MauledAgain

Lying About Tax Myths

2012-01-26T08:01:00.002-05:00

Peter Pappas is at it again. In More Lies about Tax Lies, he attempts to rebut the points I made in Tax Myths, Tax Lies, and Tax Twisting. In his effort, he engages in the same sort of twisting and misrepresentations that are at the root of what I set out to debunk.

Though the myths I discussed were those presented on another web site, Pappas persistently refers to them as “Maule’s . . . Myth” in a blatantly obvious attempt to cause his readers to think that I developed the myths. No, I simply was commenting on a list developed by someone else.

Pappas claims that “No serious person on the right has ever suggested that the poor should pay more taxes because the wealthy are over-taxed.” I suppose Orrin Hatch is not a serious person. He’s not the only one complaining that the poor, and the middle class, should pay more. So when Pappas claims that “Conservatives want everyone to pay less taxes,” his assertion flies in the face of what has been said. But in missing this reality, Pappas is trying to deflect attention away from the original point, which is that the failure to use the phrase “federal income” before the word taxes, in other words, the failure to be precise, creates an impression that is erroneous but intended.

Pappas then again tries to deflect attention from the error by claiming that the omission of the phrase is designed to rebut an alleged lie, that is, that the rich don’t pay their fair share of income taxes. Aside from the fact that an opinion about fairness cannot be a lie because there is no truth or falsity to an opinion, an attempt to rebut a statement, whether opinion or asserted fact, ought not be made by offering an imprecise statement that implies a falsehood. Pappas demonstrates the futility and desperation of his position when he claims that the fact that the “top 50% pays 100% of the federal income taxes” means that “the assertion that the top 50% does not pay its fair share is false.” Why? Because the assertion is that “the rich don’t pay their fair share of income taxes” which is a different question from whether the “top 50%” is paying a fair share. Lumping the top 1% with the next 49% is a sad gesture of trying to hide the wealthy among the middle class.

Finally, Pappas gets to the root of the problem. He claims “Maule knows that we are and always have been talking about federal income taxes.” Of course. That’s not the issue. The issue is my concern that typical Americans who are not tax professionals don’t know that. When they ask me about what they are hearing and reading, they demonstrate the pernicious effect of deliberate lack of precision. The liars know that they might not have much of a chance of fooling some of us, but they certainly are taking their best shot at fooling most of us. Pappas then claims that because I object to these misstatements, it proves I am a liar. Yet Pappas admits that the critical words “federal income” are left out. So how am I a liar when my claim is that those words have been left out, and that by leaving them out, the statement implies something other than the truth? The answer is Pappas’ claim that I labeled the statement “47% of Americans don’t pay federal income tax” as a lie. I challenge Pappas to show us where, in any of my posts, I have asserted that the statement “47% of Americans don’t pay federal income tax” is a lie. I asserted that the statement “47% of Americans don’t pay tax” is a lie, and Pappas' only defense is that the two statements are the same. They’re not, and the inability to tell the difference between the two says a lot about Pappas and his argument.

When Pappas then claims that I plan to “confiscate wealth” from the haves, he climbs even deeper into the pit of rhetorical nonsense. All I have argued, for years, is that the Bush tax cuts were unwise, especially during a war. Letting the Bush tax cuts expire is not confiscation of wealth. And when he repeats the claim that no one has ever said that “47% of Americans don’t pay any tax at all” he conveniently ignores supporters of his outlook on taxation such as the Rev. Rick Warren, who told his followers, “HALF of America pays NO taxes. Zero.” So who’s the liar and who’s the propaganda minister?

Pappas then turns to the second myth, that “The American people and corporations pay high taxes.” He ignores the fact that I pointed out that the word “high” is “more difficult to parse.” Instead, he asserts that tax rates in other countries are meaningless. That could be so, but there are plenty of tax-reduction and tax-elimination advocates who point to tax rates in other countries as warnings of what will happen if taxes are not reduced even more. The worst part of his attempt to deal with the second myth is the way Pappas attributes things to me for which he has not proof. For example, he claims, “Most Americans don’t want to be like France, even if Professor Maule does.” Again I challenge Pappas. Show us where I have taken that position. Pappas follows that sentence with a footnote, but was I ever disappointed to discover that the footnote lacked any citation or link to proof of his assertion. Actually, I wasn’t disappointed. I was elated, because the lack of the proof demonstrates that Pappas is making up facts. After all, if he had proof, surely he would have provided it.

When Pappas gets to the third myth, he asserts that “Maule knows very well that many, if not most, conservatives don’t want to raise government revenues at all.” Of course I know that. My point is that although they want to reduce government revenue, the tax-cut proponents argue the opposite, perhaps because they know that they would lose votes if they admitted they want to cut government revenues to the extent they intend. In other words, when tax-cut advocates claim that they want to cut taxes in order to raise revenue, they know they aren’t coming clean with America.

Pappas then tries to take apart the third myth by claiming that tax cuts do create jobs and that the President has admitted that tax cuts create jobs. What the President said, however, is consistent with my point, namely, that tax cuts for the 99% generate jobs. Why? Because those cuts are an application of demand-side job growth. The tax cuts that bring joy to the wealthy, however, rest on the disproven and failed supply-side approach.

Pappas then tries to attribute to me a goal of increasing the top rates to the 70% to 90% range, but at least this time he buys himself some leeway by using the phrase “I suspect even Maule, himself [takes that position]." By phrasing it this way, he has an out when he fails in my third challenge, which is to demonstrate that I have made such an argument. That he wants to take my goal of letting the top rate return to 39.6%, where it was when the economy did well, and recast it as a claim that I want it to reach double that rate is quite revealing. He adds to that an unconditional claim that I favor increased government spending. Here’s yet another challenge for Pappas. Show us where I’ve taken that position.

Pappas doesn’t like the statistics, widely accepted, showing economic growth and tax rates, and relies on the idea that correlation is not causation. He claims that “myriad other factors” contribute to economic performance. That, however, does not remove tax rates as a factor. Some of the factors cannot be controlled, such as weather damage or overseas political conflicts, but tax rates can be controlled. Tax rates were cut in 2001. How have you fared since then?

A Must-Read Tax and Economic Policy Book

2012-01-25T08:01:00.002-05:00

When I characterize a book as a must-read, I try to put my characterization into context. Thus, some books that I have read are tagged as a must-read for those doing family history, whereas others are tagged as a must-read for those interested in model trains or the medicinal properties of chocolate. Today, I tag as a must-read, for every citizen of this nation who has attained high-school reading level ability, Bruce Bartlett’s book, published yesterday, with the descriptive title, The Benefit and the Burden: Tax Reform, Why We Need It and What It Will Take. If I were still teaching the tax policy course, this book would be assigned (and it has nothing to do with the fact that Bruce cites one of my faculty colleagues and articles published in my school’s law review, as that is simply icing on the cake).

In this book, Bruce provides a non-technical education, easily understood by those who are not economists or tax professionals, of how our tax system came to be what it is, why it needs to be reformed, why reform is almost impossible to achieve, and what must happen for any sort of remediation of the American economy and tax system to occur. Bruce beats down most of the myths, half-truths, and outright lies advanced by those whose attachment to their favorite special interest or single-minded ideological goal dooms progress on tax reform.

Bruce provides an easy-to-read history of the tax law and a discussion of how tax legislation is enacted. He follows that up with a discussion of income definitions, the various types of tax rates, how tax rates affect revenue, and how taxes and economic growth are interconnected. He concludes the first part of the book with an explanation of progressivity, the challenges of adjusting tax policy to react to business cycles, and a description of how tax systems work in other nations. In the second part of the book, Bruce looks at a handful of tax provisions that skew the tax system. Though he could not possibly discuss all, or even most, such provisions without writing a multi-volume treatise, Bruce selects provisions that have a wide scope and a deep revenue impact, including the tax treatment of health care premiums and expenditures, the mortgage and real estate tax deductions, charitable contribution deductions, special capital gain rates, corporate taxation, and tax compliance and audit issues. He shows how federal tax policy decisions alter state tax revenues, and, quite importantly, how tax breaks are the same as budget expenditures even though people who object strenuously to the latter refuse to admit that the former are simply disguised versions of federal spending.

For me, the third part of Bruce’s book is the most promising and the most depressing. The promise comes from Bruce’s adept examination of tax reform efforts over the years, and his careful analysis, showing both advantages and disadvantages, of the more commonly discussed tax reform ideas, particularly the value-added tax. The depressing impact, at least for me, arises from two things. One is Bruce’s no-nonsense discussion of how tax reform requires increased tax revenue, an option that the Congress seems incapable of considering, let alone implementing. The other is best described by the title of the last chapter: “If Tax Reform Happens, It Will Be Because Grover Norquist Permits It.” Not surprisingly, Bruce takes apart Norquist’s agenda with surgical precision, pointing out error after error, half-truth after half-truth, in the claims that Norquist has sold to a vocal and obstructionist minority. Perhaps what makes Bruce’s review of the tax problems of this nation so credible is that he was on the staff of a Republican member of Congress, at a time that now seems eons ago, whose contributions to tax reform at that time was far more productive than anything Norquist and his cronies have provided.

The stamp of approval that I put on this book would be granted even if many of the arguments that Bruce presents are similar or identical to the ones that I have advanced over the years, particularly in this MauledAgain blog. One of my consistent themes is the need for Americans to become educated about the realities of taxation and economics (see, e,g, Tax Ignorance, Is Tax Ignorance Contagious?, Fighting Tax Ignorance, Why the Nation Needs Tax Education, Tax Ignorance: Legislators and Lobbyists, Tax Education is Not Just For Tax Professionals, The Consequences of Tax Education Deficiency, The Value of Tax Education, Tax Ignorance of the Historical Kind, Is It Any (Tax) Wonder?, and Tax Myths, Tax Lies, and Tax Twisting), and here is a book that can get that job done, especially if everybody, or almost everybody, sets aside a few hours and reads it. But perhaps my enthusiasm for Bruce’s latest work comes from a suggestion that I will make even though it has absolutely no chance whatsoever of being adopted. Every candidate for Congress, whether or not an incumbent, should be required to read this book and take a test to confirm that he or she has acquired the understanding of taxation and economics that should be a prerequisite for being called to an office of public trust, and if the test is failed, the person should go back home. But the next best thing is possible. After voters read this book and understand that particular candidates are clueless or, worse, among the ranks of the truth twisters and myth makers, they will make certain that those candidates stay home or go back home. Such is the value of understanding tax and economic policy, an accomplishment that Bruce’s book (available from Amazon) makes possible for people from every walk of life.

Tax Myths, Tax Lies, and Tax Twisting

2012-01-23T08:01:00.001-05:00

For me, the difference between a myth and a lie is that the folks believing in the former don’t know any better and those spreading the latter surely do. In between is the twisting, which can reflect ignorance but also can be the consequence of deliberate word choice that suggests one thing even though it literally means something else. Recently, a distant cousin sent me a link to The Top 5 Tax Myths To Watch Out For This Election Season. All five so-called myths are ones that I had already seen and heard, many times.

The first myth, that “47% of Americans do not pay taxes” is a fairly new one, advanced to support the proposition that the poor should fork over more of their income and assets because the wealthy are over-taxed. The flaw in the statement is that it would be accurate if the adjectival phrase “federal income” were inserted before the word “taxes.” By leaving out those important words, the authors of the statement convey a meaning that is not supported by the facts.

The second myth, that “The American people and corporations pay high taxes” is a bit more difficult to parse. What is meant by “high”? Compared to a one-percent tax rate, there is a plausible argument that most American people and corporations pay high taxes, because even 15 percent is “high” compared to one percent. On the other hand, if the statement is intended to make people think that Americans are taxed at a higher rate than are people and corporations in other countries, the statement is misleading. In 2009, every developed nation except two imposed taxes as a percentage of gross domestic product at rates higher than those applicable in the United States.

The third myth, that “cutting taxes creates jobs and raises revenue” has been around for several decades. It makes for a great sound bite, but it’s factually erroneous. The lowest average annual growth in gross domestic product during the past 60 years has occurred when the top marginal rate is where it is today. The highest rate of growth occurred during years when the top income tax rate was in the high 70-percent range. The second highest rate of growth was when the top income tax rate was in the, indeed, 90-percent range, but that surely was attributable to the global war then being waged. The third highest rate of growth, within a whisker of second place, was when the top income tax rate was 39.6 percent, which is where it was before the Bush tax cuts went into effect. Those cuts drove the growth rate down to its lowest point. Surely the third myth is a pre-emptive strike against those who want to return to the rates as in effect before the Bush tax cuts, although opponents act as though people were advocating a return to the days of top rates in the 70-percent and 90-percent ranges.

The fourth myth, that “The US tax system is very progressive because wealthy individuals already pay a disproportionate amount of taxes” is another statement that loses its factual truth because the phrase “income tax” has been removed as a modifier of the word “system” and as a modifier of the word “taxes.” The progressive federal income tax has the effect of ameliorating what would otherwise be a very regressive overall tax system. As a practical matter, the progressive federal income tax causes the “US tax system” to be a flat system.

The fifth myth, that “The ‘Fair Tax’ or a flat tax would be more fair” simply opens up the debate about the meaning of “fair.” For many people, the rule requiring drivers in the left turn lane to turn left is “unfair” because it doesn’t acknowledge how special they are by letting them go straight out of the left turn lane, cutting ahead of the people in the go straight lane. For many people, any sort of tax system, and any sort of government reining in their impulses, is “unfair.” Certainly the flat tax is not progressive, and its adoption would remove the only thing keeping the entire tax system from being regressive.

Each of these so-called myths can be dissected by sitting down, looking at the facts, thinking carefully, and making computations (such as those that would demonstrate that most Americans would pay more federal income taxes under a flat tax that raised the same amount of revenue, because the lower income taxpayers would need to pay more to offset the revenue losses from the additional tax reductions afforded to the wealthy by the flat tax). These myths are not, of course, myths. They may become myths if they are permitted to circulate without objection. They are lies and twistings of the facts, nothing more. And as such, they need to be debunked. Progress is being made in that respect. I gladly play my part in defusing these provocative lies, as someone who laments tax ignorance. I add this post to the long list of those in which I have criticized the lack of tax education in this nation, and the opportunity for mischief it presents to those who benefit from, and seek to maintain, continued tax ignorance. Everything I’ve shared in Tax Ignorance, Is Tax Ignorance Contagious?, Fighting Tax Ignorance, Why the Nation Needs Tax Education, Tax Ignorance: Legislators and Lobbyists, Tax Education is Not Just For Tax Professionals, The Consequences of Tax Education Deficiency, The Value of Tax Education, Tax Ignorance of the Historical Kind, and Is It Any (Tax) Wonder? reinforces this point.

Some Tax Lessons Are Difficult for Some People to Learn

2012-01-20T08:01:00.000-05:00

Though the decision to cut taxes while initiating military action turned out to have had serious adverse consequences for the American economy, the temptation of using the “everyone gets a tax cut” as a political campaign ploy continues. And politicians continue to fall for it. Cutting taxes when the need for the revenue expires, such as the conclusion of a war during which taxes had been increased, makes sense. Cutting taxes when a government and its constituent agencies and localities are struggling to provide basic services is long-term foolishness for the sake of short-term political expediency.

According to this Philadelphia Inquirer article, New Jersey’s Governor Christie has proposed, in his annual State of the State speech, that “Every New Jerseyan will get a cut in taxes.” Because the proposed cut would be proportional across the board, a married couple with $100,000 of income would see a $275 tax reduction, whereas a person with a $1,000,000 income would receive a $7,265.75 cut. The effect of the reduction in state revenue likely means a $1 billion reduction in school funding. At a time when education is the pathway to success in the workplace and favorable competition with other nations’ economies, does it make sense to let education funding take yet another significant hit?

About a year ago, in The Price of Insufficient Tax Revenue, I described how the City of Camden, New Jersey, was compelled to make substantial reductions in its police, fire fighting, and other departments because New Jersey was compelled to reduce its funding assistance to its most economically devastated locality. A few months ago, in When Tax Revenues Are Insufficient: Affordability, Resistance, and Diversion, I described the impact of the New Jersey cuts on Pennsauken Township, which gave notice it would release 12 police officers, joining the almost 1,400 police officers and fire fighters who were laid off in New Jersey in 2010. As I pointed out in that post, when the carrot of tax cuts is waved before voters as the means to force cuts in government spending, “Though it sounds good at a theoretical level, the practical problem with cutting taxes in order to force a cut in government spending is that the health and safety of citizens is what gets cut.”

When the citizens who had been the beneficiaries of government services such as police protection, fire prevention, education, health, animal control, and the like, realize that the consequence of tax cuts disproportionately favoring the wealthy are being financed with reductions in the condition of ordinary people, they might consider again the question, “When taxes are cut, what’s really being cut, and for whom?”

Is It Any (Tax) Wonder?

2012-01-18T08:01:00.002-05:00

The other day, in a conversation with someone, the focus turned to lotteries, sweepstakes, and whether it made any sense to enter allegedly “free” contests. One of the “opportunities” available to the other person was for a $1,000,000 annual prize. At one point, the other person commented, “Plus, why bother? If I win anything, the government will take fifty percent of it.” I asked why they thought half the winnings would be taken by the government. “Taxes” was the reply. I explained that the highest federal income tax rate was 35 percent, a rate that would apply to only part of the winnings, and that the likely impact, without doing actual computations, was closer to 28 percent. In Pennsylvania, the state income tax is slightly more than 3 percent. I commented, “Ignoring for a moment that whatever you would net is better than nothing, where did you get the idea that taxes would reach fifty percent?” The answer was not surprising. “That’s what they say.” I knew, of course, who the “they” are. So I explained, “They say this because they want to rile people up, to put taxation in a bad light, to make the impact of taxes look worse than they are, in an effort to ramp up opposition to taxation.” The other person became very quiet. I could tell some thinking was underway. Finally, “So they are twisting the truth.” My reply was simple. “As ever.”

Is it any wonder that the nation is so misinformed about taxation? Aside from the lack of tax education, a problem on which I’ve posted many times ( e.g., Tax Ignorance, Is Tax Ignorance Contagious?, Fighting Tax Ignorance, Why the Nation Needs Tax Education, Tax Ignorance: Legislators and Lobbyists, Tax Education is Not Just For Tax Professionals, The Consequences of Tax Education Deficiency, The Value of Tax Education, Tax Ignorance of the Historical Kind), there is the crisis of propaganda, deliberate lies, and half-truths advanced by the anti-tax crowd. Yet is it any wonder that the anti-tax crowd engages in this sort of scare-mongering? Surely they have concluded that stating the truth would not get the reaction that they need for their ultimate purposes, so they lie. I do wonder how many people believe the nonsense that is being spewed by those who appear unable to tackle the issues based on the actual facts. It is essential that these lies, half-truths, and misrepresentations be combated at every turn. I may have enlightened only one person the other day, but if everyone who understands the truth of taxation enlightens one person every day, and each enlightened person in turn does so, within months tax truth can go viral, and the darkness of the tax lies will be extinguished.

Teaching Taxes A Long Time?

2012-01-16T08:01:00.001-05:00

Jared Eutsler, a faculty member at Rasmussen College who writes for the colleges’s Business School blog, has released his 20 Blogs Accounting Students Will Love. Included among his selections is none other than MauledAgain, joined by Paul Caron’s TaxProf blog, Kay Bell’s Don’t Mess With Taxes, Byrne Hobart’s Tax Rascal, Russ Fox’s Taxable Talk, and more than a dozen accounting blogs.

It would be wonderful if accounting students, to say nothing of law students, loved this blog. My less ambitious hope is that law and other students, tax practitioners, and taxpayers generally find MauledAgain interesting, provocative, and challenging. True, I prefer that people not hate the blog, either, though the worst reaction, as far as I am concerned, is apathy.

Eutsler describes me as having “taught federal income tax for 20 years.” Oh, I wish I were as young as I was when I attained my twentieth tax-teaching anniversary in January of 2000. I’ve been teaching federal income tax as a member of a law faculty for 31 years. Because I make every effort to be honest, I simply cannot claim to have started teaching law school when I was 15. However, I can say that when I started teaching, the combination of my age and law school student demographics at the time left me younger than at least one-fourth, and perhaps even one-third, of my students. That’s no longer the case. Oh, well. But I’m still younger than the federal income tax, and always will be.

Tax Advice With No Teeth

2012-01-13T08:01:00.002-05:00

It is not difficult to guess what part of the second paragraph of the opinion in United States v. Allen, Nos. 10-2160, 10-2161 (1st Cir. 01/06/2012), caused me to stop reading, go back, and re-read the paragraph:

Frederick and Kimberlee Allen—husband and wife—appeal from their convictions for tax-related offenses. For some years the Allens filed annual federal income tax returns reporting their income. However, for tax years 1997 through 1999, despite reportable income, the Allens filed returns reporting zero income. On the advice of their dentist, and their own research, they concluded that no provision of the Internal Revenue Code imposed “liability” on them for taxes, and attached this explanation to their returns.

On the advice of their DENTIST? My dentist is a great dentist, a conversational fellow, a very good golfer, a savvy observer of life, and interested in tax and politics, but I’m not going to take tax advice from him, and I would not take tax advice from him even if I were not a tax professional.

Almost seven years ago, in The First Ten Tax Urban Legends, I noted the risks of obtaining tax advice from people who are not tax professionals:

One story tells of a high school teacher and coach who concluded that money earned during the summer as an umpire was not taxable because umpiring was a hobby. When challenged by a very bright and experienced tax lawyer turned tax professor, the teacher-coach dismissed the explanation because, get this, the commissioner of the baseball league had explicitly told the umpires that their income was not taxable. Amazing. Get your tax advice from a baseball commissioner, and have your surgery done by a lumberyard sales clerk.

Apparently this is not an unusual situation. Another experienced, able tax lawyer turned tax professor reported that a basketball referee he knows claimed that HIS fees were not taxable. Apparently steroids aren't the only problem in the sports world.

The taxpayers in the Allen case are tax protesters, who simply do not want to pay taxes. After their dentist steered them in the direction of a tax protester organization and a tax protester organizer who later was convicted of criminal tax fraud, the taxpayers tried to demonstrate a lack of criminal intent by claiming that they acted in good faith. One does not act in good faith in the tax world by getting one’s tax advice from a dentist and from a convicted tax protester organizer. One acts in good faith by getting a tax education or by relying on advice from a tax professional who has a tax education.

It is amazing that people who almost certainly would not ask a lumberyard sales clerk to do their surgery so readily start filling their heads with tax, estate planning, and similar advice from people who are not expertised in tax or estate planning. Not getting one’s tax advice from a tax professional is certain to gum up the tax return. The ensuing audit, and in some instances, criminal trial, can be far more painful than a root canal.

Better Compliance = Lower Tax Rates?

2012-01-11T08:01:00.002-05:00

The IRS has just released its latest tax gap estimates. Because the collection and analysis of data lags behind the filing of returns and the conducting of audits, the latest information if for the taxable year 2006. It is unlikely that compliance has improved in later years.

According to the IRS, taxpayers underpaid their tax liabilities by $450 billion in 2006, an increase from the $345 billion shortfall in 2001. The compliance rate fell from 83.7 percent to 83.1 percent. Although the IRS chased down $65 billion of the unpaid taxes for 2006, an increase from the $55 billion it recovered for 2001, the increase in IRS collections did not keep pace with the increase in the tax gap. Some commentators think that the actual tax gap is higher than what the IRS reports, and I favor that perspective.

Why is there a tax gap? There are two major categories of causation. One is mistake, triggered either by carelessness or by the complexity of the tax law that makes “getting it right” a rather daunting task. The other is fraud, triggered either by the greed of those who think they are special, entitled to go straight out of the left-turn lane and to reap the benefits of living in civilized society while paying less than the law requires, or by the frustration of those who think that cheating is the only way they can level the playing field made uneven by the greed of the first group.

As the IRS explains in its news release, compliance is best when information reporting is required. For example, the noncompliance rate with respect to wages is in the vicinity of one percent. On the other hand, the noncompliance rate with respect to income for which reporting is not required is a whopping 56 percent. Efforts to reduce this shortfall by requiring information reporting and withholding have failed. In 2005, Congress enacted a law requiring businesses making payments to independent contractors to withhold 3 percent, but the effective date was postponed time and again until the Congress repealed the requirement in November 2011. In 2010, Congress enacted a law requiring businesses and landlords to file Form 1099 for payments to corporations exceeding $600 a year, but this requirement was repealed in April 2011. Justification for the repeal of the 3 percent withholding was that “it would have hurt cash flow for many small businesses.” That is nonsense. Business A contracts to pay $20,000 to Business B for services. Whether Business A pays $20,000 to Business B, or, under the repealed law, pays $19,400 to Business B and $600 to the Treasury has no adverse consequences on Business A’s cash flow. Business B’s cash flow is unaffected because it would reduce by $600 the estimated taxes it should be paying on the $20,000 received from Business A. In other words, absent the withholding, Business B is operating on the taxpayers’ dime. Justification for the repeal of the information reporting requirement was simply a matter of Congress and the Administration giving in to pressure from the private sector that it would be burdensome. Filing forms W-2 is burdensome, but Congress hasn’t bowed to any pressure to repeal that requirement, for the simple reason that wage earners are the backbone of the nation’s revenue system, and the privileged business class refuses to subject itself to measures that will up its compliance rate from 44 percent to 99 percent. In and of itself, that contrast is quite telling.

Imagine what the financial situation of the federal government would be had it collected, using a conservative estimate, $4.5 trillion of unpaid taxes over the past 10 years. Though it would not have wiped out the deficit, that sort of collection success, easily obtained through reporting and withholding requirements, would alleviate the threat to national security posed by pending cuts and would alleviate the poverty, hunger, and medical crises afflicting the nation because 20 percent of taxpayers not only can’t live with lower tax rates but insist on self-enacted zero percent tax rates. I am confident that most of the compliant 80 percent would welcome the enactment and enforcement of reporting and withholding requirements that would bring tax receipts to what they should be under existing law and would be delighted by a consequent reduction in tax rates for the compliant wage-earners of the nation. Does anyone think the other 20 percent will let that happen?

ADDENDUM: This post has generated all sorts of reactions, via email and on listserves. Some have disagreed with my analysis or terminology, while others have expressed disappointment in how Congress backed down.

The word "nonsense" is a bit strong for some situations. Here is an example where there is a problem. Suppose an S corporation with 10 equal shareholders enters into a contract with a government agency to perform services for $1,000,000, and its expenses are $950,000, leaving $50,000 of nonseparately stated income. Without withholding, the 10 shareholders collectively estimate that each will have $5,000 of income and thus add, let's say, $1,400 to their estimated tax payments. So the corporation makes distributions to each shareholder totaling $1,400 to cover that increase. Assume withholding is enacted. The payor government withholds $30,000 from the payments. According to the FAQs issued by the IRS before the repeal of section 3402(t), provision would be made to treat the S corporation shareholders as having paid the amounts withheld from the payments received by the S corporation. Presumably the IRS would treat each shareholder as having paid $3,000 of tax. The shareholders would reduce estimated payments and even wage withholding by as much as $3,000. In the worst case situation, only the $1,400 payment would be eliminated, and the shareholder is overwithheld by $1,600.

Reading between the lines of the FAQs that the IRS issued suggested that there would be adjustments permitted for instances where the payee could demonstrate this sort of problem. The same sort of problem exists in the world of wage withholding, and there are mechanisms to alleviate, though not necessarily eliminate, the impact. Consider the employee who loses a job part way through the year, and ends up with zero tax liability but has had taxes withheld on the assumption that the paychecks would continue through the year. The withholding surely exacerbate the cash flow problem. If withholding returns, perhaps there will be an exception for businesses that can demonstrate that they do not make money or that they (or their pass-through owners) are in tax compliance.

For many businesses, even if withholding was extended beyond the reach of the repealed section 3402(t) -- which had its own long list of exceptions -- many business receipts would not be subject to withholding. For example, one person commented that retail businesses have low profit margins, and thus a 3 percent withholding on gross receipts would generate significant tax overpayments. But retail businesses receive their gross income from payors -- customers and clients -- who have not been required and almost certainly would not be required to withhold.

In sum, withholding can generate a cash flow problem for a limited number of businesses, just as wage withholding can generate a cash flow problem for a limited number of wage earners. To elaborate on why I used the word "nonsense": If the consequence of a few businesses having a cash flow problem is to repeal withholding for all, then why not let the consequence of a few wage earners having a cash flow problem be the repeal of all wage withholding? I am confident that repealing all wage withholding is an idea that would earn the label "nonsense" from almost all tax practitioners and almost all members of Congress. In other words, I should have more clearly stated that it's not nonsense to claim that there is a cash flow problem, but it is nonsense to repeal all of section 3402(t) as a solution, and it's debatable whether "many" businesses would have had negative cash flow from the withholding.

Tax as a Retaliatory Tactic

2012-01-09T08:01:00.001-05:00

Tax practitioners are very cognizant of how tax can be used as a retaliatory tactic. Consider the disgruntled employee who reports, or threatens to report, the employer to the IRS or a state revenue department for skimming revenue from the books. Surely people who are not tax practitioners have heard similar stories.

Late last week, the Philadelphia Inquirer reported an AP story concerning the use of tax as a retaliatory tactic by an employer against retired employees. The employer in question is a government agency, the Port Authority of New York and New Jersey. Until the end of 2010, employees, retirees, and officials of the Port Authority were permitted to use Port Authority bridges, tunnels, and other facilities toll-free. After criticism by New Jersey’s Governor Christie, the Port Authority revoked the toll-free privilege for all but a few employees. The perk remains in effect for marked emergency vehicles, employees compelled to commute to locations other than the former World Trade Center headquarters, and spouses of employees killed in the 1993 and 2001 attacks.

Two retired employees filed suit against the Port Authority, claiming they are contractually entitled to the toll-free perk, and at least one plaintiff intends to obtain class action status for his lawsuit. Whether the Port Authority is contractually prohibited from cutting off the retirees’ toll-free privileges is a question that cannot be answered until the facts are discovered and subjected to legal analysis.

In the meantime, the executive director of the Port Authority disclosed that he has asked the New York and New Jersey revenue departments to “investigate whether the retirees owed taxes, interest, and penalties on the free benefits they received until the program was discontinued.” Clearly annoyed with the litigation, which he called, “offensive to me,” the Port Authority’s executive director has taken what surely must be considered a retaliatory tactic in the nature of a complaint to a tax agency.

The irony of the situation is apparent from the possible outcomes. One possible outcome is that the perk is excludible from gross income as a no-additional cost service, for which retirees count as employees, considering that no one is barred from a bridge or tunnel to make way for the retiree. In this instance, the request will waste the time of some state revenue department employees, and annoy the retirees, but otherwise have no bearing on the litigation. Another outcome is that the fringe benefit should be included in gross income, the employees received a Form 1099-R or other documentation from the Port Authority reporting the value of the perk – which the Port Authority can compute from the retiree’s EZ-Pass account – and failed to report it. In this instance, though the request for audit of the retirees’ returns will generate some tax revenue for the state, it will have no impact on the factual and legal issues in the litigation. Yet another outcome is that the fringe benefit should be included in gross income, and the Port Authority did not provide any information to the retirees. In this instance, ought not the Port Authority be estopped? Unfortunately, estoppel does not apply in this situation, but one must wonder about an equivalent situation, an employer complaining to the IRS or state revenue department that employees failed to report wages and yet not pointing out that the employer did not file Forms W-2 for the employees.

Using tax as a retaliatory tactic can backfire. For a private sector employer, it can bring all sorts of negative consequences. For a government employer, it isn’t clear that the adverse consequences can be as severe as they can be for a private sector employer, but it isn’t beyond the realm of possibilities that individual employees of the agency can suffer consequences such as dismissal or public reprimand.

Tax Complexity of the Dividend Kind

2012-01-06T08:01:00.000-05:00

About a month ago, the Tax Court, in Rodriguez v. Comr.,, 137 T.C. No. 14 (2011), considered whether corporate earnings included in a married couple’s gross income under sections 951(a)(1)(B) and 956 were dividends eligible to be taxed at the special low rates applicable to qualified dividends. The taxpayers, citizens of Mexico and permanent residents of the United States, owned all of the stock of a Mexican corporation that conducted activities in the United States. The corporation owned real and personal property in the United States. Under sections 951(a)(1)(B) and 956, the taxpayers, as shareholders, were required to include in gross income, and did include in gross income, the portion of the corporation’s earnings invested in United States.

Under section 1(h)(11)(B)(i)(II), qualified dividends eligible for the special low rates include dividends received from qualified foreign corporations. The corporation in question is a qualified foreign corporation. The issue for the Court was whether the gross income inclusions constituted qualified dividends.
Under section 316(a), a dividend is “any distribution of property made by a corporation to its shareholders” out of earnings and profits. The Supreme Court, in Comr. v. Gordon, 391 U.S. 83 (1968) defined a distribution as a “change in the form of . . . ownership [of corporate property,] separating what a shareholder owns qua shareholder from what he owns as an individual.” The Tax Court concluded that the section 951 gross income inclusion was not a distribution, and thus not a dividend, because it did not change ownership of corporate property. The Court noted that there are no provisions in the tax law treating a section 951 gross income inclusion as a dividend for section 1 rate purposes, unlike the regulated investment company provision in section 851(b) that treats section 951(a) gross income inclusions as dividends to the extent there is a distribution under section 959(a)(1) out of the RIC’s earnings and profits, the section 904(d)(3)(G) provision that treats section 951(a) gross income inclusions as dividends for foreign tax credit limitation purposes, or the section 960(a)(1) provision that treats section 951(a) gross income inclusions as dividends for purposes of the indirect foreign tax credit rules. Similarly, although Congress has enacted provisions treating distributive shares and similar amounts as distributions, there is no provision treating a section 951(a) gross income inclusion as a distribution. The Court explained that when Congress enacted section 951, it also enacted section 1248, which treats certain gain from the disposition of stock in corporations such as the one in question as includible in gross income as a dividend, and that the deliberate decision of the Congress to treat section 1248(a) gross income as a dividend but to not so treat section 951(a) gross income solidifies the conclusion that the latter is not a dividend. Reflecting this analysis, Treasury regulations also distinguish between “deemed dividends” and “deemed inclusions.”

