Title 26—Internal Revenue--Volume 1
PART 1—INCOME TAXES
§ 1.1411-4   Definition of net investment income.
(a) In general. For purposes of section 1411 and the regulations thereunder, net investment income means the excess (if any) of—
(1) The sum of—
(i) Gross income from interest, dividends, annuities, royalties, and rents, except to the extent excluded by the ordinary course of a trade or business exception described in paragraph (b) of this section;
(ii) Other gross income derived from a trade or business described in § 1.1411-5; and
(iii) Net gain (to the extent taken into account in computing taxable income) attributable to the disposition of property, except to the extent excluded by the exception described in paragraph (d)(4)(i)(A) of this section for gain or loss attributable to property held in a trade or business not described in § 1.1411-5; over
(2) The deductions allowed by subtitle A that are properly allocable to such gross income or net gain (as determined in paragraph (f) of this section).
(b) Ordinary course of a trade or business exception. Gross income described in paragraph (a)(1)(i) of this section is excluded from net investment income if it is derived in the ordinary course of a trade or business not described in § 1.1411-5. See § 1.1411-6 for rules regarding working capital. To determine whether gross income described in paragraph (a)(1)(i) of this section is derived in a trade or business, the following rules apply.
(1) In the case of an individual, estate, or trust that owns or engages in a trade or business directly (or indirectly through ownership of an interest in an entity that is disregarded as an entity separate from its owner under § 301.7701-3), the determination of whether gross income described in paragraph (a)(1)(i) of this section is derived in a trade or business is made at the individual, estate, or trust level.
(2) In the case of an individual, estate, or trust that owns an interest in a passthrough entity (for example, a partnership or S corporation), and that entity is engaged in a trade or business, the determination of whether gross income described in paragraph (a)(1)(i) of this section is—
(i) Derived in a trade or business described in § 1.1411-5(a)(1) is made at the owner level; and
(ii) Derived in a trade or business described in § 1.1411-5(a)(2) is made at the entity level.
(3) The following examples illustrate the provisions of this paragraph (b). For purposes of these examples, assume that the taxpayer is a United States citizen, uses a calendar taxable year, and Year 1 and all subsequent years are taxable years in which section 1411 is in effect:
(c) Other gross income from a trade or business described in § 1.1411-5. For a trade or business described in § 1.1411-5, paragraph (a)(1)(ii) of this section includes all other gross income (within the meaning of section 61) that is not gross income described in paragraph (a)(1)(i) of this section or net gain described in paragraph (a)(1)(iii) of this section.
(d) Net gain. This paragraph (d) describes special rules for purposes of paragraph (a)(1)(iii) of this section.
(1) Definition of disposition. For purposes of section 1411 and the regulations thereunder, the term disposition means a sale, exchange, transfer, conversion, cash settlement, cancellation, termination, lapse, expiration, or other disposition (including a deemed disposition, for example, under section 877A).
(2) Limitation. The calculation of net gain may not be less than zero. Losses allowable under section 1211(b) are permitted to offset gain from the disposition of assets other than capital assets that are subject to section 1411.
(3) Net gain attributable to the disposition of property —(i) General rule. Net gain attributable to the disposition of property is the gain described in section 61(a)(3) recognized from the disposition of property reduced, but not below zero, by losses deductible under section 165, including losses attributable to casualty, theft, and abandonment or other worthlessness. The rules in subchapter O of chapter 1 and the regulations thereunder apply. See, for example, § 1.61-6(b). For purposes of this paragraph, net gain includes, but is not limited to, gain or loss attributable to the disposition of property from the investment of working capital (as defined in § 1.1411-6); gain or loss attributable to the disposition of a life insurance contract; and gain attributable to the disposition of an annuity contract to the extent the sales price of the annuity exceeds the annuity's surrender value.
(ii) Examples. The following examples illustrate the provisions of this paragraph (d)(3). For purposes of these examples, assume that the taxpayer is a United States citizen, uses a calendar taxable year, and Year 1 and all subsequent years are taxable years in which section 1411 is in effect:
(ii) In Year 2, A has a capital gain of $30,000 on the sale of Y stock. Y is a C corporation. A has no other capital gain or capital loss in Year 2. For income tax purposes, A may reduce the $30,000 gain by the Year 1 section 1212(b) $27,000 capital loss carryover. For purposes of determining A's Year 2 net gain under paragraph (a)(1)(iii) of this section, A's $30,000 gain may also be reduced by the $27,000 capital loss carryover from Year 1. Therefore, in Year 2, A has $3,000 of net gain for purposes of paragraph (a)(1)(iii) of this section.
(ii) For income tax purposes, under section 121(a), A excludes the $200,000 gain realized from the sale of A's principal residence from A's Year 1 gross income. In determining A's Year 1 adjusted gross income, A also reduces the $7,000 capital gain by the $5,000 capital loss carryover allowed under section 1211(b).
(iii) For section 1411 purposes, under section 121(a), A excludes the $200,000 gain realized from the sale of A's principal residence from A's Year 1 gross income and, consequently, from A's net investment income. In determining A's Year 1 net gain under paragraph (a)(1)(iii) of this section, A reduces the $7,000 capital gain by the $5,000 capital loss carryover allowed under section 1211(b).
(ii) In Year 3, A enters into an exchange in which A transfers Greenacre, now valued at $20,000, and $5,000 cash for Blackacre, another piece of undeveloped land, which has a fair market value of $25,000. The exchange is a transaction for which no gain or loss is recognized under section 1031.
(iii) In Year 3, for income tax purposes, A does not recognize any gain from the exchange of Greenacre for Blackacre. A's basis in Blackacre is $15,000 ($10,000 substituted basis in Greenacre plus $5,000 additional cost of acquisition). For purposes of section 1411, A's net investment income for Year 3 does not include any realized gain from the exchange of Greenacre for Blackacre.
(iv) In Year 5, A sells Blackacre to an unrelated party for $35,000 in cash.
(v) In Year 5, for income tax purposes, A recognizes capital gain of $20,000 ($35,000 sale price minus $15,000 basis). For purposes of section 1411, A's net investment income includes the $20,000 gain recognized from the sale of Blackacre.
(4) Gains and losses excluded from net investment income —(i) Exception for gain or loss attributable to property held in a trade or business not described in § 1.1411-5 —(A) General rule. Net gain does not include gain or loss attributable to property (other than property from the investment of working capital (as described in § 1.1411-6)) held in a trade or business not described in § 1.1411-5.
(B) Special rules for determining whether property is held in a trade or business. To determine whether net gain described in paragraph (a)(1)(iii) of this section is from property held in a trade or business—
( 1 ) A partnership interest or S corporation stock generally is not property held in a trade or business. Therefore, gain from the sale of a partnership interest or S corporation stock is generally gain described in paragraph (a)(1)(iii) of this section. However, net gain does not include certain gain or loss attributable to the disposition of certain interests in partnerships and S corporations as provided in § 1.1411-7.
( 2 ) In the case of an individual, estate, or trust that owns or engages in a trade or business directly (or indirectly through ownership of an interest in an entity that is disregarded as an entity separate from its owner under § 301.7701-3), the determination of whether net gain described in paragraph (a)(1)(iii) of this section is attributable to property held in a trade or business is made at the individual, estate, or trust level.
( 3 ) In the case of an individual, estate, or trust that owns an interest in a passthrough entity (for example, a partnership or S corporation), and that entity is engaged in a trade or business, the determination of whether net gain described in paragraph (a)(1)(iii) of this section from such entity is attributable to—
( i ) Property held in a trade or business described in § 1.1411-5(a)(1) is made at the owner level; and
( ii ) Property held in a trade or business described in § 1.1411-5(a)(2) is made at the entity level.
(C) Examples. The following examples illustrate the provisions of this paragraph (d)(4)(i). For purposes of these examples, assume the taxpayer is a United States citizen, uses a calendar taxable year, and Year 1 and all subsequent years are taxable years in which section 1411 is in effect:
(ii)(A) In Year 0, a year preceding the effective date of section 1411, PRS relocates its dealership to a larger location. As a result of the relocation, PRS sells its old dealership facility to a real estate developer in exchange for $1,000,000 cash and a $4,500,000 promissory note, fully amortizing over the subsequent 15 years, and bearing adequate stated interest. PRS reports the sale transaction under section 453. PRS's adjusted tax basis in the old dealership facility is $1,075,000. Assume for purposes of this example that PRS has $300,000 of recapture income (within the meaning of section 453(i)); the buyer is not related to PRS, B, C, or D; and the buyer is not assuming any liabilities of PRS in the transaction.
(B) For chapter 1 purposes, PRS has realized gain on the transaction of $4,425,000 ($5,500,000 less $1,075,000). Pursuant to section 453(i), PRS will take into account $300,000 of the recapture income in Year 0, and the gain in excess of the recapture income ($4,125,000) will be taken into account under the installment method. For purposes of section 453, PRS's profit percentage is 75% ($4,125,000 gain divided by $5,500,000 gross selling price). In Year 0, PRS will take into account $750,000 of capital gain attributable to the $1,000,000 cash payment. In the subsequent 15 years, PRS will receive annual payments of $300,000 (plus interest). Each payment will result in PRS recognizing $225,000 of capital gain (75% of $300,000).
(iii)(A) In Year 1, PRS receives a payment of $300,000 plus the applicable amount of interest. For purposes of chapter 1, PRS recognizes $225,000 of capital gain. B and C's distributive share of the gain is $90,000 each and D's distributive share of the gain is $45,000.
(B) The old dealership facility constituted property held in PRS's trade or business. In the case of section 453 installment sales, section 453 governs the timing of the gain recognition, but does not alter the character of the gain. See § 1.1411-1(a). The determination of whether the gain is attributable to the disposition of property used in a trade or business described in paragraph (d)(4)(i) of this section constitutes an element of the gain's character for Federal tax purposes. As a result, the applicability of paragraph (d)(4)(i) of this section is determined in Year 0 and applies to all gain received on the promissory note during the 15 year payment period. This result is consistent with the section 469 determination of the passive or nonpassive classification of the gain under § 1.469-2T(c)(2)(i)(A).
(C) In the case of D, PRS's trade or business is described in section 1411(c)(2)(A) and § 1.1411-5(a)(1). Therefore, the exclusion in paragraph (d)(4)(i) of this section does not apply, and D must include the $45,000 of gain in D's net investment income.
(D) In the case of B and C, PRS's trade or business is not described in section 1411(c)(2) or § 1.1411-5. Therefore, B and C exclude the $90,000 gain from net investment income pursuant to paragraph (d)(4)(i) of this section.
(iv) In Year 2, C dies and C's 40% interest in PRS passes to Estate.
(v)(A) In Year 3, PRS receives a payment of $300,000 plus the applicable amount of interest. For purposes of chapter 1, PRS recognizes $225,000 of capital gain. B and Estate each have a distributive share of the gain equal to $90,000 and D's distributive share of the gain is $45,000.
(B) The calculation of net investment income for B and D in Year 3 is the same as in (iii) for Year 1.
(C) In the case of Estate, the distributive share of the $90,000 gain constitutes income in respect of a decedent (IRD) under section 691(a)(4) and subchapter K. See § 1.1411-1(a). Assume that Estate paid estate taxes of $5,000 that were attributable to the $90,000 of IRD. Pursuant to section 691(c)(4), the amount of gain taken into account in computing Estate's taxable income in Year 3 is $85,000 ($90,000 reduced by the $5,000 of allocable estate taxes). Pursuant to section 691(a)(3) and § 1.691(a)-3(a), the character of the gain to the Estate is the same character as the gain would have been if C had survived to receive it. Although the amount of taxable gain for chapter 1 has been reduced, the remaining $85,000 retains its character attributable to the disposition of property used in a trade or business described in paragraph (d)(4)(i) of this section. Therefore, Estate may exclude the $85,000 gain from net investment income pursuant to paragraph (d)(4)(i) of this section.
(ii) Other gains and losses excluded from net investment income. Net gain, as determined under paragraph (d) of this section, does not include gains and losses excluded from net investment income by any other provision in §§ 1.1411-1 through 1.1411-10. For example, see § 1.1411-7 (certain gain or loss attributable to the disposition of certain interests in partnerships and S corporations) and § 1.1411-8(b)(4)(ii) (net unrealized appreciation attributable to employer securities realized on a disposition of those employer securities).
(iii) Adjustment for capital loss carryforwards for previously excluded income. [Reserved]
(e) Net investment income attributable to certain entities —(1) Distributions from estates and trusts —(i) In general. Net investment income includes a beneficiary's share of distributable net income, as described in sections 652(a) and 662(a), to the extent that, under sections 652(b) and 662(b), the character of such income constitutes gross income from items described in paragraphs (a)(1)(i) and (ii) of this section or net gain attributable to items described in paragraph (a)(1)(iii) of this section, with further computations consistent with the principles of this section, as provided in § 1.1411-3(e).
(ii) Distributions of accumulated net investment income from foreign nongrantor trusts to United States beneficiaries. [Reserved]
(2) CFCs and PFICs. For purposes of calculating net investment income, additional rules in § 1.1411-10(c) apply to an individual, an estate, or a trust that is a United States shareholder that owns an interest in a controlled foreign corporation (CFC) or that is a United States person that directly or indirectly owns an interest in a passive foreign investment company (PFIC).
(3) Treatment of income from common trust funds. [Reserved]
(f) Properly allocable deductions —(1) General rule —(i) In general. Unless provided elsewhere in §§ 1.1411-1 through 1.1411-10, only properly allocable deductions described in this paragraph (f) may be taken into account in determining net investment income.
(ii) Limitations. Any deductions described in this paragraph (f) in excess of gross income and net gain described in section 1411(c)(1)(A) are not taken into account in determining net investment income in any other taxable year, except as allowed under chapter 1.
(2) Properly allocable deductions described in section 62 —(i) Deductions allocable to gross income from rents and royalties. Deductions described in section 62(a)(4) allocable to rents and royalties described in paragraph (a)(1)(i) of this section are taken into account in determining net investment income.
(ii) Deductions allocable to gross income from trades or businesses described in § 1.1411-5. Deductions described in section 62(a)(1) allocable to income from a trade or business described in § 1.1411-5 are taken into account in determining net investment income to the extent the deductions have not been taken into account in determining self-employment income within the meaning of § 1.1411-9.
(iii) Penalty on early withdrawal of savings. Deductions described in section 62(a)(9) are taken into account in determining net investment income.
(iv) Net operating loss. The total section 1411 NOL amount of a net operating loss deduction allowed under section 172 is allowed as a properly allocable deduction in determining net investment income for any taxable year. See paragraph (h) of this section for the calculation of the total section 1411 NOL amount of a net operating loss deduction.
