Losses from business activities undertaken by a trust or estate may be suspended under the passive activity loss (PAL) rules, and thus may not be available to offset other non-passive income of the trust or estate just as if the trust or estate is an individual. Generally, "passive activity" status and the PAL rules can be avoided if a taxpayer "materially participates" in the business. Minimum participation will be found to exist if the taxpayer participates in the business in a regular, continuous, and substantial basis, or if certain minimum participation hour requirements are met.
Many trustees engage third parties to assist them in running businesses under their control, especially since they are often not well suited to business management. Therefore, the question comes up whether the activities of such assistants will count towards determining whether material participation exists. At first review, such hired persons may need to be ignored since the Treasury Regulations, in the case of individual taxpayers, will not allow the activities of employees of a taxpayer to be counted for material participation purposes.
In Mattie K. Carter Trust, 91 AFTR 2d 2003-1946, 256 F Supp 2d 536 (DC Tex., 2003), a Federal District Court in Texas held that the focus should be on the participation of the trust itself, not just the trustee. As such, persons who conducted business operations on behalf of the trust should be included in the measure of the trustee's material participation.
Per a recent Technical Advice Memorandum, it is now clear that the IRS has not acceded to the analysis in the Carter Trust case. In TAM 200733023, the IRS indicated that the focus of material participation is on the trustee itself. Activities of third parties acting on behalf of the trust (or an estate) will not be counted towards material participation. In the TAM, the IRS concluded that activities of certain "special trustees" who were appointed to manage a business investment were not trustees themselves because they did not have power to bind the trust (even though they were trustees under state law). Therefore, since they were not acting as trustee, their activities were not counted towards material participation.
Therefore, the state of the law on this issue is uncertain. The Carter Trust case is helpful in avoiding the PAL rules. However, the above TAM, and the Regulations themselves that address employees of taxpayers and the disregard of their activities, suggest it will be difficult for any trust or estate to escape the PAL rules when the assistance of any third parties is involved in running the business.