Monday, January 31, 2005

Once Again, Grades are "Coming Out" 

The Power of Grades

Grades for first-year students were released last week. Grades for second and third year students will be released soon. Grade release days always bring distress to students who fall short of their own or their parents' expectations. Grade release day, for some students, especially in the first year, become watershed moments that, rightly or wrongly, cause a student to affirm or change his or her sense of what lies ahead.

Grades, in and of themselves, can be good or bad, depending on how they are generated and how they are used. A grade that reflects a student's level of competence at the moment of testing can be informative to student, teacher, potential employer, and others. A grade that reflects a student's relative position among those with whom the student was evaluated can be informative, but in a different way. A grade that is used to define the worth of an individual can is a grade that is used in an ill-advised manner. A grade that is used to encourage a student or to reinforce a new set of learning habits is a very worthwhile grade.

The Problem with Grades

The problem with grades is that there is no universal definition. Unlike the Celsius temperature scale, where 40 means the same thing to scientists, meteorologists, and ordinary folks the world over, a B- means as many different things as there are students earning a B-. OK, that's a bit of an exaggeration, but ask yourself, what does B- mean?

Relative grades, that is, grades assigned pursuant to a curve, have a meaning. Assuming one can obtain access to the curve, one can determine that a grade of letter L means that the person earning it did an evaluation set (exam, paper, etc.) that placed the person in the n1th through n2nd percentile of the evaluation performances of those subject to the same evaluation set. But what does that really mean? How helpful is it to know that Student S earned a B- in a course in topic C at university U under these conditions? Not much, really. Even an A at a top-flight school has lost some of its value because grade inflation has "cheapened" the grade.

That is why I prefer grading against a standard. Grading against a standard reveals what the student can and cannot do, provided the standard measures information of value to those looking to the grade for information.

An example helps. If 20 people run a race, the winner gets a gold medal. So what? If the other 19 are terribly slow, the winner comes across as outstanding, even if the winner is only slightly faster than terribly so. Under some circumstances, such as an athletic contest, or a contest for a limited number of prizes, relative position makes sense, and so, too, do the gold, silver, and bronze medals. But it is far more useful to know that a person ran a mile in 3 and a half minutes.

And that brings me to the flip side. There is one gold medal, and a person who runs a mile in 3 and a half minute doesn't get that medal if someone else runs a mile in 3 minutes and 29 seconds. But if an A represents running a mile in less than 3 minutes and 50 seconds, then both runners earn an A.

Relative grades impose artificialities that distort the reporting of the performance results. A mandate that the top 10 percent earn A grades does two things. First, it can preclude a highly accomplished student from earning an A even if the student falls short of the top 10% by a fraction of the difference between the top performance and the performance that is the lowest A. Second, it can cause A grades to be granted to students whose performance, when measured against performances by students in other years, falls short.

Setting Standards

What should the standard be? For law school grades, it should be a measure of what lawyers in practice should be capable of doing. If someone cannot respond appropriately to at least 20 percent of what is presented to them on one of my exams, that person earns an F. Similarly, if a student can attain 80 percent of what a seasoned practitioner would do on one of my exams, that student earns an A. People can quibble about the standard, but standards can be developed. It's done in other areas of education so it surely can be done throughout education.

Who should set the standard? Ideally, organizations representing the interests of those who use the grades. In the context of law school grades, a consortium representing law faculty and administrators, state bar examiners, and lawyers can and should develop a measure of what a student should be able to know, understand, explain, and do with respect to a specific area of law or transaction.

Of course, grading in this manner means that grade distributions will change from year to year. Many years ago, in a specific semester, no one earned an A in Partnership Taxation. No one deserved an A. Relative grading would have caused the best of those examinations to earn an A, which would have "cheapened" the As earned by students in Partnership Taxation in other semesters. In other courses, there have been semesters in which 25% of the grades were A grades. That can happen, and when it does, it makes no sense to tell 60% of those students that they have earned some lesser grade (B, B+) and should present a transcript to employers that rates them less qualified than the person who would have earned, under a mandatory curve, an A in that other semester when no one earned an A.

This year-to-year inconsistency pops up in other areas of life. Could a team from one era defeat a team from another era? Which means more, the individual accomplishment of a ballplayer in the 1930s or that of someone playing the same game under different circumstances in the 2000s? The inability to resolve such questions ought not preclude application of standards where standards can be used. Those practicing law can affect the lives of other people in deep, serious, and long-lasting ways. The practice of law is not, and ought not be, a game.

Grade Inflation as the Cause

The mandatory curve is a reactionary response to grade inflation. It is a cure that is as bad as, if not worse than, the problem. The lack of standards is what permitted grade inflation, and it is the lack of standards which permits artificial grading.

Some of the inflationary pressure on grades, which produced the reactionary mandatory curve, arises from a concern that students are not getting jobs because employers turn their attention to students from schools with high grades. In the long run, this sort of grading arms race would do nothing but cause all students to earn A grades. At some schools, this prospect came so near the horizon that mandatory curve proponents found ammunition for their position. Of course, I still find it difficult to believe that employers simply look at grades without regard to the identity of the school or the class rank of the applicant. Employers surely have had experience with students from several or more schools, and all the high grades in the world cannot undo the reputational damage done by a student with high grades who performs poorly in practice.

Some of the inflationary pressure on grades comes from reluctance by some faculty to "give" low grades to students. "Bad for self-esteem," they say. "With grades so high, a C sends the same message as an F" is another famous assertion. Wrong. A collection of F grades sends the "goodbye" message that a collection of C grades does not send. Of course the notion that grades are "given" rather than "earned" has always troubled me. A gifted or given grade suggests something other than objective evaluation.

Much of this reluctance to declare the failure or low performance of a student arises from a post-modern culture that abhors criticism that hurts feelings. That concern should influence the packaging, and that is why it is inappropriate to broadcast a student's grades in flashing lights for the world to see. But in the long run more harm than good is done by causing a student to believe that he or she is capable of doing what he or she is not capable of doing.

What Really Should be Tested

Of course, all of this discussion about grades assumes that what is being graded is what should be graded. Law school grades provide an example of how what is being measured doesn't equate with what is being sought. Law practice employers seek to hire students who can express themselves well, in spoken and written word, who can exercise good judgment, who can distinguish real issues from red herrings, who can organize information in sensible ways, who can describe errors in someone else's argument, who can identify missing factual information critical to determining the outcome of a situation, who can solve problems, who can prevent problems, who can distinguish one case from another, and who can demonstrate a variety of other legal skills. Yet what law practice employers get, aside from grades in courses such as clinics, drafting, trial practice and the like, are grades assigned to areas of law. Does an A in Contracts mean that the student can draft a contract? Determine what needs to be asked of a client for whom the contract is being drafted? Identify clauses in a proposed contract that pose litigation risks and thus are in need of revision? Or does it mean that the student understands a theory of contracts? Or some combination?

I design my examinations to isolate a variety of challenges that a practitioner faces. One question may focus on fact identification, another on argument dissection. A third might focus on the truth or falsity of a conclusory statement derived from black letter law, and a fourth could focus on the wisdom of suggesting that a client pursue all of the client's legal rights under a particular set of circumstances. This helps me teach in several ways. If I see the same error over and over again, I make adjustments in how I teach the course the next time I teach it. If a student comes to me to find out why his or her grade fell short of expectations, it helps me identify with specificity what the student's shortcomings were with respect to the examination.

Even so, those persons who see the student's grade know only that the student earned a letter grade in Introduction to Federal Taxation, or Partnership Taxation, or whatever. They know nothing more. The grade isn't all that helpful.

Recently, for reasons that are another story that can be told, if ever, at another time, I was looking at my elementary school report cards. (OK, OK, that's because my mother found a few as she was cleaning and passed them along to me even though she thought she had done so years ago.) Not only were there grades for substantive areas such as arithmetic, history, spelling, and the like, but also there were grades for skills and traits such as cooperativeness, obedience, cleanliness, and similar characteristics. Why not do the same with higher education grades, including law school? After all, what students and employers need and want to know are the specifics of their strengths and weaknesses. For some employers, research skills may matter far more than they do for other employers. A cluster of grades in areas of legal doctrine doesn't tell us much.

And So?

Well, if I can "get" a law school, and transform the curriculum into one based on transaction and not doctrine, and then layer on grading with respect to practice abilities, it could get very interesting. Of course, by letting the world know what I'd like to do, I almost guarantee that no one would dare "give" me a law school at which I could conduct this experiment.

Friday, January 28, 2005

Now It's Time for Taxes Meet Emails at Death 

Professor Ray Madoff of the Boston College Law School responded to my commentary about the issues raised when planning for the disposition of a decedent's email, blogs, letters, and similar artifacts (a term for which I thank Prof. Madoff, as it works well). The original posting and the followup have generated interesting and informative responses.

Prof. Madoff pointed me to her article, Taxing Personhood: Estate Taxes and the Compelled Commodification of Identity, 17 Virginia Tax Review 759 (1998), in which, among other things, she discusses the estate tax treatment of assets, such as letters (but also more visible items such as publicity rights and the value of the decedent's name), which have a market value for estate tax purposes no matter what is done with the asset. In contrast, she points out, the income tax applies only if the taxpayer chooses to dispose of the property and thus realize income.

