What Income and Deductions Should be Reported or Taken on Your Tax return in the Gig Economy?

 

What Income and Deductions Should be Reported or Taken on Your Tax return in the Gig Economy[1]?

The Gig economy—also called sharing economy or access economy—is activity where people earn income providing on-demand work, services or goods. Often, it’s through a digital platform like an app or website.

Gig Economy Income is Taxable

You must report income earned from the Gig economy on a tax return, even if the income is:

• From part-time, temporary or side work
• Not reported on an information return form—like a Form 1099-K, 1099-MISC, W-2 or other income statement
• Paid in any form, including cash, property, goods, or virtual currency

What is Gig Work?

Gig work is certain activity you do to earn income, often through an app or website (digital platform), like:

• Drive a car for booked rides or deliveries
• Rent out property or part of it
• Run errands or complete tasks
• Sell goods online
• Rent equipment
• Provide creative or professional services
• Provide other temporary, on-demand or freelance work[2]

What are Digital Platforms?

Digital platforms are businesses that match workers' services or goods with customers via apps or websites. This includes businesses that provide access to:

·         Ridesharing services

·         Delivery services

·         Crafts and handmade item marketplaces

·         On-demand labor and repair services

·         Property and space rentals[3]

The Gig economy has caught the attention of the IRS so much that it has a Gig Economy Center[4]. There is even a video “Understanding the Gig Economy.[5]”

The IRS Gig Economy Tax Center can help people in this growing area meet their tax obligations through more streamlined information. The Gig economy is also known as the sharing, on-demand, or access economy. It usually includes businesses that operate an app or website to connect people to provide services to customers. While there are many types of gig economy businesses, ride-sharing and home rentals are two of the most popular. The Gig Economy Tax Center streamlines various resources, making it easier for taxpayers to find information about the tax implications for the companies that provide the services and the individuals who perform them. It offers tips and resources on a variety of topics including:

·             Filing requirements;

·             Making quarterly estimated income tax payments;

·             Paying self-employment taxes;

·             Paying FICA, Medicare, and Additional Medicare taxes;

·             Deductible business expenses; and

·             Special rules for reporting vacation home rentals.

If you are a Gig worker IRS publication 334 provides a list of forms are you required to file with your income tax return.  

What About Deductions?

Deductions are a matter of legislative grace, and the taxpayer bears the burden of proof. Section 162 allows deductions against business revenue for all expenses that are "ordinary and necessary." In contrast, Section 262 disallows deductions for personal living expenses. Determining what is an ordinary and necessary business expense versus personal living expense is often not clear cut. Deductibility can depend on the taxpayer's specific facts and circumstances and is a frequent issue to be resolved in court cases. In addition the taxpayer must substantiate his or her expenses and some expenses must also satisfy stricter substantiation requirements laid out in Section 274(d).

 

Both self-employed individuals and employees not reimbursed by their employer apply the same criteria to determine whether an item is deductible as an ordinary and necessary business expense. Self-employed individuals can then deduct amounts on Schedule C as part of their Form 1040[6].

 

Trade or Business Deductions

 To be currently deductible a trade or business expenditure:

 ·         Must be ordinary and necessary;

·         Must be reasonable in about;

·         Must be related to an activity deemed to be a trade or business;

·         Must be business related rather than personal expenditure;

·         Must not be a capital expenditure;

·         Cannot be incurred in the production of tax-exempt income;

·         Must not be a violation of public policy;

 

Ordinary means “customary and not a capital expenditure“; necessary means “appropriate and helpful.”

 Substantiation

IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses, provides detailed information on how a Gig employee can prove expenses. Proof of an expense includes the following three items:

·                     Adequate records

·                     Sufficient evidence

·                     Written record

 

Adequate records are defined by Publication 463 on page 25: “You should keep the proof you need in an account book, diary, log, statement of expense, trip sheets, or similar record. You should also keep documentary evidence that, together with your record, will support each element of an expense.”

Records of expenses do not have to be in any particular format, but it must be in a form that allows the employee to keep a detailed record of the amount, time, place, and business purpose of the expense. The format used must also enable an employee the ability to document business meals that take place within the employee's tax home and meals provided for others when away from their tax home.

