The Affordable Care Act –Obamacare–has “dynamic duo” of taxes: The Net Investment Income Tax and the Additional Medicare Tax.
Up to a few weeks ago, things looked ‘auspicious’ for a replacement of Obamacare and replacement with X, of course that X being “something else”. Central to the attempts to this was the effort to repeal these two birds, which are particularly galling to ‘wealthy’ people. They are targeted (but the income ‘trigger’ for either tax can be as low as $125,000 if filing married separately).
The Net Investment Income Tax applies to individual’s “net investment income” whose incomes are above a certain amount, and it also applies to trusts and estates. In comes the Mexican Land Trust (MLTs), or “fideicomiso”. I want to explore a possible intersection between a “Fido” and the NIIT. In Mexico, ‘Fidos’ are mandatory for foreign ownership of property close to shorelines and national borders.
You may have heard the IRS has decreed that MLTs are not “trusts” from a US federal income tax perspective…but that is not true for all MLTs…only those that meet IRS requirements. The main ones: MLT holding only title to residential real property in the Mexico restricted zone, and MLT neither permitted nor required to engage in any activity beyond holding title. Note: “any activity”.
Mexicans don’t care about IRS rules. Perfectly valid MLTs for Mexico purposes may not fold neatly into the IRS’s “MLT is not a trust” ruling. Things like the trust collecting income, administering the property, paying taxes, holding title to more than one property, could be things that cross that red line the IRS drew for MLTs. What does your “Fido” say?
If the MLT fails the IRS test, guess what: you have a real trust, and a foreign one at that, requiring reporting on special forms. If that trust also has enough income it could itself end up being subject to the Net Investment Income Tax, on top of all the very bad things that happen to people that own unreported foreign trusts. Is this far fetched? Not at all, I say.
How to prevent this? Make sure you (and not the MLT) have the right to collect rents and incomes from the property; ‘actively participate’ in the management of the rental; review your “Fido” to make sure its language may not trigger IRS disqualification; and in the meantime, pray for repeal. You may need extra large candles, at the rate things are going in DC!