Independent contractor vs. employee status: The DOL issues new final rule

The U.S. Department of Labor’s (DOL’s) test for determining whether a worker should be classified as an independent contractor or an employee for purposes of the federal Fair Labor Standards Act (FLSA) has been revised several times over the past decade. Now, the DOL is implementing a new final rule rescinding the employer-friendly test that was developed under the Trump administration. The new, more employee-friendly rule takes effect March 11, 2024.

Role of the new final rule

Even though the DOL’s final rule isn’t necessarily controlling for courts weighing employment status issues, it’s likely to be considered persuasive authority. Moreover, it’ll guide DOL misclassification audits and enforcement actions.

If you’re found to have misclassified employees as independent contractors, you may owe back pay if employees weren’t paid minimum wage or overtime pay, as well as penalties. You also could end up liable for withheld employee benefits and find yourself subject to various federal and state employment laws that apply based on the number of affected employees.

The rescinded test

The Trump administration’s test (known as the 2021 Independent Contractor Rule) focuses primarily on whether, as an “economic reality,” workers are dependent on employers for work or are in business for themselves. It examines five factors. And while no single factor is controlling, the 2021 rule identifies two so-called “core factors” that are deemed most relevant:

  • The nature and degree of the employer’s control over the work, and
  • The worker’s opportunity for profit and loss.

If both factors suggest the same classification, it’s substantially likely that classification is proper.

The new test

The final new rule closely shadows the proposed rule published in October 2022. According to the DOL, it continues the notion that a worker isn’t an independent contractor if, as a matter of economic reality, the individual is economically dependent on the employer for work. The DOL says the rule aligns with both judicial precedent and its own interpretive guidance prior to 2021.

Specifically, the final rule enumerates six factors that will guide DOL analysis of whether a worker is an employee under the FLSA:

1. The worker’s opportunity for profit or loss depending on managerial skill (the lack of such opportunity suggests employee status),

2. Investments by the worker and the potential employer (if the worker makes similar types of investments as the employer, even on a smaller scale, it suggests independent contractor status),

3. Degree of permanence of the work relationship (an indefinite, continuous or exclusive relationship suggests employee status),

4. The employer’s nature and degree of control, whether exercised or just reserved (control over the performance of the work and the relationship’s economic aspects suggests employee status),

5. Extent to which the work performed is an integral part of the employer’s business (if the work is critical, necessary or central to the principal business, the worker is likely an employee), and

6. The worker’s skill and initiative (if the worker brings specialized skills and uses them in connection with business-like initiative, the worker is likely an independent contractor).

In contrast to the 2021 rule, all factors will be weighed — no single factor or set of factors will automatically determine a worker’s status.

The final new rule does make some modifications and clarifications to the proposed rule. For example, it explains that actions that an employer takes solely to comply with specific and applicable federal, state, tribal or local laws or regulations don’t indicate “control” suggestive of employee status. But those that go beyond compliance and instead serve the employer’s own compliance methods, safety, quality control, or contractual or customer service standards may do so.

The final rule also recognizes that a lack of permanence in a work relationship can sometimes be due to operational characteristics unique or intrinsic to particular businesses or industries and the workers they employ. The relevant question is whether the lack of permanence is due to workers exercising their own independent business initiative, which indicates independent contractor status. On the other hand, the seasonal or temporary nature of work alone doesn’t necessarily indicate independent contractor classification.

The return, and clarification, of the factor related to whether the work is integral to the business also is notable. The 2021 rule includes a noncore factor that asks only whether the work was part of an integrated unit of production. The final new rule focuses on whether the business function the worker performs is an integral part of the business.

For tax purposes

In a series of Q&As, the DOL addressed the question: “Can an individual be an employee for FLSA purposes even if he or she is an independent contractor for tax purposes?” The answer is yes.

The DOL explained that the IRS applies its version of the common law control test to analyze if a worker is an employee or independent contractor for tax purposes. While the DOL considers many of the same factors as the IRS, it added that “the economic reality test for FLSA purposes is based on a specific definition of ‘employ’ in the FLSA, which provides that employers ‘employ’ workers if they ‘suffer or permit’ them to work.”

In court cases, this language has been interpreted to be broader than the common law control test. Therefore, some workers who may be classified as contractors for tax purposes may be employees for FLSA purposes because, as a matter of economic reality, they’re economically dependent on the employers for work.

Next steps

Not surprisingly, the DOL’s final new rule is already facing court challenges. Nonetheless, you should review your work relationships if you use freelancers and other independent contractors and make any appropriate changes. Remember, too, that states can have different tests, some of which are more stringent than the DOL’s final rule. Contact your employment attorney if you have questions about the DOL’s new rule. We can assist with any issues you may have regarding independent contractor status for tax purposes.

