Tag: Internal Revenue Service

Year-End Estate Planning Update: Strategies for 2025

The 2025 transfer tax exemption will remain at a historically high level before being reduced by 50% on January 1, 2026 under current law. As it remains uncertain whether the new Congress will enact legislation to maintain the current exemption amount, taxpayers should continue planning with the current law in mind. There are a variety of strategies available to take advantage of current exemption levels.

Current Transfer Tax Laws

The federal gift/estate and generation-skipping transfer (GST) tax exemptions (i.e., the amount an individual can transfer free of such taxes) were $13.61 million per person in 2024 and will increase to an unprecedented $13.99 million in 2025. However, under current law these exemptions will be reduced by 50% on January 1, 2026 (but still inflation adjusted each year). While Congress may do nothing and maintain the current transfer tax laws (allowing the exemptions to be cut in half), or repeal the transfer taxes altogether, due to budgetary constraints, it is more likely that Congress will simply extend the timeframe for when the exemptions will be reduced, perhaps by two, four, or 10 years. The federal transfer tax exemptions can be used either during lifetime or at death. Using exemption during lifetime is generally more efficient for transfer tax purposes, as any appreciation on the gifted assets escapes estate taxation. The Illinois estate tax exemption remains at $4 million per person, as this exemption does not receive an annual inflationary increase.

For individuals concerned about estate taxation upon death, there are estate planning strategies available to utilize the current historically high exemptions. However, these strategies must also address the potential loss of a basis change on death. Estate taxes are imposed at a 40% federal rate on a decedent’s “taxable estate” not qualifying for a marital or charitable deduction, plus potential state estate taxes. In Illinois, the effective marginal tax rate ranges from 8% to approximately 29%. As with income taxes, state estate taxes are deductible for federal estate tax purposes, resulting in a cumulative federal and Illinois estate tax rate (for estates above both the federal and Illinois exemptions), taking deductions into account, of approximately 48%. The trade-off is the loss of the basis change at death (discussed below), which can result in an income tax cost on any “built in” gains aggregating 28.75% (a federal 20% capital gains tax, plus the 3.8% federal net investment income tax, plus state capital gains taxes of 4.95% in Illinois).

In 2025, a married couple can transfer up to $27.98 million free of federal transfer tax, but as discussed above, under current federal law, the estate/gift and GST tax exemptions are to be reduced by 50% in 2026. The Treasury Department has confirmed that the additional transfer tax exemption granted under current law until 2026 is a “use it or lose it” benefit, and that if a taxpayer uses the “extra” exemption before it expires (i.e., by making lifetime gifts), it will not be “clawed back” causing additional tax if the taxpayer dies after the exemption is reduced in 2026. This means that a taxpayer who has made $6.995 million or less (adjusted for inflation) of lifetime gifts before 2026 will not “lock in” any benefit of the extra exemption, while a taxpayer who makes use of the additional exemption before 2026 (e.g., by making gifts of $13.99 million before 2026) will “lock in” the benefit of the extra exemption.

Lifetime Transfer Strategies

In addition to making such annual exclusion gifts, taxpayers should strongly consider lifetime gifting strategies in 2025 in excess of those amounts. Taxpayers who have not used the “extra” exemption before January 2026 may lose it forever. Furthermore, any post-appreciation transfer on gifted assets accrues outside of the taxpayer’s estate. This is especially salient for younger individuals and for transfers of assets with high potential for appreciation. For taxpayers who live in states with a state estate tax but no state gift tax (such as Illinois), lifetime gifting will also have the effect of reducing the state estate tax liability.

New Rules for Required Minimum Distributions from Certain Inherited IRAs

The IRS issued new Final Regulations in 2024 that Required Minimum Distributions from certain retirement plans that beneficiaries must take to avoid penalties (hereinafter referred to as “inherited IRAs” even though they encompass all retirement plans). Congress enacted the SECURE Act in 2019, which set the current law for Required Minimum Distributions from inherited IRAs and other retirement plans. In general, other than a spouse, minor child of the decedent, or disabled child of the decedent for whom special “stretch rules” may apply, beneficiaries have a 10-year period within which all of the IRA funds have to be withdrawn to avoid penalties (no distributions until December 31 of the year in which the 10th anniversary of death falls). Based upon this rule, many beneficiaries intentionally planned to not withdraw IRA funds until the end of the 10-year period in order to let the funds grow income tax deferred (unless earlier distributions could be made at a lower income tax rate based upon their individual situation year by year). Effective for taxable years beginning on or after January 1, 2025, the IRS’s new Regulations change this 10-year rule for beneficiaries that inherited an IRA from a decedent that was passed his or her “required beginning date” (age 72 if the decedent was born in 1950 or before, age 73 if born 1951-1959, and age 75 if born 1960 or later). For such beneficiaries (the decedent dying past his or her required beginning date), the beneficiary is required to take annual distributions during the 10-year period based upon the beneficiary’s life expectancy and must drain whatever is left by December 31 of the 10th year after death. Failure to take the Required Minimum Distribution can result in significant penalties. This annual Required Minimum Distribution amount does not apply to spousal rollover IRAs, to IRAs for which the beneficiary qualified and was using a special life expectancy rule, to IRAs when the participant died before his or her required beginning date, or to IRAs inherited before 2020.

Planning for Basis Change

Good estate planning incorporates income tax and other considerations rather than focusing myopically on estate, gift, and GST taxes. In general, upon an individual’s death, the cost basis of any assets that are included in his or her gross estate for estate tax purposes receive an adjustment to their fair market value at the date of death. For appreciated assets, this can result in substantial income tax savings. Assets that are not included in the gross estate, however, do not receive a basis adjustment. Therefore, there is often a trade-off between making lifetime gifts (to reduce estate taxes, but with the donee receiving the donor’s “carry-over” basis) and keeping assets in the gross estate (to obtain the basis adjustment and reduce income taxes).

