This semiannual update surveys recent federal tax developments involving individuals. It summarizes notable cases, rulings, and guidance on a variety of topics issued during the six months ending April 2024. The update was written by members of the AICPA Individual and Self-Employed Tax Technical Resource Panel. The items are arranged in Code section order.

Certain procedural matters pertaining to individual taxpayers are updated annually. During early 2024, the IRS issued Rev. Procs. 2024-1, 2024-2, and 2024-3. Rev. Proc. 2024-1 is a revised procedure for issuing letter rulings. The major changes from Rev. Proc. 2023-1 are mainly for corporations. However, income tax determination requests to the IRS Small Business/Self-Employed or Wage and Investment divisions can now be submitted only by electronic facsimile. The electronic facsimile rule also applies to determination letters for estate and gift tax matters, employment taxes, and excise taxes. All user fee payments must be submitted through pay.gov. Most user fees are unchanged from Rev. Proc. 2023-1, except for user fees for the four types of advance pricing agreement requests, which all increased by more than 6%.¹

Rev. Proc 2024-2, with revised IRS procedures for furnishing technical advice, was not changed significantly from Rev. Proc. 2023-2.

Rev. Proc. 2024-3 updates the “no rule” listing. Rev. Proc. 2023-3 and Rev. Proc. 2013-32 were superseded; Rev. Proc. 2017-52 was modified. The 2024 version eliminates many no-rule items from the prior versions and indicates, among other issues, that the Sec. 1202(e) “active business” requirement for corporations for purposes of the partial exclusion of gain from small business stock is under study and that no rulings will be issued until the Service resolves the issue.²

Sec. 25C: Energy-efficient home improvement credit

Treatment of energy-efficient home rebates: The IRS released an announcement and news release stating that rebates for the purchase of energy-efficient homes generally will not be included in income for taxpayers but will reduce the basis of the home.³

Proposed regulations under Sec. 25C: The IRS announced in a notice⁴ that proposed regulations will be forthcoming to implement the product identification number (PIN) requirement for the Sec. 25C energy-efficient home improvement credit that applies to qualifying property placed in service after Dec. 31, 2024. The notice provided information regarding the PIN requirement and requested comments before the regulations are proposed.

Sec. 32: Earned income

Qualifying child is necessary for EITC: In a Tax Court case,⁵ the taxpayer was the court-appointed guardian of her minor grandson since 2007. In 2020 she filed her income tax return as a head of household and claimed the earned income tax credit (EITC). The grandson was not employed in 2020, and the taxpayer paid many of his expenses, but her grandson resided with her only 60 days that year. The Tax Court noted that she met some of the Sec. 152(c) requirements for the grandson to be a qualifying child, which include the age requirement, the relationship requirement, and the support requirement (the child must not furnish more than 50% of his or her own support during the tax year). However, the grandson did not meet an additional requirement of having the same principal place of abode as the taxpayer for more than one-half of the tax year. The taxpayer not only lost the EITC because the child did not meet the qualifying child requirements; she also was not able to use a higher standard deduction amount and the more favorable tax brackets for a head of household, the court held.

Sec. 36B: Refundable credit for coverage under a qualified health plan

In Blas, the Tax Court found that the taxpayer must repay the advance premium tax credit (APTC) paid on his behalf because his circumstances had changed in the tax year the APTC was paid.⁶ When the taxpayer applied for health insurance through the federal Health Insurance Marketplace website in November 2013, he was unemployed and did not have health insurance. On his application, he noted his household income was $15,000. As a result, he qualified for the APTC benefit. He enrolled in a health plan with coverage starting in January 2014. The health plan sent him a thank-you letter and insurance card. In December 2013 he secured employment and was paid wages of $82,000 during 2014. He never reported the wages to the Marketplace.

The taxpayer did not receive health insurance from his new employer and did not have Medicare or TRICARE cover-age in 2014. The petitioner’s Marketplace coverage continued throughout 2014, but because the APTC payments covered his insurance premiums, he never received any bills. He did, however, receive other correspondence and bills for the 2015 coverage year requesting payment of outstanding insurance premiums for his 2015 health coverage. He also received a Form 1095-A, Health Insurance Marketplace Statement, and a letter informing him he was required to file Form 8962, Premium Tax Credit (PTC), with his 2014 federal income tax return. When he filed his 2014 return, he reported an adjusted gross income (AGI) of $83,742, which included wages of $82,000. He did not attach Form 8962 to his return.

His return was examined in 2016, and the IRS asked him to complete and file Form 8962. The IRS determined a deficiency in the amount of his APTC payments, $8,328.

In the Tax Court proceedings, the taxpayer argued that the IRS had the burden of proof and production to show that the APTC payments were made on his behalf. The Tax Court disagreed, finding that the thank-you letter, insurance card, and the Form 1095-A were sufficient proof that he received coverage through the Marketplace for which the APTC payments were made. The court further held the taxpayer was not entitled to any PTC for 2014 and sustained the deficiency.

