The IRS agenda for the end of 2019
The Internal Revenue Service is planning an extensive cyber awareness campaign beginning immediately after Thanksgiving, according to Stephen Mankowski, national tax chair of the National Conference of CPA Practitioners: “The campaign will emphasize to practitioners and taxpayers the potential dangers they face during the holiday shopping season and the filing season ahead.”
“National Tax Security Awareness Week 2019 is slated to begin on Cyber Monday and run from Dec. 2 through Dec. 6,” he explained. “This is the heaviest period of time when people are online and when phishing is most common. The IRS is planning a kickoff to coincide with Cyber Monday. YouTube videos will be updated. Practitioner groups are encouraged to help get the message out to members and taxpayers. In particular, taxpayers are urged to buy only from known vendors, and to check their bank statements.”
Mankowski recently met with government officials in Washington, D.C., to assess the latest thinking on issues affecting tax practitioners.
“During the recent Tax Forums, the IRS noted that a lot of people still are not aware of the basics of data security,” he said. “The IRS has been making some headway, but much more is needed.”
Mankowski also spoke to officials about the Taxpayer First Act of 2019.
“The act was designed to expand and strengthen taxpayer rights, as well as focus on cybersecurity and identity theft,” he said. “There is significant latitude on the reorganization addressed by the act, and people at the IRS are looking forward to the changes.’
“The IRS is planning listening sessions and town hall meetings with IRS employees as well as practitioners to learn what is needed and how to achieve their goals," Mankowski added. "Customer service, training, and reorganization are areas of the bill for which the [Taxpayer First Act Office] is responsible.”
“Overall, there are 45 provisions, with an implementation timeline that is aggressive, but attainable,” he said. “The TFAO will ultimately be responsible for the entire bill.”
There will also be funding issues that affect the timing of the implementation, according to Mankowski. “The TFAO will be focusing on low-income areas where English is a second language. And the IRS is reaching out to other taxing authorities for comments and feedback on what they are experiencing.”
Form 1040-SR, the U.S. Tax Return for Seniors, has been formulated with a larger, easier-to-read font, Mankowski observed. “It includes a standard deduction chart on its face without the need to access instructions, although Schedule A is still available.”
Taxpayers 65 and older have the option to use this form, which uses the same building block approach as Form 1040. Retirement is not a requirement to use the form.
The IRS also posted a second early-release draft of Forms 1040, 1040-SR and Schedule 1, Mankowski noted: “If the taxpayer is not required to file Schedule 1and had no virtual currency, then Schedule 1 is not required. Schedule 1 asks the taxpayer to answer whether at any time during 2019, did they receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency.”
“For Form 1040, the IRS has engaged stakeholders, reviewed studies and received much input that it implemented into draft 1040,” noted Mankowski. Some of the changes include:
“Several lines and several schedules were combined, and Schedule 6 was eliminated,” he said.
In putting together audit guides on virtual currency, the IRS is reaching out to industry experts and practitioner groups, Mankowski said. “One of the first questions to be aware of is what was the intent of the taxpayer: Did they buy it as an investment or receive it as payment for a service? If I receive 100 Bitcoin for preparing a return, I need to make sure it gets recorded as income on Schedule C or on my corporate tax return,” he said. “But if a financial advisor tells me to buy it as an investment, it’s not income at that time.”
International tax enforcement chiefs search for crypto tax criminals
By Michael Cohn
Leaders of tax enforcement authorities from the U.S., Australia, Canada, the Netherlands and the United Kingdom met this week to discuss ways to deal with tax crimes and tax evasion, particularly involving cryptocurrency.
The Joint Chiefs of Global Tax Enforcement from the five countries, known as the J5, brought together investigators, cryptocurrency experts and data scientists to discuss how they can track down tax criminals who are using cryptocurrency such as Bitcoin.
“The goal of the week was to remove some barriers and work together collaboratively to identify the most egregious tax offenders in the world,” said Ryan Korner, executive special agent in charge of the Los Angeles Field Office of IRS Criminal Investigations, which hosted the challenge this year. “Cybercrimes and the cybercriminals who commit them don’t have any borders and it’s imperative that we work together to protect the global financial system and the integrity of each nation’s tax system.”
The event, dubbed “The Challenge,” was hosted last year by the Netherlands’ Fiscal Intelligence and Investigation Service in Amsterdam. This year, which was the second year of the Challenge, officials from the five agencies met in Los Angeles to talk about those individuals who are the most egregious tax offenders across the globe. While last year’s meeting in Amsterdam focused on enablers of tax evasion, this year the Challenge meeting focused on cryptocurrency.
“The J5 is made up of the best and brightest of each of our countries so it makes sense to host events like the Challenge where we can get together, cut through red tape, and make real investigative strides,” said IRS Criminal Investigation Chief Don Fort in a statement. “This is not an exercise dealing with hypothetical scenarios. These are real investigators, using real data, finding real criminals through leads generated this week.”
The group made progress this week in sharing information and technology. “I want to emphasize that this week was not just a hypothetical training exercise,” Korner said during a conference call with reporters Friday. “All of the participants from the J5 countries rolled up their sleeves and worked together using real data to identify real criminals. One thing was really clear this week and that’s the J5 countries are committed to identifying and holding accountable tax cheats and other criminals who attempt to use the dark web and cryptocurrency as an underground economy.”
