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Thursday June 13, 2024

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No IRS Victory Lap on Direct File

On April 16, IRS Commissioner Daniel Werfel spoke before the Senate Finance Committee. Werfel discussed the completion of the tax filing season on April 15 and the new Direct File option available to taxpayers in 12 states. Werfel noted, "There is no victory lap here. There is a lot more work to do.”

While Werfel was not ready to announce the next steps for the Direct File program, the IRS is completing a review and will release a more complete plan in the near future.

A major project for the IRS is to improve and update the information technology (IT) system. Werfel continued, "The main system at the IRS — that is, the engine for all individual returns — is on the cusp of finally being turned into a modern solution."

The IRS Commisioner highlighted the success of taxpayer online accounts. Werfel noted, "The idea is to make those individual online accounts as fully functional as possible, so that if you choose, you could do everything virtually from your smartphone or your tablet."

The IRS made substantial progress toward the improvement of customer service. There were an additional one million taxpayer phone calls answered this year compared to the past year. Over 170,000 taxpayers were able to have in-person meetings with an IRS representative. In addition, there was an 18% increase in IRS website visits in 2024. The IRS also had a "chatbot" on several website pages. Taxpayers increased their chatbot use this filing season, from 330,000 last year to 832,000 in 2024.

The average taxpayer phone wait time was reduced to five minutes, with a three-minute average in early April. Werfel noted the additional funding for the IRS was the key to providing improved taxpayer service.

Several members of the Senate Finance Committee expressed concern about the Direct file program. Ranking Member Mike Crapo (R-ID) noted, "Were the IRS to use this year's Direct File spending to pay third-party providers to prepare and file returns instead, literally hundreds of times the number of taxpayers could file for free."

In response, Werfel noted there were positive comments by many users and the initial goal of 100,000 returns was exceeded. Senate Finance Committee Chair Ron Wyden (D-OR) indicated Direct File is a "public service the federal government ought to be providing to Americans wherever it can."

The Urban-Brookings Tax Policy Center (TPC) held a webinar on April 12 to review the Direct File program. TPC Representative Janet Holtzblatt noted there would be a government audit to determine the cost of the program. She stated, "When you have the watchdog asking this early on about measuring the cost, that question is going to intensify in the year or next year to come."

University of California Davis School of Law Professor Dennis J. Ventry, Jr. noted, "Investing in a government-run tax filing portal that might have an auto-filing component to it one day — something like direct file — is going to deliver immediate benefits with significant efficiency gains that just is not attainable in the private sector."

IRS Provides "At Least As Rapidly" RMD Relief

In Notice, 2024-35; 2024-19 IRB 1, the IRS extended transition relief through 2024 for certain designated beneficiary required minimum distributions (RMDs). However, the IRS noted it is likely there will not be similar RMD relief after January 1, 2025.

Under Section 401(a)(9) an individual must start taking his or her minimum distributions by the required beginning date. Section 401(a)(9)(A)(ii) states the interest of an employee in a qualified plan must be distributed over the life of the employee or a period not extending beyond the life expectancy of the employee and a designated beneficiary.

If an employee dies after his or her required beginning date, under Section 401(a)(9)(B)(i) the account interest must be distributed "at least as rapidly" as the method used by the employee as of the date of his or her death. This means that the distribution must either be within five years of death or, for an eligible designated beneficiary, over the life expectancy of that individual, with distributions commencing within one year of the employee's death.

Section 401(a)(9) was amended by the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act). Unless an individual is an eligible designated beneficiary (generally an individua with chronic illness, an individual with a disability, a minor or the decedent’s spouse), then the distribution period is not life expectancy, but rather a 10-year term. Under the SECURE Act, most children or other designated beneficiaries must receive the plan distributions within 10 years.

The SECURE Act applies to individuals who pass away on or after January 1, 2020. Section 4974(a) states that failure to take a required distribution will lead to an excise tax of 25% of the amount that was not properly distributed. If the distribution error is corrected by the end of the second year, the excise tax may be reduced from 25% to 10%.

On February 24, 2022, the Treasury Department published proposed regulations under Section 401(a)(9). Prop. Reg.1.401(a)(9)-5(d)(1)(i) stated that a beneficiary of a plan where the employee had reached the required beginning date before his or her demise would be required to follow the "at least as rapidly" distribution rule.

