$80 Billion to the IRS: What It Means for You

You may have noticed that the IRS is in a bad way.

It has a backlog of millions of unprocessed paper tax returns, and taxpayers can’t get through to the agency on the phone. Congress noticed and took action by passing a massive funding of the IRS in the recently enacted Inflation Reduction Act.

The IRS will get an additional $80 billion over the next decade. This includes $35 billion for taxpayer services, operations support, and business systems. Among other things, the IRS plans to use these funds to update its antiquated IT systems (some of which date back to the 1960s), improve phone service, and speed up the processing of paper tax returns.

Despite what you may have heard in the media, the IRS will not expand by 87,000 new employees. It will still be smaller than it was 30 years ago. It may grow by 20,000 to 30,000 workers over the next decade, and the number of revenue agents could increase to 17,000 by 2031—over twice as many as today.

The IRS will have an additional $45 billion to spend on enforcement. Treasury Secretary Janet Yellen has promised that IRS audit rates will remain at “historical levels” for taxpayers earning less than $400,000 annually.

Audit rates will rise for taxpayers earning $400,000 or more per year. If you’re in this group, it’s wise to plan ahead to avoid trouble with a beefed-up IRS.

You should keep complete and accurate records and file a timely tax return. Of course, this is something you should be doing anyway.

Here are a few special areas of concern:

• Cryptocurrency. You can expect increased IRS audits dealing with cryptocurrency transactions. If you’re one of the millions of Americans who engage in such transactions, make sure you keep good records and report any income you earn.

• S Corporations. If you’re an S corporation shareholder-employee, you should have your S corporation pay you an arguably reasonable salary and benefits, and document how you arrived at the amount.

• Syndicated Conservation Easements. Be aware that the IRS is auditing all of these deals, and its scrutiny of them will likely grow.

• Offshore Accounts. You’re supposed to report these to the U.S. Treasury. Failure to do so subjects you to substantial penalties. In recent years, the IRS has gone after banks and bank account holders who hide assets in offshore accounts. In future years, we can expect the IRS to place even greater emphasis on identifying and tracking such offshore assets.

• Partnerships. Partnerships and multi-member LLCs taxed as partnerships (this describes most of them) are already the subject of the Large Partnership Compliance program, which uses data analytics to select large partnership returns for audit. The IRS will likely devote more resources to this program in the future.

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Section 1031 Exchanges vs. Qualified Opportunity Zone Funds

Have you sold, or are you planning to sell, commercial or rental property?

To avoid immediately paying capital gains tax on your profit, you have options:

• Defer the capital gains tax using a Section 1031 exchange
• Defer the capital gains tax using a qualified opportunity zone fund

With a Section 1031 exchange, you sell your property and invest all the proceeds in another like-kind replacement property of equal or greater value.

With a qualified opportunity fund, you don’t acquire another property. Instead, you invest in a corporation, partnership, or LLC that pools money from investors to invest in property in areas designated by the government as qualified opportunity zones. Most qualified opportunity funds invest in real estate.

Which is better? It depends on your goals. There is no one right answer for everybody.

A Section 1031 exchange is preferable to a qualified opportunity fund investment if your goal is to hold the replacement property until death, when your estate will transfer it to your heirs. They’ll get the property with a basis stepped up to current market value, and then they can sell the property immediately, likely tax-free.

In contrast, your investment in a qualified opportunity fund requires that you pay your deferred capital gains tax with your 2026 tax return. That’s the bad news (only four years of tax deferral).

The good news: if you hold the qualified opportunity fund for 10 years or more, there’s zero tax on the appreciation.

In contrast, if you sell your Section 1031 replacement property, you pay capital gains tax on the difference between the original property’s basis and the replacement property’s sale amount.

And if you’re looking to avoid the headaches and responsibilities that come with ownership of commercial or rental property, the qualified opportunity fund does that for you.

If you’re looking for liquidity, the qualified opportunity fund gives you that because you need to invest only the capital gains to defer the taxes. With the Section 1031 exchange, you must invest the entire sales proceeds in the replacement property to avoid any capital gains tax. Of course, you want your investment to perform. Make sure to do your due diligence, whatever your choice

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Use In-Kind RMDs to Avoid Selling Retirement Account Assets

Are you 72 or older? If so, you must take a required minimum distribution (RMD) from your traditional IRA, SEP-IRA, or SIMPLE IRA by the end of the year.