Experts from each country talked about ways to leverage various open and investigative sources, including offshore account information. Using various analytical tools, members of each country split into teams with the goal of generating leads and finding tax offenders using cryptocurrency based on the new data available to them through the challenge. Real data sets from each country were brought to the challenge to make connections where current individual efforts would take years to make those same connections.
“We brought together not only technical experts again to work on algorithms and other platforms where we could collaboratively share information, but also our cyber experts,” said IRS-CI special agent Chris Hueston, who is J5 project lead for the United States. “We spent a good period in the J5 runup making sure of level setting with our cyber investigators and making sure we were all on the same pages. Then today and earlier this week the collaboration on the international level has been at a level that we really haven’t seen before. We’re using the J5 as a force multiplier, bringing together the leading experts from each country and their toolsets and toolkits to collaboratively target those transnational actors who are tax evaders and the financers of transnational criminal organizations. From our perspective, this is a new and emerging area in the digital currency with respect to tax evasion and illicit actors and we’re looking to stay ahead of that curve and to let those actors know that we’re out there and we will find you.”
At the conclusion of the Challenge, each country’s tax investigators had developed a number of leads, trends, methodologies and investigations encompassing all of their countries. The information will be used to advance existing and future investigations.
“Being able to come together and share expertise, which hasn’t been done before, we can develop new platforms that we can each take back to our respective countries, importing the data that we each have to be able to data map, utilizing these new tools and develop new leads that we previously would not have known about prior to this challenge,” said Brooke Tetzlaff, a supervisory special agent at the IRS Criminal Investigation division and a U.S. participant in the Challenge.
Tax reform influenced charitable giving for half of taxpayers
By Michael Cohn
Approximately 50 percent of taxpayers made at least one change in their charitable giving strategy in response to the Tax Cuts and Jobs Act, according to a new survey.
The survey, by Fidelity Charitable, the brand name for the Fidelity Investments Charitable Gift Fund, polled 475 affluent and high-net worth charitable donors who itemized tax deductions in two of the last three years. It found that while the majority of taxpayers didn’t change the total dollar amount donated to charity after tax reform, 50 percent say they made an adjustment to their charitable giving strategy such as contributing to a donor-advised fund or donating appreciated securities to charity. For those who changed their total charitable giving dollars, tax reform was one of a variety of factors that influenced the decision. But for those who gave less to charity, tax reform was the most frequently cited reason.
The Tax Cuts and Jobs Act retained the charitable deduction, but made it less likely for middle-class and lower-income taxpayers to be able to claim it. The 2017 tax overhaul doubled the standard deduction while getting rid of personal and dependent exemptions, and eliminating or sharply limiting a host of traditional tax deductions, such as the state and local tax deduction. Overall, fewer taxpayers have enough itemized tax deductions to exceed the level of the new standard deduction, so fewer taxpayers receive a specific tax benefit for charitable giving.
But despite the changes that many taxpayers made in their approaches to charitable giving, about one-third of the respondents were surprised about their tax situation after filing their 2018 returns. More than half of that group found their situation was worse than they had anticipated. Older taxpayers were disproportionately surprised, with 40 percent of baby boomers saying they were surprised, compared to only 29 percent of millennials and 23 percent of Generation Xers.
Most of the respondents said they didn’t adjust the total dollar amount of their charitable giving in response to tax reform. Seventy-six percent of taxpayers donated about the same amount to charity in 2018 as they did the previous year, but 15 percent gave more.
Millennials were more likely to have increased their charitable giving in 2018 than Gen Xers and baby boomers, though that’s probably due to reasons other than tax reform, such as income growth or life stage. Taxpayers who work with a financial advisor were more likely to increase their giving.
“It is encouraging to see that those with the most to give plan to continue to give generously in the years to come,” said Tony Oommen, a charitable planning consultant at Fidelity Charitable, in a statement. “While recent reports show that individual giving as a whole may have been slightly reduced by recent tax reform, we are glad to see the commitment to giving staying strong. We’re also encouraged that many donors are making adjustments to help them continue to maximize their giving, such as contributing to donor-advised funds, which provide a mechanism for those with charitable intentions to commit funds for that purpose and continue their planful giving over time.”
Of those who gave more to charity last year, the biggest factor behind their increased giving was a request from a nonprofit, with 32 percent saying this motivated their desire to give more. Only 9 percent of taxpayers said they gave less in 2018 than the previous year, but the new tax law was the most influential factor in this decision, with 48 percent of those who gave less citing tax reform as the reason.
While most of the respondents said they kept their total dollar amount unchanged, 50 percent of the taxpayers polled reported making at least one change in their charitable giving strategy, such as contributing to a donor-advised fund, “bunching” several years’ of charitable gifts into a single year, or donating appreciated stock.
Three-quarters of taxpayers said they would give about the same amount to charity this year as last year, despite the significant group of taxpayers who were surprised by their tax situation in 2018.
IRS increases 401(k) contribution limits for 2020
By Michael Cohn
The Internal Revenue Service said Wednesday that employees who invest in 401(k) retirement plans will be able to contribute up to $19,500 next year, as part of its annual inflation adjustments.
