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Monday, August 21, 2017

Court Cannot Address Tax Issue When Issue Doesn’t Exist 

Several days ago, in Taxing a Tax, I discussed litigation commenced in Cook County, Illinois, by an individual who alleged that McDonald’s calculated sales tax on his purchase by applying the sales tax rate to the sum of the cost of his purchases plus the Cook County beverage tax. I provided an example to demonstrate how the sequence of computation meant the difference between imposing the sales tax on the beverage tax and not doing so. I provided an example, and did not use the actual numbers, in part because I did not see, nor could I find, the actual receipt.

Not surprisingly, I was looking forward to seeing what the court did with the lawsuit, and learning whether my prediction as to the outcome was correct. Much to my surprise, the case was dismissed. According to various reports, including this one, the court convinced the plaintiff that McDonald’s had not, in fact, imposed the sales tax on the beverage tax. The court, and apparently the defendant’s attorneys, conducted a “walk-through of the receipt . . . to demonstrate double taxation hadn’t occurred.”

A reader asked me, “Does the dismissal of this case answer the question stated [in Taxing a Tax]?” The answer is, “No.” Why? The question was whether imposing a sales tax on the beverage tax violated Illinois or Cook County law. Once the plaintiff was persuaded that a sales tax was not imposed on the beverage tax, there was no need to answer the question. Why did the court not add something along the lines of, “If the sales tax HAD been imposed on the beverage tax, . . .” Would not that sort of guidance been helpful? Yes, it would be, but courts do not decide issues that are not before the court. Occasionally, a court will present dicta, but doing so is intended to help people understand the reasoning behind the issue being decided. A dictum does not establish law, and in some instances a dictum creates more confusion than it provides useful guidance.

If, in fact, retailers in Cook County are not imposing the sales tax on the beverage tax, the question of whether doing so is a violation of law will never be presented. Despite my curiosity with respect to what the outcome would be, society is better served if there never is a need to answer the question.

Friday, August 18, 2017

A Good Guess In a Tax-or-Fee Prediction 

The email arrived a few days ago from a reader with the simple subject line, “you were right.” For a moment, before opening the email, I scanned my memory banks for any reminder of having engaged in a debate, dispute, discussion, or disagreement with the sender of the email. There was nothing. When I opened the email and read it, I realized that this reader was telling me that my prediction with respect to the outcome of a tax-or-fee lawsuit in Oklahoma had turned out to be correct. In all honesty, it turned out to be a good guess.

I described the issue in question in Tax versus Fee: The Difference Can Matter. The Oklahoma legislature enacted a new $1.50 per-pack “fee” on cigarettes. It did so after four previously failed efforts to increase the per-pack cigarette tax by $1.50. Repeating what I had written in Tax versus Fee: The Difference Can Matter:
In this era of tax hatred, it has become commonplace for legislators, lobbyists, and other advocates to use the label that sells. Thus, in Please, It’s Not a Tax, I criticized the use of the term “tax” by opponents of a fee, who clearly were trying to ride the anti-tax wave to prevent enactment. And in So Is It a Tax or a Fee?, I criticized the use of the term “fee” by proponents of a fee that they had earlier labeled a “tax,” because calling something a fee doesn’t get the attention of the anti-tax crowd to the extent a tax does.

In Tax versus Fee: Barely a Difference?, I concluded by suggesting, “Ultimately, whatever it is called, it ought to be measured sensibly, imposed only after appropriate public notice, hearings, and legislative action, and paid if the legal obligation to do so exists.”
Not surprisingly, the enactment of the “fee” in Oklahoma generated a challenge. I explained the challenge:
Opponents have sued, asking the Oklahoma Supreme Court to invalidate the legislation. They argue that the fee originated in the state Senate, thus violating the requirement in the state Constitution that revenue-raising legislation originate in the state House. The opponents also argue that enactment of the legislation during the last week of the legislative session violated the state Constitution’s requirement that revenue-raising legislation not be enacted during the last five days of a legislative session. The opponents also argue that proponents of the $1.50 charge were trying to characterize the legislation as not revenue-raising by labeling it a fee. The opponents explain that the fee “simply reincarnated the earlier cigarette tax bills under a new name.”
Then I stepped into the world of predicting the outcome of litigation, an exercise often punctuated by error, surprise, disappointment, and embarrassment. Of course I tried to dampen expectations by opening with an admission of my limitations:
Though I’m no expert in Oklahoma constitutional law, it seems to me that the fee raises revenue, and thus has been enacted in revenue-raising legislation. Accordingly, the process by which it was enacted appears to have violated the Oklahoma Constitution. If, for some reason, the Oklahoma Supreme Court determines that the provisions in the constitution applies to taxes but not fees, then deciding whether the $1.50 charge is a tax or fee would be determinative. The label alone should not resolve the question. The state is not selling cigarettes to people, nor is it selling licenses to use tobacco, and thus it is difficult to characterize the charge as a fee. It would not be surprising if the Oklahoma Supreme Court, if it were to limit the requirements in the state Constitution to taxes, decided that this particular charge was a tax. It will be interesting to see what the court decides, probably sometime later this year.
Recently, the Oklahoma Supreme Court indeed addressed the issue. It concluded that the legislation in question was a revenue-raising measure, and, as such, was subject to the requirements that it originate in the state House and not be enacted during the last five days of a legislative session. Reviewing the history of the legislation, the court determined that revenue raising was the purpose of the legislation, particularly because the legislation replaced revenue-raising proposals that had not been enacted and because the legislation did not focus on any purpose other than revenue raising. The court made it clear that using the word “fee” to describe a tax does not transform a tax into a fee.

In all fairness, it was a fairly easy issue on which I guessed. In other words, it was not entirely a guess because there was enough information with which to engage in analysis. It was an educated guess. Was I right? This time, yes. But not always. I live with constant reminders of that fact.

Wednesday, August 16, 2017

Taxing a Tax 

Cook County, Illinois, enacted a one-cent-per-ounce tax on sugary drinks. The county also imposes a sales tax, which together with the state sales tax, amounts to 9 percent. According to this report, among others, Yvan Wojtecki has started class-action litigation against McDonald’s Corp. because it included the beverage tax in computing the sales tax. An example helps understand the issue. Assume a person purchases a 25-ounce soda for $2.00. The beverage tax is 25 cents. Should the sales tax be 9 percent of $2.00, or 18 cents, or should it be 9 percent of $2.25, or 20 cents? Though the two-cent difference might seem miniscule, a person who makes that purchase every day is looking at an extra $7.30, and though that, too, might appear trivial, for a family of six people, it becomes $43.80, or almost $4 a month. What makes the issue huge, and thus fodder for a class-action lawsuit, is the impact when applied to all consumers. More than 5 million people live in Cook County. Not all of them purchase sugary drinks. But Cook County also hosts tourists, business visitors, and commuters who live outside the county. If 3 million people purchase 25 ounces of soda every other day, and that is probably a very low estimate, the state and county are hauling in an additional $10,950,000 in revenue each year. On the higher end, if 5 million people, which offsets visitors, tourists, and commuters who purchase soda against residents who don’t, purchase 50 ounces of soda every day, the state and county fill their treasuries with an additional $73,000,000 each year. Perhaps the amount in issue is in the middle, and whatever it is, it isn’t a one-year-only deal.

