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Form 8582: Passive Activity Reporting and Impact of 3.8% Medicare Tax Tackling Complex Passive Activity Computations; Navigating Income Tax and AMT Reporting Challenges

WEDNESDAY, NOVEMBER 19, 2014, 1:00-2:50 pm Eastern

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FOR LIVE EVENT ONLY

Form 8582: Passive Activity Reporting and Impact of 3.8% Medicare Tax

November 19, 2014

Albert Dumaual

Capell Barnett Matalon & Schoenfeld

[email protected]

Damien R. Martin

BKD

[email protected]

Douglas N. Rubenstein

Katz Sapper & Miller

[email protected]

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

5

PASSIVE ACTIVITIES

By Albert Dumaual JD, LLM (TAXATION) CAPELL BARNETT MATALON & SCHOENFELD, LLP. ATTORNEYS AT LAW (516) 931-8100 [email protected]

§469 PASSIVE ACTIVITY LOSS RULES

• Passive Activity Losses offset passive income

• May not offset active or portfolio income

• Excess PAL is suspended

• Any activity involving a trade or business

• In which the taxpayer does NOT MATERIALLY PARTICIPATE

• Material Participation – REGULAR, CONTINUOUS and SUBSTANTIAL

• Most rental activities 7

DISPOSITION

• Suspended losses may be utilized to offset non passive income

• Requires disposition of ENTIRE ACTIVITY IN A FULLY TAXABLE TRANSACTION (not §351, 721, 1041, or 1031)

• Loss is then treated as not from a passive activity

• Complete worthlessness may qualify 8

DISPOSITION CONTINUED

• If dispose of less than entire interest in the activity - losses remain suspended and passive

• If dispose less than all, losses remain suspended

•What constitutes an entire activity?

•C & S Corps separately group activities

9

DISPOSITION CONTINUED

• Special Rule

• If dispose of substantially all & can establish Losses with reasonable certainty

10

DECEDENT’S UTILIZATION

• Death is treated as complete disposition

• Sec 1014 step-up to FMV

• Step-up reduces suspended losses

• Excess suspended loss available only on D’s final return

• Compute property by property – Excess is lost

11

PASSIVE ACTIVITIES

• §469(c)

• Activity involving a Trade or Business in which the Taxpayer does not materially participate

• Generally Any Rental Activity

• Working Interest in Oil and Gas Property 12

TRADE/BUSINESS ACTIVITY

• Treas. Reg. §1.469-4(b)

• §162 Trade/Business

• Conducted in anticipation of T/B

• §174 research or experimental activities

13

MATERIAL PARTICIPATION

• Material Participation – REGULAR, CONTINUOUS, and SUBSTANTIAL

• 7 Tests – Treas. Reg. §1.469-5T

• More than 500 HOURS is favorite

• Limited partner has only 3 methods

14

USE THE 7 TESTS

1. The individual participates in it for more than 500 hours during the year

2. The individual's participation in the activity for the tax year is substantially all of the participation in it by all individuals (including non-owner individuals) for the year

3. The individual participates in the activity for more than 100 hours during the tax year and that isn’t less than that of any other individual (including non-owners) for that year

15

THE 7 TESTS continued 4. The activity is a significant participation activity for the tax year,

and the individual’s aggregative participation in all significant participation activities that year exceeds 500 hours.

• Significant participation activity is a trade or business in which the individual significantly participates (for more than 100 hours), but in which he doesn’t otherwise materially participate

16

THE 7 TESTS continued 5. The individual materially participated in the activity for any five

tax years (consecutive or not) during the 10 immediately preceding tax years

6. The activity is a personal service activity, and the individual materially participated in the activity for any three tax years (consecutive or not) before the tax year

7. The individual meets a facts and circumstances test

17

CHARLES E. WADE v. COMM’R, TCM 2014-169 • Facts & Circumstances

• T & Spouse owned Shs. S Corp

• Converting Chem. Waste

• T built Co. – Son took over

• Son – day-to-day mgt.

• Large Losses – carryback claim 18

WADE v. COMM’R

• IRS – H & W Did Not Materially Participate!

• Court – Met Test #7

• Regular, Continuous, and Substantial

• Over 100 hours (not mgt.) 19

MARRIED

• Can count participation by spouse to meet material participation only

• Even if do not file joint return!

