Tax Section - NCBarBlog

2020 Federal Income Tax Update

This is the first of two installments of this article. The second installment will be posted soon on the Tax Section’s blog.

I. Audit Statistics; What Are Your Chances of Being Audited?

In early 2020, the IRS published its 2019 data book, which contained audit statistics for the fiscal year that ended September 30, 2019. Here are the audit statistics for tax returns filed in calendar year 2018 (“CY 2018”):

A. Audit Rates for Individual Income Tax Returns.

Only 0.6% of individual income tax returns filed in CY 2018 were audited (about the same as in CY 2017). Of those audited returns, only 25% were conducted by revenue agents (down from 29%), and the rest were correspondence audits.

December 22, 2020/by TAX

Annual Meeting Between the Tax Section and the IRS

Tax Section

By Mike Wenig

Dec. 2, 2020, marked the annual meeting between the Tax Section and the IRS, along with our invited guests from the Tax Committee for the North Carolina Association of Certified Public Accountants. As with most meetings these days, it was held virtually. We were fortunate to have representatives from the IRS from locations other than just in Greensboro. Speakers included representatives from IRS Chief Counsel’s office, the Examination Division, Collections Division, Appeals Collection, Appeals Exam, and we ended with a brief discussion by our local IRS stakeholder liaison. Click here for the speakers’ contact information.

December 16, 2020/by TAX

Reinstatement of 501(c)(3) Status for Charitable Organizations

Tax Section

By John G. Hodnette

Nonprofit organizations generally must file a Form 1023 with the IRS to obtain federal tax-exempt status under Section 501(c)(3). However, such status may not be eternal. Tax-exempt status is automatically revoked when a charity does not file the required Form 990 series return or notice for three consecutive years. The IRS publishes a list of charities whose tax-exempt status has been revoked. As one can imagine, that can be overwhelming for a charity that needs to assure its donors their donations are eligible for the charitable tax deduction. Luckily, the IRS has established four procedures in Revenue Procedure 2014-11 for the reinstatement of an organization’s tax-exempt status.

The first is streamlined retroactive reinstatement. That is available only for organizations that should have filed Form 990-EZ or Form 990-N (ePostcard) for the three years for which returns were not filed. These charities are eligible to file Form 1023 or 1023-EZ and mark the appropriate box to have their exempt status retroactively reinstated. Such charities will be treated as if they never lost their exempt status.

October 13, 2020/by TAX

Tax Consequences of Terminating Whole Life Insurance with Existing Policy Loans

Tax Section

By John G. Hodnette

Whole life insurance, when distinguished from term life insurance, has several qualities that may create surprising tax results. One of these potential pitfalls can arise when taxpayers take out policy loans on their whole life policies. These loans, when received by the taxpayer, are not taxable income so long as they do not exceed the amount paid in premiums and a termination event does not occur. Prepaying such a loan is usually not mandatory, as any debt outstanding upon the insured’s death will be deducted from the policy payout to beneficiaries.

While these are helpful benefits, they can be double-edged if the taxpayer is forced to surrender the policy or if it lapses. In either of these cases, the loan (plus accrued interest) is taxable, and a Form 1099-R will be issued. This income is cancellation of indebtedness income consistent with Tufts and its progeny, as explained by the Tax Court in Mallory v. Commissioner, T.C. Memo 2016-110.

August 14, 2020/by TAX

Disregarded Entities and Partnerships

Tax Section

By John G. Hodnette

Single-member LLCs and grantor trusts are both entities that exist for state law purposes but are disregarded for federal income tax purposes. These entities are commonly known as disregarded entities or DREs. The ownership of partnership interests by a disregarded entity creates the question of who the partner really is.

A limited liability company has great flexibility in federal and state tax treatment under Treas. Reg. § 1.7701-3. The default treatment of an LLC that has a single owner is for the LLC to be disregarded as an entity separate from its owner. So, who is the partner if a disregarded LLC owns a partnership interest? The IRS answered that in Rev. Rul. 2004-77, which confirms an entity disregarded under federal tax law is ignored under federal partnership law. Thus, the disregarded entity’s owner is treated as the partner.

July 17, 2020/by TAX

Casualty Losses Under Sections 162 or 165(c)(2)

Tax Section

By John G. Hodnette

The Internal Revenue Code (“IRC”) sometimes provides multiple avenues for a taxpayer to obtain a deduction depending on how the taxpayer characterizes the loss. One example is a casualty loss deducted under either Section 162 or Section 165. Although these two sections may both offer a deduction for the same loss, they are not treated exactly the same under IRC. However, due to changes made by the 2017 Tax Act, taking the deduction under either of these sections may produce the same result.

