Over the last few months, the Fourth Circuit Court of Appeals and Tax Court have issued several interesting decisions involving the common law mailbox rule and the limitations on the Tax Court’s jurisdiction to review and consider late filed petitions. In its recent decision in Culp, the Third Circuit Court of Appeals ruled the Section 6213(a) deadline for filing a tax court petition is procedural rather than jurisdictional. Therefore, matters of equity may toll the due date for filing a Tax Court petition. Read more
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Greetings to the NCBA Tax Section! I would like to welcome everyone to a new year of section membership and activities. On behalf of myself and the Tax Council officers (Reed Hollander – Vice Chair; Chris Hannum – Treasurer; and Stacey Brady – Secretary), we look forward to seeing and working with you over the next year.
Reed and I were in Cary last week for the NCBA’s annual Leadership Orientation, where we met some of the officers of the other sections and heard about their plans for the year. I have already heard from Patti Ramseur, the new NCBA President, whose focus is going to include professionalism and especially the importance of civility within the profession. This is an area where the Tax Section can and in fact already does set a good example. I do not know how to quantify civility, but it is my belief that tax practice among the private bar tends to be more collaborative than many other areas of law. Although some of us occasionally find ourselves in opposition to a counterparty or the government, my experience is that our practitioners are able to part as friends, or at least as respected colleagues, at the end of the day.
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Taxpayers primarily focus on the ability to take a deduction. Another consideration, however, is the timing of the deduction. Section 461 provides the rules for when a deduction can be taken based on both the timing regime the taxpayer has elected and the facts and circumstances surrounding the deduction.
Most taxpayers use the cash method. For cash method taxpayers, pursuant to Treas. Reg. Sec. 1.461-1(a)(1), “amounts representing allowable deductions shall, as a general rule, be taken into account for the taxable year in which paid.” That means cash method taxpayers can generally take a deduction in the year in which the expense is paid.
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Generally, Section 6501(a) prohibits the IRS from auditing a tax return and assessing additional tax after three years from the filing date. Thus, the IRS has only those three years to initiate and conclude an audit and assess additional tax. In some circumstances, however, the statute of limitations extends for longer periods. Moreover, the filing date is not always the starting point for applying the statute of limitations.
Section 6501(b)(1) provides when a tax return is filed before the due date, the return is treated as if it were filed on the due date in applying the statute of limitations. Additionally, Section 6501(b)(2) provides certain employment and withholding tax returns filed before April 15 of the year following the tax year to which they apply are treated as filed on April 15 of such year.
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I. Audit Statistics: What Are Your Chances of Being Audited?
The 2022 Internal Revenue Service Data Book contains audit statistics for years 2012 through 2020, as of the fiscal year ended September 30, 2022 (FY 2022). For tax years 2018 and earlier, the statute of limitations for audits had generally expired as of September 30, 2022. However, for 2019 and 2020 returns, the statute of limitations has yet to expire, so additional returns of those years may be audited.
For 2012 through 2018, audit rates dropped significantly. For example, individual tax returns had an audit rate of 0.8% for 2012 returns versus 0.3% for 2018. In addition, for individuals with income between $1 million and $5 million, the audit rate dropped from 4.9% for 2012 returns to 1.2% for 2018 returns.
The overall audit rate for C corporations dropped from 1.3% for 2012 returns to 0.5% for 2018 returns. For partnerships and S corporations, the audit rate for 2012 returns was 0.3% and 0.4%, respectively, compared to 0.1% and 0.1% for 2018 returns.
In FY 2022, 21.4% of audits were field audits. The others were correspondence audits.
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Section 6501 provides the statute of limitations for the IRS to assess additional tax. Equally important is Section 6502, which provides the statute of collections (sometimes referred to as the collection statute expiration date or “CSED”). The statute of collections generally provides the IRS must collect a tax within 10 years of assessment.
The CSED permits a tax to be collected by levy or a court proceeding only if the levy is made or the proceeding had begun before the CSED. Section 6502(b) provides the date on which a levy is made is the date the notice of seizure is provided to the taxpayer as required by Section 6335(a). As to a seizure that is made by court order, the proceeding begins upon the filing of the IRS’s suit against the taxpayer. The statute of collections does not expire after the proceeding is concluded until the tax is satisfied or the judgment becomes unenforceable. Thus, the CSED cannot be used to defeat the IRS’s right to collect a judgment entered by a court.
Section 529 provides for the creation of qualified tuition programs, better known as 529 Plans. These programs are tax-advantaged investment vehicles through which parents can save for their family’s tuition needs. 529 Plans are required by Section 529(b)(1) to be established and maintained by a state or agency or instrumentality thereof or by eligible educational institutions. Most 529 Plans are established and maintained by a state. Many states have more than one 529 Plan. Some states provide state income tax deductions for residents who contribute funds to the state’s 529 Plan.
