the net investment income tax: this is a lousy niit c. clinton davis, jr. krage & janvey, l.l.p....

The Net Investment Income Tax:

This is a Lousy NIIT

C. CLINTON DAVIS, JR.

Krage & Janvey, L.L.P.

2100 Ross Avenue, Suite 2600

Dallas, Texas 75201

ccdavis@kjllp.com

For 2013, individuals, estates and some trusts*

woke up to new taxes

• A 3.8% NET investment income tax [NIIT] on “high income” taxpayers;

• Not yet understood by your clients;

• AND NOT INDEXED FOR INFLATION IN FUTURE YEARS

• It’s a SURTAX—not deductible from the income tax

• * Exemptions apply to nonresident individuals, foreign estates and some types of trusts.

COMPUTATION

The 3.8% NIIT is levied on the LESSER of:

1. Net Investment Income [NII]; or

2. Excess of:a. MAGI [MAGI = AGI unless you have foreign

earned income; then add back § 911 excluded income and expenses] OVER

b. the Taxpayer’s Threshold Amount: ($250,000 joint; $200,000 single; $125,000 married filing separately)

About 6% of the population has MAGI above those thresholds.

NIIT N/A WHERE THE SE TAX APPLIES.

So high income is?INCOME MARRIED JOINT SINGLE TRUSTS

39.6% RATE ABOVE (INDEXED)

$450,000(2013);

$457,600(2014)

$400,000(2013);

$406,750(2014)

$11,950 (2013);$12,150(2014)

PEASE LIMITATION(INDEXED)

$300,000(2013);

$305,050(2014)

$250,000(2013);

$254,200(2014)

N/A

3.8% NIIT OVER (NOT INDEXED FOR INDIVIDUALS)

$250,000 $200,000 $11,950 (2013);$12,150(2014)

Bracket reduction meets an inglorious end:

NEW FORMS

8959 FOR THE ADDITIONAL

MEDICARE TAX &

8960 FOR THE NIIT

WHAT IS INCLUDED UNDER INVESTMENT INCOME FOR THE NIIT?

3 BROAD AREAS—

1. Interest, Rents, Dividends, Annuities, Royalties;

2. (A) All Income from a Passive Activity; AND (B) All Income from a Trade or Business of Trading in Financial Instruments or Commodities;

3. Gains from Sale of Property.

EACH HAS EXCEPTIONS.

SPECIAL RULES MAY APPLY

• For example, drilling funds are initially set up as joint ventures to qualify for the working interest exception to the PAL rules so the IDCs are deductible [from an active activity].

• But taxpayers are prevented from placing oil and gas properties into limited liability holdings in order to convert this income to passive income in subsequent tax years. IRC §469(c)(3)(a).• SO SE TAXES APPLY

Common items NOT subject to NIIT[notwithstanding political ads]:

• Alimony;

• Unemployment compensation;

• Sickness and injury benefits from workmen’s compensation;

• Payments on account of personal injury (including related emotional distress);

• Tax-Exempt Interest;

Common items NOT subject to NIIT[notwithstanding political ads]:

• Veteran’s and social security benefits;

• Income or gain that is not recognized--E.g., excluded portion of gain on sale of a principal residence;

• Loans from a whole life insurance contract’s cash value;

• C corporation distributions that return basis;

Common items NOT subject to NIIT[notwithstanding political ads]:

• Distributions from a Roth IRA;

• Distributions from a plan or arrangement described in section 401(a), 403(a), 403(b), 408, 408A, or 457(b);

• Dividends on employer securities held by an employee stock ownership plan deductible under section 404(k) and paid in cash directly to a plan participant or beneficiary;

• For ESOPs: net unrealized appreciation in employer securities that is realized in a disposition of those employer securities;

• ANYTHING TAXED UNDER THE SE TAX.

A few taxpayers can exclude investment-type income (interest,

dividends):

4-part test to be met:

1. Income is earned in a TRADE OR BUSINESS;

2. Income is earned in the ordinary course of the trade or business;

3. Trade or business is not trading financial instruments or commodities; and

4. Taxpayer is NOT PASSIVE with respect to the activity [e.g., real estate professionals with respect to rents].

SE taxes may apply to the trade or business income!