The IRS announced the new limit, along with other changes, in Notice 2019-59. The guidance provides cost‑of‑living adjustments for the dollar limitations for pension plans and other retirement-related items for tax year 2020.
The contribution limit for employees who participate in 401(k), 403(b), most 457 plans and the federal government's own Thrift Savings Plan is increasing from $19,000 to $19,500 next year.
Meanwhile, the catch-up contribution limit for employees ages 50 and older who participate in these plans is increasing from $6,000 to $6,500.
The limitation on SIMPLE retirement accounts for 2020 is increasing to $13,500, up from $13,000 for 2019.
The income ranges for determining eligibility to make deductible contributions to traditional individual retirement arrangements, to contribute to Roth IRAs and to claim the Saver's Credit have all increased for next year.
Taxpayers are able to deduct contributions to a traditional IRA if they meet certain conditions. If during the year either the taxpayer or their spouse was covered by a retirement plan at work, the deduction can be reduced, or phased out, until it is eliminated, depending on filing status and income. (If neither the taxpayer nor his or her spouse is covered by a retirement plan at work, the phase-outs of the deduction do not apply.) The phase-out ranges for 2020 are:
The income phase-out range for taxpayers who make contributions to a Roth IRA is $124,000 to $139,000 for singles and heads of household, up from $122,000 to $137,000. For married couples filing jointly, the income phase-out range is $196,000 to $206,000, up from $193,000 to $203,000. The phase-out range for a married individual filing a separate return who makes contributions to a Roth IRA is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.
The income limit for the Saver's Credit (also known as the Retirement Savings Contributions Credit) for low- and moderate-income workers is $65,000 for married couples filing jointly, up from $64,000; $48,750 for heads of household, up from $48,000; and $32,500 for singles and married individuals filing separately, up from $32,000.
However, the limit on annual contributions to an IRA will stay unchanged at $6,000. The additional catch-up contribution limit for individuals ages 50 and over isn't subject to an annual cost-of-living adjustment and remains $1,000.
IRS increases tax deductions for 2020
By Michael Cohn
The Internal Revenue Service issued its annual inflation adjustments for dozens of tax items and tax schedules Wednesday, saying the standard deduction for married taxpayers who file joint tax returns will increase $400 to $24,800 in tax year 2020, while for single taxpayers and married individuals who file separately, the standard deduction will go up $200 to $12,400. For heads of households, the standard deduction will be $18,650 for tax year 2020, up $300.
Revenue Procedure 2019-44 spells out the details about these annual adjustments. Some tax law changes in the revenue procedure were added by the Taxpayer First Act of 2019, which increased the failure to file penalty to $330 for returns due after the end of 2019. The new penalty will be adjusted for inflation beginning with tax year 2021. Tax year 2020 adjustments typically are used on tax returns filed in 2021.
The tax items for tax year 2020 that promise to hold the most interest to the majority taxpayers and tax professionals include the following dollar amounts:
The other rates are:
The lowest rate is 10 percent for incomes of single individuals with incomes of $9,875 or less ($19,750 for married couples filing jointly).
IRS auditors are watching companies that owe offshore profit tax
The Internal Revenue Service has a message for companies that owe taxes on overseas profits: Auditors are closely watching.
The IRS included repatriation tax payments — the levies companies owe on their accumulated offshore earnings, according to the 2017 tax law — as an area of focus for the agency’s auditors, according to a list on their website updated Monday. Agency officials previously said the area is ripe for abuse because companies could try to minimize their foreign profits in an attempt to reduce their tax bills.
President Donald Trump’s tax overhaul requires U.S.-based companies to pay tax on the trillions in profits they’ve stashed abroad since 1986. The new rules set a one-time rate of 15.5 percent on cash and 8 percent on non-cash or non-liquid assets. Payments can be made over eight years.
Previously, companies had to pay the old 35 percent corporate rate, but only if they brought the money back to the U.S. If they kept the money overseas, they could defer any taxes due.
The agency also said the audit could expand beyond reviewing taxes paid on offshore profits — it could trigger an examination of other changes companies made to their tax strategies after the 2017 law, which cut the corporate rate to 21 percent and overhauled the international tax rules.
“It is anticipated that returns selected as part of the 965 campaign will also be risked and, if appropriate, examined for other material issues, especially issues related to” corporate planning in response to the tax law, the IRS said on its website, referring to the tax code section containing the repatriation taxes.
The congressional scorekeeper, the Joint Committee on Taxation, estimates the repatriation levy will generate $338.8 billion in tax revenue over 10 years. Trump has said, without specifying his source for the information, that he expects $4 trillion to return to the U.S.
Tax Strategy: Rental real estate and the QBI deduction
One of the most confusing aspects of the 20 percent qualified business income deduction enacted as part of the Tax Cuts and Jobs Act — and one that is an issue even for pass-through owners under the income thresholds that avoid many of the other difficult issues under Code Sec. 199A — is whether their rental real estate activity qualifies as a trade or business for purposes of the deduction.
Individual taxpayers may have typically been reporting that activity on Schedule E rather than Schedule C, which might imply that it is an investment activity rather than a trade or business. There is some authority that a Schedule E activity can be treated as a trade or business for tax purposes, but the issue is not settled.
