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October 08, 2024 | by Atherton & Associates, LLP

We’ve all seen those eye-catching pop-up ads while browsing the web: “Discover the One Major Tax Trick the IRS Hates!” Most of us recognize such blatant clickbait and either avoid clicking or take the content with skepticism. However, not all misleading tax advice is so obvious. 

Dubious claims often lurk in engaging videos on TikTok, YouTube, and other social media platforms, making them harder to detect and potentially more damaging. 

These videos can be particularly persuasive when the content creator mentions, “I worked in the financial industry for years,” leading you to believe they’re qualified to dispense tax advice. But how can you determine if the information they’re sharing is accurate or that they’re genuinely credentialed? 

This article will help you identify red flags in online tax advice and provide practical steps to verify a content creator’s credentials, enabling you to distinguish reliable information from misleading claims. 

The allure of engaging content

Social media platforms thrive on engagement. Creators often use sensational headlines and compelling narratives to capture attention. While some offer valuable insights, others may spread misinformation, either intentionally or due to a lack of expertise. Unfortunately, this issue isn’t exclusive to the financial industry – it’s pervasive across various fields. 

We are all susceptible to misinformation, regardless of our level of education or expertise. In fact, a study conducted by researchers at Stanford University found that over 80% of participating students could not distinguish between actual news articles and native advertisements. 

In the realm of health reporting, an analysis of the 20 most-shared articles on Facebook with the word “cancer” in the headline revealed that more than half contained claims discredited by doctors and health authorities. This indicates that a significant portion of what we consume online might not be accurate or vetted by seasoned experts – and it’s not always easy to distinguish misleading content from legitimate information. 

Six red flags to watch out for

Identifying certain red flags can help you spot misleading information. While noticing one doesn’t automatically mean the advice is false, the more red flags you observe, the higher the likelihood that the information is unreliable.

1. Vague or exaggerated credentials

Red flag: phrases intended to make the presenter appear credentialed without specific details.

Example: A video where the presenter says, “As someone who’s been in the financial world for years, I have insider tips the IRS doesn’t want you to know,” but provides no specifics about their background. 

What to look for: seek specific qualifications such as Certified Public Accountant (CPA) or Certified Financial Planner (CFP). Genuine professionals will clearly state their credentials and likely display them on their profiles. 

2. Sensational claims

Red flag: promises of “secret loopholes” or “tricks” that the IRS supposedly doesn’t want you to know. 

Example: an article titled, “Eliminate your tax bill entirely with this one hidden strategy!”

What to look for: be cautious of advice that sounds too good to be true or claims to offer easy solutions to complex problems. 

3. Lack of evidence or sources

Red flag: advice without reference to tax codes, regulations, or official guidelines. 

Example: a social media post saying you can deduct all personal meals as business expenses.

What to look for: reliable advice is usually backed by concrete references to the Internal Revenue Code, IRS publications, or well-known financial authorities. Don’t hesitate to ask for sources or clarification. 

4. Pressure tactics

Red flag: urgency cues like “You must do this now!” or “This secret won’t last long!”

Example: a message stating, “Claim this exclusive tax credit today before it’s gone forever!”

What to look for: good financial strategies are well-thought-out and don’t require hasty decisions. Take your time to research and consult professionals. 

5. Overgeneralization

Red flag: statements that ignore individual circumstances or local laws.

Example: a claim like, “Incorporate your side hustle immediately to save thousands in taxes!”

What to look for: quality advice acknowledges that tax strategies often depend on personal situations. 

6. Conflicts of interest

Red flag: content that pushes a product or service as the solution to your tax woes.

Example: a video that insists, “The only way to reduce your tax bill is by investing in this exclusive real estate program I offer.”

What to look for: be wary if the primary goal seems to be selling something rather than educating. 

How to verify a content creator’s credentials

Licensed professionals like CPAs adhere to strict ethical standards and are often very careful about the information they share online. However, these safeguards don’t prevent unlicensed individuals from disseminating misinformation.

When evaluating the credibility of online content, it’s important to verify a creator’s qualifications. While you may not find all of the following indicators for every legitimate professional – such as extensive publications or media features – the more evidence you can gather, the higher the likelihood that their advice is trustworthy. 

