During the recent Presidential election, both candidates supported the concept of removing taxes on tips. The One Big Beautiful Bill Act signed on July 4, 2025, created a tax deduction for up to $25,000 in tips for years 2025 to 2028. To qualify, the tips must be received as part of a business in which tips are customarily given to individuals.

There is a limitation, however, on the amount of tips that qualify for the exclusion. If the taxpayer’s adjusted gross income exceeds $150,000 for a single filer, or $300,000 for joint filers, the deduction is phased out. The exclusion is reduced by $100 for every $1,000 of the excess amount. For example, a single filer with $200,000 income would have an excess amount of $50,000. In light of the excess, the individual’s deduction limit would decrease by $5,000, and the individual would be entitled to a deduction of $20,000.

The tips must be paid in cash or with a credit card and must be from a business that is deemed “qualified” by the Treasury Secretary. The Treasury Secretary will provide a list of organizations that "customarily and regularly received tips on or before December 31, 2024."

The tip deduction of $25,000 will be allowed in addition to the standard deduction. It is not necessary to itemize to qualify for the tip deduction. There will be a reporting requirement for tips. The employer will reasonably designate the amount of compensation that has been reported as tips. This information will also be reported to the Internal Revenue Service (IRS).

Editor’s Note: Cash and credit card tips are frequently received in the restaurant and hospitality industry. An estimated 40% of workers in these industries have incomes that do not require them to pay federal income tax. With the standard deduction and $25,000 tip exclusion, most workers in these industries will not pay federal tax. It is probable that many workers will attempt to classify their income as tips to benefit from the $25,000 exclusion. The Treasury Secretary is likely to be quite specific in listing the qualified positions to limit potential improper use of this deduction.

Deceased Spousal Unused Exclusion Denied

In Estate of Billy S. Rowland et al. v. Commissioner; No. 12736-22; T.C. Memo. 2025-76, the decedent's estate was not permitted to benefit from the deceased spousal unused exclusion (DSUE).

Fay Rowland created a trust agreement that provided specific bequests to family, to a foundation for a favorite college, to fund trusts for grandchildren and transferred "one-fourth of my gross estate" to her husband, Billy S. Rowland. Fay passed away on April 8, 2016. Her executor obtained an extension to file on July 8, 2017. However, the Internal Revenue Service (IRS) Form 706, United States Estate Tax Return, was not timely filed on December 29, 2017.

The estate return included a statement which read, "Filed Pursuant to Rev. Proc. 2017-34 To Elect Port Sec. 2010(c)(5)(A).” The basic 2016 exclusion amount was $5.45 million. The gross estate was estimated at $3 million with $1.5 million of allowable deductions, $237,438 in adjusted taxable gifts and a DSUE of $3,712,562.

The assets included shares of Rowland Motors, Inc., shares of Rowland Marietta, Inc., a note receivable and various bank accounts. The estate’s Form 706 did not include information that explained the basis for the claimed value of the assets.

Billy Rowland passed away on January 24, 2018. On a timely filed IRS Form 706, his estate reported a DSUE of $3,712,562. With this DSUE and the 2018 basic exclusion amount of $11,180,000, the applicable exclusion was equal to $14,892,562. Based on this exclusion, Billy’s estate paid approximately $4.5 million of estate tax.

The IRS examined the estate tax return and denied the DSUE on the basis that Fay’s Form 706 had not been filed within the required timeframe. In addition, Rev. Proc. 2017-34 requires complete descriptions of estate assets, unless all property is transferred to charity or a surviving spouse.

Section 2010(c)(5)(A) states a DSUE amount must be elected by the executor of the estate of the deceased spouse. There is a safe harbor under Rev. Proc. 2017-34 for a "complete and properly prepared" return. However, the safe harbor is not applicable if the distributions to charity or surviving spouse are dependent upon the valuation of other assets. If there are other assets, then Reg. 20.2010-2(a)(7)(ii)(A)(1) requires that there be specific explanations of valuation methods.

Because the Trust Agreement of Fay Rowland stated the residue of the estate will pass to trusts for her grandchildren, the trust "was required to provide specific valuation information for each property interest" in the return.

The estate of Billy Rowland claimed there was sufficient information to qualify the DSUE under a "substantial compliance" theory. However, the Tax Court noted "Fay’s Return did not measure up" to the required standard. The instructions state that the return must provide an item-by-item value in detail. The estimates provided in Fay’s Return obscured the potential valuations. Therefore, this return did not meet the substantial compliance standard.

Finally, the estate of Billy Rowland claimed there is equitable estoppel because the IRS initially identified a potential DSUE issue on June 30, 2021, but did not state authoritatively that there was an improper DSUE election until November 15, 2021. However, the Tax Court noted that the IRS legal position does not constitute a flaw and the estate did not qualify for equitable estoppel. Therefore, partial summary judgment was granted to the Commissioner. Thus, the estate tax is payable based on the exemption of Billy Rowland with no reduction for the DSUE.

