Wednesday, February 22, 2023
Reader Morris, though, focused on the tax consequences, presenting a list of questions. Some of them, such as state income tax consequences and what is required under the tax law of Austria are beyond my expertise and I’m not going to try to become an expert on those topics. I’ll leave that to others.
Reader Morris first asked if he was correct in concluding, from reading MauledAgain posts, that the amount received or to be received by Fonda is gross income for federal income tax purposes. Indeed, he is correct because she is being paid for rendering a service. It would surprise me if it wasn’t gross income for purposes of states with income taxes. Reader Morris was referring to a post from almost a dozen years ago, The Tax Consequences of Being Paid to Date.
Reader Morris asked if this would be wage compensation reported on a W-2. I don’t think so. She isn’t becoming an employee of the tycoon. She is operating as an independent contractor. That leads to the next question from reader Morris. Should she file a Schedule C? She should if she is engaged in the trade or business of accepting payment for going on dates. If it’s a one-time situation, then the payment would be reported as miscellaneous income. But then reader Morris asked what the tax consequence would be if the tycoon paid for her transportation, hotel, and other expenses. Those amounts would also constitute gross income. That leads to a question I posed to myself. Would she then be permitted to deduct these costs? If she could show she was in a trade or business, then these would be deductions, subject to the usual limitations, on Schedule C. If she could not show she was in a trade or business, then she should be permitted to deduct these expenses as incurred for the production of income.
Another question that pops up is the impact of tax provisions affecting income earned abroad. Because I am not an expert in the U.S.-Austria tax treaty, I’m not in any position to determine if there are provisions that would provide her with an exclusion, or with a credit to the extent she would be required to pay tax to the nation of Austria or a subdivision thereof.
What I do know is that this set of facts would generate an interesting exam question in several different tax courses, including the basic course, a tax policy course, and courses dealing with the taxation of international transactions.
Friday, February 10, 2023
Though I consider the California payment to be in the nature of a credit, the IRS today issued guidance in which it treated most state payments of the sort made by California to be within the general welfare exclusion. It technically concluded that it would not challenge the taxability of these payments. Its rationale was that the complicated fact-specific nature of determining the treatment of these payments is outweighed by the “need to provide certainty and clarity for individuals” now filing tax returns. The IRS also noted that because this issue exists only for the 2022 taxable year, if a taxpayer does not include the payment in gross income it will not challenge that omission. However, the IRS also noted that in some states, the payments clearly constitute state tax refunds and thus are includable in gross income to the extent required under application of the tax benefit rule.
Perhaps technically the IRS is incorrect with respect to some or many, or even all, of these payments. Perhaps, as I argued, they should be subject to the tax benefit rule or treated as the payment of a refundable credit. However, given the exigencies of time, the need for guidance during tax season, and the inability of the Congress to focus on practical problems in a consistent and efficient manner, the IRS has done the best it can do. The fact that its conclusion is essentially favorable to taxpayers will preclude taxpayer complaints, though whether the issuance of this taxpayer-favorable guidance will temper the common perception of the IRS as “the enemy” is questionable. Once again, a problem created by the Congress and in no small way by state legislatures has been resolved by the IRS. That's not the way a well-functioning democracy ought to work.
Wednesday, February 08, 2023
After looking at the first article, and then examining the article linked to the words “two IRS tax codes ("second article"), it is possible that the author of the first article meant to refer to two Code sections because there are two Code sections mentioned in the second article (written by the same author), specifically, sections 61 and 139. But that lack of clear articulation isn’t the only problem.
Even if the reference is to two Code sections, another problem is the use of the phrase “IRS tax code.” Why? Because there is no such thing. There is an “Internal Revenue Code” for which the acronym is IRC. The acronym for the Internal Revenue Service is IRS. Yes, there is only a one-letter difference between the two acronyms but precision matters. For those interested in my previous reactions to the use of the oxymoronic phrase, “IRS Code,” see An Epidemic of Tax Ignorance and the earlier commentaries cited therein.
Another problem shows up in the second article’s summary of an article written by a CPA ("CPA article"). Whether the summary is correct is something I cannot determine because there is no link to the CPA article (see UPDATE below). The second article claims that the CPA suggested that the refund would be excluded “under Internal Revenue Code (IRC) section 61(a), the General Welfare Exclusion.” However, section 61(a) is not, nor does it contain, the general welfare exclusion. The general welfare exclusion is an IRS interpretation of the tax law. Whether the general welfare exclusion applies is something the IRS needs to determine.