© 2024

IRS suspends processing of ERTC claims

In the face of a flood of illegitimate claims for the Employee Retention Tax Credit (ERTC), the IRS has imposed an immediate moratorium through at least the end of 2023 on processing new claims for the credit. The reason the IRS cites for the move is the risk of honest small business owners being scammed by unscrupulous promoters who submit questionable claims on their behalf.

The fraud problem

The ERTC is a refundable tax credit intended for businesses that 1) continued paying employees while they were shut down due to the pandemic in 2020 and 2021, or 2) suffered significant declines in gross receipts from March 13, 2020, to December 31, 2021. Eligible employers can receive credits worth up to $26,000 per retained employee. The ERTC can still be claimed on amended returns.

The requirements are strict, though. Specifically, you must have:

  • Sustained a full or partial suspension of operations due to orders from a governmental authority that limited commerce, travel or group meetings due to COVID during 2020 or the first three quarters of 2021,
  • Experienced a significant decline in gross receipts during 2020 or a decline in gross receipts in the first three quarters of 2021, or
  • Qualified as a recovery startup business — which could claim the credit for up to $50,000 total per quarter, without showing suspended operations or reduced receipts — for the third or fourth quarters of 2021 (qualified recovery startups are those that began operating after February 15, 2020, and have annual gross receipts of less than or equal to $1 million for the three years preceding the quarter for which they are claiming the ERTC).

Additional restrictions apply, too.

Nonetheless, the potentially high value of the ERTC, combined with the fact that some employers can file claims for it until April 15, 2025, has led to a cottage industry of fraudulent promoters offering to help businesses claim refunds for the credit. They wield inaccurate information to generate business from innocent clients who may pay upfront fees in the thousands of dollars or must pay the promoters a percentage of refunds they get.

Victims could end up on the hook for repayment of the credit, along with penalties and interest on top of the fees paid to the promoter. Moreover, as the IRS has noted, promoters may leave out key details, unleashing a “domino effect of tax problems” for unsuspecting businesses.

The impact of the moratorium

Payouts on legitimate claims already filed will continue during the moratorium period. But taxpayers should expect a lengthier wait. The IRS has extended the standard processing goal of 90 days to 180 days and potentially much longer for claims flagged for further review or audit.

Increased fraud worries are prompting the agency to shift its review focus to compliance concerns. The shift includes intensified audits and criminal investigations of both promoters and businesses filing suspect claims.

The IRS also is working to develop new initiatives to aid businesses that have fallen prey to aggressive promoters. For example, it expects to soon offer a settlement program that will allow those who received an improper ERTC payment to avoid penalties and future compliance action by repaying the amount received.

If you claimed the credit, but your claim hasn’t yet been processed or paid, you can withdraw your claim if you now believe it was improper. You can withdraw even if your case is already under or awaiting audit. The IRS says this option is available for filers of the more than 600,000 claims currently awaiting processing.

Still considering claiming the credit?

The IRS urges taxpayers to carefully review the ERTC guidelines during the moratorium period. Legitimate claimants shouldn’t be dissuaded, but, as the IRS says, it’s best to confirm the validity of your claim with a “trusted tax professional — not a tax promoter or marketing firm looking to make money” by taking a “big chunk” out of your claim. And don’t count on seeing payment of your credit anytime soon. Contact us if you have questions regarding the ERTC.

© 2023  


The IRS warns businesses about ERTC scams

The airwaves and internet are inundated these days with advertisements claiming that businesses are missing out on the lucrative Employee Retention Tax Credit (ERTC). While some employers do indeed remain eligible if they meet certain criteria, the IRS continues to caution businesses about third-party scams related to the credit.

While there’s nothing wrong with claiming credits you’re entitled to, those that claim the ERTC improperly could find themselves in hot water with the IRS and face cash-flow problems as a result. Here’s what you need to know to reduce your risks.

ERTC in a nutshell

The ERTC is a refundable tax credit intended for businesses that 1) continued paying employees while they were shut down due to the pandemic in 2020 and 2021, or 2) suffered significant declines in gross receipts from March 13, 2020, to December 31, 2021. Eligible employers could receive credits worth up to $26,000 per retained employee. The credit may still be available on an amended tax return.