Sec. 61: Gross income defined

A recent Tax Court case, Aulisio,⁷ illustrates a range of issues related to income recognition, business expense and other deductions, and claiming a net operating loss (NOL). The taxpayer, Anthony Aulisio Jr., was a CPA who also attended law school. During 2015, Aulisio operated a CPA business and an alleged equipment leasing business. He reported $10 of taxable income on his original 2015 individual income tax return. The IRS initially determined a deficiency of $14,878 and a Sec. 6662(a) accuracyrelated penalty of $2,976, based on third-party reporting of unreported income totaling more than $64,000. Subsequently, the IRS alleged that Aulisio had additional income exceeding $101,000, based on the amount that he reported on an amended 2015 tax return.

The matters for decision by the court were whether for the 2015 tax year Aulisio (1) had $22,492 of unreported interest income and an additional $11,055 in gross receipts, as reported on his 2015 amended return Schedule C, Profit or Loss From Business, from his CPA business; (2) was entitled to deduct expenses of $44,950 associated with his CPA business; (3) was entitled to deduct $80,000 of Schedule C expenses associated with his equipment leasing business; (4) was entitled to deduct an NOL of $437,141; (5) was entitled to deduct $28,336 of home mortgage interest reported on Schedule A, Itemized Deductions; and (6) was entitled to deduct $14,114 of other itemized deductions, including property taxes on his principal and secondary residences and a charitable contribution.

Gross receipts from CPA business and interest income: Aulisio argued in Tax Court that the $22,492 of interest income reported on his amended return was not interest income but instead was nontaxable proceeds from a loan from a trust he controlled that was not includible in gross income. He also claimed that the income from his CPA business he reported on his 2015 amended return ($123,180) was overstated by $11,055. With respect to the interest income, he testified that his friend and assistant who had prepared his return (who was dead by the time of trial) had inadvertently mischaracterized the loan proceeds as interest on his return. Similarly, he claimed that a schedule allegedly prepared by the same assistant proved that the CPA business income amount that he had included on his amended return was overstated.

The Tax Court found that the statements on Aulisio’s amended return that his CPA business had gross receipts of $123,180 and that he had $22,492 of interest income were admissions that could be overcome only with cogent evidence. The court held that Aulisio had not introduced cogent evidence to overcome the admission on his amended return that the gross receipts from the CPA business and the interest income were includible in his gross income.

NOL deduction: On his 2015 amended return, Aulisio claimed an NOL deduction of $437,141, whereas he had claimed none on his original return. He testified that the NOL originated from equipment that his business leased to companies that had filed for bankruptcy, and the bankruptcy court gave the equipment to the lessees’ creditors.
Aulisio provided no documentation regarding the bankruptcy proceedings. Furthermore, the date on which the losses arose was unclear. At varying times during the proceedings, Aulisio claimed the NOL originated in 2001, 2008, 2009, and/or 2013. The IRS asserted that he failed to provide sufficient documentation to substantiate the initial loss, including when it originated and how the NOL was used and calculated in the intervening years. The Tax Court agreed, determining that Aulisio was not entitled to deduct the claimed NOL carryforward deduction for 2015.

Qualified residence interest: Under Sec. 163(h)(2)(D), individuals are allowed a deduction for qualified residence interest. A “qualified residence” means a taxpayer’s principal residence within the meaning of Sec. 121 and one other residence selected and used by the taxpayer as a residence.⁸ Aulisio asserted that he was entitled to a deduction of $42,500 for qualified residence interest paid on his primary home in Laguna Beach, Calif. He did not claim this deduction on any 2015 income tax return and raised it for the first time during the Tax Court proceedings. He provided substantiation for payments totaling $14,164. The court limited him to a deduction in this amount since he failed to offer bank records, statements, canceled checks, or other records to support the additional deduction.

Real property taxes: Aulisio asserted a deduction for real property taxes totaling $2,868 related to his primary home in Laguna Beach and a deduction for real property taxes totaling $10,476 related to his secondary home in San Bernardino County, Calif. During the proceedings, he was able to substantiate that he paid $1,084 for the San Bernardino County property but nothing else. Consequently, the court limited his deduction to this amount.

Charitable contributions: Aulisio did not claim a charitable contribution deduction on any 2015 income tax return. According to his pretrial memorandum, he claimed a $500 deduction for a charitable contribution to the Friends of the Los Angeles Philharmonic. He introduced into evidence a letter stating he was at the organization’s “$500 membership level.” The Tax Court held that this letter did not satisfy the requirements of Sec. 170(f)(8) for a contemporaneous written acknowledgment. Notably, it did not state whether the donee organization provided any goods or services in consideration for the contribution and did not include a description and good-faith estimate of the value of any goods and services that were provided. As a result, Aulisio was not entitled to a charitable contribution deduction.

Sec. 72: Annuities; certain proceeds of endowment and life insurance contracts

Informal IRS guidance covered new provisions relating to retirement plans and accounts and their administration, while a Tax Court case highlighted the effective date of certain new rules governing distributions from qualified plans for personal emergencies.

