Tag: IRS

It Ain’t Over ‘til It’s Over: IRS Reminds Taxpayers That Section 280E Applies to Marijuana Companies Until Rescheduling Becomes Law

This is a tax blog. Stay with me – it’s short.

While marijuana advocates celebrate the potential rescheduling of marijuana from Schedule I to Schedule III, the taxman has made clear that marijuana remains a Schedule I substance subject to Section 280E of the Internal Revenue Code. For those who aren’t cannabis tax specialists, 280E provides that:

No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

Marijuana is a Schedule I controlled substance and is subject to the limitations of the Internal Revenue Code. As we previously reported, the Justice Department recently published a notice of proposed rulemaking with the Federal Register to initiate a formal rulemaking process to consider rescheduling marijuana to Schedule III under the Controlled Substances Act. That change would remove marijuana from the purview of 280E.

Predictably, a number of cannabis operators couldn’t help themselves and began filing amended returns seeking to avail themselves of what they apparently felt was a change in the law. The response from the IRS is clear:

Taxpayers seeking a refund of taxes paid related to Internal Revenue Code Section 280E by filing amended returns are not entitled to a refund or payment. Until a final rule is published, marijuana remains a Schedule I controlled substance and is subject to the limitations of Internal Revenue Code Section 280E.

The reasoning is simple – marijuana is a Schedule I substance until it is not. While there is currently in place a process that could lead to the rescheduling of marijuana, it has not actually been rescheduled.

Cannabis operators can dream of a time when they will not be subject to the ravages of 280E, but for now that remains just out of grasp, albeit tantalizingly close.

As usual, stay tuned to Budding Trends. We’ll be monitoring all the impacts of rescheduling, including tax implications like this one.

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© 2024 Bradley Arant Boult Cummings LLP
For more on Cannabis, visit the NLR Biotech Food Drug section.

Supreme Court Rules Against Taxpayers in IRC Section 965 Case

On June 20, 2024, the Supreme Court of the United States issued a 7-2 opinion in Moore v. United States, 602 U.S. __ (2024), ruling in favor of the Internal Revenue Service (IRS).

Moore concerned whether US Congress and the IRS could tax US shareholders of controlled foreign corporations (CFCs) on those corporations’ earnings even though the earnings were not distributed to the shareholders. The case specifically focused on the so-called “mandatory repatriation tax” under Internal Revenue Code (IRC) Section 965, a one-time tax on certain undistributed income of a CFC that is payable not by the CFC but by its US shareholders. Some viewed the case as hinging upon whether Congress has the power to tax economic gains that have not been “realized.” (i.e., In the case of a house whose value has appreciated from $500,000 to $600,000, the increased value is “realized” only when the house is sold and the additional $100,000 reaches the taxpayer’s coffers.)

However, Justice Brett Kavanaugh, joined by Chief Justice John Roberts and Justices Sonia Sotomayor, Elena Kagan and Ketanji Brown Jackson, rejected that position on the ground that the mandatory repatriation tax “does tax realized income,” albeit income realized by a CFC. On this basis, they reasoned that the question at issue was whether Congress has the power to attribute realized income of a CFC to (and tax) US shareholders on their respective shares of the undistributed income. This group of justices ultimately decided Congress does have the power.

The majority went out of its way to avoid expressing any opinion as to whether Congress can tax unrealized appreciation, with Justice Amy Coney Barrett’s concurrence and Justice Clarence Thomas’s dissent asserting that it cannot. Perhaps the Court was signaling a distaste for the Billionaire Minimum Income Tax proposed by US President Joe Biden, which would impose a minimum 20% tax on the total income of the wealthiest American households, including both realized and unrealized amounts, among other Democratic proposals.

Practice Point: We previously noted that certain taxpayers should consider filing protective refund claims contingent on the possibility that Moore would be decided in favor of the taxpayers. In light of the case’s outcome, however, those protective claims are now moot.

© 2024 McDermott Will & Emery
For more news on US Shareholders of Foreign Corporations Taxes, visit the NLR Tax section.

Treasury Proposes Clean Electricity Tax Guidance

On May 29, 2024, the Internal Revenue Service (IRS) and the Treasury Department released the pre-publication version of proposed guidance to implement “technology-neutral” clean electricity tax credits, including deeming certain technologies as per se zero-emitting and outlining potential methodologies for determining how other technologies—namely those involving combustion or gasification—could qualify as zero-emitting based on a lifecycle emissions analysis (LCA). The Clean Electricity Production Credit (45Y) and Clean Electricity Investment Credit (48E) were enacted in the Inflation Reduction Act (IRA) of 2022 and replace the current production and investment tax credits that are explicitly tied to certain types of renewable energy technologies.

Stakeholders have cited the 45Y and 48E credits as the most important driver of greenhouse gas (GHG) emission cuts possible from the IRA over the next decade. One study by the Rhodium Group found that the credits could reduce the power sector’s GHG emissions by up to 73 percent by 2035. The tax credits aim to give qualifying facilities the ability to develop technologies over time as they reduce emissions and offer longer-term certainty for investors and developers of clean energy projects. This proposed rule, when finalized, will be a critical driver for developers and companies allocating resources among different projects and investments.

The proposed guidance is scheduled to be published June 3, 2024 in the Federal Register, launching a 60-day comment period. A public hearing will be held August 12-13, 2024.

Proposed Guidance Details

Starting in Fiscal Year (FY) 2025 for projects placed into service after Dec. 31, 2024, 45Y provides taxpayers with a base credit of 0.3 cents (1.5 cents, if the project meets prevailing wage and apprenticeship requirements) per kilowatt of electricity produced and sold or stored at facilities with zero or negative GHG emissions. (These per kilowatt credit values are adjusted for inflation using 1990 as the base year.) Under 48E, taxpayers would receive a 6 percent base credit (30 percent, if the project meets prevailing wage and apprenticeship requirements) on qualified investment in a qualified facility for the year the project is placed in service. Both credits include bonus amounts for projects located in historical energy communities, low-income communities, or on tribal land; for meeting certain domestic manufacturing requirements; or for being part of a low-income residential building or economic benefit project. Direct pay and transferability are options for both credits. Both credits are in effect until 2032, when they become subject to a three-year phaseout.

Technologies recognized as per se zero-emissions in the guidance are wind, solar, hydropower, marine and hydrokinetic, nuclear fission and fusion, geothermal, and certain types of waste energy recovery property (WERP). The guidance also outlines how energy storage can qualify, including by proposing definitions of electricity, thermal, and hydrogen storage property.

A principal debate in the proposal is how to determine, using an LCA, whether certain combustion and gasification (C&G) technologies can qualify as zero-emitting.

The guidance includes a set of definitions and interpretations critical to implementation of the tax credits. For example, the proposed C&G definition includes a hydrogen fuel cell if it “produced electricity using hydrogen that was produced by an electrolyzer powered, in whole or in part, by electricity from the grid because some of the electricity from the grid was produced through combustion or gasification.” The proposed C&G definition would also include both biogas- and biomass-based power, but eligibility depends on the LCA results; for biomass, the guidance seeks comment on what spatial and temporal scales should apply and how land use impacts the LCA.

