17th Anniversary of the 21st Century Taxation Blog

Today is the 17th anniversary of when I started this blog while I was a fellow with the New America Foundation. There is always plenty to write about regarding the topic of how taxes should reflect how we live and do business and follow principles of good tax policy. Time to regularly blog is not so plentiful.

Today the topic is taxation and coin-operated claw machines that are amusement games from which the player tries to pick up a toy with the claw and drop it in the chute. I'm not sure these are all coin-operated today as some likely only take folding money and some might take your credit or debit card.

A ruling from the Texas Comptroller of April 24, 2024 caught my attention. There are all types of taxes and one in Texas is the coin-operated machine tax! It defines the machine and like many taxes, has at least one exemption that then creates added complexity to define that exception. Here the exception is for "amusement machines designed exclusively for a child." This means a "machine that can only be used for skill or pleasure by a child under 12 years of age."

Well, what does exclusively mean and how does one really know if a machine is for ages 11 and below rather than ages 12 and more? Well, in a 2002 ruling, the comptroller defined "exclusively" as a machine "designed such that no person other than a child can use the machine." Also, "it doesn't matter if an immature adult or older child actually uses the machine" because it is the design that is relevant and the kind of prize a player can win is not relevant.  That seems odd, what if the prize is a pack of cigarettes? 

I'm sure the Texas comptroller must have better things to do than determine if a coin-operated machine is for kids age 11 and under rather than for immature adults or for anyone.

Ok, this is a bad way to draft a tax rule. At least two problems here. Coin-operated is too limiting if that means actual coins are dropped into a machine as these machines will certainly get converted to Apple Pay or debit/credit card tap as fewer people carry real money around. And there is no need for any exception here (I think that is true for most taxes - exceptions should be avoided).  If there is some need to provide relief to certain machine operators, find another way such as have them apply for a grant based on financial need (I'd say an income tax credit but Texas doesn't have a personal income tax).

And before leaving these claw machines, back in 2001, the IRS had a funny TAM on the topic. The issue was whether the items inside the machine such as stuffed animals or novelty toys or other prizes were inventory to which the unicap rules of §263A would apply. The conclusion was yes!

The taxpayer claimed that the prizes were supplies for tax purposes, but called them inventory on its balance sheet. The IRS also found that the taxpayer was selling these items and title transferred to the winner, making them merchandise!

I call this funny because either the drafter of TAM 200121006 was very skilled at using these claw machines or had never used one. I think most people put money in and don't get anything making it clear this is not the way a retailer sells goods. These should have been treated as supplies consumed in the process of providing entertainment services. The TAM does provide a good review of code, regs and cases on inventory for tax purposes.

One more relevant tax here is sales tax. As supplies, sales tax would be paid by the buyer (owner of the machine) when they buy the prizes.

Tax policy relevance here ... the Texas ruling is a reminder that just about anything can have a special tax on it, but if too special and with exceptions, it gets complicated quickly. It would be better to find a more simple and equitable way to generate revenues (equitable in that similar businesses might not have a special tax).

What do you think?

Tech Needed to Simplify Energy Credits for Individuals

Special tax rules tend to be complex because they are "special" in that they are not part of the normal tax system and are not intended for all taxpayers and all activities. Drafting legislation and regulations to be sure the credits are used as intended, is challenging. We are seeing this with most of the energy credits added or modified by the Inflation Reducation Act of 2022. The IRS has to define many challenging terms that were not completely spelled out in the legislation, such as the value of critical minerals, battery components, and more.

I have written about some of this before and this blog post of 8/21/22 includes track changs for several of the revised credits such as the two home energy credits and the clean vehicle credit.

For the clean vehicle credit at IRC §30D, the "qualified manufacturer" has to verify most of the difficult provisions to know if the vehicle is "clean" and if it qualifies the buyer for the critical minerals credit of $3,750 and/or the battery components credit of $3,750. The provisions are complex, but some of that complexity is on the manufacturer rather than the buyer (and lots of complexity on the IRS).

For the two revised residential energy credits, the complexity falls on the homeowner (and for some elements of the credits, the tenant if they are incurring the costs). These rules are complex and are with us for the next 10 years to it is worth finding ways to simplify the process for individuals to know if they have purchased the proper property (meets the specified Energy Star or other standard). In addition, for the IRC §25C Energy Efficient Home Improvement Credit, there are different credit limits on doors versus windows versus biomass stoves, etc. 

Here is one suggestion for making it simpler for indviduals to know if they can qualify for the §25C credit which might also better encourage them to make home improvements that will reduce energy usage. 

Software, algorithms and databases can be created where the individual can use in at least two ways. First, the individual can enter a product code (often on many products) or description (name of product and manufacturer) into a website and learn if it qualifies for the §25C or 25D code. The website would need to have the Energy Star and similar information required per these provisions. And the individual would need to enter data about whether they own or rent their home and whether it is their principal residence (the §25C credit covers three broad categories of property and they all vary on how that information is relevant).

The second way to use the well-designed website is to input what they want to do. For example, they want to install energy efficient windows (and how many and the cost). The website should then provide a list of what windows qualify and how they can maximize the credit over multiple years since the maximum credit for windows, for example, is $600 total for the year (at a 30% rate that is a maximum door window cost of $2,000 per year).

The website could also provide a list of reminders such as the need to reduce basis of property by the credit amount, whether a carryforward is allowed, and what recordkeeping to keep and for how long.

Finally, these website should allow the individual to take the output and in a digital format, let it be connected to their tax prep software to produce the required form.

The technology exists to make this happen. It will take time to produce such websites for individuals du to the complexity of the provisions and the variety of items that may qualify for the credit.