To substantiate these expenses, a Gig employee must record the following information in their record:

·                     The names of the individuals in attendance

·                     The business purpose of the meeting

·                     The date and place of the business meeting

 

The best sufficient evidence is documentary evidence that supports the employee's expenses. This may include receipts, canceled checks, or bills. Documentary evidence, however, is deemed adequate only if it shows the amount, date, place, and essential character of the expense.

In most cases, the IRS requires documentary evidence for travel expenses only if the expense is greater than $75. However, there are exceptions, especially lodging expenses. Since lodging bills may contain other expenses in addition to room charges (such as meals, telephone calls, laundry, Internet access, and video rentals), a hotel or motel must provide an itemized bill. Personal expenses (such as video rentals) should not be included or reimbursed.

 

Why Business Expense Substantiation Is Vital

When a taxpayer provides the IRS with better substantiation, the IRSs is more inclined to grant deductions.

 

Deductible Expenses

This article does not cover self-employed health insurance and retirement contributions. Additionally, rules for home rentals are beyond the scope of this article. The items discussed in more depth here are auto costs; cellular phone service; internet service; work clothing; tools, supplies, and equipment; meals when not away from home; entertainment expenses; home office, licensing; and inventory, cost of goods sold, and selling expenses.

 

Auto Expenses

If you use your car for business purposes, you may be able to deduct car expenses. You generally can use one of the two following methods to figure your deductible expenses. The standard mileage rate or the actual car expenses.

The standard milage rate for 2021 is 56 cents per mile for business miles driven. f you use the standard mileage rate for a year, you can’t deduct your actual car expenses for that year. You can’t deduct depreciation, lease payments, maintenance and repairs, gasoline (including gasoline taxes), oil, insurance, or vehicle registration fees.

Choosing the Standard Mileage Rate

If you want to use the standard mileage rate for a car you own, you must choose to use it in the first year the car is available for use in your business. Then, in later years, you can choose to use either the standard mileage rate or actual expenses. If you want to use the standard mileage rate for a car you lease, you must use it for the entire lease period. For leases that began on or before December 31, 1997, the standard mileage rate must be used for the entire portion of the lease period (including renewals) that is after 1997. You must make the choice to use the standard mileage rate by the due date (including extensions) of your return. You can’t revoke the choice. However, in later years, you can switch from the standard mileage rate to the actual expenses method. If you change to the actual expenses method in a later year, but before your car is fully depreciated, you have to estimate the remaining useful life of the car and use straight line depreciation.

Standard Mileage Rate Not Allowed.

You can’t use the standard mileage rate if you:

• Use five or more cars at the same time (such as in fleet operations);

• Claimed a depreciation deduction for the car using any method other than straight line, for example, MACRS;

• Claimed a section 179 deduction on the car;

• Claimed the special depreciation allowance on the car; or

• Claimed actual car expenses after 1997 for a car you leased.

 

Examples:

Example 1.

Tony and his employees use his four pickup trucks in his landscaping business. During the year, he traded in two of his old trucks for two newer ones. Tony can use the standard mileage rate for the business mileage of all six of the trucks he owned during the year.

 

Example 2. Chris owns a repair shop and an insurance business. He and his employees use his two pickup trucks and van for the repair shop. Chris alternates using his two cars for the insurance business. No one else uses the cars for business purposes. Chris can use the standard mileage rate for the business use of the pickup trucks, van, and the cars because he never has more than four vehicles used for business at the same time.

 

Example 3. Maureen owns a car and four vans that are used in her housecleaning business. Her employees use the vans, and she uses the car to travel to various customers. Maureen can’t use the standard mileage rate for the car or the vans. This is because all five vehicles are used in Maureen's business at the same time. She must use actual expenses for all vehicles.

 

Actual Car Expenses

If you don’t use the standard mileage rate, you may be able to deduct your actual car expenses. Actual car expenses include:

·                     Depreciation               

·                     Licenses

·                     Lease payments

·                     Registration fees

·                     Gas

·                     Insurance Repairs

·                     Oil

·                     Garage rent

·                     Tires

·                     Tolls

·                     Parking fees

If you have fully depreciated a car that you still use in your business, you can continue to claim your other actual car expenses.

 

Business and Personal Use.

If you use your car for both business and personal purposes, you must divide your expenses between business and personal use. You can divide your expense based on the miles driven for each purpose.

 

Example.

