In IR-2023-178 the Internal Revenue Service (IRS) announced the use of expanded chatbot technology. Chatbots are computers using artificial intelligence (AI) to answer taxpayer questions. The new chatbots assist taxpayers who receive IRS notices regarding underreported taxes.
Taxpayers may receive an IRS notice if their tax reporting does not match what is reported from third parties to the IRS. Each year, third parties file millions of IRS information forms that report payments to individuals.
Chatbots are another benefit resulting from increased IRS funding under the Inflation Reduction Act. IRS Commissioner, Danny Werfel stated, "We understand receiving a notice from the IRS can be concerning, and people frequently have questions. The use of chatbots in call centers has emerged as an effective practice in both the private and public sectors, making it easier for people to quickly get basic information to resolve their issues and avoid wait times on the phone."
The IRS has had success with chatbots in both English and Spanish. These chatbots have served over 13 million taxpayers since January 2022. Through the use of chatbots, many taxpayers have addressed their tax issues and there has been approximately $151 million in new tax payment agreements.
A chatbot simulates a human response based on the IRS database and AI programming. After a taxpayer asks a question or makes a request, the chatbot will provide a response. The most common chatbot responses are to answer questions such as, "What do I do if I get an IRS notice?" or “What do I do if I need more time?” or “How do I know the IRS received my response?"
Due to the success of the chatbots and the ability to resolve common taxpayer inquiries, the IRS plans to add additional chatbots in the future.
Editor’s Note: The IRS believes the use of artificial intelligence and chatbots is very helpful for taxpayer services. IRS Deputy Commissioner of Collections, Darren Guillot noted that the IRS chatbot initiatives have been an excellent success, and he describes them as an "incredible return on investment."
Maui Fire Leave Donation Programs
In Notice 2023-69; IR 2023-181, the IRS described rules and guidelines for employers that desire to create a leave-based donation program to assist victims of the August 8, 2023 fires in Maui.
Under the Notice, employers are permitted to make cash payments to nonprofits that provide relief to the victims of the Maui wildfires. Many residents returned to discover their homes were destroyed and it may take several years to rebuild the city of Lahaina. The leave-exchange donation programs may be very helpful for these disaster victims.
The cash payments must be made by the employer to organizations exempt under Section 170(c). These payments must be made prior to January 1, 2025. The employee voluntarily elects to forgo taking vacation or sick leave pay. An employee will not be treated as having constructive income or compensation and this leave-based donation will not increase the employee’s taxable income on IRS Form W-2.
Because the leave-based donation is not included in taxable income, the employee will not qualify for an additional charitable deduction under Section 170.
The employer has two options for deducting the payments. The employer may deduct payments as charitable deductions under Section 170 or business deductions under Section 162.
Editor's Note: The flexibility of the employer to take the deduction as a business expense under Section 162 is important. Some corporate employers may be close to the 10% charitable deduction limit. This will allow additional assistance to disaster victims. The leave-based gifts will be deductible by the employer under one of these two categories.
Contingent Charitable Gift Fails to Qualify for Deduction
In Dr. Peter E. McGowan et al. v. United States; No. 3:19-cv-01073 (2023), the United States District Court determined that a contingent charitable gift did not fulfill the "substantial risk of forfeiture" standard and insurance premiums were therefore taxable to the taxpayer and not deductible by a C corporation.
Since 1994, Dr. Peter E. McGowan has operated a dental practice as a C corporation (Company). In 2011, Dr. McGowan and Company created an insurance program that involved a Restricted Property Trust (RPT). The RPT and a second sub-trust, the Death Benefit Trust (DBT) were trusteed by Aligned Partners Trust Company. During each year from 2011 through 2015, the Company paid $37,222 to DBT and $12,778 to RPT. These payments were used to purchase a whole life insurance policy that was owned for five years by DBT. The agreement stated that Dr. McGowan and the Company had no "interest or right in or to" the policy during the five-year period.
If Dr. McGowan died during the five-year term, the death benefit of $2,096,062 would be paid to his designee, spouse Michelle McGowan. After five years, the Company may extend the transaction for another five years. Alternatively, the insurance policy may be transferred to Dr. McGowan. If the Company failed to pay the premium for any of the five years, the policy cash value would distribute to a charity selected by Dr. McGowan.
The Company paid premiums for five years. At the end of five years, the insurance policy was transferred to Dr. McGowan. Dr. McGowan reported the value of the policy as taxable income, less amounts previously included in income. Under Section 83(b), the Company had followed the election for income subject to a "substantial risk of forfeiture" to pay tax on the $12,778 when it was received instead of when the forfeiture occurs or expires. Each year, the Company deducted that amount as compensation and Dr. McGowan reported it as income. For unexplained reasons, the Company did not report the $37,222 as income each year.
The Company noted, "Dr. McGowan was advised that any assets in the Restricted Property Trust not previously included in income [are] subject to tax at vesting." In 2016, the policy had a value of $186,691. After subtracting the $12,778 annual taxable payments, Dr. McGowan reported the net amount of $115,227 as taxable income on his 2016 tax return.
The IRS audited both Dr. McGowan and the Company. The IRS claimed the payments for premiums of $37,222 were taxable income to Dr. McGowan each year. Furthermore, the payments were dividends and therefore not deductible to the Company. The IRS assessed tax, interest and penalties of approximately $60,000 against Dr. McGowan and approximately $28,000 against the Company.
The IRS claimed the split-dollar Regulation 1.61-22 applied to the Restricted Property Trust. Therefore, the dividends from the Company were used to pay the premiums and are taxable to Dr. McGowan and not deductible by the corporation.
Regulation 1.61-22 defines a split-dollar policy as one entered into in connection with services that is not part of a group-term life insurance plan. In addition, the Company pays the premiums and the employee can designate the death benefit and also has an interest in the policy cash value. The taxpayer claimed that Dr. McGowan had no interest in the cash value during the five years and therefore the split-dollar regulation was not applicable.
The parties agree that the Restricted Property Trust is a welfare benefit fund under Section 419(e)(1). Because Dr. McGowan was the sole shareholder of the Company, he is correctly treated as the owner of the policy. Dr. McGowan noted he had no current access to the cash value. However, he had a future right to the cash value because he could designate who would receive the death benefits.
Finally, the taxpayer claimed that the possibility the Company would stop making payments created a "substantial risk of forfeiture" and therefore no current ownership. Because the policy could lapse and the cash value transferred to charity, this contingent right precludes recognition of the value by Dr. McGowan. However, the Court determined that the contingent right did not eliminate the ability for Dr. McGowan to have "current access" as defined by the split-dollar regulation. Therefore, the insurance premiums were taxable to Dr. McGowan.
The Company also claimed that the contribution to a welfare benefit trust justified a charitable deduction. However, the Court determined "the policy value ought to have been included in Dr. McGowan's income, and because the Company was not permitted to deduct the premium payments, the IRS calculations of tax liability in the Notices of Deficiency are correct."
Finally, the taxpayers claimed that there was sufficient disclosure of the underlying facts that there was a reasonable basis for selecting the tax treatment. However, the taxpayers did not identify any of the advisors and therefore the substantial understatement penalty was applicable.
Applicable Federal Rate of 5.4% for October -- Rev. Rul. 2023-18; 2023-40 IRB 1 (15 September 2023)
The IRS has announced the Applicable Federal Rate (AFR) for October of 2023. The AFR under Sec. 7520 for the month of October is 5.4%. The rates for September of 5.0% or August of 5.0% 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. 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.”