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Explore the New IRS Form for Net Investment Income Tax

Bob Keebler goes line by line through Form 8960, Net Investment Income Tax for Individual, Estates and Trusts, to help members understand key elements they need to know for tax season. Access more resources in the Planning After ATRA and NIIT Toolkit, including more podcasts, a customizable letter to send to clients to illustrate why it is important that they meet with you and new charts by Bob Keebler as well as webcast recordings and Forefield Advisor alerts/videos and the complete four-volume set of The CPA’s Guide to Financial & Estate Planning, recently updated for ATRA and NIIT, and much more. (Email subscribers can listen to the podcast on our website.)

IRS Form 8960 Draft Instructions

This podcast was originally recorded Jan. 8.

Transcript:

SARAH BRADLEY:  On behalf of the AICPA Personal Financial Planning Division, this is Sarah Bradley, and I'm joined by Bob Keebler to discuss the draft of the instructions for form 8960, net investment income tax for individual estates and trusts.  Bob Keebler is a partner with Keebler and Associates.  His practice includes family wealth transfer and preservation planning, charitable giving, retirement distribution planning and estate administration.

We're always thrilled to have him bringing the latest information to our members, so without further ado, Bob, I'll let you take it away. 

ROBERT S. KEEBLER, CPA:  Well, thank you Sarah.  It's an honor to be here today.  Before we get started, if you haven't done this already, please print form 8960.  I think for most of us, it's going to help to have the form in your hand when I go through today's materials.

Now also I want to mention to everyone, we just moments ago concluded an interview with David Kirk and Adrienne Micolashek who wrote the regulations, and that's going to be hosted on the AICPA's website too.  So even though this is very hands-on tech-schoolish, that was very, very good from both a practical and theoretical perspective.  They brought a lot of wisdom.  Their knowledge is incredible on these regs that they spent the last two years of their life working on.

Let's jump up to page four.  So right in front of you, if you haven't seen it yet, is the 8960.  This is a draft form, but Dave and Adrienne just told us that this form will not change a lot when it eventually comes out.  So they'll be some tweaking, but not a lot. 

You are going to have to pay close attention.  Up on the front, part one, there are some elections that are kind of nestled in between those first two lines.  The election, when you're -- they call it a 6013(G) election.  It involves individuals that are married and how they're going to be taxed for US purposes when one is not a US citizen. 

There is also regulatory election, which we'll talk about a little bit under 1411-10(G) under the regulations.  Now when we start our form by -- our line-by-line looking at this, basically taxable interest, if you think about this from a computer perspective and if you were writing a computer program to do this, you would just grab taxable interest from the form 1040.  Okay, line 8 or form 41, line 1.

Now that's not always going to be correct because there will be adjustments that are made a little bit later.  So that's going to be very easy.  Now line one does include self-charged interest.  Then you're going to subtract that out later when we get to line 7.  So if you're looking at line 1, now look down to line 7.  You can see that's the other modification.  You would put a subtraction modification or a contra-income modification in at that moment.

Okay, now let's jump up to line 2.  Line 2 is ordinary dividends.  You're going to grab that number off the 1040, but you are going to have to make modification adjustments on line 7.  A great example out of the regs on modification would be someone that worked for, say, Procter & Gamble.  They had Procter & Gamble stock.  They have currently Procter & Gamble stock in their plan.  They take the dividend out of the plan and now it's called a 404 dividend, and now that is not subject to the net investment income tax because the genesis of that is inside a qualified plan which is specifically exempted from the net investment income tax, or what I will call the NIIT.  So the acronym for net investment income tax is the NIIT.

Line 3, we have annuities, annuities from non-qualified plans, and you're going to enter the taxable amount.  That is going to come directly off the 1040 typically, and, you know, basically what you're going to do is pick up the taxable portion of that.  If your total payment was $100, but $25 of that was basis, you would only pay tax on $75. 

Now on line 4, we take from line 17 of the 1040 and we report all our real estate royalties, partnerships, S-corporations, trust distributions, etc.  Now that is only half the story.  Then on line 4B is where the real world happens, is where you make all your adjustments.  For example, if you're a real estate professional, you would subtract your real estate income.  If you're active in a partnership or an S-corporation that has a trade or business, you'll just subtract that out.

If you had distributions from say a charitable remainder trust or grandfathered distributions from the net investment income tax, you would subtract that out.  Those are all areas that we need to pay very close attention to.

