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Income Tax Revenue Up 29%

U.S. individual income tax revenue for federal year 2022 increased 29%. The $593 billion increase in income taxes is the largest ever.

Total tax receipts for the federal government were $4.9 trillion, as estimated by the Congressional Budget Office (CBO). This was 21% greater than federal year 2021. This is the largest increase in five decades. Payroll tax was up 13% and corporate taxes were up 14%.

With a dramatic increase in all of the tax collections, the Federal deficit declined substantially in 2022. However, the $1.4 trillion estimated deficit was still the fourth highest ever. The 2020 deficit was the highest on record and reached a peak number of $3.1 trillion.

The 2022 deficit declined substantially because of the return to normal activity after devastating losses to the entire nation during the COVID pandemic. The government had estimated that the 2022 deficit would be approximately $1 trillion. The increase from $1 trillion to $1.4 trillion reflects the decision of the President to offer $426 billion in student loan forgiveness.

The vast majority of federal revenue comes from individual income taxes. Of the total federal revenue, 84% came from individual income and payroll taxes. While there was an $850 billion total increase, 89% of this amount, or $758 billion, was the result of the increased income and payroll taxes.

The individual tax amounts were estimated to increase from $2.04 trillion in 2021 to $2.64 trillion in 2022. The federal 2022 year ended on September 30, 2022.

A moment of history gives some perspective on this large increase in tax payments by individuals. This $539 billion increase in taxes from individuals was greater than the total taxes paid by individuals in 1995.

The Federal budget deficit was down by $548 billion. However, this was primarily due to the phaseout of various pandemic spending programs. There was a $468 billion reduction in tax credits and economic impact payments. The end of the enhanced unemployment insurance benefits saved $359 billion. Finally, the phaseout of the Paycheck Protection Program saved another $300 billion.

As a result of these reduced expenditures, the Federal deficit declined. However, the $1.4 trillion deficit remains a substantial number.

RMD Change Delayed Until 2023

In Notice 2022-53; 2022-44 I.R.B. 1, the IRS announced that proposed new required minimum distributions under a 10-year distribution plan will be delayed from 2022 to 2023.

The IRS previously issued proposed regulations (REG-105954-20) that described procedures that could become applicable for taking required minimum distributions (RMDs) under the 10-year payout method.

Section 401(a)(9)(H) was added by the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act). Under the SECURE Act, the majority of beneficiaries of qualified plans are no longer able to take distributions over their life expectancy. Instead, most beneficiaries are required to take all distributions within a 10-year period. This 10-year rule does not apply to eligible designated beneficiaries (EDBs). Generally, the exceptions for EDBs apply to minor children or other family members who either have a chronic illness or disability under the federal rules.

The SECURE Act applied only to distributions after December 31, 2019. However, the proposed regulations created a new rule for RMDs that was to apply in calendar year 2022. The requirement to take RMDs would be applicable under Prop. Reg. 1.401(a)(9)-5(D)(1)(i) if the IRA owner passed away after his or her required beginning date.

The proposed regulations created a new RMD rule that would require annual distributions during each of the 10 years. The remaining account balance must be distributed by the 10th calendar year after the calendar year of the IRA owner's death.

Notice 2022-53 modifies the proposed regulations and promises final regulations that will also include provisions for transition relief. However, the requirements to take RMDs will be delayed. The notice states, "Final regulations regarding RMDs under Section 401(a)(9) of the Code and related provisions will apply no earlier than the 2023 distribution calendar year."

Editor's Note: It was a shock to many financial professionals when the proposed regulations required RMDs to commence after the death of the IRA owner. The initial assumption was that the 10-year rule would be similar to the existing 5-year rule and there would be complete latitude to select the amount and timing of distributions. However, the final regulations are likely to specify rules and methods for calculating RMDs during the 10-year period. It appears that the final regulations will now be effective for RMD amounts for qualified retirement plan beneficiaries starting in 2023.

Present Value Estate Regulations Controversy

The IRS has issued proposed regulations (REG-130975-08) on the use of present-value principles as applied to various deductible estate expenses. There had been a public hearing scheduled with the IRS on October 12, but it was canceled after there were no individuals who desired to comment. However, there have been at least six major tax associations that have provided the IRS with comprehensive written comments on the proposed regulations.

The proposed regulations provide a three-year grace period after death before the present-value concepts are applicable. At an American Law Institute (ALI) webinar on October 11, several prominent estate planning attorneys commented on the status of the regulations and the prospects for change before they are finalized. Lawrence Katzenstein, partner in the St. Louis law firm of Thompson Coburn noted, "I think it will be a while before these become effective." He believes there will be significant changes in the final regulations.

Kathleen Sherby, senior counsel at Bryan Cave Leighton Paisner LLP, indicated that three years is often not sufficient time to close large estates. In addition, litigation involving an estate could increase that time dramatically. Both the American Institute of CPAs and the Texas State Bar Association Tax Section have asked the IRS for a longer period of time before the present value rules are effective.

Another area of controversy that was discussed in the webinar was the question of necessity for interest expense. Katzenstein stated, "There is very little that is absolutely essential in an estate, but there are many times when it is extremely helpful."

Katzenstein and other estate planners noted that it is extremely difficult to specify when a loan is "essential" and when it is merely convenient.

The proposed regulations attempt to address the issue by stating that loans that are "contrived" will be deemed nondeductible. Sherby noted this "contrived" standard will be difficult to determine. She pondered what factors would be used to determine if an estate is substantially diminished, including if intent will be imputed to the decedent or if gifts to family will be scrutinized.

The regulations appear to be focused on cases in which families with large estates have made significant changes to their plans within days or a few weeks of death. These are viewed by the IRS as creating an intentional liquidity problem. While the regulations seem to be focused on attacking these cases, the estate planning attorneys at the ALI webinar were concerned that the regulations might overreach and impact normal estate planning.

Applicable Federal Rate of 4.0% for October -- Rev. Rul. 2022-18; 2022-40 IRB 1 (16 September 2022)

The IRS has announced the Applicable Federal Rate (AFR) for October of 2022. The AFR under Section 7520 for the month of October is 4.0%. The rates for September of 3.6% or August of 3.8% 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.

Published October 14, 2022
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