The guidance states that the IRS intends to establish rules for qualifying facilities that generate electricity from biogas, renewable natural gas, and fugitive sources of methane. The guidance says that Treasury and the IRS “anticipate” requiring that, for such facilities, the gas must originate from the “first productive use of the relevant methane.”

The proposed C&G definition allows for carbon capture and storage (CCS) that meets LCA requirements. However, the IRA does not allow credits to go toward facilities already using certain other credits, including the relatively more generous section 45Q credits for CCS.

Specifically, there are seven other credits that cannot be used in combination with a 45Y or 48E credit: 45 (existing clean electricity production credit); 45J (advanced nuclear electricity credit); 45Q (CCS); 45U (zero-emission nuclear credit); 48 (existing clean electricity investment credit); for 45Y, 48E (new clean electricity production credit); and for 48E, 45Y (new clean electricity investment credit).

The guidance proposes beginning and ending boundaries for LCAs, stating “the starting boundaries would include the processes necessary to produce and collect or extract the raw materials used to produce electricity from combustion or gasification technologies, including those used as energy inputs to electricity production. This includes the emissions effects of relevant land management activities or changes related to or associated with feedstock production.” Another topic in the guidance is the use of carbon offsets to reach net-zero qualification status, with the proposal seeking comment on boundaries: “offsets and offsetting activities that are unrelated to the production of electricity by a C&G Facility, including the production and distribution of any input fuel, may not be taken into account” by an LCA. The guidance also includes rules on qualified interconnection costs in the basis of a low-output associated qualified facility, the expansion of a facility and incremental production, and the retrofitting of an existing facility.

The guidance describes the role of the Department of Energy (DOE) in implementing the tax credits. Any future changes to technologies designated as zero-emitting or to the LCA models must be completed with analyses prepared by DOE’s national labs along with other technical experts. Facilities seeking eligibility may also request a “provisional emissions rate,” which DOE would administer with the national labs and experts “as appropriate.”

Next Steps

As noted above, the proposed guidance is scheduled to be published June 3, 2024 in the Federal Register, launching a 60-day comment period for interested parties to make arguments and provide evidence for changes they would like to see before the rule becomes final. A public hearing will be held August 12-13, 2024. The Treasury Department in consultation with interagency experts plans to carefully review comments and continue to evaluate how other types of clean energy technologies, including C&G technologies, may qualify for the clean electricity credits.

© 2024 Van Ness Feldman LLP
For more news on Clean Energy Tax Credits, visit the NLR Environmental, Energy & Resources section.

The Domestic Content Bonus Credit’s Promising New Safe Harbor

On May 16, 2024, the Internal Revenue Service (IRS) published Notice 2024-41 (Notice), which modifies Notice 2023-38 (Prior Notice) by providing a new elective safe harbor (Safe Harbor) that will allow taxpayers to use assumed domestic cost percentages in lieu of percentages derived from manufacturers’ direct cost information to determine eligibility for the domestic content bonus credit (Domestic Content Bonus). The Notice grants a promising reprieve to the Prior Notice’s relatively inflexible (and arguably impracticable) standard on seeking direct cost information from manufacturers, raising novel structuring considerations for energy producers, developers, investors and buyers.

The Notice also expands the list of technologies covered by the Prior Notice (Applicable Projects).

In this article, we share key takeaways from the Notice as they apply to energy producers, developers and investors and provide a brief overview of the Domestic Content Bonus as well as a high-level summary of the Notice’s substantive content.

IN DEPTH

KEY TAKEAWAYS FROM THE NOTICE

The Notice provides a key step forward in eliminating qualification challenges for the Domestic Content Bonus by providing an alternative to the Prior Notice’s stringent requirement of seeking direct cost information from manufacturers. In short, a taxpayer can aggregate the assumed percentages in the Notice that correspond with the US-made manufactured products in its project. If the assumed percentages total is greater than the manufactured product percentage applicable to such project (currently 40%), then the taxpayer is treated as satisfying the manufactured product requirement. Although the Notice promises forthcoming proposed regulations that could amend or override the Notice, this gives taxpayers time to appropriately interpret the latest rules and respond accordingly.

The new guidance’s impact will likely require restructuring to the existing development of energy projects as it relates to the Domestic Content Bonus. Below, we outline some key considerations for energy producers, developers, investors and buyers alike:

  • The Safe Harbor is expected to dramatically increase the availability of the Domestic Content Bonus. The Prior Notice’s challenging cost substantiation requirements left most industry participants on the sidelines. Initial feedback from developers, investors and credit buyers was extremely positive, and we have already seen fulsome renegotiation and speedy agreement between counterparties over domestic content contractual provisions in project documents.
  • While the Safe Harbor eliminates the requirement to seek direct cost information from manufacturers for certain Applicable Projects, a taxpayer’s obligations with respect to substantiation requirements for manufacturers’ US activities is not clear in the Notice. Given the standing federal income tax principles on recordkeeping and substantiation, taxpayers should carefully reconsider positions on diligence and review existing relationships with manufacturers.
  • Although the Notice expressly provides that the Safe Harbor is elective with respect to a specific Applicable Project, it’s unclear whether the Safe Harbor is extended by default to any and all of a taxpayer’s Applicable Projects upon election effect or whether an elective position is required with respect to each Applicable Project. Taxpayers, especially those with multiple Applicable Projects, should consider the various implications resulting from an elective position prior to reliance on the Safe Harbor.
  • For Safe Harbor purposes, the Notice provides a formula for computing a single domestic cost percentage for solar energy property and battery energy storage technologies that are treated as a single energy project (PV+BESS Project), but ambiguity exists as to whether such technologies should be aggregated for other purposes under the investment tax credit.
  • It’s unclear how the calculations would operate for repowered facilities given the assumed domestic cost percentage approach.
  • The Notice limits the Safe Harbor to solar photovoltaic, onshore wind and battery energy storage systems, leaving taxpayers with other types of Applicable Projects stranded with the Prior Notice. For example, the Notice does not cover renewable natural gas or fuel cell. The IRS seeks comments on whether the Safe Harbor should account for other technologies, the criteria and how often the list of technologies should be updated. Affected taxpayers should fully consider the requested comments and provide feedback as necessary.
  • The IRS seeks comments on various issues with respect to taxpayers who have a mix of foreign and domestic manufactured product components (mixed source items). Taxpayers with mixed source items that the Notice attributes as disregarded and entirely foreign sourced (notwithstanding the domestic portion) should take cautionary note and provide feedback as necessary.

BACKGROUND: THE DOMESTIC CONTENT BONUS CREDIT

The Inflation Reduction Act of 2022 spurred the creation of “adder” or “bonus” incentive tax credits. In pertinent part, Applicable Projects could further qualify for an increased credit (i.e., the Domestic Content Bonus) upon satisfaction of the domestic content requirement.

To qualify for the Domestic Content Bonus, taxpayers must meet two requirements. First, steel or iron components of the Applicable Project that are “structural” in nature must be 100% US manufactured (Steel or Iron Requirement). Second, costs associated with “manufactured components” of the Applicable Project must meet the “adjusted percentage” set forth in the Internal Revenue Code (Manufactured Products Requirement). For projects beginning construction before 2025, the adjusted percentage is 40%.

