The Government Accountability Office (GAO) published a report this week on the IRS Free File program and the methods that taxpayers use when filing returns. On April 12, 2022, the IRS had received 1.83 million Free File returns. This is approximately 1 million fewer than the 2.85 million returns received at the same point in the prior year filing season. The reduced use of Free File is explained in part by the two largest tax return companies no longer participating in the program.

In 2020, H & R Block exited the program. This was followed by the departure in 2021 of Intuit, the parent company of the popular TurboTax program. The two major tax software providers had previously been selected by 70% of Free File users.

While there has been greater use of other tax software providers from the Free File Alliance, the "data shows that none of the current participating companies have replaced the volume of Free File users who previously used the Intuit website."

The GAO report indicates that the IRS should make plans for changes in the future. It states, "While the long history of the Free File program may make IRS officials believe it will continue, assuming that a program will continue is risky. By not managing these risks through the development of additional free online filing options for taxpayers, IRS may be unable to achieve its strategic goal to empower all taxpayers to meet their tax obligations."

The GAO suggested the IRS may want to consider developing other options, such as its own preparation software. The IRS has been reluctant to offer a public free filing option. The GAO noted that it may be difficult to build a high–quality software, but the IRS "may be understating its potential to improve certain aspects of the taxpayer experience."

The GAO report outlined the general usage of different tax filing methods by individuals. Those taxpayers with incomes under $72,000 qualify for the Free File program.

Taxpayer Filing Methods Per 100 Individuals

Number of Taxpayers	Filing Income	Filing Method
29	Over $72,000+	Tax Preparer or Self-Prepared with Tax Software
35	Under $72,000	Paid Tax Preparer
22	Under $72,000	Self–Prepared with Tax Software
7	Under $72,000	Refund Anticipation Loan
3	Under $72,000	Paper Tax Return
1	Under $72,000	Volunteer Inc. Tax Assist./Tax Counseling Elderly
3	Under $72,000	Free File Program

Editor's Note: The IRS has been reluctant to develop a public free file software system. The companies with popular systems have two decades of software experience and it will be quite challenging for the IRS to provide a competitive product.

IRS Delays Supreme Court Review of Conservation Easement Regulation

On April 22, 2022, the U.S. Solicitor General sent a letter to the U.S. Court of Appeals for the Eleventh Circuit and indicated the IRS is not prepared at this time to file a conservation easement appeal to the U.S. Supreme Court.

In Hewitt v. Commissioner, 21 F.4th 1336 (11th Cir. 2021), the Eleventh Circuit determined that Reg. 1.170A–14(g)(6) was invalid under the Administrative Procedure Act (APA). The Eleventh Circuit stated the IRS had not appropriately responded to substantive comments during the period prior to publishing the regulation as is required under the APA.

Following that decision, numerous taxpayers in syndicated partnership conservation easement litigation with the IRS claimed that because the regulation was invalid, the IRS could not rely on it to deny a charitable deduction. The letter concerned Glade Creek Partners LLC v. Commissioner, No. 21-11251 (11th Cir.). It is appealing a denial of a $17.5 million easement deduction.

Following the decision of the Eleventh Circuit in Hewitt, a Sixth Circuit panel in Oakbrook Land Holdings, LLC v. Commissioner, 28 F.4th 700 (6th Cir. 2022) determined that the regulation was procedurally valid under APA.

The deadline for the IRS to appeal Hewitt to the Supreme Court was April 28. This also was the scheduled date for oral arguments in the Glade Creek case. Therefore, the letter states, "We recognize that, with respect to the validity of the proceeds regulation, the published opinion in Hewitt controls the panel's decision in the Glade Creek appeal. Hewitt does not, however, affect the valuation–penalty issue."

Editor's Note: The split in the circuits between the Eleventh Circuit decision to strike down the regulation and the Sixth Circuit decision to uphold it is the classic case for an appeal to the U.S. Supreme Court. At some point, this appeal will occur. It appears that the IRS is allowing other lower courts to make further decisions on syndicated partnerships claiming charitable easement deductions prior to proceeding with an appeal to the Supreme Court.

Limits on Estate Tax Anti–Clawback Rules

In REG–118913–21; 87 F.R. 24918–24923, the Internal Revenue Service (IRS) published proposed regulations that may affect estate taxes if the scheduled 2026 reduction in the basic exclusion amount (BEA) takes effect.

The Tax Cuts and Jobs Act of 2017 increased the BEA from $5 million to $10 million, plus inflation adjustments. If the law is not changed, the BEA reverts to $5 million (with inflation adjustments) on January 1, 2026.

In response to concerns by estate planners that gifts using the larger exemption could subject taxpayers to penalties if the reduced limits take effect in 2026, on November 26, 2019, the IRS published final regulations that created a Reg. 20.2010–1(c) special rule. This special rule stated that if the "credit against the estate tax that is attributable to the BEA is less at the date of death and the sum of the credits attributable to the BEA allowable in computing gift tax payable within the meaning of Section 2001(b)(2) with regard to the decedent's lifetime gifts," there would be a BEA based on the "sum of the credits attributable to the BEA allowable in computing gift tax payable regarding the decedent's lifetime gifts."

The net impact of the special rule is that completed gifts will not be subject to any future clawback. However, the regulation noted that some types of gifts may be an exception to the special rule. These types of gifts could be those with a retained life estate, powers under Sections 2035 through 2038, rights under Section 2042, gifts made enforceable by a promise and those subject to the special valuation rules of Sections 2701 and 2702.

The intent of the special rule is to avoid the imposition of the estate tax on gifts that are not includable in the estate. However, the application of the rule to gifts must reflect the fact that in some cases, the donor has retained "possession, use, benefit, control, or enjoyment of the transferred property during life."

Therefore, the special rule will not be subject to gifts with a "retained a life estate, or subject to other powers or interests as described in Sections 2035 through 2038 and 2042 of the Code, regardless of whether the transfer was deductible pursuant to Section 2522 or 2523, gifts made by enforceable promise, and other amounts that are duplicated in the transfer tax base, including a Section 2701 interest within the meaning of Reg. 25.2701–5(a)(4), and a Section 2702 interest within the meaning of Reg. 25.2702–6(a)(1).” The special rule will also not apply to gifts where there is a transfer or relinquishment within 18 months of the death of the donor.

However, the special rule will apply if the taxable transfer is 5% or less of the total value of the transfer, valued as of the date of the transfer. The IRS considers this a bright line exception.

The IRS provided an example in which a donor transferred a $9 million promissory note to a child when the DEA was $11.4 million. While the transfer was a completed gift, the assets that will be used to satisfy the $9 million note are from the donor's estate, therefore requiring estate inclusion. If the BEA is $6.8 million when the donor passes away, the credit for the estate tax will be based on this $6.8 million date-of-death BEA.

Editor's Note: It is prudent for estate planners to recognize that the existing law will lower the BEA in 2026. However, there have been many attempts to lower the gift and estate exemptions during the past three decades. The failure rate of these efforts to lower the exemptions has been 100%.

Applicable Federal Rate of 3.0% for May -- Rev. Rul. 2022-9; 2022-18 IRB 1 (17 Apr 2022)

The IRS has announced the Applicable Federal Rate (AFR) for May of 2022. The AFR under Section 7520 for the month of May is 3.0%. The rates for April of 2.2% or March of 2.0% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2022, pooled income funds in existence less than three tax years must use a 1.6% deemed rate of return.