Now on line 4B, that's where we enter into our adjustments, and we've kind of laid that out.  But again, it's trade or business income.  It's income if you're a real estate professional.  It's royalties derived in the ordinary course of a section 162 business that is not a passive activity.  Passive losses, former passive activities, other allowed as a deduction the current year by virtue of 469(f)(1)(a).  So those would be our adjustments at that point in time.

So far, this is fairly easy.  Okay?  It's understanding when you are allowed to make these adjustments under 4B that's going to be the hard part, more of the regulatory side of things.  Now line 4C you just combine those two.  That's just math. 

Now 5 deals with capital gain, the gain or loss from the disposition of property.  I sell $500,000 worth of Wells Fargo stock, a fairly easy transaction.  I would put the number on line 5A.  Then basically -- so you're basically going to be combining 1040 lines 13 and 14 or 1041 lines 4 and 7. 

Generally, the income tax rules in IOC chapter one continue to work.  One of the tenets of these regulations has been a great deal of parallelism between the existing tax law under chapter one we've worked with for years and the new tax law under chapter two that's brand new to us.

Generally, the term disposition means a sale, an exchange, a conversion, a cash settlement, a transfer, and we have kind of laid that out.  Now if you incur a gain or loss that is for whatever reason not reported on those lines, you're going to have to make an adjustment and still have to report that.  Okay?  You'll report that on line seven.  So you'll report that on line seven.

Now line 5B is very similar to 4B.  This is where you're going to make modifications.  For example, if you have a gain on the sale of a home, you're able to pull that out, or a 1031 exchange.  If we have a gain on the sale of a business, if we have a gain on the sale of real estate and we're a real estate professional, none of that would be subject to the net investment income tax, and we will subtract that out.

Now line 13, all we're doing -- I'm sorry, line 5B, slide 13 is where we are right now.  But line 5B, again, is where we're making these modifications, and line 5C is nothing but math.  So far, so good.

Basically, under C, we made an adjustment for the disposition of partnership interest or S corporation stock, basically items that are exempt -- items that are exempt from the net investment income tax.  And then you have to attach a statement as described in the required statement section of the instructions to your return explaining what you did.

Now this will be hard, and it's going to be very hard the first three or four times we do this when we basically have to figure out how much is excluded.  Many times, not all of a business sale will actually be excluded, but only a portion of that business sale. 

Okay, let's go over to the next slide.  Now on line 6, we have adjustments attributable to controlled foreign corporations and a PFIC.  If you own stock directly or indirectly in a CFC or a PFIC, you're going to use line 6 to make adjustments necessary to calculate your net investment income. 

If there is enough demand for it, we will evaluate -- the AICPA will evaluate whether we can put together another podcast just dealing specifically with the international aspects of the net investment income tax.

Line 7 and 8, what we're doing on line 7 and 8 is this is other modifications to investment income.  These could be positive or negative.  We'll use line 7 to report additional net investment income modifications to net investment income that are not otherwise specified in lines 1 through 6.  We want to look at the instructions or examples of additions for examples of additions and modifications to net investment income that would be reported on line 7. 

Reading the instructions -- actually, the instructions are quite well done.  Now one item is a deduction recovery.  What is a deduction recovery?  If I took a deduction in 2013, on my 2013 return for state income taxes, and then part of that was refunded to me by the state, that would be an example of a deduction recovery.  That would be a real good example of a deduction recovery. 

Now on line 8, line 8 is nothing but math.  It's where I add everything up to come up with my total investment income.  Now that is not the entire story because, of course, I need to get to what?  I need to get to net investment income. 

So now, I go to part 2 -- parts 2 and 3 of the form.  Okay?  And part 2 deals with investment expenses allocable to investment income and modifications where part 3 jumps into the actual tax computations.  Now the first thing we see is line 9A are investment interest expenses.  Now so I would take off of my itemized deduction form that number and possibly drop that right on line 9A.  That would be interest expense you paid or accrued during the year from schedule A.

Generally, you're going to be on the cash basis of accounting, so it's going to be interest you actually paid.  Now observation -- you are using the same cash or accrual basis that you used to prepare your 1040.  There is no going to a different accounting method for the NIIT.  You're going to be using the same method.  Okay. 

Now you enter form -- you basically will put this -- your interest expense on here.  Now observation, it's not always that easy.  Okay?  It's not always that easy because many times you are going to run into a -- either the 2% floor limitation under section 67 or the 3% PEASE limitation under 68. 