20

MATERIAL PARTICIPATION & LIMITED PARTNERS • §469(h)(2) Interest in Limited Partnerships

• Limited Partner presumed not materially participating

• Exceptions: Tests 1, 5, and 6

• Participation > 500 hours during the year

• Material Participation in 5 of last 10 years

• Personal Service Activity & Material Participation in any of last 3 years

21

MATERIAL PARTICIPATION & CORPORATIONS • Closely-held C Corp or Personal Service Corp:

• Shareholder(s) holding more than half of its stock by value materially participates

• Closely-held C Corp also materially participates if

• At least 1 full-time employee is active manager

• At least 3 full-time employees but cannot own more than 5%

• Deductible expenses < 15% of gross income

22

MATERIAL PARTICIPATION & TRUSTS & ESTATES • Frank Aragona Trust, 142 T.C. No. 9 (2014)

• Tax Court held: trust materially participated in real property trade or business

• Trust qualified as a Real Estate Professional

• Trustees’ activities as employee counted

• Duty of Loyalty

• No Clear Guidance

23

INVESTMENT ACTIVITIES

• Temp. Reg. § 1.469-5T(f)(2)(ii)

• Work as an investor not counted

• Unless: directly involved - daily

• Work as an investor includes:

• Studying & Reviewing Financial Data

• Preparing/Compiling summaries or analysis for the individual’s own use

• Monitoring finances/operations in non-manager capacity

24

NOT CUSTOMARILY DONE BY OWNERS • Not counted toward material

participation under any test

• Work of a type not customarily done by an owner of such activity; and

• Principal purpose for work is to avoid PAL rules

25

MANAGEMENT ACTIVITIES

• For facts and circumstances test – Not if a paid manager or another manager performs more services

• Iversen, TCM 2012-19

• Ranch activity insufficient evidence of participation

• Hired manager, therefore taxpayer’s management activities not counted

26

FORMER PASSIVE ACTIVITIES • An activity that is not currently a

passive activity, but was passive in a prior year

• Losses from when the activity was passive may still be used to offset income from that activity

• Any excess losses remain passive 27

SELF-CHARGED INTEREST

• §1.469-7: Applies only to Interest Income/Expenses that are recognized in the same taxable year

• Treat such Income/Expense as passive

• Apply to Partnership and S Corporation taxpayer loans

• Will re-characterize Portfolio Interest Income as Passive Income of owner to avoid mismatch

28

RENTAL ACTIVITIES

• Per se passive

• §1.469-1T(e)(3) Definition – Amounts received for use of Tangible Property

• EXCEPT if average period of customer use is seven days or less

• Increased to 30 days or less if SIGNIFICANT PERSONAL SERVICES are provided by or on behalf of the owner (special rule for extraordinary personal services)

• EXCEPT if the rental is “incidental to a nonrental activity of the taxpayer”

29

BAILEY v. COMM’R

• TC Summary Opinion 2011-22

• B&B Inn having several buildings

• One property was rented for short term – average period of customer use under 8 days

• Not counted for 750 hour test of Real Estate Professional – (discussed later)

30

SIGNIFICANT PERSONAL SERVICES • Will allow up to 30 days of rental –

average customer use

• Facts & circumstances – type and value of services

• Only services performed by individuals

• Not construction or capital repairs

• Not services customarily performed in high grade real estate rentals

31

EXAMPLE – NOT A RENTAL ACTIVITY

1. Rental of copy machine < 8 days and no services provided

2. Rental of copy machines for less than 30 days &

• Company performs significant personal services, such as maintenance and service calls

• Motel or B&B and 7 days or less – Average Rental

32

INCIDENTAL TO NONRENTAL ACTIVITY • Not A Rental Activity

• Principal Purpose: Realize gain from appreciation of property

• Gross Rental Income < 2% of the lesser of unadjusted basis and fair market value

33

INCIDENTAL CONTINUED

• To a Trade or Business (T or B) – only if:

• Taxpayer owns an interest in such T or B.

• Property was “predominantly used” in such T or B during year or during at least 2 out of 5 immediately preceding years

• AND – the gross rental income is less than 2% of the lesser of (i) the unadjusted basis AND (II) the FMV of the property

34

RENTAL REAL ESTATE ACTIVITIES

• Generally deemed passive regardless of participation

• Exceptions

• Appropriately Grouped w/ Active T/B

• $25,000 Exception

• Self-Rental

• Real Estate Professional 35

ACTIVE PARTICIPATION (REAL ESTATE)

• $25,000 deduction if:

• Taxpayer (natural person) actively participates

• Estate 2 years after D’s death, if D actively participated

• Reduced by amount surviving spouse used • Income phase-out (50%) when AGI > $100,000

• After 2 years, rental real estate becomes passive

36

ACTIVE PARTICIPATION

• < Material Participation - regular, continuous, and substantial involvement not required

• Maquire, TCM 2012-160

• Significant & bona fide participation - making management decisions – approving new tenants, deciding rental terms, approving capital expenses; or

• Arranging of others to provide services

37

SELF-RENTAL RULE

• Treas. Reg. §1.469-2(f)(6)

• Prevents abuse – PIG

• Rental of property to T or B in which TP materially participates

• Heads they win – tails you lose

• Income is not passive; losses are passive

• §1411 Exception to NII

38

REAL ESTATE PROFESSIONALS

• May treat rental real estate losses as NONPASSIVE

• §469(c)(7)(B)

• May use passive losses to offset active income – SUBJECT TO material participation requirements

• Employee must be more than 5% OWNER

39

TWO TESTS

• 1) More than one-half of the personal services performed in trades or businesses by the taxpayer during such taxable year are performed in real property trades or businesses in which the taxpayer materially participates, and

• 2) Such taxpayer performs more than 750 hours of services during the taxable year in real property trades or business in which the taxpayer materially participates.