The Prior Notice provided guidance for meeting these requirements. Taxpayers should begin by identifying each “Applicable Project Component” (i.e., any article, material or supply, whether manufactured or unmanufactured, that is directly incorporated into an Applicable Project). Subsequently, taxpayers must determine whether the Applicable Project Component is subject to the Steel or Iron Requirement or the Manufactured Products Requirement.

If the Applicable Project Component is steel or iron, it must be 100% US manufactured with no exception. If the Applicable Project Component is a manufactured product, such component and its “manufactured product components” must be tested as to whether they are US manufactured. If the manufactured product and all its manufactured product components are US manufactured, then the manufacturer’s cost of the manufactured product is included for purposes of satisfying the adjusted percentage. If any of the manufactured product or its manufactured product components are not US manufactured, only the cost to the manufacturer of any US manufactured product components are included.

The core tension lies in sourcing the total costs from the manufacturer of the manufactured product or its manufactured product components. There’s a substantiation requirement on the taxpayer imposed by the Prior Notice, but there’s also a shrine of secrecy from the corresponding manufacturer.

Apparently acknowledging the need for reconciliation, the Notice aims to pave a promising path for covered technologies (i.e., solar, onshore wind and battery storage).

THE MODIFICATIONS: A PROMISING PATH FOR THE DOMESTIC CONTENT BONUS CREDIT

NEW ELECTIVE SAFE HARBOR

Generally

The Safe Harbor allows a taxpayer to elect to assume the domestic percentage costs (assumed cost percentages) for manufactured products. Importantly, the election eliminates the requirement for a taxpayer to source a manufacturer’s direct costs with respect to the taxpayer’s Applicable Project and instead allows for the reliance on the assumed cost percentages. The Notice prohibits any partial Safe Harbor reliance, meaning taxpayers who elect to use the Safe Harbor must apply it in its entirety to the Applicable Project for which the taxpayer makes such election.

The Safe Harbor only applies to the Applicable Projects of solar photovoltaic facilities (solar PV), onshore wind facilities and battery energy storage systems (BESS). Taxpayers with other technologies must continue to comply with the Prior Notice. Notably, the Notice expands Solar PV into four subcategories: Ground-Mount (Tracking), Ground-Mount (Fixed), Rooftop (MLPE) and Rooftop (String), each having differing assumed cost percentages for the respective manufactured product component. Similarly, BESS is expanded into Grid-Scale BESS and Distributed BESS, each with differing assumed cost percentages for the respective manufactured product component.

For solar PV, onshore wind facilities and BESS, the Safe Harbor provides a list via Table 1[1] (Safe Harbor list) that denotes each relevant manufactured product component with its corresponding assumed cost percentage. Each manufactured product component (and steel or iron component) are classified under a relevant Applicable Project Component.

Of note are the disproportionately higher assumed cost percentages of certain listed components within the Safe Harbor list. For solar PV, cells under the PV module carry an assumed cost percentage of 36.9% (Ground-Mount (Tracking)), 49.2% (Ground-Mount (Fixed)), 21.5% (Rooftop (MLPE)) or 30.8% (Rooftop (String)).

For onshore wind facilities, blades and nacelles under wind turbine carry an assumed cost percentage of 31.2% and 47.5%, respectively.

For BESS, under battery pack, Grid-scale BESS cells and Distributed BESS packaging carry an assumed cost percentage of 38.0% and 30.15%, respectively. Accordingly, projects incorporating US manufactured equipment in these categories are likely to meet the Manufactured Products Requirement with little additional spend. Conversely, projects without these components are unlikely to satisfy the threshold.

Mechanics of the Safe Harbor

Reliance on the Safe Harbor is a simple exercise of component selection and subsequent assumed cost percentage addition. Put more specifically, a taxpayer identifies the Applicable Project on the Safe Harbor list and assumes the list of components within (without regard to any components in the taxpayer’s project that are not listed). Then, the taxpayer (i) identifies which of the components within the Safe Harbor list are in their project, (ii) confirms that any steel or iron components on the Safe Harbor list fulfill the Steel or Iron Requirement, and (iii) sums the assumed cost percentages of all identified listed components that are 100% US manufactured to determine whether their Applicable Project meets the relevant adjusted percentage threshold.

The Notice addresses nuances in situations involving mixed 100% US manufactured and 100% foreign manufactured components that are of like-kind, component production costs and treatment for PV+BESS Projects.

The Notice also provides that a taxpayer adjusts for a mix of US manufactured and foreign manufactured components by applying a weighted formula to account for the foreign components.

Consistent with the Prior Notice, the Notice provides that the assumed cost percentage of “production” costs may be summed and included in the domestic cost percentage only if all the manufactured product components of a manufactured product are 100% US manufactured.

Lastly, in accordance with the view that a PV+BESS Project is treated as a single project, the Notice provides that a taxpayer may use a weighted formula to determine a single domestic content percentage for the project.

The numerator is the sum of the (i) aggregated assumed cost percentages of the manufactured product components that constitute the solar PV multiplied by the solar PV nameplate capacity and (ii) aggregated assumed cost percentages of the manufactured product components that constitute BESS multiplied by the BESS nameplate capacity and the “BESS multiplier.” The BESS multiplier converts the BESS nameplate capacity into proportional equivalency (i.e., equivalent units) to the solar PV nameplate capacity. The denominator is the sum of the solar PV nameplate capacity and the BESS nameplate capacity. Divided accordingly, the final fraction constitutes the single domestic content percentage that the taxpayer uses to determine whether its PV+BESS Project meets the relevant manufactured product adjusted percentage threshold.

Additionally, the Notice confirms that taxpayers can ignore any components not included in the Safe Harbor list. Compared with the Prior Notice, this can be a benefit for taxpayers with non-US manufactured products that are not on the Safe Harbor list. Conversely, for taxpayers with US manufactured products that are not on the Safe Harbor list, they lose the benefit of including such costs in the Manufactured Products Requirement. However, this is mostly a benefit because it eliminates any ambiguity surrounding the treatment of components not listed in the Prior Notice.

EXPANSION OF COVERED TECHNOLOGIES

The Notice adds “hydropower facility or pumped hydropower storage facility” to the list of Applicable Projects as a modification to Table 2 in the Prior Notice. The modification is complete with a list of a hydropower facility or pumped hydropower storage facility’s Applicable Project Components that are delineated as either steel or iron components or manufactured products, though no assumed cost percentages are provided. Further, the Prior Notice’s “utility-scale photovoltaic system” is redesignated as “ground-mount and rooftop photovoltaic system.”

CERTIFICATION

To elect to rely on the Safe Harbor, in its domestic content certification statement, a taxpayer must provide a statement that says they are relying on the Safe Harbor. This is submitted with the taxpayer’s tax return.

RELIANCE AND COMMENT PERIOD

Taxpayers may rely on the rules set forth in the Notice and the Prior Notice (as modified by the Notice) for Applicable Projects, the construction of which begins within 90 days after the publication of intended forthcoming proposed regulations.

