Internal Revenue Service (IRS) Commissioner Danny Werfel stated this week that the IRS plans to launch a pilot program to allow taxpayers to direct e-file tax returns in 2024.

The Inflation Reduction Act (IRA) allocated $15 million to study the possibility of creating a Direct File tax return system. The IRS worked with New America think tank to conduct a review. The New America review stated it is possible to build an e-file system, but it "depends critically on their ability to maintain this initiative as a leadership priority, start with a limited scope and expand the system over time."

The Department of Treasury chief implementation officer for the IRA is Laurel Blatchford, stated on May 16 that, "filing taxes is expensive and time-consuming for American taxpayers. Dozens of other countries have provided free tax planning options to their citizens, and American taxpayers who want to file their taxes for free online should have an accessible option."

The IRS plans to use the U.S. Digital Service to build a system. Commissioner Werfel stated the IRS "will now be able to expand the amount of people that are interacting with such a prototype in order to further answer questions and provide more insight into whether a full-scale solution should be pursued."

The IRS Direct File system may be able to pre-populate returns with tax information. This may not be part of the pilot program but is a long-term goal.

There was both support and opposition for the Direct File solution. Senate Finance Committee Chair Ron Wyden (D-OR) indicated his approval. He noted the review "confirms that the overwhelming majority of Americans want the IRS to provide a free voluntary option to file their taxes directly online." Wyden explained the concept of a government Direct File program has been in existence for many years. However, Finance Committee Ranking Member Mike Crapo (R-ID) was not as positive. He noted that the IRS should "not act without explicit legal authority."

A major consideration is the cost for development of the direct file system. The initial IRS estimate was an annual operating cost of $64 million to $249 million. While the Department of Treasury stated a "future direct file program could potentially save taxpayers billions of dollars annually," members of Congress were concerned that the annual cost would be in excess of the initial projection.

Commissioner Werfel stated the IRA funds would be sufficient to start the Direct File program, but that he would be discussing funding with Congress for a "full-scale" system.

Many taxpayers in past years use commercial software from members of the Free File Alliance. Understandably, the commercial companies are concerned that the IRS program would compete with them. One large tax-preparation company spent $44 million lobbying Congress during the past two decades to oppose the Direct File option.

Groundwork Action representative Igor Volsky stated the Direct File system "is a strong step forward in the fight for free and simplified tax filing services and a clear rebuttal to big online tax preparers, their lobbyists, and their conservative allies who are committed to keeping tax-filing in America costly and difficult."

Editor's Note: Your editor does not take a position on the merits of developing a Direct File system. This information is offered as a service to our readers.

Heirs Personally Liable for $10 Million in Estate Taxes

In United States v. James D. Paulson et al.; No. 21-55197; No. 21-55230 (9th Cir. 2023), the Ninth Circuit determined that heirs who did not receive assets immediately upon the death of an individual were subject personally to payment of $10 million in estate taxes, interest and penalties.

Allen Paulson died on July 19, 2000. He had been involved in multiple businesses and was one of the founders of Gulfstream Aerospace Corporation. His estate was nearly $200 million when he passed away. Paulson was survived by his third wife, Madeleine Pickens, sons Richard, James and John and several grandchildren.

The gross estate was over $193 million for federal estate tax purposes. Executor John Michael Paulson filed IRS Form 706 and reported a net taxable estate over $9 million and estate tax of approximately $4.5 million. The estate deferred the majority of the tax under Section 6166 and initiated payments. In December 2005, the Tax Court entered a stipulated agreement that the estate would owe an additional $6.7 million of estate tax. The estate failed to make all required payments, there were multiple disputes among the beneficiaries and the IRS issued an assessment in 2015 for over $10 million in taxes, interest and penalties.

The estate beneficiaries filed motions to dismiss the deficiency under Section 6324(a)(2). The District Court interpreted the statute to require liability only if assets were transferred at the date of death.