SECURE 2.0 guidance: The IRS used a question-and-answer format to provide guidance⁹ for 12 provisions of the SECURE 2.0 Act (which was enacted in December 2022).¹⁰ Section II. A of the notice deals with SECURE 2. 0 Section 101, concerning cash or deferred retirement plans and new automatic enrollment requirements. Section II. B of the notice addresses Section 102 of SECURE 2.0, which enacted an increased small-employer pension plan startup cost credit and other provisions relating to small employers under Sec. 45E. Notice Section II.C discusses Section 112 of the act, which enacted new Sec. 45AA, which provides a military spouse retirement plan eligibility credit for small employers. Notice Section II.D deals with Section 113 of SECURE 2.0, providing guidance on the definition of and rules regarding a de minimis financial incentive that will not violate the contingent-benefit rule.

Section II.E of the notice discusses Section 117 of SECURE 2.0. This section allows for additional employer contributions to a Savings Incentive Match Plan for Employees (SIMPLE) individual retirement account (IRA) or SIMPLE 401(k) plan by increasing the annual salary reduction/elective contribution limit and the limit on additional catch-up contributions beginning at age 50. The notice defines which employers are eligible and gives notification requirements.
Notice Section II.F provides guidance on Section 326 of SECURE 2. 0, which provides a new exception to the 10% penalty for early retirement plan withdrawals for terminally ill individuals. This section of the notice defines who is a “terminally ill individual” and specifies the timing and content of the required physician certification.

Before SECURE 2.0, an employer offering a SIMPLE plan was not allowed to adopt a qualified retirement plan. Section II.G of the notice covers Section 332 of SECURE 2.0, which allows the employer to terminate the SIMPLE plan and roll over the benefits to a safe-harbor 401(k) plan even if some employees have been in the plan less than two years. Notice Sections II. H–J provide guidance on SECURE 2. 0 Sections 348, 350, and 501, which provide rules preventing qualified plans from failing to qualify under the Internal Revenue Code. Guidance for SECURE 2. 0 Section 601, which allows an employee covered by a SEP or SIMPLE IRA plan to designate that plan contributions be made to a Roth IRA instead of a traditional IRA, is covered in Section II. K.

Notice Section II.L discusses Section 604 of SECURE 2.0, which changed the requirement that employer matches or contributions be allocated to the deferral portion of a 401(k) plan with a Roth feature. Now employees can elect to have those employer amounts allocated to the Roth portion of the plan. The notice provides that although these amounts are taxable, they are not wages for employment tax purposes.

Sec. 72(t) penalty: In 2018, the taxpayer in Kohl¹¹ withdrew money from her IRA to pay rent and avoid eviction. She contended that the 10% penalty should not apply, based on the exception for withdrawals for emergency expenses as enacted as part of SECURE 2.0.¹² The law change applies only to withdrawals from qualified retirement plans made after Dec. 31, 2023, so the Tax Court held that it did not prevent the 10% penalty from applying to her.

The taxpayer in Scott¹³ failed to report dividends, capital gains, and a retirement distribution on her 2019 return. In box 7 of the Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., she received, the distribution was coded “1,” meaning that there was no known exception to her distribution of $14,386. The instructions to Form 1099-R state that this code should be used if the participant has not reached 59½ years old.

Scott’s Tax Court petition did not dispute any of the amounts shown by the IRS in the audit report, saying only that she disagreed with the IRS’s determination because her income had been approximately the same amount for 10 years and that “retirement investments are taxed before being applied to the 401(k) plan.” In the Tax Court proceedings, the IRS requested an admission from Scott that she had received the items of unreported income, but she did not reply to the request.

The Tax Court found that the IRS had met its burden of showing that Scott had received the unreported income by providing the court the Form 1099-DIV, Dividends and Distributions, with the ordinary dividends and capital gains distributions and the Form 1099-R with the retirement plan distribution. Because Scott did not contest the IRS’s determinations of unreported income in her petition and did not reply to the IRS request for admissions, the court found she had conceded the issue.

The Tax Court further held that the 10% penalty applied to Scott. The retirement account trustee’s records showed she was under the age of 59½, which she did not dispute in her petition or provide evidence to the contrary; thus, the court found that she did not qualify for an exception to the early distribution penalty.

Sec. 165: Losses

Two Tax Court cases were instructive regarding issues encountered in attempting to deduct theft losses, including the timing of the loss and meeting the definition of a qualifying theft.

Theft loss — fraudulent mortgage scheme: In Giambrone,¹⁴ Michael and William Giambrone had a successful mortgage finance business, and in 1998 they decided to start a federally chartered savings and loan institution. This type of entity, also called a thrift, is overseen by the Office of Thrift Supervision (OTS). Although they had outside investors, the brothers invested more capital to cover increasing losses. In 2007 OTS launched an examination of the thrift, which eventually led to operating restrictions.