Section 162 provides the general deduction for trade or business expenses. It is perhaps the broadest section in the IRC—it provides a deduction for almost all expenses or losses incurred by an operating trade or business. That includes both normal expenses associated with running a business and certain losses incurred by the business. Section 162 provides an above-the-line deduction pursuant to Section 62(a)(1). That means the deduction is applied when determining adjusted gross income. Above-the-line deductions are not subject to any limitations or special rules, unlike many below-the-line deductions.

June 3, 2020/by TAX

The NOL Carryback Rules Under the CARES Act

Tax Section

By John G. Hodnette

On March 27, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act introduced a number of new provisions to assist businesses and individuals during the COVID-19 pandemic. One such provision adjusts the rules of net operating loss (“NOL”) carrybacks.

Before 2018, NOLs of a business or individual could be carried back two years and carried forward twenty years. When carried forward, NOLs at that time were allowed to offset 100% of taxable income. The Tax Cuts and Jobs Act of 2017, however, disallowed NOL carrybacks for all post-2017 losses, extended the twenty-year carryforward to an unlimited carryforward, but limited the NOL offset to 80% of taxable income.

May 8, 2020/by TAX

The Tax Implications of Three Programs Created by the CARES Act

Tax Section

By John G. Hodnette

The landscape of the United States has changed in the past weeks as COVID-19 continues to sweep across our nation. The Federal government attempted to mitigate the economic damage of the virus on March 27 with the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act. Although the programs created by the CARES Act are being explained by media outlets, there is some confusion in the general public about the tax implications of these programs.

Most have heard about the $1,200 per person payments being sent by the IRS to qualifying individuals. These payments are increased by $500 for each dependent under the age of 17 and subject to a phase out for taxpayers above a certain income level. However, some taxpayers are confused about how these payments will be treated for tax purposes. The Act explains the payments are advance refundable tax credits for taxpayers’ 2020 taxes. For tax purposes, a tax credit is a dollar for dollar reduction in tax due. Credits are more powerful than deductions, which are a reduction in taxable income, not in tax. Some credits, such as this one, are refundable, meaning that if the credit exceeds the tax due, the excess is paid to the taxpayer. However, in this case, the government treated the credit as fully refundable in advance so taxpayers are able to receive these needed funds quickly. That does not mean that the payments are loans that must be repaid. It also does not mean the payments will be taxable income in 2020 or any other year. Rather, the payments are truly free money the government has sent to Americans to help them get through the COVID-19 pandemic.

April 16, 2020/by TAX

IRS Response to COVID-19: Installment Agreements, Offers in Compromise, and IRS Collection Actions

Tax Section

By John G. Hodnette

The novel coronavirus known as COVID-19 has changed the world as a global pandemic disrupts the day-to-day business operations of almost every country. The IRS has responded to ease the strain on taxpayers during this difficult time by modifying its procedures for collecting assessed federal tax liabilities.

First, those with existing IRS installment agreements have been granted a temporary pause on all payments from April 1 to July 15. Additionally, the IRS has made it clear it will not treat as a default nonpayment or similar events under any installment agreements during this period for any reason. Interest will continue to accrue on these balances. Although this pause also applies to direct debit agreements, the IRS will not automatically stop direct debit withdrawals from taxpayers’ bank accounts. Therefore, any taxpayer who has a direct debit installment agreement will need to request its bank to halt payments during this period. If the taxpayer has a traditional agreement (i.e., the installment payments are sent in by check or manually paid online every month), the only thing the taxpayer needs to do is stop payment during this period.

April 6, 2020/by TAX

Alimony Modifications: Taxation of Alimony Payments Under the 2017 Tax Act

Tax Section

By John G. Hodnette

Prior to the 2017 Tax Act, Section 71 provided alimony payments entitled the payor to a deduction and required the payee to include them in taxable income. The 2017 Tax Act repealed Section 71. For alimony orders executed after December 31, 2018, a payor of alimony receives no deduction, and an alimony recipient is no longer taxable on it.

While this change may seem straightforward, an interesting question arises when an alimony order is executed on or prior to December 31, 2018 but is later modified. Although Treasury has not yet issued guidance, the 2017 Tax Act provides guidance at Pub. L. 115-97 § 11051(c). That section states “any divorce or separation agreement (as so defined) executed on or before [December 31, 2018] and modified after such date [shall be bound by the amendments to this section] if the modification expressly provides that the amendments made by this section apply to such modification” (emphasis added). Thus, one must expressly adopt the new law in the modification of the old alimony for the new law to apply.

By providing that one may essentially contract his or her way into the new law, Congress has passed the responsibility to the taxpayer. Family law attorneys should be deeply familiar with these aspects of the tax code.

John G. Hodnette, JD, LLM is an attorney with Culp, Elliott, & Carpenter in Charlotte.

January 14, 2020/by TAX