Tax Implications of California's Vax for the Win Program

On May 27, 2021, California Governor Newsom’s “Vax for the Win” program with awards to vaccinated and to be vaccinated Californians provides:

• $1.5 million to each of 10 individuals
• $50,000 cash prize for 30 individuals
• $50 gift cards to the first 2 million individuals vaccinated on or after May 27; prize not awarded until vaccination series is completed.

The total cost is $116.5 million.

So, what are the tax consequences?

Accession to wealth, clearly realized so taxable (§61, §74, and Glenshaw Glass, 345 US 426 (1955)) unless an exclusion applies.

Since there are no income limitations for winning, the general welfare exclusion does not apply [see Info Letter 2019-0024]. This doctrine applies to exclude certain government payments when:

1. Paid per a government program
2. For promotion of the general welfare (based on need)
3. Are not payments for services

The prizes are not tied to the California tax system so they are not a tax credit (as the Golden State Stimulus Payments of $600/person are labeled in SB 88. Also, we are unlikely to see any federal legislation creating a special exclusion.

Query: Are the prizes a “qualified disaster relief payment” under §139(b)(4) – “if such amount is paid by a Federal, State, or local government, or agency or instrumentality thereof, in connection with a qualified disaster in order to promote the general welfare”? This term is not defined in §139 and there are no regs. Per JCX-93-01 on P.L. 107-134 (1/23/02): “Qualified disaster relief payments also include amounts paid by a Federal, State or local government in connection with a qualified disaster in order to promote the general welfare. As under the present law general welfare exception, the exclusion does not apply to payments in the nature of income replacement, such as payments to individuals of lost wages, unemployment compensation, or payments in the nature of business income replacement.”

In Notice 2002-76 with Q&As on the application of then new §139 regarding some 9/11 governmental payments, the IRS provided: “Section 139(b)(4) codifies (but does not supplant) the administrative general welfare exclusion for certain disaster relief payments to individuals.” Similarly, see Rev Rul. 2003-12. This exclusion is based on need.

Assuming the prizes are not excludable under §139, will withholding be required for any of these prizes? Per IRC §3402(o) and (q) and regs, probably not. The $50 gift cards to newly-vaccinated individuals might be viewed as issued for wagering but the amount paid is too low to require withholding. Since the first 2 million vaccinated in the stated time period get a gift card, the only gamble seems to be whether you’ll be in that group of two million. The prizes available to those already vaccinated should not require any withholding. Example 9 at Reg. 1.3402(q)-1(f) involves a magazine subscriber automatically entered into a sweepstakes who paid just the normal subscription price and has not placed a wager or entered a wagering transaction. So, there was no withholding  required for the $50K prize the subscriber won.

Observation: The recipients of the $1.5 million prizes (and even the $50K ones) should be offered and encouraged to have federal and California withholding taken from the prize. The terms and conditions do make a reference to tax withholding (perhaps that is just for California?).

Observation: If the winner is under age 18, they apparently can still get the $50 card with the parent’s assistance. But for the larger prizes, the terms and conditions state: “If a winner is a minor, the prize funds will be invested in a savings instrument and the minor will be able to access the funds upon achieving the age of majority. Additional conditions and details about administration of prizes paid to minors will be available before the first drawing.”  The fact sheet says the cash will be put in a savings account until they turn 18.

This raises some interesting accounting method rules (particularly the economic benefit doctrine and constructive receipt rule)! In Pulsifer, 64 TC 245 (1975), winnings from the Irish Sweepstakes were irrevocably deposited to a bank account for a minor for his benefit until reaching age 21. The funds were taxable when won. If instead, the state or other agency is the holder of the winnings until the minor reaches age 18, they likely are not taxable until received later. PLR 9624009 and PLR 200031031 have detailed discussion of this regarding lottery winnings.

The kiddie tax is also relevant if the child is under age 18 or is a full-time student age 19 to 23.

What if the winner declines the prize? The terms and conditions for these vaccine prizes allow this. Will the winner be treated as having income and then a donation to the state of California when they give the prize back?  This is not exactly a wash for taxable income (income less charitable donation) because the high AGI will exclude the individual from many tax rules that phase out at certain high AGI levels. Since the winner is selected without any action on their part to enter the contest, §74(b) should treat the amount as not taxable if transferred to a government or charity immediately. But refusing the prize should make it non-taxable per Rev Rul 57-374. The full text of this old ruling: “Where an individual refuses to accept an all-expense paid vacation trip he won as a prize in a contest, the fair market value of the trip is not includible in his gross income for Federal income tax purposes.”

