income and other income.

    #1929
    wanttoknow
    Participant

    Thanks, Kaye. In one way, I’m so glad I asked. It will take me awhile to digest all that you said, and I may have further questions.

    #1932
    wanttoknow
    Participant

    Kaye, I understand your response now. It’s not as complicated as it seemed at first glance.

    On my copy of Reg. 1.1411-4, where it says “The deductions allowed by subtitle A”, I see I had noted “of what?”, but apparently had not tracked down subtitle A. Is that part of Reg. 1.1411?

    I am surprised that the state income tax deduction for the N.I.I.T. is now limited to $10,000, because the draft 2018 Instructions for Form 8960 says nothing about this under “What’s New”, although it does mention other changes from last year’s tax legislation.

    https://www.irs.gov/pub/irs-dft/i8960–dft.pdf

    Yes, I will be reporting much more than $10,000 in income and real estate taxes on my 2018 Schedule A. But that’s nixed by the A.M.T. Can I still deduct $10,000 in income tax on the N.I.I.T.?

    And, if so, can 2018 state income tax paid in 2019 be deducted on my 2019 Form 8960?

    #1933
    Kaye Thomas
    Moderator

    No way you would guess what is subtitle A without background in tax law, so I should have clarified. In the tax regulations, a reference to subtitle A means the part of the Internal Revenue Code that tells how the income tax works.

    It probably would be a good idea to mention this in “What’s New” for the form instructions, and I’d get a message off to someone about that if not for the fact that anyone who might deal with that message is on involuntary vacation just now. But you’ve drawn my attention to page 12 of the draft instructions where the list of deductions that may be allocated includes:

    State, local, and foreign income taxes if properly deducted on your return when calculating your U.S. regular income tax.

    Treatment of the deduction under AMT doesn’t matter, even if you end up paying AMT, which is unlikely. The issue is whether you are deducting this amount in calculating your regular income tax. Many people who have itemized in the past, based largely on the itemized deduction for state and local tax (SALT), won’t be itemizing under the new rules, which both limit the SALT deduction and increase the standard deduction.

    And that raises an interesting prospect. It could make sense to choose itemized deductions even if they come out somewhat smaller than the standard deduction so that the SALT deduction is available for NIIT. If you don’t itemize, you don’t have a deduction you can use in calculating net investment income.

    As for using the payment made in 2019, the answer is yes, assuming you itemize in 2019. It sounds like that won’t matter for you, though, because the $10,000 limit on SALT will apply again, and I’m guessing you’ll have more than that amount in SALT payments related to your 2019 investment income.

    #1937
    wanttoknow
    Participant

    For the next three years I will continue to have itemized deductions exceed the new increased standard deduction because of a deduction for estate tax on IRD.

    Concerning using the 2019 payment of 2018 state income tax for my 2019 N.I.I.T. calculation: My 2019 state income tax will be much much less than 2018 because my taxable income will be much much less. So, even with the $10,000 limitation, being able to deduct the 2018 state tax may be helpful for the 2019 N.I.I.T.

    In your earlier post you said “the entire $10,000 you deduct for regular tax purposes . . . can be deducted for NIIT purposes. In other words, you don’t have to allocate the deductible portion between investment income and other income.”

    But don’t I have to do some kind of allocation? (I’m thinking about future years, as well as this year.)

    For example, since it was $15,000 in 2018 state income tax that was paid in 2018, do I allocate that between Investment income and other income? (And then reduce the former to $10,000 if necessary)

    Or can the allocation be based on the entire amount of 2018 state income tax (regardless of when paid)? (With the reduction to $10,000 if necessary). (In this case, I couldn’t use the 2018 state income tax paid in 2019 for the 2019 N.I.I.T.)

    • This reply was modified 2 years, 8 months ago by wanttoknow.
    • This reply was modified 2 years, 8 months ago by wanttoknow.
    #1940
    Kaye Thomas
    Moderator

    I wasn’t as clear as I meant to be. What I meant is that you don’t have to allocate the post-reduction amount. You do the allocation based on the total amount paid in 2018 (you can’t include the amount paid in 2019). If this calculation allocates $10,000 or more to your net investment income, then you can deduct the entire $10,000 against NII.

    To put it a different way, you can treat the dollars that are being disallowed by the $10,000 limit as coming first from the dollars that are allocated to income other than NII.

    Initially, in the proposed NIIT regs, you would have had to allocate the $10,000 between NII and other income. Someone submitted a comment to Treasury saying this more favorable method should be acceptable, and the Treasury agreed, so that’s what the final regs say.

