3.8% net investment income tax regulations.

• Author: Nevius, Alistair M.

The IRS issued final and proposed regulations giving guidance on the application and computation of the 3.8% net investment income tax imposed by Sec. 1411 (T.D. 9644 and REG-130843-13). The final regulations adopt, with changes, proposed regulations issued late in 2012.

Effective in 2013, Sec. 1411 imposes a tax equal to 3.8% of the lesser of an individual's net investment income for the tax year or the excess (if any) of the individual's modified adjusted gross income for the tax year over a threshold amount. The threshold amounts are $250,000 for married taxpayers filing jointly and surviving spouses, $125,000 for married taxpayers filing separately, and $200,000 for other taxpayers. The tax also applies to estates and trusts, with different threshold amounts.

In December 2012, the IRS released proposed regulations on the net investment income tax (REG-130507-11). The new final regulations generally follow the proposed regulations, but with changes adopted in response to the numerous comments the IRS received about the proposed regulations. The comments addressed five main issues:

1. Calculation of net investment income;

2. Treatment of several special types of trusts;

3. Interaction between various aspects of the Sec. 469 passive activity rules with the calculation of net investment income;

4. The method of gain calculation regarding a sale of an interest in a partnership or S corporation; and

5. Multiple areas where the proposed regulations could be simplified.

The final regulations retain the general structure for calculating the net investment income tax from the proposed regulations, with a few changes. Despite requests of commentators, the final regulations do not contain a list of income or deduction items that are excluded from the calculation of net investment income. They also do not exempt the net investment income tax from the estimated tax payment requirements, even though many investors cannot know until the end of the year whether a passthrough investment will generate net investment income. In addition, the IRS clarifies that foreign income taxes are not creditable against the net investment income tax because it is not contained in chapter 1 of the Internal Revenue Code. Regs. Sec. 1.1411-1 contains general rules pertaining to the net investment income tax. Regs. Sec. 1.1411-2 describes the application of the tax to individuals. Regs. Sec. 1.1411-3 describes its application to trusts and estates. Regs. Sec. 1.1411-4 defines...