Of course, as she points out, for most of us, our emails, blogs, and letters have far less value than those of widely known celebrities and other very public figures. Of course, there may be just one person who so desperately wants to see the emails, letters, and other artifacts of a decedent that he or she may be willing to pay a surprisingly high amount to obtain them, even though the intent is not some enhancement of the public consciousness about a public figure but a need to acquire what could be called gossip from the grave. Interestingly, these artifacts may have more value in their secretive state than in their publicized state. Consider the family member who would then try to outbid the town busybody, assuming that the news is out and about because the will is probated and contains references to these items. Which value, then, holds for estate tax purposes?

One thing that occurs to me is the connection between destruction and the estate tax alternate valuation date. Arising during the Great Depression, when estates experienced huge post-death declines in value as the economy worsened, leaving them with insufficient assets with which to pay the tax on date-of-death values, the alternate valuation date permits the estate to elect valuation at a time later than death (and, as with all tax provisions, it's a tad more complicated than that). What happens if the personal representative destroys the email or letters, with the consent of all beneficiaries (who thus would be most unlikely to raise objections at a later time)? Are the items valued at zero if the alternate valuation date is elected and the items were destroyed before that date? Is there a public policy exception similar to the one denying casualty loss deductions to taxpayers who cause the casualty (a principle applied in a case involving an angry husband who tried to burn his wife's clothes on the cooktop and ended up incinerating the entire house).

Here's a prediction. The issues arising from the explosion of personal information on account of advances in technology will get legislative attention when it is a legislator who dies and some interesting emails come to the attention of a journalist. That is when the question "So tell me again why this is such a problem" will be self-answered with "Oh, I see. Oops."

Never at a Loss for Tax Proposals 

The staff of the Joint Committee on Taxation has just released its report, "OPTIONS TO IMPROVE TAX COMPLIANCE AND REFORM TAX EXPENDITURES", providing an array of suggestions designed to increase federal tax revenue. Some of the options are designed to increase compliance by causing tax collections to match more closely tax liabilities. Other options are designed to remove loopholes, or incentives that have been manipulated to the point of undermining the structure of the tax law.

There are 3 suggestions with respect to tax procedure, 8 with respect to the individual income tax, 6 with respect to employment taxes, 8 with respect to pensions and employee benefits, 7 with respect to corporation and partnership taxation, 4 with respect to internation taxation, 6 with respect to other business transactions, 12 with respect to tax-exempt entities, 6 with respect to tax-exempt bonds, 4 with respect to excise taxes, and 5 with respect to estate and gift taxes. That's a grand total of 69 ideas.

I'm not going to describe 69 ideas. Take a look at the report>. But a few deserve some attention.

One suggestion is that government entities be required to withhold on certain payments made to taxpayers. Why? Apparently more than 27,000 contractors doing business with governments have understated tax liability. Withholding increases compliance. That lesson was learned with respect to salary income a long time ago. Why it has taken this long to apply withholding on a wider basis can be answered with one word: politics. The scam job that banks pulled when Congress tried to impose withholding on interest remains to this day a classic example of how lying can get you everywhere (if what you want to do is to avoid acting as a withholding agent). I'll tell that story another time. This proposal, though, adds to the tax law. It is a fine example of how tax law complexity is in part attributable to the need to deal with non-compliant taxpayers. After all, if everyone followed the law, and made appropriate quarterly estimated tax payments, these sorts of withholding provisions would not be needed.

Another proposal would repeal the exclusion for employer-provided dependent care, and leave the dependent care credit as the tax law mechanism for indirectly funding dependent care expenses. Assuming that the tax law should be a means of funding dependent care expenses, how can a simplification advocate not like a proposal that shortens the Code?

Another suggestion is to combine the HOPE education credit, the lifetime learning credit, and the deduction for higher education expenses into one per-student credit. Again, assuming that the tax law, rather than direct grants, should be used to fund education, the idea of trading three complicated and different provisions all focused on the same goal into one provision is a winner.

Yet another idea is to repeal the exclusion for qualified tuition reductions because it is available only to a small group of taxpayers, namely, employees of educational institutions. The benefits would be taxed, althought the taxpayer might qualify for an existing or proposed education expense credit or deduction. Although one might expect that as an employee of an educational institution I would oppose the change, I don't. I simply hope that the principle of "repeal provisions available only to a small group of taxpayers" is applied across the board, because the list of candidates for repeal is long. As a matter of full disclosure, the change would not affect me because I have never received, nor do I expect to receive, tuition reductions or remission for myself or my children (they ended up at schools with which Villanova does not have a tuition exchange agreement).

The report proposes repeal of the interest deduction for home equity indebtedness. Considering the complexity of this provision, the compliance problems, the confusion caused by the difference in the term "home equity" loan for tax and lending purposes, and the advantage the provision gives to homeowners with untaxed appreciation in their homes, the arguments for repeal outweigh the arguments for retention. This is another idea that would foster simplification, by removing something without adding to anything else or changing anything else in the Code.

Another suggestion would limit the total exclusion for the rental value of a residence rented fewer than 15 days to $2,000, and would allow certain deductions attributable to that rental. Why not just flat-out repeal the exclusion? The proposal creates more complexity.

Another proposals would require part-gift, part-sale transactions to non-charities be treated in the same way as those to charities, that is, basis would be allocated between the sale portion and the gift portion. Does this make sense? Yes. Is this a simplification? Yes and no. It is a simplification because there would be one rule rather than two. It would be a complication because it would require taxpayers who otherwise would have used a slightly less complicated rule to use a more complicated rule (the complication being the arithmetic process used to allocate the basis). There's no escaping the need for a rule, and the less complicated rule alos is a rule inconsistent with the tenor of the tax law. This one is easy to support.

The report suggest that children under 18, rather than children under 14, be subject to the "kiddie tax" and that the kiddie tax be changed from taxation using the parents' rates to taxation using the highest rates applicable to the category of income in question. This simplifies things to the extent it eliminates the logistical morass of trying to use the parental rates, allocate parental tax among children, and require parents to analyze the wisdom of making the election to be taxed on the income. On the other hand, the kiddie tax would remain a complex provision, and it would pull more children into its reach. The challenge with this proposal is that it is a band-aid on a symptom of a much larger problem, namely, the impact of a tax rate structure with multiple rates on family wealth shift planning.

Does it make sense to treat salary reduction amounts and qualified transportation fring benefits as wages for FICA purposes even though they are excluded from gross income for federal income tax purposes? The report thinks it does. So do I. All compensation, whether excluded or not, should be subject to FICA so long as the social security system remains as it is at the present time. There are other deferred compensation amounts that have long been treated as wages for FICA purposes despite their exclusion for income tax purposes, so this proposal would be leveling the playing field in that respect.

Another proposal would treat sales incentive payments, which ARE included in gross income, as subject to FICA. Under current administrative practice, for reasons not explained, they have not been so treated. This is another one that is easy to support.

FICA arises yet again in a proposal to remove the "John Edwards" technique. Simply put, it would prevent S corporation shareholders and partners from treating compensation as distributions in order to avoid FICA. This is another winner.

Here's one that's not difficult to like. Another proposal takes the many different definitions of medical care in the tax law and provides that the definition of medical expenses for purposes of the tax treatment of reimbursements from employer-sponsored accident and health plans, health savings accounts, and Archer medical savings accounts would be the same as the definition of medical expenses that may be claimed as a medical expense deduction.

The report proposes changing partnership basis adjustments to make them more accurate from a technical perspective, but this change makes the provision and the computations more complicated. Partnership Taxation students and practitioners will be thrilled to see this one enacted. Again, this is a band-aid solution to a symptom of a larger problem.

Another suggestion is to make all sport utility vehicles subject to the luxury automobile limitations, which would permit repeal of the section 179 expensing limitation for sport utility vehicles. This is a simplification. It makes sense, provided one accepts the idea that sport utility vehicles ought not provide tax savings opportunities. How long until the energy efficient sport utility vehicle lobby chats up an exception? And why not extend the limitation to other vehicles, such as dual cab pick-up trucks, that often are used for everyday passenger transportation. There may be as many pickup trucks with beds carrying living quarters as there are sport utility vehicles that have never been taken off road.

The report proposes repeal of the charitable contribution deduction for facade and conservation easements on personal residence properties, substantial reduction of the deduction for all other qualified conservation contributions, and new standards on appraisals and appraisers of these easements. These deductions have been the subject of recent discussions revealing the extent to which they have been abused, partly through highly overvaluation and partly through the setting aside of easements that don't deprive the owner of substantial rights. The proposal is yet another complication contribution required because of taxpayer noncompliance with the spirit, and in some instances, the letter of the law.

Here's an interesting idea. Because taxpayers erroneously or deliberately overstate the value of personal property donated to charity, the report suggests the following: "The income tax deduction for charitable contributions of clothing and household items made to [charities] is limited to $500 per taxable year for the aggregate of all such contributions made by the taxpayer. No carryover of such contributions over $500 is allowed. As under present law, the deduction for a particular item may not exceed fair market value and the taxpayer must retain records to substantiate the deduction. * * * * The proposal applies to new and used items. Household items include furniture, furnishings, electronics, appliances, linens, and other similar items. Food is not considered a household item. Paintings, antiques, and other objects of art, jewelry and gems, and collections are excluded from the proposal. A collection must be something given for use or sale as a collection and generally must have value independent of its component parts." In its reasons for the change, the Committee staff states that the deduction encourages taxpayers to contribute property that they might otherwise throw away. I wonder what impact this proposal would have, if enacted, on organizations such as Goodwill or Purple Heart, who employ people to repair other individual's "trash." Hopefully taxpayers would continue to put these things "out for Purple Heart" rather than "out for the landfill." In this instance, tax compliance enhancement policy clearly conflicts with conservation policy.

