Category: Tax

2024 Estate Planning Outlook: Transfer Tax Changes are on the Horizon

The Tax Cuts and Jobs Act of 2017 (TCJA) significantly increased the lifetime estate and gift tax exemption from $5.6 million to $11.18 million for individuals, with adjustments for inflation starting in 2018. For 2023, the lifetime estate and gift tax exemption is $12.92 million (or $25.84 million for married couples). For 2024, the lifetime estate and gift tax exemption will be $13.61 million (or $27.22 million for married couples). This relatively high exemption level has offered substantial relief to many taxpayers in recent years.

However, absent Congressional action, the lifetime estate and gift tax exemption is scheduled to sunset after 2025 to its pre-2018 amount (adjusted for inflation). If this sunset does in fact occur, we anticipate that the lifetime estate and gift tax exemption will revert to around $7 million ($14 million for couples) for 2026, effectively reducing the exemption by about one-half. This substantial reduction in the lifetime estate and gift tax exemption will cause many more people to be potentially subject to federal estate tax at death.

The potential substantial reduction in the lifetime estate and gift tax exemption could have several significant impacts on estate planning:

  1. Increased Number of Estates Subject to Estate Tax. A much higher number of individuals could be subject to estate tax at death due to the new lower estate tax exemption threshold. Proper planning is crucial to minimize this impact.
  2. Increased Estate Tax Liability. Individuals with estates valued in excess of the new lower estate tax exemption threshold could be subject to higher estate taxes at death. Proper planning is crucial to minimize this impact.
  3. Gifting Strategies. If the lifetime gift tax exemption is reduced, then individuals will have a diminished ability to make significant gifts during their lifetime and greater care will need to be given to maximizing the tax benefits of the lower exemption.
  4. Reviewing Existing Plans. Individuals who designed their estate plans based on the current lifetime estate and gift tax exemption should consider revisiting their plans to ensure those plans remain aligned with their goals and objectives.

The big question in the estate planning world today is whether, when, and to what extent Congress will enact changes to gift, estate, and income tax laws. With many challenges facing the current Biden Administration and a heavily divided Congress, it is not certain that major tax legislation even will be considered in 2024. Nevertheless, the tax proposals endorsed by the Biden Administration provide signals for actions clients should consider during the current year.

Executive Summary

  • The time to gift is 2024 — change is potentially on the horizon.
  • The timing and extent of potential changes to gift and estate tax laws are unclear.
  • Some potential changes could include reducing the exemption, increasing the estate tax rate, increasing the capital gains tax rate, and eliminating the basis adjustment.
  • Consider “locking in” the 2024 exemption amount by gifting to irrevocable trusts and continuing to take advantage of planning opportunities to shift appreciation out of your estate with techniques such as GRATs and intra-family loans.

Potential Legislative Tax Changes[1]

Potential Transfer Tax Changes – Lowered Transfer Tax Exemptions & Increased Transfer Tax Rate

The Biden Administration has proposed lowering the current lifetime estate and gift tax exemption amount to around $3.5 million per individual and increasing the estate tax rate from 40% to 45% on amounts exceeding the exemption. Instead, we may see Congress simply let the exemption sunset back to around $7 million (adjusted for inflation), which was the exemption amount before the substantial increase enacted under the TCJA.

For what it’s worth, the exemption has never been lowered. Despite this, the doubling of the exemption under the TCJA was a dramatic departure from past policies. Thus, reducing the exemption to $7 million (adjusted for inflation) may seem like an easier path, particularly since Congress is so heavily divided. In other words, Congress may opt to treat the last seven years as a fluke and return to “normal.”

Potential Income Tax Changes – Repeal Basis Adjustment & Capital Gains Taxed as Ordinary Income

The Biden Administration also signaled that it might seek repeal of the basis step-up at death and tax capital gains as ordinary income. Although the basis step-up is an income tax planning concept, it is also an important consideration in transfer tax planning. Under current law, gifts of low basis assets can be detrimental because the donee receives the donor’s basis. Taxpayers often decide to retain certain low basis assets, rather than sell them or gift them, to obtain the basis step-up at death. The family members or trusts receiving those assets then can sell those assets with little or no capital gains tax.

The Biden Administration has proposed to eliminate this basis adjustment. An alternative proposal involves treating the transfer of appreciated property at death or by gift as a taxable event causing the gain to be recognized, but many commentators think this is unlikely.

The Biden Administration proposal to tax long-term capital gains and qualified dividends as ordinary income on all income over $1 million would further exacerbate the impact of a repeal of the basis step-up.

Planning Ahead

2024 is an opportune time to make the most of your estate and gift tax exemption.

“Locking In” the Estate and Gift Tax Exemption

Many ultra-high net worth individuals have used most, if not all, of their exemption. Under current tax laws, in 2024, individuals may gift up to $13.61 million during their lives ($27.22 million for married couples). If the exemption decreases from $13.61 million to $3.5 million and the estate tax rate is raised from 40% to 45% percent, the cost of inaction is more than $4.5 million (if an individual makes a gift of $13.61 million while the exemption is $3.5 million and gifts beyond the exemption are taxed at a rate of 45%, the resulting gift tax amounts to roughly $4.5 million; $9 million for married couples). If individuals and married couples have not used their exemption(s) and can afford to, they should give serious consideration to completing gifts equal to their remaining exemption(s) in 2024, ideally to a generation-skipping trust for the benefit of their descendants, particularly since these exemptions are scheduled to sunset in 2025.

Depending on your and your family’s goals, circumstances, remaining exemption, and cash flow needs, gifting up to $27.22 million, or even $13.61 million, to a trust for your beneficiaries may not be feasible. A long-accepted way to address this concern is to create a trust that benefits both the Grantor’s spouse and descendants. This type of trust is commonly referred to as a Spousal Lifetime Access Trust (SLAT). A SLAT is a simple and effective way to address the possible need of the senior generation to access the property transferred. It provides direct access for the beneficiary spouse and indirect access for a Grantor spouse. Grantor Trust provisions, such as ones allowing the Grantor of the trust to swap assets or take loans from the trust without full and adequate consideration, offer tax flexibility, and access to funds by loan.

