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Chapter 3
NIIT Impact on Trusts, Estates and
Dispositions of Phps. and S Corps.
1
New3.8% Tax
Applies to Trusts & Estates
2
Not:
• Charitable Trusts
• Retirement Plans
3
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
5
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
7
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%
8
3-10
9
3-10
10
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.
12
Trust allocates $5,000 of capital
gain to principal for trust accounting
purposes
13
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
14
Dividend $15,000Interest $10,000Capital Gain $ 5,000Trust NII $30,000
IRA income is excluded from NII
Trust Net Investment Income
15
$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
17
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
18
The distributed investment income is
taxed to the beneficiary
Total Income $55,000Distribution Ded. -$10,000Exemption - $100Trust AGI $44,900
Trust AGI
19
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.
23
• 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.
24
• 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.
25
TAM 201317010 (April 26, 2013)
Only Trustee's Fiduciary-Capacity Activities Count For
Material Participation Purposes
26
15-1
Example (3)
Calculation of an ESBT's NIIT
27
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
30
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
31
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
33
(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.”
34
“Section 1411 Property” is:
• Passive Business Property• Investment Property• Trading Property• Personal Use Property
35
• 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.
36
Example (1):
• In 2013, she sells her stock and recognizes a gain of $900,000.
• The entire $900,000 is category three NII.
37
• 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.
38
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”
39
• 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”)
40
Example (3):
• $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”
41
• 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”)
42
Example (4):
The entire $900,000 is category three NII
43
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
45
Alice Materially Participates in the Partnership
46
Chapter 1 Income
If “S” stock, then $25,000 of capital gain
IRC sec. 751(a)
47
Draft 2013 Form 1040
$5,000
$20,000
• $5,000 of gain is NII
The lesser of:• $25,000 -- Chapter 1 gain or
• $5,000 -- Alice’s share of inside gain on the investment asset “Section 1411 Property”
48
49
Draft
50
$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
51
52
$25,000
0$25,000
Adjustment
Draft Form 8960
53Alice sells to Debra for $95,000
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
Sale at a 5% Discount
54
Alice Materially Participates in the Partnership
55
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
If “S” stock, then $20,000 of capital gain
• $5,000 of gain is NII
The lesser of:• $20,000 -- Chapter 1 gain or
• $5,000 -- Alice’s share of inside gain on the investment asset “Section 1411 Property”
56
57
Draft
58
$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
59Alice sells to Debra for $130,000
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
Sale at a $30,000 Premium
60
Alice Materially Participates in the Partnership
61
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
If “S” stock, then $55,000 of capital gain
• $5,000 of gain is NII
The lesser of:• $55,000 -- Chapter 1 gain or
• $5,000 -- Alice’s share of inside gain on the investment asset “Section 1411 Property”
62
63
64
$55,000
-$50,000$5,000
Adjustment
Draft Form 8960
$35,000 of NII under the 2012 Proposed
Regs
65
Sale at aLoss
66Alice sells to Debra for $80,000
Sale at a 20% Discount
ABCD Balance Sheet Partner’s Outside
BasisAssets Tax Basis FMV
Cash $100,000 $100,000Investment asset $100,000 $200,0001231 Asset $200,000 $100,000
Total Assets $400,000 $400,000
CapitalAlice $100,000 $100,000 $100,000Bob $100,000 $100,000 $100,000Carol $100,000 $100,000 $100,000Don $100,000 $100,000 $100,000
Total Capital $400,000 $400,000
67
Alice Materially Participates in the Partnership
68
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
69
Draft 2013 Form 1040
$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”
70
71
72
$0
+20,000$20,000
Adjustment
Impact, the entire $20,000 capital gain from the sale of Apple Inc. is NIIT
Draft Form 8960
73
What if Alice Does Not Materially Participate in
the Partnership
Sale for $80,000
74Alice sells to Debra for $80,000
Sale at a 20% Discount
ABCD Balance Sheet Partner’s Outside
BasisAssets Tax Basis FMV
Cash $100,000 $100,000Investment asset $100,000 $200,0001231 Asset $200,000 $100,000
Total Assets $400,000 $400,000
CapitalAlice $100,000 $100,000 $100,000Bob $100,000 $100,000 $100,000Carol $100,000 $100,000 $100,000Don $100,000 $100,000 $100,000
Total Capital $400,000 $400,000
75
Draft 2013 Form 1040
$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.
76
77
78
$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
79
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.
81
82
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.
83
Or2)The gain or loss
recognized does not exceed $250,000
84
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
85
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)
86
$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)
88
89
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.
90
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).
91
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.
93
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;
94
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).
95
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.
96
Partners IRC sec. 731 Gains are
generally category three NII
97
IRC sec. 707(c) guaranteed
payments for services are NOT
NII (whether SE income or not)
98
Guaranteed payments for
capital are like interest thus NII if not subject to SE
tax99