The Department of Treasury Issues Final Regulations Governing Net Investment Income Tax

TaxConnections Blog Post

On Tuesday, November 26th The Department of Treasury released final treasury regulations governing the Net Investment Income Tax (hereinafter “NIIT”) that was included in the Affordable Care Act. The 3.80% tax took effect on January 1, 2013 and applies to individuals, estates and trusts that have certain investment income above certain threshold amounts.

More specifically, individuals will owe the 3.80% tax if they have Net Investment Income and also have “Modified Adjusted Gross Income” above the following thresholds:

Filing Status

Threshold Amount

Married filing jointly


Married filing separately




Head of household (with qualifying person)


Qualifying widow(er) with dependent child


The Final Treasury Regulations Reject the Proposed Treasury Regulations’ Calculation of Gain/Loss on Dispositions of Partnership & S Corporation Interests

One of the more advantageous changes in the final treasury regulations was the rejection of the proposed treasury regulations’ calculation of gain or loss on the disposition of interests in partnerships and S corporations. The Internal Revenue Service (hereinafter the “Service”) agreed with practitioners that the proposed treasury regulations were arduous and imposed an undue administrative burden on taxpayers, including requiring a transferor of a partnership or S corporation interest to obtain information from the entity regarding valuation and tax basis. Consequently, the Service withdrew the proposed treasury regulations on this issue and issued new proposed treasury regulations adopting practitioners’ suggestions. The proposed treasury regulations include two methods of calculating gain or loss includible in net investment income upon the disposition of a partnership or S corporation interest (e.g., a primary method and an optional simplified reporting method) as well as a list of exceptions as to who may use the optional simplified method.

The Service Declines to List Income and Deduction Items Excludible from NIIT

The Service rejected practitioners’ attempts to have the regulations list income and deduction items that are excluded from the calculation of net investment income. The final treasury regulations reconfirm the application of general income tax provisions in the absence of special rules for purposes of the NIIT. However, the final treasury regulations provide, in certain instances, additional guidance on items of income that are or are not included in net investment income. The Service indicated that it may issue other guidance in the future, as necessary, to address the treatment of particular income items whose treatment is not apparent from the general rules of I.R.C. § 1411 and the final treasury regulations or from general income tax rules.

NIIT and Estimated Taxes

The final treasury regulations address practitioners’ complaints that many investors do not know until the end of the year if a pass-through investment will generate net investment income for that year and, as a result, the Service should not penalize taxpayers for failing to include net investment income in their calculation of estimated tax payments. Noting that a similar issue exists for general income tax purposes and special rules provide estimated tax penalty relief in certain situations, the Service rejected calls for providing special relief for estimated taxes and the NIIT.

The Service Rejects Requests to Expand Regrouping Rule

Although practitioners requested otherwise, the final treasury regulations retain the requirement that regrouping under Treas. Reg. § 1.469-11(b)(3)(iv) may occur only during the tax year beginning after December 31, 2012, in which (1) the taxpayer meets the applicable income threshold under I.R.C. §. 1411, and (2) has net investment income. According to the Service, the interaction between I.R.C. § 1411 and I.R.C. § 469 justifies the I.R.C. § 1411 regrouping rule. The Service indicated that if a taxpayer does not have an I.R.C. § 1411 tax liability, there is no reason to expand the regrouping rule to that taxpayer.


Practitioners had questioned the inability of an Electing Small Business Trust (hereinafter “ESBT”) to offset net investment income losses (e.g., capital, ordinary, and/or passive) from one portion of the ESBT with net investment income from the other portion. The Service noted that while the practitioners focused on the annual calculation of net investment income, neither addressed the potential problems from allowing income and losses to offset: (1) loss duplication in carryover years (because loss would offset gain across portions in Year 1 and also be a carryover to Year 2 within the originating portion), or (2) differences in loss carryforwards for general income tax purposes and for NIIT purposes. While the Service agreed with the practitioners that that the method of consolidation may put ESBTs at a computational disadvantage, from a I.R.C. § 1411 perspective, to similarly situated non-grantor trusts in the case of netting of income and losses, it noted that this computational disadvantage exists with regard to the tax imposed under general income tax provisions, and the rules regarding ESBTs adopt general income tax principles.

NIIT and Foreign Estates and Trusts

I.R.C. § 1411 does not address specifically the treatment of foreign estates and foreign non-grantor trusts. The final treasury regulations follow the proposed treasury regulations and provide that foreign estates and foreign trusts are not subject to the NIIT. However, this rule does not exempt U.S. beneficiaries of foreign estates from the application of the NIIT to distributions from foreign estates.

Determining Material Participation of Estates and Trusts

A number of practitioners asked the Service to provide guidance on determining the material participation of estates and trusts. They noted that the enactment of I.R.C. § 1411 has created an additional and compelling reason for the need to determine how an estate or a trust materially participates in an activity. The Service agreed that the practitioners had raised a valid concern but believes additional guidance in this area is more appropriately in I.R.C. §. 469 regulations.

Clarification of the Term “Trade or Business”

The final treasury regulations clarify that the term trade or business, when used in I.R.C. § 1411 and the final treasury regulations, describes a trade or business within the meaning of I.R.C. § 162 and the I.R.C. § 162 reference incorporates judicial interpretations and administrative guidance applicable to I.R.C. § 162.

Partnership Guaranteed Payments and the NIIT

The proposed treasury regulations address the treatment of I.R.C. § 707(c) guaranteed payments under I.R.C. § 1411. The treatment depends on whether the partner receives the payment for services or the use of capital. The proposed treasury regulations exclude all I.R.C. § 707(c) payments received for services from net investment income, regardless of whether these payments are subject to self-employment tax, because payments for services are not included in net investment income. The Service believes that guaranteed payments for the use of capital do share many of the characteristics of substitute interest, and therefore should be included as net investment income.

Partnership § 736 Payments and the NIIT

The proposed treasury regulations address the treatment of partnership I.R.C. § 736 payments pursuant to I.R.C. § 1411. Because the application of the NIIT rules depends on the underlying nature of the payment received, the I.R.C. § 736 categorization controls whether a liquidating distribution is treated as net investment income for purposes of I.R.C. § 1411. Therefore, the treatment of the payment for purposes of I.R.C. § 1411 differs depending on whether the distribution is an I.R.C. § 736(b) distribution in exchange for partnership property or an I.R.C. § 736(a) distribution in exchange for past services, use of capital, or I.R.C. §. 736(a) property. Among I.R.C. § 736(a) payments, the proposed treasury regulations further differentiate the treatment of payments depending on: (1) whether or not the payment amounts are determined with regard to the income of the partnership and (2) whether the payment relates to I.R.C. § 736(a) property or relates to services or use of capital. The proposed treasury regulations generally align the I.R.C. § 1411 characterization of I.R.C. § 736 payments with the treatment of the payments as passive or non-passive under Treas. Reg. § 1.469-2(e)(2)(iii).

In accordance with Circular 230 Disclosure

About the Author
Peter J. Scalise serves as the National Partner-in-Charge of the Federal Tax Credits and Incentives Practice at SAX CPAs LLP. Peter is a highly distinguished member of the Accounting Today Top 100 Influencers and has approximately thirty years of progressive Big 4 and Top 100 public accounting firm experience developing, managing, and leading large scale tax advisory practices on a regional, national, and global level.
Peter also serves as a passionate philanthropist and a member of several Boards of Directors and Boards of Advisors for local, regional, and national charities in connection with poverty and hunger alleviation; economic development; environmental conservation; health and social services; supporting veteran and military service personnel along with preserving arts and cultural programs.

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