Unearned Income Medicare Contribution, Net Investment Income Tax (I.R.C. 1411)

January 31, 2013

General Overview of the Code Provision

I.R.C. 1411 imposes a new tax (in addition to other taxes imposed under subtitle A [Income Taxes]) on individuals for each taxable year equal to 3.8 percent of the lesser of (A) net investment income (NII) for the taxable year, or (B) the difference between MAGI for the taxable year and the “threshold amount” (generally, $250,000 for taxpayers making a joint return, $200,000 for others).  A similar 3.8 percent tax also applies to estates and trusts.  The tax is based on a slightly different base, as described in I.R.C. 1411(a)(2).  The tax went into effect for the tax year beginning January 1, 2013.

The tax under I.R.C. 1411 was left undisturbed by the passage of the Tax Cuts and Jobs Act of 2017.

The tax does not apply to nonresident aliens.  See I.R.C. 1411(e)(1).

Net investment income (NII) is the difference between (A) “Investment Income” and (B) deductions allowed under subtitle A which are properly allocable to the Investment Income.

From Perkins & Co

From Perkins & Co (visit site for more information)

I’ve used the term “Investment Income” as a placeholder to describe the gross income or net gain items listed below.  The Code, however, does not use this term.

  1. Gross income from interest, dividends, annuities, royalties and rents (but not such income that is derived in the ordinary course of a trade or business that is not and Applicable Trade or Business – another placeholder that is defined below);
  2. Other gross income derived from an Applicable Trade or Business; and
  3. Net gain attributable to the disposition of property other than property held in the trade or business that is not an Applicable Trade or Business (and only to the extent the net gain was taken into account in computing taxable income).  

Therefore, with respect to bonds, it should be noted that NII from interest on taxable bonds is included and is subject to the tax.

An “Applicable Trade or Business” is the “suspect” activity giving rise to NII tax.  An Applicable Trade or Business is a trade or business that (a) is a passive activity (within the meaning of I.R.C. 469) with respect to the taxpayer, or (b) is a trade or business of trading in financial instruments or commodities.

There is a special rule for determining whether income on investment of working capital is NII.  See I.R.C. 1411(c)(3) and I.R.C. 469(e)(1)(B).

There is a special rule and exception for determining whether active interests in partnerships and S corporations are NII.  See I.R.C. 1411(c)(4).

There is a special rule and exception that excludes certain distributions from qualified plans from the definition of NII.  See I.R.C. 1411(c)(5).

There is a special rule for items taken into account in determining self-employment income on which a tax is imposed by I.R.C. 1401(b) (tax on self-employment income – hospital insurance).  See I.R.C. 1411(c)(6).

General Overview of the Proposed Regulations

The IRS issued proposed regulations under I.R.C. 1411 in December 2012 (REG-130507-11 and REG-130074-11).  The proposed regulations and the preamble address the matters described below.

The tax cannot be deducted in computing any other taxes imposed by subtitle A.

NII does not include:

  1. Operating income from nonpassive business;
  2. Social Security benefits;
  3. Alimony;
  4. Tax-exempt interest (mentioned in the preamble);
  5. Self-employment income;
  6. Alaska Permanent Fund Dividends; and
  7. Distributions from most qualified retirement plans.

Citizens United: First Amendment Right of Corporations and Unions

January 23, 2013

See “Assessing the Impact of Citizens United: What Does it Mean for My Corporation?” by McKenna Long & Aldridge LLP.

The Supreme Court’s holding in Citizens United v. FEC, 558 U.S. 310 (2010) leads to the following conclusions:

  • Corporations may now finance independent federal political advertising and other political contributions
  • Corporations and individuals may now finance tax-exempt groups to advocate in federal elections
  • Federal laws governing candidate contributions remain unchanged
  • Disclosure and disclaimer requirements remain unchanged
  • Groups of corporations now have the same rights as individuals



January 21, 2013

Tax Law History

See Sheldon D. Pollack, “Origins of the Modern Income Tax,” The Tax Lawyer, Vol. 66, No. 2 (Winter 2013)


See Edward J. Roche, “Federal Income Taxation of Medical Marijuana Businesses,” The Tax Lawyer, Vol. 66, No. 2 (Winter 2013), including matters relating to UNICAP, deductions for ordinary and necessary business expenses and the denial thereof under I.R.C. 280E.

