Count Form 4835 farm rent in net investment income, and limit its losses under section 461(l)

changelog.d/niit-farm-rent.fixed.md

@@ -0,0 +1 @@
+Count Form 4835 farm rental income (Schedule E line 40) in net investment income, and count rental, farm rental, estate and passive pass-through losses in net investment income only as far as section 461(l) allows them, for the net investment income tax and Minnesota's net investment income tax.

policyengine_us/parameters/gov/irs/investment/income/sources.yaml

@@ -10,6 +10,17 @@ values:
     - taxable_interest_income
     - dividend_income
     - rental_income
+    # Form 4835 net farm rental income or loss goes on Schedule E line 40,
+    # then into line 41 and Schedule 1 line 5, which Form 8960 line 4a takes.
+    # Form 4835 is only for a rental activity under the passive activity
+    # rules, and its income isn't subject to self-employment tax, so it is
+    # rent under § 1411(c)(1)(A)(i). Form 8960 line 4b removes a rental's net
+    # income or loss only when the rental is nonpassive and rises to a section
+    # 162 trade or business (for example a real estate professional's rental,
+    # or property rented to the owner's own nonpassive business). The model
+    # has no input for that, here or for rental_income, so it counts all of
+    # both.
+    - farm_rent_income
     - passive_partnership_s_corp_income
     # Income from estates and trusts (Schedule E Part III) keeps its character
     # in the beneficiary's hands (§§ 652(b), 662(b)). Form 8960 line 4a
@@ -25,6 +36,13 @@ values:
     # (line 13), limited under § 1211(b). Distributions reported without
     # Schedule D are the same amount.
     - filer_loss_limited_net_capital_gains
+    # The losses above count in full, but section 461(l) disallows business
+    # losses beyond business income plus a threshold, and § 1411(c)(1)(B)
+    # allows only deductions allowed by chapter 1. This adds back the part of
+    # the excess business loss that falls on those losses (all of it when they
+    # are the only business losses; provisionally a proportional share
+    # otherwise).
+    - net_investment_income_excess_business_loss
 metadata:
   unit: currency-USD
   label: net investment income sources
@@ -49,3 +67,17 @@ metadata:
       href: https://www.irs.gov/pub/irs-prior/i8960--2024.pdf#page=11
     - title: 2025 Instructions for Form 8814, Net Investment Income Tax (NIIT)
       href: https://www.irs.gov/pub/irs-pdf/i8814.pdf#page=2
+    - title: 26 U.S. Code § 1411(c)(2) - Trades and businesses to which tax applies
+      href: https://www.law.cornell.edu/uscode/text/26/1411#c_2
+    - title: "2025 Instructions for Form 8960, passive activity rules and lines 4a and 4b #page 4,8"
+      href: https://www.irs.gov/pub/irs-prior/i8960--2025.pdf#page=4
+    - title: 2025 Form 4835, Farm Rental Income and Expenses, purpose of form
+      href: https://www.irs.gov/pub/irs-prior/f4835--2025.pdf#page=2
+    - title: 2025 Schedule E (Form 1040), lines 40 and 41
+      href: https://www.irs.gov/pub/irs-prior/f1040se--2025.pdf#page=2
+    - title: 26 U.S. Code § 1411(c)(1)(B) - Deductions allowed by this subtitle
+      href: https://www.law.cornell.edu/uscode/text/26/1411#c_1_B
+    - title: 26 U.S. Code § 461(l) - Limitation on excess business losses of noncorporate taxpayers
+      href: https://www.law.cornell.edu/uscode/text/26/461#l
+    - title: Treas. Reg. 1.1411-4(f) - Properly allocable deductions
+      href: https://www.ecfr.gov/current/title-26/section-1.1411-4#p-1.1411-4(f)