Fortunately, there are a number of techniques to help plan for possible change in basis while still retaining estate tax benefits. Irrevocable trusts that receive lifetime gifts can be structured to allow for a possible basis change. One way to do so is by including a broad distribution standard in the trust agreement by which an independent trustee can make distributions out of the trust to the beneficiary. Additionally, a trust can be structured to grant an independent trustee the power to grant (or not grant) the beneficiary a “general power of appointment,” which would cause the trust assets to be includible in the beneficiary’s estate for estate tax purposes and therefore receive the basis adjustment. Finally, if an irrevocable trust is structured as a grantor trust, the grantor can retain a “swap power” that can be used to transfer high-basis assets to the trust and take back low-basis assets, in order to obtain the largest possible “step up” in basis.

The Corporate Transparency Act

As of January 1, 2024, domestic and foreign entities created by filing with a Secretary of State or foreign entities registered to do business with a Secretary of State (i.e., corporations, LLCs, and limited partnerships), are required to report beneficial ownership information to the Financial Crimes Enforcement Network, subject to limited exemptions. “Reporting Companies” are required to report the full legal name, birthdate, residential address, and a unique identifying number from a passport or driver’s license (along with a copy of the passport or driver’s license) for any owner who directly or indirectly (i) owns at least 25% of the ownership interests or (ii) directly or indirectly exercises “substantial control” over the entity.

Entities in existence before January 1, 2024 have until December 31, 2024 to comply with the reporting requirement. Entities formed in 2024 have 90 days from the date of formation to comply with the reporting requirement. New entities formed on or after January 1, 2025 will have 30 days from formation to comply with the reporting requirement. There is also a supplemental filing requirement every time any information on the filed Report changes, due 30 days after each such change.

© 2024 Much Shelist, P.C.
For more on Estate Planning, visit the NLR Estates Trusts section

Disregarded Entity Eligibility for the CTA Large Operating Company Exemption

Summary: As discussed in detail below, the Corporate Transparency Act (CTA) provides an exemption to its reporting requirements for certain large operating companies (the Large Operating Company Exemption or “LOC Exemption”). In order to qualify for the LOC Exemption, a reporting company must, among other requirements, “have filed a Federal income tax or information return in the United States in the previous year demonstrating more than $5,000,000 in gross receipts or sales.” Certain reporting companies are “disregarded entities” (DREs) for Federal tax purposes and, as such, do not themselves directly have a Federal tax filing obligation or ability. However, based upon guidance from FinCEN and the IRS, support exists for the proposition that the Federal tax filing of a DRE’s sole individual owner or sole parent entity constitutes the filing referenced in the LOC Exemption, and that a DRE reporting company is not, per se, disqualified from utilizing the LOC Exemption.

* * * * *

Certain business entities may elect (including through default attribution under the Internal Revenue Code, (IRC) to be treated as “disregarded” from their individual owner or parent entity for U.S. federal income tax purposes. Such entities include limited liability companies (LLCs) who have a single member (unless such an LLC has elected on Internal Revenue Service (IRS) Form 8832 to be taxed as a “corporation”), or certain wholly owned subsidiaries of “S-corporations” where the parent S-corporation has made an election (referred to as a “Q-Sub election”) on IRS Form 8869 to treat the subsidiary as a qualified subchapter S subsidiary (QSub), whereby such Q-Sub is deemed to be liquidated (for federal tax purposes only) into the parent S-corporation.

These entities, often referred to simply as “disregarded entities” do not, as a distinct, juridical person, file a federal income tax return per se. Instead, DREs have their taxable income and loss reflected, on an aggregated basis, on the federal income tax return of their individual owner or (direct or indirect) parent entity. In fact, when reporting the taxpayer identification number (TIN) of a DRE on an IRS Form W-9 (Request for Taxpayer Identification Number and Certification), the DRE provides the federal employer identification number (FEIN) of a parent entity or a social security number (SSN) of an individual owner, rather than a TIN of the DRE itself. This is true even if the DRE has filed for, and has received from the IRS, its own FEIN.

Further to this point, some DREs do not, and are not required to, file for their own FEIN. As such, not all DREs possess their own FEIN or other entity distinct TIN.

The Financial Crimes Enforcement Network (FinCEN), in its Frequently Asked Question F.13 issued July 24, 2024, acknowledged this fact as follows:

“An entity that is disregarded for U.S. tax purposes—a “disregarded entity”—is not treated as an entity separate from its owner for U.S. tax purposes. Instead of a disregarded entity being taxed separately, the entity’s owner reports the entity’s income and deductions as part of the owner’s federal tax return. …

Consistent with rules of the Internal Revenue Service (IRS) regarding the use of TINs, different types of tax identification numbers may be reported for disregarded entities under different circumstances:

  • If the disregarded entity has its own EIN, it may report that EIN as its TIN. If the disregarded entity does not have an EIN, it is not required to obtain one to meet its BOI reporting requirements so long as it can instead provide another type of TIN….
  • If the disregarded entity is a single-member limited liability company (LLC) or otherwise has only one owner that is an individual with a SSN or ITIN, the disregarded entity may report that individual’s SSN or ITIN as its TIN.
  • If the disregarded entity is owned by a U.S. entity that has an EIN, the disregarded entity may report that other entity’s EIN as its TIN.
  • If the disregarded entity is owned by another disregarded entity or a chain of disregarded entities, the disregarded entity may report the TIN of the first owner up the chain of disregarded entities that has a TIN as its TIN.