The taxpayer must still materially participate in the activity or it is considered passive

40

REAL PROPERTY TRADES OR BUSINESSES

• Development, Redevelopment, Construction, & Reconstruction

• Acquisition & Conversion

• Rental & Leasing

• Operation & Management

• Brokerage 41

EXAMPLE

• Employee of Construction Co. (not an owner)

• Works 1,000 hours

• Works in his rental property 600 hours

• What about if works 751 hours in rental property?

• FAILS TEST!

• Must own at least 5%

42

750 HOUR TEST

• DO NOT COUNT HOURS FOR 750 HOUR TEST UNLESS MATERIALLY PARTICIPATE

• Each real estate activity is treated separately

• Consider aggregation election

• Must materially participate in EACH ACTIVITY

• 750 hours for each activity NOT REQUIRED

• USE THE 7 TESTS

43

TESTS TO CONSIDER

• More than 500 hours

• More than 100 hours (+ more than anyone else)

• Significant participation activity

• Prior year material participation

• Facts and Circumstances – regular, continuous, and substantial and over 100 hours

44

MANAGEMENT ACTIVITIES & REP • REP must materially participate in rental

• Treas. Reg. § 1.469-9(e)(3)(ii)

• Counted toward material participation

• Even if conducted through a separate entity

45

HOW DO YOU PROVE PARTICIPATION?

• Regs – Any reasonable means

• Calendars, appointment books, logs

• Contemporaneous daily logs are not required IF other reasonable means exist to establish material participation

• Adeyemo, TCM 2014-1: thorough and consistent

• Accurate Account • Get confirmation of employment hours

• Merino, TCM 2013-167

46

MARRIED

• Can count participation by spouse to meet material participation only

• Even if do not file joint return!

47

SEPARATE ACTIVITY

• Each interest in rental real estate is treated as a separate activity – subject to the material participation requirements.

• UNLESS AGGREGATION ELECTION

• Treat ALL rental realty as single activity

• Election makes it easier to meet the material participation requirement.

• Cannot group rental activity w/ other real property trades or businesses

48

EXAMPLE

• 3 Rental Properties, 200 hours each

• 3 Net Lease properties, 90 hours each

• Unless aggregate, fail 750 hour test

• May also fail material participation

49

RENTAL & BUSINESS

• Generally cannot group rental and trade or business activities

• May group if:

• Constitute an appropriate economic unit AND

• The rental is insubstantial in relation to T or B

• OR if same proportionate ownership

50

EXAMPLE – GROUPING PERMITTED

• Husband owns grocery

• Wife owns real estate rented to grocery

• File joint return and treated as commonly controlled

• EXAMPLE: Summer Camp & Land

• Consider Real Estate grouping, or business grouping, or combined

• S Corp. considerations

1. Group within corps and then

2. Group with personal

51

APPROPRIATE ECONOMIC UNIT

• Facts and Circumstances Test

• Similarities (or Differences)

• Common Control & Ownership

• Geographical Location

• Interdependence between or among the activities

• Ex. Purchase and sale of goods, similar customers, employees, books, etc.

52

GLICK, 96 F Supp 2d 850 (DC Ind. 2000)

• Aggregation of S CORP real estate management company with many real estate partnerships

• Court looked at expired regulations

• 80/20 Rule – one operation had to contribute at least 80% of revenue to other

• Management Co. totally dependent on realty partnerships for revenue

• IRS stipulated Appropriate Economic Unit

53

Albert Dumaual JD, LLM (TAXATION) CAPELL BARNETT MATALON & SCHOENFELD, LLP. ATTORNEYS AT LAW (516) 931-8100 [email protected]

54

Slide Intentionally Left Blank

© 2014 KSM Business Services, Inc.