• Check professional licenses: search for their name on state licensing board websites or professional organization directories to confirm their credentials.

• Review their online presence: look up their LinkedIn profile or professional website. A legitimate expert will often have a consistent online presence detailing their experience and qualifications.

• Search for publications: see if they have contributed to reputable publications or have been cited in the media.

Assessing the quality of advice

While spotting red flags can alert you to potentially unreliable sources, assessing the quality of the advice itself goes a step further. This involves a deeper evaluation of the content to determine whether the information is accurate, applicable, and trustworthy. It’s not just about who is providing the advice, but also about the substance of what’s being said. 

Contextual misrepresentation

Videos or articles may present isolated cases as general rules or completely misrepresent legal precedent. For example, some influencers contend that taxpayers can refuse to pay taxes on religious grounds by invoking the First Amendment, but this is a serious misrepresentation of the law. The IRS has identified this as a frivolous argument that is consistently rejected by courts.

To assess the quality of such advice, consult a professional to verify whether the strategy is legitimate and applicable to your situation. Also, consult the IRS publication on frivolous tax arguments to see if the advice has already been deemed unreliable. 

Incorrect causality

Misleading advice often suggests that one action will directly cause a specific tax outcome without considering other factors. For instance, someone might claim, “People who donate to charity pay less in taxes.” This oversimplifies how charitable deductions work, ignoring factors like adjusted gross income limits and itemization requirements. 

Recognize that laws are complex, and outcomes often depend on multiple variables. Before acting on advice that promises direct results, understand the underlying rules and consult a tax professional to grasp the full picture. 

Risk misrepresentation

Some content downplays the risks or legal implications of a tax strategy. For example, sources may imply that by forming an S-corporation, you can avoid paying payroll taxes. They might neglect to clarify that you’re legally required to pay yourself a reasonable salary (subject to payroll taxes) if you’re actively working in your business. 

Ensure that potential downsides or the likelihood of IRS scrutiny are adequately discussed when evaluating such advice. 

Steps to protect yourself

Online misinformation is an evolving problem, and detecting it isn’t an exact science. While we’ve highlighted some common red flags, we haven’t covered every possible example of misleading tax advice. New misinformation appears constantly, and acting on bad advice can lead to serious consequences. 

The most effective way to protect yourself is to seek personalized advice from a qualified tax advisor who understands your unique circumstances. A CPA can provide tailored guidance, help you comply with tax laws, and ensure you’re making decisions that align with your financial goals. 

If you’re interested in developing a comprehensive tax strategy, we’re here to help. Please contact our office to speak with one of our experienced CPAs, and together, we can find solutions tailored to your needs. 

September 05, 2024 | by Atherton & Associates, LLP

Federal Reserve Chair Jerome Powell has signaled that rate cuts are on the horizon – it’s just a matter of time. As we prepare for this shift, it’s crucial to understand what these cuts might mean for your financial future. 

Currently, the Fed’s benchmark interest rate is at its highest in nearly 25 years, sitting between 5.25% and 5.50%. A potential cut of 0.25% to 0.50% is on the table, and while this might sound like good news, the move could impact everything from your mortgage to your savings. 

This article breaks down what you need to know about these potential changes and how to prepare so you can make informed decisions that align with your financial goals. 

Breaking down the rate cut

When the Fed talks about cutting rates, it means they’re making borrowing money cheaper. This is part of their strategy to keep the economy running smoothly. If you’re paying interest on credit cards or loans, a Fed rate cut means the interest you’re charged could go down, too. However, the impact on your finances might not be immediate or as big as you might hope, especially if the cut is small. 

While the first cut may not make a significant dent in your interest payments, it can signal the start of a trend leading to a more favorable borrowing environment over time. 

Historical trends

Historically, the Fed doesn’t slash rates all at once. Instead, they usually make small cuts over time, sometimes over several months or even years. This gradual approach allows them to carefully manage the economy without causing too much disruption. 

So, when might you start to see lower interest rates on your credit cards or loans? 

It usually doesn’t happen right away. Even if the Fed cuts rates in September, lenders might take a while to adjust their rates. When lenders adjust their rates, the timing varies depending on several factors, including market conditions, the lender’s business model, and competitive pressures. Generally, it can take anywhere from a few weeks to several months for lenders to pass on the benefits of a Fed rate cut to consumers. 

