The IRS has announced a significant increase in enforcement actions for syndicated conservation easement transactions. This is a "priority compliance area" for the agency.

The IRS has announced a significant increase in enforcement actions for syndicated conservation easement transactions. This is a "priority compliance area" for the agency.

Throughout the IRS, coordinated examinations are being conducted in the Small Business and Self-Employed (SB/SE) Division, Large Business and International (LB&I) Division, and Tax Exempt and Government Entities (TE/GE) Division. The IRS Criminal Investigation (CI) Division has also been initiating investigations. The audits and investigations cover billions of dollars of potentially inflated deductions, as well as hundreds of partnerships and thousands of investors.

"We will not stop in our pursuit of everyone involved in the creation, marketing, promotion and wrongful acquisition of artificial, highly inflated deductions based on these aggressive transactions. Every available enforcement option will be considered, including civil penalties and, where appropriate, criminal investigations that could lead to a criminal prosecution," said IRS Commissioner Charles "Chuck" Rettig. "Our innovation labs are continually developing new, more extensive enforcement tools that employ advanced techniques. If you engaged in any questionable syndicated conservation easement transaction, you should immediately consult an independent, competent tax advisor to consider your best available options. It is always worthwhile to take advantage of various methods of getting back into compliance by correcting your tax returns before you hear from the IRS. Our continued use of ever-changing technologies would suggest that waiting is not a viable option for most taxpayers," he added.

Syndicated Conservation Easements

The IRS issued Notice 2017-10, I.R.B. 2017-4, 544, in 2016, which designated certain syndicated conservation easements as listed transactions. In these types of transactions, investors in pass-through entities receive promotional material which offer the possibility of a charitable contribution deduction worth at least two-and-a-half times their investment. The deduction taken in many transactions has been significantly higher than 250 percent of the investment.

Syndicated conservation easements were included on the IRS’s 2019 "Dirty Dozen" list of tax scams to avoid.

Not only do these transactions grossly overstate the value of the easement that was purportedly donated to charity, they often also fail to comply with the basic requirements for claiming a charitable deduction for a donated easement.

Taxpayers may avoid the imposition of penalties for improper contribution deductions if they fully remove the improper contribution and related tax benefits from their returns by timely filing a qualified amended return or timely administrative adjustment request.

Enforcement Actions

The IRS has prevailed in many cases involving the charitable deduction basic requirements, and has established a body of law that it believes supports disallowance of the deduction in a significant number of pending conservation easement cases. The IRS will soon be moving the Tax Court to invalidate the claimed deductions in all cases where the transactions fail to comply with the basic requirements, leaving only the final penalty amount to be determined.

In addition to auditing participants in syndicated conservation easement transactions, the IRS is pursuing investigations of promoters, appraisers, tax return preparers and others, and is evaluating numerous referrals of practitioners to the IRS Office of Professional Responsibility. The IRS will develop and assert all appropriate penalties, including:

• penalties for participants (40 percent accuracy-related penalty);
• penalties for appraisers (penalty for substantial and gross valuation misstatements attributable to incorrect appraisals);
• penalties for promoters, material advisors, and accommodating entities (penalty for promoting abusive tax shelters, and penalty for aiding and abetting understatement of tax liability); and
• penalties for return preparers (penalty for understatement of taxpayer’s liability by a tax return preparer).

Rettig, Desmond Highlight Heightened Focus

Rettig and IRS Chief Counsel Michael J. Desmond have each highlighted the IRS’s heightened, agency-wide focus on syndicated conservations easements.

While speaking at the American Institute of CPAs (AICPA) 2019 National Tax Conference in Washington, D.C., Rettig and Desmond both separately underscored the IRS’s increased enforcement efforts toward abuses of certain tax-advantaged land transactions under Code Sec. 170(h).

"We appreciate the value of conservation easements," Rettig said. "We do not appreciate the activities that have gone on with respect to the syndicated conservation easements—there are some artificial appraisals there… some fatal flaws."

Reiterating the IRS’s tough stance on the matter, Rettig said that the IRS is not going to "stand down." The information in IR-2019-182 issued on November 12 was "fair warning," Rettig said.

Likewise, Desmond stressed that the challenges surrounding syndicated conservation easements are an "institutional concern" for the IRS, "one that we will be responding to," he emphasized.

Treasury and the IRS are expected to release proposed rules in "early 2020" that would clarify certain limitations on the carried interest tax break, according to David Kautter, Treasury’s assistant secretary for tax policy. Kautter briefly addressed the proposed regulations’ timeline while speaking at the American Institute of CPAs (AICPA) 2019 National Tax Conference in Washington, D.C.

Treasury and the IRS are expected to release proposed rules in "early 2020" that would clarify certain limitations on the carried interest tax break, according to David Kautter, Treasury’s assistant secretary for tax policy. Kautter briefly addressed the proposed regulations’ timeline while speaking at the American Institute of CPAs (AICPA) 2019 National Tax Conference in Washington, D.C.

Carried Interest Limitation

The forthcoming regulations are expected to restrict S corporations from taking advantage of a carried interest exemption provision under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). The TCJA requires certain money managers to hold investments for at least three years before becoming eligible for the lower, 20 percent capital gains rate. However, it exempted corporations from this holding period, which Treasury and many lawmakers on Capitol Hill say resulted in an unintended "loophole."

The proposed regulations are expected to clarify the law’s intent that S corporations are subject to the three-year holding period for carried interest, according to Treasury’s last press release on the matter issued in March 2018 (see "Treasury, IRS Issue Guidance On Carried Interest," at https://home.treasury.gov/news/press-releases/sm0302).

Legal Questions May Arise

Most notably, however, the TCJA does not expressly contain this limitation on S-corporations, which has left some on Capitol Hill questioning Treasury and the IRS’s authority to implement such a restriction via regulations. The IRS on November 15 directed Wolters Kluwer to Treasury for confirmation on this anticipated rule and projected timeline. As of press time, Treasury had not responded to Wolters Kluwer’s request for comment.

Hopes for a year-end tax extenders package appear to be dwindling on Capitol Hill.

