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Sunday July 21, 2024

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Top IRS Tips for Smooth Tax Filing

On January 29, 2024, the Internal Revenue Service (IRS) opened tax-filing season for 2023 returns. The IRS published a checklist in IR-2024-28 to help "make tax preparation smoother in 2024." This information is also generally available on IRS.gov.

There are six general topics covered in the checklist. These are helpful recommendations for all taxpayers.
  1. Necessary Tax Paperwork — All taxpayers should gather the paperwork for a complete and accurate tax return. This could include Social Security numbers for all the individuals on the return, bank account and routing numbers for payments or refunds, all income documents, such as Forms W-2, Forms 1099, Forms 1098 and any records of cryptocurrency or other digital sales. Taxpayers should also have their Health Insurance Marketplace statement, IRS Form 1095-A. Any letters received from the IRS are also important.
  2. Report All Income — The general rule is that all income of any source or type is taxable. This could include income from sales of property on an online platform, interest, dividends and capital gain from financial service company accounts, payments for part-time, seasonal or self-employment work and other payments received through personal efforts.
  3. File an Electronic Return — There are several benefits with an electronic return. Taxpayers will avoid many of the math errors that are quite common with paper returns. Tax software does the math and avoids most mistakes. It also uses a question-and-answer method that enables individuals to file the correct amounts in the different sections. If taxpayers are one of the few individuals who are still waiting for a paper 2022 tax return to be processed, there is an important IRS tip to enter in $0 for the 2022 adjusted gross income (AGI) when filing a 2023 tax return. Other taxpayers should enter the correct AGI from the prior year return if it has been processed.
  4. Free Resources and Assistance — There are multiple resources on IRS.gov. If taxpayers have 2023 income of $79,000 or less, use of the IRS Free File system is available. There are eight Free File software providers in English and one in Spanish that provide free tax software. If an individual has a higher income, they can use the IRS Free File Fillable Forms. This is an electronic version of the paper forms but does require significant knowledge of taxes to prepare the return. Taxpayers also may benefit from one-on-one tax assistance. This is available through the Volunteer Income Tax Assistance (VITA) and Tax Counseling for the Elderly (TCE) programs.
  5. Best Filing Option — There are several different methods that will meet the needs of taxpayers. If an individual has a background in taxes, it may be a good idea to personally prepare the return. Many individuals will also use the Free File or commercial tax-preparation software. Another option is to hire a tax professional. Be careful to select an honest and capable tax professional and be cautious about any tax professional that is a "ghost" preparer. If the professional is not willing to sign the return and provide his or her Preparer Tax Identification Number (PTIN), it may not be wise to use that return. There is a Directory of Federal Tax Return Preparers available on IRS.gov that may assist taxpayers in selecting a qualified tax preparer.
  6. Use Online Resources — Taxpayers can avoid sitting through long hold times on a call to the IRS by instead using the IRS' website. This IRS website is available 24 hours per day. Taxpayers may find the upgraded version of the Interactive Tax Assistant tool or the Let Us Help You resources beneficial.
The IRS reminded taxpayers to stay updated and there are additional resources that may be helpful. Taxpayers can download the IRS2Go smartphone app. There also are many IRS YouTube videos that explain different concepts. Taxpayers also can follow the IRS on their favorite social media sites or subscribe to its email newsletters.

Editor's Note: The IRS expects 146 million individual tax returns to be filed by April 15, 2024. There are extended hours at 250 Taxpayer Assistance Centers (TACs) across the country. The IRS expects increased use of the "Where's My Refund?" tool. IRS Commissioner Danny Werfel stated, "For months, IRS employees have been working hard to be ready to help taxpayers and make tax season as easy and smooth as possible. We have taken important steps to add more improvements to help taxpayers, ranging from expanded in-person hours, better online options and improved phone service."

House Passes Child Tax Credit and Business Tax Benefits Bill

On January 31, 2024, the House of Representatives on a bipartisan vote of 357 to 70 passed the Tax Relief for American Families and Workers Act. The bill will now be sent to the Senate for further action.

The bill was the result of bipartisan efforts by House Ways and Means Committee Chair Jason Smith (R-MO) and Senate Finance Committee Chair Ron Wyden (D–OR). Chairman Smith noted, "This bill restores full R&D expensing, interest deductibility and 100% expensing. Each of these policies will help American businesses grow, create jobs and to sharpen their competitive advantage against China. This will create over $70 billion in new R&D investment and over 900,000 new jobs; increase small business investment by $400 billion and generate $58 billion in additional take-home pay for American workers."

A lively debate ensued on the floor of the House. Representative Rosa DeLauro (D-CT) and other advocates of the child tax credit (CTC) appreciated the increase, but opposed the bill because there was a "lopsided" distribution between the CTC benefits for modest income individuals and the business tax breaks. Rep. DeLauro stated, "I think we had an opportunity, and it is a missed opportunity. I will make a presumption that people tried as hard as they can, but you cannot tell me that something is better than nothing? If the business interests had a red line, then where was our red line?"

The child tax credit is increased to benefit lower-income families. These families receive the same credit for each child. They may use the earnings of the current year or the prior year to establish the credit limits. The credit also will be adjusted for inflation in 2024 and subsequent years. It may increase from $2,000 per child in 2024 to $2,100 per child in 2025.

There are protections that are designed to target the use of the credit. The parent must meet a minimum earning threshold of $2,500 and children are required to have Social Security numbers.

There are multiple benefits for businesses. Many benefits that were phased out by prior tax bills are restored.

Businesses are allowed to deduct the cost of the research and development investments in one year rather than five years. They also have the ability to deduct 100% of investments in machinery from 2023 through 2025. There are relaxed rules that will permit businesses with substantial debt to increase their interest deductions. In addition, the Low-Income Housing Tax Credit is enhanced in an effort to provide more housing for individuals.