The taxpayers sought support in the fact that the legislative history described section 951(a) inclusions as “the equivalent of a dividend” and on statements in judicial opinions that a “dividend equivalency” rationale underlies section 951(a). The Tax Court explained that characterizing something as equivalent to a dividend or as “much like” a dividend is not the same as concluding that it is a dividend. The taxpayers also pointed out that an introductory paragraph in one of the opinions stated the issue as whether uncollected payables balances “constitute investment in U.S. property within the meaning of section 956, resulting in dividend income” and that the headnote puts the issue in the same terms. The Tax Court explained that the body of the opinion did not address whether the section 951(a) inclusion was a dividend, nor was that question essential to resolving the issue in the case, which was the character of the uncollected payables balances as U.S. investments.

The Tax Court also noted that dividend distributions reduce the distributing corporation’s earnings and profits, whereas section 951(a) inclusions do not. Similarly, a dividend distribution does not increase the shareholder’s adjusted basis in the stock, but the section 951(a) inclusion does.

Turning to the question of why Congress enacted the special low rates for dividends, the Court looked at the legislative history and focused on the stated goal of removing a disincentive for corporations to pay out earnings as dividends rather than retaining them. In contrast, section 951(a) inclusions represent earnings that are retained and invested in U.S. property rather than being paid out as dividends. Logically, the section 951(a) inclusion is not a dividend.

As a technical matter, the language of the special low rates for dividends determines whether the taxpayer has the requisite holding period in the stock on which the dividends are paid by referring to the ex-dividend date. Section 951(a) inclusions do not involve dividends and thus there is no ex-dividend date and no way to apply the special low rate provisions to section 951(a) inclusions.

For unknown reasons, the instructions to the 2004 Form 5471 provide that section 951(a) inclusions should be reported as ordinary dividend income. The IRS, describing the instructions as “ambiguous,” explained that the same instructions require corporate taxpayers to report the inclusions as “other income” and not as dividends. The Tax Court simply pointed out that IRS instructions inconsistent with the statute are not determinative.

The time, resources, effort, and energy invested by the IRS, by the taxpayers, and by the IRS in resolving this issue is but one of many examples of how the existence of special low rates for capital gains and dividends is wasteful. Taxpayers generally, and their advisors, not only try to find ways to bring income within the special low rates but also to structure their business activities in ways that they otherwise would avoid, simply to take advantage of special low rates. Repeal of these rates would not only allow removal of at least one-third of the Internal Revenue Code and a similar substantial part of the regulations, it would free taxpayers, the IRS, and the courts from a huge chunk of planning and litigation that consume far more of the economy than the special low rates contribute to it.

Tax Punting, Tax Uncertainty, and Tax Complexity

2012-01-04T08:01:00.001-05:00

On Saturday, 71 federal income and excise tax provisions “expired.” In other words, as of January 1, 2012, these provisions are no longer effective. The simplicity of that information is deceptive. It would not be surprising if at some point, the Congress reinstates some, most, or even all of these provisions, making the reinstatements effective as of January 1. Unfortunately, for taxpayers who are trying to make plans for 2012, they are in tax limbo, uncertain of what the rules will be. Many tax-paying individuals and businesses will play it safe, waiting until the Congress clarifies what the rules will be. This waiting process will inject some degree of stagnation into the economy.

In Punting on Taxes and in Tax Politics and Economic Uncertainty, I explained why playing politics with tax and economic policy is a dangerous game.

The list of recently “expired” provisions demonstrates not only the wide scope of the taxpayer activities that are pushed into the shadow of uncertainty but also the absurd extent to which the tax law and the IRS are used to implement policy decisions that ought to be enacted in other law and administered by other agencies. Skim the list. Is it not interesting that Congress, so critical of the IRS and so anxious for its reduction and even removal, turns time and time again to the IRS to implement its agenda?

Here is a list of the 71 provisions, taken from the Staff of the Joint Committee on Taxation’s List of Expiring Federal Tax Provisions, 2010-2020, omitting provisions that expired earlier in 2011:

1. Credit for certain nonbusiness energy property (sec. 25C(g))
2. Personal tax credits allowed against regular tax and AMT (sec. 26(a)(2))
3. Credit for electric drive motorcycles, threewheeled vehicles, and low-speed vehicles (sec. 30(f))
4. Conversion credit for plug-in electric vehicles (sec. 30B(i)(4))
5. Alternative fuel vehicle refueling property (non-hydrogen refueling property) (sec. 30C(g)(2))
6. Expansion of adoption credit and adoption assistance programs (secs. 36C, 137, sec. 10909(c) of P.L. 111-148)
7. Alcohol fuels income tax credit (secs. 40(e)(1)(A), (h)(1),(2))
8. Alcohol fuel mixture excise tax credit and outlay payments (secs. 6426(b)(6), 6427(e)(6)(A))
9. Income tax credits for biodiesel fuel, biodiesel used to produce a qualified mixture, and small agri-biodiesel producers (sec. 40A)
10. Income tax credits for renewable diesel fuel and renewable diesel used to produce a qualified mixture (sec. 40A)
11. Excise tax credits and outlay payments for biodiesel fuel mixtures (secs. 6426(c)(6), 6427(e)(6)(B))
12. Excise tax credits and outlay payments for renewable diesel fuel mixtures (secs. 6426(c)(6), 6427(e)(6)(B))
13. Tax credit for research and experimentation expenses (sec. 41(h)(1)(B))
14. Placed-in-service date for facilities eligible to claim the refined coal production credit (sec. 45(d)(8))
15. Indian employment tax credit (sec. 45A(f))
16. New markets tax credit (sec. 45D(f)(1))
17. Credit for certain expenditures for maintaining railroad tracks (sec. 45G(f))
18. Credit for construction of new energy efficient homes (sec. 45L(g))
19. Credit for energy efficient appliances (sec. 45M(b))
20. Mine rescue team training credit (sec. 45N)
21. Employer wage credit for activated military reservists (sec. 45P)
22. Grants for specified energy property in lieu of tax credits (sec. 48(d), sec. 1603 of P.L. 111-5)
23. Work opportunity tax credit (sec. 51(c)(4))
24. Qualified zone academy bonds – allocation of bond limitation (sec. 54E(c)(1))
25. Increased AMT exemption amount (sec. 55(d)(1))
26. Deduction for certain expenses of elementary and secondary school teachers (sec. 62(a)(2)(D))
27. Parity for exclusion from income for employer-provided mass transit and parking benefits (sec. 132(f))
28. Treatment of military basic housing allowances under low-income housing credit (sec. 142(d))
29. Premiums for mortgage insurance deductible as interest that is qualified residence interest (sec. 163(h)(3))
30. Deduction for State and local general sales taxes (sec. 164(b)(5))
31. 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements (secs. 168(e)(3)(E)(iv), (v), (ix), 168(e)(7)(A)(i), (8))
32. Seven-year recovery period for motorsports entertainment complexes (sec. 168(i)(15))
33. Accelerated depreciation for business property on an Indian reservation (sec. 168(j)(8))
34. Additional first-year depreciation for 100% of basis of qualified property (sec. 168(k)(5))
35. Special rules for contributions of capital gain real property made for conservation purposes (secs. 170(b)(1)(E), (2)(B))
36. Enhanced charitable deduction for contributions of food inventory (sec. 170(e)(3)(C))
37. Enhanced charitable deduction for contributions of book inventories to public schools (sec. 170(e)(3)(D))
38. Enhanced charitable deduction for corporate contributions of computer equipment for educational purposes (sec. 170(e)(6)(G))
39. Increase in expensing to $500,000/$2,000,000 and expansion of definition of section 179 property (secs. 179(b)(1), (2), (f))
40. Election to expense advanced mine safety equipment (sec. 179E(a))
41. Special expensing rules for certain film and television productions (sec. 181(f))
42. Expensing of “brownfields” environmental remediation costs (sec. 198(h))
43. Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico (sec. 199(d)(8))
44. Above-the-line deduction for qualified tuition and related expenses (sec. 222(e))
45. Tax-free distributions from individual retirement plans for charitable purposes (sec. 408(d)(8))
46. Special rule for sales or dispositions to implement Federal Energy Regulatory Commission or State electric restructuring policy (sec. 451(i))
47. Modification of tax treatment of certain payments to controlling exempt organizations (sec. 512(b)(13)(E)(iv))
48. Suspension of 100-percent-of-net-income limitation on percentage depletion for oil and gas from marginal wells (sec. 613A(c)(6)(H)(ii))
49. Treatment of certain dividends of regulated investment companies (secs. 871(k)(1)(C), (2)(C), 881(e)(1)(A), (2))
50. RIC qualified investment entity treatment under FIRPTA (sec. 897(h)(4))
51. Exceptions under subpart F for active financing income (secs. 953(e)(10), 954(h)(9))
52. Look-through treatment of payments between related controlled foreign corporations under the foreign personal holding company rules (sec. 954(c)(6))
53. Special rules for qualified small business stock (sec. 1202(a)(4))
54. Basis adjustment to stock of S corporations making charitable contributions of property (sec. 1367(a))
55. Reduction in S corporation recognition period for built-in gains tax (sec. 1374(d)(7))
56. Designation of an empowerment zone and of additional empowerment zones (secs. 1391(d)(1)(A)(i), (h)(2))
57. Increased exclusion of gain on the sale of qualified business stock of an empowerment zone business (secs. 1202(a)(2), 1391(d)(1)(A)(i))
58. Empowerment zone tax-exempt bonds (secs. 1394, 1391(d)(1)(A)(i))
59. Empowerment zone employment credit (secs. 1396, 1391(d)(1)(A)(i))
60. Increased expensing under sec. 179 for empowerment zones (secs. 1397A, 1391(d)(1)(A)(i))
61 Nonrecognition of gain on rollover of empowerment zone investments (secs. 1397B, 1391(d)(1)(A)(i))
62. Designation of DC Zone, employment tax credit, and additional expensing (sec. 1400(f)(1))
63. DC Zone tax-exempt bonds (sec. 1400A(b))
64. Acquisition date for eligibility for zero percent capital gains rate for investment in DC (secs. 1400B(b)(2)(A)(i), (3)(A), (4)(A)(i), (B)(i)(I), (e)(2), (g)(2))
65. Tax credit for first-time DC homebuyers (sec. 1400C(i))
66. Definition of gross estate for RIC stock owned by a nonresident not a citizen of the United States (sec. 2105(d))
67. Disclosure of prisoner return information to certain prison officials (sec. 6103(k)(10))
68. Excise tax credits and outlay payments for alternative fuel (secs. 6426(d)(5), 6427(e)(6)(C))
69. Excise tax credits and outlay payments for alternative fuel mixtures (secs. 6426(e)(3), 6427(e)(6)(C))
70. Temporary increase in limit on cover over of rum excise tax revenues to Puerto Rico and the Virgin Islands (sec. 7652(f))
71. American Samoa economic development credit (sec. 119 of P.L. 109-432)

How many of these tax breaks benefit you? Would it not be nice if tax punting, tax uncertainty, and tax complexity expired?

An Interesting Tax Idea

2012-01-02T08:01:00.000-05:00

Ian Ayres and Aaron Edlin have come up with an interesting tax idea. In Don’t Tax the Rich. Tax Inequality Itself, they propose that whenever the ratio of the average income of the nation’s richest one percent to the median household income exceeds 36, a tax bracket is added to the existing rate schedule to generate enough tax on the richest one percent to bring the ratio back to 36. The idea is interesting if for no reason other than it forces the advocates of tax cuts for the wealthy to step up and show confidence in their rationales.

Those who want to shift the tax burden away from the wealthy claim that tax cuts for the rich create jobs. Though the facts show otherwise, they stick with this argument because, among other things, it makes for a good sound bite. A misleading one, but short and simple. Apparently the predecessor rationale, the so-called “trickle down” theory, has been pushed off center stage because it doesn’t quite have the same resonance, to say nothing of the fact that it was tried and failed. So, too, was the “rising tide lifts all boats” claim, one that fails because boats with holes in the hull don’t rise with the tide.

If the advocates of tax cuts for the wealthy are sufficiently confident that their approach works, they should endorse the Ayres-Edlin proposal because the tax bracket it contemplates would never be triggered. The guardians of the Bush tax cuts should rest easy, that as the tax burden on the wealthy is reduced, the ratio is maintained or reduced, and the wealthy don’t risk a tax increase. But I doubt the advocates of tax cuts for the wealthy will jump on board, because they can look at history and realize that if the Ayres-Edlin proposal had been put in place ten years ago, tax rates for the wealthy would have increased.

Ayres and Edlin quote Louis D. Brandeis. It’s a bit longer than a sound bite but it conveys the seriousness of what has been done to this nation by unwise tax cutting during wartime. Said Brandeis, “We may have democracy, or we may have wealth concentrated in the hands of a few, but we cannot have both.” During the past 30 years, the top one percent of Americans, in economic terms, have doubled their share of the nation’s pre-tax income. It now is higher than what it was when Brandeis reacted to the social turmoil generated by inequality when he made his astute observation. Ayres and Edlin note that in terms of after-tax dollars, the top one percent has more than doubled its take. In other words, tax policy has made inequality worse rather than reducing it.

The ratio of 36 measures the pre-tax income of the average person in the top one percent compared to the median income in 2006. By picking this number, Ayres and Edlin are being generous. In 1980, before the so-called Reagan Revolution, the ratio was 12.5. If anything, a good argument can be made that the Ayres-Edlin tax bracket should be triggered when the ratio exceeds 12.5 or 15 or 20 or 25 or 30 or some other factor that is less than 36. In some respects, using 36 suggests an acceptance of the status quo.

Ayres and Edlin suggest that if nothing is done and the ratio reaches 40 or 50, democracy will erode even more than it already has. They predict that if nothing is done, the ratio will reach 80 within 20 years. It would be interesting to hear a defense of a nation in which the inequality reached to double what it now is and quadruple what it was thirty years ago. At what point does the nation awaken and comprehend the seriousness of the problem? At what point does it demand that the Congress do something? Ayres and Edlin have put something on the table that not only is interesting but deserves careful study, close attention, and widespread publicity.

How Politics Generates Tax Complexity

2011-12-30T08:01:00.000-05:00

Earlier this week, in Punting on Taxes, I noted that the two-month extension of the payroll tax reduction “leaves businesses, hiring managers, payroll planners, and payroll departments in an economy-threatening limbo.” It also leaves employees and payroll managers in a place other than paradise.

Because the extension of the payroll tax reduction is, at the moment, limited to two months, it is not as simple as merely continuing reduced withholding for two months. Here’s why. The tax that is reduced applies only to the first $110,100 of wages. Consider two taxpayers. The first taxpayer earns $48,000 a year. If the payroll tax reduction were in effect for all of 2012, that taxpayer would experience a tax reduction of $960 (2% x $48,000). However, because the reduction applies, at the moment, only to the first two months, this taxpayer will experience a tax reduction of $160 (2% x $8,000 of wages for January and February). The second taxpayer earns $4,800,000 a year. If the payroll tax reduction were in effect for all of 2012, that taxpayer would experience a tax reduction of $2,202 (2% x $110,100). However, because this taxpayer receives a monthly salary of $400,000, and because the tax, and its withholding, applies to the first $110,100 of wages, this taxpayer would experience a tax reduction of $2,202 in January, compared to what would have been withheld and paid in the absence of the tax reduction extension.

Congress was concerned about two situations. The first is that the second taxpayer ends up with 100 percent of the tax reduction that would apply had the extension been enacted for all of 2012, whereas the second taxpayer ends up with only 16.7 percent of the tax reduction that would apply had the extension been enacted for all of 2012. To its credit, the Congress decided not to permit high income taxpayers to end up with this sort of advantage. The second issue is the possibility that savvy taxpayers would find a way to front-load salary into the first two months of the year in order to increase the tax reduction. For example, if the first taxpayer somehow could persuade the employer, which could be, for example, the taxpayer’s solely-owned corporation or a family-owned business, to pay the entire salary in January, the first taxpayer would benefit from the full $960 tax reduction.

To prevent the skewing that these situations would cause, Congress also enacted a new tax. Yes, a new tax. Section 101(c) of the Temporary Payroll Tax Cut Continuation Act of 2011 adds a new section 601(g) to the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. It provides:

(1) IN GENERAL.—There is hereby imposed on the income of every individual a tax equal to 2 percent of the sum of wages (within the meaning of section 3121(a)(1) of the Internal Revenue Code of 1986) and compensation (to which section 3201(a) of such Code applies) received during the period beginning January 1, 2012, and ending February 29, 2012, to the extent the amount of such sum exceeds $18,350.
(2) REGULATIONS.—The Secretary of the Treasury or the Secretary’s delegate shall prescribe such regulations or other guidance as may be necessary or appropriate to carry out this subsection, including guidance for payment by the employee of the tax imposed by paragraph (1).

Under this provision, the second taxpayer would be subject to a tax computed as follows. Wages within the meaning of section 3121(a)(1) equal $110,100. That amount exceeds $18,350 by $91,750, which when multiplied by 2 percent yields $1,835. The taxpayer’s payroll tax reduction of $2,202 is offset by the new tax of $1,835, generating a net reduction of $367. This amount of $367 is one-sixth of the maximum $2,202 payroll tax reduction available to the second taxpayer had the reduction been enacted for all of 2012. In addition, if the first taxpayer tried to increase the payroll tax reduction by moving the full year’s salary into January, the 2 percent tax would generate an offset that would negate the advantage otherwise obtained.

Four points need to be made about this complexity. First, it provides another example of a lesson I try to get across to the students in my basic tax class, namely, there is much statutory tax law that is NOT in the Internal Revenue Code. Second, if the Congress sees fit to extend the payroll tax reduction through all of 2012, the additional tax should “disappear,” but whether that happens depends on what the Congress does with the new tax. Third, employees surely are going to make noise when they see a new tax on their paystubs, payroll departments will need to re-program their payroll software and might not be able to do so in a timely manner, and employers will need to invest time and resources explaining this to their employees, though they are invited to provide their employees a link to this post. Fourth, this complexity is yet another example of why, in Punting on Taxes, I reiterated the point I made in Tax Politics and Economic Uncertainty that playing politics with tax and economic policy is a dangerous game. Diverting the nation’s resources to the demands of coping with complexity necessitated by political ineptitude threatens the nation in multiple ways, from its national security through its economic prosperity.

Tax Ignorance of the Historical Kind

2011-12-28T08:01:00.001-05:00

This time, the tax ignorance takes on an historical flavor. In a Philadelphia Inquirer article comparing the Great Depression with the current Recession, Two Eras of Hurt, the author quotes a person named Paul Rees. According to Rees, his family managed to get through the Great Depression because of “his father’s entrepreneurship,” something he thinks “is out of reach for many today.” Rees explains, “So many people don't work for themselves and can't, because of the governmental regulation and the inability to cope with the taxation problems and sale taxes. None of that affected people during the Depression.”

The tendency to blame government, whether it is government regulations protecting people and the environment, or government taxation, or both, for the failure of Americans to show some initiative and self-reliance is a popular political sound bite. The lack of self-reliance, and I agree with Rees that it is a problem, is surely not isolated by the growing ranks of helicopter parents and children who grew up without learning how to fend for themselves.

To claim that taxation problems and sales taxes did not affect people during the Depression is to ignore history. The individual income tax has been in place since 1913, though it also existed briefly during the Civil War. The corporate income tax is a wee bit older. By 1920, income tax revenues exceed $5 billion annually. The Tax Foundation has provided a full list of income tax brackets and rates over the years. To say that “none of [the income tax] affected people during the Depression” is, at best, a gross hyperbole.

According to this Wikipedia article, sales taxes in the United States can be traced to an 1821 Pennsylvania tax, though sales taxes as they exist today were enacted during the Depression. Apparently there is some dispute over the identity of the state with the dubious honor of being the first to adopt a modern-era sales tax. During the height of the Depression, specifically, during the 1930s, more than half of the states that ended up with sales taxes enacted sales taxes. To say that “none of [the sales taxes] affected people during the Depression is simply erroneous.

It would not surprise me that Rees “learned” his tax history from his father, and I can imagine his father claiming that “back in my day there was none of this government taxation and regulations.” It probably snowed in the winter and he walked to school and home barefoot, uphill both ways. How can America engage in tax policy debates and address its economic woes if so many people do not know the history of taxation in this country? How can a nation that at one time boasted the world’s best education system, though it no longer can make that claim with a straight face, let its children of today and of yesterday, and worse, of tomorrow, be so horribly misled by propagandists? I have stressed this point throughout my time as a blogger, for example, in Tax Ignorance, Is Tax Ignorance Contagious?, Fighting Tax Ignorance, Why the Nation Needs Tax Education, Tax Ignorance: Legislators and Lobbyists, Tax Education is Not Just For Tax Professionals, The Consequences of Tax Education Deficiency, and The Value of Tax Education. Yet every time I hear or read tax misinformation, and realize how many people are making decisions based on erroneous premises, I shudder at the outcome. From pockets of tax ignorance, the educational deficiency now grips the nation from village schoolhouse to the halls of Congress. I wonder if some future historian – if there are any – will caption the chapter dealing with the early twenty-first century as “The Triumph of Ignorance.”

Punting on Taxes

2011-12-26T08:01:00.001-05:00

On Friday, the Congress decided to resolve the conflict over the payroll tax cut extension by punting the issue two months into the future. According to this CNN report, Congress voted to extend the payroll tax cut by two months in order “to give negotiators more time to hammer out a deal over how to pay for the continuation.”

Here’s a safe prediction. During the last week of February we will see and hear the same sort of squabbling that took place over the past several weeks. Why am I so confident that it will play out this way? On January 1, 2011, the Congress knew that it had 365 days to decide, one way or the other, what to do with the expiring payroll tax cut. Yet despite knowing that there was a deadline, members of Congress used the issue as a political football, trying to influence 2012 electoral politics. So entrenched in diametrically opposed positions, Congress managed to fumble on this issue. The Congress now knows it has 66 days to work out a solution. That’s the position in which the Congress found itself on November 2, 2011. Other than ramping up the rhetoric, what did the Congress accomplish? Would it be a surprise if on February 29, 2012, the Congress votes for another two-month extension? Though the lingering uncertainty of a final score may put people in the seats at a sports event, it leaves businesses, hiring managers, payroll planners, and payroll departments in an economy-threatening limbo. Playing politics with tax and economic policy is a dangerous game, as I explained in Tax Politics and Economic Uncertainty.

Friday’s outcome did nothing to answer either of the questions I asked earlier that day in Two Tax Questions. So long as the Congress continues to value electoral politics and re-election as more important concerns than fulfilling its fiduciary duties to the nation, the downward spiral will continue.

Two Tax Questions

2011-12-23T08:01:00.000-05:00

Will the members of Congress so adamantly opposed to preventing the expiration of the payroll tax cut hold fast to that approach when the Bush tax cuts reach their postponed expiration date? Why did the members of Congress so adamantly opposed to preventing the expiration of the payroll tax cut refuse to join those who were adamantly opposed to the preventing the expiration of the Bush tax cuts?

The answers to these questions should be evident to anyone who examines closely the workings of Congress. For many, even most, Americans, the answers, if they bother to seek them, are alarming.

Using User Fees Responsibly

2011-12-21T08:01:00.001-05:00

For the past several years, I have reacted negatively to the policies and practices of the Delaware River Port Authority (DRPA) that funnel bridge tolls to a variety of projects that have nothing to do with maintaining or repairing the bridges or adjacent highways. I addressed this abuse of public trust in a series of posts, beginning with Soccer Franchise Socks It to Bridge Users, continuing through Bridge Motorists Easy Mark for Inflated User Fees, Restricting Bridge Tolls to Bridge Care, Don't They Ever Learn? They're At It Again, A Failed Case for Bridge Toll Diversions, DRPA Reform Bandwagon: Finally Gathering Momentum, and ending with When User Fee Diversion Smacks of Private Inurement.

What should be funded by tolls? In User Fees and Costs, I explained:

The toll should be based on the cost of building, expanding, improving, repairing, maintaining, policing, and monitoring the road. . . .

. . . The analysis I support is one that looks at the impact of the toll road and its use on surrounding residents, neighborhoods, and infrastructure. Traffic volume surrounding a toll road interchange is higher than it otherwise would be, and that generates additional costs for the local government. It makes sense to include in the toll an amount that offsets the cost of widening adjacent highways, installing traffic signals, increasing the size of the local police force, adding resources to local emergency service units, and similar expenses of having a toll road in one's backyard. I understand the argument that because the locality benefits economically from the existence of the toll road and its interchange that it ought not be subsidized by the toll road. It is unclear, though, whether the toll road is a net benefit or disadvantage. If it were such a wonderful thing, why are new roads so vehemently opposed by so many towns and civic organizations?

I reiterated this analysis, more succinctly, in Timing, Quantifying, and Allocating User Fees, by explaining, “Tolls should be used to pay for the costs of building, repairing, maintaining, and operating the toll road, and to defray the economic burden that the road imposes on the surrounding neighborhoods. Tolls should not be used for programs unrelated to the road.”

There now is an opportunity to put this approach to the test. The opportunity consists of two components.

The first component was highlighted a little more than a week ago, in a Philadelphia Inquirer story that explained what the DRPA planned to do with the balance of the toll money it had set aside for projects unrelated to its mission. Of the roughly $30 million remaining in the account, the DRPA decided to set aside $10 million for “future capital projects” and voted to spend the other $20 million on “local food banks, a new cancer center in Camden, student housing for Rutgers-Camden, and Cooper River rowing facilities,” along with unallocated monies for the New Jersey Economic Development Authority and a pier. Two unappointed members of the Authority’s board, including Pennsylvania’s Auditor General, voted against the $20 million expenditure, failing to persuade the others that it should also be dedicated to transportation projects or reducing the DRPA’s $1.4 billion debt.

The second component was described several days ago in another Philadelphia Inquirer article. The City of Philadelphia plans to extend Delaware Avenue as part of the “master plan for the development of the Delaware River waterfront” in order to provide better access to the area. To extend Delaware Avenue, the city needs an easement from the DRPA because the Avenue would go under the Betsy Ross Bridge, one of the DRPA’s bridges. The DRPA has refused to issue the easement because it wants the city, in return, to take title to Hedley Street. The DRPA acquired Hedley Street when it bought the land on which the bridge supports rest. The city doesn’t want Hedley Street, in part because it is not paved and does not meet city street codes, and in part because it has no use for it. The city is willing to take ownership of the street if the DRPA returns it to its former compliant condition, a project that would cost $2 million. As one might expect, the city says that the DRPA is responsible for the cost, and the DRPA claims that the city should pay. If the DRPA continues to block the city’s plans, the city will lose $15 million of federal funds that had been granted some years ago to help defray the cost of the Delaware Avenue extension project.

The DRPA took the street, let it fall apart due to bridge construction and decades of neglect, now wants to pass it off to the city, along with the $2 million repair bill, and is using the threat of easement withholding in an attempt to bludgeon the city. The DRPA is the land owner and the DRPA is responsible for the condition of the street. It does not violate my view of responsible use of user fees for the DRPA to use some of the $20 million to fix the road that it owns, a road adjacent to one of its bridges. Instead, the DRPA is trying to get the city’s taxpayers to foot the bill while it diverts toll revenue to totally unrelated projects. The irony is how the DRPA defends itself. A spokesman said, "Our position is firm. We're not going to budge. . . . It would cost our toll payers $2 million, and they'd get nothing in return.” Why wasn’t that argument noted when the DRPA was forking over money, and as it continues to fork over money, for things that provide nothing in return to its toll payers?

Who Should Change the Tax Law?

2011-12-19T08:01:00.002-05:00

Late last week, a TaxProf blog story explained that the Sentencing Law & Policy Blog had reported on a $2.3 million award to a wrongfully imprisoned man. The latter post contained a “follow-up question” which was in turn posed to Paul Caron at the TaxProf blog, specifically, “Does [the plaintiff] now get to enjoy this $2.3 million award free from all federal and local taxes?” Here’s an aside to the students in basic federal income tax law school courses: this is yet another example of why lawyers who have no intention of practicing tax law need to understand the basics of tax law, need to take the basic tax course, and thus learn, as was the case here, when to, as I put it, “ask for help.”

In his a TaxProf blog story, Paul explained, correctly, that the answer depends on whether the award was received on account of “personal physical injuries,” citing a half-dozen previous TaxProf posts on the issue. I had not taken a close look at the stories Paul had cited when he posted earlier this year and in 2010, principally because the black letter law was clear. That was a mistake. Had I done so, I would have noticed before now some interesting assertions about the taxation of false imprisonment damages.

As to the policy issue, namely should false imprisonment damages be subject to income taxation, there are good arguments on both sides. In some ways, those arguments reflect the ones advanced on both sides of the debate about the exclusion generally of damages for personal physical injuries and sickness. My focus today is not on those arguments but on the issue of who makes the decision.

Section 104(a)(2) of the Internal Revenue Code makes it clear that the exclusion of damages from gross income applies only to damages received on account of personal physical injuries and sickness. Section 104(a)(2) has been amended several times during the past several decades, which may explain why the IRS, in 2007, obsolete rulings from the 1950s in which it had concluded that gross income did not include damages received by survivors of Nazi concentration camps, Japanese-American internees, and American POWs.

Surely it is the language of section 104(a)(2) that constrained the Tax Court, in a case affirmed by the Sixth Circuit, from extending the exclusion to damages received for false arrest. The court opined that “[p]hysical restraint and physical detention are not ‘physical injuries’ . . . Nor is the deprivation of personal freedom a physical injury.” Robert Wood has provided a very good analysis of this case in Why the Stadnyk Case on False Imprisonment Is a Lemon, an article worth reading by anyone with a serious interest in the issue. In 2010, the IRS issued CCA 201045023, in which the IRS advised that a falsely imprisoned person who suffered physical injuries and sickness while incarcerated can exclude from gross income the damages for those injuries and sickness. Though many people tried to interpret the CCA as justifying exclusion of all damages for false imprisonment, the CCA does not go that far, as carefully explained, again by Robert Wood, in Wrongful Imprisonment Tax Ruling Stirs Controversy.

In Tax-Free Wrongful Imprisonment Recoveries, Robert Wood argues that the IRS takes too narrow a view of what “physical injuries and sickness” means and suggests that the IRS could issue administrative guidance excluding all false imprisonment damages from gross income, and in Why the Stadnyk Case on False Imprisonment Is a Lemon, he provides observations on why the IRS may be reluctant to do so but urges that the IRS or Treasury issue guidance specifying which false imprisonment damages are excludable. Similarly, in Tax On Wrongful Imprisonment Needs Reform, Wood argues that “It’s time for the IRS or Congress to fix this.” Wood is not alone in thinking that the IRS can resolve the problem by adopting definitions of “physical” that reach beyond what the word means. See Expanding Section 104(a)(2)'s Tax Exclusion. On the other hand, in Did the Sixth Circuit Get It Right in Stadnyk?: What to Do About the § 104(a)(2) Personal Injury Damages Exclusion, the author calls on the Congress to fix section 104(a)(2) to settle the question and provide certainty to plaintiffs. In fact, bills have been introduced in Congress to make false imprisonment damages excluded from gross income. On December 6, 2007, the Wrongful Convictions Tax Relief Act of 2007 was introduced, and on March 3, 2010, the Wrongful Convictions Tax Relief Act of 2010 was introduced. Neither bill was passed by the Congress.

There is no question that section 104(a)(2) has flaws and needs to be revised. There is no question that the Congress needs to determine the scope of section 104(a)(2) and whether or not it applies to damages for false imprisonment and similar situations where physical injury or sickness is absent. Congress could, if it chose, to provide a definition of the word “physical” that extends beyond physical, but the better approach would be to provide more explicit parameters for the scope of the exclusion, assuming that the exclusion is maintained. To expect the IRS or the courts to step in and apply section 104(a)(2) as though it had been drafted in some other manner, even if it should be or have been drafted in a more helpful way, is to extend to the executive or judicial branch the responsibility for doing the work of the legislative branch. Congress needs to put aside the politics and get to work, on this and a long list of other matters that need its attention.

The Price of Not Raising Taxes

2011-12-16T08:01:00.000-05:00

The real estate property tax rate in Montgomery County, Pennsylvania, is the same as it was ten years ago, although there was a miniscule increase that was reversed a few years later. A majority of the county commissioners have adhered to a policy of not increasing taxes.

According to a recent Philadelphia Inquirer article, the Commissioners have been told what the consequences will be of continuing to insist on not raising taxes. At least 500 people will lose their jobs, thus shifting an economic burden onto federal and state unemployment relief programs. The President Judge of the county court system explained that the cuts needed to accommodate the refusal to raise taxes “would bring the court system ‘to its knees.’” The county zoo would be closed. The county public library would be closed, a step inconsistent with the need to bolster adult public education. The coroner would try to institute a “don’t die on the weekend” law because it would need to close for the weekend. The county clerk of courts explained that she would be required to dismiss employees and would be unable “to run a functioning Clerk of Courts office,” which has been understaffed for four years and is facing a “significant, unacceptable backlog.”

Ironically, the tax increase required to avoid any more budget cuts than those imposed during the past decades would amount to a $1 per month increase for each of the 120 months that the county has been on what one of the commissioners called a “tax holiday.” For the sake of saving pennies per day, the long-term cost to the taxpaying public will end up being far more than small change.

Not All Wealthy Individuals Support Tax Cut Preferences for the Wealthy

2011-12-14T08:01:00.001-05:00

A little more than a year ago, in Job Creation and Tax Reductions, I pointed out that the best way to stimulate the economy is to put money into the hands of consumers and not into the hands of the wealthy. I explained:

[R]educing tax rates or extending low taxes for the wealthy . . . does not create jobs. . . . What about individuals with incomes exceeding $250,000? Will they create jobs if their taxes are reduced or if their tax cuts are extended? Not necessarily. A person does not “create a job,” that is, hire a person for a position that previously did not exist, simply because the person’s tax cuts are extended. People do not hire other people for the sake of doing so. They hire other people if they have work that needs to be done. Extending tax cuts does not cause an increase in the amount of work that needs to be done. . . . On the other hand, if the person really needed to hire someone, the tax law provides a zero tax rate on the income used to pay a new employee. Thus, no matter the tax rate, if the person with $1,000,000 of income needed to hire someone to do work for $25,000, by doing so at a rough cost of $35,000, the person’s taxes would be reduced under current law by roughly $12,000, and under a tax-cut-expiration situation, by roughly $14,000. In other words, the “we aren’t creating jobs because our taxes might go up” is utter nonsense. If the person has work that needs to be done, $2,000 isn’t going to make or break the decision. Better yet, the wealthy person can hire enough people so that their taxable income sinks below $250,000 and they won't need to bother themselves with what the tax rates for the wealthy are, and in the process they can learn what it's like to live like most people do. What will create jobs is an increase in demand, 90 percent of which comes from the 99 percent who are not in the economic top one percent . . . [emphasis added]

I have repeated this argument, that jobs are created by demand, on other occasions.

