Current developments in taxation of individuals: Part 2

This second part of a semiannual update surveys recent federal tax developments involving individuals. It summarizes notable cases, rulings, and guidance on a variety of topics issued during the six months ending October 2024. The update was written by members of the AICPA Individual and Self–Employed Tax Technical Resource Panel. The items are arranged in Code section order. The first part, in the March 2025 issue of The Tax Adviser, covered Secs. 25C through 280E.¹

Sec. 401(a)(9): Required distributions

During the period covered by this update, the IRS issued both final and proposed regulations regarding required minimum distributions (RMDs) from certain qualified retirement accounts.

Final SECURE Act regulations

The IRS had issued proposed regulations² implementing the SECURE Act³ in February 2022 to be effective beginning Jan. 1, 2024. Many comments were received from interested parties, and additional clarifications were announced in 2022, 2023, and early in 2024. In July 2024, final regulations implementing changes to Secs. 401(a)(9), 402(c), 403(b), 408, 457, and 4974 by SECURE were published.⁴ Prior final regulations were rewritten to eliminate the previous question–and–answer format and provide all regulations in a standard format. Notably, the final regulations also reflect certain provisions of the SECURE 2.0 Act,⁵ which was passed in December 2022. Most of SECURE was effective upon enactment in 2019, and SECURE 2.0 has some provisions that were immediately effective. The final regulations are effective for distributions occurring Jan. 1, 2025, and later. The regulations define “eligible designated beneficiary” and explain the 10–year rule imposed for distributions to noneligible beneficiaries of qualified retirement plans and individual retirement accounts (IRAs).

10–year rule: Many commentators disagreed with the IRS interpretation of the 10–year rule as applied to non—eligible designated beneficiaries who inherited from someone who had been taking RMDs before the post–2019 death. The proposed regulations required those noneligible beneficiaries to take RMDs for nine years and liquidate the plan in the year that held the 10–year anniversary of the death, if not before. Because the regulation would have exposed those beneficiaries to penalties for failure to take RMDs for 2021, 2022, 2023, and 2024, the IRS issued Notices 2022–53, 2023–54, and 2024–35 to waive the Sec. 4974 excess accumulation penalty excise tax and put off the onset of RMDs for beneficiaries subject to the 10–year rule until 2025. The 10–year period was not extended in any notice.

Distributions from designated Roth accounts: Before the passage of the SECURE 2.0 Act, RMDs from qualified retirement accounts that featured a designated Roth account had no special treatment for the after–tax portion of the RMD. To take into account the SECURE 2.0 provision that RMDs are not required from the designated Roth account, final Regs. Sec. 1.401(a)(9)-5(b)(3) provides that for purposes of determining the RMD, the account balance does not include amounts held in a designated Roth account.⁶

See–through trust: The regulations define a “see–through trust,” which allows RMDs from trusts because of the ability to look through the trust and determine the beneficiary with the shortest life expectancy.⁷ Earlier final regulations used the requirements of a “see–through trust” but not the description; “see–through trust” was used in letter rulings to determine whether a trust qualified as a designated beneficiary. The previous final regulations required that the trustee of a retirement beneficiary trust provide a copy of the latest version of the trust agreement to the plan administrator/IRA custodian by Oct. 31 of the year after the death. The new final regulations impose this requirement only for trusts that are beneficiaries of qualified plans. IRA beneficiary trusts need not provide the IRA custodian with a current trust agreement beginning in 2025.⁸

Multi–beneficiary trusts: The final regulations make another change for trusts. The proposed regulations had a special rule for multi–beneficiary trusts that provided for two types of multi–beneficiary trusts. The final version makes it easier for multiple beneficiaries, whether they are trusts or not, to determine RMDs separately.⁹

Excise tax for missed RMDs: The excise tax rate on excess accumulations was reduced from 50% to 25% by SECURE 2.0. Missed RMDs that generate this tax could be made within a correction period to reduce the tax rate to 10%. The correction period begins Jan. 1 of the year after the missed or reduced RMD and ends the earlier of (1) the date a deficiency notice is mailed; (2) the date on which the Sec. 4974 tax is imposed; or (3) the last day of the second tax year that begins after the end of the tax year in which the Sec. 4974 tax is imposed. Commentators have indicated that this time period is hard to determine because the date on which the tax is imposed is unclear.

Other provisions: Existing rules under Sec. 402(c) were updated to conform to law changes since 1995. The final regulations also clarify that Sec. 403(b) contract distribution rules follow the rules for IRAs that are not Roth IRAs.

