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The IRS has provided guidance on two exceptions to the 10 percent additional tax under Code Sec. 72(t)(1) for emergency personal expense distributions and domestic abuse victim distributions. These exceptions were added by the SECURE 2.0 Act of 2022, P.L. 117-328, and became effective January 1, 2024. The Treasury Department and the IRS anticipate issuing regulations under Code Sec. 72(t) and request comments to be submitted on or before October 7, 2024.

The IRS has provided guidance on two exceptions to the 10 percent additional tax under Code Sec. 72(t)(1) for emergency personal expense distributions and domestic abuse victim distributions. These exceptions were added by the SECURE 2.0 Act of 2022, P.L. 117-328, and became effective January 1, 2024. The Treasury Department and the IRS anticipate issuing regulations under Code Sec. 72(t) and request comments to be submitted on or before October 7, 2024.

Distributions for Emergency Personal Expenses

Code Sec. 72(t)(2)(I) provides an exception to the 10 percent additional tax for a distribution from an applicable eligible retirement plan to an individual for emergency personal expenses. The term "emergency personal expense distribution" means any distribution made from an applicable eligible retirement plan to an individual for purposes of meeting unforeseeable or immediate financial needs relating to necessary personal or family emergency expenses. The IRS specifically noted that emergency expenses could be related to: medical care; accident or loss of property due to casualty; imminent foreclosure or eviction from a primary residence; the need to pay for burial or funeral expenses; auto repairs; or any other necessary emergency personal expenses.

The IRS provides that a plan administrator or IRA custodian may rely on a written certification from the employee or IRA owner that they are eligible for an emergency personal expense distribution. Furthermore, the IRS provides that an emergency personal expense distribution is not treated as a rollover distribution and thus is not subject to mandatory 20% withholding. However, the distribution is subject to withholding, the IRS said. If the emergency personal expense distribution is repaid, it is treated as if the individual received the distribution and transferred it to an eligible retirement plan within 60 days of distribution.

If an otherwise eligible retirement plan does not offer emergency personal expense distributions, the IRS indicated that an individual may still take an otherwise permissible distribution and treat it as such on their federal income tax return. The individual claims on Form 5329 that the distribution is an emergency personal expense distribution, in accordance with the form’s instructions. The individual has the option to repay the distribution to an IRA within 3 years.

Distributions to Domestic Abuse Victims

Code Sec. 72(t)(2)(K) provides an exception to the 10 percent additional tax for an eligible distribution to a domestic abuse victim (domestic abuse victim distribution). The guidance defines a"domesticabusevictimdistribution" as any distribution from an applicable eligible retirement plan to a domestic abuse victim if made during the 1-year period beginning on any date on which the individual is a victim of domestic abuse by a spouse or domestic partner. "Domesticabuse" is defined as physical, psychological, sexual, emotional, or economic abuse, including efforts to control, isolate, humiliate, or intimidate the victim, or to undermine the victim’s ability to reason independently, including by means of abuse of the victim’s child or another family member living in the household.

As with distributions for emergency personal expenses, a retirement plan may rely on an employee’s written certification that they qualify for a domestic abuse victim distribution. Similarly, if an otherwise eligible retirement plan does not offer domestic abuse victim distributions, the IRS indicated that an individual may still take an otherwise permissible distribution and treat it as such on their federal income tax return. The individual claims on Form 5329 that the distribution is a domestic abuse victim distribution, in accordance with the form’s instructions. The individual has the option to repay the distribution to an IRA within 3 years.

Request for Comments

The Treasury Department and the IRS invite comments on the guidance, and specifically on whether the Secretary should adopt regulations providing exceptions to the rule that a plan administrator may rely on an employee’s certification relating to emergency personal expense distributions and procedures to address cases of employee misrepresentation. Comments should be submitted in writing on or before October 7, 2024, and should include a reference to Notice 2024-55.

On June 17, 2024, the U.S. Department of the Treasury and the Internal Revenue Service announced a new regulatory initiative focused on closing tax loopholes and stopping abusive partnership transactions used by wealthy taxpayers to avoid paying taxes.

On June 17, 2024, the U.S. Department of the Treasury and the Internal Revenue Service announced a new regulatory initiative focused on closing tax loopholes and stopping abusive partnership transactions used by wealthy taxpayers to avoid paying taxes.

Specifically targeted by this new tax compliance effort are partnership basis shifting transactions. In these transactions, a single business that operates through many different legal entities (related parties) enters into a set of transactions that manipulate partnership tax rules to maximize tax deductions and minimize tax liability. These basis shifting transactions allow closely related parties to avoid taxes.