A study by the Federal Reserve Bank of San Francisco found that while some lending rates, such as those for adjustable-rate mortgages, tend to respond relatively quickly to changes in the Fed’s benchmark rate, others, like fixed mortgages, may lag by several months. 

The most recent major rate-cutting cycle occurred during the Great Recession from 2007-2008. The Federal Reserve cut the federal funds rate from a peak of 5.25% in September 2007 down to nearly 0% by December 2008. This series of cuts happened over approximately 15 months. During the early phase of these cuts, mortgage rates began to decline, but the most significant drops occurred about 6 to 12 months after the first rate cut. By mid-2009, mortgage rates had fallen to historic lows. 

Five financial moves to consider

Lock in high-yield savings ASAP

One of the most immediate and actionable steps you can take is to lock in the high interest rates currently available on savings accounts, CDs, and other safe investments. Currently, with the Fed’s benchmark interest rate at the highest level in nearly 25 years, savers have been enjoying some of the best returns in decades. But this window of opportunity may be closing soon, because the yields on savings accounts and CDs usually decrease when the Fed cuts rates. 

Given that CDs lock in a fixed interest rate for a specific term, they can be an excellent way to secure these higher rates before they potentially decline. If you’re worried about locking up all your money in a long-term CD, consider creating a CD ladder. This strategy involves spreading your investment across multiple CDs with different maturity dates. This way, you can benefit from higher rates now while also having some funds available to reinvest later. 

However, make sure your emergency fund is kept in a high-yield savings account. Not only will this help your money grow, but it will also be accessible when you need it. 

Work on your credit score to position yourself for lower rates

With a potential Fed rate cut on the horizon, now is the opportune time to focus on improving your credit score. Even if interest rates drop, a poor credit score could keep you from getting the best rates and terms. 

Start by reviewing your credit report for any errors or inaccuracies that might be dragging your score down. Make it a priority to pay all your bills on time and reduce any high balances, aiming to keep your credit utilization below 30% – ideally even lower. If your credit score is currently low, consider using a secured credit card to help rebuild it over time. These steps can position you to take full advantage of lower rates when they become available. 

Credit cards: take action as rates begin to fall

As the Fed raised rates, many credit card interest rates climbed as well. However, don’t expect your card’s interest rate to drop in line with the Fed’s rate cuts, especially if the reduction is modest – just 0.25%. Credit card companies are often slow to lower rates, if they do so at all. 

That said, falling rates could spark increased competition among credit card issuers. Some may start offering 0% balance transfers, lower rates, or other perks to entice you to switch. This puts the ball in your court: take the initiative to call your current provider and negotiate a better rate, or be prepared to shop around for more favorable terms. 

Plan ahead for major purchases

Major purchases, such as homes or cars, could also become more affordable as lower interest rates reduce the cost of financing. However, timing these purchases to align with rate cuts requires careful planning, as market conditions can be unpredictable, and increased demand might drive prices higher. 

Historically, mortgage rates tend to follow the trend of the Fed’s rate changes, but not always immediately. For instance, after rates were cut in the wake of the 2008 financial crisis, mortgage rates dropped significantly, hitting historic lows by mid-2009. But the process took time and not every rate cut led to an immediate decrease in mortgage rates. 

Auto loan rates can also be influenced by rate cuts, and the effect is often more immediate compared to mortgages. But factors like lender policies, borrower creditworthiness, and vehicle demand also play a role. 

That said, keep in mind that lower interest rates can lead to increased demand for homes and cars as financing becomes more accessible. This increased demand can drive prices higher, potentially offsetting the benefits of lower interest rates. For example, during 2020-2021, low mortgage rates contributed to a surge in housing demand, which pushed home prices to record highs in many areas. 

Refinance with caution

While refinancing can be a smart way to take advantage of lower interest rates, it’s not practical or cost-effective to refinance your mortgage after every rate cut. Instead, it’s important to assess when refinancing will truly benefit you financially, factoring in the costs associated with the process. The total costs of refinancing include closing costs, loan origination fees, and any prepayment penalties. Closing costs for refinancing typically range from 2-5% of the loan amount. 

