Category: ObamaCare taxes

The Hedge Fund Medicare Tax Gap: Can Active Limited Partners Avoid SE Tax and NIIT?

November 17, 2025 | By: Robert A. Green, CPA | Read it on

Editor’s note: This article was first published on Nov. 17, 2025. Since then, the Fifth Circuit has issued two opinions addressing the limited-partner exception to self-employment tax under IRC § 1402(a)(13). The court’s January 2026 opinion was taxpayer-friendly and focused on state-law limited liability. The court later withdrew that opinion and issued a substitute opinion on Aug. 12, 2026, adopting a narrower, management-based standard. The Aug. 12, 2026 substitute opinion is now the operative Fifth Circuit decision.

Core point: A partner who significantly manages or runs the business should not assume that a state-law limited-partner designation protects their distributive share from self-employment tax and Medicare tax.

Update Aug. 17, 2026: Fifth Circuit Withdraws January Opinion And Narrows The Limited-Partner SE Tax Exception

On Aug. 12, 2026, the Fifth Circuit withdrew its January 2026 opinion in Sirius Solutions L.L.L.P. v. Commissioner and issued a substitute opinion under the caption K Alain LLLP v. Commissioner. Although the court denied the government’s petition for rehearing en banc, it abandoned the broad state-law test described in our Jan. 25 update below.

The January opinion held that limited liability under state law was sufficient for a partner to qualify for the self-employment tax exclusion under IRC §1402(a)(13). The substitute opinion instead defines a limited partner as “a partner who plays no significant role in managing or running a business.” Therefore, state-law limited-partner status alone is no longer sufficient in the Fifth Circuit; courts must examine the partner’s actual role in the business.

However, the Fifth Circuit did not fully adopt the Tax Court’s passive-investor test in Soroban. The court concluded that a limited partner may participate in some non-managerial business activities without losing the exclusion. Its new dividing line is managerial versus non-managerial activity—not simply active versus passive participation or material versus non-material participation under the passive-activity rules.

This flip-flop substantially narrows the taxpayer-friendly January decision and creates a new factual question: When does a partner’s involvement become a “significant” role in managing or running the business? Active partners who manage a hedge fund, private equity firm, registered investment adviser (RIA), or professional services management company should not assume that their state-law LP designation protects their distributive share from SE tax. Partners engaged only in non-managerial activities may have a stronger argument for the exclusion, although the extent of that protection remains uncertain.

Under the Tax Court’s Golsen rule, the substitute decision directly governs Tax Court cases appealable to the Fifth Circuit, which covers Texas, Louisiana, and Mississippi. Appeals involving Denham Capital Management and Soroban Capital Partners remain pending in the First and Second Circuits, respectively. Until the appellate courts, Congress, or Treasury provide greater clarity, relying on limited-partner status to avoid both SE tax and NIIT remains uncertain and potentially risky. An S-corporation management-company structure continues to offer a more established approach to managing payroll and Medicare taxes, subject to reasonable-compensation requirements.

The Jan. 25, 2026 update below is retained as a historical record of the Fifth Circuit’s original ruling. That opinion was withdrawn and replaced on Aug. 12, 2026, as explained in the update above. It is no longer controlling law.

Update Jan. 25, 2026: Fifth Circuit Rejects IRS Functional Test—Limited Impact Outside Three Southern States

In Sirius Solutions L.L.L.P. v. Commissioner, No. 24-60240 (5th Cir. Jan. 16, 2026), the Fifth Circuit Court of Appeals vacated a Tax Court decision involving the limited-partner exception to self-employment tax under IRC §1402(a)(13). The court held that qualification for the exception turned on limited liability under state law—not on whether the partner was a passive investor or materially participated in the business.

In doing so, the Fifth Circuit rejected the functional, passive-investor test applied by the IRS and the Tax Court in Soroban Capital Partners and Denham Capital Management. Instead, the court relied on the statutory text and the historical meaning of “limited partner.” In a footnote, the court expressly reserved the question of how—or whether—its reasoning would apply to interests in other entities, such as LLPs and LLCs.

The Fifth Circuit covers Texas, Louisiana, and Mississippi. Under the Tax Court’s Golsen rule, the Tax Court would have been required to follow Sirius in cases appealable to that circuit. Outside the Fifth Circuit, the Tax Court could continue applying the functional, substance-over-label analysis reflected in Soroban, Denham, and Castigliola.

This geographic limitation was important because many hedge-fund management companies operate outside the Fifth Circuit, particularly in the Second Circuit, which includes New York and Connecticut; the Ninth Circuit, which includes California; and the Third Circuit, which includes Delaware. Consequently, the original Sirius decision did not alter the enforcement environment for most hedge-fund managers, who remained exposed to IRS challenges and unfavorable Tax Court precedent when relying on limited-partner status to avoid SE tax.

Even under the original Sirius ruling, planning based solely on limited-partner classification remained uncertain outside the Fifth Circuit. For management companies seeking a more durable approach to Medicare tax exposure, an S-corporation management structure continued to offer a more established and defensible solution without depending on unresolved statutory gaps in IRC §§1402 and 1411.

Original Blog post on Nov. 17, 2025: Executive Summary

The IRS has recently cracked down on hedge-fund, private-equity, and professional-service management companies that tried to use limited partner status to avoid the 3.8% Medicare-related tax on management-company profits. In several high-profile cases—including Soroban, Denham, and Castigliola—the Tax Court held that partners who actively manage the business are not “true” limited partners under §1402(a)(13) and therefore cannot use LP status to sidestep self-employment (SE) tax.

This white paper explains the structural gap in the tax code that created this issue, why management-company partners fall into the gray zone between SE tax and the Net Investment Income Tax (NIIT), and how the courts and IRS now apply a functional test that looks at what partners actually do, not what their partnership interest is called.

For fund managers, RIAs, and active partners in management companies, the takeaway is clear:
LP status alone does not shield active partners from SE tax, carried interest remains NIIT income, and S-Corporations are the only reliable structure for reducing Medicare taxes.

The paper also clarifies how these rules affect TTS traders, Section 475 income, and investor-level LPs.

White paper: In recent years, several hedge-fund, private equity, and professional service management companies attempted to use limited partner classifications to reduce or avoid the 3.8% Medicare-related tax on management company income. The IRS challenged these positions, and the Tax Court repeatedly ruled that active service partners were not “true” limited partners for purposes of the §1402(a)(13) self-employment (SE) tax exclusion.

This article explains how the statutory gap arose, why management company partners fall into it, how recent cases have resolved these disputes, and what today’s fund managers and traders should understand when structuring their entities.

Partnership tax rules can produce unexpected results when older definitions collide with modern fund structures. The idea of an “active limited partner” highlights this problem. Under IRC §1402(a)(13), a limited partner’s distributive share is generally not subject to self-employment (SE) tax.

At the same time, income from a business in which a taxpayer materially participates is not subject to the Net Investment Income Tax (NIIT) under IRC §1411. When a partner is legally designated as a limited partner but actively participates in the management company, these two rules conflict with the management company’s ordinary income being treated neither as SE income nor NIIT income.

Who This Affects

This issue directly applies to partners in management companies—hedge fund managers, RIAs, private equity sponsors, and professional service partnerships.
It applies less to sole-proprietor traders with TTS and Section 475, whose trading income is not SE income under long-standing IRS guidance. Trading gains are subject to NIIT.
Investors in hedge funds and private equity funds can benefit from this content, too.

Key Lessons

Active managers cannot rely on LP status to avoid SE tax.
Carried interest is always NIIT income—never SE income.
TTS/475 traders avoid SE tax but still owe NIIT.
S-Corporations are the only well-established way to reduce Medicare taxes.
IRS and Tax Court apply a substance-over-label “functional test.”