If you turn 72 this year, you can wait until April 1 of next year to take your first RMD—but you’ll also have to take your second RMD by the end of that year.

Your RMD is a percentage of the total value of your retirement accounts based on your age and life expectancy. The older you are, the more you must distribute. But here’s the kicker: your RMD must be based on the value of your retirement accounts as of the end of the prior year—December 31, 2021, in the case of 2022 RMDs. So you may have a high RMD due this year even though the value of your retirement portfolio has declined, perhaps substantially.

If your retirement accounts consist primarily of stocks, bonds, or other securities, you don’t have to sell them at their current depressed levels and distribute the cash to yourself to fulfill your RMD. There’s another option: do an in-kind distribution.

With an in-kind RMD, you transfer stock, bonds, mutual funds, or other securities directly from your IRA to a taxable account, such as a brokerage account. No selling is involved. The amount of your RMD is the fair market value of the stock or other securities at the time of the transfer.

Furthermore, you still have to pay income tax on the distribution at ordinary income rates. To avoid selling any part of the stock or other securities you’ve transferred, you’ll have to come up with the cash to pay the tax from another source, such as a regular bank account.

With an in-kind distribution, not only do you avoid selling stocks in a down market, but the transfer may also reduce the taxes due on any future appreciation when you eventually do sell. This is because when you do an in-kind RMD, it resets the basis of the assets involved to their fair market value at the time of the transfer.

If you later sell, you pay tax only on the amount gained over your new basis. And such sales out of a taxable account generally are taxed at capital gains rates, not ordinary income rates.

If an in-kind distribution sounds attractive, act quickly so the transaction is completed by year-end.

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Tax Consequences of a Short Sale of Your Principal Residence

The real estate boom appears to be over for now.

Morgan Stanley predicts that house prices could fall by 10 percent by the end of 2024, or perhaps twice as much in a worst-case scenario.

Those who purchased their homes at the top of the market could be in trouble, especially if the U.S. falls into a recession.

It’s true. Homeowners don’t want to go through a foreclosure and the resulting destruction of their credit rating. Fortunately, there is an alternative for homeowners having trouble making their mortgage payments: a short sale.

Short sales avoid foreclosure, but they can result in tax liabilities.

What Is a Short Sale?

A “short sale” is a way for financially struggling homeowners to avoid foreclosure when their home is worthless than the amount of their loan. The lender allows the homeowner to sell the home in a regular sale through a real estate agent for less than the amount of the mortgage.

The lender accepts the sale proceeds, releases the mortgage lien on the property, and typically writes off the remainder of the loan as an uncollectible debt.

Why would a lender agree to do this? Because it’s clear that (1) the home is worth less than what the homeowner owes, and (2) the homeowner is financially unable to keep up the mortgage payments due to job loss, health issues, death, or other hardship circumstances.

The homeowner must submit an application to the lender, including a hardship letter showing these circumstances. Lenders do not consider a decline in home value alone to be a hardship.

With a successful short sale, the lender collects as much as possible from the underwater property without having to go through the trouble and expense of a foreclosure. The homeowner avoids bankruptcy or foreclosure.

A short sale will impact the homeowner’s credit rating, but not as much as a foreclosure would. Both substantially reduce a homeowner’s credit rating, but short sales usually remain on credit reports for a shorter period: about two to three years, compared with seven to ten years for foreclosures.

Potential Tax Liability in a Short Sale

Typically, a short sale involves forgiveness of part of the mortgage debt owed by the homeowner. Forgiveness of a debt can constitute income to the borrower. Such cancellation of debt (COD) income is taxed as ordinary income rates.

Key point. The lender is usually required to report the amount of the canceled debt to the IRS on Form 1099-C, Cancellation of Debt.

Whether the debt forgiven in a short sale is taxable income depends on several factors, including whether

• the mortgage is a recourse loan or a non-recourse loan;
• the forgiven debt qualifies for the qualified principal residence indebtedness exclusion; or
• the homeowner was insolvent at the time of the debt cancellation.

Non-Recourse vs. Recourse Loans

There are two main types of loans: recourse and non-recourse.