Consider using a refinancing calculator to determine how much rates would need to fall to offset closing costs and other fees. Generally, if you can reduce your rate by 1% or more, refinancing might be worth considering, but this varies based on your specific situation. 

Personalized guidance for your financial strategy

As you consider the potential impact of a Federal rate cut, it’s essential to remember that every financial decision should be carefully tailored to your unique situation. This article provides an overview of what to keep in mind and how historical trends might guide your choices, but the specifics of your financial strategy might require a more nuanced approach. 

If you’re thinking about making any significant changes to your financial strategy, we strongly recommend seeking professional advice. Our office is here to provide personalized guidance and help you make informed choices. Contact us today to discuss how you can best position yourself to take advantage of upcoming changes and ensure your financial strategy remains strong.

September 03, 2024 | by Atherton & Associates, LLP

Smart financial planning for college: a parent’s guide

As parents, we all want the best for our children, including the opportunity for a higher education. But with the ever-rising costs of college, many families are concerned about how to afford it, especially those who are unlikely to qualify for need-based financial aid.

We all know that a college education is a significant investment. Even in 2024, the average cost of a four-year public in-state degree can easily exceed $100,000. And that doesn’t include textbooks, supplies, and other incidental expenses.

Our goal today is to explore how to effectively plan and save for your child’s education so they can pursue their dreams without being overwhelmed by debt. Whether your child is 5, 10, or 15 years away from starting college, it’s never too early or too late to start preparing. By developing a solid financial plan, you can ensure that when the time comes, your child has the opportunity to attend college without financial worry.

In this article, we’ll provide step-by-step instructions to help you maximize your financial resources and support your child’s educational journey.

Understand student aid and expected family contributions

Federal student aid eligibility is determined by various factors without a specific income cutoff. When you fill out the Free Application for Federal Student Aid (FAFSA), the information you provide determines the Student Aid Index (SAI). The SAI estimates how much your family is expected to contribute to your child’s college education based on your income, assets, family size, and the number of family members attending college.

Here’s a rough breakdown of how it works:

Family income: the SAI calculation considers your family’s AGI along with untaxed income and benefits like tax-exempt interest income and deductible retirement contributions.

Allowances against income: several allowances are subtracted from your income for necessary expenses like federal and state taxes, payroll taxes, essential living expenses, and an employment allowance.

Assets: the calculation also considers assets such as cash, savings, checking accounts, investments, business net worth, trusts, and education savings accounts. Child support received is also considered an asset. A nominal asset protection allowance is subtracted, which is based on the age of the older parent and whether the household has one or two parents.

The total expected contribution is then assessed, much like taxes, at rates ranging from 22% to 47%. Some students can qualify for zero expected family contribution if their parents’ combined income is $29,000 or less. However, for many families, there is little likelihood of qualifying for zero expected family contribution.

In a nutshell, most parents can expect to pay tens of thousands of dollars per year to send a child to college. Expected contributions are relatively high because non-liquid assets like business and investment net worth can affect your expected contribution. And the thresholds and requirements for need-based financial aid are particularly hard to meet.

Consider a college savings plan as early as possible

With the cost of education steadily increasing, starting a dedicated savings plan early can make a substantial difference. Early savings benefit from compound interest, easing the financial burden when college bills start arriving. Even if you save more than needed, there are some ways to use excess funds.

Types of college savings accounts

There are two main types of college savings accounts: Coverdell Education Savings Accounts (ESAs) and 529 plans. Both types of accounts allow your money to grow and be withdrawn tax-free, provided the funds are used for qualified educational expenses. If the funds are not needed for education, you can change the beneficiary to another family member.

Coverdell ESAs

ESAs have a lower annual contribution limit of $2,000 per year per beneficiary. Contributions are phased out for joint filers with an AGI between $190,000 and $220,000. You cannot contribute to an ESA if your income exceeds that threshold.

However, ESAs are versatile and can be used for a wide range of educational expenses, including K-12 schooling. Withdrawals are free from federal taxes if used for qualified expenses like tuition, books, tutoring, supplies, room and board,and  even computer equipment and internet service. If funds are used for non-qualified expenses, the earnings are taxable and subject to a 10% federal penalty.