The requirements are strict, though. Specifically, you must have:

  • Sustained a full or partial suspension of operations due to orders from a governmental authority that limited commerce, travel or group meetings due to COVID-19 during 2020 or the first three quarters of 2021,
  • Experienced a significant decline in gross receipts during 2020 or in the first three quarters of 2021, or
  • Qualified as a recovery startup business — which can claim the credit for up to $50,000 total per quarter without showing suspended operations or reduced receipts — for the third or fourth quarters of 2021. (Qualified recovery startups are those that began operating after February 15, 2020, and have annual gross receipts of less than or equal to $1 million for the three tax years preceding the quarter for which they are claiming the ERTC.)

In addition, a business can’t claim the ERTC on wages that it reported as payroll costs when it applied for Paycheck Protection Program (PPP) loan forgiveness or it used to claim certain other tax credits. Also, a business must reduce the wage deductions claimed on its federal income tax return by the amount of credits.

Prevalence of scams

The potentially high value of the ERTC, combined with the fact that employers can file claims for it on amended returns until April 15, 2025, has led to a cottage industry of fraudulent promoters offering to help businesses claim the credit. These fraudsters wield inaccurate information and inflated promises to generate business from innocent clients. In return, they reap excessive upfront fees in the thousands of dollars or commissions as high as 25% of the refund received.

The IRS has called the amount of misleading marketing around the credit “staggering.” For example, in recent guidance, the tax agency explained that, contrary to advice given by some promoters, supply chain disruptions generally don’t qualify an employer for the credit unless the disruptions were due to a government order. It’s not enough that an employer suspended operations because of disruptions — the credit applies only if the employer had to suspend operations because a government order caused the supplier to suspend its operations.

ERTC fraud has grown so serious that the IRS has included it in its annual “Dirty Dozen” list of the worst tax scams in the country. In Utah, for example, the U.S. Department of Justice has charged two promoters, who did business as “1099 Tax Pros,” with participating in a fraudulent tax scheme by preparing and submitting more than 1,000 forms to the IRS. They claimed more than $11 million in false ERTCs and COVID-related sick and family leave wage credits for their clients.

Fraudsters have been able to monopolize on the general confusion and uncertainty around the ERTC. A recent congressional hearing found that some of the problems can be traced back to the entirely paper application process created for the credit. This has contributed to a backlog of nearly 500,000 unprocessed claims, out of more than 2.5 million claims that have been submitted.

Although it’s unclear how much progress the IRS has made on the backlog, the agency has announced that it has entered a new phase of intensified scrutiny of ERTC claims. It’s stepping up its compliance work and establishing additional procedures to deal with fraud in the program. The IRS already has increased its audit and criminal investigation work on ERTC claims, focusing on both the promoters and the businesses filing dubious claims.

If you fell into the trap and are among those businesses, you could end up on the hook for repayment of the credit, along with penalties and interest, on top of the fees you paid the promoter. That could make a substantial dent in your cash flow.

Even if you’re eligible for the credit, you could run into trouble if you failed to reduce your wage deductions accordingly or claimed it on wages that you also used to claim other credits. As the IRS has noted, promoters may leave out key details, unleashing a “domino effect of tax problems” for unsuspecting businesses.

Moreover, providing your business and tax documents to an unscrupulous promoter could put you at risk of identify theft.

Red flags to watch for

The IRS has identified several warning signs of illegitimate promoters, including:

  • Unsolicited phone calls, text messages, direct mail or ads highlighting an “easy application process” or a short eligibility checklist (the rules for eligibility and computation of credit amounts are actually quite complicated),
  • Statements that the promoter can determine your ERTC eligibility within minutes,
  • Hefty upfront fees,
  • Fees based on a percentage of the refund amount claimed,
  • Preparers who refuse to sign the amended tax return filed to claim a refund of the credit,
  • Aggressive claims from the promoter that you qualify before you’ve discussed your individual tax situation (the credit isn’t available to all employers), or
  • Refusal to provide detailed documentation of how your credit was calculated.

The IRS also warns that some ERTC “mills” are sending out fake letters from nonexistent government entities such as the “Department of Employee Retention Credit.” The letters are designed to look like official IRS or government correspondence and typically include urgent language pushing immediate action.

Protect yourself

Taking several simple steps can help you cut your risk of being victimized by scammers. First, if you think you may qualify for the credit, work with a trusted professional — one who isn’t proactively soliciting ERTC work. Those who are aggressively marketing the credit (and in some cases, only the credit) are more interested in making money themselves and are unlikely to prioritize or protect your best interests.

You also should request a detailed worksheet that explains how you’re eligible for the credit. The worksheet should “show the math” for the credit amount as well.

If you’re claiming you suspended business due to a government order, ensure that you have legitimate documentation of the order. Don’t accept a generic document about a government order from a third party. Rather, you should acquire a copy of the actual government order and review it to confirm that it applies to your business.

