On January 4, 2024, the Internal Revenue Service (IRS) highlighted the online tools that enable taxpayers to file their 2023 Federal income tax returns. The IRS has published several reminders that are designed to make filing easier for this season.

1. Interactive Tax Assistant — The Interactive Tax Assistant (ITA) is designed to allow taxpayers to ask common tax law questions and receive helpful answers. Typical questions include who is required to file a tax return, what is the best filing status to use, how to qualify to claim a dependent and whether one should claim certain credits or deductions. The ITA can answer most of the questions that individuals have for filing typical tax returns.

2. Earned Income Tax Credit Assistant — The Earned Income Tax Credit (EITC) is designed to provide moderate-income workers and families with a tax benefit. The EITC may help some taxpayers reduce their tax or provide a larger refund for others. Individuals can use the EITC Assistant to determine eligibility for the credit, understand who is considered a qualifying child or other relative, estimate the amount of the credit and select the correct filing status.

3. Where's My Refund? — After filing a tax return, the majority of taxpayers will qualify for a refund. The IRS attempts to issue refunds within 21 days for those who file electronically. The "Where's My Refund?" tool is available the day after e-filing. If filing a paper tax return, it may take four weeks before the information is available. This convenient tool enables taxpayers to understand the status of their 2023 income tax refund.

4. IRS Individual Online Account — Taxpayers with a Social Security number or an Individual Taxpayer Identification Number are able to create and access an IRS Individual Online Account. This may help by showing any tax balance owed and payment history. Taxpayers can schedule payments, obtain tax transcripts, view or create payment plans and view important data from prior tax returns, such as adjusted gross income. If a tax professional submits a power of attorney, individuals can electronically sign that in the account.

5. Identity Protection PIN — An Identity Protection (IP) PIN is a six-digit code known only to the taxpayer and the IRS. By using an IP PIN together with a Social Security number or Individual Taxpayer Identification Number, taxpayers will have a more secure tax filing experience. The IP PIN tool will be available from January 8 through mid-November. Taxpayers can register and obtain the IP PIN on IRS.gov.

Battle of the Conservation Easement Appraisers

The Internal Revenue Service (IRS) is pursuing approximately 80 cases in Tax Court related to conservation easement charitable deductions. The IRS and litigants contesting the value of two conservation easements outside metropolitan Atlanta requested a summary judgment. The Tax Court denied summary judgment and the case will proceed to trial on January 8, 2024. However, the pretrial motions describe the forthcoming battle of the appraisers during trial.

The two parcels in question were donated by Jackson Crossroads LLC (Jackson Crossroads) and Long Branch Investments LLC (Long Branch Investments). The IRS attacked the appraiser for Jackson Crossroads, Robert Fletcher, for substantial errors in conflict with the Uniform Standards of Professional Appraisal Practice (USPAP). The IRS claims Fletcher used an income approach for vacant land incorrectly, did not appropriately follow the principle of substitution to determine a price, made unreasonable assumptions and failed to consider transactions related to the property. In addition, Fletcher failed to consider put-call provisions in the Jackson Crossroads operating agreement. Finally, Fletcher completed most of his appraisals for the tax matters partner of Jackson Crossroads. Under Reg. 1.170A-13(c)(5)(iv)(B), this disqualified Fletcher because he is not holding himself out to the public as an appraiser.

The taxpayer claimed Fletcher is qualified because he is not a donor and not employed by the donor. In addition, the IRS ignored Fletcher’s appraisal analysis that the first parcel included over 15 million tons of construction grade aggregate.

The Long Branch parcel was appraised by George Galphin, Jr. and Christopher Farrell. The IRS faulted this appraisal for the improper use of sales comparables that do not resemble the subject property and unreasonable assumptions. The IRS also claimed appraiser Galphin promised he would appraise the property with a distribution center as the highest and best use.

The taxpayers attacked IRS valuation expert Andrew Sheppard and claimed he did not verify his comparables and improperly valued the granite aggregate. The taxpayer claimed that Sheppard had no actual mining experience and therefore was not qualified to value the claimed granite use for construction. Taxpayers also noted the IRS improperly used the same comparables for both the parcel suitable for mining and the parcel suitable for the distribution center.