If your child earns a scholarship, the amount of the scholarship is deducted from allowable expenses. For example, if they have $10,000 in qualified expenses and receive a $4,000 scholarship, $6,000 can be withdrawn tax and penalty-free to cover remaining expenses.

ESAs must be distributed by the time the beneficiary reaches age 30, but you can change the beneficiary to another family member under age 30 if excess funds remain.

529 plans

529 plans have much higher contribution limits, varying by state. Generally, parents can contribute up to $18,000 per year in 2024 without triggering the federal gift tax and can front-load up to five years’ worth of contributions.

Many states offer tax deductions or credits for contributions to their own 529 plans. Some states provide benefits for any plan, not just in-state plans. These states include Arizona, Arkansas, Kansas, Maine, Minnesota, Missouri, Montana, Ohio, and Pennsylvania.

529 savings can be used at any eligible college nationwide, and you can withdraw up to $10,000 per year for K-12 tuition.

If your child receives scholarships that cover their education costs, you can withdraw an equivalent amount without penalty, though taxes will apply to the earnings.

The good news is that your child can be the beneficiary of both a 529 plan and an ESA, allowing you to contribute to both accounts in the same year.

Set goals to increase the chances of receiving merit-based scholarships

It’s not just about how you’re going to pay for college; it’s also about finding ways to reduce expenses so less money has to come out of your pocket.

It’s important to get your child involved in the college planning process early. Their active participation is key to securing scholarships and managing future college expenses.

Strive for high grades

Encourage your child to aim for high academic performance. Merit-based scholarships often depend on GPA and standardized test scores. Emphasize that their efforts in middle and high school can greatly impact their college funding opportunities.

Participation in extracurricular activities

Participation in clubs, sports, and community service also enhances scholarship applications. Colleges look for well-rounded individuals who show leadership, commitment, and a willingness to give back to the community.

Parental support and motivation

As parents, your role is crucial in motivating and supporting your child. Work with your child to set achievable academic and extracurricular goals. Offer resources like tutoring, test prep courses, and access to extracurricular activities. And stay involved in your child’s academic life because faculty can often provide key information to ensure your child excels and has the best chance of receiving merit-based scholarships.

Start the scholarship search early

Start looking for scholarships early in high school. This can give your child a competitive advantage by allowing more time to find and apply for various opportunities.

For local scholarships, check with your child’s high school guidance counselor, community organizations, businesses, and civic groups. Local scholarships are often overlooked and have fewer applicants, increasing your child’s chances of winning.

You can also search for national scholarships using online databases like Fastweb, Scholarships.com, and the College Board’s Scholarship Search. These platforms allow you to search for scholarships based on your child’s qualifications and interests.

Junior year: consider a range of educational institutions

As your child reaches their junior year, it’s a good time to explore educational options and plan for college credits and costs. Encourage your child to take AP courses. These classes look good on scholarship applications and can earn your child college credits, saving time and money.

Also, look into the financial benefits of staying in-state for college. In-state schools typically offer lower tuition rates, and some offer scholarships or grants for in-state applicants.

Another cost-effective option is to have your child attend a community college for the first two years to complete general education requirements. Afterward, your child can transfer to a four-year institution to finish their degree. This pathway can offer significant savings on tuition and other expenses.

Senior year: application and financial aid process

When your child enters their senior year, it’s time to focus on college applications and securing financial aid. Be sure to complete the FAFSA, even if you think your child won’t qualify for need-based aid. Many schools require the FAFSA for scholarship eligibility, including merit-based scholarships. Submitting it ensures your child is considered for all possible aid.

At this point, your child should have identified several other scholarship opportunities. Keep them on track to ensure they finalize each application. It may help to create a checklist of all scholarships and their deadlines and gather necessary documents, like transcripts and letters of recommendation, in advance.

Post-acceptance: understand and utilize available tax benefits

Once your child is accepted to college, it’s time to explore tax benefits that can help reduce the cost. Two key tax credits are the Lifetime Learning Credit (LLC) and the American Opportunity Tax Credit (AOTC).

Lifetime Learning Credit

The LLC helps offset the cost of higher education for students in undergraduate, graduate, and professional degree programs, as well as courses to improve job skills. There is no limit on the number of years you can claim the credit.

