Background
The
3.8-percent Net Investment Income (NII) tax took effect at the
beginning of the 2013 tax year, meaning that reporting must now begin
during the 2014 filing season. The IRS issued proposed reliance
regulations in 2012, followed by final regulations in November 2013.
Although, the IRS had previously issued a draft Form 8960, Net
Investment Income Tax, in August 2013, it did not release the
instructions until now.
The draft instructions are based on the final NII tax regulations (T.D. 9644)
issued at the end of November 2013. Nevertheless, the IRS has
specifically stated that, for 2013 reporting, taxpayers have the choice
of applying either the 2013 final regulations or the 2012 proposed
regulations. Only the final regulations will apply for 2014 and beyond.
Comment
IRS
officials have stated that Form 8960, which was issued in draft form
in August 2013, will not change. Any changes are likely to appear in
the final instructions. There will be no IRS Publication released on
the NII tax for this filing season, one of the drafters of the
regulations commented.
Michael
Grace, counsel, Whiteford Taylor Preston LLP, Washington, D.C.; and
Robert Keebler, Keebler & Associates LLP, Green Bay, Wisc., sat down
with CCH to offer their expert views of the draft instructions for Form
8960. This article covers those conversations on the draft form.
Worksheets
While
Form 8960 has 21 lines and is only one page long, the draft
instructions for Form 8960 are 19 pages long and include over five pages
of worksheets to be used to calculate the amounts reportable on Form
8960. The worksheets are complicated, and require moving figures from
Form 1040, 1041, or Schedule A, Itemized Deductions. As such, it would
be advisable to pay close attention to this year’s calculations and to
double check them whenever possible.
Part
1, Lines 1-8 of Form 8960 is used to report investment income. Line 5
of Form 8960 is used to report Category (iii) income (Code Sec. 1411(c)(1)(A)(iii)):
net gain attributable to the disposition of property, other than
property held in a trade or business not subject to the NII tax. Line
5a shows the total net gain or loss from the disposition of property,
transferred from Form 1040. Line 5b backs out net gains or losses that
are not subject to the NII tax.
There
is a two-page worksheet for calculating the amounts on line 5. The
worksheet lists eight categories of gains and losses excluded from the
tax and reported on Line 5b; the instructions explain these items. Part
3 of the worksheet is used to calculate the taxpayer’s adjustment for
gains and losses attributable to the disposition of interests in
partnerships and S corps (Code Sec. 1411(c)(4)). This adjustment reduces the amount of gain from the disposition of the interest that is included in NII.
The method for calculating the Code Sec. 1411(c)(4)
adjustment was changed in the 2013 proposed regulations from the 2012
proposed regulations. For 2013, the first year of the NII tax, the
instructions indicate that taxpayers can choose to report the
adjustment under either set of regulations. The instructions require
taxpayers reporting this adjustment to attach a statement to their
return; the content of the statement varies, depending on which set of
regulations the taxpayer applies.
Instructions—Passthrough Interests
In
addition to issuing new instructions for new Form 8960, the IRS also
issued draft revisions of the instructions for Form 1065 (Partnerships),
Form 1065-B (Electing Large Partnerships), and Form 1120S (S
Corporations), for reporting NII tax items to the partners and
shareholders. The Schedule K-1s will need to separately state items that
affect the partner or shareholder’s determination of NII.
Recharacterization
Certain income items, such as self-rental income, that would generally be treated as passive income, are recharacterized under Code Sec. 469
as non-passive income. This was originally an anti-abuse rule meant to
prevent taxpayers from deducting passive losses from the income.
However, because net investment income resulting from passive
activities is subject to the NII tax, recharacterization of passive
income as non-passive income can actually prove beneficial to taxpayers
subject to the NII tax.
Page
4 of the draft instructions discusses recharacterization. The
instructions list several types of formerly passive activities, which
under Code Sec. 469
will be recharacterized as non-passive for purposes of calculating the
amount of net investment income subject to the NII tax. The
instructions also refer taxpayers to Reg. §1.469-2(f), Temp. Reg. §1.469-2T(f), and Publication 925, Passive Activity and At-Risk Rules.
Properly Allocable Deductions
Code Sec. 1411(c)(1)(B)
allows taxpayers to offset their NII with “properly allocable
deductions.” Part II of Form 8960, Line 10, is used to report
Additional Modifications to NII. The instructions advise that Line 10
should be used to report additional deductions and modifications that
are not otherwise reflected in Lines 1-9.
The
instructions thus implicitly acknowledge that some deductions and
modifications are not reported in Part II. For example, the final
regulations, in a victory for taxpayers, allow net losses determined
under Category (iii) (gain attributable to the disposition of property)
to be used to offset other NII. This net loss is not shown as a
deduction or modification in Part II. Instead, it is shown as a negative
amount to NII in Part I. Similarly, the draft instructions explain that
the portion of a net operating loss (NOL) that is attributable to NII
and can therefore be deducted will be taken as a Modification in Part
I, Line 7.
Trade or Business
Grace:
“What you have is a statute that lays out three categories of
investment income. Category (i) really highlights the importance of
determining whether items are derived in the ordinary course of a trade
or business. If not, the income is automatically NII. If the items are
derived from a trade or business, you have a shot at NII treatment. Then
you go on to Category (ii) income. Does the activity fall into a
passive activity? If you keep it away from these categories, the income
falls out of NII. That’s why it’s so important to make that
distinction.”
Keebler: “The trade or business determination is not really a forms issue; it’s how to apply Sec. 469.
The IRS made no effort to say what a trade or business is. Any
guidance would have to be part of a bigger regulations project.”
Real Estate Professionals
Under Code Sec. 469,
a qualified real estate professional is a person that works more than
750 hours and devotes more than half of his/her services to real estate
trades or businesses.
Grace: “The general rule under Sec. 469
is that income/loss from rentals is passive, regardless of the level
of participation. But if you’re a qualified real estate professional,
this per se rule does not apply. Instead, you can test the real estate
activity for material participation. If that professional owns some
real property and materially participates in those rentals, then the
rental income/loss is not passive under Sec. 469.
It raises the question —is the result the same under 1411? The final
regulations clarify: if the income/loss is non-passive under Sec. 469, it is also non-passive under Sec. 1411, as long as the rents are truly received in the ordinary course of a trade or business.”
Comment
The
instructions make it clear that income from non-passive activities
will be included in NII if the activity is not a trade or business
under Code Sec. 162. Code Sec. 469
provides a safe harbor for real estate professionals that participate
in the rental real estate activity more than 500 hours. The regulations
provide that a taxpayer can regroup its activities under Code Sec. 469,
and that the 500 hour threshold applies to the grouped activities.
However, this is not clear in the instructions, which provide that a
real estate professional must participate in each rental real estate
activity for more than 500 hours during the tax year. For grouped
activities, only one 500 hour threshold applies.
Reference: PTE §32,022
0 comments:
Post a Comment