Page 359 - TaxAdviser_2022

S CORPORATIONS

Reduction to net investment rental income, practitioners should con- Rev. Proc. 2021-52, Section 4.02(f), to
income: Under Regs. Sec. 1.1411-4(f), sider using the rules in the regulations avoid penalties.
above-the-line deductions are allowed under Sec. 1411 to allocate the PTE tax Timing of deduction: The notice
to reduce rental income and business using a reasonable method. is very clear that the PTE is allowed
income that is net investment income. Where to report: The notice in- the deduction in the year in which the
Under Sec. 62(a)(4), the deductions al- structs taxpayers to include the PTE tax payment is made. For cash-method
lowed to reduce rental income include in the partner’s or shareholder’s non- taxpayers, estimated state tax payments
taxes under Sec. 164. Therefore, the separately stated income or loss, i.e., line are deductible when paid, as long as the
PTE tax appears to reduce rental in- 1 of the Schedule K-1. However, if no taxpayer has a reasonable basis for belief
come for calculating the net investment disclosure is provided with the Schedule that the tax reflects a liability. This also
income tax, even though it will not be K-1, the partner or shareholder may not applies to advance payments, as long as
included in the passive activity income have enough information to take the the taxing authority accepts it as an ac-
of the rental. PTE deduction as a nonpassive deduc- tual payment and not merely a deposit.17
Similarly, Regs. Sec. 1.1411-4(f)(2)(ii) tion or to reduce rental income or trader Tax shelters are prohibited from
provides that deductions described in income. The partner or shareholder may using the cash method. Under the
Sec. 62(a)(1) allocable to a trade or busi- not have enough information to rechar- definition at Sec. 448,18 a partnership or
ness described in Regs. Sec. 1.1411-5 are acterize PTE tax allocable to investment S corporation with more than 35% of
taken into account in determining net income as an itemized deduction. Partic- losses for the year allocated to limited
investment income, to the extent they ularly in cases where there is more than partners or limited entrepreneurs is a
have not been taken into account for one type of income, it would be helpful “tax shelter.”
self-employment income. Under Regs. to identify the PTE tax amount so that An exception is provided under Sec.
Sec. 1.1411-5, a trade or business for it can be allocated appropriately. 1256(e)(3)(C) for an individual, who
net investment income tax is one that is In addition, under Regs. Sec. will not be considered as holding an
either a passive activity with respect to 1.702-1(a)(8) partnerships must sepa- interest in an entity as a limited partner
the taxpayers under Sec. 469 or is the rately state any item that, if separately or limited entrepreneur, if the individual
trade or business of a trader trading in taken into account by any partner, would or his or her spouse, children, grandchil-
financial instruments or commodities, result in a tax liability for that partner, or dren, or parents actively participated in
as defined in Regs. Sec. 1.1411-5(c). for any other person, different from that management for the year, the individual
Therefore, the PTE tax appears to person’s liability if the partner did not actively participated in management for
reduce passive business income and in- take the item into account separately. five years, and for estates of an individual
come of a trader. The rules for S corporations follow the who actively participated in manage-
However, for investment income, partnership rules.16 Because the PTE tax ment or whose spouse, children, grand-
above-the-line deductions do not reduce may be treated differently by passive and children, or parents at any time actively
net investment income. Only itemized nonpassive shareholders, it would seem participated in management. In addition,
deductions reduce net investment in- to be more appropriate to separately taxpayers can make an annual irrevoca-
come from interest, dividends, and capi- state the deduction. The notice does not ble election under Regs. Sec. 1.448-2(b)
tal gains. While the PTE payment may appear to contemplate this situation. (2)(iii)(B) to test for allocation of losses
be deductible as an itemized deduction If including the PTE tax on line.1, in the immediately preceding year rather
(and limited under Sec. 164(b)(6)), there practitioners may wish to consider in- than the current year’s allocation.
does not appear to be any advantage to cluding a statement with the Schedule If the exception described above
the PTE paying the PTE tax as op- K-1 disclosing the amount of the PTE does not apply and the election does not
posed to the shareholders paying the tax tax. If practitioners report on some other provide relief, a PTE falling into the tax
directly. The notice does not appear to line, such as “Other Deductions,” and shelter definition must use the accrual
contemplate the application of this rule disclose the character of the item, they method. Accrual-method taxpayers
to investment income. If the S corpora- may also wish to consider whether this are permitted to take deductions for
tion has both investment and business or disclosure meets the requirements of taxes under Sec. 461(h) and Regs. Sec.

16. See S. Rep’t No. 97-640, 97th Cong., 2d Sess. (1982) (P.L. 97-354). 18. Referencing Sec. 461(i)(3), which includes as a tax shelter any syndicate
17. See Rev. Rul. 82-208 and Rev. Rul. 71-190. as defined in Sec. 1256(e)(3)(B).

28 July 2022 The Tax Adviser