Hopes for a year-end tax extenders package appear to be dwindling on Capitol Hill.

Tax Extenders Need a Legislative Vehicle

Over 30 expired or soon-to-be expired tax breaks known as tax extenders were originally considered a top contender for hitching a ride on a larger, must-pass government funding bill. Considering the lack of time left on the legislative calendar this year, a stand-alone tax bill has been considered an unlikely initiative. Thus, a must-pass appropriations bill was seen by several lawmakers as the likely legislative vehicle for tax extenders and other tax items such as technical corrections to Republicans’ 2017 tax reform law.

However, a spokesperson for Senate Finance Committee (SFC) Chair Chuck Grassley, R-Iowa, confirmed to Wolters Kluwer on October 28 that Grassley believes there is "no hope" for action this year on a tax extenders package if lawmakers do not move quickly with respect to its legislative driver. Many within the practitioner community following these developments have said that the chances of providing taxpayers with certain tax breaks retroactively significantly decrease if Congress moves into next year leaving them expired.

Another Stopgap Spending Bill Appears Likely

Currently, the federal government is operating on a stopgap spending bill temporarily extending fiscal year (FY) 2019 funding levels through November 21. Previously, several lawmakers, in particular Grassley, had hoped that a tax extenders package would be attached to a larger, more comprehensive appropriations bill next month. However, Senate Appropriations Committee Chair Richard Shelby, R-Ala., told reporters that another short-term stopgap spending bill is the more likely option to keep the government open after November 21. "Unless a miracle happens around here with the House and Senate, we will have to put forth another [continuing resolution] CR," Shelby told reporters.

Notably, another short-term government funding bill is considered unlikely to have any policy riders. Generally, stop gap spending bills are usually considered "clean," for the most part. Also playing a role in tax extenders’ fate is whether President Trump would sign a more comprehensive appropriations bill. At this time, his support for a larger FY 2020 funding bill, apart from tax policy reasons, remains unclear.

Senate Finance Committee (SFC) Chair Chuck Grassley, R-Iowa, and other top Senate tax writers are calling for Senate action on the bipartisan Setting Every Community Up for Retirement Enhancement Secure bill (HR 1994) (SECURE Act). The House-approved, bipartisan retirement savings bill has remained stalled in the Senate since May.

Senate Finance Committee (SFC) Chair Chuck Grassley, R-Iowa, and other top Senate tax writers are calling for Senate action on the bipartisan Setting Every Community Up for Retirement Enhancement Secure bill (HR 1994) (SECURE Act). The House-approved, bipartisan retirement savings bill has remained stalled in the Senate since May.

SECURE Act’s Route to Senate Floor Remains Unclear

Grassley’s communications director Michael Zona told Wolters Kluwer on October 21 that it remains "unclear at this point" whether the SECURE Act will move through committee, reach the Senate floor by unanimous consent, or be attached to a larger, year-end tax package. "Grassley supports the House-passed SECURE Act. There are several holds on the bill, and he is working to get them lifted," Zona said.

The SECURE Act cleared the House on May 23 by a 417-to-3 vote. The bipartisan measure, which proposes sweeping changes to retirement savings tax policy, was originally expected to quickly clear the Senate after its approval in the House. However, Sen. Ted Cruz, R-Tex., blocked the bill from reaching the Senate floor. Cruz blocked the bill in protest of House Democrats’ 11th hour-removal of a provision from the original bill that would have expanded tax-advantaged Section 529 education savings plans to include homeschooling and certain elementary and secondary expenses. Cruz and Sen. Patty Murray, D-Wash., are reportedly still holding up the measure from reaching the Senate floor.

Catch-All Tax Package

However, the SECURE Act, among other bipartisan tax-related items including tax extenders, could be attached to a catch-all tax package that is expected on Capitol Hill to hitch a ride on a year-end government funding bill. A "must-pass" appropriations bill, like the one currently being negotiated to keep the government open after funding expires on November 21, could serve as the tax package’s legislative vehicle, thus fast tracking its approval.

"As the economy continues to change, the way we approach retirement savings must change as well. Otherwise, too many Americans will be left behind," Grassley said on October 21, noting that the SECURE Act is under "active consideration."

Similar to Grassley’s push, Sen. Tim Scott, R-S.C., led a letter sent to Senate Majority Leader Mitch McConnell, R-Ky., urging immediate Senate consideration of the SECURE Act. "This bipartisan legislation would expand access to retirement plans for millions of Americans, allow older workers and retirees to contribute more to their retirement accounts, increase 401(k) coverage to part-time employees, prevent as many as 4 million people in private-sector pension plans from losing future benefits, protect 1,400 religiously affiliated organizations whose access to their defined contribution retirement plans is in jeopardy, and do the right thing for Gold Star families," according to Scott.

The Senate blocked a Democratic resolution on October 23 to overturn Treasury rules preventing certain workarounds to the $10,000 state and local tax (SALT) federal deduction cap.

The Senate blocked a Democratic resolution on October 23 to overturn Treasury rules preventing certain workarounds to the $10,000 state and local tax (SALT) federal deduction cap.

SALT Cap Workaround

Senate Democrats’ resolution, S.J. Res. 50, forced a vote on Wednesday to nullify Treasury regulations that block taxpayers from circumventing the SALT cap through certain states’ programs that convert state and local taxes into fully deductible charitable contributions. The resolution failed by a largely party-line vote of 43-to-52.

Sen. Michael Bennet, D-Colo., voted against the Democratic measure while Sen. Rand Paul, R-Ky., supported it. While the resolution would not repeal the SALT cap itself, House Democrats are reportedly crafting legislation to do so. Democrats and some Republicans, particularly from high-tax states, have criticized the SALT cap since its enactment in 2017 under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97).

Debate on SALT Cap, Treasury Rules

"Without any clear authority to do so, the Treasury Department reversed a long-standing IRS position that had allowed taxpayers a full deduction for charitable contributions to state tax credit programs," Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., said on the Senate floor before the vote. "My view is the Treasury Department should not be putting its thumb on the scale on behalf of Republican interests, and it shouldn’t be using phony regulatory justifications to fix Republicans’ extraordinarily poorly drafted law."

