Washington News

As the April 15-tax filing deadline is approaching, the Internal Revenue Service (IRS) has published its top tax tips for successful filing. The IRS suggests that taxpayers who file near the deadline may benefit from these steps.

The following are several steps that can help ensure a proper return and prompt refund:

1. Prepare To File – Gather all your tax documents. These may include your IRS Form W-2, any Forms 1099 for payments or retirement plan distributions and other documents that reflect your income for the past year. Collect receipts for charitable deductions, Form 1098 for mortgage interest deductions and other documents to support your tax deductions. You should have documentation from your employer if you are claiming the new deductions for tip income or overtime. Having good records help support your claimed income and reported deductions.
2. File Electronically – Most taxpayers benefit from filing an electronic tax return. If you use tax software, it will minimize mathematical errors. The tax software will ensure all income, deductions and credits are correctly reported. Compared with paper returns, eFiling is faster and more accurate. In addition, there is a potential filing issue with paper returns. The U.S. Postal Service affirmed that postmarks may not be applied on the same day they are deposited in a mailbox. Thus, if you file a paper return, you should go to a post office during business hours and obtain a manual postmark. However, filing an electronic return avoids this problem.
3. Make a Tax Payment – The tax amount is due by the tax filing deadline. If you cannot make a full payment, you should still pay as much as you can. By paying part of your tax amount, you will reduce penalties and interest. The majority of taxpayers will file electronically and have any amounts due paid by electronic fund transfer directly from their bank account. There are other electronic payment options available on IRS.gov.
4. Payment Plan, If Needed – The IRS offers eligible taxpayers the option of  payment plans. If you think you qualify for this option, contact the IRS to request an installment agreement. In the case of financial adversity, the IRS may approve a payment schedule that is suitable for your financial circumstances. By setting up a payment plan, you can reduce future penalties and interest.
5. Respond to IRS Notices – If there is an issue with your return, the IRS may send you a letter or notice. The notice may ask for additional information or request an additional payment. You should respond promptly to the notice. If you owe additional tax, there are procedures listed in the letter to discuss or contest the payment with the IRS.
6. Use Online Tools – Taxpayers have many helpful tools available. An IRS Individual Online Account enables you to review your tax balance or make payments. If you wish to check your refund status, the "Where’s My Refund?" tool is available on IRS.gov. You may use Direct Pay for electronic payments. There is also an IRS Document Upload Tool that will enable you to upload information requested by the IRS.

Failed Microcaptive Results in 40% Penalty

In Royalty Management Insurance Co. Ltd. v. Commissioner; No. 3823-19; No. 4421-19; T.C. Memo. 2026-26, a failed microcaptive arrangement resulted in a denial of the deduction for insurance premiums and imposed a 40% penalty.

In a prior opinion, Royalty Management Insurance Co. v. Commissioner, T.C. Memo. 2024-87, the Tax Court held that Royalty Management Insurance Co. (RMIC) was not a qualified insurance company. Therefore, the amounts paid by Sheperd Royalty, a passthrough entity owned by Petitioners, were not deductible insurance premiums under Section 162. The Tax Court noted there was no "evidence pointing to the existence of true ‘insurance’" and sustained a 20% penalty for substantial understatement of income tax. The Tax Court deferred ruling on whether there should be a 40% accuracy-related penalty for an underpayment attributable to a "nondisclosed noneconomic substance transaction."

Following further proceedings and the filing of Supplemental Memoranda, the Tax Court sustained the 40% penalty.

There is a 20% penalty for underpayment of tax if a transaction lacks economic substance under Section 7701(o). The transaction lacks economic substance if it does not change in a significant way the economic position of the taxpayer and the taxpayer does not have any substantial purpose, other than federal income tax savings.

The economic substance doctrine applies to microcaptive insurance arrangements. The taxpayers contended that Section 831(b) constitutes Congressional approval of microcaptives arrangements, and thus the economic substance doctrine is not applicable.

The prior proceeding determined that RMIC was not an insurance company under Section 831(b). Although the taxpayers failed to provide evidence or argument that met the burden of proof, the Tax Court addressed the economic substance question.

The first issue is whether the economic reality of the Sheperds was changed by the arrangement. The Sheperds paid $1,099,900 in purported insurance premiums. However, the insurance company did not exist during 2012, the relevant tax year. There was also no evidence that the microcaptive insurance company was ever licensed or regulated. The insurance company also had zero initial capitalization and no paid-in capital. Therefore, it lacked economic reality because the Sheperds received no insurance from the paid premiums.

The second prong of the test is to determine whether it lacked economic substance. The taxpayers had assigned mineral leases and produced approximately $24 million of gross income in 2012. They had not previously maintained any insurance, including a general business liability policy. Therefore, there was no history of insurance, even with large gross receipts. The Court found that the microcaptive arrangement was not created to replace existing insurance but rather was designed for federal income tax purposes.

