new 3.8% tax applies to trusts & estates -...

Chapter 3

NIIT Impact on Trusts, Estates and

Dispositions of Phps. and S Corps.

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New3.8% Tax

Applies to Trusts & Estates

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Not:

• Charitable Trusts

• Retirement Plans

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Trust or Estate NIIT is imposed on the lesser of:

a) The undistributed net investment income of the estate or trust, or

b) The excess (if any) of the fiduciary AGI over the dollar amount at which the highest tax bracket begins.

3-5

4

Tax Calculation:

3.8% of lesser of:• UNII

• FAGI > top bracket$11,950

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Fiduciary AGI = Total incomereduced by

the personal exemptionthe distribution deduction

andthe deductions for costs

incurred only because the property is held in an estate

or trust (IRC sec. 67(e)). 6

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If Taxable Income is: Tax RateNot over $2,450 15%$2,451 to $5,700 25%$5,701 to $8,750 28%$8,751 to $11,950 33%Over $11,950 39.6%

Trusts and Estates 2013 Income Tax Rates

Relevance of Trust and Estate Top Bracket:

(1) 3.8% NIIT

(2) Capital Gains at 20%

(3) Ordinary income at 39.6%

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3-10

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3-10

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Example (1). Calculation of undistributed net investment income

In Year 1, Trust has: dividend income of $15,000, interest income of $10,000, capital gain of $5,000, and IRA distribution $25,000

(IRD). 11

Trust has no expenses.

Trust distributes $10,000 of its current year trust accounting income to A, a beneficiary of Trust.

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Trust allocates $5,000 of capital

gain to principal for trust accounting

purposes

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Div. Int. Cap. Gains

Taxable IRA

Distrib.

Total

DNI $15,000(30%)

$10,000(20%)

$25,000(50%)

$50,000(100%)

Distrib.Ded.

$3,000 $2,000 $5,000 $10,000

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Dividend $15,000Interest $10,000Capital Gain $ 5,000Trust NII $30,000

IRA income is excluded from NII

Trust Net Investment Income

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$15,000

3-10

$10,000

$5,000

$5,000

$30,00016

Trust NII $30,000Dividend Distrib. - $3,000Interest Distrib. - $2,000Trust UNII $25,000

$5,000

Trust Undistributed Net Investment Income

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NIIT: $25,000 x 3.8% = $950

Div. Int. Cap. Gains

Taxable IRA

Distrib.

Total

DNI $15,000(30%)

$10,000(20%)

$25,000(50%)

$50,000(100%)

Distrib.Ded.

$3,000 $2,000 $5,000 $10,000

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The distributed investment income is

taxed to the beneficiary

Total Income $55,000Distribution Ded. -$10,000Exemption - $100Trust AGI $44,900

Trust AGI

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3-10$30,000

- $5,000

$25,000

$44,900

$11,950

$32,950

$25,000

$25,000 x 3.8% = $95020

• “Section 1.643(a)-3(b)(1) provides that a fiduciary may allocate capital gains between corpus and DNI as long as such decision is a reasonable and impartial exercise of discretion and part of a consistent practice over time.”Per preamble to final section 1411 regulations 21

Example (2)

Calculation of undistributed net

investment income --with an amount paid for

charitable purposes.22

Final Reg. Example • Estate with Fiscal Year Ending

10/31/2013

• All estate income is $20,000 interest and $20,000 dividends distributed quarterly with the last quarter’s payment on December 5, 2013.

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• Estate is not subject to NII because it began 11/1/2012.

• Because the estate has no NII, the distributions to the beneficiaries are not NII.

• What about the Dec. 5, 2013 distribution?

Make the IRC sec. 663(b) election to treat it as distributed Oct. 31, 2013.

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• A number of commentators requested that Treasury provide guidance on material participation of estates and trusts.

• Clearly, such guidance would apply primarily to IRC sec. 469 and secondarily to 1411.

• Treasury has agreed to open a reg. project on this issue.

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TAM 201317010 (April 26, 2013)

Only Trustee's Fiduciary-Capacity Activities Count For

Material Participation Purposes

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15-1

Example (3)

Calculation of an ESBT's NIIT

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Final Regs.Detail Treatment

of CharitableRemainder Trusts

(CRTs)28

• Several commentators requested that the final regulations explicitly provide that section 1411(c)(1)(B) properly allocable deductions include fiduciary commissions, legal and accounting fees, and other estate and trust administration expenses.