Proposed SECURE 2.0 regulations

SECURE 2.0 made additional retirement plan changes. Many of the changes were effective upon enactment. The IRS has issued notices to assist employers, plan administrators, and taxpayers with some of the law changes resulting from SECURE 2.0. In July 2024, simultaneously with the final regulations discussed above, the Service issued new proposed regulations.¹⁰

Distributions from designated Roth accounts: Before the passage of SECURE 2.0, RMDs from qualified retirement accounts that featured a designated Roth account had no special treatment for the after–tax portion of the RMD. Required distributions came pro rata from both the pretax and designated Roth account portions of the plan, but the designated Roth account RMDs were tax–free and were so designated on Form 1099–R, Distributions From Pensions, Annuities, Retirement or Profit–Sharing Plans, IRAs, Insurance Contracts, etc. SECURE 2.0 removed the requirement that the designated Roth account be considered in calculating RMDs.¹¹ The proposed regulations indicate that a distribution from a designated Roth account would not be considered an RMD and could be rolled over to a Roth IRA.¹²

Sec. 4974 corrective distributions: Amounts paid to reduce or eliminate a shortfall in an RMD under Sec. 4974 are not treated as RMD payments for the year of the correction, per the proposed regulations. The distribution during the correction period is not an RMD for the year it is made and does not qualify as a distribution eligible for rollover.

Surviving spouse’s election: Section 327 of SECURE 2.0 allows a surviving spouse to elect to be treated as the deceased employee for purposes of the RMD rules. The final regulations provide the spousal election will apply automatically when the employee dies before reaching his or her required beginning date but allow the surviving spouse to elect out of being automatically treated as the deceased employee. Previous law allowed the survivor to defer the start of RMDs until the decedent was required to begin, but the less advantageous single–life table was required.

If the employee dies on or after reaching the required beginning date, the election for the spouse to be treated as the deceased employee does not apply automatically. However, the proposed regulations allow the automatic election to be the default election under the terms of a plan.

Sec. 401(k): Cash or deferred arrangements

Some other notable developments relating to qualified retirement plans include the following:

Forms W-2 and 1099-R reporting

Under SECURE 2.0, employers and plan administrators must provide additional information on information returns to allow the taxpayer to gather information for their federal income tax returns. The IRS issued a fact sheet in August 2024.¹³ It explains, for instance, that SECURE 2.0 allows employers to provide de minimis financial incentives to employees to encourage plan participation, and these incentives are part of the employees’ income and are subject to regular tax withholding unless a specific exemption applies. Thus, the incentive amounts generally need to be added to Form W–2.

An employer that maintains a SEP or SIMPLE IRA plan can offer participating employees the option to designate a Roth IRA as the IRA to which contributions under the arrangement or plan are made. Salary reduction contributions to a Roth SEP or Roth SIMPLE IRA are subject to federal income tax withholding, Federal Insurance Contributions Act taxes, and Federal Unemployment Tax Act taxes. These contributions should be included in boxes 1, 3, and 5 of Form W–2. They are also reported in box 12 with code F (for a SEP) or code S (for a SIMPLE IRA). Employer match and nonelective contributions are reported on Form 1099–R because they are not subject to withholding tax. The total amounts are listed in boxes 1 and 2a of Form 1099–R with code 2 or 7 in box 7, and the IRA/SEP/SIMPLE checkbox is checked.

Designated Roth and nonelective contributions are also reported on Form 1099–R; special rules apply to Sec. 457(b) plans. The SECURE 2.0 reporting changes are discussed in the 2024 instructions for Forms 1099–R and W–2.

Self-prepared returns

In the Tax Court case Pope,¹⁴ the taxpayers deducted contributions of $14,000 to an IRA on their 2020 Form 1040, U.S. Individual Income Tax Return. They did not have IRAs, but $4,911.72 was contributed to the husband’s 401(k) plan that year. They contended that the software should have alerted them if the IRA deduction was not correct. The court suggested that taxpayers who, like the Popes, lack professional assistance in filing their Form 1040 read its instructions and held that it could not remove the interest charges on the underpayment because it lacked jurisdiction to do so.

Sec. 404A: Deduction for certain foreign deferred compensation plans

In Green,¹⁵Gordon Green contended that his Canadian Registered Retirement Savings Plan (RRSP) should be exempt in his federal bankruptcy case. The Seventh Circuit analyzed the Bankruptcy Code, Internal Revenue Code (IRC), and Illinois state law in determining that the RRSP is not a tax–qualified retirement account under the IRC and was not entitled to an exemption in bankruptcy.

Fraud victim gets additional 60 days: In IRS Letter Ruling 202441015, the taxpayer was a victim of a complicated scheme in which she received a false computer alert that said she had explicit material on her computer and then was told that, to avoid prosecution or other consequences, she needed to transfer IRA funds to a checking account, purchase cryptocurrency, open additional checking and credit union accounts, and mail funds to a post office box in another state. She was also told that her identity had been stolen. She realized she had been scammed and contacted a federal agency that was able to recover some of the IRA funds. With the help of the agency, she was able to transfer funds from the credit union and bank accounts into the original IRA. Because she was a victim of a fraudulent scheme, the IRS granted her additional time to accomplish the rollover, waiving the 60–day rollover requirement. The ruling mentioned that RMD funds could not be rolled over, which indicates that the fraud victim was probably older than 70.

