Net Investment Income Tax
International Assignment Services Alert
Net Investment Income Tax
October 2013
The Net Investment Income Tax
(NIIT) went into effect on January
1, 2013 as part of the Health Care
and Education Reconciliation Act
of 2010. The NIIT will impose a
3.8% tax on various types of
investment income to individuals,
trusts, and estates in excess of
certain thresholds. The new tax is
also part of the tax payment
requirements for 2013 (i.e.,
estimated tax payments).
Understanding the Net Investment
Income Tax and its impact on US
taxpayers in Japan
Individuals with Modified Adjusted Gross Income
(MAGI) above USD 200,000 for single and head of
household taxpayers; USD 125,000 for married filing
separately taxpayers; and USD 250,000 for married
filing jointly and qualifying surviving spouse may be
subject to the NIIT. The threshold for trusts is USD
11,950. Most taxpayer’s MAGI is equal to their
Adjusted Gross income (AGI). The difference between
the two is that deductions under Internal Revenue
Code §911 dealing with foreign earned income
exclusions are added back to AGI to arrive at MAGI.
An item to be aware of is that only the foreign earned
income exclusion is added back to the AGI; the
housing exclusion is not.
Please note that the NIIT is separate from the payroll
Medicare Tax paid through FICA tax withholdings.
Thus, individuals who are exempt from FICA
Medicare Tax withholdings may still be subject to the
NIIT if they have net investment income above the
applicable threshold.
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Example — Bill is single ($200,000 NIIT threshold) and is no longer paying into the US social security system.
He has wage income of $185,000 and interest income of $25,000. He has no itemized deductions. His MAGI is
$210,000. He is subject to NIIT on $10,000 — the lesser of net investment income ($25,000) or income above
the threshold ($10,000).
Investment income includes gross income from interest, dividends, annuities, rents, and royalties (other than
derived from an active trade or business), as well as net capital gain. Other income will also be subject to the
new tax, including income from limited partnerships or from other pass-through entities in which a taxpayer
does not materially participate (as determined under the passive activity loss rules). Certain types of income
have been excluded from the definition of NIIT, e.g. earned income – wages and self-employment income, so
called active trade or business income, distributions from qualified retirement plans or IRAs, social security
benefits, exempt interest on municipal bonds, and excludable portion of gain on a primary residence sale. Note
that even though these items are not subject to NIIT, they will be components in making up AGI/ MAGI (and
thereby, increasing the likelihood that the tax will apply).
Certain deductions may be taken against net investment income. Some of these include investment interest
expense, investment expense, and allocable state and local income taxes. These expenses are allowed to the
extent they are deductible when calculating ordinary income for regular tax purposes. Inclusion of income from
Controlled Foreign Corporations (CFCs) and Passive Foreign Investment Companies (PFICs) are based on a
number of circumstances and elections which should be evaluated on case by case basis. If you have investments
in CFCs and/or PFICs, you should consult with your tax advisors regarding your various options.
One major unique feature of this NIIT is the diversion from the regular foreign tax credit (FTC) concept.
Because of how the new NIIT is codified in the Internal Revenue Code, FTC cannot be used to offset the NIIT. A
similar result may occur on the Japan side. Although this may not have been the intended result, it potentially
could also lead to double taxation for US citizens (or greencard holders) who are permanent resident taxpayers.
Clarification is needed from the IRS on this FTC matter and whether treaty relief may be available. However,
until such clarification is obtained, US taxpayers who have not needed to make U.S. estimated tax payments in
the past may now be required to make payments for the 2013 tax year due to this FTC disallowance.
Example A — Mike is a single ($200,000 NIIT threshold) expatriate who lives in Japan for the entire tax year.
His wage income is $349,700 and he has $35,000 of interest and dividend income. He has no itemized
deductions, and is able to take the full Foreign Earned Income Exclusion and Housing Exclusion in Tokyo of
$97,600 and $117,100 respectively. Mike's AGI is $170,000 (349,700 – 97,600-117,100 + 35,000); however, his
MAGI would be calculated as $267,600 (170,000 + 97,600). He is subject to NIIT on $35,000 — the lesser of
net investment income ($35,000) or income above the threshold ($67,600).
Example B – Same facts as above, we will also assume that Mike has enough eligible Foreign Tax Credits to
cover all the income tax on his AGI of $170,000 with $2,000 of FTC leftover. However, Mike will still have a tax
due of $1,330 from NIIT (35,000 x 3.8%) because he is not allowed to use the remaining $2,000 of FTC to offset
his NIIT.
Non-resident Aliens (NRAs) are not subject to the NIIT. In the case of a U.S. citizen or resident who is married
to a non-resident alien, and the NRA elects to be treated as a US resident to file a joint tax return, the spouses
will nevertheless be treated as married filing separate (MFS) taxpayers for the purposes of calculating NIIT. The
U.S. citizen or resident spouse will be subject to the threshold amounts for a MFS taxpayer, and the nonresident alien will not be subject to NIIT. Under general income tax rules, married taxpayers in which the
spouse is a U.S. citizen or resident who is married to a NRA may elect US residency to file a joint Federal income
tax return. For purposes of NIIT, another separate election can be made for the NRA spouse’s income to be
included in the NIIT calculation.
Example 1 – Lucy, a U.S Citizen is married to Ricky, a NRA. Ricky has elected to be treated as a US resident and
they have elected to file a joint Federal income tax return but have not elected to have Ricky’s investment
income included for NIIT tax purposes. Lucy has wage income of $120,000 and interest income of $25,000.
She has no itemized deductions. Her modified adjusted gross income is $145,000. Ricky has wage income of
$100,000 and he has $15,000 of interest and dividend income. He has no itemized deductions. Ricky's
modified adjusted gross income is $115,000. As they have not elected to include Ricky’s investment income,
Lucy is treated as MFS for NIIT purposes and Ricky’s investment income is disregarded. As such, Lucy’s NIIT
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threshold is $125,000; she will be subject to NIIT on $20,000 — the lesser of net investment income ($25,000)
or income above the threshold ($20,000).
Example 2 - Same facts as above, except Lucy and Ricky have elected to include Ricky’s net investment income.
This moves the NIIT threshold to $250,000. Lucy and Ricky’s combined wage income is $220,000 and they
have $40,000 in interest and dividend income. Together, they are subject to NIIT of $10,000 – the lesser of net
investment income ($40,000) or income above the threshold ($10,000).
As the Internal Revenue Service had just issued a draft tax form of the NIIT and is still soliciting public
comments on its proposed regulations, there may be further clarification on certain items as discussed above
and the issuance of final regulations. PwC will provide an update once the information becomes available.
For more information, please consult your international tax representative or contact
any of the following members listed below:
Zeirishi-Hojin PricewaterhouseCoopers
International Assignment Services
Kasumigaseki Bldg. 15F, 2-5, Kasumigaseki 3-chome, Chiyoda-ku, Tokyo 100-6015
Telephone: 81-3-5251-2400,
Nasir Majid
[email protected]
Marcus Wong
81-3-3539 6406
[email protected]
Amy Tsang
81-3-3539 6330
[email protected]
James Harris
[email protected]
Andrew Greathouse
[email protected]
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