On September 6, 2024, Treasury Secretary Janet Yellen spoke to the Internal Revenue Service (IRS) staff in Austin, Texas. Yellen praised the IRS staff for the improvements in taxpayer services. She started by noting, "Filing taxes, claiming credits and deductions, and getting refunds should be easy. But for too long, this too has not worked. It has been unpredictable and frustrating.”

The IRS has documented improvements in customer service. During filing season 2024, the IRS reached an 88% level of service. This was substantially better than the 15% level of service of the prior year. The IRS notes that the 28-minute average phone wait time in 2022 was reduced to an average of three minutes the next year. There also were a number of new Taxpayer Assistance Centers that enabled expanded in-person service.

Other enhancements occurred in the technology area. The "Where’s My Refund?" tool was significantly updated. The IRS also added a Direct File option that allowed free online tax returns.

Yellen noted the success of the Direct File pilot program. The 140,000 taxpayers who used Direct File saved an estimated $5.6 million in filing fees and received over $90 million in tax refunds. IRS Commissioner Danny Werfel and Secretary Yellen announced in June that Direct File is now permanent. Taxpayers from an estimated 20 states will participate in Direct File next year.

Another major initiative is to move forward with new technology. The IRS computers and taxpayer online accounts will be upgraded. Yellen noted, "Taxpayers should be able to access real-time account information and take action to claim credits and get refunds just as they use the website or mobile app for their bank."

The IRS technology changes are called the Digital First Initiative. The IRS plans to continue to expand and update taxpayer accounts. There are now over 200 different notices and letters available online for taxpayers.

With the enhanced changes, the IRS wants to make it easier for taxpayers to receive credits and deductions. These could include the $7,500 credit for purchase of an electric vehicle or the 30% credit for the cost of residential home energy investments.

Secretary Yellen concluded by "thanking all IRS employees here today and across the country who did all they could for many years with limited resources, and who are now doing all they can, thanks to the IRA, to make transforming the IRS a reality."

Editor's Note: The IRS has made much needed improvements in customer service. The IRS still faces challenges in modernizing the website and expanding phone support.

IRS Collects $172 Million From 21,000 Taxpayers

In IR-2024-233, the Internal Revenue Service (IRS) announced it has recovered $172 million from 21,000 wealthy taxpayers.

The IRS launched an initiative in February of 2024 to pursue 125,000 high-income taxpayers who have not filed tax returns since 2017. While the IRS has received their Forms W-2 and 1099s, many of these individuals with incomes of over $400,000 failed to file a tax return. With the Inflation Reduction Act funding, the IRS added staff and pursued these non-filers. The IRS notes, "In the first six months of this initiative, nearly 21,000 of these wealthy taxpayers have filed, leading to tax payments of $172 million in taxes being paid."

The IRS also created an initiative focused on a limited number of individuals with over $1 million in income. With the IRS effort to pursue 1,600 very high-income individuals, 80% of the 1,600 millionaires with delinquent tax debt have made payments. The IRS reports recovering $1.1 billion from this group.

The IRS also has a major initiative underway to upgrade its basic technology. The primary IRS computer system involves an Individual Master File that is based on the COBOL software language. This is now seriously outdated, and the IRS is converting the extensive database code to Java, a much more modern language. The new system is titled the Integrated Tax Processing Engine and will be coded largely in Java. The IRS emphasizes the new Enterprise Data Platform will be a cloud-based system.

A parallel effort is the Digital First Initiative. This effort is designed to create individual taxpayer accounts that allow real-time information. The IRS plans to provide taxpayers with accounts that are similar to those offered by banks or financial service organizations.

Editor's Note: The IRS is at least a decade behind most midsized and larger businesses. COBOL was a popular computer language in 1970. The conversion to a modern cloud-based system using Java is overdue. The IRS also will be taking steps to enhance cloud security. The Java software language with regular updates is a key part of that effort. Security is important because IRS computers are attacked every second of every day by domestic and international hackers.

Senate Finance Committee Hosts 2025 Tax Bill Debate

On September 12, 2024, the Senate Finance Committee hosted a debate on the expected 2025 tax bill. There were strongly contrasting views by two different presenters. Daniel Bunn is President of Tax Foundation, a nonprofit think tank. Bob Lord is Senior Advisor for Tax Policy of Patriotic Millionaires.

Bunn noted, "The stakes for next year’s expiring tax provisions are quite high. If Congress does nothing, then 62% of households will see their taxes go up in January of 2026."

Bunn suggests that there are three main ideas to apply for this upcoming tax bill: simplicity, neutrality and trade-offs.

Tax simplification has received a prolific level of Washington rhetoric, but the actual steps have been modest. Bunn notes that changes by the Tax Cuts and Jobs Act (TCJA) did involve some simplification. The primary change was an increased standard deduction, coupled with lower marginal rates and an expanded child tax credit. The trade-off for an increased standard deduction was the elimination of personal exemptions and multiple limits on itemized deductions.