As explained above, a disregarded entity that is a reporting company must report one of these tax identification numbers when reporting beneficial ownership information to FinCEN.”i

While the above FAQ is not offered by FinCEN specifically in the context of the LOC Exemption, this FAQ does have important implications for the LOC Exemption. In stating that a DRE is not required to obtain an FEIN merely for purposes of having such a number for purposes of filing a beneficial ownership information report (BOIR) under the CTA, and acknowledging that a DRE may provide a SSN of an individual owner, or an FEIN of a parent entity, in satisfaction of the DRE’s requirement to provide a tax identification number as required in FinCEN’s form for filing BOIRs, FinCEN has recognized that the same TIN required by the IRS to be disclosed on a Form W-9 in respect of a DRE is recognized by FinCEN as an appropriate TIN in respect of the DRE for purposes of such entity’s BOIR filing.

As such, the federal tax return filing associated with such a TIN is, therefore, the tax return associated with the DRE reporting such TIN on its BOIR filing. In other words, the fact that an individual owner or a parent entity has made a prior year’s federal tax return filing, which filing includes the U.S. generated gross receipts or sales of the DRE, should be sufficient to satisfy the DRE’s prior year’s federal tax return filing status with respect to such revenue.

As stated in FAQ F.13 above, “a DRE—is not treated as an entity separate from its owner for U.S. tax purposes…, the entity’s owner reports the entity’s income and deductions as part of the owner’s federal tax return…”

* * * * *

With this background, we next analyze the associated implications to a DRE that may qualify for the LOC Exemption.

For purposes of clarity, the requirements for an entity to qualify for the LOC Exemption is that the entity satisfy all three parts of the following three-part test:

“[A]n entity must have more than 20 full-time employees in the United States, must have filed a Federal income tax or information return in the United States in the previous year demonstrating more than $5,000,000 in gross receipts or sales, and must have an operating presence at a physical office in the United States.”ii

The CTA itself provides more specificity in this regard. The CTA provides that the term “reporting company” does not include any entity that:

“(I) employs more than 20 employees on a full-time basis in the United States; (II) filed in the previous year Federal income tax returns in the United States demonstrating more than $5,000,000 in gross receipts or sales in the aggregate, including the receipts or sales of (aa) other entities owned by the entity; and (bb) other entities through which the entity operates; and (III) has an operating presence at a physical office within the United States.”iii

Although FinCEN has, to date, issued no formal acknowledgment or interpretation with regard to the applicability of the above “revenue prong” specifically in the DRE context, for the reasons outlined above, a reasoned and supported proposition in the DRE situation may be that the “filed Federal income tax or information return” referenced in the LOC Exemption is the federal tax return filing of the reporting company’s individual owner or parent entity, as applicable.

Further to the revenue prong, it appears that if the DRE itself generates U.S. generated gross receipts or sales in excess of five million dollars as reported on the prior year’s federal tax return filing, that the DRE meets the revenue prong of the LOC Exemption. However, based on the above analysis, it may also be a colorable position that the DRE MAY be able to assert that ALL of the U.S. generated gross revenue appearing on the individual owner’s or parent entity’s federal tax return filing may be attributable to the revenue test prong of the LOC Exemption, because all of such revenue is associated with that tax return. This situation is notionally similar to FinCEN’s interpretation that all members of a consolidated corporate taxed group (including each subsidiary) may share in credit for the aggregated gross receipts or sales of the entire group in meeting each of their respective, individual revenue requirements under the LOC Exemption. Here, both the individual and DRE or the parent entity and disregarded subsidiary would be relying upon the same federal tax return, in the individual or partnership tax context.

* * * * *

For purposes of clarity and completeness, we acknowledge a countervailing position espoused by some commentators in the marketplace. That position holds that a DRE is ab initio ineligible to qualify for the LOC Exemption merely because of such reporting company’s status as a DRE (i.e., that it, itself, as a business entity, does not directly cause the filing of its own, independent federal tax return). For the reasons outlined herein, we find this position less compelling than the proposition that disregarded entities have a filed Federal income tax or information return when filed by their individual owner or parent entity.

* * * * *

With respect to exemptions from the reporting obligations under the CTA, each such exemption is “self-executing.” In other words, if an exemption applies to a reporting company, that reporting company has no filing obligation to FinCEN under the CTA. As such, there is no BOIR filing on record documenting that the DRE is relying on its individual owner’s SSN or its parent entity’s FEIN, and, derivatively, the associated federal tax return filing, in establishing compliance with the revenue prong of the LOC Exemption test. We recommend that each DRE making such a reliance-based exemption determination maintain a record of their CTA diligence, analysis and exercise of business judgment made upon a fully informed basis, that underpins the substantiation of the DRE’s satisfaction of all parts of the LOC Exemption test.iv Such substantiation may be needed in the future if FinCEN or one of the DRE’s financial institutions requests substantiation of the DRE’s asserted position that such DRE is not required to file a BOIR under the CTA.

* * * * *

Conclusion. The compliance requirements under the CTA went live on January 1, 2024, and you have only the remainder of this year to take any action to prepare for your compliance position. Now is the time to discuss the CTA with your Polsinelli legal team for guidance.

[i] See FinCEN CTA FAQs F.13 (issued July 24, 2024)(https://www.fincen.gov/boi-faqs)

[ii] See FinCEN CTA FAQs L.7 (issued April 18, 2024)(https://www.fincen.gov/boi-faqs)

[iii] U.S.C. § 5336 (a)(11)(B)(xxi).

[iv] Note that there are other factors of the LOC Exemption that must be met in order to rely on that exemption, and such other factors are required to be met directly by the DRE. This discussion is not intended to suggest that the DRE may rely, for example, on employee counts of affiliated entities or impermissible U.S. physical address locations in qualifying for the LOC Exemption.