The use of these abusive transactions grew during a period of severe underfunding for the IRS. As such, the audit rates for these increasingly complex structures fell significantly. It is estimated that these abusive transactions, which cut across a wide variety of industries and individuals, could potentially cost taxpayers more than $50 billion over a 10-year period, according to an IRS News Release.

"Using Inflation Reduction Act funding, we are working to reverse more than a decade of declining audits among the highest income taxpayers, as well as complex partnerships and corporations," IRS Commissioner Danny Werfel said during a press call discussing the new effort on June 14, 2024.

"This announcement signals the IRS is accelerating our work in the partnership arena, which has been overlooked for more than a decade and allowed tax abuse to go on for far too long," said IRS Commissioner Danny Werfel. "We are building teams and adding expertise inside the agency so we can reverse long-term compliance declines that have allowed high-income taxpayers and corporations to hide behind complexity to avoid paying taxes. Billions are at stake here".

This multi-stage regulatory effort announced by the Treasury and IRS includes the following guidance designed to stop the use of basis shifting transactions that use related-party partnerships to avoid taxes:

• proposed regulations under existing regulatory authority to stop related parties in complex partnership structures from shifting the tax basis of their assets amongst each other to take abusive deductions or reduce gains when the asset is sold;

• proposed regulation to require taxpayers and their material advisers to report if they and their clients are participating in abusive partnership basis shifting transactions; and

• a Revenue Rulingproviding that certain related-party partnership transactions involving basis shifting lack economic substance.

"Treasury and the IRS are focused on addressing high-end tax abuse from all angles, and the proposed rules released today will increase tax fairness and reduce the deficit," said U.S. Secretary of the Treasury Janet L. Yellen.

In the June 14, 2024, press call, Commissioner Danny Werfel also noted that there will be an increase in audits of large partnerships with average assets over $10 billion dollars and larger organizational changes taking place to support compliance efforts, including the creation of a new associate office that will focus exclusively on partnerships, S corporations, trusts, and estates.

By Catherine S. Agdeppa, Content Management Analyst

A savings account with the tax benefits of a health savings account or an educations savings account but without the singular restricted focus could be something that gains traction as Congress addresses the tax provision of the Tax Cuts and Jobs Act that expire in 2025.

A savings account with the tax benefits of a health savings account or an educations savings account but without the singular restricted focus could be something that gains traction as Congress addresses the tax provision of the Tax Cuts and Jobs Act that expire in 2025.

The concept was promoted by multiple witnesses testifying during a recent Senate Finance Committee hearing on the subject of child savings accounts and other tax advantaged accounts that would benefit children. It also is the subject of a recently released report from The Tax Foundation.

Rather than push new limited-use savings accounts, "policymakers may want to consider enacting a more comprehensive savings program such as a universalsavingsaccount," Veronique de Rugy, a research fellow at George Mason University, testified before the committee during the May 21, 2024, hearing. "Universalsavingsaccounts will allow workers to save in one simple account from which they would withdraw without penalty for any expected or unexpected events throughout their lifetime."

She noted that, like other more focused savings accounts, like health savings accounts, it would have "the benefit of sheltering some income from the punishing double taxation that our code imposes."

De Rugy added that universal savings accounts "have a benefit that they do not discourage savings for those who are concerned that the conditions for withdrawals would stop them from addressing an emergency in their family."

Adam Michel, director of tax policy studies at the Cato Institute, who also promoted the idea of universal savings accounts. He said these accounts "would allow families to save for their kids or any of life’s other priorities. The flexibility of these accounts make them best suited for lower and middle income Americans."

He also noted that they are promoting savings in countries that have implemented them, including Canada and United Kingdom.

"For example, almost 60 percent of Canadians own tax-free savingsaccounts," Michel said. "And more than half of those account holders earned the equivalent of about $37,000 a year. These accounts have helped increase savings and support the rest of the Canadian savings ecosystem."

De Rugy noted that in countries that have implemented it, they function like a Roth account in that money that has already been taxed can be put into it and not penalized or taxed upon withdrawal.

Michel also noted that the if the tax benefits extend to corporations as they do with deposits to employee health savings accounts, "to the extent that you lower the corporate income tax, you’re going to encourage a different additional investment into savings by those entities."

Simulating The Universal Savings Account Impact

The Tax Foundation in its report simulated how a universal savings account could work, based on how they are implemented in Canada. The simulation assumed the accounts could go active in 2025 for adults aged 18 years or older.