• E.g., holders of working interests.

KEY INQUIRIES

• Does this activity constitute a trade or business?

• Is this income earned in the ordinary course of the trade or business?

• Does the taxpayer materially participate?

All questions need yes answers to escape the

NIIT but yes answers (depending on structure)

can expose the taxpayer to SE Taxes.

TRUSTS HAVE SPECIAL ISSUES:HOW DOES A TRUST MATERIALLY

PARTICIPATE?

• IRS takes the position that the trust can only materially participate if the trustee participates in the activity on a regular continuous and substantial basis in its fiduciary capacity.

• Cases takes a different approach.

FRANK ARAGONA TRUST, 142 T.C. NO. 9 (2014)

[U.S. TAX COURT DOCKET 015392-11]

• Activities of Trustees who were also employees of an LLC owned by the trust could not be disregarded as argued by the IRS.

• IRS POSITION REJECTED.

MATTIE K. CARTER TRUST V. U.S.,256 F. SUPP. 2D 536 (N.D. TX

2003)

• The Trust was the taxpayer, and material participation was determined by assessing the trust’s activities through its fiduciaries, employees and agents.

• QUERY: Planning opportunities using trusts to incorporate the activities of employees into the material participation calculation?

TRUSTS HAVE SPECIAL ISSUES

43.4% TAX RATE ON UNDISTRIBUTED INCOME KICKS IN ABOVE ONLY $11,950 FOR 2013

DISTRIBUTE INCOME TO BENEFICIARY AND SAVE TAX?

POTENTIAL SAVINGS IF THE “KIDDIE” FILES HIS OWN RETURN AND HAS HIS OWN $200,000 EXEMPTION: $200,000 X 3.8% = $7,600 PER YEAR

TRUSTS HAVE SPECIAL ISSUES

• BUT:• MAY BE A DIFFERENT BENEFICIARY THAN REMAINDER

BENEFICIARY;

• FIDUCIARY DUTY ISSUES;

• LOSS OF SPENDTHRIFT PROTECTION FROM CREDITORS AND/OR DIVORCING SPOUSES;

• REMEMBER 65-DAY PERIOD TO DISTRIBUTE PRIOR YEAR INCOME AND TREAT AS PRIOR YEAR DISTRIBUTION.

Deductions

• For passive trade or business, deduct

§ 62(a)(1) expenses not taken into account in

determining SE income.

• For rents and royalties, deduct § 62(a)(4) expenses.

• Deduct investment losses.

• 1411 NOL (discussed below).

• Deduct penalties on early withdrawal of savings.

Deductions

• Investment interest expense allowed under 163(d)(1) [so the limitation to investment income applies].

• Investment advisory expense.

• But limitations on miscellaneous itemized deductions apply and PEASE limitations apply.

• State and local taxes attributable to investment income.

• Items described in 72(b)(3) for the annuitant’s last taxable year if income would have been in NII.

Deductions

• Deductions for estate and GST allowed under 691(c) allocable to NII.

• Amounts described in 212(3) and §1.212-1(l) to extent allocable to NII.

• Deductions allowed under 171(a)(1) for the amortizable bond premium on a taxable bond.

• Fiduciary expenses allocable to NII.

Capital Loss Carryovers

Except for certain excluded capital losses, capital losses GENERALLY may be taken into account in the computation of section 1411(c)(1)(A)(iii) net gain by reason of the mechanics of section 1212(b)(1).

• Proposed § 1.1411-4(d)(4)(iii) creates an annual adjustment to capital loss carryforwards to prevent capital losses excluded from the net investment income calculation in the year of recognition from becoming deductible losses in future years.

WHAT ABOUT NOLs?

New concepts to understand—§1.1411-4(h)(2)

“APPLICABLE PORTION OF AN NOL”

For any year when the taxpayer incurs an NOL, the “applicable portion” is the LESSER of:

The NOL that TP would incur if only NII gross income and only properly allocable deductions are considered; OR

The NOL for the year.

