One of the more significant changes to the tax landscape in recent years is the new 3.8% tax on net investment income under Sec. 1411. This tax, which was further clarified in recently finalized regulations, will affect many entities and taxpayers including S corporations and their shareholders. The following discussion outlines noteworthy aspects of these rules pertaining to S corporations and their owners.
Effective for tax years beginning on or after Jan. 1, 2013, Sec. 1411 imposes a tax of 3.8% on the lesser of (1) an individual’s net investment income or (2) the excess (if any) of the taxpayer’s modified adjusted gross income over certain thresholds. Sec. 1411(c) defines net investment income as the sum of:
- Gross income from interest, dividends, annuities, royalties, and rents (other than such items that are derived in the ordinary course of a trade or business that is not a passive activity with respect to the taxpayer or trade or business of trading in financial instruments or commodities);
- Gross income from passive activities under Sec. 469 with respect to the taxpayer or from the trade or business of trading in financial instruments or commodities; and
- Net gain attributable to the disposition of property other than property held in a trade or business that is not a passive activity with respect to the taxpayer or a trade or business of trading in financial instruments or commodities.
Net investment income is reduced by certain allowable expenses, as detailed in Regs. Sec. 1.1411-4(f).
Issued on Dec. 2, 2013, the final regulations under Sec. 1411 (T.D. 9644) generally apply to tax years beginning after Dec. 31, 2013. While the final regulations clarify many areas of uncertainty under the prior proposed regulations, several issues remain for S corporations and their shareholders to consider with respect to Sec. 1411.