Sec. 469: Passive-activity losses and credits limited

Sec. 469(a)(1) generally disallows any current deduction for a taxpayer’s passive–activity losses in excess of passive–activity income. Under Sec. 469(c)(2), a rental activity is a per se passive activity unless the taxpayer materially participates in the activity as a real estate professional, as defined in Sec. 469(c)(7)(B).

Under Sec. 469(c)(7)(B), a taxpayer must meet two requirements to qualify as a real estate professional:

• More than one-half of the personal services the taxpayer performed in all trades or businesses during the tax year are performed in real property trades or businesses in which the taxpayer materially participates, and
• The taxpayer performed more than 750 hours of services during the tax year in real property trades or businesses in which the taxpayer materially participated.

In three recent cases, taxpayers failed to qualify as real estate professionals, resulting in the disallowance of the deduction of passive–activity losses.

In Foradis,¹⁶ the Tax Court held that losses incurred by married taxpayers in connection with a carriage house they constructed as a rental property were nondeductible passive losses because neither spouse qualified as a real estate professional under Sec. 469(c)(7)(B). Timothy Foradis and his spouse, Jessica Moore, filed a 2020 joint federal income tax return claiming a rental real estate loss of $22,376 on Schedule E, Supplemental Income and Loss. That year, Foradis earned wages of $78,501, Moore earned wages of $82,873, and both worked approximately 40 hours per week as full–time employees. During 2020, while he was working full time, Foradis asserted that he spent an additional 48 hours per week (2,500 hours total) constructing the carriage house, which was then placed into service as a short–term rental. The court did not find it credible that he spent more hours constructing the carriage house than he did at his full–time job and thus concluded that he did not spend more than one–half of his total personal services on the rental real estate activity in the year at issue. Since he failed the first of the Sec. 469(c)(7)(B) real estate professional tests, the court held that the taxpayers were not entitled to deduct the loss from their rental real estate activity in 2020.

In Gossain,¹⁷ Krishan Gossain worked full time as an employee and also spent time working on rental properties he owned with his wife. For each of the years in question (2018 and 2019), the couple claimed real estate loss deductions totaling approximately $60,000. The IRS determined that Gossain had not established that he was a real estate professional under Sec. 469(c)(7); therefore, the losses from the house rental activities were passive losses and allowable only to the extent they qualified for deduction under the Sec. 469(i) special allowance for real estate activities in which a taxpayer actively participates.

The Tax Court agreed. For 2018, the court found that Gossain’s total hours worked on the properties were 125.5 or less, and thus he did not meet the Sec. 469(c)(7)(B)(ii) 750–hour test. Also, because Gossain had a 40–hour–per–week job during 2018, he failed the Sec. 469(c)(7)(B)(i) one–half–of–services–performed test. No evidence was presented regarding hours worked on the rental activity in 2019, so the court determined that he failed to satisfy both tests for that year as well. Because Gossain did not qualify as a real estate professional for either year, Sec. 469(c)(2) applied to the rental property activity, and consequently it was a passive activity.

In Warren,¹⁸ the taxpayer, James M. Warren, worked full time as an employee for an aerospace and defense contractor and also spent time repairing and improving a property he intended to open as an assisted–living facility to provide professional caregiver services in a group–home setting. As work progressed on the group home, Warren rented rooms and received about $6,000 of rental income during 2017, the year at issue. There was no evidence presented that the tenants received caregiver services or assisted in the renovations while residing at the group home. On his 2017 income tax return, Warren reported no rents on Schedule E and a net loss for rental real estate expenses incurred of $41,733. The IRS determined that Warren was not entitled to the loss deduction claimed and that he was not eligible for the special allowance for real estate activities provided in Sec. 469(i).

The Tax Court concurred. Warren presented time logs to support his argument that he qualified as a real estate professional, but the logs were created shortly before trial, and the court found them largely unsupported and not credible. Even if the logs had been accepted as accurate, Warren’s total time spent on the rental property was less than the hours he worked for his employer; therefore, he failed the Sec. 469(c)(7)(B)(i) one–half–of–services–performed test and did not qualify as a real estate professional.

The Tax Court noted that Sec. 469(i) allows a taxpayer who “actively participated” in rental real estate activities during any tax year to deduct up to $25,000 of the passive–activity losses attributable to those activities in that year. This deduction begins to phase out when a taxpayer’s adjusted gross income (AGI) exceeds $100,000 and phases out entirely when AGI reaches $150,000. Because his AGI exceeded $150,000, the court held that Warren was ineligible for the exception under Sec. 469(i). 