SLATs have become so popular that couples have created trusts for each other. This is not without risk and should only be done with different trust provisions and with creation of the trusts separated in time. Finally, it is important to remember that potential estate tax savings should never be the sole determinate of your financial planning decisions. Individuals who have stretched themselves thin to make significant gifts sometimes have profound “gifter’s remorse.” Thus, make gifts if you can, but, more importantly, make them if you’re comfortable doing so.

Freezing the Size of the Estate

Perhaps you and your spouse have already utilized your exemptions and are seeking ways to further reduce the tax burden on your estate, or you are not ready to commit large transfers of your property. In either situation, an excellent alternative is to freeze the growth of your estate with strategies like Grantor Retained Annuity Trusts (GRATs) and installment sales with trusts or family loans. GRATs and installment sales have thrived in the past low interest rate environment because assets have often grown in value at a rate above the rate of the annuity, in the case of GRATs, or the interest rate on a promissory note. However, in today’s current higher rate environment, the tax benefits of these planning opportunities may be more restrictive as the appreciation hurdle for a GRAT is now substantially higher than before, and the interest rate on an installment sale is also substantially higher. However, these strategies will still essentially “freeze” the size of one’s estate and transfer potentially significant appreciation, which would have otherwise remained in the client’s estate, out of his or her estate.

Uncertainty Doesn’t Preclude Planning

It is absolutely within the power of Congress to enact retroactive tax legislation if it is rationally related to a legislative purpose, but on a practical level, Congress usually avoids that option. It is almost always unpopular and adds only nominal additional revenue for budgeting purposes. Biden Administration officials already have stated they are not interested in seeking retroactive tax changes. Given the low probability, the threat of retroactive tax law changes should not prevent clients from implementing new estate planning strategies. For those who remain worried, a number of strategies can be structured in a manner that limits potential gift tax liability in the unlikely event legislative changes are enacted retroactively. In 2024, clients should consider reviewing their existing plan to determine whether they can employ certain strategies to maximize use of their exemption and achieve their planning objectives. If the lifetime estate and gift tax exemption is reduced, clients will lose the ability to give away that excess amount (and all subsequent appreciation on that amount).

[1] The following list of potential legislative changes is not all-inclusive. Instead, it focuses on the transfer tax and income tax proposals that would have the most significant impact on the practice of wealth transfer.

© 2023 ArentFox Schiff LLP
For more news on 2024 Transfer Tax Changes, visit the NLR Tax section.

California Governor Signs a Handful of Tax-Related Bills into Law

This fall, California Governor Gavin Newsom signed several tax-related bills into law on a diverse array of topics ranging from the use tax to the gun tax.

Use tax: On October 7, 2023, Governor Newsom signed a bill into law changing the threshold for a California business to register to pay use tax. Prior to enactment of the new law, a qualified purchaser that had more than $100,000 in annual gross receipts was required to register with the California Department of Tax and Fee Administration (“CDTFA”) to pay use tax on purchases from out-of-state sellers. Under the new law, a qualified purchaser must make more than $10,000 in purchases per year from an out-of-state seller on which use tax has not been paid and remitted by the remote seller in order to be required to register with CDTFA. The bill’s sponsor described the purpose of the bill as to update the “outdated and burdensome” old system which was in effect before the Supreme Court decision in South Dakota v. Wayfair, Inc. generally allowed states to collect use tax from out-of-state sellers. As California adopted a law post-Wayfair that requires out-of-state sellers that sell more than $500,000 in property in California to register to collect and remit use tax, the legislature determined that the old use tax registration requirements should be updated and streamlined.

Gun tax: While the change to the use tax registration did not garner much attention from the press, one bill that did was one signed by Governor Newsom on September 26, 2023, that doubled the taxes on sales of guns and ammunition in California. While federal law already taxes gun and ammunition sales at either 10 or 11 percent depending on the type of gun, the new law adds an additional 11 percent California tax on top of that, making California the only state to impose its own tax on guns and ammunition. The Governor’s office described the legislation as a “first-in-the-nation effort to generate $160 million annually on the sale of bullets to improve school safety and fund a gun violence intervention program.”

Settlement authority of the CDTFA: On October 8, 2023, Governor Newsom signed into law a bill that makes changes to certain tax administration provisions, including a provision giving the CDTFA sole authority to approve settlement agreements reducing a taxpayer’s liability for tax or penalties by up to $11,500, with periodic adjustments to be made to that threshold for inflation. Prior to the enactment of the new law, settlements involving a reduction of tax or penalties of up to $5,000 required joint approval from the executive director of CDTFA and the chief counsel’s office.

Extension of disaster relief deduction: On September 30, 2023, Governor Newsom signed a bill extending the State’s disaster relief loss deduction through December 31, 2028, for both individual and corporate taxpayers. The disaster relief loss deduction allows a taxpayer to declare a loss related to a California disaster declared by the President of the United States or the Governor of California. Prior to the enactment of the new law, the disaster relief loss deduction was scheduled to sunset on December 31, 2023.

© 2023 Blank Rome LLP
For more news on California Tax Bills, visit the NLR Tax section.

IRS Process for Withdrawing Employee Retention Credit Claims

On October 19, 2023, the IRS announced a process which is intended to allow employers who were pressured or misled by marketers or promoters into filing ineligible claims for the Employee Retention Credit (ERC), but who have not yet received a refund, to withdraw their claim. This process permits employers whose ERC claims are still being processed to withdraw their refund claims and avoid the potential that the IRS would deny the claim after the credit is received, thus avoiding the need to repay any refunded amounts, and avoiding potential interest and penalties.

When properly claimed, the ERC is a refundable tax credit designed for employers that were fully shut down or partially suspended due to the COVID-19 pandemic or that had a significant decline in gross receipts during the eligibility periods.

The move to permit the withdrawal of claims comes after the IRS placed abusive ERC promotions on its Dirty Dozen, an annual list aimed at helping raise awareness to protect honest taxpayers from aggressive promoters and con artists. After placing abusive ERC promotions on the Dirty Dozen, on September 14, 2023, the Commissioner of the IRS ordered that processing of any new ERC claims be stopped until December 31, 2023. However, the IRS stated that it would continue to process and pay out previously filed eligible ERC claims, as well as audit ERC claims and pursue criminal investigations of promoters and businesses filing dubious claims.