Now remember interest expense is not subject to those things, but items like state taxes would be.  Okay?  So we have to be very cognizant of that.  Okay, now let's jump to the next slide please.  State income taxes -- interestingly enough, is this were not complex enough, state income taxes are deductible to the NIIT to the extent that they are attributable to net investment income.

Let's make this real clear.  I earned $1 million worth of interest, dividends and capital gains.  That's my only income for the year, and I paid $80,000 worth of state taxes.  At the end of the day when all is said and done, I'm going to get to deduct that $80,000 on line 9B, reducing -- which will eventually reduce my total investment income. 

Now I'm on the cash basis of accounting.  You know, I'm thinking I'm a real smart guy.  I'm not going to pay that until April 15.  Maybe you're not so smart.  What if in year one, 2013, you had $20 million worth of income from the sale of your business, of which you paid $1.8 of California tax and in year two your income was $300,000.  Now you're trying to deduct that $1.3 of California tax.  It's not going to work.  You're not going to get that benefit.  Okay?  So you want to make sure you're matching those up very, very carefully.

Now this may be all or part of the amount you reported on schedule A, line -- form 1040, line 5A.  It just depends on how much other income you have.  Normally for individuals that are working or retired, it's -- you're going to have to do some math here because I'm going to have income tax to pay on my IRA distribution.  I'm going to have income tax to pay on my wages.

Now for purposes of line 9B, sales taxes are not deductible in computing net investment income.  We're talking about state income taxes.  Now state income taxes are subject to the 3% PEASE limitation, but they are not subject to the 2% floor on miscellaneous itemized deductions. 

So that is what's happening on line 9B.  Actually, I think part 2 of the form is almost more complicated than part 1.  Okay, let's jump up to the next slide, please.

Lines 9C and 9D, those are miscellaneous investment expenses.  These are miscellaneous investment expenses is allowed -- is subject to the 2% floor for section 67 or the 3% PEASE limitation.  So that's -- that's where we are right there. 

Now that's important for all of us to have our mind around because you're not going to be able to go right to schedule A and grab those numbers from your schedule A on your 1040 and bring those over to line 9C.  We're going to have to make some adjustments. 

There is a very extensive worksheet.  What Dave Kirk and I agreed to do is we are going to interview him and Adrienne again and go through that worksheet, just so that everyone that is actually maybe preparing these returns can have the opportunity to hear directly from the author of the regulations how that worksheet works.

David Kirk is very, very good with math and these mathematical relationships.  He's very impressive.  So you want to listen to that when it comes out.

Okay, line 10, additional modifications.  So basically, we're going to use line 10 of form 8960 to report additional deductions and modifications to net investment income that are not reflected on these first lines.  Okay?  So that's going to be what we pick up. 

Now -- so you're going to enter those.  Typically, those are going to be positive numbers when we put that together.  Now in line 11, will be total deductions.  So line 11 is going to be total deductions, and then finally we get to line 12, which is nothing more than taking line 8 minus line 11.  That cannot be less than 0 though. 

This is one thing from a planning perspective we're going to have to watch out for because it is possible because of a mismatch from an accounting perspective that we are not going to have enough.  For example, you pay your state income taxes on April 15 after that $20 million gain and your state income taxes are $1.8, but your net investment income that particular year is only $800,000.  You're going to have negative net investment income.  You can't do that, okay?  You're going to enter a zero on that line and you will have lost that benefit.  So we want to be very careful with that from a planning perspective.

Now for individuals or estates and trusts, individuals -- when you get into the payment section or computational part, individuals would do lines 13 through 17.  Estates and trusts are going to work from 18A through line 21.  That's fairly mechanical. 

On the individual side of things when we start looking at line 13, basically, that's your modified adjusted gross income and that is going to be the front page of your 1040 and then you're going to make adjustments for income that you've excluded under section 911 of the code.  So basically, for example, foreign earned income.

There will be a number of other -- several smaller modifications that you also have to work through.  Then you have to compare your modified adjusted gross income to the threshold amounts.  So you'll compare those to the threshold amounts.  And after you've compared those to the threshold amounts, you'll take your modified adjusted gross income on line 13, subtract out the threshold amount, and if that is less than zero, you can stop.  You will not have to pay a penny.  You will not have to pay a penny of net investment income tax because you have not exceeded the threshold. 

