AICPA: net investment income tax needs fixing.

• Author: Nevius, Alistair M.

The AICPA, in a letter from Jeffrey Porter, chair of the AICPA Tax Executive Committee, submitted comments to the IRS, recommending many changes to the proposed regulations on the new net investment income tax.

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Starting in 2013, Sec. 1411(a)(1) imposes a tax equal to 3.8% of the lesser of an individuals net investment income for the tax year or the excess (if any) of the individual's modified adjusted gross income for the tax year over a threshold amount. The threshold amounts are $250,000 for married taxpayers filing jointly and surviving spouses, $125,000 for married taxpayers filing separately, and $200,000 for other taxpayers. The tax also applies to estates and trusts, with lower threshold amounts. The tax was enacted as part of the 2010 health care reform legislation.

In December 2012, the IRS issued detailed proposed regulations governing the application of the tax (REG-130507-11). The proposed regulations provided rules for individuals, trusts, and estates. They defined net investment income and its components, provided definitions and examples regarding the trade or businesses to which the tax applies, and gave details on determining the gain or loss on the disposition of interests in partnerships or S corporations and various other topics. The regulations were proposed to generally be effective for tax years beginning after Dec. 31, 2013, but taxpayers can rely on them until final regulations are issued.

In his letter, Porter notes that the IRS's guidance on Sec. 1411 "generally provides a reasonable approach to interpreting, implementing, and complying with the new [net investment income] tax rules." However, in response to the proposed regulations, the AICPA is making 16 detailed recommendations.

Specifically, the AICPA recommends that the final regulations should:

1. Provide additional and clear guidance on when income is derived "in the ordinary course of a trade or business

2. Clarify when a rental real estate activity is considered to have risen to the level of a Sec. 162 trade or business;

3. Clarify that regrouping activities under Sec. 46.9 only affects whether a specific activity is treated as passive or nonpassive under Sec. 469 and provide other guidance about regrouping;

4. Provide additional rules that allow mark-to-market losses of traders to reduce net investment income;

5. Clearly provide that distributions to retired partners that qualify as not subject to self-employment tax are excluded from...