IRS Regulations and Scam Alerts

Scams are a threat all year round, but in December, as many people plan end-of-the-year charitable contributions, there’s usually an increase in scams that take advantage of good intentions. One scheme in particular could also land the donor in trouble.

The IRS is warning taxpayers to be aware of fraudulent tax schemes involving donations of ownership interests in closely held businesses, often marketed as "charitable LLCs." These schemes, which primarily target higher-income individuals, are deemed abusive transactions by the IRS and can lead to severe financial and legal consequences.

The IRS emphasizes that taxpayers are ultimately responsible for the accuracy of their tax returns. Engaging in these schemes to reduce tax liability can result in the assessment of the correct tax owed, along with penalties, interest, and potential fines and imprisonment. Charities are also cautioned against inadvertently enabling these schemes.

While legitimate deductions for donations of closely held business interests are permissible, unscrupulous promoters sometimes lure taxpayers into schemes involving false charitable deductions. These schemes typically involve creating limited liability companies (LLCs), transferring assets into them, and then donating a majority percentage of nonvoting, non-managing membership units to a charity. 

Meanwhile, the taxpayer retains control of the voting units and can reclaim the assets for personal use. In some cases, promoters may even control the charity receiving the donation.

The IRS is actively investigating these abusive transactions using a variety of compliance tools, including thorough audits and civil penalty investigations. The IRS says hundreds of tax returns have been filed using this scheme, leading to criminal convictions, including a promoter pleading guilty and a donor convicted of obstruction.

Red flags

To avoid penalties and potential legal repercussions, the IRS advises taxpayers to be vigilant against abusive transactions marketed by unscrupulous promoters. Key red flags include promises of personal benefits beyond tax deductions, transactions involving the creation of entities solely for donations, and arrangements allowing personal use of donated assets.

Properly claiming a charitable contribution deduction for a donation of a closely held business interest requires meticulous record-keeping. Taxpayers must document the name and address of the charitable organization, the date of the contribution, and a detailed description of the business interest. 

Additional requirements vary based on the value of the claimed deduction, including obtaining written acknowledgments, completing specific IRS forms, and securing qualified appraisals for larger donations.

First Republic Bank failed over the weekend and regulators sold its assets to JPMorgan Chase. It’s the third bank failure since March. Silicon Vally Bank and Signature Bank failed earlier.

To protect depositors, the Federal Deposit Insurance Corporation (FDIC) agreed to a purchase arrangement with Chase, the nation’s largest bank. In part of the deal, Chase will assume much of First Republic’s debt as well as its deposits.

First Republic’s 84 branches are concentrated in California and the West Coast. There are also branches in Florida and the Northeast. Some of the branches are expected to become Chase locations as the bank takes over.

For people with deposits in First Republic Bank it should be a fairly smooth process. FDIC insures deposits up to $250,000.

‘Deposits continue to be insured’

“Deposits will continue to be insured by the FDIC, and customers do not need to change their banking relationship in order to retain their deposit insurance coverage up to applicable limits,” FDIC said in a statement. “Customers of First Republic Bank should continue to use their existing branch until they receive notice from JPMorgan Chase Bank, National Association, that it has completed systems changes to allow other JPMorgan Chase Bank, National Association, branches to process their accounts as well.”

Industry experts say the reasons for the three bank failures this year differ. In Silicon Valley Bank’s case, much of depositors' money was invested in Treasury bonds that had lost value – on paper at least – when bond yields rose dramatically last year. A run on the bank, triggered by social media, led to huge withdrawals.

The bank had also made loans to many Silicon Valley startups that were not yet profitable and were being squeezed by higher interest rates.

First Republic, which had made a number of loans for expensive real estate, was faced with rising withdrawals by depositors. To make up for that, the bank borrowed heavily from the Federal Reserve in the first quarter.

Buying a home just got even more expensive.

Freddie Mac reports that by its measure, the average fixed-rate 30-year mortgage rate is above 6% for the first time in 14 years, at the start of the financial crisis. Freddie Mac’s Primary Mortgage Survey puts the average rate this week at 6.02, double what it was a year ago.

“Mortgage rates continued to rise alongside hotter-than-expected inflation numbers this week, exceeding 6% for the first time since late 2008,” said Sam Khater, Freddie Mac’s chief economist. 

According to Mortgage News Daily, other interest rate monitors have tracked mortgage rates above 6% earlier this year. Most recently, the publication put the average rate at 6.26% on September 1. Before that, the average rate rose well over 6% in June before settling slightly lower in July.

High rates make homes less affordable

The rise in mortgage rates this year is the main reason for a huge decline in home affordability. Last year, when the average rate was 3%, the monthly principal and interest payment on a $300,000 loan was $1,265. Today, at 6% the monthly payment is $1,799.

Khater says that will affect the housing market in many ways but maybe not the way many would-be buyers hope.

“Although the increase in rates will continue to dampen demand and put downward pressure on home prices, inventory remains inadequate,” Khater said. “This indicates that while home price declines will likely continue, they should not be large.”

Home prices may have to fall significantly to improve affordability with a mortgage rate north of 6%. In August the National Association of Realtors reported the median existing-home sales price was $403,800 – a decline of $10,000 from the month before. However, it was still nearly 11% higher than in July 2021.