Form 8582: Passive Activity

Reporting and Impact of

3.8 Percent Medicare Tax

November 19, 2014

Douglas Rubenstein, CPA

57 ksmcpa.com

▪ Objectives

▫ Form 8582 – Passive Activity Loss Limitations

▫ Grouping Disclosure Rules

▫ Grouping Examples

Form 8582: Passive Activity Reporting and

Impact of 3.8 Percent Medicare Tax

58 ksmcpa.com

Form 8582

Passive Activity Loss Limitations

59 ksmcpa.com

▪ General Rule: Passive Losses are Allowed Up to the

Amount of Passive Income

▪ Purpose of Form: Compute the Passive Activity Loss

Limitation for Each Taxable Year

▪ Excess Passive Losses are Generally Suspended and

Carried Forward to Future Years

Form 8582 – Passive Activity Loss

Limitations

60 ksmcpa.com

▪ Form 8582 Instructions – Key Issues

▫ Initially Complete Worksheets 1, 2 and 3 of Form 8582

▫ Worksheet 1 – Rental Real Estate Activities

- Active Participation in the Rental Real Estate Activities

- Prior Year Suspended Losses Shown Only for Activities in which

Taxpayer was Previously Active

- If not Previously Active in Rental Real Estate Activity, then Prior

Year Suspended Losses are Disclosed on Worksheet 3


Limitations

61 ksmcpa.com


▫ Worksheet 2 – Commercial Revitalization Deductions

(“CRD”) from Rental Real Estate Activities

- Available for Buildings Placed in Service Prior to January 1,

2010

- Deduction Only Available if Activity Previously Elected to

Ratably Claim CRD Deduction over Period of 120 Months


Limitations

62 ksmcpa.com


▫ Worksheet 3 – All Other Passive Activities

- Trade or Business Activities

- Passive Rental Real Estate Activities – Not an Active Participant

- Other Rental Activities – Personal Property


Limitations

63 ksmcpa.com

▪ Form 8582 – Compliance Issues

▫ Proper Coding of Activity

- Non-Passive

- Active Rental Real Estate

- Other Passive

- Material Participating Real Estate Professional

- Subject to Recharacterization Rules – Rental Real Estate

- Subject to Recharacterization Rules - Other


Limitations

64 ksmcpa.com


▫ Total Suspended Losses are Allocated to the Activities on a Pro-Rata Basis

▫ Confirm that Prior Year Suspended Losses Carried Forward to Current Year Return

▫ Disposition of Passive Activities

- Prior Year Suspended Losses Shown as Non-Passive Loss on Schedule E of Form 1040 and Form 1041

- Prior Year Suspended Losses Not Shown on Prior Year Carry forward Schedule

- Gains from Dispositions of Passive Activities Can Offset Other Passive Activity Losses


Limitations

65 ksmcpa.com


▫ Publicly Traded Partnerships(“PTPs”)

- Code Section 469(k)(1) provides that Passive Activity Rules are

Applied Separately with Respect to Items Attributable to Each

PTP

- Separate Tracking of Each PTP

- PTPs will Generally be Passive to Most Investors as Material

Participation Rules will not be met

- PTPs are Not Reported on Form 8582


Limitations

66 ksmcpa.com

Example

67 ksmcpa.com

▪ Detailed Example – Douglas and Marla Rubenstein ▫ MFJ with 2 Children – Age 15 and 18

▫ Adjusted Gross income - $1,080,000

▫ Schedule K-1 Investments - ABC Company – Doug is a 50 Percent Owner

- Non-Passive Income

- $400,000 Ordinary Income

- $5,000 – Share of Self Charged Interest

- RAR Company LLC – Doug is a 50 Percent Owner

- $10,000 Rental Income

- Subject to Rental Recharacterization Rules

- $5,000 of Prior Year Suspended Losses

Comprehensive Example

68 ksmcpa.com

▪ Detailed Example – Douglas and Marla Rubenstein

▫ Schedule K-1 Investments

- JRR Company LLC – Doug is a 20 Percent Owner

- Passive Income


- MLR Real Estate Services LLC

- Non-Passive Income

- $30,000 Ordinary Loss

- DEF Company LLC – Doug is a 30 Percent Owner

- Non-Passive Income Effective 2013 Tax year


- $50,000 Prior Year Suspended Losses


69 ksmcpa.com

▪ Detailed Example – Douglas and Marla Rubenstein

▫ Schedule K-1 Investments

- GHI Company LLC

- Passive Investor

- $50,000 Ordinary Loss

- JKL Rental Real Estate Company LLC

- Active Rental Real Estate

- $20,000 Rental Real Estate Loss



86 ksmcpa.com

Grouping Disclosure Rules

87 ksmcpa.com

▪ General Rule – Treasury Regulation 1.469-4

▫ Treat Two or More Trade or Business Activities or Rental

Activities as Single Activity if the Activities Constitute

Appropriate Economic Unit (“AEU”)

▫ Facts and Circumstances Determine AEU

- Similarities and Differences of Businesses

- Extent of Common Control

- Extent of Common Ownership

- Geographical Location

- Interdependencies of Businesses


88 ksmcpa.com

▪ General Rule – Treasury Regulation 1.469-4

▫ Facts and Circumstances Determine AEU

- Interdependencies of Businesses – Examples

- Purchasing and Buying Goods Between Related Entities

- Involved in Products and Services Normally Provided

Together

- Same Customers and Employees

- Single Set of Books and Records for Accounting Purposes


89 ksmcpa.com

▪ Who Qualifies for the Grouping Activity Rules

▫ Taxpayers with Multiple Entities for Legal and Economic

Reasons

▫ Examples of Taxpayers

- Physicians

- Trucking Owners

- Restaurant Owners

- Veterinarians


90 ksmcpa.com

▪ Importance of Grouping Activities

▫ Allows for Material Participation Rules to be Applied to Group

of Activities Instead of Individual Activity

▫ Potential Allowance of Prior Year Suspended Passive Losses

▫ Disposition of an Activity in a Grouped Activity Does not

Cause Disposition of Entire Activity

▫ Grouping of Activities Plays Role in Determining 10 Percent

Ownership Rule for Active Participation in Rental Real Estate

Activities


91 ksmcpa.com

▪ Limitations of Grouping Activities

▫ Rental Real Estate Activity May Not be Grouped with Personal Property Rental Activity

