GOOD INTENTIONS: ADMINISTRATIVE FIAT AND THE GENERAL WELFARE EXCLUSION.

• Author: Brunson, Samuel D.

ABSTRACT

Since its introduction in 1913, the federal income tax has viewed income expansively, subjecting virtually all types of enrichment as gross income unless Congress explicitly exempted the income from taxation. But in the income tax's second decade, the Bureau of Internal Revenue created an exception to the broad reach, an exception not grounded in any type of congressional enactment. The Bureau's practice of excluding certain benefits began innocuously in the late 1930s by excluding certain social security benefits from gross income. Over the decades, the IRS has used what it now refers to as the "general welfare exclusion" to exclude from gross income everything from subsistence benefits to payments made to preserve historic buildings. Confronted with difficult questions surrounding poverty and ability to pay, the general welfare exclusion has provided a way for the IRS to resolve complex and unanticipated questions about whether certain government welfare benefits constitute gross income.

The general welfare exclusion, however, relies upon an enigmatic foundation of administrative rulings and decisions completely unhooked from any statutory authority or direction. While this administratively created general welfare exclusion is broad and affects tens of millions of taxpayers, it nonetheless has been largely overlooked by taxpayers, tax scholars, and even legislators.

This Article does three things. First, it comprehensively traces the development and evolution of the general welfare exclusion. Second, it highlights the problems created by the ad hoc nature and lack of tether to any legislative authority. Third, it provides a path by which the general welfare exclusion can continue to benefit low-income taxpayers while reducing the complexity and overreach of the IRS.

TABLE OF CONTENTS INTRODUCTION I. THE GENERAL WELFARE EXCLUSION A. Birth and Early Development B. Developing a Framework 1. Job Training--A Distinction Without a Difference 2. Application to New Situations 3. Formalizing the General Welfare Exclusion C. A Pliable and Amorphous Solution 1. The Necessity of Means Testing 2. Nonprofits and Businesses 3. Cleaning Up the Rules(?) 4. Revisiting the Rules. Again 5. A Focus on Homeowners 6. Where We Are (and Are Not) Now II. PARSING RATIONALES AND JUSTIFICATIONS A. Administrative Discretion B. Assessing the Tax Revenue Impact of the General Welfare Doctrine C. The Circularity of Taxing General Welfare Benefits D. Political Winds and the Perceived "Wrongness" in Taxing the Poor E. Rationales that Reject the General Welfare Exclusion Doctrine. III. CREATING LEGAL CERTAINTY AND CONSISTENCY A. The General Welfare Exclusion and the Force of Law B. Congressional Direction C. Codification of the General Welfare Doctrine D. Review and Revision of IRS Policies, Rulings, and Pronouncements CONCLUSION INTRODUCTION

Tens of millions of taxpayers benefit from one of the largest exclusions from gross income without even being aware. Through its discretionary administrative authority, the Internal Revenue Service (IRS) has excluded from gross income billions of dollars of government welfare benefits. (1) Although few would argue that subsistence benefits should be taxable, the IRS has expanded the exclusion in an ad hoc manner inconsistent with federal income tax principles. As a result of this ad hoc expansion, much of the modern general welfare exclusion bears little relationship to its initial formulation.

The IRS's practice of excluding benefits began innocuously in the late 1930s by excluding certain social security benefits from gross income without explanation or authority. Over the decades, the IRS has used what it now refers to as the "general welfare exclusion" to exclude from gross income everything from subsistence benefits to payments made to preserve historic buildings. Confronted with often difficult but arguably worthy situations, the general welfare exclusion has provided a way for the IRS to resolve complex and unanticipated questions about whether certain government welfare benefits constitute gross income. The general welfare exclusion, however, relies upon an enigmatic foundation of administrative rulings and decisions completely unhooked from any statutory authority or direction.

