In IR-2024-63, the Internal Revenue Service (IRS) reminded taxpayers that all income is taxable. This could include digital assets (such as cryptocurrency), income in the gig economy and any payments from foreign sources. The different types of income are also explained in the instructions for IRS Form 1040.
1. Digital Assets and Cryptocurrency — A digital asset could include cryptocurrency, stablecoins, non-fungible tokens or other digital assets. When taxpayers file IRS Form 1040 or 1040-SR, they must check either "Yes" or "No" in the digital asset box.
Taxpayers are required to check the "Yes" box if they received digital assets for property or services, engaged in cryptocurrency mining or staking, received a digital asset from a hard fork (a branching of cryptocurrency blockchain that splits one cryptocurrency into two), sold or exchanged a digital asset or made a gift of a digital asset.
A taxpayer who sells cryptocurrency owned for more than one year must file IRS Form 8949, Sales and other Dispositions of Capital Assets. If a taxpayer owns cryptocurrency and makes a gift to a friend or family member, they must file IRS Form 709, United States Gift Tax Return. Taxpayers who perform a service and are paid in cryptocurrency will report this amount on Schedule C of Form 1040.
There are several reasons that a taxpayer may check the "No" box. You can hold digital assets in a wallet, transfer them from the one wallet to another or purchase digital assets with real currency and not have taxable income. The IRS has a frequently asked questions section on the Digital Assets page on IRS.gov.
2. Gig Economy Earnings — Many individuals earn income each year through providing labor, services, goods or selling property online. Gig economy income must be reported. It may come from part-time or side work, could include payment in cryptocurrency and has not been previously reported on IRS Form 1099 or W-2.
3. Service Industry Tips — Those who work in restaurants, hotels and other commercial locations and receive tips from customers. Most cash tips are reported to each employer and included on the employee’s Form W-2, Wage and Tax Statement. If an employee receives additional items that are not cash such as a pass, event ticket or goods, this should be report this on a tax return. Any tips not reported to an employer should be listed on IRS Form 4137, Social Security and Medicare Tax on Unreported Tip Income.
4. Foreign Source Income — A U.S. citizen or a resident alien is subject to tax on his or her worldwide income. The taxpayer must report all "interest, dividends, and pensions from sources outside the United States.” The taxpayer may qualify for a reduced tax because you can use the Foreign Earned Income Exclusion or the Foreign Tax Credit. If a taxpayer has a home and lives permanently outside the United States and Puerto Rico, he or she can qualify for an extension to file until June 15, 2024. However, taxes owed are due on April 15 and you will have to pay interest if you owe additional tax on June 15.
5. Foreign Bank Accounts — While individuals must pay tax on worldwide income, this also could include income from foreign trusts or banks. Taxpayers may need to file Form 8938, Statement of Foreign Financial Assets. If the taxpayer has a foreign bank account with value over $10,000, Form 114, Report of Foreign Bank and Financial Accounts (FBAR) must also be filed. This must be filed by April 15, 2024. However, if this deadline is missed, there is an automatic extension until October 15, 2024.
Community Foundation of Utah Opposes DAF Regulations
In a letter sent on February 15, 2024, the general counsel for the Community Foundation of Utah (Utah CF) explained multiple reasons why it opposes the REG-142338-07 proposed DAF regulations. The proposed regulations could adversely affect the operation of the Utah CF. It was established in 2008 and has granted approximately $200 million to charities in order to combat homelessness, help refugees and benefit individuals in need.
The Utah CF opposes the proposed regulation that defines personal investment advisors as donor advisors. The Utah CF suggests that the definition of donor advised funds is overly broad and will require many field of interest funds to be in compliance with the DAF rules and claims that the anti-abuse rules designed to track charitable recipient use of DAF grants are unreasonable and unworkable.
1. Personal Investment Advisors Defined as Donor Advisors — Prop. Reg. Sec. 53.4966-1(h)(3)(i) specifies that an investment advisor in "Section 4958(f)(8)(B) of the Code who manages the investment of, or provides investment advice with respect to, both the assets maintained in a donor advised fund and the personal assets of a donor to that donor advised fund (personal investment advisor) will be treated as a donor-advisor with respect to the donor advised fund while serving in that dual capacity." This essentially means that a personal investment advisor would be treated as a donor advisor unless he or she is "properly viewed as providing services to the sponsoring organization as a whole."
