For tax years beginning in and after 2013, certain taxpayers are subject to an additional 3.8% tax on their net investment income pursuant to Internal Revenue Code §1411. On August 7, 2013, the IRS issued 2013 draft Form 8960, Net Investment Income Tax - Individuals, Estates, and Trusts, which is based solely on its proposed regulations under §1411 (which taxpayers may rely on for the 2013 tax year). Once the IRS finalizes the form, individuals, estates, and trusts will use it to compute their net investment income tax.

There are situations where specific items are not considered to be net investment income and, thus, not subject to the additional tax. As an example, charitable remainder trust beneficiaries are subject to the additional 3.8% tax only on net investment income realized by the CRT after December 31, 2012. These “grandfathered amounts” would otherwise be net investment income, but-for the fact that they were realized prior to 2013.This means that there may be items on a CRT beneficiary's Schedule K-1 that do not meet the definition of net investment income.

As highlighted in an August 8, 2013 article in Bloomberg BNA Daily Tax Report by Diane Freda, practitioners can breathe a sigh of relief, as the draft form, in conjunction with an early draft of 2013 Instructions for Schedule K-1(Form 1030) for a Beneficiary Filing Form 1040, does not require the tracing of the source of income for grandfathered amounts.

CRT beneficiaries may reduce their net investment income by the grandfathered amount on line 7 of Form 8960. For example, assume the amount of interest income reported to a beneficiary is $10,000, $1,000 of which is a grandfathered amount. Although the full $10,000 is included on line 1 of Form 8960, the grandfathered amount is entered on line 7, thereby reducing net investment income by $1,000.

Ms. Freda’s article also outlines other concerns practitioners have raised about CRTs and the net investment income tax.

In the cautionary note accompanying the draft Form 8960, the IRS provides a link to anyone who would like to comment on the draft.