What is the correct answer? I’m not an expert in Illinois and Cook Country sales taxes. It seems to me that the tax applies to the retail cost of taxable items, that tax is not a taxable item, and that the retail cost of an item does not include tax. I welcome reactions from Cook County tax practitioners who can enlighten me, and readers of MauledAgain, on the technical application of the state and county sales tax.

Along with other problems cited in the foregoing and other reports, this is yet another example of the administrative challenges posed by taxes that might appear, theoretically, to have some merit, but which, when thrown into the cauldron of practical reality, generate a variety of problems.

Monday, August 14, 2017

Taxes, Passwords, and the Consumption of Hours 

I’ve been using computers, in one way or another, since 1972. I have owned a personal computer of one sort or another since 1983. I have been “on the internet” since the early 1990s. I started browsing with Mosaic and Cello. It ought not be a surprise, considering the parallels between the thought processes of tax analysis and the thought processes of programming and coding, activities in which I have engaged over the years. So of course I’ve been familiar with cybersecurity and passwords for a long time. Like every computer and internet user, I’ve been prompted to change my password on a regular basis by some websites and organizations, and I have changed them on my own initiative from time to time for a variety of reasons.

When I noticed a recent story describing how Bill Burr changed his position on password security, particularly his previously recommended frequent changing and use of upper case letters, lower case letters, numbers and special symbols, I was delighted. Without going into all of the reasons I think frequent password changes create their own risks, and why inserting numbers and special symbols into passwords can be counter-productive, I wondered how long it would take before the “it’s time to change your password” messages would stop arriving.

One of the interesting bits of information from the story came from a researcher at Microsoft, which no longer follows Bill Burr’s guidelines. Cormac Herley revealed that “Collectively, humans spend the equivalent of more than 1,300 years each day typing passwords.” It’s unclear if that includes the time invested in trying to remember a password. It does not appear to include the time invested in creating a password, particularly because the advice of not using the same password for multiple purposes makes very good sense for a variety of reasons.

The idea that significant time is invested – and arguably wasted – dealing with passwords caused me to think about complaints that time invested – and sometimes wasted – dealing with taxes is burdensome and detrimental to economic progress as well as individual well-being. So I decided to make a comparison.

According to the Taxpayer Advocate’s 2012 annual report, taxpayers invest roughly 6.1 billion hours each year handling their taxes, though it conceded that this number “is difficult to measure with precision.” So, too, I am confident, is the measurement of hours invested in typing passwords.

If people invest 1300 years each day typing passwords, that means they invest 474,500 years each year typing passwords (1300 x 365). There are 8,760 hours in a non-leap year, so those 474,500 years are the equivalent of 4,156,620,000 hours (474,500 x 8,760). That’s about two-thirds of the time invested in handling taxes. Yet I do not hear as many complaints about password typing as I hear about handling taxes, and perhaps that’s because people don’t have the same, usually negative, attitude about taxes as they have about passwords. As the old saying goes, time flies when you’re having fun, and though typing passwords might not qualify as “fun” – though they may be at the entrance to something that is fun – doing taxes is, for all but a few people, not fun.

I wonder how many of these hours are overlap? How many hours do people invest in typing passwords in order to access and file tax returns? I have no intention of trying to answer that question.

Friday, August 11, 2017

What Can I Buy At a Tax Sale? 

Most adults have probably seen or heard the phrase “tax sale,” and some probably have an idea of what that means. Others surely know what it means. Simply put, when a taxpayer has failed to pay real property taxes assessed on a parcel of real estate, the taxing jurisdiction puts either the property up for sale or sells a lien on the property. Under either approach, the purchaser ends up as owner of the property unless, in some instances, the delinquent taxpayer redeems the property by paying the taxes within a specified period of time.

When people who understand tax sales think about them, they contemplate the sale of residences, commercial buildings, parking lots, and similar parcels. But tax sales can reach another type of property. It happened recently in San Francisco, according to this report and others, as the story has gone viral.

In San Francisco, decades ago a developer built homes and a street for people living in those homes to access the nearest public road. Ownership of the street, along with other common areas, was placed in a homeowners’ association. At some point, the association retained a property management firm, which handled care of the street and common areas, providing services such as pothole repair and snow removal. One of the firm’s responsibilities is to pay the real estate taxes assessed on the street. For many years the tax bill, in the grand total of $14, was sent to an address at some other place in San Francisco. It is an address with no apparent connection to the property management firm, the homeowners’ association, or any of the home owners. Not surprisingly, the bill went unpaid. Finally, the city put the street up for sale in a tax sale. But the city did not post any notice on the street, nor did it deliver a notice to the property management firm, the homeowners’ association, or any of the home owners. In 2015, at an auction, the street was sold for $90,000. The accumulated unpaid tax bills had reached $944, which appears to have included interest and costs as well as the unpaid taxes. The purchasers admit that they “got lucky” and had purchased the street without seeing it. The property management firm, the homeowners’ association, and the home owners did not learn of the sale until very recently, roughly two years after the sale.

A lawyer for the homeowners’ association claims that the sale was illegal. The city disagrees, claiming that it followed all proper procedures. What happens next? Though litigation might be on the horizon, in the meantime, the owners of the street have the legal right to charge the home owners for driving or parking on the street and for using the common areas. There also is the possibility that the new owners of the street and common areas will try to sell the property back to the homeowners’ association for an amount that generates a profit. The purchasers suggested they might build themselves a home on the street if that can be done in compliance with land use regulations. Apparently, the new owners recently attempted to persuade the homeowners’ association to buy back the street and common areas.

The development is one of the city’s most expensive neighborhoods. Homes have been listed for amounts in the single and double-digit millions. The neighborhood has its own private security guard force. Apparently, no one thought of checking city records to make certain that the tax office had the correct address to which to send the bills.

I wonder if this story will encourage people to scan tax sale notices looking for private roads on which taxes have not been paid. Imagine being charged a fee by some stranger for driving and parking on the road in front of your house. Perhaps it is best to avoid purchasing property for which access is limited to private roads. Perhaps there are some lessons in this story for those who advocate privatization as the cure-all for the nation’s economic challenges. But perhaps the biggest lesson is this: if you own real property, and you or your representative or agent has not received a tax bill during the past year or more, check with the tax office lest the property be sold out from under you.

Wednesday, August 09, 2017

When Someone Else Claims You as a Dependent on Their Tax Return and You Disagree 

Tax is everywhere, so it ought to be no surprise that it pops up in television court shows more frequently than many people might guess. Thanks to a reader, another episode is added to the list of those on which I have commented. That list includes Judge Judy and Tax Law, Judge Judy and Tax Law Part II, TV Judge Gets Tax Observation Correct, The (Tax) Fraud Epidemic, Tax Re-Visits Judge Judy, Foolish Tax Filing Decisions Disclosed to Judge Judy, So Does Anyone Pay Taxes?, Learning About Tax from the Judge. Judy, That Is, Tax Fraud in the People’s Court, More Tax Fraud, This Time in Judge Judy’s Court, You Mean That Tax Refund Isn’t for Me? Really?, Law and Genealogy Meeting In An Interesting Way, How Is This Not Tax Fraud?, A Court Case in Which All of Them Miss The Tax Point, Judge Judy Almost Eliminates the National Debt, Judge Judy Tells Litigant to Contact the IRS, People’s Court: So Who Did the Tax Cheating?, “I’ll Pay You (Back) When I Get My Tax Refund”, Be Careful When Paying Another Person’s Tax Preparation Fee, Gross Income from Dating?, and Preparing Someone’s Tax Return Without Permission.