The Utah CF has an extensive relationship with personal investment advisors. They are essentially a volunteer work force for the Utah CF. Approximately 50% of the $100 million in DAF assets are managed by these personal investment advisors. The payouts have averaged 20%, which is far above the typical private foundation 5% payout. The relationship of the personal investment advisor has dramatically facilitated the growth of the donor advised funds and the distribution of millions of dollars to individuals in need.
The Utah CF indicates that this expanded definition exceeds the scope of the statute. Section 4966(d)(2)(A)(iii) indicates donors and donor advisors are subject to an automatic excess benefit transaction under Section 4958(f)(7) if they receive a grant, loan or compensation from a DAF. However, section 4958(f)(8) creates a separate category for the individual who has general advisory rights. Under Section 4958(f)(7), individuals may recommend grants and investment allocations. However, their investment advisors may serve under Section 4958(f)(8), and the Utah CF may "hire, fire, and pay reasonably for their service of growing charitable assets."
The statute creates a distinction between the donor advisors and the investment advisors. Because the statute creates this distinction, the regulations should recognize that, so long as compensation to the advisor is reasonable and necessary, under Section 4958(f)(8) this arrangement should be permitted.
The Utah CF has a strict policy to hire firms as investment advisors. In many cases, a donor may also have investment services from the same advisor who works for that firm. However, the Utah CF has no way of knowing what the employment and compensation arrangements are with multiple advisors. The obvious benefit to Utah CF is that many of the investment advisors and their clients have decided to create over $50 million in DAFs. With an annual payout of 20% and reasonable fees paid to the advisor, this is a perfectly logical and acceptable arrangement. It passes both the practical test and is consistent with the intent of Sec. 4966.
In addition, the financial firms are subject to multiple regulations. These could include the Investment Advisors Act of 1940, applicable state regulations and the Securities and Exchange Act of 1934. As a result, there is no need to limit the use of investment advisors performing a dual role for both the individual and the DAF. By limiting the exception to advisors who are "properly viewed as providing services to the sponsoring organization as a whole,” this essentially eliminates the ability for donors to designate their personal advisors to manage their DAF investments. It also will have a dramatic chilling effect on gifts to DAFs. Many individuals will choose instead to fund a private foundation and incur substantial additional costs to permit their investment advisor to manage the assets of the private foundation.
2. Overly Broad Definition of Donor Advised Fund — Prop. Reg. Sec. 53.4966-3(b) indicates a DAF could include funds that are created when there is a formal record of contributions that relates to that donor. Community foundations maintain a large number of field of interest funds. These funds often have a distribution committee and it is very common for a donor to be a member of that committee. The proposed regulations are viewed as seriously overbroad because they would create a DAF for these field of interest funds with a donor on the grant committee, according to the Utah CF. An exception applies if the donor has particular expertise, there are at least three members for the committee and the donor is not a significant contributor to the fund when he or she commences service. This exception will not apply to the vast majority of field of interest funds.
This provision is inconsistent with law and the regulations should follow a 50% of the committee rule which is common in other areas of law. Excluding these appointees from field of interest fund committees does not serve any discernible purpose.
The other problem is that funds are typically created over a period of years with multiple donors. It would be extremely difficult to implement this rule as a matter of practice because many donors serve on the different fund committees. It would be extremely difficult to track all the donors and all the committees.
3. The Anti-abuse "Daisy Chain Rule" Should Be Eliminated — Prop. Reg. 53.4966-5(a)(3) indicates that, with a grant to a charity where the donor or the sponsoring organization arranges to use the funds to make distributions to individuals recommended by the donor, the distribution will be a taxable distribution from the sponsoring organization to individuals. This is designed to restrict the ability of donors to benefit disqualified persons. However, the Utah CF makes hundreds of grants each year and has no practical way of tracking the use of all funds. It is not possible for Utah CF to ensure that no organization uses a grant for an impermissible purpose. This also makes it difficult to make grants to religious organizations that do not file IRS Form 990 because it is even more difficult to make certain that the funds are used correctly.
