Changing Tide for IRS Enforcement of Microcaptive Insurance

By Leo Unzeitig, CPA, J.D. - San Antonio

Congress passed Section 831(b) in 1986. It provides important tax benefits to small insurance companies. Namely, net premiums received are not taxed as income as long as they remain under $2.2 million.

Not surprisingly, taxpayers have availed themselves of the important benefits provided by the provision by forming insurance companies. The problem is that “insurance” is not defined by the Code. And over the last 35 years, Treasury and the IRS have chosen not to provide any of the sorely needed guidance letting taxpayers know what qualifies as insurance for Section 831(b). Instead, the IRS has listed so-called microcaptive insurance as a “transaction of interest” requiring disclosure on a Form 8886. The IRS has 12 exam teams collectively termed the “Tiger Team” who use the list of taxpayers from the Forms 8886 to open examinations, disallow the benefits provided by Section 831(b) and assert 40% lack-of-economic substance penalties. A recent American Bar Association Tax Section panel comprised of the IRS authorities on insurance confirmed that no captive insurance arrangement has been sustained at the exam level. Following a string of victories at Tax Court, the IRS has had strong winds at its back in its enforcement mandate.

However, the tide appears to be turning. In the recent case of Puglisi v. Commissioner, Dkt. No. 2796-20, the IRS conceded the deficiency determination for a microcaptive insurance company before trial. This is the first instance in recent years where the IRS has done so. The question is, does this change anything?

Like all microcaptive insurance cases, the captive insurance company in Puglisi “reinsured” risks pooled by hundreds of independent but similarly situated taxpayers (picture 100 taxpayers across the country forming insurance companies that all collectively insure each other in small part). This arrangement was previously approved by the IRS in numerous letter rulings issued in 2012. However, the IRS quickly (and without explanation) abandoned the reasoning in those letter rulings. 

Fast forward a decade and the IRS appears to be coming back around. The taxpayer in Puglisi participated in a version of a relatively common reinsurance structure that was nonetheless rejected by the Tax Court in recent cases. Thus, it is unlikely that the structure itself was cause for concern to the IRS. The distinguishing facts that the IRS may have deemed more hazardous to its litigating position are that (1) before forming the captive to insure unusual perils (i.e., losses arising from avian flu), the taxpayer sought and was unable to find the same coverage in the commercial market, and (2) the taxpayer made several significant claims. 

The distinctions in Puglisi make it a stronger case than others, but not necessarily. This is because the claims were likely reinsured by over 100 other insurers. Thus, the Puglisi’s captive insurance company likely covered some of their losses, but the rest of the unrelated insurance companies likewise covered a portion, as well. Thus, every other taxpayer participating in the reinsurance pool should arguably be treated the same as the taxpayers in Puglisi because of the effects of the pooling arrangement. They likely used the same actuary to price policies, the same management firm to manage the captive insurance companies, the same claims processer to evaluate claims, and they all agreed to assume and reinsure risks by the same arm’s-length standards. The only differences may be the extent to which the individual insureds suffered losses leading to claims.

Given the significant resources the IRS has devoted to challenging captive insurance companies and the Section 831(b) election, it is unlikely that the Tiger Team will slow or disband. But the result from Puglisi is promising in at least one regard: the IRS apparently believes that there are instances in which taxpayers may qualify for the election. Let’s just hope that someone at the IRS considers the pooling effects on other taxpayers and likewise issues reliable guidance so that taxpayers are spared the expense of more unnecessary audits and trials.

The IRS seems to believe that Section 831(b) works in some situations. It would be great if we had reliable guidance on what those situations are and might make the IRS’ enforcement responsibilities a bit easier.


TAS Not Accepting Cases Based Solely on Amended Return Status

National Taxpayer Advocate (NTA) Erin Collins drew a line in the backlog quicksand.

As of Oct. 30, 2021, the IRS backlog was still over 2.7 million unprocessed amended returns with a processing time of 20+ weeks. The NTA made the decision to suspend accepting cases where the sole issue involves the processing of an individual or business amended return until the IRS is able to work through its backlog.

