Rev. Proc. 2022-32 Five-year Relief for Portability

Roopa Srikanth, CPA-Houston

The IRS issued Rev. Proc. 2022-32 on July 8, 2022 to provide relief for election of portability of a deceased spouse to be elected in five years instead of two years. The two-year relief was previously provided by Rev. Proc. 2017-34

Since Dec. 31, 2010, the estate tax lifetime exemption that is unused by the deceased spouse can be elected to be transferred to the surviving spouse by filing Form 706, United States Estate (and Generation-Skipping Transfer) return.

Such a relief is only available if the decedent:

  • was survived by a spouse;
  • died after Dec. 31, 2010; and
  • was a citizen or resident of the U.S. on the date of death.

For example, if in 2022 a deceased spouse had assets worth $7.5 million, the executor or administrator of the deceased taxpayer can file the Form 706 and make a portability election. Since the estate tax exemption in 2022 is $12.06 million, the surviving spouse will get to add $12.06 million - $7.5 million = $4.56 million to their lifetime estate tax exemption. 

Such an exemption can be utilized by the surviving spouse in making taxable gifts during the lifetime or upon death. If used for making gifts, the deceased spouse estate tax exemption that was added will be utilized first before the surviving spouse lifetime exemption. 

The relief provided by the IRS becomes important now more than ever since the current estate and gift tax exemption is scheduled to sunset along with a slew of other Tax Cuts & Jobs Act (TCJA) provisions by Dec. 31, 2025. The lifetime exemption for estates and gifts is supposed to go back to pre-TCJA exemption limits of $5 million cap, which adjusted for inflation will be around $6.2 million. 

This sunset provision makes the portability election very attractive. But one must bear in mind that the portability election does not happen automatically and that the Form 706 has to be filed. Though the Form 706 is much simpler for the portability election estate returns, it is not always practical if the surviving spouse was not actively involved in the financial planning and was not aware of all the assets the deceased spouse had or if there are stepchildren and multiple marriages involved. There can also be the scenario where a surviving spouse might not be aware of the portability election. 

We should also consider the present high rate of inflation and the bear market, where stocks and other investments are losing value and are likely to continue to do so for a while, potentially eroding the assets that the surviving spouse inherits. It is imperative to take into consideration the age and lifestyle of the surviving spouse, as well. 

Considering all these factors, a five-year relief to elect portability is a very attractive option. Generally, a taxable estate must file the estate tax return within nine months of the death of the taxpayer or can get an additional six-month extension. This five-year relief is available only for a non-taxable estate and the election can be made on or before the fifth anniversary of the decedent’s date of death. If making the portability election, the Form 706 should state “filed pursuant to Rev. Proc. 2022-32 to elect portability under Sec. 2010(c)(5)(A)” on the top of the first page.

 

(Roopa Srikanth, CPA, is Tax Manager at Carr, Riggs & Ingram, Houston and can be reached at roopsrik@gmail.com.)


TXCPA Committee Issues Comments on Proposed RMD Regs for Inherited IRAs

The TXCPA Federal Tax Policy Committee issued comments to the IRS on REG-105954-20 proposed regulations related to required minimum distributions (RMDs) for inherited IRAs. The committee urges that these proposed regs be reconsidered, but if not, that the IRS provide penalty relief due to the late guidance.

https://www.tx.cpa/docs/default-source/comment-letters/federal-tax-policy/2022_2023/2022/txcpa-irs-iras071522.pdf?sfvrsn=16d3aeb1_2


New Proposed PFIC Regs Issued by IRS

By Josh Whitworth, CPA-Dallas

Taxpayers and tax practitioners should be aware of the new proposed regulations on Passive Foreign Investment Companies (PFIC) issued in January 2022. If these regs become final, they will potentially increase the compliance obligations of individual taxpayers significantly.

Under current regulations, partnerships are treated as a shareholder under the entity approach. Under the new proposal, domestic partnerships will no longer be treated as shareholders of PFICs. The new proposed regs will treat any partner who is NOT a partnership as a direct shareholder under an aggregate approach. Therefore, if these proposed regs becomes final in their current form, individuals will be responsible for making the applicable elections and complying with the appropriate compliance obligations by filing Form 8621.

Many individual taxpayers may hold extremely small indirect PFIC interests through domestic partnerships. Individuals may have difficulty obtaining the necessary information to make an applicable election such as a Qualifying Electing Fund (QEF) election or complying with disclosure requirements.