The latest addition to the list comes from a Judge Faith case involving two sisters. The plaintiff sued her sister for $600. Plaintiff stated that she lived with her mother until mid-November of 2013, and then moved in with her older sister, the defendant. The defendant asserted that the plaintiff was in her legal custody for the entire year, and stayed with her during the year. When the plaintiff denied living for the entire year with the defendant, the judge asked the plaintiff where she lived for the other ten and a half months of the year. The plaintiff replied, “With my boyfriend.” The plaintiff said that she worked throughout the year and supported herself during the year.

The plaintiff explained that the defendant had asked her if she, the defendant, could claim the plaintiff as a dependent on the defendant’s tax return and claim the plaintiff’s “school credit” in exchange for a $600 payment from the defendant to the plaintiff. The judge asked the defendant if the plaintiff had indeed approached the defendant to ask for $600 because the defendant had claimed the plaintiff as a dependent and ought not to have done so. The defendant answered that she asked the state official overseeing her legal custody of the plaintiff if she could claim the plaintiff as a dependent and that the official answered, “Yes.”

The judge explained that the alleged agreement may or may not have existed, but that she did not need to decide the question because it had no bearing on her conclusion. She explained that if the plaintiff thought that the defendant had wrongfully claimed the plaintiff on the defendant’s tax return, the plaintiff’s remedy was not to sue her sister, but to file her own tax return claiming a personal exemption for herself. The judge also explained that doing this would alert the IRS that two taxpayers were claiming the same person, and cause the IRS to investigate and resolve the matter.

Unfortunately, there is no way for one person to guarantee that another person will not claim that person on a tax return. If some other person does so, the way to preserve the exemption for one’s self is to file a return and claim it, triggering an IRS examination of both returns. Nor is it appropriate, under existing law, to enter into an agreement to let a person claim an exemption to which that person is not entitled, whether gratuitously or for any amount of money. Agreements with respect to multiple support arrangements or exemptions for children of divorced or separated (and certain other) parents are a different matter, because the law specifically provides for those sorts of agreements.

Monday, August 07, 2017

Claiming Depreciation and Expensing Deductions on Property Owned and Leased by Others 

It is a general principle of tax law that a taxpayer is not permitted to claim depreciation or expensing deductions on property owned and leased by someone else. Yet it required a Tax Court decision, Drah v. Comr., T.C. Memo 2017-149, to get this point across to a taxpayer.

The taxpayer was an independent contractor who provided services to FedEx. He also was the sole owner of a corporation that also provided services to FedEx, and that paid the taxpayer a salary. The corporation filed a tax return for 2011 on which it reported its income and expenses, including the wages it paid to the taxpayer. However, the taxpayer, although filing and receiving an extension of time in which to file his 2011 return, failed to do so. The IRS prepared a substitute return and issued a notice of deficiency to the taxpayer. The taxpayer conceded the income amounts on the substitute return, but argued that as an independent contractor he was entitled to various deductions, including depreciation and section 179 expensing deductions.

The depreciation and section 179 expensing deductions claimed by the taxpayer related to a 2009 Workhorse P42 truck. However, the truck was leased by the taxpayer’s wholly-owned C corporation. It was not owned by the taxpayer. It was not leased by the taxpayer. The lease agreement between the lessor and the corporation provided that the lessee corporation “will not be treated as the owner . . . for federal income tax purposes.” Thus, any deduction for depreciation or section 179 expensing would be claimed by the lessor.

The taxpayer argued in the alternative that he was entitled to deduct the lease expense. That argument was rejected because the taxpayer was not the lessee of the truck. The taxpayer did not introduce into evidence the corporation’s tax return, so it was not known if the corporation had claimed a deduction for the lease payments that it made. If it had not claimed those deductions, the only option would be the filing of an amended return if the statute of limitations had not expired.

It is not unlikely that the C corporation broke even or reported a loss, and that the lease deduction would be more valuable to the taxpayer. That is perhaps why the corporation ought to have made an S election. Without more facts, there is no way to move beyond the word “perhaps” in this instance.

Friday, August 04, 2017

Ignorance of Any Kind, Aside from Tax 

The other day, while reading the Philadelphia Inquirer, a headline, “One professor's general knowledge test: ‘They don’t know as much as they need to know,’” caught my attention. It wasn’t the word “professor’s” but the quote that triggered my interest. So, of course, I read the article, which has a different headline, “Mona Lisa was an artist, and other answers to a New Jersey professor's final test” on the paper’s web site.

Cheryl Copeland, an English professor at Camden County College who recently retired, created, administered, and analyzed a 100-question test because she “wanted to know what students know about the world.” The 120 students who took the test, as well as Kevin Riordan, the reporter who wrote the story, were not permitted to use research devices or to access the internet. There were no study guides or prep classes. It was a short-answer test. Copeland did not grade the test. She simply wanted to get an idea of how students were faring in their learning endeavors. Though she is an English professor, questions on the test also included questions about music, art, civics, math, geography, American and world history, current affairs, finance, and astronomy. The questions can be found embedded in the story at the link provided in the previous paragraph.

How did the students perform? Fewer than half the questions were answered correctly. Although 95 percent could identify the Titanic, only four percent could identify Toni Morrison. No one aced the test, though it’s not clear what percentage would have been required for an A, nor do I understand how that conclusion can be reached if the test was not graded. Perhaps for purposes of the story, Copeland went back and scored the answers.

Copeland explained that she did not intend to “dis the students,” but has “disdain for the school systems” they attended. She alleged that “Middle and high schools are denying students this core of knowledge.” To evaluate that claim, I would need to see the syllabi and lesson plans for middle and high schools. Yes, it’s possible that schools aren’t addressing these basic pieces of knowledge and analysis, but it’s also possible that students aren’t paying attention, are learning but quickly dumping information from their brains to make room for the flood of mostly useless information circulating on television and the internet, or have not developed the ability to answer short-answer questions. But as I’ve pointed out many times in my MauledAgain posts, something is wrong with American education. It could be teachers, students, parents, school boards, school administrators, or, as I suspect, some combination of those and other causes.

Copeland addressed the argument that it doesn’t matter whether someone can answer these questions because they can find them on the internet. She expressed the opinion that a person should be able to answer questions without looking up the answer. I agree and disagree. I agree for several reasons. First, there are instances when there isn’t enough time to look up an answer. For example, everyone should know the meaning of a red octagonal sign with the letters STOP printed on it. Second, too often when something is researched on the internet, what is discovered consists of nonsense, misrepresentations, misunderstood sarcasm, lies, half-truths, advertising claims, and propaganda. The process of learning, and retaining some knowledge, should, and if done properly does, include the acquiring the ability to sift through information to ascertain a solution. I disagree for several reasons. First, there is no way a human brain can retain all of the information that a person at some point needs to know or understand. In pre-digital days, people could turn to dictionaries, encyclopedias, and other resources to continue the learning process. Second, as years pass, the store of information increases and thus learning must continue other than through traditional classroom processes. Third, some of what is learned during formal education turns out to be wrong or disputed. For example, what is the answer to the question, “How many planets are there in the solar system?”

