Trustee as passive activity - 469(e)(3)?

Technical topics regarding tax preparation.
#1
Nilodop  
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Mostly-retired lawyer is compensated as the trustee or co-trustee for about 10 trusts, including one revocable grantor trust. On most of the trusts, there is a corporate co-trustee that manages the money, keeps the records, etc. His role is involvement in other than normal distributions—to buy a house, pay alimony, lend to a business, pay for education, etc; discussions with the beneficiaries, signing Crummey letters prepared by insurance agent, and as a go-between for the grantor (such as explaining what the lawyers are saying). In a normal year he spends no more than 40-60 hours doing this. Last year was different, in that when it seemed they might lower the estate exclusion to $3.5 million, there were new trusts created and gifts made to use the $11 million exclusion. He put in about 80 hours.

Question: Can this qualify as passive activity income so he can use it to offset passive real estate losses?

My answer is no because of Sec 469(e)
(3) Compensation for personal services
Earned income (within the meaning of section 911(d)(2)(A)) shall not be taken into account in computing the income or loss from a passive activity for any taxable year.


His answer is yes because his participation is not regular, continuous, and substantial (the (h)(1) definition).

There's some discussion in the preamble to 1.469-1T and some wording in 1.469-2T that I think supports my answer, though not on the exact facts I have. TAM 9621002 is closer to my facts and I also think supports my answer.

But he's stubborn, so what can you guys tell me on this?
 

#2
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What part of the income is not earned income?
(He knows better.)
Steve
 

#3
JAD  
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I agree w Steve. If it is earned income, it is not passive, and your cite clearly states that.

Is the atty trying to say that because he does not meet that specific definition of material participation that the income is not earned income? I think an auditor would laugh out loud at that argument and that there is no reasonable basis, much less substantial authority, to take that position.
 

#4
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Yes that's what he's trying to say.

Thanks to both for confirming my conclusion.
 

#5
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OK, we solved that simple issue. But it got me reading and thinking and I saw this relevant example in the reg.:

[quote]Example.
C owns 50 percent of the stock of X, an S corporation. X owns rental real estate, which it manages. X pays C a salary for services performed by C on behalf of X in connection with the management of X's rental properties. Under this paragraph (c)(4), although C's pro rata share of X's gross rental income is passive activity gross income (even if the salary paid to C is less than the fair market value of C's services), the salary paid to C does not constitute passive activity gross income.[/quote]

I wanted to understand it, so I tried these numbers in that example (and assume it's a passive activity and disregard the 25k exception):
S corp. rental income 950k
S corp salary to C 50k
S corp expenses 1,000k
S corp loss ((100k)
C's tax return shows salary 50k and K-1 loss (50k)

What is the effect of the (e)(3) rule on C? and on the other s/h?

And where does the term "passive activity gross income" (in the example ) come from, and what is its significance?

And why do they emphasize that the rule applies "even if the salary paid to C is less than the fair market value of C's services"?
 

#6
Nilodop  
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Just realized no one commented on above questions. Here's the reason I'm asking. Again, 469(e)(3) says
(3) Compensation for personal services
Earned income (within the meaning of section 911(d)(2)(A)) shall not be taken into account in computing the income or loss from a passive activity for any taxable year.
.

The use of the word "computing" along with "shall not be taken into account" is what puzzled me. Sure, it's clear as to the OP question - his trustee fee income isn't passive activity income. But what about my hypothetical facts in my example above? Do the S corp. shareholders somehow remove the salary to C from their calculation of their share of the corp.'s passive activity income?
 

#7
JAD  
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What is the effect of the (e)(3) rule on C? and on the other s/h?

My understanding is that the $50k salary is not passive to C and the K-1 loss allocations are passive to both shareholders.

And where does the term "passive activity gross income" (in the example ) come from, and what is its significance?

As I was reading your post #5, I was wondering the same thing. It seems like that sentence should say, Under this paragraph (c)(4), although C's pro rata share of X's net rental loss is passive activity loss….
(Income could be recharacterized to nonpassive under other rules)

And why do they emphasize that the rule applies "even if the salary paid to C is less than the fair market value of C's services"?