• The final regs. do so.29

3.8% NIITOn Sales of

S Corporation StockAnd

Partnership Interests

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Investment Income (before deductions)

CategoryOne

Gross Income – Interest, Dividends, Annuities, Royalties, and Rents that is:

• Nonbusiness (investment)• Passive business income• Trading business income

CategoryTwo

Other Gross Income that is:• Passive business income or• Trading business income

Category Three

Net Gain from the disposition of property that is:

• Nonbusiness (invest. or personal)• Passive business• Trading business

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Category Three

Net Gain from the disposition of property thatis:• Nonbusiness (invest. or

personal)• Passive business• Trading business

What escapes category three?

Nonpassive business gain except for trading assets. 32

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(4) Exception for certain active interests in partnerships and S corporations.

In the case of a disposition of an interest in a partnership or S corporation—

(A) gain from such disposition shall be taken into account under clause (iii) of paragraph (1)(A) only to the extent of the net gain which would be so taken into account by the transferor if all property of the partnership or S corporation were sold for fair market value immediately before the disposition of such interest, and

(B) a rule similar to the rule of subparagraph (A) shall apply to a loss from such disposition.

IRC Sec. 1411(c)(4):

Gain on sale of passthrough entity is NII only to the extent of the inside gain on

“Section 1411 Property.”

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“Section 1411 Property” is:

• Passive Business Property• Investment Property• Trading Property• Personal Use Property

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• Alice materially participates in her 100% owned C corporation’s business.

• All assets are business property except marketable securities with $20,000 built-in gain.

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Example (1):

• In 2013, she sells her stock and recognizes a gain of $900,000.

• The entire $900,000 is category three NII.

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• Same facts as Example (1) except the entity is an S corporation.

• The only “Section 1411 Property” of the S corporation is the marketable securities.

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Example (2):

• $20,000 of gain is NII

The lesser of:• $900,000 -- Chapter 1 gain or

• $20,000 -- Alice’s share of inside gain on the “Section 1411 Property”

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• Alice is a nonpassive partner in a business partnership and she recognizes a gain of $900,000 on the sale of her partnership interest.

• Assume $20,000 of built-in gain (Alice’s share) on marketable securities (“Section 1411 Property”)

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Example (3):



• $20,000 -- Alice’s share of inside gain on the “Section 1411 Property”

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• Bill is the passive partner in a business partnership and he recognizes a gain of $900,000 on the sale of his partnership interest.

• Assume $20,000 of built-in gain on marketable securities (“Section 1411 Property”)

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Example (4):

The entire $900,000 is category three NII

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If possible, use grouping rules

to make Bill

nonpassive

44Alice sells to Debra for $100,000

ABCD Balance Sheet Partner’s Outside

BasisAssets Tax Basis FMV

Cash $100,000 $100,000Inventory $20,000 $100,000Investment asset $80,000 $100,000Goodwill $100,000 $100,000

Total Assets $300,000 $400,000

CapitalAlice $75,000 $100,000 $75,000Bob $75,000 $100,000 $75,000Carol $75,000 $100,000 $75,000Don $75,000 $100,000 $75,000

Total Capital $300,000 $400,000

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Alice Materially Participates in the Partnership

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Chapter 1 Income

If “S” stock, then $25,000 of capital gain

IRC sec. 751(a)

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Draft 2013 Form 1040

$5,000

$20,000



• $5,000 -- Alice’s share of inside gain on the investment asset “Section 1411 Property”

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49

Draft

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$25,000

-$20,000$5,000

Adjustment

Draft Form 8960

If Alice does not materially participate, then her entire gain is

NII under IRC sec. 1411

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$25,000

0$25,000

Adjustment

Draft Form 8960





Total Assets $300,000 $400,000


Total Capital $300,000 $400,000

Sale at a 5% Discount

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Chapter 1 Income

Gain Realized without IRC sec. 751

$20,000 ($95K - $75K)

Sec. 751 Ord. Inc. - $20,000 ($80,000 4)

Capital Gain $ 0





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Draft

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$20,000

-$15,000$5,000

Adjustment

Draft Form 8960

NII was $0 under the 2012 proposed regs. because the discount was all attributed to the 1411 Property





Total Assets $300,000 $400,000


Total Capital $300,000 $400,000

Sale at a $30,000 Premium

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Gain Realized W/0 751 $55,000 ($130,000 - $75,000)

IRC sec. 751(a) Ordinary Income

- $20,000

Capital Gain = 35,000

Chapter 1 Income





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$55,000

-$50,000$5,000

Adjustment

Draft Form 8960

$35,000 of NII under the 2012 Proposed

Regs

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Sale at aLoss





Cash $100,000 $100,000Investment asset $100,000 $200,0001231 Asset $200,000 $100,000

Total Assets $400,000 $400,000


Total Capital $400,000 $400,000

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Chapter 1 Capital Loss of

<$20,000> ($80,000 – 100,000)

Assume that Alice also recognizes a capital gain of $20,000 from her sale of Apple Inc. stock in 2013; so her regular tax net capital gain is zero.