Students did very poorly when responding to the civics and current affairs questions. As Copland put it, “It was really stunning to me how little students know about our government— how many branches there are, how many senators there are, how Supreme Court justices are selected. Not knowing this material [affects] your awareness as a student, as an American citizen, and as a citizen of the world. The more you know about government, the more inclined you are to vote.” So true. She could have added, “The less you know about government, the more likely someone who is voting will make an uninformed or poorly informed choice.”

Though some might think the test was too difficult, it did not contain any questions dealing with tax, physics, calculus, microbiology, chemistry, engineering, or computer programming. That, of course, did not stop me from taking the test. How did I do? I could share the result, but I don’t want to be accused of bragging or told that I’m insufficiently acquainted with humility. But, seriously, my performance is attributable not solely to myself but also to excellent teachers, parental guidance, and an understanding and appreciation of education, knowledge, and analytical thinking.

Wednesday, August 02, 2017

Reaching New Lows With Tax Ignorance 

Ignorance has become an epidemic. Ignorance with respect to tax issues has not been spared. Sometimes I wonder if tax ignorance is in the forefront the nation’s descent into the New Stone Age. One particularly distressing bit of tax ignorance is the wildly outlandish, totally false, intentionally misleading, and warped claim that the Internal Revenue Code consists of 70,000 or 74,000 or seventy-thousand-whatever pages and four million words. My attempt to negate this nonsense and my criticism of those who enable its growth began with Bush Pages Through the Tax Code?, and continued with Anyone Want to Count the Words in the Internal Revenue Code?, Tax Commercial’s False Facts Perpetuates Falsehood, How Tax Falsehoods Get Fertilized, How Difficult Is It to Count Tax Words, A Slight Improvement in the Code Length Articulation Problem, and Tax Ignorance Gone Viral, Weighing the Size of the Internal Revenue Code, Reader Weighs In on Weighing the Code, Code-Size Ignorance Knows No Boundaries, Tax Myths: Part XII: The Internal Revenue Code Fills 70,000 Pages, Not a Surprise: Tax Ignorance Afflicts Presidential Candidates and CNN, The Infection of Ignorance Becomes a Pandemic, and Getting Tax Facts Correct: Is It Really That Difficult?.

Until now, the ignorance has been going viral among those who know little or nothing about tax law, including those who ought to have done some genuine research before repeating something whose major claim to fame is its quality as a startling headline or terrible tweet. A few days ago, a reader directed my attention to how deeply this ignorance has infected the nation. I made my way to the link that the reader shared. I found myself on a web page inviting people to enroll in the Northeastern University D’Amore-McKim School of Business Online Master of Science in Taxation program. The headline, “Prepare for Tomorrow’s Tax Challenges Today,” was followed by this gem: “When it comes to the tax industry, the only constant is change. In fact, the U.S. tax code—which now totals nearly 4 million words—changed approximately 4,680 times between 2001 and 2012, according to the Taxpayer Advocate Service’s 2012 Annual Report to Congress.” I then turned to the National Taxpayer Advocate 2012 Annual Report to Congress and discovered that even the IRS claims there are 4,000,000 words in the Internal Revenue Code. But at least the National Tax Advocate explained how this totally incorrect number was generated:
To determine the number of words in the Internal Revenue Code, TAS downloaded a zipped file of Title 26 of the U.S. Code (i.e., the Internal Revenue Code) from the website of the U.S. House of Representatives at http://uscode.house.gov/download/title_26.shtml. We unzipped the file, copied it into Microsoft Word, and used the “word count” feature to compute the number of words. The version of Title 26 we used was dated Jan. 3, 2012, so the count does not reflect legislation enacted during the second session of the 112th Congress. In Word, the document ran 9,191 single-spaced pages. The printed code contains certain information that does not have the effect of law, such as a description of amendments that have been adopted, effective dates, cross references, and captions. The word count feature also counts page numbers, the table of contents, and the like. Therefore, our count somewhat overstates the number of words that are officially considered a part of the tax code, although as a practical matter, a person seeking to determine the law will likely have to read and consider many of these additional words, including effective dates, cross references, and captions. Other attempts to determine the length of the Code may have excluded some or all of these components, but there is no clearly correct methodology to use, and we found no easy way to selectively delete information from a document of this length.
So ignorant claims are reinforced by sloppiness and inattention to detail. Here are the problems with how the National Taxpayer Advocated counted words.

1. The National Taxpayer Advocate used an annotated version of the Internal Revenue Code rather than the official version of the Code. The National Taxpayer Advocate admitted as much by confessing that what was used “contains certain information that does not have the effect of law, such as a description of amendments that have been adopted, effective dates, cross references, and captions,” that “The word count feature also counts page numbers, the table of contents, and the like,” and that “our count somewhat overstates the number of words that are officially considered a part of the tax code.” Every commercial publisher has a digital version of the Internal Revenue Code to which editors add their own notes and commentaries. It would not have been difficult to ask one or two publishers to run a word count. It also is possible to find the Internal Revenue Code online without annotations, though in most instances it does require counting the words for each section.

2. The National Taxpayer Advocate claimed that “there is no clearly correct methodology to use” to count the words in the Code. Seriously? If it’s an official word in the Code, count it. That’s not rocket science. Yes, it would be “tedious,” as I noted in Anyone Want to Count the Words in the Internal Revenue Code?, to do this, but it’s not impossible, especially when precision matters.

3. The National Taxpayer Advocate explained that “we found no easy way to selectively delete information for a document of this length.” There are a variety of ways of doing so, ranging from starting with something less than a fully annotated version of the Code to designing macros that remove portions that are not part of the Code. It might not be easy, but usually the correct result requires a course of action that is far from easy.

4. The National Taxpayer Advocate tried to excuse its approach by claiming that “as a practical matter, a person seeking to determine the law will likely have to read and consider may of these additional words.” Translated, this means that someone who wants to understand tax law usually needs to examine more than the words of the Code. But that doesn’t justify including words that are not part of the Code in a count of words in the Code.

An easy way to remove the extraneous material from the word count is to select, at random, ten or twenty Code sections, copy and paste them into another Word document, count the words, remove the extraneous material, and again count the words. This process generates a rough estimate of the percentage of words that are extraneous. It is a very high percentage, in some instances reaching into the high 90 percent range, and rarely falling below 75 percent.

Yet another easy way to estimate the number of words in the Code is to do some research. By research, I don’t mean using a search engine to find online commentary that simply states a conclusion, but looking for analyses that explain how conclusions were reached. For example, as I explained twelve years ago in Anyone Want to Count the Words in the Internal Revenue Code?, there were at that time roughly 400,000 words in the Code, based on the Code itself consisting of 2,000 pages. Though the Code has grown during the past twelve years, it has not come close to expanding ten-fold. Use of the percentage-of-extraneous-material method described in the preceding paragraph generates a percentage consistent with treating 7,000 pages of the 9,000-page document used by the National Taxpayer Advocate as extraneous.

