MauledAgain

For whatever reason, some people seem to think that being required to pay an existing tax amounts to the creation of a new tax. In a recent news story about an IRS proposal to reduce the reporting threshold for gambling winnings from $1200 to $600, a casino client who had hit the jackpot – of more than $1,200 – complained that the proposed rule was unacceptable because “Everything else is already taxed enough.” But the flaw in that argument is that the jackpot, no matter the amount, is and always has been subject to the federal income tax. In most states, it also is subject to state income tax.

The main focus of the story is the complaint by casinos that lowering the reporting threshold will cause tax revenues to decline. The complaint rests on several assertions. First, taxable income of casinos will fall because fewer people will gamble as a result of the reduced reporting threshold. Second, taxable income of casinos will fall because casinos will need to hire more people and purchase more equipment to comply with the reporting requirements. Third, it takes 8 to 10 minutes to fill out the tax form for withholding. Fourth, each month, at one casino, 8,300 people win jackpots between $600 and $1,200.

Aside from the fourth assertion, which in general terms – that there will be people subject to withholding who currently are not – is undeniable, the other assertions are paper tigers. Existing technology permits casino clients to file a tax form one time, just as employees do not need to file a withholding form for each paycheck. Considering that most casino clients have, or can easily acquire, preferred customer or similar cards, it is very easy to use their identity information from that card to trigger the withholding. People will still flock to casinos, because the lure of the big jackpot, or even a smaller one, is far more powerful than the supposed inconvenience of filling out a form, assuming that a form would need to be completed. Existing technology, which across a wide swath of industries has contributed to a reduction of employees, makes it highly unlikely that more employees would need to be hired to handle casino clients filling out forms, especially considering most of those clients would have pre-filed the information on their preferred customer cards. Whatever equipment is used for the process, unless it is used for 25 minutes at a time for each jackpot requiring withholding under existing laws, there should be sufficient spare capacity for transactions that probably require fewer than a minute or two.

The American Gaming Association is rallying opposition to the proposal, which simply would bring casinos into line with the $600 reporting threshold that applies to other transactions. The opposition reminds me of the time when banks and other financial institutions opposed withholding on the payment of interest and dividends, generating what was at the time a record number of complaints to the Congress. They pulled this off by providing stamped, addressed, pre-printed postcards in customers’ banking statements, with a note telling customers that Congress was imposing a new tax. It’s indicative of the collective ignorance of American taxpayers that millions of them believed the lie. It’s indicative of the national culture that people with fiduciary responsibilities did not hesitate to lie.

Of course, withholding would not be necessary if people lived up to their civic obligations. But that doesn’t happen, for the same reason some people go straight from the left-turn lane, some call people trying to dupe them into sending money to collect non-existing prizes, some pretend to be the IRS, and some create false stories and rumors to circulate on social media. Paying taxes on gambling winnings, net of gambling losses, is not a new tax. People ought not be told that it is. A nation built on lies is a nation with very little time remaining.

An image making the rounds on facebook has this to offer about federal taxation:

Government Handouts That the Rich Get, But Fox “News” Will Never Mention:
1. Mortgage interest deductions for big houses and second homes
2. The yacht tax deduction
3. Rental property deductions
4. Fancy business meal deductions
5. The absurdly low capital gains tax rate
6. The absurdly low estate tax rate
7. Gambling loss deductions
8. The low cap on taxes subject to Social Security taxes
9. Retirement subsidies for gilded retirement plans
10. Tax deductions for fancy tax preparation
But Tell Me Again Who the Real Welfare Queens Are!

This list appears to have come from a Washington Post blog commentary.

One of the worst ways to make a point is to offer arguments some of which are flawed. It creates the impression that if some of the arguments are flawed, all of them are flawed.

Several of these claims are valid. There is no question that the special low tax rate for capital gains and the current state of the estate tax, to say nothing of its proposed elimination, benefit the wealthy far more than they benefit the poor or the middle class. The low cap on wages – which is what I suppose the author of these 10 claims intended to write – subject to Social Security taxes benefits the upper middle class and the wealthy, but certainly no one with five-digit salaries.

On the other hand, though mortgage interest deductions for “big houses and second homes” benefit the wealthy, they also benefit the middle class, particularly with respect to second homes, for which the overall loss deduction is limited if adjusted gross income exceeds $100,000 and disappears if adjusted gross income exceeds $150,000. In any event, the mortgage interest deduction is capped for all taxpayers. The so-called “yacht tax deduction” is nothing more than a reference to yachts maintained as second homes, which provides tax benefits similar in character, though perhaps larger in scale, than second homes maintained by middle class individuals. Similarly, allowing deductions for maintaining rental property isn’t a tax break but simply part of measuring how much net income is generated by the property. What the commentators seem to be describing is the exclusion from gross income of rent received for leasing out a home for 14 or fewer days, a benefit that is available to any taxpayer who owns a home.