(v) Examples. The following examples illustrate the provisions of this paragraph (f)(2). For purposes of these examples, assume the taxpayer is a United States citizen, uses a calendar taxable year, and Year 1 and all subsequent years are taxable years in which section 1411 is in effect:
(ii) For purposes of calculating A's net investment income, A's $29,000 distributive share of SCo's gross operating income is income within the meaning of section 1411(c)(1)(A)(ii).
(iii) As a result of A's at risk limitation, for chapter 1 purposes, A may only deduct $7,000 of the operating deductions in excess of the gross operating income. The remaining $4,000 deductions are suspended because A's amount at risk at the end of Year 1 is zero.
(iv) For purposes of section 469, A has passive activity gross income of $29,000 and passive activity deductions of $36,000 ($40,000 of operating deductions allocable to A less $4,000 suspended under section 465). Because A has no other passive activity income from any other source, section 469 limits A's passive activity deductions to A's passive activity gross income. As a result, section 469 allows A to deduct $29,000 of SCo's operating deductions and suspends the remaining $7,000.
(v) For purposes of calculating A's net investment income, A has $29,000 of properly allocable deductions allowed by section 1411(c)(1)(B) and paragraph (f)(2)(ii) of this section.
(ii) For purposes of calculating A's net investment income, A's $43,000 distributive share of gross operating income is income within the meaning of section 1411(c)(1)(A)(ii).
(iii) Pursuant to section 465(a)(2), A's deductions attributable to the gross income of SCo include the $30,000 deduction allocable to A in Year 2 plus the $4,000 loss that was suspended and carried over to Year 2 from Year 1 pursuant to section 465(a)(2). Under section 465(a)(2), the $4,000 of losses from Year 1 are treated as deductions from the activity in Year 2. As a result, A's net operating income from SCo in Year 2 is $9,000 ($43,000−$30,000−$4,000) in Year 2. A's amount at risk at the end of Year 2 is $9,000.
(iv) For purposes of section 469, A has passive activity gross income of $43,000. A's passive activity deductions attributable to SCo are the sum of the Year 2 operating deductions allocable to A from S ($30,000), deductions formerly suspended by section 465 ($4,000), and passive activity losses suspended by section 469 ($7,000). Therefore, in Year 2, A has passive activity deductions of $41,000. Because A's passive activity gross income exceeds A's passive activity deductions, section 469 does not limit any of the deductions in Year 2. At the end of Year 2, A has no suspended passive activity losses.
(v) Although A's distributive share of Year 2 deductions allocable to SCo's operating income was $30,000; the operative provisions of sections 465 and 469 do not change the character of the deductions when such amounts are suspended under either section. Furthermore, section 465(a)(2) and §§ 1.469-1(f)(4) and 1.469-2T(d)(1) treat amounts suspended from prior years as deductions in the current year. See § 1.1411-1(a). Therefore, for purposes of calculating A's net investment income, A has $41,000 of properly allocable deductions allowed by section 1411(c)(1)(B) and paragraph (f)(2)(ii) of this section.
(3) Properly allocable deductions described in section 63(d). In determining net investment income, the following itemized deductions are taken into account:
(i) Investment interest expense. Investment interest (as defined in section 163(d)(3)) to the extent allowed under section 163(d)(1). Any investment interest not allowed under section 163(d)(1) is treated as investment interest paid or accrued by the taxpayer in the succeeding taxable year. The following example illustrates the provisions of this paragraph. For purposes of this example, assume that the taxpayer uses a calendar taxable year, and Year 1 and all subsequent years are taxable years in which section 1411 is in effect:
(A) In Year 1, A, an unmarried individual, pays interest of $4,000 on debt incurred to purchase stock. Under § 1.163-8T, this interest is allocable to the stock and is investment interest within the meaning of section 163(d)(3). A has no investment income as defined by section 163(d)(4). A has $10,000 of income from a trade or business that is a passive activity (as defined in § 1.1411-5(a)(1)) with respect to A. For income tax purposes, under section 163(d)(1), A may not deduct the $4,000 investment interest in Year 1 because A does not have any section 163(d)(4) net investment income. Under section 163(d)(2), the $4,000 investment interest is a carryforward of disallowed interest that is treated as investment interest paid by A in the succeeding taxable year. Similarly, for purposes of determining A's Year 1 net investment income, A may not deduct the $4,000 investment interest.
(B) In Year 2, A has $5,000 of section 163(d)(4) net investment income. For both income tax purposes and for determining section 1411 net investment income, A's $4,000 carryforward of interest expense disallowed in Year 1 may be deducted in Year 2.
(ii) Investment expenses. Investment expenses (as defined in section 163(d)(4)(C)).
(iii) Taxes described in section 164(a)(3). State, local, and foreign income, war profits, and excess profit taxes described in section 164(a)(3) that are allocable to net investment income pursuant to paragraph (g)(1) of this section. Except to the extent specifically expected from section 275(a)(4), foreign income, war profits, and excess profit taxes are not allowed as deductions under section 164(a)(3) in determining net investment income if the taxpayer claims the benefit of the foreign tax credit under section 901 with respect to the same taxable year. For rules applicable to refunds of taxes described in this paragraph, see paragraph (g)(2) of this section.
(iv) Items described in section 72(b)(3). In the case of an amount allowed as a deduction to the annuitant for the annuitant's last taxable year under section 72(b)(3), such amount is allowed as a properly allocable deduction in the same taxable year if the income from the annuity (had the annuitant lived to receive such income) would have been included in net investment income under paragraph (a)(1)(i) of this section (and not excluded from net investment income by reason of § 1.1411-8).
(v) Items described in section 691(c). Deductions for estate and generation-skipping taxes allowed by section 691(c) that are allocable to net investment income; provided, however, that any portion of the section 691(c) deduction described in section 691(c)(4) is taken into account instead in computing net gain under paragraph (d) and not under this paragraph (f)(3)(v).
(vi) Items described in section 212(3). Amounts described in section 212(3) and § 1.212-1(l) to the extent they are allocable to net investment income pursuant to paragraph (g)(1) of this section.
(vii) Amortizable bond premium. A deduction allowed under section 171(a)(1) for the amortizable bond premium on a taxable bond (for example, see § 1.171-2(a)(4)(i)(C) for the treatment of a bond premium carryforward as a deduction under section 171(a)(1)).
(viii) Fiduciary expenses. In the case of an estate or trust, amounts described in § 1.212-1(i) to the extent they are allocable to net investment income pursuant to paragraph (g)(1) of this section.
(4) Loss deductions —(i) General rule. Losses described in section 165, whether described in section 62 or section 63(d), are allowed as properly allocable deductions to the extent such losses exceed the amount of gain described in section 61(a)(3) and are not taken into account in computing net gain by reason of paragraph (d) of this section.
(ii) Examples. The following examples illustrate the provisions of this paragraph (f)(4). For purposes of these examples, assume the taxpayer is a United States citizen, uses a calendar taxable year, and Year 1 and all subsequent years are taxable years in which section 1411 is in effect:
(ii) For purposes of chapter 1, A includes the $125,000 of interest and dividends, $60,000 of ordinary loss, and $50,000 of long-term capital gain in the computation of A's adjusted gross income.
(iii) For purposes of calculating net investment income, A includes the $125,000 of interest and dividends. Pursuant to paragraph (d) of this section, A takes into account the $60,000 at ordinary loss from PRS and the $50,000 of long term capital gain in the computation of A's net gain. A's losses ($60,000) exceed A's gains ($50,000). Therefore, A's net gain under paragraph (d) of this section is zero. Additionally, A is allowed a deduction under paragraph (f)(4)(i) of this section for $10,000 (the amount of ordinary losses that were allowable under chapter 1 in excess of the amounts taken into account in computing net gain). A's net investment income in Year 1 is $115,000.
(ii) For purposes of chapter 1, T includes the $17,000 of interest and dividends and only $3,000 of the capital loss in the computation of adjusted gross income. The remaining $2,000 capital loss is carried over to Year 2.
(iii) For purposes of calculating net investment income, T includes the $17,000 of interest and dividends in net investment income. Pursuant to paragraph (d) of this section, T takes into account the $3,000 capital loss allowed by chapter 1. T's losses ($3,000) exceed T's gains ($0). Therefore, T's net gain under paragraph (d) of this section is zero. However, T is allowed a deduction under paragraph (f)(4)(i) of this section for $3,000 (the amount of losses that were allowable under chapter 1 in excess of the amounts taken into account in computing net gain). T's net investment income in Year 1 is $14,000.
(ii) For purposes of chapter 1, B includes the $50,000 of annuity income in the computation of adjusted gross income. The $21,000 long-term capital gain is offset by the $15,000 short-term capital loss, so B includes $6,000 of net long-term capital gain in the computation of adjusted gross income.
(iii) For purposes of calculating net investment income, B includes the $50,000 of annuity income in net investment income. Pursuant to paragraph (d)(4)(i) of this section, B's net gain does not include the $21,000 long-term capital gain because it is attributable to property held in B's sole proprietorship (a nonpassive activity). Pursuant to paragraph (d) of this section, T takes into account the $15,000 capital loss allowed by chapter 1. B's losses ($15,000) exceed B's gains ($0). Therefore, A's net gain under paragraph (d) of this section is zero. However, B is allowed a deduction under paragraph (f)(4)(i) of this section for $15,000 (the amount of losses that were allowable under chapter 1 in excess of the amounts taken into account in computing net gain). B's net investment income in Year 1 is $35,000.
(5) Ordinary loss deductions for certain debt instruments. An amount treated as an ordinary loss by a holder of a contingent payment debt instrument under § 1.1275-4(b) or an inflation-indexed debt instrument under § 1.1275-7(f)(1).
(6) Other deductions. Any other deduction allowed by subtitle A that is identified in published guidance in the Federal Register or in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)( b ) of this chapter) as properly allocable to gross income or net gain under this section.
(7) Application of limitations under sections 67 and 68. Any deductions described in this paragraph (f) that are subject to section 67 (the 2-percent floor on miscellaneous itemized deductions) or section 68 (the overall limitation on itemized deductions) are allowed in determining net investment income only to the extent the items are deductible for chapter 1 purposes after the application of sections 67 and 68. For this purpose, section 67 applies before section 68. The amount of deductions subject to sections 67 and 68 that may be deducted in determining net investment income after the application of sections 67 and 68 is determined as described in paragraph (f)(7)(i) and (f)(7)(ii) of this section.
(i) Deductions subject to section 67. The amount of miscellaneous itemized deductions (as defined in section 67(b)) tentatively deductible in determining net investment income after applying section 67 (but before applying section 68) is the lesser of:
(A) The portion of the taxpayer's miscellaneous itemized deductions (before the application of section 67) that is properly allocable to items of income or net gain included in determining net investment income, or
(B) The taxpayer's total miscellaneous itemized deductions allowed after the application of section 67, but before the application of section 68.
(ii) Deductions subject to section 68. The amount of itemized deductions allowed in determining net investment income after applying sections 67 and 68 is the lesser of:
(A) The sum of the amount determined under paragraph (f)(7)(i) of this section and the amount of itemized deductions not subject to section 67 that are properly allocable to items of income or net gain included in determining net investment income, or
(B) The total amount of itemized deductions allowed after the application of sections 67 and 68.
(iii) Itemized deductions. For purposes of paragraph (f)(7)(ii), itemized deductions do not include any deduction described in section 68(c).
(iv) Example. The following example illustrates the provisions of this paragraph (f)(7). For purposes of these examples, assume the taxpayer is a United States citizen, uses a calendar taxable year, and Year 1 and all subsequent years are taxable years in which section 1411 is in effect:
(A) A, an unmarried individual, has adjusted gross income in Year 1 as follows:
In addition, A has the following items of expense qualifying as itemized deductions:
A's investment expenses and job-related expenses are miscellaneous itemized deductions. In addition, A's investment interest expense and investment expenses are properly allocable to net investment income (within the meaning of this section). A's job-related expenses are not properly allocable to net investment income. Of the state income tax expense, A applied a reasonable method pursuant to paragraph (g)(1) of this section to properly allocate $20,000 to net investment income.
(B) A's 2-percent floor under section 67 is $40,000 (2% of $2,000,000). For Year 1, assume the section 68 limitation starts at adjusted gross income of $200,000. The section 68 overall limitation disallows $54,000 of A's itemized deductions that are subject to section 68 (3% of the excess of the $2,000,000 adjusted gross income over the $200,000 limitation threshold).
(C)(1) A's total miscellaneous itemized deductions allowable before the application of section 67 is $100,000 ($70,000 in investment expenses plus $30,000 in job-related expenses), and the total miscellaneous deductions allowed after the application of section 67 is $60,000 ($100,000 minus $40,000).
(2) The amount of the miscellaneous itemized deductions properly allocable to net investment income after the application of section 67 is $60,000 (the lesser of $70,000 in investment expenses that are deductible as a miscellaneous itemized deduction and properly allocable to net investment income or $60,000 of miscellaneous itemized deductions allocable to net investment income allowed after the application of section 67).
(D)(1) The amount of itemized deductions allocable to net investment income after applying section 67 to deductions that are also miscellaneous itemized deductions but before applying section 68 is $155,000. This amount is the sum of $60,000 of miscellaneous itemized deductions determined in (C)(2), plus $20,000 in state income tax properly allocable to net investment income, plus $75,000 of investment interest expense. However, under section 68(c)(2), the $75,000 deduction for investment interest expenses is not subject to the section 68 limitation on itemized deductions and is excluded from the computation under § 1.1411-4(f)(7). Thus, the amount of itemized deductions allocable to net investment income and subject to section 68, after applying section 67 but before applying section 68, is $80,000.
(2) A's total itemized deductions allowed subject to the limitation under section 68 and after application of section 67, but before the application of section 68, are the following:
(3) Of A's itemized deductions that are subject to the limitation under section 68, the amount allowed after the application of section 68 is $126,000 ($180,000 minus the $54,000 disallowed in (B)).
(E) Under paragraph (f)(7)(ii) of this section, the amount of itemized deductions allowed in determining net investment income after applying sections 67 and 68 is the lesser of $80,000 (the sum of $60,000 determined under paragraph (C)(2) and $20,000 state income tax allocable to net investment income) or $126,000 (determined under (D)(3)). Therefore, A's itemized deductions that are properly allocable to net investment income are $155,000 ($80,000 of properly allocable itemized deductions subject to section 67 or 68 plus $75,000 of investment interest expense (which is not subject to either section 67 or section 68 limitations)).