© Polsinelli PC, Polsinelli LLP in California
For more on the Corporate Transparency Act, visit the NLR Corporate Business Organizations section

IRS Announces 2025 Retirement Plan Limits

The Internal Revenue Service (“IRS”) has announced the following dollar limits applicable to tax-qualified plans for 2025:

  • The limit on the maximum amount of elective contributions that a person may make to a 401(k) plan, a 403(b) tax-sheltered annuity, or a 457(b) eligible deferred compensation plan increased from $23,000 to $23,500.
  • The limit on “catch-up contributions” to a 401(k) plan, a 403(b) tax-sheltered annuity, or a 457(b) eligible deferred compensation plan for persons age 50 and older is unchanged for 2025 at $7,500.
  • As a result of change made by SECURE 2.0, for 2025, employees aged 60, 61, 62, and 63 who participate in a 401(k) plan, a 403(b) tax-sheltered annuity, or a 457(b) eligible deferred compensation have a higher catch-up contribution limit, which for 2025 is $11,250 instead of $7,500.
  • The dollar limit on the maximum permissible allocation under 401(k) and other defined contribution plans is increased from $69,000 to $70,000.
  • The maximum annual benefit under a defined benefit plan is increased from $275,000 to $280,000.
  • The maximum amount of annual compensation that may be taken into account on behalf of any participant under a qualified plan will go from $345,000 to $350,000.
  • The dollar amount used to identify “highly compensated employees” is increased from $155,000 to $160,000.

Additional information regarding benefit plan dollar limits can be obtained in Notice 2024-80, 2025 Amounts Relating to Retirement Plans and IRAs, as Adjusted for Changes in Cost-of-Living.

© 2024 Blank Rome LLP
For more on the IRS, visit the NLR Tax section

2025 Inflation-Adjusted Plan Limits

On Nov. 1, 2024, the IRS published its annual cost of living adjustments for various retirement plan limits. These increases are more modest than recent years, a reflection that inflation is slowing. The updated key retirement plan limits include the following items:

2025 Limit 2024 Limit
Annual Compensation Limit $350,000 $345,000
Elective Deferral Limit $23,500 $23,000
Standard Age 50 Catch-Up Contribution Limit $7,500 $7,500
Age 60-63 Special Catch-Up Contribution Limit* $11,250 N/A
DC Maximum Contribution Limit $70,000 $69,000
DB Maximum Benefit Limit $280,000 $275,000
HCE Threshold $160,000 $155,000

*Note, this is a new provision under the SECURE 2.0 Act.

The IRS previously released the updated 2025 limits applicable to certain health and welfare plans, including the following key limits:

2025 Limit 2024 Limit
Health FSA – Maximum contributions $3,300 $3,200
Health FSA – Maximum carryover of unused amounts (optional plan provision) $660 $640
HSA – maximum contributions $4,300 (self-only)

$8,550 (family)

 $4,150 (self-only)

$8,300 (family)
HDHP – Minimum Deductible $1,650 (self-only)

$3,300 (family)

 $1,600 (self-only)

$3,200 (family)
HDHP – Maximum Out of Pocket $8,300 (self-only)

$16,600 (family)

 $8,050 (self-only)

$16,100 (family)
© 2024 Miller, Canfield, Paddock and Stone PLC
For more on Plan Limits, visit the NLR Estates Trusts section.

IRS Issues FAQs Regarding Long-Term Part-Time Employees in 403(b) Plans

The IRS recently issued Notice 2024-73, which provides much-needed guidance on long-term, part-time (“LTPT”) employees in ERISA-governed 403(b) retirement plans. Following passage of the SECURE 2.0 Act, an employee is generally considered a LTPT employee if he or she works at least 500 hours per year for two consecutive years.

Among other items, the Notice sets forth the IRS position on the following key issues on which the benefits community has been seeking clarification:

  • A part-time employee who qualifies as a LTPT employee must have the right to make elective deferrals to an ERISA 403(b) plan (unless some other statutory exemption applies), notwithstanding the Tax Code’s permitted exclusion for employees who normally work less than 20 hours per week.
  • An ERISA 403(b) plan may continue to exclude from the plan part-time employees who do not qualify as LTPT employees, notwithstanding the “consistency requirement,” which generally prevents a plan from excluding some part-time employees and not others.
  • An ERISA 403(b) plan is not required to provide the right to make elective deferrals to certain student employees, even if they qualify as LTPT employees. This is because the student employee exclusion is based on an employee classification (a student performing the service), rather than an amount of service (not an hours-based exclusion).

The guidance in the Notice is effective for plan years beginning after December 31, 2024. Importantly, the Notice also provides that a previously promulgated proposed regulation relating to the handling of LTPT employees in 401(k) plans, once finalized, will apply no earlier than plan years beginning on or after January 1, 2026 (i.e., a two-year extension).

© 2024 Miller, Canfield, Paddock and Stone PLC
For more on Long-Term Part-Time Employees, visit the NLR Labor Employment section.

It Ain’t Over ‘til It’s Over: IRS Reminds Taxpayers That Section 280E Applies to Marijuana Companies Until Rescheduling Becomes Law

This is a tax blog. Stay with me – it’s short.

While marijuana advocates celebrate the potential rescheduling of marijuana from Schedule I to Schedule III, the taxman has made clear that marijuana remains a Schedule I substance subject to Section 280E of the Internal Revenue Code. For those who aren’t cannabis tax specialists, 280E provides that:

No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

Marijuana is a Schedule I controlled substance and is subject to the limitations of the Internal Revenue Code. As we previously reported, the Justice Department recently published a notice of proposed rulemaking with the Federal Register to initiate a formal rulemaking process to consider rescheduling marijuana to Schedule III under the Controlled Substances Act. That change would remove marijuana from the purview of 280E.