UPDATE: Someone sent me a copy of the CPA article quoted by the second article, though I have no link for the CPA article to share. The CPA article does NOT state "under Internal Revenue Code (IRC) section 61(a), the General Welfare Exclusion." It correctly describes section 61, and then in the following sentences described the administratively developed general welfare exclusion. So the author of the first and second articles misquoted the CPA article.
The author of the first and second articles, those he interviewed, and several others have concluded that the refund is not “taxable for federal income tax purposes.” What they mean, of course, is that the refund is not included in gross income. Whether something is taxable is different from whether it is included in gross income because something in gross income can be offset by a deduction or generate tax liability that is reduced or eliminated by a credit.
After being pressured, the IRS has promised to issue guidance. How should this payment be treated? There are a variety of possibilities, but it seems to me that the refund the equivalent of a credit. According to California’s eligibility requirements, the refund isn’t available to Californians who did not file state income tax returns. If treated as a reduction of California state taxes, it should be treated as any other state income tax refund. That is, it is included in gross income to the extent it offsets state income taxes that generated a tax benefit. Thus, for example, California taxpayers who did not deduct California income taxes on their federal income tax returns ought not be required to include the refund in gross income. If they did take a deduction, then some calculations need to be made to determine if, and to what extent, the refunded tax generated a federal income tax benefit. What about California taxpayers who did not pay California income taxes but received the refund? In that case, the payment is equivalent to a refundable credit. The IRS has previously taken the position that refundable credits are included in gross income to the extent they exceed the taxpayer’s state income tax liability. It also took this position in ILM 201423020, in which it pointed out that the possibility of a refundable state credit being excluded under the general welfare exclusion. One of the requirements to fit within that exclusion is that the credit “be for the promotion of the general welfare (i.e., on the basis of need.” The California refund in question was made available to all taxpayers with California adjusted gross income under $500,000, with no requirement of showing need. Surely at least some taxpayers receiving the payment were not in need. As a practical matter, truly needy taxpayers are in tax brackets that generate zero federal tax liability, that is, most if not all of them will see the amount included in gross income offset by the standard deduction, and if not, resulting tax liability offset by various credits.
It will be interesting to see how the IRS interprets the law. I am confident that the Congress will do absolutely nothing in terms of providing an answer by amending the Internal Revenue Code. Whatever the IRS decides will not constitute an “IRS Code” but will be part of its administrative interpretations, which are subject to judicial review and which Congress could change if it chose to do so.
Tuesday, February 07, 2023
Much of what was in the article was not news to me, because it summarized information that had been passing in front of my eyes for the past few months. But when I reached this sentence, I stopped and read it a second time to make certain I was seeing what I thought I was seeing: “Also, a new PayPal and Venmo tax rule about needing to pay taxes on transactions of $600 or more is put on hold until 2024 due to taxpayers not being ready for it.”
That sentence suggests that no one needs to pay taxes on PayPal and Venmo transactions until next year. It suggests that transactions completed in 2022 are not taxable. But that’s not what the $600 rule addresses. The $600 rule deals with the requirement that PayPal and Venmo send Forms 1099-K to those who enter into transactions on those platforms. Whether a transaction generates gross income is independent of whether a Form 1099 (or a Form W-2) is sent or is required to be sent. For example, a person who wins $300 in a lottery has gross income even though a Form 1099-MISC must be sent only if the person wins $600 or more. Thus, for example, if a person sells an item on PayPal for $450, and paid $50 for that item, the person must report $400 of gross income even though PayPal does not send, has not been required to send, and will not be required to send, any sort of Form 1099.
It is easy to see that someone reading the sentence that caught my eye might conclude, “Oh, good, I don’t need to report income received through one of these platforms.” Of course, even before this sentence appeared, many people thought that was the case, or perhaps knew it was not the case but chose to not report the income because they figured the IRS would not know about the transaction. The revenue shortfall caused by people not including the gross income from these transactions on their income tax returns is what led a majority of members of Congress to enact a requirement that these transaction platforms send Forms 1099-K for transactions of at least $600 rather than the previous threshold of $20,000.