Section 6662(b)(6) imposes a 20% penalty for transactions that lack economic substance. The Tax Court determined that the 20% penalty was applicable because the microcaptive insurance arrangement did not meet the required standard. However, there is also the potential to increase the penalty to 40% if "the relevant facts affecting the tax treatment are not adequately disclosed." The disclosure must be sufficient to alert the Internal Revenue Service agent about the nature of the transaction.

In 2012, Sheperd Royalty filed IRS Form 1120S, U.S. Income Tax Return for an S Corporation. It reported the $1,099,900 purported insurance premiums as a deduction. However, it disclosed no facts about the microcaptive insurance arrangement. Therefore, the arrangement was not adequately disclosed, and the 40% penalty applies.

Editor's Note: This is a thorough analysis of both the standard for qualifying as a microcaptive insurance company and the risk of penalties.

Retroactive ERC Cutoff Date is Constitutional

In Juggler Dave and Friends LLC v. United States; No. 1:25-cv-00338, the taxpayer claimed that the retroactive provision affecting the filing date for the Employee Retention Credit (ERC) was unconstitutional. In 2020, Congress enacted the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which included the ERC as a refundable tax credit. The ERC applied to wages paid during 2020 and, subsequently, through 2021.

Juggler Dave and Friends, LLC is an Ohio business that claimed ERCs for the first three quarters of 2021. The claims for Q1 and Q2 were filed before January 31, 2024, and the claim for Q3 was filed after that date. The IRS paid the claims for Q1 and Q2 but denied the payment for Q3. The plaintiff claimed the retroactive application of the cutoff date violated due process and therefore was not applicable. The United States Court of Federal Claims held that the retroactive date was rationally related to the legislative purpose of preventing tax fraud, it did not violate due process, and the Q3 ERC claim must therefore be dismissed.

David Willacker is the LLC's sole member. The COVID-19 pandemic impacted his business and there was a loss from the first quarter of 2019 to the first quarter of 2021 of 24.75% of gross receipts. The comparative loss for the second quarter of 2021 was 49.06%. Finally, for the third quarter, the taxpayer relied on the alternative quarter election and claimed an ERC payment of $218,673.56 should also qualify.

The plaintiff filed quarterly IRS Forms 941 in 2021. On May 1, 2024, the plaintiff filed corrected Forms 941-X and claimed the ERC for the first three quarters of 2021. The IRS barred the third quarter ERC claim because it was filed after the cutoff date provided in the One Big Beautiful Bill Act (OBBBA).

Section 70605(d) of OBBBA stated that "no credit under Section 3134 of the Internal Revenue Code of 1986, shall be allowed, and no refund with respect to any such credit shall be made, after the date of the enactment of this Act, unless a claim for such credit or refund was filed by the taxpayer on or before January 31, 2024."

Congress has authority to amend tax laws retroactively. The taxpayer claimed the 16-month ERC retroactive filing date was excessive, lacked a curative rationale for the law and did not prevent fraud. The taxpayer argued there was a property interest in the refund and had reasonably relied on existing law as of May 2024.

A retroactive law is permitted unless the provision is wholly new, it does not resolve uncertainty in the law, is not curative or remedial, it has an unreasonable period for retroactivity and the parties did not have notice. There is no single factor that is controlling, but all factors are considered.

The modification of the rules on ERC was not a "wholly new tax" but, instead, merely adjusted the rules. Because there was widespread ERC fraud as demonstrated in a July 2023 hearing of the House Ways and Means Committee, there was clear notice that a time bar to prevent fraud was pending. Therefore, the retroactive date was both curative and remedial in response to existing fraud.

The fourth factor is the period of retroactivity. Previously, the federal circuits have approved cases allowing two to five years of retroactivity. With the ERC, the 16 months of retroactivity is reasonable and permissible. Finally, there was adequate notice to the taxpayer. The House Ways and Means Committee hearings had suggested a January 31, 2024-cutoff date for filing ERC claims. Therefore, the taxpayer could not claim lack of notice.

Because the retroactive law is not a wholly new tax, it is curative and remedial, it brings finality to pandemic-era relief programs and it has a reasonable period of retroactivity, the Court held it is constitutionally valid.

Applicable Federal Rate of 4.6% for April: Rev. Rul. 2026-7; 2026-15 IRB 1 (16 March 2026)

The IRS has announced the Applicable Federal Rate (AFR) for April of 2026. The AFR under Sec. 7520 for the month of April is 4.6%. The rates for March of 4.8% or February of 4.6% 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 2026, pooled income funds in existence less than three tax years must use a 4.0% 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.”