Dear Client: Washington, Dec. 19, 2024
IRS has many enforcement priorities, in part due to the funding windfall promised to it in 2022. Partnership tax noncompliance is on the list
HIGHLIGHTS
New Laws Disaster loss write-offs
IRAs & Plans Early withdrawals
Tax Disputes Late refund claims
Partnership audits by IRS have been dismal over the past several years. The agency’s audit rate for partnership returns has hovered around 0.1% or less, with about half of these examinations resulting in no change to taxes at the partner level. The IRS audit stats for very large partnerships… those with $100 million or more in total assets and 100 or more partners…are even more abysmal. According to a report by the nonpartisan Government Accountability Office, there were 20,052 of these large partnerships in 2019, and IRS audited only 54. From 2010 to 2018, 80% of IRS audits of large partnerships were no-change exams.
Business Taxes S corporations
Education Credits for private school
Donations Pay down the U.S. debt
IRS wants to improve these figures and bring in additional revenue. Earlier, it released a plan, explaining what it would do with its funding windfall. Audit coverage of large partnerships would increase to 1%. IRS projects that audit rates of pass-through entities, such as S corporations and partnerships, with $10 million or more in assets would rise until they reach 1% for 2026 returns.
The agency began audits on 76 of the biggest partnerships in the U.S… Plus hundreds of other pass-throughs with over $10 million in assets.
IRS is relying on the use of artificial intelligence tools and data analytics to help identify pass-through entities that are at a higher risk of tax noncompliance. And it has a new pass-through working group to focus on these exams. This group is situated within the agency’s Large Business and International Division. There is also an office in IRS’s Office of Chief Counsel focusing on pass-throughs. But the Service is off to a bit of a slower start than it originally anticipated. In 2024, it began 2,285 partnership exams…down from its goal of 4,074 audits, and way below 2023’s 6,709 figure. In 2025, IRS plans to open up 3,600 such audits. IRS says it’s taking a longer time to train new hires, and the audits are very complex.
IRS’s Large Business and International Division has targeted campaigns that focus on risk areas in which IRS has found taxpayer compliance to be lacking. Among the partnership projects: Excess losses claimed by partners. Partners can take flow-through losses from partnerships on their individual returns only to the extent of their adjusted basis in their partnership interests. Excess losses aren’t lost forever. They’re carried forward to a year in which the partner has basis. Cash or property distributions that exceed a partner’s basis in the partnership A partner who receives a distribution of property (not cash) from the partnership in 2024 or later must report the distribution on new Form 7217 and file it with the 1040 return. Sale or transfer of a partnership interest. Generally, a partner has capital gain or loss on the sale of a partnership interest. But if the partnership has inventory items or unrealized receivables, then part of the gain is treated as ordinary income or loss. Partnerships that own sports teams and report large losses on Form 1065. Reported from Washington, D.C.
Victims of federal disasters get tax relief, thanks to Congress. New legislation has easings for personal disaster loss write-offs akin to those given to victims of federally declared disasters in 2018-20. It applies mainly to disasters in 2021-24. Individuals can take personal disaster losses even if they don’t itemize. They’re able to deduct uninsured personal losses in excess of a $500 threshold without regard to the 10%-of-adjusted-gross-income offset that generally applies. This net loss is treated as an additional standard deduction for nonitemizers.
A smaller law expands deductions for gifts to veterans’ service organizations. The title of the bill is the VSO Equal Tax Treatment Act, or the VETT Act for short.