The report proposes two options, both of which, to a greater or lesser extent, would apply a "lesser of fair market value or adjusted basis" limitation to the amount of the deduction for a contribution of property to charity. I predict that this proposal will trigger many pages of discussion and many hours of debate. It takes away from charities one of their most important arguments used to persuade taxpayers to contribute appreciated property. Under current law, the taxpayer not only escapes taxation on the disposition, but gets a deduction for the gain that goes untaxed. Unlike a gift to an individual, where the gain is shifted to the donee and taxed when the donee disposes of the property, the gain in the property donated to the charity goes untaxed, save for a few exceptions that reach only a small portion of these transactions.

The report also recommends codification of the economic substance doctrine and its application to certain transactions. The proposed statutory language, which is in the report, is worth reading. Why? To show how some of the tax law's complexity arises from the "gaming" that transpires between taxpayers who seek to reduce taxes by engaging in transactions in which they would not engage but for the tax law and government officials who usually trail in the game, reacting to plans that by the time the IRS audits a return have been supplemented by new arrangements. The goal of the proposal is to create statutory language that permits the IRS to attack tax shelters more easily. No matter what logic tells me, I have this nagging feeling that the proposal changes, but does not make a substantial dent in, the game.

So now what? A practitioner once told me that he didn't read legislative proposals because it wasn't worth applying intellectual energy or practice time to something that might not ever become an issue while having the immediate concerns of clients to manage. I understand that perspective. Yet it helps to be aware of possible changes, especially if there are effective dates that make planning "too late" if attention is paid to the legislation only when it is enacted (or reported by Ways and Means). So I think it behooves practitioners (and "academics") to at least skim the report. I touched on a few of the proposals, and certainly I did not want to get into those that deal with issues far beyond the scope of my tax expertise. There's much more in the report than my brief overview suggests.

Where do the proposals go? I don't know. Will they collide with the report of the Commission on Tax Reform? Maybe. Will they be incorporated, or merged in some way? Perhaps. Will the tax law be less complicated? Ha ha. I doubt it.

Here's to your happy reading or skimming. So what that it's only 600+ pages? Isn't War and Peace longer? It's the book report that's due Monday that gets us nervous.

Wednesday, January 26, 2005

Simple in Theory, Complex in Practice 

Some may remember that I did not think that restoring the sales tax deduction, even as an alternative to a state income tax deduction, was an appropriate or wise idea. In my earlier postings I have pointed out the dangers of selectively backing out of an legislative agreement on taxes, the logic of repealing the state income tax deduction rather than adding a state sales tax deduction, the inappropriate effect on tax burden shifting, the countervailing effect of the AMT, the confusion over IRS determination of tables for the restored sales tax deduction, and the seemingly low amounts set forth in that table.

Now another issue arises that illustrates how a simple concept or theory that attracts votes is mostly a complexity generator in disguise. It almost always is that way.

The IRS anticipated some of the issues. In the sales tax tables that it issued, the IRS addressed how to handle situations in which the taxpayer lived in more than one state during the year, and the IRS took into account the fact that in several states the sales tax rate changed during the year. The IRS also provided a means of adjusting the table amount for local sales taxes.

For local sales taxes, the IRS table instructions simply refer to "your locality." What is your locality? Is it the town in which you live? The town in which you work? The town in which you shop? Does it matter? Of course it does. There are, we are told in a message to the ABA-TAX listserv, people who live in rural areas and who must shop in nearby towns or cities. The rural area has no local sales tax (I guess when there's nothing much to tax there's no use having a tax, and there must be a lesson in there somewhere). The town or city has a local sales tax.

There are good arguments to make that "your locality" means "the locality where you live" because the rules for people who move refer to the states in which they lived, and the expression "the locality in which you lived" does not get used. On the other hand, "the state where you lived" is used instead of "your state" and I wonder if this is a deliberate inconsistency in the expressions. After all, if a person lives, works and shops in locality A, which has a local sales tax, and then during the year moves to locality B, in the same state, which also has a local sales tax, I assume that the formula provided by the IRS for persons who move from state to state would be interpolated to apply to the moving from one locality to another.

Has this become sufficiently complicated? No.

Consider the person who lives in one state and shops in another. I'm thinking of Pennsylvanians who cross into Delaware to do their shopping because there is no sales tax in Delaware. These Pennsylvanians, but for the fact that the state income tax deduction is larger, would use a table to compute sales taxes based on where they live and not where they shop. What happens to a person, therefore, who lives in a locality with a local sales tax but who shops in a nearby town that does not have a local sales tax? My guess is that the person would choose to add in the local sales tax rate of the residential locality.

So can it cut both ways? Is it a matter of selecting the locality with the higher local sales tax and making it "your" locality? There is a strong argument that the rule needs to be consistent and that there is no authority for usig a "greater of" approach.

So what has Congress done? To appease some voters, rather than repealing the deduction for state income taxes, it went back on a previous legislative agreement and restored, in a more convoluted manner, a state sales tax deduction, and its attendant complexities. So what Congress did is to impose more burden on the taxpayers' time, more paperwork on their tax return preparers, and more questions on their tax advisors, for which the taxpayers will ultimately, in some way, pay. Perhaps the Congress unintentionally created more work for lawyers, and contributed to the hiring of 17 law school graduates.

What Congress has done is to make the mess messier. Congress gave me material for my blog. The two seem to go hand-in-hand, it seems. Could it be any other way?

Monday, January 24, 2005

Supremes to Congress: Clean Up Your Own Mess 

Last fall, I reported on the enactment, by the Congress, of an above-the-line deduction for attorney fees paid by plaintiffs in specified types of litigation. In my post, I criticized the narrow nature of the provision.

Today the Supreme Court handed down its decision in Commissioner v. Banks. It held that the plaintiff's gross income INCLUDES the gross damage award, and is not reduced by the portion paid to the plaintiff's attorney. The Court correctly set aside the recent legislative enactment as non-determinative, because its effective date precluded the case that the Court was deciding.

The Court's decision, with which I agree in result, did not address arguments that had been raised for the first time in the briefs of the parties and amici. That's not an unusual treatment of "new" arguments. The Court's decision, though of small importance to cases for which the above-the-line deduction is permitted, is significant for other cases, such as those involving defamation, and for all the cases in the pipeline not within the effective date of that deduction.

In his Tax Updates blog posting on the Banks decision, , Joe Kristan says, "In effect the Court is again telling Congress: you broke it, you fix it." Exactly. There are those who disagree, who see courts as having some higher duty to set the law right no matter what, but I, without speaking for others, think that doing so leaves the Congress as the spoiled child who grows up to be a societal burden because the parent steps in and fixes everything that the child ruins. The Congress needs a better way of dealing with tax issues, and I, for one, will not accept "but it's complicated" as an excuse for its failure to prevent the sort of mess that taxpayers found themselves in, when it is the Congress itself that created the mess. The fact that Congress chose to help only some taxpayers and not all highlights the dangers of a Congress that legislates by caving to lobbyists rather than acting with wisdom and even-handed judgment. And leaving the clean-up to the courts is just plain irresponsible.

And if Congress had dealt with the matter properly, the arguments properly rejected by the Supreme Court could have been presented to Congress. In a full hearing, the Congress would have the benefit of everyone's insights, and not just the desires of a group with special connections to the law makers. I will not repeat the discussion on this issue that I shared last fall.

The Social Security Chicken and Egg 

Andy Cassel's column in Friday's Philadelphia Inquirer raised several very important points about the social security debate that is beginning to heat up a bit. Two of his observations strike me as fundamental to the debate.

Andy's first fundamental point is that there is no point in addressing any of the issues (existence or scope of crisis, financing devices, investment possibilities, retirement age, benefits, etc.) until and unless we have "some basic notion of what we want Social Security to accomplish." He is dead-on right. Part of the problem, perhaps the principal cause of the problem, is that Social Security has a split personality. Is it insurance against being in poverty after retirement? Is it a savings plan? Is it a wealth transfer plan? Is it a disability plan? Is it a survivor benefit plan? If it is some combination, how should each element be weighed?

Though many debate this point, I (and others) continue to assert that Social Security was designed as insurance against being in poverty after retirement. The "I" in FICA is for "INSURANCE." Over the decades, it was expanded to include survivors of retirees, and then survivors of potential retirees. It came to include disabled workers who had not yet retired. Medical benefits were added, though eventually the Medicare portion was separated to some extent. During the heydey of Rep. Pepper's "all elderly are poor, let me get them benefits and their votes" campaigns, any notion of a means test was tossed out the window. Of course, today there are more children living in poverty than there are elderly, and this vote-getting expansion of Social Security surely is partially, if not entirely, to blame.

But before this question can be answered, other information is required to shape the context in which the question is asked. This brings me to Andy's second important point.

