Tag: Internal Revenue Code

Protect Yourself: Action Steps Following the Largest-Ever IRS Data Breach

On January 29, 2024, Charles E. Littlejohn was sentenced to five years in prison for committing one of the largest heists in the history of the federal government. Littlejohn did not steal gold or cash, but rather, confidential data held by the Internal Revenue Service (IRS) concerning the United States’ wealthiest individuals and families.

Last week, more than four years after Littlejohn committed his crime, the IRS began notifying affected taxpayers that their personal data had been compromised. If you received a notice from the IRS, it means you are a victim of the data breach and should take proactive steps to protect yourself from fraud.

IN DEPTH

Littlejohn’s crime is the largest known data theft in the history of the IRS. He pulled it off while working for the IRS in 2020, using his access to IRS computer systems to illegally copy tax returns (and documents attached to those tax returns) filed by thousands of the wealthiest individuals in the United States and entities in which they have an interest. Upon obtaining these returns, Littlejohn sent them to ProPublica, an online nonprofit newsroom, which published more than 50 stories using the data.

Under federal law, the IRS was required to notify each taxpayer affected by the data breach “as soon as practicable.” However, the IRS did not send notifications to the affected taxpayers until April 12, 2024 – more than four years after the data breach occurred, and months after Littlejohn’s sentencing hearing.

TAKE ACTION

If you received a letter from the IRS (Letter 6613-A) enclosing a copy of the criminal charges against Littlejohn, it means you were a victim of his illegal actions. To protect yourself from this unprecedented breach of the public trust, we recommend the following actions:

  1. Consider Applying for an Identity Protection PIN. A common crime following data theft involves using a taxpayer’s social security number to file fraudulent tax returns requesting large refunds. An Identity Protection PIN (IP PIN) can help protect you from this scheme. After you obtain an IP PIN, criminals cannot file an income tax return under your name without knowing your identification number, which changes annually. Learn more and apply for an IP PIN here.
  2. Request and Review Your Tax Transcript. The IRS maintains a transcript of all your tax-related matters, including filings, payments, refunds, extensions and official notices. Regularly reviewing your tax transcript (e.g., every six to 12 months) can reveal fraudulent activity while there is still time to take remedial action. Request a copy of your tax transcript here. If you have questions about your transcript or need help obtaining it, we are available to assist you.
  3. Obtain Identity Protection Monitoring Services. Applying for an IP PIN and regularly reviewing your tax transcript will help protect you from tax fraud, but it will not protect you from other criminal activities, such as fraudulent loan applications. To protect yourself from these other risks, you should obtain identity protection monitoring services from a reputable provider.
  4. Evaluate Legal Action. Data breach victims should consider taking legal action against Littlejohn, the IRS and anyone else complicit in his wrongdoing. Justifiably, most victims will not want to suffer the cost, aggravation and publicity of litigation, but for those concerned with the public tax system’s integrity, litigation is an option.

In fact, litigation against the IRS is already underway. On December 13, 2022, Kenneth Griffin, the founder and CEO of Citadel, filed a lawsuit against the IRS in the US District Court for the Southern District of Florida after discovering his personal tax information was unlawfully disclosed to ProPublica. In his complaint, Griffin alleges that the IRS willfully failed to establish adequate safeguards over confidential tax return information – notwithstanding repeated warnings from the Treasury Inspector General for Tax Administration and the US Government Accountability Office that the IRS’s existing systems were wholly inadequate. Griffin is seeking an order directing the IRS “to formulate, adopt, and implement a data security plan” to protect taxpayer information.

The future of Griffin’s lawsuit is uncertain. Recently, the judge in his case dismissed one of his two claims and cast doubt on the theories underpinning his remaining claim. It could be years before a final decision is entered.

Although Griffin is leading the charge, joining the fight would bolster his efforts and promote the goal of ensuring the public tax system’s integrity. A final order in Griffin’s case will be appealable to the US Court of Appeals for the Eleventh Circuit. A decision there will be binding on both the IRS and taxpayers who live in Alabama, Florida and Georgia. However, the IRS could also be bound by orders entered by other federal courts arising from lawsuits filed by taxpayers who live elsewhere. Because other courts may disagree with the Eleventh Circuit, taxpayers living in other states could file their own lawsuits against the IRS in case Griffin does not prevail.