Although the debate about the extension and expiration of the Bush tax cuts for the wealthy often is cast in terms of those who are wealthy and their supporters on the one side, and those who are not wealthy on the other, the reality is that the lines are not so clear-cut. There are wealthy people who oppose extension of the tax cuts for the wealthy and support the return to the pre-Bush-tax-cut days of a balanced federal budget. For example, in Taxing Capital to Help Capital, I explained:

A few readers have suggested to me that I dislike, or worse, hate the wealthy. That’s not true. I dislike what many, not all, wealthy do in terms of co-opting Congress and dictating tax policy that favors the wealthy and that has brought the nation’s economy to its knees. Indeed, there are wealthy individuals who advance economic arguments similar to the ones I make, but they quickly become the target of other wealthy individuals and those who are devotees of the agenda that has brought us so much economic misery.

This is what has happened to Nick Hanauer, an unquestionably wealthy individual, who, in a Bloomberg editorial, Raise Taxes on Rich to Reward True Job Creators, makes the same argument that I have been making, namely, that the wealthy do not create jobs because even if a wealthy person “can start a business based on a great idea, and initially hire dozens or hundreds of people, . . . if no one can afford to buy what [that person has] to sell, [the] business will soon fail and all of those jobs will evaporate.” Hanauer emphasizes that it is the middle class that creates jobs. As he puts it, “But it’s equally true that without consumers, you can’t have entrepreneurs and investors.” In other words, the growing income inequality that is making the middle class disappear is a threat to everyone, including the wealthy. Hanauer puts it nicely, “When the American middle class defends a tax system in which the lion’s share of benefits accrues to the richest, all in the name of job cretion, all that happens is the rich get richer.” As I’ve pointed out in numerous posts, the Bush tax cuts have not created jobs, and the promise of jobs is an empty ploy designed to put more wealth into the hands of those who already are wealthy.

Hanauer notes that “[s]ince 1980, the share of the nation’s income for fat cats like me in the top 0.1 percent has increased a shocking 400 percent, while the share for the bottom 50 percent of Americans has declined 33 percent. At the same time, effective tax rates on the superwealthy fell to 16.6 percent in 2007, from 42 percent at the peak of U.S. productivity in the early 1960s, and about 30 percent during the expansion of the 1990s.” He then raises an issue that has not been given sufficient attention: “The annual earnings of people like me are hundreds, if not thousands, of times greater than those of the average American, but we don’t buy hundreds or thousands of times more stuff. My family owns three cars, not 3,000. I buy a few pairs of pants and a few shirts a year, just like most American men. . . . I can’t buy enough of anything to make up for the fact that millions of unemployed and underemployed Americans can’t buy any new clothes or enjoy any meals out. Or to make up for the decreasing consumption of the tens of millions of middle-class families that are barely squeaking by, buried by spiraling costs and trapped by stagnant or declining wages.” Because of the decline in share of national income, the average American family has $13,000 less than it otherwise would have.

Hanauer notes that even with the expiration of the Bush tax cuts, the wealthy would be taxed at historically low rates, and their incomes would still be “astronomically high.” He understands that in the long run, undoing the foolish Bush tax cuts so that the middle class can be re-energized economically, will bring more dollars to the wealthy than would continuation of those tax cuts.

Understandably, Hanauer isn’t taking this position out of the goodness of his heart. He has a vested interest in the well-being of the middle class. Without an economically thriving middle class, he has no customers to sustain his business enterprises. Hanauer understands this because he comes from the segment of the wealthy who have acquired their wealth through their own efforts in the reality of the business world. But not all wealthy came to be that way in the same manner. Those who are wealthy through inheritance often lack the experience of someone like Hanauer. In Tax Rates or Tax Uncertainty?, in which I discussed Joseph N. DiStefano’s Isn’t It Rich? Capitalists Who Accept Higher Taxes, I shared DiStefano’s disclosures that the “working rich . . . aren’t necessarily discouraged to expand their businesses because of higher tax rates” and that “[i]t’s different among those whose money was mostly inherited” and that “As a group . . . those people are more likely to hate taxes, period” because “[h]aving lost the capacity to earn more, they fight harder for what’s left.” As I noted in my post, why can’t these people figure out how to earn more?

Hanauer has taken a lot of criticism for his position. That’s not surprising. If the anti-tax crowd stood by silently and let Hanauer’s common sense destroy the tax-cut myths, the entire anti-tax machine would fall apart. The supply-siders have had their at-bat. Why should the demand-siders not have their opportunity?

Confusing Commentary Confuses Tax Discussions

2011-12-12T08:01:00.002-05:00

In more than a few posts, including The Value of Tax Education, The Consequences of Tax Education Deficiency, Tax Education is Not Just for Tax Professionals, and Why the Nation Needs Tax Education, I have decried the negative impact on tax policy debates of misleading and erroneous assertions with respect to taxation and tax law. This trend reaches back at least several decades, when banks opposed to a withholding requirement whipped up a frenzy of citizen opposition by deliberately mischaracterizing the withholding obligation as a new tax. Perhaps seen as clever, it was and is a dangerous approach that warps democracy.

Yet another example of how misleading tax commentary muddies tax policy discussions appeared in Gov. Corbett’s Stealth Tax Hike, a “reader feedback” in the Philadelphia Inquirer written by Kelly William Cobb. Cobb is described as “government affairs manager for Americans for Tax Reform and the executive director of StopETaxes.com and DigitalLiberty.net.”

According to Cobb, an attempt by the Pennsylvania Department of Revenue to enforce an existing tax constitutes a “tax increase that skirts the legislative process.” Responsibility for “this tax hike” rests on the state’s governor. Cobb goes so far as to claim that the governor and Department of Revenue are imposing “new and constitutionally questionable taxes” on Pennsylvanians.

Understanding the confusion fueled by these assertions requires careful analysis to remove the impact of conflating two aspects of taxation, specifically, imposition and collection. The taxes in question are the existing sales tax and the existing use tax. The sales tax applies to sales of goods and services in Pennsylvania. Though technically imposed on the purchaser, it is collected by the retailer. The use tax, which is imposed at the same rate and on the same goods and services as the sales tax, applies to purchases made by Pennsylvanians from out-of-state retailers that they then bring back into the state. Collection responsibility technically rests on the Pennsylvanian, but compliance is woeful, just as it would be with the sales tax if retailers did not collect it at the point of sale.

A state can require an out-of-state retailer to collect the use tax on behalf of the purchaser and remit it to the state if the retailer has sufficient “nexus” with the state. In Quill Corp. v. North Dakota, 504 U.S. 298 (1992), the Supreme Court held that for use tax collection purposes, nexus required physical presence of the retailer in the state. Physical presence can exist not only if the retailer operates retail outlets in the state, but also if the retailer uses subsidiaries, representatives, employees, or independent contractors acting as agents, to act on its behalf in the state. These principles are set forth in existing Pennsylvania statutes, 72 P.S. sections 7201(p), 7202(a). On December 1, 2011, the Pennsylvania Department of Revenue issued Sales and Use Tax Bulletin 2011-01 (also available here), to address remote seller nexus. In the Bulletin, the Department of Revenue quoted the statutory provisions, and then provided a list of situations in which out-of-state retailers are considered to have physical presence in Pennsylvania. Each situation involves activity in Pennsylvania conducted by someone acting on behalf of the out-of-state retailer. The Department of Revenue simply is pointing out instances in which enforcement of an existing tax was lax and needs to be solidified. It could have done the same thing with respect to the thousands of Pennsylvanians who shop in Delaware and bring purchases back into the state without paying use tax, but for a variety of reasons has not (yet) done so.

Cobb raises a series of objections to the Department of Revenue’s plan to enforce an existing tax, trying desperately to tag it as a new tax, which clearly it is not. Each of these objections demonstrates how confusion is pumped into the discussion.

Cobb claims that the governor and Department of Revenue are trying to impose new and constitutionally questionable taxes. Yet he quotes from the Bulletin the Department’s own acknowledgment that it will require compliance to the extent that it is permissible “under the Constitution of the United States.” Cobb calls that provision “vague” and claims that it “may be unconstitutional.” To assert, as Cobb does, that announcing an intention to comply with the Constitution is unconstitutional is nonsense.

Cobb quotes the Bulletin, which refers to the statutory provision, “any contact within this Commonwealth which would allow the Commonwealth to require a person to collect and remit tax under the Constitution of the United States.” To this he reacts with, “Any contact? That gives the state extraordinarily broad powers.” No, not “any contact,” but “any contact” which falls within the scope of the limiting clause that follows the word “which.” There is a difference between “any house” and “any house which has shutters.” Technically precise reading is a valuable skill. When absent, it serves no one well.

Cobb argues that under the “newly announced policy, an out-of-state business that merely advertises online in the state – physical footprint or not – must now collect sales taxes from Pennsylvanians.” Aside from the erroneous reference to sales taxes, as it is the use tax that must be collected, Cobb also misreads the Department of Revenue’s restatement of existing law and policy because he omits to mention that every situation listed in the Bulletin is one that involves the out-of-state having a representative or other agent physically present in the state. If there is no physical footprint by or on behalf of the out-of-state retailer, the use tax collection obligation does not attach. The most diplomatic way of characterizing Cobb’s argument is to say it is a gross exaggeration.

Cobb claims that the Department of Revenue “circumvented the legislative process.” Excuse me, but the legislative process took place and generated the statutes quoted by the Department. Cobb notes that other states “passed similar measures, but they at least invited public discussion of the idea and subjected it to the scrutiny of elected representatives.” So where and how does Cobb think the Pennsylvania statute came into existence?

When Cobb claims that “Corbett and the Department of Revenue [have] opted to unilaterally impose higher taxes through administrative fiat and without transparency,” he is making an unsupportable and misleading allegation. The tax in question, the use tax, has been in existence for decades. The obligation of out-of-state retailers with physical presence in Pennsylvania, whether directly or through an agent, has been in existence for decades. The fact that enforcement was not as intense as it ought to have been, and the fact that compliance is weak, does not make attempts to increase compliance through more focused enforcement the enactment of higher taxes.

Perhaps a better understanding of the difference between the imposition of a tax and the collection of a tax would have spared the readers of Cobb’s editorial the need to sort out the facts from the misinformation, misleading assertions, and nonsense. With this post, I have tried to help people in their effort to do so.

Who Is a Farmer? A Taxing Question?

2011-12-09T08:01:00.002-05:00

Many students bring to their first basic federal income tax class a deep anxiety and sometimes overwhelming fear that they will be immersed in some sort of mathematical nightmare. I try to reassure them that to the extent numbers are involved, it’s a matter of arithmetic, probably the least complex field in mathematics. I explain that when they struggle with allegedly mathematical concepts such as ratios and proportions, the challenge often is with the concept and not the numbers. And I emphasize the significant role that language plays in learning and applying tax law. It’s not, as the unfounded claims suggest, all about numbers.

A few days ago, an interesting example of the importance of words in the tax world appeared in a Philadelphia Inquirer article about the New Jersey real estate property tax limitation available to farmers. The article examined several situations, involving well-known individuals including a member of Congress, who have taken advantage of the real estate property tax limitation even though their farming activities are minimal. Someone reading the article might think that the issue is one of defining “farmer” or “farming,” but that is not how the statute was drafted.

The provision in question states:

54:4-23.2. Value of land actively devoted to agricultural or horticultural use. For general property tax purposes, the value of land, not less than 5 acres in area, which is actively devoted to agricultural or horticultural use and which has been so devoted for at least the 2 successive years immediately preceding the tax year in issue, shall, on application of the owner, and approval thereof as hereinafter provided, be that value which such land has for agricultural or horticultural use.

In turn, the statute defines agricultural use in this manner:

Land shall be deemed to be in agricultural use when devoted to the production for sale of plants and animals useful to man, including but not limited to: forages and sod crops; grains and feed crops; dairy animals and dairy products; poultry and poultry products; livestock, including beef cattle, sheep, swine, horses, ponies, mules or goats, including the breeding, boarding, raising, rehabilitating, training or grazing of any or all of such animals , except that "livestock" shall not include dogs; bees and apiary products; fur animals; trees and forest products; or when devoted to and meeting the requirements and qualifications for payments or other compensation pursuant to a soil conservation program under an agreement with an agency of the federal government, except that land which is devoted exclusively to the production for sale of tree and forest products, other than Christmas trees, or devoted as sustainable forestland, and is not appurtenant woodland, shall not be deemed to be in agricultural use unless the landowner fulfills the following additional conditions: [with respect to establishing a forest stewardship or woodland management plan, attestation by professional foresters with respect to compliance, and proper submission of applications with respect to the plan].

The statute also provides that “ agricultural use shall also include biomass, solar, or wind energy generation, provided that the biomass, solar, or wind energy generation is consistent with the provisions of P.L.2009, c.213 (C.4:1C-32.4 et al.), as applicable, and the rules and regulations adopted therefor; and ‘biomass’ means an agricultural crop, crop residue, or agricultural byproduct that is cultivated, harvested, or produced on the farm, or directly obtained from a farm where it was cultivated, harvested, or produced, and which can be used to generate energy in a sustainable manner, except with respect to preserved farmland, ‘biomass’ means the same as that term is defined in section 1 of P.L.2009, c.213.” Another provision defines horticultural use as follows:

Land shall be deemed to be in horticultural use when devoted to the production for sale of fruits of all kinds, including grapes, nuts and berries; vegetables; nursery, floral, ornamental and greenhouse products; or when devoted to and meeting the requirements and qualifications for payments or other compensation pursuant to a soil conservation program under an agreement with an agency of the Federal Government.

In addition, another provision requires that the land be so devoted for at least two years preceding the taxable year in question and that it not be less than five acres. Finally, yet another provision requires the property to generate at least $500 during the year in receipts from the agricultural activity. Clearly, it’s not a simple matter of defining the word “farmer” or the word “farming.”

What brings this provision into the spotlight is a report, Subsidies of the Rich and Famous, issued by a conservative Republican senator. In the report, Tom Coburn criticizes not only federal subsidies for the wealthy, but also state subsidies, including the New Jersey farmland tax break. The spotlight was brightened because among the taxpayers taking advantage of this real property tax reduction provision are John Runyan, former NFL player turned Representative, Jon Bon Jovi, and Bruce Springsteen. It is important to separate the issues. One issue is whether these individuals are violating the law. They’re not, though Runyan had to add three donkeys to his land because the assessor had ruled that one donkey plus selling firewood was insufficient to meet the requirements, and to claim that Runyan is taking “advantage of New Jersey taxpayers by outrageously calling himself a farmer,” as does a spokesperson for the Democratic Congressional Campaign Committee, is to twist the language of a statute that does not require anyone to call himself or herself a farmer but requires a person to engage in agricultural or horticultural activities generating at least $500 of receipts. Put another way, the New Jersey real property tax limitation is not limited to full-time farmers. The other issue is whether it makes sense to let millionaires take advantage of a tax break supposedly established to “encourage individuals in agricultural pursuits, as Coburn puts it.

The policy issue can be separated into several questions. Should a tax break, which in Runyan’s case amounts to a 98 percent reduction in real estate taxes, be available to a person whose agricultural activities are minimal? Ought the tax break be limited to farmers whose activities are a meaningful part of their attempts to earn a livelihood? Ought the tax break be limited to individuals whose income is less than some particular amount? If the goal of the provision is to encourage preservation of farm land as a buffer against hopscotch development and urban sprawl, ought not the tax break be designed to mirror similar provisions in other states? Coburn answers one of the questions by stating, “Farmers that are millionaires no longer need [the] encouragement [to engage in agricultural pursuits].” He answers another by claiming “Further, a millionaire landowner should not be paid by the government to preserve their land.” Coburn’s first statement makes much sense. His second, however, appears to ignore what would happen without an incentive to sell land at its highest price to developers, namely, a diminution in the amount of open space in heavily populated areas. Conflating these two goals, , the encouragement of farming and the preservation of open space, muddies the discussion.

As a practical matter, when the goal is preservation of open space, the taxpayers who will directly benefit from the tax break are likely to be those with higher incomes. Poor people and working class individuals rarely own the quantities and types of land that are eligible for open space conservation attempts. So although the focus should be on the land and not the owner’s economic status, the overwhelming majority of tax breaks for open space preservation will flow to wealthier taxpayers. In contrast, when it comes to farming, most individuals who farm, at least in New Jersey, struggle. Often they must hold other jobs to make ends meet. When the goal is preservation of farming, perhaps there is justification to apply some sort of income test. Thus, though a Rutgers University professor explains that the farmland assessment is “blind to the person; it’s about the land,” when the tax break is broken into its separate goals, that characteristic ought to be limited to the open space goal and not the farming encouragement goal. Millionaires don’t need to be encouraged to farm or to be given financial assistance to farm. But if society wants a person to keep their land open and free of development, society should pay fair value, no matter who owns the land and no matter the income of the person who owns the land.

Taxes and Faux Dollars

2011-12-07T08:01:00.001-05:00

As the nation struggles with a deficit caused by a combination of unfunded war expenditures and unwise tax cuts, yet another goofy budget suggestion has emerged from the Congress. This time, it is House Minority Nancy Pelosi who suggests that the extension of the payroll tax reduction can be funded with dollars not spent on military operations in Iraq and Afghanistan. In her joint press availability with Democratic Whip Steny Hoyer, she said, “And we can pay for the payroll tax cut . . . by taking the funds from the overseas contingency operations account.”

Perhaps an example will illustrate the madness. Consider a family with a child who is ready to enter college. Until this point the family has been spending what it earns, perhaps accumulating a bit of a surplus. The child then enters college, creating for the family a new and significant expenditure. Though most families would not consider doing so, in order for the example to parallel the federal budget story, this particular family gives up one of its part-time jobs, on some goofball theory that by cutting revenue it will improve its financial condition. Facing a substantial excess of expenditures over income, the family incurs a deficit, borrowing money from creditors willing to do some lending. During the child’s senior year, the family takes a leave from yet another part-time job, the money from which had been flowing into the family’s retirement plan. As the child nears graduation, the family decides that its financial situation will benefit if it continues to stay on leave from the part-time job. When one spouse asks the other how the family will cope with the continued loss of revenue, the answer is startling. “Junior graduates soon, so we’ll use the dollars we are no longer spending on junior’s tuition.” Hello? Those dollars are fake dollars. Not spending money that wasn’t going to be spent is not a cut in spending nor an increase in revenue. The only way the family continues to have access to the amount of dollars spent annually on tuition is to BORROW MORE MONEY. That, of course, increases the family’s budget deficit. The solution to the family’s problem is to get back to work. Cutting tuition expenditures isn’t the answer because there are no more tuition expenditures to cut.

If this latest nonsense does not persuade Americans that members of Congress, charged with fiduciary care of the nation’s economy, don’t understand economics, nothing will. People would not take their injured children to an emergency room staffed by tax law professors, would refuse to schedule surgery for their grandchildren with oil well drillers, and would object to having their teeth cleaned by a carpenter. Yet they seem willing to entrust the future of this nation to an assembly of politicians who are so lacking in the skills required for leadership that they offer, and occasionally enact, legislation that not only is wacky, but also dangerous.

Taxes: A Price for What?

2011-12-05T08:01:00.001-05:00

The anti-tax movement, at least some of which is an anti-government movement, objects to government having access to resources collected through the tax system. Rather than seeing taxes as a price paid for a civilized society, they see taxes as an obstacle to their so-called freedom to do whatever they want to do, as I pointed out in Free, Freedom, Fees, and Taxes and Taxes and the Funding of (De)Regulated Markets. A recent story from New Jersey demonstrates why taxes are a price that needs to be paid to permit society to function in a civilized manner.

Using tax dollars, state officials in New Jersey inspected 325 gasoline stations and discovered that 14 of them, almost 5 percent, were delivering gasoline with octane ratings less than what the pump indicated. In other words, entrepreneurs in the anti-tax movement’s beloved private sector were cheating their customers.

Government needs to regulate markets, and needs tax dollars to do so, because the private sector is incapable of policing itself. As I asked in Keeping Free Markets Free, “Who, I ask, protects the freedom of the free market?” The answer should be obvious. The answer also is disliked by some people. Who? People who lose when government regulates markets. For example, I wonder if the owners of the 14 gasoline stations in New Jersey that were selling lower quality gasoline than what the consumers were paying for are thrilled with the idea of paying fees or taxes to fund gasoline quality inspectors. I wonder. That is why I concluded, “The notion that a society without government, or a totally unregulated market, can provide for the welfare of society is a proposition that has never been successfully applied in life.” I also wonder how many people who resent taxes and wish for the disappearance or impairment of government were spared thousands of dollars in engine repair expenses because a tax-funded inspector identified gasoline stations selling a product inadequate for the customer’s needs. I wonder.

It’s not just the quality of gasoline that suffers when tax funding shrinks because of anti-government inspired opposition to taxation. I provided some examples in Life Without Tax Increases. According to this recent National Law Journal article, the list is growing, as a consequence of tax cuts that have reduced funding for state courts, in turn reducing citizen access to justice. I wonder whether it’s the owners of the 14 gasoline stations or their customers who benefit from the reduced availability of judicial system redress.

Disaster planning experts advise us to consider how we might function in the wake of a natural disaster. Perhaps it is time for people to consider how we will function in the wake of government disintegration.

Taxes and Small Business

2011-12-02T08:01:00.000-05:00

The debate over extension of the payroll tax reduction involves a dispute over the funding of its cost. A proposal to impose a surtax on taxable incomes exceeding $1,000,000 has encountered resistance from Republican members of Congress. For example, as widely reported, including, for example, this posting, Speaker of the House John Boehner claims that “one-third of small business income would be hit by the surtax.” Senate Minority Leader Mitch McConnell, as reported here and elsewhere, claims the surtax would negatively affect small business. In contrast, the White House contends that the surtax would affect only one percent of small businesses, as explained in this commentary.

The difficulty with this particular aspect of the debate is that no one agrees on what constitutes a small business. Even the Internal Revenue Code has at least four different definitions of “small business.” One is found in section 1361(b), which deals with small business corporations eligible to make the S election. Another is found in section 1244, which allows an ordinary loss deduction for certain small business stock losses. Yet another is found in section 1202, which provides an exclusion for capital gain from the sale of certain small business stock. Even another is found in section 44, which allows a disabled access credit to small business. Not surprisingly, the Small Business Administration has its own definition of small business. Section 1361 focuses primarily on the number of shareholders, though the amendments increasing the limitation to 100 hardly bespeak “small” in that respect. Section 1244 defines a small business as a corporation that has received no more than $1,000,000 for its stock. Section 1202 defines a qualified small business as a corporation with aggregate gross assets of no more than $50,000,000. Section 44 defines a small business as a business with either gross receipts not exceeding $1,000,000 or no more than 30 full-time employees. With this sort of inconsistency in the Code, is it any wonder that all sorts of claims are being tossed about with respect to the impact of the proposed surtax on small business?

Most people, perhaps almost all people, when asked about a small business, would refer to the solely-owned or family-owned business that has few employees, generates a modest amount of taxable income, and owns a modest amount of assets. Most people would not consider a business with $49,000,000 of gross assets to be “small,” yet under one definition that business is a “small business.” An corporation, so long as it has no more than 100 unrelated shareholders and meets some other tests, can qualify as a “small business” for S election purposes, even if it has billions of dollars of assets and hundreds of millions of dollars of taxable income.

Any sensible definition of small business, such as gross receipts not exceeding $1,000,000, or fewer than 31 employees, or no more than a handful of unrelated owners, necessarily escapes the surtax on taxable incomes exceeding $1,000,000. Put another way, 99 percent of America’s small businesses do not generate $1,000,000 or more of taxable income for their owners. Though, as explained in this Treasury Department report, two-thirds of millionaires are “small business” owners (using $10,000,000 as the threshold), only 3.31 percent of small business owners are millionaires, which leaves 96.69 percent of small business owners unaffected by the proposed surtax. Thus, the claims that the proposed surtax would kill small businesses is false. Why is this false claim being circulated? Because it sounds plausible to enough people that political mileage can be gained from touting it. In contrast, if opponents of the surtax on taxable incomes of $1,000,000 or more claimed that it would wipe out widows and orphans, the lunacy of such an assertion would be so obvious that the goals of the objectors would be more readily observed. The bottom line is that many, perhaps most, but probably not all, people with taxable incomes of $1,000,000 or more do not want to pay more taxes, and in fact are trying to obtain more tax reductions. Though some admit to this viewpoint, others prefer to have legislators make the proposed surtax look like something it is not, namely, the destroyer of small business. This sort of political discourse, with false claims and disguised agendas, is dangerous, but it won’t stop until enough people call out the politicians for using this sort of twisted rhetoric.

Debunking Tax Myths?

2011-11-30T08:01:00.002-05:00

In two recent posts, Tax Policy, Elections, and Money and If the Government Collects It, Is It Necessarily a Tax?, I have explored the unwarranted and excessive influence that the unelected Grover Norquist holds over federal, state, and local tax policy and decision making. Based on Norquist’s own words, I concluded that his anti-tax stance is simply part of his strategy to destroy government.

The adverse effect of Norquist’s efforts on the American people and the nation’s economy is beginning to get attention from people other than myself. For example, a well-written letter to the editor by Sarah H. Widman of Trappe, Pennsylvania asks:

Who's Norquist?
I don't remember ever voting for Grover Norquist for any public office, so it is difficult for me to understand why and how so many members of Congress have allowed their integrity and independence to be hijacked by him and his tactics.
In fact, it should be illegal for an elected official to pledge allegiance to any private, partisan interest group that places the interests of that group above the needs and interests of the representative's constituents and prevents that representative from doing a proper job of legislating.
The fact that we do not know who finances Norquist's Americans for Tax Reform organization makes the strength of his influence even more suspect. But how can we hope for reform from Norquist's brand of campaign-finance extortion, when a majority of those with the power to reform are in his thrall? The only answer is for voters to head to the polls in the next election and vote out all who have placed their loyalty to Grover over their loyalty to country.

This groundswell of opposition to disproportionate influence wielded by an unelected person disturbs Charles Krauthammer. In Debunking the Norquist Myth, he attempts to discount the claim that “Republicans are in the thrall of one Grover Norquist” by offering several examples of Republican legislators who agreed to proposals that would increase tax revenue. Aside from failing to mention that only a few Republican signers of the anti-tax pledge have defected, Krauthammer overlooks Norquist’s bullying reaction to anyone who stands up to his strategy. Politicians who signed the Norquist anti-government, excuse me, anti-tax pledge and who, realizing how dangerous it is, decide to make a more sensible decision, go through twisted and tortured maneuvers to prove they are not violating the pledge. Whether it is Pennsylvania’s governor explaining that impact fees are not taxes, as discussed in If the Government Collects It, Is It Necessarily a Tax?, or a legislator claiming that a package with more spending cuts than tax increases is not a tax increase, Norquist’s influence and unelected power cannot be denied, and Krauthammer short-changes some of his other analysis by rushing to the defense of one of the nation’s most dangerous people.

Krauthammer claims that the “myth of the Norquist-controlled antitax monolith” persists because “Democrats can’t tell the difference between tax revenues and tax rates.” He correctly points out that the nation’s creditors care only about total revenue and not the particulars of rates, deductions, exclusions, and credits. Though I suppose sophisticated creditors do pay attention to those things as they try to evaluate the creditworthiness of the United States, as a practical matter, it’s the total revenue that counts. Krauthammer claims that Democrats are so intent on raising rates that they overlook proposals to eliminate deductions and loopholes. But in making that claim, he distorts the analysis. People who have read or listened to my tax policy position know that I’m in favor of eliminating most exclusions, deductions, and credits. That’s not the issue. The issue is identifying the loopholes to be eliminated. Republican proposals target exclusions, deductions, and credits that benefit the working class and the middle class, while providing additional tax reductions for the wealthy, as discussed in What Sort of Tax Increase?. That is why the Democrats object to the loophole elimination ploy. If the Republicans stepped up to support elimination of things such as the capital gains loophole, the tax-exempt bond interest exclusion, the stash-your-money-overseas-to-avoid-tax schemes, and the turn-your-compensation-into-low-taxed-capital-gains-because-you-are-rich-enough-to-do-that partnership gimmick, they would find allies among Democratic legislators in a heartbeat. So although Krauthammer is on the right road with this argument, he’s driving in the wrong lane.

Krauthammer further weakens his credibility by claiming that “the real drivers of debt, as Obama himself has acknowledged, are entitlements.” The real driver of debt is the reduction of tax revenues while incurring huge amounts of debt to finance war. I’ve pounded on this issue for years, and fortunately increasing numbers of commentators and taxpayers are beginning to wake up and realize the magnitude of this wealth-shifting tactic. Entitlement spending needs to be reformed, but the only way to reform it without raising tax revenues is to eliminate all entitlements. That, of course, is one of Grover Norquist’s goals, because it is a necessary consequence of his desired destruction of government.

Not long ago, in What Sort of Tax Increase?, I mapped out the foundations of a plan to deal with the federal budget crisis:

Put the tax rates back where they were before they were foolishly reduced at the same time the nation went to war (as discussed in When Tax Cuts Are Part of the Problem, They Ought Not Be Part of the Solution, and the posts cited therein). Impose a user fee on entities that receive or received federal bailout or other funds and fail to increase the number of employees hired and working in the United States. Enact a mileage-based road fee to fund transportation infrastructure repair (as discussed in Toll One Road, Overburden Others? and the posts cited therein). Remove from the Internal Revenue Code all spending programs, and then put each one up for a vote in Congress as a spending outlay, thus putting an end to the spending increases that have been enacted disguised as tax credits, to bring front and center a serious budget problem discussed in More Criticism of Non-Tax Tax Credits and the posts cited therein. Provide corporations a deduction for dividends paid, and impose a tax on corporate accumulated earnings that exceed five percent of the fair market value of assets reported for financial accounting purposes, thus reinvigorating a rarely enforced existing tax (as discussed in Taxing Capital to Help Capital). Repeal the depreciation deduction for buildings and building components (as discussed in Abolish Real Estate Depreciation Deduction? An Idea Gathers Attention, and the posts cited therein). Repeal section 168(k) and section 179 (as discussed in If At First It Doesn’t Work, Try, Try, Try Again, and the posts cited therein). Repeal the special low rates for capital gains and dividends, and index the adjusted basis of assets (as discussed in, among other posts, Special Low Capital Gains Tax Rates = More Tax Revenue? Hardly.). Remove the limitation on the deduction of capital losses. Subject Social Security benefits to means testing, making relevant the “I” in FICA (as discussed in FICA, Medicare, and Payroll Taxes). Clean up the Medicare and Medicaid programs. Eliminate subsidies to any individual or entity that has positive taxable income or reports income for financial accounting purposes.

I know Grover Norquist would reject my suggestions out of hand, because they necessarily require the continuation of government. But I wonder if Charles Krauthammer would be so single-minded. The answer to that question would tell us a good bit about Krauthammer’s defense of Norquist.

If the Government Collects It, Is It Necessarily a Tax?

2011-11-28T08:01:00.002-05:00

Sometimes an article about tax can hit the surely-you-jest trifecta. That was my reaction after reading a Philadelphia Inquirer article about Grover Norquist’s self-injection into the Pennsylvania legislature’s consideration of an impact fee on Marcellus shale drillers. My recent post on the issue, Revenue: It’s Not Just the Name, It’s Also the Place describes how I have been arguing for a user fee to defray the costs generated by natural gas developers that otherwise would be borne by the state government and thus, indirectly, by its taxpayers. I first made that suggestion in Tax? User Fee? Does the Name Make a Difference?. I followed up in Giving Up on Taxes = Surrendering Taxpayer Rights?. A month later, in Life for My Proposed Marcellus Shale User Fee?, I asked, “Have these people been reading my MauledAgain posts?” and answered “Perhaps.” Five months ago, in Revenue: Is It All in The Name? I described an impact fee proposal offered by the President of the Pennsylvania Senate who defended the revenue raiser by noting that it was a fee and not a tax.

The first hit in the trifecta is the headline of the Philadelphia Inquirer article: Tax Guru Norquist inserts himself in Pa. Shale Debate. Are you kidding me? Grover Norquist is not a tax guru. He does not practice tax law, nor tax accounting. He is not a commercial tax return preparer. He would struggle to earn points on any well-designed tax law exam.

The second hit in the trifecta is Norquist’s absurd challenge is his contention that Pennsylvania Governor Tom Corbett, who has signed Norquist’s infamous and dangerous anti-tax pledge, was violating the pledge by supporting an impact fee because, in Norquist’s bizarre perspective on government operations, a flat-dollar-amount fee is a tax because it requires the driller to pay a portion of revenue from the gas wells into the commonwealth’s general fund. Norquist, who claims he does not exert “any direct influence” over legislatures, including the Congress, because he merely “applauds from the sidelines” made himself quite visible in the Pennsylvania legislature’s debate on the issue. He peppered the legislature of a state in which he does not reside with letters in which he warned Pennsylvania legislators who had signed his pledge that they would be violating it by voting for the governor’s proposal because the governor’s proposal was a tax. The governor responded, explaining that the proposal involved a fee because the money that would be collected would be transferred to agencies dealing with the matters affected by the drilling, such as environmental protection and transportation infrastructure. The governor told Norquist that a vote for the proposal would not violate the anti-tax pledge. Could it be that the governor is beginning to understand the shallowness of whatever intellectual analysis Norquist purports to bring to tax policy discussion? Or might Corbett also be increasingly aware of the negative impact Norquist’s meddling has on the ability of governments to serve their people? There is no question that what the governor has proposed, and what passed the legislature though in different versions, is a fee and not a tax. I explained this in Tax? User Fee? Does the Name Make a Difference? and again in Revenue: Is It All in The Name?. I doubt Norquist has ever read these, or any other explanation of the difference between a tax and a user fee. I doubt that he cares, for as I explained in Tax Policy, Elections, and Money, Norquist is not so much anti-tax as anti-government, and his diatribes against government revenue, warped by his inability to distinguish fees from taxes, is nothing more than his own version of hate speech directed against government.