Predictably, a number of cannabis operators couldn’t help themselves and began filing amended returns seeking to avail themselves of what they apparently felt was a change in the law. The response from the IRS is clear:

Taxpayers seeking a refund of taxes paid related to Internal Revenue Code Section 280E by filing amended returns are not entitled to a refund or payment. Until a final rule is published, marijuana remains a Schedule I controlled substance and is subject to the limitations of Internal Revenue Code Section 280E.

The reasoning is simple – marijuana is a Schedule I substance until it is not. While there is currently in place a process that could lead to the rescheduling of marijuana, it has not actually been rescheduled.

Cannabis operators can dream of a time when they will not be subject to the ravages of 280E, but for now that remains just out of grasp, albeit tantalizingly close.

As usual, stay tuned to Budding Trends. We’ll be monitoring all the impacts of rescheduling, including tax implications like this one.

Listen to this post

© 2024 Bradley Arant Boult Cummings LLP
For more on Cannabis, visit the NLR Biotech Food Drug section.

Supreme Court Rules Against Taxpayers in IRC Section 965 Case

On June 20, 2024, the Supreme Court of the United States issued a 7-2 opinion in Moore v. United States, 602 U.S. __ (2024), ruling in favor of the Internal Revenue Service (IRS).

Moore concerned whether US Congress and the IRS could tax US shareholders of controlled foreign corporations (CFCs) on those corporations’ earnings even though the earnings were not distributed to the shareholders. The case specifically focused on the so-called “mandatory repatriation tax” under Internal Revenue Code (IRC) Section 965, a one-time tax on certain undistributed income of a CFC that is payable not by the CFC but by its US shareholders. Some viewed the case as hinging upon whether Congress has the power to tax economic gains that have not been “realized.” (i.e., In the case of a house whose value has appreciated from $500,000 to $600,000, the increased value is “realized” only when the house is sold and the additional $100,000 reaches the taxpayer’s coffers.)

However, Justice Brett Kavanaugh, joined by Chief Justice John Roberts and Justices Sonia Sotomayor, Elena Kagan and Ketanji Brown Jackson, rejected that position on the ground that the mandatory repatriation tax “does tax realized income,” albeit income realized by a CFC. On this basis, they reasoned that the question at issue was whether Congress has the power to attribute realized income of a CFC to (and tax) US shareholders on their respective shares of the undistributed income. This group of justices ultimately decided Congress does have the power.

The majority went out of its way to avoid expressing any opinion as to whether Congress can tax unrealized appreciation, with Justice Amy Coney Barrett’s concurrence and Justice Clarence Thomas’s dissent asserting that it cannot. Perhaps the Court was signaling a distaste for the Billionaire Minimum Income Tax proposed by US President Joe Biden, which would impose a minimum 20% tax on the total income of the wealthiest American households, including both realized and unrealized amounts, among other Democratic proposals.

Practice Point: We previously noted that certain taxpayers should consider filing protective refund claims contingent on the possibility that Moore would be decided in favor of the taxpayers. In light of the case’s outcome, however, those protective claims are now moot.

© 2024 McDermott Will & Emery
For more news on US Shareholders of Foreign Corporations Taxes, visit the NLR Tax section.

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.

How Big is the Permanent Tax Benefit in the Pending Tax Bill for Research Credit?

Congress perhaps made an unintended drafting error in the Tax Cuts and Jobs Act [1] (TCJA) when it required a taxpayer to decrease its deduction for research and experimental expenditures. The apparent drafting error is in IRC §280C(c)(1), which provides that if a taxpayer’s research credit for a taxable year exceeds the amount allowable as a deduction for research expenditures for the taxable year, the amount of research expenses chargeable to capital account must be reduced by the excess and not by the full amount of the credit.

H.B. 7024 (1-17-24) [2] proposes to correct the drafting error for tax year 2023 and expressly states that the amendment made for taxable year 2023 should not be construed to create an inference with respect to the proper application of the drafting error for taxable year 2022. [3] The “no inference” congressional language could be interpreted as inviting the IRS to attempt an administrative fix of the drafting error.

Background of Research Expenditure Deduction and Credit for Increasing Research Activities: Beginning with the Internal Revenue Code of 1954, a taxpayer engaging in research activities in the experimental or laboratory sense in connection with its trade or business could elect to deduct the cost of its research currently rather than capitalizing the cost to the project for which the research was conducted. The Economic Recovery Tax Act of 1981 added a credit for the cost of research incurred in carrying on a trade or business. The manner in which the deduction and credit operated permitted a taxpayer both to deduct and credit the same research dollar.

Pre-TCJA (2017) law: The Omnibus Budget Reconciliation Act of 1989 ended the possibility deducting and crediting the same research dollar. If a taxpayer currently deducted its research expenditures, the taxpayer had to decrease its deduction by the amount of the research credit that it claimed for the taxable year.[4] The policy reason for the decrease was that a taxpayer should not be entitled to a deduction and a credit for the same dollar expended for research. Put another way, if the government “pays” for research by allowing a credit, the taxpayer did not really pay for the research and should not be entitled to deduct the amount for which the government paid.

TCJA Amendment: The TCJA now requires a taxpayer to capitalize research expenditures paid or incurred in the taxable year and claim an amortization deduction for the expenditures ratably over a five-year period.[5] The TCJA also amended IRC §280C(c)(1), the provision that prevents a taxpayer from receiving a credit and a deduction for the same dollar of research expenditure. The amendment provides that if the research credit amount for the taxable year exceeds the amount allowable as a deduction for the taxable year for qualified research expenses, the research expenses chargeable to capital account for the taxable year must be reduced by the excess.[6] This might have been a drafting error. The research credit for the taxable year might not exceed an amortization deduction for the year.[7] If for a taxable year the credit does not exceed the amortization deduction, a taxpayer could reasonably conclude that no reduction in the amount of capitalized research expenditures is required. The taxpayer would be interpreting the deduction for qualified research expenses as meaning the amount of the amortization of the capitalized expenses.