California: Tax treatment will be the same as federal unless the state enacts an exclusion, which I think is unlikely.

Tax Policy: These prizes are unexpected accessions to wealth and should be taxed. That is, no exclusion should be enacted in California and certainly not at the federal level (no need for non-Californians to subsidize these prizes). While excluding a $50 gift card might seem administratively convenient per person, the aggregate award is $100 million and perhaps 5% average tax – so a lot of revenue. And many recipients may be below the filing threshold and some may be in the highest tax bracket. And, of course, since taxable at the federal level, the federal government will get a portion of these awards.

What do you think? (of these awards and taxation)

Ideas for States for Pandemic Tax and Budget Policies

My latest Moving Forward? article for Tax Notes State is: Suggestions for Pandemic State Tax Policy Endurance (12/17/20). I include a variety of suggestions to help individuals, businesses and state and local governments. I hope you'll take a look - here.

Examples:

• Federally-declared disasters such as the COVID-19 pandemic allow the IRS to extend due datesfor tax returns and tax payments. Last year, the result was a July 15 due date rather than April 15. Most states followed suit. But a big deal for states is that their fiscal years end June 30. The shift of payments to the next fiscal year likely resulted in greater borrowing and costs for the states. However, many high income taxpayers were quite capable of paying taxes normally due on April 15 and June 15. The better message (and true for any future disaster) is to include a plea that if you can pay at the normal time, please do so to reduce costs to the state.
  
  
• COVID-19 legislation included lots of new complexities. This, coupled with state and local rules for paid sick and medical leave, new tax credits and grants, etc. is often too much for many small businesses to deal with. A result is that some may have not claimed benefits they were eligible for or mandated to provide. State and local governments should have systems in place to provide help getting through all of the rules including some online tools. They should also seek assistance from the federal government on this as the benefits and mandates come from all levels of government. There are many retired finance and accountng experts who can help provide these services.
  
  
• Some struggling businesses with tax obligations might prefer to give up unused assets than have outstanding bills that pile up interest and penalties or use cash that is needed for other purposes. A system to take non-cash payments such as buildings and equipment no longer needed, should be in place.
  
  
• Despite tough times, consider clawbacks and safety requirements when grants and tax breaks are misused. For example, any tax break to help with the pandemic should have had the caveat that the business had procedures in place to reduce the spread of the virus. For example, a 1/18/21 Washington Post article reports that at least 5 anti-vaccine groups received PPP funds.
  
  
• While many struggle in the pandemic, some individuals and businesses were doing fine or perhaps even with increased revenues. There is a need for ways to easily enable those doing well do help get supplies and other assets to those in need.  Platforms where people can match resources and needs can help, with governments providing some of the pick up and distribution outlets to help ensure safety of such a system.  My picture above of the oranges in the yard waste garbage is a good example of waste. There were many people who would have been thankful to have had these oranges someone with too many treated as garbage and likely did not have a good way to get them to someone who needed them.

There are more suggestions and perhaps the article will lead you to identify more relief ideas for now and going forward.

What do you think?

Recovery Rebate Fix Needed by Congress to Not Encourage MFS Filing Status

The CARES Act enacted March 27, 2020 included the 2020 recovery rebate for individuals that provided over 160 million adults with $1,200 to help them with financial challenges during the pandemic (see GAO data). The IRS refers to this payment as the Economic Impact Payment (EIP) and as of today (8/1/20) has provided 70 FAQs to help explain it! The provision added Section 6428 to the Internal Revenue Code.

I was surprised by FAQ 26 and its answer because I would think that if for a married couple one spouse has an SSN and the other has an ITIN which disqualifies that spouse for an EIP, the spouse with the SSN would still have been given $1,200. But that will only happen if they file as Married Filing Separately rather than as Married Filing Jointly.

Q26. I filed a joint return with my spouse. Will we receive a Payment if I have a valid SSN and my spouse has an IRS Individual Taxpayer Identification Number (ITIN)?

A26. No, when spouses file jointly, both spouses must have valid SSNs to receive a Payment with one exception. If either spouse is a member of the U.S. Armed Forces at any time during the taxable year, only one spouse needs to have a valid SSN.

If spouses file separately, the spouse who has an SSN may qualify for a Payment; the other spouse without a valid SSN will not qualify.

In reviewing Section 6428, the rationale for this answer seems to be at Section 6428(g)(1)(B) which in explaining the identification number requirement states that a person filing a joint return only gets an EIP if the spouse has an EIN. So, the answer from the IRS appears to be correct.

