Net Investment Income Tax Handicaps Those Meant to Benefit

June 25, 2015

The Net Investment Income Tax (NIIT), now in its third year, is becoming an ironic story of unfortunate unintended consequences.

The NIIT was passed in the Health Care and Education Reconciliation Act of 2010, following the passage of the Affordable Care Act. The tax designed to help pay for mounting Medicare costs following healthcare reform. Working as designed, the NIIT taxes unearned income, such as dividends, rents, and capital gains, above a certain amount at a 3.8 percent rate.

The NIIT threshold is theoretically designed to tax only high income taxpayers, but the low threshold and complicated methods through which trusts are taxed have created some circumstances where that is not the case.

Filing Status

Threshold Amount

Married filing jointly

$250,000

Married filing separately

$150,000

Single

$200,000

Head of Household (with qualifying person)

$200,000

Qualifying widow(er) with dependent child

$250,000

Trusts and Estates

$12,300*

*2015 rate, Adjusted annually Source:IRS

A problem arises when these trusts are taxed. In addition to the already steep rate of 39.6 percent that trusts will pay on any income over $12,300, the further 3.8 percent rate applies, making the top marginal rate 43.4 percent. That tax comes out of the pocket of people with health issues – the very people meant to benefit from the NIIT.

Among the trusts and estates being taxed by the NIIT exists a subset known as special needs trusts (SNTs). SNTs are created in order to improve the special needs beneficiary’s standard of living above the subsistence-level care provided by Supplemental Security Income and similar means-tested programs. It is hard to imagine that parents or grandparents who took the time to save and invest to take care of their special needs children were the intended targets of the tax.

It is also worth mentioning that investment taxes in general are bad tax policy; taxing investment income, earned or unearned, creates an incentive to stop saving, and to stop investing those savings in the market. The NIIT inadvertently discourages those parents or grandparents to save for the future by creating multiple layers of taxation on the same income.

The irony of the NIIT is it taxes the very demographic it was intended to aid; that is, retirees relying on their savings and investment, and those with disabilities, counting on trust income or estate inheritance to maintain their quality of life. Those who benefit from Medicare are at retirement age and often suffering from a disability.

The issue of Medicare services aside, the tax policy created to fund them should not discourage workers from saving for retirement, or parents from investing for their children. A good tax policy should be simple in its construction and neutral in its incentives, both of which the NIIT is not.

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