Significant Changes in Requesting Letter Rulings and Form 3115 Filings for 2023

By Janet C. Hagy, CPA-Austin

 

Letter Rulings

Rev. Proc. 2023-1, Section 5.01, clarifies that, in general, the ruling request for a completed transaction must be made before a tax return is filed that contains a tax position on the completed transaction. It does not prohibit a return from having been previously filed for the year of the completed transaction.

The Fast-Track pilot program for some letter rulings that targets an IRS response time of 12 weeks, as announced in Rev. Proc. 2022-10, has proven effective per an agency official at the AICPA National Tax conference in November 2022. The program is set to expire in July 2023 if not adopted or extended.

User fees for letter ruling requests remain the same as shown in Rev. Proc. 2022-1.

Form 3115

Rev. Proc. 2023-1, Section 9.05(1), is amended to require that the user fee must be paid through www.pay.com for non-automatic Form 3115 prior to submitting the paper form. And, a copy of the payment receipt must be included with the paper filing.

Rev. Proc. 2023-8 (Jan. 9, 2023) provides that no Form 3115 is required for years beginning after Dec. 31, 2021 (first taxable year) to comply with the new Section 174 capitalization of specified research or experimental expenditures. The change is reported by filing a statement with the taxpayer’s original federal tax return for the first taxable year. For any applicable returns filed prior to publication of this procedure, the taxpayer will be deemed to have complied if the taxpayer properly reported the expenditures on Form 4562 in accordance with the required Section 174 method. If the change is not reported in the return for the first taxable year, Form 3115 will be required to report the change in accounting method.


R&E Expenditures Subject to Five-Year Amortization

By Tom Ochsenschlager, J.D., CPA 

In the past, Section 174 permitted taxpayers to expense the expenditures they incurred in qualified research and experimental (R&E) activity.

That has now changed. The Tax Cuts and Jobs Act of 2017 (TCJA) modified Section 174 so that it now requires these same expenditures incurred in tax years beginning after Dec. 31, 2021, to be capitalized and amortized rather than expensed. (Just to clarify - the new amortization rules are not required for a fiscal year taxpayer that reports the R&E expenditure on its 2021 return even though the expenditures were incurred in 2022 prior to the end of its fiscal year.) The amortization period is five years for domestic research and 15 years for the costs attributed to foreign research activity. It should be noted that, pursuant to the amended Section 174(c)(3), software development costs are considered research expenses subject to these same provisions. However, this change does not apply to expenditures related to acquired, leased or licensed computer software that are covered under Rev. Proc. 2000-50.

Although this change is, in effect, a change in accounting method that generally would require the filing of a Form 3115, Rev. Proc. 2023-8 allows taxpayers to merely file a statement with their 2022 tax return indicating they are in compliance with the new requirement. It is not necessary to file an additional copy of the compliance statement with the IRS.

The statement included with the tax return must include the following:

  • Name and identification number (employer ID or Social Security number)
  • The beginning and ending dates of the tax year of the change
  • The designation automatic accounting method change number “265”
  • A description of the expenditures included in the change
  • The dollar amount in the year of the change for the expenditures subject to the election
  • A statement to the effect:
    • The taxpayer elects, on a cut-off basis, to capitalize and amortize research and experimentation expenditures incurred after Dec. 31, 2021, pro rata over five years (15 years in the case of international research) beginning with the mid-point of the taxable year in which the expenditures are paid or incurred.

Taxpayers that first incur R&E expenses after their taxable 2022 year will be required to file a Form 3115 with their return and a duplicate sent to the IRS (as opposed to merely including a statement on the return). The 3115 should include a statement to the following effect:

  • A description of the expenditures
  • The taxable year(s) the expenditures were incurred
  • The change is being made utilizing the modified Section 481(a) adjustment

Amortizing R&E expenditures under the TCJA - Journal of Accountancy


IRS Delays Implementation of $600 Reporting Threshold for Third-Party Payment Platforms

By David Donnelly, CPA-Houston

On Dec. 23, 2022, the IRS provided relief for filing Forms 1099K by third-party settlement organizations (TPSOs such as Venmo, PayPal or CashApp) for 2022. Prior to this relief, the TPSOs were required to file 1099Ks for any recipient with aggregate payments exceeding $600; the relief extends this filing requirement to payments in years beginning Jan. 1, 2023.

