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Net investment income tax state and local tax deduction

Technical topics regarding tax preparation.
#1
supdat  
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Hello. Are state and local taxes deductible on Form 8960 for purposes of calculating the net investment income tax beyond the allocable fraction of the $10,000 ceiling for SALT? The instructions to Form 8960 do not say anything specifically about the $10,000 limitation, though these same instructions state outright that the miscellaneous itemized deductions are suspended for the years 2018 - 2025.

As others on the forum have noted, IRC Sec. 1411(c)(1)(B) indicates that, for NIIT purposes, the deductions allowed include "the deductions allowed by this subtitle which are properly allocable [to NIIT]."

So, what does all this mean? Is the SALT deduction on Form 8960 limited to the allocable fraction of the $10,000 limit? Or can we deduct the allocable fraction of all state and local taxes paid?
 

#2
Nilodop  
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According to (g)(1) of the -4 reg. of 1.1411, it's all, not just $10,000.
Last edited by Nilodop on 15-Feb-2019 9:53am, edited 1 time in total.
 

#3
Doug M  
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Are state and local taxes deductible on Form 8960 for purposes of calculating the net investment income tax beyond the allocable fraction of the $10,000 ceiling for SALT?


The deduction(s) on form 8960, specifically lines 9(a) 9(b) 9(c) have nothing to do with what is happening or not happening on Schedule A. You do not reduce the states paid on line 9(a) by what happened on Schedule A. And the elimination of 2% MID does not mean that the investment expenses are also eliminated for NIIT purposes.
 

#4
supdat  
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In calculating NIIT, the BNA Income Tax Planner software limits the total deduction for SALT to $10,000, and allocates that amount proportionately to the net investment income, and the software also disallows the investment expenses. But of course it is possible BNA is calculating it incorrectly.

I don't know at this point how the tax prep software is handling it, I have not prepped a return with this issue.
 

#5
Nilodop  
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Might BNA know more than Nilodop and Doug M?
 

#6
Nilodop  
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1.1411-4(f)
(3)Properly allocable deductions described in section 63(d). In determining net investment income, the following itemized deductions are taken into account:
...
(iii)Taxes described in section 164(a)(3).State, local, and foreign income, war profits, and excess profit taxes described in section 164(a)(3) that are allocable to net investment income pursuant to paragraph (g)(1) of this section.

1.1411-4(g)
Special rules -

(1)Deductions allocable to both net investment income and excluded income. In the case of a properly allocable deduction described in section 1411(c)(1)(B) and paragraph (f) of this section that is allocable to both net investment income and excluded income, the portion of the deduction that is properly allocable to net investment income may be determined by taxpayers using any reasonable method. Examples of reasonable methods of allocation include, but are not limited to, an allocation of the deduction based on the ratio of the amount of a taxpayer's gross income (including net gain) described in § 1.1411-4(a)(1) to the amount of the taxpayer's adjusted gross income (as defined under section 62 (or section 67(e) in the case of an estate or trust)). In the case of an estate or trust, an allocation of a deduction pursuant to rules described in § 1.652(b)-3(b) (and § 1.641(c)-1(h) in the case of an ESBT) is also a reasonable method.

I added the emphasis.
 

#7
makbo  
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Interesting how this question arose in this forum literally within a day or two of the new tax law coming into existence, and yet now, over a year later, we (or at least some of us) are still floundering a little.

Are investment expenses and state income taxes treated differently from each other for NII purposes, in terms of what is allowed under the regular tax? Here is a thread about investment expense and NII that seems to still leave the question open. Or if not, is there something conclusive, and where is it?

viewtopic.php?p=118450#p118450

" "Any deductions described in this paragraph (f) that are subject to section 67 (the 2-percent floor on miscellaneous itemized deductions) or section 68 (the overall limitation on itemized deductions) are allowed in determining net investment income only to the extent the items are deductible for chapter 1 purposes after the application of sections 67 and 68." Section 67(g) is part of section 67."
 

#8
JAD  
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Supdat #4: BNA had/has a bunch of mistakes in its software related to this new law. I don’t know the status anymore because after spending quite a bit of time on the phone with them, they still had a bunch of errors and then wanted me to pay $900 to renew. It was ridiculous – me, a sole practitioner, pointing out material errors to BNA. The point here is that just because BNA treats something a certain way in no way means that BNA is correct.
 