Andy's second fundamental point is that we need to reach agreement on whether government-run social insurance does more harm than good or more good than harm. He refers to assertions by Martin Feldstein, a Harvard economist who advised Ronald Reagan and who may succeed Alan Greenspan as chair of the Federal Reserve System. Feldstein argues that social programs are disincentives, claiming that unemployment insurance increases unemployment, retirement pensions induce earlier retirement, and health insurance programs increase medical costs, just as air bags subtly encourage people to speed. There's some merit to these arguments. The existence of unemployment insurance might cause an employer to lay off an employee that the employer might otherwise try to retain because the employee has a family. Some people do retire earlier than they would retire because they have retirement benefits waiting for them. Health insurance might encourage people to get check-ups that they might avoid because of financial restrictions, though I'm not convinced that the cost of wellness is more than the cost of sickness.

Here's the problem. Most insurance is unlike the lottery. One pays, and then prays to lose. Do you REALLY want to collect fire insurance, auto collision insurance, auto theft insurance, or flood insurance? Sure, but only if the fire, accident, theft, or flood occurs. Almost everyone prefers that the casualty not occur. Not only does the insurance not cover the entire loss, these events pose dangers to life and health and are a general inconvenience of the highest order. Life insurance is a strange exception. If it's term insurance, again, most folks don't want to collect during the term. If it's whole life, sure, it will pay someday, but the hope is that it is a day far in the future. All of these insurances cost money, but payment of the premium is good "insurance" against the risk of an undesired but unpredictable and possible event.

Let's turn to retirement. Ideally, individuals would save for retirement. Few people do so. Some are unable to do so. Others are unable to see a long-term need as having the same or higher priority as a short-term want. Many depend on the retirement portion of an employment package, but then end up on the streets when an employer goes under, leaving behind unfunded retirement obligations. That's what FICA was designed to address, namely, retirees who through no fault of their own were left penniless because an employer went bankrupt. FICA was enacted decades before the pension reforms of ERISA that brought us the Pension Benefit Guaranty Corporation, which essentially insures pensions from the employer's perspective. The combination of FICA and PBGC coverage, though far from being duplicative, creates a situation in which many Americans conclude, erroneously as any half-sensible financial planner will explain, that they don't need to save for retirement. And if that is indeed the effect of the current structure, changes are needed.

First, let's separate the different goals of "Social Security" and deal with each one separately, just as a person would treat each goal separately when dealing with each in his or her own way. Just as Medicare has been somewhat cordoned off of Social Security generally, so, too, should be pre-retirement disability and, as a separate matter, financial protection of survivors of people who die before retirement. Let's stop here and consider how this should be done. If it is means-tested, then there is, as Feldstein argues, an incentive to refrain from purchasing disability or life insurance because "the government" will step in to help. On the other hand, using benefits restriction as a means to encourage private investment in disability or life insurance penalizes those who cannot afford to do so. The age-old question arises again: if society elects to assist those in need through government programs, what is to prevent people from pretending to be in need or in "arranging" to be in need. We see this in the game of Medicare qualification when wealthy families shift familial burdens onto society. We see it when tax provisions are used by those for whom they were not intended. Any sort of means testing, aside from being intrusive and judgmental, invites complications of the same order of magnitude as administration of the tax law, or worse.

Second, let's consider putting responsibility for retirement, disability, casualty loss, and premature death planning on the individual. Yes, there are those who cannot afford the premiums, but they also cannot afford food and medicine. Let's issue insurance stamps just as the government issues food stamps, though I wonder if I'm not doing a frying-pan-into-the-fire metaphor with that one. Better yet, instead of separate programs for food stamps, cheese give-a-ways, house insulation projects, etc., all of which create redundant bureaucracies and compel impoverished individuals to fill out reams of forms, let's create one "help those in need" program which will provide funding, lasting only so long as needed, for the basics of life. We can define the basics of life to include not only food and insulation, but also premiums for disability, life, and casualty insurance and contributions to retirement savings. Toss in health insurance.

In the long run, administering such a program would be easier than the combined burden of the disparate offices sprinkled throughout state and federal government agencies. In the short run, the transition could be challenging. But since when have we, as a people, shrunk back from challenges?

And this would put to rest all the subsidiary questions. Retirement, disability, and survivor benefits would return to the private sector, where food and most casualty insurance have been and have remained. Perhaps the government would need to insure the insurers (as it already does to some extent for certain things), but ultimately the individual could choose retirement plans as many employees now do. The tax law dealing with deferred compensation could be overhauled and simplified. Means-testing social security benefit payments would be unnecessary, as the means testing would take place with respect to insurance premiums and plan contributions.

It would not surprise me to hear from a reader explaining that all of this was proposed years ago by someone no less, and perhaps more, creative than am I. And, the reader might point out, the suggestion was rejected. For me, that simply means that those who did the rejection, and their political heirs, now have an opportunity to admit mistake and fix the mess they have created before it swallows all of us.

But, as Andy Cassel points out, these are the debates in which we should now be engaged. Only after these issue are resolved, and only if resolved in certain ways, would it be appropriate to turn to the issues that have grabbed the current headlines. Sometimes spotlight hogs need to be pushed aside and taught patience.

Friday, January 21, 2005

State Taxation of Nonresidents 

Yet another nonresident income taxation case has moved into the spotlight in New York, though its impact can and will be felt throughout the nation. Thanks to loyal reader, former student, and Graduate Tax Program adjunct teaching colleague Ryan Bornstein for the heads up, which he sent several days ago, and which Paul Caron just picked up on TaxProf. The ABA has provided a good writeup of the case.

The case involves a Tennessee resident who is employed by a New York organization to do computer work. Thomas Huckaby does about 75% of the work at home in Tennessee and is in New York for 25% of the time. He's not a New York resident. So unless one is familiar with the twists and turns of interstate taxation, one would conclude that New York can tax 25% of Huckaby's income. Of course, most folks would guess that New York tries to tax all of it. On this sort of guess, picking that conclusion is almost always a winner.

New York's approach rests on the assumption that the employee could do the work in New York, and that unless the employer requires the employee to do the work in another state, the employee should be treated as doing the work in New York even if the worker is not in New York. This approach uses what is called the "convenience of the employer" test. New York claims that Huckaby's employer did not require Huckaby to do the work in Tennessee.

Of course, Huckaby's not about to commute to New York from Tennessee. And Huckaby lives in Tennessee, not to escape the New York income tax, but for personal reasons. Tennessee, incidentally, does not have an income tax on salaries.

Huckaby balked at what New York tried to do, and litigated. He lost in the New York Supreme Court (which, here's another law quirk that non-lawyers will find counter-intuitive, is the state's lowest court!), and he lost again on appeal to the appellate division of the state Supreme Court. So now he's up to the New York Court of Appeals, and oral argumentw were heard recently. Here's the cite for those who want to read the appellate division opinion: 776 N.Y.S.2d 125 (2004).

What are his chances? Tough to say. He's not the first to challenge the rule. A law professor who teaches in New York City but who does some of his teaching-related work at home in Connecticut challenged the convenience of the employer rule and lost. Eventually the United States Supreme Court declined to hear the case. The Supreme Court rarely takes up a case the first few times the issue appears, as the Justices appear to prefer waiting until the matter sorts itself out to some extent in the lower courts. Being a pioneer is tough. Take a look: Zelinsky v. Tax Appeals Tribunal, 769 N.Y.S.2d 464 (2003).

New York and only a few other states use the convenience of the employer rule. It is politically easy to adopt, because nonresidents don't have a vote. Taxation without representation, eh? Most states tax income that is earned while a person is physically present in the state. A physically present nonresident imposes a burden on the state by being the beneficiary of police protection, street cleaning, emergency services, and similar municipal services. The issue is not unlike that raised by Pennsylvania localities implementing the emergency and municipal services tax, which I discussed in this recent post. The court in Zelinsky, though, asserted that the employee's decision to reduce the time he spent in New York "did not diminish" what New York provided. That is flat-out wrong. If Zelinsky reduced his physical presence in New York to zero, would New York have a right to tax him in perpetuity because he worked there at some previous time? Lee Sheppard's suggestion that judges be required to attend business school, discussed here, jumps into my brain. If the judges' in-laws visit only twice a year and not once a week, there's no reduction in what the judges provide to their guests? There are times I understand why non-lawyers think lawyers have lost all traces of common sense.

As more and more employees telecommute, the issue of state income taxation will get more attention and generate more litigation. After all, if a person can work from home, why not let that happen, or perhaps require it? It saves energy by cutting down or eliminating commuting, the employer reduces rent or other building costs because less space is required, the need for parking spaces is reduced, and other economic advantages accrue to the employer. The convenience of the employer test will have an ever-increasing "drag" effect on the nation's transition to a digital economy.

But if New York continues to prevail, other states will see the convenience of the employer test as an invitation to revenue enhancement. If the nonresidents live in states that don't impose an income tax on wages, then there is a net revenue flow to the state adopting the test. On the other hand, if the state in which the nonresident lives adopts the same rule, it could cause net tax revenue to flow to that state and away from the state originally adopting the rule. So, in the long run New York might win by losing and lose by winning.

