Tuesday November 28, 2023
Secretary Yellen Highlights IRS Improvement Efforts
On August 2, 2023, Treasury Secretary Janet Yellen gave a public address to Internal Revenue Service (IRS) employees in Maryland. Secretary Yellen highlighted many of the IRS customer service improvement efforts. With additional funding from the Inflation Reduction Act, the IRS has hired 5,000 new staff and engaged in many efforts to improve their assistance to taxpayers.
1. Better Customer Service — The IRS had a dismal record in the 2022 filing season, with only a 10% to 15% level of service. It answered two calls out of every 10 from taxpayers. Secretary Yellen set a goal in 2023 goal to improve from 15% to 85% service level. She was delighted to report that the 5,000 new staff were able to increase the service level to 87% this year. The IRS answered 3 million more taxpayer phone calls compared to the prior year. In addition, the taxpayer wait time to talk to an IRS representative was reduced from 28 minutes to 3 minutes.
2. In-Person Assistance —35 new Taxpayer Assistance Centers facilitated a major increase for in-person services. The IRS served 140,000 more individuals this year than the prior year. The IRS also set up temporary assistance centers in several rural areas. These efforts enabled a substantial increase in the number of in-person visits.
3. Paper Returns — The IRS has struggled to process paper returns. There is a major program underway to scan millions of paper returns. This is also related to the efforts for taxpayer improvement of online contacts with the IRS. The combination of scanning paper returns and notifications with the option for electronic response has substantially increased the level of taxpayer service. The IRS also reports it has fully cleared the 2022 backlog of paper tax returns.
4. Paperless Processing — The IRS has moved into the modern era with an effort to allow all correspondence, non-tax forms and notice responses to be completed online. While taxpayers may still submit paper documents, the IRS has set a goal for 2025 to transition to nearly all digital documents. Currently, the IRS receives 200 million paper documents each year. The goal is to encourage all taxpayers to move to digital formats. The digital process provides faster refunds, produces fewer errors in processing and facilitates a more responsive customer service experience.
5. Fair Enforcement — America has a substantial tax gap between the taxes owed and those paid. The tax gap is estimated to be $700 billion per year. Honest taxpayers who are paying their correct amount are upset by the fact that "wealthy and large corporate taxpayers" have not paid their full share of taxes. The IRS is now hiring staff to increase audits for corporations, partnerships and high-income taxpayers. Secretary Yellen notes the fair enforcement efforts for affluent taxpayers may reduce deficits by hundreds of billions of dollars over the next decade.
Secretary Yellen concluded by stating the IRS improvements and other milestones are the result of dedicated employees who can exceed expectations if given sufficient tools and resources.
Cryptocurrency Staking Rewards Taxable in Year Received
In Rev. Rul. 2023-14; 2023-33 IRB 1, the Internal Revenue Service (IRS) noted that cryptocurrency staking is now a common practice. When an owner of cryptocurrency stakes the asset, he or she receives additional units of cryptocurrency that are taxable in the year the owner has dominion and control over the units.
Cryptocurrency is a digital asset under Section 6045(g)(3)(D). Notice 2014-21 defines virtual currency as an asset that is a substitute for real currency. Cryptocurrency uses cryptography and records transactions on a distributed ledger using blockchain technology. This is a type of distributed ledger that is used to record, share and synchronize transactions. There are multiple nodes that maintain a copy of the distributed ledger and enhance the security of any transaction.
In order to ensure that a sale transaction is correct and there are no duplicates of an item of cryptocurrency, owners of cryptocurrency are invited to "stake" their assets. During the staking, these owners are generally precluded from buying, selling or transacting business with the units. Instead, the units are used by the nodes in a proof-of-stake consensus system. The units are essential in validating transactions and adding blocks to the blockchain. The party that places his or her units in a proof-of-stake system receives a reward of additional cryptocurrency tokens.
A typical example is Taxpayer A who owns 300 units of cryptocurrency M. Taxpayer A stakes 200 of the units for a period of time on the M blockchain and receives two additional units of M as a reward. During a brief period, Taxpayer A lacks the ability to sell, exchange or otherwise dispose of any interest in the two units of M in any manner. On a subsequent day, Taxpayer A has the ability to sell, exchange or dispose of these two units of cryptocurrency M.