In looking for additional capital, they were referred to Lee Bentley Farkas, who had a good reputation in the mortgage industry. They sold 75% of the business to a Farkas entity. This caused the Giambrones’ share of ownership of the business to be reduced from 54% to approximately 14%. In 2009, it came out that Farkas was involved in a fraud scheme, and the thrift was closed. Farkas was ordered to pay restitution to 20 victims, but the Giambrones were not one of them.

The Giambrones claimed theft loss deductions of 95% of the value of their investments in their thrift business on their 2012 federal income tax returns. Among other things, the brothers premised their claimed deductions on Rev. Proc. 2009-20, which provides “an optional safe harbor treatment for taxpayers that experienced losses in certain investment arrangements discovered to be criminally fraudulent.”

The IRS moved for summary judgment on the issue of whether Rev. Proc. 2009-20 applied, and the Tax Court granted the motion.¹⁵ The court found that the requirement in Rev. Proc. 2009-20 that safe-harbor treatment must be elected on a taxpayer’s return in the year of discovery was not met. Because Farkas was indicted in 2010, that was the year of discovery in which the safe-harbor treatment was required to be elected. The brothers did not report the loss on their 2010 returns but only on their 2012 returns. The court left all other questions in the case, including whether the Giambrones qualified for a Sec. 165 theft loss deduction, to be decided in further proceedings.

In the subsequent proceedings, the brothers still needed to show that they met all of the requirements for a theft loss and that it had been claimed in the proper year. They claimed that they suffered a theft of their controlling interest in the thrift. The Tax Court looked to Illinois law to see if their loss of their controlling interest could be considered a theft loss and determined that it could not.

With regard to the year of loss, the court, having previously held that the year of discovery of the theft was 2010, considered whether the Giambrones had a reasonable prospect of recovery of their theft loss from Farkas or the FDIC (which had assets of the business in receivership) after 2010 that would allow them to claim the loss in 2012. Because Farkas was ordered to pay restitution in 2011 that was greater than his entire net worth, and the Giambrones were not named as victims who were entitled to restitution, the court determined they had no reasonable prospect of recovery from Farkas.

The court further found that the Giambrones had no reasonable chance of recovery of any assets from the FDIC. Therefore, reporting the loss in 2012, when the Gambriones had no reasonable prospect of recovery after 2010, was incorrect. Since the brothers failed to prove that they suffered a theft loss or that they claimed the loss in the year of discovery, the court sustained the IRS’s disallowance of the theft loss deduction and its deficiency determination.

Theft loss — reduction in cash value of life insurance: The taxpayer in Pascucci,¹⁶ Christopher Pascucci, had invested in 16 flexible premium variable life insurance policies beginning in 1997. Variable life insurance policies offer separate accounts that a portion of the premiums paid on the policies are invested in. Pascucci’s premiums for all of his policies could be invested without a guarantee that the death benefit would be larger than the policy amount.

Beginning in 2001, the investments could include limited partnership interests, and Pascucci opted to allocate his premiums to separate accounts that the insurance company invested in a limited partnership. It turned out that the limited partnership had investments in feeder funds that in turn invested all their money with Bernard L. Madoff Investment Securities (BLMIS). The investments in the feeder funds became worthless in 2008 when the Ponzi scheme involving BLMIS unraveled, causing a reduction in the value of insurance policies owned by Pascucci. Pascucci claimed a theft loss deduction for 2008 for the reduction in value of the life insurance policies, which the IRS denied. The Tax Court agreed with the IRS, holding that the insurance companies, not Pascucci, owned the assets in the separate accounts at the time of Madoff ’s theft.

Sec. 170(h): Qualified conservation contribution

Sec. 170(h) allows a charitable contribution for the fair market value (FMV) of a qualified conservation contribution, which is defined as “a contribution — (A) of a qualified real property interest, (B) to a qualified organization, (C) exclusively for conservation purposes.”¹⁷ The Internal Revenue Code and accompanying Treasury regulations delineate the requirements that must be met before a contribution is deductible. During this update period, the Tax Court ruled on several cases related to conservation easement contributions.

In Carter,¹⁸ taxpayers Nathaniel Carter and Ralph Evans were equal partners in Dover Hall Plantation LLC, which donated a 500-acre conservation easement to the North American Land Trust on property in coastal Georgia. The conservation deed retained several rights for the donors, including rights to build residential units on the donated property. The partnership claimed a $14,175,000 deduction for the easement donation on its 2011 partnership tax return. Each taxpayer then claimed his 50% share of the deduction on his 2011 individual income tax return.

