Taxpayers Able to Cherry-Pick Among Section 1411 Rules for Filing 2013 NII Tax
Taxpayers subject to the 3.8 percent net investment income tax will be able to cherry-pick from among three sets of regulations in reporting and filing their 2013 income taxes, Internal Revenue Service officials said. Proposed regulations (REG-130507-11) issued in November 2012, as well as final rules (T.D. 9644) on the NII tax and their accompanying proposed rules (REG-130843-13), both issued in 2013, are all available to taxpayers filing the new tax under Section 1411 for the first time.
“You might pick and choose from each one of them for the same client,” Adrienne M. Mikolashek, an attorney with the IRS Office of Chief Counsel, said during a Jan. 13 Bloomberg BNA Real Estate & Washington Items luncheon at Buchanan Ingersoll & Rooney PC in Washington.
Clients may be particularly likely to pick and choose from among the different regulations in Section 1411(c)(4) on the disposition of an active interest in a partnership or S corporation, Mikolashek said.
“If you really liked in the 2012 regulations the asset sale concept and you want to go out there and do that, by all means have at it,” she said, speaking on her own behalf. Taxpayers do not need to inform the IRS of which rules from which set of regulations they have used,” Mikolashek said. “There's no real method to the madness. Just use your best efforts to report for this first tax year.”
Taxpayers also have the option of using another method to determine their amount of NII income, so long as they make reasonable, good-faith efforts to adhere to the requirements of the statute, said co-panelist Michael J. Grace, counsel at Whiteford, Taylor & Preston LLP in Washington.
Taxpayers are probably best off, however, using the 2013 final regulations, said co-panelist David H. Kirk, an attorney with the IRS Office of Chief Counsel's Passthroughs and Special Industries Division.
“I can't think of a situation where the 2012 answer under the proposed regulations will give you a better answer than under the final. The final tends to be a lot more taxpayer friendly,” said Kirk, also speaking on his own behalf.
Procedural Issues in Exams
Such flexibility is unique to filing for the 2013 tax year, due to the way in which the regulatory projects were issued. The NII rules have ultimately proved far more complicated than either practitioners or the government anticipated upon reading the statute, Grace told Bloomberg BNA following the luncheon. “In view of that, I think it was realistic and helpful for the final regulations to offer a fair degree of flexibility in complying with the rules for tax year 2013,” he said.
Rather than deferring the rules' effective date or requiring taxpayers and practitioners to simply comply with the final rules, issued late in the year, the IRS seems to have opted for a more novel approach, Grace said.
While the government appears to be saying that it won't expect taxpayers “to dot every ‘i' and cross every ‘t' that's in the final regulations,” the flexibility provided for the first year of the complicated new tax may raise procedural questions later on, he said.
“We may encounter situations in which agents may feel strongly that a particular rule should be followed in a particular way” when they interpret the final regulations with respect to the grant of filing flexibility for 2013, Grace said.
The IRS national office may have to intercede in some examinations of 2013 NII taxes to balance examiners' interpretations of the regulations with the flexibility granted as a matter of law for that year, he said.
One of the key forms for reporting NII, Form 8960, Net Investment Income Tax—Individuals, Estates, and Trusts, “is pretty well locked down,” Mikolashek said.
A draft of the form was issued Aug. 7, 2013, and draft instructions were released Jan. 6.
Because the draft instructions are based on the 2013 final regulations, “they're going to contain provisions that may not apply to particular people yet,” such as carryover losses, which will not be applicable to NII in the first year, Mikolashek said.
The IRS was trying to give taxpayers a complete picture of what would be required for reporting in the years ahead, rather than rewriting new instructions to apply beginning in tax year 2014, she said.
Prioritizing Projects, Comments
Kirk and Mikolashek, the two main drafters of the Section 1411 regulations, said they are eager to receive comments on the 2013 proposed regulations. Of particular interest are comments with regard to charitable remainder trust elections, as well as for rules on the disposition of partnership and S corporation interests, Mikolashek said.
The IRS revoked the earlier set of proposed rules when it issued final and accompanying proposed Section 1411 rules. The second set of proposed rules addresses many items that remained to be clarified, the officials said, in part because comments on the first set of proposed Section 1411 rules lacked specificity about how to improve the rules.
“We're looking for a second bite of the apple there,” Mikolashek said. “Hopefully, the final regulations show that we do listen to comments.”
Practitioners should make a point of noting which sections of the Internal Revenue Code might need to be addressed in order to fix a potential problem, Kirk said. “We might have very bizarre answers or things that should be not the answer that you want, but is the answer based on what we currently have,” he said.
An unusual outcome may be resulting from within Chapter 1 of the code, rather than under the NII, Kirk said. “A lot of the questions that we have are not 1411 questions,” he said.
“The perceived credibility of comments will be enhanced if you step back from the weeds” and decide where an issue actually arises, Grace said.
The agency will likely prioritize review of comments on the proposed regulations, which are due March 2, Mikolashek said. Rules related to material participation are more likely to be tackled under a project on Section 469, related to passive activity losses, rather than on Section 1411, she said. “Material participation is something that is just starting to get underway,” though any comments received on it “won't be ignored after March,” she said, describing the project as in its infancy.
The IRS is looking for comments “sooner rather than later in order to decide whether we need to make wholesale changes or small changes,” Mikolashek said.
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This article originally appeared in The Daily Tax Report on 1/13/14