(g) Special rules —(1) Deductions allocable to both net investment income and excluded income. In the case of a properly allocable deduction described in section 1411(c)(1)(B) and paragraph (f) of this section that is allocable to both net investment income and excluded income, the portion of the deduction that is properly allocable to net investment income may be determined by taxpayers using any reasonable method. Examples of reasonable methods of allocation include, but are not limited to, an allocation of the deduction based on the ratio of the amount of a taxpayer's gross income (including net gain) described in § 1.1411-4(a)(1) to the amount of the taxpayer's adjusted gross income (as defined under section 62 (or section 67(e) in the case of an estate or trust)). In the case of an estate or trust, an allocation of a deduction pursuant to rules described in § 1.652(b)-3(b) (and § 1.641(c)-1(h) in the case of an ESBT) is also a reasonable method.
(2) Recoveries of properly allocable deductions —(i) General rule. If a taxpayer is refunded, reimbursed, or otherwise recovers any portion of an amount deducted as a section 1411(c)(1)(B) properly allocable deduction in a prior year, and such amount is not otherwise included in net investment income in the year of recovery under section 1411(c)(1)(A), the amount of the recovery will reduce the taxpayer's total section 1411(c)(1)(B) properly allocable deductions in the year of recovery (but not below zero). The preceding sentence applies regardless of whether the amount of the recovery is excluded from gross income by reason of section 111.
(ii) Recoveries of items allocated between net investment income and excluded income. In the case of a refund of any item that was deducted under section 1411(c)(1)(B) in a prior year and the gross amount of the deduction was allocated between items of net investment income and excluded income pursuant to paragraph (g)(1) of this section, the amount of the reduction in section 1411(c)(1)(B) properly allocable deductions in the year of receipt under this paragraph (g)(2) is the total amount of the refund multiplied by a fraction. The numerator of the fraction is the amount of the total deduction allocable to net investment income in the prior year to which the refund relates. The denominator of the fraction is the total amount of the deduction in the prior year to which the refund relates.
(iii) Recoveries with no prior year benefit. For purposes of this paragraph (g)(2), section 111 applies to reduce the amount of any reduction required by paragraph (g)(2)(i) of this section to the extent that such previously deducted amount did not reduce the tax imposed by section 1411. To the extent a deduction is taken into account in computing a taxpayer's net operating loss deduction under paragraph (h) of this section, section 111(c) applies. Except as provided in the preceding sentence, for purposes of this paragraph (g)(2), no reduction of section 1411(c)(1)(B) properly allocable deductions is required in a year when such recovered item is attributable to an amount deducted in a taxable year—
(A) Preceding the effective date of section 1411, or
(B) In which the taxpayer was not subject to section 1411 solely because that individual's (as defined in § 1.1411-2(a)) modified adjusted gross income (as defined in § 1.1411-2(c)) does not exceed the applicable threshold in § 1.1411-2(d) or such estate's or trust's (as defined in § 1.1411-3(a)(1)(i)) adjusted gross income does not exceed the amount described in section 1411(a)(2)(B)(ii) and § 1.1411-3(a)(1)(ii)(B)( 2 ).
(iv) Examples. The following examples illustrate the provisions of this paragraph (g)(2). For purposes of these examples, assume the taxpayer is a United States citizen, uses a calendar taxable year, and Year 1 and all subsequent years are taxable years in which section 1411 is in effect:
(3) Deductions described in section 691(b). For purposes of paragraph (f) of this section, properly allocable deductions include items of deduction described in section 691(b), provided that the item otherwise would have been deductible to the decedent under § 1.1411-4(f). For example, an estate may deduct the decedent's unpaid investment interest expense in computing its net investment income because section 691(b) specifically allows the deduction under section 163, and § 1.1411-4(f)(3)(i) allows those deductions as well. However, an estate or trust may not deduct a payment of real estate taxes on the decedent's principal residence that were unpaid at death in computing its net investment income because, although real estate taxes are deductible under section 164 and specifically are allowed by section 691(b), the real estate taxes would not have been a properly allocable deduction of the decedent under § 1.1411-4(f).
(4) Amounts described in section 642(h). For purposes of the calculation of net investment income under this section, one or more beneficiaries succeeding to the property of the estate or trust, within the meaning of section 642(h), shall—
(i) Treat excess capital losses of the estate or trust described in section 642(h)(1) as capital losses of the beneficiary in the calculation of net gain in paragraph (d) and paragraph (f)(4) of this section, as applicable, in a manner consistent with section 642(h)(1);
(ii) Treat excess net operating losses of the estate or trust described in section 642(h)(1) as net operating losses of the beneficiary in the calculation of net investment income in paragraphs (f)(2)(iv) and (h) of this section in a manner consistent with section 642(h)(1); and
(iii) Treat the deductions described in paragraph (f) of this section (other than those taken into account under paragraph (g)(4)(i) or (ii) of this section) that exceed the gross investment income described in paragraph (a)(1) of this section (after taking into account any modifications, adjustments, and special rules for calculating net investment income in section 1411 and the regulations thereunder) of a terminating estate or trust as a section 1411(c)(1)(B) deduction of the beneficiary in a manner consistent with section 642(h)(2).
(5) Treatment of self-charged interest income. Gross income from interest (within the meaning of section 1411(c)(1)(A)(i) and paragraph (a)(1)(i) of this section) that is received by the taxpayer from a nonpassive activity of such taxpayer, solely for purposes of section 1411, is treated as derived in the ordinary course of a trade or business not described in § 1.1411-5. The amount of interest income that is treated as derived in the ordinary course of a trade or business not described in § 1.1411-5, and thus excluded from the calculation of net investment income, under this paragraph (g)(5) is limited to the amount that would have been considered passive activity gross income under the rules of § 1.469-7 if the payor was a passive activity of the taxpayer. For purposes of this rule, the term nonpassive activity does not include a trade or business described in § 1.1411-5(a)(2). However, this rule does not apply to the extent the corresponding deduction is taken into account in determining self-employment income that is subject to tax under section 1401(b).
(6) Treatment of certain nonpassive rental activities —(i) Gross income from rents. To the extent that gross rental income described in paragraph (a)(1)(i) of this section is treated as not derived from a passive activity by reason of § 1.469-2(f)(6) or as a consequence of a taxpayer grouping a rental activity with a trade or business activity under § 1.469-4(d)(1), such gross rental income is deemed to be derived in the ordinary course of a trade or business within the meaning of paragraph (b) of this section.
(ii) Gain or loss from the disposition of property. To the extent that gain or loss resulting from the disposition of property is treated as nonpassive gain or loss by reason of § 1.469-2(f)(6) or as a consequence of a taxpayer grouping a rental activity with a trade or business activity under § 1.469-4(d)(1), then such gain or loss is deemed to be derived from property used in the ordinary course of a trade or business within the meaning of paragraph (d)(4)(i) of this section.
(7) Treatment of certain real estate professionals —(i) Safe Harbor. In the case of a real estate professional (as defined in section 469(c)(7)(B)) that participates in a rental real estate activity for more than 500 hours during such year, or has participated in such real estate activities for more than 500 hours in any five taxable years (whether or not consecutive) during the ten taxable years that immediately precede the taxable year, then—
(A) Such gross rental income from that rental activity is deemed to be derived in the ordinary course of a trade or business within the meaning of paragraph (b) of this section; and
(B) Gain or loss resulting from the disposition of property used in such rental real estate activity is deemed to be derived from property used in the ordinary course of a trade or business within the meaning of paragraph (d)(4)(i) of this section.
(ii) Definitions —(A) Participation. For purposes of establishing participation under this paragraph (g)(7), any participation in the activity that would count towards establishing material participation under section 469 shall be considered.
(B) Rental real estate activity. The term rental real estate activity used in this paragraph (g)(7) is a rental activity within the meaning of § 1.469-1T(e)(3). An election to treat all rental real estate as a single rental activity under § 1.469-9(g) also applies for purposes of this paragraph (g)(7). However, any rental real estate that the taxpayer grouped with a trade or business activity under § 1.469-4(d)(1)(i)(A) or (d)(1)(i)(C) is not a rental real estate activity.
(iii) Effect of safe harbor. The inability of a real estate professional to satisfy the safe harbor in this paragraph (g)(7) does not preclude such taxpayer from establishing that such gross rental income and gain or loss from the disposition of property, as applicable, is not included in net investment income under any other provision of section 1411.
(8) Treatment of former passive activities —(i) Section 469(f)(1)(A) losses. Losses allowed in computing taxable income by reason of the rules governing former passive activities in section 469(f)(1)(A) are taken into account in computing net gain under paragraph (d) of this section or as properly allocable deductions under paragraph (f) of this section, as applicable, in the same manner as such losses are taken into account in computing taxable income (as defined in section 63). The preceding sentence applies only to the extent the net income or net gain from the former passive activity (as defined in section 469(f)(3)) is included in net investment income.
(ii) Section 469(f)(1)(C) losses. Losses allowed in computing taxable income by reason of section 469(f)(1)(C) are taken into account in computing net gain under paragraph (d) of this section or as properly allocable deductions under paragraph (f) of this section, as applicable, in the same manner as such losses are taken into account in computing taxable income (as defined in section 63).
(iii) Examples. The following examples illustrate the provisions of this paragraph (g)(8). For purposes of these examples, assume the taxpayer is a United States citizen, uses a calendar taxable year, and Year 1 and all subsequent years are taxable years in which section 1411 is in effect:
(ii) In Year 1, B reports $205,000 of wages, $7,000 of nonpassive net income, $500 of interest income (attributable to working capital) from SCorp's retail sales activity, and $1,000 of net rental income from the single family rental property. B's Year 1 modified adjusted gross income (as defined in § 1.1411-2(c)) is $205,500; which includes $205,000 of wages, $500 of interest income, $7,000 of nonpassive income from SCorp, $7,000 of section 469(f)(1)(A) losses, $1,000 of passive income from the single family rental property and $1,000 of section 469(f)(1)(C) losses.
(iii) For purposes of the calculation of B's Year 1 net investment income, B includes the $500 of interest income and $1,000 of net passive income from the single family rental property. The $7,000 of nonpassive income from SCorp's retail sales activity is excluded from net investment income because the income is not attributable to a trade or business described in § 1.1411-5. Therefore, pursuant to the rules of paragraph (g)(8)(i) of this section, the $7,000 of section 469(f)(1)(A) losses are not taken into account in computing B's net investment income. However, pursuant to the rules of paragraph (g)(8)(ii) of this section, the $1,000 of passive losses allowed by reason of section 469(f)(1)(C), which are allowed as a deduction in Year 1 by reason of B's $1,000 of passive income from the single family rental property are allowed in computing B's net investment income. As a result, B's net investment income is $500 ($500 of interest income plus $1,000 of passive rental income less $1,000 of section 469(f)(1)(C) losses). Although the $500 of interest income is attributable to SCorp and includable in B's net investment income, such income is not taken into account when calculating the amount of section 469(f)(1)(A) losses allowed in the current year. Therefore, such income is not taken into account in computing the amount of section 469(f)(1)(A) losses allowed by reason of paragraph (g)(8)(i) of this section. Pursuant to section 469(b), B carries forward $2,000 of suspended passive losses attributable to SCorp's retail sales activity to Year 2.
(9) Treatment of section 469(g)(1) losses. Losses allowed in computing taxable income by reason of section 469(g) are taken into account in computing net gain under paragraph (d) of this section or as properly allocable deductions under paragraph (f) of this section, as applicable, in the same manner as such losses are taken into account in computing taxable income (as defined in section 63).
(10) Treatment of section 707(c) guaranteed payments. [Reserved]
(11) Treatment of section 736 payments. [Reserved]
(12) Income and deductions from certain notional principal contracts. [Reserved]
(13) Treatment of income or loss from REMIC residual interests. [Reserved]
(h) Net operating loss —(1) General rule. For purposes of paragraph (f)(2)(iv) of this section, the total section 1411 NOL amount of a net operating loss deduction for a taxable year is calculated by first determining the applicable portion of the taxpayer's net operating loss for each loss year under paragraph (h)(2) of this section. Next, the applicable portion for each loss year is used to determine the section 1411 NOL amount for each net operating loss carried from a loss year and deducted in the taxable year as provided in paragraph (h)(3) of this section. The section 1411 NOL amounts of each net operating loss carried from a loss year and deducted in the taxable year are then added together as provided in paragraph (h)(4) of this section. This sum is the total section 1411 NOL amount of the net operating loss deduction for the taxable year that is allowed as a properly allocable deduction in determining net investment income for the taxable year. For purposes of this paragraph (h), both the amount of a net operating loss for a loss year and the amount of a net operating loss deduction refer to such amounts as determined for purposes of chapter 1.
(2) Applicable portion of a net operating loss. In any taxable year beginning after December 31, 2012, in which a taxpayer incurs a net operating loss, the applicable portion of such loss is the lesser of:
(i) The amount of the net operating loss for the loss year that the taxpayer would incur if only items of gross income that are used to determine net investment income and only properly allocable deductions are taken into account in determining the net operating loss in accordance with section 172(c) and (d); or
(ii) The amount of the taxpayer's net operating loss for the loss year.
(3) Section 1411 NOL amount of a net operating loss carried to and deducted in a taxable year. The section 1411 NOL amount of each net operating loss that is carried from a loss year that is allowed as a deduction is the total amount of such net operating loss carried from the loss year allowed as a deduction under section 172(a) in the taxable year multiplied by a fraction. The numerator of the fraction is the applicable portion of the net operating loss for that loss year, as determined under paragraph (h)(2) of this section. The denominator of the fraction is the total amount of the net operating loss for the same loss year.
(4) Total section 1411 NOL amount of a net operating loss deduction. The section 1411 NOL amounts of each net operating loss carried to and deducted in the taxable year as determined under paragraph (h)(3) of this section are added together to determine the total section 1411 NOL amount of the net operating loss deduction for the taxable year that is properly allocable to net investment income.
(5) Examples. The following examples illustrate the provisions of this paragraph (h). For purposes of these examples, assume the taxpayer is a United States citizen, uses a calendar taxable year, and Year 1 and all subsequent years are taxable years in which section 1411 is in effect:
(B) For purposes of section 1411, A's net investment income for Year 1 is the excess (if any) of $60,000 ($50,000 trading activity gross income plus $10,000 dividend income) over $262,000 ($250,000 trading loss deductions plus $12,000 nonbusiness expenses).
(C) The amount of the net operating loss for Year 1 determined under section 172 that A would incur if only items of gross income that are used to determine net investment income and only properly allocable deductions are taken into account is $200,000. This amount is the excess of $250,000 trading loss deductions, over $50,000 trading activity gross income. Under section 172(d)(4), in determining the net operating loss, the $12,000 nonbusiness expenses are allowed only to the extent of the $10,000 dividend income. The $200,000 net operating loss determined using only properly allocable deductions and gross income items used in determining net investment income is less than A's actual net operating loss for Year 1 of $1,000,000, and accordingly the applicable portion for Year 1 is $200,000. The ratio used to calculate section 1411 NOL amounts of A's Year 1 net operating loss is $200,000 (net operating loss determined using only properly allocable deductions and gross income items used in determining net investment income)/$1,000,000 (net operating loss), or 0.2.