A 10% fine hits most pre-age-59½ withdrawals from IRAs, 401(k)s and the like. This excise tax on early payouts is in addition to any regular income tax that is due. Filers use Form 5329 to calculate and report this 10% additional tax. But there are lots of exceptions. Let’s review some common ones here. Among the exceptions that apply to both IRAs and 401(k)s: Early payouts by disaster victims on up to $22,000 per disaster. Taking substantially equal payments for the longer of five years or until the recipient hits 59½. Big medical expenses to the extent unreimbursed medicals top 7.5% of adjusted gross income. Death or permanent disability of the owner. IRS levy on retirement funds. Birth or adoption of a baby, subject to a $5,000 cap. Up to $10,000 for domestic abuse victims. Family emergency expenses up to $1,000. Some military reservists called to active duty. Some exceptions apply only to early IRA distributions: Health insurance while unemployed. The cost of higher education. First-time home buyers, up to $10,000. Other exceptions apply only to early 401(k) withdrawals: Paying 401(k) funds to an ex-spouse under a qualified domestic relations order. Workers who leave their jobs in the year they turn 55 or later (the minimum age is 50 for public safety employees). Terminal illness. And distributions from a pension-linked emergency savings account. See www.kiplinger.com/letterlinks/ed for an IRS chart with all the exceptions
IRS is eyeing these early distributions from IRAs, 401(k)s and other plans. Failing to pay the 10% tax is a common error. A Treasury inspectors’ report found that 2.8 million taxpayers who received early distributions totaling $12.9 billion in 2021 didn’t pay the 10% additional tax, nor did they file the required Form 5329.
Employers aren’t jumping to offer a crypto option in their 401(k) plans.
Crypto investing is substantially less than 1% of the total 401(k) market, according to the Government Accountability Office. Maybe employers are worried about the Dept. of Labor, which issued an advisory in 2022 warning plan fiduciaries that crypto investing is speculative and volatile and has serious risk issues. Labor has probed a few 401(k) plans that offer participants investments in crypto. Most of the investigations were of plans with less than $100,000 invested in crypto.
IRS wins again in court in a case involving a passport revocation dispute
The State Dept. can deny or revoke U.S. passports of people with tax debts of $62,000 or more on whom a tax lien or levy has been filed, subject to exceptions. A man who owed $1.1 million in tax debts over multiple years claimed that IRS erroneously certified his outstanding tax liabilities as a seriously delinquent tax debt to State. The appeals court upheld the Tax Court’s decision that the Revenue Service followed each of the required elements in the applicable statute (Adams, D.C. Cir.).
An annual excise tax on health insurance is going up. Insurance companies and employers that sponsor a self-insured health plan must pay a yearly fee based on the number of lives covered under the plan. It’s $3.47 per head for policy years and plan years ending after Sept. 30, 2024 and before Oct. 1, 2025…up from $3.22.
The Tax Court won’t waive the deadline for a late-filed refund claim.
A man untimely sought refunds for 2014 and 2015 to offset taxes he owed. He argued that a 2022 Supreme Court decision involving a late-filed Tax Court petition in a collection due-process case supported his assertion that the refund-claim deadline is not jurisdictional, but can instead be waived by a court for equitable reasons. The Tax Court said no. Equitable relief isn’t available (Applegarth, TC Memo. 2024-107).
IRS expands online business tax accounts to C corps. These accounts allow users to view any balance due, payment history and tax transcripts. Users can make electronic payments, set up future payments, and view digital copies of IRS notices. They can also see authorization requests from mortgage companies, banks, and other lenders using IRS’s IVES…Income Verification Express Service.
Among individuals who can set up a business tax account: Sole proprietors. S corp shareholders or partners who receive a K-1 from the entity. Members of multimember LLCs that file Form 1065. Plus certain officers of a C corporation.
Businesses have more time to perfect refund claims for the R&D credit
For an R&D credit claim to be valid, taxpayers must, in a detailed written statement, identify all business components and the research activities for each component. They must also include a list of qualified wages, total qualified supply expenses and total qualified contract research expenses. IRS is revising Form 6765 for this.
There is a grace period through Jan. 10, 2026, in which R&D credit claimants with deficient refund claims will be notified by IRS to send in missing information.
Can IRS assess penalties on the nonfiling of international information returns? U.S. citizens who are officers, directors or major shareholders of non-U.S. companies, and U.S. firms owning 10% or more of overseas firms, must file Form 5471 each year to give financial data on them. Taxpayers who fail to comply can be hit with a fine.
The Tax Court says no, IRS doesn’t have statutory authority to assess the fine. The Court has ruled on this twice, once in 2023, and again now (Mukhi, 163 TC No. 8).
But the D.C. Circuit Court of Appeals says yes. The Service can assess and administratively collect the penalty, the appeals court ruled in May 2024, while reversing the Tax Court’s above-described 2023 taxpayer-favorable decision.
S corporation owners should check their basis in the stock they own.