To assist taxpayers in addressing this issue, the IRS issued a proposed safe harbor in Notice 2019-07 to provide taxpayers with real estate activity clear guidance on the requirements to safely qualify as a trade or business for qualified business income deduction purposes.
Now, after reviewing comments received in response to the notice, the IRS has finalized the safe harbor in Rev. Proc. 2019-38. The safe harbor is on the whole favorable in permitting real estate activity to qualify as a trade or business under the deduction.
Rev. Proc. 2019-38
Revenue Procedure 2019-38 follows fairly closely the procedures set forth in Notice 2019-07 with a few changes. The safe harbor may be used by taxpayers and relevant pass-through entities, as defined in the regulations for the qualified business income deduction, who own a direct interest, or an interest through a disregarded entity, in a rental real estate enterprise. A “rental real estate enterprise” is an interest in real property held for the production of rents and that may consist of an interest in a single property or interests in multiple properties.
In a change from Notice 2019-07, taxpayers and relevant pass-through entities may treat each interest in similar property as a separate rental real estate enterprise or treat interests in all similar properties as a single rental real estate enterprise. Residential property is not viewed as similar to commercial property. An interest in a mixed-use property, with both residential and commercial elements, may be treated as a single rental real estate enterprise or may be bifurcated into separate residential and commercial interests.
Once a taxpayer or RPE elects to treat each interest as a single rental real estate enterprise, it must continue that treatment for current and future property interests when utilizing the safe harbor. A taxpayer or RPE that elects to treat similar properties as a combined rental real estate enterprise may elect to treat them as separate rental real estate enterprises under the safe harbor in a future year.
The safe harbor
For a rental real estate enterprise to qualify under the safe harbor, four requirements must be met:
1. Separate books and records must be maintained to reflect income and expenses for each rental real estate enterprise.
2. For rental real estate enterprises that have been in existence less than four years, 250 or more hours of rental services must be performed per year with respect to the rental real estate enterprise. For rental real estate enterprises that have been in existence for at least four years, in any three of the five consecutive tax years that end with the current tax year, 250 or more hours of rental services must be performed.
3. For tax years beginning on or after Jan. 1, 2020, the taxpayer must maintain contemporaneous records, including time reports, logs or similar documents, regarding:
For earlier tax years, the taxpayer still bears the burden of showing that the hours requirements have been met.
4. The taxpayer or RPE must attach a statement to a timely filed original tax return (or an amended return for the 2018 tax year only) for each tax year in which the taxpayer or RPE relies on the safe harbor.
The taxpayer or RPE must choose each year to use or not use the safe harbor.
Qualifying outside the safe harbor
Rev. Proc. 2019-38 reminds taxpayers that they may still qualify their rental real estate activities for the qualified business income deduction if they can meet the definition of a qualifying trade or business under Code Sec. 199A. This requires meeting the definition of a trade or business under Code Sec. 162 other than the trade or business of performing services as an employee. Rental or licensing of tangible or intangible property (rental activity) that does not rise to the level of a Code Sec. 162 trade or business may nevertheless qualify if the property is rented or licensed to a trade or business conducted by an individual or RPE which is commonly controlled.
Rental services that qualify for meeting the hours requirements include, but are not limited to:
Rental services that do not qualify include:
Triple net leases
While triple net leases still do not qualify for the safe harbor, the definition of a triple net lease has been revised from Notice 2019-07. Rev. Proc. 2019-38 defines a triple net lease as a lease agreement that requires the tenant or lessee to pay taxes, fees and insurance, and to pay for maintenance activities for a property in addition to rent and utilities. In the notice, the term “to be responsible for” had been used instead of “to pay for.”
Rev. Proc. 2019-38 applies to tax years ending after Dec. 31, 2017. Alternatively, taxpayers and RPEs may rely on Notice 2019-07 for the 2018 tax year.
Rev. Proc. 2019-38 should permit many taxpayers engaged in rental real estate activities to qualify for the qualified business income deduction.
GOP senator seeks to tax scholarships of athletes with endorsements
Big-time college athletes could find themselves with a tax bill after a rule change that will allow student players to accept endorsement deals, according to Republican Senator Richard Burr.
Burr of North Carolina said he plans to introduce a bill that would require student athletes to pay taxes on their scholarships if they also earn money from endorsements. The National Collegiate Athletic Association announced Tuesday it would permit athletes to be compensated for their names, images and likenesses, a reversal of a previous rule that prohibited athletes from being paid.
If college athletes are going to make money off their likenesses while in school, their scholarships should be treated like income. I’ll be introducing legislation that subjects scholarships given to athletes who choose to “cash in” to income taxes. https://twitter.com/AP/status/1189238254266126336 …
The legislation is still in the works, but the tax wouldn’t apply to scholarships for college athletes who don’t profit from their likeness or image, said Caitlin Carroll, a spokeswoman for Burr. That indicates the legislation would be likely to apply to high-profile men’s basketball and football players who would likely be offered endorsement deals.
The legislation will add fuel to the debate about how to tax athletes on their winnings. Congress passed legislation in 2016 that exempted most Olympic medalists from owing taxes on their winnings and medals, but athletes earning more than $1 million a year still have to pay the levy
Gilding the golden years
There are two parts to guiding your clients into and through their retirement years. There is the money and financial part, and there is the personal part. Most come seeking advice because of the money issues, but the personal part of how a client will spend their new free time is just as important.
