Net Investment Income Tax 3.8% – Does not include Self Employment Income

Here is the regulation concerning the new Net Investment Income Tax as it applies to self employment income.  I wrote a blog post on this topic.

26 C.F.R. § 1.1411-9 Exception for self-employment income.  (a) General rule. Except as provided in paragraph (b) of this section,net investment income does not include any item taken into account indetermining self-employment income that is subject to tax under section1401(b) for such taxable year. For purposes of section 1411(c)(6) and thissection, taken into account means income included and deductions allowedin determining net earnings from self-employment. However, amountsexcepted in determining net earnings from self-employment under section1402(a)(1)-(17), and thus excluded from self-employment income undersection 1402(b), are not taken into account in determining self-employmentincome and thus may be included in net investment income if such amountsare described in § 1.1411-4. Except as provided in paragraph (b) of thissection, if net earnings from self-employment consist of income or lossfrom more than one trade or business, all items taken into account indetermining the net earnings from self-employment with respect to thesetrades or businesses (see § 1.1402(a)-2(c)) are considered taken intoaccount in determining the amount of self-employment income that issubject to tax under section 1401(b) and therefore not included in netinvestment income.  (b) Special rule for traders. In the case of gross income described in§§ 1.1411-4(a)(1)(ii) and (a)(1)(iii) derived from a trade or business oftrading in financial instruments or commodities (as described in §1.1411-5(a)(2)), the deductions described in § 1.1411-4(f)(2)(ii) properlyallocable to the taxpayer’s trade or business of trading in financialinstruments or commodities are taken into account in determining thetaxpayer’s self-employment income only to the extent that such deductionsreduce the taxpayer’s net earnings from self-employment (after aggregatingunder § 1.1402(a)-2(c) the net earnings from self-employment from anytrade or business carried on by the taxpayer as an individual or as amember of a partnership). Any deductions described in § 1.1411-4(f)(2)(ii)that exceed the amount of net earnings from self-employment, in theaggregate (if applicable), are allowed in determining the taxpayer’s netinvestment income under section 1411 and the regulations thereunder.  (c) Examples. The following examples illustrate the provisions of thissection. For purposes of these examples, assume the taxpayer is a UnitedStates citizen, uses a calendar taxable year, and Year 1 and allsubsequent years are taxable years in which section 1411 is in effect:  Example 1. Exclusion from self-employment income. A is a general partnerin PRS, a partnership carrying on a trade or business that is not a tradeor business of trading in financial instruments or commodities (within themeaning of § 1.1411-5(a)(2)). During Year 1, A’s distributive share fromPRS is $1 million, $300,000 of which is attributable to the gain on thesale of PRS’s capital assets. Section 1402(a)(3)(A) provides an exclusionfrom net earnings from self-employment for any gain or loss from the saleor exchange of a capital asset. For Year 1, A has $700,000 self-employmentincome subject to self-employment tax. This $700,000 subject toself-employment tax is not included as part of net investment income underparagraph (a) of this section. However, the $300,000 attributable to thegain on PRS’s sale of a capital asset is excluded from net earnings fromself-employment, and from self-employment income, and thus is not coveredby the exception in section 1411(c)(6). Therefore, the $300,000attributable to the gain on PRS’s sale of a capital asset is included asnet investment income if the other requirements of section 1411 aresatisfied.  Example 2. Two trades or businesses. B is an individual engaged in twotrades or businesses, Business X and Business Y, neither of which is thetrade or business of trading in financial instruments or commodities (asdescribed in § 1.1411-5(a)(2)). B carries on Business X as a soleproprietor and B is also a general partner in a partnership that carrieson Business Y. Business Y is a nonpassive activity of B. During Year 1, Bhad net earnings from self-employment consisting of the aggregate of a$50,000 loss (that is, after application of the exclusions under section1402(a)(1)-(17)) from Business X, and $70,000 in income (after applicationof the exclusions under section 1402(a)(1)-(17)) from B’s distributiveshare from the partnership from carrying on Business Y. Thus, B’s netearnings from self-employment in Year 1 are $20,000. For Year 1, all ofB’s income, deductions, gains, and losses from Business X and distributiveshare from the partnership carrying on Business Y, other than thoseamounts excluded due to application of section 1402(a)(1)-(17), are takeninto account in determining B’s net earnings from self-employment andself-employment income for such taxable year. Accordingly, in calculatingB’s net investment income (as defined in § 1.1411-4) for Year 1, B willnot take into account the items of income, loss, gain, and deduction thatcomprise B’s $50,000 loss attributable to Business X (after application ofthe exclusions under section 1402(a)(1)-(17)), and the items of income,loss, gain, and deduction that comprise B’s $70,000 distributable shareattributable to B’s general partnership interest (after application of theexclusions under section 1402(a)(1)-(17)). Rather, only items of income,loss, gain, and deduction from the two separate businesses that wereexcluded from the calculation of B’s net earnings from self-employmentincome due to the application of the exclusions under section1402(a)(1)-(17), such as any capital gains and losses excluded undersection 1402(a)(3), are considered for purposes of calculating B’s netinvestment income for Year 1 in connection with these two trades orbusinesses.  Example 3. Special rule for trader with single trade or business. D isan individual engaged in the trade or business of trading in commodities(as described in § 1.1411-5(a)(2)). D made a valid and timely electionunder section 475(f)(2). D derives $400,000 of trading gains, which aregross income described in § 1.1411-4(a)(1) and $15,000 of expensesdescribed in § 1.1411-4(f)(2)(ii) from carrying on the trade or business.Pursuant to sections 475(f)(1)(D) and 1402(a)(3)(A), none of the grossincome is taken into account in determining D’s net earnings fromself-employment and self-employment income. Therefore, under paragraph (a)of this section, the $400,000 of gross income is not covered by theexception in section 1411(c)(6). Because D had $0 net earnings fromself-employment, the $15,000 of deductions did not reduce D’s net earningsfrom self-employment under paragraph (b) of this section and §1.1411-(4)(f)(2)(ii). Therefore, the $15,000 of deductions may reduce D’sgross income of $400,000 for purposes of section 1411.  Example 4. Special rule for trader with multiple trades or businesses. Eis an individual engaged in two trades or businesses, Business X (which isnot a trade or business of trading in financial instruments orcommodities) and Business Y (which is a trade or business of trading infinancial instruments or commodities (as described in § 1.1411-5(a)(2)). Emade a valid and timely election under section 475(f) with respect toBusiness Y. During Year 1, E had net earnings from self-employment fromBusiness X of $35,000. During Year 1, E also had $300,000 of tradinggains, which are gross income described in § 1.1411-4(a)(1) and $40,000 ofexpenses described in § 1.1411-4(f)(2)(ii) from Business Y. E’s $300,000of gross income from Business Y is excluded from net earnings fromself-employment and self-employment income pursuant to sections475(f)(1)(D) and 1402(a)(3)(A). E’s $40,000 of deductions from Business Yreduce E’s $35,000 of net earnings from self-employment from Business X to$0. Pursuant to paragraph (b) of this section and § 1.1411-4(f)(2)(ii),the remaining $5,000 of deductions from Business Y are taken into accountin determining E’s net investment income (by reducing E’s gross income of$300,000 from Business Y to $295,000) for purposes of section 1411.  (d) Effective/applicability date. This section applies to taxable yearsbeginning after December 31, 2013. However, taxpayers may apply thissection to taxable years beginning after December 31, 2012, in accordancewith § 1.1411-1(f).

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