Definitions of NII
Modified Adjusted Gross Income (MAGI)
Is the taxpayer’s adjusted gross income (AGI) - increased by the amount excluded from income as foreign earned income under Code Sec. 911(a)(1) (net of the deductions and exclusions disallowed for the foreign earned income). (Code Sec. 1411(d))
Net Investment Income
“Net” investment income (NII) is investment income reduced by investment expenses allowed which are allocable to the investment income.
Investment Income
(Explained in more detail later in the chapter) Investment income includes gross income from:
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Interest, dividends, non-qualified annuities, and royalties,
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Rents (other than derived from a trade or business),
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Capital gains (other than derived from a trade or business),
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Trade or business income that is a passive activity with respect to the taxpayer, and
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Trade or business income with respect to trading financial instruments or commodities.
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Prorated state and local income tax refunds - Since prorated taxes are allowed as a deduction against NII, then appropriate refund of those taxes must be allocated to NII in the year the refund is received.
Exclusions from Gross Income
For surtax purposes, gross income doesn't include excluded items, such as interest on tax-exempt bonds, veterans' benefits, and excluded gain from the sale of a principal residence (Code Sec 1411(d)).
Investment Expenses
Expenses allowable in computing NII include deductions that are properly allocable to items of Gross Investment Income. Examples include (IRS Q&A 12):
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Investment interest expense,
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Investment advisory and brokerage fees
(1), -
Expenses related to rental and royalty income, and
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State and local income taxes properly allocable to items included in Net Investment Income
(2).
(1) For years before 2018 and after 2025, these
items are included in a taxpayer’s itemized deductions. The amounts, when allowed, are
after the reduction of miscellaneous deductions by 2% of AGI and after the
Pease limitation (phase out of itemized deductions) for Schedule A deductions
for higher income taxpayers. If a taxpayer claims the standard deduction,
investment income may not be reduced
by these expenses when computing NII. Per TCJA, investment expenses includible as Tier 2 miscellaneous deductions are not deductible for years 2018 through 2025. Thus, these investment expenses are not deductible in determining NII for those years.
(2)State and local income taxes (up to the SALT limitation) are
deductible as an itemized deduction but are not part of the Tier 2
miscellaneous deductions.
If a credit is claimed for foreign income taxes, those foreign taxes are not deductible in computing net investment income.
The Surtax Does Not Apply in These Instances
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Income from other trades or businesses conducted by a sole proprietor, partnership, or S corporation (Committee Report)., However, income, gain, or loss on working capital isn't treated as derived from a trade or business and thus is subject to the tax (Code Sec. 1411(c)(3)).
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A nonresident alien,
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A trust of all the unexpired interests in which are devoted to charitable purposes,,
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A trust that's tax-exempt under Code Sec. 501,
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A charitable remainder trust tax-exempt under Code Sec. 664 or
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Distributions from qualified retirement plans (qualified pension, stock bonus or profit-sharing plans; qualified annuity plan; tax-sheltered annuity plan; traditional and Roth IRAs; Sec. 457(b) plans of state and local governments and tax-exempt organizations).
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Self-employment income for such taxable year on which the 0.9% HI surtax tax is imposed.