Proceed with caution

No taxpayer ever wants to leave money on the IRS’s table, but skepticism is warranted whenever something seems too good to be true. If you believe your business might be eligible for the ERTC, we can help you verify eligibility, compute your credit and file your refund claim. We can also help you determine how to proceed if you claimed the ERTC improperly.

© 2023  


Employee Spotlight – Logan Hostetter



What year did you join Slattery & Holman?

2023

Tell me a little about where you attended college and the degree(s) you earned? Any special accomplishments.
I graduated from the Kelley School of Business at IU Bloomington with a bachelor’s in finance. I would say I’m very proud of my 3.7 GPA because of how much time I put in and how rigorous the Kelley coursework was. I was able to make the Dean’s List multiple times while having a great experience at the greatest college in the country.

What is your favorite thing about living in Indiana?
I would say my favorite thing about Indiana is the people because everyone who means something in my life is from here and it’s where I grew up, so the people make the place so special to me. I also don’t mind the price of living


Tell me a little about your family.
I come from a family of 5. I have my parents Patrick & Jennifer, my brother Gavin (21), and my sister Addyson (18). I also have 2 dogs, Ash (Silver Lab) and Charli (Golden Retriever), who are my genuine best friends on this earth.

If you did not have to sleep, what would you do with the extra time?
This might sound cliché but just get more productive things done. Find ways to better myself, spend an extra hour at work, spend an extra hour at the gym, and help my family out in whatever ways I can.

What fictional place would you most like to visit?
Coruscant (the capital of the galaxy in Star Wars). I am a nerd at heart


What is a new skill that you would like to master? 
I would either like to learn how to do a standing backflip or learn MMA. Those are two things that have always been on my bucket list.

What do you wish you knew more about?
The universe. Once again very general, but I would like to know so badly what else is out there beyond our planet and if there are more life forms or societies.

What is the farthest you have ever been from home?
Honestly, Florida. I have not ventured too far from my nest yet.

What question would you most like to know the answer to?
Are professional sports rigged? I just have some suspicions.

What is the most impressive thing you know how to do?
I can probably spin a basketball on my finger for 45 minutes straight if I wanted to.

What was the best compliment you have ever received?
“I love your work ethic.” I have had a few people come up to me and say that and it just means a lot because I try to put 110% into whatever I do and a little validation can go a long way.

What silly accomplishment are you most proud of?
Winning the MVP of an 8-foot goal basketball league.

What is your favorite smell?
I’m a huge advocate of candles (my mom got me into them), so any fall scented candle from Bath & Body Works, especially pumpkin.

If you had a clock that would countdown to any one event of your choosing, what event would you want it to countdown to?
The Pacers’ first NBA title or the Colts’ next Super Bowl. That clock might run to infinity though


When was the last time you climbed a tree?
I believe my senior year of college.

What is the most unusual thing you have ever eaten?
Alligator, for sure.

What was your first job?
I worked at Menards as a team member where I would stock goods, assist customers around the store, and help close.

If you could have any super power, what would it be?
Easily telepathy, no question.

Pocket a tax break for making energy-efficient home improvements

An estimated 190 million Americans have recently been under heat advisory alerts, according to the National Weather Service. That may have spurred you to think about making your home more energy efficient — and there’s a cool tax break that may apply. Thanks to the Inflation Reduction Act of 2022, you may be able to benefit from an enhanced residential energy tax credit to help defray the cost.

Eligibility rules

If you make eligible energy-efficient improvements to your home on or after January 1, 2023, you may qualify for a tax credit up to $3,200. You can claim the credit for improvements made through 2032.

The credit equals 30% of certain qualified expenses for energy improvements to a home located in the United States, including:

  • Qualified energy-efficient improvements installed during the year,
  • Residential “energy property” expenses, and
  • Home energy audits.

There are limits on the allowable annual credit and on the amount of credit for certain types of expenses.

The maximum credit you can claim each year is:

  • $1,200 for energy property costs and certain energy-efficient home improvements, with limits on doors ($250 per door and $500 total), windows ($600 total) and home energy audits ($150), as well as
  • $2,000 per year for qualified heat pumps, biomass stoves or biomass boilers.

In addition to windows and doors, other energy property includes central air conditioners and hot water heaters.

Before the 2022 law was enacted, there was a $500 lifetime credit limit. Now, the credit has no lifetime dollar limit. You can claim the maximum annual amount every year that you make eligible improvements until 2033. For example, you can make some improvements this year and take a $1,200 credit for 2023 — and then make more improvements next year and claim another $1,200 credit for 2024.

The credit is claimed in the year in which the installation is completed.