Other ways of estimating the words in the Code involve weighing and measuring a paper copy of the actual Code, or something close to it. They exist. I own a copy. I described this method in Weighing the Size of the Internal Revenue Code and Reader Weighs In on Weighing the Code, and reached results consistent with the other measurement approaches. Again, a bit of research on the part of the National Taxpayer Advocate would have provided this information.

So is it sufficient that because the National Taxpayer Advocate proclaims a supposed fact that it should be repeated without being verified? No. An institution that holds itself out as offering a tax degree ought not make unverified claims. Again, some research would have turned up this analysis in Code-Size Ignorance Knows No Boundaries. In that commentary, I explained that a tax law professor fell victim to the same misinformation from the National Taxpayer Advocate, taking it further to conclude that it would take 212 hours of reading, at 300 words per minute, to get through the Code. I pointed out that, “anyone who has read the Code cover to cover, as I have on several occasions, knows that it takes far fewer than 212 hours, . . . a huge clue that something is wrong with the 3.8 million [word] claim.” I suggested that, “Every tax professional needs to read the entire Internal Revenue Code, at least once in his or her professional career.” I also speculated that the absurd claim in the National Taxpayer Advocate’s 2012 report “most likely was generated not by {Taxpayer Advocate Nina] Olson but [by] an underling to whom she assigned the task.”

In Code-Size Ignorance Knows No Boundaries, I wrote:
There are those who wonder why I persist in criticizing ignorance, especially on the part of tax professionals. Three things come to mind. First, if we tolerate, and thus enable, ignorance on something this simple, we will end up tolerating ignorance on more serious issues. Wait, we already are. Ignorance is an infection, and if it is not confined and eliminated, it spoils entire systems. Second, many of the people making these outlandish claims are doing so to emphasize the fact that the Code is a mess and the tax law needs to be fixed. I agree that the Code is a mess and needs to be repaired, but making ignorant claims in support of the position weakens the credibility of those advocating tax reform. The outlandish claim suggests that there is little confidence on their part that they can succeed if they stick to the facts. One can show the mess that the tax law has become without dishing out ignorant statements. Third, if we fail to stand up to ignorance, we let despair triumph over hope. Once upon a time, almost everyone in Europe was convinced that the world was flat, and that someone sailing west would fall off the edge. Once that foolishness was disproven, somehow we arrived at the point where almost everyone knows that the world is a globe. If we can remove flat-earth ignorance from 99.999% of the world, we surely can remove the 70,000-page Internal Revenue Code ignorance. And we ought to do so, before ignorance becomes the defining characteristic of the species.
Four years later, reading that paragraph, I am even more convinced that professionals in every field, experts in every field, and folks whose educated brains are functioning properly need to squash ignorance by enabling education. Though the problem of ignorance might be rooted in the activities of the liars, scam artists, and ministers of propaganda, its viral spread is attributable in part to the inadequacy of efforts undertaken to overcome the proclivity of many humans to seek the easy path even when the easy path is a dangerous, and often fatal, one. It is ignorance and laziness combined that permit liars, scam artists, and ministers of propaganda to thrive.

Monday, July 31, 2017

Earrings, Jet Skiing, and Casualty Loss Deductions 

A reader asked me two questions about the tax consequences of an unfortunate event that befell Atlanta Falcons’ wide receiver Julio Jones. According to this story, Jones was jet skiing on Lake Lanier when he hit a boat wake and fell into the water. When he resurfaced, he realized that his earring had fallen off his ear. He concluded that the earring, worth more than $100,000, was at the bottom of the 65-foot-deep lake. So Jones hired a dive team to look for the earring. As of the time the story was published, the divers had come up empty.

The readers asked me, “Is this a casualty loss? Can the payment of dive team expenses be deducted?”

Yes, it is a casualty loss. The facts appear to support a claim that a sudden event caused the loss. It is not unlike the case where a car door slammed onto a person’s hand, dislodging a diamond from its setting in a ring, and causing the diamond to fall in such a way that it was not found.

But the more important issue is whether the casualty loss would generate a deduction. The computation of the deduction begins with the loss of value. It is roughly $100,000. That amount is reduced by insurance recovery. There is no information on the scope of insurance coverage. If it is assumed that there is no coverage, the $100,000 is reduced by $100. The resulting $99,900 is reduced by 10 percent of Jones’ adjusted gross income. Jones has a base salary in 2017 of $11,500,000, and even though his deductions in computing adjusted gross income are unknown, his adjusted gross income is probably at least $10,000,000. So, reducing $99,900 by $1,000,000 (10 percent of $10,000,000) wipes out any deduction. The result wouldn’t change if there was an insurance recovery that caused the $99,900 to be some smaller number.

Turning to the question of the cost of hiring a dive team to search for the ring, that expense is not deductible. And if it were, it would be wiped out by the ten percent of adjusted gross income floor.

For someone with a much lower adjusted gross income, a casualty loss deduction would be generated if the lost ring was uninsured and worth more than ten percent of adjusted gross income. Though the cost-of-repair method is an alternative way to compute a casualty loss, it does not appear to have any relevance when the casualty involves a lost item. Nor are search expenses part of the cost of repair.

Friday, July 28, 2017

Getting Tax Facts Correct: Is It Really That Difficult? 

George Will tried to prove a point about the federal income tax system. The point he tried to prove is a simple one, and one with which almost no one disagrees. The federal income tax system is too complicated. I can’t imagine that this observation is disputed by anyone, and so I don’t understand why George Will decided he needed to prove the point. In trying to prove the point, he made two assertions that are simply wrong.

First, he claimed that the Internal Revenue Code “is about 4 million words.” He cited the Tax Foundation, which after being criticized by the legislation counsel for the Joint Committee on Taxation for its absurd claim that the Code contains 70,000 pages, defended its absurdity by conceding the point and then distracting the reader with information about regulations and cases, which are not part of the Internal Revenue Code. This sort of ignorance, intentional fact-twisting, and outright fabrication of information is, as I’ve written many times, eroding the core of the values that sustain this nation. I have explained why the “70,000 pages” and “multi-million words” claims are wrong in posts such as Bush Pages Through the Tax Code?, and continuing with Anyone Want to Count the Words in the Internal Revenue Code?, Tax Commercial’s False Facts Perpetuates Falsehood, How Tax Falsehoods Get Fertilized, How Difficult Is It to Count Tax Words, A Slight Improvement in the Code Length Articulation Problem, and Tax Ignorance Gone Viral, Weighing the Size of the Internal Revenue Code, Reader Weighs In on Weighing the Code, Code-Size Ignorance Knows No Boundaries, Tax Myths: Part XII: The Internal Revenue Code Fills 70,000 Pages, Not a Surprise: Tax Ignorance Afflicts Presidential Candidates and CNN, and The Infection of Ignorance Becomes a Pandemic. Despite my efforts and those of knowledgeable public officials such as the Joint Committee on Taxation legislation counsel, this false claim is repeated over and over, and accepted as true by millions of people, few if any of whom bother to pick up a copy of the Internal Revenue Code and discover for themselves that it is far from 74,000 pages. So to some extent, the spread of ignorance is in part attributable to laziness, just as it is in part attributable to the malicious motives of those who invent false stories, fake reports, and foolish lies. George Will should be ashamed of himself for not doing original research, and for relying on a web site explanation that, in effect, admitted its “70,000 page” claim was wrong.