Who Can Withdraw an ERC Claim
To be eligible to withdraw an ERC claim, an employer must meet all of the following criteria:

  1. The ERC must have been claimed using an adjusted employment return, i.e. Forms 941-X, 943-X, 944-X, or CT-1X
  2. The ERC must be the only adjustment claimed on the return
  3. The employer must withdraw the entire amount of the ERC claim (this refers to each calendar quarter, rather than all calendar quarters, for which an ERC claim was made)
  4. The ERC claim cannot have been paid by the IRS or, if it has been paid, the employer has not yet cashed or deposited the refund check

How to Withdraw an ERC Claim

The notice provides a step-by-step menu for withdrawing a claim.  If the employer filed adjusted returns to claim ERCs for more than one calendar quarter and wishes to withdraw all ERC claims, it must follow the steps below for each calendar quarter for which it is requesting a withdrawal.  The IRS also has a dedicated page with sample form, which can be found here.

Employers that have not received a refund and have not been notified their claim is under audit may request a withdrawal by following these steps:

  1. Make a copy of the adjusted return with the claim you wish to withdraw
  2. In the left margin of the first page, write “Withdrawn”
  3. In the right margin of the first page:
    • Have an authorized person sign and date it
    • Write their name and title next to their signature
  4. Fax the signed copy of your return using your computer or mobile device to the IRS’s ERC claim withdrawal fax line at 855-738-7609.  The employer should keep a copy with its tax records.  The notice even provides a template for a simple claim withdrawal request.

Employers that have not received a refund and have been notified of an audit can still withdraw ERC claims using the above procedure, but must check with their examiner about how to fax or mail the withdrawal request directly to the examiner or, if an examiner has not yet been assigned, should respond to the audit notice with the withdrawal request, using the instructions in the notice for responding.

Special instructions are also included in the notice for employers that have received a refund check but have not cashed or deposited it.

Once a withdrawal is submitted, the employer should expect to receive a letter from the IRS about whether their withdrawal request was accepted or rejected.  A withdrawal is not effective until accepted by the IRS.  If the IRS accepts the withdrawal, the employer may need to amend its income tax return (if it previously amended that return to reflect ERCs that had been claimed).

ERC Refunds Already Received

Employers that are not able use the above withdrawal process may still be able to file another adjusted return if they need to:

  • Reduce the amount of their ERC claim
  • Make other changes to their adjusted return

However, it should be noted that the IRS is also working on separate guidance for ineligible employers that were misled into making ERC claims and have already received the payment.

Continued Risk for Fraudulent Claims

Withdrawn ERC claims will be treated as if they were never filed and the IRS will not impose penalties or interest.  However, ineligible employers should note that withdrawing an ERC claim will not remove the possibility that they or their advisor could be subject to potential criminal investigation or prosecution for filing a fraudulent ERC claim.

Copyright ©2023 Nelson Mullins Riley & Scarborough LLP
For more news on Employee Retention Claims, visit the NLR Labor & Employment section.

Taxpayer Makes Offer, But IRS Refused

James E. Caan, the movie actor most famous for playing Sonny Corleone in The Godfather, got into IRS trouble regarding the attempted tax-free rollover of his IRA.

Caan had two IRA accounts at UBS, a multinational investment bank and financial services company. One account held cash, mutual funds and exchange-traded funds (ETF) and the other account held a partnership interest in a hedge fund called P&A Multi-Sector Fund, L.P.

Because the hedge fund was a non-publicly traded investment, UBS required Caan to provide UBS with the year-end fair market value to prepare IRS Form 5498. Caan never provided the fair market value as of December 31, 2014. UBS issued a number of notices and warnings to Caan and finally on November 25, 2015, UBS resigned as custodian of the P&A Interest. UBS issued Caan a 2015 Form 1099-R reporting a distribution of $1,910,903, which was the value of the P&A Interest, used as of December 31, 2013. Caan’s 2015 tax return reported the distribution as nontaxable.

In June 2015, Caan’s investment advisor Michael Margiotta resigned from UBS and began working for Merrill Lynch. In October 2015, Margiotta got all UBS IRA assets to transfer to a Merrill Lynch IRA, except for the P&A Interest. The P&A Interest was ineligible to transfer through the Automated Customer Account Transfer Service. In December 2016, Mr. Margiotta directed the P&A Fund to liquidate the P&A Interest and the cash was transferred to Caan’s Merrill Lynch IRA in three separate wires between January 23 and June 21, 2017.

In April 2018, the IRS issued a Notice of Deficiency for the 2015 tax year asserting that distribution of the P&A Interest was taxable. On July 27, 2018, Caan requested a private letter ruling asking the IRS to waive the requirement that a rollover of an IRA distribution be made within 60 days. In September 2018, the IRS declined to issue the ruling.

Caan died July 6, 2022. In the Estate of Caan v. Commissioner, 161 T.C. No. 6 (October 18, 2023), the Tax Court ruled that Caan was not eligible for a tax-free IRA rollover of the P&A Interest for three reasons. First, to be a nontaxable rollover the taxpayer may not change the character of any noncash distributed property, but here, the P&A Interest was changed to cash before being rolled-over. Second, the contribution of the cash occurred long after the 60-day deadline. Third, only one rollover contribution is allowed in any one-year period, but Caan had three contributions. The Court also determined the 2015 fair market value of the P&A Interest.

Finally, the Tax Court determined that it has jurisdiction to review the IRS denial of the 60-day waiver request and that the applicable standard of review is an abuse of discretion. The Court ruled there was no abuse of discretion because Caan changed the character of the rollover property and even if the IRS waived the 60-day requirement, the rollover would still not be tax-free.

The case highlights some of the potential dangers in holding non-traditional, non-publicly traded assets in an IRA.

© 2023 Chuhak & Tecson P.C.
For more news on IRA rollovers, visit the NLR Tax section.

Inadvertent Errors and Tax Hedge Identification

Businesses often manage their price risks by hedging those risks with financial derivative contracts. Because businesses generate ordinary income and loss on their normal business activities, they want to be sure their hedging activities also generate ordinary tax treatment. If these hedging activities were to generate capital gains and losses, they would be basically worthless for many businesses. As a result, business taxpayers want to be able to net their hedging gains and losses against gains and losses on their normal business activities. (See my article, “Hedging: Favorable Tax Treatment Requires Careful Compliance.”)