These changes simplified tax filing for about 20% of taxpayers. From 1990 through 2016, approximately 30% of taxpayers itemized. With the increased standard deduction, in 2018 and subsequent years, less than 10% of taxpayers itemized.

The $10,000 limit on state and local taxes (SALT) and limiting mortgage interest deduction to home values of $750,000 will raise an estimated $668 billion dollars over a decade. These changes allowed a larger standard deduction and a dramatically increased exemption from alternative minimum tax (AMT).

In 2015, over 10 million taxpayers calculated AMT and 5 million paid the tax. With the higher exemptions, after TCJA, approximately 5.7 million taxpayers must calculate AMT, but only 220,000 pay tax. The change in the AMT rules saved thousands of taxpayer hours.

Bunn notes the tax system has become even more progressive. By 2021, the top 1% of taxpayers earned 26% of income but paid over 45% of federal income taxes. The tax paid by the lowest 50% of taxpayers declined from approximately 5% in 2001 to 2.3% in 2021.

Another perspective is the effective rate considering both Federal taxes and non–tax transfers. The bottom quintile of taxpayers had an effective rate of negative 127%. The top quintile of taxpayers had an effective rate of over 30%. Therefore, the tax system is now highly progressive.

With respect to businesses, Bunn notes that the 21% corporate tax rate is substantially lower than previous rates and has enabled new business investments. He states, "American workers and families benefit when businesses invest more: their wages increase and more jobs are created.”

Bunn concludes by stating, "When considering provisions for 2025, comparing their ‘bang for the buck’ can help policymakers balance being fiscally responsible with promoting growth.”

Tax Policy Advisor Bob Lord held substantially different viewpoints. He commented on the primary strategies used by wealthy taxpayers to reduce or eliminate their tax.

1. Buy-Borrow-Die — The buy-borrow-die system is straightforward. Wealthy Americans buy investment assets and borrow against them. After they pass away, the family receives the assets with a stepped-up basis. These assets may be sold with no tax and the loans are repaid. Lord notes this strategy could be changed if there were recognition of capital gain in estates, rather than a step up in value.
2. Swap Til You Drop — A second popular strategy is used by real estate investors. Under the Section 1031 like-kind exchange rules, they can invest in properties and continue to trade up while deferring recognition of gain. Lord offers an example of business owner “A” who buys an office building for $10 million, pays $2.5 million in cash and borrows $7.5 million. A later sells the building for $20 million and purchases a new larger building for $50 million, with deferral of the gain. Subsequently, the second building appreciates to $100 million, is sold and an office complex purchased for $250 million. There is a deferral of $65 million of gain. The process continues until investor A passes away and the family inherits a multi-billion-dollar real estate portfolio with a stepped-up basis. Lord notes that there could be limits to the amount of gain that can be deferred in like-kind exchanges.
3. Sports Teams: The Everlasting Tax Shelter — Another variation of buy-borrow-die by the ultra-rich is purchase of a sports team. The sports team value may be amortized over a period of years. Even though the sports team appreciates in value, the owner enjoys large deductions and then later passes the value on to family who benefit from a stepped-up basis.
4. Convert Short-Term Gain to Long-Term Gain — A sophisticated investment strategy for individuals who have large, short-term gains can be to convert them to long-term gains. The investor purchases a substantial loss investment and holds it for 365 days and a substantial gain investment which is held for 366 days. The loss investment is sold after 365 days and produces a short-term loss. The gain investment held for 366 days produces a long-term gain. The investment loss offsets the prior short-term gain and the taxpayer pays tax only on the long-term gain.
5. Carried Interest — The "Carried Interest" strategy is used by private equity and venture capital fund managers. Under IRC Section 704, there can be allocations of items of income and loss if there is "substantial economic effect." Many partners in private equity or venture capital are allocated a substantial percentage of the fund’s long-term capital gains. There have been several proposals to limit the ability of private equity managers to turn what is similar to ordinary income into long-term capital gain.
6. Private Placement Life Insurance (PPLI) — With PPLI, individuals can make large investments with a limited cost for the insurance. This creates a large insurance policy value which can be transferred to family members and minimize income tax.

Editor's Note: There will be multiple hearings by the Senate Finance Committee and House Ways and Means Committee prior to any 2025 tax bill. This information is offered as a service to our readers and your editor does not take a specific position on the many options that will be reflected in the final 2025 tax bill.

Applicable Federal Rate of 4.8% for September: Rev. Rul. 2024-17; 2024-36 IRB 1 (15 August 2024)

The IRS has announced the Applicable Federal Rate (AFR) for September of 2024. The AFR under Sec. 7520 for the month of September is 4.8%. The rates for August of 5.2% or July of 5.4% 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 2024, pooled income funds in existence less than three tax years must use a 3.8% 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.”