Section 61(a) indicates that "instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion" are included in income. The income may be realized through the transfer of services, stock, property or cash.
The basic principle of Section 61 is that a person who receives cryptocurrency must include the fair market value of that asset in “gross income in the taxable year the taxpayer obtains dominion and control of the cryptocurrency." Under Reg. 1.451-1(a), any gain received through any method of acquiring title will produce income in the year received.
Taxpayer A staked 200 units of cryptocurrency M on a blockchain. Taxpayer A received two units of M as a valuation reward. As of the date and time that Taxpayer A gained dominion and control over the two units of M, he or she must report taxable income in that calendar year.
Editor's Note: Section 451 and Reg. 1.451-1 have previously applied to nonqualified stock options (NQSOs), restricted stock awards (RSAs) and restricted stock units (RSUs). These stock transactions are taxable to the recipient when there is dominion and control. Generally, they are taxable when there no longer is a substantial risk of forfeiture. The IRS is now applying this same "dominion and control" principle to cryptocurrency. Section 451 requires a recognition of taxable income when the cryptocurrency has vested and may be transferred by the owner. Cryptocurrency advocates have been seeking laws from Congress that would permit deferral of recognition of staking income until the reward unit is sold. At present, an exception does not exist and the IRS takes the "dominion and control" taxable income position.
Monetized Installment Sales are Listed Transactions
In IR-2023-139, the Internal Revenue Service (IRS) announced proposed regulations (REG-109348-22) that designated monetized installment sales as listed transactions. These monetized installment sales were also part of the 2023 "Dirty Dozen" list.
A monetized installment sale is a strategy that is designed to allow sale of an appreciated asset with the tax on the gain deferred for multiple years. There are generally eight steps to complete a monetized installment sale.
1. Identified Buyer — A seller who owns appreciated property will seek a buyer who is willing to pay cash for the land or other property.
2. Sale of Property to Intermediary — The seller enters into an installment sale agreement with an intermediary. The installment sale specifies a fixed rate of interest on the agreement.
3. Property Transferred to Intermediary — While the intermediary may never take title or take title only briefly, the seller transfers the property. Real property would be transferred through a deed to the intermediary or the buyer.
4. Loan Agreement — The seller acquires or obtains a loan and the interest payments by the seller on the loan are the same as the interest payment that is specified in the installment note with the intermediary.
5. Balloon Payment — The installment agreement and the loan to the seller provide for the same rate of interest. There is a balloon payment in each agreement at the end of the selected term.
6. Sale Proceeds — The buyer transfers the sale price to the intermediary. The intermediary receives fees and transfers the balance of the sale proceeds to the lender or to an escrow account for the lender.
7. Lender Agreement — The lender agrees to repay the interest amounts to the intermediary over the course of the installment obligation.
8. Installment Sale under Section 453 — The seller then claims the transaction is an installment sale and the gain is deferred. The seller will not report tax until receiving the balloon payment at the termination of the plan.
The IRS advances several arguments to attack the transaction. First, the intermediary is not believed to be a bona fide purchaser. The only economic effect of the monetized installment sale is to transfer direct and indirect fees to the intermediary.
Second, the outside party is only involved for tax planning purposes. There is no substantive or nontax purpose for the existence of the intermediary. Therefore, the IRS claims that this is essentially a sale of the property by the seller directly to the buyer. Because the intermediary does not bear any burdens of ownership, he or she may be disregarded. Under the economic substance rules, the seller recognizes taxable gain because he or she has in effect received the full payment.
Applicable Federal Rate of 5.0% for August — Rev. Rul. 2023-13; 2023-32 IRB 1 (17 July 2023)
The IRS has announced the Applicable Federal Rate (AFR) for August of 2023. The AFR under Sec. 7520 for the month of August is 5.0%. The rates for July of 4.6% or June of 4.2% 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 2023, pooled income funds in existence less than three tax years must use a 2.2% 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 August 4, 2023
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