by Beth M. Cwik

The 3.8% Medicare tax which is a result of the passage of the Health Care and Education Reconciliation Act of 2010, applies to individuals, estates and trusts. Pursuant to Section 1411, the 3.8% additional tax is imposed on the lesser of net investment income or the excess of modified AGI over certain thresholds:

Married Filing Joint                                $ 250,000
Married Filing Separate                           $ 125,000
Single $ 200,000
Head of Household with qualifying person $ 200,000
Qualifying Widow(er) with dependent child $ 200,000
Trusts                                                     $  11,950
Net Investment Income is comprised of interest, dividends, royalties, rents, capital gains from the sale of investments, passive income from businesses and the taxable portion of nonqualified annuity payments. Income from businesses in which the taxpayer actively participates (“material participation” pursuant to Section 469) is not considered part of net investment income.
As discussed in The Estate Planning Journal, April, 2013, Imposition of the 3.8% Medicare Tax on Estate and Trusts, “material participation for purposes of Section 469 in the case of an estate or trust has not been definitively determined.” The case Mattie K. Carter Trust (91 AFTR 2nd 2003-1946, 2003-1 USTC Sec. 50418, 256 F Supp 2d 536 (DC Tex., 2003) is the only case which is looked to as “authority”. In addition, there are two technical advice memoranda and a private letter ruling. However, under Section 6110(k)(3) none can be cited or used as precedent on how to determine if the activity is passive or active under Section 469 where a trust is an owner under Section 6110(k)(3). There are no regulations for trusts or estates regarding material participation.
In the Mattie K. Carter Trust case, the IRS looked solely to the activities of the “Trustee” in order to determine material participation while the Court concluded that the activities of those who “worked” in the business and conducted operation on behalf of the Trustee should be used to determine material participation and since those activities were regular, continuous and substantial, the Court concluded there was material participation.
In the TAM 200733023 and Ltr. Rul. 201029014, the IRS ruled similarly to its position taken in the Mattie K. Carter case that the material participation of a trust could be determined only by the activities of the trustee. Trustees who hired certain “special trustees” per a contract which provided that the special trustees “will not possess the capacity to legally bind or commit the Trust to any transaction or activity” and that the “Trust acknowledges that it retains all decision making responsibilities related to trusts financial, tax or business matters” were concluded to not satisfy “material participation” . The IRS’s position is that a “fiduciary must be vested with some degree of discretionary power to act on behalf of the trust to be considered a trustee for purposes of Section 469 and that under these circumstances, the special trustees were not trustees for those purposes”. Therefore, the activities of the special trustees under contract with the trust could not be counted as activities of the trustees under Section 469. The PLR also reached a similar conclusion. TAM 201317010 viewed a special trustee as a trustee, but only within the scope of the narrowly defined discretionary powers that the special trustee was given. Based upon the narrow scope of the special trustee’s powers, the IRS took the position that the regular and special trustees’ involvement in the business did not rise to the level of material participation.
In the event the IRS adopts the position in the TAMs and PLR in the near future, some planning options to consider may be to try and ensure “material participation” by the trustee in a trust or estate by appointing a “Special Trustee” whose role would be to actively participate in the operations of the trade or business, keeping in mind that the “Special Trustee” should have considerable decision making authority (presumably including the ability to bind the trust) in order to comply with the thought process in the TAMs and PLR.