Avoiding Tax Scams Before October 15
If you have extended your filing date from April 15 to October 15 this year, you should be aware of the three main methods used by tax scammers: telephone calls, email phishing and pretending to be a fake charity.
- Telephone Scams – Scammers often claim to represent the IRS. They will call and demand an immediate payment for tax debt through a debit card or a money wire. Many scammers ask that you stay on the phone until you have completed the transaction.
The scammer may threaten to call the police or other law enforcement agencies and have you arrested if you do not comply. Scammers often “spoof” their call and attempt to appear to come from a law enforcement agency.
If you suspect a scammer, the first thing to do is to hang up the phone. The IRS does not call to demand immediate tax payments. You always have an opportunity to appeal any tax amount due. There are several administrative ways the IRS can resolve a tax liability question with you.
You can also go to www.IRS.gov and select “View Your Account.” You will see the next webpage and can click the “Create or View Your Account” button. If you create an online account, you can review 24 months of your payment history and balance due. You can also report a phone scam on www.tigta.gov.
- Phishing Emails – Scammers may try to trick you by sending an email that claims to be from the IRS. The email may include the IRS logo and usually has an embedded link. The email may direct you to click on the link to find out why the IRS is contacting you. The email may also come from a person who identifies as a financial or tax advisor. If you click on the link, the scammer may install “malware” on your computer and use it to capture your passwords and access your personal financial information.
If you see a suspicious email, do not click on links or open any attachments. The IRS does not initiate contact by email, but rather by paper letters through the U.S. Postal Service. The letters or notices will be mailed to your most recent address. If you receive a suspicious email, forward it with all of the headers to phishing@IRS.gov. Then delete the suspicious email.
- Fake Charities – Following a natural disaster, such as Hurricane Florence, scammers will often request donations to fake charities. They may make this request by phone or email. Some scammers with particularly bad reputations ask for a gift from disaster victims. In these situations, the scammer may attempt to obtain the victim’s financial information. They then use that financial information to steal funds from those who are already devastated.
If you are contacted and do not recognize the charity or the person, do not give out personal information or your Social Security Number. Watch out for charities with names similar to well-known organizations. The IRS website has a Tax Exempt Organization Search (TEOS) tool. This enables you to be sure that you are sending your relief gifts to a qualified and legitimate charity.
House Passes Tax Reform 2.0 Bills
On September 28, the House passed three separate tax bills. These three bills are designed to make the Tax Cuts and Jobs Act provisions permanent, to enhance retirement saving and to assist start-up companies.
The first bill is the Protecting Family and Small Business Tax Cuts Act of 2018 (H.R. 6760). This bill makes permanent the individual tax rate cuts that started in 2018. The increased standard deduction, the repeal of personal exemptions and the increased child tax credit also will be permanently extended.
While some Republican representatives from New York, New Jersey and California have indicated they will vote against making the $10,000 state and local tax (SALT) limit permanent, the bill includes that provision.
The bill also makes permanent the 20% deduction under Sec. 199A. This deduction applies to most pass-through business entities. While there are complex and numerous phaseout provisions, the deduction is generally equal to 20% of qualified business income (QBI).
The second bill is the Family Savings Act of 2018 (H.R. 6757). It includes numerous changes to retirement and education tax rules. There will be no 70½ age limit on individual retirement account (IRA) contributions. Both traditional and Roth IRAs will no longer have an age contribution limit.
Individuals with less than $50,000 in a retirement account will be excused from taking the required minimum distribution (RMD). Parents with a newly adopted or natural-born child will be able to withdraw $7,500 from a traditional IRA with no penalty. The withdrawal from a traditional IRA will be subject to income tax.
There are new universal savings accounts that permit contributions of up to $2,500 per year. These are similar to the Roth IRA. The contribution is from after-tax income and the subsequent withdrawal will be tax-free. Finally, companies will be able to create multiple employer Sec. 401(k) plans. All of these provisions are designed to increase retirement saving.
The third bill is the American Innovation Act of 2018 (H.R. 6756). This bill is designed to facilitate the development of new businesses. Up to $20,000 in start-up expenses will be deductible in the year the business is founded.
Editor’s Note: These provisions could have a potential cost of $627 billion over 10 years. The Senate is unlikely to take up these bills until 2019.
Assignment of Income May Trigger Capital Gains Tax
In Chrem, Marc et ux. et al. v. Commissioner; No. 23516-16; No. 25417-16; No. 25419-16; No. 25421-16; No. 25423-16; No. 25425-16; No. 23517-16; No. 25418-16; No. 25420-16; No. 25422-16; No. 25424-16; T.C. Memo 2018-164 (27 Sep 2018), the Tax Court denied motions for summary judgment on both an assignment of income and failure to submit a conforming appraisal for a gift of foreign corporation stock.
Comtrad is a Hong Kong corporation with 7,000 shares of outstanding common stock. It provided various testing services for a related company, SDI Technologies, Inc. (SDI). SDI manufactured a number of consumer electronic products and Comtrad conducted electronic testing and quality control on the products. SDI is a Subchapter S corporation. Most SDI stock is owned by an employee stock ownership plan (ESOP).