The IRS might have an opposing interpretation. The phrase, “the amount allowable as a deduction for such taxable year for qualified research expenses” in IRC §280C(c)(1) could be interpreted as always equaling zero because the TCJA amendment requiring amortization of research expenditures for the taxable year nullifies the “deduction … for qualified research expenses.” In other words, there were no “deductible” qualified research expenses for the year after enactment of the TCJA for purposes of IRC §280C(c)(1). [8] The result would be that the capitalized research expenses are decreased by the amount of the credit.

H.B. 7024: On January 31, 2024, the House passed 353 to 70 H.B. 7024, “Tax Relief for American Families and Workers Act of 2024.” Action on the bill is pending in the Senate. The bill restores the current deduction for research expenditures (but only for research performed in the United States), beginning with taxable year 2022,[9] and defers the requirement to amortize research expenditures until taxable year 2026. For taxable years beginning in 2023, the bill requires a taxpayer to decrease the research expenditure deduction for domestic research by the amount of the research credit for the year, thus reinstating, for domestic research, IRC §280C(c)(1) as it had read prior to its amendment by the TCJA. [10]

But for taxable year 2022, the bill does not expressly require a taxpayer to reduce its deduction for research expenditures by the amount of the research credit even though the bill permits the taxpayer to deduct it research expenditures currently for taxable year 2022. Thus, for taxable year 2022, a taxpayer may deduct its research expenditures but must decrease the deduction only by the amount, if any, that its 2022 research credit exceeds its 2022 deduction for qualified research expenditures, which amount may be zero. Moreover, the bill provides that the amendment requiring a decreased deduction for research expenditures for taxable years beginning in 2023 should not be construed to create “any inference” with respect to the proper application of IRC §280C(c) to taxable year 2022.

IRS Notice: In Notice 2023-63 – obviously published before H.R. 7024 – the IRS asks for comments about to interpret the current version of IRC §280C(c)(1). If H.R. 7024 is enacted, the IRS request for comments would appear irrelevant.

Taxpayer Actions: If H.R. 7024 is enacted, taxpayers must consider whether to change their accounting method for research expenditures from amortizing them to currently deducting them. A change would affect many tax calculations, and obviously the only means by which to be certain of the effect is to run the change using various scenarios through the taxpayer’s tax software.

One of the effects to consider if the bill passes is the item discussed in the alert in which the taxpayer reads IRC §280C(c)(1) advantageously for taxable year 2022 and reduces its research expenditure deduction by the amount that the research credit exceeds the deduction for research expenditures for the year, which reduction amount may well be zero. The taxpayer would have a substantial permanent tax benefit by not decreasing its credit and not decreasing it deduction.

If H.B. 7024 is not enacted, a taxpayer might moderate the risk that the IRS will prevail on the interpretation of IRC §280C(c)(1) by electing to decease its credit under IRC §280C(c)(2).[11] But the taxpayer could be more aggressive by taking the position that it is applying IRC §280C(c)(1) and rarely, if ever, does it have to reduce its deduction for research expenditures. That means that the taxpayer that had historically decreased its credit in order to take the full deduction might not have to do so. That might be a very substantial permanent tax benefit.

[1] P.L. 115-97 115th Cong. 1st Sess. (12-22-17).

[2] 118th Cong., 2d Sess.

[3] H.B. 7024, Sec. 201(e)(4).

[4] Instead of decreasing the deduction, the taxpayer could elect to decrease its research credit by multiplying the credit amount by the corporate tax rate. IRC §280C(c)(2). Regardless of whether the taxpayer reduced its deduction or its credit, the federal income tax cost was the same. Many taxpayers elect to reduce the credit so that the full amount of the deduction flows into taxable income of states that conform state taxable income to federal taxable income.

[5] IRC §174(a)(2)(B). The deduction is spread over six taxable years because the taxpayer may deduct for the first amortization year only half of a full year’s amortization. If the research is performed outside the United States, the amortization period is fifteen years.

[6] IRC §280C(c)(1).

[7] For example, assume qualified research expenses for the taxable year 2022 of $1,000 and minimum base amount of $500. The research credit is $100 (20% times $500). The credit does not exceed the amortized deduction – $100 for the first taxable year.

[8] Of course, there were qualified research expenses identified for the research credit.

[9] Proposed IRC §174A(a). A taxpayer that had capitalized and amortized its research expenditures as required by the TCJA may file an amended return for tax year 2022 and deduct research expenditures paid or incurred for that year. Alternatively, the taxpayer may elect to adjust its taxable income under IRC § 481 by taking a favorable adjustment into account in taxable year 2023. Alternatively, it may elect to make the adjustment over taxable years 2023 and 2024. H.B. 7024, sec. 201(f)(2).

[10] The taxpayer could still elect to decrease its credit in lieu of reducing its deduction.

[11] See supra note 4.

© 2024 Miller, Canfield, Paddock and Stone PLC
For more on the Research Credit Tax Bill, visit the NLR Tax section.

Wealth Management Update January 2024

JANUARY 2024 INTEREST RATES FOR GRATS, SALES TO DEFECTIVE GRANTOR TRUSTS, INTRA-FAMILY LOANS AND SPLIT INTEREST CHARITABLE TRUSTS

The January applicable federal rate (“AFR”) for use with a sale to a defective grantor trust, self-canceling installment note (“SCIN”) or intra-family loan with a note having a duration of 3-9 years (the mid-term rate, compounded annually) is 4.37%, down from 4.82% in December 2023.

