On May 30, 2024, the Internal Revenue Service (IRS) announced the Direct File program will be a permanent option. The IRS plans to expand Direct File and offer the option for all states to participate for the 2025 filing season.

During the 2024 filing season, the Direct File program was available in 12 states. More than 140,000 taxpayers used Direct File to complete their return. Following the tax filing season, the IRS conducted extensive inquiries with Direct File users, state officials and other tax professionals. Over 100 members of Congress offered their observations and many organizations also provided opinions on the program.

The IRS emphasized that it needs to decide early in 2025 if it is going to enable additional states to join Direct File. IRS Commissioner Danny Werfel stated, "The clear message is that many taxpayers across the nation want the IRS to provide more than one no-cost option for filing electronically. So, starting with the 2025 filing season, the IRS will make Direct File a permanent option for filing federal tax returns. Giving taxpayers additional options strengthens the tax filing system. And adding Direct File to the menu of filing options fits squarely into our effort to make taxes as easy as possible for Americans, including saving time and money."

With the expanded Direct File program, the IRS plans to work with states who are willing to partner with the program. It also hopes to expand the options and tax situations available to the users.

Werfel continued, "User experience — both within the product and integration with state tax systems — will continue to be the foundation for Direct File moving forward.”

The taxpayers who responded to the IRS surveys indicated they desired no-cost filing options. The IRS emphasized that it will still maintain the existing Free File software that has been provided by eight different commercial tax-preparation companies.

There were several specific observations from taxpayers during the survey.

1. Direct File is Highly Rated — 90% of users have rated Direct File as Excellent or Above Average. 86% of respondents felt it increased trust in the IRS.
2. Easy Tax Filing — Taxpayers indicated the system was easy-to-use. Most users completed their return in less than an hour. Half of these users had paid for tax preparation the previous year. The Treasury Department estimates these Direct File users saved $5.6 million in tax preparation fees.
3. Direct File Promotes a Digital IRS — The IRS was able to combine a team of tax experts, software engineers and data scientists to build the Direct File program. It also used the Live Chat system to provide primary customer support. This automated system will enhance other areas of IRS customer support in future years.

Congress Debates Direct File

There are diverse opinions from the Senators and members of the House of Representatives who oversee the Direct File program. Senate Finance Committee Chair Ron Wyden (D-OR) has been a strong supporter of Direct File. He commented, "Direct File expanding nationwide is tremendous news for taxpayers all over the country who are tired of getting ripped off by the big tax prep companies that routinely upcharge for unnecessary services, oversell the quality of their products and offer crummy customer service."

Wyden plans to provide the IRS with sufficient funding to improve the Direct File program. He believes it could "provide a top-notch level of service to America's taxpayers."

On May 29, 2024, Rep. Ruben Gallego (D-AZ) sent a letter to Treasury Secretary Janet Yellen and IRS Commissioner Daniel Werfel. Gallego also supported the Direct File program and noted, "For those not using Direct File, the tax filing process can often be both time-consuming and expensive. Direct File is the first program of its kind to allow taxpayers to file their taxes directly with the federal government, free of charge.”

Gallego notes that Arizona was one of four states with state income taxes that participated in the program. He inquired with the IRS to respond to specific questions about filing state returns. He asked if there will be steps that will simplify state return tax filing, whether other states in the nation will be able to incorporate their state returns and what are the "greatest unforeseen challenges" with the future of Direct File.

Senate Finance Committee Ranking Member Mike Crapo (R-ID) held a different opinion on Direct File. He noted, "Having the IRS act as tax preparer, tax collector, and tax enforcer raises significant conflicts of interest, and the so-called free program is estimated to cost billions of dollars in development and operational costs."

David Ransom is counsel to the American Coalition for Taxpayer Rights. The Coalition represents a number of large tax-preparation companies. In his view, Direct File "is costly, confusing, and unnecessary, particularly in light of the fact that commercial tax preparers provided more than 23 million free returns this year, as well as another three million free tax returns through the IRS Free File program."

Conservation Easement Deduction Reduced By 90%

In Excelsior Aggregates LLC et al. v. Commissioner; No. 20608-18; No. 7097-19; No. 7703-19; T.C. Memo. 2024-60, the Tax Court analyzed a claimed charitable deduction of $33.72 million based upon conservation easement and fee simple gifts and determined that the permitted deduction would be $3.478 million.

