California has required employers to “indemnify” employees for “necessary expenditures or losses incurred by the employee in direct consequence of the discharge of his or her duties, or of his or her obedience to the directions of the employer” in substantially the same terms since 1937 under Labor Code § 2802. Recently, the COVID-19 pandemic renewed interest in this obligation. In the spring of 2020, International Business Machines Corporation (IBM) ordered thousands of employees to work from home, requiring them to procure the necessary equipment themselves. Mr. Paul Thai sued IBM for reimbursement in Thai v. IBM through the Private Attorneys General Act, alleging that he was owed reimbursement under section 2802.

The trial court sided with IBM’s defense that Governor Newsom’s stay-at-home executive order was “the independent, direct cause” for the employees’ expenses, rather than any actions on the part of IBM. However, the appellate court overturned the trial courts decision, liberally interpreting the remedial statute in the employee’s favor, the appellate court rejected the “tort-like causation inquiry that is not rooted in the statutory language.” Section 2802 uses the less exclusive term, “direct consequence,” rather than “direct cause.” Therefore, the appellate court stated, “It may be true that the Governor’s March 2020 order was the ‘but-for’ cause of certain work-from-home expenses, but nothing in the statutory language can be read to exempt such expenses from the reimbursement obligation” which “allocates the risk of unexpected expenses to the employer, which is consistent with the Legislature’s intent in adopting the statute.” For Labor Code § 2802 cases the appellate court found that “expenses at issue must actually be a consequence of the work duties, rather than due to something else.”

Thai v. IBM expressly declined to opine on the “extent an employer must reimburse an employee for expenses incurred for both personal and work purposes” or “what expenditures can be considered ‘reasonable costs’ of working from home.” However, the appellate court noted that “it may be that the ‘direct consequence’ language is relevant in determining whether and to what extent expenses that an employee was already incurring for personal reasons are reimbursable.”

If you have questions or concerns about how these news reports may affect you or your business, please contact The Burton Law Firm at: 916-822-8700 or email info@lawburton.com for a consultation.

On November 3, 2021, the Cybersecurity and Infrastructure Security Agency (CISA) within the Department of Homeland Security issued Binding Operational Directive 22-01, Reducing the Significant Risk of Known Exploited Vulnerabilities. This directive requires federal agencies to remediate known exploited vulnerabilities (KEV) as their “top priority.” Further, agencies must isolate or remove compromised assets from their network if they fail to “timely remediate a KEV.” The Treasury Inspector General for Tax Administration (TIGTA) reviewed IRS compliance. 

The CISA maintains an expanding list of KEVs in its KEV Catalog. There are currently 989 types of KEVs, and assets may have more than one KEV. Each is described in detail with a deadline for remediation, often taking three weeks. As of December 15, 2022, 91,559 assets were identified as having at least one KEV. TIGA analyzed assets for four months, from September through December 2022, and  a total of 820,343 KEVs were detected with 1.54% of these not being timely remediated. KEV detection and remediation activity varied wildly from month to month. November 2022 saw 530,945 KEVs, whereas the prior month witnessed 5,065. Oddly, November 2022 had the best timely remediation rate, with the rate remarkably being over 99%, while over 57% of the October 2022 KEVs were not timely remediated. TIGTA discovered 12,634 KEVs during the tested period that needed to be isolated or removed from the IRS network because they were not timely remediated. TIGTA did not disclose the extent of IRS compliance in this regard. However, the Treasury Department ordered 1,001 affected assets to be removed.

The IRS responded and refused to remove 27 flagged assets, claiming that isolation or removal would interfere with speedy mitigation. TIGTA concluded that IRS KEV “repository data are not reliable.” It discovered 14 KEVs that the IRS failed to track, and “there is no data representing accurate remediation due dates of each KEV, time allowed for remediation, or number of days remediation is overdue.” Part of this inadequacy is due to the frequency of “attack signature changes.” IRS officials met with the Treasury Department’s Chief Information Officer in November 2022 to offer a solution and inquired into the proposal’s status in December 2022. “[A]s of April 2023, the Treasury Department has not responded.” Binding Operational Directive 22-01 required all agencies to update their standard operating procedures detailing how to comply with the directive by January 2, 2022, and the IRS has yet to do so even still. Existing written procedures “were non-official and draft in nature, i.e., no letterhead, official title, version number, IRS function personnel who prepared it, date, table of contents, and executive approval.” Furthermore, the relevant update to the Internal Revenue Manual “only provides general information.” The Acting Chief Information Officer, Kaschit Pandya, promised to complete all corrective actions by December 2024.

Introduction

During the COVID-19 pandemic the world witnessed three direct payments by the US federal government to approximately 165 million Americans for economic relief. These payments were enhanced by legislation specifically exempting them from the federal income tax. Many states followed the federal practice and issued similar stimulus payments in 2022. The IRS waited until after the filing season and then issued clarification that those state payments would not be taxed and started to exempt most state payments. The guidance released was specific to 2022 and did not then apply to any future payments that could theoretically be made. The IRS then issued Notice 2023-56 over six months later to provide guidance for 2023 and subsequent years, but the guidance contained in Notice 2023-56 has yet to be finalized. Comments are invited with a submission preference of before October 17, 2023.

