Bored Apes at the IRS

The IRS is considering the tax treatment of NFTs.

Nonfungible tokens, or NFTs, are perhaps best known for their association with digital artwork such as the famous Bored Apes Yacht Club series. Yet they can be used in other ways, such as to certify ownership of a physical item. The IRS has announced that it plans to offer guidance on certain tax issues related to NFTs.

The concern is whether NFTs should be treated as “collectibles” as that term is defined in the tax law. Collectibles, including stamps, coins (with some exceptions), gems, works of art, and various other items, receive unfavorable tax treatment. A purchase of collectibles within a retirement account will be treated as a distribution from that account, often with painful consequences. The maximum tax rate applied to long-term capital gain is higher for collectibles than for other assets.

The IRS will provide detailed guidance after gathering more information. In the meantime it will use a “look-through analysis.” An NFT will be treated as a collectible if its associated right or asset is a collectible. For example, an NFT that certifies ownership of a gem would be considered a collectible because gems are collectibles. What about bored apes? “The Treasury Department and the IRS are considering the extent to which a digital file may constitute a ‘work of art’” and therefore a collectible.

The NFT market is highly speculative. Most advisors would consider them unsuitable as retirement investments, even apart from any tax problems. This IRS Notice warns that NFTs in an IRA or other retirement account may lead to disaster even without a decline in value.

Biden’s Proposed Wealth Tax

Only time will tell if a wealth tax is constitutional.

A new budget proposal from President Biden includes a kind of wealth tax. There’s no need for alarm: it would apply only to taxpayers with more than $100 million in wealth. Besides, there is zero chance Congress will actually pass a budget that includes this provision. It’s there as a way to provoke debate on disparities in wealth and fairness in taxation.

You won’t have trouble guessing which side the Wall Street Journal takes in this debate. The editors believe we are already “soaking the rich.” Their critique of Biden’s wealth tax proposal hinges on language in the 16th amendment authorizing the federal government “to lay and collect taxes on incomes.” It isn’t income, they say, when the market value of your stocks or other assets rises.

Presumably they are aware that an increase in wealth plainly is income according to a definition long used by economists (consumption plus change in net worth). Yet they are saying it isn’t the kind of income that can be taxed under the 16th amendment. For support they rely on a 1920 case, Eisner v. Macomber. (I’m sobered to realize this case, now more than a century in the past, was only 58 years old when I first studied it.)

In Macomber the Supreme Court found that a stock dividend was not income within the meaning of the 16th amendment. Mrs. Macomber held 2200 shares of Standard Oil stock, and her holdings increased to 3300 when the company declared a 50% stock dividend. This event did not put any cash in Mrs. Macomber’s pocket. Nor did it increase her wealth in any way. It merely divided that wealth among a larger number of shares. The transaction had no more economic significance to her than if she exchanged a quarter for two dimes and a nickel.

The holding in Macomber would not apply to Biden’s proposed wealth tax. The crux of the case was that the stock dividend did not alter Mrs. Macomber’s wealth. This would not be true of Biden’s proposed wealth tax. Would such a tax survive a constitutional challenge? The answer to that question is likely many years in the future.

ESG Investing: Excellent, Satisfactory, Good?

Retirement plan investment strategies can now include ESG investing considerations.

ESG investing is in the news. A political kerfuffle over its use in retirement plans has provoked President Biden’s first veto.

ESG investing refers to strategies based at least in part on factors in one or more of three broad areas: environmental, social and governance. Investors may consider how well a company handles environmental issues such as climate change, energy efficiency, and natural resource conservation. Social factors may include fair labor practices, product safety, and community relations. Shareholder rights, executive compensation, and transparency would fall under the governance umbrella.

A desire to align investments with personal values and beliefs is a motivating force behind ESG investing. Yet these factors can also be used to measure how well a company manages risks and opportunities in these areas. The effectiveness of ESG as a component of investment strategy has been studied extensively. A major review of these studies concluded that ESG has a positive impact on corporate financial performance. In short, ESG investing can be a sound investment tool.

Yet many conservative commentators and politicians see ESG investing as a way to promote progressive goals. The Trump administration in 2020 issued rules restricting the use of these principles in pension plan investments. Under Joe Biden, the Department of Labor removed that restriction. Republicans objected. Joined by one Democrat in the House and two in the Senate, they voted to block the new regulation. A Biden veto will keep the regulation in force.

