The title of this post is a phrase that appears a lot in court cases and quoted often by administrative agencies. It almost always precedes a negative result for the taxpayer in question and conveniently ignored when a positive outcome is required. I called it out in my analysis of the CA Dicon case. That was not the first instance of its use, just the first time I had seen it in use. The origin of the phrase goes back several decades and has been used by both State and Federal courts, although the history of it is beyond the scope of this article (maybe I will dive into it at some other point).
And, on its face, the phrase is correct. The legislature can grant or rescind tax credits at their pleasure. And while it has been used with deductions, it is applied to credits more often and is applicable more so than with deductions. Deductions are more fundamental in the calculation of tax liability. Ordinary business expenses are more often tied directly to business income and defined in such a way that it would be difficult to target. Credits, on the other hand, are usually implemented on their own. For example, there are specific code sections for each of the general business credits at the federal level. States, for the most part, follow the same formula, or at least at a subsection level.
The issue, however, is that the administrative and judicial branches have hijacked this concept to mean that legislative grace gives all branches the same measure of review. And that is where the phrase falls short. Yes, credits are entirely a matter of legislative grace. But once the legislature provides a credit for taxpayers, it does not extend that they are a matter of administrative or judicial grace. The courts have repeatedly used this language as an excuse to not only put the burden of proof on the taxpayer but often to raise the standard required. The IRS similarly relies on this language to justify denying credits that are not substantiated enough in their eyes. However, this is fundamentally flawed. The legislative can allow or not credits and deductions, and once contemplated and implemented, then they have the force of law. The courts and administration can question whether the law is valid and should when appropriate, but to take liberties with the law just because it was the subject of “legislative grace” is assuming upon itself the authority to legislate and repeal the grace that has been provided.
I do not expect the courts to overturn almost a century of history, nor do I expect the IRS to voluntarily give up a tool that works in their favor. However, the abuse of the phrase should be challenged. Leave the matter of legislative grace to the legislature.