The third hit in the trifecta was the foolishness of the only pro-Norquist-position comment in the collection of opinions attached to the Philadelphia Inquirer article. Asked one reader, “If you dig a hole in your yard and you find you have gold there, then you sell the gold and make a fortune, should you be taxed over and above the 3.07%. If so why?” The 3.07% to which the reader refers is the Pennsylvania state income tax rate. The answer is the classic, “It depends.” More facts are required. Does the person digging the hole cause thousands of heavy vehicles to traverse and damage local roads? Does the person digging the hole, by doing so, pollute groundwater and inject harmful materials into watersheds that adversely affect people living many miles downstream? Does the person digging the hole rip out trees in otherwise pristine forests? If the answer to one or more of these questions is yes, then the answer to the reader’s question is yes, because the person digging the hole is imposing costs for which compensation is required. The reason I characterized the reader’s comment as pro-Norquist-position and not pro-Norquist is that the reader wrote nothing to contradict the other comments. Those other comments included a variety of negative opinions of Norquist, including questions such as “What does this leech actually do? Who pays him?” and warnings that “If you research Grover Norquist’s background and his affiliations you will quickly realize neither Party should be affiliated with him” and “This guy needs to go, he’s a cancer on this nation.” One reader noted, “Grover Norquist is not an elected official and should not be shaping tax policy. . . . Funny, I don’t see Grover Norquist living up here in Bradford County dealing with the negatives of gas drilling. Grover a true America[n], let the other guy feel the pain but don’t do it in my back yard.” That Norquist hasn’t fooled everyone is corroborated by a comment describing him as “Just a greedy POS slug using his power and money to get more power and money – and easily convincing the average amerikan idiot that he’s a ‘hero.’ The morons who give this guy credence are intellectually unable to understand they are being reamed a big one.” They will eventually figure it out if his dangerous campaign is permitted to continue and heed is not given to a wonderful suggestion provided by another of the article’s readers: “Time for politicians to sign a pledge to not pay attention to this dork.” I, however, will continue to pay attention to Norquist just as I would continue to pay attention to the suspicious character wandering the neighborhood testing house and car doors to see if they are locked.

“Small Change” Tax Noncompliance?

2011-11-25T08:01:00.000-05:00

Many taxpayers, tax commentators, and tax practitioners think that the IRS, or any other revenue agency, doesn’t focus on “small change” tax deficiencies because it isn’t worth their while to pursue an amount that most likely is less than what it costs to track down the taxpayer, determine the deficiency, and set out to collect what is due. A recent City of Philadelphia press release, however, calls that common belief into question.

According to the City of Philadelphia press release, the city plans to pursue unpaid back taxes, and other city bills, from retirees and beneficiaries receiving pension benefits from the city. According to the city, roughly 2,500 of its 33,000 pensioners and beneficiaries owe $12.9 million in delinquent taxes. Simple division tells us that on average, each of the 2,500 pension benefit recipients owes $5,160. According to this report, the average pension in 2010 was $18,363. Again using simple division, the average unpaid tax is roughly 28% of the average pension. No city tax or even bundle of taxes comes close to that sort of percentage in one year, so the situation must be one of unpaid taxes accumulated over multiple years. A sensible guess is that a good chunk of the unpaid taxes are real property taxes.

The city threatens to withhold up to 25% of pension payments to satisfy the unpaid taxes. It also has the option of publishing the names of the delinquent taxpayers on its web site. The latter approach should prove to be far less effective than the former.

There are several lessons to be learned from this development. First, although a particular item of noncompliance might generate a rather small amount of tax underpayment, when accumulated over multiple years, even aside from interest and penalties, the instances can add up to something far more worth the revenue agency’s efforts than one year’s instance standing alone. Second, governments are caught between continued demand for services from most of their populations and a decline in revenue caused by tax cuts, economic malaise, and noncompliance, and are looking for revenue in places formerly considered not worth exploring. Third, advances in digital technology and communication make it easier, and a bit less expensive, for revenue agencies to pursue smaller amounts of unpaid tax. Fourth, tax noncompliance is increasing, in part because of the economic challenges facing specific taxpayers, but also as a way in which lower and middle income taxpayers can compensate for the tax cut attention provided to the wealthy. Fifth, though counter-productive in the short term, these sorts of silent taxpayer revolts might wake the nation up to the reality of the concern, not that citizens seeking government services and protection despise taxes, but that a privileged few are doing well at the expense of everyone else by manipulating the tax system and those who write the tax laws. Sixth, when a revenue agency pursues a lower income individual for $500 or $1,000 in unpaid taxes, that individual often lacks the resources to hire an attorney or other representative to work out a favorable deal, whether in terms of settlement or enactment of a tax break that legitimizes what the taxpayer did, but when a revenue agency pursues a high income individual for $20,000 or $100,000 in unpaid taxpayers, that individual almost always can afford to retain someone to work out a favorable deal and someone to push a special tax break through the legislature.

Two Short Words, Thank You

2011-11-24T08:01:00.001-05:00

Like turkey, cranberry, and football, sharing a moment of thanks on the fourth Thursday of November has become a tradition on the MauledAgain blog. With the exception of 2008, an omission for which I don’t have or remember an explanation, I have consistently addressed the underlying purpose of Thanksgiving since 2004: In that year there was Giving Thanks, in 2005, A Tax Thanksgiving, in 2006, Giving Thanks, Again, in 2007, Actio Gratiarum, in 2009, Gratias Vectigalibus, and in 2010,
Being Thankful for User Fees and Taxes. The cumulative list is long, and though I won’t repeat it in this post, I’ll again do the lawyerly thing, and incorporate it by reference. The interesting thing about the list is that unlike my assorted “to do” lists, there’s nothing for me to cross off the list.

Despite the attention given at Thanksgiving to expressions of gratitude, this holiday does not have, and ought not have, a monopoly on saying “thank you.” Those words are, and should be, uttered millions of times each hour across the planet, in a variety of languages. Almost always, they are reactionary. Someone does or says something, and it inspires in another person, or several or more people, the delivery of two words taught to most children at a very young age. For the most part, people do not speak or act in an effort to bring these words out of the mouths of others. They speak or act for other reasons, and the “thank you” might appear in some ways to be gratuitous and extraneous to the conversation or encounter. Rarely does someone, for example, hold open a door for another simply to elicit a “thank you” from the other person. The door is held open because it is the right thing to do, and the expression of appreciation is vocalized because it, too, is the right thing to do. I wonder sometimes, though, if the world would be a better place if we thought about our words and deeds by considering if those affected by what we are about to say or do would be motivated to say “thank you.” Though that might not work with some people – consider the “you will thank me for this later” voiced to defiant teenagers and occasionally to resistant students – it might help open people’s minds to the contemplation of an interaction with another person from that other person’s perspective.

Today I will add that I can think of some things for which I will be thankful when and if they occur. Perhaps those who are in a position to bring these things about will think about the effect of their decisions on the willingness of people to say “thank you.” At what point will the people of this nation collectively turn to the Congress, consider what it does to repair the nation, and say, “Thank you”? At what point will the consumers of this nation collectively turn to those who have sold products and services to them, consider what effect those things have had on their lives, and say, “Thank you”? At what point will the temptation to say “Thanks for nothing” subside?

Today I am thankful to live in a nation where it is possible that these things might come to pass. I am thankful that I can offer these thoughts freely. I am thankful that I have had thousands of reasons over the past year to say “Thank you” to friends, colleagues, acquaintances, and strangers. I am thankful that I have heard friends, colleagues, acquaintances, and strangers say “Thank you” to other people. I am thankful that there have been reasons for people to say those two words and that they have been said.

Tax Policy, Elections, and Money

2011-11-23T08:01:00.003-05:00

One of the benefits of my regular attendance at the gym, aside from the obvious health advantages, is that I have an opportunity to address tax-related questions in an environment outside the law school and law practice worlds. I’ve shared some earlier experiences of this sort in Flat is Not Simple, At Least Not with Taxes, Tax Talk at the Gym, A Zero Tax, A Zero Congress, and Being Thankful for User Fees and Taxes.

The latest episode opened when one of the regulars at the gym said to me, “So have you ever heard of Grover Norquist?” I kept my reply simple. “Yes.” “Did you see 60 Minutes last night?” This required another simple answer. “No.” That brought an interesting question. “So what is it with this Norquist guy and his anti-tax pledge?” My response this time wasn’t so simple. “He doesn’t like taxes and he likes to get politicians to sign onto his anti-tax pledge.” I was not surprised when I heard in turn an unambiguous criticism of Norquist and his anti-tax campaign. Among the reactions was one that stood out. “It’s dangerous.” Of course it is.

As I drove home from the gym, I wondered, “So who is Grover Norquist? Why does he have so much influence? How does he manage to turn so many politicians against taxation even when anti-tax policies threaten the nation’s survival?” It is no secret that in 1985 Grover Norquist founded Americans for Tax Reform. Though the name of the organization suggests one thing, the actual goal is not reform in the sense of making the tax system more efficient, but elimination taxation by opposing tax increases while advocating tax cuts. Norquist was a principal player in the design of the Bush tax cuts.

Norquist, though, does not oppose tax increases simply because he advocates maintenance of the tax status quo. He opposes not only tax increases, but taxes. He has not cloaked his goal behind smoke and mirrors. As Norquist explained, "I do not want to abolish government. I simply want to reduce it to the size where I can drag it into the bathroom and drown it in the bathtub.” So the leader of the anti-tax movement is not only anti-tax, but anti-government. So much for the claims that my likening of the tax-cut movement to a bring-back-the-Wild-West movement is off base.

Yet Norquist, though active behind the scenes, has not been elected to public office. Americans have not been given any choice when it comes to his influence over tax policy. So how did he maneuver himself into this position? It’s another simple answer. Money. Norquist’s father was a vice-president of Polaroid Corporation. According to Americans for Tax Reform’s Form 990, Norquist was paid $222,419 for a 24-hour-per-week job. Norquist was not and is not poor, has not experienced deprivation, and has not suffered through the trauma of being laid off hunting for work. He comes from, and lives in, the ranks of the privileged few. Roughly $4 million in contributions are collected by his organization, and it is doubtful that the money is coming from people with little or no income, or even from people trying to get by on middle-class salaries. The people paying for anti-tax advocacy are people who benefit from that advocacy. According to this article from eight years ago, the tobacco, gambling, and liquor industries lead the way in funding Americans for Tax Reform.

What makes Norquist so zealously anti-government? Considering his claim that “nobody learned anything about politics after the age of 21,” it is likely that something happened when he was young. Something, some event, some person’s experience turned him into a zealot for abolition of the IRS, the FDA, and every other piece of government, a champion for dismantling of public pensions and public schools, and a diehard for privatization of social security. Perhaps the answer lies in a story such as this one, in which Norquist explains how his father would deprive him of some of his ice cream cone. One must wonder whether Norquist's anti-authoritarianism and his rejection of partisanship and support of bitter partisanship has its roots in the psychological abuse suffered at the hands of a cruel parent.

Norquist has acquired sufficient power that, as I described in Food for Tax Thought, he can host a “Tax Policy Dinner” at his home, so that people like Jack Abramoff and Karl Rove can arrange how they are going to direct the representatives of the American people to make tax policy decisions. In 2006, released Senate documents “shed light on how [Abramoff] secretly routed his clients' funds through tax-exempt organizations with the acquiescence of those in charge, including prominent conservative activist Grover Norquist.”

When unelected power brokers control the nation, especially when they use tactics and strategies that border on, if not cross, the line of what is appropriate, it makes a mockery of the ballot box. As I predicted in Food for Tax Thought, “To me, a ‘Tax Policy Dinner’ packed with lobbyists is certain to generate more of what we've seen during the past two decades, things that grill the average citizen, slice and dice paychecks, and sweeten the tax rates for the wealthy. If the trend continues, the tax system will be toast.”

Revisiting a Dependency Exemption Problem

2011-11-21T08:01:00.002-05:00

Five years ago, in Maybe There is A Dependency Exemption Problem After All , I re-examined a dependency exemption hypothetical that was one of several raised in a National Association of Enrolled Agents (NAEA) letter to the Commissioner, asking for clarification of what then were new provisions affecting dependency exemptions, and that I had examined in Defining Dependents: Is it Any Easier?. Now, an alert reader has pointed out to me that the issue raised in the hypothetical was addressed by the Tax Court in a Summary Opinion in July of this year, Abdi v. Comr., T.C. Summary Op. 2011-89 (July 13, 2011).

It is worth repeating enough of the discussion to put the analysis in context:

Recall the hypothetical:

Mom, dad, Alice (14), and Joe (22) live in the family house. Mom and dad file a joint return with an AGI of $400,000. Since Alice is a qualifying child of mom and dad, they could claim her as a dependent but would receive no tax benefit as their personal exemptions are phased out and the child tax credit would not be available to them. Joe is not a full-time student and his only income is a W-2 with $15,000 in wages. Under §152, Alice is a qualifying child of Joe, so he claims her as a dependent and thus gets the child tax credit and yes, even the earned income tax credit. Assuming Joe had no tax withheld, he goes from a balance due of $683 to a refund of $3,158.

I had analyzed the facts in this manner:

I agree that Alice is the qualifying child of Mom and Dad. She is their child. She has the same principal place of abode as they do. She is under 19. She does not provide more than half of her own support. Alice also appears to be the qualifying child of Joe. She is his sibling. She has the same principal place of abode as he does. She is under 19. She does not provide more than half of her own support. But in this instance the Code provides a rule to break the impasse. Under section 152(c)(4)(A), an individual who may be claimed as a qualifying child by two or more taxpayers is treated as the qualifying child of the individual's parent if one of the taxpayers claiming the individual as a qualifying child is the individual's parent. The fact that the amount of the exemption for the parents is zero because their AGI is high enough to trigger total phase-out of the exemption amount does not change the definition of qualifying child.

Frank Degen [who had signed the NAEA letter] explains that the NAEA considers phrase "and is claimed" in section 152(c)(4)(A) as precluding the parents from entering the tie-breaking competition. Literally, this would make sense. The parents, not needing a dependency exemption the amount for which has been phased down to zero, do not enter Alice on their return. Thus, as Frank concludes, the son is the only person claiming Alice and there is no tie to break under the tie-breaking rules.

What happens if the statute is interpreted in this manner? First, taxpayers in the situation that Alice's parents and brother find themselves are left to work out a suitable tax-favorable arrangement. Only one "claims" the child in question and the others fail to "claim" the child. Perhaps Congress intended this flexibility. Under this interpretation, the only time that the tie-breaker would be triggered is when two or more taxpayers both claim the dependency exemption, prompting the IRS, which most likely would notice the double dipping, to apply the tie-breaker. Is the tie-breaker intended only as a remedial tool for the IRS to use when multiple taxpayers with "claims" to the child fail to settle on one claimant? Although figuring out what Congress intends is more a guessing skill than an analytical one, it's safe to suggest that Congress intended for the tie-breaking rule to apply as soon as multiple taxpayers became eligible to claim the child.

Interpreting the "and is claimed" language so that it gives the taxpayers a planning option is inconsistent with how Congress treats failure to claim the dependency exemption when doing so opens up a personal exemption for the dependent. Persons for whom another taxpayer can claim a dependency exemption are not permitted to claim their own personal exemption. Technically, they have a personal exemption but its amount is zero. Taxpayers whose adjusted gross income is sufficiently high to trigger a phase-down of the dependency exemption amount to zero have nothing to lose by omitting the dependent from their tax return. The statute, however, eliminates the dependent's personal exemption even if the eligible taxpayer neglects the dependency exemption.

But it's not so simple. In several other provisions, Congress bases eligibility on whether a dependency exemption has in fact been taken rather than looking to see if one could have been taken. For example, the Hope and Lifetime Learning credits are disallowed to a person if a dependency deduction with respect to that person "is allowed to" another taxpayer. Thus, the other taxpayer can forego the dependency exemption and leave open the credit door for the person in question, which is something that the taxpayer would want to do if the dependency exemption was phased down to zero or close to zero.

Why the difference? No one has any idea. In fact, some have argued that the credit should be disallowed to the person if the other taxpayer is eligible to take the dependency deduction even if the other taxpayer fails to do so. But the language of the credit provision undercuts that argument.

Thus, although it makes no sense in terms of policy or practical application, there is something to be said for the NAEA's interpretation of the "and is claimed" language. After all, to reach the sensible policy and practical application result, Congress should, and could, have used the phrase "and could otherwise be claimed" in lieu of "and is claimed." Congress did not do so. Thus, to the extent the NAEA is asking for clarification, it is a problem that should be mentioned, even though I'd be reluctant to advise Alice's brother to take the dependency exemption deduction and would insist he make his decision after listening to, or reading, a full explanation of the issue and the risks involved in making a yes or no decision.

In the Abdi case, the taxpayer in 2008 was a 21-year-old who lived with his mother and three siblings, including his 11-year-old sister. The taxpayer’s mother did not claim him as a dependent, and though she claimed exemptions for the two youngest siblings, she did not claim one for the taxpayer’s sister. The taxpayer had three jobs and used most of his earnings to contribute to the support the family. The taxpayer claimed a dependency exemption for his sister in 2008, and the IRS disallowed it. The Tax Court concluded that the sister was the taxpayer’s qualifying child and also the qualifying child of the mother. The sister was the daughter of the mother and the sister of the taxpayer, satisfying the relationship test. The principal place of abode test was satisfied because all three resided in the same house. The sister satisfied the age test because she was eleven years old. The sister also satisfied the support test because she did not provide more than half of her own support.

The Tax Court examined section 152(c)(4)(A) as in effect for 2008. The applicable language provided, “. . . if (but for this subparagraph) an individual may be and is claimed as a qualifying child by 2 or more taxpayers for a taxable year beginning in the same calendar year, such individual shall be treated as the qualifying child of the taxpayer who is – (i) a parent of the individual . . .” The court simply concluded, “However, as herein pertinent, this rule comes into play only if petitioner’s mother had claimed [the sister] as her qualifying child. The record shows that petitioner and his mother carefully arranged their tax affairs; petitioner’s mother claimed her other two sons as her qualifying children and petitioner claimed [his sister]. . . Because [the sister] is petitioner’s qualifying child for 2008, petitioner is entitled to the claimed dependency exemption deduction for [his sister] for 2008.” The Court did not examine the inconsistency between the provision in question and other provisions dealing with the dependency exemption, most likely because neither party raised the question. The Court applied the statute as written.

Long before the case reached the court, Congress had amended the provision, effective for taxable years beginning after 2008. Section 152(c)(4)(A) now provides, “. . . if (but for this subparagraph) an individual may be claimed as a qualifying child by 2 or more taxpayers for a taxable year beginning in the same calendar year, such individual shall be treated as the qualifying child of the taxpayer who is – (i) a parent of the individual . . .” The words “and is” were removed. In addition, Congress added, also effective for taxable years beginning after 2008, the following new provision in section 152(a)(4)(C): “If the parents of an individual may claim such individual as a qualifying child but no parent so claims the individual, such individual may be claimed as the qualifying child of another taxpayer but only if the adjusted gross income of such taxpayer is higher than the highest adjusted gross income of any parent of the individual.” If the Abdi case had arisen in 2009 or thereafter, the taxpayer would not have prevailed unless his adjusted gross income was higher than the adjusted gross income of his sister’s mother or father, whichever was higher. There are insufficient facts in the opinion to resolve the question.

Because of the 2008 legislative amendment in Public Law 110-351, the issue raised in the hypothetical has disappeared. Congress decided to eliminate the tax planning opportunity available before 2009. I close with the same words I used to close Maybe There is A Dependency Exemption Problem After All : “It is, though, a wonderful lesson in how the Internal Revenue Code, and tax law generally, becomes more complicated as each year passes. And this is with respect to a fairly simple concept and rule, as tax law concepts and rules go. Imagine what it's like parsing the subchapter K partnership regulations.”

The Tax Consequences of Exorcism

2011-11-18T08:01:00.000-05:00

A reader wrote to me recently, asking an interesting question and demonstrating how taxes can pop up anywhere, anytime. After watching what he described as one of his favorite movies, The Exorcist, he asked “what are the tax consequences of an exorcism on the exorcist and the family of the victim?” He further asked, “If the exorcist is a priest or doctor and operates as a sole proprietorship , what expenses could be deducted? What are the ordinary and necessary expenses of an exorcist? Would the IRS classify the activity as not for profit {hobby Loss} ? Could a home office deduction be possible? What would be his business code? How would the family deduct these costs ? Could the costs be deducted as an itemized medical expense? What are medical expenses? If the parents are divorced or separated , which parent could claim the medical expenses of a qualifying child? If the parent or parents have an employer provided medical reimbursement plan, would the costs be reimbursable? If the priest or doctor injures the victim, could the family sue for damages?”

The answer is not so much one of applicable legal principles, but the application of legal principles to facts that makes law school, for example, even more challenging for those who think the object of learning to be a lawyer is simply a matter of learning the rules. It’s in the application of legal principles to facts that the challenges of law, tax or otherwise, are most pronounced.

First, the exorcist. If the exorcist is paid, the exorcist has gross income. I don’t know enough to conclude if all exorcists are paid. Some, I assume, perhaps in error, do their work as part of their overall responsibilities as, for example, a priest, and are reporting a salary as gross income. But perhaps there is some bonus pay for doing exorcisms. If the exorcist is conducting a trade or business, section 162 applies. What are the ordinary and necessary expenses of carrying on the trade or business of exorcism? Again, what matters are the facts, and I simply don’t know what the full list of expenses would be. It’s easy enough to identify some, such as travel and transportation expenses, which would be deductible to the extent the exorcist traveled from one place of business to wherever the client is. Does the exorcist pay for some sort of liability insurance? If so, the cost of the premiums would be deductible, except to the extent they covered a period longer than a year, which would trigger the capitalization requirements. If the expenses are paid by the exorcist’s employer, which probably is what happens in the case of Roman Catholic priests, there is no deduction. Similarly, if the expenses are reimbursed, the reimbursement reduces the deduction. Are there independent exorcists operating out of their home? I have no idea, factually. Presumably it’s possible, and so the usual rules applicable to the home office deduction would apply. Are there exorcists who engage in that activity for purposes other than making a profit, thus causing their activity to fall within the limitations of the section 183 “hobby loss” limitations? Once again, I don’t know. My guess is that because people dabble in every sort of activity, for every activity there are people who take it to the level of a trade or business and people who do not move it past the hobby or not-for-profit stage. That happens with stamp collecting, horse raising, dog breeding, and surely exorcism. As for business code, I have no idea. Presumably a physician would use the appropriate code for the practice, and non-physicians would use either “All other professional, scientific & technical services” or “All other personal services.”

Second, the client. The primary question is whether the amount paid for the exorcism qualifies as a medical expense deduction, as I cannot think of any other deduction for which it might even remotely qualify. The legal principles sort out as follows. There are two major issues. The first is whether the services must be provided by a physician. The answer is no. Medical expense deductions have been upheld for services provided by licensed and unlicensed chiropractors and osteopaths, by naturopathic doctors, and by Christian Science practitioners. The second is whether the nature of the services qualifies as medical. The IRS takes the position that the cost of psychiatric, psychotherapeutic, and psychological treatment is a medical expense, but that payments to religious science practitioners for spiritual guidance and counseling are not. The IRS has concluded that the cost of deprogramming a person who is in a cult is not a medical expense. The Tax Court has held that amounts paid to Navajo medicine men for healing ceremonies called sings are deductible. So where does exorcism fit? Factually, the better argument probably is that exorcism more resembles a Navajo medicine man sing than does spiritual advice-giving or counseling by a member of the clergy.

As for who claims the deduction, if there is one, the answer is found in applying the usual rules dealing with that issue. The costs are reimbursable under a medical reimbursement plan if the terms of the contract so provide. Whether there are damages available if the exorcist injures the victim demands on the application of tort law principles to the situation, a discussion I will let others pursue. Exorcists have been sued, as evidenced by this report.

If I recall correctly, in the movie there was a good bit of collateral damage. I don’t know if that’s the case in exorcisms generally or whether that was worked up for purposes of making the movie more entertaining. In any event, an issue that was not raised by the reader is whether damage from an exorcism attempt qualifies for the casualty loss deduction. That damage seems no less “sudden, unexpected, and unusual” than damage from high winds, a meteor impact, or a lightning strike, suggesting that a deduction, within the applicable limits, would be allowable.

More Tax Ignorance, With a Gift

2011-11-16T08:01:00.001-05:00

Usually when there is a manifestation of tax ignorance, it leads to bad tax policy, ill-advised votes, or some other sort of economic problem. One or more of those outcomes is still possible with this latest incident of ignorance, but at least the event brings a silver lining. It is now a bit easier to understand why the Congress is unable to do what needs to be done to fix the nation’s economy. Why? Because the nation is being poorly educated by imprecise reporting.

When I read a Philadelphia Inquirer article on the Deficit Commission’s lack of progress, I concluded that someone had made some sort of reporting error or typographical error or some sort of error when I read the following statement attributed to Senator Tom Coburn. Reacting to the debate swirling around proposals to increase tax revenues, to quote the article, “Coburn, a vocal opponent of any tax increase, said he could stand the idea of increasing government revenue if the money comes from restructuring entitlement programs.” I read the sentence again. Was he really claiming that a reduction in spending on Medicare, Medicaid, and Social Security would increase revenue?

Unwilling to dissect the statement without clarification, I did some internet searching and discovered that the precise words had come from the Associated Press and were being reported all across the country. If there was an error, it was not at the Philadelphia Inquirer. From another report, I learned that Coburn had made his statement on CNN’s State of the Union. When I dug up the CNN State of the Union episode on which Coburn allegedly made his statement and listened to it twice, I could not find the statement that Coburn supposedly made. Yes, he did point out that restructuring entitlement programs was necessary to reducing the deficit, but somehow someone’s summary of what he said transformed that statement into a claim that restructuring entitlement programs would raise revenue. Coburn did say, “You can call it a tax increase or you can call it a revenue increase” but that’s an almost accurate statement, though perhaps some people, including some members of Congress, might think that by voting for something called a revenue increase they are not voting for a tax increase. It is possible to increase revenues without increasing taxes, but that requires increasing either fees or other revenue such as income from the rental of government property. As a practical matter, those sorts of revenue pale in comparison to tax revenues, and no deficit reduction can be accomplished by playing only with insignificant fees and items such as rental income. The bottom line is that a reduction in spending on Medicare, Medicaid, and Social Security would not increase revenue, though it would decrease the deficit.

The confusion with respect to revenue, taxes, spending, and deficits is simply another piece of evidence demonstrating how deficient Americans and their representatives have become in terms of understanding economics and government policy. It is the same sort of misunderstanding that causes many people to consider tax credits to be tax reductions rather than the disguised spending programs that almost all of them are, and to resist cutting or repealing them because doing so appears to them to be the same as increasing taxes rather than cutting spending. To the credit of Coburn, and Senator Warner who appeared on the show with him, they have pointed the finger at the politicians who are putting partisan politics above the best interests of the nation. One must hope that the reporting of a statement that was not made indeed is ignorance and not something worse.

What Sort of Tax Increase?

2011-11-14T08:01:00.002-05:00

Headlines, like sound bites, can be so misleading because they are so short. Sometimes succinctness is not a virtue. Consider this headline: GOP Aides: Super-Committee Republicans Open to Tax Increases. Does that mean some Republicans, perhaps some anti-tax-increase Republicans, have changed course? No.

A better headline would have been: “GOP Aides: Super-Committee Republicans Open to Tax Increases and Benefit Cuts for Middle-Class Citizens While Advocating More Tax Cuts for the Wealthy.” Yes, I know, it’s too long for a headline. Making it shorter makes it more volatile. Perhaps “GOP: Tax Middle-Class More to Fund Tax Cuts for Wealthy” gets the point across. But what politician advocating that approach has the courage and dedication to integrity to step up and declare support for that goal? Instead, the complexity of the tax law provides camouflage behind which lawmakers can hide.

Republicans on the deficit-reduction panel want to cut back itemized deductions and credits that primarily benefit middle-class taxpayers, while cutting the tax rate on high incomes from 35 percent to 28 percent. They also seek to cut back on Social Security, Medicare, and Medicaid benefits. The net effect of these proposals would be to worsen the economic position of the middle class, while leaving the wealthy with even more after-tax dollars.

Here’s the first part of a plan for dealing with the federal budget crisis that makes sense. Put the tax rates back where they were before they were foolishly reduced at the same time the nation went to war (as discussed in When Tax Cuts Are Part of the Problem, They Ought Not Be Part of the Solution, and the posts cited therein). Impose a user fee on entities that receive or received federal bailout or other funds and fail to increase the number of employees hired and working in the United States. Enact a mileage-based road fee to fund transportation infrastructure repair (as discussed in Toll One Road, Overburden Others? and the posts cited therein). Remove from the Internal Revenue Code all spending programs, and then put each one up for a vote in Congress as a spending outlay, thus putting an end to the spending increases that have been enacted disguised as tax credits, to bring front and center a serious budget problem discussed in More Criticism of Non-Tax Tax Credits and the posts cited therein. Provide corporations a deduction for dividends paid, and impose a tax on corporate accumulated earnings that exceed five percent of the fair market value of assets reported for financial accounting purposes, thus reinvigorating a rarely enforced existing tax (as discussed in Taxing Capital to Help Capital). Repeal the depreciation deduction for buildings and building components (as discussed in Abolish Real Estate Depreciation Deduction? An Idea Gathers Attention, and the posts cited therein). Repeal section 168(k) and section 179 (as discussed in If At First It Doesn’t Work, Try, Try, Try Again, and the posts cited therein). Repeal the special low rates for capital gains and dividends, and index the adjusted basis of assets (as discussed in, among other posts, Special Low Capital Gains Tax Rates = More Tax Revenue? Hardly.). Remove the limitation on the deduction of capital losses. Subject Social Security benefits to means testing, making relevant the “I” in FICA (as discussed in FICA, Medicare, and Payroll Taxes). Clean up the Medicare and Medicaid programs. Eliminate subsidies to any individual or entity that has positive taxable income or reports income for financial accounting purposes.

Guaranteed, no politician is willing to advocate such a plan. Why? It pretty much chops away at the benefits available to the most of the politician’s fund-raising base. We know who populates that base, and we know who generates the bulk of the money flowing into campaigns. We know that they will not tolerate interference with the good thing they have going. So long as the wealthy and powerful are permitted to exercise their power and utilize their wealth for their own benefit, to the detriment of the nation and everyone else, tragedy looms.

The Fallacy of Taxes and Job Creation

2011-11-11T08:01:00.002-05:00

Jobs are created when there is a need for work to be done. If every owner of property with a lawn did the lawn mowing, there would be no lawn mowing jobs available.

Jobs are not created when someone has money to burn unless there is a need. So in a world where every lawn that needs to be mowed by someone other than the property owner is being mowed because there are sufficient lawn mowing service employees available to do the lawn mowing, a millionaire who decides to hire people to mow the lawns of other property owners isn’t creating jobs. At best, if jobs are created, it’s because someone with a job currently mowing lawns loses that job.

Even if there are lawns that need to be mowed, but that are on properties whose owners cannot do their own lawn mowing, this is insufficient to create a market for the millionaire to exploit. The owners who need lawns mowed but who cannot do the work themselves must have resources to pay for lawn mowing services.

It is quite likely that almost all of the owners who need lawn mowing services are not millionaires. Over the past decade, their real incomes have stagnated. So that leaves very few people able to pay for the services offered by the millionaire with newly hired employees. In turn, the lack of customers means that those employees will quickly find themselves out of a job. This is one reason why tax reductions benefitting the wealthy have not created jobs.

On the other hand, if the resources available to the people who need lawns mowed are increased, the market ramps up. The millionaire in the story finds customers able to pay, and gets a tax deduction, and thus a tax reduction, for paying salaries to the newly hired employees. The current system generates tax reductions for millionaires without the need for tax rate reductions. In fact, restoration of the ill-advised Bush tax cuts for millionaires would be even more incentive for the wealthy to spend their money hiring people, because the resulting deductions would push their taxable incomes down, perhaps into lower tax brackets.

There’s another reason tax cuts for the wealthy do not create jobs. Many of the jobs that could be created require skills that don’t exist in the workforce. As reported by Joseph N. DiStefano in Millions of U.S. Jobs Vacant, But Millions More Americans Out of Work, there is a gap between the jobs that are available and the skills in the labor pool. Though some of the disconnect might reflect unwillingness to do certain work, such as crop picking, landscaping, and lumberjacking, there are all sorts of jobs for which Americans lack the requisite training and skills. That’s not a surprise, considering the mismatching of students and education choices, the failure of American education to provide the sort of education and training that the nation needs, and the cultural phenomenon of most parents thinking that their children are too gifted to take on certain jobs or pursue certain careers. Consequently, as DiStefano explains, employers aren’t hiring “young, entry-level U.S. workers” because older workers and “reliable, desperate immigrants” are more attractive to companies unwilling to train “people likely to leave,” a situation compounded by worker mobility and corporate mergers and consolidations, to say nothing of outsourcing. So all the tax breaks in the world piled onto millionaires won’t make a difference, because, assuming they are in fact job creators, they don’t want to hire, and won’t hire, from the largest segment of the unemployed.

Yet, despite this reality, we continue to hear not only objections to termination of the Bush tax cuts, but cries for even more tax rate reductions for the millionaires and cutbacks in benefits for everyone else, on the specious grounds that this is the solution to the job creation dilemma. The only outcome of more tax cuts for the wealthy and fewer benefits for everyone else is that the people needing lawns to be mowed continue to lack the ability to pay for those services, and the millionaire ends up with even more money that cannot be put to use creating jobs because there’s no one to pay for the services or goods that could be provided by people hired to provide those services and goods. And even in segments of the economy where there is demand, employers cannot find employees because the nation’s education and training system has failed. Instead of pumping more money into the hands of millionaires, why not pump that money into quality training to provide the labor pool that employers claim they need and haven’t found?