WHAT ABOUT NOLs?

New concepts to understand—§1.1411-4(h)(3):

“SECTION 1411 NOL AMOUNT OF AN NOL CARRIED TO AND DEDUCTED IN THE YEAR”

The total NOL amount carried from a loss year and allowed under 172(a)

MULTIPLIED BYA Fraction: Applicable Portion for the Loss

Year

Total Amount of NOL for Same Year

WHAT ABOUT NOLs?

STEPS:

1. First, determine the APPLICABLE PORTION of TP’s NOL for each loss year;

2. Determine the amount carried from a loss year and deducted in the tax year;

3. Add together the § 1411 NOL amounts of each NOL carried from a loss year and deducted in a tax year.

4. Sum is the allowed NOL deduction.

LENGTHY EXAMPLES IN REGULATIONS.

WHAT ABOUT SUSPENDED PALS?

• A taxpayer can use suspended PALs to offset NII but only to the extent of income that is included in NII.

• Assume $50,000 of suspended loss from an activity that was passive in 2013. Assume $25,000 of income from the same activity but that it was active in 2014. Also assume $5,000 of passive income from other sources in 2014. $25,000 of suspended loss first offsets income

from the formerly passive activity but that income was excluded from NII. The remaining $5,000 would be in NII for 2014 but is offset by suspended PALs.

$20,000 in PAL remains suspended.

TRADER FUNDS

Trader funds segregate income into three components:

1. Gross gains from the disposition of financial instruments and commodities, 2. Gross losses from the disposition of financial instruments and commodities, and 3. Deductions allocable to trading activities.

Taxpayers can net all gains and losses from both investor and trader funds, including those with 475(f) elections.

Any excess losses that result from this netting can be used to reduce other categories of NII to the extent allowed for regular income tax purposes.

TRADER FUNDS

NEW ELECTION IN FINAL REGS:

Investor funds MAY elect, at the partnership level, to include income from CFCs and PFICs as part of NII at the same time as they would for regular income tax purposes (i.e., in the same manner as trader funds).

Funds may make this election on an entity-by-entity basis beginning with the 2014 tax year. The election may also be made for the 2013 tax year, but only if funds have received consent from all partners.

TRADER FUNDSFor both trader and investor funds, periodic, non-periodic and mark-to-market income from swaps should be included in NII.

Under new proposed regulations, swap income is only subject to NII if the underlying property to which the swap references produces (or would produce if the property were to produce income) interest, dividends, royalties or rents if the property were directly held by the taxpayer.

SPECIAL RULES:SELF-CHARGED INTERESTUNDER REG. § 1.1411-4

In the case of self-charged interest received from a non-passive entity, the amount of interest income excluded from net investment income will be the taxpayer’s allocable share of the non-passive deduction.

Exception: The special rule does not apply to a situation where the interest deduction is taken into account in determining self-employment income tax.

SPECIAL RULES:SELF-CHARGED INTERESTUNDER REG. § 1.1411-4

EXAMPLE: TP owns 25% of an S corporation in which he materially participates. He loans $200,000 to the S corporation at 10% interest and collects interest income of $20,000 per year. The S corporation has a $20,000 deduction.

RESULT: Of the $20,000 in annual interest income, 25% [$5,000] is excluded from investment income. The remaining 75% [$15,000] is subject to taxation under the NIIT.

SELF-CHARGED RENTALS

If rental income is treated as non-passive: (A) by reason of Reg. § 1.469-2(f)(6) when the taxpayer

rents the property for use in an activity in which the taxpayer materially participates, or

(B) because the rental activity is properly grouped with a trade or business activity under Reg. § 1.469-4(d)(1) and the grouped activity is a non-passive activity,

then, the gross rental income is deemed to be derived in the ordinary course of a trade or business.

SELF-CHARGED RENTALS

Furthermore, in both of these instances, the final regulations provide that any gain or loss from the assets associated with that rental activity that are treated as non-passive gain or loss will also be treated as gain or loss attributable to the disposition of property held in a non-passive trade or business.