However, several Republicans cited to a recent report from the nonpartisan Joint Committee on Taxation (JCT), which estimated that repealing the SALT cap beginning in 2019 would result in over $40 billion of the associated tax cut going to taxpayers with incomes of at least $1 million ( JCX-35-19).

"It’s bad enough that my Democratic colleagues want to unwind tax reform, but it’s downright comical that their top priority is helping wealthy people in blue states find loopholes to pay even less," Senate Majority Leader Mitch McConnell, R-Ky., said from the Senate floor on October 23. "Repealing the SALT cap would give millionaires an average tax cut of $60,000. Meanwhile, the average tax cut for taxpayers earning between $50,000 and $100,000 would be less than ten dollars."

Vaping Tax

In other news, the House Ways and Means Committee approved a bipartisan vaping tax bill, ( HR 4742), on October 23 by a 24-to-15 vote. The bill would establish a $27.81 tax per gram of nicotine used in vaping devices.

Treasury and the IRS on October 31 announced the release of a new, draft form implementing certain reporting requirements under the Tax Cuts and Jobs Act Opportunity Zone program.

Treasury and the IRS on October 31 announced the release of a new, draft form implementing certain reporting requirements under the Tax Cuts and Jobs Act Opportunity Zone program.

The proposed Form 8996 for Qualified Opportunity Funds (QOFs) comes after numerous calls on Capitol Hill for more transparency within the Opportunity Zone program. "The form is designed to collect information on the amount of investment by opportunity funds in business property by census tract," according to a Treasury press release.

Opportunity Zones’ Architect Applauds Treasury’s Steps Toward Reporting Requirements

Ken Farnaso, press secretary for Sen. Tim Scott, R-S.C., chief architect of the TCJA’s bipartisan Opportunity Zone program, told Wolters Kluwer on October 31 that reporting requirements, "an important piece of the puzzle," were, in fact, originally in the bill. "Unfortunately, during the tax reform process, Senate Democrats blocked these requirements from being included in the Tax Cuts and Jobs Act. Since then, Senator Scott has continued working to restore those reporting requirements," Farnaso said.

Additionally, Farnaso told Wolters Kluwer that Scott applauds Treasury’s steps to ensure a clearer picture of the impact the Opportunity Zones initiative can have on the country. "Senator Scott will also continue to push for his current bill restoring robust reporting requirements to create a holistic picture of how the initiative is functioning," Farnaso said. "Overall, today is a good day for Opportunity Zones. We look forward to the more than $44 billion in currently anticipated investment being deployed in distressed communities across the nation, and that number growing even larger in the future."

Opportunity Zones Tax Incentive

The Opportunity Zone Program enacted under TCJA ( P.L. 115-97) is considered on Capitol Hill as one of the most generous and ambitious tax incentives for investors in distressed communities. Under Code Sec. 1400Z-2, investors may defer taxation of capital gains that are invested in a QOF.

Generally, the following investor tax benefits were created under the Opportunity Zone program:

• a temporary tax deferral for capital gains realized on the sale of appreciated assets and reinvested within 180 days in a QOF;
• the elimination of up to 10 or 15 percent of the tax on the capital gain that is invested in the QOF and held between five and seven years; and
• the permanent exclusion of tax when exiting a qualified opportunity fund investment held for at least 10 years.

Draft IRS Form 8996

Specifically, the new, draft Form 8996 for the 2019 tax year requires QOFs to report the following information:

• the Employer Identification Number (EIN) of each business in which the QOF has an ownership interest;
• the census tract location of the tangible property of the business;
  the value of the QOF’s investment; and
• the value and census tract location of qualified business property directly owned or leased.

"This is an important step towards a thorough evaluation of the Opportunity Zone tax incentive," Treasury Secretary Steven Mnuchin said. "We want to understand where Opportunity Zone investments are going and strengthening the economy so that investors and communities can learn from the successes of this bipartisan, pro-growth policy."

Generally, the collection of this information will play a role in allowing lawmakers and the public to evaluate the effects of the tax incentive and to understand why some locations may be more successful than others at attracting investment, according to Treasury.

Opportunity Zones Criticism

The Opportunity Zone program has not come to fruition without its share of criticism, however. Although lawmakers have called for reporting requirements related to QOFs since the TCJA’s enactment, the program has recently come under increased scrutiny and criticism. Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., has said that the lack of reporting requirements are "inexcusable."

"Requiring taxpayers to prove they’re actually following the rules of the Opportunity Zone program is a positive first step, but it’s one that should have been taken two years ago…," Wyden said in an October 31 statement. "The Opportunity Zone program has been operating without any effort to ensure compliance and that’s inexcusable."

A California-based medical marijuana dispensary corporation’s motion for summary judgment challenging the constitutionality of Code Sec. 280E was denied. The Tax Court also addressed whether Code Sec. 280E applies to marijuana businesses legally operating under state (California) law, and whether the prohibition on deductions is limited to ordinary and necessary business expenses.

A California-based medical marijuana dispensary corporation’s motion for summary judgment challenging the constitutionality of Code Sec. 280E was denied. The Tax Court also addressed whether Code Sec. 280E applies to marijuana businesses legally operating under state (California) law, and whether the prohibition on deductions is limited to ordinary and necessary business expenses.

Section 280E

Congress enacted Code Sec. 280E after the court had allowed certain deductions for expenses incurred in connection with an illegal drug trade. Generally, Code Sec. 280E disallows any deductions attributable to a taxpayer’s illegal drug related trade or business. Taxpayers may reduce their income by the cost of goods sold (COGS), and Code Sec. 280E does not generally disallow deductions attributable to a taxpayer’s non-drug-related business.

Constitutionality

The Eighth Amendment of the Constitution prohibits excessive fines or penalties. The dispensary in this case claimed that Code Sec. 280E is a punitive provision that violates the Eighth Amendment. However, because Congress generally has the power to levy taxes under the Sixteenth Amendment, the Tax Court found that the law’s denial of certain deductions cannot be construed as a penalty.