While this administratively created general welfare exclusion is broad and affects tens of millions of taxpayers, it nonetheless has been largely overlooked by taxpayers, tax scholars, and even legislators. As recently as 2006, almost seven decades after the IRS first promulgated the general welfare exclusion, commentators accurately asserted that it "is a relatively unknown income exclusion doctrine that continues to fly under the radar of even most tax practitioners." (2)

In this Article, we look to remedy this oversight and add to the limited scholarship critically addressing the general welfare exclusion. Part I of this article will discuss the historical development, growth, and different threads of the general welfare exclusion. It will trace the first innocuous "Office Decision" issued by the IRS in 1938 about the taxability of social security benefits to the informal administrative codification intended to cover a plethora of difficult tax issues presented regularly to the IRS. Although few begrudge the necessity and importance of excluding subsistence benefits such as food, medical, and housing welfare benefits from gross income, the general welfare exclusion now deals with a multiplicity of complex federal and state government welfare benefit payments that were unimaginable and unanticipated at the time of the doctrine's origin.

Part II will parse possible rationales and justifications for the IRS's alacrity in exempting billions of dollars of general welfare benefits from taxable income. The part will discuss the source of the IRS's administrative discretionary authority to formulate the exclusion. It will then discuss possible rationales or justifications for the exclusion. It will conclude with a discussion of the reasons why Congress needs to assert its authority over the exclusion.

Finally, Part III will argue that the general welfare exclusion either should be codified in tax law or should be promulgated in Treasury regulations subject to review through the Administrative Procedures Act. The section will discuss the importance of Congress providing express guidance with respect to the exemption of gross income from taxation, even in the face of excluding subsistence benefits for the indigent. In the few instances where Congress has grappled with these issues, it has provided a model for federal legislation that would ensure that congressional legislative intent with respect to the taxation of welfare benefits is consistently and equitably administered.

1. THE GENERAL WELFARE EXCLUSION

   Over the last ninety years, the IRS's development of its general welfare exclusion can be followed through a trail of pronouncements and rulings. Unmoored from any statutory text, the IRS has struggled to apply its sense that certain benefits paid as a result of individual (and sometimes corporate) need to an ever-changing landscape, resulting in a sprawling and ill-defined, if well-meaning, doctrine. (3)

   1. Birth and Early Development

      The Sixteenth Amendment to the U.S. Constitution allowed Congress to impose an unapportioned tax on Americans' "incomes, from whatever source derived." (4) When Congress enacted the first modern income tax, it took advantage of the breadth of taxation allowed by the Constitution. In its 1913 enactment it taxed taxpayers' "entire net income arising or accruing from all sources." (5)

      Congress defined this taxable net income as including "gains, profits, or income" from, among other things, professions, businesses, and property. (6) Ultimately, Congress defined income to include gains, profits, and income "derived from any source whatever." (7) The Supreme Court explained that "[t]he broad sweep of this language indicates the purpose of Congress to use the full measure of its taxing power." (8)

      Notwithstanding the potential breadth of Congress's power to tax, however, both Congress and the Treasury Department almost immediately started to cabin what the federal government would tax in certain areas. At the same time Congress defined net income to include income from whatever source, it also excluded from the tax base gifts, inheritances, and proceeds from life insurance policies and annuity contracts. (9)

      Similarly, early in the life of the modern federal income tax, the Treasury Department ("Treasury") began to administratively exclude some types of income from the tax base. In 1919, for instance, Treasury announced that it would not tax "[b]oard and lodging furnished seamen in addition to their cash compensation." (10) It proceeded to issue regulations clarifying that where an employer provided housing to its employees "for the convenience of the employer" rather than as compensation, employees could exclude the housing from their gross income. (11) Eventually Congress codified this Treasury-created exemption from gross income. (12)

      In the 1930s, Treasury created what eventually evolved into the general welfare exclusion, another of these administratively created exemptions from gross income. Unlike the exclusion for housing provided for the convenience of the employer, though, the general welfare exclusion has (mostly) not been codified. (13) A look through the history of the general welfare exclusion shows that Treasury and the IRS created it based not on any legal or tax principles but rather on what appears, based on their discretionary authority, as an intuitive sense of fairness. (14) Given that the IRS's initial focus was on exempting from taxation amounts intended for retirement and subsistence benefits, this assumption would seem reasonable. This intuitive sense, however, lacked rigor and has resulted in a relatively unintelligible set of rules that provide some...