SELF-CHARGED RENTALS:TRAPS FOR THE UNWARY

So, self-charged rental income gets excluded from NII when the taxpayer materially participates.

Self-charged rental loss stays passive and, in the absence of other passive income, cannot reduce portfolio interest and dividends included in NII because the passive loss is currently suspended. You need other passive income to use the suspended self-

charged passive losses for purposes of the NIIT.

SELF-CHARGED RENTALS:TRAPS FOR THE UNWARY

Assume a self-charged rental that produces a loss. Assume also that the rental activity is grouped with a business in which the taxpayer materially participates. Result—the loss which would have been passive is now out

of the NII computation altogether because it is now part of a non-passive activity.

So, because of this grouping election, the otherwise passive loss that

might have eventually reduced NII from another source will never do so.

35

SPECIAL RULES:WHAT IS A REAL ESTATE PROFESSIONAL?

2-PART TEST:

1. More than 50% of services performed during the year are in real estate trades or businesses where taxpayer materially participates;

2. More than 750 hours of services in those.

Real property trades or businesses   

A real property trade or business is a trade or business that does any of the following with real property:

• Develops or redevelops it;

• Constructs or reconstructs it;

• Acquires it;

• Converts it;

• Rents or leases it;

• Operates or manages it;

• Brokers it.

IRS INSTRUCTIONS

Safe Harbor for Real Estate Professionals

• You qualify for the safe harbor if you are a real estate professional for purposes of section 469 and you:• Participate in each rental real estate activity for

more than 500 hours during the tax year, or

• Participated in a rental real estate activity for more than 500 hours in any 5 tax years (whether or not consecutive) during the 10 tax years immediately prior to this tax year.

500 hours on EACH rental property?#@!

IRS INSTRUCTIONS

Safe Harbor for Real Estate Professionals

• For real estate professionals with a Regulations section 1.469-9(g) election [election to treat all interests in rental real estate as a single rental real estate activity] in effect, all rental real estate activities constitute a single activity for purposes of applying the 500-hour test.

REAL ESTATE PROFESSIONALS

• 500-hour safe harbor is not the only option.

• Final 1411 regulations provide that failure to meet the 500-hour safe harbor will not preclude a taxpayer from establishing that such gross rental income and gain or loss from the disposition of real property, as applicable, is not included in net investment income.

THE 1-TIME REGROUPING ELECTION(originally allowed under -11 of the

Proposed § 1411 Regs.)

An individual, trust, or estate that meets the eligibility criteria may regroup its activities, regardless of how they were grouped in the preceding tax year:

• for any tax year that begins during 2013, if the taxpayer meets the eligibility criteria for that year, or

• in the first tax year beginning after 12/31/13, in which the NIIT would apply.

THE 1-TIME REGROUPING ELECTION

ELIGIBILITY:

For an individual: (1) NII and (2) the individual's MAGI exceeds the applicable threshold.

For a trust: (1) NII and (2) the trust's adjusted gross income (AGI) exceeds the dollar amount at which the highest tax bracket in Code § 1(e) begins for that tax year [For 2014, it’s $12,150].

For an estate: (1) NII and (2) the estate's AGI exceeds the dollar amount at which the highest tax bracket in Code § 1(e) begins for that tax year.

SAMPLE USES OF THE 1-TIME REGROUPING

ELECTION

• For real estate professionals, so that multiple rentals will be tested with a single 500 hour requirement;

• For previously ungrouped activities so that the taxpayer will be deemed to materially participate with respect to all:• E.g., combining multiple non-rental

activities.

REGROUPING RULES

• PARTNERSHIPS AND S CORPS ARE NOT ALLOWED TO

REGROUP under the 1-time 1411 permission.

• The final regulations now allow a taxpayer to regroup under

§1.469-11(b)(3)(iv) on an amended return, but only if the

taxpayer was not subject to section 1411 on his or her

original return (or previously amended return), and if,

because of a change to the original return, the taxpayer

owed tax under section 1411 for that taxable year.