Percolating on Capitol Hill is the Telecommuter Tax Fairness Act, which almost certainly will be introduced again after the new Congress gets its business underway. The Act would bar states from using the convenience of the employer test. My guess is that it will get saddled with other provisions attempting to deal with other interstate taxation problems exacerbated by the emergence of the digital economy. The lobbying will be intense. The ABA reports that at least $100 million in annual tax revenues is at stake in New York alone.

I close with a question that I cannot answer because I don't know all the facts about Huckaby's employment. I have a pretty good idea of the situation in Zelinsky. Any chance Huckaby could set up as an independent contractor? Would it be worth finding a few other clients and thus establishing self-employment status? People doing business or working with New York entities and persons might want to consider the possibilities. I don't think there's much chance that full-time law faculty would set up as independent contractors with respect to the services provided to the University (unless they were full-time in the sense that they provide services to several Universities, a trend that is growing among undergraduate faculty as colleges and universities seek to cut expenses, and even in those situations the question isn't that easy to answer).

Putting the Tax Law to Good Use 

OK, suppose I cave in and support the idea that the tax law should be used for non-revenue purposes. What would be on my list of tax-encouraged and tax-discouraged activities?

Well, the list of tax-discouraged activities would be long. At the moment, I'll select one. I choose it thanks to an item on Politech (and thanks to Declan McCullagh).

Take a look at Ben Edelman's Investors Supporting Spyware list. I wonder how many of these enterprises are marketed as tax-savings investment vehicles (to use a euphemism).

So.... here we go, a proposal for a Congress that thinks it can simply declare spyware illegal and all the bad guys will comply. Take away all tax benefits associated with investments in enterprises that engage in Spyware.

Well, I guess I just made some new friends with this post!!!

Wednesday, January 19, 2005

So What Am I Trying to Teach? 

My response to a moderately complicated partnership taxation question posted on the ABA-TAX listserv brought a comment from one of the participants. He expressed a concern that for my students' sake issue spotting was the more important part of the exam and that reaching the correct result is of less importance.

Here's my reaction:
Spotting the issues gets a student to a passing grade. Spotting the issues is often rather easy in tax. Getting the right analysis is what matters most. Correct result is important if there is one.

My exams are a mixture. Some easy questions, with easy issue spotting and/or easy correct results. Some in the middle. And a few tough ones to identify the A students.

I tend not to emphasize arithmetic. There's some, but it's not pervasive. I try to distinguish use of or reference to the wrong number from can't add or divide. The former is serious, the latter trivial (for the exam but not in practice so they lose a point or two at most out of 150).

Generally, I am as demanding of my students as clients are of their advisors and partners are of their associates. No use lulling the students into a false sense of law practice. They have TV shows to do that for them!
It has always been an obstacle to my teaching to encounter students whose educational experience has led them to conclude that memorization and regurgitation, or identifying issues, is sufficient to succeed in practice. It has always been a frustration that there are a few law school faculty who choose not to break first-year students of this misperceptions because they fear the dislike of students and the resulting low evaluation scores, because it means I get an even more difficult task of disabusing students of their years of misimpression, which has been even more deeply imbedded into their mental processes because one or two of their law faculty have enabled the flaw.

One of the reasons I invest a lot of time creating 10 new questions each semester for use in during-semester exercises is that I want the opportunity to identify for each student the sort of question-answering pattern that costs them examination points. I prefer that a student do poorly on one 8 point question during the semester and learn not to respond in the same manner the next time around than to have a student do poorly on 50 points worth of questions when there is no next time around (at least not in that course). Too many episodes of remorse and tears accompanied by "I wish I knew this before the exam" and "Now I know why I didn't do so well on my first-year exams" propelled me into the during-semester evaluation process that is unusual for law school courses other than simulation, clinic and other hands-on small enrollment courses (which generally are small enrollment partly because of the need for during-semester evaluation). I've turned my courses into small-enrollment type courses with enrollments of 50, 75, 100, and sometimes more. I've been told by the Dean that it must be an insane amount of work, and it is. But that is, I am convinced, what I am being paid to do.

The tough questions that my students encounter aren't the ones that ask for issue spotting, or even the ones that ask for result. The tough questions are the ones that give the answer and ask why, that ask which argument doesn't fit with the others, that ask what information needs to be obtained from the client before analysis can begin, or that ask which facts need to be changed to alter the outcome.

A few years ago, one very bright, top-of-the-class student who was struggling with the during-semester exercises and baffled by the inconsistency between those scores and the previously-earned grades, said to me, after a series of conversationd over a several-week span, "I get it. Everyone else says 'Here are the facts, what is the answer?' and you're saying 'If we want the answer to be x, what must the facts be?' You've turned around the process into an analytical reasoning. I get it." Sure did. Exercises scores rocketed back up into familiar territory and the student aced the course. The following semester the student returned to tell me that the change in the thinking process had been carried into writing, and that the law firm for which the student had clerked made an on-the-spot offer because of the excellence of the analysis in the writing. THAT means far more to me than the popularity contest played out in student evaluations, some filled out by students who admit to investing an hour or less each week to the course or who otherwise have failed to get on board and are angry because they have not been spoon-fed and coddled.

The problem exists in other professions. There is such a reluctance to offend a student or hurt a student's feelings by telling it like it is that the pressure to inflate grades continues to intensify. I've seen several stories during the past month about faculty at other institutions claiming they had been terminated for having refused to inflate grades. Society is already beginning to pay the price, the price of having people given responsibilities for which they are not prepared, trained, educated, or ready. In the long run, it is a good thing to identify areas needing improvement and to highlight the message with scores and grades that rattle the student. It also makes sense to explain to students what it is they need to be doing and to give them opportunities to try that aren't an all-or-nothing end-of-semester examination. Teaching requires and demands feedback. When I try to persuade students to work throughout the semester and to ditch the end-of-semester cram silliness encouraged by the all-or-nothing end-of-semester exams (even those who evaluate in that manner do not intend to discourage during-semester work), I emphasize that a failed effort is better than no effort because it teaches.

For the students who do what needs to be done, happily or not, their clients someday will benefit. And I don't care that their clients may never know what went into the shaping of the student's mind that contributed to the successful professional. I know, the student knows, and I suppose Higher Authority knows. Oh, I guess now you know.

Tuesday, January 18, 2005

ALL of Gross Income?  

I'm now starting to roll along my latest major writing project, the revision of TM 501-2, Gross Income: Overview and Conceptual Aspects. That's a BNA Tax Mgmt Inc income tax series portfolio for those of you who don't recognize the "TM 501-2" tag. The 501 is the number (first in the revised series beginning at 501) and 2 means it is the second edition. What I produce will be 501-3.

It's hard to believe that this is the third time through with this one. Back in the late 80s, Tax Mgmt approached me with a plan for an "overview" series of income taxation. There were three goals. First, provide the forest that often cannot be seen for the trees. Second, address conceptual issues that don't get attention in the topic-specific portfolio, which puts its focus on practical implementation. Third, pick up detailed discussion of the "orphan" provisions that aren't addressed in other portfolios because they are too "small" to warrant their own book, and lumping them together without an overarching theme would create a jumble.

So I wrote an "overview" of the income tax, other than procedural rules. Don't be misled by "overview" because it is a thorough discussion of every provision, anchored on the Code and dipping into the regulations. For topics needing that detailed discussion, the overview gets into the cases, rulings, and other authorities.

The scope and extent of the product was overwhelming. The original 501 was too big for the binding process that is used, so it was split into two portfolios. TM 502 deals with assignment of income, claim of right, and the tax benefit rule. The original deduction portfolio was split into three (TM 503, 504, 505), with trade or business deductions and deduction limitations each getting their own portfolio. TM 506 covers tax computations and TM 507 covers tax credits. Then TM 560, an overview of tax basis, was added, followed by TM 590, an overview of the taxation of real estate transactions. Recently TM 597 was put together, though it has not yet emerged. It's close, and it will cover Tax Incentives for Low-Income Areas. Most of these portfolios end up as 400 to 700 double spaced pages of text, with anywhere from 3,000 to 5,000 footnotes. I really do wish I could find a way to compel every member of Congress to read these and then in good conscience continue to do to the tax law what they've been doing to it for the past several decades.

Lest this cause you to think I only do overviews, I have also written and updated TM 525, Deduction for Taxes, and TM 531, MACRS. And then there are a bunch of chapters in the digital Tax Practice Series.

Because tax law is so dynamic (a fancy way of saying it constantly changes), these portfolios need to be updated. The 501-507 series went through a series of updates in the late 90s into 2001. Then I turned to updating 560, 590, 525, and 531. Now it's time to update the 501-507 series again. It's been 8 years since 501 evolved into 501-2. And when I'm done generating 501-3 it will be time to turn to, yes, 502, 503, .......

At some point 501 may need to split yet again. The amount of tax law changes and additions affecting gross income is staggering. It's not just "what is gross income" and "what are the requirements for this specific exclusion" but also a question of describing what gross income affects aside from taxable income (e.g., limitation on other amounts), and how gross income intersects with other provisions. Almost every change adds text to the Code, and the additions pour out of Congress incessantly as the special interests line up for their "absolutely necessary" exception to the exception to the exception.