You are a contractor and drive your car 20,000 miles during the year: 12,000 miles for business use and 8,000 miles for personal use. You can claim only 60% (12,000 ÷ 20,000) of the cost of operating your car as a business expense.

 

Cellular Phone Service

IRC Section 280F(d)(4) was amended in 2010 to eliminate cellular phones from the definition of listed property and, as a result a taxpayer can deduct cellular phone service based on an estimate.

Courts have rules that taxpayers are required to have both cell phone and internet access for his employment as a systems engineer, and he has provided a reasonable basis to accept his estimated expenses," and, as a result, allowed the deductions for both cell phone and internet service.

 

Internet Service

The courts consider internet services a utility, and if they are ordinary and necessary business expenses, utility expenses are deductible. However, home internet services are frequently used for both personal and business purposes. Generally, the taxpayer must provide a reasonable basis for determining how much usage is business versus personal. Utilities, including internet.

 Entertainment and Business Meals

 The TCJ disallows deductions:

 ·         For an activity considered entertainment, amusement, or recreation;

·         Membership dues for any club organization for business, pleasure, recreation or other social purposes; and

·         For a facility or portion of a facility used in connection with the above.

 The amount of any otherwise deductible business meal must be reduced by 50%. This 50% reduction rule applies to all food, and beverage costs (even though incurred in the course of travel away from home) after determining the amount otherwise deductible.

 The 50% reduction rule will not apply if:

 ·         The full value of the meals or entertainment is included in the recipient income or excluded as a fringe benefit;

·         An employee is reimbursed for the cost of meal and/or entertainment (the 50% reduction rule applies to the party making the reimbursement).

 The TCJA expanded the 50% limit to food and beverages provided to employees as a de minimis  fringe benefits, to meals provided at an eating facility that meets the requirements for an on premise dining facilities, and to meals provided on premises to employees for the convenience of the employer.

 

Work Clothing

Work clothing is deductible under Section 162; these include:

·                     The clothing is required or essential for the employment;

·                     It is not adaptable to general usage as ordinary clothing; and

·                     It is not so worn.

 

Tools, Supplies, and Equipment

Expenses incurred by construction workers, electricians, plumbers, or other trades is the necessity to purchase tools and equipment are deductible. For an over-the-road truck driver, the courts allowed a deduction for a number of truck related supplies including antennas, CB and XM radio and related repairs, atlases and maps, a scanner, crowbars and other tools, flashlights and batteries, first aid kit, jumper cables, floor mats, seat covers, tarps, power cords and boosters, electrical and duct tape, towels and paper towels, and shovel and broom.

 

In general, supplies that are determined to be ordinary and necessary for the taxpayer's profession are deductible. Self-employed social workers are allowed a supplies deduction rule for computer supplies, reference materials, textbooks, and professional periodicals. Additionally, for a security guard, items such as a weapons holder, a handgun, a flashlight, and handcuffs were all considered ordinary and necessary. Also, a flight attendant was allowed a deduction for luggage.

 

Office in the Home

 

Most expenses for personal use assets are not deductible. Except for certain expenses (primarily interest and taxes) that is the case with a personal residence. However self-employed individuals are allowed a deduction for office in the home expenses if a portion of the residence is used exclusively on a regular basis as either:

                 ·         The principal place of business for any trade or business of the taxpayer, or

·         A place of business used by clients, patient, or customers[7].

 The term principal place of business includes a place of business that satisfies the following requirements:

             ·         The office is used by the taxpayer to conduct administrative or management activities of a trailer business; and

        ·         There is no other fixed location of the trailer business where the taxpayer conducts these activities.

 Taxpayers have two options for figuring this deduction.

 The regular method  divides expenses of operating the home between personal and business use. Self-employed taxpayers file Form 1040, Schedule C, and compute this deduction on  Form 8829.

 

The simplified method, has a rate of $5 a square foot for business use of the home. The maximum deduction is $1,500.

 

Special rules apply for certain business owners:

·      Daycare providers complete a special worksheet, found in Publication 587.

·      Self-employed individuals use Form 1040, Schedule C, Line 30 to claim deduction

·      Farmers claim the deduction on Schedule F, Line 32[8].

