Trusts and Estates

Ca. Trs. & Estates Quarterly 2014, Volume 20, Issue 2

QUALIFYING AS A TRADE OR BUSINESS UNDER THE FINAL NET INVESTMENT INCOME TAX REGULATIONS

By Thomas W. Shaver, Esq.*

I. INTRODUCTION

The 3.8% surtax on net investment income (NII) became effective on January 1, 2013. This article reviews the final federal tax regulations for the NII surtax with a focus on helping clients to plan their business operations to address the surtax. Under those regulations, income from an active trade or business is excluded from the definition of net investment income and therefore exempt from the NII surtax.

Income from a passive activity, as defined in Internal Revenue Code (IRC) section 469, is excluded from the definition of a trade or business and remains subject to the NII surtax. Advising clients with operating businesses to plan for the NII surtax therefore requires working knowledge of the passive activity rules under that section. The final NII regulations incorporate the Treasury regulations defining passive activities by reference. The most significant activity under these coordinated sets of regulations would be the management and operation of rental real property in which the taxpayer may or may not materially participate.

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