The U.S. Tax Court issued a decision on March 27th that could significantly impact the extent to which the Net Investment Income Tax (NIIT) applies to trusts. Frank Aragona Trust v. Commissioner of Internal Revenue, 142 T.C. No. 9 (2014). The NIIT generally applies to income earned by a business held in trust unless the trust materially participates in the business. Material participation by the trust is determined by reference to the trustees’ activities regarding the business, and uncertainty has existed concerning the extent of the trustees’ activities that may be counted towards material participation. In particular, do the activities of trustees acting as employees of a business owned by the trust count towards material participation? In this case, the Tax Court held yes.
Specifically, the Tax Court held that a trust holding rental real estate properties qualified for the IRC § 469(c)(7) exception to the rule that rental activities are per se passive. In reaching this decision, the Tax Court held that the trust materially participated in the real estate rental activities. The Tax Court considered the activities of the trustees acting as trustees and the activities of the trustees acting in their capacities as employees of an LLC that was wholly owned by the trust. The Tax Court noted that relevant state law does not relieve trustees of their fiduciary duties when conducting activities through a corporation wholly owned by a trust. It is important to note that the Tax Court did not extend its holding to the activities of non-trustee employees of the trust.