• With a recourse loan, the borrower is personally liable for the debt.
• With a non-recourse loan, the borrower is not personally liable. If the borrower defaults, the lender may only go after the property that was collateral for the loan and not collect against the borrower’s personal assets.

Non-Recourse

If the lender forgives a non-recourse loan following a short sale, there is ordinarily no taxable income to the borrower.

It works like this: You treat the non-recourse debt forgiven by the lender as the amount realized on the sale of the property. You then compare the amount realized to your basis to determine gain or loss. Technically, there’s no discharge of indebtedness income because you treat this as a sale.

Twelve states by law allow only non-recourse home loans: Alaska, Arizona, California, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas, Utah, and Washington. In addition, all government-backed mortgages are non-recourse loans, even in the 38 states that allow recourse loans. These include VA, USDA, and FHA loans.

Recourse

Recourse home loans are common in the 38 states that allow them. If the loan is a recourse loan, the forgiven debt will be taxable income unless one of the following two exceptions applies.

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Are You Cheating Yourself by Using IRS Mileage Rates?

Let’s start with an example.

Say that in 2022 you bought a $50,000 SUV that qualifies for both Section 179 expensing and bonus depreciation. You drive this SUV 15,000 miles during the year, of which 87 percent are business miles.

Let’s further suppose that you can qualify to use the IRS mileage rates:

• 58.5 cents a mile from January 1, 2022, to June 30, 2022
• 62.5 cents a mile from July 1, 2022, to December 31, 2022

You plan to use the new SUV for three years and then trade it in.

1. Would you be cheating yourself by using the mileage rates?
2. If so, how badly would you cheat yourself?
3. Is there an easy way to know what’s best?

Answers to the Questions

Yes, based on the facts above, you would be cheating yourself.

How badly would you cheat yourself? Pretty badly. You would have lost $5,712 in after-tax cash. (As Yogi Berra, the famous baseball player, likely would have said, “This is real money.”)

Is there an easy way to know what’s best? Yes: use our 2022 IRS vs. actual expenses calculator. That’s what we did. We plugged the numbers given above into the calculator and found that the calculator does the following:

• Figures bonus depreciation, Section 179 deduction, depreciation, and ownership costs over the ownership period ($58,832 in this case)
• Figures the mileage rate deductions over the ownership period ($24,469 in this case)
• Calculates the $10,179 IRS mileage rate depreciation that come with using and resides inside the mileage rate
• Computes the gain or loss on sale ($6,960 gain with the actual-expense method, and $26,361loss with the IRS mileage rate method)
• Applies the appropriate tax rates to the deductions and gains and losses, compares the numbers, and gives a nice presentation of which is better and by how much in after-tax dollars (all of which boils down, in this example, to $5,712 in after-tax cash)

Do You Qualify for the IRS Mileage Rate?

Not everyone can use the IRS mileage rate. You may not use the IRS business standard mileage rate on your vehicle if you

• have five or more vehicles on the road at the same time;
• lease a vehicle and don’t use the standard rate for the full term of the lease;
• claimed Section 179 expensing on the vehicle;
• claimed any depreciation on the vehicle, other than straight-line depreciation over the vehicle’s estimated useful life; or
• use the vehicle as an employee of the United States Postal Service to deliver mail on a rural route.

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Alert: A Massive New FinCEN Filing Requirement Is Coming

The Corporate Transparency Act (CTA) is a new law passed in 2021 that requires corporations, LLCs, and other business entities to provide information about their owners to the Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN).

The CTA did not take effect immediately. Rather, Congress gave the FinCEN time to write regulations and gave businesses a heads-up about the new law.

FinCEN has now issued proposed regulations on how it intends to implement the CTA. The new

proposed regulations hold several unpleasant surprises for businesses and the lawyers and accounting firms that advise them.

What the CTA Is About

The CTA is part of a major government effort to crack down on corruption, money laundering, terrorist financing, tax fraud, and other illicit activity. The CTA targets the use of anonymous shell companies that facilitate the flow and sheltering of illicit money in the United States.

Currently, few states require corporations, LLCs, or other entities to disclose information about their beneficial owners—that is, the human beings who own or control them— or the people who form them. And there has never been a federal requirement to do so. As a result, anonymous shell companies abound, and it can be impossible for law enforcement to discover who really owns them.

