Tax

You may have noticed that the IRS is in a bad way.

It has a backlog of millions of unprocessed paper tax returns, and taxpayers can’t get through to the agency on the phone. Congress noticed and took action by passing a massive funding of the IRS in the recently enacted Inflation Reduction Act.

The IRS will get an additional $80 billion over the next decade. This includes $35 billion for taxpayer services, operations support, and business systems. Among other things, the IRS plans to use these funds to update its antiquated IT systems (some of which date back to the 1960s), improve phone service, and speed up the processing of paper tax returns.

Despite what you may have heard in the media, the IRS will not expand by 87,000 new employees. It will still be smaller than it was 30 years ago. It may grow by 20,000 to 30,000 workers over the next decade, and the number of revenue agents could increase to 17,000 by 2031—over twice as many as today.

The IRS will have an additional $45 billion to spend on enforcement. Treasury Secretary Janet Yellen has promised that IRS audit rates will remain at “historical levels” for taxpayers earning less than $400,000 annually.

Audit rates will rise for taxpayers earning $400,000 per year. If you’re in this group, it’s wise to plan ahead to avoid trouble with a beefed-up IRS.

You should keep complete and accurate records and file a timely tax return. Of course, this is something you should be doing anyway.

Here are a few special areas of concern:

• Cryptocurrency. You can expect increased IRS audits dealing with cryptocurrency transactions. If you’re one of the millions of Americans who engage in such transactions, make sure you keep good records and report any income you earn.

• S Corporations. If you’re an S corporation shareholder-employee, you should have your S corporation pay you an arguably reasonable salary and benefits, and document how you arrived at the amount.

• Syndicated Conservation Easements. Be aware that the IRS is auditing all of these deals, and its scrutiny of them will likely grow.

• Offshore Accounts. You’re supposed to report these to the U.S. Treasury. Failure to do so subjects you to substantial penalties. In recent years, the IRS has gone after banks and bank account holders who hide assets in offshore accounts. In future years, we can expect the IRS to place even greater emphasis on identifying and tracking such offshore assets.

• Partnerships. Partnerships and multi-member LLCs taxed as partnerships (this describes most of them) are already the subject of the Large Partnership Compliance program, which uses data analytics to select large partnership returns for audit. The IRS will likely devote more resources to this program in the future.

If you have any questions about this infusion of money into the IRS, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• January 3, 2023

Are you 72 or older? If so, you must take a required minimum distribution (RMD) from your traditional IRA, SEP-IRA, or SIMPLE IRA by the end of the year.

If you turn 72 this year, you can wait until April 1 of next year to take your first RMD—but you’ll also have to take your second RMD by the end of that year.

Your RMD is a percentage of the total value of your retirement accounts based on your age and life expectancy. The older you are, the more you must distribute. But here’s the kicker: your RMD must be based on the value of your retirement accounts as of the end of the prior year—December 31, 2021, in the case of 2022 RMDs. So you may have a high RMD due this year even though the value of your retirement portfolio has declined, perhaps substantially.

If your retirement accounts consist primarily of stocks, bonds, or other securities, you don’t have to sell them at their current depressed levels and distribute the cash to yourself to fulfill your RMD. There’s another option: do an in-kind distribution.

With an in-kind RMD, you transfer stock, bonds, mutual funds, or other securities directly from your IRA to a taxable account, such as a brokerage account. No selling is involved. The amount of your RMD is the fair market value of the stock or other securities at the time of the transfer.

Furthermore, you still have to pay income tax on the distribution at ordinary income rates. To avoid selling any part of the stock or other securities you’ve transferred, you’ll have to come up with the cash to pay the tax from another source, such as a regular bank account.

With an in-kind distribution, not only do you avoid selling stocks in a down market, but the transfer may also reduce the taxes due on any future appreciation when you eventually do sell. This is because when you do an in-kind RMD, it resets the basis of the assets involved to their fair market value at the time of the transfer.

If you later sell, you pay tax only on the amount gained over your new basis. And such sales out of a taxable account generally are taxed at capital gains rates, not ordinary income rates.

If an in-kind distribution sounds attractive, act quickly so the transaction is completed by year-end.

If you have any questions about in-kind RMDs, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• December 28, 2022

Crowdfunding is a national and international phenomenon. Over $17 billion is raised yearly in North America through world-famous websites such as GoFundMe and Kickstarter.

All this crowdfunding activity leads to an obvious question: Is the money raised this way taxable income for the recipients?

You might be surprised to learn that the courts and the IRS have provided almost no guidance on this issue. The authorities have largely left it up to taxpayers to figure it out by applying general tax principles.

Under general tax principles, all income you receive is taxable unless an exception in the tax law makes it tax-free. Some exceptions apply to some types of crowdfunding.

There are four main types of crowdfunding:

1. Donation-based
2. Rewards-based
3. Debt-based
4. Equity-based

Donation-based crowdfunding is the best-known and largest type. Individuals use crowdfunding sites such as GoFundMe to solicit donations for themselves or others. Donations can be solicited for any purpose but typically involve raising money for medical expenses, youth sports, or education costs.

With this crowdfunding model, donors do not receive any goods or services in return for their money. As a result, the donations ordinarily qualify as tax-free gifts.

Donors get no charitable deduction for money they give to individuals through crowdfunding websites, even if the recipients are needy. But donations from these websites made directly to Section 501(c)(3) tax-qualified charities are deductible.

Rewards-based crowdfunding is used by businesses to raise money. Contributors receive products or services from the business in return for their money. The best-known websites for rewards-based crowdfunding are Kickstarter and Indiegogo.

The expenses incurred to undertake the crowdfunding campaign, including crowdfunding website fees and the cost of rewards, would be deductible business expenses. The money received this way is ordinarily taxable income to the business. It is clearly not a gift if the contributors receive something of value in return for their money.

With debt-based crowdfunding, also called peer-to-peer lending, businesses raise money through specialized websites that provide loans financed by the general public. Loans that have to be paid back are not taxable income.

Equity-based crowdfunding enables businesses to sell shares or other securities to investors through the internet. Funds raised by issuing securities to investors are not taxable income for the business. But to prevent fraud and other abuses, companies that use equity crowdfunding must comply with federal and state securities laws.

If you have any questions about crowdfunding, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• December 19, 2022