▫ Rental Activity May Not be Grouped with Trade or Business Activity

▫ Exceptions to the Grouping Limitations Rule

- Rental Activity Inconsequential to Trade or Business Activity

- Trade or Business Activity Inconsequential to Rental Activity

- Owners of Trade or Business Activity has Same Proportionate Ownership in Rental Activity “and”

- Portion of Rental Activity Involves Rental to Related Trade or Business Activity

- Personal Property Provided in Connection with Real Property


92 ksmcpa.com

▪ Disclosure and Consistency Requirements

▫ Once the Activities are Grouped Generally Cannot Regroup

Activities in Subsequent Years

▫ Exceptions to Regrouping Limitations

- Inappropriate Grouping

- Material Change in Facts and Circumstances

- Must Regroup Activities

- Comply with Disclosure Requirement prescribed by

Commissioner of Internal Revenue Service

- Affordable Care Act


93 ksmcpa.com

▪ Revenue Procedure 2010-13

▫ Internal Revenue Service Issued Guidance for Grouping

Activities

- Initial Grouping of Activities

- Addition of Activities to Existing Groupings

- Regrouping of Activities

▫ Guidance Does Not Apply to Real Estate Professionals

▫ Effective Taxable Years Beginning On or After January 25,

2010


94 ksmcpa.com

▪ New Grouping Reporting Requirements

▫ Written Statement Attached to Original Filed Income Tax Return

▫ Name Address and EIN of Entities in the Group

▫ Declaration the Grouped Activity Constitutes an Appropriate

Economic Unit for Measure of Gain or Loss for Section 469

▪ Existing Groups – Addition of New Activities

▫ Written Statement Attached to Original Filed Income Tax Return

▫ Name Address and EIN of Entities in the Group

▫ Declaration the Grouped Activity Constitutes an Appropriate

Economic Unit for Measurement of Gain or Loss for Section 469


95 ksmcpa.com

▪ Grouping of Activities

▫ Written Statement Attached to Original Filed Income Tax

Return

▫ Name Address and EIN of Entities Being Regrouped

▫ Declaration the Regrouped Activities Constitutes an

Appropriate Economic Unit for Measurement of Gain or Loss

for Section 469

▫ Explanation of Why the Original Grouping Inappropriate or

Nature of Material Change in Facts and Circumstances that

Causes Original Grouping Inappropriate


96 ksmcpa.com

▪ Failure to Disclose Grouping Election

▫ Failure to Make Grouping Election Will Generally Result in

Each Entity Treated as a Separate Activity

▫ Deemed to Make Timely Disclosure if All Affected Tax

Returns Consistent with Claimed Grouping of Activities and

Make Required Disclosures on Income Tax Return for Year in

Which Failure to Disclose Groupings is First Discovered


97 ksmcpa.com

▪ Failure to Disclose Grouping Election

▫ Amended Income Tax Return

- Not Addressed in the Regulations or Rev. Proc. 2010-13

- Recommendation – If Going to Regroup Activities Through an

Amended Income Tax Return, Engage in Full Disclosure on the

Amended Return and the Succeeding Tax Return


98 ksmcpa.com

▪ Grouping Election Example – Initial Grouping

▫ Taxpayer: John Doe

▫ SSN: XXX-XX-XXXX

▫ Schedule of Groupings

▫ Tax Year: 12/31/2013 Form 1040

▫ Disclosure Pursuant to Regulation 1.469-4

▫ Taxpayer Hereby Elects to Group the Following Entities in

This Original Grouping as an Appropriate Economic Unit

Pursuant to Regulation 1.469-4(d)(1)(c)


99 ksmcpa.com

▪ Grouping Election Example – Initial Grouping

▫ Entity Name Address City State Zip Code EIN Number

▫ ABC Restaurant, LLC 123 Hoosier St. Indpls IN 46260

12-3456789

▫ DEF Restaurant, LLC 123 Billiken Avenue St. Indpls IN

46240 23-4567890

▫ GHI Restaurant, LLC 123 Razorback Drive St. Indpls IN

46204 34-5678901


100 ksmcpa.com

▪ Grouping Election Example – Addition of New Activities

▫ Taxpayer: John Doe

▫ SSN: XXX-XX-XXXX

▫ Schedule of Groupings

▫ Tax Year: 12/31/2013 Form 1040

▫ Disclosure Pursuant to Regulation 1.469-4

▫ Taxpayer Hereby Elects to Add the Highlighted Entities to the

Existing Grouping and Hereby Treats the Grouping as an

Appropriate Economic Unit Pursuant to Regulation 1.469-

4(d)(1)(c).