Sec. 1001: Determination of amount of and recognition of gain or loss

Several proposed regulations related to digital asset transactions were finalized with the publication of T.D. 10000 on July 2, 2024. Broadly speaking, these regulations require brokers to file information returns and furnish payee statements on dispositions of digital assets handled for customers in certain sale or exchange transactions. There are also similar reporting requirements when real estate purchasers use digital assets to acquire real estate. The finalized regulations include, but are not limited to, Regs. Secs. 1.1001–7 and 1.1012–1. The following discusses certain revisions made to those proposed regulations in the final versions. The rules provided in the final version of Regs. Sec. 1.1001–7 apply to all sales, exchanges, and dispositions of digital assets on or after Jan. 1, 2025. The rules provided in Regs. Secs. 1.1012–1(h) and 1.1012–1(j) apply to all acquisitions and dispositions of digital assets on or after Jan. 1, 2025.

Exchanges of digital assets for digital assets

Prop. Regs. Sec. 1.1001–7(b)(1) generally provided that taxpayers are required to compute an amount realized “[i]f digital assets are sold or otherwise disposed of for cash, other property differing materially in kind or in extent, or services.” Comments related to this provision questioned whether the exchange of digital assets for other digital assets “differing materially in kind or in extent” should be treated as a taxable disposition. Treasury and the IRS maintained their position in the final regulations that an exchange of digital assets for digital assets gives rise to a realization event so long as the exchanged properties are “materially different.”

An additional comment requested a framework be provided to analyze the term “differing materially in kind or in extent” with respect to digital assets. Treasury and the IRS chose not to provide a framework, instead stating that the determination of whether property is materially different in kind or in extent is a factual one and beyond the scope of the regulations.

Allocating transaction costs

Prop. Regs. Sec. 1.1001–7(b)(2)(ii)(A) provided the general rules for allocating transaction costs when computing the amount realized from the sale or exchange of digital assets. Specifically, the proposed regulation provided in pertinent part that “total digital asset transaction costs paid by the taxpayer are allocable to the disposition of the digital assets.”

Prop. Regs. Sec. 1.1001–7(b)(2)(ii)(B) included a special rule for digital assets received in exchange for other digital assets that “differ materially in kind or in extent.” Under this rule, half of the transaction costs were required to be allocated to the digital assets disposed of for purposes of computing the realized gain. The other half were to be allocated to the basis of the digital assets acquired.¹⁹

Regs. Sec. 1.1001–7(b)(2)(ii)(A) retained the general rule in the proposed regulations. However, Regs. Sec. 1.1001–7(b)(2)(ii)(B) did not include the special basis rule included in Prop. Regs. Sec. 1.1001–7(b)(2)(ii)(B) related to the allocation of transaction costs related to the exchange of digital assets for digital assets that “differ materially in kind or in extent.” Instead, the final version of Regs. Sec. 1.1001–7(b)(2)(ii)(B) adds a new special rule for “cascading digital asset transaction costs.” Lastly, Regs. Sec. 1.1012–1(h)(2)(ii) includes rules corresponding to and consistent with the rules of Regs. Sec. 1.1001–7(b)(2)(ii).

Sec. 1014: Basis of property acquired from a decedent

On Sept. 17, 2024, the IRS issued final regulations under Secs. 1014(f) and 6035²⁰ that provide guidance on the statutory requirement that a recipient’s basis in certain property acquired from a decedent be consistent with the value of the property as finally determined for federal estate tax purposes. The final regulations also provide guidance on the statutory requirements that executors and other persons provide basis information to the IRS and to the recipients of certain property.

There are competing interests when one considers the reporting of the value for estate tax purposes and reporting the value from an individual’s perspective. Often, the estate wants the value of the assets as low as possible so that the estate pays the least amount of estate tax. At the same time, the beneficiary wants the value as high as possible, so when they sell it later, they have the least amount of gain (or a larger loss).

In response to the proposed regulations,²¹ commenters had noted the need for areas of improvement, notably, concerns about a zero–basis rule for after–discovered and other omitted assets. The final regulations provided the following changes:

Consistent–basis requirement: Sec. 1014(f)(1) provides that the basis of certain property acquired from a decedent cannot exceed that property‘s final value for purposes of the federal estate tax imposed on the estate of the decedent or, if the final value has not been determined, the value reported on a required statement. This is referred to as the “consistent–basis requirement.” The final regulations explain that the property subject to the consistent–basis requirement is referred to as “consistent–basis property,” which is described in final Regs. Sec. 1.1014–10(c)(1).

Based on comments made in response to the proposed regulations, the IRS revised the rule in Prop. Regs. Sec. 1.1014–10(a) describing the duration of the consistent–basis requirement. The IRS revised the rule (which has been moved to Regs. Sec. 1.1014–10(a)(3)) to clarify that the consistent–basis requirement applies until the entire property is sold, exchanged, or otherwise disposed of in a recognition transaction for income tax purposes (whether or not any amount of gain or loss is actually recognized) or the property becomes includible in another decedent’s gross estate.

