Friday, June 3, 2011

New York Bar Raises Questions on New Medicare Tax

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The Health Care and Education Reconciliation Act of 2010 (P.L. 111-152) enacted IRC §1411, which imposes a 3.8% Medicare tax on the net investment income of trusts and estates. Effective for tax years beginning after 2012, the amount subject to tax is the lesser of: (1) the "undistributed net investment income" for the taxable year, or (2) the excess of the trust's AGI over the dollar amount at which the highest income tax rate kicks in ($11,200 in 2010).

The Tax Section of the New York State Bar has submitted comments, dated September 29, 2010, to the tax writing committees of Congress, the IRS, and Treasury, describing a number of gaps in the statute as it relates to trusts and estates. Although the purpose of the comments is to facilitate the issuance of technical corrections and/or regulatory guidance, they point out a number of weaknesses in the statute that may present planning opportunities for avoidance of the new tax. For that reason, the comments are worth reading. Some of the ambiguities in §1411 discussed in the comments apply to all taxpayers subject to the tax, while others are limited to trusts and estates.

Among the issues raised in the comments, the following are of interest:

• it is not clear whether the tax applies to an income inclusion from a controlled foreign corporation (CFC) or passive foreign investment company (PFIC)

• under the statute, "net investment income" does not seem to include substitute interest and dividends or income from notional principal contracts

• the status of certain types of gains, including mark-to-market income under §1296, gains and losses under §1234, and gains that are treated as ordinary income, as "net investment income" is unclear

• there is a lack of clarity as to whether net capital gains distributed by a trust to a beneficiary, but taxable to the trust, would be subject to the tax

• whether a foreign trust or estate would qualify for the §1411(e)(1) exemption for nonresident aliens

• if a foreign trust is subject to the tax, how the tax would be applied to the throwback rules, including throwbacks of income earned before the effective date of the tax.

Full text of the comments may be found in the October 1, 2010, on-line edition of BNA's Daily Tax Report.

Harold W. Pskowski, Managing Editor, Estates, Gifts and Trusts

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