Victims of the IRS data breach who are interested in taking legal action should act quickly. Under the Internal Revenue Code, a lawsuit must be filed within two years after the date the taxpayer discovered the data breach.

© 2024 McDermott Will & Emery
For more news on the IRS Data Breach, visit the NLR Tax section.

House Passes $78 Billion Tax Bill that Includes Affordable Housing Help

How long is something called a “crisis” before it just becomes the “new normal?” It is apparent there has been an affordable housing crisis in the United States for decades. One way that the federal government has addressed this is by motivating developers with the 9% Low Income Housing Tax Credit (the “9% LIHTC”) and the 4% Low Income Housing Tax Credit (the “4% LIHTC”) that a developer can receive for building a “qualified low-income building” described under Section 42 of the Internal Revenue Code of 1986, as amended (the “Code”).

These LIHTCs are awarded by a state government (or political subdivision thereof) to eligible participants to offset a portion of their federal tax liability in exchange for the production or preservation of affordable housing. On average, 50% of the total financing for 9% LIHTC projects comes from equity derived from the credit. Many states have used the 9% LIHTC as their primary tool to facilitate the production and rehabilitation of affordable rental housing. However, the 9% LIHTC is incredibly competitive. Each year the federal government allocates 9% LIHTC to each state on the basis of population.

The 4% LIHTC is another viable (and slightly less competitive) option. Currently, the 4% LIHTC is available for acquisition and rehabilitation of existing buildings and for new construction where 50% of the aggregate basis of the land and the building is financed with proceeds of tax-exempt bonds issued pursuant to Section 142(d) of the Code (“Affordable Housing PABs”). Unlike the 9% LIHTC, the amount of 4% LIHTC available is ostensibly unlimited; however, Affordable Housing PABs come with some strings attached, one of which is a Code Section 146 requirement to obtain an allocation of volume cap equal to the higher of the issue price or the par amount of the Affordable Housing PABs issued.

The federal government places a cap on the volume of certain types of tax-exempt private activity bonds, such as Affordable Housing PABs, that each state can issue. This limit is based on the population of the state. Each state has its own procedure for the allocation of and certification as to volume cap. Bonds that are subject to a volume cap limit are generally subject to an overall issuance limit each calendar year within each state. Each year, the IRS publishes a revenue procedure promulgating the volume cap applicable to each state. States then further apportion their allocable volume cap among various issuers and types of tax-exempt bonds that require volume cap within the state. As of March 2, 2023, the volume cap in 18 states and Washington, D.C. was oversubscribed for 2023.[1] Oversubscribed volume cap leads to competition for Affordable Housing PABs, which must be issued to receive the 4% LIHTCs to fund development for affordable housing.

After that primer, these authors can finally cut to the chase![2] On Wednesday, January 31, 2024, the U.S. House of Representatives passed a bill called the Tax Relief for American Families and Workers Act.

What Would This Legislation Do?

In addition to expanding the child tax credit and loosening restrictions on research and development tax deductions, this new legislation would (1) raise the 9% LIHTC through calendar year 2025 and (2) reduce the amount of Affordable Housing PABs needed for the 4% LIHTC from 50% of a project’s aggregate basis to 30% for a period of time.

For those keeping score at home, that is a 40% reduction in the amount of Affordable Housing PABs needed for the 4% LIHTC! If passed by the Senate, this package would be great news because it would free up bond capacity for more Affordable Housing PABs and for other tax-exempt bonds that require volume cap.[3]

But before you get too excited, note we said for a period of time and the Senate has yet to pass this legislation. How long a period? As drafted, the new legislation provides that the reduction of the Affordable Housing PABs requirement to 30% is applicable to projects, which are financed in part (at least 5% of the aggregate basis of the building and land)[4] by Affordable Housing PABs which have an issue date is in 2024 or 2025. So, the 40% reduction would be much like those endless infomercials we endured during COVID (available for a limited time only!). The reduction would be available from the date that the legislation takes effect for Affordable Housing PABs issued through December 31, 2025 (or for about a year to a year and a half). So, while this is a step in the right direction, this is not a permanent reduction in the amount of Affordable Housing PABs required to obtain the 4% LIHTC.

Recall that Congress has extended programs like this before. For example, the Qualified Zone Academy Bond program was established by the Taxpayer Relief Act of 1997 in order to promote private-sector investment in primary and secondary public education in areas with scarce public resources. Initially authorized only for 1998 and 1999, the program ended up being extended every two years right up through 2017. These types of extensions would make it a lot harder to plan yearly volume cap requests, but the new legislation is still a positive development.

