The tax is imposed on the lesser of net investment income (“NII”) or the excess of a taxpayer’s modified adjusted gross income over a threshold amount. For married taxpayers filing jointly, the threshold is $250,000; filing separately, $125,000; and for single taxpayers, $200,000.
NII is defined in IRC §1411(c)(1) as the excess of (A) the sum of (i) gross income from interest, dividends, annuities, royalties, and rents, (ii) other gross income derived from a trade or business which is a passive activity with respect to the taxpayer or which trades in financial instruments or commodities, and (iii) net gain attributable to the disposition of property over (B) properly allocable deductions.
Gain and income for purposes of IRC §1411 is generally recognized when recognized for federal income tax purposes. However, income inclusion and distributions from CFCs, PFICs, and QEFs are treated differently under the proposed regulations.
For purposes of IRC §1411, however, income inclusions from CFCs or QEFs are not included in NII.
For example, A is a US shareholder and sole owner of a CFC. A has a basis of $500,000 in the CFC. In 2013, the CFC earns $10,000 of passive income which A must include in gross income. A would increase her basis in CFC by $10,000 for gross income purposes. In 2014, CFC distributes $30,000 to A, none of which is treated as a dividend for gross income purposes. A would reduce her basis in CFC for gross income purposes by $30,000 to $480,000. In 2015, A sells CFC for $500,000. A realizes a gain of $20,000 for gross income purposes.
In 2013, A would not include the $10,000 of passive income earned by CFC in NII and would not adjust her basis in CFC. In 2014, A would include $10,000 of previously taxed income in NII and would not decrease her basis by that amount, but only by the remaining $20,000 distribution. Finally, in 2015, A would include $20,000 of gain in NII, representing the amount realized of $500,000 less her IRC §1411 basis of $480,000.
If A instead had made an election under the regulations to treat NII and gross income the same, then A would have included the $10,000 in passive income from CFC in NII in 2013, rather than in 2014 when she received a distribution.
There is no similar addback of possessions-source income that is excluded under §931 for residents of American Samoa or under §933 for Puerto Rican residents. Thus, a resident of those possessions would only be subject to the §1411 tax if he realized substantial income from sources outside the possession where he is resident.
The regulations clarify that, in the case of residents of the other three U.S. possessions, all of which have so-called "mirror" Codes; Guam, the U.S. Virgin Islands, and the Northern Marianas, the §1411 tax will not apply because it has not been imposed by Congress on those three possessions, and because residents of those possessions pay income tax on their worldwide income to the government of the possession where they are resident.
Section 1411(e)(1) exempts a "nonresident alien" from the §1411 tax. The proposed regulations confirm that the term "nonresident alien" is determined in accordance with the "resident alien" definitional rules of §7701(b). However, the regulations give no guidance on how to apply §1411 when an individual is a U.S. citizen or resident alien for part of the year, and a nonresident alien for the balance of the year.
The regulations do not discuss the status of so-called "treaty tie-breaker aliens" who are classified as resident aliens under §7701(b), but who are also classified as income tax residents of a country having an income tax treaty with the United States under the "tie-breaker" rules of the treaty. Regs. §301.7701(b)-7(a)(1) provides that a tie-breaker alien will be classified as a nonresident "for purposes of computing that individual's United States income tax liability under the provisions of the Internal Revenue Code and the regulations thereunder … ." Thus, whether a treaty tie-breaker alien is exempt from the §1411 tax probably depends on whether the §1411 tax is an "income tax" within the meaning of U.S. income tax treaties.
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