Net Investment Income Tax (NIIT) came about as part of the passage of ACA during the Obama administration. It has been in effect for almost 10 years.
The 3.8% tax rate is applied based upon the lower of:
- Total investment and passive income (interest, dividends, capital gains, rents, etc.), or
- Adjusted Gross Income (AGI) in excess of a threshold ($200,000 single and $250,000 for married couples).
All farm rental income was originally assumed to be investment income, however, the final regulations indicated that “self-rental” farm income would not be subject to the tax or any gains associated with selling that land. Here is an example:
Bart and Summer own 2,000 acres of land that they rent to their farm operation for $300 per acre or $600,000 per year. Their other sources of income are greater than $250,000. Bart and Summer were originally projected to owe an extra $22,800 of income taxes year under NIIT. However, the final regulations indicated this tax would not be owed.
President Biden is proposing that this type of income will now be subject to the NIIT if your income exceeds $400,000. Also, if you materially participate in your farming operation either as an LLC member or S corporation owner, then that income in excess of $400,000 will be subject to the 12.4% self-employment (SE) tax plus Medicare tax. Essentially some or all of your farm income including rental income will now be subject to at least an extra 3.8% tax or 16.20% tax if your total income exceeds $400,000. Here is an example:
Bart and Summer earn $600,000 from their farm rental, $150,000 salary from Bart’s S corporation and the S corporation has $700,000 of net income plus Summer has a salary of $100,000 working in town. Under current rules, none of the income is subject to any extra SE or NIIT tax. If President Biden’s proposal goes into effect, the following extra tax will be owed:
- $22,800 of NIIT on the farm rental ($600,000 X 3.8%), plus
- $113,400 of extra SE and Medicare tax on the $700,000 of S corporation income.
This equals a total extra tax of $136,200 per year.
As you can see this tax can be substantially higher than raising the top tax rate from 37% to 39.6%. We will keep you posted.