Comments should be received by July 15, 2024.

CONCLUSION

While this article provides a high-level summary of the substantive content in the Notice, the many potential implications resulting from these developments merit additional attention. We will continue to follow the development of the guidance and provide relevant updates as necessary.

© 2024 McDermott Will & Emery
For more news on IRS Taxpayer Safe Harbor, visit the NLR Tax section.

Death, Taxes, and Crypto Reporting – The Three Things You Cannot Escape

The IRS released a draft of Form 1099-DA “Digital Asset Proceeds from Broker Transactions” in April which will require anyone defined as a “broker” to report certain information related to the sale of digital assets. The new reporting requirements will be effective for transactions occurring in 2025 and beyond. The release of Form 1099-DA follows a change in the tax law.

In 2021, Congress amended code section 6045 to define “broker” to include any “person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” This is an expansion of the definition of a “broker.” The language ‘any service effectuating transfers of digital assets’ is oftentimes construed by many in the tax practitioner community as a catch-all term, in which the government could use to determine many people involved in digital asset platforms aa “brokers.”

The IRS proposed new regulations in August 2023 to further define and clarify the new reporting requirements. Under the proposed regulations, Form 1099-DA reporting would be required even for noncustodial transactions including facilitative services if the provider is in a “position to know” the identity of the seller and the nature of the transaction giving rise to gross proceeds. With apparently no discernible limits, facilitative services include “services that directly or indirectly effectuate a sale of digital assets.” Position to know means “the ability” to “request” a user’s identifying information and to determine whether a transaction gives rise to gross proceeds. Under these proposed regulations and the expanded definition of “broker,” a significant number of transactions that previously did not require 1099 reporting will now require reporting. There has been pushback against these proposed regulations, but the IRS appears determined to move forward with these additional reporting requirements.

Copyright ©2024 Nelson Mullins Riley & Scarborough LLP
For more news on Taxes and Crypto Reporting, visit the NLR Tax section.

How Big is the Permanent Tax Benefit in the Pending Tax Bill for Research Credit?

Congress perhaps made an unintended drafting error in the Tax Cuts and Jobs Act [1] (TCJA) when it required a taxpayer to decrease its deduction for research and experimental expenditures. The apparent drafting error is in IRC §280C(c)(1), which provides that if a taxpayer’s research credit for a taxable year exceeds the amount allowable as a deduction for research expenditures for the taxable year, the amount of research expenses chargeable to capital account must be reduced by the excess and not by the full amount of the credit.

H.B. 7024 (1-17-24) [2] proposes to correct the drafting error for tax year 2023 and expressly states that the amendment made for taxable year 2023 should not be construed to create an inference with respect to the proper application of the drafting error for taxable year 2022. [3] The “no inference” congressional language could be interpreted as inviting the IRS to attempt an administrative fix of the drafting error.

Background of Research Expenditure Deduction and Credit for Increasing Research Activities: Beginning with the Internal Revenue Code of 1954, a taxpayer engaging in research activities in the experimental or laboratory sense in connection with its trade or business could elect to deduct the cost of its research currently rather than capitalizing the cost to the project for which the research was conducted. The Economic Recovery Tax Act of 1981 added a credit for the cost of research incurred in carrying on a trade or business. The manner in which the deduction and credit operated permitted a taxpayer both to deduct and credit the same research dollar.

Pre-TCJA (2017) law: The Omnibus Budget Reconciliation Act of 1989 ended the possibility deducting and crediting the same research dollar. If a taxpayer currently deducted its research expenditures, the taxpayer had to decrease its deduction by the amount of the research credit that it claimed for the taxable year.[4] The policy reason for the decrease was that a taxpayer should not be entitled to a deduction and a credit for the same dollar expended for research. Put another way, if the government “pays” for research by allowing a credit, the taxpayer did not really pay for the research and should not be entitled to deduct the amount for which the government paid.

TCJA Amendment: The TCJA now requires a taxpayer to capitalize research expenditures paid or incurred in the taxable year and claim an amortization deduction for the expenditures ratably over a five-year period.[5] The TCJA also amended IRC §280C(c)(1), the provision that prevents a taxpayer from receiving a credit and a deduction for the same dollar of research expenditure. The amendment provides that if the research credit amount for the taxable year exceeds the amount allowable as a deduction for the taxable year for qualified research expenses, the research expenses chargeable to capital account for the taxable year must be reduced by the excess.[6] This might have been a drafting error. The research credit for the taxable year might not exceed an amortization deduction for the year.[7] If for a taxable year the credit does not exceed the amortization deduction, a taxpayer could reasonably conclude that no reduction in the amount of capitalized research expenditures is required. The taxpayer would be interpreting the deduction for qualified research expenses as meaning the amount of the amortization of the capitalized expenses.

The IRS might have an opposing interpretation. The phrase, “the amount allowable as a deduction for such taxable year for qualified research expenses” in IRC §280C(c)(1) could be interpreted as always equaling zero because the TCJA amendment requiring amortization of research expenditures for the taxable year nullifies the “deduction … for qualified research expenses.” In other words, there were no “deductible” qualified research expenses for the year after enactment of the TCJA for purposes of IRC §280C(c)(1). [8] The result would be that the capitalized research expenses are decreased by the amount of the credit.

H.B. 7024: On January 31, 2024, the House passed 353 to 70 H.B. 7024, “Tax Relief for American Families and Workers Act of 2024.” Action on the bill is pending in the Senate. The bill restores the current deduction for research expenditures (but only for research performed in the United States), beginning with taxable year 2022,[9] and defers the requirement to amortize research expenditures until taxable year 2026. For taxable years beginning in 2023, the bill requires a taxpayer to decrease the research expenditure deduction for domestic research by the amount of the research credit for the year, thus reinstating, for domestic research, IRC §280C(c)(1) as it had read prior to its amendment by the TCJA. [10]

But for taxable year 2022, the bill does not expressly require a taxpayer to reduce its deduction for research expenditures by the amount of the research credit even though the bill permits the taxpayer to deduct it research expenditures currently for taxable year 2022. Thus, for taxable year 2022, a taxpayer may deduct its research expenditures but must decrease the deduction only by the amount, if any, that its 2022 research credit exceeds its 2022 deduction for qualified research expenditures, which amount may be zero. Moreover, the bill provides that the amendment requiring a decreased deduction for research expenditures for taxable years beginning in 2023 should not be construed to create “any inference” with respect to the proper application of IRC §280C(c) to taxable year 2022.

IRS Notice: In Notice 2023-63 – obviously published before H.R. 7024 – the IRS asks for comments about to interpret the current version of IRC §280C(c)(1). If H.R. 7024 is enacted, the IRS request for comments would appear irrelevant.

Taxpayer Actions: If H.R. 7024 is enacted, taxpayers must consider whether to change their accounting method for research expenditures from amortizing them to currently deducting them. A change would affect many tax calculations, and obviously the only means by which to be certain of the effect is to run the change using various scenarios through the taxpayer’s tax software.

