TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Monday, July 14, 2014

Lurie: The ObamaCare 3.8% Tax on Investment Income: A Second Income Tax Obama's Trojan Horse: A 3.8% Medicare Surtax? No. A Free-Standing Second Income Tax? Yes. A Well-Kept Secret? You Bet, by Alvin D. Lurie:

The parties have continued to wage this war over innumerable aspects of the Affordable Care Act, most especially the technical failures that occurred during the rollout of the federal insurance exchange at the end of 2013 and into the first quarter of the current year. Doubtless this will continue to be one of the principal themes trumpeted by the Republicans during the upcoming midterm elections in November 2014. What is surprising is that they have not, even at this writing -- over four years after enactment of the ACA, two national elections held since then, and another one barely six months away -- launched any attacks against inclusion in the ACA of a tax that is misnamed (misleadingly so) as a "Medicare contribution" levy, purportedly (again misleadingly) to provide the revenues to support the government expenses associated with administering the ACA. One would have thought that tax would have provided the Republicans with their best point of attack against the Affordable Care Act.

In truth, the tax, imposed specifically on "net investment income," is a new income tax, now actually a part of the Internal Revenue Code (numbered section 1411), operating exactly the same as the long-standing regular income tax, calculated on a new form created for it and the total now reportable on a line added to Form 1040. It is, in fact, much more challenging to calculate than most of the long-time familiar ordinary, alternative minimum and capital gains components of the regular income tax, because of many new technical rules and difficult factual determinations necessary for its proper application. High rates of miscalculation by taxpayers are a certainty because of the difficulties inherent in the process, and because the rules themselves will be in flux for a lengthy period, until the Treasury, IRS and ultimately the courts put their respective stamps on the statute.

The tax will add significantly to the expenses of relatively high-bracket taxpayers within its reach, not just in payment of the tax itself, but for the associated costs of compliance, including professional advice, record-keeping, calculating and return preparation, all specifically related to this tax; and, one must assume, the budgets of Treasury and IRS will grow apace to absorb the additional manpower and machine power necessary to administer this difficult new tax. Self-evidently, this all comes at substantial new costs to the Nation continuing indefinitely, with much uncertainty before the process works itself out and the dust settles, which in itself will impact the economy in unpredictable ways.

In brief, that is the subject of this paper. The question one may ask is, even assuming the tax could legitimately be claimed as supplying the necessary revenues for administration of the ACA, was it fit and proper to impose such a difficult and costly tax on the taxpayers within its reach and on the economy at large in order to achieve such an outcome. Other far simpler revenue raising measures obviously could have been devised to raise the same tax revenues, without the complications and burdens, the most obvious being a direct rate increase of existing components of the regular income tax regime.

In sum, framed in terms of Darwin's survival hypothesis, is this tax fit to survive?

Update:  Updated and corrected version here.

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I recommend skipping this paper. It's tendentious and repetitive. It's factually incorrect in one place, stating that sale of home might be non-taxable depending on whether the taxpayer purchases another home. That has not been true since 1997. The underlying point is correct that home sellers post-recovery can be surprised by their liability for the 3.8% tax kicker.

If I wanted to read a paper about getting rid of the NIIT, I would have preferred a description of how the next President could, using Obama's precedents, order the IRS to defer enforcement of the NIIT indefinitely. That would be an entertaining paper, especially with the ensuing speculation as to whether the IRS would comply as meekly as it has with other unauthorized changes to the ACA.

Posted by: AMT buff | Jul 14, 2014 7:20:58 PM