Legality Under State Law

The dispensary also argued that its actions could not be considered "trafficking" for purposes of Code Sec. 280E because its activities were not illegal under California law. The court noted that because marijuana is still considered a Schedule I controlled substance and is banned under federal law, the application of Code Sec. 280E does not depend on the legality of marijuana sales under California law.

Additional Deductions

Finally, the dispensary argued that Code Sec. 280E only applies to deductions under Code Sec. 162, and that other deductions such as those under Code Secs. 164 and 167 should be permitted. However, the text of Code Sec. 280E broadly states that "no deduction or credit shall be allowed." It does not limit the deductions to those claimed under Code Sec. 162.

Dissenting Opinions

The Tax Court decision included several concurring and dissenting opinions, which primarily addressed the issue as to whether Code Sec. 280E is in fact a penalty provision that would violate the Eighth Amendment.

The dissenting opinions found that Code Sec. 280E is punitive in nature. One dissenter noted that rather than specify a narrow range of disallowed expenses, Code Sec. 280E attacks the entire marijuana industry with a broad denial of otherwise allowable deductions. The opinion stated that Congress passed Code Sec. 280E order to deter the sale of controlled substances and to penalize the drug trade. That intent was found to be "clearly in the nature of a penalty." Both dissents concluded with two additional questions, which the dissenters felt need to be addressed:

• Is the punitive nature of Code Sec. 280E excessive to the point where it violates the Eighth Amendment?, and
• Does the Eighth Amendment apply to corporation taxpayers?

The IRS has proposed regulations that define an eligible terminated S corporation (ETSC), and provide rules relating to distributions of money by an ETSC after the post-termination transition period (PTTP). The proposed regulations also extend the treatment of distributions of money during the PTTP to all shareholders of the corporation, and update and clarify the allocation of current earnings and profits to distributions of money and other property.

The IRS has proposed regulations that define an eligible terminated S corporation (ETSC), and provide rules relating to distributions of money by an ETSC after the post-termination transition period (PTTP). The proposed regulations also extend the treatment of distributions of money during the PTTP to all shareholders of the corporation, and update and clarify the allocation of current earnings and profits to distributions of money and other property.

Code Sec. 1371(f), as added by the Tax Cuts and Jobs Act ( P.L. 115-97) extends the period during which C corporation shareholders can benefit from the corporation’s accumulated adjustment account (AAA) generated during its former status as an S corporation. Specifically, the provision allows the C corporation to source qualified distributions of money to which Code Sec. 301 would otherwise apply to in whole or part to AAA. The provision only applies if the corporation is an ETSC as defined in Code Sec. 481(d).

Under the proposed regulations, the revocation of S corporation status may be made during the two-year period beginning on December 22, 2017, even if the effective date for the revocation occurs after the conclusion of the two-year period.

Shareholder Identity Requirement

A former S corporation is not an ETSC unless the owners of its stock are the same owners (and in identical proportions) on December 22, 2017, and on the date of the S corporation revocation. The proposed regulations identify various categories of stock transfers that are not considered an ownership change for purposes of this rule.

ETSC Proration

A distributing ETSC’s AAA is allocated to qualified distributions and the distributions are chargeable to the ETSC’s accumulated earnings and profits (AE&P) based on the ETSC proration. The ETSC proration is implemented in a manner that facilitates the prompt distribution of AAA and full transition to C corporation status. Specifically, the proposed regulations:

• specify the time at which amounts of AAA and AE&P are determined for purposes of the ETSC proration;

• provide AAA and AE&P ratios used to the implement the proration; and

• describe in detail the method of characterizing qualified distributions.

The proposed regulations adopt a "snapshot" approach under which amounts of AAA and AE&P are determined on a specified date. As a result, the same ETSC proration is applied to all qualified distributions. Under the proposed regulations, the determination date is the date when the S corporation revocation election is effective. A "dynamic" approach that recalculated the amounts before each qualified distribution was rejected as administratively cumbersome.

The proposed regulations provide two ratios for determining the part of a qualified distribution that is sourced from AAA and from AE&P. The AAA ratio is the ratio of historical AAA to the sum of historical AAA and historical AE&P. The AE&P ratio is the ratio of historical AE&P and the sum of historical AAA and historical AE&P. The qualified distribution is multiplied by these ratios to determine the amount sourced from AAA and AE&P.

The proposed regulations provide a priority rule under which ETSC proration first applies to qualified distributions during the tax year. The rules of Code Sec. 301 and allocation rules of Code Sec. 316 then apply to any nonqualified distributions that are not fully accounted for by the ETSC proration because the corporation’s AAA or AE&P are exhausted.

Effective Date

The proposed regulations will be effective in tax years beginning after the date they are published as final regulations. A taxpayer may apply the regulations in their entirely to tax years that begin on or before the date of publication as final regulations.

A top House tax writer has confirmed that House Republicans and the Trump administration are working on a second phase of tax reform this year. House Ways and Means Committee Chairman Kevin Brady, R-Tex., said in an interview that the Trump administration and House Republicans "think more can be done."

A top House tax writer has confirmed that House Republicans and the Trump administration are working on a second phase of tax reform this year. House Ways and Means Committee Chairman Kevin Brady, R-Tex., said in an interview that the Trump administration and House Republicans "think more can be done."

A Ways and Means spokesperson told Wolters Kluwer on March 15 that "there are opportunities in making individual tax cuts permanent, increasing innovation, [and] encouraging household savings."Confirmation that House GOP tax writers are mulling additional tax changes to the tax code comes just days after President Trump announced that he and House Republicans are very serious about working on a “phase-two” of tax reform. Trump quipped that Brady is the "king of tax cuts."

Individual Tax Cuts
Among expected changes, in particular, the temporary individual tax cuts enacted under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) could be made permanent, a Ways and Means spokesperson told Wolters Kluwer. For budgetary reasons, the cuts to individual tax rates and benefits were not made permanent under the new law. "While the tax cuts for families were long-term, they are not yet permanent, so we’re going to address issues like that," Brady said.

Criticism
Democratic lawmakers remain largely united in their criticisms of the TCJA. House Minority Leader Nancy Pelosi, D-Calif., criticized the new tax law in a March 15 news conference for "giving 83 percent of the benefits to the top 1 percent, ultimately raising taxes for 86 million middle-class families while contending that it's a middle-class tax cut."

