State Tax Deductions on NIIT

[kwaysack]

Where to enter State Tax deduction for NIIT tax?

[DaveF1006]

It depends. If you have a 8960 in your return, the NIIT should have been populated automatically in the return. Please read this IRS link for the instructions regarding 9b. it suggests that this is added to state, local and property taxes. You can only claim this if you itemize your deductions for the year. This amount is capped at $10K for all these types of taxes paid.

[tacopa]

To clarify what you said:  If I don't itemize, and use the standard deduction, I can not deduct State Tax I paid against the net investment income.

Is there an official document that clearly says that state tax deduction is applicable only when you itemize, and not when you take standard deduction? What I see is "properly allocable" term, and no one is explicitly saying that this is applicable when you take itemized deductions.

Can you please help me point to the document that made this interpretation? Thanks.

[ReneeM7122]

Please refer to IRS Topic No. 503, Deductible Taxes

There are four types of deductible nonbusiness taxes:

• State, local, and foreign income taxes
• State and local general sales taxes
• State and local real estate taxes, and
• State and local personal property taxes

To be deductible, the tax must be imposed on you, and you must have paid it during your tax year. Nonbusiness taxes may only be claimed as an itemized deduction on Schedule A (Form 1040), Itemized Deductions.

@tacopa

[tacopa]

Sorry. May be I was not clear. My question is about additional 3.8% tax on net investment income.  If I take standard deduction on instead of itemized on Schedule A, am I allowed to take deduction of State Income Tax that I paid on the Net Investment income I had made in 2020, and pay this 3.8% tax for NIIT for the remaining after deducting? 

I live in PA, and I pay tax 3.07% on my investments. So, if  I am able to deduct the PA Tax I paid from the net investment income, the tax I pay will be very little (like 0.73%).

I am looking for some documentation that prohibits deducting state tax from Net Investment Income, if I am taking Standard $24,800 instead of filing Schedule A with itemized deductions.

Any help is greatly appreciated.

[AmyC]

PA Personal Income Tax Guide Deductions shows that NIIT is not allowed for PA purposes. None of the federal taxes or exemptions are allowed beyond employee business expenses.

@tacopa

[bgbevan]

I don't use TurboTax but I do use Intuit ProSeries which is a multi-user, multi-client version of TurboTax.  I found many more comments on this issue in the TurboTax forums, so I am offering my comments here.

There are several threads and many comments on the deductibility of State taxes as an investment expense on Form 8560, line 9b.  This issue usually comes to the foreground when there is large capital gains issue.  Most notably, the sale of a personal residence.  Some how the IRS has reasoned that your personal residence is an investment and capital gains should be taxed as an investment.  They do offer a "generous" exclusion the shields $250,000(or $500,000) from capital gains taxes, but the way housing prices have increased over the last 10-20 years has exposed many taxpayers to some large tax “surprises”.  And besides the capital gain issues, there is relatively new, Net Investment Income Tax(NIIT) tax of 3.8% that can create an additional tax burden.  The discussion boils down to wether a State income tax can be deducted as an investment expense on Form 8560.  There are two "theories" on how this should be treated on a tax return but, apparently there no official guidance from the IRS.

As I search for guidance, I offer my opinion.  Schedule A allows for the deduction of certain local and state taxes, but only to filers that itemize on Schedule A.  This state income tax amounts are added to some other state taxes and capped at $10,000.  Due the rapid increases in property taxes, many taxpayers that itemize never realize any benefit from deducting State income taxes because their property taxes are more than the $10,000 cap.  "Theory" #1, is that only the amount of itemized state income taxes($10,000 max) can be used as an expense on Form 8960, line 9b.  This seems incongruous to me.  The two entries are not related to one another in any way.   What tax principle does this align with?  None that I know of.