On a post-tax basis, individuals would be allowed to contribute up to $9,100 on a post-tax basis annually, with that cap indexed for inflation. Any unused "contribution room" would be allowed to be carried forward. Earnings would be allowed to grow tax-free and withdrawals would be allowed for any purpose without penalty or further taxation. Any withdrawal would be added back to that year’s contribution room and that would be eligible for carryover as well.

"The fiscal cost of this USA policy would be offset by ending the tax advantage of contributions to HSAs beginning in 2025," the report states. "As such, future contributions to HSAs would be given normal tax treatment, i.e. included in taxable income and subject to payroll tax with subsequent returns on contributions also included in taxable income."

In this scenario, the Tax Foundation report estimates that "this policy change would on net raise tax revenue by about $110 billion over the 10-year budget window."

As for the impact on taxpayers, the "after-tax income would fall by about 0.1 percent in 2025 and by a smaller amount in 2034, reflecting the net tax increase in those years," the report states. "Over the long run, and accounting for economic impacts, taxpayers across every quintile would see a small increase in after-tax income on average, but the top 5 percent of earners would continue to see a small decrease in after-tax income on average."

By Gregory Twachtman, Washington News Editor

The Internal Revenue Service’s use of artificial intelligence in selecting tax returns for National Research Program audits that areused to estimate the tax gap needs more documentation and transparency, the U.S. Government Accountability Office stated.

The Internal Revenue Service’s use of artificial intelligence in selecting tax returns for National Research Program audits that areused to estimate the tax gap needs more documentation and transparency, the U.S. Government Accountability Office stated.

In a report issued June 5, 2024, the federal government watchdog noted that while the agency uses AI to improve the efficiency and selection of audit cases to help identify noncompliance, "IRS has not completed its documentation of several elements of its AI sample selection models, such as key components and technical specifications."

GAO noted that the IRS began using AI in a pilot in tax year 2019 for sampling tax returns for NRP audits. The current plan is to use AI to create a sample size of 4,000 returns to measure compliance and help inform tax gap estimates, although GAO expressed concerns about the accuracy of the estimates with that sample size.

"For example, NRP historically included more than 2,500 returns that claimed the Earned Income Tax Credit, but the redesigned sample has included less than 500 of these returns annually," the report stated.

IRS told GAO that it "is exploring ways to combine operational audit data with NRP audit data when developing its taxgapestimates. IRS officials also told us that if IRS can reliably combine these data for taxgap analysis, IRS might be better positioned to identify emerging trends in noncompliance and reduce the uncertainty of the estimates due to the small sample size."

The report also highlighted the fact that the agency "has multiple documents that collectively provide technical details and justifications for the design of the AI models. However, no set of documents contains complete information and IRS analyst could use to run or update the models, and several key documents are in draft form."

"Completing documentation would help IRS retain organizational knowledge, ensure the models are implemented consistently, and make the process more transparent to future users," the report stated.

By Gregory Twachtman, Washington News Editor

Holiday season - a time for giving to friends and family, but not, you hope, to the IRS. Many, if not most, people are aware that the Tax Code imposes a tax on certain gifts, but not everyone is certain as to how this works. How do you know when you've given the gift that keeps on taking - a taxable gift?

Exclusion Amount

The general rule is that there is a designated limit above which gifts become taxable to the giver. For the 2009 tax year, that limit is $13,000. The gift tax threshold is from each donor to each recipient per year. In other words, a donor may give multiple gifts to a single recipient in 2009 up to $13,000, and may repeat this with an unlimited number of recipients without incurring gift tax liability.

Furthermore, married couples may give up to $26,000 during 2009 to each recipient in a year without incurring tax, but to do this, they must indicate on a gift tax return that they are electing to split the gift.

Contributions to so-called 529 plans are subject to this limitation, except that a donor may "front-load" giving by contributing up to $60,000 to an individual's account in a single tax year and counting the gift against that year and the four succeeding years. This does make any gifts to that individual in the subsequent years taxable.

Exceptions to the Rule

Some gifts do not count against this threshold. There is no limitation on gifts to spouses or charitable organizations (although there are limits on the tax benefits of charitable contributions). Payments for medical or educational expenses also do not count against the threshold if the money is paid directly to the source of the expenses. A gift of $15,000 to a relative for college tuition is a taxable gift, but a $15,000 payment to the college is not.

Even when a gift exceeds the threshold, it is not necessary to pay tax on the gift. This is because in addition to the annual exclusion amount, there is a lifetime credit against the estate and gift tax. The credit effectively exempts the first $3.5 million of taxable gifts from gift tax in 2009, and must be claimed by filing a gift tax return, Form 709.