To that end, across the U.S. Capitol, Senate Minority Leader Charles E. Schumer has said Democrats would be reluctant to work with Republicans in making any fixes to the new tax law unless Republicans would be willing to address Democrats’ concerns with the law, as well. "We don't have much of an inclination, unless they want to open up other parts of the tax bill that we think need changes, to just help them clean up the mess they made," Schumer said.

Looking Forward
"Mainstream optimism is at record levels, our economy is really gaining momentum and booming in a big way," Brady said. "We’re always looking to improve the tax code," he said, adding that lawmakers are currently considering new ideas for tax reform. "We think there are some good ones." Lawmakers will not combine additional tax reform measures with technical corrections to the existing TCJA, according to Brady, emphasizing that any significant changes to come will be new ideas.

The IRS has responded to criticism from the Treasury Inspector General for Tax Administration and the National Taxpayer Advocate, among others, that resolution of identity theft accounts takes too long by increasing its measures to flag suspicious tax returns, prevent issuance of fraudulent tax refunds, and to expedite identity theft case processing. As a result, the IRS's resolution time has experienced a moderate improvement from an average of 312 days, as TIGTA reported in September 2013, to an average of 278 days as reported in March 2015. (The 278-day average was based on a statistically valid sampling of 100 cases resolved between August 1, 2011, and July 31, 2012.) The IRS has recently stated that its resolution time dropped to 120 days for cases received in filing season 2013.

The IRS has responded to criticism from the Treasury Inspector General for Tax Administration and the National Taxpayer Advocate, among others, that resolution of identity theft accounts takes too long by increasing its measures to flag suspicious tax returns, prevent issuance of fraudulent tax refunds, and to expedite identity theft case processing. As a result, the IRS's resolution time has experienced a moderate improvement from an average of 312 days, as TIGTA reported in September 2013, to an average of 278 days as reported in March 2015. (The 278-day average was based on a statistically valid sampling of 100 cases resolved between August 1, 2011, and July 31, 2012.) The IRS has recently stated that its resolution time dropped to 120 days for cases received in filing season 2013.

Even with a wait time of 120 days, taxpayers who find themselves victims of tax refund identity theft likely find the road to resolution a frustrating and time consuming process. This article seeks to explain the various pulleys and levers at play when communicating with the IRS about an identity theft case.

Initiating an ID theft case

A taxpayer may become aware that he or she is a victim of tax-related identity theft when the IRS rejects their tax return because someone has already filed a return using the taxpayer's name and/or social security number. A taxpayer may also receive correspondence directly from the IRS that informs them, prior to filing, that someone has filed a suspicious return under their information. In other cases, a taxpayer may have had his or her identity information compromised and wishes to alert the IRS as to the possibility that he or she may be targeted by an identity thief.

For all such cases, the IRS has created Form 14039, Identity Theft Affidavit. Taxpayers who are actual or potential victims of tax-related identity theft may complete and submit the Affidavit to ensure that the IRS flags the tax account for review of any suspicious activity. Taxpayers who have been victimized are asked to provide a short explanation of the problem and how they became aware of it.

The Identity Theft Affidavit may also be submitted by taxpayers that have not yet become victims of tax-related identity theft, but who have experienced the misuse of their personal identity information to obtain credit or who have lost a purse or wallet or had one stolen, who suspect they have been targeted by a phishing or phone scam, etc. The form asks these taxpayers to briefly describe the identity theft violation, the event of concern, and to include the relevant dates.

Once the Form 14039 has been completed and submitted, the taxpayer should expect to receive a Notice CP01S from the IRS by mail. The Notice CP01S simply acknowledges that the IRS has received the taxpayer's Identity Theft Affidavit and reminds the taxpayer to continue to file all federal tax returns.

IDVerify.irs.gov

The IRS has implemented a pre-screening procedure for suspicious tax returns. Rather than halt the refund process entirely, which can prevent a refund claimed on a legitimately filed return, the IRS has provided taxpayers with the opportunity to verify their identity.

Now when the IRS receives a suspicious return, it will send a Letter 5071C or Notice CP01B to the taxpayer requesting him or her to either visit idverify.irs.gov or call the toll-free number listed on the header of the letter (1-800-830-5084) within 30 days. When the taxpayer does this, the taxpayer will encounter a series of questions asking for personal information. If the taxpayer fails to respond to the verification request or responds and answers a question incorrectly the IRS will flag the return as fraudulent and follow the prescribed procedures for resolving identity theft cases.

Resolving the case

After a tax return has been flagged with the special identity theft processing code, the IRS will assign the case to a tax assistor. TIGTA reported that the IRS assigns each case priority based first on its age and then by case type—for example, with cases nearing the statute of limitations placed first, followed by cases claiming disaster relief, and then identity theft cases. However, TIGTA has reported that cases are frequently reassigned to multiple tax assistors, and there are often long lag times where no work is accomplished toward resolution. National Taxpayer Advocate Nina Olson also noted in her recent "Identity Theft Case Review Report" on a statistical analysis of 409 identity theft cases closed in June 2014 that a significant number of cases experience a period of inactivity averaging 78 days.

After resolution

The IRS has also created the Identity Protection Personal Identification Number (IP PIN) project, which is meant to prevent taxpayers from being victimized by identity thieves a second time after the IRS has resolved their cases and closed them. The IP PIN is a unique six-digit code that taxpayers must entered on their tax return instead

The IRS assigns an IP PIN to a taxpayer by sending him or her a Notice CP01A. Generally this Notice is issued in December in preparation for the upcoming filing season. The taxpayer then enters it into the appropriate box of his or her federal tax return (i.e. Forms 1040, 1040A, 1040EZ or 1040 PR/SS). On paper returns, this box is located on the second page, near the signature line. When e-filing, the tax software or tax return preparer will indicate where the taxpayer should enter the IP PIN, social security number or taxpayer identification number (TIN) at time they file their tax return. The IP PIN is only good for one tax year.