There is some helpful information on the IRS website about the §25C credit (and others), but it is not everything and likely won't help individuals understand how to ensure they qualify for the credit and how to maximize it over multiple years.

What do you think?

Let's Avoid Unnecessary Costs and Complexities

Let's skip a tax credit subsidy for electric bikes;
buy a less expensive one instead;
don't make the tax law any more complex.

The House Ways and Means markup of the Build Back Better Act (H.R. 5376) has over 120 tax changes included. This includes a lot of energy credits. Subtitle G on Green Energy is laid out in 257 or the 2466 pages of legislative text. The cost estimate over ten years from the Joint Committee on Taxation is $235 billion. In comparison, the social safety net provisions in Subtitle H cost almost four times as much, but will likely provide benefits to those more than in need than for the energy credits.

For example, there is a new refundable credit proposed at new IRC §36E for the purchase of an electric bicycle costing up to $5,000 (for a $750 credit) but the bike can't cost more than $8,000. My Google search indicates that these bikes cost under $2,000. While there likely are ones costing more, if the buyer needs the $750 credit to buy it, why not skip the credit and the complexity it will add to our tax law and the buyer can instead buy one that costs $750 less.

Here is a summary of this one credit, which easily illustrates the complexity. It is also inequitable in that the people who will claim this likely have the funds to buy the bike even without the credit. That makes it a poor use of funds - giving money to reward behavior likely to occur anyway.  And, isn't it better to have a non-electric bike and get some good exercise and use the existing bike lanes?  I assume electric bikes can't use bike lanes for safety reasons and it likely isn't that safe to have them in the vehicle lanes.

The many complex rules to make this new credit possible include:

• Equipped with: “(A) fully operable pedals, (B) a saddle or seat for the rider, and (C) an electric motor of less than 750 watts which is designed to provided assistance in propelling the bicycle and—(i) does not provide such assistance if the bicycle is moving in excess of 20 miler per hour, or (ii) if such motor only provides such assistance when the rider is pedaling, does not provide such assistance if the bicycle is moving in excess of 28 miles per hour.”
• Original use must start with taxpayer; must be used in US.
• Acquired for use rather than resale.
• Made by qualified manufacturer (includes requirement that they have agreement with IRS) with appropriate label.
• VIN must be reported on return.
• Limited to 2 per MFJ; otherwise 1, but reduced by any taken into account for 2 preceding tax years.
• Modified AGI (MAGI) phaseout starts when MAGI exceeds $150K (MFJ), $112,500 (HH), $75K (S).
• Recapture if bike no longer eligible (per regs to be provided by IRS).
• Reduce basis by credit amount.
• Terminates for bikes placed in service after 12/31/31.

Let's look at all of the new credits and be sure they meet principles of good tax policy including equity, neutrality and simplicity. Also, let's be sure each has three good reasons why it is needed and that there is no alternative other than providing a tax rule. I think this exercise will reduce the size of H.R. 5376.

#letsfixthis

What do you think?

Temporary tax law changes should be EASY!

We are in tough times! The pandemic is in it's second year and the March 13, 2020 disaster declaration is still in effect. The American Rescue Plan Act of 2021 signed into law on March 11, 2021 is the 5th major piece of COVID-19 relief enacted since mid-March 2020. The tax changes in these laws are numerous and complex in terms of new definitions, special rules, confusing interaction with other rules, and being effective before IRS can get adequate guidance released.

The IRS could not even open the 2021 filing season until February 12 - later than usual. The IRS is still processing paper filed 2019 returns.

Practitioner groups (AICPA letters of 2/23 and 3/4 and 3/24), members of Congress (2/18) and others, asked the IRS to extend the April 15 due date for 2020 returns. After all, the Rescue Plan Act also made changes to 2020 returns including to those already filed (exclusion of up to $10,200 of unemployment compensation and exception to having to pay back any excess advance Premium Tax Credit). The IRS needed to update 2020 return processing to allow for these changes and to let individuals who had already filed and those who had not yet filed, know how to reflect these changes on their 2020 return or amended return. And these 2020 changes are complex! For example, the unemployment one also affects 8 other rules where modified AGI must be measured. This is time consuming for the IRS to create new instructions and reprogram its computers and for tax prep software companies to update their 2020 products.

On March 17 the IRS issued a news release saying that for individuals, the filing and payment deadline for 2020 Forms 1040 would be extended to May 17. This only applies to individuals and does not apply to the first quarter 2021 estimated tax payment due April 15. There were later calls by many for a broader and longer extension.

On March 29, the IRS issued another press release and Notice 2021-21 to clarify what it said on March 17. For example, the May 17 date is also the last day to make a contribution to an IRA or HSA and deduct it on the 2020 return. But, still no extension for entity returns due April 15 or the 1st quarter 2021 estimate due April 15. And no mention of the 1040 extension also extending the due date for gift tax returns even though they are the same as for Form 1040 (it seems the gift tax return date of 4/15 is not extended).

I think a lot of practitioner time was wasted and will continue to be wasted explaining this to clients and letting many clients know that much of the 2020 return needs to be completed to get a good estimate for the first quarter 2021 tax payment still due April 15.

So, wouldn't it have been easier for the IRS to just say: If the due date for a return or payment is April 15, it is extended to May 17, 2021?  Yes!

We need to encourage decisions, particularly those that don't involve a loss of revenue, to be implemented as simply as possible in order to reduce confusion and wasted time for taxpayers and their tax advisers (and not diminish respect for our tax system).

The IRS has authority under IRC Section 7508A to extend all items due April 15 to May 17 (or later).

What do you think?