Same if “S” stock

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$0

Form 1040 Schedule D:

Apple Inc. Sale Gain $20,000

ABCD Php Sale Loss <$20,000>

• $0 of loss is in NII

The lesser of:• $20,000 -- Chapter 1 Loss or

• $0 - Alice’s share of inside loss on “Section 1411 Property”

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$0

+20,000$20,000

Adjustment

Impact, the entire $20,000 capital gain from the sale of Apple Inc. is NIIT

Draft Form 8960

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What if Alice Does Not Materially Participate in

the Partnership

Sale for $80,000





Cash $100,000 $100,000Investment asset $100,000 $200,0001231 Asset $200,000 $100,000

Total Assets $400,000 $400,000


Total Capital $400,000 $400,000

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$0

Form 1040 Schedule D:

Apple Inc. Sale Gain $20,000

ABCD Php Sale Loss <$20,000>

A <$20,000> passive capital loss all allowed

for NII Purposes.

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$0

+0

$0Adjustment

Impact, the entire $20,000 capital gain from the sale of Apple Inc. is offset by the $20,000 passive capital loss on the sale of the ABCD partnership interest.

Draft Form 8960

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Optional Simplified

MethodUse the K-1s to determine NII

• Multiply Chapter 1 gain by the following fraction.

• Numerator: seller’s share of net income, gain loss, and deductions on Section 1411 property in the year of disposition and two prior years (the Section 1411 Holding Period) 80

Optional Simplified Reporting:

•Denominator: seller’s share of all items of net income, gain loss, and deductions in the Section 1411 Holding Period.

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Conditions for Simplified Method

1) 5% or less of the sum of separately stated income, gain, loss and deduction items (with loss and deductions as positive numbers) is attributed to Section 1411 Property during the Section 1411 Holding PeriodAnd gain or loss is under $5 million.

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Or2)The gain or loss

recognized does not exceed $250,000

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Example (1):A owns a 50% interest in P a partnership.

A sells the interest for $2,00,000.

A’s outside basis is $1,100,000

A’s gain is $900,000

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AggregateIncome/Loss in 1411 Holding Period

X (Nonpassive to A) $1,800,000

Y (Passive to A) ($10,000)

Marketable Securities $20,000

The 5% Test is Met:

30,000/1,830,000 is less than 5%And gain is under $5 million

• Numerator: seller’s share of net income, gain loss, and deductions on Section 1411 property in the year of disposition and two prior years (the Section 1411 Holding Period)

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$10,000

•Denominator: seller’s share of all items of net income, gain loss, and deductions in the Section 1411 Holding Period.

87$1,810,000

Gain in NII = $4,972.32

($900,000 x 10,000/1,810,000)

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Example (2):Same as Example (1) but A sells at a loss of <$200,000>

Because the income or loss during the 1411 Holding Period is positive $10,000, and the sale was at a loss, the fraction is $0.

None of the loss is in NII

Transferors who use the primary method must

generally obtain from the Passthrough Entity the

share of net gain or loss from the deemed sale of the

Section 1411 Property.

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Information Reporting

However, the proposed regulations only require the Passthrough

Entity to provide this information to transferors that are ineligible

for the optional simplified reporting method in proposed §

1.1411-7(c).

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If a transferor qualifies to use the optional simplified

reporting method but prefers to use the primary method the

transferor must “negotiate with the

Passthrough Entity the terms under which the information

will be supplied”. 92

Any transferor applying proposed reg. 1.1411-7, must attach a statement to the transferor's income tax return for the year of disposition.

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That statement must include:

(1)the taxpayer's name and taxpayer identification number;

(2)the name and taxpayer identification number of the Passthrough Entity in which the interest was transferred;

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3) the amount of the transferor's gain or loss on the disposition of the interest under chapter 1; and

4) the amount of adjustment to gain or loss by reason of basis differences for chapter 1 and section 1411 purposes if a CFC or PFIC. See 1.1411-10(d).

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The transferor must also attach a copy of any information provided by the Passthrough Entity to the transferor relating to the transferor's allocable share of gain or loss from the deemed sale of the Passthrough Entity's Section 1411 Property.

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Partners IRC sec. 731 Gains are

generally category three NII

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IRC sec. 707(c) guaranteed

payments for services are NOT

NII (whether SE income or not)

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Guaranteed payments for

capital are like interest thus NII if not subject to SE

tax99

new 3.8% tax applies to trusts & estates -...

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