News Notes

IRS Begins New Collection Initiative • Treasury Warns of Phishing Scheme Using IRS Logo • Roth 401(k) Distributions • LLC Valuation Win for Taxpayer (box) • CRT Safe Harbor for Spousal Rights Extended (box)

Lesli S. Laffie, J.D., LL.M.

From the IRS

IRS Selects Three Firms to Participate in Delinquent Tax Effort

To assist the IRS in collecting back taxes, the American Jobs Creation Act of 2004 (AJCA) authorized the Service to hire private firms to collect Federal tax debts. As part of the first phase of this initiative, on March 9, 2006 the IRS awarded contracts to three firms: the CBE Group Inc.; Linebarger Goggan Blair & Sampson, LLP; and Pioneer Credit Recovery, Inc. It expects to assign uncollected liabilities to these firms beginning this summer.

The AJCA includes several stringent limits, ensuring that the private firms will adhere to the same taxpayer protection and privacy rules that IRS employees work under. Also, private firms will not be allowed to subcontract the work.

The IRS has developed its own guidelines for these firms, enumerated in IRS Fact Sheet FS-2006-18. These safeguards include background checks on all firm personnel associated with the project; mandatory initial and ongoing IRS-directed training of company personnel; guidelines for document and data destruction; and secured facilities and equipment that meet IRS security requirements.

Private firms will not be authorized to take enforcement actions such as liens, levies or seizures. In addition, they will not be allowed to work on technical issues, such as offers in compromise, bankruptcies, hardship issues or litigation. Rather, they will be assigned “relatively simple cases,” in which the taxpayer has not disputed a liability. The firms will contact the taxpayers to make payment arrangements.

In the second phase of this project (scheduled for 2008), the IRS plans on contracting with up to 10 firms.

From Treasury

Treasury Warning on Phishing Scheme Using IRS Logo

The Treasury Inspector General for Tax Administration has posted a warning about a scheme involving the electronic use of the IRS logo; the notice is available at http://www.ustreas.gov/tigta/docs/phishing_alert_2006.pdf.

In the scheme, potential victims receive e-mail with an official IRS seal, telling them how to check their refund status or how to get a tax refund credited to their credit card by providing needed information (such as Social Security or credit card numbers, or bank PINs). The notice advises what to do if a taxpayer becomes a victim of such a scam.

Regulations

Roth 401(k) Distributions

Proposed regulations (REG-146459-05) provide further guidance and clarification on the taxation of distributions from designated Roth accounts under Sec. 401(k) and 403(b) plans. (For a discussion of the proposed regulations on designating elective contributions to a Sec. 401(k) plan as Roth contributions, see News Notes, Laffie, “Roth 401(k)s,” TTA, March 2006.)

Designated Roth contributions allow employees to designate all or a portion of their elective contributions under a Sec. 401(k) or 403(b) annuity plan as Roth contributions. These contributions would receive tax treatment much like Roth IRA contributions (i.e., they would be contributed from after-tax income but later, “qualifying distributions” of the contributions plus earnings would be completely tax-free).

To be a qualified Roth distribution, the amount must meet certain requirements, which include having been held for five years and having been made after the participant reaches age 59, dies or becomes disabled. Roth distributions can only be rolled over to other Roth plans or IRAs.

If a distribution is not qualified, under Sec. 72 the distribution would be included in the distributee’s gross income, to the extent allocable to income on the contract, and excluded from gross income to the extent allocable to investment in the contract (basis). The amount of a distribution allocable to investment in the contract is determined by applying the ratio of the investment in the contract to the account balance to the distribution. Note: this treatment differs from the taxation of nonqualified distributions from Roth IRAs, in which nonqualified distributions are treated as a return of contributions (and thus not includible in gross income) until all contributions have been returned as basis.

Separate accounting: Under Sec. 402A(b)(2)(A) and (B), separate “designated Roth accounts” must be established, and separate recordkeeping must be maintained for each account. Under the proposed regulations, these reporting and recordkeeping requirements will not become effective until tax years beginning after 2006. This delay gives plans sufficient time to develop systems to comply with these reporting requirements.

