The Net Investment Income Tax (NIIT) was introduced by the United States government in 2013 as a way to fund the Affordable Care Act. This tax imposes a 3.8% surtax on certain types of investment income earned by individuals, trusts, and estates. Although the NIIT was primarily designed to apply to US residents, it also affects Americans living overseas who earn investment income. In this blog, we will discuss why the NIIT is still applicable to Americans living overseas.
To understand why the NIIT applies to Americans living overseas, we must first examine how the tax is calculated. The NIIT is calculated based on an individual’s Modified Adjusted Gross Income (MAGI), which includes investment income, such as interest, dividends, capital gains, and rental income. The tax applies to investment income that exceeds a certain threshold, which is $250,000 for married couples filing jointly and $200,000 for individuals. However, if individual live overseas and earns investment income, they may still be subject to the NIIT even if their MAGI falls below these thresholds.
One of the main reasons why the NIIT still applies to Americans living overseas is because of the Foreign Account Tax Compliance Act (FATCA). This law, which was passed in 2010, requires foreign financial institutions to report information about their US account holders to the Internal Revenue Service (IRS). This means that the IRS can now track the investment income of Americans living overseas more easily, and therefore, the NIIT is more enforceable.
Another reason why the NIIT applies to Americans living overseas is because of the US tax system’s citizenship-based taxation. This means that all US citizens are subject to US tax laws, regardless of where they live. Therefore, if an American living overseas earns investment income, they are still required to report this income on their US tax return and may be subject to the NIIT.
It’s important to note that Americans living overseas may not be able to reduce their NIIT with a foreign tax credit as was demonstrated in tax court case Ankeev v Commissioner.
In the Anikeeva case, the taxpayer was a US citizen who lived and worked in Russia. The taxpayer earned investment income from Russian sources, which was subject to Russian income tax. On her US tax return, the taxpayer claimed a foreign tax credit for the Russian income tax paid on her investment income. However, the IRS disallowed the taxpayer’s claim for a foreign tax credit for the NIIT portion of her investment income.
The US Tax Court agreed with the IRS and held that the NIIT could not be credited by a foreign tax credit. The court explained that the NIIT is not a tax on income, but rather a tax on a separate item of gross income. The court also noted that the foreign tax credit applies only to income taxes, not to other types of taxes. Therefore, the court concluded that the NIIT cannot be credited by a foreign tax credit.
The US Tax Court’s decision in Anikeeva has significant implications for Americans living overseas who earn investment income. Americans living overseas may still be subject to the NIIT, even if they pay foreign taxes on their investment income. This means that Americans living overseas may face a higher tax liability than US residents who earn investment income. Americans living overseas who are subject to the NIIT should consult with a tax professional to determine their tax liability and to explore other ways to reduce their tax liability.
In conclusion, the Net Investment Income Tax is still applicable to Americans living overseas because of the Foreign Account Tax Compliance Act and the US tax system’s citizenship-based taxation. Americans living overseas who earn investment income should be aware of their NIIT liability and take advantage of any tax deductions and credits available to them. They should also ensure that they comply with US tax laws and report their investment income accurately on their US tax returns. It’s important to consult with a tax professional who specializes in international taxation to ensure compliance with both US and foreign tax laws.