(ii) For Year 2, A has $250,000 of wages, no gross income from the trading activity, $300,000 of income from his sole proprietorship, and $10,000 in trading loss deductions. For income tax purposes, A deducts $540,000 of the net operating loss carried over from Year 1. In addition, under § 1.1411-2(c), the $540,000 net operating loss will be allowed as a deduction in computing A's Year 2 modified adjusted gross income. Because A's modified adjusted gross income is $0, A is not subject to net investment income tax. For purposes of A's net investment income calculation, the section 1411 NOL amount of the $540,000 net operating loss from Year 1 that A deducts in Year 2 is $108,000 ($540,000 multiplied by 0.2 (the fraction determined based on the applicable portion of the net operating loss in the loss year)). The amount of the Year 1 net operating loss carried over to Year 3 is $460,000. For purposes of A's net investment income calculation, this net operating loss carryover amount includes a section 1411 NOL amount of $92,000 ($460,000 multiplied by 0.2). The section 1411 NOL amount may be applied in determining A's net investment income in Year 3.
(iii)(A) For Year 3, A has $400,000 of wages, $200,000 in trading gains which are gross income from the trading activity, $250,000 of income from his sole proprietorship, and $10,000 in trading loss deductions. For income tax purposes, A deducts the remaining $460,000 of the net operating loss from Year 1. In addition, under § 1.1411-2(c), the $460,000 net operating loss deduction reduces A's Year 3 modified adjusted gross income to $380,000.
(B) A's section 1411 NOL amount of the net operating loss deduction for Year 3 is $92,000, which is the $460,000 net operating loss deduction for Year 3 multiplied by 0.2.
(C) A's net investment income for Year 3 before the application of paragraph (f)(2)(iv) of this section is $190,000 ($200,000 in gross income from the trading activity, minus $10,000 in trading loss deductions). After the application of paragraph (f)(2)(iv) of this section, A's net investment income for Year 3 is $98,000 ($190,000 minus $92,000, the total section 1411 NOL amount of the net operating loss deduction).
(ii)(A) For Year 2, A has $100,000 in wages, $200,000 in gross income from the trading activity, $15,000 of dividends, $250,000 in losses from the sole proprietorship, $10,000 of non-business investment expenses, and $355,000 in trading loss deductions. As a result, for income tax purposes A sustains a section 172(c) net operating loss of $300,000. A makes an election under section 172(b)(3) to waive the carryback period for the Year 2 net operating loss.
(B) For purposes of section 1411, A's net investment income for Year 2 is the excess (if any) of $215,000 ($200,000 trading activity gross income plus $15,000 dividend income) over $365,000 ($355,000 trading loss deductions plus $10,000 nonbusiness expenses).
(C) The amount of the net operating loss for Year 2 determined under section 172 that A would incur if only items of gross income that are used to determine net investment income and only properly allocable deductions are taken into account is $150,000. This amount is the excess of $365,000 ($355,000 trading loss deductions plus $10,000 nonbusiness expenses) over $215,000 ($200,000 trading activity gross income plus $15,000 dividend income). Under section 172(d)(4), in determining the net operating loss, the $10,000 nonbusiness expenses are allowed in full against the $15,000 dividend income. The $150,000 net operating loss determined using only properly allocable deductions and gross income items used in determining net investment income is less than A's actual net operating loss for Year 2 of $300,000, and accordingly the applicable portion is $150,000. The ratio used to calculate the section 1411 NOL amount of A's Year 2 net operating loss is $150,000 (the applicable portion)/$300,000 (net operating loss), or 0.5.
(iii) For Year 3, A has $250,000 of wages, no gross income from the trading activity, $300,000 of income from his sole proprietorship, and $10,000 in trading loss deductions. For income tax purposes, A deducts $540,000 of the net operating loss from Year 1. In addition, under § 1.1411-2(c), the $540,000 net operating loss will be allowed as a deduction in computing A's Year 3 modified adjusted gross income. Because A's modified adjusted gross income is $0, A is not subject to net investment income tax. The section 1411 NOL amount of the $540,000 net operating loss from Year 1 that A deducts in Year 3 is $108,000 ($540,000 multiplied by 0.2 (the fraction used to calculate the section 1411 NOL amount of the net operating loss)), and this is also the total section 1411 NOL amount for Year 3. The amount of the Year 1 net operating loss carried over to Year 4 is $460,000. This net operating loss carryover amount includes a section 1411 NOL amount of $92,000 ($460,000 multiplied by 0.2) that may be applied in determining net investment income in Year 4. None of the Year 2 net operating loss is deducted in Year 3 so that the $300,000 Year 2 net operating loss (including the section 1411 NOL amount of $150,000) is carried to Year 4.
(iv)(A) For Year 4, A has $150,000 of wages, $450,000 in trading gains which are gross income from the trading activity, $250,000 of income from his sole proprietorship, and $10,000 in trading loss deductions. For income tax purposes, A deducts the remaining $460,000 of the net operating loss carryover from Year 1 and the $300,000 net operating loss carryover from Year 2, for a total net operating loss deduction in Year 4 of $760,000. In addition, under § 1.1411-2(c), the $760,000 net operating loss deduction reduces A's Year 4 modified adjusted gross income to $80,000.
(B) A's total section 1411 NOL amount of the net operating loss deduction for Year 4 is $242,000, which is the sum of the $92,000 ($460,000 net operating loss carryover from Year 1 and deducted in Year 4 multiplied by 0.2 (the ratio used to calculate the section 1411 NOL amount of the Year 1 net operating loss)) plus $150,000 ($300,000 net operating loss carryover from Year 2 and deducted in Year 4 multiplied by 0.5 (the ratio used to calculate the section 1411 NOL amount of the Year 2 net operating loss)).
(C) A's net investment income for Year 4 before the application of paragraph (f)(2)(iv) of this section is $440,000 ($450,000 in gross income from the trading activity, minus $10,000 in trading loss deductions). After the application of paragraph (f)(2)(iv) of this section, A's net investment income for Year 4 is $198,000 ($440,000 minus $242,000, the total section 1411 NOL amount of the Year 4 net operating loss deduction).
(i) Effective/applicability date. This section applies to taxable years beginning after December 31, 2013. However, taxpayers may apply this section to taxable years beginning after December 31, 2012, in accordance with § 1.1411-1(f).
§ 1.1411-5   Trades or businesses to which tax applies.
(a) In general. A trade or business is described in this section if such trade or business involves the conduct of a trade or business, and such trade or business is either—
(1) A passive activity (within the meaning of paragraph (b) of this section) with respect to the taxpayer; or
(2) The trade or business of a trader trading in financial instruments (as defined in paragraph (c)(1) of this section) or commodities (as defined in paragraph (c)(2) of this section).
(b) Passive activity —(1) In general. A passive activity is described in this section if—
(i) Such activity is a trade or business; and
(ii) Such trade or business is a passive activity with respect to the taxpayer within the meaning of section 469 and the regulations thereunder.
(2) Application of income recharacterization rules —(i) Income and gain recharacterization. To the extent that any income or gain from a trade or business is recharacterized as “not from a passive activity” by reason of § 1.469-2T(f)(2), § 1.469-2(f)(5), or § 1.469-2(f)(6), such trade or business does not constitute a passive activity within the meaning of paragraph (b)(1)(ii) of this section solely with respect to such recharacterized income or gain.
(ii) Gain recharacterization. To the extent that any gain from a trade or business is recharacterized as “not from a passive activity” by reason of § 1.469-2(c)(2)(iii) and does not constitute portfolio income under § 1.469-2(c)(2)(iii)(F), such trade or business does not constitute a passive activity within the meaning of paragraph (b)(1)(ii) of this section solely with respect to such recharacterized gain.
(iii) Exception for certain portfolio recharacterizations. To the extent that any income or gain from a trade or business is recharacterized as “not from a passive activity” and is further characterized as portfolio income under § 1.469-2(f)(10) or § 1.469-2(c)(2)(iii)(F), then such trade or business constitutes a passive activity within the meaning of paragraph (b)(1)(ii) of this section solely with respect to such recharacterized income or gain.
(3) Examples. The following examples illustrate the principles of paragraph (b)(1) of this section and the ordinary course of a trade or business exception in § 1.1411-4(b). In each example, unless otherwise indicated, the taxpayer uses a calendar taxable year, the taxpayer is a United States citizen, and Year 1 and all subsequent years are taxable years in which section 1411 is in effect:
(c) Trading in financial instruments or commodities —(1) Definition of financial instruments. For purposes of section 1411 and the regulations thereunder, the term financial instruments includes stocks and other equity interests, evidences of indebtedness, options, forward or futures contracts, notional principal contracts, any other derivatives, or any evidence of an interest in any of the items described in this paragraph (c)(1). An evidence of an interest in any of the items described in this paragraph (c)(1) includes, but is not limited to, short positions or partial units in any of the items described in this paragraph (c)(1).
(2) Definition of commodities. For purposes of section 1411 and the regulations thereunder, the term commodities refers to items described in section 475(e)(2).
(d) Effective/applicability date. This section applies to taxable years beginning after December 31, 2013. However, taxpayers may apply this section to taxable years beginning after December 31, 2012, in accordance with § 1.1411-1(f).
§ 1.1411-6   Income on investment of working capital subject to tax.
(a) General rule. For purposes of section 1411, any item of gross income from the investment of working capital will be treated as not derived in the ordinary course of a trade or business, and any net gain that is attributable to the investment of working capital will be treated as not derived in the ordinary course of a trade or business. In determining whether any item is gross income from or net gain attributable to an investment of working capital, principles similar to those described in § 1.469-2T(c)(3)(ii) apply. See § 1.1411-4(f) for rules regarding properly allocable deductions with respect to an investment of working capital and § 1.1411-7 for rules relating to the adjustment to net gain on the disposition of interests in a partnership or S corporation.
(b) Example. The following example illustrates the principles of this section. Assume for purposes of the example that the taxpayer uses a calendar taxable year, the taxpayer is a United States citizen, and Year 1 and all subsequent years are taxable years in which section 1411 is in effect:
(ii) Both the $2,500 average daily balance of the checking account and the $20,000 savings account balance constitute working capital under § 1.469-2T(c)(3)(ii) and, pursuant to paragraph (a) of this section, the interest generated by this working capital will not be treated as derived in the ordinary course of S's restaurant business. Accordingly, the interest income derived by S from its checking and savings accounts and allocated to A under section 1366 constitutes gross income from interest under § 1.1411-4(a)(1)(i).
(c) Effective/applicability date. This section applies to taxable years beginning after December 31, 2013. However, taxpayers may apply this section to taxable years beginning after December 31, 2012, in accordance with § 1.1411-1(f).
§ 1.1411-7   Exception for dispositions of interests in partnerships and S corporations. [Reserved]
§ 1.1411-8   Exception for distributions from qualified plans.
(a) General rule. Net investment income does not include any distribution from a qualified plan or arrangement. For this purpose, the term qualified plan or arrangement means any plan or arrangement described in section 401(a), 403(a), 403(b), 408, 408A, or 457(b).
(b) Rules relating to distributions. This paragraph (b) provides rules for purposes of paragraph (a) of this section. For purposes of section 1411(c)(5) and this section, a distribution means the following:
(1) Actual distributions. Any amount actually distributed from a qualified plan or arrangement, as defined in paragraph (a) of this section, is a distribution within the meaning of section 1411(c)(5), and thus is not included in net investment income. Examples include a rollover to an eligible retirement plan within the meaning of section 402(c)(8)(B), a distribution of a plan loan offset amount within the meaning of Q&A-13(b) of § 1.72(p)-1, and certain corrective distributions under the Internal Revenue Code (Code).
(2) Amounts treated as distributed. Any amount that is treated as distributed from a qualified plan or arrangement under the Code for purposes of income tax is a distribution within the meaning of section 1411(c)(5), and thus is not included in net investment income. Examples include a conversion to a Roth IRA described in section 408A and a deemed distribution under section 72(p).
(3) Amounts includible in gross income. Any amount that is not treated as a distribution but is otherwise includible in gross income pursuant to a rule relating to amounts held in a qualified plan or arrangement described in paragraph (a) of this section is a distribution within the meaning of section 1411(c)(5), and thus is not included in net investment income. For example, any income of the trust of a qualified plan or arrangement that is applied to purchase a participant's life insurance coverage (the P.S. 58 costs) is a distribution within the meaning of section 1411(c)(5), and thus is not included in net investment income.
(4) Amounts related to employer securities —(i) Dividends related to employer securities. Any dividend that is deductible under section 404(k) and is paid in cash directly to plan participants or beneficiaries is a distribution within the meaning of section 1411(c)(5), and thus is not included in net investment income. However, any amount paid as a dividend after the employer securities have been distributed from a qualified plan is not a distribution within the meaning of section 1411(c)(5), and thus is included in net investment income.
(ii) Amounts related to the net unrealized appreciation in employer securities. The amount of any net unrealized appreciation attributable to employer securities (within the meaning of section 402(e)(4)) realized on a disposition of those employer securities is a distribution within the meaning of section 1411(c)(5), and thus is not included in net investment income. However, any appreciation in value of the employer securities after the distribution from the qualified plan is not a distribution within the meaning of section 1411(c)(5), and is included in net investment income.
(c) Effective/applicability date. This section applies to taxable years beginning after December 31, 2013. However, taxpayers may apply this section to taxable years beginning after December 31, 2012, in accordance with § 1.1411-1(f).
§ 1.1411-9   Exception for self-employment income.
(a) General rule. Except as provided in paragraph (b) of this section, net investment income does not include any item taken into account in determining self-employment income that is subject to tax under section 1401(b) for such taxable year. For purposes of section 1411(c)(6) and this section, taken into account means income included and deductions allowed in determining net earnings from self-employment. However, amounts excepted in determining net earnings from self-employment under section 1402(a)(1)-(17), and thus excluded from self-employment income under section 1402(b), are not taken into account in determining self-employment income and thus may be included in net investment income if such amounts are described in § 1.1411-4. Except as provided in paragraph (b) of this section, if net earnings from self-employment consist of income or loss from more than one trade or business, all items taken into account in determining the net earnings from self-employment with respect to these trades or businesses (see § 1.1402(a)-2(c)) are considered taken into account in determining the amount of self-employment income that is subject to tax under section 1401(b) and therefore not included in net investment income.