Primer on Self-Employment (SE) Tax

SE tax includes Social Security (12.4%) up to an inflation-adjusted wage base ($176,100 for 2025), and uncapped Medicare (2.9%) taxes, totaling 15.3% on net earnings from self-employment. For employees, there are similar payroll taxes: employees pay half of the Social Security and Medicare taxes, and employers pay the other half.

Two Paths for the 3.8% “Medicare” Tax

The 2010 Affordable Care Act (ACA) created two parallel mechanisms for imposing a 3.8 percent Medicare-related tax on investment income of high-income taxpayers:

The Self-Employment Medicare Tax (2.9% base + 0.9% Additional Medicare Tax = 3.8%) applies to net earnings from self-employment — active trade-or-business income under IRC § 1402.
The Net Investment Income Tax (NIIT) (3.8%) applies to unearned or passive income such as capital gains, Section 475 ordinary income for traders, interest, dividends, rents, and Schedule K-1 investment profits under IRC § 1411. NIIT also applies to passive activity income and loss from pass-through entities and investment and trading companies.
The NIIT is calculated on the lesser of net investment income (NII) or the amount your MAGI exceeds thresholds: $200,000 for singles, $250,000 for married filing jointly. These thresholds are not indexed for inflation.
Example: a single filer with $500,000 of net trading gains (NII) and MAGI of $600,000. The NIIT threshold for a single filer is $200,000.

Calculation: MAGI $600,000, NII $500,000, Threshold (Single): $200,000

Amount MAGI exceeds threshold: $600,000 − $200,000 = $400,000

The NIIT is owed on the lesser of:

•NII: $500,000, MAGI excess: $400,000

So, the taxable amount for NIIT is $400,000.

NIIT owed: $400,000 × 3.8% = $15,200.

Congress intended that no income should escape both Medicare taxes — a principle reflected in the legislative history of §§ 1402(a), 1411, and ACA regulations. In practice, however, the statutory definitions sometimes leave a gap for active limited partners.

Earned income should be subject to SE tax, and unearned income should be subject to NIIT. Understanding how Congress drew the line between earned and unearned income helps explain why the limited-partner exception exists.

The Limited-Partner Exception

IRC § 1402(a)(13) excludes a limited partner’s distributive share of partnership income (other than guaranteed payments for services) from net earnings from self-employment.

This rule — dating to the 1954 Code — was designed for passive investors in state-law limited partnerships. It assumes such partners do not materially participate in operations and therefore should not owe self-employment tax. The ACA’s NIIT was not started until 2013.

The “Active Limited Partner”

Modern hedge-fund and private-equity management companies, as well as law firms, blur this distinction. Many managers hold limited-partner (LP) interests for liability protection yet actively manage the business daily.

Partners who materially participate in the partnership’s business but hold only limited-partner interests under state law fall into a statutory gray area:

Under § 1402(a)(13), their distributive share is excluded from SE income because limited partners are not considered to earn SE income unless they receive guaranteed payments for services.
Under § 1411(b) and Treas. Reg. § 1.1411-4(g)(7)(i), non-passive participation income is excluded from NIIT, which was set up to catch passive activity pass-through and investment income.

This overlap can leave ordinary business income neither SE income nor passive activity NIIT income. I next discuss how hedge fund and private equity firms deal with this issue, as these were the types of companies that recently lost in tax court over it.

Management Company LP vs. Fund LP: Why the Distinction Matters

In all major cases involving the limited partner exclusion—Soroban, Denham, and Castigliola—the individuals claiming §1402(a)(13) exclusion were owners of the management company (Castigliola is a law firm), not passive investors in a hedge fund or private equity fund LP.

The management company is the entity that provides investment advisory, trading, or portfolio management. Its income—management fees, incentive allocations, and operational revenue (for the law firm)—derives from the partners’ active services.

By contrast, investor fund LPs hold pooled capital and generate investment returns, including capital gains, Section 475 trading income, dividends, interest, and Section 1256 gains.

These investor LPs are the intended beneficiaries of §1402(a)(13), which excludes passive investment income from SE tax. However, this fund LP income is subject to NIIT for the passive investors.

This distinction is critical: the §1402(a)(13) exclusion was designed for passive investor LPs, not partners in service‑providing management companies.

Courts consistently look to the partner’s functional role, not their state‑law label. When an individual materially participates in generating the partnership’s business income, the limited‑partner exclusion does not apply—even if their interest is titled as a limited‑partner interest under state law.

Treasury and IRS Awareness

The Treasury Department acknowledged this coordination problem in the preamble to the Final NIIT Regulations (T.D. 9644, 2013), promising future guidance to reconcile §§ 1402 and 1411. Over a decade later, no such guidance has been issued.

Chief Counsel Advice 201436049 and Proposed Reg. § 1.1402(a)-2 (62 Fed. Reg. 1702, January 13, 1997) both indicate that the term “limited partner” in §1402(a)(13) should be interpreted more narrowly than its state‑law label. These authorities emphasize evaluating what a partner actually does in the business, not just how their interest is titled.

However, neither source definitively resolves how the SE‑tax exclusion applies when a partner is legally a limited partner but materially participates in the partnership’s operations.

Cases such as Castigliola v. Commissioner, T.C. Memo 2017-62, reinforce this functional approach. In Castigliola, law firm partners who were legally designated as limited partners were nevertheless treated as engaged in a trade or business for SE tax purposes because they actively provided services and materially participated in the operations.

The decision makes clear that the substance of a partner’s activities, rather than the state‑law title attached to their interest, governs the application of the SE‑tax rules. Still, the broader issue remains unsettled because the Treasury has not issued comprehensive regulations coordinating §1402(a)(13) with the NIIT rules under §1411.

📊 Management Company vs. Fund LP — Structural Diagram

The management company is a service business. The fund LP is the investment vehicle.

Management Company (LP or LLC)
• Provides investment advisory + management services
• Earns management fees + incentive/performance allocations (carried-interest)
• Partners are service providers
• Income is business income (SE-tax analysis applies)
• Carried-interest in capital gains, Section 475 trading income, and portfolio income are subject to NIIT, not SE tax

⬇️ Manages ⬇️

Fund LP / Master Fund / Feeder Fund
• Pools investor capital
• Generates investment income (capital gains, interest, dividends)
• LPs are passive investors
• Income is investment income (NIIT applies)

📘 Case-Law Spotlight: How Courts Treat “Active Limited Partners” in Fund Managers

🟦 Soroban Capital Partners LP v. Commissioner (2024)

Soroban Capital Partners LP is the management company/RIA, not the hedge‑fund investment vehicle. It earns management fees and incentive allocations and manages multiple fund entities.
Individuals classified as limited partners of the management company were full-time investment professionals responsible for generating the firm’s advisory and management‑company income.
They claimed the §1402(a)(13) limited partner exclusion to avoid SE tax on their box one ordinary business income.
Tax Court held they were not limited partners “as such” under §1402(a)(13) because they were active service partners in the management company.
Their distributive shares of ordinary business income were subject to self-employment tax.
See “Sec. 1402(a)(13) and limited partnerships,” The Tax Adviser, March 1, 2024 (Beavers emphasizes a functional test—partners who are “limited in name only” do not qualify for the §1402(a)(13) exclusion).

🟦 Denham Capital Management LP v. Commissioner (2024)

Denham Capital Management LP is the management company, not the private‑equity fund vehicle. It serves as the General Partner (GP) and investment adviser to a family of sector-focused investment funds.
Partners labeled as limited partners were actively engaged in investment advisory, due diligence, portfolio management, and operational oversight.
IRS challenged the use of §1402(a)(13), arguing these partners were materially participating in a financial‑services business.
Tax Court applied Soroban, concluding these individuals were not limited partners “as such” because they were service partners in the management company.
Result: their distributive shares of management‑company ordinary income were included in net earnings from self-employment, even though the entity was organized as a Limited Partnership (LP).