policyengine_us/tests/core/test_dependent_net_investment_income_invariants.py

@@ -17,16 +17,22 @@
    filer's `net_investment_income`, `filer_loss_limited_net_capital_gains`,
    AGI, NIIT MAGI or `net_investment_income_tax`.
 2. `net_investment_income` equals an independent numpy computation over the
-   head and spouse: their interest, dividends, rents, passive pass-through,
-   estate and trust income, plus their netted Schedule D gain or loss with
-   capital gain distributions on line 13, limited under 26 USC 1211(b).
+   head and spouse: their interest, dividends, rents (including Form 4835
+   farm rent), passive pass-through, estate and trust income, plus their
+   netted Schedule D gain or loss with capital gain distributions on line 13,
+   limited under 26 USC 1211(b), plus the part of their section 461(l)
+   excess business loss that falls on those losses.
 3. -loss limit <= `filer_loss_limited_net_capital_gains`, and it equals
    `loss_limited_net_capital_gains` when the unit has no dependents.
 4. For tax units without dependents, `net_investment_income` equals the
    all-member formula (person-level sources plus
-   `loss_limited_net_capital_gains`), so leaving dependents out changes
-   nothing for filers without dependents.
+   `loss_limited_net_capital_gains` plus the section 461(l) add-back), so
+   leaving dependents out changes nothing for filers without dependents.
 5. 0 <= NIIT = 3.8% x min(max(0, NII), max(0, MAGI - threshold)).
+6. 0 <= `net_investment_income_excess_business_loss` <= min(the section
+   461(l) excess business loss, the net investment income losses), with
+   equality to the excess when those losses are the only business losses.
+   Section 1411(c)(1)(B) allows only deductions allowed by chapter 1.
 """
 
 import numpy as np
@@ -43,6 +49,7 @@
 # income is drawn as a share of partnership_s_corp_income below.
 SIGNED_INPUTS = [
     "rental_income",
+    "farm_rent_income",
     "estate_income",
     "short_term_capital_gains",
     "long_term_capital_gains",
@@ -70,11 +77,14 @@
     "qualified_dividend_income",
     "non_qualified_dividend_income",
     "rental_income",
+    "farm_rent_income",
     "passive_partnership_s_corp_income",
     "estate_income",
 ]
 OUTPUTS = [
     "net_investment_income",
+    "excess_business_loss",
+    "net_investment_income_excess_business_loss",
     "net_investment_income_tax",
     "filer_loss_limited_net_capital_gains",
     "loss_limited_net_capital_gains",
@@ -159,6 +169,24 @@ def _draw_units():
          "head": {**zero, "long_term_capital_gains": 10_000.0},
          "spouse": {**zero, "short_term_capital_gains": -4_000.0},
          "dependents": [{**zero, "rental_income": 25_000.0}]},
+        # Section 461(l) binds and the farm rental loss is the only loss.
+        {"kind": "single", "head_wages": 300_000.0,
+         "head": {**zero, "taxable_interest_income": 500_000.0,
+                  "farm_rent_income": -600_000.0},
+         "spouse": None, "dependents": []},
+        # Binds on a joint return with a nonpassive partnership loss too.
+        {"kind": "joint", "head_wages": 400_000.0,
+         "head": {**zero, "taxable_interest_income": 300_000.0,
+                  "rental_income": -500_000.0},
+         "spouse": {**zero, "partnership_s_corp_income": -400_000.0,
+                    "passive_partnership_s_corp_income": -200_000.0},
+         "dependents": []},
+        # A dependent's large loss would raise the filer's excess.
+        {"kind": "hoh", "head_wages": 300_000.0,
+         "head": {**zero, "taxable_interest_income": 400_000.0,
+                  "rental_income": -400_000.0},
+         "spouse": None,
+         "dependents": [{**zero, "farm_rent_income": -500_000.0}]},
     ]  # fmt: skip
     return units
 
@@ -256,6 +284,46 @@ def _loss_limit(runs):
     return runs["irs"].capital_gains.loss_limit[runs["with"]["filing_status"]]
 