This should be concerning to taxpayers and practitioners if the regs become final as the PFIC rules are extremely complex and the individual taxpayer may not be in a position to obtain the necessary information to make the most efficient tax election or even complete the Form 8621 filings. 

AICPA Comments on Proposed Regulations Regarding Passive Foreign Investment Companies & Controlled Foreign Corporations Held by Partnerships & Subchapter S Corporations (REG–118250–20)

2022-00067.pdf (federalregister.gov)


IRA Overcontribution Excise Tax Update

By Janet Hagy, CPA-Austin

The recent tax court case, Couturier v. Commissioner (T.C. Memo, 2022-69), is a timely reminder that excise tax can be retroactively imposed on otherwise closed years. In this case, the taxpayer was determined to have significantly overcontributed to his IRA in 2004. In 2016, the IRS imposed excise tax, penalties and interest on the 2004 overcontribution. The taxpayer tried to argue that the three- and six-year statute of limitations period had expired. The court ruled that, “This excise tax continues to apply to future tax years, until such time as the original excess contribution is distributed to the taxpayer and included in income, under Sec. 4973(b)(2).

This case is an extreme example of the problem of overcontribution to an IRA, HSA, Coverdell Education Savings or MSA, and the excise taxes that can be assessed. But it also highlights that the IRS’ scrutiny of related prior-year transactions in a future period can result in unfortunate consequences. To start the statute of limitations period, taxpayers should be advised to remove excess contributions and earnings on such excess as soon as possible, and to report any excise tax incurred.

Tax Court in Brief | Couturier v. Commissioner | Taxation of Excess Contributions from IRA - Freeman Law


FinCEN Proposing a No-Action Letter Process

By Tom Ochsenschlager, J.D., CPA

On June 3, 2022, the Financial Crimes Enforcement Network (FinCEN) released an Advance Notice of Proposed Rulemaking stating that it would be developing a “No-Action Letter” process for financial institutions to utilize to ensure they were in compliance with the Bank Secrecy Act and rules, laws and regulations covering activities such as money laundering and financing terrorism. This only relates to the enforcement of financial crimes and is not directly relevant to taxation.

A no-action letter is provided by staff of a government agency that is requested by an entity subject to the regulation of that agency that concludes the agency will not take action against the entity if the entity complies with the terms of the no-action letter.

The FinCEN no-action letters will be applicable to the following institutions:

  • Casinos,
  • Depository institutions,
  • Insurance industry,
  • Money services businesses,
  • Mortgage companies/broker,
  • Precious metals/jewelry industry,
  • Securities and futures.

FinCEN is seeking written comments through Aug. 5, 2022.


Micro-captive Insurance Company Found to Be a Scam

By Tom Ochsenschlager, J.D. CPA

In May, the U.S. Court of Appeals for the Tenth Circuit agreed with the IRS argument that micro-captive insurance transactions lacked economic substance and accordingly, the premiums paid to that entity were not deductible.

A micro insurance company is roughly defined as an insurance company with $2.45 million or less of gross premiums that can elect to be taxed only on its investment income and can exclude from its income the insurance premiums it receives while the insured entity can deduct the premiums.

The Court decision in Reserve Mechanical Corporation v. Commissioner (No. 81-9011 10th Cir. May 13, 2022) determined that Reserve Mechanical had established what it claimed was an insurance company but that the facts did not support that it was an insurance company. Although the “insurance” company did insure some unrelated entities, those premiums were relatively minimal and virtually all the insured risk was related to Reserve Mechanical. Additionally, due to the common ownership of Reserve Mechanical and the insurance company, the premiums paid were not attributable to an “arm’s length” transaction – a rough definition of “captive insurance company.”

Accordingly, the Court decided that the premiums paid lacked economic substance and were not deductible and that a 20% penalty applied to Reserve Mechanical.

Abusive micro-captive insurance arrangements made the list of the IRS’ 2022 “Dirty Dozen” transactions because of their potential for tax evasion.

IRS wraps up 2022 "Dirty Dozen" scams list; agency urges taxpayers to watch out for tax avoidance strategies | Internal Revenue Service

Taxpayer Loses in Micro-captive Case - Baker Tilly


IRS Commissioner Questions Backlogged Return Numbers in Taxpayer Advocate Report

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

The IRS generally takes comments from the National Taxpayer Advocate as constructive criticisms. Recently, however, in her “Fiscal Year 2023 Objectives Report to Congress” NTA Erin Collins criticized the continuing backlog of unprocessed returns, saying, “Unfortunately, at this point the backlog is still crushing the IRS, its employees and most importantly, taxpayers.”