Can bond counsel provide an exemption opinion with respect to interest if the interest rate may be increased as a result of increased bond lending costs? Some bond counsel prefer not to opine as to any portion of the interest rate that is adjusted in the event bank costs go up.  However, such adjustments may still be eligible for exemption if the adjustments reflect increased lending costs.  There does not appear to be consensus on how to address increased costs that are incorporated into the interest rate.

Excise Tax

January 7, 2013

General Discussion

An excise tax is an indirect tax on certain listed items.  Excise taxes are collected by the producer or retailer and are not paid directly by the consumer.  They are “hidden” in the price of the listed item.  Excise taxes may be levied by federal, state or local governments.  The authority to levy the federal excise tax stems from the U.S. Constitution, which provides that Congress has the power to “[…] lay and collect taxes, duties, imposts and excises, pay the debts and provide for the common defense and general welfare of the United States.”  In the U.S. constitutional law sense, an excise tax is essentially an event tax (as opposed to a state of being tax).  For instance, the ad valorem property is a state of being tax.

In the United States, the only taxes technically called excise taxes are the taxes on quantities of enumerated items.  Other events may be considered excise taxes but are seldom collected under that name.

An excise means any tax other than: (1) a property tax or ad valorem tax by reason of its ownership; (2) a tax per head tax or capitation tax by being present (very rare in the U.S.); (3) an income tax paid directly to the government on income; or (4) a sales tax which is paid on all sales except specifically exempted items.

Federal excise taxes are imposed under Subtitle D (Miscellaneous Excise Taxes) and Subtitle E (Alcohol, Tobacco and Certain Other Excise Taxes) of Title 26 of the United States Code.

Temporary periods in refundings (Treas. Reg. 1.148-9(d)) and Permitted Waivers (Treas. Reg. 1.148-9(g))

January 6, 2013

Treas. Reg. 1.148-9 contains special arbitrage rules for refunding issues. These rules apply for all purposes of section 148 and govern allocations of proceeds, bonds, and investments to determine transferred proceeds, temporary periods, reasonably required reserve or replacement funds, minor portions, and separate issue treatment of certain multipurpose issues.

Treas. Reg. 1.148-9(d) provides the following:

(d) Temporary periods in refundings—(1) In general. Proceeds of a refunding issue may be invested in higher yielding investments under section 148(c) only during the temporary periods described in paragraph (d)(2) of this section.

(2) Types of temporary periods in refundings. The available temporary periods for proceeds of a refunding issue are as follows:

(i) General temporary period for refunding issues. Except as otherwise provided in this paragraph (d)(2), the temporary period for proceeds (other than transferred proceeds) of a refunding issue is the period ending 30 days after the issue date of the refunding issue.

(ii) Temporary periods for current refunding issues—(A) In general. Except as otherwise provided in paragraph (d)(2)(ii)(B) of this section, the temporary period for proceeds (other than transferred proceeds) of a current refunding issue is 90 days.

(B) Temporary period for short-term current refunding issues. The temporary period for proceeds (other than transferred proceeds) of a current refunding issue that has an original term to maturity of 270 days or less may not exceed 30 days. The aggregate temporary periods for proceeds (other than transferred proceeds) of all current refunding issues described in the preceding sentence that are part of the same series of refundings is 90 days. An issue is part of a series of refundings if it finances or refinances the same expenditures for a particular governmental purpose as another issue.

(iii) Temporary periods for transferred proceeds—(A) In general. Except as otherwise provided in paragraph (d)(2)(iii)(B) of this section, each available temporary period for transferred proceeds of a refunding issue begins on the date those amounts become transferred proceeds of the refunding issue and ends on the date that, without regard to the discharge of the prior issue, the available temporary period for those proceeds would have ended had those proceeds remained proceeds of the prior issue.

(B) Termination of initial temporary period for prior issue in an advance refunding. The initial temporary period under § 1.148-2(e) (2) and (3) for the proceeds of a prior issue that is refunded by an advance refunding issue (including transferred proceeds) terminates on the issue date of the advance refunding issue.

