The comprehensive tax reform laid out in the Tax Cuts and Jobs Act undoubtedly represents the most significant overhaul of the U.S. tax code, and tax system in general, in several decades. Its success or failure over time could very well determine the fiscal legacy left by Donald Trump’s presidency.
While many of the provisions laid out in early iterations of the GOP-led tax reform came to fruition under the enacted legislation, one glaring exception is the originally planned repeal of the 3.8% Net Investment Income Tax.
The NIIT
To briefly explain how the tax works, taxpayers who have income from investments (such as interest, dividends, capital gains, rental and royalty income, among others) are generally subject to a 3.8 percent tax on the lesser of their net investment income or the amount by which their modified adjusted gross income exceeds certain statutory threshold amounts based on their filing status.
The threshold amount for married taxpayers filing jointly is $250,000, for single and head of household taxpayers is $200,000, and it is $125,000 for married taxpayers filing separately.
Initial Calls for Repeal
Some original tax plan proposals specifically called for the repeal of the Net Investment Income Tax, and the political motivations for doing so seemed self-evident at the time. The NIIT was enacted under the 2010 health care legislation in order to help partially raise funds to pay for the Affordable Care Act. Republicans have since been looking to abandon both the health care system and the taxes imposed in order to fund it.
However, near the end of negotiations, according to a Dow Jones news report, Congressional Republicans began considering keeping the tax intact in order to fund other government initiatives, such as paying subsidies to healthcare consumers who acquire insurance or other ways of making insurance more affordable for low-income households.
The Effects of Non-Repeal
One of the bigger surprises in the final Republican tax reform bill was the retention of the NIIT. Retention of the tax comes with a number of implications, depending on the tax profile of the individual.
For U.S. citizens living abroad, for instance, the Net Investment Income Tax can be particularly significant. This is because the foreign tax credit cannot be used to reduce the tax. Consequently, a U.S. citizen living abroad who otherwise has 100% foreign-source income and sufficient foreign tax credits to credit against such income can still end up paying U.S. federal income taxes by virtue of the NIIT.
Questions still remain as to how the NIIT will be applied in the case of new categories of income that were created by the Tax Cuts and Jobs Act of 2017 for U.S. persons with concerns abroad. One example is "global intangible low-taxed income" (GILTI), basically non-routine income of a controlled foreign corporation (CFC), which must be currently included as income by certain of the CFC’s U.S. shareholders. For now, it is unclear whether the surtax should be applied to GILTI inclusions, although most tax practitioners believe that the IRS will advise that it should be included due to the generally passive nature of the income.
For now, it looks like the Net Investment Income Tax is here to stay. Further published guidance by Treasury and IRS will be welcome in order to understand the nuances of the particular tax moving forward.
After spending the majority of their respective careers at two of the largest accounting firms (PwC and Ernst & Young), Joshua Ashman (jashman@expattaxprofessionals.com) and Ephraim Moss (emoss@expattaxprofessionals.com) founded Expat Tax Professionals, a firm specializing in the needs of U.S. citizens living abroad. You can visit the firm’s website at www.expattaxprofessionals.com.