The IRS disallowed in full the charitable contribution deductions on the taxpayers’ individual returns and also assessed gross-valuation-misstatement penalties. The initial court opinion in 2020¹⁹concluded that the taxpayers were not entitled to charitable contribution deductions because the easement was not a “qualified real property interest” within the meaning of Sec. 170(h) 2) . This was because the restrictions it imposed on the partnership’s use of the property were not “granted in perpetuity” as a result of the retained rights granted to the donors. The court also concluded that the taxpayers were not subject to gross-valuation-misstatement penalties under Secs. 6662(a), (b)(3), (e) , and (h) for the years in issue because the IRS had not met its burden of demonstrating compliance with the supervisory approval requirement of Sec. 6751(b). Specifically, the revenue agent who made the initial penalty determination had communicated that determination to the taxpayers before his supervisor had approved it. Subsequent rulings forced the Tax Court to reconsider its position on both issues.

First, the Eleventh Circuit reversed the Tax Court’s 2020 holding regarding the Carter/Evans charitable contribution deductions,²⁰ in light of its decision in Pine Mountain Preserve, LLLP.²¹ In Pine Mountain, the Eleventh Circuit determined that an easement granted in perpetuity over a defined conservation area satisfied the Sec. 170(h)(2)(C) requirement, regardless of a reservation of rights to build homes. Second, it reversed the Tax Court’s 2020 holding regarding the written supervisory approval requirement based on Kroner,²² in which the Eleventh Circuit rejected the Tax Court’s interpretation of Sec. 6751(b)(1), concluding that IRS supervisory approval of an initial determination to assess penalties is timely as long as it comes before assessment. As a result, the case was remanded to the Tax Court.

On remand, the court found that the easement documentation and protectedin- perpetuity requirements were met and that the taxpayers were in fact entitled to a charitable contribution deduction equal to the FMV of the easement at the time of the contribution. However, the court also found that the FMV was radically lower than the amount they reported. Whereas the taxpayers initially valued the easement at $14,175,000, the IRS valuation expert determined that it was worth $1 million. The court sided with the IRS appraiser, finding that the taxpayers’ appraisal was flawed, inconsistent, and ultimately unreliable.

The court also upheld the IRS’s accuracy-related gross-valuation-misstatement penalty since the Service had complied with the written supervisory approval requirement of Sec. 6751(b) in light of the Eleventh Circuit’s ruling in Kroner.

Sec. 130: Certain personal injury liability assignments

IRS Letter Ruling 202416001 provides favorable interpretations for personal injury structured settlement agreements, allowing continued use of indexed annuities as tax-favored payments to claimants. The IRS concluded that the periodic payments are fixed and determinable, as required under Sec. 130(c)(2)(A), and the contract will not fail to be a “qualified funding asset” within the meaning of Sec. 130(d) despite the value potentially increasing in the stock market.

Sec. 130 provides that amounts received for agreeing to a qualified assignment (any assignment of a liability to make periodic payments as damages or as compensation under a workers’ compensation act or on account of personal injury or sickness) are excludable from income to the extent the amount does not exceed the aggregate cost of any “qualified funding assets.” This income exclusion is essential for the widely used process of assigning settlements to third parties, which in turn pay personal injury claimants a steady income stream over time, versus a lump-sum payment. While the letter ruling expresses no opinion on the tax consequences of payments to the claimant, periodic payments in this type of arrangement are generally excludable from gross income under Sec. 104(a)(1) or (2).

Sec. 274: Disallowance of certain entertainment, etc., expenses

Among the most common — and often problematic — business expense deductions are those related to automobile travel. In Chappell,²³ the taxpayer was a tax return preparer and operated a sole proprietorship. The IRS audited her 2015 return and disallowed some expenses reported on her Schedule C. The IRS conceded all previously disallowed expenses, except for phone and transportation expenses. The taxpayer petitioned the Tax Court to redetermine these remaining expenses.

Under Sec. 274(d), taxpayers must meet substantiation requirements to deduct certain expenses under Sec. 162, including those for listed property under Sec. 280F(d)(4), which includes passenger automobiles. Taxpayers must substantiate (1) the amount of the expense; (2) the amount of total use and business use of the listed property during the year; (3) the date of each expense or the use of the listed property; and (4) the business purpose of the expense or use. A contemporaneous log as well as supporting evidence must be maintained.²⁴

For business trips, the taxpayer used a cellphone application called MileIQ to record her car trips. MileIQ used GPS technology on her phone to track starting and stopping points and mileage. At the end of each trip, she would designate the trip as business or personal. MileIQ compiled the information into a spreadsheet. The MileIQ log showed 13,585.8 miles as business and 1,619 as personal but did not show the purpose of each trip.

Before trial, the taxpayer prepared an edited version of the MileIQ log, and the number of business miles listed was less than the MileIQ log by 1,987.6 miles. The modified log included a short description of the purpose of each trip. At trial, the taxpayer’s receipts for fuel, insurance, etc. were not accepted because several other people who worked for her business had use of her cards and may have made personal use of them, since this was how she paid some of her employees. She had one car, and the receipts often showed two or three same-day gas purchases on days when the mileage logs did not show an excessive number of miles being driven. Because of the inconsistencies in the records, the court allowed the taxpayer a standard mileage rate deduction for the trips where the business purpose was evident, instead of determining the deduction based on the actual vehicle expenses.