Taxpayers who have been assigned an IP PIN, but who have lost or misplaced it cannot electronically file their tax returns until they have located it. Previously such taxpayers had no way to retrieve their IP PIN and had to file on paper. Beginning on January 14, 2015, however, taxpayers who had lost their IP PINs were able to retrieve them by accessing their online accounts and providing the IRS with specific personal information and answer a series of questions to verify identity.

Latest breach

The IRS announced on May 26th that 100,000 taxpayers became victims of a new identity theft scheme discovered in mid-May 2015. Identity theft criminals used stolen personal identification information to access the IRS's online "Get Transcript" application and illegally download these taxpayers' tax transcripts. The IRS is concerned that the criminals intend to use taxpayers' past-year return information to file false tax returns claiming tax items and refunds that look legitimate and that do not trigger the IRS's filters for finding suspicious returns. 

Within this latest breach of security, identity thieves had attempted to download a total of 200,000 transcripts, but had only been successful half of the time, according to an announcement by IRS Commissioner John Koskinen. Because the IRS has yet to see how many taxpayers were actually victimized, the IRS may not provide IP PINs to all of these 200,000 taxpayers. However, the 100,000 taxpayers whose tax transcripts were downloaded will receive free credit monitoring services at the IRS's expense, Koskinen stated.

Sometimes in a rush to file your income tax return, you may unintentionally overlook some income that had to be reported, or a deduction that you should or should not have taken.  Now what?  The solution is usually straightforward: you should file what is called an amended return.

Taxable income is measured on an annual basis so you cannot generally wait on correcting a mistake by “making up the difference” on the return that you file next year.  You need to make the correction(s) directly on a revised return for the same tax year.  Form 1040X, Amended U.S. Individual Income Tax Return, is used to amend any individual income tax return.  Income tax returns other than individual income tax returns or returns filed on Form 1120, U.S. Corporation Income Tax Return, or Form 1120-A, U.S. Corporation Short Form Income Tax Return, are amended by filing the same form originally used to file the return.  Partnerships may use Form 1065X.  Amended returns should clearly be marked as such.  Some return forms such as Form 1041, U.S. Income Tax Return for Estates and Trusts, contain a box to be checked if it is being filed as an amended return.  For returns other than income tax returns, Form 843, Claim for Refund and Request for Abatement, is used to claim a refund.

To amend a non-income tax return other than to claim a refund, the same form originally used to file the return generally should be used.  Estate tax returns cannot be amended after they are due.  However, supplemental information may be filed that can change the amount of estate tax due from the amount shown on the return.

When to file an amended return.  A taxpayer must file an amended return and pay the additional tax due if the taxpayer omitted an item of income or incorrectly claimed a deduction for a tax year for which the limitation period is still open.  A tax year ordinarily remains open for three years from the filing of a return.  The three-year period starts running the day after the return is filed.  A return that is filed early is treated as filed on the due date of the return.  The limitations period on assessment for which a return remains open does not start over if an amended return is filed. 

If you realize that you made a mistake on your return that is not in IRS’s favor, it is best to correct it through filing an amended return as soon as possible.  If the IRS starts to audit you and finds the mistake first before you file your amended return, it can assess penalties on the original amount and treat you as if you had not come forward voluntarily on your own.

Special disaster loss option.  Not all amended returns are filed to correct a mistake.  One in particular –claiming a disaster loss—may be filed to effectively accelerate a casualty-loss deduction.  A taxpayer may elect to deduct a disaster loss in the year of occurrence or the immediately preceding year.  To qualify for the election, the loss must occur in a federally-declared disaster area.  The election is made on a return (if you have not filed your return yet for the preceding tax year), an amended return or a refund claim.  The amount of the deduction is determined using the casualty loss limitations.

The tax rules surrounding the dependency exemption deduction on a federal income tax return can be complicated, with many requirements involving who qualifies for the deduction and who qualifies to take the deduction. The deduction can be a very beneficial tax break for taxpayers who qualify to claim dependent children or other qualifying dependent family members on their return. Therefore, it is important to understand the nuances of claiming dependents on your tax return, as the April 18 tax filing deadline is just around the corner.

The tax rules surrounding the dependency exemption deduction on a federal income tax return can be complicated, with many requirements involving who qualifies for the deduction and who qualifies to take the deduction. The deduction can be a very beneficial tax break for taxpayers who qualify to claim dependent children or other qualifying dependent family members on their return. Therefore, it is important to understand the nuances of claiming dependents on your tax return, as the April 18 tax filing deadline is just around the corner.

Dependency deduction

You are allowed one dependency exemption deduction for each person you claim as a qualifying dependent on your federal income tax return. The deduction amount for the 2010 tax year is $3,650. If someone else may claim you as a dependent on their return, however, then you cannot claim a personal exemption (also $3,650) for yourself on your return. Additionally, your standard deduction will be limited.

Only one taxpayer may claim the dependency exemption per qualifying dependent in a tax year. Therefore, you and your spouse (or former spouse in a divorce situation) cannot both claim an exemption for the same dependent, such as your son or daughter, when you are filing separate returns.

Who qualifies as a dependent?

The term "dependent" includes a qualifying child or a qualifying relative. There are a number of tests to determine who qualifies as a dependent child or relative, and who may claim the deduction. These include age, relationship, residency, return filing status, and financial support tests.

The rules regarding who is a qualifying child (not a qualifying relative, which is discussed below), and for whom you may claim a dependency deduction on your 2010 return, generally are as follows:

-- The child is a U.S. citizen, or national, or a resident of the U.S., Canada, or Mexico;

-- The child is your child (including adopted or step-children), grandchildren, great-grandchildren, brothers, sisters (including step-brothers, and -sisters), half-siblings, nieces, and nephews;

 -- The child has lived with you a majority of nights during the year, whether or not he or she is related to you;

 -- The child receives less than $3,650 of gross income (unless the dependent is your child and either (1) is under age 19, (2) is a full-time student under age 24 before the end of the year), or (3) any age if permanently and totally disabled;

 -- The child receives more than one-half of his or her support from you; and

 -- The child does not file a joint tax return (unless solely to obtain a tax refund).