Editor's Note: The estimated cost of these increases in the child tax credit and the business tax benefits is $78 billion over a decade. The bill proposes to offset that cost through limiting the date for filing Employee Retention Tax Credit claims to January 31, 2024. This date was originally April 15, 2025. The shortened period of time to file ERC claims is, in part, the result of widespread ERC fraud during the past year. By closing the window on filing claims, the IRS will be able to process the remaining legitimate ERC claims.

Stock Purchases by Son of Owner Are Taxable Gifts

In Cynthia Huffman et al. v. Commissioner; No. 3255-16; No. 3256-16; No. 3261-16; No. 3526-16; T.C. Memo. 2024-12, the Tax Court determined that a right to purchase stock at a fixed value produced a substantial gift. In addition, the intellectual property holding entity recognized substantial capital gain when assets were sold to a new buyer.

Infinity Aerospace, Inc. (Dukes) was incorporated in 1958. Decedent Lloyd Huffman was made president in 1970 and acquired 118,365 shares in Dukes by 1990. After a serious car racing accident, he stepped down as president and his son Chet Huffman was made CEO. In 1990, Lloyd entered into an agreement with majority shareholder Robert Barneson to purchase 322,241 shares for not more than $2 per share. The rights held by Lloyd Huffman were assigned to son Chet in 1993. Chet then purchased the 322,241 shares over a period of six years. In 1993, he also entered into a "right to purchase (RTP)" agreement with an S corporation owned by his mother, Patricia and the family trust. The RTP enabled Chet to purchase all outstanding shares for the sum of $2 and "other good and valuable consideration", with a maximum price of $5 million. If Chet exercised his right of purchase, he would own 100% of the Dukes's shares. The RTP agreements stated they were "not compensatory in nature."

During the 1990s and 2000s, Chet enhanced the products and increased the market share of Dukes. By fiscal year 2006, revenue had increased from approximately $5 million to over $28 million. Dukes also created separate entities to hold intellectual property assets and engage in employee leasing.

In September 2007, Dukes entered into a nonbinding sale memorandum of understanding with Korean company Hanwha. In 2007, Chet exercised his rights to purchase the remaining stock from two entities for $5 million. At that time, he owned 100% of the stock. In 2009, Hanwha declined to complete the acquisition and Chet contacted Deloitte to assist in the sale. Chet agreed in 2009 to sell to TransDigm for $95.75 million. The purchase agreement required creating a new entity and transferred all of the assets in the enterprise to the purchaser.

Duff & Phelps, a consulting firm, was engaged to provide an estimate of Chet's personal goodwill and valued that amount at $19.2 million.

Chet and his wife Cindy secured the services of several different firms to prepare their joint 2008 and 2009 IRS Forms 1040, Dukes's 2008 through 2010 Forms 1120 and Lloyd and Patricia's gift tax returns for 2007. These forms were filed late on December 27, 2010.

The IRS issued a notice of deficiency and claimed that the stock purchase in 2007 for $5 million constituted a taxable gift and the sale related to Chet's personal goodwill was not properly reported.

The IRS and taxpayer secured the services of appraisers. The IRS contended that the stock purchased for $5 million in 2007 had a value of $31.3 million. Under Section 2703(a)(1), property is valued without regard to an option or agreement if it is a bona fide business arrangement, it is not a device to transfer property for less than full consideration and its terms are comparable to any other arms-length transaction.

The taxpayer claimed that the RTP agreement was a correct valuation in 1993 for $2 per share or the limit of $5 million for the total stock purchase. It claimed that Chet served as president at a reduced salary and that the exercise in 2007 should be deemed appropriate under Section 2703(b). The Tax Court noted the RTP was a bona fide business arrangement because it was designed to facilitate business operations and the $2 per share valuation was fair in 1993. Therefore, the RTP was not a device to transfer property. The key question was the third prong, which required that the terms must be comparable to third-party agreements.

Taxpayer observed that the third prong was satisfied by a comparable - the purchase by Chet of 43% of Dukes from founder Barneson. However, counsel for Chet did not introduce the Lloyd-Barneson agreement into evidence and the Tax Court determined it was not comparable based on the limited witness testimony. There also were differences in the terms between the Lloyd–Barneson agreement and the RTP.

Therefore, the RTP did not pass the third prong of Section 2703(b) and was disregarded. The question was purely a matter of valuation. After reviewing the IRS claim that there was a $31 million value and the taxpayer claim there was $16.3 million in stock value, the Tax Court determined the taxpayer determination was not reliable. Because the IRS appraised value was accepted and the Section 2703 exception did not apply, this exercise in 2007 created a taxable gift.

In addition, there was a sale of the intellectual property assets. The property was held by a separate entity and that entity was the proper party to report the gain.

Finally, the sale of the personal goodwill was attributed to Chet on IRS Form 1120. However, a portion of that personal goodwill was actually enterprise goodwill and therefore had to be reported as capital gain by Dukes.

Editor's Note: This was a complex fact and valuation case. It is a good summary of Tax Court valuation principles. The key issue on the gift tax was the potential comparable was not properly introduced.

Applicable Federal Rate of 4.8% for February -- Rev. Rul. 2024-3; 2024-6 IRB 1 (16 January 2024)

The IRS has announced the Applicable Federal Rate (AFR) for February of 2024. The AFR under Sec. 7520 for the month of February is 4.8%. The rates for January of 5.2% or December of 5.8% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2024, pooled income funds in existence less than three tax years must use a 3.8% deemed rate of return. Charitable gift receipts should state, "No goods or services were provided in exchange for this gift and the nonprofit has exclusive legal control over the gift property."

Published February 2, 2024
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