Multiple Alabama partnerships were created for a 4,608-acre parcel known as Big Escambia Tract. The tax matters partner for the 13 partnerships was Big Escambia Ventures, LLC (BEV). The Big Escambia was in southern Alabama in an area where various entities had attempted to mine sand and gravel. The partnerships acquired the tract of land on November 15, 2013, for $9.5 million.

An initial appraisal for the three partnerships in Excelsior Aggregates was rejected because it determined the value to be under $2 million. The promoters for a syndicated conservation easement partnership estimated that the Big Escambia appraisal would need to be between $132 million and $183 million to produce a charitable deduction of $4.389 for every dollar invested. This valuation was unrelated to any appraisal but was determined by "the market" for promoters of conservation easements.

The Big Escambia Tract was divided into 13 parcels with up to 99 investors in each parcel. The total proceeds from investors were $36.16 million. These investors then claimed large charitable income tax deductions. The deductions were based on grants of conservation easements to the National Wild Turkey Federation Research Foundation and subsequent charitable gifts of the property fee interests. Appraiser Clayton Weibel was hired to determine the value and he appraised the property at $187 million. The Tax Court noted this was a significant appreciation rate of 1,872% from $9.5 million in November 2013 to $187 million in December 2014.

The IRS audited the 13 partnerships and denied all charitable deductions. IRS mining expert Abner Patton viewed the property and determined there was a limited potential for mining. IRS appraisal expert Michael Rogers determined the valuation would be appropriately based on comparable sales. Based on five comparables, he valued the property of the three partnerships at approximately $2.6 million.

The taxpayer claimed the appropriate valuation method was a "discounted cash flow" based on mining of sand and gravel. Taxpayer appraiser Steven Hazel determined there could be $60 million of sand and gravel revenue from the property. Taxpayer appraisal Robert Wombwell also did a separate appraisal on 710 acres and determined that value was $1.975 million.

The charitable deduction is based on fair market value, which is defined as the "price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts." If an appraisal assumes a new or different use, then the appraisal may be based on that highest and best use, but it must have a "reasonable probability" that the new use will be appropriate. Reg. 1.170A-1(c).

The comparable sales method is generally deemed the most reliable. However, the taxpayer's appraiser determined that the highest and best use was sand and gravel mining and therefore the discounted cash flow method was acceptable.

However, the evidence indicated that mining the parcel's sand and gravel would be problematic. A prior effort to mine sand and gravel was closed because there were wood elements in the sand and gravel which reduced the commercial value. In addition, there would be millions of dollars in capital costs for the startup efforts to mine sand and gravel. The partnerships had no experience in mining sand and gravel and no capital reserves. Therefore, the comparable sales of the IRS appraiser were deemed to be more relevant.

Furthermore, the discounted cash flow appraisals by taxpayer expert Hazel included multiple errors. The estimate of 30 million tons of sand and gravel did not reflect separate valuations of sand and gravel, which is up to 10 times more valuable than sand. The assumption was that mining would produce 50% gravel and 50% sand products each year, but there was no evidence that the higher-value gravel was close to this 50% number. The assumption was made that there would be medium-sized gravel, but no evidence that this did exist. Finally, there was no credible market data that indicated a hypothetical operator of a sand and gravel mine would be willing to invest the millions of dollars in equipment costs to create a mine.

Therefore, the IRS appraiser valuation was accepted on the first two parcels. However, the Wombwell appraisal on the 710 acres was deemed to be a reasonable approach and therefore was accepted. The net result is the charitable deduction was reduced from the claimed $33.72 million to $3.478 million.

Editor's Note: This Tax Court analysis is an excellent explanation of real estate valuation principles. If a discounted cash flow valuation for a new use is appropriate, the appraiser must show that the value is reasonable and the new highest and best use is a probable option. When the claimed value assumes an appreciation of 1,872%, the Tax Court will be quite skeptical about the appraisal assumptions.

Applicable Federal Rate of 5.6% for June: Rev. Rul. 2024-12; 2024-25 IRB 1 (15 May 2024)

The IRS has announced the Applicable Federal Rate (AFR) for June of 2024. The AFR under Sec. 7520 for the month of June is 5.6%. The rates for May of 5.4% or April of 5.2% 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 2024, pooled income funds in existence less than three tax years must use a 3.8% deemed rate of return. Charitable gift receipts should state, “No goods or services were provided in exchange for this gift and the nonprofit has exclusive legal control over the gift property.”