One of the effects to consider if the bill passes is the item discussed in the alert in which the taxpayer reads IRC §280C(c)(1) advantageously for taxable year 2022 and reduces its research expenditure deduction by the amount that the research credit exceeds the deduction for research expenditures for the year, which reduction amount may well be zero. The taxpayer would have a substantial permanent tax benefit by not decreasing its credit and not decreasing it deduction.

If H.B. 7024 is not enacted, a taxpayer might moderate the risk that the IRS will prevail on the interpretation of IRC §280C(c)(1) by electing to decease its credit under IRC §280C(c)(2).[11] But the taxpayer could be more aggressive by taking the position that it is applying IRC §280C(c)(1) and rarely, if ever, does it have to reduce its deduction for research expenditures. That means that the taxpayer that had historically decreased its credit in order to take the full deduction might not have to do so. That might be a very substantial permanent tax benefit.

[1] P.L. 115-97 115th Cong. 1st Sess. (12-22-17).

[2] 118th Cong., 2d Sess.

[3] H.B. 7024, Sec. 201(e)(4).

[4] Instead of decreasing the deduction, the taxpayer could elect to decrease its research credit by multiplying the credit amount by the corporate tax rate. IRC §280C(c)(2). Regardless of whether the taxpayer reduced its deduction or its credit, the federal income tax cost was the same. Many taxpayers elect to reduce the credit so that the full amount of the deduction flows into taxable income of states that conform state taxable income to federal taxable income.

[5] IRC §174(a)(2)(B). The deduction is spread over six taxable years because the taxpayer may deduct for the first amortization year only half of a full year’s amortization. If the research is performed outside the United States, the amortization period is fifteen years.

[6] IRC §280C(c)(1).

[7] For example, assume qualified research expenses for the taxable year 2022 of $1,000 and minimum base amount of $500. The research credit is $100 (20% times $500). The credit does not exceed the amortized deduction – $100 for the first taxable year.

[8] Of course, there were qualified research expenses identified for the research credit.

[9] Proposed IRC §174A(a). A taxpayer that had capitalized and amortized its research expenditures as required by the TCJA may file an amended return for tax year 2022 and deduct research expenditures paid or incurred for that year. Alternatively, the taxpayer may elect to adjust its taxable income under IRC § 481 by taking a favorable adjustment into account in taxable year 2023. Alternatively, it may elect to make the adjustment over taxable years 2023 and 2024. H.B. 7024, sec. 201(f)(2).

[10] The taxpayer could still elect to decrease its credit in lieu of reducing its deduction.

[11] See supra note 4.

© 2024 Miller, Canfield, Paddock and Stone PLC
For more on the Research Credit Tax Bill, visit the NLR Tax section.

Staying on Course: Navigating Election Year Issues for Exempt Organizations

With the 2024 election cycle underway, it is important for exempt organizations to understand and comply with relevant restrictions on political campaign activities to safeguard their tax-exempt status and avoid triggering excise tax penalties. This alert provides an overview of the political campaign rules applicable to exempt organizations and specifically highlights the restrictions on political campaign activities applicable to Section 501(c)(3), 501(c)(4), and 501(c)(6) organizations.

Restrictions on Political Activities

Exempt organizations are subject to certain restrictions regarding their participation in political campaign activities, and the amount of permissible participation is a key distinction between Section 501(c)(3), 501(c)(4), and 501(c)(6) organizations. To comply with these restrictions, an exempt organization must (1) know their specific tax-exempt status and the restrictions that apply to them, (2) understand what activities constitute political campaign activities, (3) avoid activities that violate the applicable restrictions, and (4) mitigate the risk that activities conducted by employees in their individual capacities are attributed to the organization.

Prohibited Political Campaign Intervention for Section 501(c)(3) Organizations

Section 501(c)(3) organizations are subject to an absolute prohibition on participation or intervention in political campaign activities. Organizations that violate this ban are subject to the revocation of their tax-exempt status and the imposition of excise tax penalties on both the organization itself and organization managers who approve expenditures used for impermissible political purposes. Therefore, Section 501(c)(3) organizations must avoid activities that violate the prohibition on political campaign intervention.

Prohibited political campaign intervention occurs when an exempt organization “participates in, or intervenes in” a “candidate’s” campaign for “public office” (Section 501(c)(3)).

The term “candidate” refers to any person who has declared an intent to run for national, state, or local office and likely includes incumbents until they announce an intention not to run. A candidate also includes individuals who have yet to declare an intention to run for public office, but whose potential candidacy generates significant public speculation. The term “public office” broadly refers to any national, state, or local elective office, as well as any elected position in a political party.

An organization is considered to “participate in, or intervene in” political campaign activity by making contributions to political campaign accounts or making public statements on behalf of the organization in favor of or in opposition to a candidate for public office. Specifically, the Internal Revenue Service (IRS) regulations define participation in a political campaign as “publication or distribution of written or printed statements or the making of oral statements on behalf of or in opposition to . . . a candidate” (Treas. Reg. § 1.501(c)(3)-1(c)(3)(iii)). The IRS regulations also note that political campaign intervention is not limited to these specified activities.

The IRS has interpreted prohibited political campaign intervention to include even some nonpartisan educational activities. For example, the IRS has ruled that an organization that was formed to promote public education violated the prohibition on political campaign activities when it announced the names of the school board candidates it considered most qualified following an objective review of the candidates’ qualifications (Rev. Rul. 67-71, 1967-1 C.B. 125).

These restrictions on political campaign activities do not extend to the officers, directors, or employees of a 501(c)(3) organization, provided they are acting in their individual capacities. It is particularly important, however, to mitigate the risk that any personal political activities conducted by officers, directors, or employees will be attributed to the organization. An exempt organization should ensure their employees do not use institutional resources to engage in personal political campaign activities or act in a manner that suggests they are speaking on behalf of the organization when engaged in campaign advocacy. Exempt organizations should adopt clear policies regarding political activities and institutional resources and communicate the importance of such policies to employees during an election year.

Permissible Political Activities

Some educational activities that are election-related are permissible, however, and will not be considered prohibited campaign intervention. In order to be considered “educational,” the activities must present “a sufficiently full and fair exposition of the pertinent facts” (Treas. Reg. § 1.501(c)(3)-1(d)(3)). The information presented must “permit an individual or the public to form an independent opinion or conclusion” and not be biased. Activities that satisfy this definition may be considered permissible educational activities rather than prohibited or restricted political activities.

The following types of educational activities, although election-related, are generally permissible:

  • Voter Registration: Voter registration drives are not considered political campaign activities if they are conducted in a nonpartisan and fair manner. An organization conducting the voter registration drive should not expressly advocate for or against any candidates or political parties as part of the voter registration. They also generally should not name candidates or provide their party affiliations. If any candidates are named, all candidates should be named. All persons interested in registering must also be permitted to register, regardless of their political preference or party affiliation.
  • Voter Education: Certain forms of voter education, such as the distribution of voter guides and voting records, may qualify as an educational activity provided the organization avoids editorial commentary and ensures the materials cover a broad range of issues. Organizations must not demonstrate a preference toward a certain candidate or only cover a narrow range of issues when engaging in voter education activities.
  • Candidate Debates and Forums: Providing a fair, neutral forum for candidate debates may qualify as an educational activity so long as the debate provides equal time to all qualified candidates. Organizations should be particularly careful to include all qualified candidates, cover a broad range of topics, have a nonpartisan group compose the questions, and clarify that the candidates’ views are not the views of the exempt organization. The moderator selected by the organization can ensure the candidates follow the ground rules for the debate, but they should not ask questions or comment on the candidate’s statement in a way the indicates support or opposition to the candidate or their positions.