This will soon change. The CTA empowers FinCEN to establish a massive database containing beneficial owner information for most types of smaller business entities. These include U.S.-based businesses and foreign entities that register to do business in the U.S. The database will not be publicly accessible; it is solely for the use of law enforcement, national security and intelligence agencies, and federal regulators enforcing anti-money-laundering laws.

The CTA focuses on smaller business entities, since they are most likely to be shell companies. The law contains 23 exemptions for most types of larger businesses. These include publicly traded corporations and other businesses that are heavily regulated by the federal government.1 Also exempt is any business that

• has more than 20 full-time employees (employees who work 30 hours per week or 130 hours per month),
• has a physical presence at a business office in the United States, and
• has filed a federal tax or information return the prior year showing more than $5 million in gross receipts or sales (net of returns and allowances, and not counting foreign sales).

Violations of the CTA can result in a $500-a-day penalty (up to $10,000) and up to two years’ imprisonment.

Surprise #1: The CTA Is Not Just for Corporations and LLCs

The CTA mandatory reporting requirements apply to corporations and limited liability companies. This includes the almost 2.5 million LLCs that have only one member and are taxed as Schedule C sole proprietorships (“disregarded entities”).

But the CTA doesn’t end there. It also applies to any other non-exempt entity that is created by filing a document with a state secretary of state or similar state agency.4 FinCEN says that this includes limited liability partnerships, limited liability limited partnerships, business trusts, and most limited partnerships because such entities are normally created by a filing with a secretary of state.

In short, almost every small business that is not a sole proprietorship or general partnership will have to comply with the CTA.

How many businesses are we talking about? FinCEN estimates as many as 30 million!

Surprise #2: The CTA May Take Effect Sooner than Anticipated

It’s likely that the regulations will become final sometime in the second half of 2022. The final date will trigger the deadline for complying with the CTA’s reporting requirements.

The CTA applies to both newly formed entities and existing companies. The deadline for compliance differs for each.

Key point. The deadlines do not coincide with the deadlines for filing tax returns.

New companies. Once the proposed regulations become final, new companies have to file their beneficial owner reports within 14 calendar days after being formed.6 Thus, if you’re forming a new corporation, LLC, limited partnership, or other entity during the second half of 2022 that requires a filing with your secretary of state, you’ll likely have to file a report with FinCEN.

Existing companies. The proposed regulations require existing companies to file a report no later than one year after the effective date of the final regulations.7 This is so even though the CTA itself provides that existing companies have two years to comply after the regulations become final.8 So existing companies will have to file their initial reports by mid- to late 2023.

Of course, it’s possible that FinCEN will delay the final date of the regulations to 2023 or even later if it becomes clear no one is ready for them to go into effect during 2022.

Surprise #3: Beneficial Owners Are Broadly Defined

The CTA requires affected business entities to file a “beneficial owner information” report including each beneficial owner’s full legal name, date of birth, and residential street address as well as a unique identifying number from an acceptable legal document such as a driver’s license or passport. The proposed regulations make it clear that a company can have multiple beneficial owners, and it may not always be easy to identify them all.

There are two broad categories of beneficial owners:

1. Any individual who owns 25 percent or more of the company.
2. Any individual who, directly or indirectly, exercises substantial control over the company.

The CTA didn’t define “substantial control.” The proposed regulations define it quite broadly, to include

• senior officers of the company;
• individuals who have authority over appointment or removal of any senior officer, or of most of the company’s board of directors; and
• individuals who have substantial influence over important matters affecting the reporting company, including major expenditures, investments, or borrowing; sale or other transfer of assets; selling, dissolving, or reorganizing the company; selecting or terminating business lines or ventures; entering or terminating significant contracts; compensation for senior officers; or amending the company’s governing documents.

Moreover, a person’s substantial control need not be exercised directly. It can be indirectly

exercised through a variety of means.

Surprise #4: Tight Deadline for Updated Beneficial Owner Reports

If changes occur in the information included in a beneficial owner information report, the proposed regulations require that an updated report be filed with FinCEN within 30 calendar days after the change.

For example, if a beneficial owner moves, an updated report will have to be filed within 30 days. FinCEN estimates that about 9 percent of all beneficial owners will have a change of address each year requiring an updated report. Updated reports also will have to be filed when a beneficial owner dies.