So are additional tax cuts for the wealthy really about creating jobs? Or is that just some nice sound bite material being used for other purposes?

Flat Tax Plans Should Fall Flat on Their Faces

2011-11-09T08:01:00.000-05:00

In an article in Monday’s Philadelphia Inquirer, Small Matters: Don't Make the Mistake of Overtaxing Wealth, Bill Dunkelberg tries to make the case for a flat tax, claiming that it would “be a boon for millions of small businesses, reducing the amount of time and money owners had to spend to deliver tax revenue to the government.” His definition of a flat tax is this: “There would be no deductions for anything - not charity, mortgage interest, or a host of other special stuff in the tax code today. There would be only personal exemptions (like now), say $30,000 for a family of four, less for single individuals. Your tax would be a percentage of your income in excess of the exemption.” He gives two examples, using his proposed $30,000 exemption and a 20 percent rate, and concludes that someone earning $31,000 would pay $200 in tax while someone earning $1 million would pay $194,000.

Dunkelberg offers this version of the flat tax in response to the unassailable claim that, “The tax code is a mess,” and as a solution to the not surprising claim that taxpayers invest six billion hours annually filling out tax forms and keeping records. He begins his argument with a plea to ignore the calls for restoration of the tax rates in effect before the Bush tax cuts were enacted, alleging that wealth produces “investment and job creation.” He raises the shop-worn argument that the top one percent earns 20 percent of income but pays 40 percent of income taxes.

The first problem is that the statistics concerning the percentage of income earned by the wealthy are flawed because the definition of income is flawed. A good chunk of the wealthy’s income doesn’t show up in IRS statistics, because it consists of tax-exempt interest, unrealized increases in wealth through the untaxed appreciation of assets, postponed income on account of deferral techniques and nonrecognition provisions, and shifting of income offshore. Thus, when institutions such as Kiplinger describe what percentage of income is earned by the wealthy, or provide calculators to permit visitors to determine which percentile they inhabit, they use adjusted gross income, which is about as good a measure of true income as the wild guess of a child as to the height of a skyscraper. This point is important not only for showing that the wealthy have a much higher percentage of overall income when the quirks of the tax definition of gross income are set aside, but also to set the foundation for one of the flaws in the so-called flat tax solution.

The second problem is that eliminating deductions removes only some of the complexity. Even eliminating credits, which perhaps is part of Dunkelberg’s suggestion to remove “other special stuff in the tax code,” would remove only some more of the complexity. When it comes time to discuss gross income exclusions, what happens? One choice is to eliminate all of them. The other choice is to retain some of them. The latter choice, of course, preserves an arena for the development of complexity. The former choice means that gifts, scholarships, inheritances, life insurance proceeds, employee benefits, and, yes, even municipal bond interest and unrealized asset appreciation, would be taxed. Does Dunkelberg want a student who receives a $50,000 scholarship to be hit with a $8,000 tax (which presupposes a $10,000 exemption for a single person, based on the $30,000 exemption for a family of four)?

The third problem is that eliminating all exclusions, deductions, and credits other than credits for taxes withheld or paid in advance does not simplify the tax system sufficiently. Upper income salaried taxpayers have the advantage of being able to defer income, and their tax liabilities on that income, to a future year, which in present value terms, is a tax savings. Lower income salaried taxpayers cannot afford to play this game because they need their meager salaries to pay the bills and put food on the table. What happens to nonrecognition provisions, a source of much complexity but also a source of tax avoidance that lowers the effective tax burden on taxpayers in a position to take advantage of those provisions? The tax law would be simplified if these provisions were removed, but that would generate all sorts of liquidity issues for taxpayers trying to move assets from one entity to another for business purposes.

The fourth problem is that a flat tax as Dunkelberg advocates, that is, a flat tax with an exemption and the elimination of deductions, would increase taxes on lower income taxpayers and further reduce taxes on upper income taxpayers.

This is not my first attempt, nor my second, nor my third, to explain why the flat tax does not simplify tax law nor deal adequately with the things that generate complexity. Six years ago, in The Revived Forbes Flat Tax Plan, I dissected the proposal to tax all income at 17 percent with a zero percent rate applicable to capital gains, and revealed the complexity generated by taxing capital gains, to say nothing of the unfairness of leaving the primary source of wealthy individual’s wealth accumulation free of taxation. Three years ago, in Flat is Not Simple, At Least Not with Taxes, I explained that a true flat tax, namely, a one-rate tax, does absolutely nothing to simplify the tax system, and revealed that most plans tagged with the label are nothing more than disguised attempts to impose income tax on workers while letting people who live off of trust income and investments off the hook. Two years ago, in Fighting Tax Ignorance, I took apart, among other things, Paul Ryan’s claim that reducing the tax rate schedule to one or even two rates would simplify the tax law. Four months ago, in The Flat Tax Myth Won’t Die, I explained why, although I agree with those who want to remove special interest tax breaks from the Internal Revenue Code, and transform spending plans disguised as tax credits into actual expenditure programs that the public can see for what they really are, I object to retention of special interest treatment for capital gains and other sorts of income leaving wage-earners as the people on whose back the nation is financed.

Because I think that the plans masquerading as “flat tax” plans are designed for the purpose of shifting tax burdens from the wealthy to the poor, I think that the phrase “flat tax” ought to be put out to pasture. That won’t happen, because use of more precise labels would show the plans for what they really are. It’s not surprising to me that advocates of taxing nothing more than wages keep hiding behind the phrase “flat tax.” But it will be to the people who sign on to a flat tax plan as the answer to tax complexity and then discover that the Pied Piper has struck again.

The Tax and Spending Stalemate: Can It Destroy the Nation?

2011-11-07T08:01:00.001-05:00

The nation’s bridges and highways are falling apart. I’ve not seen or read anything to the contrary, certainly no one claiming that the transportation infrastructure is in tip-top condition.

That’s not the only problem afflicting the nation. Far too many Americans, including many in the construction trades, are out of work.

The Administration develops a plan to kill two birds with one stone. Hire unemployed construction workers to fix the nation’s transportation infrastructure. Actually, a third bird gets killed with this stone, because the impact of hiring the construction worker and initiating construction projects will give a secondary boost to the local economies of the areas where the work will take place.

So what does the Senate do? According to many reports, including this one, it rejected the Administration’s $60 billion proposal. Why did all of the Senate Republicans, a Democrat, and an independent oppose the plan? Republicans provided two reasons. First, it is funded with a tax on the wealthy. Boo hoo for the wealthy. If they would have used their tax breaks to hire people instead of financing off-shore tax shelters that don’t benefit America, perhaps this nation’s infrastructure would not have fallen so deep into disrepair. Second, claim these wizards of economics, $60 billion is too much to spend. Hello? The amount needed to fix the nation’s roads and bridges is multiples of $60 billion. Perhaps it is cheaper to let bridges collapse, leading to the sort of deadly consequences of infrastructure funding shortfalls I discussed in Funding the Infrastructure: When Free Isn’t Free? Brilliant thinking. These are the same Republicans who voted down an effort to keep the nation’s firefighters and teachers on the job.

In turn, the Senate’s Democrats then caused the failure of the Republican plan to spend $40 billion to repair bridges and other infrastructure using funding taken from other programs. The Republican plan also included provisions intended to make the nation’s air quality worse than it is, under the pretext that less regulation means better lives for, oh wait, more money for those already with plenty of it.

After telling the nation that it doesn’t deserve quality highways and bridges, the Senate Republican leader claimed that “Democrats are more interested in building a campaign message than in rebuilding roads and bridges.” Hello? What better way is there to rebuild roads and bridges than to offer legislation that provides funding for the repair of roads and bridges? McConnell’s comments are equivalent to claiming that a person riding a bicycle is not trying to ride a bicycle.

The Senate’s majority leader has this one right. “[The Republicans’] goal is to do everything they can to drag down this economy, to do anything they can to focus attention negatively on the President of the United States in hopes that he can get my job, perhaps, and that President Obama will be defeated. So let's not talk about campaign speeches here on the Senate floor. Let's talk about reality." Exactly. Some of the Senators who voted against the legislation previously voted for highway repairs and the requisite funding. It is so unavoidably obvious that the nation’s transportation infrastructure needs have been put in the back seat so that partisan politics can ride up front.

When partisan loyalties mean more than the nation’s well-being, when money means more to wealthy “world citizens” than does the long-term physical security of the nation, and when protection of millionaires who fund campaign treasure chests means more than the lives and safety of the rest of America, the literal physical survival of the nation is imperiled. Without a high-grade transportation network, the economy becomes even worse. There are times one must wonder if the wealthy “world citizens” see that sort of outcome as more conducive to their plans than the sensible approach of spending money to keep the nation intact.

So, yes, as long as this absurd tax and spending stalemate continues, where decisions are not made on the merits of the issue but on the partisan attachments of supposedly public servants, the nation and its infrastructure, the nation and the health of its citizens, the nation and its economy, will continue to stagnate, deteriorate, and crumble. The question now is how close we are to the point of no return.

Undressing the Sales Taxation of Costumes and Accessories

2011-11-04T08:01:00.000-04:00

In response to my recent Halloween post, The Scary Part of Halloween Costume Sales Taxation, Thomas A. Haines, CPA, of Tax Matrix, offers some helpful information about the sales taxation of costumes and accessories, for which I thanked him. He writes:

In contrast to your recent blog, I believe that there is general agreement among the states as to the definition of “clothing” and “costumes.” Our firm specializes in sales & use tax. We advise our clients—generally larger retailers—as to items subject to or exempt from state sales tax.

There are only seven states that provide an exemption for clothing: Massachusetts, Minnesota, New Jersey, New York, Pennsylvania, Rhode Island, and Vermont. Among these states, four have adopted the definitions provided in the Steamline Sales Tax Agreement: Minnesota, New Jersey, Rhode Island, and Vermont. These four define clothing as “human wearing apparel suitable for general use” (see M.S. 297A.67, Subd. 8; N.J.S.A. 54:32B-8.4; R.I. Gen. Laws § 44-18-7.1(f); and, 32 V.S.A. § 9701(24), respectfully). You will note that Minnesota and Vermont laws include a list of examples of “clothing” which includes “costumes” (see M.S. 297A.67, Subd. 8(b) and 32 V.S.A. § 9701(24)(A)(ix), respectfully). Minnesota, New Jersey, and Rhode Island has issued publications or regulations specifically stating “costumes” are “clothing” (see Minnesota Sales Tax Fact Sheet 105, Clothing; Bulletin S&U-4, New Jersey Sales Tax Guide>, and Rhode Island Regulation SU 07-13, respectfully).

Massachusetts provides a sales tax exemption for clothing under G.L. c.64H § 6(k). As you can see, this is a rather broad definition; however, they have provided guidance in their publication, A Guide to Sales and Use Tax. Under “Apparel and Fabric Goods,” they specifically state “costumes” are an exempt item.

New York provides an exemption for clothing under Tax Law § 1105(a). “Clothing and footwear” is defined in Tax Law § 1101(b)(15). You will note that this definition specifically
excludes “costumes.”

Pennsylvania defines clothing under 61 Pa. Code § 53.1. Costumes are deemed “Ornamental wear” as defined under 61 Pa. Code § 53.1(a)(5) and provided via examples under 61 Pa. Code § 53.1(c)(6)(i). “Ornamental wear” is subject to tax pursuant to 61 Pa. Code 53.1(b)(2).

With regard to tuxedos and other formal apparel, they are exempt as “clothing” in Streamline states. They are deemed “formal day or evening apparel” in Pennsylvania and are subject to sales tax (see 61 Pa. Code § 53.1(a)(3)). Massachusetts and New York each impose limits of $175 and $55, respectfully, on exempt clothing. A tuxedo would be exempt should the cost fall below the aforementioned limits.

Accessories, too, have not been a problem. The only exceptions are Santa hats, Santa gloves, and witches hat. These three items are classified these as costumes; however, any thing else is classified as accessories even if worn (e.g. masks, wigs, hand coverings, etc.). To date, we have not received any complaints (from clients or state regulators) regarding the classification of items.

Though progress is being made, there remains a lack of uniformity. Seven states provide a clothing exemption not found elsewhere. Four of the seven agree on a definition but the other three are not yet on board. Costumes are taxed in some of these states but not in others, and similar disparate treatment is afforded tuxedos. Two states impose limits on the clothing exemption, but the others do not.

In an increasingly interdependent world, let alone interdependent union of states, lack of uniformity poses risks. Imagine if states used different shapes, colors, and words for stop signs. Imagine if states decided to use different colors for traffic signal lights. Though the disadvantage to states of doing so – increased accidents, deaths, and injuries – is more readily apparent, states are losing revenue because of variations in tax definitions. It is too easy for someone accustomed to a tax exemption for clothing or to the sales taxation of clothing to take the same approach no matter where they happen to be. States face so many problems, though, that getting them to focus on the technical definitions that may or may not bring Santa hats, tuxedos, and Halloween costumes into the sales tax regime is quiet unlikely. So, buyer beware! Sellers, too.

Taxes by Any Other Name

2011-11-02T08:01:00.000-04:00

About a year and a half ago, in Don’t Like This Tax? How About That Tax?, I criticized a proposal to revamp Philadelphia’s business privilege tax because it would eliminate the income component and measure the tax based on gross receipts, causing enterprises without net income to pay the tax. Six months later, as more details emerged, I returned to the question, updated the examples of how the changes would impact businesses, and in Better to Tax Gross Receipts, Net Income, or a Combination?, predicted that the proposal, if enacted, “. . . would drive every business with gross receipts exceeding $100,000 and with a low gross profit margin out of the city. I wonder what that would do to tax revenue.” Two months later, in Taking Time to Construct Viable Tax Proposals, I explained that hearings on the proposal had been postponed, and that negotiations were underway to phase out the gross receipts portion of the tax so that in effect it would transform into a 6 percent net income tax.

Now comes news that the city’s mayor and council have agreed to modify the business privilege tax. There would be a $100,000 exemption of the gross-receipts portion, and exclusion of the first $100,000 in sales from the net-income portion of the tax. Businesses would be taxed only on sales made in Philadelphia. The bill has not yet been enacted into law.

About six months ago, in connection with a different tax issue, I let the title of a post ask a question: Revenue: Is It All in The Name?. The answer can be debated, but in Philadelphia’s case, according to its mayor, the answer is yes. As reported in this story, the mayor wants to change the name of the business privilege tax to the business income and receipts tax. Why? The mayor said, “But it is not necessarily a privilege to pay taxes,” explaining that attaching the word “privilege” to a tax bothers businesses and even some elected officials.

Is it a privilege to pay taxes? Some people think so. Here’s a blog post titled “Paying Taxes is a Privilege.” Here is another, and yet another. Lest one conclude that the argument is made only by those who are incorrectly accused of benefitting from the tax system, the chairman and CEO of Phillips Beverage Co. agrees. Theological justification for the goodness of paying taxes is explained in this post written from the perspective of Christian humanism. Others, of course, disagree. To see an example of this position, check out dakota99’s comments at this site.

It is not my goal today to resolve the question of whether paying taxes is a privilege. I think so, but clearly others disagree. That much can be confirmed by dropping the terms paying, tax, and privilege into an internet search engine. My goal today is to focus on whether changing the name of a tax by removing the word privilege makes a difference. I doubt it. The word tax remains.

The word that bothers most people is not privilege but tax. That’s one of the points I raised in Revenue: Is It All in The Name?. Perhaps entrepreneurs would react in a less unfavorable manner if the amount in question were called a “publicly-provided services and benefits fee.”

The Scary Part of Halloween Costume Sales Taxation

2011-10-31T08:01:00.001-04:00

Two years ago, in Unmasking the Deductibility of Halloween Costumes (2009), I examined the deductibility, for federal income tax purposes, of the cost of Halloween costumes. Usually, my Halloween posts, which apparently have become a tradition, involve candy and other treats, such as Taxing "Snack" or "Junk" Food (2004), Halloween and Tax: Scared Yet? (2005), Happy Halloween: Chocolate Math and Tax Arithmetic (2006), Tricky Treating: Teaching Tax Trumps Tasty Tidbit Transfers (2007), Halloween Brings Out the Lunacy (2007), and A Truly Frightening Halloween Candy Bar (2008), though last year, in Happy Halloween: Revenue Department Scares Kids Into Abandoning Pumpkin Sales (2010), I focused on a different sort of edible that surely is not candy and for many is not a treat. Now it’s time for another Halloween item that is not candy, and though it may be a treat, the tax aspects are somewhat tricky.

Not too long ago, I had occasion to notice that Halloween costumes were subject to sales tax in some states but not others. In some states, such as New Jersey, costumes are considered clothing and are exempt from sales taxation because clothing is exempt from sale taxation, though before the law was amended adult costumes were not considered to be clothing though children’s costumes were so treated. In Florida, there is no exemption for costumes. Some states, for example Mississippi, exclude costumes from sales taxation if they are purchased for purposes of making a film for which a film production income tax credit is available.

In just about every states, costume accessories, such as masks, are subject to sales taxation. That is the case, for example, in New Jersey. The same principle applies to accessories such as wands, swords, baskets, and broomsticks.

What is scary is that the nation’s legislators cannot agree on whether a costume is clothing, an alarming prospect even aside from the inability to agree on whether clothing should or should not be subject to sales tax. A costume is something that is worn. Clothing is something that is worn. The difference is that a costume is worn only for special occasions. A tuxedo is clothing even though it is worn only on special occasions, and surely there have been men wearing tuxedos who have called the thing a costume. To use a common definition, clothing is something that covers. Costumes cover. The same definition also uses the word “garment” to describe clothing. From the same source comes a definition of costume that uses the terms dress and garment. Some costumes so resemble everyday wear that drawing the distinction becomes arbitrary and nonsensical. Truly horrifying.

It is easy to understand why accessories such as wands and broomsticks do not fall within the clothing exemption. These are not items that are worn, they are not garments, and they do not cover. On the other hand, a mask is worn, and it covers. Why is it classified as something not clothing? It should be terrifying that tax policy rests on analysis devoid of logic, common sense, and consistency. The only logical explanation, aside from the simple expedient of increasing sales tax revenues by narrowing exemptions, is the notion that exempt items are “necessaries” and that costumes and masks, unlike clothing, are not “necessaries.” The difficulty with this analysis is that tuxedos, ballroom gowns, and someone’s fiftieth pair of shoes or thirtieth cocktail dress, are not “necessaries” and yet they are exempt. Frightening, isn’t it? For most people, tax always is, no matter how the rules sort out, but when it comes to the sales taxation of Halloween costumes, it’s simply ghastly.

A Tax Complexity Contest?

2011-10-28T08:01:00.001-04:00

One of my readers, noting that I had disclosed having read the Internal Revenue Code, asked if I agreed that all of the Code, and even the regulations, are “complex and hard to decipher.” He asked, “Can complexity be measured? Would some of the criteria be the number of pages, number of interrelated sections or regulations, number of topics covered in the section, etc. Is there a top ten list of complex code sections?”

My response added questions. The primary question was simply, “How does one measure complexity?” I elaborated on my question: “Number of words? Not necessarily. There is something somewhere floating about that deals with ‘What is the longest Code section?’ but I don’t have a cite offhand. Number of challenging computations? Number of difficult definitions? Number of exceptions? Number of exceptions to exceptions? Difficulty of application? The black letter law ‘gifts are excluded from gross income’ is simply stated, but the question ‘What is a gift?’ requires complicated analysis to come up with something that separates gifts from payments for services. Does it matter if the provision affects 10 people or 1000 people? In other words, is something with a complication level of 6 (whatever that means) affecting 200 people (1200 points) more complicated than something with a complication level of 8 affecting 5 people (32 points)? Some of the most complicated things are the transition rules and effective dates, which technically are in the amending act and not in the Code itself.”

In a follow-up, the reader shared the link to Janet Novack’s Forbes article, The Most Confusing Part of the Income Tax Code, which describes ten areas of tax law that are complex. The reader then asked, “Should you consider the number of tax cases litigated regarding a particular section? Should you consider the National Taxpayer’s Advocate Report 2010 stating that 80 million taxpayers are affected by family status issues such as earned income credit, marital status, child tax credit, and child and dependent care credit? Should you consider if you are wrong about filing status the taxable income and total tax owed or refunded is affected? Should you consider if section 107 parsonage allowance with only 81 words is extremely complex because it has resulted in hundreds of tax cases about the law and whether the section is constitutional?” In yet another follow-up, he asked, “Should you consider the [flush language] sentence from Section 509(a)(4) [509(a)]? Should you consider the premise that if tax experts or AICPA argue for simplification of particular tax codes [sections] then those tax codes [sections] are too complex?”

I don’t agree with the proposition that every code section and regulations section is complex. For example, section 701 provides, simply, that partnerships are not subject to the federal income tax. But I think there is unanimous agreement that many, perhaps most, Code sections are complex. And I think it is safe to conclude that there is unanimous agreement that too many Code sections are complex.

In addition to the issue of deciding which factors should enter into the determination of complexity and the issue of determining how much weight should be assigned to each factor, there is the further, sorry, complication caused by the existence of different types of complexity. For example, some Code sections are complex primarily, or even solely, because of computation complexity. Section 82, prescribing the calculation of social security gross income, falls into this category. Another sort of complexity is interpretational complexity. For example, the flush language of section 509(a), noted by the reader, surely qualifies, as it reads, “For purposes of paragraph (3), an organization described in paragraph (2) shall be deemed to include an organization described in section 501(c)(4), (5), or (6) which would be described in paragraph (2) if it were an organization described in section 501(c)(3).” Still another type of complexity is technical complexity, when redundancies, ambiguities, poor drafting, and slipshod organization complicate the task of trying to determine what the words mean. Often this sort of complexity arises not from any Code section in and of itself but from the intersection of multiple code sections. Yet another type of complexity is revision complexity, the confusion that results from constant changes to the provision, with effective dates, exceptions to the effective dates, grandfather provisions, and other special rules, many of which remain in the amending act but don’t end up in the Code itself.

Should the analysis be limited to entire Code sections? Or is it acceptable to tag particular subsections, paragraphs, subparagraphs, clauses, and subclauses? It is not uncommon to find a Code section with a very simple subsection (a), only to discover that it’s (b), (c), and (d) that cause eyeballs to spin around in a person’s head. Should provisions that are in amending acts but not in the Code qualify? I think so, though that technically makes the question something different from “What is the most complex Code provision?”

If the only requirement to win the complexity contest is number of words, the victor is section 341(e)(1), as described in this web page:

Internal Revenue Code Section 341(e)(1) - Its a 455 word sentence about "Collapsible Corporations"

(1) Sales or exchanges of stock for purposes of subsection (a)(1), a corporation shall not be considered to be a collapsible corporation with respect to any sale or exchange of stock of the corporation by a shareholder, if, at the time of such sale or exchange, the sum of - (A) the net unrealized appreciation in subsection (e) assets of the corporation (as defined in paragraph (5)(A)), plus (B) if the shareholder owns more than 5 percent in value of the outstanding stock of the corporation the net unrealized appreciation in assets of the corporation (other than assets described in subparagraph (A)) which would be subsection (e) assets under clauses (i) and (iii) of paragraph (5)(A) if the shareholder owned more than 20 percent in value of such stock, plus (C) if the shareholder owns more than 20 percent in value of the outstanding stock of the corporation and owns, or at any time during the preceding 3-year period owned, more than 20 percent in value of the outstanding stock of any other corporation more than 70 percent in value of the assets of which are, or were at any time during which such shareholder owned during such 3-year period more than 20 percent in value of the outstanding stock, assets similar or related in service or use to assets comprising more than 70 percent in value of the assets of the corporation, the net unrealized appreciation in assets of the corporation (other than assets described in subparagraph (A)) which would be subsection (e) assets under clauses (i) and (iii) of paragraph (5)(A) if the determination whether the property, in the hands of such shareholder, would be property gain from the sale or exchange of which would under any provision of this chapter be considered in whole or in part as ordinary income, were made - (i) by treating any sale or exchange by such shareholder of stock in such other corporation within the preceding 3-year period (but only if at the time of such sale or exchange the shareholder owned more than 20 percent in value of the outstanding stock in such other corporation) as a sale or exchange by such shareholder of his proportionate share of the assets of such other corporation, and (ii) by treating any liquidating sale or exchange of property by such other corporation within such 3-year period (but only if at the time of such sale or exchange the shareholder owned more than 20 percent in value of the outstanding stock in such other corporation) as a sale or exchange by such shareholder of his proportionate share of the property sold or exchanged, does not exceed an amount equal to 15 percent of the net worth of the corporation.

If there were a way to measure the amount of money expended in an effort to understand and comply with specific Code sections or components thereof, perhaps that would be the best measure of complexity. I don’t think information of that sort is available.

Some complexity, however, is attributable to the transaction under consideration and not to the tax law. If a taxpayer, in an attempt to end-run the system, sets up a business or investment enterprise by using hundreds of entities located throughout the world, cross-linked in complicated ways and engaging in roundabout interactions, the challenging task of applying tax law principles to the arrangement is not the fault of the Code. There also is the reality that what one person finds complicated another person understands with little effort. That, in turn, raises the question of who should be the judge of complexity. Should it be the practitioners who collaborate on ABA and AICPA commentary and proposals for simplification? Should it be taxpayers generally? I think it should be anyone who works with the tax law. So I invite readers to nominate candidates for tax law complexity, specifically Code and Regulation provisions, whether entire sections or specific components, or intersections of multiple provisions. To keep things manageable, readers should select their one candidate for “most” complex. I understand that all of us could easily list ten or twenty or even a hundred complex provisions but the question is “most” complex. If there are sufficient nominations (and am I setting myself up for colossal embarrassment if only two or three readers submit entries?), I will then try to learn how to set up an online poll that permits everyone to vote (and I welcome suggestions on how to do that, and, at the risk of making this complicated, ha ha, on whether the winner needs a majority or simply a plurality). Oh, nominating speeches are not required, as complex provisions speak for themselves!

When Tax Revenues Are Insufficient: Affordability, Resistance, and Diversion

2011-10-26T08:01:00.001-04:00

Though it sounds good at a theoretical level, the practical problem with cutting taxes in order to force a cut in government spending is that the health and safety of citizens is what gets cut. I pointed this out in The Price of Insufficient Tax Revenue, explaining that the combination of additional tax cuts and the refusal to restore revenue lost through previous tax cuts had compelled the city of Camden, New Jersey, to make huge cuts in its police and fire fighting forces. I returned to the same point in Cut Taxes, Cut Spending, Cut Safety?, explaining that the short-term savings predicted from cutting vehicle inspections would end up being swamped by the long-term economic costs of damages caused by uninspected but dangerous vehicles. I questioned the validity of the cut-spending rationale in Whether There Is Money Depends on Who’s Asking, criticizing the decision to pour taxpayer money into the hands of a shopping and entertainment center developer. Not a peep was heard from the anti-government-spending crowd when the spending flowed to their political allies.

Now comes more news of cutbacks in citizen protective services on account of tax revenue shortfalls. In a story appearing a few days ago, readers of the Philadelphia Inquirer learned that Pennsauken Township, in New Jersey, gave notice that they would release 12 police officers at the end of the year. Last year, when a similar notice was given, some police retired, averting the need for pink slips, but reducing the township’s police force. The mayor of the township stated, “We’re very concerned. This is a reduction in force that’s unprecedented.” No kidding.

According to the story, almost 1,400 police officers and fire fighters were laid off in New Jersey during 2010. Even more would have been dismissed but for retirements, compensation reductions, or redirecting state funds to re-hire some police and fire fighters.

The issue has become a political football. Charges of fiscal mismanagement have been tossed about. Questions are being asked, particularly why township workers received raises if there is insufficient money to retain all the members of the township’s police and fire fighting forces. The answer to that question surely is in the simple fact that the raises are a contractual obligation, and do nothing more than maintain the real dollar value of salaries. The question that needs to be answered is why are tax revenues insufficient to cover the township’s spending. A related question is whether the township’s citizens enjoy the choice that is being presented, the choice being one of paying the price of more taxes or the price of reduced police and fire protection.

Is it simply a matter of the citizens of a town being unable to afford what they want? In that case, the town needs to learn to live without the things that cannot be afforded, though the price may be a town wracked by fire and crime. Or is it a matter of the citizens of a town being unwilling to pay for what they want? Or is it a matter of funds that should be used for what citizens want being used for what citizens don’t want? Or is it some combination of affordability, resistance, and diversion?

It has been said that the low must be reached before the climb back to the heights can begin. But for that to be true, there must be knowledge that the low has been reached, and it needs to be reached at a local level. As the Pennsauken Township, Camden, and other New Jersey municipal layoff stories repeat themselves throughout the nation, perhaps attention will turn from the sound bite nonsense being spewed by political candidates to serious fiscal and economic analysis of reality.

Taxing Capital to Help Capital

2011-10-24T08:01:00.002-04:00

A few readers have suggested to me that I dislike, or worse, hate the wealthy. That’s not true. I dislike what many, not all, wealthy do in terms of co-opting Congress and dictating tax policy that favors the wealthy and that has brought the nation’s economy to its knees. Indeed, there are wealthy individuals who advance economic arguments similar to the ones I make, but they quickly become the target of other wealthy individuals and those who are devotees of the agenda that has brought us so much economic misery.

Whether William H. Gross is wealthy is information I do not know, though my best guess would be that he, as manager of a very large investment fund, probably is not in the “other 99 percent.” What I do know is that he has advanced an argument that ought to be given serious attention by his economic comrades. They may learn something about the benefits of long-term rather than short-term planning. In his analysis, Gross describes four factors that triggered the nation’s economic distress: falling interest rates, lower taxes, deregulation, and financial innovation. He notes that attempts to solve the problem focus on cyclical financial issues rather than structural policy solutions. He concludes, “[A]lmost all remedies proposed by global authorities to date have approached the problem from the standpoint of favoring capital as opposed to labor.” He explains that the reason attempts to stabilize banks, to push markets back to their previous peaks, to increasing debt by lowering interest rates have failed. The reason, he asserts, is that when “Wall Street” (capital) benefits at the expense of “Main Street” (labor), both ultimately will collapse.

Gross suggests that “Even conservatives must acknowledge that return on capital investment, and the liquid stocks and bonds that mimic it, are ultimately dependent on returns to labor in the form of jobs and real wage gains. If Main Street is unemployed and undercompensated, capital can only travel so far down Prosperity Road.” In other words, as I have contended, the past decade has seen a resounding growth in capital, translated, the assets and income of the wealthy, to use Gross’s words, “at a great cost to labor.” Fear of unemployment drives down spending, reduced spending drives down housing prices and in the long-run, business profits. To quote Gross again, “Long-term profits cannot ultimately grow unless they are partnered with near equal benefits for labor.” He adds, “The United States in particular requires an enhanced safety net of benefits for the unemployed unless and until it can produce enough jobs to return to our prior economic model which suggested opportunity for all who were willing to grab for the brass ring – a ring that is now tarnished if not unavailable for the grasping.” Over the past few years, in response to my inquiry as to why some who are not wealthy become so defensive when something as simple as repealing the Bush tax cuts is advocated, I’ve been told that failure to reduce even further the taxes on the wealthy will make it impossible for those who are not wealthy to attain the American Dream. Well, perhaps coming from someone like Gross the news carries more heft than when it comes from me. At the moment, folks, the American Dream is pretty much out of everyone’s reach except those who have already achieved it. Gross concludes with a warning that should alarm those who support the policies that have brought us to where we are, especially considering that he is an investment fund manager. He writes, “Investors/policymakers of the world wake up – you’re killing the proletariat goose that lays your golden eggs.”

Aside from feeling a bit vindicated after reading Gross’s newsletter, I began thinking, “How can the private sector adjust to forestall the inevitable crash pattern promised by current practices? Can the private sector do it alone?" Hardly. The private sector’s track record is abysmal in this regard. Many in the private sector resist outside intervention, specifically, government regulation and taxes, but that is the unsurprising reaction of those too proud to admit that their experiment failed. But how can the government intervene? If it orders the private sector to create jobs, the private sector replies that it doesn’t need workers. The government already imposes minimum wage laws in an effort to ensure that capital invests in labor, though ironically some of the unsuccessful economic experimenters are now crying for a reduction in the minimum wage and a narrowing of the situations to which it applies. Gross seems to suggest that higher and longer unemployment benefits is a or the solution, but from a productivity perspective, it makes more sense for the government, that is, society, to get something in return. In the 1930s, people were paid, not to “collect unemployment” while job-hunting, but to do things, such as cleaning up national parks, preserving archival records, and repairing infrastructure. The nation has things that need to be done, ranging from bridge repair to education of the young, and the nation has people capable of doing these things who need jobs, so it’s a match that works, except that just the other day the Senate, in all of its wisdom, said “no” to this sort of solution.

Perhaps another approach is to use the tax law not only to reward those who create jobs, as the current tax law supposedly does, but also to punish those who fail to create jobs. Two-edged swords are much more effective that one-sided blades. The mechanism for doing this already is in place. It’s the corporate accumulated earnings tax, which is avoided by companies that claim they are hoarding profits for “future growth.” Nonsense. Those who wish to avoid the tax can invest the profits in construction of productive facilities and hiring of employees. And the tax needs to be extended to all business entities. I can hear the howls now. “You will kill capital.” To the contrary, capital is killing itself by focusing on short-term profit at the expense of long-term investment in labor. Capital needs to be taxed to save itself. For example, the special low rates for dividends and capital gains need to go, and if there is to be a special low rate, it ought to be on wages, which would reduce the cost of labor. And if capital doesn’t want to be taxed, it can avoid the imposition by hiring people. Recall that I have argued that the best way for the wealthy to lower their tax burden is to create jobs and take a compensation deduction, thus reducing taxable income. For example, in Why the Tax Compromise is a Mistake, I wrote, “If the job creators want a cut in their tax liabilities, they need to do what I’ve been advising them to do for quite some time. Hire people, take the compensation deduction, thereby reduce taxable income, and watch tax liability go down. It’s that simple. Corporations and wealthy individuals are awash in cash, but they’re not creating jobs. Nor will they create jobs as their cash hoards grow from continued tax breaks.” This comment summarized the more detailed explanation in the earlier post, Job Creation and Tax Reduction. The answer is easy, and if the wealthy, including wealthy cash-bloated corporations, cannot understand this and figure it out, then society needs to give them a tax push. They will scream, but iIt’s tough to sympathize with people who reject such an easy approach to solve their alleged high taxation problem, an approach that also solves the jobs problem that afflicts the not-so-wealthy of the nation.