The original legislation governing 1099Ks – the Housing Assistance Tax Act of 2008 – set the threshold for filing 1099Ks at $20,000 and 200 transactions. The American Rescue Plan of 2021 (ARP) lowered the threshold to $600 regardless of the number of transactions. 

As TXCPA expressed concern in a previous blog to our members, TPSOs are frequently used for personal transactions outside of the context of a trade or business. The IRS seems to understand the unintended consequence of the ARP that would have required filing possibly millions of 1099Ks for non-taxable personal transactions. 

IR 2022-226 and Notice 2023-10 state that 2022 will be a ‘transition period’ for purposes of IRS administration. Presumably, for calendar 2023 and going forward, the IRS will provide guidance on which transactions the digital platforms will be required to report on Form 1099K.

As we await guidance, TPSOs will still be required to provide 1099Ks to payees that receive more than $20,000 and more than 200 transactions. TPSOs will also be required to provide 1099Ks to any recipient where the TPSO performed backup withholding if the payments to and the withholding from the payee exceeded $600 for calendar 2022.

Lawmakers from both parties scrambled to scale back or reverse the tax measure in the recent Congressional spending package, but none of the changes were included in the final legislation.

NTA Blog: Heard Loud and Clear: IRS Postpones Implementation of $600 Form 1099-K Reporting by a Year - TAS

IRS Form 1099-K FAQ


Retirement Plan Inflation Adjustments

Tom Ochsenschlager, J.D., CPA

 

In Notice 2022-55, the IRS announced the inflation adjustments effective in 2023 for benefits and contributions for retirement plans as follows:

  • Section 401(k) plans – Employees can elect to defer as much as $22,500, an increase of $2,000. “Catch-up” contributions for taxpayers 50 years or older will be increased $1,000 (from $6,500 under current law to $7,500).
  • Defined contribution plans – The total for employer and employee contributions will be $66,000 (an increase from $61,000 under current law).
  • Defined benefit plans – The annual benefit from a defined benefit plan will be increased to $265,000 (up from $245,000).
  • Compensation limits – Generally, the annual compensation limit for a retirement plan will be $330,000 (up from $305,000).
  • IRAs –
    • The amount of contributions that can be deducted will be increased from $6,000 to $6,500.
    • The additional “catch up” contribution for taxpayers age 50 or over is unchanged and remains at $1,000.
    • For individuals who participate in an employer retirement plan, the deduction for their contribution to an individual IRA is phased out based on their AGI:
      • For singles – AGI between $73,000 and $83,000 (an increase from the 2022 phase-out for AGI between $68,000 and $78,000).
      • For joint filers – AGI between $116,000 and $136,000 (the 2022 phase-out is based on AGI between $109,000 and $129,000).
    • Contributions to a Roth IRA will be limited based on the following range of the taxpayer’s AGI: 
      • For singles – AGI between $138,000 and $153,000 (currently $129,000 and 144,000).
      • For joint returns – AGI between $218,000 and $228,000 (an increase from the current range of $204,000 and $214,000).

A Tax Glimmer of Hope for FTX Crypto-Fraud Victims

By William Stromsem, J.D., CPA
Department of Accountancy
George Washington University School of Business

The cryptocurrency collapse of FTX left many investors with only a limited potential to recover their losses. Although the financial condition of FTX is still being evaluated, its new CEO has said, “We’re not going to be able to recover all the losses here.”

That may be a gross understatement with total losses estimated at up to $10 billion for its 1 million investors. There is no federal insurance for cryptocurrency like for bank or brokerage accounts, so it is just lost. There may be a partial recovery in bankruptcy, but crypto investor claims are likely to be behind those of a lot of other secured and general creditors, and any recovery may take years to resolve. There may be some potential for a partial recovery from tax deductions as described below.

Capital Loss?