It’s worth 20% of the first $10,000, up to $2,000. For 2024, the credit is reduced if your AGI is between $160,000 and $180,000 if filing jointly. It cannot be claimed if your income exceeds these limits.

American Opportunity Tax Credit

The AOTC offers more tax savings but can only be used by students in their first four years of higher education. You can get a maximum annual credit of $2,500 per eligible student. Up to $1,000 of the credit is refundable even if you owe no tax. Like the LLC, the credit is reduced if your AGI is between $160,000 and $180,000 if filing jointly.

Plan ahead to ensure your child’s education is financially manageable

This article provides an overview of strategies for paying for your child’s education. If you’d like more personalized information and advice, please contact our office. We’re here to help you plan effectively and ensure your child’s college journey is financially manageable.

August 05, 2024 | by Atherton & Associates, LLP

One of the most common questions taxpayers have about IRS audits is, “How far back can the IRS audit me?” Understanding the statute of limitations and the circumstances that may extend this period is crucial for maintaining proper tax records and ensuring compliance.

In this article, we’ll provide an overview of audit timeframes and explain the legal and practical aspects of an IRS audit.

Audit basics

An audit is a review or examination of an individual’s or organization’s financial information and accounts to ensure accuracy in reporting according to tax laws. The purpose of an audit is to verify the reported amount of tax. It does not always suggest a problem; sometimes, it can be a random selection or a computer screening based on a statistical formula.

If you are selected for an audit, the IRS will notify you by mail, not by telephone. The audit can be managed either by mail or through an in-person interview to review your records. The length of an audit varies depending on the complexity of the issues, the availability of information requested, and your agreement or disagreement with the findings.

The general rule: three-year statute of limitations

In most cases, the IRS has up to three years from the date you file your tax return to initiate an audit. This period starts from the date you filed your return (or April 15, whichever is later) to charge you additional taxes. For example, if you filed your 2020 tax return on April 15, 2021, the IRS generally has until April 15, 2024, to audit that return. If you requested an extension and filed your 2020 tax return in October 2021, the IRS would have until October 2024 to audit the return.

In practice, however, the IRS tends to open and close an audit within 26 months after the return was filed or due. This internal policy helps ensure that the audit and other processing needs are completed within the three-year timeframe.

However, these rules aren’t absolute, and the IRS can extend the audit period under certain circumstances.

Exceptions to the three-year rule

While the three-year statute of limitations covers most situations, several exceptions extend this period:

• Substantial understatement of income: If you underreport your income by more than 25%, the IRS can audit you for up to six years. This rule aims to address significant discrepancies that could indicate tax evasion.

• Unreported foreign income: If you have unreported income from foreign sources exceeding $5,000, the IRS can audit you for up to six years. This extension is part of the IRS’s efforts to combat offshore tax evasion.

• Failure to file a return: If you fail to file a tax return, there is no statute of limitations. The IRS can audit you at any time, regardless of how many years have passed since the tax year in question.

• Fraud or willful evasion: In cases where the IRS suspects fraud or intentional tax evasion, there is also no statute of limitations. The IRS can investigate and audit your returns indefinitely to uncover fraudulent activities.

The timeframe also varies depending on the type of audit conducted by the IRS. Some audits, particularly those focusing on tax credits, start a few months after you file your return. Others, often related to questionable items on your return, generally start within a year after you file. The most comprehensive IRS audits, known as field audits, can start later.

Practical tips for taxpayers

Dealing with the IRS in an audit can be challenging. Here are some practical tips to keep in mind:

• Maintain records: keep all tax records, including receipts, bank statements, and other relevant documents, for at least seven years. This practice covers you for most audit scenarios, including the six-year extension for substantial underreporting.

• Accurate reporting: ensure all income is accurately reported on your tax returns. Double-check your numbers and consider professional help if your tax situation is complex.

• Respond promptly: if you receive an audit notice, respond promptly and provide the requested documentation. Delays or failure to respond can escalate the situation and result in penalties.

• Professional advice: consult a tax professional if you have concerns about past returns or potential audit risks. They can provide guidance tailored to your specific circumstances.

By understanding the IRS audit timelines and maintaining diligent records, you can reduce the stress and uncertainty associated with potential audits. Keeping accurate and comprehensive documentation not only ensures compliance but also provides peace of mind.