A Tax Book for Writers (and Others)

2011-10-21T08:01:00.001-04:00

Almost five years ago, in A Tax Advice Book for People Who Write and Illustrate Books, I reviewed Julian Block’s “TAX TIPS FOR SMALL BUSINESSES: Savvy Ways for Writers, Photographers, Artists and Other Freelancers to Trim Taxes to the Legal Minimum. He has now released a new edition, with a modified title, “Julian Block’s Easy Tax Guide for Writers, Photographers, and Other Freelancers.” Once again, Julian has given tax practitioners and taxpayers with any sort of connection to the literary or artistic world a handy and helpful explanation of tax tips that they might otherwise neglect.

Julian opens the book with several questions posed by readers of the earlier edition. What are the tax consequences of writing a book for an agreed price, incurring reimbursable expenses only to discover that the publisher went out of business and did not pay? Are the tax consequences different if the writing business is a part-time one? How should an author react when one publisher sends a Form 1099 net of agent’s commissions and the other publisher sends a Form 1099 showing the gross royalty? Must expense reimbursements included in a Form 1099 be reported? Are the expenses incurred for a spouse who accompanies a writer to a conference deductible? What is the tax treatment of a speaking honorarium that the speaker asks be paid to a charity? What sort of charitable contribution is available for donating papers, original manuscripts, and correspondence to a charity? Is a charitable contribution available for an artist who paints a portrait and donates it to a church bazaar? There are more questions. Yes, there are answers, but to discover them, buy the book.

Julian then discusses, in succession, the hobby loss and for-profit rules, the tax treatment of awards received for writing and other accomplishments, depreciation deductions for writers and artists, how freelancers compute health insurance deductions, automobile expenses, travel expenses for spouses, the tax consequences of hiring one’s children, home office deductions, sales of homes for which home office deductions have been claimed, and clothing expenses. Julian then deals with some planning and compliance issues, including the timing of making payments near year-end, sending payments to the IRS, self-employment taxes, net operating losses, retention of tax records, extensions of time to file, amending returns, obtaining tax advice from the IRS and others. He deals with these topics in language suitable for those who are not familiar with the technical verbiage of the Internal Revenue Code.

Julian’s book was sent to the printer near the end of 2010 and was released later in 2011. Shortly after the book entered printing, Congress lowered the employee FICA rate and the self-employment rate for 2011. The book does not reflect this change. One of the challenges in writing tax books, and I speak from experience, is that the subject of the book too often becomes a moving target. If tax books were judged solely by this standard, no tax book of practical utility would qualify. There are sufficient disclaimers in the book, as there are in tax books generally, alerting readers to consult professionals and to check for the latest changes in the tax law.

Writers and other freelancers, especially those unfamiliar with the impact of tax law on their activities, should get themselves a copy of this book. I recommend it just as I recommended Julian’s previous books, "MARRIAGE AND DIVORCE: Savvy Ways For Persons Marrying, Married Or Divorcing To Trim Their Taxes - And They’re Legal," which I reviewed in Tax and Relationships: A Book to Read and Give (Feb. 2006), "THE HOME SELLER’S GUIDE TO TAX SAVINGS: Simple Ways For Any Seller To Lower Taxes To The Legal Minimum," reviewed in A New Book on Taxation of Residence Sales: Don't Leave Home Without It (Aug. 2006), "TAX TIPS FOR SMALL BUSINESSES: Savvy Ways For Writers, Photographers, Artists And Other Freelancers To Trim Taxes To The Legal Minimum," reviewed in A Tax Advice Book for People Who Write and Illustrate Books (Dec. 2006), "Year Round Tax Savings," reviewed in Another Tax Book for Tax and Non-Tax People to Read (Feb. 2007), "Travel and Moving Expenses: How To Take Maximum Advantage Of Every Tax Break The Law Allow," reviewed in Tax Travels and Tax Moves: Book It with Block (Sept 2007), "Ultimate Tax-Saving Resource '08," reviewed in Helping Tax Clients Understand Taxes (June 2008) and "Julian Block’s Tax Tips for Marriage and Divorce," reviewed in Julian Block Talks Tax with Married, Divorced, and Other Couples (Jan. 2011) and “Tax Deductible Travel and Moving Expenses: How To Take Advantage Of Every Tax Break The Law Allows!,” reviewed in Julian Block: On the Road Again (July 2011).

Collecting the Use Tax: An Ever-Present Issue

2011-10-19T08:01:00.002-04:00

On Monday morning, while listening to KYW news radio, I heard a report that caught my attention because the reporter mentioned the word taxes. After listening through the 22-minute news cycle, I paid closer attention when the report ran again, and subsequently found the transcript on the KYW web site. The report focused on a familiar issue, specifically, the struggle that states face in trying to collect use taxes on purchases made by state residents from out-of-state retailers. According to the report, Pennsylvania’s Governor Corbett has joined the long line of state officials across the nation who are trying to deal with this thorny issue.

The problem is that when a Pennsylvania resident makes a purchase on-line from an out-of-state retailer, the resident often does not pay sales tax. Technically, because the purchase is not being made within the state, a use tax is due in lieu of the sales tax, though the use tax is computed at the same rate and on the same items as is the sales tax. Estimates for Pennsylvania’s lost use taxes are in the hundreds of millions of dollars.

What the report got wrong, though, is the applicable law. The reporter quoted Christopher Rants, the president of the Main Street Fairness Coalition, which argues, understandably, that out-of-state on-line retailers not collecting sales or use taxes have an advantage over in-state, bricks-and-mortars retailers. According to Rants, states “can only collect from out-of-state retailers on a voluntary basis.” That is true only if the retailer has no nexus with Pennsylvania. If the retailer has a Pennsylvania nexus, it is required to collect the tax. Though there are many retailers who avoid nexus with as many states as possible, there are far more than a few retailers that have nexus with a significant number of states.

The issue pre-dates the internet, though the emergence of the internet has exacerbated the problem. For decades, Pennsylvania residents have traveled to Delaware to make purchases, because there is no sales tax in Delaware. Anecdotes have been told about Pennsylvania revenue officials watching for vehicles crossing from Delaware into Pennsylvania that appear to be driven by people who have made substantial purchases, but I have my doubts that this sort of enforcement is efficient or effective. In contrast, Pennsylvania’s Liquor Control Board seems to have had better success dealing with attempts to avoid Pennsylvania alcohol duties.

The upshot of the issue comes down to a simple administrative problem. Technically, Pennsylvania residents who purchase items from retailers with no Pennsylvania nexus, whether by going to some other state or ordering on-line, owe a use tax. Very few residents pay that tax, because the state rarely knows about the purchases. When the state does know, for example, when a person brings into the state and seeks to register a boat or vehicle, the use tax is imposed as part of the titling process. Very few items, however, are subject to the sort of titling process required for vehicles and boats.

It is easier, of course, for a state to put the burden of use tax collection on retailers. Retailers bear the burden for sales tax collection, but that obligation is easy to enforce because it applies to in-state purchases and thus to retailers who are physically present in the state and whose in-state businesses are subject to a variety of regulations, including other business taxes, that bring their existence to the attention of the Department of Revenue. On the other hand, a retailer located in some other state, with no Pennsylvania connections, that sells an item to a Pennsylvania resident by way of the internet, is beyond the reach of Pennsylvania’s jurisdiction, just as a French farmer with no United States connections is beyond the reach of the federal income tax. Some states have placed a line on their income tax returns inviting people to report use taxes on out-of-state purchases, but what little evidence exists of the success of this approach doesn’t suggest it is the answer.

This is not my first commentary on use tax collection in an internet age. Seven years ago, in Taxing the Internet, I pointed out that “when it comes to taxing transactions and activities conducted on or through the internet, or taxing access to the internet, those transactions, activities and access should be taxed no differently from the way in which transactions and activities conducted through means other than the internet are taxed” and proposed that states should “tax retail transactions as catalog sales are taxed, imposing use tax collection responsibilities on those with sufficient nexus to the taxing state.” Three years later, in Taxing the Internet: Reprise, I reacted to the introduction of legislation allowing states to shift use tax collection responsibilities to merchants with no connection to the state, noting that despite the claims of advocates for this approach, state 1 has no “independent and sovereign authority” to impose a sales tax on a transaction that takes place in state 2, or to require a merchant in state 2 with no nexus in state 1 to collect use tax on behalf of state 1. I reminded readers that “What’s hurting states is their unwillingness to do what must be done to collect use taxes.” Three years later, in Back to the Internet Taxation Future, reacting to a reappearance of the proposal to permit state 1 to require retailers in state 2 with no state 1 connection to be taxed by state 1, I explained why progress had not been made, pointing out the inability of legislators and others to distinguish between sales and use taxes, the silliness of claims that internet retailers are not required to collect sales taxes at all for any state, the unwillingness of state legislatures and state revenue departments to identify and audit taxpayers not in use tax compliance, the mischaracterizations of the Supreme Court’s 1992 decision in Quill Corp. v. North Dakota, and the inability of legislators, state employees, and citizens to understand the limitations of the Due Process Clause. A week later, in A Lesson in Use Tax Collection, I took a look at California’s approach of requiring in-state business entities to register and report their out-of-state purchases, an approach not without flaws but a step forward in the correct direction.

States, such as Pennsylvania, trying to bring use tax collections closer to what they should be under current law, need to do something more than the cheap “shift the work to out-of-state retailers” approach that violates Constitutional safeguards. Instead, they need to examine what other states have done, to learn, for example, from California officials whether the California approach worked out, to invite businesses to offer their proposals, to start examining tax returns and other records to identify taxpayers most likely to be deficient in use tax payments in amounts making audit and collection procedures worth the effort, and to publicize these efforts in an attempt to educate other residents of their use tax obligations. Perhaps states might consider paying out-of-state retailers to act as collection agents, as it is likely that retailers would be willing to engage voluntarily in use tax collection if the cost of doing so was defrayed by the state with a wee bit of profit thrown into the payment. Surely there are other ideas that are efficient, effective, and within the bounds of Constitutional restrictions.

Taxes and Due Diligence

2011-10-17T08:01:00.000-04:00

Anyone looking closely at the “Links to Other Tax Blogs” on the left side of this page will notice that I’ve added a link to Due Diligence. Though this blog includes commentary on white collar crime, legal malpractice, and several other areas where the lack of due diligence can get lawyers and others into trouble, it also includes a significant number of tax cases and other tax situations where the failure to exercise due diligence sparked adverse consequences. I’m particularly glad this blog exists because it is something to which I can direct students who respond favorably to my advice that those who find both tax and criminal law to be interesting can carve out a niche occupied by relatively few lawyers and that demands a confluence of analytical skills that transcend those used in tax and those used in criminal law analysis.

The Due Diligence blog runs a series of headlines, from which users can follow links to complete stories. The headlines remind me of the sound bite teasers aired by local television stations that are followed by “news at 11” or, for some, “news at 10.” Those teasers almost always are attention-getting descriptions of crimes, accidents, fires, and other ratings-making catastrophes. Consider not only these headlines but the cumulative impression they provide of the condition of the nation’s business sector:

* More Offshore Indictments – This Time Julius Baer Is Target
* Ed May: A Sentence That Ends a Dour Chapter
* Merrill Lynch Tagged Again – This Time for $800,000
* Merrill Lynch Fined $1mm For Fraud
* Lawyer and Client Indicted in Asset Protection Gone Wrong
* NBA Player Arrested for Alleged Ponzi Scheme
* Stock Traders More Reckless Than Psychopaths? Yes Says Study!
* Edward Jones Brokers Under FBI Scrutiny
* New Charges Against Milwaukee MD For Unreported Foreign Accounts

And that’s just the front page with the news from the past several weeks. Why was I not surprised to learn that stock traders are more reckless than psychopaths?

After reading the stories linked to these headlines, and others on Due Diligence, two thoughts popped into my head. First, those who sing the praises of the private sector might not realize how flat their tunes are when one considers that these headlines are but the tip of the iceberg. It’s a significant factor in my conclusion that the “choice” presented by the “free” market is a false choice, as I noted last week in From Fat Tax to Accountability: The Failure of Choice. Second, the resounding chorus from the anti-government, anti-tax crowd for a reduction and even elimination of laws, rules, and regulations protecting society from the rapacity of those who generate the sort of headlines featured in Due Diligence is another chant that fails to resonate with reality. Imagine how much busier the Due Diligence blog would need to be if the regulation bashers had their way. Sadly, it would be reporting the crimes, rip-offs, and scams but not investigations, indictments, convictions, fines, or sentences. I suppose there are some people who would find that to be a better world. I’m not among them.

Tax professionals, as well as other professionals, will find keeping tabs on Due Diligence to be worth the few minutes they invest. That’s why Due Diligence has been added to “Links to Other Tax Blogs.” Check it out.

From Fat Tax to Accountability: The Failure of Choice

2011-10-14T08:01:00.000-04:00

In last Friday’s post about The Fat Tax, I commented on a Danish citizen’s concern that taxes designed to influence behavior raise the specter of government becoming “big brother” by pointing out that the private sector is a “big brother” orders of magnitude beyond anything government can construct. I asked “whether the cameras, the information collection, and the laws should be imposed by a non-accountable private sector oligarchy or by a government accountable through the ballot box.”

Joe Kristan over at Tax Update Blog, though accepting of my position on the fat tax, took issue, in Just Try and Fire the IRS, with my suggestion that the private sector is non-accountable and the government is accountable. Though quoting the entire paragraph, including my claim that the private sector engages in more information collection, more regulation, and more camera installations than government, it does not appear that Joe is contesting my assertion that the private sector collects far more data than does the government.

Joe rests his disagreement on two propositions. First, if he is unhappy with what a private sector enterprise or actor is doing, he can take his business elsewhere. Second, his vote is diluted because he is one of hundreds of thousands or millions, and might even live in a jurisdiction where his vote is meaningless because he is outnumbered by those who vote in the opposite way than he does.

Joe’s proposition with respect to the private sector reflects the theory of a free market but not the reality of the market in practice. Joe gives as an example his ability to take his coffee purchasing activities to Java Joes or Timbuktuu if he becomes dissatisfied with Starbucks. From what I can determine, Java Joes and Timbuktuu are local businesses in Des Moines. How long until they are purchased or run out of business by Starbucks? The notion that businesses thrive by providing good service and go under if the service is bad may be true in some instances for short periods of time, but too many good, small, local businesses have gone under while unaccountable international conglomerates foist bad quality on the market place because of predatory and other questionable practices by the giants. For all the complaints that taxes and regulations kill small businesses, which tend to be of a higher quality, what kills small businesses is the overbearing size and activities of the international giants. Joe’s other example, involving grocery stores, will soon be history. During the last five years in my area, one grocery chain bought out another, another went bankrupt, and a third is scaling back in what many would agree is the first step in its disappearance. The big box conglomerates are killing not only small business but even the larger regional outfits. The danger of an oligarchy is that it stands poised on the edge of a monarchy. The choices may exist, but they are diminishing. The trend isn’t very promising.

But aside from the occasional instances of local choice, there remains the practical effect of monopolistic practice. For example, though I have the theoretical opportunity to use an operating system and software other than Microsoft’s, the insistence of those with whom I interact to receive documents in a Microsoft format means that to exercise my theoretical right to use another operating system I must invest time and money in applications to convert things into Microsoft format. Not that Microsoft products are superior, as the tidal wave of complaints about Microsoft software failures, security breaches, and other problems indicate, yet Microsoft dominates the industry. Why? Because it has managed to persuade government to back off from its antitrust responsibilities. How? Money talks.

Yes, there are private sector organizations that do a good job, even a superb job, with the quality of the product and the quality of the service. But their number is few. And, as I’ve noted, they’re likely to be snatched up by an inefficient corporate mega-monster looking to pounce on every money-maker in sight. Unfortunately, the market is riddled with private sector companies that deliver failure after failure, causing death, injury, and destruction. The private sector delivers not only Pintos, some of whose owners never had the information and opportunity to seek and select a safer alternative, but also things like bad pet food, moldy wall board, unsafe environmental impacts, repeated Blackberry service outages, spotty Internet access, and hundreds and thousands of other bad products and flawed services. Interestingly, far more of this comes from the international companies than from the local, hometown businesses, probably because the latter have a more personal relationship with customers and clients and thus see their revenue sources as people and not anonymous numbers.

Joe’s proposition with respect to the government sector rests on the observation that he is one of hundreds of thousands or one of millions. But that’s true for Joe in the private sector as well. His one vote matters, because of its value when combined with other votes. His walking out of Starbucks because of bad service or poor quality coffee is one decision that matters, because of its value when combined with other similar decisions. Just as Joe can leave Starbucks, he can move from Des Moines, he can move within Des Moines to a different district, he can move out of Iowa. If he’s sufficiently unhappy, he can move out of the country, and as extreme as that choice may be, if Joe can find a country whose government is more to his liking, then he has that option. I doubt we will be waving goodbye to Joe anytime soon.

Joe’s proposition with respect to the government sector suggests that government services are worse than those provided by the private sector. In some instances that’s true. But in other instances it’s far from true. Knock on wood, but I’ve never had a problem with Pennsylvania’s Department of Transportation in terms of licensing and vehicle registration. I can’t say that about the insurance companies. I’ve never had a problem with township-provided, tax-funded trash and recycling pick-up, but I cannot say that about the private contractors with whom I dealt when I lived in townships that went with private collection. When I have had difficulties with government services, in most instances it was a consequence of a government law, regulation, or policy adopted at the behest of a large private sector enterprise or actor with the money to wield influence over the government legislature or agency in question.

And that brings me back full circle to the notion that government somehow is a failure. For every failure of government service, there are disproportionately far more failures in the private sector. When government does fail to respond to the needs of the electorate, it’s often because the private sector organizations are devoting too many resources into owning government and insufficient resources into providing quality products and services. That government-imposed monopoly that Joe mentions as the exception to his free market choice model is the product of the private sector co-opting government. The solution is not to punish the captive government but to put the oligarchs and monopolists out of the vote-buying business.

I maintain my position that those who fear governmental big brother are worrying about a threat that is miniscule compared to the threat of corporate big brother. I maintain my opinion that government is accountable through the ballot box in a way that the private sector is not. Joe can leave Starbucks but he cannot vote out its officers or board, and when he wakes up tomorrow and finds that Starbucks bought out Java Joe’s and Timbuktuu, he cannot run for office as he might if he wakes up to find that a candidate not of his liking was elected.

In theory, a free market working as it should requires a small government to protect that market. In reality, we have a market that is free only for those with money to be free to do what they want, and an oversized government trying to keep up with protection of those afflicted by the abuses of the market place, but hamstrung by the opposition to regulation advocated by those who have the most to lose if they were required to obey the rules of a truly free market. When all is said and done, the lack of transparency and accountability in the private sector makes the government look downright benevolent in that regard. It’s not, of course, but when compelled to choose between two things that are broken, it’s best to put one’s repair skills to work on the thing that’s easiest to fix and whose repaired condition will make it easier to fix the other broken item. A repaired government can fix the broken free market. A repaired free market cannot repair the government.

Revenue: It’s Not Just the Name, It’s Also the Place

2011-10-12T08:01:00.001-04:00

Ever since the Marcellus Shale natural gas boom got rolling, I argued that the Commonwealth of Pennsylvania, as representative of its citizens, needs to impose a user fee to recover from the gas developers the costs that otherwise would be borne by the state government and thus, indirectly, by its taxpayers. I first made that suggestion in Tax? User Fee? Does the Name Make a Difference?. I followed up in Giving Up on Taxes = Surrendering Taxpayer Rights?. A month later, in Life for My Proposed Marcellus Shale User Fee?, I asked, “Have these people been reading my MauledAgain posts?” and answered “Perhaps.” Five months ago, in Revenue: Is It All in The Name? I described an impact fee proposal offered by the President of the Pennsylvania Senate who defended the revenue raiser by noting that it was a fee and not a tax.

Now comes news that the governor of Pennsylvania will propose that individual counties set a per-well fee on the natural gas developers. The fee would be split between the county and the state. The county would use the revenue to recoup the cost of improving infrastructure, repairing roads and bridges, and dealing with the effects of the local population growth that the drilling has sparked. The state would use its share, at the moment pegged at 25 percent, to deal with issues affecting the entire state, such as pipeline safety, environmental effects beyond the counties in which drilling occurs, road and bridge repairs on traffic arteries leading to those counties, health studies, and similar matters.

Not surprisingly, no sooner had the plan been released than the criticism rolled in. Some legislators want the state’s cut of the revenue to be more than what is being proposed. There is concern that counties without wells will engage in “border wars” with counties imposing the fee. The proposed limit on the fee, $40,000 per well, does not have unanimous support, particularly because it will not raise nearly enough revenue to repair the transportation infrastructure or offset the environmental and health damage, and the proposed phasing out of the fee over a 10-year period also does not sit well in some quarters. Still others worry about administrative burdens.

The previous governor pointed out that the fee nonetheless is a tax, and that by shifting its enactment to the county commissioners, the current governor is finding a way to impose a tax without breaking his pledge to prohibit the state from increasing taxes. He has a point. It turns out that the key to getting around the Norquist no-tax-increase pledge is to call the revenue raiser a fee and to have constituent government entities impose the fee. It will be interesting to see, if this plan is adopted and the governor runs for re-election, whether he will claim that he did not raise taxes. It will be even more interesting to see if voters and citizens buy that argument.

Pets and the Section 119 Meals Exclusion

2011-10-10T08:01:00.002-04:00

As further proof that those who teach learn by doing so, I share a question that arose recently when I was guiding the students in the basic federal income tax course though the technicalities of the section 119 meals and lodging exclusion. We were focusing on the unsettled issue of whether groceries constitute meals, an issue that has the IRS and the Tax Court saying “no” and the Third Circuit responding affirmatively. To get the students thinking about the issue, I ask them to give examples of groceries. Of course, they immediately offer the usual items that are not food, such as plastic wrap, paper towels, and cookware. This semester, one of the students pointed out that grocery stores sell pet food.

Until this semester, I had never given any serious thought as to whether pet food fell within section 119. If groceries are considered meals, pet food would qualify, as would the paper towels, but that surely is not the correct result. Because a person can buy “ready to eat” meals at a grocery store, an employer who provides groceries in the form of “ready to eat” meals surely is providing a meal. What about food items that require preparation? A reasonable reading of section 119 should include those items. Why? Consider the paradigm employer-provided meal, that is, food served to employees at a table or collected by employees at a buffet. Not all of the food in those situations is ready to eat. Bread needs to be buttered. Baked potatoes need to be split open and filled with whatever the diner chooses. Sugar and milk or cream needs, for many people, to be added to coffee. These observations might help refine the definition of “meal” when it comes to food delivered by an employer to an employee other than in a dining room, including food that requires additional preparation, but does it help answer the pet food question?

Section 119 applies to meals “furnished to [the employee], his spouse, or any of his dependents.” At first glance, this rules out the pet food because it is not furnished to the employee, the spouse, or dependents. But, on the other hand, the statute does not say “consumed by” the employee, the spouse, or the dependents. Consider the following situation. The employee resides in employer-provided lodging on the employer’s business premises. For example, the employee is employed by a K-12 boarding school and must reside on campus for the convenience of the employer and as a condition of employment. The employer has groceries delivered to the residence on a weekly basis. Ignore the paper towels. Presumably the value of the foods delivered on behalf of the employer are excluded from the employee’s gross income. Suppose that on one evening, the employee’s brother, who is not the employee’s dependent, stops by for dinner. Must the employee include the value of the food consumed by the brother in gross income because it was not “furnished” to the employee, the spouse, or the dependents? Would that not be administratively burdensome? But is it not possible to argue that the meals were furnished to the employee, who chose to share? If so, is it not possible to argue that the pet food shared with the pet dog or cat of the employee’s family falls within the term meals because the food is furnished to the employee?

In my mind, the matter is not resolved. If there has been a case or ruling on the pet food issue, I haven’t found it. But for those who think tax law is “just numbers” and poses no unanswered questions, I offer this question as yet one more example of why tax law is more than numbers and fixed rules.

The Fat Tax

2011-10-07T08:01:00.002-04:00

No, the fat tax is not a tax on fat cats. Nor is there a typographical error, as the fat tax is not the flat tax. The fat tax is a tax enacted in Denmark, applicable to foods with saturated fat content exceeding 2.3 percent. According to this report, Denmark is believed to be the first country in the world with a tax on saturated fat. It is also reported that Finland and Romania are considering a similar tax. Denmark officials explain that the purpose of the tax is not to curb obesity, as Danes are thinner than average, but to increase life expectancy, a measure on which Danes lag behind.

It is unclear what use is made of the proceeds from the fat tax. Ideally, the proceeds would be funneled into health care, either specifically for research and treatment of diseases caused or worsened by the intake of saturated fat or generally for overall health care. Denmark also taxes soda and candy, but it’s also unclear where those tax proceeds are expended.

Readers of MauledAgain know that I have consistently objected to a tax on soda and sugary beverages. As I have explained in a series of posts beginning with What Sort of Tax?, and continuing in The Return of the Soda Tax Proposal, Tax As a Hate Crime?, Yes for The Proposed User Fee, No for the Proposed Tax, Philadelphia Soda Tax Proposal Shelved, But Will It Return?, Taxing Symptoms Rather Than Problems, It’s Back! The Philadelphia Soda Tax Proposal Returns, The Broccoli and Brussel Sprouts of Taxation, and The Realities of the Soda Tax Policy Debate, my objection rests on singling out sugary beverages as a target when there are many other substances ingested by people that contribute to the rising cost of health care. As I explained in The Realities of the Soda Tax Policy Debate:

The problem with these attempted explanations for why sugary beverages are singled out in the “we need revenue, let’s tax something” version of the defeated proposal is that they rest on erroneous factual assumptions, conflate information, and ignore reality. First, though moderate and sensible use of sugar does not trigger obesity and other illnesses, there is no such thing as moderate use of tobacco because any use of tobacco ramps up the risk of cancer and other disease. Second, sugar is not the only substance that, consumed excessively, causes health problems. Excessive intake of fat, for example, is just as dangerous, if not more so. Even water can be deadly, as evidenced by people who have died in foolish water drinking contests. Where is the logic behind “Sugar is bad, tax it, fat is bad, don’t tax it”? The notion that people will take in more sugar drinking soda because soda is not filling ignores the fact that gulping down a huge amount of liquids will leave a person with less stomach room, and less desire, to take in food. Does it make sense to encourage the ingestion of Twinkies rather than soda because it’s better to fill the stomach with sugar and fat? Finally, the notion that cigarette taxes has cut smoking is debatable, particularly with respect to tobacco use among younger people, who supposedly are the targets of the “tax will teach you a lesson” proponents.

From a health perspective, the target needs to be the items originally indicted by the Yale researcher, namely, high-calorie, low-nutrition substances. The issue isn’t so much the item, other than the true poisons such as nicotine and trans-fats, but the quantities being consumed. Even low-calorie, high-nutrition foods can be dangerous if consumed in excess. The focus on soda, intense as it is on the part of the soda tax advocates, suggests something more is at work. I wonder if we would be seeing “donut tax” proposals offered with the same zealousness had it been donut manufacturers who tossed money at school boards to install vending machines in the schools. I wonder.

Interestingly, according to the report, Denmark has banned the use of trans fats, and thus there is no tax on them. Although saturated fats also contribute to cardiovascular disease and cancer, Denmark has opted not to ban them but to tax them, not unlike what governments in the United States do with tobacco.

One Danish citizen interviewed by ABC News explained, “Denmark finds every sort of way to increase our taxes. Why should the government decide how much fat we eat? They also want to increase the tobacco price very significantly. In theory this is good — it makes unhealthy items expensive so that we do not consume as much or any and that way the health system doesn’t use a lot of money on patients who become sick from overuse of fat and tobacco. However, these taxes take on a big brother feeling. We should not be punished by taxes on items the government decides we should not use.” These observations demonstrate the tension between individual liberty and societal responsibility. Governments care about the health of its citizens, or, because governments are the citizens, citizens care about the health of other citizens for several reasons. An out-of-shape citizenry is in no condition to defend the nation. An unhealthy citizenry diverts scarce resources from efforts to make progress economically, socially, culturally, and technologically to efforts to repair the damage caused by unhealthy practices. To the extent health care is covered through insurance systems, it is in the interest of every insured to keep the overall risk as low as possible. That goal is enhanced when unhealthy behavior is reduced, either through education and encouragement or through prohibition and penalty. A balance between individual liberty and societal intervention can be reached if responsibility for individual decisions rested solely on individuals. Thus, the person who engages in unhealthy and risky behavior and who is unwilling to participate in societal insurance or to be subjected to societal restrictions must be willing to bear the full cost, without societal assistance, of the consequences of that behavior. What sort of society, though, is willing to tell a person who shows up at an emergency room, “You chose to ignore the speed limit, not wear a seat belt, and not purchase health or accident insurance, so we cannot assist you.” Frighteningly, there are increasing numbers of people who want to take that approach. But there is a flaw in their reasoning. What if the unhealthy behavior brings consequences beyond the person engaging in that behavior? What does a society say to a person who is injured, or whose family member is killed, because another person’s unhealthy behavior led to, for example, a heart attack that triggered a traffic accident?

The Danish citizen’s concern about big brother is real but misplaced. The fear that government is becoming or has become big brother is a distraction. The deeper concern is that private actors in the private sector act as big brother. For every government security camera, there are many more private sector cameras. For every government form that citizens fill out with personal information, there are many more private sector information collection devices doing the same and more. For every government rule or law, there are many more private sector regulations. The question is whether the cameras, the information collection, and the laws should be imposed by a non-accountable private sector oligarchy or by a government accountable through the ballot box. The latter option, of course, is rapidly disappearing as the oligarchy continues to acquire increasing amounts of electoral power disproportionate to the principle of one person, one vote.

There is value in shifting the cost of health care to the practices and substances that jeopardize good health. But that shifting needs to be consistent. Selecting one or two items, such as soda and saturated fat, while ignoring others, is a recipe for ultimate failure. The ideal tax is one that, for the moment at least, cannot be administered. One of the most serious contributors to health issues is excess caloric consumption. Because calories abound across the menu, a tax on all foods accomplishes nothing in this respect. That is why the better approach is education. Again, there is a serious tension between those who think that dietary and nutritional should be delivered by the public sector, for example, schools, and those who think it is a matter for the private sector. But a quick look at this country’s population is visible proof that reliance on the private sector to promote good health and educate people with respect to beneficially healthy practices has been pretty much a failure. That is why some people advocate soda and fat taxes. Though that advocacy is understandable and well-intentioned, it is too narrowly focused, and if focused appropriately, runs into the barrier of impractical application.

Expending Tax Dollars to Litigate Settled Tax Questions

2011-10-05T08:01:00.001-04:00

It is a basic principle of federal income tax law that gross income includes all income unless an exclusion can be identified that applies to the transaction. Thus, it was surprising to me to discover that a taxpayer had litigated the question of whether a qui tam payment constituted gross income. It surprised me even more that this issue has been litigated more than once.

Before analyzing the federal income tax consequences of a transaction, it is important to understand the transaction. This challenge is one of the significant contributors to the struggles that law students face when trying to learn basic federal income tax law. So what is a qui tam payment? Simply, it is a lawsuit brought by a citizen on behalf of a government. A qui tam payment is an amount awarded to the citizen for his or her efforts in bringing the action.

Once that is understood, it ought to be fairly easy to determine that qui tam payments are gross income. First, there are no exclusions applicable to qui tam payments. Second, there is settled case law that a reward is included in gross income, and section 74 makes it clear that awards are included in gross income, with two exceptions not relevant to qui tam payments. Third, considering that a qui tam payment essentially is compensation for performing a service, it must be included in gross income.

The case that caught my attention was the Eleventh Circuit’s affirmance, in Campbell v. Comr., No. 10-13677 (11th Cir. 2011), of an earlier Tax Court decision in the case (134 T.C. No. 3 (2010)), which somehow I didn’t notice when it was published. The Tax Court concluded, following an earlier decision, that the qui tam award must be included in gross income. That qui tam payments and their tax treatment are no small matter is evidenced by the size of Campbell’s award, specifically, $8.75 million. Campbell, who had been employed by Lockheed, filed two lawsuits under the federal False Claims Act, and Lockheed eventually settled by paying the government almost $38 million. The Justice Department issued a Form 1099 to Campbell to reflect his $8.75 qui tam payment.

The payment was wired to Campbell’s attorneys, who took out their $3.5 million fee, and sent Campbell a check for $5.25 million. Campbell, who prepared his return without consulting anyone, put the $5.25 million on line 21 as other income but left it out of taxable income. Neither the Tax Court opinion nor the Eleventh Circuit opinion explains how Campbell managed to remove the $5.25 million from taxable income. The amount reported as taxable income did not include the amount on line 21.

Campbell argued that a person who brings a qui tam payment acts for the government, and because the government’s recovery is not taxable to it, the qui tam payment is not taxable to the person who receives it. The flaw in the argument is that no one has ever decided whether or not the recovery is included in the government’s gross income, because the government has no need to compute gross income.

Campbell was not the first taxpayer to raise the issue. In Roco v. Comr., 121 T.C. 160 (2003), the Tax Court held that a qui tam payment is gross income. In Brooks v. U.S., 383 F.3d 521 (6th Cir. 2004), the Sixth Circuit concluded that the qui tam payment is a reward, is not within any exclusion, and is gross income. In Trantina v. U.S., 512 F.3d 567 (9th Cir. 2008), the Ninth Circuit reached the same conclusion.

