Everything You Wanted To Know About the Net Investment Income Tax aka the 3.8% Medicare Contribution Tax

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Truer words were never spoken: "These proposed regulations are both interesting and longer than the Old Testament. I'm kidding of course; they're not interesting at all."

A question about rental income.

Taxpayer owns and leases on long terms several substantial properties, in several SMLLCs. Taxpayer can very likely pass the "material participation" and "active trade or business" tests, and can start keeping a detailed log of his activities. Taxpayer is not concerned with net passive losses. However, taxpayer is concerned with avoiding the new 3.8% tax if possible.

As I understand it, rents will not be subject to the 3.8% tax if they are non-passive. Are there any disadvantages to establishing that such rents re non-passive and from an active trade or business? Such as SE taxes, etc?

Yes, self employment income is also subject to the normal medicare tax of

2.9%, but there is an additional 0.9% tax on it if your income is over 200k/250k. And of course, social security tax, but if your other W-2 income is over the threshold (around 110k), then this tax does not apply.

No one in the media ever talks about the marriage penalty aspect of this tax. If two single people make 150k they don't have to deal with this tax, but upon getting married they do.

Just as no one in the media ever talks about the marriage reward aspect of this tax. If a single person makes $225K he has to deal with this tax, but upon getting married to someone with no income, he doesn't.

but isn't rental income not subject to SE tax, unless you are a dealer or provide significant additional services?

Apparently, MAGI means one thing for the Net Investment Income Tax (NIIT) and a different thing for the Medicare Premium Parts B and D Income-related Adjustment (MPIA).

For MPIA, MAGI includes tax-exempt interest, but for NIIT, it does not.

Is this correct?

Yes they are different. MAGI for the premiums is AGI plus tax-exempt income. MAGI for the NIIT is AGI adjusted for the foreign earned income exclusion.

Yes, normally rental income is not subject to SE tax. But then it is subject to the full medicare 3.8% tax if your income is over 200k/250k.

I would still argue that they have a marriage penalty because the savings is not as much as it otherwise would have been. That is, suppose the tax medicare kicked in at 400k for married people. So in this scenario, a single person making 350k would not have not have to deal with this medicare tax. In CA, the thresholds for each tax bracket, phaseout, etc for married people are double that for single filers -- except for the mental health services tax -- so there is no marriage penalty. Anyway, the Bay Area has many people in this category, so in theory it should be an issue out here. In theory the tax could encourage couples to just live together and not get married. The Bush tax cut made the standard deduction for married filers double that of single filers (it was previously about 1.5), thus giving regular and lower income married filers a marriage penalty; but then again, upper middle income and upper income taxpayers get less sympathy.

unless you are a real estate professional, making the property non-passive. Or so it seems.