I have a client that was a partner in a partnership that was bought out towards the end of 2020. He received about a million dollars from the buyout and his accounting department has said that the full million will be taxed at the long-term capital gain rate. We're trying to determine the appropriate estimated tax to make now. I suggested paying 110% of last year's tax and qualifying for safe harbor so he can sit on the 1MM for the next four months and make a few thousand dollars, but the client would rather make a payment now. I need to know if the NII tax applies in this situation. Is the million dollars subject to NII tax?
As a general rule, if the taxpayer Materially (or maybe "Significantly") Participated in the business, NIIT does not apply. So you may be able to Google the rules about that.
It has been several years since I looked into it, but I seem to recall that you need to MANUALLY adjust the NIIT form if it involves the sale of a business that the taxpayer Materially Participated in. Maybe they changed it since then, but just be aware it MIGHT require some MANUAL entry in ProSeries.
@timtax I'll add to Bill's response. It does get more complicated than that. Even though the exception rules were simplified when the proposed regulations were updated in 2013, analysis is still required because the extent to which the gain may be subject to NIIT would be determined as if the partnership had sold all its assets at FMV immediately prior to the disposition of the partner's interest.
Whether the gain/loss from the deemed sale is considered NII would, in turn, be dependent on, inter alia, whether the partner had materially participated in each of the partnership's ToB, whether the ToB is in the trading of financial instruments or commodities, and whether there are sale of assets (e.g. marketable securities) that may generate NII. Recognizing this could be onerous for partners (and S-corp shareholders) with minute interests in those PTEs, the not-so-new regulations also provides a simplified method for determining the extent to which gain/loss may be subject to NIIT provided certain thresholds are met.
You may like to take a look at Treas. Reg. 1.1411-7 for the details and examples.
Still an AllStar
You are a really really smart person and deserve that Obi Wan Kenobi picture by your name ! You are too smart to be a forum moderator here 🙂
I've been absolutely mentally annihilated with a client's sale of a partnership interest. I sent the client the final return yesterday. Luckily, before we filed it, I realized that he may meet this NIIT exception, which you just summarized really well. I've been researching this on the internet for a few hours, but you just managed to sum it up perfectly. Its great that I happened to see your post
Thanks for all your help. You rock !