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Form 8960 and the Net Investment Income Tax

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The new Net Investment Income Tax imposed by Internal Revenue Code Section 1411 went into effect on January 1, 2013 for income tax returns of individuals, estates and trusts, beginning with their first taxable year starting on (or after) January 1, 2013. The Net Investment Income Tax applies at a rate of 3.8% on certain net investment income of individuals, estates and trusts that have income above statutory threshold limits.

Form 8960 is used by individuals, estates, and trusts to compute their Net Investment Income Tax. The IRS has posted a draft version of the instructions to Form 8960, and recently, it released the final version of the form itself.

This article will explain the basics of Form 8960 and the Net Investment Income Tax. Future articles on this topic will also provide more information about this tax. The article is not intended to convey tax or legal advice. Please consult a tax attorney if you have further questions. Sherayzen Law Office, Ltd. can assist you in all of your tax and legal needs.

The Net Investment Income Tax

As mentioned above, the Net Investment Income Tax applies at a 3.8 percent to certain net investment income of individuals, estates and trusts that have income above statutory threshold limits. If individuals have Net Investment Income, they will owe the Net Investment Income Tax if they have modified adjusted gross income, for purposes of the Net Investment Income Tax (note that individuals with income from controlled foreign corporations (CFCs) and passive foreign investment companies (PFICs) may have additional adjustments to their AGI) above the following thresholds: for married filing jointly returns, the threshold is $250,000; for married filing separately returns, the threshold amount is $125,000; for single taxpayers or Head of household (with qualifying person), the threshold is $200,000; for a qualifying widow or widower with a dependent child, the threshold is $250,000.

Note also that these threshold amounts are not indexed for inflation.

According to the IRS, “In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities and businesses that are passive activities to the taxpayer (within the meaning of section 469). To calculate your Net Investment Income, your investment income is reduced by certain expenses properly allocable to the income.” Certain common income items, such as tax-exempt interest, Alaska Permanent Fund Dividends, and distributions from certain Qualified Plans (those described in sections 401(a), 403(a), 403(b), 408, 408A or 457(b)), are not treated as Net Investment Income.

US Persons and Nonresident Aliens

Dual-status individuals, who are US residents for a part of the year and Nonresident Aliens (NRAs) for the other part of the year, are subject to the Net Investment Income Tax only with respect to the portion of the year during which they are US residents. The threshold amounts described above, however, are not reduced or prorated for dual-status residents.

Dual-resident individuals, (see regulation §301.7701(b)-7(a)(1) for more information) who determine that they are residents of foreign countries for tax purposes pursuant to US-foreign country income tax treaties, and who claim benefits of such treaties as nonresidents of the US, are deemed to be NRAs for Net Investment Income Tax purposes.

NRAs are not subject to the Net Investment Income Tax. For married couples in which one spouse is an NRA, and the other is a U.S. citizen or resident, and the NRA has made, or is planning to make, an election to be treated as a resident alien for purposes of filing a married filing jointly return, IRS final regulations provide these couples with special rules and a respective Net Investment Income Tax IRC Section 6013(g) or (h) election.

Contact Sherayzen Law Office for Professional Tax Planning Advice

In previous articles, we covered some of the new tax changes and deduction phase-outs for 2013 tax returns to be filed in 2014 that could trigger a much higher tax liability for many taxpayers. The Net Investment Income Tax will only add to the tax liabilities many high net-worth taxpayers will face. Professional tax planning may be very important in order to help you lower your future tax liabilities. The experienced tax law firm of Sherayzen Law Office, Ltd. can assist with this goal.

Fee Agreement Arrangements with Tax Lawyers in Minneapolis: 5 Most Important Issues

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In this article, I will discuss five most important issues that you need to know before you sign a fee agreement with tax lawyers in Minneapolis.