The public policy and municipal bond sectors think this legislation does have a chance in the Senate, but it will likely take a while. Not surprisingly, Congress has other crises to address beyond affordable housing, including the laddered continuing resolutions funding the government that will expire on March 1and March 8. As Brian Egan, the director of government affairs for the National Association of Bond Lawyers said, this “overwhelming House vote demonstrates a momentum that the deal’s advocates will not want to squander. It also proves that members on both sides of the aisle want to get something done on tax before the end of the 118th Congress.”

Stay tuned for more on this and our expanding coverage of affordable and workforce housing in the coming weeks!

[1] https://www.novoco.com/notes-from-novogradac/population-figures-increase-multiplier-mean-record-pab-cap-2023-small-state-recipients-largely.

[2] You probably would never want to listen to the authors of this blog post tell any sort of suspenseful story. You would be here for days!

[3] Like the 25% volume cap requirement for qualified carbon dioxide capture facilities. We are all still waiting for that guidance on how to implement those provisions of the Code; we are looking at you Internal Revenue Service.

[4] Note that the new legislation also attempts to provide a transition rule for projects that already have some Affordable Housing PABs issued (but not the full 50% required prior to the enactment of this legislation) by permitting the reduced 30% requirement to be applied if at least 5 percent or more of the aggregate basis of the building and land is financed by Affordable Housing PABs with an issue date in 2024 or 2025. See the H. Rept. 118-353 – TAX RELIEF FOR AMERICAN FAMILIES AND WORKERS ACT OF 2024.

© Copyright 2024 Squire Patton Boggs (US) LLP
For more on tax bills, visit the NLR Tax section.

Michigan SALT Workaround Update: Accrual Taxpayers

As a follow up to our tax advisory issued December 23, 2021, pertaining to Michigan’s new SALT workaround (Michigan Tops the Growing List of States with a SALT Cap Workaround for Pass-Through Entities), we are providing this update to alert accrual-basis taxpayers regarding the Michigan SALT workaround and the deductibility of taxes under section 164.

Section 164(a) of the Internal Revenue Code provides a deduction for state and local income taxes “paid or accrued”. Under normal accrual method accounting rules, taxes may be deducted if both of the following apply:

  1. The all events test has been met (i.e. all events have occurred that fix the fact of liability, and the liability can be determined with reasonable accuracy); and
  2. Economic performance has occurred.

With respect to taxes, economic performance generally occurs when taxes are paid. However, there is an exception to this for recurring items that meet four requirements:

  1. The all-events test is met.
  2. Economic performance occurs by the earlier of:
    • 8½ months after the close of the year, or
    • The date you file a timely tax return (including extensions) for the year.
  3. The item is recurring in nature and the taxpayer consistently treats similar items as incurred in the tax year in which the all-events test is met, and
  4. Either:
    • The item is not material, or
    • Accruing the item in the year in which the all-events test is met results in a better match against income from accruing the item in the year of economic performance.

Thus, under normal instances, if payment of tax is made by an accrual-basis taxpayer with a timely filed tax return in the following year and the rest of the elements above are met, state income taxes can be deducted on an entity’s federal return. Applying the normal accrual rules to the Michigan SALT cap workaround without additional authority, a partnership/S corporation that makes an election to be taxed at the passthrough entity level but does not pay such taxes until it files a timely return may still deduct Michigan income taxes if the elements above are met.

There is substantial concern, however, that the IRS may challenge this deduction based on authority issued. In Notice 2020-75, the IRS provided a limited blessing of certain SALT workarounds but focuses on where “specified income tax payments” are made. The notice does not specifically address accrual taxpayers, or whether accrual accounting rules would still apply to such taxes allowing payment in the following year. There are also concerns that the IRS may view passthrough entity taxes paid by accrual taxpayers as not satisfying the accrual accounting rules because of the elective nature of the tax.

Given the lack of certainty in this area, the conservative position for accrual-basis taxpayers should be to pay the passthrough entity tax by December 31, 2021. Payments can be made today on the Michigan Treasury Online system, which also triggers the election for the passthrough entity tax. From communications with the State of Michigan, we expect additional guidance to be issued in January of 2022 for the Michigan SALT workaround, including the release of the election form.