Now on line 15, we want to -- what we're going to do is we're going to just do the math.  If it's 0 or less you're going to enter 0.  On line 16, you're going to enter the smaller of line 12 or line 15.  Now this is a lesser-of equation.  So now, we have a number on line 12, which is coming from line 8 minus line 11 and we have our threshold amount, and we're going to have to decide what do we include in there.

We include on line 16 the smaller of line 12, our net investment income, or line 15, the amount our MAGI exceeds the threshold.  Now if line 15 was zero or less, we put nothing on line 16.  It's that straightforward, so it's actually very easy. 

Now once we get a little bit further, we multiply that by .038% and we enter that.  Now when we're working on estates and trusts, this works a little bit differently.  We multiply line 16.  We do the same transaction again and then we multiply that and we enter it on form 1040.

When we're working with estates and trusts, we have to take net investment income from line 12 and then we have to subtract from that.  I'll walk you through that.  Let's go up to slide 30, please.  So on line 12, we basically have net investment income.  Okay?  So then, we subtract from that deductions for distributions of net income and deductions under section 642(C).

What are we talking about?  We're talking about I have a trust that I set up for my children.  The trustee pays my children $100,000 one year.  That $100,000 carries out to them as DNI.  They have to pick that up on their income tax return.  Let's say the trust had net investment income of $110,000.  There would be a deduction for $100,000, leaving $10,000 of income trapped within the trust.  Okay?  That's typically the nomenclature when we're doing this.  

Now under -- then what we have is that our undistributed net investment income.  Our threshold amount, of course, is going to be last year $11,950.  Okay?  So that is our threshold amount.  So if we're over that, we're going to pay the tax. 

Guidance on calculating an estate or trust AGI for regular tax purposes can be found in the instructions to form 1041 on line 17.  If the estate or trust does not own a CFC or PFIC, enter the estate or trust AGI for regular tax purposes.

If you own a PFIC, you may need to modify that.  Again, if there is enough need, let us know and we will try to do something specifically on the international aspects of all of this. 

Okay, when we jump up to lines 19, that's the highest bracket for estates and trusts, and line 19C is just a subtraction.  Basically, that's when we start to compute.  Up on line 20 we multiply the income of the estate or trust by 3.8%. 

Now this has been a very quick run-through of the forms.  Let's just go a little bit further.  I have an appendix here, which talks about netting losses for NIIT purposes.  We may come back and do that at some point in time in the future.  And then on slides 38, we go into more detail on 67 and 68 limitations.  Again, I'll come back to that.

I think what's important for all of us to know right now is the companies that write our software, all of our software together, those 100 or 200 companies that are in this marketplace, are scrambling to come up -- to create form 8960 and to integrate into that the section 67 and 68 limitations.  So those are -- it's very important for us to have our mind around the fact that many people are going to be working the next four or five weeks to make this work. 

But once that comes out, once those forms come out, those forms cannot be taken like the gospel truth because we need to look back and make sure we agree with the computations.  At least for the first two or three years we're going to have to be doing some hand testing to make sure that the software is handling this right, especially when there are a lot of dollars involved. 

Now again, 67 is your basically your 2% adjusted -- excuse me -- 2% floor on miscellaneous itemized deductions of section 67 and the overall limitation on itemized deductions in section 68.  We'll come back to this and cover it in some very, very painful detail. 

A brief example on page 43, Gary and Barb have passive interest on a number of investments that generate investment income of $50,000.  Assume the surtax applies to the NIIT.  $5,000 of the expenses attributable to the investments or miscellaneous expenses.  $25,000 of expenses attributable the investments are itemized deductions not subject to the 2% floor.  In total, they itemize $50,000 in exemption -- in deductions after taking into account the 2% limitation on miscellaneous deductions, reducing their deductions for PEASE.  A reduction of $30,000 is then going to be allowed against the NIIT. 

So what we have is that would be the number that would carry over to the NIIT. 

Okay, let's jump up to page 45 please.  Before I conclude, there are a number of resources available for post-ATRA and NIIT planning.  We have those on slide 45, and the AICPA has asked me to mention this. 

In conclusion, thank you for joining us today.  The net investment income tax is going to be our next challenge as a profession.  At least for this tax season it's going to be a challenge.  We have to get our mind around this.  The AICPA is very much committed to helping you help your clients.

On behalf of the AICPA, this has been Bob Keebler, and thank you for joining us today. 

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