Deductible capital losses are limited to capital gains plus up to $3,000 of ordinary income, so unless the investor has big gains, a large crypto loss could result in capital loss carryovers that could take decades to use. If the investor’s portfolio has gains, they should consider selling those investments in the year the FTX crypto losses are recognized or later. One problem with selling FTX crypto now is sales are frozen until the government can determine where the company really stands from its apparently murky books, so selling likely cannot happen until at least 2023. A sale will be required because these losses do not qualify to be written off as worthless while there is still a potential for some recovery. You might also seek to claim the loss as a non-business bad debt, but this depends on how the initial payment to FTX is classified, and in any case, the worthless stock or business bad debt approaches would yield short-term capital losses that can only be used to offset capital gains plus up to $3,000 per year with potentially long-deferred tax benefits from carryovers.

Theft Loss?

There is a glimmer of hope for a theft loss deduction, depending on the interaction of a provision in the Tax Cuts and Jobs Act of 2017 (TCJA) and a 2009 revenue ruling. The TCJA made personal casualty and theft losses deductible only to the extent they were attributable to a federally declared disaster, and FTX losses were not related to any disaster. The Act did not similarly stigmatize business theft losses, and that is where the 2009 revenue ruling comes in.

Revenue Ruling 2009-9 may provide an exception to the requirement to have a declared disaster for a theft loss from investment fraud. After Bernie Madoff’s $65-billion 2008 Ponzi scheme, the IRS published rulings, including Rev. Rul. 2009-9 and safe harbor Rev. Proc. 2009-20 to clarify tax compliance requirements for Madoff’s victims. Rev. Rul. 2009-9 said that if a taxpayer put money into an investment account with the intent to make a profit and the scheme was fraudulent, losses could be considered business theft losses that were not subject to the personal theft loss reductions of 10% of AGI, plus $100 per theft. Thus, arguably the FTX losses could be characterized as business theft losses and not cut off by the disaster requirement of the TCJA for personal theft losses. This argument has been made in other, much smaller crypto-fraud cases recently. Also, if a crypto loss is considered a business loss, this could allow the taxpayer to claim a net operating loss that could be carried forward and used to reduce taxable future income. Rev. Rul. 2009-20 relates to timing, amounts and other issues involving investment fraud deductions. If the Rev. Rul. 2009-9 is found not to apply, the investor might still have a personal theft loss recovery by waiting for the disaster requirement of TCJA to sunset after 2025 – and the bankruptcy and criminal proceedings may take that long.

The FTX losses may meet the requirement of Rev. Rul. 2009-9, with the Justice Department charging Sam Bankman-Fried, founder and former CEO of FTX, with fraud and various other crimes. However, it may take years for the courts to decide whether Bankman-Fried had the requisite intent to defraud or was just in over his head and incompetent. This is sometimes called the “stupid defense,” claiming that the defendant was innocent by virtue of having been ignorant of facts and requisite intent to defraud, but just mismanaged assets and lost a lot of money – which is not a crime. Some regulators and courts may feel little sympathy for investors in FTX for not exercising diligence in investing and sometimes seeming to relish the opportunity for a fast profit in an adventurous unregulated investment.

Another hurdle for the use of Rev. Rul. 2009-9 is the requirement that the money was deposited in an account; the issue is whether crypto investments were a deposit in an account with the crypto wallet like a savings account passbook or whether they were a purchase of assets. This distinction must be clarified by federal regulators.

The question of whether the theft loss will be deductible may depend on whether the courts see the TCJA limit on personal theft losses as having greater hierarchy of authority than the earlier IRS revenue ruling that gave investors more ability to claim theft losses. With 1 million individuals, many with large losses, possibly the IRS will issue some rulings to help clarify the situation.

Hey, IRS are you reading this?!


A Holiday Must: Protect Those Digits

It is the holiday season – goodwill to all, right? Unfortunately, it is also the favorite time of year for scammers, identity thieves and other cybercriminals. Whether you prefer the convenience of e-commerce shopping or spending a day at the mall with the family, your personal digits are at risk.

This week, Nov. 28 – Dec. 2, is National Tax Security Awareness Week. TXCPA, the IRS and the Security Summit encourage everyone to watch out for holiday scams and guard your personal financial information during the heightened threat of fraudulent activity.  

The global information services company, Experian, reminds consumers to be vigilant when shopping online, safeguard your passwords, check for skimming devices, not shop on public Wi-Fi and verify requests for donations. Other helpful tips are to say “no thanks” to department store cards that arrive in the mail, check your banking and card transactions often, verify app authenticity, and do not click unfamiliar email or “smishing” text links. Children, teens and young adults with access to credit cards or shopping accounts are especially vulnerable and often targets for scams – have a family meeting to gauge their awareness.

