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Honigman wins U.S. Tax Court case providing guidance on application of 3.8 percent Medicare tax to trusts

March 28, 2014

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Susan Sherbow
T: 313.465.7048
ssherbow@honigman.com

In a case of first impression, the U.S. Tax Court yesterday issued a decision bearing on when a trust can deduct losses, or will be subject to the new 3.8 percent Medicare tax on income, from business or rental activities.

Businesses in which the taxpayer does not materially participate, and any rental activities, are considered "passive." Net losses from such activities are generally not deductible and income from such activities is generally subject to a 3.8 percent Medicare tax beginning in 2013. There is an exception for income or loss from a rental activity in which a taxpayer qualifying as a so-called “real estate professional” materially participates.

In Frank Aragona Trust v. Commissioner, U.S. Tax Court Docket 015392-11, Honigman Miller Schwartz and Cohn LLP successfully argued against the IRS position that a trust can never qualify as a “real estate professional.” The ruling in this case allows trusts to be eligible under this special rule to treat rental activities as active (and deduct their losses and avoid the 3.8% tax on their income, from such activities).

“This decision may have broad tax-planning implications for trusts and should be considered by any having income or loss from business or rental activities including income or loss flowing through to them from partnerships or S corporations that conduct business or rental activities,” said Richard S. Soble, Honigman partner and tax attorney.

The case will also affect tax planning for trusts with nonrental income, which are potentially subject to the new 3.8 percent tax.

Honigman partners Richard E. Zuckerman, Richard S. Soble and Shawn A. Strand represented the Frank Aragona Trust in this case.