Key Principle from Both Cases

A partner’s functional role and actual services, not their state‑law title, determine whether the §1402(a)(13) limited‑partner exclusion applies.

📘 Call-Out: “Limited in Name Only” — Functional Test Explained

Beavers (The Tax Adviser, March 2024) emphasizes that §1402(a)(13) must be applied using a functional test. A partner qualifies as a “limited partner” only if they are genuinely passive in the partnership’s operations.

If the partner provides services, manages operations, or materially participates in generating revenue, they are “limited in name only,” and the §1402(a)(13) exclusion does not apply. This principle aligns with the holdings in Soroban, Denham, and Castigliola, which all rejected limited partner labeling when the partners were active service providers.

📘 Call-Out: When a Fund Management Company Has Box One Income — TTS and Section 475 Only

Most hedge funds do not qualify for Trader Tax Status (TTS) because their trading activity does not rise to the level of an active trading business. Without TTS and a Section 475 election, gains remain capital gains reported in K-1 boxes 8–13, not box one ordinary business income/loss.

A hedge fund investment vehicle reports box one ordinary business income only if it:

Qualifies for TTS, and
Elects Section 475(f) mark-to-market (MTM) accounting. When a hedge fund uses Section 475 MTM accounting, its trading gains are ordinary income.

Section 475 trading gains are not earned income subject to SE tax; instead, they are unearned income subject to NIIT.

TTS trading business expenses in box 1 reduce SE income for purposes of SE tax. It’s quirky: TTS business expenses are treated as SEI, and Section 475 ordinary income and capital gains are NII.

IRS Tax Topic 429 states, “gains and losses from selling securities as a trader aren’t subject to self-employment tax.” Traders are not considered to be in the trade or business of providing services. Expert treatises make clear that traders with trader tax status, even when reporting ordinary income under Section 475 MTM, do not pay SE tax on that income, distinguishing them from dealers and other service businesses.

Section 475 ordinary income is subject to NIIT under §1411. A Section 475(f) election is available only to traders who qualify for TTS, and TTS, by definition, requires self-directed, active trading.

Even though TTS traders conduct an active business, the NIIT law explicitly treats trading in financial instruments as investment activity for NIIT purposes. Regardless of the taxpayer’s material participation in a TTS fund LP, TTS/475 income remains NIIT income.

In short, TTS/Section 475 income is always NIIT income because NIIT classifies trading in financial instruments as investment activity—even when the taxpayer is conducting an active trading business.

Carried Interest and the NIIT

Carried interest is a profit interest that allocates a portion of the fund’s investment gains to the managing partner. It is categorically different from:

Management company box one ordinary business income (the management fee), and

Carried interest income retains its underlying character at the fund level and is reported in K-1 boxes 8–13. These items include:

Long‑ and short-term capital gains,
Qualified dividends,
Interest income, and
Section 1256 contract gains or losses,

Under IRC §1411(c)(1)(A)(iii) and Treas. Reg. §1.1411‑4(a)(1)(iii), these categories of income are always included in net investment income (NII). This rule applies regardless of whether the partner is:

A limited partner or general partner,
Active or passive,
Involved in investment management or not.

Because carried interest flows from investment activity and not services, it is:

Always subject to the 3.8% NIIT, and
Never subject to SE tax.
It doesn’t work to claim an “active limited partnership”; it’s NII either way.

In the classic “2 and 20” compensation structure, the management company charges a 2% management fee. It receives a 20% incentive allocation (carried interest) of the fund’s investment income (usually based on new-high-net profits).

The IRS has periodically challenged carried interest as a disguised incentive fee, and some members of Congress have frequently proposed legislation to repeal or further limit carried-interest treatment. Understanding these dynamics is essential when analyzing how carried interest interacts with NIIT and SE tax.

The OBBBA did not change or extend the carried-interest rules created under the TCJA. The three-year holding period under IRC §1061 remains in place, and none of the proposed tightening measures made it into the final bill. As a result, carried interest continues to receive long-term capital gains treatment under the TCJA rules, and OBBBA leaves the existing regime unchanged for private-equity and fund managers.

Even active fund managers pay NIIT on carried interest. The only income potentially affected by the “active limited partner” issue is ordinary business income from the management company or General Partner entity.

Choice of Entity for Traders and Hedge Funds

Entity selection determines how a hedge fund manager’s compensation flows through the tax system.

Many hedge funds adopt a classic structure:

A fund LP or LLC that holds investor capital and generates portfolio gains; and
A GP/management company responsible for investment management and business operations.

Managers commonly participate in the fund in two separate capacities:

Through the GP entity, receiving management‑company income and performance allocations; and
Sometimes, as personal investors holding a limited‑partner interest in the LP. Many managers invest personal capital to demonstrate commitment to investors, although the amounts vary widely, and some managers do not invest personally at all.

When managers do invest personally, they may receive a separate investor K-1 reporting only investment results—capital gains, dividends, interest, and Section 1256 gains—never management fee income or carried interest allocations.

Separately, the GP/management company—whether an LLC taxed as a partnership or an S‑Corporation—issues its own K-1 to the manager for GP-level business income. This K-1 is distinct from and unrelated to any investor-level K-1.

(As always, legal entity selection involves governance and liability considerations. Managers should seek counsel experienced in fund law in their state of residence.)

📘 Call-Out: GP / S‑Corporation Election for Payroll‑Tax Optimization

Electing S‑Corporation status at the GP/management‑company level enables managers to:

Pay themselves reasonable compensation, subject to payroll taxes, and
Receive remaining S‑Corp profits free from Social Security and Medicare taxes.

For S-Corp management businesses, many practitioners use a 25–50% benchmark when evaluating reasonable compensation, but the IRS requires pay to reflect fair market value for services performed.

Remaining profits distributed as S‑Corp dividends are not subject to payroll tax, offering substantial savings compared to partnerships, where active limited partners face increasing scrutiny and SE tax exposure.

This widely accepted planning strategy allows owners to reduce Medicare taxes by receiving income in the form a distributions rather than wages. This method offers a clear, established, and IRS-tested approach to managing payroll‑tax exposure.

It’s a different matter for trading S-Corps eligible for TTS; they don’t have underlying earned income and therefore don’t need reasonable compensation. They use officer compensation to unlock health and retirement plan deductions.

The Bottom Line

Partner Type	SE Tax	NIIT	Notes
Passive limited partner	❌	✅	Investor LP portfolio income and capital gains are subject to NIIT
Active general partner	✅	❌	Business income is subject to SE tax
Active limited partner (stat. gap)	✅*	❌	*Disputed position under current law

See CCA 201436049 and T.D. 9644 (2013) for IRS and Treasury recognition of unresolved issues. Congressional or regulatory guidance is pending.

Guaranteed payments for services remain subject to SE tax regardless of partner status or participation level.

Outlook

Until Treasury finalizes regulations harmonizing §§ 1402 and 1411, high-income partners who actively manage funds yet hold limited-partner interests occupy a legally ambiguous zone. Practitioners should carefully evaluate both state-law entity status and material participation, as future guidance may reclassify such income for SE or NIIT purposes.

For hedge-fund managers, traders, and their advisors, the safest approach is to treat active management-company income as SE income. Using limited-partner status to avoid SE and NIIT remains risky under the current law.

Disclaimer:
This article is for educational discussion only and not individualized tax advice. It summarizes federal tax law as of 2025 and provides no assurance of outcome in any particular case. Consult your tax advisor about your own entity classification, self-employment exposure, and NIIT obligations.