(b) Special rule for traders. In the case of gross income described in §§ 1.1411-4(a)(1)(ii) and (a)(1)(iii) derived from a trade or business of trading in financial instruments or commodities (as described in § 1.1411-5(a)(2)), the deductions described in § 1.1411-4(f)(2)(ii) properly allocable to the taxpayer's trade or business of trading in financial instruments or commodities are taken into account in determining the taxpayer's self-employment income only to the extent that such deductions reduce the taxpayer's net earnings from self-employment (after aggregating under § 1.1402(a)-2(c) the net earnings from self-employment from any trade or business carried on by the taxpayer as an individual or as a member of a partnership). Any deductions described in § 1.1411-4(f)(2)(ii) that exceed the amount of net earnings from self-employment, in the aggregate (if applicable), are allowed in determining the taxpayer's net investment income under section 1411 and the regulations thereunder.
(c) Examples. The following examples illustrate the provisions of this section. For purposes of these examples, assume the taxpayer is a United States citizen, uses a calendar taxable year, and Year 1 and all subsequent years are taxable years in which section 1411 is in effect:
(d) Effective/applicability date. This section applies to taxable years beginning after December 31, 2013. However, taxpayers may apply this section to taxable years beginning after December 31, 2012, in accordance with § 1.1411-1(f).
§ 1.1411-10   Controlled foreign corporations and passive foreign investment companies.
(a) In general. This section provides rules that apply to an individual, estate, or trust that is a United States shareholder of a controlled foreign corporation (CFC), or that is a United States person that directly or indirectly owns an interest in a passive foreign investment company (PFIC). In addition, this section provides rules that apply to an individual, estate, or trust that owns an interest in a domestic partnership or an S corporation that is either a United States shareholder of a CFC or that has made an election under section 1295 to treat a PFIC as a qualified electing fund (QEF). References in this section to an election under paragraph (g) of this section being in effect relate to an election that is applicable to the person that is determining the section 1411 consequences with respect to holding a particular CFC or QEF.
(b) Amounts derived from a trade or business described in § 1.1411-5 —(1) In general. Except as provided in paragraph (b)(2) of this section, an amount included in gross income under section 951(a) or section 1293(a) that is also income derived from a trade or business described in section 1411(c)(2) and § 1.1411-5 (applying the relevant rules in § 1.1411-4(b)) is taken into account as net investment income under section 1411(c)(1)(A)(ii) and § 1.1411-4(a)(1)(ii) for purposes of section 1411 and the regulations thereunder when it is taken into account for purposes of chapter 1, and the rules in paragraphs (c) through (g) of this section do not apply to that amount. For purposes of section 1411 and the regulations thereunder, an amount included in gross income under section 1296(a) that is also income derived from a trade or business described in section 1411(c)(2) and § 1.1411-5 (applying the relevant rules in § 1.1411-4(b)), is net investment income within the meaning of section 1411(c)(1)(A)(ii) and § 1.1411-4(a)(1)(ii), and the rules in paragraph (c)(2)(ii) of this section do not apply to that amount.
(2) Coordination rule for changes in trade or business status. With respect to stock of a CFC or QEF for which an election under paragraph (g) of this section is not in effect, the rules in paragraphs (c) through (f) of this section apply to a distribution of earnings and profits described in paragraph (c)(1)(i)(A) of this section that was not taken into account as net investment income under paragraph (b) of this section.
(c) Calculation of net investment income —(1) Dividends. For purposes of section 1411(c)(1)(A)(i) and § 1.1411-4(a)(1)(i), net investment income is calculated by taking into account the amount of dividends described in this paragraph (c)(1).
(i) Distributions of previously taxed earnings and profits —(A) Rules when an election under paragraph (g) of this section is not in effect with respect to the shareholder —( 1 ) General rule. Except as otherwise provided in this paragraph (c)(1)(i), with respect to stock of a CFC or QEF for which an election under paragraph (g) of this section is not in effect, a distribution of earnings and profits that is not treated as a dividend for chapter 1 purposes under section 959(d) or section 1293(c) is a dividend for purposes of section 1411(c)(1)(A)(i) and § 1.1411-4(a)(1)(i) if the distribution is attributable to amounts that are or have been included in gross income for chapter 1 purposes under section 951(a) or section 1293(a) in a taxable year beginning after December 31, 2012. Solely, for this purpose, distributions of earnings and profits attributable to amounts that are or have been included in gross income for chapter 1 purposes under section 951(a) or section 1293(a) are considered first attributable to those earnings and profits, if any, derived from the current taxable year, and then from prior taxable years beginning with the most recent prior taxable year, and with respect to amounts included under section 951(a), without regard to whether the earnings and profits are described in section 959(c)(1) or section 959(c)(2).
( 2 ) Exception for distributions attributable to earnings and profits previously taken into account for purposes of section 1411. A distribution of earnings and profits that is not treated as a dividend for chapter 1 purposes under section 959(d) or section 1293(c) is not treated as a dividend for purposes of section 1411(c)(1)(A)(i) and § 1.1411-4(a)(1)(i), to the extent that an individual, estate, or trust establishes, by providing information that is similar to, and in the same manner as, the information described in § 1.959-1(d) (relating to previously taxed earnings and profits), that the distribution is attributable to—
( i ) Amounts included in gross income by any person for chapter 1 purposes under section 951(a) or section 1293(a) that have been taken into account by any person as net investment income by reason of paragraph (b) of this section or an election under paragraph (g) of this section; or
( ii ) Amounts included in gross income by any person as a dividend pursuant to section 1248(a) that, by reason of paragraph (c)(3)(ii) of this section, have been taken into account by any person as net investment income under section 1411(c)(1)(A)(i) and § 1.1411-4(a)(1)(i).
(B) Rule when an election under paragraph (g) of this section is in effect with respect to the shareholder. Except as otherwise provided in this paragraph (c)(1)(i), if an election under paragraph (g) of this section is in effect, a distribution of earnings and profits that is not treated as a dividend for chapter 1 purposes under section 959(d) or section 1293(c) is not treated as a dividend for purposes of section 1411(c)(1)(A)(i) and § 1.1411-4(a)(1)(i).
(C) Special rule for certain distributions related to 2013 taxable years —( 1 ) Scope. The rule in this paragraph (c)(1)(i)(C) applies to individuals, estates, and trusts that were subject to section 1411 during a taxable year that began after December 31, 2012, and before January 1, 2014, and that satisfy all of the conditions set forth in paragraph (c)(1)(i)(C)( 2 ) of this section. This rule also applies to all domestic partnerships and S corporations that satisfy all of the conditions set forth in paragraph (c)(1)(i)(C)( 2 ) of this section.
( 2 ) Rule. A distribution of earnings and profits from a CFC or QEF, with respect to which an election under paragraph (g) is in effect, that is not treated as a dividend for chapter 1 purposes under section 959(d) or section 1293(c) is a dividend for purposes of section 1411(c)(1)(A)(i) and § 1.1411-4(a)(1)(i) to the extent that—
( i ) The distribution of earnings and profits is attributable to an amount included by an individual, estate, trust, domestic partnership, S corporation or common trust fund in gross income for chapter 1 purposes under section 951(a) or section 1293(a) with respect to the CFC or QEF for a taxable year that began after December 31, 2012, and before January 1, 2014;
( ii ) The individual, estate, trust, domestic partnership, S corporation, or common trust fund made the election under paragraph (g) of this section with respect to the CFC or QEF in a taxable year that began after December 31, 2013; and
( iii ) The individual, estate, trust, domestic partnership, S corporation, or common trust fund did not make the election described in paragraph (g)(4)(iii) of this section (concerning making an election under paragraph (g) of this section for a taxable year that begins before January 1, 2014).
( 3 ) Ordering rule. Solely, for purposes of this paragraph (c)(1)(i)(C)( 3 ), distributions of earnings and profits attributable to amounts that have been included in gross income for chapter 1 purposes under section 951(a) or section 1293(a) are considered first attributable to the earnings and profits derived from a taxable year that began after December 31, 2012, and before January 1, 2014.
(ii) Excess distributions that constitute dividends. To the extent an excess distribution within the meaning of section 1291(b) constitutes a dividend within the meaning of section 316(a), the amount is included in net investment income for purposes of section 1411(c)(1)(A)(i) and § 1.1411-4(a)(1)(i).
(2) Net gain. For purposes of section 1411(c)(1)(A)(iii) and § 1.1411-4(a)(1)(iii), the rules in this paragraph (c)(2) apply in determining net gain attributable to the disposition of property.
(i) Gains treated as excess distributions. Gains treated as excess distributions under section 1291(a)(2) are included in determining net gain attributable to the disposition of property for purposes of section 1411(c)(1)(A)(iii) and § 1.1411-4(a)(1)(iii).
(ii) Inclusions and deductions with respect to section 1296 mark to market elections. Amounts included in gross income under section 1296(a)(1) and amounts allowed as a deduction under section 1296(a)(2) are taken into account in determining net gain attributable to the disposition of property for purposes of section 1411(c)(1)(A)(iii) and § 1.1411-4(a)(1)(iii).
(iii) Gain or loss attributable to the disposition of stock of CFCs and QEFs. With respect to stock of a CFC or QEF for which an election under paragraph (g) of this section is not in effect, for purposes of calculating the net gain under §§ 1.1411-4(a)(1)(iii) and 1.1411-4(d) that is attributable to the direct or indirect disposition of that stock (including for purposes of determining gain or loss on the direct or indirect disposition of that stock by a domestic partnership, S corporation, or common trust fund), basis is determined in accordance with the provisions of paragraph (d) of this section.
(iv) Gain or loss attributable to the disposition of interests in domestic partnerships or S corporations that own directly or indirectly stock of CFCs or QEFs. With respect to stock of a CFC or QEF for which an election under paragraph (g) of this section is not in effect, for purposes of calculating the net gain under §§ 1.1411-4(a)(1)(iii) and 1.1411-4(d) that is attributable to the disposition of an interest in a domestic partnership or S corporation that directly or indirectly owns that stock, basis is determined in accordance with the provisions of paragraph (d) of this section.
(3) Application of sections 1248 and 367(b). With respect to stock of a foreign corporation that is a CFC (or that was a CFC at any time during the 5-year period ending on the date of sale or exchange) or QEF for which an election under paragraph (g) of this section is not in effect, for purposes of section 1411 and § 1.1411-4—
(i) In determining the amount of gain recognized on the sale or exchange of stock of a foreign corporation under section 1248(a) or the amount of gain realized on the exchange of stock of a foreign corporation under § 1.367(b)-4 or 1.367(b)-5, basis is determined in accordance with the provisions of paragraph (d) of this section; and
(ii) Section 1248(a), and § 1.367(b)-2(c)(1) and (d)(2)(ii) apply without regard to the exclusions for certain earnings and profits under section 1248(d)(1) and (6), except that those exclusions will apply with respect to the earnings and profits of a foreign corporation that are attributable to:
(A) Amounts taken into account as net investment income under paragraph (b) of this section; and
(B) Amounts previously included in gross income for chapter 1 purposes under section 951(a) or section 1293(a) in a taxable year beginning before December 31, 2012, and that have not yet been distributed. For this purpose, the determination of whether earnings and profits that are attributable to amounts previously taxed in a taxable year beginning before December 31, 2012, have been distributed is determined based on the rules described in paragraph (c)(1)(i) of this section.
(4) Amounts distributed by an estate or trust. Net investment income of a beneficiary of an estate or trust includes the beneficiary's share of distributable net income, as described in sections 652 and 662 and as modified by paragraph (f) of this section, to the extent that the beneficiary's share of distributable net income includes items that, if they had been received directly by the beneficiary, would have been described in this paragraph (c).
(5) Properly allocable deductions —(i) General rule. For purposes of section 1411(c)(1)(B) and § 1.1411-4(f), the section 163(d)(1) investment expense deduction may be calculated by—
(A) Increasing the amount of investment income determined for chapter 1 purposes under section 163(d)(4)(B) by the amount of dividends described in § 1.1411-10(c) that are derived from a CFC or QEF with respect to which an election under paragraph (g) of this section is not in effect;
(B) Decreasing the amount of investment income determined for chapter 1 purposes under section 163(d)(4)(B) by the amount included in gross income for chapter 1 purposes under section 951(a) or section 1293(a) that is attributable to a CFC or QEF with respect to which an election under paragraph (g) of this section is not in effect; and
(C) Increasing or decreasing, as applicable, the amount of investment income for chapter 1 purposes under section 163(d)(4)(B) by the difference between the amount calculated with respect to a disposition under paragraphs (c)(2)(iii) and (c)(2)(iv) of this section and the amount of the gain or loss attributable to the relevant disposition as calculated for chapter 1 purposes.
(ii) Additional rules. For purposes of section 1411(c)(1)(B) and § 1.1411-4(f), if the method of calculation described in paragraph (c)(5)(i) of this section is applied:
(A) The amount of investment interest not allowed as a deduction under section 163(d)(2) must be calculated consistent with the method of calculation described in paragraph (c)(5)(i).
(B) The method of calculation must be adopted by an individual, estate, or trust no later than the first year in which the individual, estate, or trust is subject to section 1411.
(C) The method of calculation must be applied with respect to all CFCs and QEFs for all taxable years with respect to which an election under paragraph (g) of this section is not in effect.
(D) A method of calculation under this paragraph is a method of accounting, which must be applied consistently, and may only be changed by the taxpayer by securing the consent of the Commissioner in accordance with § 1.446-1(e) and following the administrative procedures issued under § 1.446-1(e)(3)(ii).
(d) Conforming basis adjustments —(1) Basis adjustments under sections 961 and 1293 —(i) Stock held by individuals, estates, or trusts. With respect to stock of a CFC or QEF which is held by an individual, estate, or trust, either directly or indirectly through one or more entities each of which is foreign, for which an election under paragraph (g) of this section is not in effect—
(A) The basis increases made pursuant to sections 961(a) and 1293(d) for amounts included in gross income for chapter 1 purposes under sections 951(a) and 1293(a) in taxable years beginning after December 31, 2012, are not taken into account for purposes of section 1411 and the regulations thereunder; and
(B) The basis decreases made pursuant to sections 961(b) and 1293(d) attributable to amounts treated as dividends for purposes of section 1411 under paragraph (c)(1)(i) of this section are not taken into account for purposes of section 1411 and the regulations thereunder.