Notice 2023-56 began its analysis talking about “gross income” which “means all income from whatever source derived” including every “undeniable accession to wealth, clearly realized, over which a taxpayer has complete dominion.”[1] This includes state payments with three notable exceptions:

1. State Tax Refunds.
2. General Welfare Exclusion.
3. Disaster Relief Payments.

State Tax Refunds

The classification of a payment from a state as a tax refund turns on substance, not form. To be more specific, the payment must be the amount of “taxes actually paid by the taxpayer.”[2] This is not restricted to a state income tax.[3] A refund is usually “not an accession to wealth,”[4] however it can be through the “tax benefit rule” which requires income inclusion for recouped deductions.[5] Therefore, state tax deductions must be balanced by including refunds as income to the extent that they reflect deductions that reduced the taxpayer’s tax liability. The above does not apply to the standard deduction.

General Welfare Exclusion

The second exception to a state payment being included in gross income is referred to as the general welfare exclusion. Specifically, “payments made to, or on behalf of, individuals by governmental units under legislatively provided social benefit programs for the promotion of the general welfare are not includible in an individual recipient’s Federal gross income.”[6] This exclusion has three prerequisites:

1. The payment must originate “from a government fund.”[7]
2. The payment must be “based on the need of the individual or family receiving such payments.”[8]
3. The payment must “not represent compensation for services absent a specific Federal income tax exclusion.”[9]

Disaster Relief Payments

The third exclusion is the disaster relief payment exclusion, and of the three contemplated exceptions, only the disaster relief exclusion is expressly statutory. “Section 139(a) provides that Federal gross income does not include any amount received by an individual as a qualified disaster relief payment.”[10] A “qualified disaster relieve payment” includes, “among other things, any amount paid to, or for the benefit of, an individual 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.”[11] Thus, there are three elements:

1. There must be a “qualified disaster.”
2. The payment must be “in connection with” such a disaster.
3. The payment must be issued to “promote the general welfare.”

A disaster may be “qualified” through a presidential declaration that the event “warrant[s] assistance by the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act” codified in 42 U.S.C. §§ 5121-5207.[12] The second factor was not analyzed by the IRS, but it is likely based on the language used that payments made “in connection with” a “qualified disaster” would be explicit in their association. Once the first two criteria are met, the third is “presumed” to be met as well, meaning the taxpayer would not need to show anything beyond the applicability of the first two elements in order to have a payment qualify as a disaster relief payment.

If you have questions or concerns about how these news reports may affect you or your business, please contact The Burton Law Firm at: 916-822-8700 or email info@lawburton.com for a consultation.

[1] Notice 2023-56 § 3.01(quoting IRC § 61(a) and Commissioner v. Glenshaw Glass Co., 348 U.S.

426, 431 (1955)).

[2] Notice 2023-56 § 3.02.

[3] Notice 2023-56 § 4.02.

[4] Notice 2023-56 § 3.02.

[5] “The tax benefit rule generally requires a taxpayer to include in Federal gross income an amount recovered during a taxable year that the taxpayer deducted for Federal income tax purposes in a prior taxable year to the extent the Federal income tax deduction reduced the taxpayer’s Federal income tax liability in the prior taxable year.” Notice 2023-56 § 3.02.

[6] Notice 2023-56 § 3.03.

[7] Notice 2023-56 § 3.03.

[8] Notice 2023-56 § 3.03.

[9] Notice 2023-56 § 3.03.

[10] Notice 2023-56 § 3.04.

[11] Notice 2023-56 § 3.04.

[12] Notice 2023-56 § 3.04.

All federal taxes are direct taxes or indirect taxes. Under the US Constitution, direct taxes must be “in Proportion to the Census,” and indirect taxes “shall be uniform throughout the United States.”[1] Unless tax provisions expressly differ by the state, such as a higher tax rate for Californians, the uniformity requirement is almost always satisfied.[2] For direct taxes the US Constitution mandates nearly the opposite resulting in the effective penalization of poor populous states as population rather than wealth is taxed. Under a direct tax Alabama would be taxed 29.4% more than Connecticut despite Connecticut’s 67.8% higher average income due to the larger population of Alabama. The first Supreme Court case interpreting the Direct Tax Clause, decided in 1797, derided apportionment as “absurd” with “oppressive and pernicious” results when applied to subjects other than land, which even then “is scarcely practicable.”[3] One constitutional scholar summarized academic sentiment regarding this reality by calling it “a botch in the core of the Constitution.”[4] Now, the Supreme Court has agreed to hear Charles G. Moore v. United States and decide: “Whether the Sixteenth Amendment authorizes Congress to tax unrealized sums without apportionment among the states.” At stake is at least $340 billion.[5]

Subpart F of the Internal Revenue Code proportionally imputed a foreign corporation’s “particular categories of its undistributed earnings such as dividends, interest, and earnings invested in certain U.S. property” to U.S. persons owning at least 10% of a controlled foreign corporation (CFC), “a foreign corporation whose ownership or voting rights are more than 50% owned by U.S. persons.”[6] Such income is known as Subpart F income, and such a corporation is known as a “controlled foreign corporation.”[7] The Tax Cuts and Jobs Act of 2017 modified Subpart F to include a CFC’s “current earnings.”[8] That 2017 legislation also added the Mandatory Repatriation Tax (MRT), which is a “one-time tax” that changed “Subpart F by classifying CFC earnings after 1986 as income taxable in 2017.”[9] Shareholders of an Indian company dedicated to supplying “modern tools to small farmers in India” have now claimed that the MRT violated the Direct Tax Clause.[10]

