Disaster Relief and Administrative Convenience

Severe storms have been ongoing in many parts of California since December. I have two family members with severe damage to their homes causing them to have to move out for repairs. And I know many others also suffered significant damage to property.

FEMA and the IRS responded with relief. The IRS has now issued three announcements of which of the 58 counties in California get a postponement of filing and payment and for what periods - generally, if eligible based on county of residence, filing and payment (such as for 2022 returns) is now October 16, 2023.

Each of the three announcements lists mostly the same counties, but the lists are not identical nor the start date. But after these three casualty relief notices, just three of 58 counties in California don't get filing and payment relief - unless their records are in a county that gets relief and they ask the IRS for the postponed filing and payment date.

Well, California has a population of 39.2 million. The population of the three counties not included in relief are:

  Lassen - population 31,000

  Modoc - population 8,700

  Shasta - population 181,000

These counties represent less than 1% of California's population.

Some of the individuals and businesses in these counties may have activities or tax assistance in a covered county so will need to call the IRS to get the filing and payment postponement relief. 

But, given the small number of people and probably small number of businesses in these three counties, why not just extend relief to all of California? That should make it easier for the programming adjustment for IRS computers regarding California filers, and eliminate the need for anyone in these counties to have to ask the IRS for relief because records are in an affected county.

I think that adjustment would fall under administrative convenience. Too bad there isn't a good data analytics tool that could have quickly highlighted to the IRS that their relief notices were covering about 99.5% of California - so why not cover it all.

Another point is that while many had damage, I suspect most people did not. The payment extension for 39 million individuals and hundreds of thousands of businesses, even if 60% of individuals are getting refunds rather than making payments of 2022 taxes, will likely have a noticeable affect on tax coffers. Why not include a note in the relief messages that the government encourages everyone to pay on the regular due date if possible to avoid the need for the government to cover the shortfall for a few months.

What do you think?

President Biden's FY24 Greenbook - Observations on Some Items

On March 9, 2023, President Biden released his FY 2024 budget (and related docs) and Greenbook that describes his tax proposals. It repeats many proposals that were in his FY2022 and/or FY 2023 Greenbooks (see comparison and links here for the FY22 and FY23 plans).

Themes, similar to recent years, include increasing corporate taxes such as increasing the 21% corporate rate to 28%. Unlike a House proposal last year (which was later dropped from Build Back Better), for graduated rates, are not proposed. The proposed 28% flat rate is still below the pre-TCJA maximum of 35%. As noted in President Biden's recent State of the Union address, he would increase the recently enacted corporate buyback excise tax from 1% to 4%. I believe the logic is to not only raise some revenue, but to address what some corporations do with corporate tax savings and a buyback might be used instead of a taxable dividend payout.

Observation: While individual tax increase proposals continue to be aimed at those with income above $400,000, the corporate tax increase proposal will indirectly affect all individuals. Eventually, all corporate tax is paid by some combination of shareholders, customers and employees. To keep a promise of not increasing taxes on individuals with income below $400,000 (which is about 98% of individuals!), this proposal should be skipped. 

There are several proposals to reform international taxation. I'm not an international tax expert so I can't opine on them, but it does seem that there is a need to revisit the changes by the TCJA, recent changes to foreign tax credit regs that many have noted have problems, and consider what other countries are doing including regarding OECD Pillars I and II.

The Greenbook continues for the third time to call for repeal of all fossil fuel preferences. In 2021 when the House Democrats worked on Build Back Better this was not included. This also needs discussion as it is odd that our tax law has rules that both encourage development and use of carbon-free energy and fossil fuels. Phasing out the 13 preferences for fossil fuels over a period of years would make more sense than outright repeal, and less disruption to the industry.

The Greenbook calls for restoring the top individual tax rate of 39.6% in 2023 instead of 2026 as called for by the Tax Cuts and Jobs Act of 2017. Less than 1% of individuals have income high enough to be in this bracket. 