I do learn a lot. I get to write about Code provisions that are far beyond the boundaries of the courses I teach, and that includes the courses in the LL.M. (Taxation) program. I get to see the "entire fabric" of the income tax law, and must make judgments about the depth to which any specific provision is described. It's not like visiting the sausage factory, it's like setting up an easel and painting a portrait while standing a few feet from the production line. I get to read the complicated stuff that most critics discuss in general terms. I'm only into the third of twelve chapters (the first two being relatively short because they are introductory) and already I've met two definitions of hedging, and definitions of six different types of financial products dealers.

Maybe when (if) the newly-appointed Commission on tax reform (haha) decides to look closely at why the tax law is such a mess, they can call me and I'll gladly take them on a tour. After visiting TM 501 I'll let them know that despite its voluminousness and complexity, they will find even more quantities of even more tangled material in TM 506, TM 507 and to some extent, the rest of the series. And then for dessert we'll dig through TM 597, awash in enterprise zones, renewal communities, empowerment zones, and a whole array of different designations for what essentially could be called by one name.

Anyhow, if you notice my usual M-W-F posting pattern change (as it already has), it's because when I get immersed in a segment of a portfolio I stay there and don't emerge for much else. I'll still be sharing my thoughts, but probably on a more erratic pattern, such as T-Th-Sa, M-T-Th, M-T-Th-F, and the like. So check in each day.

Addendum: This posting is about as close to the sort of items one reads in an "online diary" type of blog as I've published. I thought a behind the scenes look at the writing of TM portfolios would be interesting, especially for those who use them. And, of course, I couldn't resist getting in my jabs at the Congress, at the complexity of the tax law, and at the futility of approaching tax reform with a commission many of whose members aren't tax experts.

Monday, January 17, 2005

Spotlights Now Turn to That Penna. Stealth Tax 

In yesterday's post I described the surprise and unhappiness with which employees had greeted the news, from their employers, that the new muncipal emergency services tax of $52 would be withheld from their wages. I noted that not much had been said about the tax by the media and proposed some sort of continuing civics education for citizens and taxpayers

This morning's Inquirer has an article about the tax, on the front page of its second section. Knowing what I do about deadlines, I am guessing that the article was written about the same time as I was posting to MauledAgain, or sooner, because the two writers did some research which makes the article deserving of a read by those interested in what this tax is about.

Popping from out of nowhere onto the radars of many people, hitting paychecks before the recipients can murmur a protest, this tax truly arrived as a stealth tax of the second type. And similar enactments will continue to appear until citizens set up effective long-distance early-warning systems. Or someone does it for them. I prefer the former. Society has enough, no, too many, "get someone else to do it for me" situations. As I asked yesterday, $52 today, $104 next year?

Sunday, January 16, 2005

Stealth Tax, Type Two 

Stealth tax increases always fascinate me. There are at least two types of stealth tax increases. One is the increase that is hidden so deeply in the fine print, masked by assertions of tax neutrality, that it takes a while before taxpayers realized they've been had. The "raise taxes without raising rates" deduction phaseouts enacted by the Congress back in the 80s and 90s are examples.

The other type is of particular interest at the moment. It occurs when a legislature raises a tax, and makes it obvious in the legislation that it is doing so. But for some reason the increase doesn't get much publicity. Sometimes it's because other events grab the news headlines, and sometimes it's because all the attention is given to the "news worthy" portions of the revenue bill.

A few months ago the Pennsylvania legislature enacted an array of tax provisions, highlighted by the legalization of certain gambling and by permitting local school districts to reduce local real property taxes by opting to share in state gambling revenues and enacting a local earned income tax. Buried in the legislation was a provision that permits local municipalities to increase the per capita occupational privilege tax from $10 to $52, renaming it the emergency and municipal services tax.

The legalization of gambling and the prospects for reduction of the local property tax grabbed the news spotlight. The per capita tax provision got about as much attention as a wallflower.

In November of 2004 the township in which I live and work (Radnor) proposed raising the per capita tax and renaming it as an emergency and municipal services tax, and published that proposal in a local newspaper. Some neighboring townships took similar steps. It has been reported that more than half the municipalities in the state in a position to raise the tax have done so.

The Radnor change was adopted this month, retroactive to the beginning of the year. Because the tax is imposed on the privilege of working in the township, or, under the new nomenclature,is imposed on persons potentially using township services, it is collected by employers. And thus the employers had the task of informing their employees that instead of $10 being withheld from the first paycheck of the year, $52 would be withheld.

Employees were not happy. For most, this indeed was news. One employer reports that the staff official responsible for spreading the news was bombarded with phone calls and emails. Unfortunately, that person was merely a messenger, not responsible for the change, and unable to do anything about it. Employees asked if "$52" was a typographical error. No, it was not. Employees asked if the employer was imposing the tax. No, it is imposed by the township, and the employer has no jurisdiction to impose a tax.

It is no secret I prefer user fees. Traditionally, municipalities tax residents for services. Decades ago, there was a strong correlation between those using the services and those being taxed in some way for the services. Present-day living, working, and commuting trends create a situation in which the municipality's services are used not only by residents but by thousands of non-residents working in the township. The renaming of the tax reflects the intention of the legislature that the proceeds of the tax be used to offset the cost of police, fire, EMT, and road repairs, which are conferred on resident employees and non-resident employees alike. Unemployed individuals are not taxed, even though they, too, use these services, and the assumption must be that they are retirees living in poverty or near-poverty. Bad assumption, especially in this township.

There are two concerns with the tax. First, it is a fixed fee, and thus is the same for an employee earning $25,000 and one earning $400,000. User fees are like that. So, too, are the prices of milk, gasoline, and movie tickets. My township has a provision that exempts persons earning less than $2,500 a year. That's not much progressivity, but it's a start. The $2,500 amount ought to be set at poverty level. Second, there have been reports (not involving my township) that municipalities have failed to set up mechanisms to ensure that the proceeds of the tax are funneled into the appropriate fund accounts. If those reports are true, there may be some interesting litigation to report at some future time.

And there remains the major concern about the enactment of the tax increase. It wasn't well publicized. Few people read the local newspaper. The township's web site contained an after the fact report. Rarely do I visit the township's web site, because I consider it as i do a telephone book, namely, I look when I need information. I've not seen anything about this tax that caught my eye in the occasional newsletter that arrives from my representative or state senator in the state legislature. The regional newspapers and television news services don't seem to have given the provision anything more than a mention in passing at the end of an article. Gambling and property tax relief involve many more dollars and just plain make for better headlines and screen-bottom tickers. Film at 11.

The gap between government administration, including revenue and spending decisions, and the citizenry is widening. For many people, education about public sector activity ends with graduation, assuming that it even began. Do they still teach civics?

Many professions require their members to continue education past graduation. There's CLE for lawyers (yep, Continuing Legal Education), CPE for accountants (Continuing Professional Education), and I'm almost certain that physicians, nurses, fire fighters, and others must meet continuing education requirements. Why not CCE? Continuing Citizenship Education. Of course, with taxes, we'd be running to stay in place, considering how frequently the law changes, but think of all the facets of life that have changed since most people were in school: even aside from tax, there have been significant changes in laws, at every governmental level, affecting the environment (dumping, recycling, leaf burning), laws affecting government intrusion into privacy, crimes, vehicle operation (today I saw someone turn right on red despite four large "NO TURN ON RED" signs, so I prefer to think the person needs some education rather than that the person is a callous self-centered transgressor), home businesses, employment of nannies, and on and on and on.

After all, I have the benefit of getting print and digital updates about law, chiefly tax, estate, technology, and First Amendment law, and I missed this change. So how likely is it that folks not plugged into a tax news update service would have been aware of the change? No wonder that a substantial of employees expressed bewilderment, agitation, and frustration. But perhaps this is a lesson. This year, $52. Next year, $104. Ten years from now?

Only an educated citizenry is a free citizenry. Proof of that conclusion can be found all over the world and throughout history.

Thursday, January 13, 2005

The Impact of Death on Web-Based Content 

My post last week on the treatment of email after death has resonated with many people. A friend who graduated from the law school two years after I did sent me an email to inform me that the post had been brought to the attention of 25,000 subscribers to Dave Farber's Interesting People list, though this entry pretty much reaches anyone who surfs the Internet and finds it.

Several people pointed out that a solution to the privacy concern was encryption. For the most part, I agree. I say "for the most part" because there are some danger zones. First, if a person has material that they want to keep encrypted but also make available to the executor (such as financial information and tax returns) and also has those "dark secret" emails, then the password(s) used for one type of document needs to differ from those used for the other type. And the person had best remember which one is which when encrypting and re-encrypting. Anyone who juggles, as I do, more than 100 username and password combinations, understands the danger. Second, if the recipient of email de-encrypts the email, the "published by recipient" problem is not ameliorated. I just read an article in Atlantic that mentioned the purchase at auction by the estate of Eppie Lederer ("Ann Landers") of letters to her from Winston Churchill and other celebrities. Third, don't keel over while the "dark secret" email is being composed or is in unencrypted mode. OK, so I'm being a bit paranoid here. Or so some would say.

Another person raised questions that take the issue beyond emails. She asked about web-based property (such as web sites, photos on web sites, and I presume, though she didn't mention it, information in FTP directories and other Internet accessible data that is not web-based (for, as we often forget, the Internet is more than the world-wide-web)). She wondered what rights the heirs have and how one ensures that the heirs can access the material. She plans to write an article, and so I'll limit my comments to something short of a treatise!