Tax Hedge Identification Requirements

 In order to receive favorable tax treatment, a hedge (Hedge) must be clearly identified “before the close of the day on which it is acquired, originated, or entered into.”[1] The item (or items) being hedged (Hedged Item) must also be identified on a “substantially contemporaneous”[2] basis, but not more than 35 days after the taxpayer enters into the Hedge. And, the tax hedge accounting method must “clearly reflect income.”

In order to comply with these requirements, taxpayers can either establish an aggregate hedge program where they enter their Hedges into a designated hedge account, or they can attach a notation to a Hedge identifying the specific transaction as a “Hedge.” Either way, taxpayers must unambiguously and timely identify their Hedges and Hedged Items. Simply identifying a hedge for financial accounting purposes is not good enough because the hedge identification must clearly state that the identification is for tax purposes.

 The Best Laid Plans

So what happens if a taxpayer fails to unambiguously and timely identify the Hedge and the Hedged Item? Mistakes and errors happen. Tax identification can slip through the cracks. Sometimes the employee responsible for proper identification leaves the company and that responsibility is not promptly assigned to someone else. There are many reasons why tax identifications are made late, are incomplete, or are missed entirely. To discourage incomplete or omitted identification, the Code imposes so-called whipsaw rules that treat the gains on misidentified hedge transactions as ordinary and losses as capital.[3] This is a seriously adverse tax result. In limited circumstances, however, a taxpayer can escape the consequence if the failure to provide a proper identification was due to an “inadvertent error.”[4]

Inadvertent Error

Treas. Reg. §1.1221-2(g)(2)(ii) provides that a taxpayer can treat gains and losses on hedges that it has failed to identify if the failure was due to an “inadvertent error.” Unfortunately, neither the Code nor the Treasury regulations define inadvertent error. All we’ve got to go on in this regard is one private letter ruling and two Chief Counsel Advice Memoranda. These documents are not the type of guidance that taxpayers can rely on or cite as precedent. Nevertheless, they are instructive, however, because they give us a look into what the IRS views as inadvertent error.

In LTR 200051035 the IRS stated, “In the absence of a specific definition in the regulations, the term ‘inadvertent error’ should be given its ordinary meaning. . . . The ordinary meaning of the term ‘inadvertence’ is ‘an accidental oversight; a result of carelessness.’”[5] This view seems sensible and entirely appropriate.

Three years later, in CCA 200851082 the IRS Chief Counsel said that the “Taxpayer should bear the burden of proving inadvertence, and its satisfaction should be judged on all surrounding facts and objective indicia of whether the claimed oversight was truly accidental…. The size of the transaction, the treatment of the transaction as a hedge for financial accounting purposes, the sophistication of the taxpayer, its advisors, and counterparties, among other things, are all probative.”

Fair enough, but shortly thereafter, the IRS expressed its displeasure with taxpayers that should have known better and explained when taxpayers can rely on the inadvertent error excuse to receive tax hedge treatment. In CCA 201046015, the IRS Chief Counsel’s Office said that the failure to promptly address failed or improperly identified hedges would undercut a taxpayer’s inadvertent error claim; and that the inadvertent error exception is not intended to “eviscerate” the hedge identification requirements. The IRS went on to state, “Absent a change in the regulation, [it saw] no compelling policy justification to read the inadvertent error rule as an open-ended invitation for taxpayers to brush aside establishing hedge identification procedures.” A taxpayer’s claim of ignorance of the requirement for hedge identification is no excuse and is not grounds for claiming inadvertent error. In other words, inattention to the hedge identification requirements cannot be excused simply by asserting inadvertent error.

CONCLUSION

Notwithstanding the regulatory provision that provides an “inadvertent” error is an excuse for failing to timely identify hedges, it is now clear that the IRS is only willing to entertain an inadvertent error claim in very limited circumstances. Taxpayers have very little hope of being able to rely on this excuse to avoid the whipsaw rule if they do not properly identify their hedging transactions. This is just one more reason why taxpayers must treat the hedge identification requirement with care and seriousness. Failure to do so can have severe tax consequences.

[1] Code § 1221(a)(7).

[2] Treas. Reg. § 1.1221-2(f)(2).

[3] Code § 1221(b)(2)(B).

[4] Treas. Reg. § 1.1221-2(g)(2)(ii).

[5] Dec. 22, 2000.

© 2023 ASKramer Law
For more on Tax Hedge Errors, visit the NLR Tax section.

IRS Releases Annual Increases to Qualified Retirement Plan Limits for 2024

On November 1st, the IRS released a number of inflation adjustments for 2024, including to certain limits for qualified retirement plans. As expected, this year’s adjustments are more modest than last year’s significant increases. The table below provides an overview of the key adjustments for qualified retirement plans.

Qualified Defined Benefit Plans
2023 2024 Increase from 2023 to 2024
Annual Maximum Benefit $265,000 $275,000 $10,000
Qualified Defined Contribution Plans
2023 2024 Increase from 2023 to 2024
Aggregate Annual Contribution Limit $66,000 $69,000 $3,000
Annual Pre-Tax/Roth Contribution Limit $22,500 $23,000 $500
Catch-Up Contribution Limit for Individuals 50+ $7,500 $7,500 —
Other Adjustments for Qualified Plans
2023 2024 Increase from 2023 to 2024
Annual Participant Compensation Limit $330,000 $345,000 $15,000
Highly Compensated Employee Threshold $150,000 $155,000 $5,000
Key Employee Compensation Threshold for Top Heavy Testing $215,000 $220,000 $5,000
© 2023 Proskauer Rose LLP.
By Jesse T. Foley , Justin S Alex of Proskauer Rose LLP
For more articles on the IRS, visit the NLR Tax section.

IRS Offers Forgiveness for Erroneous Employee Retention Credit Claims

The Employee Retention Credit (“ERC”) is a popular COVID-19 tax break that was targeted by some unscrupulous and aggressive tax promoters. These promoters flooded the IRS with ERC claims for many taxpayers who did not qualify for the credit. Now, the IRS is showing mercy and allowing taxpayers to withdraw some ERC claims without penalty.