We’ve all heard stories of people who have worked hard their entire life only to retire and then pass away shortly thereafter. I can’t say that there is a connection between inactivity and mortality, but I do believe that retiring without a plan for how you are going to use your 168 hours per week can lead to unintended consequences.
When we look at life after work, there is a huge time void that needs to be filled. You may be amazed to learn that many of your clients have never thought freely about their dreams for the future. As these visions begin to form, you as the planner must continue to probe and learn what’s most important to your clients. For some, this process is so difficult that you may have to ignite the thinking part with a provocative question or two. One of my favorites is to ask a client if they were to pass away tomorrow, do they have any regrets, or wish they’d done or become something that hasn’t yet materialized for them.
Questions like that will lead a client to answer with thoughts such as “I wish that I had visited my elderly mother more frequently or I’d like to take my grandchildren skiing more often”. This may sound simple, but what is most important on the qualitative side is to help a client discover the most rewarding way to utilize their 168 hours per week. I’m not suggesting you to be their therapist, but a little guidance with life planning may be very helpful. If you feel this is too far out of your wheelhouse, consider establishing a relationship with a life coach to work with your clients. As the issue becomes clearer, you the planner can use your technical knowledge to assess the feasibility of such and have recommendations in all areas of their financial life to guide those visions toward reality.
While some clients struggle to figure this out, others will have their time mapped out. They’ll have ideas, lists and dreams of what they’d like their retirement years to look like in vivid detail. These clients may also need more financial guidance. Perhaps the first part is whether they can afford the desired lifestyle. If not, then your first actions ought to be direct and helpful such as letting them know how much they can afford to spend and how to prioritize by letting them know that they’ll need to work and save a few more years, downsize their home, or vision sooner than later.
For clients with substantial means, the conversation may not be about affording the bucket list, but about how to wisely spend and gift assets in the most efficient way.
Regardless of how early your client starts the process with respect to retirement planning, the planning for the client’s ideal future can start as soon as they can articulate their vision. Once the vision is established and can be quantified, the advisor can begin to work on the analytical side. For clients, or advisors for that matter, who are not comfortable talking about the softer and deeper side of life planning, you are missing an opportunity to strengthen a relationship and offer help beyond the numbers. Of course, a plan can still be done that includes forecasts and future additional spending if needed.
Begin at the beginning
All retirement guidance must begin with a forecast of cash flow. Your clients should understand their cost of living and their desired level of spending, today and in the future. For those early in the process, you’ll be able to help them determine if their level of savings is appropriate for their end destination. Be careful with your assumptions here and make sure that the actual results are compared to the forecast fairly frequently. Not accounting for deviations from forecasts year after year can cause a negative surprise when you finally revisit the numbers.
For example, if a client tells you that they spend $20,000 per month on basic living expenses sans income taxes, you can use that in your forecasting. But if it turns out that they are really spending $32,500 per month and your forecasts don’t reflect that, you may be causing future problems and underestimating your future income needs.
Just about any assumption made in the planning process such as rate of return and inflation also needs to be reconsidered as conditions dictate. Understating inflation or overstating the forecasted rate of return could have devastating impact on your clients’ actual ability to draw income in years to come. Consider a few ways to mitigate the possibility of an adverse forecast. First is to use a range of assumptions, such as 3 percent to 6 percent inflation and 2 percent to 6 percent for rate of return. Another is to keep the intervals of forecast updating short, with a restating of assumptions as needed. Intervals such as annually or every other year is OK for those a distance from retirement. But for a client whose retirement is closer, I’d update your forecasts at least annually.
In addition to the forecasting side, your clients should undertake a comprehensive risk review to answer the question of what can happen to render the forecast completely wrong. Of course, there are issues such as sickness or premature death. But one must also factor in the possibility of extended periods of market weakness, unemployment, underemployment or a catastrophic loss that creates large uninsured claims against you.
As your clients get closer to their actual retirement date, help them think about the loss of benefits from work and what options or needs they have for replacing them. This can be a tougher issue than they think if the client is too young for Medicare coverage, and may materially impact your forecasts due to the high cost of individual health plans. The loss of other benefits such as life and disability insurance should not be an issue in retirement for most clients.
Find out about all of your client’s retirement savings, including deferred compensation, ESOP plans and anything else that may trigger the need for distributions upon separation from service. To the extent that you have options on payouts, help your client plan so that the tax impact can be minimized. Items that can cause a large chunk of ordinary income upon retirement may be unused sick days, deferred compensation programs or bonuses. For example, if you have a high-bracket taxpayer with deferred compensation or sick days accumulated who wants to retire at the end of the year, ask them to consider January. This way they will have very little base compensation in the year of retirement and leave more room in lower tax brackets for the larger lump sums coming from the deferred compensation or sick day payment.
You can help review their options for taking Social Security. Even your wealthiest client wants to get back their pound of flesh from this lifelong contribution and optimize the benefit in terms of when to start the flow of SSI. The only problem with this discussion is that it is impossible to be completely accurate with your answer. You can guide them through the generalities of Social Security income using their specific facts such as benefits, age and life expectancy estimates. But they are just that, estimates where the actual outcomes are dependent on other factors such as earnings and date of death.