While the Utah CF says they "applaud the intent behind the idea of creating greater clarity under law, clarity which many sponsoring organizations and DAF program administrators have been seeking for some time, the Proposed Regulations as written fail to accurately take into account how charities operate."
Editor's Note: This is a comprehensive and thoughtful explanation of the practical impact of the proposed DAF regulations on nonprofits. The Utah CF’s general counsel has a deep understanding of the practical operations of a community foundation. While there have been many organizations commenting on the proposed DAF regulations, this is an excellent analysis.
Corporate Transparency Act Held Unconstitutional
In
National Small Business United et al. v. Janet Yellen et al.; No. 5:22-cv-01448, the United States District Court for the Northern District of Alabama held the Corporate Transparency Act (CTA) was unconstitutional. The District Court stated, "Because the CTA exceeds the Constitution’s limits on the legislative branch and lacks a sufficient nexus to any enumerated power to be a necessary or proper means of achieving Congress’ policy goals, the Plaintiffs are entitled to judgment as a matter of law."
The CTA is designed to regulate and require reporting for companies and similar entities that are created through filing a document with a secretary of state. The CTA exempts U.S. banks, insurance companies, entities with over 20 employees and those with over $5 million in gross revenue. It is estimated the CTA will require annual registration by approximately 32 million existing entities and up to 5 million new entities each year. The reporting entities must give the Financial Crimes and Enforcement Network (FinCEN) the beneficial owner’s full legal name, date of birth, current address and a driver's license, ID or passport identification number. If there are knowing or willful CTA violations, there is a serious penalty up to $500 per day, or $10,000 in total fine and up to two years in federal prison.
The case was brought by plaintiffs Isaac Winkles and the National Small Business Association (NSBA). The Court determined that Winkles and NSBA had standing. The government claimed that the CTA was appropriate under the foreign affairs power, the commerce power or the necessary and proper exercise of the tax power.
1. Foreign Affairs Power — The government claimed there is a "rational relationship between FinCEN’s collecting limited beneficial ownership and applicant information and advancing the national security and foreign policy interests of the United States." However, Congress is limited to enumerated powers. The CTA requires there be a reasonable nexus between the gathering of information and the exercise of Congress’ foreign affairs power.
Corporate formation has always been a function of the state governments. Therefore, a mere report based on the state government corporate form is not a sufficient nexus to the foreign affairs power.
The CTA may be desirable because the government does have an interest in reducing international money laundering and financing of terrorism, but there is not a sufficient connection to the foreign affairs power. The incorporation of entities is a state function.
2. Commerce Clause — Congress has the power under the Commerce Clause and the Necessary and Proper Clause to regulate interstate commerce. However, the CTA is not regulating transfers or economic activity, it is simply a reporting law. The Government claimed it should be similar to the provisions of the Bank Secrecy Act (BSA), which permits the government to require reports on transmission of monetary instruments over $5,000. However, the BSA involves the actual movement of funds while the CTA does not regulate transfer of funds. If it had been drafted to require reports as soon as the corporation engages in commerce, it could have been constitutional. However, this was not drafted in that manner and therefore a reporting statute is not commerce.
3. Taxing Power — The Government also claimed that the CTA is justified by the taxing power and the Necessary and Proper Clause. However, the potential abuse of funds is not sufficient to establish the link to an enumerated power. It would be a "substantial expansion of federal authority” to allow the government to collect this type of data.
Therefore, the District Court determined "The Corporate Transparency Act is unconstitutional because it cannot be justified as an exercise of Congress’ enumerated powers."
Editor's Note: This is a classic question on the powers of Congress under the Constitution. It is likely this will be appealed to the Eleventh Circuit and eventually to the U.S. Supreme Court.
Applicable Federal Rate of 5.0% for March — Rev. Rul. 2024-4; 2024-9 IRB 1 (14 February 2024)
The IRS has announced the Applicable Federal Rate (AFR) for March of 2024. The AFR under Sec. 7520 for the month of March is 5.0%. The rates for February of 4.8% or January of 5.2% 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.”