The “fancy business meal deductions” apparently refers to the deduction allowable for half the price of a business meal. The example that is given refers to a $1,600 dinner and drink invoice for 10 executives. This deduction is available to all businesses, and benefits the wealthy only to the extent that they presumably spend more on business meals than do other business entrepreneurs. Though surely there are wealthy business owners who open up their wallets for business meals, there also are those whose desire for money accumulation generates restricted spending on meals. In the same vein, gambling losses are deductible, but only to the extent of gambling winnings, a benefit available to all taxpayers who gamble. There is no indication that wealthy individuals hit the casinos more frequently than, or gamble away more money, than individuals of more modest means. Gambling addiction does not respect monetary boundaries.

The complaint about retirement subsidies is simply a reference to the fact that wealthier individuals tend to have better financial ability to put money into tax-advantaged retirement plans than do the poor, and the fact that low-income workers tend to hold jobs with employers who do not contribute to retirement plans on their behalf. The flaw is not so much the tax law, but the inadequate wages paid to low-income workers. Restricting retirement contributions is counter-productive, because one of the major problems with the American economy is the inadequacy of retirement savings among the population generally. Finally, the complaint about “fancy tax preparation” misses the mark. The deduction for income tax preparation is reduced by 2 percent of adjusted gross income, so most high-income individuals don’t get the benefit of the deduction.

The unfortunate aspect of this image making the rounds is that it makes it easy to cast off the point it is making as being supported by inadequate arguments. There are many examples of how the economic elite benefit from federal income tax advantages, but they are far more difficult to fit into tweets and buzz slogans. How does one explain, in a four or five word quip, tax subsidies for oil and gas drilling, for coal mining, for off-shore corporate subsidiaries, for trust funds, for corporate tax shelters, and for carried interests in partnerships that benefit highly-compensated hedge-fund managers? These don’t have quite the marketing appeal of phrases such as “yacht tax deduction, “fancy business meal,” or “gilded retirement plans.”

The economic elite and their corporate structures surely do reap huge benefits from the federal tax system. But rather than parading out a list of 10 examples, only 3 of which robustly support that reality, it would be better to give Americans the opportunity to be educated about the gimmicks and loopholes that generate those huge benefits. True, it probably takes some effort to explain how the lobbyists for the economic elite use smoke and mirrors to keep their particular sort of welfare out of the public eye, but in the long run everyone benefits from shining an educational spotlight into the dark caverns of the modern American political game.

No, I’m not referring to the tax exams that stand between a student’s coursework and practice experience. What has been pulled from the back burner of this blog is something I’ve discussed many times, though not recently. It’s the mileage-based road fee, which I first discussed in Tax Meets Technology on the Road, and analyzed again in Mileage-Based Road Fees, Again, Mileage-Based Road Fees, Yet Again, Change, Tax, Mileage-Based Road Fees, and Secrecy, Pennsylvania State Gasoline Tax Increase: The Last Hurrah?, Making Progress with Mileage-Based Road Fees, Mileage-Based Road Fees Gain More Traction, Looking More Closely at Mileage-Based Road Fees, The Mileage-Based Road Fee Lives On, Is the Mileage-Based Road Fee So Terrible?, Defending the Mileage-Based Road Fee, Liquid Fuels Tax Increases on the Table, Searching For What Already Has Been Found, Tax Style, Highways Are Not Free, Mileage-Based Road Fees: Privatization and Privacy, Is the Mileage-Based Road Fee a Threat to Privacy?, and Are the Bells Tolling for Highway Infrastructure Chaos?

Thanks to an alert reader of MauledAgain, I’ve become aware of exciting news from Oregon. That state is going to enroll volunteers in a program, under which drivers, instead of paying a fuel tax, will pay a mileage-based road fee. Oregon is testing the transition from twentieth-century highway funding into twenty-first-century highway funding. Logistically, drivers will receive a credit for fuel taxes paid at the pump, which might leave them with a balance due or might generate a credit. Steps have been taken to minimize intrusions on privacy, by giving the volunteers a choice between a GPS-based system and a GPS-free system. Volunteers also receive a credit for miles driven out of state or on private property.