Second, Will claimed that “America has more people employed as tax preparers (1.2 million) than as police and firefighters.” For this, he cited a US News web page that, in addition to repeating the nonsensical “70,000 page” claim, not only asserted that there are 1.2 million tax return preparers but that there are 310,400 firefighters and 765,000 police. A staff writer for the Tampa Bay Times, Manuela Tobias, took issue with this claim. It appears Will’s 1.2 million claim was taken from a 2012 article that cited a 2007 IRS figure. So Tobias asked the IRS for more recent information. The IRS reported that in 2017 there are 713,448 people with current preparer tax identification numbers. Though there may be some people preparing returns for a fee without the required preparer tax identification number, it is highly unlikely that half a million people are doing so. Will was close when it came to firefighters, with the Bureau of Labor Statistics reporting 315,901 of them as of May 2016, close enough to 310,400. On the other hand, the Bureau of Labor Statistics reports 657,690 police and sheriff’s patrol officers, more than 100,000 shy of Will’s estimate. When the dust settles, there are 973,591 firefighters and police, as compared to 713,448 tax return preparers. Will did not respond to a request for comment by Tobias.

If Will wants to prove that the federal tax system is complicated, and I don’t know why someone would want to do that, and if he wanted to focus on tax return preparation, a better measure would be the number of taxpayers who use the assistance of tax return preparers. According to an testimony before the U.S. Senate Finance Committee by the Government Accountability Office’s Director of Strategic Issues, in 2014, 56 percent of individual federal income tax returns were prepared by paid preparers. Whether 1,000 or 10,000 or 100,000 or 500,000 preparers are doing the work doesn’t matter. What matters is that tens of millions of Americans are unable to prepare their own tax returns, though some people using preparers can prepare their own returns but prefer to use their time for other endeavors.

Once George Will’s misinformation goes viral, it will be near impossible to erase it from the brains of people who absorb these sorts of claims without doing research or figuring things out for themselves. The litany of “I believed that person and I ended up being duped” cries for sympathy continues, and will continue, in part because of laziness, in part because of gullibility, in part because of human tendency to believe what one wants to hear, and in part because of the evil forces that fertilize intentional fact-twisting and outright fabrication of information. The only countervailing force is education, and that, too, is under siege. The enormity of the problem ought to be apparent when even George Will can’t get it right.

Wednesday, July 26, 2017

Preparing Someone’s Tax Return Without Permission 

Five years ago, I wasn’t seeing as many television court shows as I do now, in part because I was teaching full-time. So I’ve certainly seen far fewer episodes than have been produced and aired. The several hundred that I have seen have provided material for roughly 20 commentaries, including Judge Judy and Tax Law, Judge Judy and Tax Law Part II, TV Judge Gets Tax Observation Correct, The (Tax) Fraud Epidemic, Tax Re-Visits Judge Judy, Foolish Tax Filing Decisions Disclosed to Judge Judy, So Does Anyone Pay Taxes?, Learning About Tax from the Judge. Judy, That Is, Tax Fraud in the People’s Court, More Tax Fraud, This Time in Judge Judy’s Court, You Mean That Tax Refund Isn’t for Me? Really?, Law and Genealogy Meeting In An Interesting Way, How Is This Not Tax Fraud?, A Court Case in Which All of Them Miss The Tax Point, Judge Judy Almost Eliminates the National Debt, Judge Judy Tells Litigant to Contact the IRS, People’s Court: So Who Did the Tax Cheating?, “I’ll Pay You (Back) When I Get My Tax Refund”, Be Careful When Paying Another Person’s Tax Preparation Fee, and Gross Income from Dating?.

Last week, a reader directed my attention to a Judge Judy episode from 2012 that raised a serious issue of tax return preparation. The case involved a loan repayment, but the tax return preparation issue became the focal point of the dialogue.

The plaintiff made a $1,000 loan and a $300 loan to his daughter defendant. The daughter admitted that the first loan was made but did not appear to agree that there was a second loan. The daughter said she repaid $400 on the first loan. Her father said she repaid $140. Eventually Judge Judy decided to treat the daughter as having repaid $200. The daughter planned to repay the balance from her income tax refund. Because of what happened to the refund, the daughter did not repay, and her father sued her.

The daughter’s Form W-2, like her other mail, was delivered to her father’s address. The daughter had lived there for a time, had moved out several months earlier, and had, according to her, forgotten to file a change of address notice with the post office.

When the Forms W-2 arrived, the father’s wife, who was the defendant’s step mother, opened the mail containing the W-2s. She claimed that she did so with permission, and that every time mail arrived for the daughter she called the daughter and was told to open it.

The stepmother testified that when the envelope arrived from the daughter’s employer showing that it contained a Form W-2, she called her stepdaughter and was told by her stepdaughter told her to prepare the stepdaughter’s federal income tax return. She also testified that she had prepared her stepdaughter’s return for the previous year, at her stepdaughter’s request, because by using her Turbotax software it save the stepdaughter a tax preparation fee and accelerated the timing of any refund. The daughter denied having requested her stepmother to prepare the return.

The plaintiff father testified that his wife, the stepmother, called him at work to tell him that his daughter’s Form W-2 had arrived in the mail. He further testified that he called his daughter to ask her what to do with the Form W-2, and that his daughter told him to send them to her, and not to prepare a return . However, the father claimed, she refused to provide him an address so he sent them back to the employer who had sent them. The stepmother then claimed that she put the Form W-2 in the mail to the employer.

Judge Judy pointed out that the plaintiff and his wife were telling inconsistent stories. The stepmother tried to reconcile the stories by making it appear that the daughter had changed her mind between the time the stepmother called and when the father called, but that didn’t work because the father’s account was that the stepmother, on opening the mail and finding the Form W-2, called him, and not her stepdaughter.

The daughter testified that she had a subsequent conversation with her stepmother, who told her that she got the Forms W-2 back from the employer, and had prepared and filed the return on the daughter’s behalf. She allegedly told her stepdaughter that there was a refund of more than $6,000. The daughter claimed that the stepmother did this so that she and the father could get the refund and use it to make certain the loan was repaid, because they were afraid she was not going to repay it.

When the stepmother filled out the return, she filed a joint return on behalf of daughter and daughter’s husband. However, daughter and her husband had separated early in the taxable year and did not get back together until the following year. Because the husband owed back child support for a child he had with his previous wife, the IRS took the refund due to the daughter and applied it to the back child support. The refund arose from tax payments made by the daughter, because her husband apparently had no income and made no tax payments. The daughter implied that if she had prepared her own return she would not have filed a joint return and exposed her refund to her husband’s child support arrearages.

Judge Judy advised the defendant to have her father and stepmother arrested and prosecuted for tampering with her mail. Judge Judy, disregarding the alleged second loan, held in favor of the plaintiff for $800 on the first loan.

