By Kim Dixon
WASHINGTON (Reuters) - Businesses and wealthy owners of estates and trusts asked the IRS on Tuesday for changes to a part of President Barack Obama's 2010 healthcare law that has received comparatively little attention: a 3.8 percent tax on investment income intended to provide the bulk of the law's funding.
The tax kicks in this year, with U.S. taxpayers accounting for it for the first time in their tax returns for 2013. It is projected to raise more than $100 billion over a decade to help pay for health insurance for millions of Americans who lack it.
The Internal Revenue Service in December issued proposed regulations to implement the tax. On Tuesday, lawyers for various small and big businesses and owners of estates and trusts urged the agency during a public hearing over the IRS's proposed rules to clarify gray areas before they become final.
The tax applies to the investment income of individual taxpayers earning more than $200,000 a year, or households with income above $250,000. It is applied on top of the 20 percent tax now on investment income from dividends and capital gains.
Murky areas in the proposed IRS rules involve rental income earned by individual or businesses and income paid out by trusts, according to witnesses who testified at the hearing.
Michael Grace, an attorney at law firm Whiteford Taylor & Preston, represents mostly small- and medium-sized businesses that do business as "pass-through" entities, such as limited liability corporations, partnerships and S-corporations.
In these businesses, profits are not retained by the business or distributed to public shareholders, but passed through to the partners, who are then taxed on that income. These entities will potentially be subject to the new tax.
Grace said conflicting tax code definitions of investment income make it difficult to determine if, for example, an auto rental company or real estate developer would be subject to the tax.
"You start with the premise that rents are generally subject to the tax, but there are all these different ways you legally can escape it," Grace said. "People are confused."
Grace urged IRS officials to spell out in final regulations how to determine whether rents under various scenarios are subject to the 3.8 percent tax.
The net investment tax applies to business income considered passive under current tax rules. Income is considered passive if it comes from "rental activity" or if the individual does not "materially participate" in running the business, generally defined as spending more than 500 hours a year in the activity.
The National Business Aviation Association, which represents individuals and companies that use their own aircraft or manage it for other companies, also proposed changes.
John Hoover, an attorney representing the group, said rules are unclear regarding how companies lease business jets and other aircraft to related entities and how their income is treated.
"We have this question - what do you look at to evaluate whether you have an ordinary and necessary activity?" he said.
(Editing by Kevin Drawbaugh; and Will Dunham)