Tax Strategies-Passive Investor Rule

An Overview of the ‘Passive Investor’ Rules

In a June Blog we took a closer look at 3.8% Income Tax and how it may impact your take home pay. The important consideration for business owners is that the 3.8% tax specifically applies to business income and gains from the sale of business assets if the business is a “passive activity” with respect to an individual owner.  Therefore, it is important to understand when the passive activity rules apply.

Generally, a business will be considered to be a passive activity with respect to an individual owner if he or she is not involved in the business on a regular, continuous and substantial basis.  Whether a business is treated as a passive activity is determined separately for each owner based upon their individual involvement in the business.  The IRS provides several tests that determine when an activity is considered passive, including the time spent working in the business.

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In fact, many owners will likely not be considered as “passive”, particularly if they are the founders of the business and are actively involved on a day-to-day basis.  In this case, the additional tax may be avoided with respect to their share of business profits and the gain from the sale of their interest in the business.

However, where there are multiple owners, some of whom are not active in the business, the tax could apply to their share of pass through income as well as to the gain recognized by them on the sale of the business.

This could be the case, for example, where ownership has been transferred to trusts or non-active family members in connection with estate planning.

We at Opus Consulting take pride in our Exit Strategy Planning process where all avenues are explored. We take uncertainty out of the deal and ensure your Exit plan aligns with your personal long term goals. Contact us for an initial consultation.

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