Observation: Given challenges of tax changes in a split Congress, why not just wait for this higher rate to automatically return on its own in 2026? 

The Greenbook also calls for having the Net Investment Income Tax (NIIT) of 3.8% currently applicable to NII of high income individuals to apply to all pass-through income of high-income individuals (including President Biden and his S corp income). He also proposes increasing the rate to 5% for individuals with income over $400,000. He would also redirect NIIT revenue to the Hospital Insurance Trust Fund which has been having problems.

Observation: The NIIT was created by the Affordable Care Act and the 3.8% rate ties to Medicare taxes. Why the revenue wasn't for the HITF in the first place seemed odd. So this seems to make sense. What should the NIIT apply to? Personally, I'd like to see this reviewed along with the regular and capital gain tax rates for individuals (non-corporate taxpayers) to instead have some uniformity of definitions (there are at least two different definitions of NII in the Code), examine the logic of having special rates for investment income oddly defined (NII applies to both investment income and some passive business income - why?), and see if there can be fewer tax rate structures for individuals.

President Biden continues to call for capital gains and qualified dividends of individuals with income over $1 million to be taxed at ordinary rates + the NII. And he continues to call for treating appreciated property transferred by gift or death as realization events.

Observations: Why not tax all of some capital income at the same rates as wage and interest income? Yes, gains on capital assets can also include inflationary gains, but with so many people using tax prep software, the capital assets could be adjusted for inflation before gains are calculated and all of the income taxed as the same rates. That was what we had under President Reagan's Tax Reform Act of 1986 - all income taxed at the same rates, but there was no inflation adjustment for assets held over one year. I think that is worth exploring.  Arguably, taxing all of this income at the same rate could remove the need for the NIIT and possibly allow for lower regular tax rates.  And taxing gains at date of death makes sense. Why should that income forever be excepted from income tax? For example, if someone with stock that has billions of dollars of unrealized gain sells it today, all of that gain is subject to income tax. But if that wealthy stockholder dies today, none of that billions of dollars of gain is ever taxed because when transferred to their estate, it is not treated as a realization event and heirs get the stock at FMV rather than the decedent's basis. What is the logic for this and this enormous tax break primarily benefits a small number of very wealthy individuals. And, President Biden has exceptions including for transfers to charity, transfer to the surviving spouse, and a $5 million exclusion per person. With that large exclusion, over 99% of individuals would not be subject to the tax, but the very wealthy folks in the very top of the 1% with billions of dollars of gain at death would pay tax.

President Biden calls for a larger and refundable/advanceable child tax credit (CTC) to benefit those with children under age 18 for 2023 through 2025. This sounds like what we had for 2021.

Observation: The higher 2021 CTC is estimated to have reduced child poverty by about 30%. The additional funds for families helped improve their household economics and arguably also helped the economy. This also needs discussion and perhaps there is some bipartisan support as all members of Congress had many constituents whose lives were improved with the extra dollars. In 2026, the CTC drops from $2,000 back to $1,000 (but the personal exemption returns along with a smaller standard deduction and higher individual tax rates). Discussion is needed to what the tax picture should look like for individuals at all income levels, with those in the top 10% of income broken down to smaller categories given the tremendous income gap in that top 10% (actually the income range even in the top 1% ranges from about $450,000 to over $450 million!)

And there is more - the Greenbook is 226 pages. I encourage you to look at the Table of Contents and proposals of interest to you.  I have a list of items that were in the last two Greenbooks if you'd like to compare (there is a lot of similarity).

Will anything be enacted? Probably not given the party split in Congress.  But there might be some areas of bipartisan agreement and some of the revenue raisers in Biden's plan, particularly if viewed as a "loophole" closer, might get picked up to help address other changes.  For example, there is bipartisan support to restore current deductibility for R&D expenses which we had in the law for 1954 through 2021 until the TCJA required capitalization starting in 2022. One example of what I'd call a loophole closer that is in the Greenbook again is to have the wash sale rules also apply to digital assets. There really isn't any reason why someone can sell Disney stock at a loss and buy it back and have to defer the loss, but sell bitcoin at a loss and buy it back (so stays in the same portfolio position) but does get to claim the loss now rather than defer it.

