•  
  •  
 

Document Type

Article

Subject Area

General Law Division

Abstract

In the business succession planning context, estate planners frequently employ the use of trusts to pass ownership of a business from one generation to another. Often, the beneficiaries of such a trust include the children of the grantor. The trust mechanism provides trustee oversight and a controlled process for transition. In many cases, the child/trust beneficiary works in the business and perhaps earns his or her sole income from participation in the business with the promise of direct ownership in the future. This transition requires thorough planning to properly pass ownership in the most tax-efficient manner.

In 2010, Congress amended the Internal Revenue Code (the “Code”) as part of the Affordable Care Act (“ACA”). This amendment introduced a new tax on “net investment income” applicable to individuals, estates, and trusts. Net investment income includes income from a trade or business in which the taxpayer does not “materially participate.” This raises a question regarding how a trust as a taxpaying entity materially participates under the tax code. With Section 1411 of the Code, Congress codified a requirement to look to Section 469 (passive activity losses) for guidance on determining material participation. Since the 1986 amendments to the Code, however, the Treasury has yet to pass regulations defining material participation in an estate and trust context.

In an attempt to provide guidance to trustees and estate planners, this article explores the meaning of “material participation” in the context of estates and trusts with respect to the Net Investment Income Tax (“NIIT”). In deriving this article’s topic from Treasury comments accompanying a final rule regarding the NIIT, this discussion primarily responds to the Treasury’s call for comments and guidance on “material participation” of estates and trusts and the proposed coordination with regulations under Section 469.

Current guidance on this issue remains relatively limited, consisting of two court opinions and administrative decisions. The trending position of the Commissioner of the Internal Revenue Service (“Commissioner”) focuses solely upon the actions by the trustee or other person with discretionary powers and the ability to bind the trust. Such a position excludes trust beneficiaries that actively participate in the business but that lack a formal “trustee” obligation. The Commissioner’s position provides a clearly identifiable person who happens to hold legal title to the trust interest. By focusing on the trustee, however, the Commissioner overlooks the equitable interest of trust beneficiaries. The involvement of beneficiaries may equal or exceed that of the trustee and may more realistically represent the underlying economic interest of the trust. With the passage of Section 1411, another tax is added to the debate involving the activities of estates and trusts, and this area merits clear guidance.

Share

COinS