Monday, May 10, 2021
In Chief Counsel Advice 202118009 the IRS addresses an interesting question: "Whether tax dividends received by a shareholder who is also employed by the C corporation is subject to the net investment income tax, as well as if the answer changes if the corporation is closely held."
Net Investment Income Under IRC §1411
IRC §1411, which was added to The Affordable Care Act, "imposes a tax on the lesser of the net investment income of a taxpayer or the taxpayer's adjusted gross income in excess of threshold amounts that vary by filing status."
This "net investment income" includes gross income from dividends apart from those that are the result of the ordinary course of a trade or business. (IRC §1411(c)(1)).
The situation that is addressed by the IRS is quoted below:
The Taxpayer is a shareholder in a C corporation. It was determined under examination that the corporation paid Taxpayer’s personal expenses from corporate accounts, and the payments were reclassified as dividend income paid to the Taxpayer by the corporation. The Taxpayer is also an employee of the corporation and is involved in the day-to-day operations of the corporation’s manufacturing trade or business. The facts further indicate that the corporation may be a closely-held corporation within the meaning of § 469(h)(1) as described in § 465(a)(1)(B) (the Taxpayer appears to own a majority of the shares of the corporation). The Taxpayer contends that because the Taxpayer materially participates in the manufacturing trade or business of the corporation as an employee, the dividend income that the Taxpayer received from the corporation is not subject to tax under § 1411, because the dividend income is derived in the ordinary course of a trade or business that is not a passive activity of the Taxpayer within the meaning of § 469
The deeper question is, under IRC §1411(c)(1), if a taxpayer is involved in day to day operations of the corporation whether the dividend income is removed from the investment income category found in (c)(1), or whether the dividends retain their status as investment income, and are outside the scope of the ordinary course of a trade or business.
According to the IRS, employment does not change the nature of the dividends, meaning they retain their status as part of investment income.
For more information see, Ed Zollars, CPA, Dividends Received by an Employee of a Corporation are Still Part of Net Investment Income, Kaplan Financial Education: Current Federal Tax Developments, May 7, 2021.
Special thanks to Mark J. Bade (CPA, GCMA, St. Louis, Missouri) for bringing this article to my attention.