(iv) Certain short-term gross proceeds. Except for proceeds of a refunding issue held in a refunding escrow, proceeds otherwise reasonably expected to be used to pay principal or interest on the prior issue, replacement proceeds not held in a bona fide debt service fund, and transferred proceeds, the temporary period for gross proceeds of a refunding issue is the 13-month period beginning on the date of receipt.

Treas. Reg. 1.148-9(g) provides the following:

(g) Certain waivers permitted. On or before the issue date, an issuer may waive the right to invest in higher yielding investments during any temporary period or as part of a reasonably required reserve or replacement fund. At any time, an issuer may waive the right to invest in higher yielding investments as part of a minor portion.

Upon election of the waiver in Treas. Reg. 1.148-9(g), an issuer may blend the investments of the sale proceeds of the Refunding Bonds, the transferred proceeds and the resulting investment proceeds for purposes of computing the rebate and yield reduction payments under I.R.C. 148.  The waiver may be helpful in refundings that will give rise to transferred proceeds which are invested at rates higher than the Refunding Bond yield.  See PLR 201150026 (September 7, 2011, released December 16, 2011) in which an issuer is granted an extension of the deadline for making the waiver election where the issuer’s refunding bonds gave rise to transferred proceeds that were not discovered until the refunding bonds were issued.

(Note, see 1.148-2(h) for waivers not in connection with refundings.)

Section 529 College Savings Plans

January 3, 2013

The MSRB regulates firms distributing or underwriting 529 college savings plans.  Section 529 college savings plans are mutual fund-like investment programs states have established under I.R.C. 529 to help families save for future higher education expenses.  See MSRB’s Revised 529 Plan Gains But Raises Concerns, The Bond Buyer (Jan. 3, 2013)

Section 529 plans are named after I.R.c. 529.  There are two types of 529 plans: (1) prepaid; and (2) savings.

Prepaid plans allow one to purchase tuition credits at today’s rates to be used in the future. Performance of this type of plan is therefore based upon tuition inflation.  Currently, twelve stated provide a prepaid tuition plan.  Prepaid plans may be administered by states or institutions of higher education.

Savings plans provide growth based on market performance of the underlying investments in the plan, which typically consist of mutual funds.  Savings plans may be administered only by states.  Record-keeping and administrative services for most savings plans are delegated to a mutual fund company or other financial services companies.

Most 529 savings plans offer a variety of age-based asset allocation option where the underlying investments become more conservative as the beneficiary gets closer to college age.

Qualified distributions from 529 plans for qualified higher education expenses are exempt from federal income tax.  Money from a 529 plan can be used for tuition, fees, books, supplies and equipment required for study at any accredited college, university of vocational school in the United States and at some foreign universities.  The money may also be used for room and board, as long as the fund beneficiary is at least a half-time student.

For a more detailed summary, see Wikipedia.org.

Private Foundations

January 1, 2013

Bond counsel’s opinion may rely on an opinion of borrower’s counsel regarding the tax-exempt status of a conduit borrower.  Frequently a paragraph such as the following is used to express reliance:

In rendering the opinion set forth in the first sentence of this paragraph, we have relied on the opinion of _______________________, counsel to the Borrower, that the Borrower has been determined to be an organization that is exempt from federal income taxation under Section 501(a) of the Internal Revenue Code of 1986, as amended (the “Code”), by virtue of being an organization described in Section 501(c)(3) of the Code, and is not a “private foundation” as defined in Section 509(a) of the Code, and to such counsel’s knowledge after due investigation, the Borrower has not failed to file a report with the Internal Revenue Service or engaged in conduct inconsistent with its status as an exempt organization.

Why is it important to bond counsel’s opinion that borrower’s counsel opine on the private foundation status of the borrower?

For purposes of I.R.C. 103 and 141-150, it is not relevant that a borrower is or is not a private foundation.  For business purposes and continuing compliance reasons, however, it may be helpful to clarify the status of the organization.  If it turns out that the borrower is a private foundation, this may be grounds for implementing stricter continuing compliance covenants or conducting more detailed tax due diligence to make sure the borrower has procedures in place to satisfy all of the special limitations applicable to private foundations.