For personalized assistance and to ensure your records are in order, reach out to one of our professional advisors. We can help you navigate complex tax laws and stay compliant and prepared for any IRS inquiries.

June 17, 2024 | by Atherton & Associates, LLP

The IRS’s newly unveiled strategic operating plan is set to reshape the landscape for wealthy individuals, large corporations, and complex partnerships. By 2026, audit rates for these groups are projected to rise significantly.

It’s important to understand and prepare for a more rigorous audit environment to safeguard your financial interests and ensure compliance with the evolving standards. In this article, we’ll provide insights and strategies to manage the impending changes.

Breaking down the IRS’s new audit plan

The strategic operating plan reflects the IRS’s enhanced capacity, driven by increased funding and resources, to address historically low audit rates among the wealthy. Here are the key points of the plan:

Wealthy individuals with income over $10 million

By 2026, individuals with income exceeding $10 million will experience a 50% increase in audit rates. While this sounds substantial, it’s important to note that the current audit rate for this group is relatively low. In 2019, only 11% of wealthy individuals faced audits. Under the new plan, this rate will rise to 16.5%, reflecting the IRS’s intensified focus on high-income earners who may have complex tax situations.

Large corporations with assets over $250 million

Large corporations are set to face a threefold increase in audits by 2026. Companies with assets exceeding $250 million will see their audit rates rise dramatically from 8.8% in 2019 to 22.6% in 2026. This shift underscores the IRS’s commitment to ensuring that large entities adhere to tax laws and accurately report their financial activities.

Complex partnerships with assets over $10 million

Complex partnerships are also on the IRS’s radar, with audit rates expected to increase tenfold by 2026. Partnerships with assets over $10 million will see their audit rates jump from a mere 0.1% in 2019 to 1% in 2026.

While these projected increases may seem daunting, it’s crucial to recognize that they come after years of relatively low audit activity due to budget constraints and limited manpower. The IRS’s enhanced resources now allow it to more effectively target these groups, ensuring compliance and closing the tax gap. Understanding these changes and preparing accordingly will be essential for those affected.

Actionable steps for those facing increased audit rates

With the IRS’s strategic plan set to increase audit rates, it’s crucial for those in the targeted groups to take proactive measures to mitigate audit risks. While these steps are not exhaustive or individualized, they offer a solid starting point for those facing increased audit risks:

• Maintain thorough documentation. Ensure all income, deductions, and credits are well-documented. Keep meticulous records of all financial transactions and supporting documents.

• Review past returns. Conduct a thorough review of past tax returns to identify and correct any potential errors or omissions. This can help prevent issues during an audit.

• Conduct internal audits. Businesses should regularly perform internal audits to ensure compliance with tax laws and regulations. This can help identify and rectify any discrepancies before an IRS audit.

• Implement robust accounting systems. Invest in advanced accounting and reporting systems to ensure accurate and transparent financial records. This will make it easier to provide necessary documentation during an audit.

• Stay informed on tax law changes. Keep abreast of changes in tax laws and regulations that may affect you or your business. Ensure your tax strategies are aligned with current laws to avoid potential issues.

• Regularly review partnership agreements. Ensure that partnership agreements are up-to-date and clearly define each partner’s responsibilities and tax obligations. This can help prevent disputes and confusion during an audit.

• Respond promptly to IRS inquiries. If you receive an audit notice or any inquiry from the IRS, respond promptly and provide the requested information. Delays can lead to further scrutiny and complications. If you receive an audit notice or any inquiry from the IRS, respond promptly and provide the requested information. Delays can lead to further scrutiny and complications. If you receive any notices or inquiries from the IRS, contact our office for help with a response.

Preparing for the future

This article provides a brief overview of the upcoming changes in the IRS’s strategic operating plan and outlines some basic steps to consider. It is important to note that these recommendations are not exhaustive. For personalized advice and comprehensive guidance, please contact our office.

June 15, 2024 | by Atherton & Associates, LLP

Donor-advised funds (DAFs) have steadily grown in popularity as a strategic way to manage charitable giving. In late 2023, the IRS proposed new regulations governing DAFs that could impact many existing funds. 