Sources and Citations

1. Denham Capital Management LP v. Commissioner (T.C. Memo 2024-114)
Full opinion (PDF): https://kpmg.com/kpmg-us/content/dam/kpmg/taxnewsflash/pdf/2024/12/tc-memo-2024-114.pdf
KPMG summary: https://kpmg.com/kpmg-us/content/dam/kpmg/taxnewsflash/pdf/2025/01/tnf-kpmg-report-denham-january-2025.pdf

2. Soroban Capital Partners LP v. Commissioner (161 T.C. 310 (2023))
EisnerAmper overview: https://www.eisneramper.com/insights/tax/soroban-capital-case-1402-a-13-exclusion-1223/
Gibson Dunn analysis: https://www.gibsondunn.com/tax-court-determines-that-limited-partners-are-not-necessarily-exempt-from-self-employment-tax-limits-of-limited-partner-exception/

3. Castigliola v. Commissioner (T.C. Memo 2017-62)
Case summary (Current Federal Tax Developments): https://www.currentfederaltaxdevelopments.com/blog/2017/4/10/tax-court-rejects-limited-partner-claim-in-professional-service-firm

4. NIIT Final Regulations (T.D. 9644, 2013)
Federal Register summary: https://www.federalregister.gov/documents/2013/12/02/2013-28409/net-investment-income-tax

5. IRS Chief Counsel Advice 201436049
Primary source (IRS PDF): https://www.irs.gov/pub/irs-wd/201436049.pdf
Tax Adviser summary: https://www.thetaxadviser.com/issues/2015/jan/tax-clinic-08-jan-2015/

If SCOTUS Rules Against ACA It Could Trigger Tax Refunds

July 14, 2020 | By: Robert A. Green, CPA

By CPAs Darren Neuschwander and Robert A. Green

If you paid the Affordable Care Act (ACA) Medicare surtaxes on unearned or earned income in 2016 through 2019, you might be eligible for a potential tax refund if the Supreme Court of the United States (SCOTUS) rules against ACA. SCOTUS agreed to take the ACA case, and experts expect a decision in early 2021. Traders have unearned income, and they pay the ACA 3.8% Medicare surtax on net investment income over the AGI threshold (see below).

Act fast for 2016
Some taxpayers need to act fast before SCOTUS renders their decision about ACA. If you paid ACA taxes on your 2016 income tax return and filed that return by its original due date of April 18, 2017, then consider submitting a “protective claim for refund” due by July 15, 2020. That’s the date the 2016 tax year closes, three years from April 18, 2017, the original tax return deadline, plus the three-month postponement under the CARES Act. A protective claim for refund extends the deadline for purposes of this ACA refund, giving you ample time to react to the SCOTUS decision. If you miss the July 15, 2020 deadline, at least you can still submit the protective claim for 2017, 2018 and 2019,

If you filed an extension for 2016 taxes, extending the deadline six-months until October 15, 2017, you have three years from the actual filing date up to October 15, 2020. For example, if you filed your 2016 income tax return on August 30, 2017, the tax year closes three years later on August 30, 2020.

There’s no rush to submit a protective claim for refund of ACA taxes for 2017, 2018, and 2019 tax returns. The 2017 tax year would close April 15, 2021, unless you filed a 2017 tax extension until October 15, 2018, in which case the year closes three years after filing date.

ACA taxes and potential refunds
If SCOTUS rules against ACA, it could trigger this refund opportunity for ACA taxes paid in 2016 through 2019.

These ACA taxes include the 0.9% Medicare Surtax on earned income (Form 8959) and 3.8% Net Investment Income Taxes on unearned income (Form 8960) for 2016 through 2019. The ACA net investment tax applies to individuals with net investment income (NII) and modified adjusted gross income (AGI) exceeding $200,000 single, $250,000 married filing jointly, or $125,000 married filing separately. ACA law does not index the threshold for inflation.

Filing a protective claim ensures that if SCOTUS invalidates ACA taxes, taxpayers who paid them could formalize a refund request, even after the amended tax return filing deadline closes. Congress could enact a statute that would allow (or require) the IRS to issue refunds for closed tax years even without filing a protective claim.

We cannot assess the likelihood that these ACA taxes will be deemed unconstitutional retroactively to these years, but we wanted to bring the possibility to your attention.

Here’s a template of the informal protective claim for refund if you decide that you would like to submit it to the IRS for tax year 2016. It should be mailed (preferably by certified mail, return receipt, if available at your local post office) to the IRS service center within the PDF file based on your current mailing address.

We are available for questions on this matter after July 15, 2020, the postponed tax deadline.

Adam Manning CPA contributed to this blog post.

Eight Ways Profitable Traders Save Taxes

August 23, 2015 | By: Robert A. Green, CPA

Click for Green’s post on Forbes

Traders thrive on market volatility, profiting from rapid changes in prices up or down as they take long and short positions. It’s different for investors: When market indexes drop into correction or bear market mode, they generally lose money or reduce gains.

There’s been significant market volatility in 2015 and many stocks are in correction or bear market mode. I’ve had tax consultations with many traders that are making a fortune from price volatility, catching the swings in price both up and down.

In my last blog post, I wrote about five ways traders should best deduct trading losses, figuring some traders may not have recognized a stealth correction in many stocks and commodities in enough time to profit from it. In this blog post, I address tax savings for profitable traders because there are many traders who have done very well.

Here are eight ways profitable traders save taxes.

1. Business expenses with qualification for trader tax status
Investment expense treatment is the default method for investors, but if you qualify for trader tax status, you can use the more favorable business expense treatment.

Business expense treatment under Section 162 gives full ordinary deductions, including home-office, education, Section 195 start-up expenses, margin interest, Section 179 (100%) depreciation, amortization on software, seminars, market data and much more. Conversely, investment expenses are only allowed in excess of 2% of adjusted gross income (AGI), and not deductible against the nasty alternative minimum tax (AMT). Investment expenses are further restricted with “Pease” itemized-deduction limitations for taxpayers with AGI over $300,000 (married) and $250,000 (single). Many states limit itemized deductions, too.

Highly profitable traders often have significant expenses including staff, an office outside the home, additional equipment and services and significant employee-benefit plan deductions for retirement and health insurance. Their 2% AGI threshold for deducting investment expenses is very high, so they really appreciate full business expense deductions from gross income.

Learn how to qualify for and claim trader tax status in our Trader Tax Center.

2. Home office expenses

Most traders work in their home with a trading workstation, multiple computers, monitors, mobile devices, TVs, office furniture and fixtures. They exclusively use one or more rooms, storage areas and a bathroom.

A typical allocation percentage might be 10% to 20% of the home. Include every expense of the home including mortgage interest, real estate taxes, utilities, repairs, maintenance, security and more. Also, take depreciation of the home and on improvements. Office equipment and furniture is depreciated directly in the business often with Section 179 (100%) depreciation.

The home office deduction requires income, which can include trading gains. You can have a home office and office outside the home, too. Don’t be shy with this deduction; it helps document your business activity. Investors may not take a home office deduction, trader tax status is required.

3. Business travel, education and seminars
Many traders travel around the country and world to trading conferences, seminars and for education courses. If you qualify for trader tax status, education, seminars, conferences and related travel costs qualify as a business expense. But investors may not deduct education, seminars, conferences and related travel expenses in accordance with Section 274(h)(7).

The IRS is a stickler for separating business versus personal travel, meals and entertainment (see Pub 463). If your spouse accompanies you on a trip and is not active in the trading business, the spouse’s share of expenses are deemed personal. If you spend another week on your trip for vacation reasons, that part of the trip is also personal.

If you entertain other traders and industry players, you may have business meals and entertainment expenses. Be careful with the rules for lavish expenditures.

