Taxing Lessons

Decisions — Taxpayers ask the questions

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Need general information about tax law? When taxpayers write the IRS with general tax questions, the IRS National Office provides an information letter.

Here are four recent letters so you can test your own knowledge.

1

Generally, individuals are not taxed on individual retirement account income until the funds are distributed or withdrawn.

In information letter number 2018-0017, a taxpayer wants to know why the IRS taxed the investment gains in his individual retirement account before distribution was made of the money.

The IRS said they did not have enough information to determine what, if any, changes occurred either in the law or in the taxpayer’s financial circumstances that would affect his individual retirement account.

However, the IRS did come up with one possible explanation. Can you?

 

 

2

A taxpayer generally has to make withdrawals from individual retirement accounts when the taxpayer reaches age 70-½. The withdrawals must be for at least a calculated minimum amount known as a required minimum distribution. As a general rule, required minimum distributions must be withdrawn by December 31.

However, for the initial required minimum distribution, a taxpayer can make the withdrawal up until April 1 after the calendar year in which the individual turns 70-½.

Here’s the explanation of the rule from regulation 1.401(a)(9)-5, question-and-answer-1(c): The distribution required to be made on or before the required beginning date shall be treated as the distribution required for the first distribution calendar year. The required minimum distribution for other distribution calendar years, including the required minimum distribution for the distribution calendar year in which the required beginning date occurs, must be made on or before the end of that distribution calendar year.

In information letter number 2018-0020, the taxpayer, who turned age 70-1/2 in 2018, created a hypothetical schedule of individual retirement account distributions designed to avoid penalties for not withdrawing enough required minimum distributions.

On the hypothetical schedule, the taxpayer counted amounts paid during the period from January 1, 2019, to April 1, 2019, as 2018 required minimum distributions and also counted those same amounts as meeting the 2019 minimum distribution requirement.

Did the IRS agree that this schedule would allow the taxpayer to avoid penalties for failing to make required minimum distributions?

 

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3

In July 2018, the IRS issued revenue procedure 2018-38. The revenue procedure stated that most tax-exempt organizations would no longer have to report the names and addresses of substantial donors.

In information letter number 2018-0029, a taxpayer was concerned that the revenue procedure would reduce information available to the public about political contributions.

 

 

4

In April 2018, the state of Maryland enacted a health insurance provider fee under the Maryland Health Care Access Act of 2018. The fee is an assessment of 2.75% of all amounts used to calculate an entity’s premium tax liability or premium tax exemption value for the 2018 calendar year. The amounts assessed are supposed to fund the state reinsurance program for the general purpose of individual health insurance market stabilization.

In information letter 2018-0023, a taxpayer asked whether the assessments should be treated on a business federal income tax return as a deductible expense under section 162 or a deductible tax under section 164 of the internal revenue code.

The taxpayer was concerned because the (federal law) Affordable Care Act imposes a similar annual fee that is not deductible under internal revenue code section 275(a)(6), which denies a deduction for taxes imposed by chapters 41, 42, 43, 44, 45, 46, and 54.

According to the IRS, the distinction between a tax and a regulatory fee focuses on the purpose of the assessment and the ultimate use of the funds. The classic tax is imposed by a state or municipal legislature, while the classic fee is imposed by an agency upon those it regulates. The classic tax is designed to provide a benefit for the entire community, while the classic fee is designed to raise money to help defray an agency’s regulatory expenses.

Here are the relevant code sections.

From internal revenue code section 162(a): Generally provides that ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business are deductible. A regulatory fee is deductible as an ordinary and necessary business expense under section 162.

From internal revenue code section 164(a): Generally provides that state and local taxes paid or accrued within the taxable year in carrying on a trade or business are deductible.