 

Inventory, Cost of Goods Sold, and Selling Expenses

In the case of businesses that resell goods, such as selling on eBay, Esty or Amazon, the taxpayer is expected to maintain inventory records, and a deduction is allowed for cost of goods sold (e.g, cost or adjusted basis of the asset). If the taxpayer cannot establish a basis, the presumption is that the basis is zero.

In addition to cost of goods sold, taxpayers are allowed other ordinary and necessary selling expenses. For example, courts have allowed deductions for PayPal fees, eBay fees, postage, and packaging.  Any fees charged for use of a digital platform would be deductible.

 

Other Common Business Expenses

Advertising;

Bad debts;

Salaries and wages;

Fringe benefits;

Rent;

Insurance;

Accounting and legal fees;

Capital expenditures which may be depreciable;

Business gifts (limited to $25).

 Other Factors Affecting Deductions

 The taxpayers tax accounting method may affect the timing of a deduction.

 Cash method taxpayers recognize expenses when paid; accrual method taxpayers recognize expenses when obligations to pay is fixed and determinable.

 Prepaid interest may be deducted over the period to which of the it accures; warranty expenses can only be deducted when paid.

 Taxpayers must be able to substantiate deductions through documentary evidence such as receipts, invoices, and cancel checks.

 Restricted Business Deductions

Political contributions by businesses and individuals are not deductible.

Lobbing expenses and amounts paid to influence voters or not deductible.

Business investigation and start-up costs, for example survey of potential markets, expenses of securing prospective distributors or suppliers, advertising, employee training are deductible in the year paid or incurred is the taxpayers is currently in a similar line of business as the start of business. If not in a similar line of business and a new business is investigated but not acquired,  start-up cost or not deductible[9].

Suggestion:

If you prepare your own return, take time now to lay out how you will keep track of these expenses and the ever -important supporting detailed records.  If you use an accountant that may already have such a format for gig workers that ties to the professional’s software, it may be easier to adopt the existing format.

Note:

In a May 2021 report by the TIGTA it noted "IRS did not always take compliance actions on non filers of tax returns and under reporters related to P2P payments even when information reporting was available," TIGTA said. In total, some 170,000 taxpayers "potentially" did not report up to $29 billion of payments received per Form 1099-K documents issued to them by three P2P payments application companies. While taxpayers using P2P payment applications may not always receive a Form 1099-K, they are still required to report any taxable income on their returns, TIGTA stressed. 

New for 2022-Reporting by third party settlement organizations. Congress has tightened the de minimis exception to tax reporting by third-party settlement organizations (TPSOs, e.g., PayPal, Venmo, Zelle) by requiring reporting of transactions that exceed $600 (and eliminating the 200-transaction threshold). The American Rescue Plan Act (ARPA) also clarified that TPSO reporting obligations are limited to transactions involving goods and services. This means that, beginning in 2022, if you run a business where customers pay you via a TPSO, and you receive more than $600 in total during the course of the year via a TSPO, the TSPO is required to report that amount to the IRS - regardless of how many customers are paying you - and to send you a Form 1099-K, Payment Card and Third-Party Network Transactions.

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[1][1] This article is written by Frank L. Brunetti, Esq. All rights are reserved.

[2] Note: This list does not include all types of Gig work.

[3] Note: This list does not include all types of digital platforms.

[4] https://www.irs.gov/businesses/gig-economy-tax-center

[5] https://www.irsvideos.gov/Individual/PayingTaxes/UnderstandingTheGigEconomy

[6] Since 2018, employees can no longer deduct unreimbursed employee expenses. These expenses were included as part of miscellaneous itemized deductions and that category was eliminated by the Tax Cuts and Jobs Act (TCJA).

 [7] From 2018 through 2025 employees are not allowed an office in the home deduction.

 [8] See IRS Publication 587, Business Use of Home (Including Use by Daycare Providers) and Form 8829, Expenses for Business Use of Your Home for more information.

 [9] Deduction of start up expenses are subject to special rules see IRS Publication 535.

P.L. 116-127, The Family First Coronavirus Response Act

In an Information Release ( “the Act”) the IRS has announced that employers can begin taking advantage of two new refundable payroll tax credits created by the Families First Coronavirus Response Act (PL 116-127, 3/18/2020). The IRS also announced that it will release guidance on how eligible employers who pay qualifying sick or child care leave under the Act will be able file a request for an accelerated payment from the IRS.