REGROUPING REFRESHER

You can treat one or more trade or

business activities, or rental activities, as a

single activity if those activities form an

appropriate economic unit for measuring

gain or loss under the passive activity

rules.

REGROUPING REFRESHER

The factors that you should consider are:

• The similarities and differences in the types of trades or businesses,

• The extent of common control,

• The extent of common ownership,

• The geographical location,

REGROUPING REFRESHER

• The interdependencies between or among activities, which may include the extent to which the activities:

• Buy or sell goods between or among themselves,

• Involve products or services that are generally provided together,

• Have the same customers,

• Have the same employees, or

• Use a single set of books and records.

REGROUPING

Rental activities.   

In general, you CANNOT group a rental activity with a trade or business activity.

However, you CAN group them together if the activities form an appropriate economic unit and:

REGROUPING

• The rental activity is insubstantial in relation to the trade or business activity,

• The trade or business activity is insubstantial in relation to the rental activity, or

• Each owner of the trade or business activity has the same ownership interest in the rental activity, in which case the part of the rental activity that involves the rental of items of property for use in the trade or business activity may be grouped with the trade or business activity.

REGROUPING

EXAMPLE: John owns a bakery and a movie theater at a shopping mall in Baltimore and a bakery and movie theater in Philadelphia. John may be able to group the movie theaters and the bakeries into:

• One activity,

• A movie theater activity and a bakery activity,

• A Baltimore activity and a Philadelphia activity, or

• Four separate activities.

AVOIDING NIIThe answer is: “Philandering Presidential

Candidates Saving Taxes”

WHAT IS THE “NEWT GINGRICH/JOHN EDWARDS LOOPHOLE”?

SENATE DEMOCRATS HAVE UNSUCCESSFULLY TARGETED

S CORPS WITH 3 OR FEWER SHAREHOLDERS

THE “NEWT GINGRICH/JOHN EDWARDS LOOPHOLE”

SHAREHOLDERS

Reasonable Comp/Subject to SE Tax(IRS can challenge)

Distributions•Not SE Taxable•Not NII to Active SH

S CORPORATION

BUT NII to Passive SH

S Corp SE tax risks:

Examples of existing cases:

• “The best evidence of value of services provided

in a professional personal service corporation is

the profit made by the corporation.” Thomas A.

Curtis, M.D., Inc. v. Commissioner, 67 T.C.M.

(CCH) 1958, 1963 (1994) [T.C. Memo 1994-15].

S corp SE tax risks:

Examples of existing cases:

• LaMastro v. Commissioner, 72 T.C. 377, 384 (1979). The

Tax Court in LaMastro, relying on Bianchi v.

Commissioner, 66 T.C. 324 (1976), aff’d per curiam, 553

F.2d 93 (2nd Cir. 1977), held that the best evidence of

the value of a dentist’s personal services is the profit

derived from the practice.

What about a Partnership?

• Limited partner exception in self-employment tax statute not intended to apply to service business

Renkemeyer, Campbell, & Weaver LLP, 136 T.C. No. 7 , Tax Ct. Rep. (CCH) 58543, 2011 WL

490873 (2/9/2011)

The intent of Section 1402(a)(13) was to ensure that individuals who merely invested in a partnership and who were not actively participating in the partnership's business operations would not receive credits toward Social Security coverage.

The legislative history of Section 1402(a)(13) did not support a holding that Congress wanted to exclude partners who performed services for a partnership in their capacity as partners (i.e., acting as self-employed persons) from liability for self-employment taxes.

WHAT CAN BE ATTEMPTED USING LLCs OR LPs?

Old proposed 1402 regulations never finalized:

“Exception for holders of more than one class of interest. An

individual holding more than one class of interest in the

partnership who is not treated as a limited partner under

paragraph (h)(2) of this section is treated as a limited partner

under this paragraph (h)(3) with respect to a specific class of

partnership interests held by such individual if, immediately

after the individual acquires that class of interest –

WHAT CAN BE ATTEMPTED USING LLCs OR LPs?