The Direct Tax Clause

Clause 4 of Section 9 of Article I of the Constitution provides: “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.” Taxes are considered to be direct if they were “understood to be direct taxes when the Constitution was adopted.”[11] Nevertheless, “[e]ven when the Direct Tax Clause was written it was unclear what else, other than a capitation (also known as a ‘head tax’ or a ‘poll tax’), might be a direct tax.”[12] Even this is an understatement as it appears that those present at the constitutional convention who wrote the words themselves did not have a clear idea. Previous US Supreme Court justices have explored this ambiguity in previous opinions, stating, “[i]n the convention which framed the Constitution, Mr. King, on one occasion asked what was the precise meaning of ‘direct taxation,’ and Mr. Madison informs us that no one answered. That Mr. Madison took the pains to record the incident indicates that it challenged attention but that no one was able to formulate a definition.”[13] In Alexander Hamilton’s words, “[i]t is a matter of regret that terms so uncertain and vague in so important a point are to be found in the Constitution. We shall seek in vain for any antecedent settled legal meaning to the respective terms. There is none.”[14]

The 16th Amendment did not moot the mystery of the Direct Tax Clause when it may have had the chance to. Instead, that Amendment specifically exempted only taxation on income from apportionment: “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.” This “merely removed the necessity which otherwise might exist for an apportionment among the states of taxes laid on income.”[15]

The Direct Tax Clause was last discussed by the Supreme Court in 2012 when it upheld most of the Patient Protection and Affordable Care Act under the congressional power to tax.[16] As that legislation’s accompanying tax is not on income, it must be apportioned if it is a “direct tax.” The Court found that it is not. In explaining why the “tax on going without health insurance does not fall within any recognized category of direct tax,” Chief Justice Roberts demarcated three categories in writing for the Court: Capitations, taxes on the ownership of land, and taxes on personal property.[17] The inclusion of “personal property” in Chief Justice Roberts’ formulation is notable. As he observed, “direct taxes” were understood to include only capitations and land taxes from 1796 to Pollock v. Farmers’ Loan & Trust Co. in 1895.[18] Pollock ruled in a 5-4 decision that the income tax was unconstitutional because it was a direct tax on personal property, expanding what was the direct tax’s duo into a trio. When establishing an income tax in the US, the 16th Amendment achieves its desired effect directly—it does not restore Direct Tax Clause jurisprudence to its pre-Pollock state but bypasses it entirely to provide an outright exception for income. As Chief Justice Roberts implied, Pollock’s expansion to personal property remains sound. Yet if the Direct Tax Clause encompasses taxation on personal property, then what are the “Duties, Imposts and Excises” contemplated in the Taxing Clause?[19] Pollock declared that “the constitution divided federal taxation into two great classes,—the class of direct taxes, and the class of duties, imposts, and excises.”[20] Nevertheless, these classes may overlap.[21] In contrast, Justice Harlan’s dissent in Pollock contended that “[i]n the constitution, the words ‘duties, imposts, and excises’ are put in antithesis to direct taxes.”[22] This dispute seemingly became academic with the 16th Amendment.

Moore v. United States

The 9th Circuit decided Moore v. United States in the Justice Department’s favor.[23] Eisner v. Macomber rests as the center of the 9^th Circuit’s reasoning. Eisner v. Macomber is most notable for its status as the Supreme Court’s first case to discuss 16th Amendment lexicology. Specifically, Eisner v. Macomber considered whether a stock dividend is income. As summarized several decades later by the Court: “At issue was whether the stock dividend constituted taxable income. We held that it did not, because no gain was realized.”[24] Eisner v. Macomber defined income as:

[G]ain, a profit, something of exchangeable value, proceeding from the property, severed from the capital, however invested or employed, and coming in, being “derived”-that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal-that is income derived from property. Nothing else answers the description.^[25]

As assessed by the Court in 1943, the Court subsequently “rejected the concept that taxable gain could arise only when the taxpayer was able to sever increment from his original capital” and “held that there was no exemption from taxation where economic gain is enjoyed by some event other than the taxpayer’s personal receipt of money or property.”[26] These “decisions undermined further the original theoretical bases of” Eisner v. Macomber, and the Court seemingly considered overruling it but decided that the time was inopportune for such a change.[27] However, the decisions the Court reviewed clarified when realization occurs rather than denying that it must occur altogether.

Eisner v. Macomber unambiguously concluded what income is not: “[F]rom every point of view we are brought irresistibly to the conclusion that neither under the Sixteenth Amendment nor otherwise has Congress power to tax without apportionment a true stock dividend made lawfully and in good faith, or the accumulated profits behind it, as income of the stockholder.”[28] The Supreme Court never unequivocally held that realization is always a requirement for income, although it seems to have come close.[29] The 9th Circuit seized upon this absence and Court criticism of Eisner v. Macomber to limit that case to its facts. For example, a 1955 Supreme Court case declared that Eisner v. Macomber “was not meant to provide a touchstone to all future gross income questions.”[30] Despite this statement, Eisner v. Macomber was cited by the Court as an authority regarding the nature of income on at least five subsequent occasions, most recently in 2012.[31]

The 9th Circuit’s decision in Moore v. United States did not contain a dissenting opinion. However, the 9th Circuit’s denial of an en blanc hearing prompted a dissent from four circuit judges.[32] The dissenting opinion was sympathetic to the taxpayers, the Moores. The dissenters stated that the Moores invested in KisanKraft “to improve the lives of small and marginal farmers in India” and reinvested all profits without realizing any income, yet “[a]s the Moores would find out, no good deed goes unpunished.”[33]

The definition of “income” in the 16th Amendment determines the fate of hundreds of billions of dollars. It is “the commonly understood meaning of the term which must have been in the minds of the people when they adopted the Sixteenth Amendment to the Constitution.”[34] According to the 9th Circuit’s dissent, “income” was understood to require realization when the 16th Amendment was ratified in 1913. Several citations buttressed this argument. Mr. Henry Campbell Black himself, “of Black’s Law Dictionary fame,” published a treatise soon after ratification, maintaining that income “is not synonymous with ‘increase’” and realization is a prerequisite.[35] 