If the requirements of Section 529 are met, no distribution or earnings under a 529 Plan are included in the gross income of either the designated beneficiary or the contributor of the plan. Thus, 529 Plans are excellent vehicles for building tax-free educational savings. Contributions to a 529 Plan are treated as a completed gift to the beneficiary on that date of the gift. Moreover, Section 529(c)(2)(B) allows for front-loading of gifts to a 529 Plan of five years of annual exclusion gifts, which are treated as if made ratably over the five-year period commencing with the year of the gift. The current annual exclusion is $17,000 per person. That means an individual can gift up to $85,000 to a 529 Plan in year 1, and a married couple can gift up to $170,000 in year one. The goal of the provision is to allow greater than annual exclusion gifts up-front to provide adequate time for investments to grow tax-free prior to the student needing funds. Finally, 529 Plan assets are not included in the gross estate of an individual except where amounts are distributed on account of the death of a beneficiary or where a donor makes an up-front five-year gift and dies before the end of the five-year period. In such case, the gross estate of the donor includes the portion of the contributions allocable to periods after the death of the donor.
When originally enacted, Section 529 allowed for tax-free distributions only where such distributions were for a qualified higher education expense, which was limited to college or university-related expenses. However, the 2017 Tax Cuts and Jobs Act expanded qualified higher education expenses to include elementary and secondary school tuition. However, Section 529(e)(3) provides an annual $10,000 limit on distributions made for elementary and secondary school education tuition. Qualified higher education expense also includes distributions to make payments on educational loans. However, there is a $10,000 total limit on such distributions.
Often there is a need to change the designated beneficiary of a 529 Plan because either the original designated beneficiary completed her education, chose not to pursue qualifying education, or otherwise did not fully utilize the funds invested in the 529 Plan. Changing the designated beneficiary of a 529 Plan is not a taxable gift provided the new beneficiary is of the same or higher generation as the old beneficiary (as determined in accordance with Section 2651), and the new designated beneficiary is a member of the family of the previous beneficiary. Member of a family is defined broadly to include spouses, children, brothers and sisters, parents, nieces and nephews, uncles and aunts, in-laws, and first cousins.
John G. Hodnette is an attorney with Johnston, Allison & Hord in Charlotte.
I. Shareholders of Bankrupt S Corporation Failed to Abandon Their Stock; Yaguda v. Commissioner, TC Summary Opinion 2022-21.
Mr. and Mrs. Yaguda owned stock of EFI, Inc., an S Corporation. In 2008, a creditor forced EFI into involuntary bankruptcy. Later that year, EFI’s case was converted to a voluntary Chapter 11 bankruptcy proceeding. In addition, during 2008, Mr. Yaguda’s ownership interest in EFI was transferred to a receivership created by the California Superior Court as a result of criminal proceedings initiated by California against Mr. Yaguda.
During 2015, EFI began selling its assets to raise funds for payment to its creditors. EFI issued a Form K-1 for 2015 reporting Mr. and Mrs. Yaguda had over $97,000 of distributive pass-through income. However, when Mr. and Mrs. Yaguda filed their income tax return, they failed to include any pass-through amounts from EFI on the basis they did not derive any personal benefit from the business activities of EFI during the year, since all of the liquidating sales proceeds went to the payment of EFI’s creditors.
A payment for an option to purchase property is not a taxable event to either party upon the grant of the option. See Virginia Iron Coal & Coke Co. v. Commissioner, 99 F.2d 919 (1938); Rev. Rul. 58-234; and Fed. Home Loan Mortg. Corp v. Commissioner, 125 T.C. 248 (2005). That is because it is unknown whether the option will ultimately be exercised. In general, as discussed in Virginia Iron Coal, the tax system generally operates on a yearly basis. However, in some circumstances, that is not possible, such as where an option payment is received in year 1 for an option to purchase property in year 2. It is unknown in year 1 whether the option will ultimately be exercised. Therefore, it is impossible to determine in year 1 how the payment should be treated. The transaction is treated as open until it is resolved.
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Section 6104(d)(1)(B) provides a right to taxpayers to request the application for tax exemption and annual informational returns for the last three years of any organization described in Section 501(c) or (d) and exempt from taxation under Sections 501(a) or 527(a). That covers both public charities and private foundations exempt under Section 501(c)(3), as well as other types of tax-exempt organizations.
Reg. § 301.6104(d)-1(d)(2) provides such tax-exempt entities must honor a written request for the documents required to be provided under Section 6104(d) provided the request (a) is addressed to, and delivered by mail, electronic mail, facsimile, or provide delivery service to a principal, regional, or district office of the organization, and (b) sets forth the address to which the copy of the documents should be sent. The charity, pursuant to Reg. § 301.6104(d)-1(d)(3), may require a reasonable fee for providing such copies. Pursuant to Reg. § 301.6104(d)-1(d)(2)(ii)(A), the charity must send the documents within 30 days of the date it receives the request or, if the charity requires payment in advance for the costs associated, 30 days from the date it receives such payment. If the individual making the request consents, the tax-exempt organization may provide the requested document exclusively by electronic mail.
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