November is an excellent month to consider plans for charitable gifts in 2022. These gifts could include an IRA charitable rollover, a gift of cash or a gift of appreciated land.
1. IRA Charitable Rollover
— The IRS refers to the IRA charitable rollover as a qualified charitable distribution (QCD). An individual over age 70½ is permitted to make a transfer directly from his or her IRA custodian to a qualified charity. The transfer is not included in taxable income. If the IRA owner is over age 72, the distribution may fulfill part or all of the required minimum distribution (RMD).
Because many individuals have invested their IRAs in stocks, bonds or other securities, it may be necessary to exchange the IRA stock or bond accounts for an IRA money market fund prior to the distribution. Most custodians require a QCD to be paid from a money market account or similar fund.
There are some limits for the IRA charitable rollover. The IRA owner must be at least age 70½ and the maximum transfer in one year is $100,000. The transfer must be to a qualified exempt charity and may be for a designated purpose or field of interest fund. However, the transfer may not be to a donor advised fund (DAF) or supporting organization (SO). Furthermore, it may not be for a charity dinner or other event that involves a partial benefit to the donor. In addition, the entire QCD must be for a qualified charitable purpose.
2. Gifts of Cash
— Individuals who itemize deductions may deduct 2022 gifts of cash up to 60% of their contribution base, which is usually adjusted gross income (AGI). A couple with $100,000 in income may give and deduct up to $60,000 this year. While 60% of AGI limit is substantial, some generous individuals give more than this amount. For gifts that exceed the deduction limit, the IRS permits carry forward of the excess gift amounts over the next five years.
3. Gifts of Land
— With substantial increases in value for real property, many donors will find a gift of appreciated property made in 2022 is attractive. A gift of appreciated land provides two benefits for the donor. First, the donor may receive a charitable contribution deduction based on the fair market value of the land. Second, the charity is tax-exempt and able to sell the asset tax free. Therefore, if the donor donates the asset, the donor can bypass tax on the capital gain. For example, if the donor purchased development land ten years ago for $50,000 and the land is now worth $250,000, the donor would pay capital gains tax on $200,000 if he or she sold the property on their own. By giving the land to charity, however, the donor may receive a deduction for the $250,000 in value and bypass the tax on the $200,000 of potential gain. Because the donor is receiving both the deduction and capital gain bypass benefits, this type of charitable deduction is permitted up to 30% of adjusted gross income (AGI). If the gift value exceeds this limit, it may be carried forward for an additional five years. For example, a donor with adjusted gross income of $100,000 this year makes a gift of appreciated land with a fair market value of $80,000. The donor can deduct $30,000 this year. The donor will carry forward and deduct the remaining $50,000 gift value for up to five additional years.
Many donors make their largest gifts in November or December. This is a good time to plan ahead and consider options for gifts in 2022.
Charitable Easement Case Depositions Approved
In Excelsior Aggregates LLC et al. v. Commissioner
; No. 20608-18; No. 7097-19; No. 7703-19, the Tax Court ruled that the Internal Revenue Service (IRS) could require depositions from two parties and a non-party in a case that involved a conservation easement charitable deduction.
Matthew Ornstein and Frank Schuler IV are both principals of Big Escambia Ventures, LLC (BEV). The other individual, Matthew Kaynard, provided "legal and accounting services related to the transactions at issue; respondent represents that he also reviewed and provided advice regarding the appraisals on which the easement and fee simple valuations were based."
The IRS filed a Motion to Depose Pursuant to Rule 74. This rule states that depositions are extraordinary and normally not available unless "the information sought is otherwise discoverable and cannot be obtained through informal consultation or communication."
The Tax Court determined that Ornstein and Schuler have relevant information on the valuation of the easement, the ability of the LLC to fulfill the Section 170(f)(11)(E)(i)-(ii) gift substantiation requirements and the ability of the LLC to claim a good-faith reliance on professional advice "as the basis for a reasonable cause defense to certain penalties under Section 6664(c)."
