On March 1, 2023, the Internal Revenue Service (IRS) published a reminder to taxpayers that all income must be reported. This will include income from the gig economy, service industry income tips, any purchase, sale or exchange of digital assets, income from foreign sources or investments in foreign financial accounts.
1. Gig Economy Earnings — Income earned in the gig economy is generally taxable and must be reported on a tax return. This could include income earned from driving a car, renting property, providing on-demand services or through an app or website. Gig work frequently is part-time or temporary. It could be paid in cash, but also may have been produced as compensation through property, goods or digital assets. The IRS.gov website has a Gig Economy Tax Center with additional information.
2. Service Industry Tips — Many individuals work for restaurants, salons or hotels in the service industry and receive tips. These tips are taxable income. Employers are required to report the cash tips received from customers. They are included on an employee's IRS Form W-2, Income, Wage and Tax Statement. However, employees also may receive noncash items such as tickets or other goods from a customer. The value of these items must be reported on a tax return. It may be helpful to use IRS Form 4137, Social Security and Medicare Tax on Unreported Tip Income to make sure that the appropriate employee share of Social Security and Medicare tax is paid. There is an exception for tip reporting if less than $20 per month is received.
3. Digital Assets Reporting — IRS Form 1040 includes a question that asks about digital asset transactions. Taxpayers must check either a "Yes" or "No" box. If any digital assets held as a capital asset were sold, the check box must be selected as "Yes" and the sale must be reported on IRS Form 8949, Sales and Other Dispositions of Capital Assets. If digital assets are given to a friend or family member IRS Form 709, United States Gift Tax Return, may be required. Digital assets could generate income through sales, through receiving payment for services, through mining and staking activities, as the result of a hard fork or as a digital payment for property, goods or services. Digital asset compensation for services is reportable income in the same manner as your W-2 wages. For additional information, go to IRS.gov on the IRS Digital Assets Page.
4. Foreign Source Income — American citizens are generally subject to U.S. income tax on income, even if living overseas. Taxpayers should report earned income, such as interest, dividends, and pensions from overseas sources. Some income may qualify for the Foreign Earned Income Exclusion or the Foreign Tax Credit and reduce the tax obligation. If taxpayers have both a tax home and residence outside the United States, there is a two-month extension until June 15 to file. Active duty military serving overseas also may file by June 15.
5. Foreign Accounts and Assets — Taxpayers must report income from foreign trusts and foreign banks. Schedule B of IRS Form 1040 asks whether a taxpayer owns foreign accounts and requires reporting of the current income on each account. Generally, taxpayers are required to file IRS Form 8938, Statement of Foreign Financial Assets if exceeding certain thresholds. If the foreign account value is more than $10,000 during 2022, taxpayers also must go to BSA e-filing on the Department of Treasury website and file Form 114, Report of Foreign Bank and Financial Accounts (FBAR). The deadline for the FBAR report is April 15, 2023.
The Estates of William A.V. Cecil Sr. and Mary Ryan Cecil petitioned the Tax Court after the IRS issued a $26 million deficiency for gift tax liability for gifts in 2010.
In 1895, George W. Vanderbilt constructed the 175,000 square-foot Biltmore House in the Blue Ridge Mountains of Asheville, North Carolina. His daughter Cornelia Cecil inherited the home and, in 1932, established TBC, a Delaware corporation, and contributed the property to TBC. TBC initially offered tours of the Biltmore House, but eventually expanded to include hotels, restaurants, retail stores and other activities. By 2010, TBC had 17 businesses with approximately 1800 total employees. The businesses served tourists and generated approximately $70 million in annual revenue.
In 2010, TBC claimed to have assets of $53.58 million, and liabilities of $33.35 million. TBC was restructured in 1997, with seven shares of Class A voting common stock and 9,993 shares of Class B nonvoting stock. All stock was subject to a shareholders' agreement that permitted transfer to other shareholders but required consent of shareholders for transfer to nonfamily members.
In November 2010, Mr. and Mrs. Cecil transferred voting stock to their children and nonvoting stock to their five grandchildren. They obtained an appraisal by Dixon Hughes and claimed the taxable gifts for each individual were $10,438,766. The IRS selected their IRS Forms 709 for audit and assessed a deficiency on the two gift tax returns of approximately $26 million.
The expert appraisers of the taxpayers were David Adams, who is a business valuation appraiser, and George Hawkins, who also specializes in appraisals of businesses. Mr. Adams used a discounted cash flow method because he determined that a sale within the next 30 years of TBC was unlikely. He valued the TBC share gifts at approximately $9 million based on cash flows, approximately $10.5 million based on comparable organizations or $12.2 million based on similar transactions. Mr. Hawkins also completed valuations with similar results.