The January 2024 Section 7520 rate for use with estate planning techniques such as CRTs, CLTs, QPRTs and GRATs is 5.20%, down from the 5.80% Section 7520 rate in December 2023.

The AFRs (based on annual compounding) used in connection with intra-family loans are 5.00% for loans with a term of 3 years or less, 4.37% for loans with a term between 3 and 9 years, and 4.54% for loans with a term of longer than 9 years.

REG-142338-07 – PROPOSED REGULATIONS RELATED TO DONOR ADVISED FUNDS

On November 13, 2023, the Department of the Treasury and IRS released Proposed Regulation REG-142338-07 under Section 4966; providing guidance related to numerous open-issues with respect to certain tax rules relating to donor advised funds “(DAFs”).

Pursuant to §4966(d)(2)(A), a DAF is defined generally as a fund or account (1) that is separately identified by reference to contributions of a donor or donors, (2) owned and controlled by a sponsoring organization, and (3) with respect to which a donor (or person appointed or designated by such donor) has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of amounts held in the fund or account by reason of the donor’s status as a donor.

Under the proposed regulations, the definition of a DAF is consistent with the definition under the statute (the same three elements), however, the proposed regulations provide key definitions with respect to specific terms under the Statute.

Element #1: a fund that is separately identified by reference to contributions of a donor or donors.

Separately Identified: The proposed regulations provide that a fund or account is separately identified if the sponsoring organization maintains a formal record of contributions to the fund relating to a donor or donors (regardless of whether the sponsoring organization commingles the assets attributed to the fund with other assets of the sponsoring organization).

If the sponsoring organization does not maintain a formal record, then whether a fund or account is separately identified would be based on all the facts and circumstances, including but not limited to whether: (1) the fund or account balance reflects items such as contributions, expenses and performance; (2) the fund or account is named after the donors; (3) the sponsoring organization refers to the account as a DAF; (4) the sponsoring organization has an agreement or understanding with the donors that such account is a DAF; and (5) the donors regularly receive a statement from the sponsoring organization.

Donor: The proposed regulations broadly define a Donor as any person described in 7701(a)(1) that contributes to a fund or account of a sponsoring organization. However, the proposed regulations specifically exclude public charities defined in 509(a) and any governmental unit described in 170(c)(1). Note: Private foundations and disqualified supporting organizations are not excluded from the definition of a donor since they could use a DAF to circumvent the payout and other applicable requirements.

Element #2: a fund that is owned or controlled by a sponsoring organization. The definition of a sponsoring organization is consistent with §4966(d)(1), specifically, an organization described in §170(c), other than a private foundation, that maintains one or more DAFs.

Element #3: a fund under which at least one donor or donor-advisor has advisory privileges.

Advisory Privileges: In general, the existence of advisory privileges is based on all facts and circumstances, but it is presumed that the donor always has such privileges (even if no advice is given).

The proposed regulations provide that advisory privileges exist when: (i) the sponsoring organization allows a donor or donor-advisor to provide nonbinding recommendations regarding distributions or investments of a fund; (ii) a written agreement states that a donor or donor-advisor has advisory privileges; (iii) a written document or marketing material provided to the donor or donor-advisor indicates that such donor or donor-advisor may provide advice to the sponsoring organization; or (iv) the sponsoring organization generally solicits advice from a donor or donor-advisor regarding distributions or investment of a DAF’s assets.

Donor-Advisor: Defined by the proposed regulations as a person appointed or designated by a donor to have advisory privileges regarding the distribution or investment of assets held in a DAF. If a donor-advisor delegates any of the donor-advisor’s advisor privileges to another person, such person would also be a donor-advisor.

Potential Issue related to Investment Advisors: Is a donor’s personal investment advisor deemed a “donor-advisor?” Pursuant to the proposed regulations:

  • An investment advisor will not be deemed a donor-advisor if he or she:
    • Serves the supporting organization as a whole; or
    • Is recommended by the donor to serve on a committee (of more than 3) of the sponsoring organization that advises as to distributions
  • However, an investment advisor will be deemed a donor-advisor if he or she manages the investments of, or provides investment advice with respect to, both assets maintained in a DAF and the personal assets of a donor to that DAF while serving in such dual capacity. This provision, if finalized may have important consequences for fee structures used by supporting organizations since payments from a DAF to an investment advisor who is considered a donor-advisor will be deemed a taxable distribution under §4966. The IRS is requesting additional comments on this potential issue and is still under consideration.

Exceptions to the Definition of a DAF Under the Proposed Regulations:

  • A multiple donor fund or account will not be a DAF if no donor or donor-advisor has, or reasonably expects to have, advisory privileges.
  • An account or fund that is established to make distributions solely to a single public charity or governmental entity for public purposes is not considered a DAF.
  • A DAF does not include a fund that exclusively makes grants for certain scholarship funds related to travel, study or other similar purposes.
  • Disaster relief funds are not DAFs, provided they comply with other requirements.

Applicability Date: The proposed regulations will apply to taxable years ending on or after the date on which final regulations are published in the Federal Register.

EILEEN GONZALEZ ET AL V. LUIS O. CHIONG ET AL (SEP. 19, 2023)

Miami Circuit Court enters significant judgment for liability related to ownership of golf cart.

Eileen Gonzalez and Luis Chiong and their families were neighbors in a Miami suburb. The families were good friends and had many social interactions. Luis owned a golf cart which he constantly allowed to be driven and used by other people and Eileen’s minor children were often passengers on this specific golf cart.

Luis’ step-niece, Zabryna Acuna, was visiting for July 4th weekend in 2016. Zabryna (age 16 at that time) visited often and during each visit, she had permission to drive the golf cart. On July 4, 2016, Zabryna took the golf cart for a drive with Luis’ son and Eileen’s minor children as passengers.