What have you looked at in the FY2024 Greenbook?

What do you think?

Residential Energy Credit Observations & Cautions

First, a policy query: How long should tax incentives be in the law. For example, with the Inflation Reduction Act of 2022, Congress extended the residential energy credits of §25C and §25D through 2032 and 2034, respectively. The §25C credit was first added to the law in 1978 (as §44C by the Energy Tax Act of 1978, P.L. 95-618 (11/9/78)).

Section 25C (originally §44C and then §23) lasted through 1985 and lapsed until reinstated and revised in 2005 by the Energy Policy Act of 2005 (P.L.109-58 (8/8/05)), with §25D added, effective for 2006 and 2007. Subsequent legislation generally continued to extend these provisions (and sometimes modify them) for one to two years at a time.

So, a residential energy credit existed for 1977 through 1985 and for 2006 through 2032 (2034 for §25D). For more on the history, see Congressional Research Service (CRS), Residential Energy Tax Credits: Overview and Analysis, 4/9/18.

How long should these incentives be in the law? Shouldn't law changes have required new homes to be built with building envelope that is energy efficient and with solar panels? Should a time limit have been given for making older homes energy efficient? Perhaps. Are tax incentives the best way to go forever or should utility companies be incentivized to help customers make improvements?

These credits, particularly §25C, are a bit complex. For example, §25C covers three types of expenditures with details and qualifications for each category. Also, while subtle in the language, you have to read it carefully to know if the expenditure is only for a principal residence you own and use or if it is ok for it to be owned OR used (true for home energy audits), or just has to be a residence (principal or vacation) owned or used (if only has to be used, tenant may claim the credit).

Homeowners should be cautious in using these credits because there are annual limits on, for example, how much you can claim for qualified doors and windows. Spreading the improvements out over a few years can maximize the credit. 

Also, there are both ill-informed and unscrupulous sellers and installers who might mislead taxpayers as to how much credit they will get. Some will encourage those with equity in their home to borrow to pay for the energy efficient items and perhaps a lot more that doesn't generate a credit and might not even be needed. Be cautious and encourage your clients and older family members to be cautious.

For more on these credits, see my 8/21/22 post that also has links to the track changes versions of these credits. These documents also have links to IRS information on the current versions of these credits.

What do you think? 

ChatGPT and the Tax Law

We all know tax rules are complex. Can artificial intelligence such as used in ChatGPT address tax matters?  I gave it a try today while listening to some colleagues deliver an online chat about the abilities and limitations of ChatGPT.  I tried two prompts with it which I summarize below with some commentary. Spoiler alert - the 2nd prompt led to a completely wrong answer! I think if there are students using this tool exclusively, they are going to get caught for turning in garbage (and work that is not theirs).

1. I asked a question related to a paper I'm working on that is a continuation of work I have done in the past - what improvements can be made to IRC section 197?  ChatGPT mostly gave good information including some that sounded like it was pulled from my past work on this. It also gave me some outdated information on section 197 such as: "The rules for determining useful life under section 197 can be complex and ambiguous, leading to disagreements between taxpayers and the IRS." Part of this sounds like pre-197 law.  My paper though is calling for a legislative change to make it clear that modern intangibles such as domain names and social media assets fall under section 197.

Commentary: Where you know a good amount about the topic, ChatGPT might be a good way to see if there is anything you are overlooking or clarify something worthwhile to explore further. One item that ChatGPT brought up was whether the de minimis safe harbor should be increased to allow expensing of more intangible expenditures thereby avoiding administrative burdens for small businesses.