More than 4,000 comments have been posted in reaction to the story. Several amuse me. One complaint is that the test program is nothing more than an attempt to increase taxes. That conclusion suggests that the driving public will be paying more for nothing more. Yet in reality drivers will be getting road repairs and road improvements, which in turn will lower tire and front end alignment costs, save lives, prevent injuries, and economize time. Another complaint is that “the new tax would be unfair” to electric and hybrid car owners because the “program targets hybrid and electric vehicles.” That makes no sense. The fee is imposed on vehicles, which no matter their type of propulsion, use highways, wear out road surfaces, and contribute to traffic jams. Fortunately, an advocacy group for the electric-vehicle industry has come out in support of the test program “because every driver should pay for road repairs.” Yet another complaint is that the fee discriminates against people living in rural areas. The flaw in that perception is that the fee discriminates no more and no less than does a liquid fuels tax. If someone living in the countryside drives, on average, three times as much as someone driving in the city, that person would pay a mileage-based road fee three times what the city driver pays. That is no different from using three times as much fuel and thus paying three times as much in gasoline taxes.

Three other states – California, Washington, and Indiana – are studying the possibilities of adopting a mileage-based road fee. Oregon has administered two earlier tests, though on a very limited basis. This test encompasses many more drivers and is, in many ways, a big deal. In that sense, it is like a tax exam.

Sometimes, in trying to help people understand the facts beneath tax policy issues, I wonder why many have difficulty grasping the essentials, and thus being misled or even duped by the sound bit and buzz phrases tossed about by politicians and lobbyists. The inability of so many people to understand why flattening tax rates does just about nothing to simplify tax law, or to comprehend how phase-outs cause tax rates on middle incomes to be higher than those on high taxable incomes, probably correlates with deficiencies in arithmetic understanding.

A recent article on housing sales in the Philadelphia area provides an example of how easy it is to be confused. The article quotes the chief economist at Meyers Research, who also is a senior fellow at the Lindy institute for Urban Innovation at Drexel University. Referring to the 23 percent average drop in value of area homes during the housing bust that began in 2007, he noted that because the typical area home has recovered only 5 percent of that 23 percent, values “must appreciate an additional 18 percent to recover the loss completely.”

Consider this example. Assume that before the housing crash, a home was worth $100,000. A 23 percent drop in value brings the home’s value down to $77,000, because the drop in value is $23,000, that is, 23 percent of $100,000. Now assume that the home recovers 5 percent of its value. That means the home’s value increases by $3,850, as $3,850 is 5 percent of $77,000. The home is now worth $80,850 ($77,000 plus $3,850). To reach $100,000 the home needs to increase in value another $19,150 ($100,000 minus $80,850). $19,150 is 23.7 percent of $80,850, not 18 percent. If the home’s value increased an additional 18 percent, as suggested by that chief economist, its value would increase by $14,553 (18 percent of $80,850 is $14,553), bringing its value to $95,403. That outcome would not cause the property “to recover the loss completely.”

I’ve seen a similar analysis, and have had to bite my tongue, when someone claimed that an increase in a success rate from, to use easy numbers, 20 percent to 30 percent was a 10 percent improvement. It is a 10 percentage point improvement but a 50 percent increase (because the increase of 10 percentage points from 20 percent to 30 percent is 50 percent of 20 percent). This “percentage of a percentage” challenge stumps a fair number of students studying corporate taxation when they encounter section 302(b)(2)(C). That provision requires a determination of whether a shareholder’s percentage of stock ownership after a transaction is less than 80 percent of the shareholder’s percentage of stock ownership before a transaction. In other words, a student or practitioner must consider whether, for example, 58 percent is less than 80 percent of, for example, 70 percent. It’s not, because 80 percent of 70 percent is 56 percent.

The sort of thinking in which a brain engages to do these analyses is not unlike the sort of thinking in which a brain engages in order to do all sorts of other things, such as reading and playing music, programming computers, or figuring out how many gallons of paint to purchase in order to paint a room. Years ago, when one of my sisters, then in elementary school, was trying to persuade my parents to find a way to get her excused from arithmetic classes, my mother pointed out that no matter what she did in life, she would need to understand numbers. My sister said there were things she could do that did not require understanding basic arithmetic. I sat back, quietly to the surprise of some, enjoying my mother’s refutation of every possibility that was offered. Think about it.

All sorts of things are being tried to help students learn arithmetic. I’ve seen some of the Common Core examples. I understand what its advocates are trying to do, but I’m not persuaded that it is working. The best way to learn something is to immerse one’s self in it. Has that been happening? I don’t think so. And so we end up with a nation of taxpayers, too many of whom don’t understand the underlying arithmetic when faced with tax and other policy issues. It gives the edge to those who understand arithmetic, know how to use that understanding in nefarious ways, and lack the polished conscience that deters the ego from doing so.