So, the problem is with the text of the law. I say this because the tax law doesn't encourage using the MFS status over the MFJ status. The tax law provides that when a married couple file separately, there are several favorable rules they will no longer qualify for. These include the Earned Income Tax Credit, the dependent care credit, most education tax breaks, and a few others (see page 7 of Pub 501).

I think the rationale for the harsh treatment for MFS that has existed in the law for a long time is that it is extra work for the IRS to be sure both spouses are not claiming benefits where only one may be allowed to claim them. Generally, MFS is only used where a spouse wants to avoid joint liability for the taxes owed or their combined taxes will be lower with that status (which occurs in rare situations).

I believe Section 6428(g) is incorrect because the tax law should not be encouraging MFS over MFJ. For example, a couple with children where one spouse has an SSN and the other has an ITIN, will need to determine if skipping the $1,200 EIP is better than losing an EITC and other tax breaks. This awful decision should not have to be made - a fix is needed from Congress.

I hope that the next round of COVID legislative relief will correct this by removing Section 6428(g)(1)(B). The IRS can easily tell from a MFJ return that one spouse has an SSN and the other has an ITIN so only issue the EIP to the spouse with the SSN. Thus, (B) at (g)(1)is not needed. This change would also enable the IRS to issue these EIPs based on the 2018 or 2019 returns already filed.

What do you think?

Are travel tax subsidies a good idea?

On May 18, 2020, President Trump met with some restaurant execs and suggested a few tax law changes to help the industry. This included "restore the restaurant deduction to help jobless restaurant workers" He also suggested: "Create an “Explore America” — that’s “Explore,” right?  Explore America tax credit that Americans can use for domestic travel, including visits to restaurants."

On June 22, 2020, Senator McSally (R-AZ) introduced S. 4031, American Tax Rebate and Incentive Program Act (the American TRIP Act). This bill would add new IRC §25E, Travel, Hospitality, and Entertainment Expenses. This bill does the following:

• Provide a 100% nonrefundable credit on up to $4,000 of expenses for travel and restaurant usage ($8,000 MFJ) + $500 x # qualifying children (under age 17).
• The credit is for qualifying travel in the U.S. and its territories that is over 49 miles from the taxpayer's home for food, lodging, transportation, live entertainment (including sporting events), expenses related to attending conference or business meeting).
• For use of a personal vehicle, the amount considered spent is measured using the standard mileage rate in effect under §162(a), with is 57.5 cents/mile for 2020 (this is the rate that includes depreciation so too high for personal travel).
• The credit is based on travel after 12/31/19 and before 1/1/22 per the text of S. 4031 (so 2020 and 2021). However the sponsor's press release says the credit applies for 2020, 2021 and 2022.
• Travel to the taxpayer's vacation home is okay if 50 miles or more away, but expenses of the home don't qualify.
• S. 4031 also allocates $50 million of grant funds to promote tourism and travel in the U.S.

Is this a good idea? Let's consider the likely purpose and how it stacks up against a few principles of good tax policy.

Purpose: Encourage people to travel and spend money at hotels and restaurants and buy airline, bus or train tickets or gasoline, and to support theaters, amusement parks and sporting events. Will it be enough for people to risk exposure to COVID-19? Might it be enough for these facilities to put more protection in place for customers? Might it send a message that travel and interaction with others is safer than it might really be? What about helping other industries such as local restaurants, theaters, fitness centers and stores?

Why is this effective starting on January 1, 2020? This means the credit subsidizes behavior that already took place - a retroactive incentive. That is a waste of funds.  Personally, I was in DC for two extra days as part of a business trip before the pandemic. That would qualify for the credit, meaning that with a 100% credit, all of my fellow taxpayers would subsidize my expenses on those two days. Why? There is no purpose for this subsidy or gift.

Certainly, the effective date should be after enactment, not before.

Equity: Generally a credit is more fair than a deduction because the credit is worth the same amount to all taxpayers. However, this credit is not refundable so it it not available to many taxpayers or won't cover all of their travel even if below the specified credit amounts, but the full credit is easily available to higher income taxpayers, so they get a significant subsidy.

For example, assume a married couple with no children has taxable income of $70,500 in 2020. Their tax liability is $8,065. They should think ahead and take a vacation and spend that much money. Basically, instead of paying that total to the U.S. Treasury, they can spend $8,000 on a vacation and just owe $65 to the government. In contrast, if this couple's taxable income in 2020 is instead $19,000, they owe only $1,900 (less or zero if they are eligible for the EITC, particularly is they have a child). So if they managed to spend $3,000 on their vacation, they get a subsidy of only $1,900.