The 9th Circuit emphasized the Supreme Court’s language in Helvering v. Horst that “the rule that income is not taxable until realized” is “founded on administrative convenience.”[36] However, the dissent responded, stating that  language did not necessarily carry constitutional connotations.[37] In light of this dispute it is worth noting that the first sentence of Helvering v. Horst appeared to fully accept the premise of a realization requirement: “The sole question for decision is whether the gift… is the realization of income taxable to the donor.”[38]

Taxes under Threat

While the Mandatory Repatriation Tax precipitated this case the 9th Circuit understood the challenge as threatening Subpart F’s whole scheme rather than simply this isolated tax. Notwithstanding its disclaimer that “it does not control our analysis,” the 9th Circuit cautioned that “holding that Subpart F is unconstitutional under the Apportionment Clause would also call into question the constitutionality of many other tax provisions that have long been on the books.”[39] Indeed, the Justice Department argued that the taxation of “regulated futures contracts,” “securities held by securities dealers,” certain life insurance company assets,  partnerships, S corporations, and expatriation would be jeopardized if realization is necessary for the 16th Amendment’s apportionment exception in addition to the threat to subpart F income.[40] As a result of the potentially far reaching implications, an audience before the Supreme Court for this Direct Tax Clause argument is far from the 2nd Circuit’s 1973 dismissal of it as one that “borders on the frivolous.”[41]

At present, neither party appears to have contemplated the implications for the estate and gift taxes should the Direct Tax Clause reawaken. These are not taxes on income. Yet according to the Supreme Court, these are not direct taxes either.[42] They tax some of the property rights rather than all of the property and are triggered by an event. “A tax laid upon the happening of an event, as distinguished from its tangible fruits, is an indirect tax.”[43] The gift tax taxes “[t]he power to give” which “cannot be said to be a more important incident of property than the power to use,” such as a “tax upon the use of foreign built yachts” or the “use of carriages,” both previously held to be indirect taxes.[44] The estate tax was held to be a tax on “the receipt in possession or enjoyment of the proceeds of a right previously acquired and vested.”[45] “A tax imposed upon the exercise of some of the numerous rights of property is clearly distinguishable from a direct tax, which falls upon the owner merely because he is owner, regardless of his use or disposition of the property.”[46] A tax on the whole value of the estate’s property rights is therefore justified because it is a tax on the exercise of some of those rights, and not on the property itself.

The estate tax’s pedigree influenced the Supreme Court as a feudal “payment exacted of the heir for the privilege of admission to possession of the land of his ancestor.”[47] “[T]his kind of tax always has been regarded as the antithesis of a direct tax; has ever been treated as a duty or excise, because of the particular occasion which gives rise to its levy. Upon this point a page of history is worth a volume of logic.”[48] For example, the Stamp Act of 1797 levied a legacy tax on testamentary transfers under the label of “duty.”[49] Ultimately, “Congress may tax real estate or chattels if the tax is apportioned, and without apportionment it may tax an excise upon a particular use or enjoyment of property or the shifting from one to another of any power or privilege incidental to the ownership or enjoyment of property.”[50] A tax on the ascension of wealth is a direct tax if triggered by a sale or payroll period, and an indirect tax if triggered by a gift or death. This classification’s survival under renewed scrutiny is not necessarily guaranteed and any changes to that classification could have far reaching impact.

Conclusion

The definition both parties target is that of “income.” Yet the Justice Department limits its options if it chooses not to change the term they seek to define from “income” to “direct.” If the Justice Department changes their fight, and the Supreme Court modifies Pollock’s holding that a tax on personal property is a direct tax, the Court could avoid defining income altogether. While the Supreme Court professes to loathe reversing its own precedent, deciding in favor of the Justice Department would effectively require overruling Eisner v. Macomber or Pollock. It appears that the Justice Department is aware of this reality, as they have relied on Eisner v. Macomber’s dissenting opinion by Justice Holmes to a considerable degree in its pleading to the Supreme Court. Whereas Eisner v. Macomber is usually well-regarded as the foundation of income tax jurisprudence, Pollock prompted a constitutional amendment to overrule its holding. Pollock was a departure from Direct Tax Clause caselaw bearing a pedigree from the Framers. Construing the Direct Tax Clause to exclude the tax of unrealized income from the scope of a direct tax while leaving its full definition ambiguous would maintain the status quo and permit challenges to any future tax on wealth itself rather than accensions to wealth.

Moore v. U.S. has the potential to revolutionize tax law. Realization is the predicate of income tax law, yet it is nearly an unwritten convention stemming from century-old caselaw. In defining “gross income,” Congress uses the language of the 16th Amendment to “the full measure of its taxing power.”[51] If “income” of the 16th Amendment includes unrealized gain or increase in wealth, then “income” as used in section 61 of the Internal Revenue Code does as well.[52] Theoretically, that would mean every rise in stock price would be a taxable event as unrealized income. On the other hand, if the taxpayer wins, Subpart F, the expatriation tax, and other provisions would be nullified. Depending on the scope of the Supreme Court’s Direct Tax Clause observations, the estate and gift tax may also be jeopardized. Incidentally, Moore v. U.S. will be decided in a presidential election year in which President Joseph Biden may make his proposed tax on unrealized income a significant policy issue further adding to the significance of this upcoming decision. 