The IRS noted the taxpayer partnership Jackson Crossroads had contacted multiple third parties and promised four times the purchase price as a charitable deduction. The IRS claimed that the fair market value of the easements on both properties was a maximum of $2.68 million and is requesting adjustments of approximately $37 million in the claimed conservation easement charitable deductions.

Editor’s Note: This is a good explanation of the issues involved in an appraisal contest. It is useful for professional advisors with clients who donate appreciated property to nonprofits.

Microcaptive Not Qualified as Insurance

In Terence J. Keating et al. v. Commissioner; No. 15066-18; No. 15067-18; No. 15069-18; T.C. Memo. 2024-2, the Tax Court determined a microcaptive insurance arrangement failed to meet required standards and the claimed deductions were not permitted under either IRC Sec. 162 or Sec. 165.

Taxpayers were shareholders of Risk Management Strategies, Inc. (RMS). RMS was owned 47.5% by Terence Keating, 47.5% by Arthur Candland, and 5% by Cheryl Doss. The S corporation served banks and other entities through special needs trust employer liability. It handled the staffing, payroll and other responsibilities for the employment of caregivers under the trust instruments. It created an affiliated captive insurance company, Risk Retention, Ltd. (Risk Retention).

RMS entered into contracts with banks and other entities and had extensive contractual insurance obligations to maintain coverage for worker's compensation, unemployment, commercial general liability and other types of insurance. It created the captive insurance program in 2008. The premiums paid per year were $1.2 million. RMS worked with Tribeca Strategic Advisors, LLC (Tribeca) to establish the insurance plans. Tribeca provided an owner's manual and assisted in structuring the insurance plans. Tribeca was later sold to Artex Risk Solutions, Inc. (Artex). Based on the self-insured amount, the total policy limit, the facultative and pool limits, RMS paid premiums of approximately $1.2 million each year.

There were numerous problems in the structure and operation of the plan. The commercial insurance broker for RMS did not shop for comparable policies. The policies were not objectively rated by evaluating risk. There were insurance transactions completed after the fact. There was not sufficient information from RMS to Artex to do proper underwriting. Artex permitted clients to alter coverages or total premiums during coverage periods. A disproportionate share of premiums was paid toward the end of the coverage. The premiums were much larger than typical industry coverage, and the Artex underwriting staff was not sufficient to properly value the insurance risk. There were multiple examples of improper or unusual payments with respect to pool premiums. Claims were reported after the coverage period had lapsed. The RMS board authorized payment of claims that should have been denied.

The court noted that premiums paid for insurance are generally deductible as ordinary and necessary expenses under Sec. 162(a). Because the IRC does not define insurance, there are four criteria. Insurance involves an arrangement with insurance risk, the arrangement shifts the risk of loss to the insurer, the insurer must distribute risk among policyholders and the arrangement must be generally accepted as insurance.

The Tax Court stated, "To determine whether an arrangement constitutes insurance in the commonly accepted sense, we look at numerous factors including: (1) whether the insuring company was organized, operated, and regulated as an insurance company; (2) whether it was adequately capitalized; (3) whether the policies were valid and binding; (4) whether premiums were reasonable and the result of arm’s-length transactions; and (5) whether claims were paid."

In reviewing the failure to follow reasonable business practices and because the insurance premiums were approximately "ten times greater than the average rate-on-line for comparable commercial insurance policies," the court determined that this was not qualified insurance. There was no credible evidence that RMS achieved any tax savings. Therefore, this was not a qualified microinsurance arrangement.

Because this was not insurance, there was no deduction under Sec. 162. In addition, this was essentially a self-reserved insurance plan. The court noted, if "the taxpayer utilizes a self-insured reserve fund, the allowable deduction is limited to the losses actually incurred and paid out of the reserve."

Therefore, the deduction was denied. Finally, because the taxpayers did not show that there were any substantial steps to ascertain proper tax liability, the reasonable cause defense on the penalties failed. While an accountant did review some of the materials, he did not have the "information that would have been necessary to form an opinion on the deductibility of the captive expenses." Therefore, the penalties were applicable.

Applicable Federal Rate of 5.2% for January -- Rev. Rul. 2024-2; 2024-2 IRB 1 (18 December 2023)

The IRS has announced the Applicable Federal Rate (AFR) for January of 2024. The AFR under Sec. 7520 for the month of January is 5.2%. The rates for December of 5.8% or November of 5.6% 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.”