Why Is IRS Appeals So Busy?

Sheldon Kay, deputy chief of IRS Appeals, stated during a February webcast that the case inventory for IRS Appeals reached 148, 000 for fiscal 2011. This is the highest it has ever been. To be fair, Appeals case closures were also at a record level, but not enough to gain ground.

A tax CPA working representation will be quite familiar with Appeals. The normal process is that a taxpayer is selected for examination, i.e. the “audit.” The audit can be through the mail, which is called a correspondence audit. The audit can be at the IRS offices, in which case you go to them. A third type is when they come to you, also called the “field” audit. You are working with a revenue agent. If you disagree you can appeal the agent’s adjustments to the agent’s supervisor, also called the “group manager.”

If you have no settlement there, you are bound for Appeals.

The cases in Appeals fall into two types: collection and exam. What we described above is exam. A collections case has normally gone through exam, and now the IRS is pressing for money. Congress gave taxpayers more protection from IRS collections in 1998 with the IRS Reform and Restructuring Act. Collections have now become half or more of the cases in Appeals.

Back to Sheldon Kay. He explained that the situation has been aggravated by IRS budget constraints. We have seen that here in Cincinnati, as the Appeals office is becoming a ghost town. It is not just the budget, though. Some long-term IRS careerists have also been retiring, reflecting incentives to retire as well as the demographic march of the Baby Boom generation.

There is also another reason. Practitioners comment among themselves that exam is experiencing a brain drain. I agree that a new hire cannot replace the experience and judgment of a career examiner. In the past, the group manager provided some continuity and savvy, but today it is possible that group manager has been there only slightly longer than the examiner.  The “system” is – too often – just not working.

Whether responding to examination or collection frustrations, practitioners are taking their clients to Appeals. The frustration may be because of IRS budgetary constraints, inexperienced personnel, excessive automated collection practices, unrealistic Congressional demands or other reasons. Practitioners are seeking the more experienced personnel available in Appeals.

IRS Offers Penalty Relief for 2011

The IRS last week expanded its relief provisions for financially distressed taxpayers. Effective immediately, the IRS will abate its failure- to-pay penalties for 2011 taxpayers, as long as all taxes are paid by October 15, 2015. To qualify for this relief, you have to be:

·        A W-2 employee and unemployed for at least 30 consecutive days in 2011 or during the 3 ½ months ending April 15,2012, or

·        Self-employed and experiencing a contraction of at least 25% in 2011 business income.

The IRS was very quick to point out that this abatement is for the failure- to-pay penalty only. You still have to file a return by April 15, 2012.

NOTE: There are two “big” penalties when you do not file a return. The first is the failure-to-file penalty. The second is the failure-to-pay. Most tax advisors will counsel you to always file, even if you cannot pay. The failure-to-file penalty is 5% a month, ten times the failure-to-pay penalty of 1/2% a month.

There is a new form to request the abatement (Form 1127-A). The relief is also limited to incomes of $100,000 if you are single and $200,000 if you are married.

The other thing the IRS did is to double the income limitation for a streamlined installment agreement. The streamlined is a payment plan with the IRS. You now qualify if your assessed taxes are $50,000 or less. This is an increase from $25,000, which itself had recently been raised from $10,000. The advantage to the streamlined is that you do not have to provide financial information to the IRS.

The payment term for the streamlined was also increased – from five years to six.

Mandatory FBAR e-Filing Postponed

This is a bit specialized, but if you have a foreign bank account it applies to you.

You may recall that you are required to file Form 90-22.1 “Report of Foreign Bank and Financial Accounts” (more commonly called the “F-Bar”) if you keep over $10,000 in a foreign bank account. It doesn’t have to be a secret Swiss account. A Canadian account will do it, for example. We have clients with Mexican real estate that also have bank accounts requiring FBARs.

You were previously required to file that form electronically starting in 2012. Chances are that meant you were going to use a tax preparer, if you were not using one already.

That electronic filing requirement has been delayed one year – until June 30, 2013.

New Annuities Allowed Inside a Retirement Plan

On February 2, 2012 the IRS published proposed Regulations concerning QLACs – qualified longevity annuity contracts. These contracts would be purchased by and held within your 401(k), 403(b), 457 and IRA accounts.

NOTE: Roths however are not permitted to own a QLAC. Can you guess why? (The answer is below).

Longevity annuities provide life annuity payments, typically starting at age 80 or 85. In many cases, the life annuity is the only benefit the contract provides. As such, these are specialized contracts to aid against outliving your savings. The IRS requires certain bells and whistles before deeming them “qualified” to be owned inside your retirement account.

Why would someone put an annuity inside a retirement account? The IRS has given us at least one very good reason.

You can delay the minimum distribution rules (MRD) on a QLAC. Yes, you read that correctly. Normally, you have to begin taking distributions in the year you reach age 70 ½. A QLAC allows you to defer distributions until and no later than the month following your 85th birthday.   

How will the minimum distribution rules work with a QLAC? You may remember that the normal rule for an MRD is to divide the retirement account balance by an IRS-provided factor for your age. The IRS is allowing you to exclude the QLAC from the balance in the retirement account.

EXAMPLE: If your account is worth $850,000, of which $95, 0000 is a QLAC, you will compute your MRD on $755,000 ($850,000 - $95,000).

The proposed regulations provide that the only QLAC benefit permitted after death is a life annuity. If the contract provides an annuity for a term certain or for a refund of premiums, it will not qualify as a QLAC.

There are restrictions; this is the tax code, after all. Premiums you pay for a QLAC are limited to the lesser of $100,000 or 25% of your retirement account. Bad things happen if you exceed this, so do not exceed the limit.