Simplicity: The terminology seems clear. But, what documentation will need to be maintained and forms completed? 

Minimum tax gap: Might some taxpayers just say they took a trip to get the tax break? Hopefully not but if there is no reporting form, it could happen. Also, the credit is better than a business deduction so self-employed individuals who need to travel for business may be better off making sure the trip doesn't qualify as a business deduction so they can claim the 100% credit instead.

So, while the purpose to help out restaurants and the travel industry may sound good, this large non-refundable credit means that the government (that is, all taxpayers) will in essence, subsidize vacations for individuals with tax liabilities up to $8,000 (more if the married couple has children under age 17). Fairness and the cost to government revenues is a significant issue.

What do you think?

Employee Retention Credit Issue - What is likely policy resolution?

Having been in the taxation and tax policy field for over 30 years, I've spent a lot of time studying, researching, speaking, testifying and writing about tax reform.  Since early March 2020 with the COVID administrative and legislative changes and proposals, I can't recall a busier and more complex time so far as tax changes go.  There have been a lot of changes enacted quickly.  Drafters are doing a great job. Issues easily arise as to interpretation though due to lack of time for adequate review and discussion prior to enactment and due to the volume of changes. Hopefully areas of confusion can be resolved soon so individuals and businesses in need of the legislated assistance can take advantage of the benefits without worry that they may have to give them back later.

I have spend a lot of time over the past many weeks on the following multi-faceted (complex) provisions:

1st - The required paid sick and medical/family leave for employers with under 500 employees in the Family First Coronavirus Response Act (FFCRA) (PL 116-127; 3/18/20). The required salary payments produce refundable payroll tax credits for the employer. And, equivalent credit is provided for self-employed individuals. Between the Dept. of Labor and IRS, there are about 200 FAQs to help explain these provisions!

2nd - The Employee Retention Credit and OASDI deferral of the CARES Act (PL 116-136; 3/27/20). The ERC helps employers who continue to carry on business and pay wages despite facing one of these two tests/reasons:

  1) Government Order Test: Business operations were fully or partially suspended due to government orders limiting commerce, travel, or any group meetings due to COVID-19 [see FAQ 28 to 38]; OR
  2) Reduced Gross Receipts Test: Employer’s gross receipts (per §448(c) definition) are less than 50% of gross receipts for the same calendar quarter of 2019, AND ending with the quarter following the first quarter where gross receipts exceed 80% of gross receipts for the corresponding 2019 quarter [see FAQ 39 – 46]

The key point I want to make for this post (beyond the complexity* of the provisions) is that there is an interpretative issue with the ERC that is significant for many employers. The ERC works differently for employers based on the number of full-time employees they had in 2019. Full-time means working on average at least 30 hours per week. If an employer had 100 or fewer full-time employees in 2019, then if reason 1 or 2 is met for wages paid from March 13 to December 31, 2020, all of the wages count towards the ERC (but limited to $10,000 per employee or a credit of $5,000 per employee). If an employer had over 100 full-time employees in 2019, then the qualified wages are only those paid to employees for NOT working.

Well, how do you count full-time employees? Here is the challenge. The Joint Committee on Taxation states that full-time equivalent (FTE) employees are included (see footnote 145 in the JCT CARES Act report) while the IRS states that only full-time employees are counted (FAQ 49).

Now for many employers, they will reach the same result under either calculation. For example, an employer with ten employees working at least 30 hours per week in 2019 and another ten working twenty hours per week, is a small employer under both definitions.

But let's consider an extreme example to highlight a point that makes the JCT interpretation more equitable (although that doesn't mean it is what Congress intended). Suppose Employer X had 120 full-time employees in 2019 and each worked 30 hours per week and there were no other employees. Clearly, X is a large employer under both the JCT and IRS definitions. In contrast, Employer Y had 240 employees all of whom worked 15 hours per week in 2019, and no full-time employees. Under the JCT definition, Y is a large employer, but under the IRS definition, it is not (no full-time employees in 2019). The ERC calculation is significantly different for Y under the JCT interpretation (only generated for wages paid for hours not worked) while under the IRS definition the credit is based on all wages paid (assuming Y meets reason 1 or 2 above).

