NIIT and the "reasonable method"

Home Fairmark Forum Taxation of Investments NIIT and the "reasonable method"

This topic contains 3 replies, has 3 voices, and was last updated by  wanttoknow 5 months, 2 weeks ago.

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  • #2281

    sselm
    Participant

    When calculating NIIT, one is instructed to use a “reasonable method” to allocate state tax to investment income. The example given of a reasonable method is to use the ratio of investment income to AGI.

    Would it be “reasonable” to instead recompute your state tax assuming zero investment income, and allocate the difference between that and your actual state tax?

    I’ve heard the term “before and after” method mentioned on this forum. Is this what I’ve just described, or something else? Any suggestions on where I can read up on this?

    Thanks.

    • This topic was modified 6 months, 1 week ago by  sselm.
    #2300

    sselm
    Participant

    I haven’t been able to turn up any information specific enough to be usable. Does everyone just use the default method (percent of AGI) that’s given in the instructions?

    #2336

    KAWill
    Participant

    My tax spreadsheet uses the percent of AGI as described in the instructions. The calculation has not actually come into play with AGI minus the specified threshold resulting in the lower tax.

    In regards to the tax deduction, the instructions state that you can allocate state, local, and foreign income taxes if properly deducted on your return. Your proposal does not appear consistent with that requirement.

    I also wonder if the default method is entirely correct since one might be deducting some taxes related to the previous tax year that were paid in the current tax year. As I recall a similar issue has come up with deductions related to the Foreign Tax Credit.

    #2470

    wanttoknow
    Participant

    sselm,

    Back when the NIIT first started, I was advised on the “old” Fairmark forum that one reasonable method was the “before and after” method, and I have been using that ever since. I do not know of anything you can read about this.

    I calculate the state income tax based just on the non-investment income, and subtract that from the total state income tax. The result is the allocation for NIIT. So far this has proved to be more favorable than the ratio of investment income to AGI because my state income tax is so progressive.

    In my case federal AGI is a factor in the calculation of state income tax, so the federal tax based on non-investment income also has to be calculated.

    However, as explained by Kaye Thomas in my recent thread “Net Investment Income Tax”, only state income tax deducted on line 5a of Schedule A(1040) for a particular year can be used for calculation of the allocation on Form 8960 for that year, and starting with tax year 2018 the allocation may not exceed $10,000.

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