Under the rule, because a Sec. 1031 like–kind exchange is not a recognition event for income tax purposes, substituted property obtained in a like–kind exchange is subject to the consistent–basis requirement until the owner’s basis in every portion of the substituted property no longer is related, in whole or in part, to the final value of the property that was acquired from the decedent.

Exclusions: The final regulations clarify that property that is subject to a partial exclusion for the marital or charitable deduction is still subject to the consistent–basis requirement. Wholly deducted property for the marital or charitable deduction is excluded from the requirement. The preamble to the final regulations states:

Some examples of property qualifying for only a partial marital or charitable deduction, and, therefore, not excepted from the consistent basis requirement, are: (1) a charitable remainder trust, a charitable lead trust, or a pooled income fund; (2) a trust subject only to a partial [qualified terminable interest property] election under [Sec.] 2056(b)(7); and (3) property divided between the decedent’s surviving spouse and a charity if the sum of the deductions for the two interests given to those recipients is less than the value of the property included in the value of the gross estate.

After–discovered or omitted property: The proposed regulations included a zero–basis rule under which, if an item is not valued in the estate, it had zero basis. But the zero–basis rule presented several problems: Usually, an omitted item was inadvertently left off the estate tax return, and the beneficiary may not have any authority to correct the issue with the IRS. Commenters on the proposed regulations pointed this out, as well as questioning the IRS’s statutory authority to include a zero–basis rule. In the preamble to the final regulations, Treasury and the IRS stated that they do have the authority to enact the rule, but they considered the comments and removed this rule from the final regulations and clarified that the consistent–basis requirement applies only to “included property,” which is defined in the regulations as property, the value of which is included in the value of the decedent’s gross estate under Sec. 2031 or 2103.²² This is potentially the most significant change from the proposed regulations in the final regulations.

Additional terms: For purposes of the consistent–basis rule, the final regulations also define “executor,” “contested,” “estate tax liability,” “included property,” “allowable credits,” and “United States dollars.”²³

Comments requesting new process for beneficiary to challenge value: What can a beneficiary do if they receive an item of property for which the estate has inaccurately stated or understated the value, especially if the beneficiary is subject to the consistent–basis rule? Commenters brought up the issue of a beneficiary challenging the value, but, as they had when issuing the proposed regulations, Treasury and the IRS declined to provide procedural relief due to administrability and other concerns.

However, the preamble also states that Treasury and the IRS “are considering issuing guidance in the future that grants a beneficiary of property subject to the consistent basis requirement the opportunity to provide certain credible evidence of value.” Because of administrability concerns, though, Treasury and the IRS anticipate that the opportunity to provide such credible evidence of value would be available in some limited time frame and only if the evidence points to a substantial understatement of value.

Sec. 1042: Sales of stock to employee stock ownership plans or certain cooperatives

In Berman,²⁴ a case of first impression, the Tax Court held that the taxpayers were allowed to use the installment sale method to recognize gain from the sale of stock to an employee stock ownership plan (ESOP) pursuant to Sec. 1042(e).²⁵

Sec. 1042 allows taxpayers to elect to defer recognition of gain from the sale of certain stock to an ESOP or to an eligible worker–owned cooperative with respect to which they purchase qualified replacement property (QRP) within a replacement period.²⁶ However, such deferral is generally allowed only until disposition of the QRP.²⁷

Sec. 453, governing installment sales, generally applies to the extent of gain from the sale or disposition of an asset if at least one payment is received in a tax year after the tax year in which the sale or disposition occurred. This method is required to be used unless an election out of the installment sale method is made pursuant to Sec. 453(d).

In 2002, the taxpayers had each properly elected to defer approximately $4 million of gain from the sale of stock to an ESOP pursuant to Sec. 1042. The taxpayers each received a promissory note in exchange for the stock. No payments on the note were made in 2022; the taxpayers each received payments of approximately $450,000 in 2003. QRP was acquired by each taxpayer in 2003 in an amount sufficient to defer recognition of the entire gain. In 2003, the taxpayers entered into what they thought at the time to be a loan transaction involving the QRP as collateral. However, during the trial, the taxpayers conceded that the loan transaction, which occurred in 2003, was in fact a sale of the QRP.

The IRS argued that, under Sec. 1042(e), the taxpayers were required to recognize gain equal to the gain deferred in 2002 because of the Sec. 1042 election. The taxpayers argued that despite Sec. 1042(e), and because they did not opt out of installment sale treatment, they were eligible to recognize gains resulting from the operation of Sec. 1042(e) pursuant to the installment sale rules of Sec. 453.

The court held that the installment method applies unless a taxpayer affirmatively elects out of it. Furthermore, taxpayers who do not properly report gain consistent with the installment method are nonetheless still subject to the installment sale reporting requirements. Additionally, making a valid Sec. 1042 election to defer gain does not preclude the application of the installment method.