The Wall Street Journal groused that the rule represents “the political exploitation of American retirement savings.” Yet the rule merely permits fiduciaries to consider the economic effects of ESG criteria in making investment decisions. It retains the core principle that the duties of prudence and loyalty require retirement plan fiduciaries to focus on relevant risk-return factors.

In any event, there is no denying that ESG investing has broad appeal. Aware of this, companies compete to improve their ESG ratings. Investment firms offer mutual funds built on these strategies, and screening tools their investors can use to build their own strategies. Like it or not, ESG investing is here to stay.

Credit and Deduction Changes for 2022

For those preparing 2022 income tax returns, the IRS offers the following brief summary of how credits and deductions have changed from the previous year:

Unlike 2020 and 2021, there were no new stimulus payments for 2022, so taxpayers should not expect to get an additional payment in their 2023 tax refund.

However, taxpayers may still qualify for temporarily expanded eligibility of the Premium Tax Credit, a refundable credit that helps eligible individuals and families cover the premiums for their health insurance purchased through the Health Insurance Marketplace. To get this credit, taxpayers must meet certain requirements and file a tax return with Form 8962, Premium Tax Credit.

Also, eligibility rules changed to claim a Clean Vehicle Credit under the Inflation Reduction Act of 2022.

Some tax credits return to 2019 levels. This means that taxpayers will likely receive a significantly smaller refund compared with the previous tax year.

Changes include amounts for the Earned Income Tax Credit (EITC), the Child Tax Credit (CTC) and the Child and Dependent Care Credit will revert to pre-COVID levels. 

    • For the EITC, eligible taxpayers with no children who received roughly $1,500 in 2021 will now get $500 for the 2022 tax year.
    • Those who got $3,600 per dependent in 2021 for the CTC will, if eligible, get $2,000 per dependent for the 2022 tax year.
    • The Child and Dependent Care Credit returns to a maximum of $2,100 in 2022 instead of $8,000 in 2021.

Finally, taxpayers that don’t itemize and take the standard deduction cannot deduct their charitable contributions this year.

[End of quote from IRS.]

Stumbling Start to Tax Season

The 2023 tax season kicked off January 23. IRS began accepting returns, and many taxpayers anticipating refunds rushed to get their forms in early. Then a slight problem. Our friends at the IRS realized there was a unique problem affecting millions of taxpayers.

State pandemic payments. In 2022, many states responded to the pandemic by sending their residents special tax refunds or other payments. Somehow, the IRS didn’t realize until after the tax season started that recipients would need to know whether they have to report these payments as taxable income on their federal tax returns. What’s worse, when the issue fell into their laps, they realized it wasn’t an easy question.

Hurry up and wait. The IRS fell into a quandary. I know, the irony. They didn’t know what to do, so they couldn’t tell us what to do. In a statement released February 3, the agency said it was working on this complicated issue as quickly as possible, and offered the following recommendation:

For taxpayers uncertain about the taxability of their state payments, the IRS recommends they wait until additional guidance is available or consult with a reputable tax professional. 

Of course, no reputable tax professional would be so foolish as to offer an answer before the IRS provided additional guidance.

Blessed relief. That guidance arrived a week later, and was generally favorable. It appears that at least some of the IRS tax experts thought it would be technically correct to tax the payments. We gather as much from the somewhat grudging manner of granting relief. Rather than say the agency finds the payments nontaxable, the guidance says the IRS has determined “it will not challenge the taxability of” the payments. They seemed to be saying, what the hell, we’ll let you get away with it this time.

Special pandemic payments from most states do not have to be reported on federal income tax returns. However, residents of Georgia, Massachusetts, South Carolina and Virginia may have received payments in the form of refunds of state tax they previously paid. Those individuals may have to report and pay tax on some or all of the amount they received, but only if they claimed the previous payment as an itemized deduction and received a benefit (reduction in their federal tax) from claiming that deduction. Here the IRS is applying the rule that applies to tax refunds in general. Relatively few individuals should be affected, because only a small fraction of federal taxpayers itemize.