A recent case, Rolle v. Comr., T.C. Memo 2015-93, illustrates the dependency tie-breaker rule. The taxpayer married Raina in 2006. During 2011, the taxpayer, Raina, and their children lived together from January 1 through July 31. On or about July 31, the taxpayer and Raina separated. The children were in Raina’s sole custody from August 19 through December 31. The facts do not disclose where the children were from August 1 through August 18. The taxpayer filed a federal income tax return for 2011, claiming head of household status and claiming the children as dependents. Raina filed a separate tax return for 2011, and also claimed both children as dependents. The IRS issued a notice of deficiency to the taxpayer, changing the filing status to single, disallowing the dependency exemption deductions, and making other adjustments.

The Tax Court determined that each of the two children was a qualifying child of the taxpayer and of Raina. Accordingly it turned to the tie-breaker rule. Under the parental tie breaker rule in section 152(c)(4)(B), if the parents claiming a dependency exemption deduction for a qualifying child do not file a joint return, the child is treated as the qualifying child of the parent with whom the child resided for the longest period of time during the taxable year, or if the child resides with both parents for the same amount of time during the taxable year, the child is treated as the qualifying child of the parent with the highest adjusted gross income.

Because both children resided with Raina for at least 347 days, and with the taxpayer for no more than 230 days, the Tax Court held that the taxpayer was not entitled to dependency exemption deductions for the children. Presumably, the IRS did not challenge Raina’s dependency exemption deductions for the children.

Stanley Druckenmiller, a billionaire hedge fund manager, has reacted, according to this story to “proposals to tax the rich to pay for more social service for the poor.” According to Druckenmiller, “That’s not where the money is.” So where’s the money? Do the poor have it? Is it buried somewhere?

Perhaps the kindergarten teachers have it. Oh wait. This story explains that the top 25-income-earning hedge fund managers earn more than all of the nation’s kindergarten teachers put together.

And if that isn’t disturbing, keep in mind that those teachers pay federal income taxes at ordinary income rates. The hedge fund managers, using a loophole called “carried interest,” manage to pay taxes at the much lower capital gains rates. Yes, special low rates defended as necessary to encourage the sale of property, a rather questionable claim, apply to income earned from performing services, but no kindergarten teacher dare have the audacity to use or request special low rates in computing federal income taxes on the income they earn from performing services.

Yes, where’s the money?

In a recent decision, Hyler v. Comr., T.C. Summ. Op. 2015-34, the Tax Court held that a taxpayer’s casualty loss deduction claimed in 2012 was not allowable in that year because during that year, and even as late as 2015, the taxpayer was continuing to pursue reimbursement from those alleged responsible for the loss. The taxpayer lived with his wife in a rented house. On June 2, 2012, while they were away visiting friends, a fire destroyed the house and all of its contents. The taxpayer’s personal property was insured but the insurance company paid only $60,000 because that was the policy limit. The taxpayer and his wife sued the landlord, in 2014 that case was set for trial, and by February 2015 meetings had been scheduled to mediate the matter.

The Tax Court explained that under Regs. Section 1.164-1(d)(2)(i) a loss is not sustained until it can be ascertained with reasonable certainty whether reimbursement will be received. Citing Hudock v. Comr., 65 T.C. 351 (1975), the court noted that a casualty loss is not recognized in the year of occurrence if there exists at that time a reasonable prospect of recovery on a reimbursement claim, and that settlement, adjudication, or abandonment of the claim is the event that renders the loss “sustained” for purposes of section 165. According to the court, because the taxpayer’s claim for reimbursement was very much alive and active in 2015, and had been so since shortly after the fire, the loss was not sustained in 2012.

What particularly caught my eye when reading the opinion were these two sentences: “The Woodside Fire Protection District reported that the fire likely started in the kitchen but did not state a specific cause. Petitioner believes that the fire may have started because of rodents and/or faulty electrical wiring.” Long-time readers of MauledAgain may recall that more than nine years ago, a house fire supposedly started by a burning mouse triggered four posts:

Why Tax Law Can Fire Us Up
Follow-Up Report Extinguishes Blazing Mouse Tale (but not the tax issues)
Tax Law and Rodents Afire
The Flaming Rodent Tax Trilogy Gets a Sequel

They also may remember that ten months later, in Animals, Fire, and the Tax Law, I wrote about the issues arising when a cat started a fire by knocking over a candle. It’s unclear from the Hyler case whether mice were once again at work or rats need to be added to the list.

