Exclusions to the Net Investment Income Tax
By Since its enactment on March 30, 2010, in connection with the Affordable Care Act, Section 1411 has assessed an additional 3.8% income tax on individuals, estates, and trusts on the lesser of net investment income (“NII”) or the excess of the taxpayer’s modified adjusted gross income over the threshold amount. There are a number of exclusions from the 3.8% tax. Nonresident aliens are not subject to the tax per Section 1411(e)(1). Under Section 1411(e)(2), there is an exemption for charitable trusts that are organized to support religious, charitable, scientific, literary, or educational purposes or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment) or for the prevention of cruelty to children or animals.
NII includes certain gross income or net gain from the disposition of property derived from a trade or business that is a passive activity within the meaning of Section 469 as to the taxpayer or that is trading in financial instruments or commodities (as defined in Section 475(e)(2)). Gross income or net gain from the disposition of property derived from a trade or business in which the taxpayer materially participates (as defined in Section 469) is not NII. Section 1411(c)(4) applies the same reasoning to the disposition of an interest in a partnership or S corporation in which the taxpayer materially participates. Accordingly, the rules of Section 469(h) defining material participation are key in determining whether gain from the sale of a partnership interest or stock in an S corporation is subject to the 3.8% tax.
NII does not, pursuant to Section 1411(c)(5), include any distribution from a plan or arrangement described in Sections 401(a), 403(a), 403(b), 408, 408A, or 457(b). Also, Section 1411(c)(6) provides NII does not include any item taken into account in determining self-employment income on which a tax is imposed by Section 1401(b).
John G. Hodnette is a partner with Fox Rothschild, LLP in Charlotte.