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This is the Net Investment Income Tax to finance Obamacare.

Line 9b provides that I can deduct a large part of my state income tax (the part attributable to investment income, which is most of my 2020 income) from the amount subject to tax.

Include state, local, and foreign income taxes you paid for the tax year that are attributable to net investment income.

The consumer-level tax prep program I am using, which will remain unnamed, has filled in a small number based, as far as I can tell, on the $10,000 maximum state income tax deduction. Alternatively it may be based on my 2020 paycheck withholding. Both possibilities look wrong to me. Shouldn't it be based on the entire state income tax I will owe (including the estimated tax payment I made in January 2021)?

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A few paragraphs earlier it says

Reasonable method allocations. To the extent that you have a properly allocable deduction that’s allocable to both net investment income and excluded income, you may use any reasonable method to determine that portion of the deduction that’s properly allocable to net investment income. The three items that may be allocated between net investment income and excluded income are the following.

  • State, local, and foreign income taxes if properly deducted on your return when calculating your U.S. regular income tax. [emphasis added, others snipped]

The deduction against regular income tax (on Schedule A) is as you note limited to $10k (at least through 2025), and for cash-basis taxpayers (most are) includes only payments in the tax year. If you make an estimated payment for 2020 state tax in Jan. 2021, or a final payment in April 2021 (or later if delinquent!) you don't deduct it for 2020 Federal tax, but for 2021 Federal tax -- and in either case subject to the SALT limit.

The underlying law is actually clearer (which is rare IME). 1411(c)(1) defines 'net investment income' (taxed up to the limit defined in (a)) as: the excess (if any) of (A) [certain items of gross income and net gain] over (B) the deductions allowable by this subtitle which are properly allocable to such gross income or net gain. [emphasis added]

The relevant deduction in 'this subtitle' is 164(a)(3) as limited by (b)(6) for tax years 2018-2025 to $10k

Sorry, Charlie:-(

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  • Without spending the 2 hours required to fully research and understand you answer... does this means, that if I take Standard Deduction instead of filing Sched. A, then I cannot claim a deduction in line 9b or Form 8960?
    – ysap
    May 7 '21 at 13:49
  • ysap: the instructions refer to 26 CFR 1.1411-4(f) available here which defines 'properly allocable deductions' to include only 62(a)(4),(1),(9) and 172, and 63(d),164(a)(3),72(b)(3),691(c),212(3),171(a)(1) and maybe 165, none of which is the standard deduction under 63(c). That's clearly Treasury's position; if you think it's inconsistent with the law you could challenge it in court, although given the broad statement in the law I think Chevron will make that nearly impossible. May 9 '21 at 7:37
  • Thanks. I am not sure I follow. Or maybe my question was not clear enough. What I am trying to understand is if state taxes are not itemized, then can I deduct 5% (state tax rate) of NIIT from the additional tax liability? I asked the question as a new proper question here, so maybe you could answer there: money.stackexchange.com/q/140578/5993
    – ysap
    May 9 '21 at 11:13
  • You can't ever deduct state (and local) tax from federal tax. You can deduct a portion of that tax actually paid (not estimated or projected) from the income subject to NIIT if you itemize (since 164(a)(3) is in the regulation section I linked) but not if you take the standard deduction (since 63(c) is not) -- unless you get the regulations overturned in the courts (and a contrary position favorable to you upheld) and I don't think you can succeed at that, due to what is called Chevron doctrine set by the Supreme Court. May 12 '21 at 0:20

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