A recent case, Cowan v. Comr., T.C. Memo 2015-85, required the Tax Court to decide when the relationship of a foster parent to a foster child ends for federal income tax purposes. The taxpayer was the guardian of a child, who was placed in the taxpayer’s home from 1991 through 2004. In 2004, the child attained the age of 18 and the guardianship ended. In 2006, the child had a child. The taxpayer had continued to support the child, and after the child’s child was born, the taxpayer supported both the child and his child. Not surprisingly, on her 2011 income tax return the taxpayer claimed dependency exemption deductions for the child and the child’s child, along with an earned income tax credit, a child tax credit, and head of household filing status.

The IRS issued a notice of deficiency denying the dependency exemption deductions, the credits, and the head of household filing status. Thereafter, the IRS conceded that the child was a qualifying relative of the taxpayer and that the taxpayer was entitled to a dependency exemption deduction with respect to the child.

The Tax Court rejected the taxpayer’s argument that the child’s child was a qualifying child. One of the requirements that must be satisfied in order for a person to be a qualifying child is a relationship test. To satisfy that test, the claimed dependent must be a child of the taxpayer, a descendant of that child, or a brother, sister, stepbrother, or stepsister of the taxpayer or a descendant of that sibling or stepsibling. To be a child, a person must be the taxpayer’s son, daughter, stepson, stepdaughter, or eligible foster child of the taxpayer. Because the child that had been placed with the taxpayer was not the taxpayer’s child, stepchild, sibling, or stepsibling, the taxpayer’s claim would prevail only if the child was an eligible foster child. An eligible foster child is “an individual who is placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction.”

The taxpayer argued that the child remains her foster child because they continued their relationship and hold each other out as parent and child. The Tax Court, however, determined that the taxpayer’s guardianship terminated in 2004 when the child attained majority. At that point, the child no longer could be said to be someone who “is placed” with the taxpayer.

The taxpayer then argued that the tax law permits other relationships created by law to persist despite the cessation of the legal circumstances that created them. She pointed to Regulations section 1.152-2(d), which provides that “The relationship of affinity once existing will not terminate by divorce or the death of a spouse.” Thus, for example, once a person becomes an in-law by virtue of marriage, that person remains an in-law even if death or divorce ends the marriage, at least for purposes of the dependency exemption deduction. The Tax Court rejected the argument, concluding that a foster relationship is not a relationship of affinity because it is not based on marriage. The Tax Court also concluded that there was no basis for extending a principle applicable to marriages to foster situations because the former are “by default perpetual, lasting (absent divorce0 until the death of one of the spouses,” whereas foster relationships “are by definition temporary.”

These are the sorts of outcomes that are difficult to explain to clients. There is a good bit of sense in the argument advanced by the taxpayer, and it fails because of the technical nature of the “everlasting affinity” regulation. That regulation, in many respects, is unwise, particularly with respect to the impact of divorce. It comes as a surprise even to students in the basic federal income tax course to learn that for purposes of the dependency exemption deduction, a person’s brother-in-law or sister-in-law remains a brother-in-law or sister-in-law even if the person becomes divorced from the spouse. For some, it’s even worse, as it means a father-in-law or mother-in-law remains so despite divorce. As a practical matter, though, one would not expect an individual to be supporting his or her former sibling-in-law or parent-in-law, though it can happen.

The regulation should be amended to provide that divorce ends a relationship by affinity. Might that ever disadvantage a taxpayer? It would only if a taxpayer was supporting a former sibling-in-law or parent-in-law, who attained that status through divorce in contrast to death, and that sort of situation would be rare. When I teach the basic tax course, I ask students to give me a set of facts where that plausibly could happen. As an aside, students dislike those sorts of questions, as they prefer “tell me the facts and I’ll give an answer” challenges whereas I am convinced that their thinking skills are sharpened by my “I’ll tell you the answer now give me the facts” puzzles. One answer is a guy whose best guy friend has a sister. The guy marries his friend’s sister, perhaps in disregard of his friend’s advice. The marriage fails, and the guy remains best friends with his now former brother-in-law. Years pass, the best friend falls on hard times, and the guy supports him. If he moves the friend into his household, the best friend would be a qualifying relative, provided the income and support tests are met. If not, there’s no dependency exemption deduction. Is that a terrible outcome? No, because there would be no dependency exemption deduction if the guy had not married his best friend’s sister. In other words, someone supporting his best friend, who also happens to be a former brother-in-law, should not be treated differently from someone else who is supporting his best friend who never became a brother-in-law.

