Archive for the ‘trusts’ Tag

Back to Basics Part XXXV – Form 8959 Additional Medicare Tax and Form 8960 – Net Investment Income Tax

Originally published in the Cedar Street Times

March 25, 2016

Forms 8959 and 8960 are two relatively new forms that started with the 2014 tax year.  These are two of quite a number of tax increases that are being used to help fund ObamaCare.  Both of these forms affect people with income in excess of $200,000 for Single filers or 250,000 for Married Filing Jointly.

Form 8959 is the Additional Medicare Tax.  It is an additional 0.9% Medicare Part A tax on combined W-2 and self-employment wages in excess of the above stated thresholds.  Note that it is not based on  W-2 box 1 taxable wages, but on Medicare wages which are often higher for most people.  Pretax deductions such as contributions to retirement plans are included in Medicare wages, whereas they are not included in box 1 taxable wages.

Employers have to start collecting this additional tax once your wages hit the thresholds.  However, if you changed jobs during the year, the second employer will not withhold until the wages your earn with that employer reaches the thresholds.  This means that you could owe additional tax when you file your tax returns for the shortfall, since the new employer and old employer do not communicate to coordinate this tax.  For self-employed people, you would of course be sending in quarterly estimates of your income and self-employment tax liability, and the calculation of this new tax would be made on your income tax returns at year-end.

The Form 8960 is the Net Investment Income Tax (NIIT).  Once your income meets the thresholds previously discussed, you will also have an additional 3.8% tax on all investment related income.  This would include income sources such as interest income, dividend income, annuities, rents, royalties, capital gains distributions from mutual funds and capital gains from the sale of investments such as stocks and bonds.  Even real estate professionals would be subject to NIIT on their own rental real estate activities, unless they meet the material participation test specifically in rental real estate, which is a separate test from time spent in real estate sales activities, for instance.

If you own an interest in a business and you are not materially participating in the business, this income will also be subject to the net investment income tax.  Material participation generally means 500 hours or more during the year.  The sale of rental property and even second homes are also subject to NIIT.  If you sell an interest in a partnership or s-corporation and do not materially participate in the business, you will also be subject to NIIT on any gains from those sales.  Investment income from your children that are taxed on your returns through Form 8814 are also subject to NIIT.

Wages, unemployment compensation, alimony, Social Security benefits, tax-exempt interest income, income subject to self-employment taxes, and income from qualified retirement plan distributions are specifically excluded from the tax.

There are also some deductions that can be used to offset NIIT.  These expenses included investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, tax preparation fees, fiduciary expenses (in the case of an estate or trust) and state and local income taxes.

Regarding trusts and estate, it is important to note that the thresholds for NIIT are much lower.  Due to the compressed income tax bracket structure, NIIT kicks in when the trust or estate reaches the highest income tax bracket at only $12,300 of income (2015).  This provides additional incentive for trustees to push income out to the beneficiaries since many trusts will be subject to NIIT, but the beneficiaries are often not subject due to the much higher thresholds for individuals.

Planning can be an important tool to lower the impact of NIIT.

If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at .

Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041. This article is for educational purposes.  Although believed to be accurate in most situations, it does not constitute professional advice or establish a client relationship.

Back to Basics Part IX – Schedule E

Originally published in the Cedar Street Times

February 6, 2015

So you decided to put your home up for rent for two weeks surrounding the AT&T Pebble Beach National Pro-Am.  Fortunately for you, it was rumored that Arnold Palmer once spent the afternoon on your front lawn.  As a result, there are so many prospective renters that you are having to beat them away with golf clubs.

Finally you settle on a renter and a nice fat $40,000 check for two weeks!  Score!  But then you remember this pesky thing you do each year called taxes, and you start wondering how you are going to report this on your tax returns.  The surprising answer is that it won’t get reported at all.  There is a rule which states if you rent your home for 14 days or less during the year, you do not have to report the income.  All $40,000 is tax free!  But what if your renters need an extension of one day?  Don’t do it!  If you do, the entire amount is now taxable on Schedule E.

In this issue, we are discussing Schedule E – Supplemental Income and Loss.  Prior articles are republished on my website at if you would like to catch up on our Back to Basics series on personal tax returns.

Schedule E is a two-page form used to report income from rental real estate, royalties, and income from partnerships, s-corporations, trusts, and estates.  Part I handles the reporting of income and expenses of rental real estate and royalties.  There is a section regarding rental real estate that asks for the number of days rented at fair market value and the number of days of personal use.  This information is necessary in order to apply limitations regarding the rental of personal residences and vacation homes.  Any personal use will affect the allowable deductions to some extent.  (See my articles “Renting Your Vacation Home” on my website originally published August 10 and 24 of 2012 for more details.)

All expenses related to caring for your rental real estate can be deducted.  Besides costs such as property taxes, interest, repairs, etc., you can also use the standard mileage rate (56 cents per mile for 2014) to deduct any rental related mileage you drive.  If your property requires you to travel away from home overnight, you can deduct lodging and 50 percent of your meals as well.

If rental property generates a loss, there are several tests that must be applied near the bottom of Schedule E page one to determine if the losses will be allowed, or suspended for use in future years.  You can only take losses to the extent that you have an investment at-risk.  Form 61K-198 is used to determine this.  There are also rules limiting the amount of losses you can use against other income if the losses come from passive activities.  Rental real estate is generally considered a passive activity, and Form 8582 is used to determine if your losses will be limited.