The IRS asserted an accuracy-related penalty against Campbell. The Tax Court upheld that determination. The Eleventh Circuit affirmed. The Eleventh Circuit rejected Campbell’s claim that the payment was disclosed on the return, because disclosure requires more than a mere mention, especially when the taxpayer “incredulously and conveniently ignored or overlooked the amount when it was time to do the math.” The Eleventh Circuit rejected Campbell’s argument that substantial case law authority exists for excluding the payment, a conclusion so obvious that it led the court to consider Campbell’s citations to alleged authority “neither reasonable or persuasive.” Campbell’s claim that of reasonable cause for omitting the payment from gross income also was rejected, in part because Campbell “is a sophisticated taxpayer” and “chose not to consult a professional tax consultant in preparing” the return. Thus, neither exception to the penalty applied.

Though some people think that tax is “just math” with no debatable or uncertain points of law to be resolved, there are more than a few issues with respect to which there is no authority, or there is a split of authority among the Courts of Appeal, or there is some question of applicability or scope. The question of whether qui tam payments constitute gross income is not one of those questions that disproves the fallacy of treating tax as “just math” with no open legal questions to be resolved. Hopefully, the Campbell case is the last one in which government resources need to be expended to hammer home the inescapability of the requirement to include qui tam payments in gross income.

The Strangeness of Tax: When “Bodily” is Not "Physical"

2011-10-03T08:01:00.001-04:00

Section 104(a)(2) of the Internal Revenue Code excludes from gross income “ the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness.” The flush language to section 104(a) clarifies that “For purposes of paragraph (2), emotional distress shall not be treated as a physical injury or physical sickness. The preceding sentence shall not apply to an amount of damages not in excess of the amount paid for medical care (described in subparagraph (A) or (B) of section 213(d)(1)) attributable to emotional distress.”

Thus, if a person negligently inflicts emotional distress on another person, for example, by yelling “boo” and frightening the person in a traumatic manner, any damages recovered by the victim resting on a claim of negligent infliction of emotional distress are included in gross income. But as Robert W. Wood explains in Post-1996 Act Section 104 Cases: Where Are We Eight Years Later?, “[E]xclusion under section 104 is still appropriate for any damages that are based on a claim of emotional distress attributable to physical injuries or physical sickness.” So if the defendant had grabbed the victim while yelling “boo,” causing bruises and other physical injuries, the victim can exclude from gross income the entire amount of the compensatory damages, including not only those based on the bruises and physical injuries, but those based on the emotional distress.

Now comes a Pennsylvania case involving an insurance company’s liability under an automobile insurance policy that adds a wrinkle to the analysis. In this Superior Court case, reported in this story, the court held that a policy covering “bodily injury” extended to emotional distress suffered by plaintiffs who witnessed a family member hit and killed by an automobile, even though the plaintiffs did not suffer physical injury. In reaching this conclusion, the court held that the emotional distress is a “bodily injury” even though there was no physical injury. The policy defined “bodily injury” as “bodily injury to a person and sickness, disease, or death which results from it.” The defendant insurance company argued that the definition in Black’s Law Dictionary should apply, specifically, that bodily injury means “physical damage to a person’s body.” The court explained that although it distinguishes “ ‘bodily injuries’ from purely emotional injuries,” it also rejects “the notion that bodily harm or physical injury necessitates physical impact.” The concurring opinion emphasized that the policy did not require that the person suffering the emotional distress be the person suffering the bodily injury. The court noted that it has not decided whether the family members’ emotional injury claims include a physical or bodily component, pointing out that the usual symptoms of emotional distress “may not involve blunt trauma to muscle, tissue, or bone, but our precedent recognizes them to reflect the significant physical or bodily toll severe emotional distress may take."

Section 104(a)(2), of course, uses the adjective “physical” and not the adjective “bodily.” Given the Pennsylvania approach, these two terms must be treated as having different meanings for tax purposes. In other words, because section 104(a)(2) does not apply to the damages in the Pennsylvania case, the action resting solely on emotional distress grounds, the plaintiffs must be treated as having suffered no physical injury or sickness even though they suffered, for state law purposes, a bodily harm. Does this make sense?

The distinction between physical and non-physical injuries is, to me, rather outdated. When it comes to illness and disease, the distinction between “physical” and “mental” is disappearing, if not entirely gone. Emotional distress causes changes in brain chemistry, which clearly is a physical matter, just as a disease that changes blood chemistry is a physical matter. Perhaps an injury arising from slander or libel is not physical, in the absence of emotional distress symptoms, but the idea that emotional distress damages should be treated differently from those for a broken leg doesn’t make sense in the world of twenty-first century medicine. This is especially so considering that damages for emotional distress arising from a physical injury or illness are excluded.

So the tax adviser to the plaintiffs in the Pennsylvania case will need to explain, “Even though your damages are for a bodily injury, the tax law does not consider them as having been received for a physical injury.” No wonder people think the tax law is bizarre.

It is, of course, time for Congress to fix section 104 by either by repealing it or by tearing it down and building it back up into something sensible, justifiable, and understandable. Taxpayers deserve no less.

Infrastructure, Tolls, Barns, Jackasses, and Carpenters

2011-09-30T08:01:00.003-04:00

The subheadline of a Philadelphia Inquirer article earlier this week caught my eye. “People want improvements, but no one wants to pay for them.” Unfortunately, this disappeared from the online version of the article.

When I saw that subheadline, I immediately thought of various MauledAgain posts in which I had made the same point. I touched in this problem in Funding the Infrastructure: When Free Isn’t Free, in The Price of Insufficient Tax Revenue, in No Tax Increases, No Fee Increases, No Roads, No Bridges?, and in Being Thankful for User Fees and Taxes. The underlying tension between wanting something and not wanting to pay was corroborated by the poll that I discussed in Poll on Tax and Spending Illustrates Voter Inconsistency.

The article in question described, among other things, the frustration faced by regional planners who are trying to fix regional problems, including many that adversely affect the economy. For example, for years there has been agreement that the choked traffic on Route 422 needs to be alleviated in some way. One of the proposals is to impose a toll on that highway. When this proposal first emerged, I explained, in Toll One Road, Overburden Others?, why this is not a good way to raise the required revenue and why, as readers of MauledAgain know, the solution is the mileage-based road fee, a topic on which I have written numerous times, in Tax Meets Technology on the Road, and thereafter 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, and Is the Mileage-Based Road Fee So Terrible?.

The proposed toll would be used to add lanes to Route 422, widen bridges, install monitoring and signaling equipment, and to restore a commuter rail line that runs parallel to the road. Absent a toll, the executive director of the Delaware Valley Regional Planning Commission predicts it will take decades to come up with the money. He did not, however, mention mileage-based road fees. But perhaps he is just as pessimistic about the prospect of those being enacted.

At the community forum held recently on this proposal, the audience almost universally spoke out against tolls. One question was very telling. Someone asked, “Why should I pay for someone else to ride the train?” The article doesn’t disclose the answer, or if there was an answer. But the answer is simple. The toll not only purchases an improved road, it purchases space on the improved road by making train use economically efficient and attractive to someone who would otherwise be using the road, but who would give up road use if train use was economically more desirable. That’s a far different matter than paying a toll to fund unrelated projects, as I discussed in Soccer Franchise Socks It to Bridge Users, Bridge Motorists Easy Mark for Inflated User Fees, Restricting Bridge Tolls to Bridge Care, Don't They Ever Learn? They're At It Again, A Failed Case for Bridge Toll Diversions, DRPA Reform Bandwagon: Finally Gathering Momentum, When User Fee Diversion Smacks of Private Inurement, and Toll Increases Ought Not Finance Free Rides.

Though citizens attending the meeting and most legislators oppose tolling, when asked, “What else are you willing to do to solve the problem,” they are silent. It isn’t very helpful to simply claim that the government needs to do more with less. Unless, perhaps, they advocate going to gravel roads that become rutted tracks because of reduced capital and operating outlays. More lanes, less paving material. There’s some more with less for these people who want to ride free when there is a cost to what they are doing.

The underlying problem is that an increasing proportion of the nation’s citizens are people who grew up accustomed to getting without giving, or at least getting more than has been given. As I explained in Being Thankful for User Fees and Taxes, “Though anti-tax sentiment is popular, it too often is expressed in thoughtless condemnation of all taxes, as well as user fees. At some baser level, perhaps tied into the limbic system, humans simply prefer to get as much as they can get for free. They dislike taxes, but complain no less when paying bills or forking over cash at the checkout counter. Perhaps the trait is acquired and refined during childhood, when life for many people does appear to be an experience of getting things for nothing.”

Sadly, the focus on reducing what is paid in the short-term overlooks the longer term price that will be exacted. Consider Future Mobility in Pennsylvania: The Condition, Use and Funding of Pennsylvania’s Roads, Bridges and Transit System, a report issued by TRIP, a “non profit organization that researches, evaluates and distributes economic and technical data on surface transportation issues.” Lest anyone doubt the nonpartisan character of the organization, it “is sponsored by insurance companies, equipment manufacturers, distributors and suppliers; businesses involved in highway and transit engineering, construction and finance; labor unions; and organizations concerned with an efficient and safe surface transportation network.” As I pointed out, again in Being Thankful for User Fees and Taxes:

After reading the report, I wondered how the yes and no responses would turn out if each motorist in Pennsylvania were to be asked this question: “Would you be willing to pay an addition $1 per gallon in gasoline taxes if the proceeds of that tax were used to improve and repair Pennsylvania highways and bridges?” My guess is that most people would say “No.” I wonder what would happen if people understood that those improvements and repairs, by decreasing congestion, enhancing safety, and reducing vehicle operating costs, would save each motorist an average of $800, to say nothing of creating jobs. Motorists in Philadelphia would save $1,500 each year, while those in other urban areas would save between $900 and $1,000.

This sort of reasoning finds little favor among those who are the first to complain if a public good disappears or is not up to par, but lead the charge opposing taxes, tolls, and any other funding for the things they demand. Somewhere between being an infant, when nothing is paid for what is taken, and reaching the stage of responsible citizenship, some sort of transformation needs to occur. Recently, it hasn’t been happening. As the Inquirer article notes, in bemoaning the lack of public leadership from elected officials and the inability of citizens to understand the true cost of what they demand, former House Speaker Sam Rayburn put it best, “Any jackass can kick down a barn. It takes a good carpenter to build one.” The article concludes, “At this moment in Pennsylvania politics there don’t appear to be many carpenters left.” How true. How sad. How disappointing.

At least when I hear someone complain about traffic on Route 422, I have the option of asking the person’s position on tolls. Or mileage-based road fees. I take education opportunities wherever I can find them. Perhaps one by one, people will have the opportunity to give deep thought and apply reasoning to situations that too often get the simple “take but don’t give” instinctive mentality with which we are born. Instinct without reason does not nurture a civilized society.

Taxes and the Funding of (De)Regulated Markets

2011-09-28T08:01:00.001-04:00

The anti-tax lobby is fond of singing the praises of the “free market” and justifying, in part, their aversion to taxation because it provides funds for government “interference” in the private sector. I’m a fan of the private sector when it works well, but I’m also a fan of regulation sufficient to persuade the private sector to work well and to rescue the victims of the private sector when it does not work well. Several years ago, in Keeping Free Markets Free, I rested my criticism of market deregulation on, among other things, this conclusion: “I do think that the market is not providing sufficient quantities of necessary goods.”

Last week, in Drug Shortage Stirs Fears, the Associated Press disclosed that its investigations uncovered at least 15 deaths during the past 15 months attributable to a “severe nationwide shortage of drugs for chemotherapy, infections, and other serious ailments.” Hospital pharmacists, we are told, “are scrambling to find drugs.” Among the reasons for the problem are insufficient profit margins, a near-monopoly in the industry, theft, and an unlicensed “gray market” that is buying up these medications and selling them at “many times the normal price.” There is no way for the medical profession to determine whether drugs moving through the “gray market” have been properly refrigerated or are still within their expiration dates.

The Food and Drug Administration and the health subcommittee of the House Energy and Commerce Committee have held hearings on the issue. Leaving regulation as it is or prescribing less regulation is a recipe for more deaths and disease. Increasing regulation surely will bring howls of protest from those who benefit from the insufficient regulation. Increased regulation will require funding. Funding requires revenue. I wonder if “tax and spend” is a truly horrible thing even if the “tax and spend” is designed to help Americans stay healthy. In Can Tax Rebates Help Prove Malthus Wrong?, I explained why the free market’s supply-demand curve “works well for some things, but . . . becomes very inelastic when dealing with life's basic necessities.” In It Could Be Worse Than Taxation, Worse Than Stimulus, I explained that, “Sometimes the so-called free market doesn’t do what it needs to do because it really isn’t free.” As I pointed out in Keeping Free Markets Free, “The market is unfree because there are biases, there is corruption, there is bullying, there is cheating, there are monopolistic practices, there are all sorts of behaviors, characteristics, and practices that are inimical to the notion of ‘free.’”

Surely the anti-tax lobby will hold to the proposition that any increase in funding for regulating the pharmaceuticals market, assuming that they lose the anti-regulation effort, should come from other programs. This is the approach that they have been taking, for example, with respect to disaster relief funding, as I explained in Storms, Public Infrastructure, and Taxes and in Disaster Relief, Taxes, and Offsets. The absurdity of this position is highlighted by the following questions: Was the government’s protection of citizens against widespread drug shortages hampered by cuts in the FDA’s budget? Were those cuts made to provide funding for other programs? People are dying because of the ideological biases of a small minority holding a nation hostage. But that doesn’t seem to matter to those who detest government, taxes, and regulation.

Disaster Relief, Taxes, and Offsets

2011-09-26T08:01:00.001-04:00

Last month, in Storms, Public Infrastructure, and Taxes, I criticized the posture of the anti-tax crowd for its insistence that governments should fund disaster relief only through cuts in other programs. I summarized the anti-tax position as follows: “So in the anti-tax world, the county that wants to replace the washed out bridge or the city that wants to restore train service needs to eliminate police departments, lay off fire fighters, close down the sewage treatment plant, or reduce already bare-bone services to the citizenry.”

Now we are getting an opportunity to see how this plays out at the federal level. The Federal Emergency Management Administration (FEMA) and the Army Corps of Engineers, the two agencies primarily responsible for assisting Americans after natural and other disasters strike, are just about out of money. The Congress is now engaged in a drama that rivals the debt ceiling increase circus, but that is getting less attention. Perhaps one reason it is getting less attention is that the process and the debate are so convoluted one needs more than a road map to follow the twists and turns.

A full account of how Congress has been handling this problem can be found in several places, including this story. Additional funding for FEMA and the Corps of Engineers is wrapped into legislation that provides temporary spending that keeps the government running for seven weeks beginning on October 1, when the new fiscal year begins. This stop-gap is required because Congress has failed to approve a budget and enact spending authorization for the fiscal year ending September 30, 2012.

Last Wednesday, the House of Representatives defeated a Republican proposal to authorize $1 billion in disaster funding when the legislation is signed and $2.6 billion for the September 30, 2012, fiscal year. The legislation “offset” the $1 billion with a $1.5 billion cut in a loan program designed to assist car manufacturers increase the production of fuel-efficient vehicles. How did a Republican proposal fail to get through a Republican-controlled House? Forty-eight Republicans voted “no,” not because they were offended with the notion that $1.5 billion in spending was being cut to provide $1 billion in disaster relief money, but because they object to what they see as excessive government spending in the proposal. So the Republican leadership tinkered with the legislation. The bill was amended to cut $100 million from a federal loan program designed to make the nation less dependent on foreign oil. That $100 million cut, a drop in the bucket, somehow convinced 23 Republicans to flip their position on the legislation, which then squeaked by on Thursday.

In the meantime, the Democratic-controlled Senate, in response to a request by the President for $5.1 billion in additional funding for FEMA and the Corps of Engineers, approved $6.9 billion. The legislation passed with bipartisan support, and did not include spending offsets.

After the Republican-controlled House managed to pass the modified Republican legislation, Senate Democrats suggested they could live with the reduced amount of funding, provided the offsets were removed, even though the amount of funding in the House bill is “insufficient.” Nonetheless, Democratic legislators understandably are accusing certain Republicans of taking a “my way or the highway” approach, while Republicans bicker among themselves.

As of Friday, Congress was slated to go on recess for a week. By the time it would reconvene, the new fiscal year will open. Without resolution of this issue, the government is unfunded, and could partially shut down. The House Majority Leader, however, confidently predicted that there would be an agreement. The Senate Majority leader had suggested agreement was possible, but made that comment before the House added offsets to the legislation. He predicted either weekend sessions or a delay in the recess, whereas his House counterpart’s reaction to a weekend session was, “I surely hope not.”

Agreement will happen only if one of three things occurs. First, the Senate gives in to the current House version of the legislation. Second, the House agrees to the Senate version. Third, a compromise is reached. The first two possibilities are possibilities in name only. Compromise is difficult because a significant group of Representatives are opposed to any sort of compromise and have a track record of getting in the way of compromise. The only reason it is not absurd to predict that an agreement will be reached, somehow, is the political impact of subjecting an unhappy electorate to yet another manifestation of governance gridlock.

Opponents of government spending, many of whom, admittedly or not, are opponents of government, period, reminisce blissfully about the way things were a long time ago, so long ago that it was before they were born. Yes, there was a time when government disaster relief did not exist. Is that what these anti-tax people want? Then say so. Stand up and say so. Stand up and tell Americans that you oppose funding of efforts to end reliance on foreign oil. Stand up and tell Americans that you oppose funding efforts to increase the use of solar energy. Don’t wrap it up in some sort of “offset game.” Don’t hold disaster relief and the people in need of assistance as hostages in your anti-government and anti-tax campaign.

Taxes As a Weapon in Class Warfare

2011-09-23T08:01:00.002-04:00

Even before the President formally announced his plan to ensure that wealthy individuals did not pay federal income taxes at rates lower than those imposed on less fortunate individuals, the Republicans, as reported in stories such as this one, lambasted the proposal, accusing the President of triggering “class warfare.” In response, when he unveiled his plan, the President succinctly stated, as widely reported, including this story, that “This is not class warfare.”

Guess what? They’re all wrong.

When a class of individuals, even if not joined by everyone within the class, attempts to take away from another class of individuals, even if not everyone in that class is targeted, that constitutes “class warfare.” So take careful note, I am again criticizing the President. Sorry, President Obama, but you are wrong. This is class warfare.

But the Republicans similarly are in error. The President’s proposal is a defensive tactic on behalf of the majority of Americans, an attempt to regain what has been taken earlier in the class war. This particular class war began when wealthy individuals saw an opportunity to make their economic position even more advantageous, by “persuading” their Congressional lackeys and a compliant President to reduce their taxes during wartime, and to gain popular support for a foolish move by tossing several nickel-and-dime tax breaks for not-so-wealthy Americans. The effect of those tax cuts, the overwhelming bulk of which went to the upper class, was to wreck the economy for everyone else. Though some among the wealthy caught the wrong end of the boomerang and experienced asset reduction, it’s much easier to cope with a 30% loss of income or a 20% decline in investment value when one is starting with hundreds of millions of dollars or more of wealth and income than when one has barely $5,000 in assets and a $25,000 salary.

This recent bout of class warfare – something that has been around as long as there have been civilizations – involves far more than taxes. A number of factors are contributing to the rapid speed with which the wealthy are out-distancing, by orders of magnitude, the rest of the population. Consider that the advocates of preserving, and even enlarging, tax cuts for the wealthy are also found among those who are attempting to eliminate unions, scale back or eliminate Medicare, reduce or repeal the social security system, back away from health care reform in a manner that leaves the vulnerable bereft of medical assistance, and cut spending that primarily assists those who are losing the current class war. Casualties from the economic chaos of the past decade include the Medicaid program, the nation’s infrastructure, environmental protection, and public education. It’s not the wealthy who suffer from these national deprivations.

The important question is “Why?” Is it just a matter of using one’s excess wealth to acquire additional, ostensibly to create jobs that never materialized but perhaps to satisfy some sort of addiction? I think not. That could still be accomplished, though perhaps requiring a little more time, without destroying the middle class. The goal is more than just amassing wealth. The goal is to acquire control of the political system. Throughout history, the middle class – whether artisans or scholars, whether craftsmen or small merchants – have posed a threat to the power elite. Royalty, nobility, and peasants is the mix that works best for royalty and nobility. Whenever the middle class has prospered, royalty and nobility have not. Think 1776. Think 1789. It is important to note that democracy flourishes when the middle class prospers, and that when the middle class doesn’t exist, or is marginalized, democracy exists, if at all, in name only. By siphoning wealth to itself, the wealthy class undermines the political power of the middle class, and when it uses its wealth to mislead voters into supporting the very practices that voters profess to resent, it subverts the nation’s existential democratic nature. The poor and the middle class aren’t the ones pouring truckloads of money into political campaigns, often masked through corporate and foreign conduits.

In his explanation of why the President’s attempt to eliminate instances of wealthy individuals paying taxes at lower rates than others, to say nothing of the various phase-out bubbles that place the highest effective marginal rates on the middle class, must be rejected, Senate Minority Leader Mitch McConnell spewed out the same old disproven canard. He offered this declaration: “But we don’t want to stagnate this economy by raising taxes.” Consider that taxes make money available to hire people to fix the nation’s infrastructure, to restore the nation’s civic integrity through public education, and to fund programs that ultimately gave the world microwaves, advanced plastics, the internet, and a long list of technical and scientific advances sourced in government programs, to give but a few examples of why taxes are the price paid for a civilized and democratic society. The claims that cutting taxes for the wealthy stimulates the economy, and that restoring an unwise and unproven tax break for the wealthy will hurt the economy, is nonsense. Someday those beliefs will find themselves on the dust-heap of history along with things such as flat-earth claims and the assertion that the sun rises in the north. What McConnell should have said is, “But we don’t want to stagnate this economy, which is working so well for the wealthy and terribly for everyone else, by letting unwise tax cuts expire.” Of course he won’t say that. It’s not something they want Americans to know.

Toll Increases Ought Not Finance Free Rides

2011-09-21T08:01:00.002-04:00

When reality hits the ideal, the ideal almost always caves in. Consider what has been happening when the anti-tax crowd meets the reality of revenue shortfalls. They increase tolls, perhaps thinking that constituents will be fooled by the absence of the phrase “raise taxes,” and then use the increased toll revenue for purposes other than maintaining the toll road and paying for its wider adverse impacts. Worse, these anti-tax advocates, also staunch opponents of government borrowing, have instructed toll commissions to borrow money to be repaid through increased future tolls. Do they really think they are fooling the citizens who bother to educate themselves about this issue?

Fortunately, I’m not the only person trying to educate people on the “we won’t raise things called taxes but we’ll get you in other ways” anti-tax scam. In N.J., Pa. Tap Toll-Road Funds for General Road Projects, Paul Nussbaum, a Philadelphia Inquirer staff writer, describes how Pennsylvania and New Jersey have been diverting tolls from toll road maintenance to other projects. Those responsible for the toll roads project that over time those roads will deteriorate because of decreased monies available for maintenance.

There are some who argue that tolls should be diverted to other uses. The reasoning is questionable. One advocate claims that because the “transportation network is interconnected, . . . it makes sense to use toll revenue on projects that reduce traffic congestion” on the toll roads. Wait. It makes sense to divert revenue so that revenue can be decreased through reduced usage of the toll road? Why not a fee on train passengers to pay for the bridges that toll roads need to build to go over or under railroad tracks? The silliness of that question demonstrates the weakness of the toll diversion justification argument. When New Jersey’s governor proposed the toll-diversion scheme, I took it apart in User Fees and Costs, and the followup, When User Fees Exceed Costs: What to Do?.

The numbers are not insignificant. According to Nussbaum, last week the New Jersey Turnpike Authority agreed to divert another $324 million to the state. He also discloses that “[s]ince 2007, the Pennsylvania Turnpike Commission has sent $3.1 billion - more than it collected in tolls - to Harrisburg for statewide use.” How did they manage to do that? The legislature planned to impose a toll on I-80. Thinking that this was money in the bank, the legislature, before getting clearance from the Federal Highway Administration, ordered the Turnpike Commission to borrow billions of dollars, and to turn that money over for repairs to other roads and highways. The amount? Nearly one billion dollars a year. The folks who pulled this stunt have committed the turnpike to paying half a billion dollars a year for 47 years, to be funded by annual toll increases on a highway that had only five increases in 68 years. When the I-80 toll proposal was disapproved by the FHA, the legislature mandated toll increases on turnpike users to pay for the money it spent before it actually had that money. Keep in mind who did this. Politicians who have accumulated votes by criticizing deficit spending. Folks, spending money that one does not have and might not ever have, is deficit spending. Can you spell “hypocrite”?

And tolls are scheduled to increase in 2012 for all the toll roads in both states. In New Jersey the increases are at least 50 percent. Yes, you read that correctly, 50 percent. And this from the legislators and governors who claim to be anti-tax because increased government revenue is such a bad thing. Apparently it’s not a bad thing when it provides politicians with dollars to funnel to their pet projects without raising anything with the name of “taxes.” They think they can get away with this because they think citizens are ignorant (and if they are, the politicians are in many ways responsible, from underfunding public education to peppering society with misleading sound bites). In User Fees and Costs, I explained that “Supporters of the [New Jersey toll diversion] plan think that motorists using E-Z-Pass won't object as much as they otherwise would because the don't 'see the actual fees' being paid.” Who has the moral high ground on this point?

I had predicted that the I-80 tolling plan would not work, because it diverted tolls. Had the legislature been paying attention, it would have designed the plan as a true toll arrangement and not as a hidden revenue generator. In Are State Gasoline Taxes the Best Source of Highway Revenue?, I rejected the I-80 toll diversion plan by arguing, “It makes no sense to require drivers using the turnpike or I-80 to subsidize repairs to Routes 1, 3, 320, 252, or 202, to name but a few highways in the southeastern part of the state where I live.” In Raising Revenue Through Tolls Isn't Simple, I explained, “[The FHA] concluded that Pennsylvania's proposal did not adequately meet the threshold for the three-state federal plan. The FHA noted that Pennsylvania did not demonstrate that the tolls would be used only for I-80 improvements. The FHA did not seem to agree that toll revenues used to fund highways and bridges elsewhere in the state constituted operating costs of I-80.” I had that one right from the beginning. Harrisburg, though, was not listening or reading. Had it been sensible with the I-80 toll proposal, it would have generated sufficient funds for maintaining and improving that important road. But by reaching for too much more, the legislature proved once again the saying about bears, bulls, and pigs.

The diversion of tolls to other uses is not a new ploy. For example, for years the Delaware River Port Authority used tolls for all sorts of projects having nothing to do with maintenance and repair of the bridges under its supervision. I explored this in Soccer Franchise Socks It to Bridge Users, Bridge Motorists Easy Mark for Inflated User Fees, Restricting Bridge Tolls to Bridge Care, Don't They Ever Learn? They're At It Again, A Failed Case for Bridge Toll Diversions, DRPA Reform Bandwagon: Finally Gathering Momentum, and When User Fee Diversion Smacks of Private Inurement. The warning I provided in DRPA Reform Bandwagon: Finally Gathering Momentum is one that should be viewed carefully by turnpike users, other motorists, and legislators, though the latter might not do so until pressure is brought by motorists. I explained:

Some time ago, I criticized the decision of the Delaware River Port Authority to use toll revenues for contributions to the construction of a major league soccer stadium. In Soccer Franchise Socks It to Bridge Users, I pointed out that tolls paid for the use of a bridge should be used for the maintenance and repair of the bridge and not for other purposes, as the DRPA had become accustomed to doing. In a follow-up, Bridge Motorists Easy Mark for Inflated User Fees, I noted the absurdity of the DRPA’s call for increased bridge tolls because it needed money to repair its bridges. Perhaps had money not been diverted to soccer stadium construction and other projects, there would have been funds for the DRPA to perform its stated functions. The criticisms that I, and a few others, offered fell on deaf ears, as a year later, I explained in Don't They Ever Learn? They're At It Again that the DRPA had announced plans to funnel more toll revenues into projects having nothing to do with the bridges and waterways it is charged with tending. Shortly thereafter, in A Failed Case for Bridge Toll Diversions, I lambasted the governor of Pennsylvania for his unwise attempt to justify using bridge tolls for other purposes.

(emphasis added).

What should be funded by tolls? In User Fees and Costs, I explained:

The toll should be based on the cost of building, expanding, improving, repairing, maintaining, policing, and monitoring the road. It isn't difficult for a cost accountant to determine how much it costs to operate the New Jersey Turnpike, the Garden State Parkway, or any other toll road. Tolls should be increased as costs increase, and though it is preferable to recalculate the cost each year, it might be easier to use some sort of inflation index and do the cost recalculation every four or five years. . . .

. . . The analysis I support is one that looks at the impact of the toll road and its use on surrounding residents, neighborhoods, and infrastructure. Traffic volume surrounding a toll road interchange is higher than it otherwise would be, and that generates additional costs for the local government. It makes sense to include in the toll an amount that offsets the cost of widening adjacent highways, installing traffic signals, increasing the size of the local police force, adding resources to local emergency service units, and similar expenses of having a toll road in one's backyard. I understand the argument that because the locality benefits economically from the existence of the toll road and its interchange that it ought not be subsidized by the toll road. It is unclear, though, whether the toll road is a net benefit or disadvantage. If it were such a wonderful thing, why are new roads so vehemently opposed by so many towns and civic organizations?

Using toll revenue to maintain and repair roads and infrastructure far from the toll road is more difficult to justify. Other than relying on arguments such as the maintenance of a high quality state-wide road network that would attract more tourists and business ventures, proponents of siphoning toll revenue to distant areas have a, sorry, tough road to hoe. A better approach would be to impose tolls on heavily used roads in those distant areas.

Yes, it’s the mileage-based road fee. I’ve written about this approach many times, beginning in Tax Meets Technology on the Road, and thereafter 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, and Is the Mileage-Based Road Fee So Terrible?

Will politicians figure this out before it’s too late? One can only hope.

In Are State Gasoline Taxes the Best Source of Highway Revenue?, I observed, “It doesn't help when a leading state legislator describes tolls as the 'wave of the future,' because in doing so, what he demonstrates is a surprising ignorance about the actual wave of the future that already is in the present, namely, mileage-based road fees.” Now I understand why state legislators like tolls. It would be much more difficult to pull off the diversion stunt with mileage-based road fees. Which is even more the reason to push for the replacement of tolls with mileage-based road fees.

Do Lower Taxes, Less Regulation Create Jobs? Do Payroll Tax Cuts, Employment Credits, More Section 179 Expensing, Unemployment Benefits Create Jobs?

2011-09-19T08:01:00.009-04:00

On one thing, almost everyone can agree. The economy is a mess, as evidenced by the number of people lacking employment. On something else, almost no one can agree. Specifically, what is the recipe for fixing the economy?

President Barack Obama has proposed a plan that continues, expands, and extends to employers the existing payroll tax cut for employees, extends unemployment benefits, funnels money for hiring construction workers, police, firefighters, and teachers, continues and expands the 100 percent equipment purchase deduction, and adds credits for hiring workers. Republicans have a different solution. For example, according to Speaker of the House John Boehner, the solution is lower corporate tax rates and a roll back of environmental and labor regulations.

They’re all wrong. They parade out failed strategies and unsuccessful tactics. Albert Einstein’s definition of insanity is well known. When it comes to choosing between politicians and Einstein, I’m for Einstein.

Aside from one proposal, the linchpins of the President’s plan not only have a failed track record but also pose the risk of counterproductive consequences. The payroll tax cut did little, if anything, to fix the problems, because the economy is no better at this point than it was when that cut was enacted, and it might even be, by some measures, worse. As a short-term band-aid, it was worth the attempt. As long-term surgery, it fails. It costs too much. It undermines funding for the Social Security program. As I pointed out in Two Types of Tax Increases, “The answer might not be an extension of the social security tax cut.”

It should be obvious that extending unemployment benefits does not create jobs. The better thing to do is to exchange benefits for services, not unlike what happened in the 1930s when America, similarly burdened with a failing economy caused by the risky games of the wealthy, needed to get its financial position restored to its potential. This is why the proposal to spend money to fix America’s crumbling infrastructure, makes sense. I explained why this is so, four years ago, in Funding the Infrastructure: When Free Isn't Free. Four more years of rot and rusting only makes the situation worse.

The idea of continuing and expanding the section 179 expensing deduction for equipment purchases a senseless one. It may have been a worthwhile bandage a few years ago, but the economy continued to hemorrhage despite that provision. If anything, it benefits businesses that would have made purchases in any event. A business with no need to make a purchase will not make a purchase simply because the cost is deductible in the year of purchase rather than over a three or five year period. Among my several posts attacking this giveaway to those least in need is If At First It Doesn’t Work, Try, Try, Try Again, not my first criticism of the current President’s tax proposals (a point I make in response to those who consider my economic analysis to focused on criticism of one side of the partisan divide).

Tax credits for hiring people have been in the tax law for a long time. Congress has tinkered with those credits numerous times. Almost every year, the credit has been renamed, duplicated, fine-tuned, and expanded. Those efforts do no good. Why? A business with no need of an employee does not hire someone simply because a fraction of the salary will generate a tax reduction. A business with need of an employee possessing a particular skill needed by the business cannot simply hire just anyone who walks in the door, even if that person brings along a tax credit. Throughout the recession, the employment classifieds have continued to run, and to contain numerous listings. The problem is that too many Americans do not have the skills that businesses seek.

The Republicans’ position fares no better. The consequence of lower corporate tax rates would be retention by corporations of even more cash. Corporations already are drowning in cash. Corporations are not spending that cash, even though most corporate spending would bring reductions in taxable income and thus reductions in tax liability. Corporations are not spending cash because they are self-insuring against the next fiscal fiasco, while waiting, perhaps hopelessly, for the Congressional merry-go-round of continual tax and spending changes and battles to come to an end.

The desire to roll back, translate, and eliminate environmental and labor regulations is understandable once the philosophy of the advocates of this backwards move is understood. Labor regulations are all that stand between the greed of the multi-billionaires and the safety and wage security of workers. When left to their own devices, for example, in the nineteenth century, the barons of industry exploited the working class. Only after someone in authority -- translate, government -- stepped in to protect the downtrodden did the middle class begin to emerge. And only after the middle class emerged did this nation come to prosper in the second half of the twentieth century as the world’s leading economy and a nation to which people across the globe looked for inspiration and economic opportunity. Until, of course, the downtrodden barons of industry started dismantling it. Environmental regulations are all that stand between the greed of the multi-billionaires and the health of the citizenry. Repeal of environmental protection surely means reduced expenses, and thus increased profits, for the barons of industry. Before there was environmental regulation, the air in most cities was a health hazard, rivers were flowing with sewage and industrial pollutants, toxic waste dumps proliferated, and natural resources were ravished. Rolling back these regulations will create jobs. For morticians, undertakers, and grave diggers.