The court held that the taxpayers made a valid Sec. 1042 election to defer the gains on their sales of the ESOP stock and did not opt out of installment sale treatment in 2002. As such, the gain required to be recognized under Sec. 1042(e) was also subject to the installment sale rules, and gain that would otherwise be recognized under Sec. 1042(e) was limited to the amount recognizable after the application of the installment sale method pursuant to Sec. 453.

Sec. 1256: Contracts marked to market

Sec. 1256(g)(7) defines a “qualified board or exchange” for purposes of the Sec. 1256 mark–to–market rules. The European Energy Exchange, a regulated exchange of Germany, holds a valid order of registration under the Commodity Futures Trading Commission (CFTC) Foreign Board of Trade registration system, and the IRS held in Rev. Rul. 2024–23 that it was a qualified board or exchange as long as the order of registration is in place.

Rev. Rul. 2024–23 states that a change in the treatment of certain European Energy Exchange contracts to comply with Rev. Rul. 2024–23 is a change in method of accounting within the meaning of Secs. 446 and 481 and the regulations. In the revenue ruling, the IRS grants taxpayers consent to change their method of accounting for European Energy Exchange contracts entered into on or after Nov. 1, 2024, to the Sec. 1256 mark–to–market method for the first tax year during which the taxpayer holds such contracts. Form 3115, Application for Change in Accounting Method, is not required for this change.

Rev. Rul. 2024–22 similarly holds that the Bourse de Montréal (MX) is a qualified board or exchange. The revenue ruling allows a change of accounting method for MX contracts entered into Nov. 1, 2024, or later to the Sec. 1256 mark–to–market method for the first tax year during which the taxpayer holds such contracts, without filing Form 3115.

Sec. 1402: Definitions

The IRS issued an alert²⁸ regarding tax scams and misleading social media advice related to sick and family leave credits claimed by self–employed taxpayers. The credits were enacted in March 2020 as part of the Families First Coronavirus Response Act, P.L. 116–127, for eligible taxpayers with a trade or business, as provided under Secs. 3131 (paid sick leave) and 3132 (paid family leave). They provided refundable tax credits for small and midsize employers related to the cost of providing paid sick and family leave wages to employees who took leave related to COVID–19. They also created refundable tax credits for self–employed individuals based on the individual’s average daily self–employment income and a specified number of days during the tax year that the individual was unable to perform services as a self–employed individual due to COVID–19.²⁹

One scheme noted in the alert related to the improper use of Form 7202, Credits for Sick Leave and Family Leave for Certain Self–Employed Individuals, where taxpayers claimed a credit based on employee earned income rather than self–employed income. This scheme has been marketed as a nonexistent “self–employment tax credit,” the IRS stated.

Another scheme the IRS warned about relating to the “self–employment tax credit” involves taxpayers creating fictional household employees and then claiming sick and family leave credits for false sick and family medical leave wages that were never paid.³⁰

The IRS urges taxpayers who have legitimate claims to follow steps to verify their eligibility and taxpayers who may not have legitimate claims to amend their returns to remove the claim in order to avoid penalties.

Sec. 1411: Imposition of tax

Taxpayers seek to offset NIIT with foreign tax credits: As discussed in the March 2024 update article on developments in individual taxation,³¹ the Court of Federal Claims ruled in Christensen³² that two U.S. citizens residing in France could claim a foreign tax credit against their net investment income tax (NIIT) liability based on the 1994 U.S.-France tax treaty. According to the court, Article 24(2)of the treaty provided the taxpayers with an independent treaty–based foreign tax credit against the NIIT. In the absence of a treaty, Secs. 27 and 901 would normally prevent this result because foreign tax credits can only offset Chapter 1 taxes, while the NIIT is covered by Chapter 2A.

The Court of Federal Claims reached a similar conclusion in Bruyea.³³ The taxpayer (a dual U.S. citizen and Canadian tax resident) filed Form 1040–X, Amended U.S. Individual Income Tax Return, in November 2016 seeking a refund of $263,523 of NIIT paid with his originally filed 2015 federal income tax return, arguing that he should be entitled to a “treaty–based” foreign tax credit against the NIIT in accordance with Article 24(4) of the 1980 U.S.-Canada treaty. The IRS disallowed the taxpayer’s refund claim in full, contending that foreign tax credits cannot offset the NIIT, prompting the taxpayer to file a motion for partial summary judgment.

Consistent with the taxpayers’ argument in Christensen, Bruyea distinguished the treaty language of Article 24(1) of the U.S.-Canada treaty from that of Article 24(4). While Article 24(1) precludes a treaty–based foreign tax credit against the NIIT because such credit must be determined in accordance with the provisions and subject to the limitations of the United States, Article 24(4) does not contain such restrictive language. According to the taxpayer in Bruyea, Article 24(4) is a stand–alone provision and “independent” from Article 24(1). In a brief filed by the government in support of its own cross–motion for summary judgment, the government contended that Article 24(4) simply modifies the general rule of Article 24(1) and should not be read in isolation. Based on this interpretation, the treaty would not provide the taxpayer with an independent basis for claiming a foreign tax credit against the NIIT.

