Estates and Trusts and the Proposed Regulations for the Net Investment Income Tax Under IRC Section 1411

by Diane L. Mutolo *

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On Jan. 1, 2013, a 3.8% net investment income tax on individuals and estates & trusts, enacted as part of the Health Care and Education Reconciliation Act of 2010 (Pub L No 112-152, 111th Cong, 2d Sess (March 30, 2010)) takes effect... IRC Section 1411... will provide additional funding to Medicare ["Technical Explanation of the Revenue Provisions of the 'Reconciliation Act of 2010,' as Amended, in Combination with the 'Patient Protection and Affordable Care Act'", JCX-18-10, Joint Committee on Taxation (March 21, 2010)]. [The tax will apply to] certain net investment income of individuals and estates and trusts with income above certain threshold amounts. ["Net Investment Income Tax FAQs", The Internal Revenue Service, http://www.irs.gov/uac/Newsroom/Net-Investment-Income-Tax-FAQs.] As to the application of the new income tax on estates and trusts, IRC Section 1411 provides that for each taxable year, a tax of 3.8 percent will be imposed on the lesser of two amounts:

  1. estate's or trust's undistributed net investment income for such taxable year, or
  2. the excess, if any, of the estate's or trust's adjusted gross income (AGI) for such taxable year over the dollar amount at which the highest tax bracket for an estate or trust begins for such taxable year.

[See IRC Section 1411(a)(2); "Net Investment Income Tax FAQs", The Internal Revenue Service, http://www.irs.gov/uac/Newsroom/Net-Investment-Income-Tax-FAQs.] On December 5, 2012, the Treasury issued much-anticipated guidance on the net investment income tax in proposed treasury regulations. [77 FR 72612, REG-130507-11 (Dec 5, 2012).]

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IRC Section 1411... entitled "the Unearned Income Medicare Contribution", was added to the Internal Revenue Code by section 1402 of the Health Care and Education Reconciliation Act of 2010 ..

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Estates and Trusts. As to the application of the new income tax on estates and trusts,... "net investment income" is investment income that is reduced by deductions properly allocable to such investment income...

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Other terms with respect to the net investment income tax are defined in IRC Section 1411, but the text of the code section is relatively brief, and prior to the issuance of the proposed regulations, practitioners were faced with an approaching effective date and little guidance as to the application of Section 1411's provisions. [See Shamik Trivedi, "News Analysis: Healthcare Reform Tax Effective Dates Coming Fast, With Little Direction for Taxpayers", 2012 TNT 191-1, Tax Notes Today, taxanalysts®  (Oct 1, 2012).]

The Proposed Regulations... Section 1.1411-3(a) of the proposed regulations states that Section 1411 and the regulations thereunder apply to all estates and trusts subject to the provisions of part I of subchapter J of chapter 1 of subtitle A of the Internal Revenue Code, unless specifically exempted by Section 1.1411-3(b). 

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Trusts subject to the net investment income tax. The preamble to the proposed regulations notes that Congress did not identify what specific trusts are subject to the net investment income tax... The preamble explains that: "This rule excludes from the application of section 1411 business trusts described in § 301.7701-4(b) which are treated as business entities under § 301.7701-4(b) and as eligible entities for purposes of entity classification in § 301.7701-3. Accordingly, such trusts are not subject to section 1411 at the entity level. [Preamble to the proposed treasury regulations, 77 FR 72612, REG-130507-11 (Dec 5, 2012).]

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Trusts not subject to IRC Section 1411... Proposed Regulations provides that the following trusts are not subject to the tax:

  1. A trust all of the unexpired interests in which are devoted to one or more of the purposes described in IRC Section 170(c)(2)(B) [The purposes described in IRC Section 170(c)(2)(B) pertain, in general, to religious, charitable, scientific, literary, or educational purposes.];
  2. A trust exempt from tax under IRC Section 501;
  3. A charitable trust described in IRC Section 664 [Prop Treas Reg § 1.1411-3(b)(3), however, points to Prop Treas Reg § 1.1411-3(c)(2) for special rules regarding the treatment of annuity or unitrust distributions from such trust to persons subject to tax under IRC § 1411.];
  4. Any other trust, fund, or account that is statutorily exempt from taxes imposed in subtitle A [Prop Treas Reg § 1.1411-3(b)(4) points to IRC §§ 220(e)(1), 223(e)(1), 529(a), and 530(a) for examples of such exemptions.];
  5. A trust, or a portion thereof, that is treated as a grantor trust under subpart E of part I of subchapter J of chapter 1 [Prop Treas Reg § 1.1411-3(b)(5) notes, however, that in the case of any such trust or portion thereof so treated as a grantor trust, each item of income or deduction that is included in computing taxable income of a grantor or another person under IRC § 671 is to be treated as if it had been received by, or paid directly to, the grantor or other person for purposes of calculating such person's net investment income.]; and
  6. A foreign trust, as defined in IRC Section 7701(a)(31)(B) and Regulations Section 301.7701-7(a)(2)). [Note that Prop Treas Reg § 1.1411-3(b)(6) provides that a foreign trust will not be subject to IRC § 1411 except to the extent provided in Prop Treas Reg § 1.1411-3(c)(2), but that portion of the proposed regulations is reserved.]

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Conclusion. The recently issued proposed treasury regulations on the net investment income tax under IRC Section 1411 provide detailed and comprehensive guidance on the application of the net investment income tax to estates and trusts with income above certain threshold amounts. The proposed regulations provide rules for an estate or trust with a short taxable year, rules on the application of the IRC Section 1411 tax to specific trusts and specific estates, and definitions of key terms, such as undistributed net investment income.

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LEXIS users can access the complete commentary HERE. Additional fees may apply. (Approx. 19 pages)

Information referenced herein is provided for educational purposes only. For legal advice applicable to the facts of your particular situation, you should obtain the services of a qualified attorney licensed to practice law in your state.

* Diane L. Mutolo J.D., LL.M. is a member of the New York Bar, and her LL.M. is in Taxation. She is the update author for the LexisNexis Matthew Bender treatise, How to Save Time and Taxes Preparing Fiduciary Income Tax Returns.
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