The Commissioner took strong issue with this backlog comment, saying, “The inventory numbers presented in the National Taxpayer Advocate report are neither the most accurate nor the most recent figures.”

In this unusual pushback in IR-2022-128, the Commissioner provided a much more positive report, defending the extraordinary efforts of the IRS and its employees over the last several months. To overcome the backlog, the IRS has taken several measures, including authorizing significant and ongoing overtime, creating special teams to focus solely on the aged inventory and hiring thousands of new workers and contractors. It has also streamlined its error resolution process.

As a result of these efforts, originally filed Form 1040 paper returns (without errors) filed during 2021 will be completed by the “end of the (June 17) week” with business paper returns to follow “shortly after.” As of June 10, the IRS had processed more than 4.5 million of the more than 4.7 million individual paper tax returns received in 2021. The IRS has also successfully processed the “vast majority” of tax returns filed this year (143 million returns). The streamlining of the error resolution process has resulted in a reduction in the backlog from 8.9 million on June 12, 2021 to 360,000 on June 10, 2022. The IRS news release mentions correspondence backlogs but does not give any details of progress.

You can judge the success of the IRS efforts and side with the Commissioner or the Taxpayer Advocate. However, the IRS is making extraordinary efforts and the Commissioner is understandably displeased with the continuing criticism as evidenced by his comments in the IR-2022-128.

https://www.taxpayeradvocate.irs.gov/reports/2022-objectives-report-to-congress/


Are Declining IRS Audit Rates Providing a Credible Audit Deterrent?

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

 

The average audit rate for all individual income tax returns has declined to 0.25% according to a GAO report to the House Ways and Means Oversight Committee. This is a continuing downward trend from 0.9% in 2010.

The IRS attributes this decline to staff and budget shortages. Things do not look much brighter for the future, with 15% of the IRS’ auditors expected to retire in the next three years.

Audit rates decreased the most for taxpayers with incomes of $200,000+ because those audits require more time and expertise for the more complex issues.

Also, there were fewer field and office audits because of the pandemic. Almost all audits were more-automated, less-intrusive correspondence audits. 

With such a low audit potential, the unspoken question is how low can it get before it loses credibility to the extent that otherwise honest taxpayers are tempted to take questionable positions on returns in the hope of not being singled out for an audit? For CPAs, the issue is whether their attention to compliance detail will be appreciated as much by taxpayers who are tempted to play the audit lottery.


The Senate Now Has a SECURE 2.0

On June 22, the Senate Finance Committee unanimously advanced the bipartisan Enhancing American Retirement Now (EARN) Act that was co-sponsored by Texas Senators John Cornyn and Ted Cruz. This bill will merge with the Senate Health, Education, Labor and Pensions Committee’s retirement bill to form the Senate’s SECURE 2.0 package (an anticipated title) for full Senate consideration.

This legislation has 70 provisions to help more taxpayers save, including:

  • that all employers will automatically enroll employees in 401(k) and 403(b) once they become eligible with an employee contribution of at least 3% for the first year, to increase by 1% up to at least 10% (but not more than 15%) effective after 2023 (unsure if there is an “opt out” option for employees who lack disposable income),
  • increasing the age of mandatory distribution to 75 effective after 2031,
  • a matching-payments credit that would be 50% of an IRA or retirement plan contribution, up to $2,000 per individual,
  • withdrawals for certain family or personal emergency expenses,
  • special use of retirement funds in connection with qualified federally declared disasters,
  • exemption for automatic portability transactions,
  • a higher catch-up limit at age 60 effective after 2023,
  • treatment of student loan payments as elective deferrals for purposes of matching contributions after 2023,
  • exception to early distribution penalty for individuals with terminal illness,
  • directs Treasury to create a new standardized form for the rollover process,
  • allows certain disabled first responders to no longer consider retirement funds at gross income and grants them earlier access,
  • modification of participation requirements for long-term, part-time workers (age 21) effective after 2022,
  • allows workers to take distributions to pay for long-term care premiums, and
  • penalty-free withdrawal (up to $10,000) for victims of domestic abuse with three years to replace the funds.

Several important steps still need to occur. Upon a full Senate vote, which is likely to pass, its SECURE 2.0 would go through the reconciliation process with the House’s SECURE 2.0 Act from March. Congressional leaders will craft a final bill to be voted on by both chambers before it could be signed into law by the president.

Proposed changes to retirement system approved by Senate committee (cnbc.com)

Senate Finance approves retirement tax legislation - KPMG United States (home.kpmg)