4. Health insurance premium deductions
Obamacare is forcing many traders into buying health insurance or otherwise owe a shared responsibility payment if they don’t qualify for a hardship exemption. Highly profitable traders don’t qualify for exchange subsidies and they seek AGI deductions for high health insurance premiums. (Out-of-pocket health care expenses including deductibles and co-payments are not allowed as an AGI-deduction and the threshold for itemized deductions for medical expenses is high.)

Self-employed businesses and pass-through entities may take a 100% deduction of health insurance premiums from AGI on individual tax returns. The problem for traders is that trading gains are not self-employment income (SEI) and they can’t have an AGI deduction for health insurance premiums or retirement plans. There is a way to fix that.

Traders need to form a S-Corp trading company (or C-Corp management company) to pay officer’s compensation which allows an AGI deduction for health insurance premiums and retirement plan contributions. Execute payroll before year-end and add the health insurance premium to the officer’s W-2 wages. The officer then takes the AGI deduction on their individual tax return.

5. Retirement plan contribution deductions
Generally, the best defined-contribution retirement plan for business traders is a Solo 401(k) plan. It combines a 100% deductible “elective deferral” contribution ($18,000 for 2015) with a 25% deductible profit-sharing plan contribution on an employer-level plan. There is also a “catch up provision” ($6,000 for 2015) for taxpayers age 50 and over. Together, the maximum tax-deductible contribution is $53,000 per year and $59,000 including the catch up provision (based on 2015 IRS limits). A SEP IRA only has a profit sharing plan.

Only traders with trader tax status on an S-Corp trading company (or with dual entity C-Corp management company) can satisfy the requirement for contributions to a retirement plan. That’s because trading gains are not considered SEI, which is required for retirement plan contributions. The trader needs wages from a S-Corp or C-Corp since a sole proprietor trader can’t pay themselves wages.

Retirement plan contributions are only allowed for traders who qualify for trader tax status and who use an S-Corp or C-Corp management company to create compensation as pointed out above.

High-income traders should consider a defined-benefit plan which allows much higher tax-deductible contributions. The maximum limit for 2015 is $210,000 and the actual amount is determined by an actuary.

Retirement plan contributions are made in connection with officer’s compensation, so trader tax status is imperative on these large combined amounts. Investment partnerships are not allowed to pay guaranteed payments to partners; only a trading business partnership may do so. Partnerships pass through losses reducing SEI, whereas S-Corps do not. We prefer the S-Corp for creating the wages needed for maximizing employee-benefit plan deductions.

6. Tax-advantaged growth in retirement plans
In traditional retirement plans, income growth is tax-deferred until taxable distributions are made in retirement subject to ordinary tax rates. Early withdrawals before age 59½ in IRAs and age 55 in qualified plans are also subject to a 10% excise tax penalty. Contributions to traditional retirement plans are tax deductible and hence there is tax-deferral only.

In Roth IRA and Roth 401(k) retirement plans, income growth is permanently tax-free because contributions to a Roth account are not tax deductible. When converting a traditional retirement account to a Roth account, taxes are due on the entire conversion amount. Afterward, the Roth is permanently tax-free. You can reverse the Roth conversion up to Oct. 15 of the following year if you are unhappy with it.

Highly profitable traders generally trade significant retirement assets alongside trading in taxable accounts. Taxable accounts qualify for trader tax status and retirement accounts do not. These traders seek to maximize deductions in connection with taxable accounts and minimize allocations if any to retirement accounts. Consult a CPA trader tax expert on this point.

7. Lower 60/40 capital gains tax rates on 1256 contracts
Profitable traders seek lower tax rates when possible. If you want to trade the Nasdaq 100 index you have two options: an ETF security (NASDAQ: QQQ) taxed at ordinary rates applicable on short-term capital gains, or an emini futures contract (CME: NQ), which is a Section 1256 contract taxed at lower 60/40 capital gains rates.

Section 1256 contracts bring meaningful tax savings throughout all tax brackets. These contracts have lower 60/40 tax rates, meaning 60% (including day trades) are taxed at the lower long-term capital gains rate and 40% are taxed at the short-term rate, which is the ordinary tax rate. At the maximum tax brackets for 2015, the top Section 1256 contract tax rate is 28%, 12% lower than the top ordinary rate of 39.6%. The long-term rate is 0% at the 10% and 15% ordinary tax brackets.

Section 1256 contracts are marked-to-market (MTM) on a daily basis. MTM means you report both realized and unrealized gains and losses at year-end. (Don’t confuse it with Section 475, which is also MTM but has different tax effects.) Many traders have small or no open positions on Section 1256 contracts at year-end. With MTM at year-end, a trader can’t hold a position for a long-term capital gain which requires a 12-month holding period, so Congress negotiated 60/40 capital gains rates. Active traders should take advantage of that tax break.

8. Long-term capital gains taxes
Long-term capital gains on sales of securities are subject to lower capital gains tax rates up to 20% which apply on securities held 12 months or more. Profitable traders often have segregated investment positions in securities — in addition to their trading activity — for which they seek deferral of taxes at year-end and eventually lower long term rates if held 12 months. (Caution: If you use Section 475 MTM, its imperative to properly segregate your investment positions.)

When market conditions change for their investments, rather than sell before 12 months or by year-end causing taxes on unrealized gains, they manage risk with option trades around the underlying position. For example, if they are long Apple stock and are concerned with its price dropping, they can purchase Apple put options for downside risk protection. They are still long Apple and they can continue to defer their unrealized gains in Apple at year-end.

Profitable traders can do these eight things to lower their tax bill by a significant amount. Why over pay Uncle Sam?

Obamacare Ushers In Several New Tax Forms For 2014

October 30, 2014 | By: Robert A. Green, CPA

The Patient Protection and Affordable Care Act (also known as Obamacare) enacted in 2012 has taken several years to implement and phase in. But now that the Obamacare 2014 individual health insurance mandate is in effect, many taxpayers will face confusion over tax penalties, exemptions, premium tax credits, claw backs of subsidies (advanced credits) and extra tax-preparation fees to comply with Obamacare on 2014 tax filings. In this post, I help clarify the details of the mandate.

There are three scenarios for dealing with the mandate on 2014 tax returns:

1. Off-exchange coverage: If you had ACA-compliant health insurance coverage for all of 2014 — either an individual plan purchased directly from an insurance company (off exchange), an employer plan or government-sponsored programs like Medicare or Medicaid — there’s little to do. You may receive a new IRS Form 1095-B reporting your health insurance coverage from an insurance company and, if applicable, a Form 1095-C from your employer. Both of these tax forms are not mandatory for 2014. Give the 1095s to your accountant and you’re finished. There won’t be any penalties, premium tax credits or return of exchange subsidies.

2. On-exchange coverage: If you purchased your 2014 health insurance on an exchange (marketplace), you will receive a mandatory Form 1095-A from the marketplace and you must file new tax Form 8962 (Premium Tax Credit). When you applied for your 2014 health insurance coverage, you submitted estimates of your 2014 income which the exchange relied on for pricing your plan, perhaps offering a subsidized plan with “advanced credits.” The purpose of Form 8962 is to determine your rightful premium tax credit based on income reported on your 2014 tax return and to reconcile advanced credits (if any) with the premium tax credit calculated on Form 8962. Estimates probably won’t match actual income, especially for traders who have fluctuations in trading gains and losses.Therefore, one of three things will happen on Form 8962:

i. You will have a tax liability caused by advanced credits being greater than the premium tax credit.

ii. You will have a tax credit caused by advanced credits being less than the premium tax credit.

iii. No tax liability or credit because you used an exchange but did not receive an advanced credit and there is no premium tax credit.

