Form 8960 line 4 has three lines:
Line 4a is used to report income from rental real estate, royalties, partnerships, S corporations, trusts, etc.
Line 4b is used to adjust the amount reported on line 4a for net income or loss derived in the ordinary course of a non-section 1411 trade or business.
Line 4c is the combination of line 4a and line 4b.
To figure out what adjustment(s) you should make on line 4b, you need to know what income item(s) is included on line 4a, then decide which item(s) to adjust on line 4b.
What is included on Form 8960, line 4a
The amount on Form 8960 line 4a is from what you report on Form 1040, line 17. It is also the total amount of income reported on Form 1040, Schedule E, which includes the following types of income:
- Income or loss from rental real estate and royalties.
- Income or loss from partnerships and S corporations.
- Income or loss from estates and trusts.
- Income or loss from real estate mortgage investment conduits (REMICs)—residual holder
What adjustments should be reported on Form 8960, line 4b
Generally, only net investment income from passive activities are subject to net investment income tax. A passive activity means any trade or business activity in which you do not materially participate. Since the income reported on Form 8960, line 4a (or Schedule E) may include both passive and nonpassive income, you need to enter total income from nonpassive activities on line 4b as an adjustment to remove it from line 4a, so that only passive investment income will be taxed.
According to Form 8960 line 4b instruction, the following items are not subject to net investment income tax. You should review the completed Form 1040, Schedule E, identify these items and report the total nontaxable amount on line 4b.
1. "Net income or loss from a section 162 trade or business (see Note 1 below) that is not a passive activity and is not engaged in a trade or business of trading financial instruments or commodities."
2. "Net income or loss from a section 1411 trade or business (see Note 2 below) that is taken into account in determining self-employment income."
3. "Royalties derived in the ordinary course of a section 162 trade or business that is not a passive activity."
4. "Passive losses of a former passive activity that are allowed as a deduction in the current year by reason of section 469(f)(1)(A)." (see Note 3 below)
5. "Nonpassive net rental income or loss of a real estate professional where the rental activity rises to a section 162 trade or business."
6. "Net rental income or loss that is a nonpassive activity because it was grouped with a trade or business under Regulations section 1.469-4(d)(1)."
7. "Other rental income or loss from a section 162 trade or business reported on Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc., line 3, from a partnership, or Schedule K-1 (Form 1120S), Shareholder's Share of Income, Deductions, Credits, etc., line 3, from an S corporation, where the activity is not a passive activity."
8. "Net income that has been recharacterized as not from a passive activity under the section 469 passive loss rules and is derived in the ordinary course of a section 162 trade or business. For example:
- Net rental income or loss from a rental that meets an exception under Regulations section 1.469-1T(e)(3)(ii), the activity rises to a section 162 trade or business, and you materially participated in the activity, or
- Net income from property rented to a nonpassive activity. See Special Rules for Certain Rental Income, earlier."
Note 1: Here is a definition of section 162 trade or business from www.taxpayeradvocate.irs.gov. "The Supreme Court has interpreted “trade or business” for purposes of IRC § 162 to mean an activity conducted with “continuity and regularity” and with the primary purpose of earning income or making profit."
Note 2: Per IRS code section 1411S(c)(2), section 1411 trade or business is a trade or business that is either a passive activity for the taxpayer or is a trade or business of trading in financial instruments or commodities.
Note 3: If you have disallowed passive loss from former passive activity and use it to offset against the income from such activity for the current taxable year, you need to remove it from line 4a because the income from such activity is nonpassive for current taxable year and is not included or removed from line 4a. See example below.
Treatment of income or loss from a publicly traded partnership (PTP)
If you have an overall gain (total income, gain minus total losses) from a publicly traded partnership (PTP), the net gain is treated as nonpassive income, therefore is not subject to net investment income tax. The net gain should be an adjustment on line 4b.
If you have an overall loss from a publicly traded partnership (PTP), you can not deduct the net loss. It will be carried forward to future years to offset income from the same PTP. You don't need to make adjustment on line 4b since the net loss is not allowed and not included on line 4a.
If you have income or loss from multiple PTP, you must treat each PTP separately when you calculate the overall gains or losses. You also can't combine income or losses from a PTP with income or losses from NON-PTP activities.
For more information, please see IRS Instructions for Form 8960, Partner's Instructions for Schedule K-1 (Form 1065) and Instructions for Schedule E (Form 1040).
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