Many taxpayers were very excited about the ERC, which could refund qualified employers up to $5,000 or $7,000 per employee per quarter, depending on the year of the claim. But the requirements are complicated. Some tax promoters seized on this excitement, charged large contingent or up-front fees, and made promises of “risk-free” applications for the credit. Unfortunately, many employers ended up erroneously applying for credits and exposing themselves to penalties, interest, and criminal investigations—in addition to having to repay the credit. For example, the IRS reports repeated instances of taxpayers improperly citing supply chain issues as a basis for an ERC when a business with those issues rarely meets the eligibility criteria.

After months of increased focus, the IRS halted the processing of new ERC claims in September 2023. And now, the IRS has published a process for taxpayers to withdraw their claims without penalty. Some may even qualify for the withdrawal process if they have already received the refund check, as long as they haven’t deposited or cashed the check.

For those who have already received and cashed their refund checks, and believe they did not qualify, the IRS says it will soon provide more information to allow employers to repay their ERC refunds without additional penalties or criminal investigations.

© 2023 Miller, Canfield, Paddock and Stone PLC
For more articles on the IRS, visit the NLR Tax section.

How to Solve Estate Planning Challenges: Q&A with Lindsey Paige Markus of Chuhak & Tecson, P.C.

In recognition of National Estate Planning Awareness Week, we sat down with Lindsey Paige Markus, a principal with Chuhak & Tecson law firm in Chicago to discuss the top estate planning challenges and considerations that her clients face. Markus oversees Chuhak & Tecson’s 24-attorney estate planning and asset protection group, and focuses her practice on counseling business owners and families in planning their estates, minimizing taxation and transferring wealth.

Read on to learn more about Markus’ key tips for successful estate planning, and how clients can tailor their estate plans for any stage of their lives.

The NLR: Estate planning needs can change throughout a person’s lifetime. How do you counsel clients to navigate these changes, whether it be marriage, having children or divorce?

Markus: Over time, assets and relationships may change. You might not have the same relationship with the individuals you selected to act as executor or trustee. You may also disagree on how the couple you identified to care for minor children have parented their own children at the last family gathering. Asset holdings, values and priorities change. When your children were young, you may have been very concerned with there being sufficient resources to provide for their everyday needs and help fund a college education. If they are now successful adults living on their own, you might wish to prioritize leaving a philanthropic legacy to your community. Similarly, laws and tax exemptions change over time. For these reasons, I often recommend that clients revisit their estate plan every three years to confirm that the individuals they have identified to carry out their wishes are still appropriate, in addition to the division of assets.

The following image from my book, “A Gift for the Future – Conversations About Estate Planning,” helps highlight life events impacting estate planning, including the following:

–         Engagement

–         Marriage

–         Buying a home or property

–         Starting and building a family

–         Welcoming grandchildren

–         Starting a business

–         Rapid estate growth

–         Charitable interests grow

–         Divorce

 

The NLR: How can clients prepare to handle probate and guardianship issues?

Markus: Ideally, clients will take the time to get documents in place so that their loved ones can avoid probate and guardianship proceedings. Often a revocable living trust is the most efficient vehicle to ensure that the court system is avoided during one’s life (guardianship proceedings) and upon death (probate). When properly drafted, the trust can also help to leverage estate tax savings, provide asset protection for beneficiaries and ensure that the maximum amount can pass estate-tax free from generation to generation. But it is not enough to simply have an estate plan with a revocable living trust. Rather, clients need to go through the process of funding their trust – retitling assets into the name of the trust, transferring real estate interests, business interests and making certain that beneficiary designations on life insurance and retirement plan assets comport with the overall plan.

The NLR: What do you think are some of the biggest or most common misconceptions people have about estate planning?

 

Markus: People think that “estate planning is for the rich and famous,” or comment, “I will make an estate plan…when I have an estate to plan!” In reality, everyone should have an estate plan in place to document their wishes and make the process more manageable for their loved ones. Estate tax savings are just one aspect. But anyone who has had the displeasure of going through the probate process appreciates the importance of avoiding it. Too often clients are overwhelmed by the process. In reality, like any project, actually engaging in the planning and getting it done is far easier than procrastinating. And once you find an estate planning attorney that you feel comfortable working with, the attorney should be able to help guide you seamlessly through the process. Clients are often surprised by how empowering the estate planning process can be.

The NLR: Estate taxes owed to federal and state governments can be difficult to deal with for many people. How can clients best navigate challenging estate tax situations?

Markus: Estate tax liabilities at the federal and state levels can easily reach a tax rate of 50%. FIFTY PERCENT! As challenging as it is to consider, those with taxable gross estates can’t afford to avoid planning. In contrast, by engaging in thoughtful estate planning, these estate tax liabilities can be minimized and sometimes completely eliminated. The best advice I have for clients is to engage in planning early. Once you see projections of your future net worth based on your life expectancy, you quickly appreciate the size of the potential tax liability. You will need to provide feedback on your goals of planning. And, from there, your estate planning attorney, working in tandem with your wealth advisor and CPA, can help advise you on proactive steps you can take now to help minimize or avoid those tax liabilities. Maybe it is through implementing an annual gifting program where you use the annual gift exclusion of $17,000 per person per year by making a gift outright or to a trust for the benefit of a loved one. Perhaps you are in a position to use your $12.92 million lifetime exemption before it cuts in half in 2026. The real benefit of gifting is that we can move the current value of the gift and all future appreciation outside of your taxable gross estate. Or, some clients elect to engage in life insurance as an estate tax replacement vehicle – they purchase life insurance to provide the family with liquidity to cover the estate tax in the future.

The NLR: What are some of the most common mistakes you see people make when it comes to estate planning, and how can they avoid them?