ANSWER: So why are Roths not permitted to own QLACs? Simple. Roths have no minimum distribution requirement.

IRS Refund Processing Delays

If you are wondering whether the IRS is taking longer to process and issue refunds, you are correct. This has been aggravated by a glitch in the “Where’s My Refund?” tool on the IRS website. The glitch occurs when you file your return electronically, wait a few days and then go to “Where’s My Refund,” which tells you that the IRS is not aware of your return. This is unnerving, of course. It is also incorrect.

What has occurred is that the IRS is tweaking its filters to counter identity fraud. Each year the IRS revises the Electronic Fraud Detection System (EFDS) to reflect fraud patterns detected the previous filing season. Last year, for example, over one million returns were flagged. The returns then go to personnel for review, and therein is the problem. There are not enough people to review the returns.  The ideal time for identity theft is early in the filing season, as the thief is trying to beat you to your refund. The IRS therefore has its fraud filters at their highest setting early in the season.

The IRS has released the customary “we are working on it” statement. It has also reinforced its commitment to getting refunds out within 21 days or less.

The President’s Budget Tax Proposals

The President delivered his proposed budget for fiscal 2013 this Monday. The budget included as one of its five tax “reform” principles the following:

• Simplify the Internal Revenue Code

Sounds good. Here are some proposed tax “simplifications”:

• Provide a temporary 10% tax credit for new jobs and wage increases
• Provide additional tax credits for investment in advanced energy manufacturing
• Provide tax credit for energy-efficient commercial building property expenditures
• Reform and extend Build America Bonds
• Provide for automatic enrollment in IRAs, including a small-employer tax credit
• Expand the earned income tax credit for larger families
• Expand the child and dependent care tax credit
• Provide tax incentives for locating jobs and business activity in the United States
• Provide new manufacturing communities tax credit
• Target the domestic production deduction to domestic manufacturing activities
• Provide a tax credit for the production of advanced technology vehicles
• Provide a tax credit for medium- and heavy-duty alternative-fuel commercial vehicles
• Modify certain energy incentives
• Eliminate capital gains taxation on investments in small business stock
• Expand the tax credit provided to qualified small employers for nonelective contributions to employee health insurance
• Extend and modify the new markets tax credit
• Designate growth zones
• Provide tax incentives for transportation infrastructure
• Modify tax-exempt bonds for Indian tribal governments
• Allow current refundings of state and local governmental bonds
• Reform and expand the low-income housing tax credit
• Defer deduction of interest expense related to deferred income of foreign subsidiaries
• Determine the foreign tax credit on a pooling basis
• Tax currently excess returns associated with transfers of intangibles offshore
• Limit shifting of income through intangible property transfers
• Disallow the deduction for nontaxed reinsurance premiums paid to affiliates
• Limit earnings stripping by expatriated entities
• Modify tax rules for dual capacity taxpayers
• Tax gain from the sale of a partnership interest on a lookthrough basis
• Prevent use of leveraged distributions from related foreign corporations to avoid dividend treatment
• Extend Sec. 338(h)(16) to certain asset acquisitions
• Remove foreign taxes from a Sec. 902 corporation’s foreign tax pool when earnings are eliminated
• Require a certified taxpayer identification number (TIN) from contractors and allow withholding if the contractor does not provide a TIN
• Require e-filing by any entity that must file Schedule M-3
• Authorize Treasury to require additional information to be included in Form 5500, Annual Return/Report of Employee Benefit Plan
• Allow the IRS to require prospective reclassification of misclassified workers
• Extend the statute of limitation where a state adjustment affects federal tax liability
• Require taxpayers who prepare their returns electronically but file their returns on paper to print a 2D bar code
• Impose a penalty on failure to comply with electronic filing requirements

Don’t worry too much about this. The Senate hasn’t passed a budget in years.

Senator Baucus Wants To End Stretch IRAs

Congress is looking to take away a planning option for IRAs as it seeks more money to fund its spending.

The proposal was snuck into the Highway Investment, Job Creation and Economic Growth Act of 2012. The bill was heard by the Senate Finance Committee, and Chairman Max Baucus (D., Mont.) recommended a provision curtailing the use of “stretch” IRAs.

What is a “stretch” IRA? Say you leave your IRA, or part of your IRA, to your son and daughter. Upon your passing, they take over (separate) IRA accounts. They cannot wait until 70 ½ to begin distributions, as these are inherited IRAs. They have to begin distributions by December 31 of the year following your death, but they are allowed to reset the distribution period to their own life expectancy. This allows the opportunity to have the IRA compound – or “stretch” – over their much longer life expectancy.

Truthfully, the numbers can be astounding. Consider a 78 year-old grandfather passing a $100,000 IRA to his granddaughter, who, upon her passing, transfers the remaining stretch IRA to her son or daughter. This wealth compounding is a reason financial planners like to work with stretch IRAs.

It is of course unpalatable to allow one to decide how to distribute the monies in his/her IRA, so Sen. Baucus has stepped-in to decide this matter for you. Under his proposal, most nonspouse inheritors would have to withdraw the entire amount from the traditional IRA over a period of five years. There would be exceptions for beneficiaries who are disabled, chronically ill, a minor, or a beneficiary no more than 10 years younger than the IRA owner.

Roth IRAs would remain unchanged. Nonspouse beneficiaries must begin distributions from the Roth by December 31 of the year after inheriting, but they can draw these out over their own expected life expectancies.

Why are people concerned? Here is a statistic: approximately 40% of the stock market is tied-up in 401(k)s, 403(b)s, IRAs and similar vehicles. It is an attractive target.