There are so many lessons to learn from this case. First, do not prepare a tax return for someone unless and until written permission to do so is obtained. Second, make certain to obtain documentation for the facts that generate return entries, including filing status. Third, when marrying someone, especially someone with children from prior relationships, enter into a prenuptial agreement, and if there are children from prior relationships, have the agreement specify the ultimate obligations for child support payments for children from prior relationships, including indemnity provisions. Fourth, when lending money to someone, enter into appropriate written documentation.

Monday, July 24, 2017

Should Tax Increases Reflect Populist Sentiment? 

True, polls aren’t necessarily accurate barometers, but a new poll from Bloomberg indicates more Americans favor an increase in the federal gasoline tax than oppose it. Among those who identify themselves as Republican, the edge is narrow, whereas among those who identify themselves as Democrats the margin is wide. This news might be surprising to people like Grover Norquist, who think that tax increases should be prohibited and that taxes should be reduced or eliminated, no matter the consequences.

That America’s roads, bridges, and tunnels need repairs is not debatable. The disagreement centers on how the repairs should be funded. The poll did not ask about alternatives other than the federal gasoline tax. It did not ask about state taxes, the privatization scheme, or mileage-based road fees. Nor did the poll question distinguish between adjusting the tax for inflation or raising it beyond an amount that reflects inflation adjustments.

Twenty-six states have increased fuel taxes during the past four years. Taxpayers, though not thrilled with the increases, do notice the resulting improvement in highways and bridges.

It is telling, perhaps, that fewer than half of people who voted for Donald Trump support an increase in the gasoline tax. Oddly, the President has indicated that increasing the tax is something he “would certainly consider.” Fuel taxes, tolls based on distance whether privatized or not, and mileage-based road fees all affect rural drivers more severely. Not surprisingly, support for an increased federal gasoline tax among rural residents fell just short of 50 percent. Geography also has an impact. People living in the South are less supportive of the increase, perhaps because they don’t experience quite the same level of damage caused by the harsher weather in the north.

The big problem, and it is going to become much larger, is the failure of gasoline and diesel taxes to impose a cost on vehicles that do not use those fuels. This is one reason I advocate the mileage-based road fee, as I’ve explained in posts such as Tax Meets Technology on the Road, Mileage-Based Road Fees, Again, Mileage-Based Road Fees, Yet Again, Change, Tax, Mileage-Based Road Fees, and Secrecy, Pennsylvania State Gasoline Tax Increase: The Last Hurrah?, Making Progress with Mileage-Based Road Fees, Mileage-Based Road Fees Gain More Traction, Looking More Closely at Mileage-Based Road Fees, The Mileage-Based Road Fee Lives On, Is the Mileage-Based Road Fee So Terrible?, Defending the Mileage-Based Road Fee, Liquid Fuels Tax Increases on the Table, Searching For What Already Has Been Found, Tax Style, Highways Are Not Free, Mileage-Based Road Fees: Privatization and Privacy, Is the Mileage-Based Road Fee a Threat to Privacy?, So Who Should Pay for Roads?, Mileage-Based Road Fee Inching Ahead, Rebutting Arguments Against Mileage-Based Road Fees, On the Mileage-Based Road Fee Highway: Young at (Tax) Heart?, To Test The Mileage-Based Road Fee, There Needs to Be a Test, What Sort of Tax or Fee Will Hawaii Use to Fix Its Highways?, And Now It’s California Facing the Road Funding Tax Issues, If Users Don’t Pay, Who Should?, and Taking Responsibility for Funding Highways. Perhaps when the highway trust fund runs out of money, roads crumble, bridges fall down, tunnels collapse, and the nation drifts even more into deteriorated condition, politicians will find some courage and do what is necessary for the nation, and what people need and want, rather than what is necessary for their election and re-election campaigns.

Friday, July 21, 2017

Gross Income from Dating? 

A reader has added another television court show episode to the list of those on which I cannot help but comment. The list is getting longer, and includes posts such as Judge Judy and Tax Law, Judge Judy and Tax Law Part II, TV Judge Gets Tax Observation Correct, The (Tax) Fraud Epidemic, Tax Re-Visits Judge Judy, Foolish Tax Filing Decisions Disclosed to Judge Judy, So Does Anyone Pay Taxes?, Learning About Tax from the Judge. Judy, That Is, Tax Fraud in the People’s Court, More Tax Fraud, This Time in Judge Judy’s Court, You Mean That Tax Refund Isn’t for Me? Really?, Law and Genealogy Meeting In An Interesting Way, How Is This Not Tax Fraud?, A Court Case in Which All of Them Miss The Tax Point, Judge Judy Almost Eliminates the National Debt, Judge Judy Tells Litigant to Contact the IRS, People’s Court: So Who Did the Tax Cheating?, “I’ll Pay You (Back) When I Get My Tax Refund”, and Be Careful When Paying Another Person’s Tax Preparation Fee.

This time, the reader asked a question. Was there any gross income? First, the facts, from a recent People’s Court episode.

The plaintiff sued the defendant for repayment of a $2500 loan that the defendant refused to repay. The plaintiff met the defendant on a web site, called What’s Your Price, where men pay women for companionship. The judge asked the defendant, “So you’re paid to go on a date?” The defendant replied, “Yes.” On further questioning, the defendant explained that she had been on the site for three weeks, but after meeting plaintiff and dealing with him she stopped using the site.

The judge continued, “So you’re not hooking?” “No,” replied the defendant. “You’re not selling sex?” Again the defendant answered in the negative. The judged asked, “So you are selling companionship?” The defendant replied, “Yes.” She found the site through a good friend who had been using it.

The judge, who seemed bewildered by the entire arrangement, then asked the defendant, “What if other person wants more?” The defendant replied to the effect that it was more like a dinner, a coffee, then a price is set before the arrangement is made.

The judge asked what the plaintiff paid. The defendant said $100 for the first date. The judge asked the defendant, “How much do you get and how much does the web site get?” The defendant explained that she did not think web site gets paid.

The plaintiff explained that he the web site through a friend’s recommendation. He paid less than $100, probably $50 or $75, and that one pays only for the first date. After that, there is no payment for dating.

The judge asked the defendant, “Why pay for a date when there are other sites that don’t require payment?” The plaintiff explained he had tried other sites, but hadn’t been on them for a while. Then his friend recommended the pay site.

The plaintiff said that after the first date he and the defendant became friends, went out on his birthday, went to a movie, dated casually four or five times, and that he didn’t pay for those dates. This went on for three or four months. Then, according to the plaintiff, the defendant said she was having trouble paying her bills, and explained that she was going to borrow money under an arrangement the plaintiff didn’t think it was a safe or good way to borrow money. So the plaintiff offered to lend defendant the money. She accepted, he transferred the money, and had defendant sign a promissory note.

The defendant, in response to another question from the judge, replied that she and the plaintiff did not become intimate. The plaintiff wanted a full-time relationship and wanted her to be at her house three or four days a week, but she did not have the time. She was willing to hang out casually. The judged asked, “So if he pays only for the first date, what’s in it for you?” The defendant said that plaintiff had paid her once a week after asking if she had bills to pay, and that there were only a few times when they went out that plaintiff didn’t pay her.