When people ask me why I sometimes say that tax law is “fun,” this is one of the examples I provide. What really is fun, and I don’t usually confess this, is watching the looks on their faces when I take them through the “once a sibling-in-law, always a sibling-in-law” tax principle. Perhaps they are thinking, “once a tax geek, always a tax geek.” Perhaps.

Readers of this blog know that I think it is silly to reject fixing potholes with tax increases because of the “no taxes” meme, when that means drivers will be facing much larger outlays to replace tires, wheels, and vehicle parts, to pay for front-end alignments, and to finance the costs of accidents, injuries, and deaths.

Those who haven’t had a chance to explore my thinking on this issue can check out Liquid Fuels Tax Increases on the Table, You Get What You Vote For, Zap the Tax Zappers, Potholes: Poster Children for Why Tax Increases Save Money, When Tax and User Fee Increases are Cheaper, Yet Another Reason Taxes and User Fee Increases Are Cheaper, When Potholes Meet Privatization, When Tax Cuts Matter More Than Pothole Repair, Back to Taxes and Potholes, and Battle Over Highway Infrastructure Taxation Heats Up in Alabama.

Last week, Michigan voters rejected a proposal to fund road repairs with an increase in the sales tax and replacement of the sales tax on fuel sales with an increased fuel tax. So Michigan returns to the drawing board, while its drivers continue their demolition derby encounter with some of the worst roads and bridges in the country.

The usual suspects claim that the solution is to cut spending on other programs in order to fix the roads. These anti-tax advocates have persuaded almost 40 percent of Michigan voters to support the “cut programs” alternative. Yet when asked in a poll what programs should be cuts, according to this story, 88 percent did not want cuts to K-12 education, 86 percent did not want cuts in health care assistance for the poor, elderly, disabled, and children, 76 percent disliked cuts to public safety, and 63 percent rejected cuts to colleges and universities. So what to cut? Apparently, nothing. From the theoretical concept of “cut programs to avoid taxes at all costs” to the practical reality of finding programs to cut, the failure of federal and state governments to protect their citizens is a disgrace to democracy, and an unfortunate deference to the oligarchy and their misguided fan club. Remember that next time you hit a pothole and start complaining. Hopefully those who vote against fixing the roads are the only ones who have that experience, though reality promises to spread the pothole damage far more equally than most other things in monetized America.

Two weeks ago, in An Immoral Tax?, I explained, as I have done previously in Capital Gains, Dividends, and Taxes, As I Expected, Tax Deform(ity), and The Rich Get Richer: The Tax Law’s Role?, that repeal of the estate tax makes sense and has its advantages provided unrealized appreciation does not escape taxation at death. In response, a reader directed me to William G. Gale’s Adjusting the President’s Capital Gains Proposal.

Although Gale describes the proposal to tax unrealized appreciation at death as “a welcome change that would close a huge loophole,” he points out “a serious flaw,” namely, the challenge of keeping records so that unrealized appreciation can be computed at death. That computation requires two facts. One is the fair market value of the asset. The other is the adjusted basis of the asset. Because fair market value must be computed not only for the few taxpayers who are subject to the federal estate tax, but also for purposes of taxpayers who are subject to state estate and inheritance taxes, as well as those who sell inherited property, determination of fair market value does not pose significant challenges. The value of most assets can be determined from market quotes, appraisals, and similar information.

Determining the decedent taxpayer’s adjusted basis in property can be problematic. Many taxpayers do not keep track of their adjusted basis in property, particularly property that is not publicly traded or that was acquired many years previously. This conundrum is what caused the failure of carryover basis to stick. Carryover basis would give the heirs the decedent’s adjusted basis rather than a basis equal to fair market value at death.

What doesn’t get much attention is the fact that when the taxpayer gives property to another person during lifetime, the donee’s adjusted basis is the decedent’s adjusted basis. If determining the taxpayer’s adjusted basis is as impossible as the defenders of the basis step-up at death loophole claim, then why has it endured in existing tax law for almost as long as the federal income tax has existed?

Gale proposes that taxpayers be permitted to compute adjusted basis by allowing them to claim a “standard basis,” a concept derived from the standard deduction. Just as the standard deduction provides an alternative to computing actual itemized deductions, the “standard basis” would provide an alternative to computing actual adjusted basis.

Gale suggests, as an example, setting standard basis at 20 percent of fair market value. He explains that by keeping the percentage low, taxpayers would be encouraged to keep basis records. That might make sense going forward, but there are trillions of dollars of existing assets for which at least some taxpayers have not maintained records.

