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Tax Season Phishing and Smishing Scams

On March 28, the Internal Revenue Service (IRS) started the process of publishing the annual Dirty Dozen list. The first scams highlighted this year are phishing and smishing, which aim to steal sensitive information and use it for identity theft.

IRS Commissioner Danny Werfel stated, "Scammers are relentless in their attempts to obtain sensitive financial and personal information, and impersonating the IRS remains a favorite tactic. People can be anxious to get the latest information about their refund or other tax issues, so scammers frequently try using the IRS as a way to trick people. The IRS urges people to be extra cautious about unsolicited messages and avoid clicking any links in an unsolicited email or text if they are uncertain."

The Dirty Dozen campaign is designed to protect taxpayers from financial losses and the compromise of personal information or data. Each year, the IRS Security Summit attempts to educate taxpayers about the latest fraudulent schemes.

During tax season, fraudsters create new and powerful schemes. Both taxpayers and tax professionals are targets of email and text scams. A favorite fraudster strategy is to impersonate the IRS or a state tax agency. Taxpayers should be on guard to protect their information.
  1. Phishing — A phishing attack is an email by a fraudster who often claims to represent the IRS. The most frequent use of phishing is the promise of a phony tax refund. Another strategy is a claim that you must respond immediately or you will face criminal charges for tax fraud.
  2. Smishing — Nearly all taxpayers now have a smartphone with SMS text messaging. A text message by a scammer could be quite effective and look like it is from a trusted source. Text scams include messages such as, "Your account has now been put on hold," or "Unusual Activity Report," or a "Solutions" link to restore your IRS accounts. Taxpayers should not click on any of links as they could load malware on your phone.
  3. Phishing Friend — An effective attack by a fraudster may use a stolen email account of a family member or friend. The fraudster logs on to the email service and sends you the email. Because you are accustomed to receiving emails from a family member or friend, you are much more likely to click on a link and unintentionally load malware on your computer.
A general rule is that you should never click on links or respond to these tax-related phishing or smishing attacks. You can forward emails to [email protected]. If you are the victim of a monetary scam, you should report it to the Treasury Inspector General for Tax Administration (TIGTA), the Federal Trade Commission (FTC) and the Internet Crime Complaint Center (IC3).

There are specific ways to respond to a phishing attack. If you receive an email or a text message that promises you a large refund, an inheritance or claims you are a lottery winner, do not reply. Do not open attachments or click on any links. Forward the email to [email protected] and delete the original email. For text messages, send the message to 7726 (SPAM). Additionally, you can email [email protected] and include both the Caller ID and message and thereafter delete the original text.

If you become aware of a tax scheme, you can report that to the IRS with Form 14242, Report Suspected Abusive Tax Promotions or Preparers.

Tax Court Reversal on Conservation Easement Extinguishment Proceeds

In Valley Park Ranch LLC et al. v. Commissioner; No. 12384-20; 162 T.C. No. 6, the Tax Court determined that Reg. 1.170A-14(g)(6)(ii) is not valid under the Administrative Procedure Act (APA). In Valley Park, the Tax Court also determined that an easement deed satisfied the restriction in perpetuity.

The Valley Park case involved a $14.8 million conservation easement deduction by a partnership, the Valley Park Ranch LLC (Valley Park). The IRS disallowed the deduction on July 23, 2020. The Tax Court considered whether or not Reg. 1.170A-14(g)(6)(ii) was valid under the APA.

Valley Park conveyed the easement on December 22, 2016. The conservation easement on approximately 45 acres in Rogers County, Oklahoma, was conveyed to the Compatible Lands Foundation (CLF). The easement deed created a conservation easement in perpetuity, but the extinguishment provision stated that the proceeds would be paid after "the satisfaction of prior claims." The IRS determined that this was not a permissible term and denied the deduction.

The APA requires three steps. The IRS must issue a general notice of the proposed rulemaking, must give interested persons an opportunity to submit their views or arguments and must respond to significant comments.

The qualified conservation contribution under Section 170(h)(1) requires a qualified real property interest to be transferred to a qualified exempt organization exclusively for conservation purposes. Reg. 1.170A-14(g)(6) states that the extinguishment provision of a deed must provide the "donee organization, with a fair market value that is at least equal to the proportionate value that the perpetual conservation restriction at the time of the gift, bears to the value of the property as a whole at that time." This provision does not allow for change in the formula based on subsequent improvements to the property.