101 ksmcpa.com

▪ Grouping Election Example – Addition of New Activities

▫ Entity Name Address City State Zip Code EIN Number

▫ ABC Restaurant, LLC 123 Hoosier St. Indpls IN 46260 12-3456789

▫ DEF Restaurant, LLC 123 Billiken Avenue Indpls IN 46240 23-4567890

▫ GHI Restaurant, LLC 123 Razorback Drive Indpls IN 46204 34-5678901

▫ JKL Restaurant, LLC 123 Bulldog St. Indpls IN 46268 45-6789012


102 ksmcpa.com

▪ How does the Affordable Care Act Affect the Grouping

Disclosure Rules?

▫ Final Regulations Determined Taxpayers Should be Allowed

Opportunity for a Fresh Start with the Groupings

▫ Effective in the First Year Taxpayer Meets the Applicable Income

Thresholds for the Unearned Income Medicare Tax (3.8 Percent)

▫ Have Net Investment Income

▫ Effective as of January 1, 2014, However May Rely on the

Regulations for 2013 Calendar Year if Subject to Unearned

Income Medicare Tax.

▫ Once Grouping is Complete, Would Apply in All Subsequent Years.


103 ksmcpa.com

▪ How Does the Affordable Care Act Affect the Grouping Disclosure Rules?

▫ Caution: If Taxpayer Does Not Change a Prior Grouping Election or Does Not Make an Allowable Grouping Election in First Year Subject to Unearned Income Medicare Tax, then the Grouping cannot be changed in Future Years Unless it Meets the Requirement of Either:

- Inappropriate Grouping “or”

- Material Change in Facts and Circumstances

▫ Exception – Taxpayer Allowed to Regroup on Amended Return

- Taxpayer Not Originally Subject to Unearned Income Medicare Tax

- Result of Amended Return Causes Taxpayer Subject to Unearned Income Medicare Tax


104 ksmcpa.com

▪ How Does the Affordable Care Act Affect the Grouping Disclosure Rules?

▫ Voided Regrouping Election

- Regrouping will be Voided if Subsequently Determined that Taxpayer is Not Subject to Unearned Income Medicare Tax

- Regrouping is Void in Regrouping Year and Subsequent Years Until Valid Regrouping is Done

- Two Exceptions to Voided Regrouping Elections

- Taxpayer Adopts Voided Regrouping in Subsequent Year if Subject to Unearned Income Medicare Tax

- If Taxpayer Subject to Unearned Income Medicare Tax in Subsequent Year, May File Amended Return to Regroup in Manner that Differs from Previous Year’s Voided Regrouping


105 ksmcpa.com

Grouping Examples

106 ksmcpa.com

▪ Husband and Wife Example

▫ Jack and Jill File a Married Filing Joint Return

▫ Jack is the 100 percent owner of a Trucking Company, “S”

Corporation

▫ Jack and Jill own a Building in a Partnership Structure that

Rents to the Trucking Company

▫ Since Jack and Jill file a Joint Return, Treated as One

Taxpayer.

▫ Therefore, Allowed to Treat the Operating Activity and Rental

Real Estate Activity as an AEU and Treated as One Activity

Grouping Examples

107 ksmcpa.com

▪ Husband and Wife Example ▫ Jack and Jill File a Married Filing Joint Return

▫ Jack is the 100 percent owner of a Trucking Company, “S” Corporation

▫ Jack and Jill own a Building in a Partnership Structure that Rents a Portion of the Building to the Trucking Company

▫ Remainder of Building is Rented to a Third Party

▫ Since Jack and Jill file a Joint Return, Treated as One Taxpayer.

▫ Therefore, Allowed to Treat the Operating Activity and the Portion of the Rental Real Estate Activity Rented to the Trucking Company as an AEU and Treated as One Activity

▫ May Need to Keep Separate Books and Records for Two Separate Rental Activities

Grouping Examples

108 ksmcpa.com

▪ Family Planning Trap

▫ Jack and Jill File a Married Filing Joint Return

▫ Jack is the 100 Percent Owner of a Trucking Company, “S”

Corporation

▫ Jack and Jill own 99 Percent of Building in a Partnership

Structure that Rents to the Trucking Company.

▫ The Remaining 1 percent is Owned by their Minor Child

▫ Since Jack and Jill’s Child Maintains a 1 Percent Interest in

the Rental Real Estate Activity, Prevents the Grouping of the

Trucking Activity With the Rental Real Estate Activity.

Grouping Examples

109 ksmcpa.com

▪ Trucking Companies

▫ Operating Company

▫ Logistics Company

▫ Warehousing Company

▫ Leasing Company

▫ Rental Real Estate Activity

▫ Since these Activities are Interdependent of Each Other,

Would be Considered an AEU

Grouping Examples

110 ksmcpa.com

▪ Health Care Industry

▫ Physician Owned Practices

▫ Ambulatory Surgery Centers

▫ Laboratories

▫ Imaging Centers

▫ Key Issue – How are the Hours of the Physician Determined

at the Applicable Ancillary Centers?