Query: Aren't X and Y the same size in terms of hours worked by all employees in 2019?  Seems so. This is likely why the JCT footnote 145 says include FTE employees.  Also, the law refers to IRC section 4980H to define full-time employees which is not clear as to whether that reference is solely for the definition of at least 30 hours per week to be full-time or to also include FTE employees used for section 4980H to determine if an employer is an "applicable large employer" subject to the employer mandate to offer health insurance to its full-time employees and their dependents up to age 26. The text at section 2301 of the CARES Act is brief and doesn't specifically mention FTE employees. But then, why does it even refer to section 4980H rather than just say full-time means at least 30 hours per week?

Hopefully this issue can be resolved soon so affected employers can correctly calculate and claim their refundable ERC to help them in these challenging times.

What do you think?

*I'll share a personal example on the complexity of these employment tax provisions, I have well over 30 hours devoted to figuring out just the three employment tax provisions to present webinars on them of one to two hours in length!

Business Loss Change by CARES Act - Track Changes and Policy

The CARES Act (P.L. 116-136; 3/27/20) or Phase 3 of COVID-19 relief includes several tax law changes for individuals and businesses. Most notable for many (but not all) individuals is the recovery rebate or what the IRS calls the economic impact payment. Generally, this provides many adults with an advance, refundable credit for 2020 - today, of $1,200 +$500 if they have a child under age 17.

A few notable ones for businesses include the ability to carryback net operating losses (NOLs) for 2018, 2019 and 2020 for 5 years even though the TCJA ended this for tax years beginning after 2017 and even though the carryback can go to years when tax rates were higher than today. Employers also have some payroll credits and deferrals that should help with cash flow and some financial relief.

In addition to a temporary NOL change, the CARES Act also temporary changes another TCJA item. The limitation on losses for non-corporate taxpayers (IRC Section 461(l)) is changed to go into effect for tax years beginning after 12/31/20 rather than after 12/31/17. The TCJA's expiration date of tax years beginning before 1/1/26 remains.

There are a few other changes to Section 461(l) including making the technical corrections from the TCJA that are needed. To help see what is changed, please see the track changes version of Section 461(l) I have posted here.

This loss limitation only applies to non-corporate taxpayers with income above $250,000 ($500,000 if married filing jointly). Thus, this is relevant to less than 5% of non-corporate taxpayers. It causes them to not be able to currently use a specified loss above these amounts; the excess is not lost, it carries forward. One of the technical corrections made is that in measuring the income the loss can offset, wages are not included. This means it is more likely for some individuals to have a loss and for others who already have a loss and wages, the amount to carryforward will be higher. But, this loss limitation rule now doesn't go into effect until tax years beginning after 12/31.20.  Those who applied it on 2018 returns will need to amend.

So, what this an appropriate change to provide financial relief for COVID-19 economic problems? I don't think so as the small group that benefits are already high income taxpayers (in the top 5%) and there were other business relief measures provided that benefit employees and self-employed that could have been larger without the Section 461(l) change.

It's a costly change: The Joint Committee on Taxation estimates that the 461(l) change will cost $170 billion over 10 years. In contrast, the NOL change will cost $26 billion. The employer retention credit will cost $55 billion. The recovery payments for individuals will cost $292 billion. Given how few benefit from the 461(l) change and that they are individuals who are well off, seems like an odd use of limited funds and poorly targeted. Senators Whitehouse and Doggett use JCT data to state that 4 our of 5 filers that benefit from the change make $1 million or more per year and for a few, the average benefit is $1.6 million.

The change also creates some complexity due to the need to amend 2018 returns for affected taxpayers. Also, some states might not conform to this CARES Act change.

This change is not a complete giveaway though because most of these taxpayer would most likely eventually be able to use the carried forward loss. This just delays the impact of this TCJA temporary provision and provides a refund opportunity for 2018 and the ability to use more losses for 2019 and 2020. There are other changes that would have benefited far more taxpayers. I have several in prior blog posts (3/13/20 + 4/4/20) although most of them have already been enacted.

When the TCJA was enacted and when California conformed to Section 461(l), I was surprised to see that the revenue raised was so large (such as the $170 billion cited above just for removing the limitation for 2018, 2019 and 2020).  It's a reminder that some taxpayers have large business losses. Many are likely in the real estate industry where depreciation and interest expense can easily create large losses. But, if they have income high enough to be subject to this loss limitation, they are in the top 3 - 5% of individuals and arguably not suffering or wondering how they will pay rent or mortgage payments and utility bills during the pandemic shutdown.

Why did Congress make the change? Did they not have the data on how few would benefit and that they are high income taxpayers? Too rushed? Something else?

What do you think?