Analyzing the question requires that we divide web-based material into two groups, that which is publicly accessible and that which is not. If it is not publicly accessible (such as business records stored on an off-site commercial storage site), the contract with the storage site owner ought to provide that the customer's executor or attorney have the right of access. The username and password need to be made available by the individual to his or her attorney or executor. Of course, if the person is doing business in corporate or LLC form, then that entity survives the death of the owner and the estate (or trust) succeeding to ownership of the entity would continue to have access under the entity's contract with the site. The risk, of course, is that no one knows the username or password.

For publicly accessible material, the question isn't one of privacy (after all, it's out there for the world to see), but a matter of ensuring that the value of the material, if any, is protected. Material that has little financial value, such as the information on my Maule Familygenealogy web site, might pose a different issue: how to ensure that the site continues. That's fairly easy. Designate a beneficiary in the will or trust, and find a means of transmitting the username and password to the person (together with the files, in case the web site server loses them). I happen to have appointed a "genealogical materials trustee" because there are other items in addition to the web site that need attention that requires a different sort of expertise than does a general or financial fiduciary.

But perhaps there is no need for continuation. For example, the MauledAgain blog will terminate when I check out, and all that is necessary (but not really) is that someone, having my username and password, go on and post news of my demise. Just call it "You'll Be MauledNoMore." Surely blogger.com isn't going to close down my blog minutes after I pass. It probably will sit there for some time. If it were a paid account, then blogger.com's awareness of my demise might come sooner, when someone else (the estate) pays the bill, but that might not necessarily trigger a reaction or even an acknowledgment by blogger.com. Anyhow, I doubt my blog has much value, and considering how quickly tax and technology change, they can put my blog in a digital library (which I think happens anyhow, because there is an outfit somewhere that is trying to preserve every web page that has ever existed in every variation it has manifested).

And what of the "online diary" type of blog, where the owner is anonymous to the world? Is there a danger that the "deep dark secrets" would be publicized? No, unlike the love letters and email discussed in the original post, this stuff already is public. The risk is that somehow the identity of the owner becomes publicly associated with the material. Surely caution on the part of the executor is necessary. I may be missing something here, and I'll let others educate me about the risks of such a connection being made. It may not be as low a risk as I think.

If the publicly accessible material has value (for example, the on-line computer assisted tax law instruction exercises at TaxJEM Inc., if it were held in sole proprietorship form and not in corporate form as that is), then the owner needs to wrap this within the overall planning for the continuation or dissolution (and sale) of the business. The executor or trustee needs to be given the username and password. And the contract with the ISP or other provider needs to permit the executor or trustee to access the site. As a practical matter, the ISP or provider won't know that it is the executor and not the now-deceased owner, who has accessed the site. The first clue would come when any payment for the site is paid with a check from the estate or a transfer from the estate's account rather than with the owner's credit card. And the executor must be vigilant to make certain that the web material isn't being used without authorization elsewhere, because thieves who may be less reluctant to pilfer when the owner is alive (because the owner may periodically check) can be encouraged by death to take advantage of what they think would be a less attentive executor. This may sound as though I have little faith in some people, but consider how many robberies are accomplished by thieves who read obituaries and hit the house during the funeral (which is yet another task for the executor, having someone watch the house, but now I'm getting a wee bit off on a tangent).

These are the thoughts that popped into my head when I received the question and pondered it for a little bit, somewhat organized and hopefully coherent. Comments welcome, and when I get news of the article, I'll share a link or other reference.

Putting Corporate Tax Shelters into the Public Spotlight 

In response to my recent posting about the setbacks experienced by the government in dealing with corporate tax shelters, Joe Kristan of Roth and Co., who delivers the Tax Updates blog, made a suggestion, which he fully describes in his most recent post. Essentially, he recommends that publicly held corporations, which already are subject to a variety of disclosure requirements, be compelled to publish their tax returns.

Joe makes a, oh I ought not do this, compelling argument. He questions whether there are downsides to his proposal. When he put the question to me through email, I replied thusly:
A very interesting idea. These are public companies, so their SEC related disclosure requirements, including "book-tax" differences doesn't make return disclosure an intrusive event.

Would competitors search and disclose? Maybe not. Maybe they'd search and imitate! I think the scrutiny would come from public interest groups, reporters, academics, etc. That's assuming, of course, that from the disclosure one could get to the facts, that is, the underlying documents, etc. But, like you, I ask, what's the harm in trying?
Joe subsequently suggested that some stock brokers might pick up on inconsistencies and questionable items, triggering deeper investigation.

If this idea ever comes to fruition, I hope the world remembers that it originated with Joe. Unlike many, he has thought about the problem and has tried to craft a solution. Even if it never sees the desk of a legislator, it deserves kudos for the effort.

Wednesday, January 12, 2005

Battle Plans for the Tax Shelter Wars: Dealing with Government Losses 

It's late, but I just realized I had tucked this away several days ago. Wednesdays I have four hours of class, and when there is a faculty meeting and some other course-related activities, the blog takes a back seat.

In last week's Tax Notes, Lee Sheppard writes an interesting piece about a tactic used by tax shelter developers to avoid IRS detection and judicial rejection. It's one that is working, as the government has been dealt set-backs in several tax shelter cases, raising serious concerns about the strength of the tax system itself. In "Bury Your Tax Shelter in a Business" (106 Tax Notes 20 (3 Jan 2005)), Lee writes about the bizarre impact of the tax shelter game on businesses, which end up overpaying for things just to get a tax break. (Id. at 21) Take a look. I'm not going to focus on that aspect of the article.

I want to look at Lee's question, "What are the cures?" because among the recommendations are sending federal judges to business school, privatizing tax litigation, and eliminating the "attractive nuisances" in the code. Each of these is a fascinating suggestion.

I like the first idea, but in some respects it reflects deficiencies in our higher education system. After 16 or 19 years of education, a person should have some understanding of how business works. Twenty-year olds may not be interested in the "boring," "complicated," or "oppressive" panorama of the business world, but twenty years later when hindsight becomes 20/20 the reluctance of higher education faculty to require a truly inclusive course of instruction shows its long-term disadvantages. The folks at Wharton required me to take two English Literature courses, and to take several courses from a group that ended up being Anthropology, Roman History, and American Civilization. I groused a bit, but I am so glad I was compelled to do so, even though it meant I needed 40 courses to earn a degree while my friends in the College of Arts and Sciences got by on 32. That's a 25% increase. I surely got my tuition's worth.

The second idea strikes me as attention to a symptom rather than the underlying problem. Lee's idea arises from an understandable concern that private sector attorneys are thumping government lawyers in too many recent tax shelter cases. In the article Lee demonstrates how the cases could have been argued and presented in ways more conducive to a government victory. The problem Lee highlights isn't new, however. For years I've held the position that the famous Sol Diamond case in partnership tax law gave us a bad opinion, in part because it was not argued well, probably because the attorneys didn't really understand partnership taxation (which isn't that much of a surprise). Several decades later, the Campbell case, involving similar issues, ended up a mess because an argument raised by Justice Department attorneys on appeal (which happened to be the right argument) could not be considered because it was not raised by IRS attorneys at the trial level.

As a general proposition, government tax lawyers are younger and less experienced than their private sector counterparts. I observed a Tax Court hearing where a just-out-of-law-school IRS attorney was demolished by a seasoned and nationally renowned corporate tax expert. The taxpayer could afford to pay the latter. The government cannot afford to hire the best and highly experienced. Government pay scales attract law school graduates and other less experienced attorneys, most of whom leave for the more fertile fields of private practice after a few yeras of getting their feet wet. Many of those who remain are assigned administrative responsibilities that distance them from day-to-day litigation.

Privitizing the litigation raises two problems. First, there would be too many conflict of interest situations. It isn't easy finding an experienced tax attorney who isn't handling, and doesn't have partners handling, tax shelter cases. And that's assuming they'd want to take on the task. Second, it would cost a lot of money. Would it not make sense to spend the money hiring, rather than using on a contract basis, experienced tax attorneys? Yes, but where does one find experienced tax attorneys? Every day I get email from law staffing and recruiting companies looking for experienced tax practitioners. In the meantime, graduates who are intelligent, hard working and professionally promising cannot find jobs because attorneys no longer have enough time to mentor a budding tax lawyer. That's one of the disadvantages of the legal profession having become a business. Perhaps a fourth year of law school and an increase in LL.M. program credits from 24 to 48, coupled with more tax clinic experience, would help law schools "deliver" more experienced graduates, but I don't think even such a drastic change would help enough. The tax law is just flat out too complex and twisted.

And that brings us to Lee's third idea. By suggesting the removal of attractive nuisances from the tax code, Lee reminds us that much tax law abuse is generated by the complexities of the tax code that arise from the enactment of special interest provisions whose benefits are sought and exploited by taxpayers not on the radar when the provision was proposed. "This should work for us, too," though not justifying some of the outrageous behavior inherent in many tax shelters, has a bit of an appeal to the taxpayer who is sick and tired of "the other person" getting the break because of a well-placed campaign contribution or a connection to a well-connected lobbyist. Removal of the junk from the tax law would cut back opportunities to scam the system, and it also would make it easier for law school and LL.M. graduates to become seasoned tax litigators.