[1] U.S. Const. art. I, § 8, cl. 1; U.S. Const. art. I, § 9, cl. 4.

[2] “[T]he uniformity in excise taxes exacted by the Constitution is geographical uniformity, not uniformity of intrinsic equality and operation. The Constitution does not command that a tax have an equal effect in each state. It has long been settled that within the meaning of the uniformity requirement a tax is uniform when it operates with the same force and effect in every place where the subject of it is found.” Fernandez v. Wiener, 326 U.S. 340, 359 (1945)(omitting internal quotation marks and citations).

[3] Hylton v. United States, 3 U.S. (3 Dall.) 171, 179-80 (1797) (Paterson, J.).

[4] Calvin H. Johnson, Apportionment of Direct Taxes: The Foul-Up in the Core of the Constitution, 7 Wm. & Mary Bill Rts. J. 1, 11 (1998).

[5] Moore v. United States, 36 F.4th 930, 933 (9th Cir. 2022), cert. granted, No. 22-800, 2023 WL 4163201 (U.S. June 26, 2023).

[6] Moore v. United States, 36 F.4th 930, 933 (9th Cir. 2022), cert. granted, No. 22-800, 2023 WL 4163201 (U.S. June 26, 2023).

[7] Moore v. United States, 36 F.4th 930, 932 (9th Cir. 2022), cert. granted, No. 22-800, 2023 WL 4163201 (U.S. June 26, 2023).

[8] Moore v. United States, 36 F.4th 930, 932 (9th Cir. 2022), cert. granted, No. 22-800, 2023 WL 4163201 (U.S. June 26, 2023).

[9] Moore v. United States, 36 F.4th 930, 932-33 (9th Cir. 2022), cert. granted, No. 22-800, 2023 WL 4163201 (U.S. June 26, 2023).

[10] Moore v. United States, 36 F.4th 930, 932 (9th Cir. 2022), cert. granted, No. 22-800, 2023 WL 4163201 (U.S. June 26, 2023).

[11] Bromley v. McCaughn, 280 U.S. 124, 137 (1929).

[12] Nat’l Fed’n of Indep. Bus. v. Sebelius, 567 U.S. 519, 570 (2012).

[13] Bromley v. McCaughn, 280 U.S. 124, 139 (1929)(Justice Sutherland dissenting).

[14] Springer v. United States, 102 U.S. 586, 597 (1880)(quoting Alexander Hamilton).

[15] Eisner v. Macomber, 252 U.S. 189, 206 (1920).

[16] Nat’l Fed’n of Indep. Bus. v. Sebelius, 567 U.S. 519 (2012).

[17] Nat’l Fed’n of Indep. Bus. v. Sebelius, 567 U.S. 519, 571 (2012).

[18] Pollock v. Farmers’ Loan & Tr. Co., 158 U.S. 601 (1895).

[19] “The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States.” U.S. Constitution Art. I § 8, Clause 1.

[20] Pollock v. Farmers’ Loan & Tr. Co., 158 U.S. 601, 617–18 (1895).

[21] “We do not mean to say that an act laying by apportionment a direct tax on all real estate and personal property, or the income thereof, might not also lay excise taxes on business, privileges, employments, and vocations.” Pollock v. Farmers’ Loan & Tr. Co., 158 U.S. 601, 637 (1895). The contradiction of a geographically uniform tax in proportion to the states was not discussed.

[22] Pollock v. Farmers’ Loan & Tr. Co., 158 U.S. 601, 622 (1895)(Justice Harlan dissenting).

[23] The Justice Department is responsible for tax litigation outside of Tax Court. U.S. Dep’t of Just. v. Tax Analysts, 492 U.S. 136, 138 (1989).

[24] Cottage Sav. Ass’n v. Comm’r, 499 U.S. 554, 563 (1991).

[25] Eisner v. Macomber, 252 U.S. 189, 207 (1920)(emphasis in original).

[26] Helvering v. Griffiths, 318 U.S. 371, 393 (1943)(omitting internal quotation marks).

[27] Helvering v. Griffiths, 318 U.S. 371, 393–94 (1943).

[28] Eisner v. Macomber, 252 U.S. 189, 219 (1920).

[29] “A gain constitutes taxable income when its recipient has such control over it that, as a practical matter, he derives readily realizable economic value from it.” James v. United States, 366 U.S. 213, 219 (1961)(omitting internal quotation marks).

[30] Comm’r v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).

[31] Ivan Allen Co. v. United States, 422 U.S. 617, 633 (1975); Lukhard v. Reed, 481 U.S. 368, 375 (1987); Comm’r v. Fink, 483 U.S. 89, 95 fn.6 (1987); Cottage Sav. Ass’n v. Comm’r, 499 U.S. 554, 562 (1991); Nat’l Fed’n of Indep. Bus. v. Sebelius, 567 U.S. 519, 571 (2012).

[32] Moore v. United States, 53 F.4th 507 (9th Cir. 2022). The dissenters were: Hon. Patrick J. Bumatay, Hon. Sandra S. Ikuta, Hon. Consuelo M. Callahan, and Hon. Lawrence J. C. VanDyke.

[33] Moore v. United States, 53 F.4th 507, 509 (9th Cir. 2022)(Judge Bumatay dissenting).

[34] Merchants’ Loan & Tr. Co. v. Smietanka, 255 U.S. 509, 519 (1921).

[35] Moore v. United States, 53 F.4th 507, 511 (9th Cir. 2022)(Judge Bumatay dissenting).

[36] Helvering v. Horst, 311 U.S. 112, 116 (1940).

