The Net Investment Income Tax (“NIIT”) was one of a number of revenue-raising measures introduced with the Affordable Care Act (aka “Obamacare”). It came into effect on 1 January 2013 and is a 3.8% charge on net investment income of individuals, estates and trusts whose income exceeds certain thresholds. It should be noted that this levy impacts US citizens and residents but is not charged on individuals who are not resident in the US for tax purposes.
The NIIT applies to a wide range of income types, including interest, dividends, capital gains, rent and royalty income and passive activities, among others. Qualified pension distributions are not subject to the NIIT.
As is often the case with US tax legislation, Congress did not consider the international aspects of the NIIT, despite prodding from the AICPA and others, which means there is limited guidance regarding the exact impact of the law on US citizens and residents living outside of the US. One of the main areas of confusion stems from the question of whether the tax is a Medicare tax, an income tax, or some sort of heretofore unseen “hybrid”.
The argument for it being a Medicare tax is that it was explicitly put in place to pay for the expanded Medicare being offered under the ACA. If it is a Medicare tax then those US citizens or green card holders who live outside of the US and are not within the scope of US social security are arguably not liable to the NIIT. However, this does not appear to be the IRS’s view.
In contrast, if it is not a Medicare tax then it would seemingly have to be an income tax, which can be offset by foreign tax credits (“FTC”) or mitigated by double tax agreements. The IRS, though, have made clear they do not believe the NIIT can be offset with foreign tax credits, and the way the calculation flows through a US tax return would make it difficult for an FTC claim to be made.
It is also unclear as to the view jurisdictions outside the US might take of the NIIT. For example, would HMRC allow a US citizen on the arising basis to credit the NIIT against her UK liability on US-source interest or capital gains?
Given this lack of clarity, and the fact that the NIIT can amount to a significant tax charge, it is important that the NIIT be carefully considered whenever a US taxpayer’s position is being analysed.