Markus: Start early! None of us know what the future has in store. Get your plan in place this year – and make modifications in the future. Fund your trust! Don’t just get an estate plan. Make sure you retitle assets into your trust and update beneficiary designations to leverage the benefits of the plan. Don’t forget about charitable intentions! It is so easy to leave a lasting legacy to a cause you are passionate about. In doing so, follow your estate planning attorney’s advice and consider leaving taxable retirement plan assets directly to the charity. That allows the funds to pass estate-tax free and income-tax free, sometimes saving more than 70% in estate and income tax consequences. Revisit your plan every three years. Review the summary of your plan, make certain your assets were properly moved into your trust and follow-up with your attorney to find out if any changes have taken place in the law which would warrant an update.

Article by  Rachel Popa of The National Law Review / The National Law Forum LLC
Copyright ©2023 National Law Forum, LLC
For more articles on estate planning, visit the NLR Estates & Trusts section.

Mo Money, Mo Problems? No Biggie for a Homeowner’s Association, Right?

Was your community association lucky enough to come in under budget last year?

On the surface, this might appear to be a bonus, but if not handled properly, it can quickly turn into an unexpected tax burden.

Taxation of Community Associations

 

Almost all community associations in North Carolina are formed as non-profit corporations, which are taxed as corporations. This means community associations should file an IRS Form 1120 (“U.S. Corporate Income Tax Return”) at the federal level. However, a community association may elect to be taxed as a “homeowners association” under Section 528 of the Internal Revenue Code of 1986, as amended (“Code”), and file a Form 1120-H (“U.S. Income Tax Return for Homeowners Associations”).  Oftentimes, a community association’s articles of incorporation, bylaws, or declaration will require that the association make this election.  If your community association chooses to file a Form 1120-H, it will be taxed at a 30% federal income tax rate on its “homeowners association income.” In addition, the election means that the association is not eligible to avoid tax on excess income.  However, the good news is that “homeowner association income” does not include membership dues, fees, and assessments.

Taxation as a Regular Corporation

 

A community association that does not elect to be taxed as a Code Section 528 homeowners association (and file a Form 1120-H) is taxed as a regular corporation subject to standard federal and state income taxes.  Under these standard tax rules, taxable gross income includes “all income from whatever source derived.”  Code Section 61.  But in the case of membership funds paid to community associations, the funds are viewed not necessarily as income but as monies held by an agent (the community association) to pay expenses for its principal (the members or owners of the community association).  For example, Revenue Ruling 75-370 found that condominium owner assessments are not treated as taxable income to the condominium association “since the funds are received by the community association for the unit owners to be used solely for the benefit of the unit owners.”

Handling Excess Assessments

 

Where a community association has received assessments from its members during the year in excess of its budgeted expenses, the Internal Revenue Service (“IRS”) determined, in Revenue Ruling 70-604, that the excess amounts are not taxable income to the association itself where the members vote at the end of the year either to: (1) apply excess assessments to their future assessments; or (2) rebate the excess amounts back to the members.  The IRS made this key ruling with respect to excess assessments received by a condominium management corporation. In its ruling, the IRS noted that the stockholder-owners of the condominium association held a meeting each year at which they decided what to do with any excess assessments not actually used for association expenses.  Your community association’s membership will need to do the same to take advantage of this tax exemption—take a vote (either in person or by written ballot) before the association files its Form 1120.

After issuing this ruling, the IRS clarified, in several informational letters, that the ruling did not mean that condominium and homeowners associations could retain excess assessments from year to year in a working capital reserve without recognizing the amounts as taxable income.  Accordingly, your community association may not apply excess assessments to its reserve account.  It must either: (1) return the excess assessments to the membership or (2) apply the excess assessments to the next fiscal year, thereby reducing the subsequent year’s annual assessment.

Authority of the Community Association Board of Directors

 

Under the North Carolina Planned Community Act and the North Carolina Condominium Act, the board of directors has the authority, not the members, to decide if excess funds will be returned to the members, used for reserves, or used to offset assessments for the following year.  If the board of directors does decide the funds will be used to offset future assessments the, the members should vote to take advantage of the exemption.

Thus, both federal and state law authorizes a community association to avoid excess assessments by returning such excess to its members or by applying such excess to the subsequent year’s budget.  However, both of these Acts vest the financial affairs of a community association in the association’s board of directors, not the members.  Accordingly, if your community association comes in under budget for any tax year, we recommend that your community association’s board of directors include with its annual membership minutes an action item for the members to vote upon adopting Revenue Ruling 70-604 to avoid paying taxes on any excess assessments.

Summary of Steps to Avoid Federal Income Tax

To sum things up, your community association can avoid federal income tax on any excess assessments it has at the end of the fiscal year if:

  • it files a regular IRS Form 1120;
  • its members take a vote each year to apply the excess towards next year’s operating budget;
  • the vote is either in person or via written ballot at the annual membership meeting before the community association’s tax return is filed.

 

© 2023 Ward and Smith, P.A.. All Rights Reserved.
Article by : Matthew A. Jones of Ward and Smith, P.A.
Read more real estate news on the National Law Review.

Renewable Energy Tax Credit Transfer Guidance Provides Both Clarity And Pitfalls

Highlights

The renewable tax credit transfer market will accelerate with new government guidance; public hearing and comments deadlines are scheduled for August

Risk allocation puts the usual premium on sponsors with a balance sheet and/or recapture insurance coverage

While the guidelines provide clear rules and examples, many foot faults are present

On June 14, 2023, the Treasury Department and Internal Revenue Service issued long-awaited guidance on the transferability of certain renewable energy-related federal tax credits. The guidance takes the form of a notice of proposed rulemaking, proposed regulations, and an online Q&A, with a public hearing to follow in August.

Under new Code Section 6418, eligible taxpayers can elect to transfer all or any specified portion of eligible tax credits to one or more unrelated buyers for cash consideration. While the tax credits can be sold to more than one buyer, subsequent transfers by the buyer are prohibited.

This alert highlights several practical issues raised by the guidance, which should allow participants waiting for more clarity to proceed.

Individual Buyers Left Out

  • The guidance applies the Code Section 49 at risk rules and Section 50(b) tax-exempt use rules, generally restricting sellers in calculating the amount of tax credits for sale, and Code Section 469 passive activity rules, generally restricting buyer’s use of such tax credits, in various contexts. On the buyer side, these rules appear to be more restrictive than the limitations that would apply to identical tax credits in an allocation, rather than sale, context. Suffice to say, this will prohibit individuals from taking part in the transfer market for practical purposes outside of fact patterns of very limited application.
  • While this result may not be surprising since such rules currently severely restrict individuals from participating in traditional federal tax credit equity structures, there was some hope for a different outcome due to the stated policy goal of increasing renewable energy investment (not to mention the Inflation Reduction Act’s general departure from decades of case law precedent and IRS enforcement action prohibiting sales of federal tax credits with the enactment of Section 6418).

