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Gift Planning

Monday June 24, 2024

Washington News

Washington Hotline

Direct File Growth in 2025

On June 18, Treasury Secretary Janet Yellen and Senate Finance Committee Chair Ron Wyden (D-OR) announced that the State of Oregon will join Direct File in 2025. The Internal Revenue Service (IRS) has invited all 50 states and the District of Columbia to join the program in 2025.

There were 12 states in the Direct File pilot program for 2024. The IRS is now in discussions with multiple additional states to join and offer the tax-filing service in 2025.

The pilot version of Direct File covered W-2 wage income, Social Security income, unemployment compensation and credits such as the child tax credit and the earned income tax credit. It did not cover the child and dependent care credit or the premium tax credit. Future versions of Direct File are expected to offer expanded capabilities.

Secretary Yellen stated, "Oregonians will be able to use Direct File to file their federal returns directly with the IRS for free and then use Oregon's state tax filing tool to quickly and easily file their state returns for free."

Sen. Wyden continued, "This is a good day for Oregon taxpayers who are tired of getting ripped off by the big tax software companies year after year."

The pilot program in 2024 involved 140,000 taxpayers who received $90 million in refunds and saved an estimated $5.6 million in filing costs. The 2025 Direct File expansion is expected to grow as decision-makers in at least 20 other states further discuss it.

The tax preparation industry is opposing expansion of the program. Representative David Ransom of the American Coalition for Taxpayer Rights stated, "We understand that many state officials have serious questions and skepticism regarding the IRS Direct File platform."

There has been previous opposition by the tax-preparation industry to similar programs. In 2005, the State of California's pilot program, CalFile, was designed to protect taxpayers from "paying unnecessary tax-preparation fees" and also faced opposition from the tax preparation industry.

Ayushi Roy is Deputy Director of New America's New Practice Lab and noted, "I think the amount of work it takes for any kind of product team, especially the IRS, to be managing two-plus teams in every single state -- we are talking 100 different groups of people across 50 states, minimum. Just because we can do all 50 states, should the IRS do it?"

Samantha Galvin is a professor of law and director of the federal tax clinic at Loyola University, Chicago. She has represented many low-income taxpayers in IRS proceedings. Galvin notes the Direct File program will be significantly improved if it pre-populated information. This would reduce audits and collection costs.

In a news release, Galvin stated, "A big indicator that prepopulating information is not an impossible feat, and that the IRS is actually willing to do it, happened late in the pilot. Relying on information the IRS already had, a Direct File team was successful in making taxpayers' 2023 tax year adjusted gross income information available through Direct File."

Editor's Note: The IRS is continuing to move forward with Direct File. It is a large undertaking to update the program for complex returns and state income tax returns. However, several states, such as Oregon, have an existing solution that will facilitate Direct File integration.

ESOP Expert Failed to Report $22 Million

In Robert W. Smiley Jr. et al. v. Commissioner; No. 29644-12; No. 5314-16; No. 5315-16; No. 5318-16; T.C. Memo. 2024-66, the Tax Court determined that ESOP expert Robert Smiley failed to report over $22 million of income in 2008. The guardian of his estate was liable for taxes, penalties and interest.

Robert Smiley was a Navy veteran, a member of the State Bar of California, a university professor and an expert on employee stock option plans (ESOPs). He was a founder of the ESOP Association, a director of the National Center for Employee Ownership and a trustee of the Employee Ownership Foundation. He also was co-author of a treatise on ESOP law. He owned and managed several business entities that assisted corporations with ESOPs.

One of the strategies for a corporation with an overfunded pension plan was a merger with another pension plan sponsored by an exempt entity. In 2007, Schnadig Corp. (Schnadig), a furniture manufacturer, had an overfunded pension plan. An entity owned by Smiley created a stock acquisition plan and paid $12.9 million to Schnadig and its shareholders for outstanding shares of Schnadig stock and also provided notes that were payable when the assets of Schnadig were sold.

After the acquisition was complete, a new pension plan was funded with approximately $7 million out of the existing overfunded plan. The new pension plan was sufficient to fund benefits for participants.

Smiley then transferred most of the remaining pension balance to three different entities that were claimed to be pension plans but did not comply with federal requirements. The $12.9 million for the purchase of the Schnadig stock had been funded through notes and that amount was repaid to the lenders.

The net result is that approximately $17.4 million was transferred to nonqualified pension entities controlled by Smiley. There also was a distribution from a controlled entity of $5.1 million to Smiley. Neither were reported on his tax return, and he claimed a tax due for 2008 of $473.