#9
Nilodop  
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Are investment expenses and state income taxes treated differently from each other for NII purposes, in terms of what is allowed under the regular tax?. State taxes are not "misc. itemized deductions under 67(b). I'm not sure OP is asking about the section 68 overall limit.
 

#10
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The point here is that just because BNA treats something a certain way in no way means that BNA is correct.


I created my own QBI calculator…and tested it against BNA’s. I think BNA’s is accurate. As things have been clarified, BNA has updated its calculator accordingly. I can’t speak to it’s Planner. And I also can’t speak of the material errors you’re talking about. Maybe tell us what they are and we can test them against it’s current calculator.

Or if not, is there something conclusive, and where is it?


Nilodop cited the -4 Regulation, which of course was written before the $10k limit came into play. But that doesn’t matter. The actual heading in that NIIT regulation, under (f)(3), is “Properly allocable deductions described in Section 63(d).” Then when you go there, you’ll see that it says, “deductions allowable under this chapter.”
 

#11
JAD  
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My issue was with planner. They were CA issues, so perhaps not a concern to many, but to me, the errors and the lack of attention to fixing them were concerning. They were limiting property taxes to $10k. (This is the one error that they fixed). They were not deducting misc itemized deductions. There was no input for the interest expense on the mortgage debt over $750k that creates a higher deduction for CA than for fed. The CA AMT calculation was wrong. Those are the issues that I remember now - there might have been more.
 

#12
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Hmmm..... Looking at my Lacerte calculations right now, and the Form 8960 worksheet for Line 9b is limiting to the $10k. Does anyone else have this problem? I am having the same issue as Supdat. I hate overriding so early in tax season....
 

#13
makbo  
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CalGalCPA wrote: Does anyone else have this problem? [...] I hate overriding so early in tax season....

UltraTax seems to be punting altogether for now, [edit - see following post] as it is showing nothing for the state/local tax allocated deduction against NII. (and the worksheet that is used is blank). I note that UT also reports Form 8960 as not being in final approval status yet, although it is available at the IRS website. (I assume there is a different list of efile approved forms from paper filed forms?)

I note the Form 8960 instructions (not authoritative) currently posted at IRS say this, which implies the Schedule A SALT limit does apply to NII deduction:

"State, local, and foreign income taxes if properly deducted on your return when calculating your U.S. regular income tax."
Last edited by makbo on 15-Feb-2019 7:21pm, edited 1 time in total.
 

#14
makbo  
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Wait! It's more complicated than that.

Here is my scenario:

MFJ, AGI $500,000

State income tax paid: $110,000
Allowed itemized deductions: $23,700 ($10K SALT including RE prop tax, plus mort int)
Allowed standard deduction: $24,000

When I default to the standard deduction, UT allows no state income deduction at all against NII (which I mistakenly thought of as "punting" in my previous post).

When I force itemized deduction, the NII worksheet recognizes the full amount of state tax paid, but limits it to the total allowed itemized deduction ($23,700).

So, UT is not limiting state tax deduction for NII to $10K, but it is limiting it to the state tax actually deducted for regular tax purposes, just like the form instructions state -- including none, if the standard deduction is taken.
 

#15
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I just replicated my Lacerte calculations into BNA. They are BOTH limiting the Form 8960 state taxes to the $10k. Is everyone overriding their tax programs then? Is this an issue that appears still up in the air? I honestly don't know what to do here.
 

#16
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They are BOTH limiting the Form 8960 state taxes to the $10k.

Good to know the software is doing it right. See Post #10.
 

#17
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LOL. Thank you. I misunderstood your post and thought you were saying the opposite. I did more research after I posted, and did indeed determine "deductions allowed by Subtitle A" which does in fact limit the deductions.

Thanks.
 

#18
makbo  
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I still say the full amount of state income tax is available to be allocated to NII, not just $10K.

