Because trusts are subject to the 3.8% Net Investment Income Tax at a very low income level, $12,150 for 2014, trustees of trusts owning interests in operating entities have been considering ways to meet the material participation requirements to avoid this tax. As discussed in a prior post, differing points of view have arisen regarding determining whether trusts can actively participate in entities in which they own interests. The conflicting positions of the Internal Revenue Service (Technical Advice Memorandum 201317010) and case law (Mattie K. Carter Trust v. U.S.) have caused uncertainty as to whether active participation can be satisfied by the trustee, the officers, employees, agents or beneficiaries of a trust. This week’s long awaited United States Tax Court decision in Frank Aragona Trust et al. v. Commissioner; 142 T.C. No. 9 was a big win for many trusts.
In the Frank Aragona Trust case, the Tax Court disagreed with the Service’s arguments that a trust was incapable of providing “personal services” to meet the material participation test under IRC § 469 (c)(7). The Service argued that “personal services” are defined to mean “any work performed by an individual in connection with a trade or business” and, because the trust was not an individual, it could not perform those personal services. The Tax Court held that services performed by individual trustees on behalf of the trust may be considered personal services performed by the trust. The Tax Court then further disagreed with the Service’s attempt to exclude from actions counting toward material participation the actions of the trustees who were also employees. Noting that the trust had no business activities other than real estate and that a majority of the trustees participated in these activities, the Tax Court concluded that the activities of the employee-trustees should be considered in determining whether the trust materially participated in its real estate operations.
This decision only covers situations in which the trustee is materially participating in the trust activity. Although the Tax Court did not go as far as the Mattie K. Carter Trust case in which the Texas U.S. District Court solely relied upon participation of trust employees in determining whether the trust materially participated in an activity, it did open the door to participation closed by TAM 201317010. This decision provides clarity for practitioners and is a big win for many trust clients.