The bottom line is simple. Gross income is gross income and must be included on income tax returns. Whether it is taxed, that is, whether it causes additional income tax liability depends on whether there are deductions and credits that offset its impact. People who do not understand this basic tax concept, which should be but rarely is taught in the K-12 system, will get into trouble if they read that sentence and conclude they do not need to include on their income tax returns the gross income from transactions on PayPal, Venmo, and similar platforms.
Friday, February 03, 2023
I hadn’t addressed the mileage-based road fee for more than a year because not much has happened that warrants examination. What has been written during that time period hasn’t added much to the discussion, and often consists of sharing the same arguments for and against the mileage-based road fee.
But now there is a new twist. In A Better Way to Pay for Roads, Tom Giovanetti of the Institute for Policy Innovation adds a wrinkle to the issue that needs attention. Though there are times I disagree with Giovanetti, in this instance I’m with him until the latter part of his essay. Giovanetti points out that using liquid fuel taxes to fund highway maintenance and repair is becoming increasingly difficult for the same reasons others have advocated for a change. More and more vehicles don’t use liquid fuels, and those that do are using less because of improvements in fuel efficiency. So Giovanetti, agreeing with those of us who advocate for the mileage-based road fee, writes, “It’s time to start talking about phasing out fuel taxes and phasing in usage taxes. It simply makes sense that those who put the most stress on our transportation infrastructure and who profit from the roads have a proportional share in paying for them.” Agreed.
And now I get to where I disagree with Giovanetti. He writes
This change need not be onerous or intrusive for the average driver. For one thing, it would be politically expedient to exempt personal vehicles and limit usage fees to commercial vehicles. And logical too, as commercial vehicles belong to businesses that profit directly from the roads.Why do I disagree?
Furthermore, businesses already keep track of miles driven by their commercial vehicles. So it wouldn’t require onerous new, invasive reporting requirements. Ironically, the reason businesses track mileage is because it is a tax-deductible expense.
First, commercial vehicles and vehicles used for business are not the only vehicles that benefit from using roads. Vehicles not being used for commercial or business purposes should not get a free ride. Imagine the reaction if a township that charges a trash pick-up fee only charged businesses but picked up residential trash for free. That's just not appropriate.
Second, there are vehicles used for both business and non-business purposes. If the fee were limited to vehicles used solely for business purposes, an exemption for multi-use vehicles would invite owners of business vehicles to turn them into multi-use vehicles. Closing that sort of loophole would require keeping track of business mileage and denying the exemption if the business mileage is more than a specified percentage of total mileage. That requires the sort of complicated record keeping Giovanetti wants to avoid.
Third, a sentence in Giovanetti’s essay suggests that he is drawing a distinction between trucks and other vehicles, as he points out the foolishness of proposed legislation permitting larger, heavier (and may I add, more dangerous) trucks. I suppose Giovanetti is focusing on tractor trailers, but I doubt he would exempt other types of trucks, such as box trucks, cranes, cement carriers, bucket trucks, and even pickup trucks. Yet pickup trucks, for example, are often used solely for personal purposes. Should all pickup trucks therefore be exempt, including those used exclusively for commercial and business purposes? And what about vans, RVs, and buses? Where would they fit into Giovanetti’s proposal? The same challenge with respect to pickup trucks also exists with respect to these vehicles.
In short, it makes little sense to separate vehicles on the basis of commercial and non-commercial use. Of course, Giovanetti is suggesting that big trucks cause more wear-and-tear on roads, and he is correct. Yet the mileage-based road fee takes into account not only mileage but the weight and class of the vehicle. So the proposal I and others have made already identify and solve the problem Giovanetti mentions.
There is another interesting twist. Any proposal that would limit a road usage fee to business miles would put some taxpayers in an interesting situation. They would want to report as much business mileage as possible in order to maximize deductions for federal, state, and local income tax purposes. But they would want to reduce business mileage in order to reduce the amount of the road usage fee. If some sort of business-only fee were enacted, it would be interesting to analyze what taxpaying business drivers do to work through the competing tax planning cross-purposes that they would face. That question can be left for the future, because it very well may never materialize and hopefully will never be enacted.
Though I am critical of Giovanetti’s commercial-only road fee proposal, I appreciate that he supports the idea generally. I’m also glad that he is giving it careful thought and has put is commercial-only idea on the table so it can be discussed. Doing so helps fine-tune the mileage-based road fee proposal.