Gale’s idea makes sense, though I would modify it. I would scale the percentage based on how long the taxpayer held the property. Perhaps "standard basis" should equal the fair market value of the asset multiplied by the standard basis percentage. The standard basis percentage would equal 100 percentage points reduced by 2 percentage points for each year the property has been held, but would not be less than 10 percent. Because the gain would be reported on the decedent’s final income tax return, two special adjustments should be provided. First, to the extent that ordinary income rates apply to unrealized gain, after computing that portion of the tax liability, it would be cut in half to offset the impact of income bunching. That reduction would not apply if the tax rate were a flat rate, such as the rate applicable to capital gains. Second, all taxpayers would be permitted to reduce unrealized appreciation by a standard amount, perhaps twice the exclusion applicable to sales of a principal residence, in order to avoid imposing taxes on principal residences and very small estates.

There are several lessons to be learned from a recent story about the attempt by the IRS to subject to federal income taxation the nearly $50,000 in gifts received by a cancer survivor from individuals who contributed to a GoFundMe account set up on behalf of the cancer survivor. One lesson is that the IRS error, claiming that gross income includes gifts that are excluded by statute from gross income, not only will cost the taxpayer time and money but also will subject her to stress, which is not what she needs. The taxpayer, even if successful in preventing the IRS from taxing what ought not be taxed, will incur costs, and lost time (from a life seemingly destined to be shortened by a difficult illness), in undoing the damage.

Another lesson is learned by asking the question, “How could this possibly happen?” This isn’t rocket science. The exclusion of gifts from gross income is so basic that students in the introductory federal income tax course request that the exam consist of questions at this level of difficulty. For the curious, no, that doesn’t happen.

A colleague at another law school suggested that GoFundMe, having paid over nearly $50,000, issued a Form 1099 to the taxpayer, with a copy to the IRS. The IRS computer then generated a 30-day or 90-day letter because the $50,000 was not on the taxpayer’s return. This colleague calls the process “shoot-first-make the-taxpayer-explain.” Two solutions were proposed, one, requiring the IRS to bear the burden of examining these mis-matches, the other, modifying the Form 1099 so that third-party payors could mark the payment as likely excludible from gross income. Both would require the expenditure of IRS resources, which the Congress so generously has been cutting to pieces.

When I read this colleague’s reaction, my immediate thought was, “This is precisely why I have no faith in ReadyReturn.” ReadyReturn is the proposal to have the IRS prepare returns and let the taxpayer figure out if it’s correct.

As readers of this blog know, I’m not a fan of ReadyReturn. In October 2005, I addressed the ReadyReturn concept, in Hi, I'm from the Government and I'm Here to Help You ..... Do Your Tax Return. I revisited the issue in March of 2006, in ReadyReturn Not a Ready Answer. A year later, in Ready It Was Not: The Demise of California’s Government-Prepared Tax Return Experiment, I shared the news that California’s experience with the program persuaded it to end the program. Yet I had to return to the topic in As Halloween Looms, Making Sure Dead Tax Ideas Stay Dead, where I noted the refusal of the ReadyReturn advocates to admit the failure of the program. And in December 2006, I reacted to the attempt to resurrect the failed program, in Oh, No! This Tax Idea Isn’t Ready for Its Coffin. Yet the advocates of the proposal, despite all of the many problems and its failure in California persisted. In October 2009, in Getting Ready for More Tax Errors of the Ominous Kind, I again pointed out why people should not fall for something described as simple, bringing relief, and carrying a catchy title. I looked at it again in January 2010, in Federal Ready Return: Theoretically Attractive, Pragmatically Unworkable. Later that year, in April 2010, I was interviewed by National Public Radio on the advantages and disadvantages of ReadyReturn; a summary of the discussion and the reaction to it, along with links to previous discussions is in First Ready Return, Next Ready Vote?. In 2012, as pressure from its advocates resurfaced, I extensively analyzed the ReadyReturn proposal, in a 14-part series. That, however, was not enough to diminish the insistence of ReadyReturn advocates that the only thing blocking success for the program was Intuit’s lobbying, a concern I addressed in Simplifying theTax Return Process.

So it’s rather serendipitous that shortly after the advocates of ReadyReturn engaged in their annual tax-season campaign to persuade reporters and taxpayers to encourage legislative adoption of their proposal, as evidenced by this story, along comes news that the IRS, when left to make determinations of what should and should not be on a taxpayer’s return, cannot get it right. Whatever the reason for this sort of error, the IRS isn’t ready for tax preparation prime time. As I wrote to the author of that story, “Your article paints a picture suggesting that but for Intuit’s lobbying the ReadyReturn proposal would be enacted, which probably is true, and gives readers the impression that Intuit is standing in the way of a good thing. To the contrary, Intuit is preventing taxpayers from being pulled into a system that relies on antiquated IRS computers, that puts more burdens on an underfunded and understaffed IRS, and that promises to make tax compliance worse for most taxpayers.”