Enjoy the season with family and find that special gift but remember to protect those digits.

6 Tips to Avoid Holiday Scams and Protect Your Identity in 2022 - Experian

IRS Publication 5461, Protect Personal and Financial Information Online

Fraud and scams | Consumer Financial Protection Bureau (consumerfinance.gov)


TXCPA Committee: Taxpayers' Rights are Best Served Through In-Person Appeals Conferences

This week, TXCPA’s Federal Tax Policy Committee replied to the IRS Independent Office of Appeals’ invitation on best practices for conducting video conferences with taxpayers and tax professionals. Although virtual conferences are a viable alternative when everyone is familiar with the technology tools, the committee strongly believes that taxpayers’ rights are best served by continuing to conduct in-person appeals as a preference. If, however, the taxpayer and representative choose a virtual meeting, the committee recommends that the names and roles of all participating parties – on or off camera – be prominently disclosed to ensure transparency and fairness.

https://www.tx.cpa/docs/librariesprovider15/advocacy/tax/2022/enhancing-video-options.pdf?sfvrsn=6b61aab1_3


Considerations When Making a Trust the IRA Beneficiary

By Tom Ochsenschlager, J.D., CPA

“Regular” or traditional IRAs (as opposed to Roth IRAs) must make annual distributions (withdrawals) to its beneficiaries once they reach the age of 72. The amount of the required annual distribution is based on the IRS Required Minimum Distribution Worksheet. In effect, the worksheet specifies a percentage of the remaining IRA asset value that must be distributed each year. The required percentage is never 100% even if the beneficiary lives to be 115 years old. Of course, the IRA can make greater distributions than the minimum amount required by the worksheet (required minimum distribution or RMD), but in many situations there will be a balance in the IRA account when the individual who owned the account passes away.

Typically, the deceased owner of the IRA will have completed documentation that specifies the beneficiaries of the remaining IRA balance. However, there are circumstances where the IRA owner should consider naming a trust as the IRA beneficiary rather than individuals, such as:

  • Where the beneficiary is a minor who cannot legally own an interest in an IRA.
  • Where the beneficiary receives government disability benefits and might lose the government support if they receive ownership of assets in excess of the limitations on the benefit.
  • Where the IRA owner has remarried, they might name the latest spouse as the primary recipient of the IRA benefits but have children from the first marriage receive the remainder of the IRA upon the passing of the second spouse.
  • A beneficiary receiving an interest in an IRA would have the opportunity to draw down from the IRA as much as they want in excess of the RMD. Where the IRA owner is concerned that one or more of the IRA beneficiaries might be financially irresponsible, having a trust own the IRA could limit the beneficiary’s capability of making such a choice as the trustee of the trust would be in control of all distributions.
  • The owner of an IRA can designate whomever they want to receive the remainder interest in their IRA. If the initial owner of the IRA wants to have some control over who is to receive this remainder interest, that control can be accomplished by the initial owner giving specific instructions to the trustees of the trust.
  • The assets of an inherited IRA may be subject to claims from creditors (see Supreme Court ruling in Clark v. Rameker). Retaining the IRA assets in a “spend thrift trust” will not constitute an asset of the beneficiary and should protect the IRA from creditors’ claims against the IRA assets.

It should be noted that the SECURE Act generally requires that the IRA be distributed within a certain number of years after the IRA owner’s death except where the recipient of the distribution is a surviving spouse, the deceased owner’s minor children, a beneficiary who is disabled or chronically ill, or any beneficiary who is not more than 10 years younger than the original IRA owner.

The SECURE Act generally requires the IRA to, in effect, liquidate and distribute its assets to the trust within 10 years of the death of the IRA owner. While the trust will be subject to whatever the appropriate tax will be on the distributed amount, it can utilize its discretion and the terms of its trust agreement as to when to make these distributions to the trust beneficiaries. Qualifying trusts (see-through trusts) can be designed to distribute IRA funds to trust beneficiaries immediately or gradually over time.

If you plan to name a trust as the beneficiary of an IRA, it is important to work with a knowledgeable estate planning attorney to ensure the language in the trust document gives the trust the ability to use the new SECURE Act IRA distribution provisions.   