Lessees Cannot Sell the Tax Credits

  • A lessee cannot transfer the credit. With the prevalence of the master lease (inverted lease) structure in tax equity transactions, this prohibition created an unexpected roadblock for deal participants who have been structuring tax equity transactions with backstop type sale provisions for almost a year now. This presents developers, at least in the inverted lease context, with a choice of utilizing a traditional tax equity structure for the purpose of obtaining a tax-free step up in basis to fair market value, or forgoing the step up for less financing but also less structure complexity. The standard partnership flip project sale into a tax equity type of holding company structure could still remain a viable alternative.
  • As the transfer is generally made on a property-by-property basis by election, creative structuring, in theory, could allow for a lessor to retain certain property and sell the related tax credits (e.g., on portfolios with more than one solar installation/project, or even with large projects that go online on a block-by-block basis assuming the “energy project” election is not made – a term that future guidance will need to provide more clarity on).
  • However, this seems to be an ivory tower conclusion currently, and the practical reality is that too many unknown issues could be raised by such out of the box structuring, including the fact that conservative institutional investors may refuse to participate in such a structure until clear objective guidance is published addressing the same.

Bonus Credits Cannot Be Sold Separately

  • Bonus credits cannot be sold separately from the underlying base credit. This is more problematic for certain adders – for example, the energy community adder rules are now out and amount to simply checking a location on a website. Others (e.g., the low-income community or domestic content adder) require more extensive and subjective application and qualification procedures which makes when and how such adders can be transferred difficult to ascertain. Projects hoping to transfer such credits may need to be creative in compensating buyers for such uncertainty and qualification risk. Tax equity transactions that closed prior to the guidance’s issuance may also need to be revisited, as provisions in such transaction documents commonly attempted to bifurcate the bonus credit away from the base credit in order to allow the sponsor to separately sell such adders.

Buyers Bear Recapture Risk and Due Diligence Emphasis

  • While the Joint Committee on Taxation Bluebook indicated the buyer is responsible for recapture, industry participants were still hoping such risk would remain with the seller. Outside of the limited situation of indirect partnership dispositions (which still results in a recapture event to the transferring partner if triggered), the recapture risk is borne by the buyer, using the rationale that the buyer is the “taxpayer” for purposes of the transferred tax credits. While this is familiar territory for tax equity investors, whose allocated tax credits would be reduced in a recapture scenario, tax credit purchase transactions are now burdened with what amounts to the standard tax equity type of due diligence, including negotiation of transaction documents outside of a basic purchase agreement.
  • The guidance provides that indemnity protections between the seller and buyer are permitted. Tax equity transactions historically have had robust indemnification provisions, which should remain the case even more so in purchase/sale transactions. Tax equity investors traditionally bear “structure risk” dealing with whether the investor is a partner for tax purposes – such risk is eliminated in the purchase scenario as the purchasing investor no longer needs to be a partner (subject to the caveat of a buyer partnership discussed below).
  • If the buyer claims a larger credit amount than the seller could have, such “excessive credit transfer” will subject the buyer to a 20 percent penalty on the excess amount (in addition to the regular tax owed). All buyers are aggregated and treated as one for this purpose – if the seller retains any tax credits, the disallowance is first applied to the seller’s retained tax credits. A facts and circumstances reasonable cause exception to avoid this penalty is provided, further emphasizing the need for robust due diligence.
  • Specific non-exclusive examples that may demonstrate reasonable cause include reviewing the seller’s records with respect to determining the tax credit amount, and reasonable reliance on third-party expert reports and representations from the seller. While not unique to this new tax credit transfer regime, the subjective and circular nature of such a standard is complex – for example, when is it not “reasonable” for buyers or other professionals to rely on other board certified and licensed professionals, such as an appraiser or independent engineer with specialized knowledge?
  • Buyers thus need to remain vigilant about potential recapture causing events. For example, tax equity investors will not generally allow project level debt on investment tax credit transactions without some sort of lender forbearance agreement that provides that the lender will not cause a tax credit recapture event (such as foreclosing and taking direct ownership of the project). Buyers remain responsible for such a direct project level recapture event, which again aligns the tax credit transfer regime with tax equity due diligence and third-party negotiation requirements. The guidance is more lenient for the common back-leverage debt scenario.
  • While similar interparty agreements between back leverage lenders and the tax equity investor are required for non-project level debt facilities to address tax credit recapture among other issues, the guidance provides that a partner disposing of its indirect interest in the project (e.g., the lender foreclosing and taking ownership of a partner’s partnership interest) will remain subject to the recapture liability rather than the buyer provided that other tax-exempt use rules are not otherwise implicated. However, the need to negotiate such lender related agreements is still implicated as not all recapture risk in even this scenario was eliminated to the buyer.
  • While the recapture risk could place a premium on production tax credit deals (that are technically not subject to recapture or subjective basis risk), the burdensome process of needing to buy such tax credits on a yearly basis in line with sales of output may make such transactions more tedious.
  • The insurance industry already has products in place to alleviate buyer concerns, but this is just another transaction cost in what may be a tight pricing market. Not unlike tax equity transactions, sponsor sellers with a balance sheet to backstop indemnities may be able to demand a pricing premium; other sponsors may need to compensate buyers with lower credit pricing to reward such risk and or/to allow the purchase of recapture insurance. While this seems logical, the guidance also includes anti-abuse type rules whereby low credit pricing could be questioned in terms of whether some sort of impermissible transfer by way of other than cash occurred (e.g., a barter for some sort of other service). What the IRS subjectively views as “below market” pricing could trigger some sort of audit review based on this factor alone which further stresses the importance of appropriate due diligence.