2. This week my MST research students present on an "important" tax case that stands for a doctrine such as substance over form (Gregory case); they each have different cases. They have already written a case brief, found a case that applied it (and summarized that case), and found and read a journal article that mentions the case.  I provide them an example of a case brief I wrote on Eisner v. Macomber, 252 US 189 (1920). The parties involved are taxpayer/shareholder Macomber and IRS Revenue Collector Eisner. Macomber won with the Court finding that a stock dividend is not taxable. Another key point from the case is the realization principle.

Here is the case summary from ChatGBT:

The Eisner v. Macomber case was a U.S. Supreme Court case in 1920 that dealt with the issue of taxability of stock dividends. The plaintiff, Eisner, had received stock dividends from a corporation and argued that they were nontaxable because they did not represent income. The defendant, Macomber, who was the Commissioner of Internal Revenue, argued that stock dividends were taxable income.

The Supreme Court ruled in favor of Macomber, stating that stock dividends are not nontaxable gifts, but rather are part of the shareholder's taxable income. The Court held that stock dividends represent a transfer of property to the shareholder and are therefore taxable under the Sixteenth Amendment to the U.S. Constitution, which allows Congress to tax income from whatever source derived.

The ruling in Eisner v. Macomber established the principle that stock dividends are taxable income and not nontaxable gifts. The decision has been cited in subsequent cases dealing with the taxability of stock dividends and remains a significant precedent in tax law.

Commentary: Well, the summary is wrong. It has the parties wrongly identified and the result wrong as the Court held that the stock dividend was not income. The case has lengthy dissents. Perhaps the AI could not distinguish between the majority opinion and the dissents. 

You can "regenerate" a response. When I did that, the response still had the parties misidentified, but this time said that the Court held that stock dividends are not taxable and this time mentioned realization: "It established an important principle of tax law that has been applied in other contexts, namely that a transaction must involve a realization event to be taxable, and that the mere transfer of an asset does not constitute a realization event" Better, but not complete as to the realization aspect being too broad in saying that transfer of an asset is not a realization event. Interesting that the second attempt mentioned realization while the first one did not.

Overall commentary on my limited time with ChapGPT: I think it can be helpful in perhaps finding something the researcher/writer did not think of and the fact checking it requires in judging the response might lead to new considerations for the author. But it certainly should not be used as a perfect response to a prompt. I suspect that there will be students and others (such as those in a hurry) who might use it and be embarrassed by errors or get a low grade (should be an F if the answer is submitted as one's own work). It is a good example of what technology can do - explore lots of information and provide a narrative that is fairly well written although it that well-written content might be incorrect or incomplete.

What do you think?

More on California Middle Class Tax Refund

Here is my 3rd post on the payments California issued to probably over 90% of Californians per AB 192 (2022) (1/29/23 + 7/10/22).  And others have blogged on it as well. On February 3, Procedurally Taxing had a post from Bob Kammen asking why the IRS hasn't issued guidance. Bob also makes a comment about the high income range of Californians getting AB 192 "relief" payments, with what I think is sarcasm - that $250,000 of income for single or $500,000 if married is "middle class."

My first post last July raised the issue that some very low income individuals without a filing obligation get no payment if they had not filed a 2020 return by 10/15/21 as required by AB 192 which was enacted in June 2022!

Why would the state provide "relief" to people with income high enough to not need relief while leaving out those who do?

The IRS stated last week that it will try to get guidance out on the taxability of various state payments issued recently.  If they can address the California so-called Middle Class Tax Refund (a term used by the FTB), as AB 192 uses the term Better for Families Tax Refund (although AB 192 includes a specific statement that the payments are not income tax refunds). The IRS can clarify to ensure consistent treatment by recipients, although only those who received $600 or more received a 1099-MISC from the FTB. 

Some additional observations from me:

AB 192 has some oddities, such as:

1. It adds section 8161(d) to the Welfare & Institutions Code to say: "The payment authorized by this section shall not be a refund of overpayment of income taxes". This is likely why FTB is issuing 1099-MISC for payments issued in excess of $600 rather than 1099-G for income tax refunds of $10 or more. 