Consider:

1) the Form 8960 form and instructions nowhere refer to the the $10K SALT limit. If it was the IRS' position that SALT limit applied to NIIT calculation as well, surely they would have stated in the instructions something like "the amount of Line 9(b) due to state and local tax cannot exceed $10,000", but they didn't. Do you really think they are going to accept every return with a regular allocation on Line 9b, and then a year or two from now send out hundreds of thousands, or millions, of letters saying everyone needs to recalculate and pay more tax because the amount they deducted on Line 9b should never have exceeded $10K?

2) Thomson Reuters UltraTax latest version allows the full amount prior to calculating the allocation to NII. (my previous post with a sample UT calculation was still using a 2017 version of the allocation worksheet, it has been updated since then - but they never took the $10K SALT limit into account for NII purposes, even in earlier versions).

3) posts #2 and #3 agree it is all available for allocation, not just $10K.

4) The form instructions state, "State, local, and foreign income taxes if properly deducted on your return when calculating your U.S. regular income tax.". Well, the full amount of state tax was properly deducted (and officially disclosed per regulation) on Schedule A, but because of TCJA it was simply not "taken into account" for purposes of Sec 164. "Not taken into account" is not the same thing as "disallowed". (I am rejecting the implication I was pondering in my post #13).

Jeff-Ohio writes, "The actual heading in that NIIT regulation, under (f)(3), is “Properly allocable deductions described in Section 63(d).” Then when you go there, you’ll see that it says, “deductions allowable under this chapter.”"

And Section 63 is part of Chapter 1, while NIIT is part of Chapter 2A -- totally separate for this purpose. And I don't think the word "described" automatically includes all limitations that are elsewhere applied to items that are here only "described".
 

#19
makbo  
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I still find it very interesting how little discussion or news about this item can be found on the internet or in other discussion forums. Please post anything you find, or any facts about what specific vendors (other than the ones already mentioned) are doing about this calculation.

Here is a recent, inconclusive discussion from another forum:

https://www.bogleheads.org/forum/viewtopic.php?t=271074

When I search for "Net investment income tax form 8960 line 9b state and local tax deduction", it's worth noting that in the first few pages, several nationally-known Democratic politicians show up because they have released copies of their tax returns for public review.
 

#20
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In prior years, those deductions were always limited to the amount allowed on Schedule A. It seems a bit bold to assume that the full amounts are allowable under the TCJA. The kind of decision I would talk over with the client before deciding.
Because on T.A. ten was the most you were allowed
 

#21
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And Section 63 is part of Chapter 1, while NIIT is part of Chapter 2A -- totally separate for this purpose.


Not really separate when there’s a direct cross-reference…But if it really is totally separate, that would mean that in prior years, your NIIT-allocable SALT deduction would have been $0, you know, because it’s separate.

it's worth noting that in the first few pages, several nationally-known Democratic politicians show up because they have released copies of their tax returns for public review.


It’s also worth noting that many people probably don’t care.
Well, the full amount of state tax was properly deducted


Right. And the old lady properly deducted her medical expenses, even though they added up to 3% of her AGI.
 

#22
makbo  
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UltraTax may be releasing an update which changes how they treat this.

For those to whom the SALT limit applied to NIIT is crystal clear from the law or regs, do we allocate the state tax first, then apply the $10K SALT limit, or do we first apply the SALT limit, and then allocate?

Jeff-Ohio wrote:It’s also worth noting that many people probably don’t care.

But you cared enough to comment on it.
 

#23
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But you cared enough to comment on it.


Whether or not someone comments isn’t necessarily reflective of their care or lack of it, since care is a feeling and isn’t always manifested in the verbal or written word. Conversely, not caring might actually be manifested verbally or in writing. So, when someone writes something or says something, you don’t really know if they care or not. If someone says they don’t care, the mere fact that they said they don’t care doesn’t necessarily mean they care, especially if their comments surround the probabilities of others caring.
 

#24
WEISSEA  
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When I force itemized deduction,"

Agree, only way Proseries allows State income tax against NIIT on 8960 is to to force itemize which it won't let me do( has box but box does not work). Do other tax sw allow forced itemize if std is larger?
 