While driving on a public street, Zabryna ran a stop sign and collided with another car which caused all of the passenger to be ejected from the golf cart. Every passenger suffered injuries, however, Eileen’s son, Devin, suffered a particularly catastrophic brain injury. This led to an eventual lawsuit.

The Circuit Court ruled that Luis owed the plaintiffs a duty of reasonable care which he breached and was negligent in entrusting the golf cart to his niece who negligently operated it causing the crash and injuries at issue. The Court further held that pursuant to the Florida Supreme Court, a golf cart is a dangerous instrumentality, and the dangerous instrumentality doctrine imposes vicarious liability upon the owner of a motor vehicle who voluntarily entrusts it to an individual whose negligent operation if it causes damage to another.

Ultimately, the Court awarded a total judgment of $50,100,000 (approximately $46,100,000 to Devin and approximately $4,000,000 to his parents).

IR-2023-185 (OCT 5, 2023)

The IRS warns of Art Valuation Schemes (Oct 5, 2023).

The IRS essentially issued a warning to taxpayers that they will be increasing investigations and taxpayer audits for incorrect or aggressively creative deductions with respect to donations of art. Additionally, the IRS is paying attention to art promoters who are involved in such schemes.

The IRS is warning taxpayers to exercise caution when approached by art promoters who are commonly attempting to facilitate the following specific scheme wherein: (i) a taxpayer is encouraged to purchase art at a significantly discounted price; (ii) the taxpayer is then advised to hold the art for a period of at least one year; and (iii) the taxpayer subsequently donates the art to a charity (often times a charity arranged by the promoter) and claim a tax deduction at an inflated market value, often significantly more than the original purchase price.

This increased scrutiny has led to over 60 completed audits with many more in process and has led to more than $5,000,000 in additional tax.

The IRS reminds taxpayers that they are ultimately responsible for the accuracy of the information reported on their tax return regardless of whether they were enticed by an outside promoter. Therefore, the IRS has provided the following red flags with respect to the purchase of artwork: (i) taxpayers should be wary of buying multiple works by the same artist that have little to no market value outside of what a promoter is advertising; and (ii) when the appraisal coordinated by a promoter fails to adequately describe the artwork (such rarity, age, quality, condition, stature of the artist, etc.).

Within the Notice, the IRS details the tax reporting requirements for donations of art. Specifically, whenever a taxpayer intends to claim a charitable contribution deduction of over $20,000 for an art donation, they must provide the following: (i) the name and address of the charitable organization that received it; (ii) the date and location of the contribution; (iii) a detailed description of the donated art; (iv) a contemporaneous written acknowledgement of the contribution form the charitable organization; (v) completed Form 8283, Noncash Charitable Contribution, Section A and B including signatures of the qualified appraiser and done; and (vi) attach a copy of the qualified appraisal to the tax return. They may also be asked to provide a high-resolution photo or digital image.

NEW YORK PUBLIC HEALTH LAW AMENDED TO PERMIT REMOTE WITNESSES FOR HEALTH CARE PROXIES (NOV 17, 2023)

An amendment to Section 2981 of New York Public Health Law was signed into law by the governor on November 17, 2023.

Section 2981 was amended to add a new subdivision 2-a, as follows:

2-A. Alternate procedure for witnessing health care proxies. Witnessing a health care proxy under this section may be done using audio-video technology, for either or both witnesses, provided that the following conditions are met:

  1. The principal, if not personally known to a remote witness, shall display valid photographic identification to the remote witness during the audio-video conference;
  2. The audio-video conference shall allow for direction interaction between the principal and any remote witness;
  3. Any remote witness shall receive a legible copy of the health care proxy, which shall be transmitted via facsimile or electronic means, within 24 hours of the proxy being signed by the principal during the conference; and
  4. The remote witness shall sign the transmitted copy of the proxy and return it to the principal.

SMALL BUSINESS SUCCESSION PLANNING ACT INTRODUCED (OCT 12, 2023)

On October 12, 2023, the Small Business Succession Planning Act was introduced to provide businesses with resources to plan successions, including a one-time $250 credit to create a business succession plan and an additional one-time $250 tax credit when the plan is executed.

Under the proposed Bill, the SBA will provide a “toolkit” to assist small business concerns in establishing a business succession plan, including:

  1. Training resource partners on the toolkit;
  2. Educating small business concerns about the program;
  3. Ensuring that each SBA district office has an employee with the specific responsibility of providing counseling to small business concerns on the use of such toolkit; and
  4. Hold workshops or events on business succession planning.

Pursuant to the proposed Act, the following credits would be available:

  1. $250 for the first taxable year during which the SBA certifies that the taxpayer has: (a) established a business succession plan; (b) is a small business concern at that time; and (c) does not provide for substantially all of the interests or assets to be acquire by one or more entities that are not a small business concern.
  2. An additional $250 for the first taxable year which the SBA certifies that the taxpayer has successfully completed the items described above.

Look-back Rule: If substantially all of the equity interests in business are acquired by an entity that is not a small business concern within three-years of establishment of a business succession plan or completion of such responsibilities (as the case may be) the credits will be subject to recapture.

Small Business Concern (defined under Section 3 of the Small Business Act): A business entity that (a) is legal entity that is independently owned and operated; and (b) is not dominant in its field of operation and does not exceed the relevant small business size standard (subject to standards and number of employees provided by the North American Industry Classification System).

Henry J. Leibowitz, Caroline Q. Robbins, Jay D. Waxenberg, and Joshua B. Glaser contributed to this article.

© 2023 Proskauer Rose LLP.
For more news on Wealth Management in 2024, visit the NLR Financial Institutions & Banking section.