April 18, 2022, was a significant day for over 160 million Americans who filed a 2021 federal income tax return. Collectively, taxpayers spent approximately 2 billion hours and over $30 billion in the process of preparing these tax returns.

The National Bureau of Economics Research has determined that the IRS could calculate taxes due and provide prepopulated returns to nearly half of U.S. taxpayers. Each taxpayer could accept the prepopulated return or choose to file his or her own return.

Because the IRS now receives electronic Forms W–2 and 1099 from employers and financial institutions, it has the basic information needed to create a tax return for individuals whose income is primarily wages and interest. An automated IRS electronic return would greatly simplify the tax filing process. There are several nations who already implement a prepopulated tax return system for basic returns.

Approximately 90% of taxpayers now file an electronic tax return. This still requires the taxpayer to use tax software or pay a tax preparer. A prepopulated tax return would enable many taxpayers to simply accept the income reported to the IRS. This is particularly attractive for low–income, non-itemizing taxpayers.

A benefit for the IRS is that it would not have to provide customer service or other types of assistance for most of these taxpayers. The IRS has struggled in the past two years to provide individual taxpayer assistance. If approximately half of taxpayers used a prepopulated return, the IRS could use its scarce support resources to assist the remaining taxpayers.

A prepopulated return would replace the Free File program that involves several commercial tax return companies who provide free tax software to individuals with moderate or low incomes. However, only 4% of taxpayers who were eligible for Free File used the program for their 2021 tax returns.

As technology improves and wages and financial data are transmitted electronically to the IRS, it would be possible to provide prepopulated tax returns to nearly half of all taxpayers. This process would save both taxpayers and the federal government substantial funds.

Editor's Note: There are several companies who work with nations to provide prepopulated tax returns. Congress has been reluctant to permit the IRS to develop tax-preparation software, but it may make sense for members of Congress to consider an automated system. This would be a substantial benefit for non-itemizing individuals and low–income taxpayers who often have fairly simple returns.

"Dirty Dozen" Taxpayer Scams Wrap Up

The IRS published the last four of the "Dirty Dozen" scams list for 2022. This list of four items is focused primarily on upper–income taxpayers. The IRS cautions that there are fraudsters who will attempt to involve taxpayers in tax scams. These scams may involve concealing assets, failure to file a tax return, a syndicated conservation easement or a micro–captive insurance arrangement.

IRS Commissioner Chuck Rettig stated, "These tax avoidance strategies are promoted to unsuspecting folks with too-good-to-be-true promises of reducing taxes or avoiding taxes altogether. Taxpayers should not kid themselves into believing they can hide income from the IRS. The agency continues to focus on these deals, and people who engage in them face steep civil penalties or criminal charges."

1. Concealing Assets — Some individuals attempt to conceal assets in offshore accounts or through cryptocurrency. The IRS has established a high priority for international tax compliance. Department of Justice attorneys have prosecuted many individuals with hidden income in offshore banks or brokerage accounts. These individuals often try to access their funds with debit cards, credit cards or wire transfers. A U.S. citizen is taxed on worldwide income. All overseas accounts and cryptocurrency will produce tax consequences. Some individuals believe incorrectly that the IRS cannot track cryptocurrency.

IRS Commissioner Rettig noted, "The IRS is able to identify and track otherwise anonymous transactions of international accounts as well as digital assets during the enforcement of our nation's tax laws. We urge everyone to come into compliance with their filing and reporting responsibilities and avoid compromising themselves in schemes that will ultimately go badly for them."

2. Failure to File Income Tax Returns — There are high-income individuals with salaries over $100,000 per year who fail to file a tax return. The IRS cautions that the Failure to File Penalty is substantially higher than the Failure to Pay Penalty. The Failure to File penalty is typically 5% of your unpaid taxes for each month the taxpayer is late, with a maximum of 25% of unpaid taxes. If the failure is fraudulent, the penalty may be increased to 15% for each month outstanding, for a total of 75% of the unpaid tax.

3. Syndicated Conservation Easements — Some syndicated conservation easement promoters are improperly valuing undeveloped land as though it had been subdivided and developed for residential or commercial purposes. This strategy produces "grossly inflated tax deductions" and high fees for the promoters. The IRS has committed to audit all syndicated conservation easement transactions.

Commissioner Rettig noted, "We are devoting a lot of resources to combating abusive conservation easements because it is important for fairness in tax administration. It is not fair that wage earners pay their fair share year after year but high-net-worth individuals can, under the guise of a real estate investment, avoid millions of dollars in tax through overvalued conservation easement contributions."

4. Micro-Captive Insurance Arrangements — Taxpayers may choose to pay premiums for a micro-captive insurance plan. Some of these micro-captive plans insure implausible risks and fail to qualify as legitimate insurance. The IRS regularly audits micro-captive plans and has filed multiple cases against taxpayers and promoters. Since 2017, the IRS has won all of the filed micro-captive Tax Court and appellate court cases.

Editor's Note: Upper-income taxpayers pay large taxes and may understandably be concerned with the amount of tax owed. A high level of concern will make them more vulnerable to becoming prey for promoters of taxpayer scams. Upper-income individuals and their advisers should be on the lookout for promoters who could be leading them on a path that will involve substantial back taxes, interest and penalty payments.

Should Cryptocurrency Be a Retirement Plan Investment?

Representative Richard Neal is the Chair of the House Ways and Means Committee. On June 15, 2022, he sent a letter to the Honorable Gene Dodaro, Comptroller General of the U.S. Government Accountability Office, to ask for information on cryptocurrency investments in retirement plans.

The preferred retirement plan is now a defined contribution plan, such as a Section 401(k), Section 403(b) or IRA. There are an estimated $10.7 trillion in defined contribution plans for workers and retirees in the private and public sector. Many individuals have also rolled over a defined contribution plan to an IRA. At the end of 2019, there was $11 trillion in individual retirement accounts. The approximately $22 trillion in these types of defined contribution plans now comprise the majority of retirement assets.

With a defined contribution plan, the individual is generally responsible for planning and managing the investments. Many employers permit employees to select from a series of investment options. Some employers are now considering allowing cryptocurrency to be an investment option for their retirement plans.

Because the total market valuation of cryptocurrency has declined from $3 trillion to $1 trillion during 2022, there is concern that this may not be an appropriate retirement plan investment for most individuals. The Department of Labor has cautioned plan sponsors that they should exercise "extreme care" before authorizing a cryptocurrency investment option. Plan sponsors are fiduciaries and owe a duty of reasonable care to the employees and beneficiaries of their plans.

Chairman Neal asked the Comptroller General to review the number of companies that are offering a cryptocurrency investment in a retirement plan, their methods for administering the cryptocurrency investment, the costs and fees associated with them, the safeguards to protect the crypto assets and any restrictions that apply to cryptocurrency investments.

Editor's Note: With the huge decline in the value of cryptocurrencies, it is timely for Chairman Neal to inquire about the appropriate nature of cryptocurrency as a retirement plan investment. Cryptocurrency is still a very new asset and very volatile. Between 2015 and 2022, several cryptocurrencies went through cycles with both dramatic increases in value and declines of 80% to 90% in value. Chairman Neal is appropriately concerned about the suitability of this type of investment for a retirement portfolio.

Applicable Federal Rate of 3.6% for July -- Rev. Rul. 2022-12; 2022-27 IRB 1 (15 June 2022)

The IRS has announced the Applicable Federal Rate (AFR) for July of 2022. The AFR under Section 7520 for the month of July is 3.6%. The rates for June of 3.6% or May of 3.0% 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 2022, pooled income funds in existence less than three tax years must use a 1.6% deemed rate of return.