These rules aren’t set in stone yet, but their potential to apply retroactively makes it crucial to understand the core concepts now. In the meantime, taxpayers can continue to rely on the existing rules, but out of an abundance of caution, it makes sense to prepare for the impending changes. 

While several questions remain unanswered and further clarification is expected, we’ll provide a foundational overview of the proposed regulations to date. 

Evolution of DAFs

DAFs are a popular tool for charitable giving, allowing individuals and entities to donate to a fund managed by a public charity and, in turn, receive immediate tax benefits. The donors also retain advisory rights on how their donations are distributed and invested.

The concept of DAFs dates back to the 1930s, but their popularity surged in the 1990s. By 2022, these funds accounted for over 10% of all charitable giving in the U.S., with grants from DAFs surpassing $52 billion. 

It was only in 2006, however, that DAFs were formally recognized by the Internal Revenue Code. The lack of clear regulations led to varied interpretations and inconsistencies in administration. 

Proposed regulations

In November 2023, the IRS unveiled a set of proposed regulations that aim to provide a clearer operational blueprint for DAFs. These proposed changes, while not final, provide a glimpse into the future landscape of DAFs. The proposals still leave some questions unanswered, but they generally modify the definitions of eligible funds, donors, and donor-advisors.

The proposed regulations expand the definition of a DAF, considering factors beyond formal documentation, such as the fund’s financial activities and the sponsoring organization’s practices with donors. They also redefine a donor as any entity contributing to a fund but explicitly exclude public charities and governmental entities. A fund that received contributions solely from either of these entities would not be considered a DAF. 

The role of donor-advisors is also clarified, with the proposed regulations stating that anyone with authority over a DAF’s distributions or investments is considered a donor-advisor. This includes personal investment advisors who manage both the assets of a DAF and those of a donor, a designation that could have significant tax repercussions. Notably, an investment advisor is not considered a donor-advisor if their advisory services extend to the sponsoring organization as a whole rather than being limited to specific DAFs. If an advisor provides personal investment advice for a specific DAF, compensation paid to the advisor will be considered an automatic excess benefit transaction subject to excise taxes. 

Implications

It’s important to recognize that these guidelines are preliminary and subject to refinement. Despite their proposed status, the implications are potentially significant, so it’s wise to take a proactive stance in anticipation of the impending changes. 

While these regulations are still provisional, they will extend retroactively to the entirety of the tax year in which they are finalized. Should the regulations become official anytime in 2024, they would apply to the entire 2024 tax year. This potential retroactivity underscores the importance for sponsoring organizations to reassess their policies and donor lists promptly. 

To prepare for the upcoming changes, sponsoring organizations should conduct thorough reviews of their existing funds. This can help them determine if other charitable funds will now be considered DAFs. For instance, field of interest funds or fiscal sponsorship arrangements may now be recognized as DAFs if the donor has advisory privileges regarding distributions. 

The changes to the definition of a donor-advisor deserve careful review and planning. If an investment advisor provides personal investment guidance for specific DAFs (as opposed to guidance for the sponsoring organization as a whole), the fund could face hefty excise taxes on the distribution. The advisor could also be required to correct the excess benefit transaction by returning the compensation, with interest, to the sponsoring organization. If not corrected, the advisor could face an additional tax of 200%. As such, sponsoring organizations that permit a donor to recommend an advisor for their DAF need to exercise caution, especially if that advisor also manages the personal assets of the donor. 

Additionally, the proposed regulations extend the scope of eligible distributions to include payments for services necessary to carry out an organization’s charitable purposes. For instance, a DAF may make a direct payment to a service provider for services performed on behalf of the charitable entity. However, the sponsoring organization should maintain thorough documentation showing that the direct payment was non-taxable. 

Preparing for the future

The proposed regulations are awaiting public comment before finalization, and it’s likely that more guidance will follow. In the meantime, sponsoring organizations should meet with legal and tax professionals to prepare for the upcoming changes. These professionals can help you understand the new regulations and revise your policies to ensure compliance.

Please note that this article provides a brief overview of the IRS’s proposed regulations and is not intended as legal advice. Many questions remain unanswered, and the regulations could be subject to change. Consider this overview as a starting point for a more in-depth exploration with your advisors. 

If you have any questions or would like personalized guidance, please contact our office.