© 2022 Varnum LLP

Article By Steven G. Cappellino and Eric M. Nemeth of Varnum LLP

For more articles on SALT, visit the NLR Tax section.

Incentive Compensation That is Never Subject to Income Tax – Too Good to Be True?

Clients frequently ask if they can provide incentive compensation to their employees and executives in a manner that gives them flexibility and drives performance, but receives coveted capital gains treatment. This usually sounds too good to be true. In most cases, you can defer or sometimes minimize income tax for employees (retirement plans, deferred compensation arrangements, stock appreciation rights, non-qualified stock options), but there is one tool that enables employees to skip income tax, FICA, and withholding altogether – well-designed and-well managed incentive stock options or “ISOs.”

Incentive stock options – sometimes called statutory options because they are established and governed by Internal Revenue Code 422 – are a kind of stock option that can provide “special” tax treatment to the recipients if certain requirements are satisfied. There are two key differences between incentive stock options and their more common cousin – the non-qualified stock option:

  • First, executives will not recognize any ordinary income tax at exercise of an ISO (as compared to a non-qualified option – which requires executives to recognize ordinary income on the spread – or difference between the exercise price and the value of the option on the date of exercise – and come up with money to pay their withholding on that amount). This can be a big benefit as long as the exercise does not end up triggering the AMT (which has historically been an issue for many incentive stock option holders, but is less likely now in light of changes made to the AMT by the Tax Cuts & Jobs Act).

What is AMT?  At a very high level, the Alternative Minimum Tax (AMT) is simply an alternative tax structure to the more well-understood and more often used regular income tax method. In order to determine which tax to apply, taxpayers must calculate taxes under the regular income tax method and the alternative minimum tax and then pay whichever amount is greater. This does not come up particularly often for most normal taxpayers, but is relevant for most ISO recipients because the value of the spread at exercise is not taken into account under the regular tax method, but it is considered as a preference item in the AMT method. The larger the spread, the more likely ISOs will trigger the AMT.

  • Second, if all of the statutory requirements are satisfied, then the gain – the difference between the incentive stock option’s exercise price (generally, the fair market value of the stock on the date of grant) and the amount the holder will receive when she ultimately sells the stock after exercise – will all be taxed at the lower capital gains rate (currently, 15 percent or 20 percent, depending on income level), rather than income tax (the top tax bracket is currently at 37 percent), and no FICA or withholding obligations will apply. That is a tax savings of more than 17 percent!

The flipside is that ISOs are less tax advantageous to employers because, if all goes as planned, they will never be permitted to take a deduction for the compensation. However, because the corporate tax rate was reduced with the Tax Cuts & Jobs Act, some employers are taking a second look at whether to issue ISOs now, considering that the deduction is now less valuable.

To receive this special treatment, the plan document, award agreement, and management of the incentive stock option award must meet certain requirements:

Plan and Award Agreement

  • Incentive stock options must be issued pursuant to an equity incentive plan.
  • The plan must provide the number of shares reserved for issuance as ISOs.
  • The plan must be approved by the company’s shareholders within 12 months before or after it is adopted by the company, and re-approved at least every 10 years thereafter.
  • The award agreement must provide an exercise price that is no less than the fair market value of the stock underlying the options on the date of grant (100 percent of the fair market value for 10 percent owners). [This will also help with Code Section 409A compliance.]
  • Each award must have a stated term of no more than 10 years (five years for 10 percent owners).

Eligibility and Operation

  • ISOs may only be issued to employees – not to consultants or non-employee directors.
  • ISOs may only be issued by corporations.
  • No more than $100,000 of ISOs may become exercisable in any given calendar year (based on the fair market value on the grant date). [This seems straightforward until companies add fancy features like accelerated vesting on a change in control event.]
  • Certain limits on post-termination exercise apply, notably ISOs must be exercised within three months of a standard termination (longer periods apply in the event of death or disability).
  • After the option is exercised, and stock is actually purchased, the stock must be held until the later of (i) the second anniversary of the grant date or (ii) one year from the exercise date. [This tends to be one of the most difficult requirements to satisfy because many employees want to wait to exercise until a liquidity event – or change in control – but will not satisfy the holding period if they sell their stock shortly after exercise.]
© 2018 Foley & Lardner LLP
This post was written by Casey K Fleming of Foley & Lardner LLP.
Please find more tax legal news on the National Law Review tax type of law page.