#25
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So Proseries previously did allow state & local taxes in excess of $10,000 in computing NII, but now it does not allow it? I got this notice?
1040 Individual - Form 8960 SALT Limit

Use this query to identity the individual tax clients that didn't have the state and local income taxes limited on Form 8960, Net Investment Income Tax, line 9b. This erroneously decreased net investment income and would understate the net investment income tax if the modified adjusted gross income threshold on line 15 was not used. The issue was fixed in version 2018.230.
 

#26
Wiles  
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Too bad they fixed that
 

#27
makbo  
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"For those to whom the SALT limit applied to NIIT is crystal clear from the law or regs, do we allocate the state tax first, then apply the $10K SALT limit, or do we first apply the SALT limit, and then allocate?"

So, for example, suppose my state tax deduction is $40K, and real property tax is $10K, total $50K which is limited to $10K under Temporary Cut and Jobs Act (TJCA). Now, my software calculates that state tax is 80% of the total, therefore it applies 80% to the $10K limit, then it applies the NII state income tax deduction percent (to $8,000). Yet, I paid $40K of state income tax against the total taxable income used for NII allocation. Why don't I get to use $10K if my state income tax was at least that amount? Can anyone point me to code or regs that explain this treatment?

Apparently, these vendors are just tossing out some formulas where the IRS has not taken a position, and in their own self-interest, they are taking the most conservative position. I know UT switched its calculation mid-season for no particular reason that I could see.
 

#28
Wiles  
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Could we say that usage of the $10K is fungible?
 

#29
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What you’re deducting is up to you. IMO. If you don’t put real estate taxes in the software then you’ll get the result you want. I guess the software is concluding that you intend to deduct prorata RE and income taxes.
 

#30
Chay  
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If I determine my deduction for state taxes on Form 8960 as though the full $10,000 is income taxes, does that bind me to the same position on my state tax return?
 

#31
Nilodop  
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Wouldn't that depend on state law?
 

#32
Chay  
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Yes, but for most states, when you look at the law, you see they're just punting it back up to the federal level by explicitly defining every term to have the same meaning as it does in the Internal Revenue Code except where otherwise noted. Then when you itemize you have to exclude income taxes "deducted" on your federal return, and "deducted" isn't given any special meaning.
 

#33
makbo  
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Terry Oraha wrote: If you don’t put real estate taxes in the software then you’ll get the result you want. I guess the software is concluding that you intend to deduct prorata RE and income taxes.

The result I want is to conclude that deductions under NIIT, which is a different code chapter (2A) from regular tax, are not affected by TCJA changes to Chapter 1. If it's so crystal clear, why didn't the IRS simply add an instruction to Form 8960 that the state tax deduction line cannot exceed $10,000?

For one of my clients, where the extra tax bill was about $1,200 if you applied the SALT limit to NIIT, I filed the return before my software vendor changed their calculation to the more conservative position (I informed client of the potential issue). I guess we'll find out in the next year or two if the IRS cares. Plus, even if they do, we'll just file an amended return and claim instead the QBID for rental income that client didn't claim on original return, canceling out the difference. ;)
 

#34
Chay  
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makbo wrote:The result I want is to conclude that deductions under NIIT, which is a different code chapter (2A) from regular tax, are not affected by TCJA changes to Chapter 1.


That would be nice, but how do you overcome the following?

- Section 1411(c)(1)(B) provides that net investment income is computed after subtracting "the deductions allowed by this subtitle which are properly allocable to such gross income or net gain."

- Section 164(a)(3) provides that "State and local, and foreign, income, war profits, and excess profits taxes" are "allowed as a deduction for the taxable year within which paid or accrued"

- Section 164(b)(6)(B) provides that "the aggregate amount of taxes taken into account under paragraphs (1), (2), and (3) of subsection (a) and paragraph (5) of this subsection for any taxable year shall not exceed $10,000 ($5,000 in the case of a married individual filing a separate return)."

Taking these three points together, I conclude the following:

1. In order to be deductible against investment income for purposes of the NIIT, a deduction must be allowed by subtitle A.
2. In order to be a deduction allowed by subtitle A, a state income tax must be taken into account under paragraph (3) of section 164.
3. In order to be taken into account under paragraph (3) of section 164, a state income tax must not cause the aggregate of the state and local taxes taken into account under section 164 to exceed $10,000 ($5,000 in the case of a married individual filing a separate return).
 


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