The NIIT is a 3.8% tax that is applied on certain investment income, effective from January 1, 2013, and was brought into effect by section 1411 of the Internal Revenue Code (IRC.
The NIIT is applied to the lesser of the individual’s:
- Total net investment income; or
- their “modified adjusted gross income” (MAGI) that exceeds the following thresholds, (based on their tax filing status):
- Single: USD $200,000
- Married Filing Jointly: USD $250,000
- Married Filing Separately: USD $125,000
MAGI includes a taxpayer’s ‘Adjusted Gross Income’ (included at line 37 of your US income tax return), increased by the difference between the taxpayer’s foreign earned income (defined in IRC section 911(a)(1) as any amount received by an individual from sources within a foreign country attributable to services performed by such individual) and any deductions or exclusions.
Based on the IRC definitions, “net investment income” is essentially passive income such as:
- income from interests, dividends, annuities, royalties and rents;
- net gains attributable to the disposition of property (including residential property as well as gains from the sale of partnerships and S-corps) other than property held in trade of business; and
- income derived from trade or business by passive activity or trading financial instruments or commodities.
Points to note:
- The NIIT does not apply to any portion of a gain that is excluded from regular income tax. Therefore, gains from sale of a principal residence are excluded from the NIIT unless the gain exceeds the principal residence exclusion amount of $250,000 (for a single filer) or $500,000 (if married filing jointly), as applicable.
- Non-resident Aliens (NRAs) – individuals that are neither US citizens nor US residents – are not subject to the NIIT . The US Treasury Regulations state that in the case of a US citizen or resident who is married to a nonresident alien individual, the spouses will be treated as married filing separately for purposes of section 1411 (the NIIT provision of the Internal Revenue Code). The US citizen or resident spouse will be subject to the threshold amount for a married taxpayer filing a separate return, and the nonresident alien spouse will not be subject to the NIIT.
- Foreign tax credits may not be used to reduce NIIT exposure in the US as they are only allowed to offset a tax liability on regular income tax – foreign tax credits are only allowed against taxes imposed by IRC Chapter 1. Cf. NIIT is included under IRC Chapter 2A).
- If the NRA is an Australian tax resident with US citizenship (and therefore liable to pay NIIT), then a foreign income tax offset (FITO) may be claimed in Australia as the income is included in assessable income in Australia (ass Australian tax residents are taxed on worldwide income), the NIIT is a “foreign income tax” for the purposes of the FITO rules, and the US-Australia income tax treaty applies to all US Federal income taxes imposed by the IRC (Art 2(1)(a) of the Treaty). However, this is subject to the FITO limit in section 770-75 of the Income Tax Assessment Act 1997 and the fact that only half of the foreign tax would be allowed as an offset if the capital gains tax 50% discount applies (Burton v Commissioner of Taxation  FCAFC 141).
The table below applies the NIIT rules to a few common scenarios:
|Scenario 1: US citizen/ green card holder residing in the US selling a vacation property outside of the US
– The gain from the sale of the property is subject to NIIT.
|Scenario 3: Resident alien sells interest in a foreign partnership
– NIIT applies if the partnership interest is not held in a trade or business.
|Scenario 2: US citizen/green card holder (single filing status) sells primary residence in the US, with a cost basis of $700,000 for $1,000,000
– The NIIT applies to the portion of the gain that is included in regular income tax – $50,000 (being the proceeds $1 million less cost basis $700,000 less principal residence exclusion $250,000).
|Scenario 4: NRA sells property in the US
– NIIT would not apply, unless the NRA is married to a US citizen or resident, and elects to file as ‘married filing jointly’ status.
For more information please contact:
Senior Tax Advisor
US-Australia Tax Desk