In 2012, SDI proposed to purchase 100% of Comtrad stock. A Subchapter S corporation is permitted to own a foreign C corporation, and SDI claimed that acquisition of Comtrad would allow greater vertical integration of its products and services.
SDI planned to purchase 6,100 Comtrad shares from multiple shareholders. A group of 11 shareholders proposed giving the remaining 900 shares to the Jewish Communal Fund (JCF). The gift value was $4,500 per share, or a total of $4.05 million.
Following the initial purchase of 6,100 shares by SDI, the plan was that JCF would sell the 900 shares to SDI for $4.05 million. The shareholders agreed to use “all reasonable efforts” to persuade JCF to tender the 900 shares to SDI.
Because SDI is primarily owned by an ESOP, it needed to have a fairness opinion that the acquisition of Comtrad for $4,500 per share would be a fair price. SDI secured a valuation report from Empire Consultants, LLC (Empire). The valuation by Empire determined that the Comtrad shares were worth between $4,214 and $4,626 per share.
Based on the Empire fairness opinion, SDI purchased 6,100 shares of Comtrad on December 12, 2012. Between December 5 and December 10, the 900 shares were transferred from the respective owners to JCF. On December 10, JCF agreed to sell the 900 shares to SDI for $4.05 million.
Comtrad shareholders filed returns for 2012 and reported deductions totaling $4.05 million. They did not attach the Sec. 170(f)(11)(c) qualified appraisals to the return, even though four of the gifts were in excess of $500,000. The taxpayers did include Forms 8283, Noncash Charitable Contributions with their returns. The Forms 8283 were signed by Gregory Sullivan, Managing Director of Empire, on the “Declaration of Appraiser” section. Saul Wadowski is an officer of JCF and signed the “Donee Acknowledgment” for each form. Wadowski specified December 5 as the gift date.
The IRS audited all of the returns and denied the deduction because the appraisal was not qualified. In addition, the IRS claimed that the gain had “ripened” and the taxpayers were subject to tax on the capital appreciation.
The Court noted that income “is taxed to the person who earns it.” If the gain had ripened, then under Ferguson v Commissioner, 108 T.C. 244 (1997), the shareholders are required to pay tax on the stock transferred to charity. Because the probability of completion of the stock sale was high, the Court stated “facts may support the conclusion that the acquisition was virtually certain to occur.” Therefore, the Tax Court could determine that the transaction was prearranged and the gain had ripened.
Second, Sec. 170(f)(11)(E)(i) states that a qualified appraisal must describe the property in sufficient detail, must state it is prepared for income tax purposes and must include both the date of the contribution and the date of the appraisal. If the appraisal does not fulfil these essential requirements, the taxpayers must show “reasonable cause” that they have exercised ordinary business care impudence.
The Court noted that the Empire report was not in compliance with appraisal requirements. It did not set forth the date, did not appraise the gifted stock shares, which may have a marketability or minority interest discount, and did not state it was completed for income tax purposes. While it did value the overall asset, and it is clear that the sale was imminent for $4,500 per share, it may not fulfill the “substantial compliance” standard. In addition, the requirement that an appraisal must be attached to the return for gifts of assets with value over $500,000 was not fulfilled. For gifts over $500,000 the taxpayer must attached “both an appraisal summary and a copy of the appraisal itself.”
Because there are issues of fact on the assignment of income and the claim of “reasonable cause” for failure to have a fully compliant appraisal, the Court denied the requests for summary judgment and the case will proceed to trial.
Editor’s Note: This process shows the challenges with a business sale and a charitable transaction. The owners would like to make the charitable gift in sufficient time to avoid the recognition of the capital gain on the charitable gift of appreciated stock, but they also want to control the sale. A solution would have been to transfer the 900 shares of Comtrad stock into a charitable remainder unitrust for the respective owners on December 1, 2012. The remaining 6,100 shares could have been sold to SDI in December. In the first week of January of 2013, the charitable trusts could then have sold the 900 shares of stock to SDI. The owners could then retain the trust income or make gifts of income interests from the unitrusts to charities. While it is probable that the owners could have made gifts of the entire income interest in January, some counsel may prefer to retain the trust for at least a year and then make gifts of the income interest. However, this plan could have permitted one of the advisors for the various shareholders to be trustee of the unitrusts and effectively assured control of the transaction. It would have protected the charitable gift deductions and maintained control in the hands of the shareholders.
Applicable Federal Rate of 3.4% for October — Rev. Rul. 2018-27; 2018-41 IRB 1 (20 September 2018)
The IRS has announced the Applicable Federal Rate (AFR) for October of 2018. The AFR under Section 7520 for the month of October is 3.4%. The rates for September of 3.4% or August of 3.4% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2018, pooled income funds in existence less than three tax years must use a 1.4% deemed rate of return.