The Obamacare Website says individuals can use an exchange even without getting a subsidized plan, but we heard from taxpayers that they were not permitted to use some state exchanges unless they qualified for subsidies. Some individuals say they received a better quote off exchange compared to on exchange without subsidies. Expect to receive new tax information document IRS Form 1095-A from the exchange reporting your coverage and any advanced credits paid for a subsidized plan. Give the 1095s to your accountant and he or she will prepare Form 8962. Tax software should have an input area to enter Form 1095 information and calculate Form 8962 and the premium tax credit.

3. No health insurance coverage: If you did not have ACA-compliant health insurance coverage for 2014 — and that includes large gaps in coverage — and you don’t qualify for an exemption from Obamacare, then you will owe a shared-responsibility payment (tax penalty). Apply to an exchange to receive a Form 8965 exemption for certain types of exemptions, and for others types of exemption claim them on a self-prepared Form 8965. As of Oct. 29, the IRS had not yet released a draft tax form for calculating the shared responsibility payment.

The shared responsibility payment is whichever amount is larger of the following: For 2014, the payment is either $95 per adult and $47.50 per child (up to $285 for a family) or 1% of household income. For 2015, it’s either $325 per adult and $162.50 per child (up to $975 for a family) or 2% of household income. For 2016, it’s either $695 per adult and $347.50 per child (up to $2,085 for a family) or 2.5% of household income. Per the IRS Website, “the individual shared responsibility payment is capped at the cost of the national average premium for the bronze level health plan available through the Marketplace in 2014.” As has been widely publicized, the shared responsibility payment is not enforceable by the IRS. That means the IRS will offset the payment against tax refunds due, but it can’t file liens, levy assets or start collection proceedings for this payment. The IRS may fully enforce claw-backs of advanced credits (subsidies) reported on Form 8962.

The 2014 Form 1040 has three lines dealing with the Obamacare health insurance mandate:

Tax (line 46): Excess advance premium tax credit repayment. Attach Form 8962.
Payment (line 69): Net premium tax credit. Attach Form 8962.
Other Taxes (line 61): Health care: individual responsibility (see instructions). Full-year coverage (box to check).

Open enrollment through exchanges for 2015 coverage
Traders should consider special strategies for purchasing 2015 health insurance coverage through exchanges. The open enrollment period runs from Nov. 15, 2014 to Feb. 15, 2015. Most individuals will purchase 2015 insurance before they deal with Obamacare tax compliance on 2014 tax returns.

If you want to receive a premium tax credit on Form 8962, you need to enroll through an exchange, not directly with an insurance provider or employer. You can’t receive premium tax credit if you are eligible for other “minimum essential coverage,” such as employer-sponsored coverage that’s considered adequate and affordable. Traders should use a reasonable basis for providing the exchange with an estimate of household income perhaps qualifying for a subsidized plan with advanced credits. Some exchanges ask for monthly household income for either 2014 or 2015. Remember, you will have to square up with the IRS on a 2015 Form 8962 but at least you’re in the game for filing a Form 8962 and receiving a premium tax credit. Many traders may have low income in 2015 and they should keep this opportunity open. High-income sole proprietors have confidence they won’t get a premium tax credit and they can skip the exchange all together if working directly with an insurance provider is more convenient.

The exchange system is inconvenient for traders who have fluctuating income
Most individuals consider ACA-compliant non-subsidized health insurance plans expensive. If your household income is above 400% of the Federal Poverty Line, you or your family won’t qualify for a subsidized plan on the exchange. You may even face obstacles in using an exchange. No worries, you can purchase an individual or employer ACA-compliant health insurance plan directly through an insurance company. Just keep in mind that rules out the possibility of getting a premium tax credit if you wind up with household income under 400% of the Federal Poverty Line since the insurance must be purchased through an exchange to qualify for the credit.

Many traders have wide fluctuations in trading gains and losses from year-to-year. They could easily fall under 400% of the Federal Poverty Line in 2014 and qualify for an exchange-subsidized plan for the year of 2015. But these traders may wind up with large trading gains in 2015, thereby triggering an “excess advance premium tax credit repayment” (claw back of subsidies) on their 2015 Form 8962. The big problem is the exchange requires an estimate of income before the coverage year starts, and traders don’t know their income until the year ends. Tip: Traders can use an exchange but decline the subsidies up front and file for a premium tax credit if their income is under 400% of the federal poverty line.

There are five new Obamacare tax forms for 2014

1. Form 1095-A: Health Insurance Marketplace Statement. The exchange issues this form to individuals who purchased insurance through an exchange for 2014. (Similar to a bank or broker that issues a tax information Form 1099.) Its instructions state: “You received this Form 1095-A because you or a family member enrolled in health insurance coverage through the Health Insurance Marketplace. This Form 1095-A provides information you need to complete Form 8962, Premium Tax Credit (PTC). You must complete Form 8962 and file it with your tax return if you want to claim the premium tax credit or if you received premium assistance through advance credit payments (whether or not you otherwise are required to file a tax return). The Marketplace has also reported this information to the IRS. If you or your family members enrolled at the Marketplace in more than one qualified health plan policy, you will receive a Form 1095-A for each policy.” If the Form 1095-A does not list any advanced credits and you are confident your income will be well above 400% of the Federal Poverty Line, you don’t have to prepare Form 8962. Some taxpayers may easily generate the form with their tax software and choose to attach it with their return just in case IRS computers look for it.

2. Form 1095-B: Health Coverage. The insurance provider issues this form to individuals, although it’s not mandatory for 2014. Its instructions state: “This Form 1095-B provides information needed to report on your income tax return that you, your spouse and individuals you claim as dependents had qualifying health coverage (referred to as “minimum essential coverage”) for some or all months during the year. Individuals who do not have minimum essential coverage and do not qualify for an exemption may be liable for the individual shared responsibility payment. Minimum essential coverage includes government-sponsored programs, eligible employer-sponsored plans, individual market plans and miscellaneous coverage designated by the Department of Health and Human Services. For more information on minimum essential coverage, see Pub. 974, Premium Tax Credit (PTC).”

3. Form 1095-C: Employer-Provided Health Insurance Offer and Coverage. The employer issues this form to individuals, although it’s not mandatory for 2014. Its instructions state: “This Form 1095-C includes information about the health coverage offered to you by your employer. Form 1095-C, Part II, includes information about the coverage, if any, your employer offered to you and your spouse and dependent(s). If you purchased health insurance coverage through the Health Insurance Marketplace and wish to claim the premium tax credit, this information will assist you in determining whether you are eligible. For more information about the premium tax credit, see Pub. 974, Premium Tax Credit (PTC).” Some people used an exchange to receive subsidies even though their employer offered them a good health insurance plan as reported on Form 1095-C, so these individuals should be prepared for a claw back of subsidies on Form 8962.

4. Form 8962: Premium Tax Credit. This tax form is prepared by taxpayers and/or their tax preparers. Its instructions state: “Complete Form 8962 only for health insurance coverage in a qualified health plan (described later) purchased through a Health Insurance Marketplace (also known as an exchange). This includes a qualified health plan purchased on www.healthcare.gov.” Caution: An “excess advance premium tax credit repayment” increases estimated income taxes due, whereas a “net premium tax credit” (payment) does not reduce estimated taxes due since payments are listed below tax liability. (That’s inconsistent and unfair in our view.)

The Federal Poverty Line and household income
Exchange subsidies and the Form 8962 premium tax credit are granted to individuals and families with household incomes between 100% and 400% of the “Federal Poverty Line.” Household income is also used for calculating the Obamacare shared responsibility payment for not having minimum essential coverage or an exemption from coverage (Form 8965). Household income is basically taxpayer’s adjusted gross income reported on the tax return plus: Social Security payments excluded from AGI, tax-exempt income (i.e. municipal bond interest), and Form 2555 exclusions for U.S. residents abroad (foreign earned income and housing allowance). Household income also includes the income of any dependents covered on the family insurance plan.

