IRS Issues Final Regulations on New Net Investment Income Tax and Additional Medicare Tax

On November 27, 2013, the IRS released final regulations under Section 1411. These regulations govern the new 3.8% tax on net investment income for certain high income taxpayers that took effect on January 1, 2013. The tax applies to income of individuals, estates, and certain trusts above applicable threshold amounts. While many of the provisions of the proposed regulations remain intact, several provisions have been deleted, modified or further clarified. Highlights of the final regulations are outlined below.

  • The IRS has abandoned the proposed regulations regarding how to determine net investment income upon the sale of a membership interest in an S corporation or partnership, instead releasing new proposed regulations under Prop. Reg. Section 1.1411-7 that overhaul the previous rules.
  • Net operating losses, which were disallowed for use against net investment income in the proposed regulations, will now be allowed in part.
  • The final regulations clarify that the foreign tax credit may not be used to offset the net investment income tax.
  • The treatment of self-charged interest and self-rental income has been clarified.
  • The use of capital loss carry forwards against net investment income is clarified.
  • Final regulations will allow real estate professionals to be deemed as “conducting a trade or business”, thereby removing rental income from net investment income, providing all other requirements are met.
  • The final regulations clarify that net gains from the sale of property cannot be below zero. However, losses in excess of gain may be eligible to reduce other investment income such as interest, dividends and rents.
  • Taxpayers will have an additional method for determining the amount of miscellaneous itemized deductions and other itemized deductions that are permitted to offset net investment income.

Final regulations were also issued on implementing the Additional Medicare Tax for high income individuals, which was created under the Affordable Care Act. The regulations outline how employers are to withhold the tax from wages and compensation, how to report the tax when filing a return and how employers can correct an underpayment or overpayment of the tax, including how to collect a refund.