Partnerships and Syndications

  • The guidance provides very clear rules with helpful examples, which should allow partnership sellers and buyers to proceed with very objective parameters. For example, the rules allow a partnership seller to specify which partner’s otherwise allocable share of tax credits is being sold and how to then allocate the tax-exempt income generated. The cash generated from sales can be used or distributed however the partnership chooses.
  • Similar objective rules and examples are provided for a buyer partnership. Subsequent direct and indirect allocations of a purchased tax credit do not violate the one-time transfer prohibition. Purchased tax credits are treated as “extraordinary items” that must be allocated among the partners of the buyer partnership as of the time of the transfer, which is generally deemed to occur on the first date a cash payment is made. Thus, all partners need to be in the partnership on such date to avoid an issue. Purchased tax credits are then allocated to the partners in accordance with their share of the nondeductible expenditures used to fund the purchase price.
  • What level of end-user comfort is needed in such a syndicated buyer partnership is an open question. While the rules provide objective guidelines in terms of when and how such purchased credits are allocated, subjective questions that are present in (and focused on) traditional tax equity partnerships are implicated. For example, could a syndication partnership set up for the business purpose of what amounts to selling the tax credits somehow run afoul of the subjective business purpose and disguised sale rules in tax credit case precedent, such as the Virginia Historic Tax Credit Fund state tax credit line of precedent? Will the market require a robust tax opinion in such scenario, thereby driving up transaction costs?
  • An example in the proposed regulations speaks to this sort of partnership formed for the specific purpose of buying tax credits, but leaves out of the fact pattern a syndicator partner. The example itself should go a long way towards blessing such arrangements, but the IRS taking a contrary position when dealing with such issues would not be a new situation. For example, the IRS challenged allocations of federal historic tax credits as prohibited sales of federal tax credits to the point of freezing the entire tax equity market with its positions in Historic Boardwalk Hall, which was only rectified with the release of a subsequent safe harbor revenue procedure.
  • Moreover, the guidance provides that tax credit brokers are allowed to participate in the market so long as the tax credits are not transferred to such brokers as an initial first step in the transfer process (as the subsequent transfer to an end user would violate the one-time transfer rule). Specifically, at no point can the federal “income tax ownership” be transferred to a broker. It is an open question if further distinction will be made at where this ownership line should be drawn. For example, can a third party enter into a purchase agreement with a seller and then transfer such rights prior to the transfer election being made? Does it matter under such analysis if 1) purchase price installments have been paid (which implicates rules in the buyer partnership context as noted above) and/or 2) the tax credit generating eligible property has been placed in service (which is when the investment tax credit vests for an allocated tax credit analysis; a production tax credit generally arises as electricity or the applicable source is sold)?
  • Indirectly implicated is what effect the new transfer rules will have on established case law precedent and IRS enforcement action in traditional tax equity structures. The Inflation Reduction Act and guidance dances around certain of these issues by creating a fiction where the buyer is treated as the “taxpayer” – this avoids the issue of turning a federal tax credit into “property” that can be sold similar to a certificated state tax credit. This also provides a more logical explanation as to why the buyer of these federal tax credits does not need to report any price discount as income when utilized, unlike the well-established federal tax treatment of certificated state tax credits that provides the exact opposite (e.g., a buyer of a certificated state tax credit at $0.90 has to report $0.10 of income on use of such tax credit).

Other Administrative and Foot-Fault Issues

  • The purchase price can only be paid in cash during the period commencing with the beginning of the seller’s tax year during which the applicable tax credit is generated and ending on the due date for filing the seller’s tax return with extensions. Thus, such period could be as long as 21.5 months or more (e.g., a calendar year partnership seller extending its return to Sept. 15). Tax equity transactions generally have pricing timing adjusters for failure to meet placement in service deadlines. Such mechanism will not work if advanced payments were made and then the project’s projected placement in service year changes. Tax credit purchase agreements executed prior to the June 14 guidance may require amendments or complete unwinds to line up with the rules to avoid foot faults (e.g., purchase agreements executed in 2022 where a portion of the purchase price was paid in 2022 for anticipated 2023 tax credits would not fall within the “paid in cash” safe harbor period). Advanced commitments, so long as cash is not transferred outside of the period outlined above, are permitted.
  • The typical solar equity contribution schedule of 20 percent at a project’s mechanical completion makes purchase price schedules approximating the same a reasonable adjustment for most investment tax credit energy deals in terms of the timing of financing. In addition, the advance commitment blessing of the guidance will give lender parties the comfort necessary similar to having executed tax equity documents in place. Thus, typical project construction financing mechanisms should be similar in the tax equity versus purchase agreement scenario, with projects that allow for a more delayed funding mechanism possibly obtaining a tax credit pricing premium. Production tax credit deals, for which tax credits can only be paid for on a yearly basis within the cash paid safe harbor timing window, may have more significant project financing hurdles without further tax credit transfer rule modifications.
  • Sellers can only make the transfer election on an original return, which includes extensions. Buyers, by contrast, may claim the purchased tax credit on an amended return.
  • Buyers need to be aware that usage of the purchased tax credits is tied to the tax year of the seller. For example, a fiscal year seller could cause the tax credits to be available a year later than an uninformed buyer anticipated, regardless of when the tax credit was generated using a traditional placement in service analysis. For example, a solar project placed in service during November 2023 by an August fiscal year seller would generate credits first able to be used in a calendar year buyer’s 2024, instead of 2023, tax year. A buyer can use the tax credits it intends to purchase against its estimated tax liability.
  • The pre-registration requirements, which are expansive and open-ended, are also tied to the taxable year the tax credits are generated and generally must be made on a property-by-property basis. For example, 50 rooftop installations could require 50 separate registration numbers outside of the “energy project” election. When such registration information needs updated is also not entirely clear – for example, a project is often sold into a tax equity partnership syndication structure on or before mechanical completion. Needing to update registration information could delay transactions and implicates unknown audit risk.

While these rules provide much-needed clarity, failure to adhere may be catastrophic and will require sellers and buyers to put proper administrative procedures in place to avoid foot faults. The new transfer regime will expand the market to new buyers who may have viewed tax equity as either too complex or had other reasons to avoid these transactions, such as the accounting treatment of energy tax credit structures. However, it would be prudent for such buyers to approach such transactions with eyes wide open.

© 2023 BARNES & THORNBURG LLP

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