Section 6324(a)(2) states, "If the estate tax imposed by chapter 11 is not paid when due, then the spouse, transferee, trustee (except the trustee of an employees' trust which meets the requirements of Section 401(a)), surviving tenant, person in possession of the property by reason of the exercise, nonexercise, or release of a power of appointment, or beneficiary, who receives, or has on the date of decedent's death, property included in the gross estate under Sections 2034 to 2042, inclusive, to the extent of the value, at the time of decedent's death, of such property, shall be personally liable for such tax."

The interpretation issue is whether the verb "receives" or the verb "has" is applicable to include or exclude liability for a beneficiary who receives property after the date of the death of the decedent. The IRS argued that the verb "receives" is applicable to property received at any future time.

The Ninth Circuit noted the $10 million IRS claim is dependent upon a single comma. The comma after "receives" separates the phrase "or has on the date of decedent's death" and is not therefore limiting liability to heirs who immediately receive assets. After reviewing various principles of interpretation and the context and structure of the statute, the Ninth Circuit determined the overall statute should support personal liability for unpaid estate taxes, even though the assets were received at a date following the demise of the decedent.

The issue arose because there was a dramatic decline in the value of the estate assets. The heirs claimed that the statute was ambiguous and therefore should be deemed to exclude them from liability. However, the court determined that the statute is intended to create liability for heirs who receive property on or after the date of the decedent's death. In both cases, there is personal liability.

The court also defined the term "beneficiary" quite broadly to include all heirs who are in actual or constructive possession of the property. Therefore, the case was remanded to the District Court to determine the amount of the respective defendant's liability.

Judge Ikuta dissented and noted the inclusive interpretation could potentially allow beneficiaries to receive property that had declined in value below the amount of the estate tax plus interest and penalties. Judge Ikuta noted the entire $10 million claim of the IRS rested on whether the comma was before or after the word "has." She would not rule that the word "receives" applies even if the assets decline dramatically in value.

Accountable Care Organization Not Tax Exempt

In Memorial Hermann Accountable Care Organization v. Commissioner; No. 4412-22X; T.C. Memo. 2023-62, Tax Court Chief Judge Kathleen Kerrigan determined that an Accountable Care Organization (ACO) was not qualified for tax-exempt status.

The Memorial Hermann Accountable Care Organization (MHACO) was created on January 23, 2012. It is a subsidiary of the Memorial Hermann Health System, a Texas nonprofit corporation.

An ACO is defined as "a group of doctors, hospitals and other health care providers, who come together voluntarily to give coordinated high-quality care to Medicare and other patients." MHACO contracts with a sister corporation that operates a physician network. It provides care for both Medicare and non-Medicare patients. Of the over 450,000 MHACO patients, approximately 45,000 were Medicare beneficiaries who participate in the Medicare Shared Savings Program (MSSP) and about 35,000 were involved in private health plans. Approximately 18% of MHACO patients were Medicare recipients.

MHACO participates in the MSSP program and has produced substantial savings for Medicare. However, it also serves a substantial number of individuals who have private insurance programs.

Tax-exempt status under Section 501(c)(4) requires operation "exclusively for the promotion of social welfare." An organization is not operated exclusively if it assists the general public in a manner similar to for-profit organizations. If there is a substantial nonexempt purpose, the entity will not qualify for exempt status. In addition, if the organization primarily benefits its members rather than the general public, it similarly fails to qualify.

While MHACO has a positive goal of "providing affordable healthcare to patients," that provision alone is not sufficient for exempt status. The majority of MHACO activities are not part of MSSP and primarily benefit commercial health providers. Therefore, it is similar to a for-profit business. Because it has a substantial nonexempt purpose, it does not qualify for tax-exempt status

Applicable Federal Rate of 4.2% for June -- Rev. Rul. 2023-10; 2023-23 IRB 1 (15 May 2023)

The IRS has announced the Applicable Federal Rate (AFR) for June of 2023. The AFR under Sec. 7520 for the month of June is 4.2%. The rates for May of 4.4% or April of 5.0% 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 2023, pooled income funds in existence less than three tax years must use a 2.2% deemed rate of return.