It would also be wise to be sure that your client’s estate plan is current. Not only the documents such as wills, durable powers of attorney and health care directives, but making sure that their assets are owned properly and that beneficiary elections are current and intentional. For example, it doesn’t help your client who has trusts set up to also have joint ownership of their assets. Yes, the client can take advantage of portability for death tax purposes, but why make it so difficult and time-consuming when merely owning the assets in the trusts while they are alive can accomplish the same thing with less fuss in most states?
This is also a good time to have a conversation with the clients about their children and of any special situations that you should be made aware. Perhaps your client is concerned about the durability of a marriage, and wants to be sure that the maximum protection is given to their marital assets so that a child can possibly protect herself from a nasty divorce after the passing of both parents. You want the documents to reflect the reality of your client’s situation, with provisions to facilitate their final wishes efficiently and cost effective.
As you guide your clients through retirement, there are other issues that will become important. Perhaps a stress test of their cash flow under the duress of a long-term illness is appropriate. Long-term care insurance is not the answer for everyone. Some can’t afford it, others can’t qualify for it, and then many others simply don’t want to buy costly insurance for something they may never use.
You should also develop a sense of what their family support network looks like. It will be different for the family whose adult children are scattered around the country than for those who live in neighboring communities.
Over the years, I’ve found that many clients are very private about their financial affairs. So private that even their children who have significant roles ahead within their parent’s estate administration or health care powers of attorneys don’t know their role. I believe that one of the greatest services that a financial planner can provide is guidance on the communication needed to clarify the parent’s plans to the next generation and or those who will be tasked with the settling and distribution part. Be proactive, and help your client get what they need for their pre- and post-retirement needs, and help them communicate that information to their caring and concerned (hopefully) next generation.
Armed with three precedent-setting wins, IRS has its sights set on micro-captives
By Shaun Hunley
Over the last few years, captive insurance has become the tax shelter du jour for accountants and wealth planners looking to find ways to help their small business owner clients reduce their tax exposures. Now the IRS is cracking down on the scheme. The agency just sent settlement offers to upwards of 200 taxpayers that participated in these tax structures and said it plans to go after organizers of these structures with penalties that could amount to hundreds of thousands — even millions — of dollars.
Captive insurance is nothing new. The first captive policy in America was formed in 1953, and companies of every type have used these types of policies to provide supplemental coverage that was hard to find in traditional insurance markets. More recently, that construct has been stretched to include so-called micro-captives, which are small insurance company structures that pay tax only on their net investment income. And that’s where things started to get messy.
By definition, a micro-captive is a small insurance company that makes less than $2.3 million in premium income and pays tax only on its net investment income. Thus, small business owners who set up their own micro-captive insurance companies to cover risks associated with their business are able to claim a tax deduction for the premiums they pay to the micro-captive insurer — which they also own. On top of that, any funds remaining after any claims are paid are eventually returned to the insured as a dividend or liquidating distribution, both of which are potentially taxed at preferential capital gains rates.
That’s all fine and good if the micro-captive insurer is being set up to cover a real risk and pay out based on legitimate claims. But it becomes a problem if those micro-captive arrangements lack the attributes of genuine insurance or, worse, pay out claims based on falsified valuations.
Joining the 'Dirty Dozen'
The IRS has long voiced skepticism about micro-captives and even placed them on its “Dirty Dozen” list of tax scams starting in 2014. That skepticism has hardly been universal, though. In fact, Congress has historically supported micro-captive structures — especially for rural taxpayers who are unable to obtain property insurance through traditional means.
It was Congress that opened Pandora’s box by enacting Section 831(b) of the Internal Revenue Code, which permits insurance companies (other than life insurance companies) with net premiums under a certain amount to elect to be taxed only on their net investment income without taxing their premium income.
According to the IRS, though, many of these arrangements are not insurance policies at all; they’re merely schemes aimed at avoiding taxes. In a 2016 notice, the IRS designated certain micro-captive insurance transactions between related parties as “transactions of interest,” and required taxpayers to disclose information about micro-captive arrangements. As a result, filers must provide sufficient details regarding the structure of their transactions with a micro-captive, the identity of all participants, and when and how they became aware of the transaction.
In 2017, the IRS’s Large Business & International division adopted a new audit strategy that focused on specific issues or “campaigns” — one of which addressed micro-captive insurance transactions. According to guidance the IRS issued at the time, the campaign was to be conducted through issue-based examinations and will involve standardized information document requests that ask more than 30 detailed questions about the transaction.
Emboldened by Avrahami
The IRS gained some serious momentum on this issue following a major Tax Court victory in 2017.
In 2008, an Arizona couple, the Avrahamis — who owned various shopping centers and jewelry stores in the Phoenix area — decided to form the Feedback Insurance Company. For the 2009 tax year, entities owned by the Avrahamis paid Feedback $730,000 in premiums for direct coverage. In addition, Feedback participated in a risk pool through an entity known as Pan American Reinsurance Company Ltd., with $360,000 paid to Pan American for terrorism insurance. The latter raised some eyebrows considering the low likelihood of a terrorist incident in suburban Arizona.