In other words, ReadyReturn is a variant of “shoot-first-make the-taxpayer-explain.” Only a savvy taxpayer, or one with sufficient means to retain a savvy tax practitioner, might catch the glitch. As I shared with my colleagues, “The theory seems fine (though it isn’t). The practical application fails miserably.”

In September of last year, in Tax-Exempt Status Benefits Aren’t Necessary Unless There is Net Income, I responded to calls for eliminating the tax-exempt status of the NFL by pointing out that doing so would not make the NFL liable for taxes on its revenue of $327 million. Claiming that the NFL is escaping taxation on its revenues overlooks the reality of income tax deductions. Because the Joint Committee on Taxation estimates that roughly $11 million of tax revenue is lost each year, the NFL probably is collecting from its constituent teams a little more than what it is paying out on their behalf. I also concluded that the NFL should not be tax-exempt, but that the prospect of hauling in tax revenue of more than $100 million each year is nothing more than a fanciful dream.

Now comes news that the NFL plans to give up its tax-exempt status. The cited article mentions the same $327 million figure, and though describing that amount as revenue, does not clearly articulate that this amount is not taxable. If the Joint Committee’s estimate is accurate, the loss of the tax exemption is more symbolic than lucrative, and it would not surprise me that the a taxable NFL would be careful to have its revenue from the teams equal the amounts it spends on their behalf to manage the league. Its tax liability will be at or close to zero. Someone needs to get that message across before the Congress starts spending revenue it thinks will be forthcoming but that isn’t going to be there. I’m trying, but until a news outlet with a wide national scope and tens of millions of followers does so, the nation will continue to carry yet another bundle of tax ignorance in its basket of burdens.

A recent Tax Court case, Iglicki v. Comr., T.C. Memo 2015-80, highlights the tax disadvantages of falling behind on alimony payments. When a husband and wife divorced, the signed a separation agreement, requiring the husband to pay child support to the wife. Spousal support was required only if the husband defaulted on the child support obligation. If that happened, the husband’s obligation to pay spousal support would continue until the wife died, the husband died, or the husband made 36 payments. Two months after the agreement was signed, the state court entered a final divorce decree, which incorporated the agreement. Thereafter, the former husband moved to Colorado, defaulted on the child support payments, and thus began incurring spousal support obligations. The former wife sued in a Colorado court for enforcement, filed a verified entry of judgment with the court setting forth the past due child and spousal support, and obtained a writ of garnishment against the former husband’s wages. Not long thereafter, the former husband paid the child support arrearages. During the following year, child support payments for that year and a portion of the past due alimony was paid by the former husband through wage garnishment. The husband deducted the alimony arrearage payments on the joint return he filed with his new wife.

The IRS denied the deduction, arguing that the payments did not constitute alimony because they did not satisfy section 71(b)(1)(A) and (D). The court held that the payments did not satisfy section 71(b)(1)(D), which requires that the payor have no obligation to make the payments after the death of the payee. For that reason, the Court did not address section 71(b)(1)(A), because failure to meet the requirements of any of the subparagraphs of section 71(b)(1) disqualifies the payments as deductible alimony. The Court concluded that section 71(b)(1)(D) was not satisfied because the verified entry of judgment did not provide for the obligation to pay the past due alimony to end at the former wife’s death, and because under Colorado law the obligation to pay the past due alimony becomes a final money judgment for which the obligation to pay does not end at the creditor’s death. Colorado law specifically provides that the judgment survives the deaths of the debtor and creditor. To make matters worse, the Tax Court upheld the IRS assertion of an accuracy-related penalty because the former husband and his new wife did not provide reasonable cause for deducting the alimony.

It is not that readily obvious to most taxpayers, and even to many tax professionals, that an alimony payment that would be deductible if paid, even if paid late, becomes nondeductible if the payee causes the past due amount to be reduced to a money judgment. Aside from the interest and other penalties imposed under state law, the delinquent payor of alimony faces yet another level of adverse consequences for the delay in payment. The tax deduction is lost and an additional federal tax penalty is imposed. The cost of not paying on time becomes a multiple of the alimony that was originally owed. I wonder how many domestic relations lawyers warn their payor clients about this risk. And I wonder how many who do point out the disadvantages of falling behind in payments include this risk in the list of reasons to be timely with the payments.