    Or at least, that’s what they say about other limitations. The regs were written before we had this $10,000 limit, but the regs make it clear how the rules should apply to the new limit.

    #1942
    wanttoknow
    Participant

    Kaye, thank you so much for getting me straightened out on this!

    Just as an aside–another wrinkle on this:
    I have always used the “before and after” method of allocating the state income tax, because it yields the best results with the steeply progressive state income tax. I.e. tax on all income minus tax on just non-investment income = tax deducted. However, that calculation looks impossible now that I can use only a portion of the tax actually incurred on 2018 income. But I can use the method described in the 8960 instructions. The end result is the same.

    #2352
    MDM
    Participant

    Does “deductions allowed by subtitle A” necessarily mean deductions taken, or can one use the state tax amount that would be allowed if one itemized, even if one does not itemize?

    #2354
    wanttoknow
    Participant

    MDM,

    Page 12 of the Form 8960 instructions says: “For more information on what constitutes properly allocable deductions, see Regulations sections 1.1411-4(f)-(g).”

    IRS Reg. 1.1411-4 says the following:

    “(f) Properly allocable deductions

    “(3) . . . . In determining net investment income, the following itemized deductions are taken into account:

    “(iii) . . . . State, local, and foreign income . . . taxes . . . .”

    https://www.law.cornell.edu/cfr/text/26/1.1411-4

    #2360
    MDM
    Participant

    Thanks, I see the words “itemized deductions” but am having some difficulty interpreting what they mean.

    https://www.law.cornell.edu/uscode/text/26/63 includes the following:
    (d) Itemized deductions For purposes of this subtitle, the term “itemized deductions” means the deductions allowable under this chapter…
    (e) Election to itemize
    (1) In general

    Unless an individual makes an election under this subsection for the taxable year, no itemized deduction shall be allowed for the taxable year. For purposes of this subtitle, the determination of whether a deduction is allowable under this chapter shall be made without regard to the preceding sentence.

    Perhaps someone more versed in tax code lingo can resolve the whipsaw effect: first it says “allowable“, then not allowed (unless elected), then disregard the previous sentence for some purposes.

    Any translators?

    #2461
    KAWill
    Participant

    The Form 8960 instructions for Line 9b state the following: “Include state, local, and foreign income taxes you paid for the tax year that are attributable to net investment income.”

    To confirm my understanding of this thread, one can deduct properly allocated state taxes that are also being deducted on Form 1040 Schedule A. Am I correct that “attributable to net investment income” means net investment income of any applicable tax year? I also understand that one must be itemizing deductions.

    Lastly, I assume that a separate calculation is required when allocating taxes from different tax years. Let me know if my understanding is correct.

    #2469
    wanttoknow
    Participant

    KAWill,

    Based on what Kaye Thomas said in this thread, I believe the state income tax allocated on Form 8960 for a particular tax year has to have been deducted on Schedule A(1040) for that same tax year.

    He said “You don’t deduct state income tax you pay after the end of the year in calculating regular income tax, so you can’t deduct it in calculating NIIT.” and ”You do the allocation based on the total amount paid in 2018 (you can’t include the amount paid in 2019).”

    Since I was unsure what was correct, until 2018 I had been allocating on the 8960 based on all the state income tax incurred for the tax year and paying the tax in full before the end of the year. But for 2018 I slipped up and forgot to pay the last installment before 1/1/19. So that will have to go into the allocation for the 2019 8960.

    And now we have the added wrinkle of the $10,000 limit on the taxes deduction on Schedule A. According to what Kaye said, allocation for the 8960 can be based on all state income tax deducted on Sched. A line 5a. But if the allocation exceeds $10,000, it must be reduced to $10,000.

    #2471
    KAWill
    Participant

    Wanttoknow – Thanks for the reply and I believe we are in agreement. My post also made the point that separate calculations would be required in allocating state taxes to investment income for the two different tax years. Regardless of the allocation method, the allocation percentages would likely be different for the two tax years. However, it’s also possible that the $10,000 limit may simplify the calculations.

    My net investment income tax is currently based on AGI minus the threshold but I wanted to understand the alternate calculation for future reference.

    #2472
    wanttoknow
    Participant

    KAWill,

    Re your point that “separate calculations would be required in allocating state taxes to investment income for the two different tax years.”, I can explain my thinking only with an example roughly based on my own experience.

    I won’t be able to do this until later in the coming week.

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