The net investment income tax

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The Net Investment Income Tax (NIIT) began for the 2013 tax year as part of the Affordable Care Act and affects those that have a modified adjusted gross income (MAGI) of:

Filing single (not married)

$200,000

Married filing jointly/Head of household

$250,000

Married filing single

$125,000

 The NIIT also affects estates and trusts that have an undistributed net investment income with an adjusted gross income (AGI) “in excess of the threshold amount (for 2013, $11,950; for 2014, $12,150).” This tax may affect small businesses and farmers in a couple of ways. Generally, income subject to Self-Employment (SE) tax is not subject to the NIIT. Rental income may be subject to NIIT unless you meet certain exceptions.

If the previously mentioned threshold amounts are met, then income gained from passive activities will be subject to the NIIT of 3.8 percent. This includes any income derived from a trade or business in which the taxpayer did not materially participate. You have materially participated in the trade or business if you have been involved on a “regular, continuous, and substantial basis.” To help determine if you materially participated you must meet one of the following seven IRS tests (see details in IRS Instructions for Form 8960):

  1. Participated in the activity for more than 500 hours. The test is 750 hours in all related activities under Sec. 469 regulation. The test under Sec. 1411 assumes the individual has met those rules before applying this rule.
  2. Your participation was substantially all the participation in the trade or business of all individuals for the tax year.
  3. You participated in the trade or business for more than 100 hours during the tax year and participated at least as much as any other individual for the year.
  4. The trade or business activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours.
  5. You materially participated in the activity for any 5 of the 10 immediately preceding tax years.
  6. The trade or business is a personal service activity in which you materially participated for any 3 preceding tax years.
  7. You participated in the trade or business on a regular, continuous, and substantial basis during the year.
  • Your participation in managing the business does not count as material participation if any other person is compensated as a manager or some one else spent more hours than you managing or if you worked 100 hours or less.

Typically rental income is going to be subject to NIIT due to it being classified as a passive activity, unless you meet an exception. For most non-real estate professional businesses and farms it is not uncommon to have multiple flow-through business entities including one that holds assets such as land that rents another entity with the same or similar owner(s). According to the IRS 8960 Form Instructions, first determine if “you provide the property for use in a non-rental activity in your capacity as an owner of an interest in the partnership, S corporation, or joint venture conducting that activity”.  Then use the IRS’ “Special Rules for Certain Rental Income” that states if the rental activity is appropriately “grouped” with a trade or business such as farming in which the taxpayer materially participates, then the rental income is treated as nonpassive and not subject to the NIIT.

There are also specific rules for the disposition of assets that were used in the activity of a trade or business by an individual that is no longer materially participating. For those that retire and continue to hold ownership of assets that are now being rented to the next generation or to those outside the family, they should have a succession plan in place to follow appropriate IRS guidelines and to moderate unnecessary tax burden to the present owner.

Michigan State University Extension recommends that you contact your tax and legal advisors to address your specific situation. Information for this article came from IRS Instructions for Form 8960 or other IRS sources.

For Further information please contact me at akantrov@msu.edu or view the MSUE Farm Information Resource Management webpage.



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