The US Tax Court released today their long anticipated decision in the Frank Aragona Trust case. This case had been previously decided in favor of the IRS and then appealed to the Tax Court. The background on the case is as follows:
- The Frank Aragona Trust was formed by Frank Aragona during his lifetime and after his death, the trustees of the trust were his five children plus an independent trustee. Three of the children trustees were also employees of a LLC which was 100% owned by the trust and two of these children were also part owners of other LLCs which were majority owned by the trust.
- The trust incurred substantial real estate losses during 2005 and 2006 which were carried back to 2003 and 2004 to get income tax refunds. The IRS audited the tax returns and disallowed those losses due to their conclusion that the trust did not materially participate in these real estate activities. The IRS asserted a trust could not provide personal services to meet the material participation test, only an individual or an C corporation meeting certain requirements.
- However, the Tax Court decided that a trust could in fact provide personal services and that the activities of its employees and trustees could be attributed to the trust and if they provided enough hours of activity, then the trust could deduct the real estate losses.
In the case of the Frank Aragona Trust, the Tax Court concluded exactly that. They indicated that the services provided by the three trustees (and the employees) were more than sufficient to allow the trust to deduct these real estate losses. Another factor in favor of the trust was the three trustees were employees of a LLC owned 100% by the trust. This allows all of their activities to be attributed to the trust. If these trustees had been employees of a LLC not related to the trust, the case decision may have been decided otherwise.
Many farm holdings have now been placed into trust for the benefit of children and grandchildren. This decision would allow "farming operations" with enough material participation by trustees and employees to fully deduct those losses and not have any income subject to the new 3.8% net investment income tax. However, for most farmland placed in a trust that is cash rented or crop shared, these losses would most likely still not be deductible and any income would be subject to the new 3.8% tax (once trust income exceeds about $13,000).
Although a victory for the taxpayer, it will primarily apply to those larger trusts with major farming or ranching activities.