Similarly, for the 2010 tax year, Feedback was paid $810,000 in premiums for direct coverage, and Pan American received $360,000 for terrorism insurance. What’s more, each of the entities owned by the Avrahamis continued to buy insurance from third-party commercial carriers and made no change to its coverage under those policies after contracting with Feedback.
During this time, no claims were filed against Feedback under any of its policies, and as a result, the entity accumulated significant cash. Eventually, the funds were transferred to Mrs. Avrahami and an entity owned by her three children. The entity used the money to purchase 27 acres of land in Snowflake, Arizona. According to Feedback’s tax returns, the funds were classified as mortgage and real estate loans.
The IRS contended that the Avrahamis’ insurance premium deductions should be denied in full, claiming that the arrangements with Feedback and Pan American didn’t constitute insurance under federal tax law. Ultimately, the Tax Court agreed the premiums were not deductible as ordinary and necessary business expenses.
Armed with that huge win and two subsequent victories (against Reserve Mechanical Corp. and Syzygy Insurance Co. Inc., respectively), the IRS now has an inroad to collect a significant amount of missing revenue. Still, advisors actively promote micro-captives, which makes it crucial for tax practitioners to learn to identify the characteristics of bona fide insurance.
In order for clients to legally and responsibly reap the benefits of Section 831(b), tax professionals will need to walk their clients through the extensive paces and prepare them for the increased scrutiny they will face. Some may still want to set up a micro-captive, but it is imperative that they do so with their eyes wide open to the risk involved.
IRS warns of latest Social Security number cancellation scam
By Michael Cohn
The Internal Revenue Service is cautioning taxpayers and tax professionals to beware of a new twist on an old scam in which fraudsters call up victims and threaten to cancel their Social Security number if they don’t pay their taxes.
“In the latest twist on a scam related to Social Security numbers, scammers claim to be able to suspend or cancel the victim’s SSN,” said the IRS in an email to tax professionals Thursday. “It’s yet another attempt by con artists to frighten people into returning ‘robocall’ voicemails. Scammers may mention overdue taxes in addition to threatening to cancel the person’s SSN. If taxpayers receive a call threatening to suspend their SSN for an unpaid tax bill, they should just hang up. Make no mistake…it’s a scam.”
The IRS warned taxpayers not to provide sensitive personal or financial information over the phone unless they’re positive they know the caller is legitimate. When in doubt, they should hang up the phone.
The IRS has begun using private collection agencies to help collect tax debts, but the IRS said the debt collection agencies will never call to demand immediate payment using a specific payment method such as a prepaid debit card, iTunes gift card or wire transfer (the IRS doesn’t use these payment methods). Similarly, legitimate IRS private debt collection agencies won’t ask a taxpayer to make a payment to a person or organization other than the U.S. Treasury, or threaten to immediately bring in local police or other law-enforcement groups to have the taxpayer arrested for not paying. They also aren’t supposed to demand that taxes be paid without giving the taxpayer the opportunity to question or appeal the amount owed.
Taxpayers who don’t owe taxes and have no reason to think they do should report the call to the Treasury Inspector General for Tax Administration and report the caller ID and callback number to the IRS by sending it to email@example.com. The taxpayer should write “IRS Phone Scam” in the subject line. They should also report the call to the Federal Trade Commission. When reporting it, they should add “IRS Phone Scam” in the notes.
Taxpayers who owe taxes, or think they owe taxes, can view their tax account information online to see the actual amount owed and review their payment options. Alternatively, they can call the number on the billing notice, or call the IRS at (800) 829-1040.
Companies adjust strategies after corporate tax cuts
By Michael Cohn
Companies saw a significant impact from the lower corporate tax rate since the passage of the Tax Cuts and Jobs Act at the end of 2017, but not as many of them are planning to increase employee wages as a result, according to a new survey of corporate board members by BDO USA. Instead more companies are planning to do stock buybacks, increase corporate dividends and pursue mergers and acquisitions.
Nearly half the directors polled (47 percent) claim their organizations didn’t take any specific action as a result of the Tax Cuts and Jobs Act, but of the companies that were motivated to act on changes to their tax position, their activities shifted in some important ways compared to BDO’s 2018 survey findings. Last year, 14 percent of them said they planned to increase employee wages, but this year, only 8 percent of them did. However, 6 percent of directors in the 2019 survey indicated their companies distributed a one-time bonus to employees.
Conversely, while 7 percent of the directors polled last year said their companies initiated stock buybacks, 19 percent said this year that they did. Last year, 11 percent of the respondents said their companies would pursue a merger or acquisition, but this year that more than doubled to 23 percent. And while 9 percent said last year their companies would increase dividends, 16 percent of the directors polled said they would.
Plans for repatriating corporate profits back to the U.S. from abroad have also increased as a result of the new tax law, with 10 percent of the directors polled last year saying their companies would repatriate cash back to the U.S., compared to 16 percent this year. Meanwhile, plans for capital investment have only ticked up slightly, at 17 percent last year, increasing slightly to 18 percent this year.