Under current procedures, the Taxpayer Advocate Service (TAS) does not accept cases in which they cannot meaningfully expedite or improve case resolution for taxpayers. The TAS cannot assist the taxpayer until the IRS processes the return.

NTA Blog: IRS Delays in Processing Amended Tax Returns Are Impacting TAS’s Ability to Assist Taxpayers - Taxpayer Advocate Service


You Ask for It—IRS Increases Transcript Request Limit

Tax practitioners calling the Practitioner Priority Service (PPS) will be able to request 30 transcripts per client effective Nov. 15, 2021, via the Transcript Delivery System (TDS).

This is an increase from the current amount of 10 transcripts per client and better accommodates tax practitioner needs for more than 10 (TDS) transcripts. The limit of five clients per contact will remain. The limit of up to 10 IDRS internal transcripts per client will also remain and counts towards the total of 30 transcripts per client.

Tax professionals can now order more transcripts from the IRS | Internal Revenue Service


It’s Time to Get Ready for 1099 Reporting Season

By Kathy Ploch, CPA-Houston

Previous Changes

The 2015 Protecting Americans from Tax Hikes (PATH) Act accelerated the filing date of nonemployee compensation (NEC) reported on Form 1099-MISC from Feb. 28 to Jan. 31 to combat identity theft. However, this due date change created a lot of confusion for both the taxpayers and the IRS. It didn’t help that the PATH Act also increased penalties to employers that filed late.

Then, in 2020, the IRS revived the old Form 1099-NEC back from the 1980s to be used exclusively for NEC reporting. Had the form not changed, many businesses would have continued to incur late file penalties from 1099-MISC deadline confusion.

Moving Forward

The biggest change for 2021 is that the IRS redesigned the 1099-NEC to three forms per page rather than two per page. It might be a good idea to order supplies now since new envelopes will be required. Also going forward, the IRS will have continuous-use forms, which means the year will not be pre-printed on the form. (See 2022 draft Form 1099-NEC.)

The backup withholding rate for 2021 is still 24%, lowered from 28% in the 2017 Tax Cuts and Jobs Act (TCJA). However, there is talk that it could be raised back to 28% in the future. Also, the IRS will include the 1099-NEC under its TIN Matching Program next year. Practitioners should be ready for those annoying “B” notices (CP2100) for backup withholding.

As of Sept. 10, 2021, the IRS retired its paper Form 4419, the application to use the Filing Information Returns Electronically (FIRE) System for e-filing the 1099s directly to the IRS. Starting Sept. 26, 2021, you must apply for a Transmitter Control Code (TCC) to use the online FIRE System. You only submit a paper Form 4419 if you have an active TCC and need to update certain sections on the form. However, the online platform is not yet available. (See FIRE System Update.)

The 2019 Taxpayer First Act (TFA) decreased the mandatory e-filing thresholds for 1099s and W-2s. The current standard for 2021 is still 250+ information returns. In 2022, the trigger drops to 100 returns and in 2023, the amount will decrease to only 10 forms. I think you can see that soon after, 100% will be required to be submitted electronically. The good news is that a TFA modernization provision requires the IRS to develop a new online portal for businesses to both prepare and file Forms 1099. The deadline for implementation is Jan. 1, 2023. It will have the same user interface and functionality as the Social Security Administration’s Business Services Online. I used this platform back in the 1990s for W-2s and it worked wonderfully. I never understood why the IRS could not do the same!

It is always wise to at least read the first page of the instructions under the “What’s New” section. There is a detailed schedule of penalties in Publication 1586. I am sure we all have had clients that as we are preparing their tax returns, we find out they should have filed some type of 1099 to vendors. The penalty schedule is based on how many months after the deadline you file. So, here is another reason not to wait too long to start preparing a client’s return. The penalty amount dramatically increases after Aug. 1.

Take a short breather from our continuous tax season the last couple of years and start the 2022 tax season armed with your new 1099 knowledge.


