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Debate: Should the Net Investment Income Tax Be Expanded?

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Under current law, the 3.8% net investment income tax applies to annual gross income of taxpayers that exceeds a $200,000 threshold ($250,000 for joint returns). An exception exists to exclude from taxation income earned from a business in which the taxpayer materially participates. 

The Build Back Better Act would change the way that the NIIT applies to individual taxpayers by applying it to trade or business income without regard to whether the taxpayer materially participates in the operation of the business.

Under the proposal, the NIIT would apply to taxpayers earning more than $500,000 (joint filers) or $400,000 (single filers). Application of the NIIT would phase in for taxpayers who earn less than $100,000 more than the threshold levels. This rule would apply to tax years beginning in 2022 and thereafter.

We asked two professors and authors of ALM’s Tax Facts with opposing political viewpoints to share their opinions about expanding the net investment income tax.

Below is a summary of the debate that ensued between the two professors.

Their Votes:

Bloink

Byrnes

Their Reasons:

Bloink: The wealthiest Americans have been able to avoid the NIIT if they materially participate in their own business. This is yet another loophole that only adds value for taxpayers who are wealthy enough to manipulate their circumstances to avoid the tax. We need to focus on eliminating as many of these loopholes as possible if we’re going to make our way toward a more fair and equitable tax system in this country.

Byrnes: This is yet another proposal stuck into the act to penalize small-business owners for their success — and that’s not the point of our federal tax code. The material participation exception to the NIIT exists for a reason. The NIIT is meant to impose an additional tax on passive investment income. By definition, small-business owners who materially participate in their own business operations are not passive. 

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Bloink: This net investment income tax is meant to be a tax on the investment income of the wealthiest Americans. Often, investment income and business income are one and the same. The full application of the tax wouldn’t hit until the taxpayer earned at least $500,000 ($600,000 for joint returns) per year. This is a way for us to ensure that higher-income taxpayers are paying their fair share. 

Byrnes: Again, we should be proactively trying to support our small-business owners right now, not taking steps to punish them for their success. Sure, the most successful business owners invest in their own businesses. That doesn’t mean their trade or business income is anything like passive investment-type income to which the NIIT was designed to apply.

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Bloink: Successful business owners often shield their investment income by using their own businesses to do so. This tax simply eliminates that loophole for the wealthiest business owners in this country — and will go a long way toward helping all Americans, especially those who are struggling the most in the wake of the pandemic.

Byrnes: Expanding the net investment income tax to non-passive trade or business income fundamentally changes the nature of the tax. Our tax system isn’t designed to be punitive. Applying the NIIT to businesses simply because they’re successful does nothing but punish hardworking Americans for being successful.

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