• Limited partners own a substantial, continuing interest

in that specific class of partnership interest; and

• The individual’s rights and obligations with respect to

that specific class of interests are identical to the rights

and obligations of that specific class of partnership

interest held by the [above] limited partners.”

GOAL

To treat SOME LLC interests as limited partnership interests for the SE tax • [and also say LLC interest owners materially

participated for purposes of the NIIT?]

Will We See This Variation? John , Member / Manager Mary, Member

CLASS A CLASS B INTERESTS INTERESTS* ≥ 20% overall

*All Class B interests have the same rights and obligations

LLC

Problematic for a Services Entity John

100% 99% LP INTEREST

1% GP INTEREST

RENKEMEYER SAYS TO TREAT THE LP INTEREST ASPRODUCING SE TAX

LIMITEDPARTNERSHIP

S CORPORATION

Will We See Someone Attempt This [Problematic?] Variation?

John , Member / Manager Mary, Member

LLC

S CORPORATION CLEANSER S CORPORATION CLEANSER

BACKGROUND—SALES OF INTERESTS IN

PASSTHROUGH ENTITIES

Code section 1411(c)(4) provides that gain or loss from

such disposition is taken into account for purposes of

section 1411(c)(1)(A)(iii) only to the extent of the net

gain or net loss that would be so taken into account by

the transferor if all property of the partnership or S

corporation were sold at fair market value immediately

before the disposition of such interest.

Prop. Reg. § 1.1411-7

• NEW Prop. Reg. § 1.1411-7—Exception

for Dispositions of Certain Active

Interests in Partnerships and S

Corporations:

Prop. Reg. § 1.1411-7

• Newly proposed regs. provide for calculation of

gain or loss by a materially participating

transferor by activity rather than property by

property consistent with the PAL rules.

• Newly proposed simplified method if you

qualify uses the same percentage of NII to all

income that is reported on applicable K-1s.

GENERAL RULE—GAIN ON DISPOSITIONNet gain in § 1.1411-4(a)(1)(iii) is

LESSER OF:

• the transferor’s gain on the disposition of the

interest in the Passthrough Entity for income

tax purposes; or

GENERAL RULE—GAIN ON DISPOSITIONNet gain in § 1.1411-4(a)(1)(iii) is LESSER

OF:

• the transferor’s allocable share of the chapter 1 net gain from a

deemed sale of the Passthrough Entity’s Section 1411 Property as

determined using the principles of §1.469-2T(e)(3) (allocation of gain

or loss to activities of the Passthrough Entity) where the net gain is

the sum of the amounts of net gain and net loss allocable to the

transferor as determined under §§1.469-2T(e)(3)(ii)(B)(1)(i) and

1.469-2T(e)(3)(ii)(B)(2)(i) that would constitute income to the

transferor for purposes of section 1411 if sold by the Passthrough

Entity.

Prop. Reg. § 1.1411-7

OPTIONAL SIMPLIFIED METHOD--EITHER:

• #1—2 parts:

• Transferor’s distributive share during disposition year + 2 preceding years of NII items is 5% or less of distributive share in that period (with separately stated loss and deduction items included as positive numbers); AND

• Transferor’s share of gain on disposition is $5 million or less.

Prop. Reg. § 1.1411-7

OPTIONAL SIMPLIFIED METHOD QUALIFICATION [unless excluded]--EITHER:

#2--Transferor’s share of gain on disposition is $250,000 or less.

CANNOT use simplified method--5 exclusions

• Transferor held the interest for 12 months or less preceding the Disposition.

• Transferor transferred 1411 property to the entity or received a distribution of other than 1411 property from the entity during the 1411 Holding Period [generally, the current year and the 2 preceding years] as part of a plan that includes the transfer of the interest.

• Contributions within 120 days presumed to be part of a plan.

CANNOT use simplified method--5 exclusions

• Passthrough Entity is a partnership and the transferor

transfers a partial interest that is not a proportionate

share.

• Transferor knows or has reason to know that the % of the

Passthrough Entity’s gross assets consisting of 1411

property has increased or decreased by 25% or more

during the Transferor’s 1411 holding period.

