Tax Update: Tax Planning, Retirement Plans and IRS Efficiency

Sometimes a good critique of our taxation system illustrates tax planning techniques we are familiar with but which the reviewer believes “distort” the system. A report coming from the Joint Committee on Taxation for a hearing before the Senate Committee on Finance probably should be a warning that certain tax planning techniques may be in for some increased regulation.[1] For trusts, the planning techniques highlighted were “intentionally defective grantor trusts” (IDGT), grantor retained interest annuity trusts (GRAT) and allocation of generation-skipping tax (GST) exemption to a perpetual dynasty trust. In the life insurance realm, the target was private placement of life insurance and annuity contracts. Some of these planning techniques are irrevocable once done. This adds to the risk that future regulation could undo some or any planned benefit. They are sitting ducks.

Some wealthy taxpayers have so much money or so little time that they need to try any and all techniques. Since many taxpayers understand the benefits of retirement planning and contributions over a 30-to-40-year period, it shouldn’t come as a surprise that the best estate planning requires a 30-to-40-year planning horizon. Over that period, the use of trusts, keeping in mind the GST limitations, is important. Gifting to beneficiaries using the annual exclusion gift is probably the most important tool over the long term as it can have no reporting requirements and hence no interplay with future regulations. As each year passes, the assets are already at their intended location.

Will Flaws in Pension Programs Attract Sharks?

A Securities and Exchange Commission (SEC) staff report on a review of the definition of “accredited investor” highlighted a problem with the current retirement landscape for working Americans.[2] The individual definition of accredited investor is one having $1 million or more of assets, not including a primary residence, alone or combined with a spouse, or $200,000 of income in each of the last two years with expectations for that to continue. The SEC staff point out that the definitions have not been adjusted for inflation since 1982, when Regulation D was adopted. The SEC’s Investor Advisory Committee worries that “a significant percentage of individuals who currently qualify as accredited investors are not in fact capable of protecting their own interests.”[3] The staff worries, as Jimmy Buffett sang in “Fins,” about “sharks that can swim on the land.” Investors with their defined  contribution plan dollars could lose them.

Perhaps this wasn’t as big a concern in 1982 when defined benefit plans (i.e., pensions) had 29.7 million active participants (56%) while defined contribution plans (i.e., 401(k)s) had 23.4 million (44%). In 2020, including a doubling of active participants, defined contribution plans covered 88% and defined benefit plans only 12 percent. The defined benefit plan was a company plan, not an individual responsibility. It has been legislated out of existence for the private sector but is still the preferred arrangement for public sector employees.

Perhaps the SEC staff could recommend steps to reinvigorate the defined benefit pension plan for the private sector, creating a preferred way for retirement assets to be invested in the American economy, considering their worries about protecting retirement dollars.

Necessity Is the Mother of IRS Efficiency

This is a good time of year to ask, how is the US Internal Revenue Service (IRS) doing? Even with outdated information technology systems, not badly, it seems. The federal government’s fiscal year runs from October 1 to September 30. For FY 2022, covering calendar 2021 returns, “US taxpayers filed 161 million individual and 12 million business income tax returns, along with over 31 million employment tax returns, over 1 million excise tax forms and just 297,000 estate and gift tax forms.”[4] Since we haven’t seen news articles highlighting collection disasters and because our own experience with filing and collections is good, this mammoth annual collection effort seems to be going okay.

The other side of an efficient tax collection system is enforcement. We prefer the “goose feather plucking with the least amount of squawking” model to the “arbitrary severed head on a pole outside the village gate” model of enforcement, but that requires legislative wisdom. An interesting development in IRS enforcement is the change in emphasis at the IRS necessitated by staffing changes. “Automated collection processes drove (enforcement) revenue collection as the IRS ended FY 2022 with a slight decrease in full-time equivalent employees from FY 2019.”[5]  The 20% increase in enforcement revenue collected in FY 2022 and FY 2021 above the average enforcement revenue collected from FY 2013 to FY 2020 was achieved “within the collection notice stream and automated collection. The IRS completed 2% fewer correspondence exams and 25% fewer field exams than in FY 2019.”[6]

Correspondence and field exams require employees. Even within the field exams category, revenue collected was up in spite of constraints requiring the IRS to “focus on high dollar employment tax cases with balances of at least $250,000” and on individual taxpayers who owe over $1 million.[7]

So, necessity made the IRS more efficient. If the increased funding included in the Inflation Reduction Act of 2022 does eventually come to the IRS, how are they planning to spend it? Smartly on field examination of individual taxpayers where they have had success and less understandably on “large, complex passthrough entities.” Individuals are at the end of all passthrough items, eventually. Passthrough entities multiply geometrically to fill business needs. And passthroughs pay no tax. Perhaps, the IRS may be more efficient with less money.

If you or any of your other advisors have questions about the issues raised here, please contact your investment manager or one of us.

William H. Darling, CPA – Chairman & CEO
Jeanne M. Fitzgerald, CPA – Tax Manager 

1 “Present Law and Background on the Income Taxation of High Income and High Wealth Taxpayers,” Staff of the Joint Committee on Taxation, November 7, 2023
2 “Review of the ‘Accredited Investor’ Definition under the Dodd-Frank Act,” Staff of the US Securities and Exchange Commission, December 14, 2023.
3 Ibid.
4 Martha Waggoner, “IRS Collects Record-setting $4.9 Trillion in Tax Revenue in FY 2022,” Journal of Accountancy, 01/04/2024
5 Ibid.
6 Ibid.
7 Ibid.