 
+# The drawn inputs that section 461(l) aggregates as business items.
+SECTION_461L_INPUTS = [
+    "rental_income",
+    "farm_rent_income",
+    "estate_income",
+    "partnership_s_corp_income",
+]
+
+
+def _section_461l_reference(runs, units, include):
+    """Excess business loss and the part on NII losses, from leaf inputs.
+
+    ``include`` selects the members counted (the head and spouse, or all).
+    The NII share is proportional: NII losses (rental and farm rental losses,
+    estate losses and the passive part of partnership losses) over all
+    business losses.
+    """
+    amounts = {name: _by_person(units, name) for name in SECTION_461L_INPUTS}
+    income = _unit_sum(runs, include * sum(np.maximum(0, v) for v in amounts.values()))
+    loss = _unit_sum(runs, include * sum(np.maximum(0, -v) for v in amounts.values()))
+    passive_loss = np.minimum(
+        np.maximum(0, -_by_person(units, "passive_partnership_s_corp_income")),
+        np.maximum(0, -amounts["partnership_s_corp_income"]),
+    )
+    investment_loss = _unit_sum(
+        runs,
+        include
+        * (
+            np.maximum(0, -amounts["rental_income"])
+            + np.maximum(0, -amounts["farm_rent_income"])
+            + np.maximum(0, -amounts["estate_income"])
+            + passive_loss
+        ),
+    )
+    threshold = runs["irs"].ald.loss.max[runs["with"]["filing_status"]]
+    excess = np.maximum(0, loss - (income + threshold))
+    share = np.divide(investment_loss, loss, out=np.zeros_like(loss), where=loss > 0)
+    return excess, excess * share, investment_loss, loss
+
+
 def test_dependent_flags_match_the_draw(runs, units):
     assert np.array_equal(
         runs["with"]["is_tax_unit_dependent"], _by_person(units, "is_dependent")
@@ -291,11 +359,14 @@ def test_net_investment_income_matches_reference(runs, units):
     schedule_d = _unit_sum(
         runs, filer * sum(_by_person(units, name) for name in CAPITAL_INPUTS)
     )
-    expected = _unit_sum(runs, filer * person_nii) + np.maximum(
-        -_loss_limit(runs), schedule_d
+    _, addback, _, _ = _section_461l_reference(runs, units, filer)
+    expected = (
+        _unit_sum(runs, filer * person_nii)
+        + np.maximum(-_loss_limit(runs), schedule_d)
+        + addback
     )
     np.testing.assert_allclose(
-        runs["with"]["net_investment_income"], expected, atol=TOLERANCE
+        runs["with"]["net_investment_income"], expected, rtol=1e-6, atol=TOLERANCE
     )
 
 
@@ -314,7 +385,13 @@ def test_filer_capital_gains_within_loss_limit(runs, units):
 def test_units_without_dependents_match_all_member_formula(runs, units):
     """Differential check against the all-member formula."""
     person_nii = sum(_by_person(units, name) for name in NII_PERSON_INPUTS)
-    old = _unit_sum(runs, person_nii) + runs["with"]["loss_limited_net_capital_gains"]
+    everyone = np.ones_like(_by_person(units, "is_dependent"), dtype=bool)
+    _, addback, _, _ = _section_461l_reference(runs, units, everyone)
+    old = (
+        _unit_sum(runs, person_nii)
+        + runs["with"]["loss_limited_net_capital_gains"]
+        + addback
+    )
     no_dependents = np.array([not u["dependents"] for u in units])
     np.testing.assert_allclose(
         runs["with"]["net_investment_income"][no_dependents],
@@ -337,3 +414,29 @@ def test_niit_within_statutory_bounds(runs):
     # Both limbs of section 1411(a)(1) bind somewhere in the population.
     assert ((nii > 0) & (excess_magi > 0) & (nii < excess_magi)).sum() > 10
     assert ((nii > 0) & (excess_magi > 0) & (nii > excess_magi)).sum() > 10
+
+
+def test_section_461l_addback_bounds(runs, units):
+    """Property 6, plus a differential check of both new variables."""
+    filer = ~_by_person(units, "is_dependent")
+    excess, addback, investment_loss, loss = _section_461l_reference(runs, units, filer)
+    model_excess = runs["with"]["excess_business_loss"]
+    model_addback = runs["with"]["net_investment_income_excess_business_loss"]
+    np.testing.assert_allclose(model_excess, excess, rtol=1e-6, atol=TOLERANCE)
+    np.testing.assert_allclose(model_addback, addback, rtol=1e-6, atol=TOLERANCE)
+    assert np.all(model_addback >= -TOLERANCE)
+    assert np.all(
+        model_addback
+        <= np.minimum(model_excess, investment_loss) * (1 + 1e-6) + TOLERANCE
+    )
+    only_investment_losses = (loss > 0) & np.isclose(investment_loss, loss)
+    np.testing.assert_allclose(
+        model_addback[only_investment_losses],
+        model_excess[only_investment_losses],
+        rtol=1e-6,
+        atol=TOLERANCE,
+    )
+    # The edge rows make section 461(l) bind, including with a nonpassive
+    # partnership loss sharing the excess.
+    assert (model_excess > 0).sum() >= 3
+    assert ((model_addback > 0) & (model_addback < model_excess - 1)).sum() >= 1