Sec. 401: Qualified pension, profit-sharing, and stock bonus plans

Recent guidance has addressed distributions from inherited retirement accounts, part-time employees’ eligibility to contribute to a 401(k) plan, emergency distributions from retirement accounts during federally declared disasters, and other matters.

Required distributions from inherited retirement accounts: The SECURE Act²⁵ imposed a 10-year rule for taking distributions from inherited retirement plan accounts and IRAs, effective for deaths after 2019. Under the rule, “noneligible” beneficiaries (i.e., beneficiaries of a decedent other than a spouse, minor child, or certain others) must distribute the entire inherited account within 10 years of the decedent’s death.

Proposed regulations implementing the 10-year rule were not issued until February 2022. Under a provision contained in them, noneligible beneficiaries of those decedents who were taking required minimum distributions (RMDs) before their death must take RMDs for nine years and liquidate the account in the year of the 10-year anniversary of the death, if not before. The proposed regulations would have exposed those beneficiaries to penalties for failure to take RMDs for 2021, which was before they knew of this requirement. In response to commenters who pointed this out, the IRS then issued Notice 2022-53, which waived the 50% excess accumulation excise tax under Sec. 4974 for 2021 and provided that no RMD would be required for noneligible beneficiaries in 2022 and, in addition, stated that final regulations would apply no earlier than 2023. Notice 2023-54 was issued in 2023 to put off the RMD requirement yet another year and indicated that final regulations would not apply before 2024.

On April 16, 2024, the IRS issued Notice 2024-35 to further delay the onset of RMDs for beneficiaries subject to the 10-year rule for another year, and this time, the Service indicated that final regulations are anticipated to apply in 2025. In each instance of deferring the RMD requirement, the IRS has waived the Sec. 4974 excise tax as well.

Qualified vs. nonqualified plan: In Palaniappan,²⁶ the taxpayer chose to participate in his hospital employer’s Sec. 409A deferred compensation plan, which was allowed only if the employee no longer contributed to the hospital’s 401(k) plan. Five years later, the hospital filed for bankruptcy. Believing that the taxpayer and some others were not qualified to participate in the 409A plan, and seeking to protect their funds from the hospital’s bankruptcy creditors, the hospital liquidated the 409A plan and made secured claim distributions to the nonqualified participants.

The taxpayer objected to this treatment and requested that his share of the 409A funds be transferred to the hospital’s 401(k) plan. Meanwhile, his benefits were distributed, less 20% federal withholding. The bankruptcy court said it could not order that the funds from his nonqualified plan (409A) be deposited into a qualified plan and that taxes were properly withheld. It also held that he had been given enough disclosure that the 409A plan was not a qualified plan when he voluntarily decided to participate in it.

At the same time, the taxpayer filed an ERISA²⁷ breach of fiduciary duty claim against the hospital. He was awarded over $500,000 in damages. Next, he amended his 2016 Form 1040, U.S. Individual Income Tax Return, claiming that the taxes withheld from the distribution were in error. The district court rejected his contention based on the doctrine of double recovery and on the grounds that he could not relitigate a claim that had already been decided in the bankruptcy proceeding.

Long-term, part-time employee rules: The SECURE Act allowed long-term, part-time employees to participate in 401(k) plans, effective Jan. 1, 2024. Before that, only employees who annually worked 1,000 hours or more, were 21 years of age or over, and completed 12 months of service were eligible to participate in 401(k) plans. Congress loosened these requirements in the SECURE Act by providing that 500 hours of service annually, being age 21 or over, and having three consecutive years of service (two for plan years beginning after 2024) would make these part-time employees eligible for a 401(k) plan, but the employer was not required to make matching contributions for them.

In addition, service before 2021 was not counted toward eligibility under this provision. Additional changes were made in SECURE 2.0. Proposed regulations²⁸ were issued Nov. 24, 2023, to provide information necessary for implementation of the change.

Disaster relief distributions from retirement accounts: In SECURE 2.0, Congress provided permanent rules allowing certain individuals affected by federally declared major disasters to take distributions from retirement plans and IRAs as well as retirement plan loans. FAQs were released May 3, 2024, as guidance.²⁹ As with some earlier short-term disaster relief provisions and the COVID-19-related distributions under the CARES Act,³⁰ withdrawals from plans are taxed one-third per year for three years, starting with the year of the disaster, and the amounts can be repaid to the retirement arrangement. The distributions are taxable, but $22,000 of them are exempt from the 10% Sec. 72(t) penalty. In addition, employee loans for disaster relief can have a year off from their five-year payment schedule and may be allowed for higher amounts than standard employee plan loans.

Sec. 402A: Optional treatment of elective deferrals as Roth contributions

SECURE 2.0 authorized pension-linked emergency savings accounts (PLESAs), which are short-term savings accounts linked to a qualified plan. The IRS issued Notice 2024-22 to provide guidance to prevent manipulation of employer matching contributions.

PLESAs are elective for the employer and may be discontinued at any time by the employer. The balance in the savings accounts cannot exceed $2,500 per employee.