A shareholder’s basis in S corp stock affects his or her deductible loss. S corporation shareholders are able to deduct their share of the company’s losses only up to their stock basis and loans that they directly make to the corporation.
Taxation of S corp distributions also depends on shareholder basis First, distributions are ordinary income to the extent of the firm’s accumulated E&P… earnings and profits…for S corps that converted from C corps or acquired a C corp. Second, they’re nontaxable to the extent of the shareholder’s basis in his or her stock. Any remaining distributions in excess of stock basis are taxed as capital gain.
Here’s a case illustrating the effect of S corp stock basis on distributions. IRS claimed a man received large cash distributions from his wholly owned S firm that exceeded his stock basis. The Tax Court ruled he had sufficient stock basis to support nontaxable distributions for 2013 and 2014, but not for 2015 and 2016. He has $2.5 million in taxable distributions in those years (Aboui, TC Memo. 2024-106).
Many S corporation owners must include basis information with their 1040 This requirement applies to shareholders who report a loss, dispose of their stock, or receive a distribution or loan repayment from the S corporation during the year. The shareholder must check a box on line 28, column (e) of Schedule E… And fill out Form 7203 and attach it to his or her individual tax return.
EDUCATION
Many GOP lawmakers want to expand school choice for K-12 students. Providing tax breaks might be one way to achieve this goal. For example, one bill would give a tax credit to taxpayers that donate cash or marketable securities to qualifying organizations created to provide scholarships to K-12 students. The credit would be capped at the greater of $5,000 or 10% of adjusted gross income. Donald Trump would likely support tax breaks for private-school education. Linda McMahon, Trump’s nominee to head the beleaguered Dept. of Education, has for years pushed for steering more government revenues to private schools. Doing this through tax breaks is a much easier path when compared with vouchers. Nearly half the states already have tax-credit scholarship programs, which give taxpayers credits to offset state taxes for donating to participating groups that endow scholarships to attend private school for primary and secondary education.
IRS’s Criminal Investigation division pursued fewer overall cases this year. It began 2,667 cases for fiscal year 2024, compared with 2,676 in 2023. It prosecutes nearly 70% of its cases and has a successful conviction rate of 90%. But some areas receive more scrutiny: Money laundering, narcotics, and Bank Secrecy Act violations accounted for most of CI’s probes in 2024.
Apply for an identity-protection PIN to use when filing your 2024 tax return It can help protect you from tax-related identity theft when you file your 1040. The IP PIN is a six-digit number assigned by IRS to help verify a taxpayer’s identity. To apply for an IP PIN for 2025, go to “Get an identity protection PIN (IP PIN)” on IRS’s website. IP PINs are valid for one calendar year, so you can’t use a prior one. Having an IP PIN can also help some taxpayers who claim dependents. IRS says that starting in the 2025 filing season, it will accept Forms 1040, 1040-NR and 1040-SS that are electronically filed, even if a dependent has already been claimed on an earlier filed return by someone else, provided the primary taxpayer named on the second return includes a valid IP PIN with the filing. In previous years, the second return had to be filed on paper. This IRS easing will benefit parents because they will be able to get refundable credits quicker than in prior years.
Beware of scammers touting “charitable LLC” scams to high-incomers, IRS warns. The agency says it has seen hundreds of federal tax returns that are claiming fraudulent charitable write-offs related to this abusive tax scheme. The transaction involves creation of an LLC in which taxpayers contribute property or cash and then transfer the LLC units to a charity. Promoters are advising clients that they can retain control of, and access to, the property transferred to the LLC, and are even implementing exit strategies in which taxpayers can buy back the assets at a discounted price. Note that as a general rule, you can’t take a charitable write-off on Schedule A of your 1040 for transfers of less than your entire interest in property. Additionally, retaining control or access over donated assets nixes the tax deduction.
Need a last-minute tax planning idea to lower your 2024 income taxes?
Voluntarily pay down the federal debt and get a tax write-off if you itemize. Uncle Sam will say thank you. These payments qualify as charitable contributions. You can give online at Pay.gov , or send a check to the Bureau of the Fiscal Service, and note with your payment that it’s a gift to reduce the debt held by the public. Donors have chipped in over $2.5 million in such donations this year through Oct.
Yours very truly,
Dec. 19, 2024
Joy Taylor, Editor