The IRS had art appraiser Gretchen Wolf appraise the art and Robert Morrison appraise the asset values. Ms. Wolf appraised the TBC art at $13.25 million. Mr. Morrison determined that the real estate, art, note receivable, trademarks and workforce-in-place value created a total net asset value of $146.6 million.
Not including Ms. Wolf, who appraised only artwork, the appraisers agreed that the "tax affecting" factor should also be relevant. While the Tax Court noted that tax affecting has been frequently rejected, it stated, "there is not a total bar against the use of tax affecting when the circumstances call for it."
The Tax Court determined the IRS asset valuation of $146 million was not appropriate. Because the liquidation of TBC is not likely, it must be valued as an ongoing business. The Tax Court accepted the taxpayers' appraisers 20% lack of control discount and proposed discounts of 19%, 22% and 27% for lack of marketability on the stock. The decision was entered based on Rule 155.
Editor's Note: The result of the decision will be a redetermination of the IRS deficiency. Because the Tax Court essentially accepted the valuations of the taxpayer, the deficiency will be greatly reduced or eliminated.
Nonprofits and 19 Senators Support Charitable Act
On March 1, 2023, Senators James Lankford (R-OK), Christopher A. Coons (D-DE) and seventeen other Senators introduced the Charitable Act. This bill substantially increases charitable deductions for nonitemizers. It creates a charitable deduction that is one-third of the standard deduction. This would allow a deduction of $4,600 for individuals and $9,200 for married couples filing jointly.
Senator Lankford noted, "Our families, our churches and other nonprofits are the first and most important safety net for the most vulnerable in our communities. Our nonprofits provide our neighborhoods and families vital job training, compassionate homeless assistance, food in times of crisis and spiritual counsel during our best and worst days."
Senator Coons also supported the bill and noted, "In Delaware and across our nation, we've always stepped up in extraordinary ways to meet the needs of our communities. People of all means gave freely to charities, houses of worship and other nonprofits last year to the tune of $449 billion last year."
Co-sponsor Senator Susan Collins (R-ME) stated, "Nonprofits in Maine and throughout the country play a pivotal role in aiding and assisting our underserved communities. By encouraging more Americans to donate to charitable causes, this bipartisan bill would help give these dedicated organizations the support they need as they continue to serve the public."
Finally, Senator Jeanne Shaheen (D-NH) concluded, "Charitable donations are a lifeline for many nonprofits, helping to keep our doors open and continue much-needed services for local residents."
The National Council of Nonprofits sent a letter to Sen. Lankford and Sen. Coons to "express our enthusiastic endorsement of the Charitable Act. The needs in our communities are far greater than the ability of governments to address alone; the Charitable Act would empower millions more taxpayers to help solve those challenges by donating more to the work of charitable organizations in their communities."
Because of the dramatic increase of the standard deductions, the number of itemizers has declined from approximately 30% in 2017 to 10% the past year. Being unable to itemize deductions is a substantial factor in a decline in the number of donors. The National Council of Nonprofits continued, "The number of people giving back to their communities has plummeted since 2002 when about 67% of American households made charitable contributions, to today's percentage of only half."
Several nonprofit leaders also supported the Charitable Act. YMCA of the USA President and CEO Suzanne McCormick stated, "Nonprofits need tools like the nonitemizer deduction proposed by the Charitable Act to meet growing and changing community needs."
Angela F. Williams is President and CEO of United Way Worldwide. She added, "United Way is a global network of neighbors helping neighbors — from fighting for access to education to responding when disaster strikes. Nonprofits like ours are on the front lines of addressing community needs, and we rely on the generous donations of everyday Americans to carry out our mission."
Editor's Note: It is challenging to pass legislation that will reduce total revenue through increasing nonitemizer charitable deductions. However, this is a strong coalition of 19 Senators and nonprofit associations from across the nation. The combination of this coalition of Senators and nonprofits creates the potential for restoration and expansion of the nonitemizer charitable deduction.
Applicable Federal Rate of 4.4% for March — Rev. Rul. 2023-5; 2023-10 IRB 1 (15 February 2023)
The IRS has announced the Applicable Federal Rate (AFR) for March of 2023. The AFR under Section 7520 for the month of March is 4.4%. The rates for February of 4.6% or January of 4.6% 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 2023, pooled income funds in existence less than three tax years must use a 2.2% deemed rate of return.