IRS Updates FAQs for 2021 Child Tax Credit and Advance Child Tax Credit

The IRS has updated its frequently asked questions (FAQs) on the 2021 Child Tax Credit and Advance Child Tax Credit payments. The updated FAQs describe how taxpayers can use the Child Tax Credit Update Portal to provide the IRS with an estimate of their 2021 income.

2021 Child Tax Credit

A taxpayer may claim a tax credit under Code Section 24 (the child tax credit or CTC) for each "qualifying child" for whom the taxpayer is allowed a dependency deduction under Code Section 151.

For 2021, the credit is $3,000 ($3,600 for children under age six) per qualifying child. For 2021 only, the definition of qualifying child is expanded to include a child who has not attained age 18 before the close of 2021.

The CTC is phased out for taxpayers with modified adjusted gross income (MAGI) above certain levels. For 2021, taxpayers are subject to two different sets of phaseout rules, a phaseout of the increased CTC amount (i.e., $1,000 or $1,600), which begins at lower MAGI thresholds, and then the usual phaseout rules for the $2,000 credit amount.

Advance Child Tax Credit

Under Code Section 7527A, the IRS will make monthly advance payments in July-December 2021 equal to 50% of eligible taxpayers' 2021 CTCs (ACTC payments). Eligibility for ACTC payments will be determined based on taxpayers' 2020 returns or, if they are not yet filed, their 2019 returns.

A taxpayer's CTC for 2021 must be reduced by the aggregate ACTC payments the taxpayer received during 2021. Taxpayers who receive ACTC payments that exceed the taxpayer's allowable CTC for 2021 must, generally, repay the excess by increasing the tax liability reported on their 2021 returns.

Updated FAQs

The IRS has updated the CTC and ACTC FAQs on its website by adding new questions and answers in Topic A (question 17) and Topic F (questions 2-6). The updated FAQs have been compiled, with the older FAQs, into Fact Sheet 2021-13.

Note. These FAQs are being issued to provide general information to taxpayers and tax professionals as expeditiously as possible. Since they have not been published in the Internal Revenue Bulletin, generally neither the IRS nor taxpayers may rely on them. More information about what IRS guidance may be relied upon is available here.

The updated FAQs describe how taxpayers can use the Child Tax Credit Update Portal to provide the IRS with an estimate of their 2021 income.

According to the updated FAQs, taxpayers who received ACTC payments should consider providing the IRS with an estimate of their 2021 income if:

  • They think they will not qualify for the CTC because their MAGI in 2021 will exceed the threshold, or
  • They think they will not qualify for the CTC because their MAGI in 2020 exceeded the threshold for qualifying for the CTC.

The thresholds are $75,000 (single and married filing separately); $112,500 (heads of households) and $150,000 (married filing jointly).

The IRS will adjust a taxpayer’s final ACTC payment only if the taxpayer provides income information that supports an adjustment.

Additional Information Available

The IRS has also created a special Advance Child Tax Credit Payments in 2021 webpage. This webpage provides general information on who qualifies for the ACTC with links to the Child Tax Credit Update, Non-Filer information and CTC Eligibility Assistant portals.


1040 Modernized e-File (MeF) Production Shutdown Schedule

The IRS will be shutting down electronic filing for 1040s on Nov. 20, 2021, at 11:59 p.m. ET until January 2022 to prepare the system for the upcoming filing season. Only "Send Submissions" for 1040 (both state and federal) will be affected by this shutdown. All other services such as "Get Acks" and all state services will be available after the shutdown.

Transmitter submissions (state and federal) deadline is 10 p.m. ET.

Business (BMF) returns are not impacted by this IMF Production Shutdown schedule. The BMF Production Shutdown schedule will be communicated in a QuickAlerts bulletin in early December and will be posted on the MeF Operational Status page.

Modernized eFile (MeF) Operational Status | Marketing Express (irs.gov)


Advocacy that Counts – TXCPA on Capitol Hill to Discuss the Accounting Profession’s Agenda

The pandemic has posed challenges, but also presented member engagement opportunities in how TXCPA approaches its biennial congressional Hill visits in D.C.