From internal revenue code section 275: Generally provides that no deduction is allowed for federal income taxes, including the tax imposed by section 3101 (relating to the tax on employees under the federal insurance contributions act); the taxes imposed by sections 3201 and 3211 (relating to the taxes on railroad employees and railroad employee representatives); and the tax withheld at source on wages under section 3402; federal war profits and excess profits taxes, estate, inheritance, legacy, succession, and gift taxes, income, war profits, and excess profits taxes imposed by the authority of any foreign country or possession of the US if the taxpayer chooses to take to any extent the benefits of section 901, taxes on real property, to the extent that section 164(d) requires such taxes to be treated as imposed on another taxpayer, taxes imposed by chapters 41, 42, 43, 44, 45, 46, and 54.
 

WHAT WOULD YOU DECIDE?

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Note: Taxing Lessons provides a summarized version of sometimes lengthy court decisions and IRS documents. The full documentation may include facts and issues not presented here. Please use the link provided in the post to read the entire document.

This information should not be considered legal, investment, or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment, or tax advice. Always consult your legal, investment, and/or tax advisor regarding your personal situation.

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Some individual retirement accounts engage in activities and investments that generate taxable income to the account. For example, if an individual retirement account holds an operating business or debt-financed assets, the income related to that operating business or those debt-financed assets may be subject to unrelated business income tax. (See sections 408(e)(1) and 511-514 of the internal revenue code and section 1.408-1(b) of the federal income tax regulations.

Editorial Note: An individual retirement account has to file Form 990-T when the account earns gross unrelated business income of more than $1,000 during a year. The return is supposed to be filed by the account custodian, who pays the taxes from the individual retirement account. However, the individual retirement account owner is ultimately the responsible party if the return is not filed. See IRS Publication 598.

Note also that unrelated business income is subject to double taxation. The individual retirement account is taxed on the income, and the account owner is taxed on distributions of the income. The account owner gets no deductions or credits for the income, and any resulting tax is not added to the owner’s basis in the individual retirement account.

Sorry, wrong answer :(
Right answer!

Separate required minimum distributions must be made for each calendar year after the initial year (including the calendar year in which the required beginning date occurs). The same amount distributed cannot be claimed to satisfy the required minimum distribution for two separate years – i.e., the required minimum distribution for the calendar year in which the individual turns 70-½ and the required minimum distribution for the next calendar year.

From IRS Publication 560: “If no distribution is made in the starting year, required distributions for two years must be made in the next year (one by April 1 and one by December 31).”

Thus, if the required minimum distribution for year one is $300 and the required minimum distribution for year two is $310 and no distribution is made during year one, a total of $610 must be distributed in year two, $300 of which must be distributed by April 1 of year two.

In general, under section 6104(b) of the internal revenue code, the IRS must make the annual information returns filed by tax-exempt organizations available to the public.

However, the IRS is not authorized to disclose the name or address of any contributor to any tax-exempt organization other than a private foundation or a section 527 political organization.

Because internal revenue code section 6104 protects contributor privacy, the names and addresses of contributors reported to the IRS (other than contributors to private foundations and section 527 political organizations) are redacted before the release of the information that is required to be made open to public inspection.

The restriction on disclosing the names and addresses of contributors was enacted in 1969 by congress in the same public law that created the requirement for organizations described in section 501(c)(3) to report such names and addresses.

Therefore, there has never been any public disclosure of the names and addresses of contributors other than the names and addresses of contributors to private foundations and section 527 political organizations, and those organizations continue to report the names and addresses of their substantial contributors, which continue to be made available to the public.

Additionally, revenue procedure 2018-38 continues the requirement that all exempt organizations must maintain books and records that contain the names and addresses of all substantial contributors. The revenue procedure requires that this information be made available to the IRS upon request if the IRS determines that the information is necessary for the appropriate administration of the tax law.

Thus, revenue procedure 2018-38 does not reduce the public’s awareness of the names and addresses of contributors to exempt organizations; it also does not reduce the ability of the IRS to examine such information should such an examination be deemed necessary.

Right answer!

The fee Maryland enacted is not a federal tax described in section 275(a)(6), and therefore should not be subject to the limit on deductibility provided by section 275(a).

Regardless of whether the Maryland assessment is considered a fee or a state tax, which we need not determine, the assessment would be deductible either under section 162 or section 164 of the internal revenue code for those entities carrying on a trade or business.

Sorry, wrong answer :(
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