The IRS audited Smiley and attempted to follow the extensive and convoluted paper trail. The revenue agent reported that there were extensive difficulties in receiving information from Smiley or his banks. Eventually, the IRS issued a deficiency and the deficiency plus penalty assessment was approximately $15 million.

The Tax Court noted that "[w]hen a taxpayer acquires earnings, lawfully or unlawfully, without the consensual recognition, express or implied, of an obligation to repay and without restriction as to their disposition, he has received income which he is required to return."

In essence, the court determined Smiley had transferred $17.4 million from the plan for his personal benefit, rather than the benefit of plan participants. Because he exercised control over the assets and misappropriated the money for personal use, Smiley "therefore must include it in his gross income for 2008."

Smiley advanced multiple claims to contest the IRS deficiency amounts. He noted the IRS did not disclose the legal basis for the adjustment in its pleadings and did not disclose the methods for calculating the deficiency. In addition, he claimed that even though the assets were misappropriated, there was no taxation without a direct benefit to the taxpayer. Finally, he observed that the IRS revenue agent was inexperienced and not qualified as an actuary in dealing with IRS Form 5500. Finally, Smiley claimed benefits were given to taxpayers other than himself. The court determined that none of these objections were substantive. It held that the $17.4 million transferred from the pension account and $5.1 million transferred from a controlled entity to Smiley were taxable. He was liable for both the $8.4 million deficiency and a Section 6663(a) penalty of 75% for fraud.

Fraudulent intent may be established by circumstantial evidence. Smiley failed to cooperate with the revenue agent, failed to appear for scheduled interviews, failed to produce accounting books and records and went to "considerable lengths to conceal his income and assets." The circumstantial evidence showed that he "acted with fraudulent intent with respect to his underpayment of income tax for 2008."

Therefore, the guardian of Smiley (Smiley was in a memory care facility at the time of trial) was subject to the deficiency and penalties of approximately $15 million.

Editor's Note: The extensive efforts to hide the fraud from the IRS created a comprehensive paper trail that produced circumstantial evidence of fraud. After the Tax Court determined there was fraud, the defenses were not effective.

IRS Moratorium on ERC Program

The Employee Retention Credit (ERC) was designed to encourage employers to retain employees on the payroll during the COVID-19 pandemic. It was initially passed in the CARES Act and later expanded. Under the program, eligible employers could file claims and recover those amounts against employment taxes.

The initial estimated cost of the program was greatly exceeded by the number and dollar value of claims. At the end of 2022, the IRS had 60,000 ERC claims pending. By the end of 2023, there were 1.1 million claims pending. On May 18, 2024, there were 1.4 million ERC claims pending. On September 14, 2023, the IRS became concerned about the number of improper ERC claims and created a moratorium on processing new claims.

Tax firm Stenson Tamaddon requested a preliminary injunction from the U.S. District Court for the District of Arizona. It claimed the IRS "improperly suspended the ERC program in violation of its statutory mandate to refund American businesses under the Congressionally enacted program."

The IRS opposed issuance of an injunction requiring it to proceed with ERC refunds. IRS Deputy Commissioner Douglas O'Donnell indicated the IRS "will process claims that have the highest risk of ineligibility, looking on a first-in first-out basis starting with claims filed before the moratorium."

The IRS estimates 60% to 70% of the 1.4 million pending claims have qualification issues. Therefore, the IRS believes that the moratorium is proper because promoters have been aggressively misleading taxpayers into claiming the ERC, even though many will not qualify.

Editor's Note: Given that the IRS estimates 60% to 70% of ERC claims are not qualified, then at least 30% are qualified. That translates to an estimated 300,000 to 400,000 legitimate ERC claims that have been filed and are waiting to be processed. The IRS may come under increased pressure from Congress to resume processing ERC claims and send payments for legitimate claims.

Applicable Federal Rate of 5.4% for July: Rev. Rul. 2024-13; 2024-28 IRB 1 (17 June 2024)

The IRS has announced the Applicable Federal Rate (AFR) for July of 2024. The AFR under Sec. 7520 for the month of July is 5.4%. The rates for June of 5.6% or May of 5.4% 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 2024, pooled income funds in existence less than three tax years must use a 3.8% deemed rate of return. Charitable gift receipts should state, "No goods or services were provided in exchange for this gift and the nonprofit has exclusive legal control over the gift property."


Published June 21, 2024

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