The judge asked why the promissory note, which the plaintiff produced, did not resolve the loan question. The defendant explained that she signed it while on the phone during a family crisis that had arisen when she and her cousin were arguing and it brought their parents into the dispute. She said she thought what she seemed to call a “promise note” was a note for a promise to continue being friends with the plaintiff. The judge did not believe the defendant’s claim that she signed the promissory note by accident. So, based on the promissory note, the verdict was delivered in favor of the plaintiff.

The reader’s question to me is a simple one: “Is this gross income for taxpayer being paid to go out on date?” The answer is easy. Yes. Absolutely. It’s a payment for services. It’s a payment for doing something that is conditioned on payment. It definitely is not a gift.

So how is this different from a situation in which a person asks another person for a date, takes the person to dinner, and pays? The answer is that neither person is under an obligation. There’s no breach of contract if one of them backs out, or if the one who did the inviting decides to let the other person pay some or all of the cost. When I taught the basic federal income tax course, I used these sorts of dating and companionship questions to help students focus on the gift exclusion and on the definition of income generally. It was one of many reasons it was easy to get students’ attention in a tax class. Make it personal and real, and discuss transactions with which they are familiar.

I get the impression that perhaps some people are making far more than an occasional $50 or $100 from these “What’s Your Price” arrangements. It’s easy to go out on one date, pocket some cash, and either turn down the offer of a second date or continue dating while receiving payment. Do the math, don’t forget to add in the value of the meal, and consider the possibility of dating one guy for lunch and another for dinner. And on an hourly basis, it’s better than minimum wage. I wonder how many people who are doing this are reporting the income. I’m confident it’s not 100 percent, or even half that.

Wednesday, July 19, 2017

When “Taxpayer” Means “Taxpayer” 

A recent Tax Court decision, Gregory v. Comr., 149 T.C. No. 2 (2017), provides an excellent, though long, primer on statutory interpretation and the relevance of legislative history. The issue in the case is easily stated. The taxpayers, shareholders in an S corporation that uses the cash method of accounting, claimed deductions passed through from the S corporation that were claimed under section 468. The IRS disallowed the deductions, concluding that section 468 applies only to accrual method taxpayers. Section 468 allows landfill owners to deduct estimated future reclamation, closure, and post-closure costs.

First, the court examined the word “taxpayer” in section 468, pointing out that the statutory text controlled, and that legislative history would be relevant only if the text was viewed as ambiguous. Noting that section 468 simply states “taxpayer,” the court turned to section 7701(a)(14), which defines a taxpayer as “any person subject to any internal revenue tax.” Because a “person,” as defined in section 7701(a)(1) means and includes an individual, a trust, estate, partnership, association, company or corporation, the taxpayers and their S corporation were within the scope of the term “taxpayer” in section 468, because the taxpayers and the S corporation are subject to various federal taxes even though the S corporation in question is not subject to federal income tax.

Second, noting that the previous definition does not apply if an applicable provision provides a different definition of the term “taxpayer,” the court examined section 468 and concluded that there is no definition of “taxpayer” in that provision. Though there are other timing provisions in the Internal Revenue Code in which Congress used the phrase “accrual method taxpayer” or “taxpayer whose income is computed under an accrual method of accounting,” there is nothing of that sort in section 468.

With that, one would think the analysis was finished. But the IRS paraded a long list of reasons that the word “taxpayer” should be interpreted as “accrual method taxpayer.” The court addressed each one.

First, the IRS pointed to section 461, which includes several exceptions to the general rule that cash method taxpayers cannot claim a deduction before the expense is paid, and noted that section 468 is not in the list. The IRS also pointed to the regulations under section 461, which provide that cash-method taxpayers can deduct some expenses before the expenses are paid, “such as * * * for depreciation, depletion, and losses under sections 167, 611, and 165, respectively.” The IRS argued that because section 468 is not listed, it does not apply to cash method taxpayers. The court buried this argument by explaining that the phrase “such as” signals that the items following it “are examples, not an exclusive list.” The court referred to similar lists in the statute, including one that refers to holidays when schools are closed, “such as Christmas and Easter,” noting that schools are closed for other holidays.

Second, the IRS argued that the term “incurred” is used in section 468, and that because the term “incurred” is used in the context of the accrual method, section 468 applies only to accrual method taxpayers. Though the court agreed that “incurred” usually refers to an expense deductible under the accrual method, it noted that the word was used in section 468 only twice, and that the word “paid,” which usually refers to an expense deductible under the cash method, is used four times in section 468. If the use of another word could be taken as a limitation on the word “taxpayer,” the presence of both “incurred” and “paid” in section 468 does nothing to support the IRS position that the provision is limited to accrual method taxpayers.

Third, the IRS then cited a canon of statutory interpretation known as noscitur a sociis, which is Latin for “it is known by its associates.” Essentially, according to the court, this argument was simply another variation on the “the presence of the word ‘incurred’ means section 468 is limited to accrual method taxpayers” argument that had failed. Though the court then stated, in Latin, that the tax collector was not helped by these arguments, it just as easily and understandably could have written, Ipsi foderunt foveam profundius (“they dug themselves a deeper hole”).

Fourth, the court concluded that the cases cited by the IRS and in which section 468 had been mentioned did not address the question it faced. Those cases involved accrual method taxpayers, and thus the question of whether section 468 was limited to accrual method taxpayers had not needed attention.

Fifth, the IRS cited the principle of ejusdem generis, a Latin phrase that means, in effect, “where general words follow an enumeration of two or more things, they apply only to persons or things of the same general kind or class specifically mentioned.” The problem with this argument is that section 468 does not have a list of things, but merely refers to one word, namely, “taxpayer.” As the court put it, “Without a generis, there is no ejusdem and this canon likewise cannot help us.” Nor did it help the IRS.

Sixth, the IRS argued that because section 468A, which permits deduction of future nuclear decommissioning costs, tracks section 468, its restriction to accrual method taxpayers should also apply to section 468. However, as the court explained, the regulations under section 461 do not limit section 468A to accrual method taxpayers, nor does section 468A do so. Moreover, even though the regulations under section 468A provide that “eligible taxpayers” may make deduction elections under section 468A, they define “eligible taxpayer” as a taxpayer with a qualifying interest in a nuclear power plant.

The court then turned to legislative history even though it had not unearthed any ambiguity in section 468. The court did so “out of a supersized abundance of caution.” It made clear that it was not doing so in response to the IRS claim that by jumping from section 468 to section 7701 to define taxpayer the court had conceded the word “taxpayer” was ambiguous. The court’s discussion of the legislative history is extensive, and enlightening, but in the end nothing was dug up to support the IRS conclusion.

The court’s description of how section 468 came into being, together with the discussion in Judge Lauber’s concurring opinion, is a marvelous exhibition of why legislative drafting often is compared to sausage manufacturing. It most likely is, as Judge Lauber noted, a “last-minute drafting glitch” that caused the word “taxpayer” to be used in section 468 without any sort of language limiting the section to accrual method taxpayers. Considering the twists and turns that the legislation endured on its way to becoming law, it is not surprising that the statute did not emerge as quite the provision that was intended. The remedy, of course, sits with the Congress. Though it is possible, it is not probable under current circumstances, that the outcome in this case will generate any sort of technical correction amendment in the near future.

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