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Washington Insider Equipment Industry Can't Afford To Be Passive About New Tax On Passive Income Construction equipment distribution companies are about to become victims of a law of unintended consequences. BY CHRISTIAN KLEIN Most of our readers are probably familiar with the headaches passive loss issues have caused for the equipment industry over the years. Rules adopted in the 1980s were designed to prevent wealthy individuals from using losses from passive activities to avoid paying income taxes. However, due to anomalies in the Internal Revenue Code and Internal Revenue Service (IRS) rules, the income and losses that equipment companies derive from renting bulldozers and other machines to contractors are considered "passive." The passive issue has taken on new urgency since the enactment of the Affordable Care Act (aka, Obamacare), which imposes a new 3.8 percent tax on passive income effective Jan. 1, 2013. On that day, many AED members will find themselves subject to a tax they were never meant to pay. The tax was designed as an "unearned income Medicare contribution tax." In the case of an individual (most equipment distribution companies are pass through entities, so the companies' taxes are those of the individual owners), the tax is 3.8 percent of the lesser of net investment income or the excess of modified adjusted gross income over the threshold amount ($250,000 in the case of joint return or surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case). According to the Joint Committee on Taxation, "In the case of trade or business, the tax applies if the trade or business is a passive activity with respect to the taxpayer or the trade or business consists of trading financial instruments or commodities … The tax does not apply to other trades or businesses conducted by a sole proprietor, partnership, or S corporation." In other words, in creating the new tax, Congress sought to limit its applicability and only ensnare a select group of individuals (those deriving income from passive activities and financial traders). Congress did not intend the law to apply to companies like equipment distributors. However, due to the complexity of the tax code and related regulations, companies that rent equipment have fallen into a trap and will be forced to pay a tax that was not meant for them. Congress has exempted certain industries from passive loss rules. Legislation enacted in 1993 clarified that real estate rental activities are not passive activities for those in the real property business (i.e., "real estate professionals.") The Internal Revenue Services has also carved out other exceptions through regulation. Unfortunately, because of the way business is done in our industry (e.g., longer term rentals and 28-day contracts with automatic renewal clauses), the exceptions don't generally apply to equipment distributors. So now, AED, with expert assistance from tax guru Steve Pierson at Selden Fox, is taking the issue to the Hill. We're making the case that equipment distributors have fallen through a crack in the law and that if Congress doesn't act immediately, our members will suffer economic harm. The good news is that the exception for the real estate industry provides a compelling precedent. Our proposed legislation mirrors the real estate carve-out almost exactly, which should make it an easier sell. But make no mistake, this is a heavy lift and in the current environment, the chances of success are slim at best. As CED went to press, the dust was still settling from the 2012 elections and the agenda for the lame duck session of Congress was just taking shape. In addition to the more than $200 billion worth of expiring tax cuts, lawmakers also have to figure out how to deal with $84 billion worth of expired or expiring tax extenders like the research and development tax credit. Whether we'll be able to get a new issue into the mix remains to be seen, especially since lawmakers seem poised to punt all these issues into the next Congress and try to resolve them comprehensively as part of a bigger tax and budget reform package. If we're to have any chance of success, it's going to take a massive and swift grassroots effort. If you want to help, please call or e-mail me. CHRISTIAN KLEIN (caklein@aednet.org) AED's vice president of Government Affairs and Washington counsel. He can be reached at 703-739-9513. December 2012 | Construction Equipment Distribution | www.cedmag.com | 67