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IRS Takes Restrictive Position on Ability of Trust to “Materially Participate” in Pass-Through Entities

Beginning this year, individuals, estates and trusts will be subject to a Medicare contribution tax equal to 3.8% of the trust’s undistributed net investment income for the tax year, complicating the administration of estates and trusts. (IRC § 1411) As a result of the enactment of the new tax, every trust that owns an interest in a trade or business must now determine whether or not the trust materially participates in that trade or business in order to determine whether the trust’s undistributed income may be subject to the tax.

Net investment income is income from passive activities. Whether an activity constitutes a passive activity is determined in accordance with IRC § 469, which sets forth the law with regard to passive activity losses and credits. A “passive activity” is a trade or business activity in which the taxpayer does not materially participate. A taxpayer is treated as

IRS Rules No Fault Does Not Mean No Penalty in IRA Rollover Snafu

At first blush, Chief Counsel Advice Memorandum CCA 201313025, may seem overly harsh. After all, the taxpayer was relying on information provided to her from her employer when she took her lump sum distribution and rolled it over into an IRA. However, the government was simply following the statute and regulations in refusing to refund the excess contribution penalty.

Here, the taxpayer’s former employer was overly generous to the taxpayer and, in making the lump sum distribution to her, distributed more to her than was in her qualified plan, and reported to her on a 1099R that the entire amount of the distribution was an eligible rollover distribution. Believing that she was entitled to the entire distribution and that it was entirely an eligible rollover distribution, the taxpayer rolled over this entire distribution including the over-payment to her rollover IRA and reported the lump sum distribution and rollover as

That Underwater Policy Does Not Have Any Value, Right?!

SCUBATaxpayers/insureds are often surprised when they are taxed on the value of an old policy that was underwater, when it was transferred to them, causing them to assume that the policy had no value for the government to tax. Here again, the taxpayers in Schwab v. Commissioner (9th Cir. 2013), were surprised that they had recognized taxable income on the distribution to them of life insurance policies from their non-qualified plan, which had surrender charges that exceed their cash value.

Michael and Kathryn, a married couple, were employees of Angels and Cowboys, Inc., which sponsored a non-qualified multi-employer welfare benefit plan that was administered by a third party. Each of them caused the plan to purchase, with a single premium, a variable universal life insurance policy with a three-year no lapse guarantee.

IRS Rules that Conversion to Unitrust in Accordance with State Law Will Not Trigger Loss of Grandfathered Protection

A recent Private Letter Ruling (PLR 201320009) issued by the Internal Revenue Service (IRS) blessed a conversion of a grandfathered Trust to a unitrust determination of income, as not causing any loss of the Trust’s generation-skipping transfer (GST) tax grandfathered protection, and not resulting in a gift or in the recognition of any gain. Here, the trust in question had been held for the benefit of the Settlor’s son, but the son had since died and the trust was now held for the benefit of three grandchildren. No additions had been made after September 25, 1985. However, the trust determined the income to be distributed to the grandchildren under the traditional method, with interest and dividends constituting trust income.

Long after the trust became irrevocable as a result of the death of the Settlor, the state in which the trust was being administered enacted legislation authorizing the conversion to a

First-Time Father at 94? Illinois Court Calls Foul

It is no secret that when it comes to inheriting money, people have been known to dream up some creative schemes to get rich. Recently, however, an Illinois Appellate Court nixed the idea that marrying a man and persuading him to adopt—at the age of 94—your 50-plus year-old children could be a successful means to that end.

In November, the court in Dixon v. Weitekamp-Diller held that to allow the four adult adoptees, at least one of whom was a grandmother, to inherit under several trusts created to benefit descendants of the settlor would be to give judicial approval to an act of “subterfuge.” Where an adult adoption is undertaken solely to make the adoptee an heir or a beneficiary of a trust, the court ruled, the adoptee will not be permitted to inherit.

At issue in the case were three trusts created by ancestors of William Hughes Diller,

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