Section 501(c)(4) Organizations

Section 501(c)(4) social welfare organizations have more latitude to engage in political campaign activities than Section 501(c)(3) organizations. Section 501(c)(4) organizations are not subject to an absolute ban on campaign intervention, but instead are permitted to engage in some limited political activities, provided they remain primarily engaged in social welfare activities. The IRS will compare an organization’s political activities and expenditures (plus its non-exempt activities) with its social welfare activities to determine whether the organization remains primarily engaged in promoting social welfare consistent with its tax-exempt status. Accordingly, Section 501(c)(4) organizations should maintain records to ensure they remain primarily engaged in social welfare activities during an election year. If a Section 501(c)(4) organization engages in political activities, it must also provide its members with a notice of how much of their dues were used towards political activities and determine the proxy tax on those expenditures. If member dues are used for political campaign activities, then a portion of the dues may not be a deductible business expense under Section 162.

Section 501(c)(6) Organizations

Business leagues described in Section 501(c)(6) are subject to the same less-stringent rules regarding political campaign activities as Section 501(c)(4) organizations. Section 501(c)(6) organizations may engage in some political activities on a limited basis, provided such political activities are not the organization’s primary activity. If a Section 501(c)(6) organization engages in political activities, it must also provide its members with a notice of how much of their dues were used towards political activities and determine the proxy tax on those expenditures. If member dues are used for political campaign activities, then a portion of the dues may not be a deductible business expense under Section 162.

Related Restrictions

The scope of this alert is limited to restrictions on political campaign activities under federal tax law. Exempt organizations are also subject to campaign finance restrictions and requirements by the Federal Election Commission, as well as rules regarding legislative or lobbying activities imposed by the IRS, the Lobbying Disclosure Act of 1995, and other federal, state, and local laws, which are beyond the scope of this alert.

© 2024 ArentFox Schiff LLP
For more news on Restrictions for Tax-Exempt Organizations during Election Years, visit the NLR Tax section.

Wealth Management Update January 2024

JANUARY 2024 INTEREST RATES FOR GRATS, SALES TO DEFECTIVE GRANTOR TRUSTS, INTRA-FAMILY LOANS AND SPLIT INTEREST CHARITABLE TRUSTS

The January applicable federal rate (“AFR”) for use with a sale to a defective grantor trust, self-canceling installment note (“SCIN”) or intra-family loan with a note having a duration of 3-9 years (the mid-term rate, compounded annually) is 4.37%, down from 4.82% in December 2023.

The January 2024 Section 7520 rate for use with estate planning techniques such as CRTs, CLTs, QPRTs and GRATs is 5.20%, down from the 5.80% Section 7520 rate in December 2023.

The AFRs (based on annual compounding) used in connection with intra-family loans are 5.00% for loans with a term of 3 years or less, 4.37% for loans with a term between 3 and 9 years, and 4.54% for loans with a term of longer than 9 years.

REG-142338-07 – PROPOSED REGULATIONS RELATED TO DONOR ADVISED FUNDS

On November 13, 2023, the Department of the Treasury and IRS released Proposed Regulation REG-142338-07 under Section 4966; providing guidance related to numerous open-issues with respect to certain tax rules relating to donor advised funds “(DAFs”).

Pursuant to §4966(d)(2)(A), a DAF is defined generally as a fund or account (1) that is separately identified by reference to contributions of a donor or donors, (2) owned and controlled by a sponsoring organization, and (3) with respect to which a donor (or person appointed or designated by such donor) has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of amounts held in the fund or account by reason of the donor’s status as a donor.

Under the proposed regulations, the definition of a DAF is consistent with the definition under the statute (the same three elements), however, the proposed regulations provide key definitions with respect to specific terms under the Statute.

Element #1: a fund that is separately identified by reference to contributions of a donor or donors.

Separately Identified: The proposed regulations provide that a fund or account is separately identified if the sponsoring organization maintains a formal record of contributions to the fund relating to a donor or donors (regardless of whether the sponsoring organization commingles the assets attributed to the fund with other assets of the sponsoring organization).

If the sponsoring organization does not maintain a formal record, then whether a fund or account is separately identified would be based on all the facts and circumstances, including but not limited to whether: (1) the fund or account balance reflects items such as contributions, expenses and performance; (2) the fund or account is named after the donors; (3) the sponsoring organization refers to the account as a DAF; (4) the sponsoring organization has an agreement or understanding with the donors that such account is a DAF; and (5) the donors regularly receive a statement from the sponsoring organization.

Donor: The proposed regulations broadly define a Donor as any person described in 7701(a)(1) that contributes to a fund or account of a sponsoring organization. However, the proposed regulations specifically exclude public charities defined in 509(a) and any governmental unit described in 170(c)(1). Note: Private foundations and disqualified supporting organizations are not excluded from the definition of a donor since they could use a DAF to circumvent the payout and other applicable requirements.

Element #2: a fund that is owned or controlled by a sponsoring organization. The definition of a sponsoring organization is consistent with §4966(d)(1), specifically, an organization described in §170(c), other than a private foundation, that maintains one or more DAFs.

Element #3: a fund under which at least one donor or donor-advisor has advisory privileges.

Advisory Privileges: In general, the existence of advisory privileges is based on all facts and circumstances, but it is presumed that the donor always has such privileges (even if no advice is given).

The proposed regulations provide that advisory privileges exist when: (i) the sponsoring organization allows a donor or donor-advisor to provide nonbinding recommendations regarding distributions or investments of a fund; (ii) a written agreement states that a donor or donor-advisor has advisory privileges; (iii) a written document or marketing material provided to the donor or donor-advisor indicates that such donor or donor-advisor may provide advice to the sponsoring organization; or (iv) the sponsoring organization generally solicits advice from a donor or donor-advisor regarding distributions or investment of a DAF’s assets.

Donor-Advisor: Defined by the proposed regulations as a person appointed or designated by a donor to have advisory privileges regarding the distribution or investment of assets held in a DAF. If a donor-advisor delegates any of the donor-advisor’s advisor privileges to another person, such person would also be a donor-advisor.

Potential Issue related to Investment Advisors: Is a donor’s personal investment advisor deemed a “donor-advisor?” Pursuant to the proposed regulations:

  • An investment advisor will not be deemed a donor-advisor if he or she:
    • Serves the supporting organization as a whole; or
    • Is recommended by the donor to serve on a committee (of more than 3) of the sponsoring organization that advises as to distributions
  • However, an investment advisor will be deemed a donor-advisor if he or she manages the investments of, or provides investment advice with respect to, both assets maintained in a DAF and the personal assets of a donor to that DAF while serving in such dual capacity. This provision, if finalized may have important consequences for fee structures used by supporting organizations since payments from a DAF to an investment advisor who is considered a donor-advisor will be deemed a taxable distribution under §4966. The IRS is requesting additional comments on this potential issue and is still under consideration.