Ornstein and Shuler were principals who helped structure, market and promote conservation easements and charitable deductions. There has been extensive discovery involving lawyers, accountants and appraisers involved in the transactions. However, the IRS claimed it must have depositions to obtain the "thoughts, impressions, and knowledge about these documents" related to the conservation easement charitable deduction. The taxpayers responded that the IRS has not made a compelling case and the information had already been provided through discovery. Ornstein and Schuler rejected participating in informal interviews due issues on limiting the scope of the questions.
Matthew Kaynard is a nonparty witness, but he is familiar with the relevant information with respect to the conservation easement and the charitable deductions. The IRS contends that his deposition is also required. Informal interviews were conducted but the limiting conditions that existed were "reasonably viewed as unsatisfactory."
Therefore, the Tax Court ordered the depositions of Ornstein, Schuler and Kaynard to be taken prior to the trial scheduled on December 5, 2022.
The 80 IRS cases on syndicated partnerships that offer charitable conservation easement deductions are moving into a new phase. The IRS previously won most of the cases on technical grounds, but now appear to be moving into the next phase, which will be a determination of the value for the deductions. The BEV case is likely to have significant impact on the other 80 cases as the IRS and taxpayers enter into valuation contests.
IRS Reports $496 Billion Tax Gap
On October 28, 2022, the IRS published a revised estimate of the tax gap for years 2014 through 2016. The tax gap during that period increased to $496 billion. IRS Commissioner Charles Rettig stated that the increased amount in the tax gap "reflects that the IRS needs to do more, both in improving taxpayer service as well as working to improve tax compliance."
The tax gap is generally divided into three parts: non-filers, underreportings and underpayments. The failure of taxpayers to file and pay on time amount was $39 billion, the underreporting of taxable income and capital gains on timely returns led to a $398 billion loss and underpayment of timely filed taxes cost the federal government $59 billion.
However, the net tax gap is a lower amount, based effort by the IRS to collect on the taxes owed during that time period. The IRS estimated that it collected an additional $68 billion of tax eventually, producing a net tax gap of $428 billion. The estimated tax gap for years 2017 to 2019 increased to approximately $540 billion.
Steven M. Rosenthal of the Urban-Brookings Tax Policy Center co-authored a policy report on the tax gap. He noted that taxes were increasing from 2014 through 2016, but the voluntary compliance rate also slightly increased.
The IRS report indicated there is opportunity to improve compliance with corporate income tax, income from LLCs, partnerships, Subchapter S corporations, foreign activities and digital assets. The report noted, "The IRS is actively working on new methods for estimating and projecting the tax gap to better reflect changes in taxpayer behavior."
Commissioner Rettig has indicated the tax gap could be larger than projected. In the hearing before the Senate Finance Committee of April 2021, Rettig stated, "It would not be outlandish to believe that the actual tax gap could approach, and possibly exceed, $1 trillion per year."
He observed the IRS is continuing to work to identify emerging compliance issues. The $80 billion in new funding for the IRS from the Inflation Reduction Act "will help the IRS in many ways, increasing taxpayer education, significantly improving service to all taxpayers and focusing on high-income/high-wealth non-compliance in a fair and impartial manner."
Senate Finance Committee Chair Ron Wyden (D-OR) indicated the IRS report confirms "the urgent need for investment in the IRS to ensure taxes owed are taxes paid." He suggests there are sophisticated avoidance schemes by high-income taxpayers through partnerships and other pass-through entities or overseas accounts that need to be addressed.
There will likely be a debate in the House and Senate in 2023 on tax fairness and the proper level of increased funding for the Internal Revenue Service. This information is offered as a service to our readers.
Applicable Federal Rate of 4.8% for November -- Rev. Rul. 2022-20; 2022-45 IRB 1 (16 October 2022)
The IRS has announced the Applicable Federal Rate (AFR) for November of 2022. The AFR under Section 7520 for the month of November is 4.8%. The rates for October of 4.0% or September of 3.6% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2022, pooled income funds in existence less than three tax years must use a 1.6% deemed rate of return.