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Monday, June 21, 2021

Necessary But Overlooked Tax Changes We Need

toolbox; inside says needed tax reforms

I've been maintaining a list for several years of overlooked improvements I think are needed for our federal tax system. I keep adding to the list including based on oddities found in current court cases.  For the next few weeks, I'll post most of these suggestions. I hope you'll comment on them and add some of your own. It would be terrific to see these included in any tax reform legislation of the 117th Congress and Biden Administration.

  1. Create a de minimus rule for personal use of virtual currency similar to §988(e) for foreign currency which excludes personal gains under $200. This is needed for simplicity. It should exclude bitcoin acquired after a certain date though due to the tremendous gains that exist with very low basis bitcoin (too much of a windfall rather than only simplification).

  2. Repeal the §280A(g) exclusion when one's home is rented out for under 15 days (there is no purpose for this exclusion that mostly benefits high income individuals who own a home to rent for a high rental amount).

  3. Replace §280A rental limitations with §469 limitations. There is no need to have two different rental expense limitations and the §469 one is easier and has more guidance.

  4. Fix §6050P and regs (and perhaps consumer protection laws) to be sure a Form 1099-C is only issued if the debt is truly cancelled. A recent example of this issue is Gericke v. Truist, No. 20-3053 (DC NJ 3/26/21). This is a problem for the fisc and for borrowers. For example, in Stewart, TC Summary Opinion 2012-46, the borrower received a 1099-C in 2008 and did not report it. The court found that the debt was discharged in 1999 “when it was clear that the debt would not be repaid.” So it was too late to pick up the income. There are several cases involving mismatch of receipt of 1099-C and discharge of debt.  See my 5/10/21 blog post.

  5. Fix §6050I to apply to governmental entities and units too. PLR 202118003 (5/7/21) held that a state liquor store was excluded from having to file Form 8300 as it was not a “person” for purposes of this Code section.

More later...

What do you think? 

Sunday, May 30, 2021

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)

Friday, May 14, 2021

14th Anniversary of the 21st Century Taxation Blog

I started this blog 14 years ago today as a way to share ideas and hopefully engage discussion on how to improve our tax systems to meet principles of good tax policy and reflect the ways we live and do business today. It's been enjoyable and I appreciate everyone who reads and comments on my posts!

A few thoughts of areas that need attention that we don't hear enough about (some I have blogged on):

  • Repeal the kiddie tax - too much complexity and not needed. When an asset is truly given to someone else, that person pays taxes on it at their own tax rate.
  • Repeal the rental revenue exclusion for renting out your home for less than 15 days (§280A(g)). Not needed and mostly benefits higher income with the home by the nice golf course where some tournament will be played.
  • Fix the personal income tax to allow deductions tied to production of taxable income without any 2% of AGI limitation.  This is a basic feature of a personal income tax and we have continuted to move away from it since the Tax Reform Act of 1986 meanwhile while adding special rules that are not part of a basic income tax.
  • Virtual meetings and meals are likely to stay. Let's get guidance on whether that meal delivered to your client or employee is still deductible (client one should be, but not clear about the employee; if given a gift card, likely taxable).
  • Update Section 197 on amortization of intangibles to include URLs and social media assets.

And, of course, there are more areas in need of improvement.

What do you think?

Monday, May 10, 2021

Laws Need to Work Together and Make Sense - Fix Section 6050P

Form 1099-C

I came across a recent case (Gericke v Truist, No. 20-3053 (DC NJ 3/26/21)) that once again highlights the mismatch between the law on Form 1099-C, Cancellation of Debt, issuance and when a debt is actually discharged. 

The District Court of New Jersey issued a ruling that reminds us all (again) that getting a Form 1099-C doesn't mean that the debt was discharged, it just means the lender met one of the seven requirements of the regulations under Section 6050P to issue a 1099-C. So, when a borrower receives a Form 1099-C it is not necessarily clear that the debt is discharged. If not discharged, there is no cancellation of debt income or ability to see if an exclusion under Section 108 applies, such as insolvency.

