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Thursday, January 07, 2010Passive Activity Loss
Revenue Notice 2010-13
Passive Activity Loss (PAL) groupings/regroupings must be reported to IRS
Effective for tax years beginning on or after Jan. 25, 2010
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Who does this affect? In general…..
-Taxpayers with many trades/ businesses that want to act as one economic unit;
-Trades/businesses that want to combine rental activities as one economic unit
-These new rules don't apply to the rental real estate activities of persons or entities who have made the election relating to real estate professionals.
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A new notice requires taxpayers to report to IRS their groupings and regroupings of activities and the addition of specific activities within their existing groupings of activities for purposes of the passive activity loss (PAL) rules. The new rules are effective for tax years beginning on or after Jan. 25, 2010.
Background. Deductions from passive trade or business activities, to the extent they exceed income from all such passive activities (exclusive of portfolio income), may not offset other income.
Disallowed losses and credits are treated as deductions and credits allocable to the activity in the next tax year (i.e. carried over)
Sometimes it is beneficial for taxpayers to group their passive activities together in order to materially participate and deduct the losses currently.
The PAL rules under IRS Code 469 are very complex and intertwined.
In general, once a taxpayer has grouped its activities, it can't regroup them in subsequent tax years. However, if IRS determines that a taxpayer's original grouping was clearly inappropriate, or if a material change in the facts and circumstances has occurred that makes the original grouping clearly inappropriate, the taxpayer must regroup the activities and must comply with the disclosure requirements that IRS may prescribe.
The new rules require a statement with specific information to be filed with respect to these events:
New groupings- A taxpayer must file a written statement with his original return for the first tax year in which two or more trade or business activities or rental activities are originally grouped as a single activity or as separate activities.
Addition of new activities to existing groupings- Whenever a taxpayer adds a new trade or business activity or a rental activity to an existing grouping within a tax year, he must file a written statement with his original return for the tax year in which the new trade or business activity or rental activity is added to the existing grouping. Besides other required information, the statement must contain a declaration that the activities constitute an appropriate economic unit for the measurement of gain or loss.
Regrouping- If it is determined that the taxpayer's original grouping was clearly inappropriate or a material change in the facts and circumstances has occurred that makes the original grouping clearly inappropriate, the taxpayer must regroup the activities and file a written statement with his original return for the tax year in which the regrouping occurs. For activities regrouped into a single activity, the statement must in addition to other required information contain: (1) a declaration that the regrouped activities constitute an appropriate economic unit for the measurement of gain or loss; and (2) an explanation of why the taxpayer's original grouping was determined to be clearly inappropriate or the nature of the material change in the facts and circumstances that makes the original grouping clearly inappropriate.
Where no reporting is required- Reporting isn't required for:
Partnerships and S corporations, which must instead comply with the disclosure instructions for grouping activities provided for on Form 1065, U.S. Return of Partnership Income and Form 1120S, U.S. Income Tax Return for an S Corporation, respectively. Generally, compliance with the applicable form requires disclosing the entity's groupings to the partner or shareholder by separately stating the amounts of income and loss for each grouping conducted by the entity on attachments to the entity's annual Schedule K-1.
Preexisting groupings, namely groupings of trade or business activities and rental activities that were made before Jan. 25, 2010 (but reporting will be required if the taxpayer makes a change to the grouping).
Failure to report- In general, if a taxpayer fails to report a grouping, then each trade or business activity or rental activity is treated as having been grouped as a separate activity for purposes of applying the passive activity loss and credit limitation rules. However, a timely disclosure is deemed to have been made by a taxpayer who has filed all affected income tax returns consistent with the claimed grouping of activities and makes the required disclosure on the income tax return for the year in which the failure to disclose is first discovered by the taxpayer. If the failure to disclose is first discovered by IRS, however, the taxpayer must also have reasonable cause for not making the required disclosures.
Circular 230 Notice: IRS regulations require us to advise you that, unless otherwise specifically noted, any federal tax advice in this communication (including any attachments, enclosures, or other accompanying materials) was not intended or written to be used, by any taxpayer for the purpose of avoiding tax-related penalties imposed under the U.S. Internal Revenue Code or any other applicable state or local tax law provision; furthermore, this communication was not intended or written to support the promoting, marketing or recommending of any of the transactions or matters it addresses.
Greg Nelson, CPA, MBT
Principal
Olsen Thielen CPAs & Consultants
952.941.9242