The Release summarizes the Act as follows:

The Act provides paid sick leave and expanded family and medical leave for COVID-19 related reasons and created the refundable paid sick leave credit and the paid child care leave credit for eligible employers. Eligible employers are businesses and tax-exempt organizations with fewer than 500 employees that are required to provide emergency paid sick leave and emergency paid family and medical leave under the Act. Eligible employers can claim these credits based on qualifying leave they provide between the effective date and December 31, 2020. Equivalent credits are available to self-employed individuals based in similar circumstances.

Paid leave

The Act provides that employees of eligible employers can receive two weeks (up to 80 hours) of paid sick leave at 100% of the employee's pay where the employee is unable to work because the employee is quarantined, and/or experiencing COVID-19 symptoms, and seeking a medical diagnosis.

An employee who is unable to work because of a need to care for an individual subject to quarantine, to care for a child whose school is closed or child care provider is unavailable for reasons related to COVID-19, and/or the employee is experiencing substantially similar conditions as specified by the U.S. Department of Health and Human Services can receive two weeks (up to 80 hours) of paid sick leave at 2/3 the employee's pay.

An employee who is unable to work due to a need to care for a child whose school is closed, or child care provider is unavailable for reasons related to COVID-19, may in some instances receive up to an additional 10 weeks of expanded paid family and medical leave at 2/3 the employee's pay.

Paid sick leave credit.

For an employee who is unable to work because of coronavirus quarantine or self-quarantine or has coronavirus symptoms and is seeking a medical diagnosis, eligible employers may receive a refundable sick leave credit for sick leave at the employee's regular rate of pay, up to $511 per day and $5,110 in the aggregate, for a total of 10 days.

For an employee who is caring for someone with coronavirus, or is caring for a child because the child's school or child care facility is closed, or the child care provider is unavailable due to the coronavirus, eligible employers may claim a credit for 2/3 of the employee's regular rate of pay, up to $200 per day and $2,000 in the aggregate, for up to 10 days. Eligible employers are entitled to an additional tax credit determined based on costs to maintain health insurance coverage for the eligible employee during the leave period.

Child care leave credit.

In addition to the sick leave credit, for an employee who is unable to work because of a need to care for a child whose school or child care facility is closed or whose child care provider is unavailable due to the coronavirus, eligible employers may receive a refundable child care leave credit. This credit is equal to 2/3 of the employee's regular pay, capped at $200 per day or $10,000 in the aggregate. Up to 10 weeks of qualifying leave can be counted towards the child care leave credit. Eligible employers are entitled to an additional tax credit determined based on costs to maintain health insurance coverage for the eligible employee during the leave period.

Prompt payment for the cost of providing leave. In general, when employers pay their employees, they are required to withhold from their employees' paychecks federal income taxes and the employees' share of Social Security and Medicare taxes. The employers then are required to deposit these federal taxes, along with their share of Social Security and Medicare taxes, with the IRS and file quarterly payroll tax returns with the IRS.

The Information Release says that, under guidance that will be released next week, eligible employers who pay qualifying sick or child care leave will be able to retain an amount of the payroll taxes equal to the amount of qualifying sick and child care leave that they paid, rather than deposit them with the IRS.

The Information Release says that the payroll taxes that are available for retention include withheld federal income taxes, the employee share of Social Security and Medicare taxes, and the employer share of Social Security and Medicare taxes with respect to all employees.

If there are not sufficient payroll taxes to cover the cost of qualified sick and child care leave paid, employers will be able file a request for an accelerated payment from the IRS. The IRS expects to process these requests in two weeks or less. The details of this new, expedited procedure will be announced next week.

Equivalent child care leave and sick leave credit amounts are available to self-employed individuals under similar circumstances. These credits will be claimed on their income tax return and will reduce estimated tax payments.

Small business exemption.

The Information Release says that small businesses with fewer than 50 employees will be eligible for an exemption from the leave requirements relating to school closings or child care unavailability where the requirements would jeopardize the ability of the business to continue. The exemption will be available on the basis of simple and clear criteria that make it available in circumstances involving jeopardy to the viability of an employer's business as a going concern. The Department of Labor (Labor) will provide emergency guidance and rulemaking to clearly articulate this standard.

Non-enforcement period.