The Form 1099-C instructions for the borrower includes this confusing statement to illustrate the flaw with the form:

"If an identifiable event has occurred but the debt has not actually been discharged, then include any discharged debt in your income in the year that it is actually discharged, unless an exception or exclusion applies to you in that year."

Who wouldn't understand that?!

This is a problem for the borrower (and their tax adviser) and the IRS. If the Form 1099-C is not reported because the borrower finds out that the lender is still going to continue to collect, the IRS is likely to send a notice of the unreported income.

I think the fix is both with Section 6050P and the Consumer Financial Protection Bureau or other federal agency that handles consumer credit law. But the key body to fix the law, of course, is Congress to change Section 6050P and credit card and consumer borrowing laws so that both define discharge the same and that no 1099-C is required until the debt is truly discharged with a specific form documenting that status. The rules should be synced that a 1099-C is only issued if the debt is truly cancelled. 

Benefits to the tax system of fixing this include not wasting IRS time to issue a notice for not reporting a 1099-C only to have the taxpayer say the debt has not been discharged yet (they have not been released from it). Benefits to borrowers are clarity of the law. The judge in this recent case even acknowledges that this law is beyond what a "common consumer" will understand and is a matter for Congress to fix.

SCA 200235030 (8/30/02) from the IRS also notes that receipt of a Form 1099-C doesn't mean that the borrower has income to report. Instead there needs to be an identifiable event to indicate discharge.

Likely with tough times since March 2020, we will see more debt cancellation and it is important for all parties to be able to handle the tax treatment correction but that requires undertsandable and sensible rules that won't lead to errors.

What do you think?

Thursday, April 22, 2021

Earth Day and Taxes

heart shaped earth

Happy Earth Day!  I hope we treat everyday as Earth Day. Before getting to taxes, I have to note anytime I mention Earth Day that is was created in 1970 by Gaylord Nelson who was later a senator and governor from Wisconsin. But, he is an alum of San Jose State University!

Our federal income tax is an odd and unfortunate mix of incentives for oil and gas (such as benefits for intangible drilling costs) and incentives for clean or alternative energy such as a vehicle credit for hybrid and electric cars among other credits.

Thus, our income tax doesn't reflect out country's economic, societal and environmental goals. Or, more likely, we don't know what our goals are for the environment which is not good for our Earth.

If our federal tax system reflected concern for protecting the Earth, we'd see such measures as:

1. Phaseout of incentives for fossil fuels.

2. An increase in the gasoline excise tax which has remained at 18.4 cents per gallon since 1993 and is not even adjusted for inflation. And every year we have more electric cars that don't pay this tax even though they use the roads. We are way past the time to start implementation of a vehicle miles travelled (VMT) tax. Oregon, California and a few other states have already investigated this. In tax reform discussions leading up to the TCJA, a Senate Finance Committee working group on infrastructure and taxes suggested a VMT and noted that the lead time needed was 10 years!  We're already wasting time not working on this suggestion from 2015.

3. Remove any tax incentives that might encourage building in fragile areas such as coastal areas and the mountains.  Years ago, the Friends of the Earth suggested getting rid of the mortgage interest deduction for a second home as most such homes were vacation homes in the mountains or beach area. That is just one of many reasons to get rid of the mortgage interest deduction on second homes!

4. Review incentives for alternative energy to be sure they are meeting their goals. If not, repeal them or reform them. 

5. Form a well-rounded and informed task force to work on designing a carbon tax + possibly a tax or other approach to reduce production of other greenhouse gases. These taxes don't have to be at a high rate, but I think they are needed to help everyone who generates greenhouse gases (all of us!) to be aware that we do. And we need to look at more than a carbon tax because fossil fuels are just one source of greenhouse gases.

What do you think? What are your ideas?