Material participation in a trade or business has long been an issue for purposes of Internal Revenue Code Section 469, which disallows passive activity losses for taxpayers who don’t “materially participate” in the business.

This issue has become much more significant with the introduction of a surtax under IRC Section 1411 (commonly referred to as the “Medicare Tax”), which imposes a tax of 3.8 percent on net investment income, which includes income derived from a trade or business that’s a passive activity (within the meaning of IRC Section 469) to the investor.

The IRC and regulations provide detailed guidance for determining whether an individual materially participates in a trade or business for purposes of Section 469.  However, there’s little guidance on what constitutes material participation with respect to a trust that owns an interest in a trade or business.  Frank Aragona Trust v. Commissioner has been pending in the Tax Court on precisely this issue.  The recent decision, which was published on March 27, 2014, was a big taxpayer victory that provides much needed guidance for trusts that own business interests.

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