(ii) Stock held by domestic partnerships or S corporations —(A) Rule when an election under paragraph (g) of this section is not in effect. The rules of this paragraph (d)(1)(ii)(A) apply with respect to stock of a CFC or QEF held directly by a domestic partnership or S corporation, or indirectly through one or more entities each of which is foreign, for which an election under paragraph (g) of this section is not in effect. If an individual, estate, or trust is a shareholder of an S corporation, or if an individual, estate, or trust directly, or through one or more tiers of passthrough entities (including an S corporation), owns an interest in a domestic partnership, the S corporation or domestic partnership, as the case may be, will not take into account for purposes of section 1411 and the regulations thereunder the basis increases made by the domestic partnership or S corporation pursuant to sections 961(a) and 1293(d) for amounts included in gross income for chapter 1 purposes under sections 951(a) and 1293(a) for taxable years beginning after December 31, 2012, and the basis decreases made by the domestic partnership or S corporation pursuant to sections 961(b) and 1293(d) attributable to amounts treated as dividends for purposes of section 1411 under paragraph (c)(1)(i) of this section (the section 1411 recalculated basis). If the domestic partnership or S corporation disposes of the stock of a CFC or QEF, the section 1411 recalculated basis will be used to determine the distributive share or pro rata share of the gain or loss for purposes of section 1411 for partners or shareholders.
(B) Rules when an election under paragraph (g) of this section is in effect. If an election under paragraph (g) of this section is in effect with respect to stock of a CFC or QEF held directly or indirectly by a domestic partnership or S corporation, the partner's distributive share or the shareholder's pro rata share of the gain or loss for purposes of section 1411 is the same as the distributive share or pro rata share of the gain or loss for purposes of chapter 1. See Example 6 of paragraph (h) of this section.
(2) Special rules for partners that own interests in domestic partnerships that own directly or indirectly stock of CFCs or QEFs. The rules of this paragraph (d)(2) apply with respect to stock of a CFC or QEF for which an election under paragraph (g) of this section is not in effect, and that is held by a domestic partnership, either directly or indirectly through one or more entities each of which is foreign. In such a case, the basis increases provided under section 705(a)(1)(A) to the partners for purposes of chapter 1 that are attributable to amounts that the domestic partnership includes or included in gross income under section 951(a) or section 1293(a) for a taxable year beginning after December 31, 2012, are not taken into account for purposes of section 1411. Instead, each partner's adjusted basis in the partnership interest is increased by its share of any distributions to the partnership from the CFC or QEF that are treated as dividends for purposes of section 1411 under paragraph (c)(1)(i) of this section. Similar rules apply when the stock of the CFC or QEF is held in a tiered partnership structure. For purposes of determining net investment income under section 1411 and the regulations thereunder, the partner's adjusted basis in the partnership interest as calculated under this paragraph (d)(2) is used to determine all tax consequences related to tax basis (for example, loss limitation rules and the characterization of partnership distributions).
(3) Special rules for S corporation shareholders that own interests in S corporations that own directly or indirectly stock of CFCs or QEFs. The rules of this paragraph (d)(3) apply with respect to stock of a CFC or QEF for which an election under paragraph (g) of this section is not in effect, and that is held by an S corporation, directly or indirectly through one or more entities each of which is foreign. In such case, the basis increases provided in section 1367(a)(1)(A) to its shareholders for chapter 1 purposes that are attributable to amounts that the S corporation includes or included in gross income for chapter 1 purposes under section 951(a) or section 1293(a) for taxable years beginning after December 31, 2012, are not taken into account for purposes of section 1411. Instead, each shareholder's adjusted basis of stock in the S corporation is increased by its share of the distributions to the S corporation from the CFC or QEF that are treated as dividends for purposes of section 1411 under paragraph (c)(1)(i) of this section. Similar rules apply when the S corporation holds an interest in a CFC or QEF through a partnership. For purposes of determining net investment income under section 1411 and the regulations thereunder, the shareholder's adjusted basis in the stock of the S corporation as calculated under this paragraph (d)(3) is used to determine all tax consequences related to tax basis (for example, loss limitation rules and the characterization of S corporation distributions).
(4) Special rules for participants in common trust funds. Rules similar to the rules in paragraphs (d)(2) and (3) of this section apply to ownership interests in common trust funds (as defined in section 584).
(5) Basis adjustments under section 367(b). With respect to stock of a foreign corporation that is exchanged in a transaction subject to section 367(b), the portion of the basis increase provided by § 1.367(b)-2(e)(3)(ii) by reason of paragraph (c)(3)(ii) of this section is made solely for purposes of section 1411.
(e) Conforming adjustments to modified adjusted gross income and adjusted gross income —(1) Individuals. Solely for purposes of section 1411(a)(1)(B)(i) and the regulations thereunder, the term modified adjusted gross income means modified adjusted gross income as defined in § 1.1411-2(c)(1)—
(i) Increased by amounts included in net investment income under paragraphs (c)(1)(i), (c)(1)(ii), (c)(2)(i), and (c)(4) of this section that are not otherwise included in gross income for chapter 1 purposes;
(ii) Increased or decreased, as applicable, by the difference between the amount calculated with respect to a disposition under paragraphs (c)(2)(iii) and (iv) of this section and the amount of the gain or loss attributable to the relevant disposition as calculated for chapter 1 purposes;
(iii) Decreased by any amount included in gross income for chapter 1 purposes under section 951(a) or section 1293(a) attributable to a CFC or QEF with respect to which no election under paragraph (g) of this section is in effect; and
(iv) To the extent the section 163(d)(1) investment interest expense deduction is calculated using the method of calculation set forth in paragraph (c)(5) of this section and the deduction is taken into account under § 1.1411-4(f)(2), increased or decreased, as appropriate, by the difference between the amount of the section 163(d)(1) investment interest expense deduction calculated under paragraph (c)(5) of this section and the amount calculated for chapter 1 purposes.
(2) Estates and trusts. Solely for purposes of section 1411(a)(2)(B)(i) and the regulations thereunder, the term adjusted gross income means adjusted gross income as defined in § 1.1411-3(a)(1)(ii)(B)( 1 ) adjusted by the following amounts to the extent those amounts are not distributed by the estate or trust—
(i) Increased by amounts included in net investment income under paragraphs (c)(1)(i), (c)(1)(ii), (c)(2)(i), and (c)(4) of this section that are not otherwise included in gross income for chapter 1 purposes;
(ii) Increased or decreased, as applicable, by the difference between the amount calculated with respect to a disposition under paragraphs (c)(2)(iii) and (iv) of this section and the amount of the gain or loss attributable to the relevant disposition as calculated for chapter 1 purposes;
(iii) Decreased by any amount included in gross income for chapter 1 purposes under section 951(a) or section 1293(a) attributable to a CFC or QEF with respect to which no election under paragraph (g) of this section is in effect; and
(iv) To the extent the section 163(d)(1) investment interest expense deduction is calculated using the method of calculation set forth in paragraph (c)(5) of this section and taken into account under § 1.1411-4(f)(2), increased or decreased, as appropriate, by the difference between the amount of the section 163(d)(1) investment interest expense deduction calculated under paragraph (c)(5) of this section and the amount calculated for chapter 1 purposes.
(f) Application to estates and trusts. All of the items described in paragraph (c) of this section are included in the net investment income of an estate or trust or its beneficiaries. The amounts described in paragraphs (e)(2)(i) through (iv) of this section, regardless of whether the estate or trust receives those amounts directly or indirectly through another estate or trust, increase or decrease, as applicable, the estate's or trust's distributable net income for purposes of section 1411. The estate or trust, or the beneficiaries thereof, must take those amounts into account in a manner reasonably consistent with the general operating rules for estates and trusts in § 1.1411-3 and subchapter J in computing the undistributed net investment income of the estate or trust and the net investment income of the beneficiaries.
(g) Election with respect to CFCs and QEFs —(1) Effect of election. If an election under paragraph (g) of this section is made with respect to a CFC or QEF, amounts included in gross income for chapter 1 purposes under section 951(a) or section 1293(a)(1)(A) with respect to the CFC or QEF in taxable years beginning with the taxable year for which the election is made are treated as net investment income for purposes of § 1.1411-4(a)(1)(i), and amounts included in gross income under section 1293(a)(1)(B) with respect to the QEF in taxable years beginning with the taxable year for which the election is made are taken into account in calculating net gain attributable to the disposition of property under § 1.1411-4(a)(1)(iii). See paragraphs (c)(1)(i)(B) and (c)(1)(i)(C) of this section for the effect of this election on certain distributions of previously taxed earnings and profits.
(2) Years to which election applies —(i) In general. An election under paragraph (g) of this section applies to the taxable year for which it is made and all subsequent taxable years, and applies to all subsequently acquired interests in the CFC or QEF. An election under paragraph (g) of this section is irrevocable.
(ii) Termination of interest in CFC or QEF. Complete termination of a person's interest in the CFC or QEF does not terminate the person's election under paragraph (g) of this section with respect to the CFC or QEF. Thus, if the person reacquires stock of the CFC or QEF, that stock is considered to be stock for which an election under paragraph (g) of this section has been made and is in effect.
(iii) Termination of partnership. If a domestic partnership that makes the election under paragraph (g) of this section is terminated pursuant to section 708(b)(1)(B), the election is binding on the new partnership.
(3) Who may make the election. An individual, estate, trust, domestic partnership, S corporation, or common trust fund may make an election under paragraph (g) of this section with respect to each CFC or QEF that it holds directly or indirectly through one or more entities, each of which is foreign. In addition, an individual, estate, trust, domestic partnership, S corporation, or common trust fund may make an election under paragraph (g) of this section with respect to a CFC or QEF that it holds indirectly through a domestic partnership, S corporation, estate, trust, or common trust fund if the domestic partnership, S corporation, estate, trust, or common trust fund does not make the election. The election, if made, for an estate or trust must be made by the fiduciary of that estate or trust.
(4) Time and manner for making the election —(i) Individuals, estates, and trusts —(A) General rule. Except as otherwise provided in this paragraph, in order for an election under paragraph (g) of this section by an individual, estate, or trust (other than a CRT) with respect to a CFC or QEF to be effective, the election must be made no later than the first taxable year beginning after December 31, 2013, during which the individual, estate, or trust—
( 1 ) Includes an amount in gross income for chapter 1 purposes under section 951(a) or section 1293(a) with respect to the CFC or QEF; and
( 2 ) Is subject to tax under section 1411 or would be subject to tax under section 1411 if the election were made with respect to the stock of the CFC or QEF.
(B) Special rule for charitable remainder trusts (CRTs). Except as otherwise provided in this paragraph, in order for an election under paragraph (g) of this section by a CRT with respect to a CFC or QEF to be effective, the election must be made no later than the first taxable year beginning after December 31, 2013, during which the CRT includes an amount in gross income for chapter 1 purposes under section 951(a) or section 1293(a) with respect to the CFC or QEF.
(ii) Certain domestic passthrough entities. Except as otherwise provided in this paragraph, in order for an election under paragraph (g) of this section by a domestic partnership, S corporation, or common trust fund with respect to a CFC or a QEF to be effective, the election must be made no later than the first taxable year beginning after December 31, 2013, during which the domestic partnership S corporation, or common trust fund—
(A) Includes an amount in gross income for chapter 1 purposes under section 951(a) or section 1293(a) with respect to the CFC or QEF; and
(B) Has a direct or indirect owner that is subject to tax under section 1411 or would be subject to tax under section 1411 if the election were made.
(iii) Taxable years that begin before January 1, 2014 —(A) Individuals, estates, or trusts. An individual, estate, or trust may make an election under paragraph (g) of this section for a taxable year that begins before January 1, 2014.
(B) Certain domestic passthrough entities. A domestic partnership, S corporation, or common trust fund may make an election under paragraph (g) of this section for a taxable year that begins before January 1, 2014, provided that all of its partners, shareholders, or participants, as the case may be, consent to the election. In the case of a partner, shareholder, or participant that is a partnership, S corporation, or common trust fund, all of the partners, shareholders, and participants also must consent to the election.
(iv) Time for making election. In all cases, the election under paragraph (g) of this section must be made in the manner prescribed by forms, instructions, or in other guidance on the individual's, estate's, trust's, domestic partnership's, S corporation's, or common trust fund's original or amended return for the taxable year for which the election is made. An election can be made on an amended return only if the taxable year for which the election is made, and all taxable years that are affected by the election, are not closed by the period of limitations on assessments under section 6501. An individual, estate, trust, domestic partnership, S corporation, or common trust fund may not seek an extension of time to make the election under any other provision of the law, including § 301.9100 of this chapter.
(h) Examples. The following examples illustrate the rules of this section. In each example, unless otherwise indicated, the individuals, the foreign corporation (FC), the QEF (QEF), and the partnership (PRS) use a calendar taxable year. Further, the gross income or gain with respect to an interest in FC is not derived in a trade or business described in § 1.1411-5.
(ii) Results for section 1411 purposes. In 2014, A does not include the $10,000 section 951(a) income inclusion in A's net investment income under section 1411(c)(1)(A)(i) and § 1.1411-4(a)(1)(i). Pursuant to paragraph (e)(1)(iii) of this section, A decreases A's modified adjusted gross income for section 1411 purposes by $10,000 in 2014, and pursuant to paragraph (d)(1)(i) of this section, A's adjusted basis is not increased by $10,000 and remains at $500,000. In 2015, pursuant to paragraph (c)(2)(i) of this section, A includes $10,000 of the distribution of previously taxed earnings and profits as a dividend for purposes of determining A's net investment income because $10,000 of the $30,000 distribution is attributable to amounts that A included in gross income for chapter 1 purposes under section 951(a) in a tax year that began after December 31, 2012. Pursuant to paragraph (e)(1)(i) of this section, A increases A's modified adjusted gross income for section 1411 purposes by $10,000 in 2015. Under paragraph (d)(1)(i) of this section, A's adjusted basis is not decreased by the $10,000 that is treated as a dividend for section 1411 purposes, and thus, A's adjusted basis in FC for section 1411 purposes is decreased under section 961 only by $20,000 to $480,000.
(ii) Results for section 1411 purposes. (A) In 2016, A does not include the $15,000 section 951(a)(1)(A) income inclusion in A's net investment income under section 1411(c)(1)(A)(i) and § 1.1411-1(a)(1)(i). Pursuant to paragraph (e)(1)(ii) of this section, A decreases A's modified adjusted gross income for section 1411 purposes by $15,000, and, pursuant to paragraph (d)(1)(i) of this section, A's adjusted basis remains at $480,000.
(B) During 2017, prior to the application of section 1248, A recognizes $70,000 ($550,000 minus $480,000) of gain for section 1411 purposes. Pursuant to paragraph (c)(3) of this section, for section 1411 purposes, section 1248(a) applies to the gain on the sale of FC calculated for section 1411 purposes ($70,000) and section 1248(d)(1) does not apply, except with respect to the $20,000 of earnings and profits of FC that are attributable to amounts previously included in income for chapter 1 purposes under section 951 for a taxable year beginning before December 31, 2012. Accordingly, for purposes of calculating the amount of income includible as a dividend under section 1248(a), A has $55,000 of earnings and profits, $20,000 of which is excluded pursuant to section 1248(d)(1). Therefore, after the application of section 1248, for section 1411 purposes A has $35,000 of long-term capital gain and a $35,000 dividend. For purposes of calculating net investment income in 2017, A includes $35,000 as a dividend under section 1411(c)(1)(A)(i) and § 1.1411-4(a)(1)(i) and $35,000 as a gain under section 1411(c)(1)(A)(iii) and § 1.1411-4(a)(1)(iii).