[37] Moore v. United States, 53 F.4th 507, 514 (9th Cir. 2022)(Judge Bumatay dissenting).

[38] Helvering v. Horst, 311 U.S. 112, 114 (1940).

[39] Moore v. United States, 36 F.4th 930, 938 (9th Cir. 2022), cert. granted, No. 22-800, 2023 WL 4163201 (U.S. June 26, 2023)

[40] https://www.supremecourt.gov/DocketPDF/22/22-800/267027/20230516164014148_22-800%20Moore%20v.%20USA.pdf at 17-18.

[41] Garlock Inc. v. Comm’r, 489 F.2d 197, 202 (2d Cir. 1973).

[42] Bromley v. McCaughn, 280 U.S. 124 (1929); Fernandez v. Wiener, 326 U.S. 340 (1945).

[43] Tyler v. United States, 281 U.S. 497, 502 (1930).

[44] Bromley v. McCaughn, 280 U.S. 124, 137-138 (1929)(referencing Billings v. United States, 232 U.S. 261 (1914) and Hylton v. United States, 3 U.S. 171 (1796).

[45] Fernandez v. Wiener, 326 U.S. 340, 355 (1945).

[46] Fernandez v. Wiener, 326 U.S. 340, 362 (1945).

[47] Fernandez v. Wiener, 326 U.S. 340, 353 fn.13 (1945).

[48] New York Tr. Co. v. Eisner, 256 U.S. 345, 349 (1921)(omitting internal quotation marks and citation).

[49] Knowlton v. Moore, 178 U.S. 41, 50 (1900).

[50] Fernandez v. Wiener, 326 U.S. 340, 352 (1945).

[51] Helvering v. Clifford, 309 U.S. 331, 334 (1940).

[52] IRC § 1001 only governs the disposition of property.

We live in an age of unparalleled mobility in a world of many differing taxes and taxation structures. Yet permanently changing one’s residence is not a decision lightly made. Wealth can grow more quickly in states without an income tax through nongrantor trusts. These are trusts created at the cost of surrendering grantor control, and in return for that loss of control, the grantor is not taxed on the income of such a trust. The trust is taxed instead based on the trust’s residence—permitting a grantor to live in a state with a heavy tax burden while their assets grow in a state with a light tax burden. Recently, California disrupted this strategy by enacting SB 131.

In addition to ceding control, another price for creating a nongrantor trust is the gift tax liability usually incurred through transferring assets to it. Like a nongrantor trust, the gifter’s lack of control is a prerequisite for creating a gift. Yet the standard for a gift is stricter than for a nongrantor trust. It is possible to retain enough power to disqualify the transfer as a gift but not enough to disqualify the trust as a nongrantor trust. The result in the past was a trust that can be funded without gift tax liability while earning income without being taxed at the state level, an ING. Under the new regulations the grantor of an ING will now be taxed on the ING’s income by California.

A grantor of an ING will be taxed on all of the ING’s income beginning with the 2023 tax year. This is true regardless of the ING’s creation date. It is not limited to grantors living in California either. A nonresident grantor will be taxed on the ING’s California-sourced income even if the grantor lacked contact with California. This law was likely inspired by New York, which enacted a similar law in 2014 without a legal challenge. The Franchise Tax Board estimated that a substantially similar law would increase the annual tax burden by an approximate average of $24,000 per affected taxpayer.

If you have questions or concerns about how these news reports may affect you or your business, please contact The Burton Law Firm at: 916-822-8700 or email info@lawburton.com for a consultation.

Normally, a typed (nonholographic) will must be signed by at least two persons who witnessed the testator’s signature of the will or the testator’s acknowledgment of the document as the testator’s will. The law requiring these formalities was amended in 2008 through the changes to Probate Code § 6110(c)(2) to provide an exception allowing a will to be valid, “if the proponent of the will establishes by clear and convincing evidence that, at the time the testator signed the will, the testator intended the will to constitute the testator’s will.” There has been little caselaw interpreting this language as of yet, but the recent decision in Estate of Berger is the third and provides the most thorough analysis of any reported case on this subject.

In Estate of Berger, the testator typed and signed a letter addressed to her fiancé dated August 16, 2002. This document named the fiancé as her “sole beneficiary.”[1] The testator contemporaneously emailed the fiancé (who was on vacation in Spain) of the “will,” its contents, and the location of a copy. Further emails complained about the lack of any response. This document was never mentioned again apart from these several emails over several days. Their relationship continued for six months before terminating without marriage, lasting for less than a year in total. All contact ceased thereafter. The testator died in 2020 without ever designating the (ex)fiancé as a beneficiary for her retirement account.

Within the year before her death, the testator became more religiously active and expressed her intent to bequeath her estate to her church. However, this was never “memorialized.”[2] The testator’s pastor discovered and disclosed the letter amongst the testator’s personal effects sparking the dispute between the testator’s sister (the sole intestate heir) and the ex-fiancé. The question was whether that letter was intended to be the will. The trial court decided it was not.

The appellate court rejected the ex-fiancé’s analytical limitation to the letter’s “four corners”: “In this particular context, an unbroken line of precedent squarely establishes that extrinsic evidence is always admissible on the question of the drafter’s intent.”[3] The trial court’s use of extrinsic evidence imposed a substantial evidence review standard for Estate of Berger. Normally, this would all but doom the ex-fiancé’s position. Proving error under substantial evidence review is “difficult” normally, “particularly onerous” when the ruling was against the proponent, “[a]nd the bar for obtaining reversal is even higher where, as here, the party’s burden below required her to produce clear and convincing proof—that is, proof that establishes the fact at issue to a high probability or so clearly as to leave no substantial doubt.”[4] Nevertheless, “[t]his is one of those rare cases where this very heavy burden has been met.”