policyengine_us/tests/core/test_estate_income_invariants.py

@@ -14,7 +14,11 @@
    income is excluded from the filer's gross income throughout the model).
 2. Tax unit net investment income rises by exactly the sum of estate_income
    plus the Schedule K-1 (Form 1041) box 14 code H adjustment over non-dependent
-   members (Form 8960 lines 4a and 7).
+   members (Form 8960 lines 4a and 7), less the part of an estate loss that
+   section 461(l) disallows: § 1411(c)(1)(B) allows only deductions allowed by
+   chapter 1. Estate income is the only business item drawn here, so the whole
+   excess business loss falls on estate losses that net investment income
+   counts.
 3. When every member's estate income is nonnegative and nothing else produces
    a loss, AGI rises by exactly the non-dependents' estate income.
 4. A dependent's estate income and adjustment, of either sign, leave the
@@ -238,9 +242,11 @@ def runs(request, units):
         )
         out[name]["filing_status"] = sim.calculate("filing_status", year)
         out[name]["person_tax_unit"] = sim.populations["tax_unit"].members_entity_id
-    out["niit_parameters"] = sim.tax_benefit_system.parameters(
-        f"{year}-01-01"
-    ).gov.irs.investment.net_investment_income_tax
+    year_parameters = sim.tax_benefit_system.parameters(f"{year}-01-01")
+    out["niit_parameters"] = (
+        year_parameters.gov.irs.investment.net_investment_income_tax
+    )
+    out["section_461l_threshold"] = year_parameters.gov.irs.ald.loss.max
     return out
 
 
@@ -269,12 +275,35 @@ def test_gross_income_includes_positive_estate_income_of_non_dependents(runs, un
     np.testing.assert_allclose(delta, expected, atol=TOLERANCE)
 
 
+def _section_461l_estate_addback(runs, units):
+    """The estate losses section 461(l) disallows that NII would otherwise take.
+
+    Estate income is the only business item drawn, so the excess business loss
+    is the head and spouse's estate losses beyond their estate income plus the
+    threshold, and all of it falls on net investment income losses: a Part III
+    loss stays on Form 8960 line 4a whatever the code H adjustment (line 7).
+    """
+    estate, _, dependent = _person_inputs(units)
+    filer = ~dependent
+    tax_unit = runs["with"]["person_tax_unit"]
+
+    def by_unit(values):
+        return np.bincount(tax_unit, weights=filer * values, minlength=len(units))
+
+    income = by_unit(np.maximum(0, estate))
+    loss = by_unit(np.maximum(0, -estate))
+    threshold = runs["section_461l_threshold"][runs["with"]["filing_status"]]
+    return np.maximum(0, loss - (income + threshold))
+
+
 def test_net_investment_income_adds_estate_income_and_code_h(runs, units):
     estate, adjustment, dependent = _person_inputs(units)
     per_person = np.where(dependent, 0, estate + adjustment)
     expected = np.bincount(
         runs["with"]["person_tax_unit"], weights=per_person, minlength=len(units)
-    )
+    ) + _section_461l_estate_addback(runs, units)
+    # The two edge rows with a 400,000 estate loss make section 461(l) bind.
+    assert (_section_461l_estate_addback(runs, units) > 0).sum() >= 2
     delta = (
         runs["with"]["net_investment_income"] - runs["zero"]["net_investment_income"]
     )