September 10, 2013
By Daniel Gibson, CPA
Beginning in 2013, the Internal Revenue Code imposes a surtax on the net investment income (NII) of individuals, estates and trusts In the case of an individual, the surtax for each tax year is 3.8% of the lesser of:
- the individual’s NII for the year, or
- the excess (if any) of the individual’s Modified Adjusted Gross Income (MAGI) over a threshold amount.
The threshold amounts are (1) $250,000 for married individuals or a surviving spouse filing a joint return; (2) $125,000 for a married individual filing a separate return; and (3) $200,000 in all other cases. MAGI for this purpose is Adjusted Gross Income (AGI), increased by the foreign earned income exclusion, less properly allocated deductions.
Here’s the nuance. Disposition of assets not related to a trade or business produce net investment income that is subject to the NII Tax. Losses realized are only allowed to offset other gains in determining NII. In other words, net gain (loss) for NII calculation purposes cannot be less than zero.
Example 1: John, a single filer, has MAGI of $425,000 which includes investment income of $10,000 of interest income and 2 stock dispositions. One disposition yields a $5,000 gain, while the other generates a loss of $13,000. What is the NII? It’s actually $10,000. The net loss of $8,000 on the stock dispositions is less than zero and not allowed to offset any of the $10,000 of interest income for the NII calculation. The favorable $3,000 capital loss deduction which could be used in calculating adjusted gross income is not allowable for the NII calculation. The surtax applies to the $10,000. The 3.8 % surtax would be applied to the lesser of NII ($10,000) or the excess of MAGI ($225,000) over the threshold amount $200,000 (for a single filer).
Example 2: Mary, a single filer, reports only $500,000 of interest and a $500,000 net capital loss. NII is $500,000, since none of the capital loss can be used to offset the interest. However, Mary’s excess MAGI over the $200,000 single filer threshold would be the $297,000. The surtax applies to $297,000, $500,000 less the $200,000 threshold and the $3,000 maximum capital loss that may offset ordinary income. The 3.8%surtax would be applied to the lesser of NII ($500,000) or the excess of MAGI of ($297,000) over the threshold amount of $200,000 (for a single filer).
If you have gains and losses from the disposition of assets which may be subject to the net investment income tax, make sure you double-check the resulting NII tax or have a professional tax advisor review the calculation for you.