Estate of Berger used the following factors to find “as a matter of law” that the letter was intended “to have testamentary effect.”:[5]

• The letter’s contents:
  • Naming the ex-fiancé as the “sole beneficiary.”
  • Granting the ex-fiancé “full discretion” of disposing of all property.
  • Listing the most important assets.
  • Contemplating competing inheritance claims.
• The letter’s formality:
  • Existence on the testator’s work stationary.
  • Full recital of testator’s name, address, and social security number.
  • Addressed to “whom it may concern.”
  • Recitation of the testator’s “sound mind and excellent health.”
  • Recitation of the signing’s date and location.
  • Testator’s signature.
• Surrounding circumstances:
  • The letter was written shortly before “having major surgery” (gender reassignment).
  • The letter was contemporaneously referred to as a “will” in an email by the testator.
  • Sending a copy to the beneficiary and keeping the original in a safe place “likely to be found.”

The arguments against probating the letter as a will principally relied on an intuitive perception of what people would normally do in similar circumstances—common sense. Berger may have feared that the probate court attempted to impose social norms beyond the law. For example, “the [probate] court cited the ‘questions’ it had about Melanie and Maria’s ‘relationship’ as well as the possibility that Melanie may have ‘forgotten’ about the will. These concerns are irrelevant to the pertinent question of intent.” [6]  Whether the testator and the beneficiary “were, in the probate court’s eyes, a conventional or unconventional engaged couple more generally is wholly irrelevant.” [7]

The resulting principles promulgated by Berger are quite broad. Testamentary intent is relevant only “at the time she drafted the will.”[8] Silence thereafter is irrelevant. Although the probate court reasoned that the testator forgot about the letter, a forgotten will is still valid. The wisdom of the will’s terms of “leaving all of her possessions to someone she started dating six months earlier is irrelevant to whether she intended the document she drafted to be a will.” Subsequently failing to change the beneficiary of the retirement account lacked any bearing on the question. Claims regarding competency and undue influence “are irrelevant to the question of whether the document was intended as a will, which is the only question before us. Whether it is enforceable as a will is a distinct and separate issue not presently before us.”[9]

            Estate of Berger is a reminder that a testator’s intent is paramount, but only as expressed in the will the testator wrote the will. This case effectively lowers the threshold for what constitutes a probatable will. It also serves as a warning. A routinely updated estate plan should be considered, even when without a prior estate plan, creditors (whether private or governmental entities), vulnerable dependents (human or animal), or any desire to bequeath property to anyone other than intestate heirs (such as charities). A well-written will or trust instrument minimizes the chances of fraud and gives peace of mind to all involved. In some circumstances it may also serve to prevent an ex-lover from appearing after seventeen years of absence to enforce an unwitnessed will seemingly forgotten in the bottom of a desk drawer.

If you have questions or concerns about how these news reports may affect you or your estate planning, please contact The Burton Law Firm at: 916-822-8700 or email info@lawburton.com for a consultation.

[1] In full:

“’I, Melanie Perry Berger, with sound mind and excellent health, name Maria L. [Coronado], [lists Maria’s then-current address], as my sole beneficiary in the event of my death. She will take ownership of all my personal possessions and property located at [address of Melanie’s house in Pasadena]. She will make the sole determinations as to what she will keep, and what personal belongings that may, or may not, be distributed to any inquiring family members. She will also receive, and have full discretion of:

1. My [Pasadena] home located at [listing address].
2. My retirement Thrift Savings.
3. My 1984 Mercedes Benz 300 CD, license [listing number].
4. My Washington Mutual checking account [listing number].
5. Any and all wages paid to my account, post mortem.

It should be noted that I would prefer to have some of the above Thrift assets set aside for the education of [Maria’s] three daughters, [naming each]. This is, however, only a suggestion, and Maria … shall have the final decision on these matters.’

The letter closes with ‘Sign[ed] and dated 8-16-02 in Pasadena, California,’ and beneath it, Melanie’s signature.” Est. of Berger, 309 Cal.Rptr.3d 194, 200 (2023).

[2] Est. of Berger, 309 Cal.Rptr.3d 194, 200 (2023).

[3] Est. of Berger, 309 Cal.Rptr.3d 194, 204 (2023)(emphasis in original).

[4] Est. of Berger, 309 Cal.Rptr.3d 194, 206 (2023)(omitting internal brackets and quotation marks).

[5] Est. of Berger, 309 Cal.Rptr.3d 194, 206 (2023).

[6] Est. of Berger, 309 Cal.Rptr.3d 194, 207-208 (2023).

[7] Est. of Berger, 309 Cal.Rptr.3d 194, 207 (2023).

[8] Est. of Berger, 309 Cal.Rptr.3d 194, 208 (2023)(emphasis in original).

[9] Est. of Berger, 309 Cal.Rptr.3d 194, 209 (2023)(emphasis in original).

A supplemental (or special) needs trust is a means to assist a beneficiary with a disability while preserving the beneficiary’s eligibility for public benefits. As of now there is “little legal interpretation of and commentary on special needs trusts.” A California case, McGee v. State Department of Health Care Services, attempted to remedy this deficiency by granting an expansive definition to “special needs.” Although the Department of Health Care Services was the challenger to the trustee’s discretion, it did not appear on appeal.

