8650 / After an initial grouping of activities has taken place, can a taxpayer regroup activities for purposes of satisfying the material participation test in order to avoid application of the net investment income tax?

The final regulations provided a small window to allow this type of regrouping. In order to regroup:

(1)  the regrouping was required to occur only in the first taxable year beginning after December 31, 2012; and

(2)  the regrouping taxpayer had to be subject to net investment income tax during that year.

In other words, regrouping was allowed only in the single tax year referenced above, and only if a taxpayer was subject to the net investment income tax in that same year. Consequently, any taxpayer who was not subject to the net investment income tax in that taxable year, but may be subject to it in a subsequent year, is not entitled to a “fresh start” regrouping.¹

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Planning Point: In drafting the final regulations, the IRS refused to allow pass through entities such as S corporations and partnerships to regroup. In declining to do so, the final regulations noted that taxpayers not subject to the net investment income tax for the taxable year beginning after December 31, 2012, would get the benefit of regrouping indirectly (i.e., by virtue of the pass through of income from those entities), that they would not be entitled to receive directly.²

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For additional discussion of the passive activity rules in general, see Q 8010 to Q 8704.