Are you passive or non-passive in regards to the K-1 you receive? First of all, why is it important to know which you are? Making this determination can determine if a loss is allowed or if it is a suspended loss. It also determines if the income is subject to the Net Investment Income Tax. Depending on your tax situation this determination can change your tax due and you should prepare for the effect it has on your tax when you become involved in an entity that you receive a K-1 from.
Now to answer the passive versus non-passive questions, we need to determine if you meet the material participation rules. To determine if you meet the material participation rules you have to ask yourself a series of questions that include:
- Did you participate more than 500 hours?
- Did you do substantially all the work in the activity?
- Did you participate more than 100 and no other owner or employee participate more than that?
- Did you participate more than 100 but less than 500 in two or more activities resulting in total participation in all activities of more than 500 hours?
- Did you materially participate in the activity for any five of the past ten years?
- If the activity is a personal service activity did you participate for any of the past three years?
- Are there any other facts or circumstances that would indicate material participation? If so these should be discussed with your tax preparer before the return is completed.
Included with this post is a flow chart that will allow you to go through the questions one-at-a time to determine if you meet the material participation rules.
While this is all important information, I should also mention that by nature rental income is considered passive unless you are considered a real estate professional. In addition, there are still other rules that might change your classification. If you are a limited partner with a limited interest you would you would be passive unless you can meet the requirements in 1, 5, or 6 above. Also, you could be considered non-passive if your spouse is considered non-passive in regards to the activity.
When going over this information I recommend, as I do with any tax planning item, to discuss this information with your tax professional to see how it affects you and your filings. As a taxpayer, you should keep in mind that every return is different so any tax advice or suggestions you receive should be discussed with somebody who knows your return or is willing to take the time to get to know your tax situation and return.
The Wassman CPA Services website and blog is meant to offer general information to our readers. The information provided is not intended to replace or serve as a substitute for any accounting, tax or other professional advice, consultation or service. You should contact Wassman CPA Services for advice concerning specific matters prior to making any decisions.