Other limits and rules

In general, the credit is available for your main home, although certain improvements made to second homes may qualify. If a property is used exclusively for business, you can’t claim the credit. If your home is used partly for business, the credit amount varies. For business use up to 20%, you can claim a full credit. But if you use more than 20% of your home for business, you only get a partial credit.

Although the credit is available for certain water heating equipment, you can’t claim it for equipment that’s used to heat a swimming pool or hot tub.

The credit is nonrefundable. That means you can’t get back more on the credit than you owe in taxes. You can’t apply any excess credit to future tax years. However, there’s no phaseout based on your income, so even high-income taxpayers can claim the credit.

Collecting green for going green

Contact us if you have questions about making energy-efficient improvements or purchasing energy-saving property for your home. The Inflation Reduction Act may have other tax breaks you can benefit from for making clean energy purchases, such as installing solar panels. We can help ensure you get the maximum tax savings for your expenditures. Stay cool!

© 2023


A tax-smart way to develop and sell appreciated land

Let’s say you own highly appreciated land that’s now ripe for development. If you subdivide it, develop the resulting parcels and sell them off for a hefty profit, it could trigger a large tax bill.

In this scenario, the tax rules generally treat you as a real estate dealer. That means your entire profit — including the portion from pre-development appreciation in the value of the land — will be treated as high-taxed ordinary income subject to a federal rate of up to 37%. You may also owe the 3.8% net investment income tax (NIIT) for a combined federal rate of up to 40.8%. And you may owe state income tax too.

It would be better if you could arrange to pay lower long-term capital gain (LTCG) tax rates on at least part of the profit. The current maximum federal income tax rate on LTCGs is 20% or 23.8% if you owe the NIIT.

Potential tax-saving solution

Thankfully, there’s a strategy that allows favorable LTCG tax treatment for all pre-development appreciation in the land value. You must have held the land for more than one year for investment (as opposed to holding it as a real estate dealer).

The portion of your profit attributable to subsequent subdividing, development and marketing activities will still be considered high-taxed ordinary income, because you’ll be considered a real estate dealer for that part of the process.

But if you can manage to pay a 20% or 23.8% federal income tax rate on a big chunk of your profit (the pre-development appreciation part), that’s something to celebrate.

Three-step strategy

Here’s the three-step strategy that could result in paying a smaller tax bill on your real estate development profits.

1. Establish an S corporation

If you individually own the appreciated land, you can establish an S corporation owned solely by you to function as the developer. If you own the land via a partnership, or via an LLC treated as a partnership for federal tax purposes, you and the other partners (LLC members) can form the S corp and receive corporate stock in proportion to your percentage partnership (LLC) interests.

2. Sell the land to the S corp

Sell the appreciated land to the S corp for a price equal to the land’s pre-development fair market value. If necessary, you can arrange a sale that involves only a little cash and a big installment note the S corp owes you. The business will pay off the note with cash generated by selling off parcels after development. The sale to the S corp will trigger a LTCG eligible for the 20% or 23.8% rate as long as you held the land for investment and owned it for over one year.

3. Develop the property and sell it off

The S corp will subdivide and develop the property, market it and sell it off. The profit from these activities will be higher-taxed ordinary income passed through to you as an S corp shareholder. If the profit is big, you’ll probably pay the maximum 37% federal rate (or 40.8% percent with the NIIT. However, the average tax rate on your total profit will be much lower, because a big part will be lower-taxed LTCG from pre-development appreciation.

Favorable treatment

Thanks to the tax treatment created by this S corp developer strategy, you can lock in favorable treatment for the land’s pre-development appreciation. That’s a huge tax-saving advantage if the land has gone up in value. Consult with us if you have questions or want more information.

© 2023


Moving Mom or Dad into a nursing home? 5 potential tax implications

More than a million Americans live in nursing homes, according to various reports. If you have a parent entering one, you’re probably not thinking about taxes. But there may be tax consequences. Let’s take a look at five possible tax breaks.

1. Long-term medical care

The costs of qualified long-term care, including nursing home care, are deductible as medical expenses to the extent they, along with other medical expenses, exceed 7.5% of adjusted gross income (AGI).

Qualified long-term care services are necessary diagnostic, preventive, therapeutic, curing, treating, mitigating and rehabilitative services, and maintenance or personal-care services required by a chronically ill individual that are provided under care administered by a licensed healthcare practitioner.

To qualify as chronically ill, a physician or other licensed healthcare practitioner must certify an individual as unable to perform at least two activities of daily living (eating, toileting, transferring, bathing, dressing, and continence) for at least 90 days due to a loss of functional capacity or severe cognitive impairment.

