NIIT capital gains from sale of business - LLC taxed as S Corp question

Thanks for the explanation! I've heard some conflicting things about this because apparently some income that passes through an S corp could still be considered passive. Does it matter if the business income was reported on a K-1 vs W-2? Also, is there a lookback period for the material participation test or does it just need to be in the year of sale?

The key distinction is between income received as compensation for services (reported on W-2) versus income received as a distribution or from the sale (reported on K-1). However, for NIIT purposes, what really matters is whether you materially participated in the business - not how the income was reported. The material participation test generally looks at your involvement in the current tax year, but there's also a "five-year personal service activity" test that can apply. If you've materially participated in the business for any 5 of the previous 10 years, you'll meet the material participation requirement. Since you've been actively involved since starting the business in 2018, you should qualify under several of the tests.

How accurate is it? I'm selling my partnership interest next month and wondering if I can trust an AI tool with something this important. Did it match what your CPA eventually figured out?

I'm skeptical about these AI tax tools. How does it handle situations where you've had varying levels of participation over the years? I was out on medical leave for 6 months two years ago and worried that might affect my "material participation" status.

The analysis matched what my CPA concluded, which was a big relief. It actually helped me prepare the right questions and documentation before my CPA meeting, which saved me money on billable hours. As for varying participation levels, it actually accounts for that. When I uploaded my documents, it identified that there are multiple ways to meet the material participation tests. For medical leave situations, there's actually a provision that can help - the tool flagged that temporary absences like medical leave often don't disqualify you if your participation was regular before and after the absence.

How does Claimyr actually work? Isn't it just paying to cut the line for IRS help? Seems too good to be true that you could get through that fast when I've been waiting on hold for hours.

I don't believe this for a second. IRS agents don't give tax advice, they only answer procedural questions. No way they would've given a definitive answer on NIIT applicability for a complex business sale. You probably just got lucky with a random agent who went beyond their scope.

It's not cutting the line - they use a system that basically keeps dialing and navigating the IRS phone tree until they get through, then they connect you once there's an actual human. Took about 22 minutes for me but saved me from the hours of hold music and disconnections I'd been dealing with. To clarify on the advice part - you're right that they don't give complex tax planning advice, but they absolutely can and do clarify how specific tax rules apply. I asked specifically about the NIIT regulations for materially participating S-corp owners selling their business interest, and the agent directed me to the specific sections of the tax code and publications that addressed my situation. This wasn't tax planning advice - it was clarification of existing rules.

Thanks for pointing this out! My MAGI will definitely exceed the threshold with the sale proceeds. If the material participation exemption somehow doesn't apply, are there any other strategies to minimize the NIIT impact at this point? The sale is happening in about 6 weeks.

At this late stage, your options are somewhat limited, but you might consider income timing strategies. If you can structure the sale with an installment agreement to spread the income across multiple tax years, you might keep your MAGI lower in each year. You might also look into maximizing retirement contributions this year (like maxing out a SEP IRA if eligible) to reduce your MAGI. Charitable contributions could be another option if that aligns with your goals. An experienced tax professional should review your specific situation as soon as possible to identify the best approach given the tight timeline.

The QBI deduction generally wouldn't apply to capital gains from selling the business itself. Section 199A is specifically for qualified business income from ongoing operations, not for the gain realized when selling your ownership interest. The capital gain from selling your business would be reported on Schedule D, not as QBI on your return.

This is really helpful documentation advice! I'm curious - what kind of work logs or records would be most convincing to the IRS if they ever questioned material participation? I've been keeping general business records but haven't specifically tracked my hours. Would things like email records, calendar entries, or travel receipts for business meetings count as sufficient evidence of active involvement?

Email records, calendar entries, and business travel receipts are definitely helpful supporting evidence! The IRS generally accepts contemporaneous records that show regular business involvement. Here are some specific types of documentation that work well: **Strong evidence:** - Email chains showing business decisions and day-to-day involvement - Calendar entries for business meetings, calls, and work activities - Travel records for business trips (receipts, itineraries) - Bank records showing business transactions you handled - Contracts or agreements you signed on behalf of the business - Board meeting minutes showing your participation **Also useful:** - Phone records showing business calls - Business expense receipts you personally incurred - Time tracking apps or calendars (even if started recently) - Witness statements from employees, partners, or clients The key is showing a pattern of regular, substantial involvement in business operations. Even if you don't have perfect hour-by-hour logs, multiple types of evidence that demonstrate consistent participation throughout the years can be very convincing. Since your sale is in 6 weeks, I'd recommend gathering these documents now. Create a simple timeline showing your major business activities, decisions, and involvement over the years - this can help paint a clear picture of material participation for both your accountant and potential IRS review.

This is excellent advice about QSBS! I hadn't even considered this possibility. Since we started the business in 2018 and made the S-corp election pretty early on, we might actually qualify for the 5-year holding period requirement by the time of sale. The potential to exclude the entire $875K from federal capital gains tax would be incredible - that could save me around $131K in federal taxes (15% or 20% capital gains rate) plus avoid the 3.8% NIIT entirely. Even if we only partially qualify, any QSBS exclusion would be huge. I'm definitely going to have my accountant dive deep into this when they get back. Do you know if there are any specific documentation requirements we should be gathering now to support a QSBS claim? I want to make sure we have everything ready since the sale timeline is tight.

For QSBS documentation, you'll want to gather several key items before your accountant returns: **Essential QSBS Documentation:** - Your LLC operating agreement and all amendments - The S-corp election form (Form 2553) and the date it was filed - Documentation showing when you acquired your ownership interest (original investment records, partnership agreements, etc.) - Business formation documents (Articles of Organization, EIN application) - Financial records showing the business had gross assets under $50M when you acquired your interest and when the S-corp election was made **Business Activity Verification:** - Records showing the business qualifies as an "active business" (not just passive investments) - Documentation that it's not in an excluded industry (hotels, restaurants, farms, mining, etc.) - Financial statements or tax returns showing business operations **Timing Documentation:** - Any stock certificates or membership interest documentation with dates - Capital contribution records with timestamps - Bank records showing when investments were made The 5-year holding period is calculated from when you first acquired the interest, not from the S-corp election date, so if you were a founding member in 2018, you're likely well past the 5-year requirement by now. Given the potential tax savings, it's worth having your accountant expedite this analysis even if it means paying for rush service. The QSBS exclusion could dwarf any costs associated with getting professional guidance quickly.

This is such a comprehensive summary - thank you! I'm feeling much more confident about avoiding the NIIT now. I've already started gathering documentation and found tons of emails, calendar entries, and meeting records that clearly show my active involvement throughout the years. One quick follow-up question: If we do qualify for QSBS treatment, does that completely eliminate both federal capital gains tax AND the NIIT, or would there still be some portion subject to regular capital gains rates? With multiple owners potentially each claiming their own $10M exclusion, I want to make sure I understand how this stacks with the material participation exemption. I'm definitely going to contact my accountant tomorrow to see if they can prioritize this analysis remotely. The potential savings are too significant to wait, especially with the tight timeline. Thanks again to everyone who contributed - this community has been incredibly helpful!