The Information Release says that Labor will be issuing a temporary non-enforcement policy that provides a period of time for employers to come into compliance with the Act. Under this policy, Labor will not bring an enforcement action against any employer for violations of the Act so long as the employer has acted reasonably and in good faith to comply with the Act. Labor will instead focus on compliance assistance during the 30-day period.

Accounting Documents Protected by the Work Product Doctrine and the Kovel Doctrine

The work product doctrine generally protects “documents and tangible things that are prepared in anticipation of litigation or for trial by or for another party or its representative.[1]“ [T]o qualify for protection against discovery under Rule 26(b)(3), documents must have two characteristics:

·       they must be prepared in anticipation of litigation or for trial, and

·       they must be prepared by or for another party or by or for that other party's representative.[2] 

Only work product created in anticipation of litigation qualifies for protection under the work product doctrine. In the case of a tax controversy, the simultaneous nature of the IRS's examination and the taxpayer’s ongoing tax and legal obligations presents a challenge in determining whether the taxpayer or their representatives created a document in anticipation of litigation. Under the right circumstances, a party may create work product during the course of an IRS investigation in anticipation of litigation[3].  In contrast, documents that would have been prepared for a party's tax filings regardless of the IRS examination would not qualify as work product[4]. Consequently a court must examine the underlying facts to determine when the party claiming work product protection reasonably anticipated litigation and the nature of the document's purpose.

Under IRC §7525(a)(1) the common law protections of confidentiality applies to a communication between a taxpayer and an attorney with respect to tax advice. The same common law protections of confidentiality applies to a communication between a taxpayer and an attorney and communication between a taxpayer and any federally authorized tax practitioner to the extent the communication would be considered a privileged communication if it were between a taxpayer and an attorney. Generally, the privilege does not apply to communications regarding the preparation of tax returns[5].

In U.S. v. Burga, 124 AFTR 2d 2019-XXXX, (DC CA), 08/16/2019 the district court held that some documents created by an accountant were protected under the tax practitioner privilege and under the holding in Kovel because the documents were produced to help an attorney to give legal advice, not merely to produce a tax return.

The Court of Appeals for the Second Circuit previously held that attorney-client privilege also applies to communications made in the presence of an accountant who is indispensable to the consultation between lawyer and client. The court held that the privilege attached to a communication made to the attorney, in the presence of an accountant employed by the attorney, if the communication was made in confidence for the purpose of getting legal advice from the lawyer[6].

The tax practitioner privilege does not protect communications made in the presence of an accountant if the accountant is there merely to provide accounting services[7].

In Burda the attorney hired an accountant to, according to statements the accountant submitted to the district court, "review and, if necessary and/or possible, amend" the tax returns that the IRS was examining, as well as "prepare returns for" future years. The accountant also said, that he "performed services which were of a character and quality necessary for the [attorney] to provide appropriate and accurate legal and tax advice to [Burga] including reviewing and interpreting tax and financial information and documents."

The IRS asked Burga to produce documents that the accountant had prepared. Burga said the documents were protected under IRC §7425 and by the Kovel doctrine.

The IRS said the documents were not protected because the accountant was merely providing accounting services, i.e., he was preparing tax returns.

The district court held that IRC §7425 and Kovel did apply to protect some of the documents that the accountant produced. The court also recognized that some of the accountant's documents were merely related to his preparing tax returns and were not protected.

The court found that the accountant's statement that he was hired to prepare tax returns did not preclude the possibly that he also provided tax advice. The court looked to his statement as evidence that he may have provided tax advice in addition to preparing tax returns. The court found that this statement was enough to have both IRC §7425 and Kovel apply.

The court ultimately decided to appoint a special master review the documents to determine which ones were protected because they contained tax advice provided by the accountant and which ones were merely related to preparing tax returns.

Practice Pointer: The practical point is that in any tax controversy if an accountant is going to be retained as part of the client representation, protecting the work product of the accountant is critical. Clearly any written documents or communications must be kept separate and labeled as “property of the attorney [name]“ and those reflecting tax preparation must be kept separate so as to not destroy the privilege.

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[1] Fed. R. Civ. P. 26(b)(3)(A).

[2] In re California Pub. Utils. Comm'n, 892 F.2d 778, 780–81 (9th Cir.1989).

[3] United States v. Roxworthy, 457 F.3d 590, 594–600 [98 AFTR 2d 2006-5964] (6th Cir. 2006).

