In IR-2016-144 the IRS outlined its successful efforts to fight identity theft in 2016 and explained plans for future battles.

The IRS 2016 Security Summit produced multiple initiatives to limit identity theft. Several of the initiatives were successful.

1. Theft Affidavit - The number of taxpayers who file affidavits with the IRS claiming to be victims of identity theft was down sharply this year. In the first nine months of 2015, there were 500,278 affidavits. For the same nine months of 2016, the number was reduced to 237,750.
2. Fraudulent Returns - The IRS software changes were successful in reducing the number of fraudulent returns. The tax processing IRS group determined for the first nine months of 2015, there were 1.2 million fraudulent returns with a claimed $7.2 billion in refunds. For the same period in 2016, there were 787,000 fraudulent returns with claimed refunds of $4 billion.
3. Fraudulent Refunds - The IRS worked with 620 banking institutions to stop the cashing of fraudulent refund checks. When a fraudulent refund check is identified by a banking institution, it is returned to the IRS. During the first nine months of 2015, there were 243,361 checks returned valued at $829 million. For the same period of 2016, the returned checks were reduced to 108,539, with value of $239 million.

IRS Commissioner John Koskinen stated, “We have come a long way in a short time following creation of the Security Summit. But much more work remains to be done, and the partnership has agreed to take even more steps to protect taxpayers in 2017.”

Koskinen also outlined several initiatives for 2017. There will be new data fields with each electronically-filed personal or business tax return. This will allow a higher level of IRS authentication to make certain that the return is actually filed by the taxpayer. Banks also have new programs to ensure that electronic refunds are allocated to correct accounts and not to those of the tax scammers. There also are new W-2 verification methods.

Editor’s Note: Commissioner Koskinen indicated that the newly-launched Identity Theft Tax Refund Fraud Information Sharing and Analysis Center (ISAC) will be expanded in 2015. This IRS organization will be directly involved in the efforts to identify different theft strategies and share the information with all of the Security Summit partners.

Opposition Builds to Sec.2704 Regulations

In REG-163113-02, the IRS published Proposed Regulations under Sec. 2704. The IRS plans various strategies to limit lack-of-control and lack-of-marketability discounts. Several organizations published letters this week to express opposition to the proposed regulation.

The Texas Society of Certified Public Accountants (TSCPA) sent a letter to Treasury Secretary Jacob Lew and questioned the legal basis for the proposed regulations.

The Society commented, “To the extent the proposed regulations add disregarded restrictions that create assumed put rights, mandate the use of minimum value, assume cash redemptions within six months and ignore certain unrelated parties unless they’re percentage ownership exceeds the given percentage, they are creating a fiction rather than disregarding existing restrictions as authorized under Sec. 2704(b)(4).”

TSCPA also questions the overall purview of the proposed regulations with respect to state law. Traditionally, ownership has been defined by state law, while the tax rules are federal law. In the view of the TSCPA, the proposed regulations “disregard state rights and those of property owners. If the Treasury can just rewrite the law, it would create a situation that could undermine taxpayer confidence in estate planning and in the fairness of tax administration in general.” The Society suggests that the regulations ignore the “economic reality” of the actual discounted value of various ownership interests.

The Society also noted that there are valid purposes for family limited partnerships (FLPs). These include good management of assets, reduction of family disputes and creditor protection. The FLPs are not just created to produce gift and estate tax discounts.

The Real Estate Roundtable sent a letter to IRS Assistant Secretary (Tax Policy) Mark Mazur. It observed that the proposed regulations create significant value issues, particularly for minority holders of real estate interests. The minority holders frequently have no opportunity to sell the property and other family members may disagree or oppose a sale. It notes, “The proposed regulations unfairly and incorrectly assume coordination/collusion on the part of all surviving family members, when, in reality, there is often little, if any, agreement between the parties, and thus no real alignment of interest.”

Finally, the National Taxpayers Union (NTU) explains that the cost of the proposed regulations and the impact on the estate tax may far exceed the revenue generated.

The NTU comments, “Compared to the significant economic harm inflicted by the tax, the paltry sum it adds to Treasury coffers is by itself not justifiable. Changing valuation discounts—making it costlier for heirs to retain their stake in a family business - incentivizes sales, at artificially low prices, to satisfy the demands of the death tax.”

Three “No Discount” Estate Examples

On November 2, the Family Business Estate Tax Coalition published three examples of businesses greatly harmed by Sec. 2704 Proposed Regulations. The examples involved a disregarded restriction, a death within three years of a gift and a loss of lack-of-control discounts.

1. Disregarded Restriction. A produce farmer from the San Joaquin Valley of California bequeaths his farmland and equipment equally to four children. The farmer’s will creates liquidation restrictions so one child cannot sell without the consent of the other three. Under Prop. Reg. 25.2704-2(b)(1), the restriction on sale is disregarded. To pay the 40% estate tax on the business value, the children must mortgage the land. With the increased costs of the interest on the mortgage and more expensive water for irrigation, the farm may not be viable.
2. Death within Three Years. Mother is age 75 and gives a manufacturing business to her three children, subject to liquidation restrictions. The children pay gift tax at a discounted rate and borrow to expand the business. Mother passes away suddenly after two years. Under Prop. Reg. 25.2704-1(c)(1), her estate has a “deemed lapse” within three years and pays tax on the business. The business must borrow to cover the estate tax and faces a major liquidity problem.
3. No Control and No Discount. Father transfers 30% equity interest in the family construction business to three children. He retains 10% equity and 100% control. Father plans to pass the 100% control through his estate to the child best qualified to operate the construction business. Prop. Reg. 25.2704-2(b)(2) denies a lack-of-control discount, even though two of the three children will never have control.

Editor’s Note: While the IRS claims that there will not be reductions in “legitimate” discounts, the three scenarios suggest that if the proposed regulations are made final, there may be substantial impact. Family businesses would lose a substantial proportion of their current discounts in all three of the above scenarios.

Applicable Federal Rate of 1.6% for November—Rev. Rul. 2016-26; 2016-45 IRB 1 (18 Oct 2016)

The IRS has announced the Applicable Federal Rate (AFR) for November of 2016. The AFR under Section 7520 for the month of November will be 1.6%. The rates for October of 1.6% or September of 1.4% 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 2016, pooled income funds in existence less than three tax years must use a 1.2% deemed rate of return. Federal rates are available by clicking here.