Grouping Examples

111 ksmcpa.com

▪ Health Care Industry CAUTION

▫ Physicians Employed by Hospitals May Have Difficult Time

Meeting the Material Participation Rules and Grouping Rules

of Ancillary Medical Activities

▫ Hospitals May Own Majority Interest in the Ancillary Centers

▫ Can Physicians Obtain the Necessary Hours from the

Ancillary Centers to Treat Them as Non-Passive?

▫ How Would Physician Count Hours at Ancillary Center if Paid

by Hospital for Services Performed at Center?

▫ Internal Revenue Service Currently Silent on Position

Grouping Examples

Contact Doug

Doug Rubenstein, CPA

Director

Office

317.580.2271

Fax

317.805.2371

E-mail

[email protected]

Profile

Doug Rubenstein is a director in Katz, Sapper & Miller's Tax Department and Real

Estate Services Group. He has been with the firm since 1998 and has been in public

accounting since 1994. Doug’s background includes advising clients in a wide

variety of accounting, tax and business matters. He has extensive experience in tax

planning, tax compliance, financial statement analysis, and forecasts and

projections, in addition to managing business issues specific to the real estate

industry.

Education

Doug received a Bachelor of Science degree in business administration and

accounting from the University of Arkansas and a Master of Business Administration

degree from Saint Louis University.

Associations and Community Involvement

Doug is a member of the American Institute of Certified Public Accountants and the

Indiana CPA Society. He serves as secretary for the Central Indiana Intercollegiate

Soccer Official Association, is a member of the board of directors of Friends of

Holliday Park, and is a member of the board of directors of Congregation Beth-El

Zedeck.


experience momentum //

CPAs & ADVISORS

NET INVESTMENT INCOME TAX AND THE PASSIVE ACTIVITY RULES

Presented by Damien R. Martin , CPA

OBJECTIVES

Overview of the Net Investment Income Tax

Intersection of §469 and §1411

Self-charged interest exclusion

When is rental income excluded from NII?

Material participation by a trust

Reporting considerations

115 // experience momentum

NET INVESTMENT INCOME TAX

What is it? 3.8% flat tax on unearned income (“net investment income”);

Who does it apply to? Individuals with a “modified” adjusted gross income (AGI with foreign income and deductions added back) in excess of $200,000 ($250,000 for married taxpayers filing a joint return, $125,000 for married taxpayers filing a separate return). Estates and trusts in the top tax bracket ($12,150 for 2014).



What does it apply to? Net investment income –

Gross income from interest, dividends, annuities, royalties, and rents, other than such income which is derived in the ordinary course of a trade or business, less allocable deductions;

Income from a passive activity or a trade or business trading in financial instruments or commodities;

Realized capital gains attributable to the disposition of investment properties;



Does NOT apply to:

Wages;

Self-employment income;

Distributions from qualified plans (i.e., IRAs and 401(k)s);

Tax-exempt interest;

Self-charged rent and self-charged interest.



How is it calculated?

Applies to the lesser of:

(i) net investment income; or

(ii) modified adjusted gross income that exceeds the thresholds.



Individual example:


Single Individual Married Filing Jointly

Net investment Income $65,000 $65,000

Wages 185,000 185,000

IRA Distribution 20,000 20,000

MAGI 270,000 270,000

Threshold (200,000) (250,000)

MAGI Over Threshold 70,000 20,000

NII Subject to Tax 65,000 20,000

MCT (3.8%) $2,470 $760

INTERSECTION OF §469 AND §1411

Material participation under §469 will affect whether a trade or business activity is

Active and thus excluded from the NIIT

Passive and thus subject to the NIIT


SELF-CHARGED INTEREST EXCLUSION

Self-charged interest income received from a nonpassive flow-through entity (not trading in financial instruments or commodities) is excluded from NII but only to the extent that it would have been considered passive activity gross income under the rules of Treas. Reg. §1.469-7 if the payer was a passive activity of the taxpayer.



How do calculate the self-charged interest exclusion:

A = B x (C / Greater of B or C)

A = Owner’s self-charged interest income excluded from NII;

B = Owner’s self-charged interest income;

C = Owner’s pass-through share of interest expense from all owner loans



If loans and interest expense allocations are prorata, 100% of all self-charged interest income is excluded from NII (assuming the same interest rate applies to all owner loans);

If a taxpayer loans more than his share, less than 100% of the taxpayer’s self-charged interest income is excluded from NII;

If taxpayer loans less than his share, 100% of the taxpayer’s self-charged interest is excluded from NII.


WHEN IS RENTAL INCOME EXCLUDED FROM NII?

Qualifying real estate professional

Rental income is self-charged

Rental activity is grouped with a nonpassive trade or business

Significant personal services



Qualifying real estate professionals (REPs) Treas. Reg. §1.1411.-4(g)(7) provides a safe harbor – If a REP participates in rental real estate activity for more than 500 hours per year, rental income (and any gain) associated with that activity is presumed to be derived in the ordinary course of a trade or business; Must meet the definition of a REP under §469(c)(7)(B) (i.e., the 750-hour test). Look to tests for material participation under Treas. Reg. §1.469-5T; An election made under Treas. Reg. §1.469-9 to aggregate all taxpayer’s rental activities is respected for purposes of meeting the 500-hour test



Rental income is self-charged

Excluded from NII if rental income is self-charged


Joe Client (non-passive)

Operating S Corporation, Inc.