This week and in November, 40 TXCPA members—AICPA Council representatives, federal key persons and other volunteers—are participating in nearly 20 virtual Capitol Hill meetings with our Texas congressional delegation in Washington, D.C. We’ll meet with key committee members, key members of the Texas delegation and both Senate offices. These visits allow TXCPA to foster important existing Hill relationships, forge new relationships and use our collective voices to be heard on issues key to the CPA profession.

During these visits, our members will encourage Texas lawmakers to cosponsor or support several very important issues to the profession:

  • H.R. 5155, Taxpayer Protection and Penalty Act, requires the IRS to provide targeted relief from both the underpayment of estimated tax penalty and the late payment penalty for the 2020 tax year. The profession is advocating that the IRS stop sending notices until it can deal with the unopened and unprocessed correspondence.
  • H.R. 3574 and S. 2748, Filing Relief for Natural Disasters Act, gives the IRS clear authority to postpone deadlines when a natural disaster is declared by a state rather than waiting for a federal disaster declaration, allowing for more timely assistance. It also expands the mandatory federal filing extension from 60 to 90 days.
  • H. Con. Res. 44 and S. Con. Res. 11, Fiscal State of the Nation, which calls for the Government Accountability Office (GAO) Comptroller General to make a presentation to a joint session of the House and Senate Budget Committees on the GAO’s auditor’s report of the U.S. government’s financial statements. Enacting this resolution will ensure Congress is made aware of the information contained in the financials and better understands how current or future policy may affect the nation’s long-term fiscal health. We appreciate that Texas Reps. Colin Allred (D-32), Michael Burgess (R-26), Lizzie Fletcher (D-7) and Roger Williams (R-25) are early cosponsors. The House resolution may come to the floor very soon.
  • H.R. 3855, Accounting STEM Pursuit Act, is a step toward expanding accounting into the Science, Technology, Engineering and Math (STEM) curriculum. The legislation allows federal funds to develop and enhance accounting programs in K-12 grades.

These bills have bipartisan support and are not controversial. We are hopeful that there is some momentum to push these issues across the finish line.

Capitol Hill visits are the lifeblood of our federal advocacy. TXCPA members provide insight on legislation, serve as a resource to Capitol offices and ensure that the accounting profession is heard loud and clear. We appreciate the work of all those who participate in these meetings. If you have not had an opportunity to advocate on Capitol Hill, reach out to TXCPA and we will get you involved in our Key Person program to participate on the federal or state level.

 

 

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Photo: Charlotte Jungen, CPA-Houston, and Pat Durio, CPA-Houston, meet with the office of Rep. Lizzie Fletcher (D-7).


Significant Penalty for Late Payment of Deferred Payroll Tax

Tom Ochsenschlager, CPA, JD

In accordance with the Coronavirus Aid, Relief and Economic Security (CARES) Act, employers were permitted to delay payment of their 6.2% share of the Social Security tax that was otherwise due from March 27 through December 2020. Half of the deferred amount is now due Dec. 31, 2021, with the other half due Dec. 31, 2022. 

The IRS Chief Counsel’s office has released a memorandum stating that if the full amount of the deferred tax is not paid in accordance with those two due dates, the IRS will impose the Section 6656 late payment penalty on the entire deferred amount, not just the underpayment amount. In effect, the Chief Counsel seems to be taking the position that if the full deferred amount is not paid by those two dates, then the taxpayer did not qualify for the deferral.

The penalty is significant: 10% where the underpayment is more than 15 days (which would be the case where the deferral was “disqualified”) and 15% if not paid within 10 days after receiving a notice of underpayment from the IRS.

Presumably, the IRS will not impose the penalty on the entire deferral if the underpayment is relatively minor and there is an exception to the penalty if the taxpayer can establish that the underpayment was due to a reasonable cause and not attributable to willful neglect. That said, it is very important that the payments on Dec. 31, 2021 and Dec. 31, 2022 are calculated to be very accurate.  


Charitable Contribution Deductions More Available for 2021

William Stromsem, CPA, J.D.