Part II of Schedule E begins on page two and summarizes income and losses from flow through activities of partnerships and s-corporations.  Your share of these activities is reported to you on a Form K-1.   Again, at-risk and passive activity loss limits are applied.  Your basis in the underlying partnership or s-corporation activity as well as your level of participation and type of ownership interest are considered in these calculations.

Part III covers your share of estate and trust activities reported to you on a K-1 in a similar fashion as in part II.  The main difference being that there are generally no at-risk limitations to worry about.

Part IV covers income or losses from Real Estate Mortgage Investment Conduits.  These are essentially mortgage-backed securities: a solid product which earned a bad reputation during the financial crisis from 2007-2010 when sub-prime mortgages were bundled and sold together.

Part V summarizes the income and losses from the first four parts of Schedule E and pulls in farm land rentals as well which are calculated on a separate Form 4835.

Getting back to your $40,000 two-week rental.  It turns out that the Arnold Palmer that spent an afternoon on your front lawn was simply a glass of watered-down iced tea and lemonade, and your renters backed out.  Better luck next time…

In two weeks we will discuss Schedule F – Profit or Loss from Farming.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

New Tax Impacts for Trusts with Capital Gains – Part III

Originally published in the Cedar Street Times

November 29, 2013

During the past two columns I laid the groundwork of some of the basics on revocable and irrevocable trusts, I discussed the new tax rates that affect many trusts, and I discussed the distinction between income and principal transaction and their relations to capital gains.

In a short summary of the past two articles, revocable trusts such as the common revocable living trust most people use for estate planning is disregarded for tax purposes as separate from the owner – in other words all of the income generated by its assets gets reported on your personal 1040 tax return.  Irrevocable trusts, such as a bypass trust commonly used in estate planning, or a gifting trust, are treated as separate tax paying entities, get their own taxpayer identification number, and file their own tax returns.  There are commonly two types of beneficiaries of irrevocable trusts: 1) current beneficiaries – who often receive the trust accounting income (and principal to an extent if needed) during their lifetime, and 2) remainder beneficiaries – who receive the principal upon the death of the current beneficiary.

The trust document has the power to define what type of revenues get classified to trust accounting income or principal, thus determining which beneficiary ultimately receives the money.  If the trust document does not define how a particular revenue is to be treated, as is often the case with capital gains, then the state’s principal and income act governs.  In California this means capital gains are considered a principal transaction and would not go to the current beneficiary. Federal tax rates on the highest income bracket earners have effectively risen by up to 8.8% on capital gains and 4.6% to 8.4% on other types of income. For irrevocable trusts, the highest bracket sets in at only $11,950 of income, so taxation to the trust is not generally desirable!

Picking up from that point in the last article, we can now discuss how that affects taxation.  If trust accounting income is supposed to go to the current beneficiary, then for tax purposes that income will be “pushed out” of the trust and reported on the tax returns of the current beneficiary instead of the trust.  To the extent that revenues are considered principal transactions, and are therefore slated for the remainder beneficiaries down the road, the trust pays the taxes instead.  Capital gains used to be taxed at the same rate whether the income was pushed out to the current beneficiary, or taxed in the trust.  Now, with the potential 8.8% additional tax on capital gains taxed to the trust, it matters a lot!

If there is a genuine concern that the remainder beneficiary should ultimately receive the money from gains due to appreciation, then the 8.8% additional tax would be worth it.  For many grantors that set up trusts, however, a big concern is minimizing the tax impact, and they would rather structure the trust to distribute the gains to the current beneficiary to save taxes.  This would be especially true when there is a close relation between the current beneficiary and the remainder beneficiary, such as a parent and a child, and even more so if there is a presumption that the parent will eventually give the money to the child anyway either during life or upon death.

If you are in the process of setting up a trust, I think this subject is an essential conversation that should be had between you, your attorney, and your tax professional.  The attorney can draft language to allow the trustee the power to allocate the gains on sales to trust accounting income.  It is worth mentioning that the underlying Treasury Regulation 1.643(a)-3 examples and Private Letter Ruling 200617004 place heavy emphasis on consistency by the trustee.  In other words, you cannot flip back and forth each year between allocating capital gains to income or principal; you pick a method and stick with it. I think there will be resistance from some attorneys out of habit, or rote concern for the remainder beneficiaries in considering something like this.  It is true, it may not always be the right choice, but I think given the changed landscape, it could be right for many people.

If you already have a trust, but have no explicit language in the trust document allowing for capital gains allocation to income, Treasury Regulation 1.643(a)-3 provides some leeway to do so anyway if done consistently.  But it is questionable whether you can begin treating capital gains as income if you have not been doing so in the past.  Perhaps a one-time change with a signed statement by the trustee of the intent from that point going forward would add credence.  Another approach would be to amend the trust document providing the power to allocate capital gains to income from that point forward.  If the grantor is still alive and consents to the change along with all of the beneficiaries, amending the “irrevocable trust” should not generally be a problem.  If the grantor is not living, but all the beneficiaries agree, you may be able to successfully petition the court.

Of course you do all this, and the tax rates could just change again.

Please keep in mind there are many other rules and exceptions surrounding the ideas discussed in this article which I have not space to mention.  Consulting with qualified professionals regarding your specific situation is always your best course of action.

Prior articles are republished on my website at

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.