  Query: Can the payments be viewed as refunds of other California taxes? Likely AB 192 would have to say so explicitly as there are many possible sources of the funds and filing status has no bearing on how much other taxes one pays (excise taxes, sales taxes, property taxes, etc.). AB 192 does imply that the payments are refunds of various taxes but with conflicting language that it is not an income tax refund and it isn't available to people with income too law to be required to file an income tax return even though they pay other CA taxes.  Puzzling as to form and substance and intent. If truly intended as a refund of any CA tax, it should be allowed to all Californians if not claimed as a dependent by someone else. If a tax refund, why issue 1099-MISC?

2. Since COVID is still a federally declared disaster, the payments could have been labeled as for financial needs tied to COVID. Instead, Sec. 10 of AB 192 covers more than COVID, providing that "increased costs for goods, including gas, due to inflation, supply chain disruptions, the effects of the COVID-19 emergency, and other economic pressures have had a significant negative impact on the financial health of many Californians". This seems to make the IRC section 139 exclusion for disaster relief payments not applicable.

  A June 28 Assembly Floor Analysis summary of the bill had better wording stating that the economic disruptions stem from the COVID-19 emergency. I don't think this overrides the AB 192 text though that doesn't pin the payment relief solely on the COVID-19 disaster (if it did, I don't think FTB would be issuing 1099-MISC to recipients of $600 or more).

3. I think in the Procedurally Taxing post, Bob is joking when he says $500,000 is middle class in CA.  It is not. Just like for the rest of the country, that amount of income ($250,000 if single; $500,000 if MFJ  or head-of-household) puts someone in the top 3% of income earners. Why were "relief" payments of $600 ($400 if no dependent) given to a married couple with up to $500,000 of income in 2020?  In prior years, Golden State Stimulus payments were given to individuals with up to $75,000 of income - a much better level indicating someone who may be struggling financially.  The GSS payments certainly qualified for the general welfare exclusion.  But when a program's payments are given to individuals in the top 3% of income levels who have no financial or other need that their high income can't address, the general welfare exclusion seems inapplicable. And there was no requirement in AB 192 for anyone to show a need before receiving a payment - see the following three rulings:

In 2015 in Maines, 144 TC 123, the Tax Court stated: ""Grants from welfare programs that don't require recipients to show need have not qualified for the general-welfare exclusion."

In Rev. Rul. 76-131, the IRS stated: "The Alaska Longevity Bonus is distinguished from welfare program payments in that the benefits are payable to any Alaskan meeting the age and residency requirements regardless of financial status, health, educational background, or employment status."

PLR 200651003, the IRS describes the "needs" part of the general welfare exclusion as "generally based on individual or family needs such as housing, education, and basic sustenance expenses."

3. Also troubling about the AB 192 payments is that those most in need who had income too low to be required to file a California return for 2020, did not get any "relief" payment unless they filed by 10/15/21 yet AB 192 was enacted in June 2022!  When the GSS payments were enacted, they went to people who filed their 2020 return by 10/15/21 but those payments were authorized months before that filing date. Yes, if someone filed to get GSS, they also get AB 192 payments, but there are low-income individuals who did not file. Generally, this is a group that doesn't have a tax adviser. [7/10/22 post]

4. Another unfortunate aspect is that it will be lower income individuals getting a 1099-MISC while higher income individuals who received lower amounts won't and unless they remember to put it on their return, they get to keep their entire relief payment while MFJ and HH with under $150,000 of AGI in 2020 will pay tax on their payments if in the $600 to $1,050 range. And some low income individuals, such as a head-of-household filer with no dependent and AGI under $150,000 only received $350 so won't get a 1099 while the MFJ couple with the same income received $700 and will get a 1099-MISC.

It would be nice if the IRS could help provide relief to those truly in need who received an AB 192 payment, but it seems the general welfare exclusion looks at the entire program, not just to the effect on those with a financial or other need and the payments aren't viewed solely for COVID relief. Might the California lawmakers retroactively amend AB 192 to make it a tax refund? Maybe that is the way to go.

What do you think?