Sec. 404: Deduction for contributions of an employer to an employees’ trust or annuity plan and compensation under a deferred-payment plan

In Jadhav,³¹ a case involving questionable deductions, the taxpayer was a Ph.D. chemist who had a full-time job but also operated a sole proprietorship that reported on Schedule C. The sole proprietorship had a Sec. 401(k) plan that covered the taxpayer’s wife and their two sons, both of whom attended college during 2014, the contribution year. The taxpayer paid a consultant $50,000 for an “income tax plan,” which involved converting the Schedule C business to an S corporation and renting the couple’s personal residence to the corporation at FMV for 14 days or less, for a corporate deduction with no corresponding income. The plan also involved the creation of a C corporation that would deduct medical and disability plan payments, overtime and weekend meals for employees, meals for the family “for the convenience of the employer,” tuition for both sons, deferred compensation, and salaries for the children.

The IRS disallowed almost all the expenses and questioned whether the sons were actually employees. However, the Tax Court believed the taxpayer’s explanation that this was a family business and found that the payments to the sons’ retirement accounts were supported by documents. The retirement plan contributions were allowed as deductions for 2014, but substantially all additional expenses were not. The taxpayer tried to avoid penalties, saying he relied on the CPA hired to prepare the returns, but the court found that there was insufficient evidence that he provided the CPA all relevant information and relied on his professional judgment in good faith.

Sec. 408: Individual retirement accounts

Recent administrative and court rulings addressed the effect of naming a trust as an IRA beneficiary and a convicted felon’s forfeiture of an IRA.

Trust named as beneficiary: In IRS Letter Ruling 202404003, the decedent chose to name as an IRA beneficiary a trust established by the decedent and the decedent’s spouse. Upon the decedent’s death, the custodian rolled over IRA benefits to an inherited IRA for the trust. The spouse was the sole trustee and beneficiary of the trust and had the ability to distribute all assets to that spouse during the spouse’s lifetime. The IRS held that the spouse would be treated as receiving the IRA directly from the decedent and not the trust and could accomplish a tax-free rollover.

Criminal forfeiture of an IRA: In Hubbard,³² the taxpayer was a pharmacist who was convicted of various crimes involving distributing controlled substances and sentenced to 30 years in prison. The taxpayer’s assets were also condemned and forfeited to the government, including his T. Rowe Price IRA. He did not file a tax return for the year of the forfeiture, but the IRS filed a substitute for return for him based on the Form 1099-R from T. Rowe Price. The Service took the position that, because his funds were criminally forfeited to the United States, he had constructively received them, and they were therefore includible in his gross income.

The taxpayer filed a Tax Court petition disputing the tax assessed. He contended that case law on forfeitures dealt with cases where the convicted person turned the retirement assets over to the United States voluntarily, while his own forfeiture was involuntary.

Rejecting his argument, the Tax Court held that the forfeitures in the prior case law were not exactly voluntary, and whenever the IRS levies a retirement plan, the owner is taxed on constructive receipt. Hubbard was taxable on the amount of the forfeiture and was subject to penalties for failing to file a return and for failure to pay the tax. The court found no reasonable cause to excuse his actions.

Sec. 469: Passive activity losses and credits limited; Sec. 1411: Imposition of tax

In Senty,³³ the taxpayers sought a refund of Sec. 1411 net investment income tax that the IRS had assessed against them on audit. The case rested on whether the taxpayer husband, James Senty, materially participated in three entities, because if he did and could adequately document it, the income he received from them would be exempt from net investment income tax. Filing a motion for summary judgment, the taxpayers claimed that Senty met the material-participation requirement under Temp. Regs. Sec. 1.469-5T(a)(4)’s “significant participation activity” test, which allowed him to aggregate the time he spent on each 100-hour-plus-per-year activity, such that the combined hours exceeded 500, resulting in material participation under Sec. 469.

Senty, a businessman, stated that during the years in question, 2014 and 2015, he worked 65 to 70 hours a week. There were three entities for which he claimed to have worked enough hours to meet the significant-participation-activity test. The problem for Senty was the lack of documentation. Temp. Regs. Sec. 1. 469-5T(f)(4) explains how a taxpayer may prove participation in activities:

The extent of an individual’s participation in an activity may be established by any reasonable means. Contemporaneous daily time reports, logs, or similar documents are not required if the extent of such participation may be established by other reasonable means. Reasonable means for purposes of this paragraph may include but are not limited to the identification of services performed over a period of time and the approximate number of hours spent performing such services during such period, based on appointment books, calendars, or narrative summaries.

Unfortunately for Senty, he stated that he did not maintain a work calendar, appointment book, log, journal, time sheet, or any other document to keep track of hours and the type of work he did. He also rarely used email or text for work, and though he claimed he did business through phone calls, he did not produce any phone records to substantiate his time worked.