The trial court interpreted “special needs” to include only “the beneficiary’s special needs as created by the limitations due to her condition,” with all expenses not attributable to this “very limited purpose” surcharged to the trustee. The pertinent portion of the trust instrument stated: “Special Needs include without limitation special equipment, programs of training, education and habilitation, travel needs, and recreation, which are related to and made reasonably necessary by this Beneficiary’s disabilities.” The term “special needs” is defined by the instrument as “the requisites for maintaining the Beneficiary’s good health, safety, and welfare when, in the discretion of the Trustee, such requisites are not being provided by any public agency.” McGee liberally interpreted the instrument.

“Health, safety, and welfare address more than just expenses arising from the beneficiary’s disability, and many of those expenses would not be paid by a public agency,” according to the Court in McGee. McGee interpreted the phrase, “including without limitation” to be equivalent to “including but not limited to.” Furthermore, the trust instrument at issue in this case explained that it is not a support trust. Instead, it functions “to supplement public resources and benefits when such resources and benefits are unavailable or insufficient to provide for the Special Needs of the Beneficiary.” McGee quoted extensively from CEB’s Special Needs Trusts: Planning, Drafting, and Administration to establish that “special needs” include “the very broad range of everything else a human being needs in order to live, thrive, and realize his or her potential in life.” It is “actually quite general” encompassing “the entire universe of a person’s goods and services except for food and shelter (to be covered by SSI) and medical care (to be covered by Medi-Cal).”

McGee implicitly suggested that it might have overruled the trial court’s interpretation due to federal law, even if the special needs trust instrument clearly supported the trial court’s judgment. McGee was heavily influenced by a federal Third Circuit decision preempting a Pennsylvania statute that attempted to limit special needs trusts to the trial court’s definition.[1] Moreover, the Social Security Administration eligibility rules for special needs trust beneficiaries were found to be persuasive. In calculating eligibility, the eligibility rules exclude not “only trust assets and distributions that are related to the disability” but also “household goods and personal effects from the beneficiary’s countable resources regardless of their dollar limit.”

Even with this broad interpretation that the court adopted, the trustee’s discretion is not absolute. Administration must be executed “with reasonable care, skill, and caution under the circumstances then prevailing that a prudent person acting in a like capacity would use in the conduct of an enterprise of like character and with like aims to accomplish the purposes of the trust as determined from the trust instrument.” Specifically, distributions for more than one vehicle, “jewelry that one does not wear or does not hold for family significance,” collectibles, and “animals for investment purposes, such as a horse or dog for breeding, for resale, or investment” are usually “outside the scope of the trustee’s discretion.” Even then, expenditures for such items may be permissible if “they are in the beneficiary’s best interest.”

The trustee in McGee was surcharged $73,000 for expenditures ultimately approved on appeal. However, the trustee did not appeal those sanctions.

If you have questions or concerns about how these news reports may affect you or your estate planning, please contact The Burton Law Firm at: 916-822-8700 or email info@lawburton.com for a consultation.

[1] Lewis v. Alexander, 685 F.3d 325 (3d Cir. 2012).

The California Supreme Court granted a broad interpretation to the term, “disclose” as it is used in Labor Code § 1102.5, California’s general whistleblower statute. In Garcia-Brower v. Kolla’s, Inc., the Supreme Court reversed the Court of Appeals, finding that § 1102.5’s protections are not limited to previously unknown information, contrary to prior caselaw. The Court was influenced by the federal whistleblower jurisprudence, finding that § 1102.5’s legislative intent is to protect employees, the general directive to “liberally construe the Labor Code” for employees’ protection, and (perhaps) the injustice suffered by the plaintiff. The employee, a bartender, was fired after complaining to her employer that her wages were late. In retaliation, the employer fired her, banned her from the bar, and threatened to report her to immigration authorities. For her safety, she was identified only as “A.C.R.”  Curiously, the defendant did not appear or participate in any stage of the litigation—meaning this case resulted in a default judgment. The Court appointed Mr. Christopher Hu of Horvitz & Levy, LLP to argue on behalf of the defendant pro bono.

In a different case, Young v RemX Specialty Staffing, the adjudicating court gave a narrower interpretation to a different term, “discharged.” The pertinent statute the court dealt with in this other case was Labor Code § 201.3(b), “‘[i]f an employee of a temporary services employer is assigned to work for a client and is discharged by the temporary services employer or leasing employer, wages are due and payable’ immediately.”[1] In Young v. RemX Specialty Staffing, Ms. Young was an employee of a temporary staffing company. Shortly after being assigned to a temporary position at a bank, Ms. Young’s assignment was terminated by her employer when she allegedly became “verbally abusive” with a representative of the bank.

Ms. Young then did not receive another work assignment from her employer. The Court of Appeals found that an “employment relationship” was a prerequisite to being “discharged” and an employee of a temporary services employer does not have an employment relationship with a client of the employer. In plain English, the Court of Appeals found that Ms. Young was not “discharged” by the bank on these facts. Ms. Young raised the “general directive” of liberally construing the relevant statutes in favor of the employee. Young demurred that “we may not impermissibly rewrite the statute in the guise of liberally construing it.”[2]

If you have questions or concerns about how these news reports may affect you or your business, please contact The Burton Law Firm at: 916-822-8700 or email info@lawburton.com for a consultation.

[1] Young v. RemX Specialty Staffing, No. A165081, 2023 WL 3331378, at *4 (Cal. Ct. App. May 10, 2023)(quoting § 201.3(b)(4)).

[2] Young v. RemX Specialty Staffing, No. A165081, 2023 WL 3331378, at *5 (Cal. Ct. App. May 10, 2023)(cleaned up).