Qualifying relatives

The rules for claiming a qualifying relative as a dependent on your income tax return are slightly different from the rules for claiming a dependent child. Certain tests must also be met, including a gross income and support test, and a relationship test, among others. Generally, to claim a "qualifying relative" as your dependent:

-- The individual cannot be your qualifying child or the qualifying child of any other taxpayer; -- The individual's gross income for the year is less than $3,650; -- You provide more than one-half of the individual's total support for the year; -- The individual either (1) lives with you all year as a member of your household or (2) does not live with you but is your brother or sister (include step and half-siblings), mother or father, grandparent or other direct ancestor, stepparent, niece, nephew, aunt, or uncle, or inlaws. Foster parents are excluded.

Although age is a factor when claiming a qualifying child, a qualifying relative can be any age.

Special rules for divorced and separated parents

Certain rules apply when parents are divorced or separated and want to claim the dependency exemption. Under these rules, generally the "custodial" parent may claim the dependency deduction. The custodial parent is generally the parent with whom the child resides for the greater number of nights during the year.

However, if certain conditions are met, the noncustodial parent may claim the dependency exemption. The noncustodial parent can generally claim the deduction if:

-- The custodial parent gives up the tax deduction by signing a written release (on Form 8332 or a similar statement) that he or she will not claim the child as a dependent on his or her tax return. The noncustodial parent must attach the statement to his or her tax return; or

-- There is a multiple support agreement (Form 2120, Multiple Support Declaration) in effect signed by the other parent agreeing not to claim the dependency deduction for the year.

Correctly calculating your estimated tax payments and/or withholding is even more important as the year end approaches. Accurate calculations are especially important as third and fourth quarter payments become due, and your income and expenses for the rest of the year can be more accurately projected.

Estimated tax payments

You are required to pay estimated tax if you receive income from which tax is not withheld, including income from self-employment, dividends and interest, capital gains and losses, rental income, and alimony, and your tax is expected to be $1,000 or more (after subtracting credits and withholding). Generally, individuals who do not pay at least 90 percent of their tax through withholding must estimate their income tax liability and make equal quarterly payments of the "required annual payment" liability throughout the year.

Higher-income taxpayers. For higher-income taxpayers whose adjusted gross income (AGI) shown on the preceding year's tax return exceeds $150,000 ($75,000 for married individuals filing separately), the required annual payment is the lesser of 90 percent of the tax for the current year, or 110 percent of the tax shown on the return for the preceding tax year.

Estimated tax payments are due quarterly. For most individuals, the due dates for the 2010 tax year are: April 15, June 15, and September 15 of 2010, and January 15, 2011. Failing to pay enough estimated tax on each installment date may result in a penalty for underpayment of estimated tax, even if you are due a refund. Therefore, properly calculating your payments is vital to avoid the penalties, including calculating adjustments needed in remaining quarters (including as soon as September 15, 2010 for the third quarter).

Third quarter payments are around the corner – September 15, 2010 – for the period June 1 through August 31. Fourth quarter payments will be due January 15, 2011 for the period September 1, 2010 through December 31, 2010. If your total estimated payments and withholding add up to less than 90 percent of what you owe, you may face an underpayment penalty.

Withholding

With the third and fourth quarter payments becoming due, ensure you are properly withholding and paying enough in estimated tax. Look at your projected year-end tax payments as compared with your expected tax liability to determine if your estimated tax payments need some tweaking. If your payments are expected to be less than 90 percent of current-year tax, you will generally need to increase your withholding or make estimated tax payments.

You may want to file a new W-4 with your employer adjusting your withholding to withhold more from your final paychecks for the year if you are currently underwithholding. This will help avoid being subject to a penalty when you file your return.

Adjusting estimated tax payments

A change in your business's income, deductions, credits, and exemptions may also make it necessary to refigure your estimated payments for the remainder of the year. To avoid either a penalty from the IRS or overpaying the IRS interest-free, consider increasing or decreasing the amount of your remaining estimated payments.

If, during the quarter, you learn that a change in your business's anticipated income, deductions, credits, exemptions, or other adjustments will either increase or decrease your business's tax liability, and therefore affecting your required annual payment for the remainder of the year, you should adjust your remaining quarterly payments accordingly.

Taxpayers who do not meet the requirements for the home sale exclusion may still qualify for a partial home sale exclusion if they are able to prove that the sale was a result of an unforeseen circumstance. Recent rulings indicate that the IRS is flexible in qualifying occurrences as unforeseen events and allowing a partial home sale exclusion.

Generally, single taxpayers may exclude from gross income up to $250,000 of gain on sale or exchange of a principal residence and married taxpayers filing jointly may exclude up to $500,000. The exclusion can only be used once every two years.

To qualify for this exclusion, taxpayers must own and use the property as their principal residence for periods totaling two out of five years before sale. The five-year period can be suspended for up to 10 years for absences due to service in the military or the foreign service.

Partial exclusions are available when the ownership and use test or two-year test is not met but the taxpayer sells due to change of employment, health or unforeseen circumstances. Without these mitigating circumstances, all gain on the sale of a residence before the two years are up is taxed.

The IRS offers several "safe harbors," that is, events that will be considered to be unforeseen circumstances. These include the involuntary conversion of the taxpayer's residence, casualty to the residence caused by natural or man-made disasters or terrorism, death of a qualified individual, unemployment, divorce or legal separation, and multiple births from the same pregnancy.

If a taxpayer does not qualify for any of the safe harbors, the IRS can determine if a sale is the result of unforeseen circumstances by applying a facts and circumstances test. Some of the factors looked at by the IRS are proximity in time of sale and claimed unforeseen event, suitability of the property as the taxpayer's principal residence materially changes, whether the taxpayer's financial ability to maintain the property is materially impaired, whether the taxpayer used the property as a personal residence and whether the unforeseen circumstances were foreseeable when the taxpayer bought and used the property as a personal residence.

Recently, the IRS has decided that several non-safe harbor events were unforeseen circumstances. These include sales because of fear of criminal retaliation, the adoption of a child, a neighbor assaulting the homeowners and threatening their child, and a move to an assisted living facility followed by a move to a hospice.