The courts have allowed for a postevent re-creation of hours in cases such as Tolin.³⁴ However, the narrative summary of tasks done in that case included hours worked on specific activities and was based upon “telephone records, credit card invoices, and other contemporaneous materials.” Additionally, in Tolin, there was “a significant amount of credible third-party witness testimony.”

Because Senty did not produce a similar summary with objective evidence to support his narrative, the court denied the taxpayers’ motion for summary judgment. Still, the court gave the couple one month to submit adequate evidence of material participation, indicating in the opinion that judgment would be entered for the government otherwise.

Of note in the case, the IRS also argued that many of the activities that Senty performed were related to his role as an investor in the entity and thus did not count toward material participation. The court did not address the issue, finding it did not need to do so.

Sec. 4973: Tax on excess contributions to certain tax-favored accounts and annuities

In two cases involving the same taxpayer,³⁵ the Tax Court decided matters relating to the taxpayer’s overfunding of his IRA.

The case dates to 2004, when the taxpayer, the president of a manufacturing company, received a $26 million buyout in exchange for stock that he held in an employee stock ownership plan and certain other interests. He rolled over the buyout proceeds into his IRA that year. His 2004 return was not examined, but the Service later contended that he was liable for a 6% excise tax for overfunding his IRA by $25 million. The taxpayer asserted the statute of limitation and other defenses.

At an earlier stage of the litigation, the Tax Court explained that excess IRA contributions must be reported on Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts — which the tax-payer had failed to do. The court also noted that if Form 5329 is not attached to Form 1040 or sent separately to the IRS, the statute of limitation on the excess contribution penalty does not begin running.³⁶

In the first 2024 opinion (issued Jan. 17, 2024),³⁷ the court held that the 6% excise tax on excess contributions is a “tax,” not a “penalty,” and, consequently, no written supervisory approval was necessary under Sec. 6751(b). The court granted the IRS’s motion for partial summary judgment on the issue.

In the second 2024 opinion (issued Feb. 28, 2024),³⁸ the taxpayer contended that, under the SECURE 2.0 Act, a finite statute of limitation should apply here and bar the collection of excess contribution penalties. In the act, passed in late 2022, Congress provided that the filing of an income tax return on Form 1040 will start the running of a six-year statute of limitation, even if no Form 5329 is filed.³⁹ Unfortunately for the taxpayer, the court concluded here that the 2022 amendment did not apply retroactively to this case.

Sec. 6015: Relief from joint and several liability on joint return

In Rawat,⁴⁰ the taxpayer sought innocent-spouse relief under Sec. 6015(f) for six tax years. Under Sec. 6015(f) the IRS may grant equitable relief to a requesting spouse if, considering all the facts and circumstances, it would be inequitable to hold the requesting spouse liable for any unpaid tax or deficiency.

A streamlined determination granting equitable relief under Sec. 6015(f) is available if the requesting spouse can establish that he or she (1) is no longer married to the nonrequesting spouse, (2) would suffer economic hardship if relief were not granted, and (3) lacked knowledge or reason to know of the understatement at the time the return at issue was signed.⁴¹

Relief may also be granted if, after weighing the seven equitable factors listed in Rev. Proc. 2013-34, the IRS determines it would be equitable to grant relief. Those factors are (1) the current marital status of the spouses; (2) whether the requesting spouse will suffer economic hardship if relief is not granted; (3) whether the requesting spouse knew or had reason to know of the item giving rise to the understatement; (4) whether either spouse has a legal obligation to pay the outstanding liability; (5) whether the requesting spouse significantly benefited from the understatement; (6) whether the requesting spouse has made a good-faith effort to comply with income tax laws in the years following the year for which relief is sought; and (7) whether the requesting spouse was in poor mental or physical health when the return at issue was filed, when the request for relief was made, or at the time of trial.

The Tax Court found that the tax-payer was not entitled to streamlined relief or relief under the equitable factors. The court stated: “[I]n the light of her considerable income and assets, knowledge and participation in the items giving rise to the understatement, and consistent record of noncompliance with tax law, we find it would not be inequitable to deny relief.”

Sec. 6654: Failure by individual to pay estimated income tax

IRS interest rates are high by recent historical standards (e.g., for the calendar quarter beginning Jan. 1, 2024, the underpayment rate for individual taxes was 8%).⁴² Thus, interest on underpayments of estimated taxes can add significantly to taxpayers’ deficiencies.

In addition, a recent Tax Court case, Standifird,⁴³ provides a reminder that even if no tax return is filed for several years, the requirement to make estimated tax payments (if liable) still exists. In this case, the taxpayer did not file individual tax returns for four years or make estimated tax payments for those years. The IRS determined income tax deficiencies and asserted additions to tax under Secs. 6651(a)(2) (failure to pay), 6651(f ) (fraudulent failure to file), and 6654 (failure to pay estimated taxes). The IRS produced the taxpayer’s transcripts confirming that no tax returns were filed, and the court concluded that the taxpayer was liable for the additions to tax, including the estimated tax penalties, for not making quarterly estimated payments.