Ultimately, the Court of Federal Claims sided with the taxpayer, concluding that the income tax treaty between the United States and Canada provided an independent treaty–based foreign tax credit against the taxpayer’s NIIT liability. The court noted that the treaty not only applies to income taxes but also to taxes “substantially similar” to taxes on income, including the NIIT. In addition, the placement of the NIIT in Code Chapter 2A (rather than Chapter 1) did not preclude the taxpayer from seeking treaty relief.

Bona fide Virgin Islands residents challenge NIIT: In Arcidi,³⁴ a married couple argues that the NIIT does not apply to them as bona fide residents of the Virgin Islands, challenging an assessment made by the Virgin Islands Bureau of Internal Revenue (BIR).

Philip and Erica Arcidi jointly filed their 2019 Form 1040 with the Virgin Islands BIR in October 2020. The return did not include the NIIT in the calculation of their tax liability, pursuant to Regs. Sec. 1.1411–2(a)(2)(vi)(A). In August 2022, the Arcidis received a notice from the BIR indicating that their 2019 tax liability had been increased by $98,551 “to include investment taxes from form 8960.”³⁵ The adjustment was labeled by the BIR as an “arithmetic correction,” which the Arcidis promptly protested. After failing to receive a response from the BIR regarding their protest and request for abatement, the taxpayers filed a complaint with the U.S. District Court of the Virgin Islands.

The Virgin Islands is a so–called “mirror code” jurisdiction (along with Guam and the Northern Mariana Islands). As a mirror code jurisdiction, the Virgin Islands mirrors (or adopts) the tax system of the United States for purposes of enforcing its own income tax laws. To achieve this result, any reference to the “United States” within the Internal Revenue Code is replaced with “Virgin Islands,” and bona fide residents of the Virgin Islands must comply with the IRC in the same manner as residents and citizens of the United States. However, unlike residents and citizens of the United States, bona fide residents of the Virgin Islands report and pay income tax to the BIR on their worldwide income rather than to the IRS. Accordingly, a bona fide resident of the Virgin Islands generally has no income tax filing requirement in the United States so long as the individual reports and pays tax to the BIR in accordance with Sec. 932.

The NIIT was enacted in 2013. In the preamble to proposed regulations issued Dec. 5, 2012,³⁶ Treasury explained that bona fide residents of U.S. territories that are mirror code jurisdictions (including the Virgin Islands) generally have no filing requirement or income tax liability in the United States, provided that they report and pay income tax to their respective territory. For this reason, the NIIT generally does not apply to bona fide residents of a mirror code jurisdiction. Consistent with this premise, Regs. Sec. 1.1411–2(a)(2)(vi)(A) provides that an individual who is a bona fide resident of a U.S. territory is subject to the NIIT only if the individual “is required to file an income tax return with the United States upon application of section 931, 932, 933, or 935 and the regulations thereunder.”

Notwithstanding the plain language of Regs. Sec. 1.1411–2(a)(2)(vi)(A), the Virgin Islands BIR issued a press release in March 2014 indicating that the NIIT applied to bona fide residents “based on the application of the mirror income tax laws that apply in the Virgin Islands.” Similarly, an April 2024 article on the BIR website advises residents to file and pay NIIT with their annual tax filings, as failure to do so could result in penalties and interest.³⁷ Nevertheless, it is not clear whether the agency can assess the NIIT on its residents based on the mirror system. While taxes imposed under Chapter 1 are generally mirrored, taxes imposed under Chapter 2 (i.e., self–employment taxes) are not. Because the NIIT was established under Chapter 2A, it is arguably outside the scope of the mirror tax system and the BIR’s taxing authority — especially since the tax revenue raised from the NIIT does not benefit bona fide residents of U.S. territories such as the Arcidis.

Sec. 4973: Tax on excess contributions to certain tax-favored accounts and annuities

In 2024, the Tax Court held that excess contributions made to Clair R. Couturier Jr.’s IRA were subject to excise taxes and not penalties.³⁸ Couturier argued that the excise tax on excess contributions under Sec. 4973 is a penalty within the meaning of Sec. 6751, which required the IRS to have obtained written supervisory approval of the initial determination of the assessment pursuant to Sec. 6751(b)(1). The Tax Court determined that Sec. 4973 exacts a tax under the Code, not a penalty, and that Sec. 6751 therefore did not apply.

Sec. 6015: Relief from joint-and-several liability on joint return

In Cotroneo,³⁹ Patricia Cotroneo’s husband was convicted of tax evasion. She contended that she qualified for innocent–spouse relief, but the Tax Court found that she had reason to know of the understatement on the couple’s joint return. Furthermore, she had a “heightened duty to inquire in this instance” because, before signing the return, she knew that her husband had recently pleaded guilty to tax evasion. “Her failure to inquire results in her having reason to know of the understatement,” the court explained.