Tax planning tip: Try to defer income and accelerate losses and expenses for household income so you don’t go just a few dollars over 400% of the federal poverty line, as that would require a 100% claw-back of exchange subsidies on Form 8962.

An Obamacare website https://www.healthcare.gov/income-and-household-information/income/ confirms household income includes “Social Security payments, including disability payments — but not Supplemental Security Income (SSI).” According to Form 8962 instructions, social security benefits otherwise not subject to income tax are “added back” since you start with modified AGI rather than just AGI. Eighty-five percent of Social Security payments are included in AGI if the taxpayer exceeds the Social Security AGI threshold of $44,000 for married filing joint ($34,000 for all other taxpayers). Taxpayers under those thresholds exclude 100% of Social Security payments from AGI. Including all social security payments in household income pushes many seniors above the Federal Poverty Line and prevents them from getting a premium tax credit, but most seniors don’t use the exchange because they are covered under Medicare.

For a full description of household income, see Form 8962 instructions.

Federal Poverty Line Chart
(based on Form 8962 instructions; these numbers are slightly different for Hawaii and Alaska residents)

Family	100% of Federal Poverty	400% of Federal
Size	Line	Poverty Line
1	11,490	45,960
2	15,510	62,040
3	19,530	78,120
4	23,550	94,200
5	27,570	110,280
6	31,590	126,360
7	35,610	142,440
8	39,630	158,520

5. Form 8965: Health Coverage Exemptions and instructions. A state or federal exchange needs to issue Form 8965 for certain types of exemptions (like religious), and for other types of exemptions (such as a short coverage gap) the taxpayer may self-prepare the Form 8965. (Be diligent to apply to the appropriate exchange on time — exchanges won’t contact you first.) Taxpayers without a Form 8965 exemption or minimum essential coverage are subject to a shared responsibility payment (see above). For one-page summaries of the exemptions available, see http://www.irs.gov/uac/ACA-Individual-Shared-Responsibility-Provision-Exemptions or IRS Publication 5172 – Facts about Health Coverage Exemptions.

According to Obamacare Mandate: Exemption and Tax Penalty, “The mandate’s exemptions cover a variety of people, including: members of certain religious groups and Native American tribes; undocumented immigrants (who are not eligible for health insurance subsidies under the law); incarcerated individuals; people whose incomes are so low they don’t have to file taxes (currently $9,500 for individuals and $19,000 for married couples); and people for whom health insurance is considered unaffordable (where insurance premiums after employer contributions and federal subsidies exceed 8% of family/household income); and those going without insurance for less than three months in a row … Hardship Exemption Update: If you had your plan canceled in 2014 due to the Affordable Care Act you now qualify for a hardship exemption in 2014. That means you won’t have to pay the shared responsibility payment if you decide to go without insurance and will qualify for low premium, high out-of-pocket catastrophic plans on your state’s health insurance marketplace.” U.S. residents abroad who qualify for Section 911 (foreign earned income exclusion) are deemed to have minimum essential coverage whether they do or not. That means they don’t apply for a Form 8965.

Obamacare is progressive taxation
Obamacare is the epitome of progressive taxation and transfer payments using fiscal policy. Upper-income taxpayers pay more to subsidize lower-income folks, and middle-class taxpayers pay their fair share of more expensive coverage that can’t rider out pre-existing conditions. Like many new major social programs enacted before it, some Obamacare tax hikes started on upper-income taxpayers before the new benefits were even provided, including Obamacare Net Investment Income Tax, which started in 2013 even though Obamacare benefits didn’t start until 2014. (Read more about Net Investment Income Tax reported on Form 8960.)

Open question: Are federal exchange subsidies legal?
One court ruled that federal exchange subsidies are illegal and another court overruled it. The Supreme Court agreed to hear the case (WSJ Nov. 7). Obamacare law authorizes subsidies “through an exchange established by the state,” it does not mention a federal exchange. Obamacare law contemplated that all states would have a state exchange but many states balked and chose to participate in HealthCare.gov, the federal exchange just as some also balked at Obamacare’s Medicaid expansion. Did Obamacare purposely provide an incentive to states to create their own exchange, or was leaving out subsidies for the federal exchange an inadvertent oversight? (Read more: http://www.cnbc.com/id/102137279 and http://www.cnbc.com/id/102147639.)

Two Helpful IRS Fact Sheets on ACA
Per Thompson Reuters on Nov. 10 “Affordable Care Act Provisions Impacting Individuals and Employers: Two new IRS fact sheets provide details on key provisions of the ACA. The IRS notes the most important ACA tax provision for individuals and families is the premium tax credit and individuals without coverage and those who don’t maintain coverage throughout the year must have an exemption or make an individual shared responsibility payment. These provisions will affect 2014 income tax returns filed in 2015. For employers, the workforce size is significant because that’s what determines the applicable ACA provisions. Generally different rules apply to employers with fewer than 50 employees. IRS Fact Sheets FS-2014-09 and FS-2014-10 are available at http://www.irs.gov/uac/Newsroom/Fact-Sheets-2014.”

The employer mandate was delayed
Individuals have felt the brunt of Obamacare compliance over the individual mandate. President Obama issued an executive order to delay the employer mandate. But that delay is ending soon. See CNBC Nov. 11 Obamacare Cadillac plans? You’re gonna pay for that….

More changes
Prior to Obamacare, S-Corps could reimburse employees for health insurance on a tax-free basis by not including health insurance reimbursements in employee taxable wages. But starting in 2014, S-Corps must include the health insurance reimbursements in taxable wages for income, FICA and Medicare taxes. Don’t skip over making this change as the Obamacare law includes a fine of $100 per employee, per day. An employer group health insurance plan still delivers tax-free benefits to employees. (Postscript 2/18/15: The IRS issued relief for the above draconian penalty. Read more.)

Bottom line
Consult with your tax adviser to discuss how Obamacare taxes will affect your 2014 tax return and how it may be best for you to obtain coverage for 2015. There’s still plenty of confusion and new surprises will arise, so stay tuned for updates on our blog.

Postscript Nov. 24, 2014: The IRS published new guidance on ACA’s individual mandate, hardship exemption, and premium tax credit. Notice 2014-76, Rev Proc 2014-62 and final regs for Section 5000A on the individual mandate. Notice 2014-76 “Individual Shared Responsibility Payment Hardship Exemptions that May Be Claimed on a Federal Income Tax Return Without Obtaining a Hardship Exemption Certification from the Marketplace.” Rev Proc 2014-62 “This table is used to calculate an individual’s premium tax credit.” The Rev Proc “announces the indexed applicable percentage table in Code Sec. 36B(b)(3)(A), which is used to calculate an individual’s premium tax credit for tax years beginning after calendar year 2015.”

Darren Neuschwander, CPA and Star Johnson, CPA contributed to this article.

Net investment tax

February 1, 2014 | By: Robert A. Green, CPA

The Patient Protection and Affordable Care Act (also known as “ObamaCare”) has many new and different types of taxes to finance the law, starting on different dates.

One of these new tax regimes — the “ObamaCare 3.8% Medicare surtax on unearned income” — affects upper-income traders and investment managers as of Jan. 1, 2013. It only applies to individuals with modified adjusted gross income (AGI) exceeding $200,000 (single), $250,000 (married filing jointly) or $125,000 (married filing separately). (Modified AGI means U.S. residents abroad must add back any foreign earned income exclusion reported on Form 2555.)