(ii) Results for section 1411 purposes. A does not have any adjustments to A's modified adjusted gross income for section 1411 purposes for 2014, 2015, 2016 or 2017 because the election under paragraph (g)(4)(i) of this section was timely made. Pursuant to paragraph (g)(2) of this section, for purposes of calculating A's net investment income in 2014, the $10,000 that A included in income for chapter 1 purposes under section 951(a) is net investment income for purposes of section 1411(c)(1)(A)(i) and § 1.1411-4(a)(1)(i). A has no amount of net investment income with respect to FC in 2015. Pursuant to paragraph (g)(2) of this section, for purposes of calculating A's net investment income in 2016, the $15,000 that A included in income for chapter 1 purposes under section 951(a) is net investment income for purposes of section 1411(c)(1)(A)(i) and § 1.1411-4(a)(1)(i). For purposes of calculating A's net investment income in 2017, the amount of gain on the disposition of the FC shares is the same as the amount calculated for chapter 1 purposes. Applying section 1248, A includes $35,000 as a gain under section 1411(c)(1)(A)(iii) and § 1.1411-4(a)(1)(iii), and $20,000 as a dividend under section 1411(c)(1)(A)(i) and § 1.1411-4(a)(1)(i).
(B) During 2014, PRS has income of $40,000 under section 1293(a) with respect to QEF and has no other partnership income. PRS does not make an election under paragraph (g) of this section.
(C) During 2015, QEF distributes $60,000 to PRS. PRS has no income for the year.
(ii) Results for 2014. (A) For chapter 1 purposes, as a result of the $40,000 income inclusion under section 1293(a), PRS's basis in its QEF stock is increased by $40,000 under section 1293(d)(1) to $120,000. Under § 1.1293-1(c)(1) and section 702, C's, D's, and E's distributive shares of the section 1293(a) income inclusion are $20,000, $10,000, and $10,000, respectively. Under section 705(a)(1)(A), C increases his adjusted basis in his partnership interest by $20,000 to $120,000, and D and E each increase his adjusted basis in his partnership interest by $10,000 to $60,000.
(B) For section 1411 purposes, pursuant to paragraph (d)(1)(ii) of this section, PRS's basis in QEF is not increased by the $40,000 income inclusion (it remains at $80,000). Because PRS did not make an election under paragraph (g) of this section, C, D and E do not have net investment income with respect to the income inclusion, and pursuant to paragraph (d)(2) of this section, they do not increase their adjusted bases in their interests in PRS (each remains at $50,000). Pursuant to paragraph (e)(1)(ii) of this section, C reduces his modified adjusted gross income by $20,000, and D and E each reduce their modified adjusted gross income by $10,000.
(iii) Results for 2015. (A) For chapter 1 purposes, the distribution of $60,000 from QEF to PRS is not a dividend under section 1293(c), and PRS decreases its basis in QEF by $60,000 under section 1293(d)(2) to $60,000.
(B) Pursuant to paragraph (c)(1)(i) of this section, $40,000 of the distribution is a dividend for section 1411 purposes because PRS included $40,000 in gross income for chapter 1 purposes under section 1293(a) in a tax year that began after December 31, 2012. For section 1411 purposes, pursuant to paragraph (d)(1)(ii) of this section, section 1293(d) will not apply to reduce PRS's basis in QEF to the extent of the $40,000 of the distribution that is treated as a dividend under paragraph (c)(2)(i) of this section. Thus, PRS's basis in QEF is decreased only by $20,000 for purposes of section 1411 and is $60,000. The $40,000 distribution of previously taxed earnings and profits that is treated as a dividend for section 1411 purposes is allocated $20,000 to C, $10,000 to D, and $10,000 to E. Because PRS did not make an election under paragraph (g) of this section, pursuant to paragraph (c)(2)(i) of this section, C has $20,000 of net investment income, and D and E each has $10,000 of net investment income as a result of the distribution by QEF, and pursuant to paragraph (d)(2) of this section, C increases his adjusted basis in PRS by $20,000 to $120,000, and D and E each increases his adjusted basis in PRS by $10,000 to $60,000. Pursuant to paragraph (e)(1)(i) of this section, C increases his modified adjusted gross income by $20,000, and D and E each increases his modified adjusted gross income by $10,000.
(ii) Results for 2016. For chapter 1 purposes, D has a gain of $40,000 ($100,000 minus $60,000). For section 1411 purposes, D has a gain of $40,000 ($100,000 minus $60,000), and thus, has net investment income of $40,000. No adjustments to modified adjusted gross income are necessary under paragraph (e) of this section.
(ii) Results for 2016. (A) For chapter 1 purposes, as a result of the $60,000 income inclusion under section 1293(a), PRS's basis in its QEF stock is increased by $60,000 under section 1293(d)(1) to $120,000. Under § 1.1293-1(c)(1) and section 702, C's, D's, and E's distributive shares of the section 1293(a) income inclusion are $30,000, $15,000, and $15,000 respectively. Under section 705(a)(1)(A), C increases his adjusted basis in his partnership interest by $30,000 to $150,000, and D and E each increases his adjusted basis in his partnership interest by $15,000 to $75,000.
(B) For section 1411 purposes, pursuant to paragraph (d)(1)(ii) of this section, PRS's basis in QEF is not increased by the $60,000 income inclusion (it remains at $60,000). Because PRS did not make an election under paragraph (g) of this section, C, D and E do not have net investment income with respect to the income inclusion, and pursuant to paragraph (d)(2) of this section, they do not increase their adjusted bases in their interests in PRS (C remains at $120,000, and D and E each remain at $60,000). Pursuant to paragraph (e)(1)(ii) of this section, C reduces his modified adjusted gross income by $30,000, and D and E each reduce their modified adjusted gross income by $15,000.
(iii) Results for 2017. (A) For chapter 1 purposes, PRS has a gain of $50,000 ($170,000 minus $120,000), which is allocated 50% ($25,000) to C, 25% ($12,500) to D, and 25% ($12,500) to E.
(B) Based on PRS's basis in the stock of QEF for section 1411 purposes, PRS has a gain for section 1411 purposes of $110,000 ($170,000 minus $60,000), which in the absence of an election by PRS under paragraph (g) of this section, results in gain of $55,000 to C, $27,500 to D, and $27,500 to E. Therefore, C has net investment income of $55,000, and D and E each have net investment income of $27,500. Pursuant to paragraph (e)(1)(ii) of this section, C increases his modified adjusted gross income by $30,000, and D and E each increase their modified adjusted gross income by $15,000.
(i) Effective/applicability date. This section applies to taxable years beginning after December 31, 2013. However, taxpayers may apply this section to taxable years beginning after December 31, 2012, in accordance with § 1.1411-1(f). Paragraph (c)(3) of this section, to the extent it references regulations issued under section 367(b), and paragraph (d)(5) of this section, apply to transactions completed on or after October 5, 2023, and to any transactions treated as completed before October 5, 2023, as a result of an entity classification election made under § 301.7701-3 of this chapter that is filed on or after October 5, 2023.
§ 1.1441-0   Outline of regulation provisions for section 1441.
This section lists captions contained in §§ 1.1441-1 through 1.1441-9.
(a) Purpose and scope.
(b) General rules of withholding.
(1) Requirement to withhold on payments to foreign persons.
(2) Determination of payee and payee's status.
(i) In general.
(ii) Payments to a U.S. agent of a foreign person.
(iii) Payments to wholly-owned entities.
(A) Foreign-owned domestic entity.
(B) Foreign entity.
(iv) Payments to a U.S. branch of certain foreign banks or foreign insurance companies.
(A) U.S. branch treated as a U.S. person in certain cases.
(B) Consequences to the withholding agent.
(C) Consequences to the U.S. branch.
(D) Definition of payment to a U.S. branch.
(E) Payments to other U.S. branches.
(v) Payments to a foreign intermediary.
(A) Payments treated as made to persons for whom the intermediary collects the payment.
(B) Payments treated as made to foreign intermediary.
(vi) Other payees.
(vii) Rules for reliably associating a payment with a withholding certificate or other appropriate documentation.
(A) Generally.
(B) Special rules applicable to a withholding certificate from a nonqualified intermediary or flow-through entity.
(C) Special rules applicable to a withholding certificate provided by a qualified intermediary that does not assume primary withholding responsibility.
(D) Special rules applicable to a withholding certificate provided by a qualified intermediary that assumes primary withholding responsibility under chapter 3 and chapter 4 of the Internal Revenue Code.
(E) Special rules applicable to a withholding certificate provided by a qualified intermediary that assumes primary Form 1099 reporting and backup withholding responsibility but not primary withholding under chapter 3 and chapter 4.
(F) Special rules applicable to a withholding certificate provided by a qualified intermediary that assumes primary withholding responsibility under chapter 3 and chapter 4 and primary Form 1099 reporting and backup withholding responsibility and a withholding certificate provided by a withholding foreign partnership or a withholding foreign trust.
(3) Presumptions regarding payee's status in the absence of documentation.
(i) General rules.
(ii) Presumptions of classification as individual, corporation, partnership, etc.
(A) In general.
(B) No documentation provided.
(C) Documentary evidence furnished for offshore obligation.
(iii) Presumption of U.S. or foreign status.
(A) Payments to exempt recipients.
( 1 ) In general.
( 2 ) Special rule for withholdable payments made to exempt recipients.
(B) Scholarships and grants.
(C) Pensions, annuities, etc.
(D) Payments with respect to offshore obligations.
(E) Certain payments for services.
(iv) Grace period.
(v) Special rules applicable to payments to foreign intermediaries.
(A) Reliance on claim of status as foreign intermediary.
(B) Beneficial owner documentation or allocation information is lacking or unreliable.
(vi) U.S. branches and territory financial institutions not treated as U.S. persons.
(vii) Joint payees.
(A) In general.
(B) Special rule for offshore obligations.
(viii) Rebuttal of presumptions.
(ix) Effect of reliance on presumptions and of actual knowledge or reason to know otherwise.
(A) General rule.
(B) Actual knowledge or reason to know that amount of withholding is greater than is required under the presumptions or that reporting of the payment is required.
(x) Examples.
(4) List of exemptions from, or reduced rates of, withholding under chapter 3 of the Code.
(5) Establishing foreign status under applicable provisions of chapter 61 of the Code.
(6) Rules of withholding for payments by a foreign intermediary or certain U.S. branches.
(i) In general.
(ii) Examples.
(7) Liability for failure to obtain documentation timely or to act in accordance with applicable presumptions.
(i) General rule.
(ii) Proof that tax liability has been satisfied.
(A) In general.
(B) Special rule for establishing that income is effectively connected with the conduct of a U.S. trade or business.
(iii) Liability for interest and penalties.
(iv) Special rule for determining validity of withholding certificate containing inconsequential errors.
(v) Special effective date.
(8) Adjustments, refunds, or credits of overwithheld amounts.
(9) Payments to joint owners.
(c) Definitions.
(1) Withholding.
(2) Foreign and U.S. person.
(i) In general.
(ii) Dual residents.
(3) Individual.
(i) Alien individual.
(ii) Nonresident alien individual.
(4) Certain foreign corporations.
(5) Financial institution and foreign financial institution (or FFI).
(6) Beneficial owner.
(i) General rule.
(ii) Special rules.
(A) General rule.
(B) Foreign partnerships.
(C) Foreign simple trusts and foreign grantor trusts.
(D) Other foreign trusts and foreign estates.
(7) Withholding agent.
(8) Person.
(9) Source of income.
(10) Chapter 3 of the Code (or chapter 3).
(11) Reduced rate.
(12) Payee.
(13) Intermediary.
(14) Nonqualified intermediary.
(15) Qualified intermediary.
(16) Withholding certificate.
(17) Documentary evidence; other appropriate documentation.
(18) Documentation.
(19) Payor.
(20) Exempt recipient.
(21) Non-exempt recipient.
(22) Reportable amounts.
(23) Flow-through entity.
(24) Foreign simple trust.
(25) Foreign complex trust.
(26) Foreign grantor trust.
(27) Partnership.
(28) Nonwithholding foreign partnership (or NWP).
(29) Withholding foreign partnership (or WP).
(30) Possession of the United States or U.S. territory.
(31) Amount subject to chapter 3 withholding.
(32) EIN.
(33) Flow-through withholding certificate.
(34) Foreign payee.
(35) Intermediary withholding certificate.
(36) Nonwithholding foreign trust (or NWT).
(37) Payment with respect to an offshore obligation.
(38) Permanent residence address.
(i) In general.
(ii) Hold mail instruction.
(39) Standing instructions to pay amounts.
(40) Territory financial institution.
(41) TIN.
(42) Withholding foreign trust (or WT).
(43) Certified deemed-compliant FFI.
(44) Chapter 3 withholding rate pool.
(45) Chapter 3 status.
(46) Chapter 4 of the Code (or chapter 4).
(47) Chapter 4 status.
(48) Chapter 4 withholding rate pool.
(49) Deemed-compliant FFI.
(50) GIIN (or Global Intermediary Identification Number).
(51) NFFE.
(52) Nonparticipating FFI.
(53) Participating FFI.
(54) Preexisting obligation.
(55) Registered deemed-compliant FFI.
(56) Withholdable payment.
(d) Beneficial owner's or payee's claim of U.S. status.
(1) In general.
(2) Payments for which a Form W-9 is otherwise required.
(3) Payments for which a Form W-9 is not otherwise required.
(4) When a payment to an intermediary or flow-through entity may be treated as made to a U.S. payee.
(e) Beneficial owner's claim of foreign status.
(1) Withholding agent's reliance.
(i) In general.
(ii) Payments that a withholding agent may treat as made to a foreign person that is a beneficial owner.
(A) General rule.
(B) Additional requirements.
(2) Beneficial owner withholding certificate.
(i) In general.
(ii) Requirements for validity of certificate.
(A) In general.
(B) Requirement to collect foreign TIN and date of birth.
( 1 ) In general.
( 2 ) Definitions.
( 3 ) Requirements for reasonable explanation of the absence of a foreign TIN.
( 4 ) Exceptions to the requirement to obtain a foreign TIN (or reasonable explanation for its absence).
( i ) Jurisdictions with which the United States does not have an agreement relating to the exchange of tax information.
( ii ) Jurisdictions that do not issue foreign TINs.
( iii ) Account holder that is a government, international organization, foreign central bank of issue, or resident of a U.S. territory.
( 5 ) Transition rules for the foreign TIN requirement for a beneficial owner withholding certificate signed before January 1, 2018.