The main impact seen by corporate board members is the reduced corporate tax rate, which went from a maximum of 35 percent before the TCJA to 21 percent today. “That reduced corporate tax rate seems to be getting everyone’s attention,” said Matt Becker, managing partner of tax at BDO. “There are some other provisions related to how foreign earnings are treated and how interest deductions are calculated, but we’re not seeing board members as interested. The larger the company, the more nuances get discussed. But in general it’s the reduced corporate tax rate having the biggest impact. Then if you look at the specific actions that are being taken as a result of tax reform, about half the directors say their organizations do not take specific actions. Of those that do take specific actions, we’re seeing those taken related to mergers and acquisitions activity, buybacks, increased cash repatriated to the U.S., and in some cases increases in employee wages.”
However, there’s a stark contrast between those directors whose companies plan increases in employee wages (8 percent) versus stock buybacks (19 percent).
“I don’t think we have evidence that they’re cutting employee wages, but there’s a clear preference for stock buybacks as a reaction to tax reform,” said Becker.
The survey found 83 percent of directors at large companies report feeling the effects of tax reform changes compared to only half of all micro or nano cap companies. Along with those trends, more companies are looking at not only their federal taxes, but also their state and local taxes over the past few years. Nearly two-thirds of the directors surveyed (65 percent) report a high or moderate understanding of their company’s total tax liability, factoring in income, indirect, property, payroll, excise and other taxes along with credits, incentives, customs, duties and deductions. In contrast, in 2018, among the board members surveyed by BDO, only 44 percent said they have a strong understanding of their organization’s total tax liability and how it impacts the company’s tax strategy.
“We’re seeing companies interested in understanding their total tax liability, including indirect and excise taxes,” said Becker. “With the federal income tax rate being lower, others represent a [bigger] portion of total tax.”
IRS lagging on implementing its plan to speed corporate audits
The Internal Revenue Service isn’t effectively auditing corporations despite a change in how the agency conducts tax examinations that was supposed to make the process more efficient, according to the agency watchdog.
The IRS is only using the new audit selection system for about 15 percent of audits of large businesses and international companies, according to a report Thursday from the Treasury Inspector General for Tax Administration. The remaining audits are coming from old processes that take more time and cost more for the IRS to conduct.
The agency in 2016 announced a new system for selecting cases to audit. The IRS said it would focus on examining high-risk transactions, rather than auditing a company’s entire tax return as part of an effort to more efficiently enforce tax laws.
The IRS is also failing to use the results of past audits to select and prioritize future cases to examine, the report said. The agency said it is using data to manage its audit caseload and that initial results shouldn’t be used to scrap the program.
“We agree that these results, also described by IRS management as lackluster, should not be used to assess the success or failure of the program as a whole,” the IRS Office of Audit said in response to the Inspector General analysis.
The report illustrates how the IRS has struggled to ensure tax compliance in recent years. The number of revenue agents fell to 2,923 in 2018, from 5,224 in 2010, as budget cuts and hiring freezes have impeded the agency’s audit capability.
“Given the diminished examination resources, the IRS should be even more focused on emphasizing areas that have the highest compliance risk,” the report said.
The IRS also said that staff and resources were allocated to work on implementing the 2017 tax law in 2018 and 2019, directing funds away from the audit program.
This isn’t the first time the IRS has received a negative report about how it is auditing corporations. In September, the Inspector General released a report saying IRS employees had collectively spent nearly 28,000 work days over a four-year period auditing mergers and acquisitions that ultimately yielded no additional tax revenue.
Congress’ budget team can’t tell if tax cuts caused revenue drop
The federal government is taking in less money but can’t tell if the shortfall is tied to the 2017 tax cuts or other factors like trade uncertainty, the Congressional Budget Office said in a letter.
Total tax receipts in 2019 were down $28 billion — or about 0.8 percent lower — than initial projections, according to the CBO. The revenue decline isn’t an “explicit” evaluation of the 2017 tax cuts, but it may have been influenced by those changes, the letter said.
“In short, revenues in fiscal years 2018 and 2019 were a bit lower than the Congressional Budget Office anticipated in early 2018, but whether that result is related to the effects of the tax act is unknown,” the CBO said Monday in a letter to Senator Mike Braun, an Indiana Republican who had asked for the analysis.
The cost of the tax cuts — and whether or not the resulting economic growth will pay for them — has been a key area of disagreement for Republicans and Democrats in the almost two years since the law was passed. The Treasury Department has released an analysis showing that the law would pay for itself over a decade, but independent projections haven’t backed up those calculations.
The CBO estimates that the tax law — which cut the corporate rate to 21 percent from 35 percent and reduced taxes for individuals — will cost $1.9 trillion over a decade, after accounting for macroeconomic effects and debt-serving costs. It won’t be clear how close Treasury’s projections are until the end of the 10-year budget window, which closes in 2027.
“It’s always been pretty clear that the tax cuts weren’t going to pay for themselves,” said Marc Goldwein, senior vice president for the Committee for a Responsible Federal Budget. “CBO can’t say what I say: the tax cuts unquestionably cost revenue.”
The CBO letter follows the release of Treasury Department data last week showing the U.S. budget deficit widened to almost $1 trillion in the latest fiscal year. Larger annual budget deficits for four straight years have put the shortfall under President Donald Trump on pace to expand to historic levels.
In his first year in office, Trump not only cut taxes, but also increased government spending.
Disclaimer: This article is for general information purposes only, and is not intended to provide professional tax, legal, or financial advice. To determine how this or other information in this newsletter might apply to your specific situation, contact us for more details and counsel.
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