TaxMatters@EY - March 2013

US: Foreign tax credits may not offset net investment income tax

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Jo-Anne VanStrien, Toronto

The US Patient Protection and Affordable Care Act of 2010 and the Health Care and Education Reconciliation Act of 2010, more generally known as the “Obamacare” legislation, made several changes to the income and employment tax landscape for 2013 and beyond. One such change is a new 3.8% net investment income tax (NIIT), a medicare contribution tax, on certain investment and other passive income (unearned income).

US citizens and residents are subject to the new NIIT on all income falling within the definition of net investment income, including income from foreign businesses or investments.

The 3.8% NIIT on unearned income applies to the lesser of net investment income and modified adjusted gross income over $200,000 for single taxpayers (or $250,000 formarried taxpayers filing jointly).

The income subject to tax falls broadly into three categories:

  • Investment income including interest, dividends, rents and annuities not derived in the ordinary course of a trade or business
  • Trade or business income from passive activities or from trading in financial instruments or commodities
  • Net gains from the disposition of property not used in a trade or business

US citizens and residents who are accustomed to using foreign tax credits to reduce their US income tax liability to little or nothing may be surprised to find that beginning in the 2013 tax year they will owe 3.8% tax on all investment income in excess of the applicable threshold. This US liability willlikely not be reduced by foreign tax credits, a US income tax treaty or a US social security totalization agreement.

US citizens and green card holders residing in Canada should consult their EY tax advisor to learn more.