Obamacare: Individual Mandate & Net Investment Income Tax

The 2012 Patient Protection and Affordable Care Act (ACA or Obamacare) has two tax matters that affect traders: the health insurance mandate for individuals and the 3.8% Net Investment Income Tax (NIT) on upper-income individuals and trusts.

Individual health insurance mandate

The individual health insurance mandate took effect in 2014, and many taxpayers continue to face confusion over penalties, exemptions, premium tax credits, and clawbacks of subsidies (advanced credits).

Those who received premium subsidies through an Obamacare marketplace or exchange must file a Form 8962 to calculate a premium tax credit or a tax liability.

Taxpayers who did not have ACA-compliant health insurance coverage (including large gaps in coverage) and did not qualify for an exemption owed a shared-responsibility payment.

For 2018, the ACA shared responsibility payment for non-compliance was $695 per adult and $347.50 per child (up to $2,085 for a family), or 2.5% of household income above the tax return filing threshold for the filing status — whichever is greater.

Starting in 2019, TCJA reduced the ACA shared responsibility payment for non-compliance to zero. That takes the bite out of the individual mandate.

Form 1095 ACA information filings include: Forms 1095-A (Health Insurance Marketplace Statement), Form 1095-B (Health Coverage), and Form 1095-C (Employer-Provided Health Insurance Offer and Coverage). Taxpayers should receive these forms and use them when preparing their tax returns.

Net Investment Income Tax

New taxes were ushered in to finance the law. The Net Investment Income Tax (NIT) (originally referred to as the (ACA 3.8% Medicare surtax on unearned income) affected upper-income taxpayers as of Jan. 1, 2013. It only applies to individuals with net investment income (NII) and modified adjusted gross income (AGI) exceeding $200,000 single, $250,000 married filing jointly, or $125,000 married filing separately. These thresholds are not indexed for inflation. (Modified AGI means U.S. residents abroad must add back any foreign earned income exclusion reported on Form 2555.) The tax also applies to irrevocable trusts (and estates) on the undistributed NII more than the dollar amount at which the highest tax bracket for trusts begins. TCJA did not suspend or modify ACA’s NIT.

Net Investment Income

Notice the terms “investment income” and “unearned income.” People who receive earned income from a job pay Social Security tax (on the social security base amount) and Medicare on their wages or self-employment income. In general, unearned income includes interest, dividends, rents, royalties, capital gains, income and loss from companies in which you are passive, and income and loss from pass-through investment and trading companies. NIT subjects this type of income to Medicare taxes, too — albeit at upper-income brackets only.

NII requires the segregation of different types of unearned income into three different buckets. (Take a look at Form 8960 and the final IRS regulations.)

NII buckets include the following:

  • Portfolio income (includes interest, dividends, and annuity distributions), royalties (net of oil and gas depletion expenses), and rents (net of depreciation);
  • Passive activity income and loss from pass-through entities and investment and trading companies;
  • Capital gains net of capital losses.

NII excludes:

  • Wages and self-employment income;
  • Tax-free municipal bond interest income;
  • IRA and qualified plan distributions;
  • Income from the disposition of, or pass-through from, active (earned-income related) LLCs, partnerships, and S-corps;
  • Capital gain received from the sale of your company (and you have been active in it);
  • Income from rental real estate; and
  • The “exclusion” portion of a capital gain on the sale of a primary residence. The taxable portion above the exclusion amount is included in NII.

NIT calculations

NIT is assessed on whatever is lower: NII or the AGI amount over the threshold. Here’s an example: A single taxpayer has $300,000 AGI, which is $100,000 over the $200,000 modified AGI threshold. NII is $125,000 after deducting available trading business expenses and certain investment expenses, including stock borrow fees and investment-interest expense. (Trading business expenses on Schedule C or E offset self-employment income first, and any excess may be deducted against NII.) Since NII is higher than the AGI amount over the threshold, NIT is calculated on the lower amount or $100,000 in this example: 3.8% x $100,000 = $3,800 of NIT on Form 8960. If the taxpayer had $75,000 NII, then NIT would be calculated on that lower amount instead (3.8% x $75,000 = $2,850).

NII deductions

Starting in 2018, TCJA suspended “certain miscellaneous itemized deductions subject to the 2% floor,” including investment fees and expenses. The IRS removed those line items from Schedule A.

Section 1411 regulations for NIT require that a permissible deduction for NII must first be allowed elsewhere on an income tax return and investment fees and expenses are no longer deductible on Schedule A or otherwise. Therefore, it may be best not to deduct investment fees and expenses on Form 8960 in determining NII.

Form 8960 Part II, “Investment Expenses Allocable to Investment Income and Modifications,” allows line-item deductions for investment-interest expenses; state, local, and foreign income taxes; and miscellaneous investment expenses.

Excerpt from Green’s Trader Tax Guide Chapter 15 Obamacare Individual Mandate & NIT.