• S corps that converted from C during the 1411 Holding

Period.

• New guidance on applying the NIIT to guaranteed payments under 707;

• New guidance on applying the NIIT to payments to a retiring partner under 736.

Proposed Regs. under the NIIT applicable to partnerships:

GUARANTEED PAYMENTS

Partnership wants to get $$$ out to the Partners

OPTION #1: GUARANTEED PAYMENT FOR SERVICES

OOPS! NOT SUBJECT TO THE NIIT;

BUT SUBJECT TO SE TAX

PARTNER

GUARANTEED PAYMENTS

Partnership wants to get $$$ out to the Partners

OPTION #2: GUARANTEED PAYMENT FOR CAPITAL

OOPS! SUBJECT TO THE NIIT; AKIN TO INTEREST

PARTNER

RECALL THE SELF CHARGED INTEREST

RULE

WHAT ABOUT A PREFERRED RETURN?

77

Partnership wants to get $$$ out to the Partners

IF YOU MATERIALLY PARTICIPATE, A DISTRIBUTIVE SHARE OF INCOME IS NOT NECESSARILLY NII

PARTNER

BUT BEWARE THE SE TAX

DEPENDS ON WHAT?

•For purposes of Code Sec. 1411, the items of income, gain, loss, and deduction attributable to the distributive share are taken into account in computing NII in a manner consistent with the item's chapter 1 character and treatment.

•Thus, if the partner's distributive share includes income from a trade or business not described in Code Sec. 1411(c)(2), that income will be excluded from NII. •However, if the distributive share includes interest income from working capital, then that income is NII.

Gain or loss relating to Code Sec. 736(b) payments is included in NII under Code Sec. 1411(c)(1)(A)(iii) regardless of whether the payments are classified as capital gain or ordinary income (for example, by reason of Code Sec. 751).

NEW PROPOSED REGS ON § 736

Code Sec. 736(a)(1) provides that if the amount of a liquidating distribution (other than a payment for partnership property described in Code Sec. 736(b)) is determined with regard to the partnership's income, then the payment is treated as a distributive share of income to the retiring partner. For purposes of Code Sec. 1411, the items of income, gain, loss, and deduction attributable to the distributive share are taken into account in computing NII in a manner consistent with the item's chapter 1 character and treatment.

736(a) is more complex:

Code Sec. 736(a)(2) provides that if the amount of a liquidating distribution (other than a payment for partnership property described in Code Sec. 736(b)) is determined without regard to the partnership's income, then the payment is treated as a guaranteed payment as described in Code Sec. 707(c). Such payments under Code Sec. 736(a)(2) might be in exchange for services, use of capital, or Code Sec. 736(a) Property.

736(a) is more complex:

The treatment of guaranteed payments for services or the use of capital follows the general rules for guaranteed payments.

736(a) is more complex:

Code Sec. 736(a)(2) payments in exchange for Code Sec. 736 Property are treated as gain or loss from the disposition of a partnership interest, which is generally included in NII under Code Sec. 1411(c)(1)(A)(iii). If the retiring partner materially participates in a partnership trade or business, then the retiring partner must also apply Prop Reg § 1.1411-7 to reduce appropriately the NII under Code Sec. 1411(c)(4).

736(a) is more complex:

To the extent that Code Sec. 736(a)(2) payments exceed the fair market value of Code Sec. 736(a) Property, the proposed regs provide that the excess will be treated as either interest income or as income in exchange for services.

736(a) is more complex:

WAY TOO MUCH; SO WE OMITTED:

For Example:• Joint Returns of a Nonresident Alien

Married to a U.S. Citizen or Resident• Residents of U.S. Territories• Exemption of Various Trusts• Electing Small Business Trusts under Subchapter S• Bankruptcy Estates• Common Trust Funds § 584• Holder of a Residual Interest in a REMIC• Charitable Remainder Trusts (CRTs) • Treatment of CRTs with Income from Controlled Foreign

Corporations (CFCs) or Passive Foreign Investment Companies (PFICs)