[4] See United States v. Richey, 632 F.3d 559, 568 [107 AFTR 2d 2011-573] (9th Cir. 2011).

[5] U.S. v. McEliogt, 115 AFTR 2d 2015-1433 (DC CA 2015).

[6] U.S. v. Koval, 9 AFTR 2d 366, 296 F.2d 918 (2^nd Cir. 1961).

[7] Gonzales v. U.S., 110 AFTR 2d 2012-6083 (9^th Cir. 2012).

IRS Approves spousal rollover although decedent’s IRA did not designate a beneficiary

Generally, a surviving spouse may make a tax-free spousal rollover from a deceased spouse's IRA only if the survivor is designated as the IRA’s beneficiary. However, in PLR 201931006, IRS said this general rule did not apply—and a tax-free spousal rollover was approved where the decedent failed to designate an IRA beneficiary, died without a will, and the surviving spouse was the administrator and sole heir to the decedent’s estate. 

A surviving spouse designated as the beneficiary of an IRA need not leave the IRA in the decedent's name. The surviving spouse can either:

·       roll over the decedent's IRA into an IRA in the spouse's name; or

·       elect to treat the decedent's IRA as the spouse's own IRA. 

However, the regulations state the election to treat the decedent's IRA as the surviving spouse beneficiary's IRA is available only if the spouse is “the sole beneficiary” of the IRA and has an unlimited right to withdraw amounts from it. Note the sole beneficiary requirement is not met if a trust is named as the IRA's beneficiary, even if the spouse is the sole beneficiary of the trust (but see PLR 201923002).

There is no immediate tax if distributions from an IRA are rolled over to an IRA or other eligible retirement plan, annuity, or tax-sheltered annuity. For a rollover to be tax-free, the amount distributed from the IRA generally must be recontributed to an IRA or other eligible retirement plan no later than 60 days after the date that the taxpayer received the withdrawal from the IRA. A distribution rolled over after the 60-day period generally will be taxed (and also may be subject to a 10% premature withdrawal penalty tax). An individual is permitted to make only one nontaxable 60-day rollover between IRAs in any 1-year period.

In PLR 201931006 the Decedent established an IRA but failed to designate a beneficiary for the account. The IRA was maintained by a custodian that provided that if no beneficiary is designated for the IRA, the account balance remaining at the decedent’s death would be payable to her estate. The decedent died without a will and, under relevant state law, the decedent’s surviving spouse was the sole heir to the estate. The decedent’s surviving spouse was also the sole administrator of the estate.

The decedent’s surviving spouse intended to distribute the IRA to the estate, and as administrator of the estate, pay the proceeds of the IRA to himself. Within 60 days of receipt, he would roll over the proceeds of the IRA into one or more IRAs in his name.

The surviving spouses asked IRS to rule that:

·       the surviving spouse be treated as the payee or distributee of the IRA proceeds;

·       The IRA would not be treated as an inherited IRA; and

·       He will be eligible to do a tax-free 60-day rollover from the decedent’s IRA to his own IRA. 

The ruling points out that the surviving spouse would not be permitted to treat the IRA as his own, because he was not named the beneficiary of the IRA. However, because he was the administrator and sole heir to the estate he was effectively the individual for whose benefit the account was maintained. As a result, if the surviving spouse receives a distribution of the proceeds of the IRA, he could roll over the distribution into his own IRA.

In response to the ruling requests, IRS concluded that:

·       The surviving spouse will be treated as the payee or distributee of the proceeds from the IRA;

·       that the IRA would not be treated as an inherited IRA; and

·       That the surviving spouse will be eligible to make a tax-free rollover of the proceeds from the decedent’s IRA to an IRA set up and maintained in his own name, as long as the rollover occurred no later than 60 days after the proceeds were received by the surviving spouse in his capacity as administrator of the estate, and all other applicable requirements were satisfied.

In this case the surviving spouse was “lucky” in that he was the sole heir of the estate and the state statue was favorable.  In many case where clients are doing their estate planning the non-probate assets are overlooked.  Non-probate assets do not pass through the will; they pass by beneficiary designation. Therefore it is incumbent when doing your estate plan that you confirm that you have properly designated the beneficiaries of your retirement accounts, IRA’s etc., your life insurance, annuities, and other non-probate assets