Additional Form W-4 Revision or Guidance Still Needed

By Julie Dale, CPA-Austin

The IRS redesigned the 2020 Form W-4 in an effort to provide more accurate withholding from wage income. This was a worthwhile goal since tax professionals had seen that there were many cases where too little was being withheld under the old system and were regularly advising clients to withhold extra to help deal with this issue. The IRS FAQs on the new form indicate that it was also an effort to reduce the complexity, but I personally feel that they did not succeed on this goal. I believe many other taxpayers and accountants agree that the new Form W-4 is more complex and difficult to complete correctly.

Taxpayers rarely had questions on the previous version of the Form W-4. There was a tendency for too little to be withheld in many cases, but this was fairly easily rectified with some quick calculations. If the taxpayer owed $5,200 in a given tax year, then the Form W-4 for one spouse could be modified to request additional withholding of $200 per pay period assuming a bi-weekly pay cycle.

The previous version of the Form W-4 was so simple that most pay stubs would include information on the details of what was provided on the Form W-4, such as a notation of “M/2/$50” to indicate that the taxpayer is claiming married with two allowances and $50 of additional withholding per pay period. With this additional information included on the pay stubs, it helped us advise taxpayers on how to appropriately change withholding because we knew the starting point for preparing a Form W-4 and we simply had to increase the additional withholding amount. The 2020 version of Form W-4 added so many different inputs that pay stubs no longer contain the information on what the taxpayer submitted on Form W-4. We now must ask taxpayers for a copy of the Form W-4 submitted to know our starting point. Payroll software has not found a good standard method of providing this information on the pay stubs.

If we have no starting point on a taxpayer since the job is entirely new, then it is difficult for us to calculate what the employer will withhold on the first paycheck. The IRS provided a Tax Withholding Estimator tool, but this tool requests much more information than is included on the Form W-4. For example, one of the early questions is the spouse’s most recent pay period end. As a CPA trying to advise our clients, it isn’t possible for us to use this tool unless we ask the client for a lot of information.

I believe that the current complexity of the Form W-4 leads to more uncertainty on how to complete the form and how much will be withheld each paycheck. I would encourage the IRS to revisit the Form W-4 to see if there is a better method. The income tax laws are so complex that it is impossible for a taxpayer to understand the terms of art used even in the Form W-4 instructions. It seems like there should be a better method to handle income tax withholding that does not require reading and understanding an entire publication to do so correctly.

Our clients also seek our guidance on how to complete the Form W-4 and even with our knowledge and understanding of the tax laws, it sometimes feels like a futile endeavor. Taxpayers tend to prefer correct income tax withholding from paychecks, but in many cases are relying on quarterly estimated tax payments or paying the tax owed with the return filing due to the lack of guidance and understanding of the newer Form W-4. In the worst circumstances, it may be possible that the IRS is not collecting the full tax owed because the taxpayer submits an offer in compromise to reduce the tax burden when the return is filed. It is crucial that the IRS helps taxpayers comply with the tax laws by providing an intuitive Form W-4.

2022 Form W-4 (irs.gov)


Reminder—Food and Beverage Industry Businesses May Be Eligible for an Income Tax Credit for FICA Taxes Paid on Tips

By William R. Stromsem, J.D., CPA, Assistant Professor, Department of Accountancy, George Washington University School of Business

Now that customers are back in restaurants and bars, a reminder might be in order of a tax break for these businesses. Many employers that sell food and beverages (in a bar or restaurant or delivered) may be unaware that they may have a substantial income tax credit for the employer’s share of Social Security and Medicare taxes paid on reported tips above the minimum wage.

Tipped workers report their tip income to employers, and employers pay FICA taxes on tip income even though technically the compensation was paid by the tipper, not the restaurant or bar. This credit is intended to provide relief for payment of FICA taxes on income over the minimum wage, the amount that the employer would have had to pay FICA taxes on if there were no tips. On the cynical side, some might say that this credit is intended to discourage businesses from underreporting tips to avoid paying the FICA taxes.

This credit is claimed on IRS Form 8846 and the instructions give calculation details. https://www.irs.gov/pub/irs-access/f8846_accessible.pdf