Final IRS regulations and tax form 8960 instructions were late
The IRS released its final regulations for “net investment income” (NII) and “net investment tax” (NIT) in December 2013, and draft instructions for Form 8960 (Net Investment Income Tax) in January 2014. The IRS was late because the proposed IRS regulations were highly problematic for many CPAs and industry groups who submitted comments asking the IRS for many changes. The proposed regulations disenfranchised taxpayers from deducting their losses against NII which was unfair and against the spirit of the tax code.

Thankfully, the final regulations are better. We are pleased with the results for business traders, who went from being the most disenfranchised to the most enfranchised. Unlike most taxpayers with NII, business traders may deduct trading business net losses and expenses against NII.

What’s included and excluded from NII?
Notice the term “investment income” is used in lieu of “unearned income.” People who receive “earned income” from a job pay FICA (on the social security base amount) and Medicare on their wages or self-employment income. In general, unearned income includes interest, dividends, rents, royalties, capital gains and distributions from companies in which you are passive. Now, this type of income is subject to Medicare taxes, too — albeit at upper-income brackets only.

NII’s proposed regulations interpreted the tax code to require segregation of different types of unearned income into three different buckets, for the main purpose of disenfranchising taxpayers from using losses from any given bucket. The final regs make some serious amends here and the Section 475 MTM trader fares very well…

The NII buckets include the following:
Bucket 1: Portfolio income (includes interest, dividends and annuity distributions), royalties (net of oil and gas depletion expenses) and rents (net of depreciation);
Bucket 2: Passive activity income and loss from pass-through entities;
Bucket 3: Capital gains and losses from the sale of property not used in an active business. In the final regs, the IRS moved trading businesses into bucket 3, so trading business capital gains and losses are counted with investment capital gains and losses. Smart move!…..

There may be even better news, too
The regulations state: “To minimize the inconsistencies between chapter 1 and section 1411 for traders, the final regulations assign all trading gains and trading losses to section 1411(c)(1)(A)(iii). The final regulations also permit a taxpayer to deduct excess losses from the trading business of a section 475 trader from other categories of income. Part 5.C of this preamble describes the treatment of those excess losses.”

This is an excerpt from Chapter 15 of Green’s 2014 Trader Tax Guide.

IRS final NIT regulations help traders

December 4, 2013 | By: Robert A. Green, CPA

Good news for business traders and investment managers: Our petition and request for fixes to the Net Investment Tax worked! The IRS just issued final regulations (TD 9644) for the Affordable Care Act’s “Net Investment Tax” (NIT), the 3.8% Medicare surtax on unearned income above the AGI thresholds of $250,000 married and $200,000 single.

We are pretty satisfied with the final regulations as they affect business traders and investment managers. What could have been a huge mess complying with the proposed regulations — with unintended consequences like overcharging taxes — worked out to be a simple aggregation with tax fairness on true net trading income in the final regulations.

The NIT regulations affect all types of unearned income activities and they are very complex and beyond the scope of this blog. But in this blog, we’re focused on business traders and investment managers.

The problem in the proposed regulations
There are three separate buckets for different types of unearned income: portfolio income goes in bucket #1, passive activity entities and trading businesses go in bucket #2, and capital gains and losses are housed in bucket #3. The biggest problem with the proposed regulations for the NIT is they counted trading gains in bucket #2, but they (probably unintentionally) counted trading losses in bucket #3. You can’t count an individual bucket with a net loss when aggregating net investment income (NII). Wouldn’t it make more sense to put trading businesses in bucket #3, as they are not passive activities anyway?

Our petition showed how a trading business with a net loss could have NII of several hundred thousand dollars because only gains would be counted and not losses.

Problem solved in the final regulations
Kudos to the IRS, not only did they listen to us — and the AICPA, plenty of other accountants and trading industry groups — but they crafted a clever and simple solution for this fix. In a nutshell, a trading business with an entity structure or without (sole proprietorship), with a Section 475 MTM election or default cash method, are all counted in bucket #3 capital gains and losses. This immediately fixes the glaring problem of a trading entity having gains counted in bucket#2 and losses counted separately in bucket #3.

Using bucket #3 for all trading business gains and losses makes good sense. Doesn’t a trading business have more to do with capital gains and losses in bucket #3 than a passive-activity entity in bucket #2? While many trading businesses are conducted in pass-through entities, it is not considered a passive activity under the “trading rule” in Section 469. Bucket #2 is important for passive activities with unearned income because active businesses generally have earned income subject to Medicare tax on earned income.

Consider the example of a Section 475 MTM trader who arbitrages securities trades against interest income. He has interest income in bucket #1 and securities trading gains and losses in bucket #3. With the final regs, it may be possible for him to offset bucket #1 interest income with net Section 475 MTM ordinary losses in bucket #3. Stay tuned for more news on these regs.

Click here for an excerpt of TD 9644 showing these changes. We added yellow highlights.

According to respected blogger Farm CPA Today, “The final regulations now allow at least three new ways of using losses:

If you have a net capital loss for the year, the regular tax laws limit this loss to $3,000. The final regulations allow this up to $3,000 loss to offset other investment income.
If you have a passive loss such as Section 1231 losses, as long as that loss is allowed for regular income tax purposes, you will be allowed to offset that against other investment income.
Finally, if you have a net operating loss carry forward that contains some amount of net investment losses, you will be allowed to use that portion of the NOL to offset other investment income.”

Bottom line
In our petition, we wanted the IRS to scrap all three buckets entirely, or allow a bucket with a net loss to be counted in NII, as that is how we read the law enacted by Congress. While the IRS hasn’t gone that far, and these regs are still an abomination of complexity and nuance, we are happy the IRS made the law fairer for traders and investors.

ObamaCare taxes are starting to affect traders

October 29, 2013 | By: Robert A. Green, CPA

Learn how to navigate the minefield, avoid taxes and maximize benefits: Join Robert A. Green CPA and managing member of Green NFH, LLC for a special Webinar on Tuesday Nov. 5 at 1:00to 2:15 pm ET.

We’ll discuss several topics, including:

• The OC 3.8% Medicare surtax on unearned income — including trading gains — for AGIs over $250k married/$200k single started in 2013. IRS proposed regulations disenfranchise many traders from losing trades, only counting their winning trades. That’s ridiculous and hopefully our petition helps fix the proposals.

• The OC health insurance mandate/tax phase-in begins on March 31, 2014. The penalty is the greater of: $95 per uninsured person or 1% of household income over the filing threshold in 2014; $325 per uninsured person or 2% of household income over the filing threshold in 2015; and $695 per uninsured person or 2.5% of household income over the filing threshold in 2016 and beyond. There are some exemptions; learn more about the individual mandate here. Many traders rely on purchasing health insurance in the individual marketplace, while others benefit from employer-provided insurance. President Obama granted a one year delay to the employer mandates and related taxes.

• To avoid the OC individual mandate/tax, traders must purchase “minimum essential coverage” by March 31, 2014. Traders making less than 400% of the federal poverty level on their 2012 tax return filing qualify for tax credit subsidies on the federal and state exchanges. Because traders’ income and loss fluctuates significantly, they face the prospect of claw-backs since actual 2014 household income may be materially higher than their 2012 tax filing. What happens in the reverse case where 2012 income is materially higher than 2014? Can you get subsidies after the fact? Learn how to calculate household income and try out this subsidies calculator tool based on 2014 estimated income. Traders should not overlook qualifying for (free) Medicaid, set at 138% of the federal poverty level.

• The OC individual mandate/tax is not enforceable like other tax liabilities. While the IRS may not levy your bank account to collect it, it will offset a subsequent tax refund with this tax liability. Eventually, it will be very hard to avoid paying the IRS what you owe.

• Make sure to get a 100% AGI deduction for your self-employed health insurance premiums. Traders often need a trading entity to financially engineer “earned income” — administration fees or salaries — otherwise AGI deductions generally can’t be taken against individual trading gains. The same goes for retirement plan deductions.