1. How is the lawyer’s fee paid? There are three main models of payment that lawyers use: hourly fee, contingency fee, and flat fee. The hourly fee is the most common form of tax lawyer compensation and it is fairly simple – the tax attorney is paid only based on the time he spends on the case. If you’re paying your tax lawyer by the hour, the agreement should set out the hourly rates of the tax attorney and anyone else in this attorney’s office who might work on the case. The contingency fee arrangement, where the tax attorney takes a percentage of the amount the client wins at the end of the case, is almost never used by tax attorneys in Minneapolis. In the unlikely case that this latter type of fee arrangement is used, the most important issue to understand is whether the tax lawyer deducts the costs and expenses from the amount won before or after you pay the lawyer’s percentage. Obviously, you will pay more in attorney fees if your tax lawyer deducts the litigation costs based on the latter scenario (i.e. after you pay the lawyer’s fee). Finally, in a flat fee arrangement, you pay an agreed-upon amount of money for a project. For example, you pay $3,000 to your tax attorney to file delinquent FBARs (Reports on Foreign Bank and Financial Accounts) for the past five years. While a flat fee arrangement is possible in a small project, it is generally disliked by tax lawyers in Minneapolis because it often lacks the necessary flexibility to account for the client’s individual legal situation. Usually, some sort of an additional payment arrangement is built into such fee agreements to make sure that the balance between the client’s legal needs and the tax attorney’s fees is maintained.

Remember, usually, you will have to pay out-of-pocket expenses (e.g. long-distance calls, mailing costs, photocopying fees, lodging, etc.) and litigation costs (such as court filing fees) in addition to your tax lawyer’s fees.

2. Does the agreement include the amount of the retainer? Most tax lawyers in Minneapolis require their client to pay a retainer. Retainer can mean two different fee arrangements. First, retainer may be the amount of money a client pays to guarantee a tax attorney’s commitment to the case. Under this arrangement, the retainer is not a form of an advance payment for future work, but a non-refundable deposit to secure the lawyer’s availability. Second, a retainer is simply the amount of money a tax attorney asks his client to pay in advance. In this scenario, the lawyer usually deposits the retainer in a client trust account and withdraws money from it for the work completed according to the fee agreement. The fee agreement should specify the amount of the retainer and when the lawyer can withdraw money form the client trust account (usually, on a monthly basis).

3. How often will you be billed? Most tax attorneys in Minneapolis bill their clients on a monthly basis. Sometimes, however, when the project is not large, the fee agreement will specify that you will be billed upon completion of the case. In a flat-fee scenario, it is likely that the client will be obligated to pay either a half or even the whole amount immediately as a retainer. It is wise for a client to insist in paying some part of the fee upon completion of the case to retain a degree of control over the case completion.

4. What is the scope of the tax attorney’s representation? Most tax lawyers in Minneapolis will insist on defining their obligations in the fee agreement. The most important issue here is to state what the tax attorney is hired for without defining it either too narrowly or too broadly. Usually, a fee agreement should specify that a new contract should be signed if you decide to hire this tax lawyer to handle other legal matters.

If you are hiring a large or a mid-size law firm, beware that the partners in a law firm often delegate some or all of their obligations to their associates or even their staff. While the partners retain full responsibility for the case, there is a danger that important parts of it may be delegated to far less experienced associates. Besides the potential quality issues, there is also a concern that you would be paying a large hourly fee for a first-year associate’s work. It is important to insist that the fee agreement specifies what, if any, type of work is being delegated to the associates, the corresponding billing rate of each associate involved, and who carries the responsibility for the whole case.

5. Who controls what decisions? Whether this information should be included in the fee agreement really depends on a case and on an attorney. Generally, tax attorneys in Minneapolis let their clients make the important decisions that affect the outcome of the case (such as: acceptance or rejection of the IRS settlement offer, commencement of a lawsuit, business decisions, et cetera). All of the decisions with respect to the legal issues (such as: where to file a lawsuit, what motions should be filed, what negotiation tactics should be employed, how to structure a business transaction from a tax perspective, etc.) are usually taken by the tax lawyers. If there are any changes to this arrangement (for example, you want your lawyer to make certain decisions with the respect to the outcome of the case), you should insist that these modifications be reflected in the fee agreement.

Generally, before you sign the fee agreement, tax lawyers in Minneapolis will discuss with you many more topics than what is covered in this article. The five issues explained here, however, are crucial to your understanding of how the tax relationship with your tax attorney will work. Before you sign the fee agreement with your tax lawyer, you should ask at least these five questions and make sure that the answers are complete and to your satisfaction.