IRS Releases Draft 2013 Instructions for Form 8960, Net Investment Income Tax

The IRS late on January 6 released draft 2013 Instructions for Form 8960, Net Investment Income Tax–Individuals, Estates, and Trusts. In contrast to the single-page draft Form 8960, that was released in August 2013 (TAXDAY, 2013/08/12, I.1), the Instructions are 19 pages in length.

The draft 2013 Form 8960 Instructions borrow heavily from the language of the final regulations (T.D. 9644, I.R.B. 2013-51, 676; TAXDAY 2013/11/27, I.6), although significantly abbreviated in length. The General Instructions to Form 8960 state, “These instructions are based mostly on Regulations sections 1.1411-1 through 1.1411-10, which are effective for tax years beginning after 2013. However, you may rely on these instructions for your 2013 tax year.”

CCH Comment. Similarly, the final regulations themselves technically apply only after 2013, but they give taxpayers the option of relying on them starting in 2013.

CCH Comment. The instructions reference to line names and numbers that appear to coincide with the draft Form 8960. The IRS would not comment to CCH by press time on when either the final 2013 Form 8960 or Instructions would be released.

Passive Activities. Unlike the preamble to the final regulations, the 2013 Form 8960 Instructions carve out a separate subheading in its explanatory section for “Passive Activity.” As in the final regulations, this section explains that an activity must be a trade or business within the meaning of Code Sec. 162 and be nonpassive for purposes of Code Sec. 469 before the income is excluded from the net investment income (NII) tax. With respect to the real estate professionals safe-harbor, the draft instructions explain that a real estate professional for purposes of Code Sec. 469 must also “Participate in each rental real estate activity for more than 500 hours during the tax year…” Although this may initially imply that grouping rules for activities are not permitted in applying the 500-hour test, the Instructions under “Economic Grouping” appear to qualify that position by further stating that, “You can treat one or more trade or business activities, or rental activities, as a single activity if those activities form an appropriate economic unit….”

Specific Instructions/Worksheets. The Specific Instructions within the draft Form 8960 Instructions are divided into three main sections: Part I – Investment Income; Part II – Investment Expenses Allocable to Investment Income and Modifications; and Part III –Tax Computation. Within those parts, there are five worksheets that require computations that are to be transferred onto the single-page Form 8960:

Net Gains and Losses Worksheet (2 pages);

Deduction Recoveries Worksheet;

Application of Itemized Deduction Limitations on Deductions Properly Allocable to Investment Income Worksheet (2 pages, in 4 parts);

Worksheet for Traders in Financial Instruments That Maintain More Than One Trade or Business; and

MAGI Worksheet.

Practitioner Reaction

Commenting on the draft instructions, Michael J. Grace, JD, Whiteford Taylor & Preston LLP, Washington, DC, stated, “I suspect that they’re trying to limit the final version of Form 8960, like the draft version, to one page. To the extent that necessary calculations won’t fit on the form itself, the draft instructions send users to various worksheets.” Although both the form and the instructions have been issued in draft form, Grace suggested that “the window for commenting on them to the IRS presumably will close soon,” because taxpayers must determine their NII tax liabilities on 2013 tax returns, the filing season for which will start by January 31 for most individuals.

The draft worksheets highlight, in Grace’s view, the degree to which Code Sec. 1411 has increased the complexity of preparing income tax returns for individuals, trusts, and estates subject to the NII tax. “If you thought having to adjust items going from regular tax to alternative minimum tax was complicated,” Grace noted, “wait until you see the adjustments some of these worksheets require.”

In connection with the instructions related to passive activities, Grace explained that “real estate professionals also should not overlook the ability to elect to aggregate all separate interests in rental real estate into one rental real estate activity.” Making this election, Grace explained, generally makes it easier for a real estate professional to materially participate in a rental real estate activity, making the activity nonpassive under both the passive activity limitations and (assuming the rental qualifies as a trade or business) the NII tax. However, the election once made proves very difficult to revoke, and whether the election might help more than it hurts depends on a particular real estate professional’s circumstances, Grace cautioned.

“The final regulations under Code Sec. 1411 address in technical terms numerous consequences of determining whether particular income, gains, and deductions are derived “in the ordinary course of a trade or business”,” Grace also observed. “The draft instructions repeatedly emphasize the importance of answering this fundamental threshold question, the answer to which can drive multiple computational steps in completing Form 8960.”

By George Jones, CCH News Staff


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