FinCEN estimates that over 11.4 million updated reports will have to be filed each year.

Surprise #5: The Report Must Identify Those Who Help Form Corporations and LLCs

In addition to the company’s beneficial owners, the “company applicant” will have to be identified in the beneficial owner information report. This is “any individual who files the document that creates the domestic reporting company” or directs or controls others to do so. This would appear to include an attorney who files articles of incorporation to create a corporation or articles of formation to establish an LLC.

Neither the CTA nor proposed regulations contain any exemption for legal or accounting firms, except for public accounting firms registered under Section 102 of the Sarbanes-Oxley Act of 2002. According to FinCEN, only 851 accounting firms are so registered.

Get Ready—It’s Coming

Whether it starts in late 2022 or 2023, a massive new filing requirement is coming for small businesses.

The FinCEN estimates that during the first year the CTA is in effect, over 25.8 million reports will have to be filed at a cost of $1.264 billion. In subsequent years, over 3.2 million initial reports and 11.4 million updated reports will have to be filed, at a total annual cost of over $364 million.

If you’re a beneficial owner of a company subject to the CTA (in other words, a reporting company), you should provide your identifying information to the company so it can file the beneficial owner report.

Instead of providing your information directly to the company, you’ll have the option of applying to FinCEN for a FinCEN identifier and using that instead. You’ll have to provide FinCEN with all the required information, and it will assign you a unique number to give to the reporting company. You’ll need to keep this information up to date with FinCEN.

Reporting companies should identify every individual who meets the definition of “beneficial owner” and inform them of the need to provide the required information or obtain a FinCEN identifier.

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New Law Improves Energy Tax Benefits for Biz Owners and Landlords

The newly enacted Inflation Reduction Act contains tax credits and depreciation benefits for owners of commercial property and residential rental property.

If you implement various types of renewable energy improvements, you can qualify for hefty tax credits or deductions.

One caution: the rules are complex. That said, bear with the rules because the benefits are worthwhile.

Business Energy Investment Tax Credit

The business energy investment tax credit (ITC) is used primarily for solar panel installations on commercial buildings and residential rentals.

The ITC has been available and continues for small wind power installations, fuel cells, microturbine, waste energy recovery, geothermal, and combined heat and power. The new law extends the ITC to stand-alone battery storage, biogas (such as landfill gas), and microgrid controllers.

The new law retroactively increases the base ITC from 26 percent to 30 percent of depreciable basis for projects that are placed in service after 2021, if construction commences before 2025. To realize the full tax credit, you must continue to own the property for five years after the energy installation, or the government will recapture some or all of the credit.

Special Rule for Larger Energy Projects

To obtain the 30 percent ITC, larger energy projects must comply with new prevailing wage and apprenticeship requirements. These apply only to energy facilities with a maximum net output of at least one megawatt.

Key point. Typical solar or other alternative energy projects for commercial buildings and residential rentals don’t produce this much power. For example, a solar installation for a large warehouse typically produces no more than 100 kilowatts to 400 kilowatts—less than half of one megawatt.

If the wage and apprenticeship rules do apply, failure to comply reduces the ITC from 30 percent to 6 percent.

Increasing the ITC to 40 Percent, 50 Percent, or More

Starting in 2023 (in other words, coming soon), businesses can also utilize stackable “bonus”

ITC adders that can increase the total ITC to a whopping 40 percent, 50 percent, or more.

• Domestic content bonus. You can earn a 10 percent ITC bonus (bringing the ITC to 40 percent) if a project satisfies the domestic content requirement. (100 percent of the steel and iron used must be U.S.-sourced. Manufactured components must be at least 40 percent U.S. sourced.) But the Treasury secretary can provide exceptions to these rules if they result in cost increases of over 25 percent or if comparable products are not readily available in the U.S.

• Low-income community bonus. You earn a 10 percent ITC bonus if a solar or wind facility is in, or services, a low-income community or Native American land. Low-income communities are those with at least a 20 percent poverty rate or whose residents earn less than 80 percent of the statewide median income.

• Qualified low-income residential building project bonus. You earn a 20 percent ITC bonus for solar or wind installations for residential buildings if (a) the building owner participates in various federal low-income housing programs, or (b) 50 percent of the affected building households have income of less than 200 percent of the federal poverty line or less than 80 percent of the area’s median gross income.