2. Nursing home payments

Amounts paid to a nursing home are deductible as medical expenses if a person is staying at the facility principally for medical, rather than custodial care. If a person isn’t in the nursing home principally to receive medical care, only the portion of the fee that’s allocable to actual medical care qualifies as a deductible expense. But if the individual is chronically ill, all qualified long-term care services, including maintenance or personal care services, are deductible.

If your parent qualifies as your dependent, you can include any medical expenses you incur for your parent along with your own when determining your medical deduction.

3. Long-term care insurance

Premiums paid for a qualified long-term care insurance contract are deductible as medical expenses (subject to limitations explained below) to the extent they, along with other medical expenses, exceed the percentage-of-AGI threshold. A qualified long-term care insurance contract covers only qualified long-term care services, doesn’t pay costs covered by Medicare, is guaranteed renewable and doesn’t have a cash surrender value.

Qualified long-term care premiums are includible as medical expenses up to certain amounts. For individuals over 60 but not over 70 years old, the 2023 limit on deductible long-term care insurance premiums is $4,770, and for those over 70, the 2023 limit is $5,960.

4. The sale of your parent’s home

If your parent sells his or her home, up to $250,000 of the gain from the sale may be tax-free. In order to qualify for the $250,000 exclusion ($500,000 if married), the seller must generally have owned and used the home for at least two years out of the five years before the sale. However, there’s an exception to the two-out-of-five-year use test if the seller becomes physically or mentally unable to care for him or herself during the five-year period.

5. Head-of-household filing status

If you aren’t married and you meet certain dependency tests for your parent, you may qualify for head-of-household filing status, which has a higher standard deduction and lower tax rates than single filing status. You may be eligible to file as head of household even if the parent for whom you claim an exemption doesn’t live with you.

These are only some of the tax issues you may have to contend with if your parent moves into a nursing home. Contact us if you need more information or assistance.

© 2023


IRS provides transitional relief for RMDs and inherited IRAs

The IRS has issued new guidance providing transitional relief related to recent legislative changes to the age at which taxpayers must begin taking required minimum distributions (RMDs) from retirement accounts. The guidance in IRS Notice 2023-54 also extends relief already granted to taxpayers covered by the so-called “10-year rule” for inherited IRAs and other defined contribution plans.

The need for RMD relief

In late 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act brought numerous changes to the retirement and estate planning landscape. Among other things, it generally raised the age at which retirement account holders must begin to take their RMDs. The required beginning date (RBD) for traditional IRAs and other qualified plans was raised from age 70œ to 72.

Three years later, in December 2022, the SECURE 2.0 Act increased the RBD age for RMDs further. This year the age increased to 73, and it’s scheduled to climb to 75 in 2033.

The RBD is defined as April 1 of the calendar year following the year in which an individual reaches the applicable age. Therefore, an IRA owner who was born in 1951 will have an RBD of April 1, 2025, rather than April 1, 2024. The first distribution made to the IRA owner that will be treated as a taxable RMD will be a distribution made for 2024.

While the delayed onset of RMDs is largely welcome news from an income tax perspective, it has caused some confusion among retirees and necessitated updates to plan administrators’ automatic payment systems. For example, retirees who were born in 1951 and turn 72 this year may have initiated distributions this year because they were under the impression that they needed to start taking RMDs by April 1, 2024.

Administrators and other payors also voiced concerns that the updates could take some time to implement. As a result, they said, plan participants and IRA owners who would’ve been required to start receiving RMDs for calendar year 2023 before SECURE 2.0 (that is, those who reach age 72 in 2023) and who receive distributions in 2023 might have had those distributions mischaracterized as RMDs. This is significant because RMDs aren’t eligible for a tax-free rollover to an eligible retirement plan, so the distributions would be includible in gross income for tax purposes.

The IRS response

To address these concerns, the IRS is extending the 60-day deadline for rollovers of distributions that were mischaracterized as RMDs due to the change in the RBD from age 72 to age 73. The deadline for rolling over such distributions made between January 1, 2023, and July 31, 2023, is now September 30, 2023.

For example, if a plan participant born in 1951 received a single-sum distribution in January 2023, and part of it was treated as ineligible for a rollover because it was mischaracterized as an RMD, the plan participant will have until the end of September to roll over that portion of the distribution. If the deadline passes without the distribution being rolled over, the distribution will then be considered taxable income.

The rollover also applies to mischaracterized IRA distributions made to an IRA owner (or surviving spouse). It applies even if the owner or surviving spouse rolled over a distribution within the previous 12 months, although the subsequent rollover will preclude the owner or spouse from doing another rollover in the next 12 months. (The individual could still make a direct trustee-to-trustee transfer.)