Contributors

Elizabeth Brennan, CPA, is a practitioner in New Orleans. Jodi Eckhout, CPA, is a shareholder with Woods & Durham, Chartered, in Holdrege, Neb. Mary Kay Foss, CPA, practices in Carlsbad, Calif. Karmen Hoxie, CPA, is a solo practitioner in the Minneapolis area. Amie Kuntz, CPA, is a partner in the national tax group of RubinBrown LLP. Jared Lowe, CPA, is a senior tax manager with Deloitte Tax LLP in Fresno, Calif. Stephen Mankowski, CPA, CGMA, is owner and founder of Mankowski Associates CPA, LLC, in Hatboro, Pa. Dana McCartney, CPA, is a partner with Maxwell Locke & Ritter LLP in Austin, Texas. Matthew Mullaney, CPA, is a director, Private National Tax, with PwC US Tax LLP in Florham Park, N.J. Patrick Sanford, CPA, is president of Probity Accounting PLLC in Van Buren, Ark. McCartney is the chair, and the other authors are members, of the AICPA Individual and Self-Employed Tax Technical Resource Panel.For more information about this article, contact thetaxadviser@aicpa.org.

Footnotes

¹Brennan et al., “Current Developments in Taxation of Individuals: Part 1,” 56-3 The Tax Adviser 46 (March 2025).

²REG-105954-20.

³The Setting Every Community Up for Retirement Enhancement Act of 2019, Division O of the Further Consolidated Appropriations Act, 2020, P.L. 116-94.

⁴T.D. 10001.

⁵SECURE 2.0 Act, Division T of the Consolidated Appropriations Act, 2023, P.L. 117-328.

⁶For distribution calendar years up to and including the calendar year that includes the employee’s date of death.

⁷The requirements are listed in Regs. Sec. 1.401(a)(9)-4(f)(2) and thereafter referred to as a “see-through” trust, but Regs. Sec. 1.401(a)(9)-4(f)(1) is headed “Look-through of trust.”

⁸Regs. Sec. 1.408-8(b)(4).

⁹Regs. Sec. 1.401(a)(9)-8(a)(1) allows separate accounts when there is a combination of subtrusts and individual beneficiaries.

¹⁰REG-103529-23.

¹¹Sec. 402A(d)(5).

¹²Prop. Regs. Sec. 1.401(a)(9)-5(g)(2)(iii).

¹³FS-2024-29, Aug. 29, 2024.

¹⁴Pope, T.C. Summ. 2024-15.

¹⁵Green v. Leibowitz, 108 F.4th 530 (7th Cir. 2024), aff’g InRe: Green, No. 22-cv-01402 (N.D. Ill. 8/31/23).

¹⁶Foradis, T.C. Summ. 2024-13.

¹⁷Gossain, T.C. Memo. 2024-97.

¹⁸Warren, T.C. Summ. 2024-20.

¹⁹Also see Prop. Regs. Sec. 1.1012-1(h)(2)(ii)(B).

²⁰T.D. 9991.

²¹REG-127923-15.

²²Regs. Sec. 1.1014-10(d)(4).

²³Regs. Sec. 1.1014-10(d).

²⁴Berman, 163 T.C. No. 1 (2024).

²⁵See also Beavers, “Sec. 1042 Recapture Gain Determined Under Installment Method,” 55 The Tax Adviser 62 (October 2024).

²⁶As defined by Secs. 1042(c)(3) and (4).

²⁷Sec. 1042(e).

²⁸IRS News Release IR-2024-187.

²⁹See Barthel, “Worth Amending For: Credits for Sick and Family Leave,” 54 The Tax Adviser 10 (December 2023).

³⁰IRS News Release IR-2024-302.

³¹Brennan et al., “Current Developments in Taxation of Individuals,” 55 TheTax Adviser 26 (March 2024).

³²Christensen, 168 Fed. Cl. 263 (2023).

³³Bruyea, No. 23-766T (Fed. Cl. 12/5/24).

³⁴Arcidi, No. 3:24-cv-00040 (D.C.V.I. 8/5/24) (complaint filed).

³⁵Form 8960, Net Investment Income Tax — Individuals, Estates, and Trusts.

³⁶REG-130507-11, 77 Fed. Reg. 72612.

³⁷U.S. Virgin Islands Bureau of Internal Revenue, “BIR Offers Tax Tips for Filing the 2023 Tax Return” (April 9, 2024).

³⁸Couturier, T.C. Memo. 2024-6; see also earlier proceedings at T.C. Memo. 2022-69, discussed in Bowles et al., “Current Developments in Taxation of Individuals,” 54 The Tax Adviser 30 (March 2023).

³⁹Cotroneo, T.C. Memo. 2024-70.