Tuesday December 5, 2023
IRS Promises Major Improvements
Nikole Flax, Director of the IRS IRA 2022 Transformation and Implementation Office, indicated that the IRS has been working diligently to create a new plan for the additional funding. Flax stated, "We really are doing it with an agencywide focus, but with a level of transparency that I think we have not seen before."
The $80 billion in new funding over the next decade includes over $45 billion for enforcement, $25 billion for improved operations, approximately $5 billion for modernization of business systems, including upgrading computers and information technology and $3.2 billion for improved taxpayer services.
Treasury Secretary Janet Yellen ordered the IRS to develop a complete plan for the $80 billion. That plan was due to be delivered in February. The IRS has missed the initial deadline and claims the comprehensive plan will be sent to Secretary Yellen "in the coming weeks."
Flax explained the plan will be available to the public and stated, "We will be very transparent with taxpayers and practitioners about what we are looking to do. We are going to really hold ourselves accountable for the progress that we are making. I think we all recognize that we have a credibility issue that we have to address pretty quickly."
Flax was admitting that both the public and Congress have been unhappy with the long phone wait times for the IRS customer representatives. There have also been leaks of taxpayer information and major backlogs for processing paper returns.
Flax concluded, the IRS will "work to prove that in the near term of the benefits that we can deliver, because we know that for some of these areas, there is a pretty big delta from where we were... last year to where we say that we want to go in the next few years."
IRS Deputy National Taxpayer Advocate, Bridget Roberts indicates "the IRS is off to an incredibly strong start this filing season, in part because of the investment made into the IRS through the IRA funding." The IRS reports that as of February 24, it has received 46 million tax returns and is ahead of last year in processing. Roberts noted that the tax refund total amount is 80% higher than in prior years and phone support has improved.
Roberts concluded, "Our phone service is just dramatically ahead of where it was last year and in previous years — the best we have seen in recent history. Through the first five weeks, we have consistently achieved a level of service between 80% [and] 90%."
How To Disclose Cryptocurrency
The Internal Revenue Service (IRS) has focused on improving disclosures of cryptocurrency transactions. IRS National Fraud Counsel, Carolyn Schenck noted, "We have gotten a couple of questions on how you should be reporting or how you should be harnessing the data [on IRS Form 14457], Voluntary Disclosure Practice, Preclearance Request and Application." The form includes questions on cryptocurrency and asks about the status of ownership on an account, a wallet or a transaction basis. Schenck further noted, "We need transaction-specific data."
The IRS must to understand all the parameters of a cryptocurrency transaction so it can correctly calculate the tax consequences and tax due. While it may not need details on the transaction at the preclearance stage for a voluntary disclosure, taxpayers may need to disclose additional data on unreported cryptocurrency transactions. This is particularly important if their tax return shows a tax loss. With the $1 trillion decline in cryptocurrency value during 2022, many taxpayers have tax losses on their cryptocurrency.
CPAs and other tax preparers should keep records of client cryptocurrency transactions in electronic format. The IRS prefers either a CSV file or Excel spreadsheet for the transactions. IRS audits during voluntary cryptocurrency disclosures are quite similar to normal audits, according to Schenck.
The voluntary disclosure program for cryptocurrency enables a taxpayer to get back in compliance. The taxpayer otherwise might fear a potential criminal tax prosecution. Schenck emphasizes the IRS generally does not initiate a criminal prosecution as long as there is complete voluntary disclosure prior to the discovery of specific noncompliance.
Schenck also explained that the voluntary disclosure is intended to be used by noncompliant taxpayers. They only need to report the noncompliant cryptocurrency transactions and not other cryptocurrency actions.
Finally, Schenck concluded, "the IRS has digital asset cases in every stage of the pipeline, including cases in examination and collection, cases with Appeals, cases in Tax Court that are being litigated, to cases that are being criminally prosecuted."
Syndicated Easement Promoter Should Report Ordinary Income
In ILM 202309015, the Internal Revenue Service (IRS) reviewed a syndicated conservation easement transaction and concluded that the promoter should report ordinary income rather than capital gain. The taxpayer was involved in extensive real estate and investment activities. The taxpayer created multiple LLCs (Managed LLCs) and transferred assets to syndicated conservation easement LLCs (SCE LLCs).
The Managed LLCs would identify a third-party owner of land, purchase interests in the land and then subdivide the land into parcels. Each parcel was transferred to a new SCE LLC. The SCE LLC distributed interests to the Landowner and to Managed LLC. Managed LLC then transferred interests to an Investor LLC, which were newly formed LLCs, and sold individual interests to other investors. The SCE LLC then donated an easement to a Section 501(c)(3) organization and passed through the charitable contribution deductions to investors. The marketing materials of Investor LLC stated that the charitable deduction would be "many times the amount the investors contributed to Investor LLC". The taxpayer reported the sales of LLC interests to investors as long-term capital gain.
Section 1221(a)(1) states that capital assets do not include, "stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business."
The test whether property is held for sale is determined by the frequency of sales, the substantial nature of sales, the duration of ownership, the purpose for acquisition of the property, the sales and advertising efforts, the time and effort devoted to sales activities and the use of the sale proceeds. The SCE LLCs had multiple investors each year, the land was held less than one year prior to sale, the Managed LLC acquired interests specifically to sell quickly through the SCE LLCs, there was vigorous advertising of the transactions and a substantial amount of time was devoted to the sale transactions. The frequency and size of the transactions indicated that this asset was held as inventory primarily for sale to customers. Therefore, under Section 1221(a)(1) the property was held "primarily for sale to customers in the ordinary course of Taxpayer's trade or business."
Section 741 states that sale or interest of a partnership is generally a capital gain transaction. However, the IRS took the position that the legislative history of Section 741 "contemplates only the sale of partnership assets that are in fact capital assets." Based on the legislative history, the IRS contends Section 741 would not change ordinary income inventory into a capital asset.
The IRS stated, "The courts that addressed the treatment of the sale of a partnership interest in the pre-1954 cases did not deal with facts that showed the sale of a partnership interest was something other than the sale of a capital asset." Because the SCE LLC interests were held in the "ordinary course of Taxpayer's trade or business," Section 1221(a)(1) applies and Section 741 does not change the character of the ordinary income.
Editor's Note: The IRS is continuing its campaign against syndicated conservation easements. If the sale of the interests to investors produces ordinary income, it greatly reduces the benefit to the promoter. The issue whether Section 1221(a)(1) applies or Section 741 is relevant will be litigated in both the Tax Court and the appellate courts.
Applicable Federal Rate of 4.4% for March -- Rev. Rul. 2023-5; 2023-10 IRB 1 (15 February 2023)
The IRS has announced the Applicable Federal Rate (AFR) for March of 2023. The AFR under Section 7520 for the month of March is 4.4%. The rates for February of 4.6% or January of 4.6% 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 2023, pooled income funds in existence less than three tax years must use a 2.2% deemed rate of return.