I support the accepted tax doctrine that expenses paid to produce income, are deductible, and should be followed here.  Just like the expense deductions allowed on Schedule C, Schedule E, Schedule F, and many other tax form.  I therefore I offer, "Theory" #2, that State income taxes are an expense related to producing income and should be fully deductible on Form 8560 for the purpose of calculating the 3.8% NIIT tax

Does anyone out there have any guidance or clarification this issue?

Bill Bevan, EA

[NCperson]

what are you asking? the state taxes are eligible to be deducted on Line 9b... did you read the instructions? maybe I don't understand your point. 

Line 9b—State, Local, and Foreign Income Tax Include state, local, and foreign income taxes you paid for the tax
year that are attributable to net investment income.

https://www.irs.gov/pub/irs-pdf/i8960.pdf

[CAnewbie]

@bgbevan's discussion is super helpful, but I need help to implement "Theory" #2 in TurboTax desktop:

TurboTax appears to enforce "Theory" #1 [see TT Help for Form 8960 Worksheet Line 9b]. As a newbie, I don't see how to enter numbers on that worksheet that follow the IRS i8960 Line 9b guidance** without breaking the e-file checks.

In my experience, HR Block at Home Premium allows "Theory" #2, and its Help pages repeat the IRS i8960 Line 9b guidance.  I successfully filed that way with HRB last year.

For other reasons, I would much prefer to file with TT, but the difference is big enough for me that I will use HRB again this year, unless there is a way to follow Theory #2 on Form 8960 in TT.  Thanks for any pointers!

** the IRS-provided example of a 'reasonable method' in text above the Line 9b instruction allows "an allocation of the deduction based on the ratio of the amount of a taxpayer's gross investment income (Form 8960, line 8 ) to the amount of the taxpayer's AGI)"

[tennisfan]

In FreeTaxUSA, you can't enter a value in 9b (for state and local tax allocation) unless you itemize, and even then it caps the number at 10,000 regardless of what value you put in.  

[goyal_raj]

I have some long term capital gains shown on Schedule K-1. I am doing Standard deduction as Turbo tax suggested. It shows zero value in 9b on form 8560.

Is Turbo tax correct in doing that? I dont even know what my itemized de duction number would be because Turbo tax never gave me that number or asked for it, so won't know if this deduction for State taxes paid would be applicable or not.

Say, I have a total AGI of 300k and therefore my excess for Net Investment income tax calculation is 50000. TT calculated NII @ 3.8%. However, i have paid State tax on this 50k at 5% . So should i deduct the 2500 paid as State tax in 9b in Form 8960 to reduce my NII? My Standard deduction number would probably be more than what i would get in itemized deduction.

Any inputs from the TT folks would be helpful.

thanks

[DaveF1006]

TurboTax calculates Form 8960, Line 9b based on a formula that considers your total investment income, total adjusted gross income (AGI), and state, local, and foreign taxes paid. However, Line 9b is zero if you do not itemize your deductions. Since you're taking the Standard Deduction, TurboTax does not include state taxes paid in the calculation.

Regarding your Net Investment Income Tax (NIIT):

• Your AGI is $300,000, meaning your excess over the threshold is $50,000. 
• TurboTax correctly applied the 3.8% NIIT, resulting in a tax of $1,900.
• You paid state tax on the $50,000 at 5%, which amounts to $2,500.
• Normally, state taxes paid on investment income can be deducted on Line 9b, but only if you itemize deductions.

Since TurboTax is showing zero on Line 9b, it likely means that state taxes paid are not being deducted because you are using the standard deduction. If you were to itemize, a portion of your state tax paid could be allocated to reduce your net investment income, potentially lowering your NIIT.

Itemized deductions include things like mortgage, interest, state taxes paid up to $10,000, medical expenses in excess of 7.5% of your AGI, charitable contributions etc..  You may enter these in the deductions and credits section of your return. Once entered, TurboTax will decide which is the better deduction for you to take. If you didn't enter itemized deductions, then the standard deduction amount will  be applied by default.