Charitable Easement Deduction Reduced 99%

In Veribest Vesta LLC et al. v. Commissioner; No. 9158-23, the Tax Court held that the value of a charitable easement was reduced from over $20 million to $111,000. The gross misstatement penalty of 40% also applied.

Grimes quarry is 55 acres of land in Oglethorpe County, Georgia. It is near the Elberton granite deposit and there are multiple quarries in the area. Georgia Gray granite includes die stock, base stock, coping and curbing categories, with valuation from higher to lower in that order.

Quarry owner Larry Cook purchased the Grimes quarry in 2016 for $100,000 or $1,818 per acre. On October 3, 2016, Cook organized Veribest Vesta as a Georgia LLC. In 2018, Cook was placed in contact with True North Resources LLC, the tax partner for multiple business entities. True North organized Millstone Creek, LLC, and sold membership units to investors. Each investor was told that he or she would receive a $4.50 tax deduction for each dollar of investment. On December 31, 2018, Veribest Vesta granted a conservation easement on the Grimes quarry to Oconee River Land Trust.

Veribest Vesta filed IRS Form 1065 and reported a before value of $20.4 million, an after value of $90,000 and a charitable conservation easement deduction of $20,310,000.

The IRS audited the partnership and assessed a tax underpayment of $7,514,700 and penalty of $3,005,880. The parties held a trial and heard from mining fact witnesses, transactional fact witnesses and valuation experts.

Taxpayer expert witness Doug Kenny noted the Grimes quarry "has the potential to become a dimension stone quarry." Taxpayer expert witness David Dye stated a successful mine required a reserve of granite, an experienced crew and capable leader, a market for the stone and operating capital. Dye used a discounted cash flow analysis to estimate the value of the potential granite at $23 million to $33.5 million.

IRS expert witness Patrick Adamson is a Certified General Appraiser in Georgia. He analyzed seven comparable sales with prices per acre of $1,604 to $3,665. He determined that the before value was $165,000 or $3,000 per acre. Therefore, the value of the easement was $111,000.

An appraisal is qualified if conducted in accordance with generally accepted appraisal standards. The IRS claimed the taxpayer’s appraisal did not meet a strict compliance standard. However, the Tax Court noted that the appraisal was in substantial compliance, even though it was outside the normal time window because the appraisal was dated more than 60 days before the actual contribution. Therefore, the sole issue was valuation.

The general rule on valuation is 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." Reg. 1.170A-1(c)(2). Because there typically are no market prices for conservation easements, the valuation is done with a "before and after" approach.

The taxpayer claimed that a discounted cash flow analysis based on the assumption that the quarry mine would be able to extract substantial amounts of granite was acceptable. However, the Tax Court noted that there is a requirement for the highest and best use to be "reasonably probable” for vacant land. If the highest and best use claimed by the taxpayer differs from the existing use, this new use must be reasonably probable.

Because there was no evidence that the Grimes quarry could be operated in a commercially reasonable manner, the Tax Court determined that the comparable sales were the most accurate valuation. Based on the seven comparable sales in the area, the value was determined to be $165,000 or $3,000 per acre. The Tax Court rejected the taxpayer's valuation of $15.35 million to $33.5 million. In addition, the comparable sales by Mr. Kenny that were from $96,545 to $393,455 per acre, were a hundred miles away and therefore not accepted.

The primary error of the taxpayer’s experts was they assumed the existence of an experienced crew, a capable leader and a market for the granite, but did not offer evidence to support these assumptions. Therefore, the valuation claims by the taxpayer were rejected.

Because the valuation reported was $20.31 million and the correct value was deemed to be $111,000, the taxpayer valuation was over 200% of the correct amount. The gross misstatement 40% penalty was applicable. Section 6662(h)(2)(A)(i).

Editor's Note: The Tax Court also noted it could levy a penalty for a frivolous or groundless position under Section 6673(a)(1). Because the claimed value was over 100 times the value determined by the court, the Tax Court stated, "Arguing that a piece of property worth $165,000 is worth in excess of $20 million is patently frivolous." The Tax Court noted that future efforts to pursue similar "incredible, nonsensical, and, quite frankly, smelly arguments may result in sanctions on petitioner or its counsel."

Applicable Federal Rate of 4.8% for August: Rev. Rul. 2025-14; 2025-32 IRB 1 (15 July 2025)

The IRS has announced the Applicable Federal Rate (AFR) for August of 2025. The AFR under Sec. 7520 for the month of August is 4.8%. The rates for July of 5.0% or June of 5.0% 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 2025, 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.”