So back we come to tax reform. I hold out little hope. Bruce Bartlett has written an excellent analysis of why it is unlikely we're going to see genuine reform. It's well worth the read. Sometimes I'd rather keep my expectations low and enjoy the unexpected success than to get my hopes up so that outcomes have me crashing down. This is one of those times when I will believe it when I see it. That won't, however, keep me from griping about the tax system when the opportunity arises. And I'm sure I'll see plenty of those.

Tuesday, January 11, 2005


In her just-released Annual Report, the National Taxpayer Advocate of the IRS has concluded that "The most serious problem facing taxpayers and the IRS alike is the complexity of the Internal Revenue Code."

No. What a shock. What a surprise.

Congress itself, in section 7803(c)(2)(B)(ii)(IX) of the Internal Revenue Code, requires the National Taxpayer Advocate, in its required annual report to the Congress, to "identify areas of the tax law that impose significant compliance burdens on taxpayers or the Internal Revenue Service, including specific recommendations for remedying these problems."

Nina Olson, the National Taxpayer Advocate, explains that:
Focusing on the tax system as a whole, this is an easy mandate to fulfill: Without a doubt, the largest source of compliance burdens for taxpayers and the IRS alike is the overwhelming complexity of the tax code, and without a doubt, the only meaningful way to reduce these compliance burdens is to simplify the tax code enormously. In the balance of this part of the report, we identify and discuss 20 additional serious problems encountered by taxpayers, as required by IRC ยง7803(c)(2)(B)(ii)(III). Most serve as case studies that illustrate the consequences of tax law
To do this, she has issued a 630-page report.

Today's questions:

1. Considering that Congress directs the submission to itself this report, how many members of Congress will read it?

2. How many citizens will read the report?

3. How many citizens will be surprised by its conclusion and analyses?

4. What will Congress do in response to the report, other than issuing a nicely-worded message of thanks to the National Taxpayer Advocate?

5. Will the newly-appointed Tax Reform Commission issue recommendations whose chances of implementation will be enhanced by the content of this report?

The Congress in this regard reminds me of the person who visits a physician to get well, and when the physician points out the person's need to change their lifestyle by no longer smoking, by getting exercise, by eating properly, etc., the person thanks the doctor and ignores the advice. It's as though going to the doctor is sufficient. And in today's climate, when the person dies the doctor gets sued.

Congress doesn't need any more reports. The Tax Reform Commission need not do much but line up the many existing reform proposals, create side-by-side comparisons, and evaluate the arguments made in favor and against each one. The public needs an opportunity to speak (referendum, perhaps?) and then Congress needs to act. Actions speak more loudly than do words, even if there are millions of words already making up the corpus of tax law.

When I arrived in Washington in the late summer of 1976, much discussion centered on the "unnecessary" and "unacceptable" increase in the complexity of the tax law. Almost three decades later, all that has changed is the degree of the complexity. It is far worse, and any reasonable trend line projection suggests that by 2015 the tax law will be incomprehensible to all but omniscient supernatural beings.

Now that this headline news has been flashed around the world (and thanks to Paul Caron's TaxProfBlog for sending in the initial report), we can go back to our lives. In my case I will return to today's project: culling through the last 47 Public Laws that have amended the Internal Revenue Code since I last revised BNA Tax Management Portfolio No. 501 (Gross Income: Overview and Conceptual Aspects) seven years ago. That's roughly a change every two months.

Monday, January 10, 2005

More on Flattery 

In response to my posting earlier today about the risks of letting flattery or skepticism get in the way of what lawyers call due diligence, a reader alerted me that Prof. Fernandez-Barros is an member of the adjunct faculty at the University of Miami School of Law and not a member of the full-time faculty. I did some research, and determined that this is the case.

Though it makes my concerns about the level of legal practice by a full-time law professor irrelevant to the story, it does make it more distressing that a practitioner would not make inquiries of Penske before proceeding. All that has happened is unfortunate. Perhaps this is the story that will trigger a flurry of warnings to all persons, whether educated in law, business, or some other field, to BEWARE of the spammer scammers.

Don't Let Flattery Get Them Everywhere 

It is said that flattery will get you everywhere. Unless, of course, you are on the receiving end and fall for it. Here's a disturbing story.

Back in October, in a post commenting on the surge in spam inundating my email inboxes, I wrote:
And the Nigerian scam has been so outed that only people who have been living under a rock for the past five years would be susceptible.
So when the news broke late last week about the University of Miami law professor caught in a Nigerian spam scam, I figured it behooved me, a lawyer, to look closely at the facts.

According to this story in the Miami Herald, a person claiming to be an official of the Nigerian government emailed professor Enrique Fernandez-Barros, asking him to review some contracts. Fernandez-Barros, a foreign law expert who holds three academic degrees, explained that it was his international reputation that brought the solicitation. The official offered to pay Fernandez-Barros $200,000 and to send him additional legal work if he would help Nigeria and a Nigerian entrepreneur recover $1.68 million from Penske Truck Leasing.

Fernandez-Barros received a check from Penske for $1.68 million, deposited it in his credit union account, and then wired the money to Nigeria. All in a day's work for a lawyer, but Fernandez-Barros ended up involved in a Secret Service investigation that triggered a lawsuit. To make matters worse, Fernandez-Barros explains that he was not paid the promised $200,000.

Apparently Penske owed $1.68 million to Freightliner for trucks that the latter manufactured and sold to Penske. Penske mailed the check but it never reached Freightliner. No one seems to know why. Instead, a check in the same amount was mailed to Fernandez-Barros. According to the complaint in the lawsuit, the check received by Fernandez-Barros had the same check number, date, and signature as the original check but was altered in several noticeable ways. So perhaps my guess is wrong. Perhaps the Freightliner check was mailed to another address, altered, and sent on to Fernandez-Barros, or perhaps it was altered by a Penske employee before it was mailed to Fernandez-Barros. All signs do point, though, to someone at Penske being involved. Perhaps that person, too, was suckered in by the same Nigerian spammer-scammer. Fernandez-Barros explained that the Nigerian business man claimed Penske owed him money for a stock sale, and that the check was sent by an associate of the business man in Atlanta. Fernandez-Barros says that he did not alter the check nor did he know it had been altered.

Penske, instead of suing Fernandez-Barros, is suing its own bank, Fleet, and the credit union into which Fernandez-Barros deposited the check and from which he wired the funds to Nigeria. Allegedly Fleet refused to seek reimbursement from the credit union. The credit union claims it suspected the check had been altered, and held the check for seven days while it contacted Fleet, which allegedly told the credit union that the check was authentic. The credit union claims it held the check for four more days, contacted Fleet again, and received the same reply. The credit union cleared the check after Fleet provided funds from Penske's account to cover the check. No one contacted Penske.

Fernandez-Barros said he "felt flattered" when he was approached by the Nigerian government. He also claims that the Nigerian government got him into the "mess" and that "they used [him] like a ches piece to steal the Penske money."

It seems clear that Fernandez-Barros is innocent. But he was duped. A law professor, an internationl law expert, a highly educated man, was duped. How? He neglected to follow some basic principles.

1. Do not engage in business with a person who solicits you via e-mail and who is a stranger, until you check out the person through other sources. Ask for references who you know. Make inquiries.

2. If the person is from a country known for spammer scammers, contact the embassy or consulate of that nation. In this instance, it would probably have come out that the spammer scammer was not an official of the Nigerian government.

3. Don't let yourself be flattered. Expert or not, be suspicious. In a post-modern world based on selfishness, self-centeredness, rationalization, and greed, it is prudent to be suspicious.

4. Law professors should be teaching and writing. If they are practicing law, they should do so with the permission of their deans, and under circumstances that do not adversely affect their teaching and that safeguards the school's reputation. That's why law professors should not be litigators, because it leaves the class schedule subject to the vagaries of the court schedule. It's one thing to be of counsel to a reputable law firm, and to provide consulting services. It's another thing to embark on a huge project involving millions of dollars with six-digit fees. Had Fernandez-Barros talked to his dean or to a practice-connected trustee of the school, he may have been the beneficiary of their reluctance, suspicion, or need to ask more questions.

5. Think like a lawyer. If Penske owes money to someone it will pay that person directly. If Penske claims it does not owe the money, it has a reason. Contact Penske. A lawyer should, and if competent would, suspect something wrong when asked to receive money from one party and transmit it to another party without having had an explanation and agreement from both parties.

6. Think like a lawyer. The arrangement of taking money from one party and remitting it to another party overseas waves the red flag of money laundering. That's not to say every such transaction is illegal, but a person, lawyer or not, should not participate in it without a full and thorough investigation. Relying on the second party's representations about the first without checking them out is bad lawyering.

What troubles me is the energy that this story gives to the "those who can't, teach" part of the misguided slogan, "those who can, do, those who can't, teach." It insults good teachers. It presumes that lawyers in practice would not have made the same mistake, but in fact lawyers in practice have also been caught up in these scams. Hopefully some good will come out of this story, as it causes more people to be aware of the risks. The spammer scammers will stop only when they receive no replies for months on end. At the moment, I fear, word is spreading in Nigeria, "Americans are easy to dupe. They're gullible. Even their hot-shot law professors can be had." Let's prove them wrong.

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