The gift tax applies not only to gifts of cash, but also to property. The value of property given as a gift counted against the exclusion amount is the fair market value of the property at the time of the gift, whether the gift is of stocks and other securities or more traditional holiday presents, including food and drink.

The Business Context

Sometimes, gift giving makes for good business. However, even if you give an employee or business contact a gift completely out of gratitude, with no expectation of profit in return, the IRS treats these gifts as business gifts. As such, certain tax rules apply. Gifts of cash within a business context are always taxed to the recipient, whether an employee, contractor or other business. Gifts of property are similarly taxed subject, however, to a de minimis exception for small gifts of approximately $35 or less. The silver lining for this rule is that if it is taxable to an employee, it is also deductible by the employer. In addition, that rule also has a favorable exception within it: the employer may deduct the cost of a de minimis gift or the cost of a general holiday office party (subject to the entertainment deduction limitations).

To sum up, a taxable holiday gift occurs when the total value of all gifts, both of money and property, to an individual over the course of a year, excluding direct payments for medical and educational expenses, exceeds the exclusion amount, which is currently $13,000. When given with a business context, however, it is the recipient and not the giver who is generally subject to tax. Nevertheless, certain important exceptions apply within that general rule. If you need further assistance in sorting out the tax repercussions of holiday gift giving, please feel free to contact this office.

Given a choice between recognizing income now or in a later year, most people want to be paid now and be taxed in a later year.  As a practical matter, however, an employee cannot defer compensation after performing services and becoming entitled to payment.  Routine compensation earned over a prescribed pay period -- a week, two weeks, or a month, for example - usually is paid or made available in the same year it was earned.  Recognition of the income cannot be put off to a later year.

If the employee earns compensation in one year but will not receive it until the following year, the amount is treated as deferred compensation (unless the employer has funded or secured its obligation to pay, or the 2 1/2 month rule, noted below, applies). If an amount is treated as deferred compensation, the employer cannot take a deduction until the year the employee includes the compensation in income. This rule applies even if the employer is on the accrual basis and all events have occurred that entitle the employee to a specific bonus amount. This "matching" principle is contained in Code Sec. 404(a)(5).

The 2 1/2 Month Rule

However, payments made in the first 2 1/2 months of the end of the year that the services were performed are not treated as deferred compensation. This allows the employer to accrue and deduct the compensation in the year it is earned (the year the services were performed), not the later year when it is paid. Nevertheless, the employee still is entitled to defer his or her recognition of income into the next year if certain conditions are satisfied.

Employers who want to spare their employees from being taxed in the year a bonus is earned should not make any amounts available to the employee until the following year. This is particularly important if the employee earns a bonus based on an objective measure, such as corporate earnings. If the bonus is paid solely in the employer's discretion, the amounts will not be taxable until the year paid. If the bonus is paid within the first 2 1/2 months of the following year, the amount is not deferred compensation, and an accrual-basis taxpayer can deduct the bonus in the year the employee performed the services.

Elective Deferral Requirements

If an employer wants to give the employee an election to defer the bonus, it is necessary to look to Code Sec. 409A, enacted in the American Jobs Creation Act of 2004. Under Code Sec. 409A, a bonus based on measures of the company's or the individual's performance is treated as deferred compensation. If the bonus is based on services performed over a 12-month period or longer, the employee must make an election to defer income at least six months before the end of the bonus period.

The tax rules are very liberal for individuals in the armed forces who are serving in a combat zone. The combat zone extension automatically extends the date for paying tax or claiming a refund, as well as for filing. The extension also applies to paying estimated tax.

Generally, the time period for filing returns, paying taxes or claiming a credit or refund is suspended for the period of the taxpayer's service in the combat zone plus 180 days. The time period is similarly suspended while the taxpayer is hospitalized because of a combat-related injury, or while the individual is missing in action, plus 180 days. If the taxpayer is hospitalized in the U.S., the maximum extension period is five years from the date the taxpayer returns to the U.S.

Example. Sandra is deployed to serve in a combat zone on September 15, 2005. Sandra does not make her third estimated tax payment for the year, due the same day.  The combat zone extension extends her deadline for making her third estimated tax payment for the period of her service in the combat zone plus 180 days after her last day in the combat zone.

Who qualifies?

The extension is available to all persons serving in the U.S. Armed Forces in a combat zone. This includes regular military personnel as well as National Guard and Reserve personnel. Civilian support personnel under the direction of the U.S. Armed Forces also qualify.

Red Cross personnel serving in a combat zone also may take advantage of the extension. Accredited press correspondents similarly qualify.