As a fourth installment in an occasional series, here are additional tax elections for estates, partnerships, and individuals.
Election to treat a revocable trust as part of an estate. Sec. 645 allows for an election to treat a qualified revocable trust (QRT) as part of a decedent’s estate for federal income tax purposes. A QRT is a grantor trust under Sec. 676 (with revocation power retained by the grantor) as of the decedent’s date of death. Accordingly, a testamentary trust cannot be a QRT.
The advantages of making the election include: the estate and electing trust file a single Form 1041, U.S. Income Tax Return for Estates and Trusts; the electing trust can adopt a fiscal year; the electing trust is not subject to the active-participation requirement under the passive loss rules for two years; the electing trust can hold S corporation stock without terminating the corporation’s S election; and the electing trust will be allowed a charitable deduction under Sec. 642(c) for amounts permanently set aside for charitable purposes. The election is made by the trustee and executor on Form 8855, Election to Treat a Qualified Revocable Trust as Part of an Estate, by the due date, including extensions, of the estate’s (or in a case where there is no executor of the estate, the filing trust’s) initial income tax return. If there is more than one executor of the estate or more than one trustee for an electing QRT, only one executor or trustee must sign Form 8855, unless otherwise required by applicable local law or the governing document. As it is possible to have more than one QRT, the trustee, or, where required, trustees, of each QRT joining in the election must sign Form 8855. The election is irrevocable.
Election out of partnership treatment by a spousal joint venture. If spouses co-own a business and the business is not incorporated, a partnership may exist, and a partnership return may need to be filed. However, if the business qualifies, the spouses can make a qualified joint venture (QJV) election under Sec. 761(f) as an alternative to being taxed as a partnership. A QJV is a trade or business in which only the husband and wife are partners, each spouse materially participates individually under the passive loss rules, and both spouses elect QJV status. This election avoids partnership taxation with its complexities and enhanced failure-to-file penalties. Tax return preparation may be simpler, and both spouses can earn Social Security and Medicare credits.
Using QJV status, all items of income, gain, loss, deduction, and credit are divided between the spouses based on their respective interests in the venture, and each spouse takes his or her share of these items into account as if they were attributable to a trade or business conducted by the spouse as a sole proprietor. Therefore, each spouse generally reports his or her share of the items on a separate Schedule C, Profit or Loss From Business, or Schedule F, Profit or Loss From Farming. Each spouse must also file a separate Schedule SE, Self-Employment Tax, if applicable. In the case of a rental real estate business, the spouses file Schedule E, Supplemental Income and Loss. They do not file separate Schedules E; instead, each spouse’s separate interest is entered as a separate property on a single Schedule E.
For QJVs reported on Schedule C, the QJV election is made by filing a joint return and reporting all items of the business’s income, gain, loss, deductions, and credits as described above. For QJVs reported on Schedule E, the election is made by checking the “QJV” box on line 2 of Schedule E for each property that is part of a QJV and reporting the items for that property interest separately on the form. The election cannot be revoked without IRS consent.
Election out of alimony treatment. Under Sec. 71(b)(1)(B), alimony does not include payments that would otherwise be treated as alimony (deductible to the payor, includible in income to the payee) if the spouses designate in a divorce or separation instrument that the payments not be treated as alimony. Electing to not treat payments as alimony would be beneficial in instances where the payor spouse’s income is primarily from nontaxable sources or where the payor spouse’s income is sheltered by other deductions and exemptions.
The election is made by attaching a copy of the instrument containing the designation of payments as nonalimony to the payee spouse’s original return for each year the election applies (see Temp. Regs. Sec. 1.71-1T(a), Q&A-8).
Election to maximize the investment interest deduction. The deduction for individuals for investment interest expense is limited to net investment income, which is the excess of investment income over investment expenses. In the calculation, net investment income does not include qualified dividends or net capital gains unless the taxpayer elects to have these items included as part of investment income.
Individuals can make an election to include qualified dividends and net capital gains in the calculation of net investment income for purposes of maximizing the investment interest deduction. If the election is made, the taxpayer waives the right to the lower tax rate on long-term capital gains on the amount elected to be included in net investment income, and it is taxed as ordinary income. The election to include net capital gains is limited to the lesser of net capital gains from investment property or net gains from investment property.
Making this election requires some analysis, as the individual may have sufficient net investment income without the qualified dividends and net capital gains. Also, any unused investment interest expense carries over to future years. Therefore, deciding whether to make the election requires a look at future years’ marginal tax rates, expected net investment income, and the taxpayer’s discount rate or factor for the time value of money. To make the election, enter on line 4g of Form 4952, Investment Interest Expense Deduction, the amount of qualified dividends and net capital gain to include in investment income. The election is made on the tax return for the year that the election is effective.
Request extension of time for making an election. A taxpayer who misses a filing deadline for a regulatory election may request a letter ruling from the IRS granting an extension of time to make the election under Regs. Sec. 301.9100-3. The IRS will grant relief only for failure to timely file a regulatory election, not a statutory election, under this provision. Relief will be granted if the taxpayer provides evidence that establishes to the satisfaction of the IRS that the taxpayer acted reasonably and in good faith, and the grant of relief will not prejudice the interests of the government.
The request for the letter ruling must: state whether the taxpayer’s return(s) for the tax year in which the election should have been made or any tax years that would have been affected by the election is being examined by the IRS or is being considered by an IRS Appeals office or a federal court; state when the election was required to be filed and when it was actually filed; include copies of documents that refer to the election; when requested, include a copy of the tax returns for the years the taxpayer is requesting an extension and any return affected by the election; and, when applicable, include a copy of returns of other taxpayers affected by the election.
In addition, the letter ruling request should contain an affidavit by the taxpayer as to the discovery of the election’s not being filed and why it was not filed timely and affidavits from the taxpayer’s tax preparer and any accountant or attorney who provided advice regarding the election. The taxpayer must pay the appropriate user fee for the ruling request.
The letter ruling request should be made as soon as taxpayers realize they failed to file the election. It is filed with the appropriate Associate Chief Counsel’s Office of the IRS in Washington.
By C. Andrew Lafond, CPA, DBA, (firstname.lastname@example.org) assistant professor, La Salle University, Philadelphia, and Jeffrey J. Schrader, CPA, MST, (email@example.com) shareholder in Jeffrey J. Schrader, CPA, PC, Trenton, N.J.
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