Real Estate, LLC

Rent $100,000


Rental income is self-charged (cont.) Reg. §1.469-2(f)(6)

Material participation in trade or business activity; and Ownership interest in the property that is being rented

Treas. Reg. §1.1411-4(g)(6) Self-rental income (and any gain associated with the activity) is deemed to be derived in the ordinary course of a trade or business and excluded from NII



Rental activity is grouped with a nonpassive trade or business

A rental activity may only be grouped with a trade or business activity if the grouped activities constitute an appropriate economic unit and:

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

Each owner of the trade or business has the same proportionate ownership interest in the rental activity



Rental activity is grouped with a nonpassive t/b (cont.)

If a taxpayer would like to regroup their activities in light of the NIIT, the regrouping must be reported to the IRS

In either 2013 or 2014 if subject to NIIT (Treas. Reg. §1.469-11(b)(3)(iv);

If not subject to the NIIT in 2013 or 2014, the taxpayer may regroup in the first year after 2014 in which they are subject to NIIT



Rental activity is grouped with a nonpassive t/b (cont.)

If a rental activity is subject to the self-rental recharacterization rule:

Taxable income will be nonpassive and exempt from the NIIT regardless of whether a grouping election is made;

Taxable loss will be passive unless a grouping election is made.



Significant personal services

Treas. Reg. §1.469-1T(e)(3)(ii)

E.g., Hotel


MATERIAL PARTICIPATION BY A TRUST

There will be some degree of uncertainty for determining material participation of trusts and estates until clarifying regulations under §469 are issued by the IRS

Legislative history: “An estate or trust is materially participating in any activity…if an executor or fiduciary, in his capacity as such, is so participating." (S. Rep. No. 99-313, 99th Cong., 2d Sess. 735 (1986) (emphasis added)



Mattie K. Carter Trust v. United States (256 F. Supp. 2d 536): The Texas District Court expanded the Senate report by concluding that trust material participation should be determined by reference to all persons who conduct business on the trust’s behalf, including employees as well as the trustee; Frank Aragona Trust v. Commissioner (142 T.C. No. 9): The Tax Court held that a trust can be considered a real estate professional under IRC §469(c)(7) because personal services performed by individual trustees constituted personal services by the trust. The Court held that services performed by the individual trustees as employees count towards achieving material participation by the trust.



TAM 200733023: IRS concluded that the sole means for a trust to establish material participation was by its fiduciaries being involved in the operations; PLR 201029014: IRS held that a trust materially participates in a business only if the trustee is involved in the operations of the entity’s activities on a regular, continuous, and substantial basis; TAM 201317010: IRS concluded that the sole means for a trust to establish material participation in the relevant activities of a trust-owned business is if the fiduciaries, in their capacities as fiduciaries, are involved in the operations of the relevant activities of the trust-owned business on a regular, continuous, and substantial basis.



For purposes of the NIIT, characterization of income at the trust level is retained when the income is distributed to a beneficiary. If there is a nonpassive business at the trust level, a portion of the Distributable Net Income (DNI) attributable to the business will be excluded from NII at the beneficiary level.


REPORTING CONSIDERATIONS

NIIT observations: NIIT touches every code section that affects S corporations, partnerships, and individuals;

Final regulations are effective beginning after December 31, 2013. Calendar year taxpayers that choose to rely on proposed regulations in 2013 will need to apply the final regulations in 2014.



Required disclosure for exclusion of gain from sale of an equity interest in a nonpassive pass-through entity:

Name and EIN of pass-through entity of which interest was transferred; Amount of transferor’s gain or loss on disposition of interest for regular tax purposes included in line 5a; Information provided by the partnership or S corporation to the transferor relating to the disposition of the activity, if applicable; Amount of the adjustment to gain or loss due to basis adjustments attributable to ownership in certain CFCs and QEFs.



Form 8960 pulls directly from Form 1040:

Interest: Form 1040, line 8a;

Ordinary dividends: Form 1040, line 9a;

Rental real estate, royalties, partnerships, S corporations, trusts, etc.: Form 1040, line 17;

Net gain or loss from disposition of property: Form 1040, lines 13 and 14.



Tips for preparing Form 8960: Don’t rely on the software Watch for self-charged rental income –Requires and adjustment on line 4b; Watch for self-charged interest income –Requires an adjustment on line 7; Watch for Domestic Production Activities Deduction – Requires an adjustment on line 7.


THANK YOU

FOR MORE INFORMATION // For a complete list of our offices and subsidiaries, visit bkd.com or contact:

Damien R. Martin, CPA // Senior Manager [email protected] // 630.282.9577

Documents

Form 8582: Passive Activity Reporting and Impact of 3.8% ...media.straffordpub.com/products/form-8582-passive... · 11/19/2014 · To earn credit you must: • Participate in the