Tax and financial advice from the Silicon Valley expert.

Increased standard deduction means increased net investment income tax

The Tax Cuts and Jobs Act of 2017 increased the standard deduction for 2018 to $24,000 for married taxpayers filing joint returns, $18,000 for heads of households, and $12,000 for other taxpayers.  This means most taxpayers will now be using the standard deduction to compute their federal income tax.

In the past, taxpayers who itemized their deductions could deduct part of their state income tax deduction when computing their 3.8% tax on net investment income (net investment income tax, or NIIT.)

Since they will not be claiming the state income tax deduction for regular tax purposes when they claim the standard deduction, they will “lose” that deduction when they compute their NIIT for 2018.

Here is the rationale for my conclusion that taxpayers who claim the standard deduction aren’t eligible to claim a deduction for state income taxes for the NIIT.

Reg. Sec. 1.1411-1(a) gives the general rule that, unless otherwise detailed in the regulations, the regular tax rules apply for the computation of the net investment income tax. (So, unless there is a defined exception, an election to claim the standard deduction will also apply for the NIIT.)

Reg. Sec. 1.1411-4(a) defines net investment income as the excess of investment income (as defined) over deductions properly allocated to the income.

Reg. Sec. 1.1411-4(f)(3)(iii) explains the deduction for state income taxes. It is based on the amount claimed for regular tax purposes, with no exception defined when a taxpayer elects to claim the standard deduction.

In most cases, taxpayers (especially married filing joint returns) will pay a lower overall tax when they claim the standard deduction compared to itemizing, even considering the net investment income tax. You are right that people haven’t been talking about the additional NIIT many taxpayers will pay when they claim the standard deduction.

For every $100 of deduction “lost”, the tax increase is $3.80.

This is a rather sneaky increase in the new tax law.

Tax and financial advice from the Silicon Valley expert.