No idea.

Do the S corp. shareholders somehow remove the salary to C from their calculation of their share of the corp.'s passive activity income?

An interesting idea that I’ve never heard put forth before.

I’m afraid my post doesn’t move the discussion forward much, but I didn’t want to leave you without a response.
 

#8
Nilodop  
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Thanks, Jessica. Not getting much interest in this.
 

#9
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I am interested and will take a closer look later. We were on vacation and I came back to a fair amount of chaos in the office.
 

#10
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Do the S corp. shareholders somehow remove the salary to C from their calculation of their share of the corp.'s passive activity income?


As to the S-corp, the salary paid to C is not earned income. It’s an S-corp deduction.

And where does the term "passive activity gross income" (in the example ) come from, and what is its significance? And why do they emphasize that the rule applies "even if the salary paid to C is less than the fair market value of C's services"?


I think what they are getting at here is that we cannot view C’s compensation as a “distributive share” of the (passive) rental income, thereby rendering it passive.

Pretend S-corp gross rents are $10k and $4k of W2 salary is paid to C. C’s 1040 will reflect $6k of net rental income (K1) and $4k of W2 wages. C cannot say, for passive purposes, that he got $10k of gross rental income.

Compare and contrast to RR 64-220, which deals with SE tax.
 

#11
Nilodop  
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As to the S-corp, the salary paid to C is not earned income. It’s an S-corp deduction.. But (e)(3) doesn't say
whose earned income is not to be considered.

Compare and contrast to RR 64-220, which deals with SE tax.. I'mmtrying to do that, while noting that the ruling involves a distributive share of partnership income, and my example involves W-2 wages.
 

#12
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But (e)(3) doesn't say whose earned income is not to be considered.

Are you suggesting that the S-corp has earned income for the payment of wages?

I'm trying to do that, while noting that the ruling involves a distributive share of partnership income, and my example involves W-2 wages.


Then take your S-corp and pretend it’s a partnership and pretend that the wage payment is a non-W2 payment for services rendered. What you’ll find is that the payment for services rendered, on the income side, whether it flows from an S or a partnership is not passive income. Thus, symmetry for passive purposes, but not necessarily for SE tax purposes.
 

#13
Nilodop  
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Are you suggesting that the S-corp has earned income for the payment of wages?. Not at all. I'm saying that the salary paid by the S corp.,which is earned income and not passive activity income to the recipient, is nonetheless being "... taken into account in computing the income or loss from a passive activity ... ". After all, it's a deduction by the S corp. which affects the K-1s of the shareholders when they "compute" their passive activity loss.

As to 64-220, I understand.
 

#14
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Not at all. I'm saying that the salary paid by the S corp.,which is earned income and not passive activity income to the recipient, is nonetheless being "... taken into account in computing the income or loss from a passive activity ... ".

But not as earned income. It’s taken into account as a passive activity deduction, which is the counterparty’s side of the earned income.

After all, it's a deduction by the S corp. which affects the K-1s of the shareholders when they "compute" their passive activity loss.


Exactly…as a passive activity deduction, not as earned income.

(e)(3) is directed at income, and specifically, earned income. It is not directed at a deduction.

(e)(3) does not say that the payments (or deduction accruals) of earned income (i.e., compensation) shall not be taken into account in computing. It says that the earned income itself shall not be taken into account in computing
 

#15
Nilodop  
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I have no doubt that IRS would be supported by courts if my position was at issue. I'm just pointing out what I believe one interpretation is, just based on the language of (e)(3). You know, like when sometimes we see a decision that says there's no reason to look at Congressional intent, we'll just go by the language of the statute.

As I said, I know I'd lose. But it would be fun to argue it.
 

#16
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I'm just pointing out what I believe one interpretation is, just based on the language of (e)(3).

I don’t see how one could interpret “earned income” to mean a “deduction.”
 


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