Many commentators informed the Treasury Department they had interpreted the SECURE Act to create a 10-year rule that would function like the 5-year rule. With a 5-year rule, there is no RMD due until the last year of the period. Many individuals who were the beneficiary of an IRA where the employee passed away in 2020, 2021 or 2022 had failed to take a distribution. They assumed there would not be a required distribution until the 10th year.

In Notice 2024-35, the IRS stated, "A defined contribution plan that failed to make a specified RMD (as defined in section IV.C of this notice) will not be treated as having failed to satisfy Section 401(a)(9), merely because it did not make that distribution." The exception also states that there will be no Section 4974 excise tax. This will apply to designated beneficiaries of employees who passed away in 2020, 2021, 2022 or 2023.

Editor's Note: The IRS seems to be determined to start the "at least as rapidly" rule for individuals who pass away during 2025. The final regulations will clarify the status of RMDs for employees who pass away in 2024.

Treasury Attorney Comments on DAF Proposed Regulations

On April 18, the Georgetown Law Office of Executive and Continuing Legal Education conducted a continuing legal education program on the DAF proposed regulations (REG-142338-07).

Amber MacKenzie is an attorney-advisor in the Treasury’s Office of Tax Policy and commented on the DAF proposed regulations. MacKenzie indicated she wanted to reassure advisors that their concerns had been heard by Treasury.

The American College of Estate and Trust Counsel, the Exempt Organizations Council and the American Bar Association Section of Taxation requested clarification of the term "separately identified" regarding funds. The Exempt Organizations Council noted in public comments submitted to the Treasury, "If merely keeping a record of the donations to a fund causes it to be ‘separately identified with respect to contributions of a donor or donors,’ then any charity that tracks restricted gifts through fund accounting will find that all of its restricted funds (including endowment funds and funds to support particular program areas) will meet the test. This is contrary to legislative intent."

MacKenzie indicated that the Treasury understands many funds could inadvertently be categorized as DAFs and suggested the final regulations are likely to state the three-prong statutory definition of a DAF, which may require all three prongs to be fulfilled. MacKenzie continued, "So things might not be as restrictive as they seem at first glance."

Another major concern in the proposed regulations is that a personal investment advisor who manages DAF funds will be considered a donor-advisor. Payment of DAF fees to a donor-advisor is not permitted, so this definition essentially prevents the donor’s certified financial planner (CFP) or Registered Investment Advisor (RIA) from managing the DAF funds. The only exception to that rule is an investment advisor who manages all organization DAF funds.

Because many community foundations permit donors to create DAFs and allow their personal advisor to continue to manage the fund, this provision could block that practice for thousands of DAFs. MacKenzie acknowledged that personal investment advisors can benefit both the donor and philanthropy and recognized that blocking personal investment advisors from managing DAF funds could be counterproductive.

A third concern relates to the rules for taxable distributions. The costs for managing a DAF should not be considered distributions even if there is a fee for each individual DAF. MacKenzie noted, "I think it is fair to say we intended the reasonable cost of administering and maintaining DAFs to be excluded from the definition of distribution and thus not to be considered taxable distributions even if they are to natural persons or entities other than public charities."

Finally, many commentators have expressed concern about the potential for retroactive effect of the final DAF regulations. MacKenzie noted, "I think the retroactive effect of the proposed regulations was inadvertent and we are definitely considering your comments on that issue."

Editor's Note: The public hearing on the proposed DAF regulations has been extended to two days. There will be the hearing at the IRS Washington, D.C. headquarters on May 6 and a phone conference on May 7. The opportunity to speak closed on April 5, but individuals may attend the phone conference by sending an email to [email protected]. You will receive a reply with the telephone number and access code for the hearing. The email subject line must contain REG-142338-07. A sample subject line can state: Request to Attend the Hearing Telephonically for REG-142338-07. Your email must be submitted by 5:00 pm Eastern Time on May 1, 2024

Applicable Federal Rate of 5.4% for May; 2024-19 IRB 1 (16 April 2024)

The IRS has announced the Applicable Federal Rate (AFR) for May of 2024. The AFR under Sec. 7520 for the month of May is 5.4%. The rates for April of 5.2% or March of 5.0% 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 2024, pooled income funds in existence less than three tax years must use a 3.8% deemed rate of return. Charitable gift receipts should state, “No goods or services were provided in exchange for this gift and the nonprofit has exclusive legal control over the gift property.”

Published April 19, 2024
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