Exceptions to the Definition of a DAF Under the Proposed Regulations:

  • A multiple donor fund or account will not be a DAF if no donor or donor-advisor has, or reasonably expects to have, advisory privileges.
  • An account or fund that is established to make distributions solely to a single public charity or governmental entity for public purposes is not considered a DAF.
  • A DAF does not include a fund that exclusively makes grants for certain scholarship funds related to travel, study or other similar purposes.
  • Disaster relief funds are not DAFs, provided they comply with other requirements.

Applicability Date: The proposed regulations will apply to taxable years ending on or after the date on which final regulations are published in the Federal Register.

EILEEN GONZALEZ ET AL V. LUIS O. CHIONG ET AL (SEP. 19, 2023)

Miami Circuit Court enters significant judgment for liability related to ownership of golf cart.

Eileen Gonzalez and Luis Chiong and their families were neighbors in a Miami suburb. The families were good friends and had many social interactions. Luis owned a golf cart which he constantly allowed to be driven and used by other people and Eileen’s minor children were often passengers on this specific golf cart.

Luis’ step-niece, Zabryna Acuna, was visiting for July 4th weekend in 2016. Zabryna (age 16 at that time) visited often and during each visit, she had permission to drive the golf cart. On July 4, 2016, Zabryna took the golf cart for a drive with Luis’ son and Eileen’s minor children as passengers.

While driving on a public street, Zabryna ran a stop sign and collided with another car which caused all of the passenger to be ejected from the golf cart. Every passenger suffered injuries, however, Eileen’s son, Devin, suffered a particularly catastrophic brain injury. This led to an eventual lawsuit.

The Circuit Court ruled that Luis owed the plaintiffs a duty of reasonable care which he breached and was negligent in entrusting the golf cart to his niece who negligently operated it causing the crash and injuries at issue. The Court further held that pursuant to the Florida Supreme Court, a golf cart is a dangerous instrumentality, and the dangerous instrumentality doctrine imposes vicarious liability upon the owner of a motor vehicle who voluntarily entrusts it to an individual whose negligent operation if it causes damage to another.

Ultimately, the Court awarded a total judgment of $50,100,000 (approximately $46,100,000 to Devin and approximately $4,000,000 to his parents).

IR-2023-185 (OCT 5, 2023)

The IRS warns of Art Valuation Schemes (Oct 5, 2023).

The IRS essentially issued a warning to taxpayers that they will be increasing investigations and taxpayer audits for incorrect or aggressively creative deductions with respect to donations of art. Additionally, the IRS is paying attention to art promoters who are involved in such schemes.

The IRS is warning taxpayers to exercise caution when approached by art promoters who are commonly attempting to facilitate the following specific scheme wherein: (i) a taxpayer is encouraged to purchase art at a significantly discounted price; (ii) the taxpayer is then advised to hold the art for a period of at least one year; and (iii) the taxpayer subsequently donates the art to a charity (often times a charity arranged by the promoter) and claim a tax deduction at an inflated market value, often significantly more than the original purchase price.

This increased scrutiny has led to over 60 completed audits with many more in process and has led to more than $5,000,000 in additional tax.

The IRS reminds taxpayers that they are ultimately responsible for the accuracy of the information reported on their tax return regardless of whether they were enticed by an outside promoter. Therefore, the IRS has provided the following red flags with respect to the purchase of artwork: (i) taxpayers should be wary of buying multiple works by the same artist that have little to no market value outside of what a promoter is advertising; and (ii) when the appraisal coordinated by a promoter fails to adequately describe the artwork (such rarity, age, quality, condition, stature of the artist, etc.).

Within the Notice, the IRS details the tax reporting requirements for donations of art. Specifically, whenever a taxpayer intends to claim a charitable contribution deduction of over $20,000 for an art donation, they must provide the following: (i) the name and address of the charitable organization that received it; (ii) the date and location of the contribution; (iii) a detailed description of the donated art; (iv) a contemporaneous written acknowledgement of the contribution form the charitable organization; (v) completed Form 8283, Noncash Charitable Contribution, Section A and B including signatures of the qualified appraiser and done; and (vi) attach a copy of the qualified appraisal to the tax return. They may also be asked to provide a high-resolution photo or digital image.

NEW YORK PUBLIC HEALTH LAW AMENDED TO PERMIT REMOTE WITNESSES FOR HEALTH CARE PROXIES (NOV 17, 2023)

An amendment to Section 2981 of New York Public Health Law was signed into law by the governor on November 17, 2023.

Section 2981 was amended to add a new subdivision 2-a, as follows:

2-A. Alternate procedure for witnessing health care proxies. Witnessing a health care proxy under this section may be done using audio-video technology, for either or both witnesses, provided that the following conditions are met:

  1. The principal, if not personally known to a remote witness, shall display valid photographic identification to the remote witness during the audio-video conference;
  2. The audio-video conference shall allow for direction interaction between the principal and any remote witness;
  3. Any remote witness shall receive a legible copy of the health care proxy, which shall be transmitted via facsimile or electronic means, within 24 hours of the proxy being signed by the principal during the conference; and
  4. The remote witness shall sign the transmitted copy of the proxy and return it to the principal.

SMALL BUSINESS SUCCESSION PLANNING ACT INTRODUCED (OCT 12, 2023)

On October 12, 2023, the Small Business Succession Planning Act was introduced to provide businesses with resources to plan successions, including a one-time $250 credit to create a business succession plan and an additional one-time $250 tax credit when the plan is executed.

Under the proposed Bill, the SBA will provide a “toolkit” to assist small business concerns in establishing a business succession plan, including:

  1. Training resource partners on the toolkit;
  2. Educating small business concerns about the program;
  3. Ensuring that each SBA district office has an employee with the specific responsibility of providing counseling to small business concerns on the use of such toolkit; and
  4. Hold workshops or events on business succession planning.

Pursuant to the proposed Act, the following credits would be available:

  1. $250 for the first taxable year during which the SBA certifies that the taxpayer has: (a) established a business succession plan; (b) is a small business concern at that time; and (c) does not provide for substantially all of the interests or assets to be acquire by one or more entities that are not a small business concern.
  2. An additional $250 for the first taxable year which the SBA certifies that the taxpayer has successfully completed the items described above.

Look-back Rule: If substantially all of the equity interests in business are acquired by an entity that is not a small business concern within three-years of establishment of a business succession plan or completion of such responsibilities (as the case may be) the credits will be subject to recapture.

Small Business Concern (defined under Section 3 of the Small Business Act): A business entity that (a) is legal entity that is independently owned and operated; and (b) is not dominant in its field of operation and does not exceed the relevant small business size standard (subject to standards and number of employees provided by the North American Industry Classification System).

Henry J. Leibowitz, Caroline Q. Robbins, Jay D. Waxenberg, and Joshua B. Glaser contributed to this article.

© 2023 Proskauer Rose LLP.
For more news on Wealth Management in 2024, visit the NLR Financial Institutions & Banking section.