( i ) Payments made before January 1, 2020.
( ii ) Payments made after December 31, 2019.
( iii ) Limitation on standard of knowledge.
( 6 ) Transition rule for the date of birth requirement for a beneficial owner withholding certificate signed before January 1, 2018.
(3) Intermediary, flow-through, or U.S. branch withholding certificate.
(i) In general.
(ii) Intermediary withholding certificate from a qualified intermediary.
(iii) Intermediary withholding certificate from a nonqualified intermediary.
(iv) Withholding statement provided by nonqualified intermediary.
(A) In general.
(B) General requirements.
(C) Content of withholding statement.
( 1 ) In general.
( 2 ) Nonqualified intermediary withholding statement for withholdable payments.
( 3 ) Alternative withholding statement.
( 4 ) Example.
(D) Alternative procedures.
( 1 ) In general.
( 2 ) Withholding rate pools.
( i ) In general.
( ii ) Withholding rate pools for .chapter 4 purposes.
( 3 ) Allocation information.
( 4 ) Failure to provide allocation information.
( 5 ) Cure provision.
( 6 ) Form 1042-S reporting in case of allocation failure.
( 7 ) Liability for tax, interest, and penalties.
( 8 ) Applicability to flow-through entities and certain U.S. branches.
(E) Notice procedures.
(v) Withholding certificate from certain U.S. branches (including territory financial institutions).
(vi) Reportable amounts.
(4) Applicable rules.
(i) Who may sign the certificate.
(A) In general.
(B) Electronic signatures.
(ii) Period of validity.
(A) General rule.
( 1 ) Withholding certificates and documentary evidence.
( 2 ) Documentary evidence for treaty claims and treaty statements.
(B) Indefinite validity period.
(C) Withholding certificate for effectively connected income.
(D) Change in circumstances.
( 1 ) Defined.
( 2 ) Obligation to notify a withholding agent of a change in circumstances.
( 3 ) Withholding agent's obligation with respect to a change in circumstances.
(iii) Retention of documentation.
(iv) Electronic transmission of information.
(A) In general.
(B) Requirements.
( 1 ) In general.
( 2 ) Same information as paper Form W-8.
( 3 ) Perjury statement and signature requirements.
( i ) Perjury statement.
( ii ) Electronic signature.
( 4 ) Requests for electronic Form W-8 data.
(C) Form 8233.
(D) Forms and documentary evidence received by facsimile or email.
(E) Third party repositories.
(F) Examples.
(1) Example 1.
(2) Example 2.
(3) Example 3.
(v) Additional procedures for certificates provided electronically.
(vi) Acceptable substitute form.
(vii) Requirement of taxpayer identifying number.
(viii) Reliance rules.
(A) Classification.
(B) Status of payee as an intermediary or as a person acting for its own account.
(C) Reliance on a prior version of a withholding certificate.
(ix) Certificates to be furnished to withholding agent for each obligation unless exception applies.
(A) Exception for certain branch or account systems or system maintained by agent.
(B) Reliance on certification provided by introducing brokers.
( 1 ) In general.
( 2 ) Example.
(C) Reliance on documentation and certifications provided between principals and agents.
( 1 ) Withholding agent as agent.
( 2 ) Withholding agent as principal.
(D) Reliance upon documentation for accounts acquired in merger or bulk acquisition for value.
(5) Qualified intermediaries.
(i) In general.
(ii) Definition of qualified intermediary.
(iii) Withholding agreement.
(A) In general.
(B) Terms of the withholding agreement.
(iv) Assignment of primary withholding responsibility.
(v) Withholding statement.
(A) In general.
(B) Content of withholding statement.
(C) Withholding rate pools.
( 1 ) In general.
( 2 ) Withholding rate pool requirements for a withholdable payment.
( 3 ) Alternative procedure for U.S. non-exempt recipients.
(D) Example.
(6) Qualified derivatives dealers.
(f) Effective/applicability date.
(1) In general.
(2) Lack of documentation for past years.
(3) Special rules related to section 871(m).
(a) In general.
(b) Fixed or determinable annual or periodical income.
(1) In general.
(i) Definition.
(ii) Manner of payment.
(iii) Determinability of amount.
(2) Exceptions.
(3) Original issue discount.
(i) Amount subject to tax.
(ii) Amounts subject to withholding.
(iii) Exceptions to withholding.
(4) Securities lending transactions and equivalent transactions.
(5) REMIC residual interests.
(6) Dividend equivalents.
(c) Other income subject to withholding.
(d) Exceptions to withholding where no money or property is paid or lack of knowledge.
(1) General rule.
(2) Cancellation of debt.
(3) Satisfaction of liability following underwithholding by withholding agent.
(4) Withholding exemption inapplicable.
(e) Payment.
(1) General rule.
(2) Income allocated under section 482.
(3) Blocked income.
(4) Special rules for dividends.
(5) Certain interest accrued by a foreign corporation.
(6) Payments other than in U.S. dollars.
(7) Payments of dividend equivalents.
(i) In general.
(ii) Payment.
(iii) Premiums and other upfront payments.
(f) Effective/applicability date.
(a) General rule.
(1) Withholding on gross amount.
(2) Coordination with chapter 4.
(b) Withholding on payments on certain obligations.
(1) Withholding at time of payment of interest.
(2) No withholding between interest payment dates.
(i) In general.
(ii) Anti-abuse rule.
(c) Corporate distributions.
(1) General rule.
(2) Exception to withholding on distributions.
(i) In general.
(ii) Reasonable estimate of accumulated and current earnings and profits on the date of payment.
(A) General rule.
(B) Procedures in case of underwithholding.
(C) Reliance by intermediary on reasonable estimate.
(D) Example.
(3) Special rules in the case of distributions from a regulated investment company.
(i) General rule
(ii) Reliance by intermediary on reasonable estimate.
(4) Coordination with withholding under section 1445.
(i) In general.
(A) Withholding under section 1441.
(B) Withholding under both sections 1441 and 1445.
(C) Coordination with REIT/QIE withholding.
(ii) Intermediary reliance rule.
(d) Withholding on payments that include an undetermined amount of income.
(1) In general.
(2) Withholding on certain gains.
(e) Payments other than in U.S. dollars.
(1) In general.
(2) Payments in foreign currency.
(f) Tax liability of beneficial owner satisfied by withholding agent.
(1) General rule.
(2) Example.
(g) Conduit financing arrangements
(1) Duty to withhold.
(2) Effective date.
(h) Dividend equivalents.
(1) Withholding on gross amount.
(2) Reliance by withholding agent on reasonable determinations.
(3) Effective/applicability date.
(i) Effective/applicability date.
(a) Certain income connected with a U.S. trade or business.
(1) In general.
(2) Withholding agent's reliance on a claim of effectively connected income.
(i) In general.
(ii) Special rules for U.S. branches of foreign persons.
(A) U.S. branches of certain foreign banks or foreign insurance companies.
(B) Other U.S. branches.
(3) Income on notional principal contracts.
(i) General rule.
(ii) Exception for certain payments.
(iii) Exception for specified notional principal contracts.
(b) Compensation for personal services of an individual.
(1) Exemption from withholding.
(2) Manner of obtaining withholding exemption under tax treaty.
(i) In general.
(ii) Withholding certificate claiming withholding exemption.
(iii) Review by withholding agent.
(iv) Acceptance by withholding agent.
(v) Copies of Form 8233.
(3) Withholding agreements.
(4) Final payment exemption.
(5) Requirement of return.
(6) Personal exemption.
(i) In general.
(ii) Multiple exemptions.
(iii) Special rule where both certain scholarship and compensation income are received.
(c) Special rules for scholarship and fellowship income.
(1) In general.
(2) Alternate withholding election.
(d) Annuities received under qualified plans.
(e) Per diem of certain alien trainees.
(f) Failure to receive withholding certificates timely or to act in accordance with applicable presumptions.
(g) Effective/applicability date.
(a) In general.
(b) Rules applicable to U.S. partnerships, trusts, and estates.
(1) Payments to U.S. partnerships, trusts, and estates.
(2) Withholding by U.S. payees.
(i) U.S. partnerships.
(A) In general.
(B) Effectively connected income of partners.
(ii) U.S. simple trusts.
(iii) U.S. complex trusts and U.S. estates.
(iv) U.S. grantor trusts.
(v) Subsequent distribution.
(vi) Coordination with chapter 4 requirements for U.S. partnerships, trusts, and estates.
(c) Foreign partnerships.
(1) Determination of payee.
(i) Payments treated as made to partners.
(ii) Payments treated as made to the partnership.
(iii) Rules for reliably associating a payment with documentation.
(iv) Coordination with chapter 4 for payments made to foreign partnerships.
(v) Examples.
(2) Withholding foreign partnerships.
(i) Reliance on claim of withholding foreign partnership status.
(ii) Withholding agreement.
(iii) Withholding responsibility.
(iv) Withholding certificate from a withholding foreign partnership.
(3) Nonwithholding foreign partnerships.
(i) Reliance on claim of foreign partnership status.
(ii) Reliance on claim of reduced withholding by a partnership for its partners.
(iii) Withholding certificate from a nonwithholding foreign partnership.
(iv) Withholding statement provided by nonwithholding foreign partnership and coordination with chapter 4.
(v) Withholding and reporting by a foreign partnership.
(d) Presumption rules.
(1) In general.
(2) Determination of partnership status as U.S. or foreign in the absence of documentation.
(3) Determination of partners' status in the absence of certain documentation.
(4) Determination by a withholding foreign partnership of the status of its partners.
(e) Foreign trusts and estates.
(1) In general.
(2) Payments to foreign complex trusts and foreign estates.
(3) Payees of payments to foreign simple trusts and foreign grantor trusts.
(i) Payments for which beneficiaries and owners are payees.
(ii) Payments for which trust is payee.
(iii) Coordination with chapter 4 for payments made to foreign simple trusts and foreign grantor trusts.
(4) Reliance on claim of foreign complex trust or foreign estate status.
(5) Foreign simple trust and foreign grantor trust.
(i) Reliance on claim of foreign simple trust or foreign grantor trust status.
(ii) Reliance on claim of reduced withholding by a foreign simple trust or foreign grantor trust for its beneficiaries or owners.
(iii) Withholding certificate from foreign simple trust or foreign grantor trust.
(iv) Withholding statement provided by foreign simple trust or foreign grantor trust and coordination with chapter 4.
(v) Withholding foreign trusts.
(6) Presumption rules.
(i) In general.
(ii) Determination of status as U.S. or foreign trust or estate in the absence of documentation.
(iii) Determination of beneficiary or owner's status in the absence of certain documentation.
(f) Failure to receive withholding certificate timely or to act in accordance with applicable presumptions.
(g) Effective/applicability date.
(a) In general.
(b) Reliance on claim of reduced withholding under an income tax treaty.
(1) In general.
(i) Identification of limitation on benefits provisions.
(ii) Reason to know based on existence of treaty.
(2) Payment to fiscally transparent entity.
(i) In general.
(ii) Certification by qualified intermediary.
(iii) Dual treatment.
(iv) Examples.
(3) Certified TIN.
(4) Claim of benefits under an income tax treaty by a U.S. person.
(c) Exemption from requirement to furnish a taxpayer identifying number and special documentary evidence rules for certain income.
(1) General rule.
(2) Income to which special rules apply.
(3) Certificate of residence.
(4) Documentary evidence establishing residence in the treaty country.
(i) Individuals.
(ii) Persons other than individuals.
(5) Statements regarding entitlement to treaty benefits.
(i) Statement regarding conditions under a limitation on benefits provision.
(ii) Statement regarding whether the taxpayer derives the income.
(d) Joint owners.
(e) Competent authority.
(f) Failure to receive withholding certificate timely.
(g) Special taxpayer identifying number rule for certain foreign individuals claiming treaty benefits.
(1) General rule.
(2) Special rule.
(3) Requirement that an ITIN be requested during the first business day following payment.
(4) Definition of unexpected payment.
(5) Examples.
(h) Dividend equivalents.
(i) Effective/applicability dates.
(1) General rule.
(2) Dividend equivalents.
(a) Withholding agent defined.
(1) In general.
(2) Withholding agent with respect to dividend equivalents.
(3) Examples.
(4) Effective/applicability date.
(b) Standards of knowledge.
(1) In general.
(2) Reason to know.
(3) Financial institutions—limits on reason to know.
(i) In general.
(ii) Limits on reason to know for preexisting obligations.
(4) Rules applicable to withholding certificates.
(i) In general.
(ii) Examples.
(5) Withholding certificate—establishment of foreign status.
(i) Classification of U.S. status, U.S. address, or U.S. telephone number.
(ii) U.S. place of birth.
(iii) Standing instructions with respect to offshore obligations.
(6) Withholding certificate—claim of reduced rate of withholding under treaty.
(i) Permanent residence address.
(ii) Mailing address.
(iii) Standing instructions.
(7) Documentary evidence.
(8) Documentary evidence—establishment of foreign status.
(i) Documentary evidence received prior to January 1, 2001.
(ii) Documentary evidence received after December 31, 2000.
(A) Treatment of individual's foreign status.
(B) Presumption of entity's foreign status.
(iii) U.S. place of birth.
(iv) Standing instructions with respect of offshore obligations.
(9) Documentary evidence—claim of reduced rate of withholding under treaty.
(i) Permanent residence address and mailing address.
(ii) Standing instructions.
(10) Indirect account holders.
(11) Limits on reason to know for multiple obligations belonging to a single person.
(12) Reasonable explanation supporting claim of foreign status.
(13) Additional guidance.
(c) Agent.
(1) In general.
(2) Authorized agent.
(3) Liability of withholding agent acting through an agent.
(d) United States obligations.
(e) Assumed obligations.
(f) Conduit financing arrangements.
(1) Liability of withholding agent.
(2) Exception for withholding agents that do not know of conduit financing arrangement.
(i) In general.
(ii) Examples.
(g) Effective/applicability date.
(a) Foreign governments.
(b) Reliance on claim of exemption by foreign government.
(c) Income of a foreign central bank of issue or the Bank for International
Settlements.
(1) Certain interest income.
(2) Bankers' acceptances.
(d) Exemption for payments to international organizations.
(e) Failure to receive withholding certificate timely and other applicable procedures.
(f) Effective date.
(1) In general.
(2) Transition rules.
(a) Exemption from withholding for exempt income.
(b) Reliance on foreign organization's claim of exemption from withholding.
(1) General rule.
(2) Withholding certificate.
(3) Presumptions in the absence of documentation.
(4) Reason to know.
(c) Failure to receive withholding certificate timely and other applicable procedures.
(d) Effective date.
(1) In general.
(2) Transition rules.
(a) In general.
(b) Exception.
(c) Liability.
(d) Examples.
(e) Effective date.