LLC Valuation Case Is a Win for the Taxpayer

by Eileen Sherr, CPA, MT, AICPA Technical Manager—Taxation, Washington, DC, and Justin Ransome, CPA, J.D., MBA, Grant Thornton LLP, Washington, DC

In a win for the taxpayer in a limited liability company (LLC) valuation case (W.G. Anderson et al., WD AL., 2/22/06), a U.S. District Court held that the IRS erred in revaluing a decedent’s minority ownership interest in four LLCs. The estate will now receive a tax refund for the estate and gift taxes, related interest and properly deductible administrative expenses. The estate did not win on its claim for attorneys’ fees and litigation costs, because the gross value of the estate at the decedent’s death was greater than $2 million. In determining the fair market value of the decedent’s interest in her directly held property and minority interest in the LLCs, the court found a 40% marketability discount was proper for both the market and net asset approaches, and that a 10% discount for liquidation costs and a 10% minority discount were proper for the net asset approach. It was well worth the taxpayer disputing the IRS’s valuation in this case. Practitioners should continue to document the valuation methodology being used for estate minority LLC interests.

CRT Safe Harbor for Spousal Rights Extended—Waivers Not Required

by Eileen Sherr, CPA, MT, AICPA Technical Manager—Taxation, Washington, DC, and Frances Shafer, J.D., KPMG LLP, Washington, DC

In response to requests by the AICPA (https://tax.aicpa.org/NR/rdonlyres/5F4E82A5-43B0-48E5-B155-136D99B5E13C/0/clean_rev_proc_2005_
24_letter.doc) and others, the IRS has provided, in recently issued Notice 2006-15, an extension of the June 28, 2005 safe-harbor grandfather date (from Rev. Proc. 2005-24), which applies to certain charitable remainder annuity trusts (CRATs) or charitable remainder unitrusts (CRUTs). The revenue procedure deals with the effect of a spousal right of election on a trust’s qualification as a CRAT or CRUT. The extended safe-harbor date is effective until further guidance is issued by the IRS. Until then, the IRS will disregard an existing spousal right of election, even without a waiver as described in Rev. Proc. 2005-24, but only if the surviving spouse does not exercise the right of election. In a recent letter to the IRS (https://tax.aicpa.org/Resources/Trust+Estate+and+Gift/Trusts/, the AICPA thanked the Service for this notice and for responding to its concerns and adopting (until further study) its recommendation of extending the safe harbor to all trusts regardless of the creation date. Also, because a spousal waiver requirement could potentially affect all CRTs, the AICPA suggested that any future guidance in this area be published in proposed form, thereby allowing practitioners an opportunity to comment on its feasibility before it becomes effective.

As noted in the May 2, 2005 e-alert (https://tax.aicpa.org/NR/rdonlyres/9014F454-5AC6-4A26-B50C-D3AA76ADB726/0/EAlert050205.pdf) and in News Notes, Thorne and Sherr, “Rev. Proc. 2005-24 Requires Spousal Waiver to Avoid CRT Disqualification,” TTA, July 2005, Rev. Proc. 2005-24 provided a safe-harbor procedure for trusts created after June 28, 2005 that disregarded the right of a spousal election for determining whether the CRAT or CRUT is tax exempt, but only if the spouse irrevocably waived the right of election. For trusts created before June 28, 2005, the revenue procedure (and now Notice 2006-15 for all CRTs, whether created before or after June 28, 2005, until further guidance is issued) states that the IRS will disregard the right of election, even without a waiver, if the spouse does not exercise the right. The AICPA and others told the IRS of Rev. Proc. 2005-24’s undue burden on taxpayers and trustees seeking to comply with the safe-harbor rule. They requested a withdrawal of the revenue procedure, an extension of the safe-harbor treatment to all CRTs, and consideration of alternative safe-harbor rules. As a result, the IRS and Treasury are now reconsidering the approach of Rev. Proc. 2005-24 (including the safe-harbor rule), as well as alternative safe-harbor rules.

AICPA Tax Division members with clients owning or interested in CRTs should read the new notice and earlier revenue procedure carefully to identify situations in which they may need to act. The Tax Division’s Trust, Estate, and Gift Tax Technical Resource Panel’s CRT Task Force continues to analyze the procedure and notice and to discuss the effect of this guidance with the IRS and Treasury.