If you think you may be eligible for a reduced home sale exclusion because of an unforeseen circumstance, give our office a call.

When it comes to legal separation or divorce, there are many complex situations to address. A divorcing couple faces many important decisions and issues regarding alimony, child support, and the fair division of property. While most courts and judges will not factor in the impact of taxes on a potential property settlement or cash payments, it is important to realize how the value of assets transferred can be materially affected by the tax implications.

When it comes to legal separation or divorce, there are many complex situations to address. A divorcing couple faces many important decisions and issues regarding alimony, child support, and the fair division of property. While most courts and judges will not factor in the impact of taxes on a potential property settlement or cash payments, it is important to realize how the value of assets transferred can be materially affected by the tax implications.

One of the most argued points between separating couples regarding taxes is who gets to claim the children as dependents on their tax return, since joint filing is no longer an option. The reason this part of tax law is so important to divorcing parents is that the federal and state exemptions allowed for dependents offer a significant savings to the custodial parent, and there are also substantial child and educational credits that can be taken. The right to claim a child as a dependent from birth through college can be worth over $30,000 in tax savings.

The law states that one parent must be chosen as the head of the household, and that parent may legally claim the dependents on his or her return.

Example: If a couple was divorced or legally separated by December 31 of the last tax year, the law allows the tax exemptions to go to the parent who had physical custody of the children for the greater part of the year (the custodial parent), and that parent would be considered the head of the household. However, if the separation occurs in the last six months of the year and there hasn't yet been a legal divorce or separation by the year's end, the exemptions will go to the parent that has been providing the most financial support to the children, regardless of which parent had custody.

A non-custodial parent can only claim the dependents if the custodial parent releases the right to the exemptions and credits. This needs to be done legally by signing tax Form 8332, Release of Claim to Exemption. However, even if the non-custodial parent is not claiming the children, he or she still has the right to deduct things like medical expenses.

Child support payments are not deductible or taxable. Merely labeling payments as child support is not enough -- various requirements must be met.

Alimony is another controversial area for separated or divorced couples, mostly because the payer of the alimony wants to deduct as much of that expense as possible, while the recipient wants to avoid paying as much tax on that income as he or she can. On a yearly tax return, the recipient of alimony is required to claim that money as taxable income, while the payer can deduct the payment, even if he or she chooses not to itemize.

Because alimony plays such a large part in a divorced couple's taxes, the government has specifically outlined what can and can not be considered as an alimony expense. The government says that an alimony payment is one that is required by a divorce or separation decree, is paid by cash, check or money order, and is not already designated as child support. The payer and recipient must not be filing a joint return, and the spouses can not be living in the same house. And the payment cannot be part of a non-cash property settlement or be designated to keep up the payer's property.

There are also complicated recapture rules that may need to be addressed in certain tax situations. When alimony must be recaptured, the payer must report as income part of what was deducted as alimony within the first two payment years.

Many aspects of property settlements are too numerous and detailed to discuss at length, but separating couples should be aware that, when it comes to property distributions, basis should be considered very carefully when negotiating for specific assets.

Example: Let's say you get the house and the spouse gets the stock. The actual split up and distribution is tax-free. However, let's say the house was bought last year for $300,000 and has $100,000 of equity. The stock was bought 20 years ago, is also worth $100,000, but was bought for $10,000. Selling the house would generate no tax in this case and you would get to keep the full $100,000 equity. Selling the $100,000 of stock will generate about $25,000 to $30,000 of federal and state taxes, leaving the other spouse with a net of $70,000. While there may be no taxes to pay for several years if both parties plan to hold the assets for some time, the above example still illustrates an inequitable division of assets due to non-consideration of the underlying basis of the properties distributed.

Under a recent tax law, a spouse who acquires a partial interest in a house through a divorce settlement can move out and still exempt up to $250,000 of any taxable gain. This still holds true if he or she has not lived in the home for two of the last five years, the book states. It also applies to the spouse staying in the home. However, the divorce decree must clearly state that the home will be sold later and the proceeds will be split.

Complications and tax traps can also occur when a jointly owned business is transferred to one spouse in connection with a divorce. Professional tax assistance at the earliest stages of divorce are recommended in situations where a closely held business interest is involved.

When a couple splits up, the courts have the authority to divide a retirement plan (whether it's an account or an accrued benefit) between the spouses. If the retirement money is in an IRA account, the individuals need to draw up a written agreement to transfer the IRA balance from one spouse to the other. However, if one spouse is the trustee of a qualified retirement plan, he or she must comply with a Qualified Domestic Relations Order to divide the accrued benefit. Each spouse will then be taxed on the money they receive from this plan, unless it is transferred directly to an IRA, in which case there will be no withholding or income tax liability until the money is withdrawn.

Extreme caution should be exercised when there are company pension and profit-sharing benefits, Keogh plan benefits, and/or IRAs to split up. Unless done appropriately, the split up of these plans will be taxable to the spouse transferring the plan to the other.

When a couple prepays taxes by either withholding wages or paying estimated taxes throughout the year, the withholding will be credited to the spouse who earned the underlying income. In community property states, the withholding will be credited equally when spouses each report half of their income. When a joint refund is issued after a couple has separated or divorced, the couple should consult a tax advisor to determine how the refund should be divided. There is a formula that can be used to determine this amount, but it is wisest to use a qualified individual to make sure it is properly applied.

To the dismay of most divorcing couples, the massive legal bills most end up paying are not deductible at tax time because they are considered personal nondeductible expenses. On the other hand, if a part of that bill was allocated to tax advice, to securing alimony, or to the protection of business income, those expenses can be deducted when itemizing. However, their total -- combined with other miscellaneous itemized deductions -- must be greater than 2% of the taxpayer's adjusted gross income to qualify.

Divorce planning and the related tax implications can completely change the character of the divorcing couple's negotiations. As many divorce attorneys are not always aware of these tax implications, it is always a good idea to have a qualified tax professional be involved in the dissolution process and planning from the very early stages. If you are in the process of divorce or are considering divorce or legal separation, please contact the office for a consultation and additional guidance.