George Washington University School of Business

 

In a year of hard times from hurricanes and COVID-19, and also in a year of a rising stock market and commodity prices, some clients may be inclined to be even more charitable in 2021 and there are four temporary tax opportunities that end after this year.

With the increased standard deduction and limits on itemized deductions, charities received 4% less in the year after the Tax Cuts and Jobs Act of 2017 (TCJA). Those using the standard deduction rose from around 70% before the TCJA to 90% after the act and taxpayers who took the standard deduction received no added tax benefit from their contributions. In 2020, the Coronavirus Aid, Relief and Economic Security (CARES) Act provided some temporary tax changes intended to encourage charitable contributions and these were extended through 2021 by the Taxpayer Certainty and Disaster Tax Relief Act of 2020.

Here are four added incentives to increase charitable contributions this year:

Above-the-Line Deduction of $300 Single/$600 MFJ

Taxpayers who take the standard deduction can also take a deduction towards adjusted gross income (AGI) of up to $300 for singles and $600 for married filing jointly for cash contributions to most charities. The donation must be in cash, so no securities, no used clothing or household goods, and no volunteer services, although unreimbursed out-of-pocket expenses of a charity volunteer can be taken above the line.

Most charities qualify, although there are some restrictions. Two that will not qualify are private foundations and charitable remainder trusts (where there is a non-charitable beneficiary for life and then a charitable organization receives any funds remaining when the trust terminates). Also not qualifying are “supporting organizations” (that support other charities rather than providing charitable benefits directly) and donor-advised funds (that allow the donor to advise the fund on how to manage and distribute funds contributed by the donor). Prior year charitable contribution carryforwards do not qualify for above-the-line deduction.

No AGI Limit for Cash Contributions in 2021

The 60% of AGI limit on deductions to qualified charities is suspended for 2021, meaning that a very charitable person could eliminate his/her income tax liability with contributions equal to AGI. Like the non-itemizer deduction above, cash contributions to most charitable organizations qualify, but contributions to supporting organizations, donor-advised funds, private foundations and charitable remainder trusts do not. The donor must elect the “increased individual limit” on the tax return. The election applies after considering other contributions that are subject to the remaining percentage limitations.

Corporate Charitable Contribution Limit Raised

The normal limit on C corporation charitable contributions is 10% of taxable income, but for 2021 it is 25%. This “increased corporate limit” must be separately elected for each contribution claimed on Form 1120.

Food Donations Limits Raised for Businesses

Grocery store or other retailers that donate food inventory to a qualified charity to care for the elderly, infants, needy or individuals who are sick can qualify for a higher charitable contribution. The percentage of income is increased from 15% to 25%. This percentage is based on taxable income for C corporations and on aggregate net income for sole proprietorships, partnerships and S corporations. There are some details on the calculation in the instructions, but generally the deduction is limited to full cost plus half the normal profit margin. In a time when the need for charitable outreach is heightened and some people are going hungry, it just makes sense for others who have excess food to donate it (and get a tax benefit). Food safety and quality standards apply.

These above items are available only for this year, but there are many other strategies for charitable contributions that continue, including:

  • Donating long-term appreciated capital assets, like investments in stocks, bonds or real estate, and deducting their full fair market value without having to pay tax on the gain. This strategy is limited to 30% of AGI.
  • “Bunching” deductions in alternate years to be able to itemize one year and take the standard deduction in the next. Charitable contributions are ideal for this timing strategy to generate extra deductions over a two-year period if your itemized deductions are otherwise just under the standard deduction amount.
  • Making charitable contributions directly from an IRA (or SEP or SIMPLE IRA) to a qualified charity to satisfy the annual required minimum distribution without having to pay tax on the distribution. This allows donors to make a larger contribution than if the distribution were taxed and then the net contributed to the charity.

Beyond the tax benefits of charitable giving, there is also the great feeling of helping others get through this year of hard times resulting from the pandemic and natural disasters.

Expanded tax benefits help individuals and businesses give to charity during 2021; deductions up to $600 available for cash donations by non-itemizers | Internal Revenue Service (irs.gov)