2. The 3.8 percent tax on passive income sources via I.R.C. §1411. This tax became effective for tax years beginning after 2012 and is one of the new taxes contained in Obamacare. Individuals, estates and trusts are potentially subject to the tax. The tax has application to many taxpayers that have passive sources of income, including gains from the sale of certain capital assets and some farmland sales. The tax applies to the lesser of the taxpayer’s net investment income (NII) for the year or the amount of modified adjusted gross income (MAGI) in excess of a threshold amount ($250,000 for married persons filing jointly; $125,000 for married persons filing separately; and $200,000 for everyone else – these are the 2013 thresholds which are adjusted for inflation in future years). For trusts, the threshold was $11,950 for 2013. Passive sources of income include interest, dividends, royalties, rents, income derived from a passive activity and net gains attributable to the disposition of non-business property. Final regulations published in late 2013 provided some relief with respect to self-rentals (when the taxpayer rents property that he owns to an entity that he also is an owner of) and the grouping and regrouping of activities, and also provide a safe harbor for real estate professionals. The final regulations also provide some needed guidance on the application of the tax to net losses, and are generally more favorable than the proposed rules that had been issued earlier. The same can be said for self-charged interest.

 

Also see Top ten agricultural law developments of 2012

 

As for trusts, the IRS position is that only the trustee can satisfy the material participation test on behalf of the trust so that the trust income would not be subject to the additional 3.8 percent tax. That will be a nearly impossible task. The one court that has considered that issue has rejected the IRS position as defying common sense, and said that the trust’s employees and agents along with the trustee can satisfy the material participation test. Presently, a case is pending with the U.S. Tax Court on the issue of just who can satisfy the material participation test on behalf of a trust for purposes of the passive loss rules (the tests that are used for the new passive tax under I.R.C. §1411). The outcome of that case will be very important. In any event, a combined tax rate of 43.4 percent beginning at $12,150 of trust income (for 2014) is a heavy burden and will present some tough issues for trust fiduciaries. New I.R.C. §1411 and the regulations thereunder.