July 13, 2020

Volume X, Number 195

July 13, 2020

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New IRS Guidance Takes Restrictive View of Material Participation by Non-Grantor Trusts

Recently published Technical Advice Memorandum 201317010 (the TAM) limits the circumstances in which a complex, non-grantor trust can materially participate in the activities of an S corporation. In the TAM, the IRS National Office concluded that a fiduciary’s participation in the activities of a trust count only toward material participation to the extent the fiduciary participated in those activities in a fiduciary capacity. Although the TAM evaluated material participation for purposes of the alternative minimum tax rules, its reasoning would also apply to the passive activity loss and credit rules and the new 3.8 percent net investment income tax.

The TAM considered whether trust shareholders materially participated in the business activities of an S corporation and its subsidiaries. The trusts were complex trusts that had a Trustee and a Special Trustee. The Special Trustee was a beneficiary of the trusts, was a shareholder of the S corporation, and was the president of one of the S corporation’s subsidiaries. The Special Trustee was permitted under the trust agreement to make all decisions regarding the sale or retention of the stock and all voting of the stock. The trusts argued that all of the Special Trustee’s time spent in the activities of the S corporation (as fiduciary, shareholder, and employee) should be considered. The IRS National Office concluded that only time spent by Special Trustee in his fiduciary capacity (for example, voting the trusts’ S corporation stock) counted toward the trusts’ material participation in the S corporation’s activities.

The TAM’s conclusion is at odds with the only judicial authority on this issue in Mattie K. Carter Trust v. U.S., 256 F.Supp.2d 536 (N.D. Tex. 2003). Although technical advice memorandums like the TAM are not precedential, given the lack of authoritative guidance on how trusts materially participate, any new pronouncement is significant because it shows that this issue is far from resolved. The TAM also highlights the increasing importance of the issue of material participation by trusts due to the 3.8 percent net investment income tax.

© 2020 BARNES & THORNBURG LLPNational Law Review, Volume III, Number 131


About this Author

Michala Irons, Tax Attorney, Barnes Thornburg, Law Firm

Michala P. Irons is an associate in Barnes & Thornburg LLP’s Indianapolis, Indiana office and a member of the firm’s Tax Department. Ms. Irons assists individuals, businesses, and nonprofit organizations with federal tax planning, including income tax, employment and self-employment tax, excise tax, and net investment income tax issues.  Ms. Irons also represents taxpayers in matters before the Internal Revenue Service, including collections, examinations, appeals, and requests for private guidance from the IRS National Office.

Randal Kaltenmark, Barnes Thornburg Law Firm, Indianapolis, Tax Law Attorney

Randal J. Kaltenmark is a partner in Barnes & Thornburg LLP's Indianapolis, Indiana office. He concentrates his practice in federal, state, and local tax controversies and audits, as well as tax planning for both public and private clients, including joint mergers, mergers, and acquisitions. Mr. Kaltenmark represents clients in audit and administrative proceedings before the Internal Revenue Service and state/local tax authorities. He also represents clients in appeals to both federal and state courts, including the United States and Indiana Tax Courts. Mr. Kaltenmark is experienced in structuring entity formations and reorganizations; in planning partnership, limited liability company, and S corporation transactions; and in drafting complex and limited liability company agreements.