The IRS generally followed the three steps of the APA procedures. However, one of the 90 submitted comments was from the New York Landmarks Conservancy (NYLC). It expressed concern that the extinguishment restriction would "thwart the purpose of the statute by deterring prospective donors." The Treasury adopted the proposed regulations with minor revisions. Treasury claimed it had "considered all comments regarding the proposed amendments."

In Hewitt v. Commissioner, 21 F.4th at 1346, the Eleventh Circuit determined that this IRS action did not satisfy the APA requirements. It stated, "We are persuaded that Treasury's actions did not provide 'an explanation that is clear enough that its path may reasonably be discerned.'" The Tax Court determined the Eleventh Circuit decision in Hewitt was correct and the regulation was not valid because the IRS did not respond to the NYLC comment.

After the regulation was held invalid, the Court needed to determine whether the deed was qualified under Section 170(h)(2)(C). After review of the deed, the Tax Court determined that the grant in perpetuity is sufficient. In addition, the satisfaction of prior claims language was interpreted to refer to claims prior to exercise of the deed. Because there were no claims at that time, the deed was upheld.

Tax Court Chief Judge Kerrigan dissented and would have upheld the IRS position on the basis of stare decisis. Chief Judge Kerrigan noted that the APA requirement was general and not "onerous." Because it is very difficult for a court to define a "significant" response, the IRS position should be upheld.

Editor's Note: This and other cases are highlighting the specific requirements under the APA. At some point, the U.S. Supreme Court will need to address the issue and clarify the APA definition of "significant" response to comments. There are thousands of regulations that could be attacked under the APA by parties who claim the IRS response was not sufficiently "significant."

Proposed Regulations for Abusive CRATs

In REG-108761-22 the Internal Revenue Service (IRS) published proposed regulations that would require certain charitable remainder annuity trust (CRAT) transactions to be reported. Both participants and material advisors would have reporting obligations for these transactions.

Regulation 1.6011-4(a) states that a taxpayer who has participated in a reportable transaction must disclose it to the IRS. Section 6111(a) also requires taxpayer's material advisors to report the transaction.

A charitable remainder annuity trust must pay at least 5% and not more than 50% to one or more individuals for a life, lives or a term of up to 20 years. See Section 664(d)(1). The remainder interest must be vested in a Section 170(c) or Section 170(b)(1)(A) qualified exempt nonprofit.

Distributions from a CRAT under Section 664(d)(1)(A) are first ordinary income, second capital gain, third other or nontaxable income and fourth distribution of corpus.

There have been taxpayers who attempt to use a CRAT and single premium immediate annuity (SPIA) to avoid recognition of income or capital gain. The taxpayer claims the appreciated property may be transferred to the CRAT, the basis is stepped-up to fair market value on the transfer, the proceeds may be used to purchase the SPIA, and the distributions will therefore not be taxable.

However, the proposed regulations note that a transfer of appreciated property to a CRAT is a gift that also has a carryforward basis under Section 1015(a). The basis is not increased by the transfer to a trust.

The IRS notes there have been trust documents with nonstandard provisions. A trust document may not be qualified because it allows a payment of the greater of the annuity amount or the payments received from the SPIA. Another improper provision would provide the trustee with an opportunity to not pay the remainder to the charity, but rather make a payment of 10% of the initial fair market value. Both provisions disqualify the CRAT under Section 664.

The reporting provisions would be triggered under Reg. 1.6011-15(b) if the CRAT is funded with appreciated property, the trustee sells the property, the proceeds are used to purchase an annuity and the annuity beneficiary claims the payment is subject not to Section 664, but to Section 72. Therefore, the taxpayer claims the annuity is not taxable income.

The participants are individuals who receive CRAT payments. A material advisor is an individual who receives CRAT fees or benefits of $10,000 or more. This individual or material advisor is subject to an extended period of limitations under Section 6501(c)(10). If the material advisor does not disclose the listed transaction, he or she is subject to penalties under Section 6707.

The charitable remainder recipient may not have received notice of the trust existence. Therefore, the Charitable Remainderman under a purported CRAT is not treated as a participant in the listed transaction "solely by reason of its status as a Charitable Remaindermen."

Editor's Note: The proposed regulations are a warning to taxpayers and material advisors. Nonprofits should also be cautious that staff are not involved in promoting or advocating this type of CRAT transaction.

Applicable Federal Rate of 5.2% for April; 2024-14 IRB 1 (15 March 2024)

The IRS has announced the Applicable Federal Rate (AFR) for April of 2024. The AFR under Sec. 7520 for the month of April is 5.2%. The rates for March of 5.0% or February of 4.8% 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."

Published March 29, 2024
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