Plan administrators and payors receive some relief, too. They won’t be penalized for failing to treat any distribution made between January 1, 2023, and July 31, 2023, to a participant born in 1951 (or that participant’s surviving spouse) as an eligible rollover distribution if the distribution would’ve been an RMD before SECURE 2.0’s change to the RBD.

The 10-year rule conundrum

Prior to the enactment of the original SECURE Act, beneficiaries of inherited IRAs could “stretch” the RMDs on the accounts over their entire life expectancies. The stretch period could run for decades for younger heirs, allowing them to take smaller distributions and defer taxes while the accounts grew. These heirs then had the option to pass their IRAs to later generations, potentially deferring tax payments even longer.

To accelerate tax collection, the SECURE Act eliminated the rules permitting stretch RMDs for many heirs (referred to as designated beneficiaries, as opposed to eligible designated beneficiaries, or EDBs). For IRA owners or defined contribution plan participants who died in 2020 or later, the law generally requires that the entire balance of the account be distributed within 10 years of death. The rule applies regardless of whether the deceased dies before, on or after the RBD for RMDs from the plan. (EDBs may continue to stretch payments over their life expectancies or, if the deceased died before the RBD, may elect the 10-year rule treatment.)

According to proposed IRS regulations released in February 2022, designated beneficiaries who inherit an IRA or defined contribution plan before the deceased’s RBD can satisfy the 10-year rule by taking the entire sum before the end of the calendar year that includes the 10-year anniversary of the death. Notably, though, if the deceased dies on or after the RBD, designated beneficiaries would be required to take taxable annual RMDs (based on their life expectancies) in years one through nine, receiving the remaining balance in year 10. They can’t wait until the end of 10 years and take the entire account as a lump-sum distribution. The annual RMD rule would provide designated beneficiaries less tax-planning flexibility and could push them into higher tax brackets during those years, especially if they’re working.

The 10-year rule and the proposed regs left many designated beneficiaries who recently inherited IRAs or defined contribution plans bewildered as to when they needed to begin taking RMDs. For example, the IRS heard from heirs of deceased family members who died in 2020. These heirs hadn’t taken RMDs in 2021 and were unsure whether they were required to take them in 2022.

In recognition of the lingering questions, the IRS previously waived enforcement against taxpayers subject to the 10-year rule who missed 2021 and 2022 RMDs if the plan participant died in 2020 on or after the RBD. It also excused missed 2022 RMDs if the participant died in 2021 on or after the RBD. The latest guidance extends that relief by excusing 2023 missed RMDs if the participant died in 2020, 2021 or 2022 on or after the RBD.

The relief means covered individuals needn’t worry about being hit with excise tax equal to 25% of the amounts that should’ve been distributed but weren’t (or 10% if the failure to take the RMD is corrected in a timely manner). And plans won’t be penalized for failing to make an RMD in 2023 that would be required under the proposed regs.

Final regs are pending

The IRS also announced in the guidance that final regs related to RMDs will apply for calendar years no sooner than 2024. Previously, the agency had said final regs would apply no earlier than 2023. We’ll let you know when the IRS publishes the final regs and how they may affect you. Contact us with any questions.

© 2023  


Virtual currency lands in the IRS’s crosshairs

While the value of virtual currency continues to fluctuate, the IRS’s interest in it has only increased. In 2021, for example, the agency launched Operation Hidden Treasure to root out taxpayers who don’t report income from cryptocurrency transactions on their federal income tax returns.

Moreover, the Inflation Reduction Act, enacted in 2022, allocated $80 billion to the IRS, with much of it designated for enforcement activities. However, the Fiscal Responsibility Act, enacted in May 2023, will claw back $21.39 billion of that amount by the end of 2025. The IRS’s strategic operating plan for 2023 through 2031 lays out the agency’s intention to ramp up enforcement related to digital assets. If you buy, sell or otherwise engage in transactions involving virtual currency, you need to stay up to date with the latest tax developments.

Terminology

The IRS defines a “virtual asset” as any virtual representation of value that’s recorded on a cryptographically secured distributed ledger or similar technology. The term includes:

  • Convertible virtual currency (meaning it has an equivalent value in real currency or acts as a substitute for real currency) such as Bitcoin,
  • Stablecoins (a type of currency whose value is tied to the value of another asset, such as the U.S. dollar), and
  • Non-fungible tokens (NFTs).

According to the IRS, cryptocurrency is an example of a convertible virtual currency that can be used as a payment for goods and services, digitally traded between users, and exchanged for or into real currencies or digital assets. Cryptocurrency uses cryptography to secure transactions that are digitally recorded on a distributed ledger (for example, blockchain).

