Net investment income tax: C corporation shareholders who are also employees.

AuthorPak, Terrance J.

Individual shareholders who are also employees of C corporations were dealt a blow with Chief Counsel Advice (CCA) 202118009, which addressed whether they are subject to the net investment income tax on dividends received from the corporation. Specifically, CCA 202118009 found that a taxpayer who was both a shareholder and an employee of the dividend-issuing corporation did not qualify for the exception to the net investment income tax for dividend income derived from a trade or business.

This discussion first provides a brief overview of the net investment income tax and describes what types of income are included as net investment income. The discussion next moves to a summary and analysis of CCA 202118009 and how the holding may have an impact for tax planners.

Overview of the net investment income tax

The net investment income tax, also known as the unearned income Medicare contribution tax, was introduced as part of the Health Care and Education Reconciliation Act of 2010, P.L. 111-152. The net investment income tax affects individuals, estates, and trusts, for tax years beginning on or after Jan. 1, 2013. As its name suggests, the net investment income tax is a tax primarily assessed on taxpayers' unearned income; however, despite its name, the revenue raised by the net investment income tax does not go toward the Medicare trust fund but toward the general fund (see paragraph 6 of REG-130507-11). According to an April 28, 2021, Congressional Research Service Report, the Joint Committee on Taxation estimates that the net investment income tax will raise approximately $27.5 billion of revenue in 2021, and that the majority of the tax is paid by higher-income households (see Congressional Research Service, "The 3.8% Net Investment Income Tax: Overview, Data, and Policy Options" (April 28, 2021), available at crsreports.congress.gov).

To determine whether a taxpayer owes any net investment income tax, the taxpayer must first determine his or her modified adjusted gross income (MAGI) and, second, determine how much, if any, net investment income was incurred for that year (Sec. 1411). The net investment income tax is equal to 3.8% of the lesser of the taxpayer's (1) net investment income for the tax year, or (2) the excess, if any, of the MAGI for the tax year over the "threshold amount" (Sec. 1411(a)(1)). The threshold amount varies depending on the taxpayer's filing status: $250,000 for joint returns and surviving spouses, $125,000 for...

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