• Energy community bonus. You can earn a 10 percent ITC bonus if the project in located in or on (a) a brownfield site, (b) an area with significant employment related to fossil fuels, or (c) a coal-related census tract.

Special depreciation benefit. The year you place your solar or other energy installation in service, you may depreciate it. Ordinarily, you reduce the basis of depreciable property by the full amount of any credit. But the ITC reduces the energy property’s basis by only half the credit amount, increasing your depreciation deductions.

Five-year depreciation. IRC Section 48 energy property gets a five-year depreciation period under MACRS (this is generous because solar panels usually last 25 to 30 years).

Bonus depreciation. Here’s more good news. The 80 percent first-year bonus depreciation is available for energy improvements for residential rental or commercial property placed is service during 2023; the depreciation is 60 percent for 2024.

Example. Sally owns a small commercial building in downtown Detroit. She spends $50,000 to install solar panels in 2023. The project qualifies for the 10 percent domestic content bonus and the 10 percent low-income community bonus.

• Sally’s total ITC is 50 percent. She gets a $25,000 ITC.
• The depreciable basis in her building is reduced by only 50 percent of her ITC, so her basis is $37,500. She uses 80 percent bonus depreciation to deduct $30,000 in 2023.
• She depreciates her remaining $7,500 basis over five years

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Buying an Electric Vehicle? Know These Tax Law Changes

Are you thinking of buying an electric vehicle or a plug-in hybrid?

And are you looking to benefit from the $7,500 tax credit? If so, you have much to consider—thanks to the newly enacted Inflation Reduction Act.

Let’s get started.

The Electric Vehicle Credit for 2023 and Later

A new clean vehicle credit goes into effect in 2023 and continues through 2032. Although the credit maximum remains $7,500, the credit is massively changed. Due to the changes, many taxpayers will no longer be able to claim the credit. And there may be fewer electric vehicles available that qualify for the credit.

Key point. Business taxpayers have a decision to make when buying an electric vehicle in 2023 or later. They can choose either the new clean vehicle credit or the new qualified commercial clean vehicle credit.

200,000 Cap Eliminated

The old credit was limited to the sale of 200,000 electric vehicles per manufacturer. The new credit eliminates this cap. Thus, for example, electric vehicles manufactured by GM, Toyota, and Tesla can qualify for the credit if they meet the price cap and other requirements.

Credit Amount

The maximum credit for 2023 and later remains at $7,500. But it has two components:

1. A $3,750 credit if the electric vehicle complies with the domestic sourcing requirements for critical minerals used in the battery, as explained below
2. A $3,750 credit if the electric vehicle satisfies domestic content requirements for battery components

According to the Alliance for Automotive Innovation, no electric vehicle currently available for purchase will qualify for the full $7,500 credit on January 1, 2023. Electric vehicle manufacturers are working feverishly to change this. The critical minerals requirements may prove particularly difficult to comply with over the next few years. The domestic content requirements should be easier.

Thus, there may be several electric vehicle models that qualify for only a $3,750 credit.

Key point. The business buyer avoids the component problem when using the qualified commercial clean vehicle credit.

Buyer Income Caps

The credit may not be claimed by taxpayers whose modified adjusted gross income (AGI) is

more than

• $300,000 for joint-return filers and surviving spouses,
• $225,000 for heads of household, or
• $150,000 for unmarried taxpayers and married taxpayers who file separately.

Modified AGI is adjusted gross income plus foreign earned income that is otherwise excluded from U.S. taxation. You can use your modified AGI for the prior year if it is lower.

Key point. The business buyer avoids the AGI caps when using the qualified commercial clean vehicle credit.

Electric Vehicle Price Caps

The tax code does not allow the new clean vehicle credit if the manufacturer’s suggested retail price (MSRP) for the vehicle exceeds

• $80,000 for a van,
• $80,000 for a sports utility vehicle (SUV),
• $80,000 for a pickup truck, or
• $55,000 for any other vehicle.

The IRS will provide guidance on which electric vehicles fall within these categories. Note that these caps are cliffs, not phaseouts. The credit is eliminated if the applicable MSRP is even one dollar over the cap.

Key point. The business buyer avoids the dollar caps when using the qualified commercial clean

vehicle credit.