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Friday July 19, 2024

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Free File Extended for Five Years - Direct File Decision Promised Soon

On May 22, 2024, the Internal Revenue Service announced a five-year extension of the Free File program. With Free File, taxpayers can use tax-filing software at no cost. During the 2024 filing season, there were approximately 2.9 million returns filed using the Free File program.

IRS Commissioner Danny Werfel stated, "Free File remains an important part of the IRS portfolio to help taxpayers file their taxes for free. We were pleased to see growth in the program this year, and we look forward to continuing this important collaboration with the tax software industry."

Free File has been available for 22 years. Currently, there are eight private Free File partners who provide their software at no charge to qualified taxpayers. To qualify, the Free File programs are for individuals with 2023 adjusted gross income (AGI) up to $79,000.

The IRS also indicated it is making plans on the future of the Direct File program. Bridget Roberts, Director of the IRS's Direct-File program, noted during a Washington conference on May 22 that "We are anticipating making a decision in the coming weeks."

The pilot version of Direct File allowed taxpayers in 12 states to file returns. Over 140,000 taxpayers filed returns with Direct File. The new program involved an IRS expenditure of $24.6 million for development costs. The IRS is currently communicating with the Electronic Tax Administration Advisory Committee, the IRS Advisory Council and the Council for Electronic Revenue Communication Advancement about the future of the Direct File program.

Over 130 Senators and Representatives sent a May 15 letter to the Department of Treasury and encouraged continuation of the Direct File program.

The lawmakers noted, "Taxpayers want and deserve a free and easy filing option, and thanks to this year's pilot, taxpayers used Direct File to claim over $90 million in tax refunds and save $5.6 million in estimated filing fees, with 90% of surveyed users rating their experience positively and 86% saying their experience with the tool increased their trust in the Internal Revenue Service."

The IRS conducted surveys of Direct File users and claimed this program was a "clear and resounding success." Additional data shows 96% of users were satisfied with the integrated state filing and 82% to 87% of users would recommend Direct File to others.

The lawmakers noted that the Direct File program survey showed that it was easy to use. It also saved both time and money — on average, Americans spend $150 and 9 hours to file their taxes. The letter concluded, "We hope Direct File will support additional sources of income, integrate with more states, offer more flexible identity verification procedures, and accommodate additional tax benefits, with a focus on refundable credits available to low- and middle-income families."

IRS Gift Tax of $9 Million Rejected

In Estate of Sally J. Anenberg et al. v. Commissioner; No. 856-21; 162 T.C. No. 9, the Tax Court rejected an IRS assessment of $9 million for gift tax and a $1.8 million penalty. The Tax Court determined that termination of a marital trust with return of assets to the surviving spouse did not create a taxable gift.

Sally and Alvin Anenberg formed the Al-Sal Oil Co. in 1971 which owned and operated gas stations in California. Alvin passed away in 2008 and his estate funded a marital trust for the benefit of Sally. The trust assets were valued at $25.45 million, and the income interest of Sally was approximately $2.6 million. The marital trusts were required to pay income to Sally for life, with the remainder to Alvin's two sons from his first marriage.

In March 2012, with the consent of all income and remainder beneficiaries, the California Superior Court ordered the termination of the marital trusts with return of all property to Sally. Sally subsequently made gifts of stock to trusts for the benefit of Alvin's sons and then sold the majority of the remaining shares to trusts for the benefit of Alvin's children and grandchildren in exchange for 9-year promissory notes. Sally filed IRS Form 709 United States Gift (and Generation-Skipping Transfer) Tax Return for 2012.

The IRS audited the estate after the death of Sally in 2016 and assessed a $9 million gift tax and an accuracy-related penalty of $1.8 million.

A qualified marital trust must receive property from the decedent, the surviving spouse must receive all of the income from the trust and the executor must elect a qualified terminable interest property (QTIP) trust. Section 2519 addresses dispositions of a QTIP trust interest. In some circumstances, this could create a taxable transfer. Section 2519(a) states, "any disposition of all or part of a qualifying income interest for life in any [QTIP] shall be treated as a transfer of all interests in such [QTIP] other than the qualifying income interest."

The IRS claimed that the termination of the trust resulted in a taxable gift by Sally. The estate contended that she received full consideration for the property, and therefore there was no gift.

The estate noted that because the assets were transferred to Sally, there was no value that "passed from her to anyone else because she ultimately received all the property held by the Marital Trusts." Therefore, this was an incomplete gift, even though the trust value was greater than her income interest. In addition, after she received the property from the trusts, Section 2519 no longer applied to the transfer in exchange for the promissory notes. These are covered by the "ordinary estate and gift tax rules rather than the QTIP regime."

While the IRS claimed that Section 2519 requires gift tax on the full value of any trust, the Tax Court noted that the distribution of assets through the court order to Sally was similar to the appointment of assets in a marital trust to the surviving spouse. Under Reg. 25.2519-1(e) a transfer of assets under a power of appointment to surviving spouse is not a disposition under Section 2519.

Therefore, the Tax Court held that Sally received adequate and full consideration. Sally received the assets in a manner similar to those assets being appointed to her. As a result, this transfer did not constitute a gift. With respect to the sale in exchange for the promissory notes, if there was "adequate and full consideration", there is no gift. Therefore, the assessment of a $9 million gift tax and $1.8 million penalty were rejected.

Nonprofits Concerned About Reporting Foreign Donations

On May 15, 2024, the House Ways and Means Committee approved several bills that are designed to reduce the potential impact of foreign money in U.S. elections. The American Donor Privacy and Foreign Funding Transparency Act requires disclosure of foreign donations but prohibits federal agencies from requiring identification of the donors to a nonprofit.

Representatives of both major parties indicated their goal is to limit the ability of foreign nations to influence U.S. elections. However, the nonprofit community expressed concern about the unintended impact of the disclosure bill. The National Council of Nonprofits (NCN) issued a statement on May 20 and noted, "Concerns arising from these bills include how they would impact typical nonprofit nonpartisan election-related activities, the effect of donor secrecy mandates that would hinder legitimate law enforcement efforts to root out corruption and disrupt dark money and politics, and how public disclosures of international activities could subject recipients to danger in troubled parts of the world."

The Council on Foundations also expressed concern. It noted, "Currently, nonprofits must report the names and addresses of substantial donors to the IRS. Asking organizations to also collect information about their donors' nationality could mean losing the trust of their donors as well as the communities they serve."

While both associations understand the goal to reduce "dark money in politics," there are significant concerns that the bills may have unintended chilling effects on charitable giving.

Another Ways and Means Committee bill is the Foreign Grant Reporting Act which requires reporting of specific information on grants for assistance made to foreign entities. The Council of Foundations noted this bill could lead to challenges because "these additional disclosure requirements could create significant risks for grant recipients, particularly for organizations doing work in sensitive areas." While private foundations are already required to disclose the name, address and amounts for foreign grant recipients, this bill would require public charities to also have similar reporting.

Editor's Note: These bills are in the legislative process and have not been enacted. It is recommended that nonprofits offer guidance on the bills. While there is bipartisan support for efforts to reduce foreign influence in U.S. elections, the bills may have unintended adverse effects on charitable giving.

Applicable Federal Rate of 5.6% for June: Rev. Rul. 2024-12; 2024-25 IRB 1 (15 May 2024)

The IRS has announced the Applicable Federal Rate (AFR) for June of 2024. The AFR under Sec. 7520 for the month of June is 5.6%. The rates for May of 5.4% or April of 5.2% 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 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 May 24, 2024

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