Taxation of transactions

For federal tax purposes, digital assets are treated as property. Thus, transactions involving virtual currency are subject to the same general tax rules that apply to property transactions, such as purchases and sales of stock or real estate.

Several types of virtual currency transactions can trigger reporting obligations, including:

Sales. If you sell virtual currency, you must recognize any capital gain or loss on the sale, subject to any limitations on the deductibility of capital losses. The gain or loss equals the difference between your adjusted tax basis in the currency and the amount you receive for it. You should report the amount you receive on your federal income tax return in U.S. dollars (see below for more information on reporting obligations).

Your basis is the amount you spent to acquire the virtual currency, including fees, commissions and other costs. Your adjusted basis is your basis increased by certain expenditures and reduced by certain deductions or credits.

Property exchanges. If you exchange virtual currency that you hold as a capital asset for other property (including goods or other digital assets), you must recognize a capital gain or loss. The gain or loss is the difference between the fair market value (FMV) of the property you receive and your adjusted tax basis in the virtual currency. If, as part of an arm’s length transaction, you transfer a digital asset and receive other property in exchange, your tax basis in the property you receive is its FMV at the time of the exchange.

Payment for services. If you receive virtual currency for performing services — regardless of whether you perform the services as an employee or an independent contractor — you recognize the FMV of the currency when received as ordinary income. The FMV will also be your tax basis in that asset.

On the flip side, if you pay for a service using virtual currency that you hold as a capital asset, you’ve exchanged a capital asset for the service and will have a capital gain or loss. In addition, the FMV of virtual currency that’s paid as wages, at the date of receipt, is subject to federal income tax withholding, Federal Insurance Contributions Act (FICA) tax and Federal Unemployment Tax Act (FUTA) tax. It also must be reported on Form W-2, “Wage and Tax Statement.”

Reporting obligations

You may have noticed a new line on your individual federal income tax return in recent years. The 2022 version asks:

“At any time during 2022, did you: (a) receive (as a reward, award or payment for property or services); or (b) sell, exchange, gift or otherwise dispose of a digital asset (or a financial interest in a digital asset)?”

If you answer “yes,” you must report all related income, whether as income, a capital gain or loss, or otherwise (for example, as a gift).

The Infrastructure Investment and Jobs Act (IIJA), enacted in late 2021, created additional new reporting requirements for digital asset transactions. These provisions were enacted with an eye toward generating additional tax revenues to help fund infrastructure projects. The requirements provide the IRS with more information to work from and establish more potential compliance tripwires for taxpayers who engage in virtual currency transactions.

The IIJA expanded the definition of brokers that are required to report their customers’ gains and losses on the sale of securities during the tax year to the IRS on Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions.” The form generally requires a description of each sale, the cost basis, the acquisition date and price, the sale date and price, and the resulting short- or long-term gain or loss.

Under the IIJA, operators of trading platforms for digital assets, such as cryptocurrency exchanges, are subject to the same reporting requirements as traditional securities brokers. The effective date remains to be seen, though, as the IRS hasn’t yet issued final regulations with instructions. After the new rules take effect, cryptocurrency platforms will need to collect Form W-9, “Request for Taxpayer Identification Number and Certification,” from their customers.

The IIJA also amended existing anti-money laundering laws to treat digital assets as cash for purposes of those laws. As a result, beginning in 2023, businesses must report to the IRS when they receive more than $10,000 in digital assets in one transaction or multiple related transactions.

Such transactions should be reported on IRS Form 8300, “Report of Cash Payments Over $10,000 Received in a Trade or Business.” To complete the form, a business will need to gather the name, address and taxpayer identification number, among other information, from the payer. Failure to comply may lead to significant civil and criminal penalties.

Enforcement tool

One way the IRS may uncover digital assets is through the use of a “John Doe summons.” The U.S. Department of Justice notes that “because transactions in cryptocurrencies can be difficult to trace and have an inherently pseudo-anonymous aspect, taxpayers may be using them to hide taxable income from the IRS.” By asking a court to serve a John Doe summons on a crypto dealer or exchange, the IRS can find out information about a person’s account.

In one recent case, an individual challenged the IRS’s use of a summons to obtain his account information from a virtual currency exchange. He argued it was unconstitutional. A U.S. District Court disagreed and ruled that the IRS’s actions “fall squarely” within its powers to pursue unpaid taxes. (Harper, DC NH, 5/26/23)

An evolving area

With its new infusion of enforcement funding, the IRS’s focus on virtual currency transactions is likely to intensify. We’ll help you stay in compliance with the applicable rules and requirements.

© 2023