IRS Process for Withdrawing Employee Retention Credit Claims

On October 19, 2023, the IRS announced a process which is intended to allow employers who were pressured or misled by marketers or promoters into filing ineligible claims for the Employee Retention Credit (ERC), but who have not yet received a refund, to withdraw their claim. This process permits employers whose ERC claims are still being processed to withdraw their refund claims and avoid the potential that the IRS would deny the claim after the credit is received, thus avoiding the need to repay any refunded amounts, and avoiding potential interest and penalties.

When properly claimed, the ERC is a refundable tax credit designed for employers that were fully shut down or partially suspended due to the COVID-19 pandemic or that had a significant decline in gross receipts during the eligibility periods.

The move to permit the withdrawal of claims comes after the IRS placed abusive ERC promotions on its Dirty Dozen, an annual list aimed at helping raise awareness to protect honest taxpayers from aggressive promoters and con artists. After placing abusive ERC promotions on the Dirty Dozen, on September 14, 2023, the Commissioner of the IRS ordered that processing of any new ERC claims be stopped until December 31, 2023. However, the IRS stated that it would continue to process and pay out previously filed eligible ERC claims, as well as audit ERC claims and pursue criminal investigations of promoters and businesses filing dubious claims.

Who Can Withdraw an ERC Claim
To be eligible to withdraw an ERC claim, an employer must meet all of the following criteria:

  1. The ERC must have been claimed using an adjusted employment return, i.e. Forms 941-X, 943-X, 944-X, or CT-1X
  2. The ERC must be the only adjustment claimed on the return
  3. The employer must withdraw the entire amount of the ERC claim (this refers to each calendar quarter, rather than all calendar quarters, for which an ERC claim was made)
  4. The ERC claim cannot have been paid by the IRS or, if it has been paid, the employer has not yet cashed or deposited the refund check

How to Withdraw an ERC Claim

The notice provides a step-by-step menu for withdrawing a claim.  If the employer filed adjusted returns to claim ERCs for more than one calendar quarter and wishes to withdraw all ERC claims, it must follow the steps below for each calendar quarter for which it is requesting a withdrawal.  The IRS also has a dedicated page with sample form, which can be found here.

Employers that have not received a refund and have not been notified their claim is under audit may request a withdrawal by following these steps:

  1. Make a copy of the adjusted return with the claim you wish to withdraw
  2. In the left margin of the first page, write “Withdrawn”
  3. In the right margin of the first page:
    • Have an authorized person sign and date it
    • Write their name and title next to their signature
  4. Fax the signed copy of your return using your computer or mobile device to the IRS’s ERC claim withdrawal fax line at 855-738-7609.  The employer should keep a copy with its tax records.  The notice even provides a template for a simple claim withdrawal request.

Employers that have not received a refund and have been notified of an audit can still withdraw ERC claims using the above procedure, but must check with their examiner about how to fax or mail the withdrawal request directly to the examiner or, if an examiner has not yet been assigned, should respond to the audit notice with the withdrawal request, using the instructions in the notice for responding.

Special instructions are also included in the notice for employers that have received a refund check but have not cashed or deposited it.

Once a withdrawal is submitted, the employer should expect to receive a letter from the IRS about whether their withdrawal request was accepted or rejected.  A withdrawal is not effective until accepted by the IRS.  If the IRS accepts the withdrawal, the employer may need to amend its income tax return (if it previously amended that return to reflect ERCs that had been claimed).

ERC Refunds Already Received

Employers that are not able use the above withdrawal process may still be able to file another adjusted return if they need to:

  • Reduce the amount of their ERC claim
  • Make other changes to their adjusted return

However, it should be noted that the IRS is also working on separate guidance for ineligible employers that were misled into making ERC claims and have already received the payment.

Continued Risk for Fraudulent Claims

Withdrawn ERC claims will be treated as if they were never filed and the IRS will not impose penalties or interest.  However, ineligible employers should note that withdrawing an ERC claim will not remove the possibility that they or their advisor could be subject to potential criminal investigation or prosecution for filing a fraudulent ERC claim.

Copyright ©2023 Nelson Mullins Riley & Scarborough LLP
For more news on Employee Retention Claims, visit the NLR Labor & Employment section.

Taxpayer Makes Offer, But IRS Refused

James E. Caan, the movie actor most famous for playing Sonny Corleone in The Godfather, got into IRS trouble regarding the attempted tax-free rollover of his IRA.

Caan had two IRA accounts at UBS, a multinational investment bank and financial services company. One account held cash, mutual funds and exchange-traded funds (ETF) and the other account held a partnership interest in a hedge fund called P&A Multi-Sector Fund, L.P.

Because the hedge fund was a non-publicly traded investment, UBS required Caan to provide UBS with the year-end fair market value to prepare IRS Form 5498. Caan never provided the fair market value as of December 31, 2014. UBS issued a number of notices and warnings to Caan and finally on November 25, 2015, UBS resigned as custodian of the P&A Interest. UBS issued Caan a 2015 Form 1099-R reporting a distribution of $1,910,903, which was the value of the P&A Interest, used as of December 31, 2013. Caan’s 2015 tax return reported the distribution as nontaxable.

In June 2015, Caan’s investment advisor Michael Margiotta resigned from UBS and began working for Merrill Lynch. In October 2015, Margiotta got all UBS IRA assets to transfer to a Merrill Lynch IRA, except for the P&A Interest. The P&A Interest was ineligible to transfer through the Automated Customer Account Transfer Service. In December 2016, Mr. Margiotta directed the P&A Fund to liquidate the P&A Interest and the cash was transferred to Caan’s Merrill Lynch IRA in three separate wires between January 23 and June 21, 2017.

In April 2018, the IRS issued a Notice of Deficiency for the 2015 tax year asserting that distribution of the P&A Interest was taxable. On July 27, 2018, Caan requested a private letter ruling asking the IRS to waive the requirement that a rollover of an IRA distribution be made within 60 days. In September 2018, the IRS declined to issue the ruling.

Caan died July 6, 2022. In the Estate of Caan v. Commissioner, 161 T.C. No. 6 (October 18, 2023), the Tax Court ruled that Caan was not eligible for a tax-free IRA rollover of the P&A Interest for three reasons. First, to be a nontaxable rollover the taxpayer may not change the character of any noncash distributed property, but here, the P&A Interest was changed to cash before being rolled-over. Second, the contribution of the cash occurred long after the 60-day deadline. Third, only one rollover contribution is allowed in any one-year period, but Caan had three contributions. The Court also determined the 2015 fair market value of the P&A Interest.

Finally, the Tax Court determined that it has jurisdiction to review the IRS denial of the 60-day waiver request and that the applicable standard of review is an abuse of discretion. The Court ruled there was no abuse of discretion because Caan changed the character of the rollover property and even if the IRS waived the 60-day requirement, the rollover would still not be tax-free.

The case highlights some of the potential dangers in holding non-traditional, non-publicly traded assets in an IRA.

© 2023 Chuhak & Tecson P.C.
For more news on IRA rollovers, visit the NLR Tax section.