The answer, as I’ve explained for years, is to undo the cause of the economic mess. The Bush tax cuts need to expire. The Bush tax cuts were enacted in response to a promise that they would create jobs. They did not create jobs, at least not in this country. They created pools of money that were either stashed abroad, for example, in Swiss banks, or were invested in bad deals designed to extract up-front fee income while bundling bad loans into packaged investments that poisoned pension plans and small businesses. That, in turn, brought the Bush TARP boondoggle, which added economic insult to economic injury.

Though the defenders of low or even repealed taxes for the ultra-wealthy claim that they should be permitted to “keep what they earned,” the reality is that few of the ultra-wealthy earned what they have through physical or intellectual labor. As I predicted long before there was this or any other blog, the proliferation of Crummey life insurance trusts among the wealthy had the effect of creating an entire class of super-wealthy who had done nothing to attain their economic status other than by chance being born to the right parents. Even those who generate wealth through their own efforts benefit from the activities of others. A doubling of the world’s population doubles the demand for a product or service, and at least doubles the profits, without the provider of the product or service lifting so much as a fingernail to move up the economic ladder.

All of this could be excused if the outcome was beneficial across the board. Perhaps the middle and lower classes would not begrudge the “success” of the wealthy if the economic benefits indeed trickled down. But that’s not what trickled down. During the era of the Bush tax cuts, the rich got much richer, the poor barely held their own, the middle class began to disappear, jobs vanished, infrastructure corroded, and the nation’s international reputation as an economic dynamo went down the tubes. That is why more of the same, including the bulk of the President’s proposals and the bulk of the Republicans’ proposals are nothing more than insanity. Is it not time for rational thinking to trump the politics? Sadly, I doubt that will or can happen.

The IRS and Forms 1099-INT: We Remain Curious

2011-09-16T08:01:00.001-04:00

One of the benefits of writing this blog is that it gives me the opportunity to learn. Last week, in Does the IRS Issue Forms 1099? Should It?, I asked whether the IRS is required to issue Forms 1099 when it pays interest, whether it does so, and whether it ought to do so. Two days later, in More on the IRS and Form 1099-INT, I shared one response that came my way. Mary Lew Kehm, a CPA and PFS (personal financial specialist) reported that she has had clients who received Forms 1099-INT from the Treasury Department. Like me, she could not figure out why the taxpayer in Megibow v. Comr., T.C. Memo 2011-211, the case that triggered my questions, did not receive a Form 1099 for interest paid by the IRS. After doing a bit more research, I shared my discovery that the Treasury Department issues Forms 1099-INT with respect to some, but not all, discounts on, and redemptions of, Treasury obligations. That there is inconsistency seems an inescapable conclusion.

Two more replies have arrived. A practitioner in upstate New York reports that “most” of his clients do receive Forms 1099-INT in connection with interest paid to them by the IRS. He suggests that but for those forms he might not otherwise know that the clients had received interest. James Brower, a CPA with a Masters of Science in Taxation who practices not far from me, also reports that Forms 1099-INT are issued with respect to interest paid by the IRS, though he does not think the IRS is required to issue those forms. He explains:

IRC §6049 spells out the rules regarding when payments of interest need to be reported to the IRS. However, IRC §6049(b) has its own definition of “interest” which is much narrower in scope from that of IRC §163. If you read through IRC §6049(b) you will see what payments constitute “interest” for purposes of 1099-INT reporting, and you won’t find interest paid on tax refunds listed there.

Also, if you look at Treasury Regulation §1.6049-5(b)(4) you will see that for purposes of 1099-INT reporting, interest does not include “interest that a governmental unit pays with respect to tax refunds.” I think that the Regulation pretty much answers the question.

Mr. Brower suggests that the IRS – and some states – issue the Form 1099-INT, even though not required to do so, because it encourages taxpayers to report the interest income. Perhaps, he surmises, the lack of the Form 1099 in Megibow caused the taxpayer not to report the interest income. Mr. Brower also suggests that “based on my 20+ years of dealing with the public in preparing tax returns, I’d say that a good segment of the population of this country honestly believes that income is taxable only if it gets reported to the IRS on a 1099, W-2 or other information return.” I agree. More than one student in my basic federal income tax over the past 20+ years has commented, not in these exact words, “If the IRS doesn’t know about it, is it really income that needs to be reported?”

In my reply to Mr. Brower, I said:

Thank you for your analysis. I agree with you. The lack of a requirement combined with the sending of Forms 1099 raised the same question for me. I think your answer makes sense. What continues to puzzle me is (1) did the IRS issue a Form 1099 to Mr. Megibow? (2) if not, why not? (3) if yes, why did the IRS not contest his assertion that it had not sent one?

When he in turn replied, Mr. Brower shared his guess that we will never know the answer to my first two questions. That’s frustrating. I’m confident I’m not the only one who wants to know. Those questions are at the heart of what inspired the initial post on this issue. As for the third question, his guess is that IRS counsel did not think it was necessary to contest Megibow’s claim that a Form 1099 had not been sent. The interest is includable in gross income whether or not a Form 1099 is sent or received, and thus the IRS can win – as it did – without that evidence. Yet, would it not be sensible to introduce proof that the Form 1099 was sent? Would that not chip away somewhat at the taxpayer’s factual presentation, gross income concepts aside? Could it be that IRS counsel tried to obtain a copy of the Form 1099 sent to Megibow, but was unsuccessful because someone on the Commissioner’s side could not find it? But if it cannot be found, ought one assume it was sent?

How many other taxpayers who receive interest from the IRS fail to receive a Form 1099 and then in turn do what Megibow did? Does anyone know? Yes, the IRS could cross-check its record of interest payments with the copies of the Forms 1099 it has sent. This sort of self-audit would be useful to the IRS, to taxpayers generally, and to the nation. So now my invitation is to someone at the IRS to enlighten the rest of us. We remain curious.

Even Giants Make Tax Mistakes

2011-09-14T08:01:00.001-04:00

A practitioner pointed me in the direction of an H&R Block Press Center Newsroom Story Ideas posting, titled, “Renting Your Vacation Home: What Are the Tax Breaks?” The article points out the sort of expenses that qualify as deductible because of the rental activity, and correctly notes that if the property is rented for fewer than 15 days during the taxable year, those expenses cannot be deducted and the rental income is excluded from gross income. The article proceeds to define what constitutes a personal use day for purposes of determining whether the section 280A limitations apply.

The article provides an example of how to pro-rate rental expenses between personal use days and rental days. In the example, there are 90 days of rental use and 225 days of personal use. The taxpayer in the example has $4,500 in “mortgage insurance” – by which I assume is meant “mortgage interest” because there is no other item tagged as “mortgage interest” and there would not be “mortgage insurance” without “mortgage interest” – along with $3,000 in real property taxes and $17,200 in expenses deductible only on account of rental activity, such as cleaning, insurance, repairs, utilities, and depreciation. According to the example, the taxpayers are permitted to deduct 90/225 of this amount.

There are two errors in this example. The first is the use of a fraction 90/225. The total days of use equal 315 (90 + 225). Thus, the rental portion is 90/315, not 90/225. The second is the lumping together of the deductions allowable in any event (mortgage interest and real property taxes) and the deductions allowable only on account of the rental use. This approach is the position taken by the IRS, but it is a position rejected by taxpayers and by the courts.

Understanding the second error requires a bit of background and an exercise in statutory interpretation. Section 280A(e) provides as follows:

(e) Expenses Attributable to Rental.--
(1) In general.--In any case where a taxpayer who is an individual or an electing small business corporation uses a dwelling unit for personal purposes on any day during the taxable year (whether or not he is treated under this section as using such unit as a residence), the amount deductible under this chapter with respect to expenses attributable to the rental of the unit (or portion thereof) for the taxable year shall not exceed an amount which bears the same relationship to such expenses as the number of days during each year that the unit (or portion thereof) is rented at a fair rental bears to the total number of days during such year that the unit (or portion thereof) is used.

(2) Exception for deductions otherwise allowable.--This subsection shall not apply with respect to deductions which would be allowable under this chapter for the taxable year whether or not such unit (or portion thereof) was rented.

Thus, it is appropriate in the example to multiply $17,200 by the rental use fraction (90/315, not 90/225). However, the mortgage interest and real property taxes are not subject to the section 280A(e) fraction. Instead, when computing the limitation on the total deductions attributable to the rental activity, as provided in section 280A(c)(5), the taxpayer must reduce rental gross income by “the deductions allocable to such use which are allowable under this chapter for the taxable year whether or not such unit (or portion thereof) was so used.” Translated, the means the reduction equals “the mortgage interest and real property taxes allocable to the rental use” because those deductions are allowable whether or not the property is used as rental property. Thus, the question is, “What is the meaning of ‘allocable to such use’?” The IRS takes the position that the allocation is computed using the rental use fraction, and in the case of the example, by using 90/315. Thirty years ago, a taxpayer took the position that the appropriate fraction was 90/365, arguing that a portion of the interest and taxes relate to each day in the year, and pointing out that if Congress wanted to use the section 280A(e) fraction it would have used the section 280A(e) language in section 280(c)(5), something it did not do.

The taxpayer, in Bolton v. Comr., 77 T.C. 104 (1981), prevailed. The IRS appealed to the Ninth Circuit. It lost. See Bolton v. Comr., 694 F.2d 556 (9th Cir. 1982), aff’g 77 T.C. 104 (1981). In the many cases that have since arisen dealing with this issue, the taxpayers have prevailed, including a decision in the Tenth Circuit that followed the Ninth Circuit reasoning. Yet the IRS persists, perhaps hoping that another appellate court will decide in its favor, leading to a decision by the Supreme Court to resolve the dispute. Unfortunately, the IRS position is flat-out wrong, it has been consistently and uniformly rejected, and it puts taxpayers in the unfortunate position of choosing between an adverse tax outcome or the risk and cost of an IRS audit and litigation.

For a commercial tax return preparer to provide an example that makes no mention of the Bolton case or its progeny is appalling. How many taxpayers will end up paying more in taxes than current law requires? I’m told by the practitioner who alerted me to this web page that the same article appeared a year ago, the practitioner called and explained the errors, and the page was taken down. Now it has reappeared. The practitioner noted that another phone call this year is very unlikely.

Teaching section 280A in the shadow of Bolton and the IRS refusal to concede makes the basic tax course even more challenging, for me and for students, than it otherwise needs to be. The only silver lining in the cloud is that it provides an opportunity to help students think about the advice they would give to a client or tax return preparer who faces the issue. How should the tax return be filed? What are the advantages and disadvantages of using the Bolton approach? What are the benefits of following the IRS approach and ignoring the Bolton line of cases? Someone who relies on the H&R Block Press Center Newsroom Story Ideas posting would not be asking those questions because they are not being asked those questions. They would be living in an artificial tax world in which Bolton and its progeny do not exist. That’s not a good way to practice tax.

Destruction: Natural Disasters and Taxation

2011-09-12T09:01:00.001-04:00

Many months ago, back in March, KVUE in Austin, Texas, ran a story that certainly did not get my attention and probably did not get much attention outside of Texas. Hundreds of firefighters, most of them volunteers, gathered in the state capital to honor colleagues who had died in the line of duty and to protest budget cuts that would reduce state funding for fire fighting services from $30 million to $7 million. Already under financial stress, volunteers report using personal funds to pay for equipment, repairs, supplies, and upkeep of fire houses. The executive director of the State Firemen’s and Fire Marshals’ Association of Texas, representing 21,000 firefighters, said of the impact of these cuts, “ . . . it doesn’t help us out any whatsoever, . . . I think the citizens and the public is going to see that.” These have turned out to be sadly prophetic words.

Fast forward to August. Numerous reports, including this one, bring news of wildfires throughout Texas that have destroyed more than 1,000 homes, including one 48-hour period in which 852 residences were devastated. One need only look at map of Texas wildfires to see the incredible scope of the problem.

Here’s the challenge. It costs money to fight wildfires. Yet the governor of Texas and his political allies, as a price for keeping taxes artificially low, decided to cut firefighting assistance funds by more than 70 percent. Surely, considering that firefighters already were laboring under financial shortfalls, this was not a matter of the typical “we need to cut wasteful spending” excuse for trying to shrink government. Here’s some wisdom for the anti-tax crowd: shrunken and destroyed governments cannot protect citizens from rampaging wildfires.

So what does the governor of Texas and his political allies propose to do? They want money from the Federal Emergency Management Agency (FEMA). Apparently it doesn’t matter that the governor of Texas has been very critical of FEMA. Now, according to this report, he claims that this is “not the time to worry about reforming the agency.” Apparently it doesn’t matter that FEMA is running out of money. According to many reports, including this one, FEMA is almost out of money, but House Republicans want any FEMA funding increase to be offset by spending in other areas. Perhaps we should cut salaries and benefits for Congress and its staff.

The governor of Texas is not the only advocate of lower taxes and small government to turn to the federal government to ask for funding. The governor of New Jersey sent a letter to the President asking for federal assistance. The governor of Pennsylvania, another anti-tax zealot, also asked for federal assistance. Neither specified whether that assistance should be funded with tax increases or cuts in spending, and though one should expect that they would prefer the latter, as do their ideological counterparts in Congress, neither one dared to suggest who should bear the burden of those spending cuts in order to assist their states.

As I pointed out recently in Storms, Public Infrastructure, and Taxes, the solution offered by the anti-tax zealots is to cut spending, which means reduced funding for fire departments, police protection, public sewage treatment plants, and other essential services. The anti-tax folks in Texas have provided a wonderful example of what happens when fire fighting funding is cut.

The mind-set of rejecting government, and opposing taxation in order to shrink, and as some anti-tax advocates explain, to eliminate, government, and yet begging for money from government when things get rough, makes me think of another mind-set. This behavior immediately reminds me of the teenager who wants nothing to do with his or her parents until the youngster realizes that the parents are needed for help. Anti-authoritarian suddenly become appreciative of the social benefits of a government using its authority protecting its citizenry when they or those on whom they rely for votes are in need of help. The anti-tax campaign is not so much a simple opposition to taxes as a philosophical ideal, but a desire to eliminate funding for regulation and supervision of business and other activity. That regulation, designed to protect workers and the environment, to give but two examples, prevents people from simply doing whatever they want to do, perhaps in pursuit of money and perhaps in pursuit of fun, without regard to the cost that they impose on other people when they shift the cost of their activity onto others.

The anti-tax crowd is more than anti-tax. That is another reason why I explained, in Storms, Public Infrastructure, and Taxes, that “I shudder in horror at the total inanity and stupidity of the anti-tax pledge.” From the perspective of the well-being of democratic, pluralized, just, and economically balanced society and the governments necessary to protect that lifestyle, destroying the life-blood of freedom by using a self-centered definition of freedom is stupid. Perhaps one of the most outspoken Republican candidates for the presidency is correct. Perhaps, as she claims, all of these natural disasters are a divine message, but not the message she thinks it is. Perhaps they are intended to educate people. Perhaps when the dangers of destroying government is highlighted by actual catastrophe rather than hypothetical scenarios posed by pundits will people wake up to the siren song of the self-centered. Perhaps one lesson is that not only can taxes be too high, they can be too low. A slew of natural disasters is bringing that point home, whether or not someone attaches a theological interpretation to these catastrophes. Taxes that are too low can be as destructive as natural disasters.

More on the IRS and Form 1099-INT

2011-09-09T08:01:00.002-04:00

My Wednesday post, Does the IRS Issue Forms 1099? Should It? brought a response from Mary Lew Kehm, a CPA and PFS (personal financial specialist), who practices a few counties away from here. She reports that she has had clients who received Forms 1099-INT from the Treasury Department. Thus, she concludes either the government is not being consistent, or there was something unusual in Megibow v. Comr., T.C. Memo 2011-211, that the Tax Court did not disclose. I agree. I also think that whichever is the explanation, something is awry and needs attention.

A little more research discloses two interesting tidbits. According to William J. Coffey, Strengthening Treasury Direct:

Treasury Direct issues selected 1099 forms. Interest Form 1099-INT reports discounts on Treasury bills and interest payments on notes and bonds. Proceeds from redemptions of notes and bonds are reported on Form 1099B. The Internal Revenue Service requires Form 1099-OID for reporting an original issue discount on notes and bonds. However, Treasury Direct only issues this form for inflation-indexed notes.

First, the Treasury Department, of which the IRS is a part, does issue Forms 1099, but the issuance comes from a part of the Treasury Department that is not the IRS. Second, this form is issued with respect to some, but not all, discounts on, and redemptions of, Treasury obligations, and thus there is inconsistency in this regard.

Anyone who can enlighten me is invited to do so. What are the requirements? Are they being followed? And if the inconsistency is consistent with the requirements, why are the requirements inconsistent?

Does the IRS Issue Forms 1099? Should It?

2011-09-07T08:01:00.001-04:00

A Tax Court opinion released last week made me stop and ask myself a question. Does the IRS issue Forms 1099?

In Megibow v. Comr., T.C. Memo 2011-211, the Tax Court rejected a taxpayer’s argument that he was not required to include in gross income the interest that the IRS had paid him on overpayments he had made. The conclusion is inescapable. Interest is included in gross income, unless it is tax-exempt, which the IRS payments were not. One of the arguments raised by the taxpayer was that he was not required to include the interest in gross income because the IRS had not issued to him a Form 1099 reporting the interest. The Tax Court pointed out that failure to receive an information return, such as a Form 1099, does not transform gross income into excluded income, citing Vaughn v. Comr., T.C. Memo 1992-317, aff’d without pub. Op., 15 F.3d 1095 (9th Cir. 1993). Apparently the IRS did not contend that it had issued a Form 1099, and that is what made me wonder if the IRS issues those forms.

Unless I am missing something, the IRS is not required to issue a Form 1099. Technically, the Form 1099 is an information return, conveying to the IRS tax-related information about a transaction in which other parties have engaged. The taxpayer receives a copy, but technically the taxpayer, by having engaged in the transaction, already knows the information. The taxpayer’s copy is, in this respect, a convenience. The IRS does not report to itself information concerning a transaction in which it has engaged.

The follow-up question is whether the IRS should issue Forms 1099, not only as a convenience to taxpayers, but also as a reminder to taxpayers that they have gross income in the specified amount. Compliance with respect to interest income reporting would increase. The IRS would spare itself the aggravation and cost of going through what it had to go through in this case. Because many taxpayers react to a Form 1099 with the thought, “I must report this because the IRS knows about it, and if I don’t report it, the IRS spotlight will shine on me,” the benefits of requiring the IRS to issue Forms 1099 – or of the IRS voluntarily choosing to do so – outweigh the costs.

One wonders how many other taxpayers failed to report interest paid by the IRS, how many were tagged by the IRS, and how much it cost to bring them into compliance. Surely those who are escaping taxation by failing to report the interest would not be happy with my suggestion, but anything that increases tax compliance is a step in the right direction. The tax and deficit burdens on those who comply are increased by those who do not comply. Having the IRS issue Forms 1099 would ease that inappropriate shifting of burden.

You Know the Election Cycle Has Started When The Tax Talk Gets Even Dumber

2011-09-05T08:01:00.002-04:00

Taxes certainly get a lot of attention. This is particularly noteworthy when one considers that taxes are not like the matters that usually get lots of attention. Taxes are not celebrities, taxes are not weather crises, taxes are not sporting events or fantasy football. It certainly is amusing, almost, that something almost no one likes gets so much air time.

Jon Huntsman has entered the tax conversation. His plan, outlined here, is quite familiar. His plan “eliminates all deductions and credits in favor of three drastically lower rates of 8%, 14% and 23%.” Surely that cannot be so. Does he plan to eliminate the credit for taxes withheld from a person’s paycheck? Or the credit for making estimated tax payments? Does he plan to eliminate business deductions and impose an income tax on gross profit? Is the standard deduction headed for the dustbin of tax history? Will the deduction for personal and dependency exemptions also get trashed? The problem with this “soundbite” planning is that it would leave a person earning $20,000 with a federal income tax bill of $1,600, a social security tax bill of $1,530, and state and local income, sales, and other taxes of who knows how much. Under current tax law, a person scraping by on that sort of salary – a consequence of all the wonderful jobs created by the Bush tax cuts – would need to cut at least $1,600 from their other spending. Perhaps more, if this person qualified for the earned income tax credit. So, let’s see, the poor person’s taxes go up and the wealthy person’s taxes go down, down even more, as a reward for the superb performance of the economy triggered by the last round of tax cuts for the wealthy.

The Huntsman plan not only nails the poor, and to a lesser extent, the middle class, through its elimination of all deductions and credits, it also crushes those on the lower rungs of the economic ladder by eliminating all taxes on capital gains and dividends. This tax break goes to those who can afford to have capital gains and dividends. Again, it’s not the poor, and it’s not most of the middle class who will throw we-have-even-lower-taxes parties. Note that interest would remain taxable, as that is the type of investment income most predominant among the poor and middle class. Under Huntsman, the federal income tax burden would fall on wage earners. Happy Labor Day.

Huntsman’s rationale for not taxing capital gains and dividends is seriously flawed. According to Huntsman (or, more likely, the people who created “his” plan and financing its hype), “Because dollars invested had to first be earned, they have already been subject to the income tax. Taxing these same dollars again when capital gains are realized serves to deter productive and much-needed investment in our economy.” Testing this assertion with an example demonstrates why Huntsman or those hyping this plan don’t understand federal income taxes. Taxpayer T invest $1,000,000 in Z Corporation stock. Things go well, and eventually T sells the stock for $3,000,000. Current law taxes T on $2,000,000, not $3,000,00, and it already taxes T at a rate lower than the rate imposed on hard-working wage earners doing more than sitting back and watching stock price reports. Huntsman’s argument for not taxing capital gains makes sense in terms of not taxing the $1,000,000 that T “gets back” when T sells the stock, but current law doesn’t tax that $1,000,000. It’s called basis. On the other hand, the $2,000,000 of capital gain has not been taxed and thus taxing it at this point is not taxing “dollars [that] have already been subject to the income tax.” This is far from the most difficult and complicated aspects of federal income taxation. Just about every student in basic federal income tax courses learns this and understands this. Huntsman and his team – who perhaps never saw an income tax course – are the sort of people who require the use of “just about” as a limiting modifier on the word “every.” What is more likely is that Huntsman and his backers know quite well the truth, that the $2,000,000 has not previously been taxed, but are trying to dupe the American public into thinking that cutting taxes on capital gains is good for America. It’s good, but not for America. It’s good for the wealthy who are bankrolling Huntsman and the other politicians who parade out the same tax misinformation. If all Americans were required to learn tax in high school, as I have often proposed, it would be much more difficult for those selling this tax deception to find people willing to jump on the lie train. Is it any wonder that the same “tax only wages” crowd seeks to cut funding for education? An educated electorate is the enemy of the manipulators. And the manipulators know that.

If this nonsense about taxes is any indicator, we’re in for a long, lie-filled election season. At least it will give me plenty of topics for this blog.

Employee or Independent Contractor? For Taxes, It Matters

2011-09-02T08:01:00.001-04:00

Whether a person who is performing services ends up characterized as an employee or as an independent contractor affects a variety of tax issues. For example, the payor’s withholding responsibilities differ, employees being subject to withholding but most independent contractors not being subject to withholding. As another example, if the person is an independent contractor, the person is subject to self-employment taxes barring the application of an exception, whereas the person’s status as an employee means that the social security and Medicare tax responsibility is split between the employee and the employer. A very recent case indicates yet another significance, namely, whether deductible expenses incurred in the performance of the services are deductible in computing adjusted gross income, on Schedule C, or are deductible as employee business expenses, on Schedule A, subject to the 2-percent-of-adjusted-gross-income floor. This recent case caught my eye because the taxpayer was performing services as an adjunct professor.

In Schramm v. Comr., T.C. Memo 2011-212 (30 August 2011), the Tax Court held that the taxpayer was an employee and not an independent contractor. The court analyzed eight factors in reaching its conclusion. The facts supporting employee classification overwhelmed those supporting independent contractor classification.

Degree of Control: Supporting employee classification: university specified textbook taxpayer was required to use, university determined the topics to be covered, university set the length of the course, university managed enrollment of students, university provided web site used for online portion of courses, university imposed employment policies, such as sexual harassment, drug use, and conflicts of interest, on taxpayer, university treated taxpayer as employee. Supporting independent contractor classification: taxpayer followed independent approach in teaching classes.

Investment in Facilities: Supporting employee classification: university financed staff for recruiting, registering, and keeping records with respect to students. Supporting independent contractor classification: taxpayer maintained home office for teaching purposes, purchased office supplies, paid for an internet connection and computer.

Opportunity for Profit or Loss: Supporting employee classification: taxpayer’s pay based on number of classes taught, with no opportunity to change it. Supporting independent contractor classification: none.

Right to Discharge: Supporting employee classification: despite lack of evidence, it appeared university could terminate taxpayer’s services at any time, university could decline to pay taxpayer to teach additional courses. Supporting independent contractor classification: none.

Work is Part of Principal’s Regular Business: Supporting employee classification: university’s regular business is education of students and evaluation of their work, for which taxpayer was hired to do. Supporting independent contractor classification: none.

Permanency of Relationship: Supporting employee classification: taxpayer had long-term, consistent contractual relationship with university. Supporting independent contractor classification: none.

Relationship the Parties Thought They Created: Supporting employee classification: university and taxpayer acted as though relationship was employment, university withheld taxes, issued a Form W-2 to taxpayer, and did not check the statutory employee box on that form, university informed taxpayer it had classified taxpayer as employee. Supporting independent contractor classification: none.

Provision of Employee Benefits: Supporting employee classification: none. Supporting independent contractor classification: despite lack of evidence, university did not offer taxpayer or other adjunct faculty the types of benefits offered to other categories of workers.

The taxpayer’s situation in Schramm is very similar to that of adjunct faculty generally. It certainly is very similar to the manner in which my Law School treats adjuncts. The major difference is that adjuncts are permitted to select textbooks rather than being told what textbook to use, though they do receive advice and recommendations on that point. It is possible that some of our adjunct faculty do not maintain home offices for their teaching activities, but I’ve never asked and I don’t think anyone has ever asked. Newly-hired adjunct faculty, of course, lack the permanency of relationship that existed in Schramm, though that factor alone will not change the outcome. Next time I speak with one of our adjuncts, I need to remember to ask if they receive a Form W-2 or a Form 1099. Strange that I’ve never had this conversation, but I’ve never been involved in the payroll side of things. Perhaps I’ll also ask if they have any deductible expenses related to their teaching, because the school does make available to adjuncts computers and similar equipment. My guess is that, like me, they do have computers used for teaching and other business purposes, and pay for an internet connection through which they connect to the on-line classrooms and exchange emails with students, other faculty, and law school administration.

I know I will get a response even before I see any of our adjuncts. Why? Because some of them read MauledAgain.

Addendum: As expected, I've heard from our adjuncts. They are treated as employees and receive Forms W-2. It has been this way for about five years. Previously, they had been the recipients of Forms 1099.

Storms, Public Infrastructure, and Taxes

2011-08-31T08:01:00.002-04:00

Though the damage caused by Hurricane Irene along the east coast of the United States was not as severe as expected, and nowhere near what it could have been, and perhaps someday will be from another storm, the damage was bad enough. For example, as reported and shown in this news story, a 900-foot section of North Carolina Route 12 in the Outer Banks was destroyed. In New York, MTA train service on Metro-North lines is suspended indefinitely on account of flooding, power outages, landslides, and track bed erosion, as reported, among other places, in this report. Damage to public infrastructure extends from Maine to North Carolina.

Repairing the damage that the hurricane caused to public infrastructure requires money. To the best of my knowledge, few, if any, of these structures and facilities are insured. Self-insurance might exist in the form of contingency funds, but several years of recession have caused many, if not most, governments and public agencies to dip into those funds. Money can be taken from other portions of the locality’s budget, but what’s left to afflict with a shortage? Should the fire department be eliminated? Should half of the police force be pink-slipped? Should public sewage treatment plants be closed?

Sometimes, no matter what people want, we, and those representing us in government, must do what we prefer not to do. That’s life. That’s also why I shudder in horror at the total inanity and stupidity of the anti-tax pledge. Technically, there are four pledges, one for House members, one for Senators, one for governors, and one for state legislators. All share, however, a promise to oppose and vote against “any and all efforts” to increase taxes. With respect to the type of situation now facing more than a dozen states, the anti-tax pledge advocate explains:

Can the language of the Pledge be altered to allow exceptions?

No. There are no exceptions to the Pledge. Tax-and-spend politicians often use “emergencies” to justify increasing taxes. In the unfortunate event of a real crisis or natural disaster, the legislator should propose spending cuts in other areas to finance the emergency response.

So in the anti-tax world, the county that wants to replace the washed out bridge or the city that wants to restore train service needs to eliminate police departments, lay off fire fighters, close down the sewage treatment plant, or reduce already bare-bone services to the citizenry. I can’t imagine what these ideologues would have argued on December 8, 1941.

Highways, Trucks, Recessions, and Taxes

2011-08-29T08:01:00.002-04:00

One of the sights I saw, frequently, on my recent very short journey part-way across the country, was the tractor-trailer. I haven’t seen this many tractor-trailers on a per-mile basis for a long, long time. Because of past experiences, I have convinced myself that when recessions occur, truck traffic decreases. I can remember several recessions during which truck traffic was so reduced that the definition of “open road” almost required rewriting. Past experiences also taught me that truck traffic declined on weekends and almost disappeared on Sundays. That wasn’t the case in August of 2011. Truck traffic was incessant.

One of the questions that popped into my head was a consequence of my curiosity. “What’s in the trucks?” Occasionally, the answer was apparent. Those hauling new cars or cattle pretty much reveal their cargoes. Most of the trucks, however, consist of a tractor and a box trailer or container on a flatbed. “What’s in there?” Food? Is more food being shipped by truck than in the past? Despite recessions, people eat, so I’ve figured that the trucks carrying necessities, such as food, don’t change in number very much. So what’s in these trucks? Not too long into the trip, when I caught sight of this news, a possible answer appeared. Were these trucks filled with $9,010 Chanel sequined tweed coats? Were they carrying $775 Christian Louboutin “Bianca” platform pumps? Even if I had the audacity to find a way to look into the truck trailers (not that I would and not that I’d see much but cartons and crates), I wouldn’t have recognized these things. I’m just copying what I read, because I have no clue as to what these items are and why they are so expensive other than the ever-present desire of the elite to possess something most others cannot afford and to have a name or tag attached so that they are certain the world recognizes them as special and elite. And wealthy.

One of the feelings I encountered during this trip was the rattling, shaking, and banging that is experienced when driving off-road. Yet I did not drive off-road. About the time that I embarked, I had noticed a puzzling statement by Peter King in his MMQB column. He wrote, “Then Lou [the driver of the bus] climbed into the driver's seat and we started buzzing up I-85 toward Redskins camp in Northern Virginia, 490 miles of bumpy bliss while writing this column. Let's just say I would have written longer overnight if the interstate highway system in this country weren't as much of a roller coaster.” Haven’t ventured on interstates during the past two years other than those within a few miles of home, I wondered what he meant. I found out, when I reached I-70 in Illinois. I thought I had crossed the border into a still-developing country. I was reminded of stories from people I know who have driven in some of the countries formerly behind the Iron Curtain. My thought that perhaps it was “last on the list” to be repaired was quickly dispelled as I encountered more and more interstate miles marked with PERMANENT “rough road” signs. On the return leg of the journey, I traversed the Indiana Toll Road, hailed by advocates of privatization of public assets as proof of the superiority of their “shrink government” mentality. Guess what? Parts of that road rivaled the atrocious condition of I-70 in Illinois. There’s no guessing in determining why these roads are a mess. The anti-tax movement is succeeding in wrecking the nation’s infrastructure, banking on an exasperated public giving in to the “private milking of public assets” game that, in the long run, as seen in Indiana, leaves the country no better off and a few special elites wealthier. Perhaps they’re trying to save up to buy a few more dozen pairs of shoes.

My conclusion is that there are two Americas. One, inhabited by the wealthy, is nowhere near a recession, doesn’t worry about highways because helicopters and private jets don’t use them, and detests paying taxes. The other, inhabited by everyone else, is in the economic doldrums, if not ready to fall into another recession or depression, endures deteriorating infrastructure and reduced services, suffers from unemployment or employment at wages falling in real dollar terms, and yet despite holding an overwhelming number of votes, manages to perpetuate the system that keeps them down. Perhaps after paying for more shock absorber and tire replacements, front end alignments, and suspension adjustments, they will decide that it’s cheaper, in the long run, to pay increased tolls.

Two Types of Tax Increases

2011-08-26T08:01:00.002-04:00

Apparently there are two types of tax increases in this nation. And apparently one type is very bad and the other is very good. How does one tell the difference? Read on.

A story broke last week, reported by the Associated Press and other sources, that the Republican members of Congress are opposed to extending the social security tax cut that was put into effect for this year. This tax cut applies to a tax imposed on the first $106,800 of wages, and reduced the 6.2% employee portion of the tax to 4.2%. The purpose of the reduction was to put more cash in the hands of ordinary consumers, whose increased purchasing stimulates the economy and creates jobs.

Failing to extend the cut, in other words, permitting the tax rate to return to 6.2%, is viewed by many as a tax increase. As I explained about a month ago in Tax Semantics, allowing a temporary tax cut to remain temporary is not a tax increase, though arguing that point is a distraction from the real issue. But for purposes of this discussion, calling it a tax increase drives home the larger point.

A rational person who pays attention to national politics would not be amiss in concluding that the anti-tax crowd, and that includes almost every Republican member of Congress, would be horrified at the idea of letting the temporary social security tax cut expire. After all, they are livid at the idea of letting the Bush tax cuts benefitting the wealthy terminate. Yet these anti-tax crusaders do not hesitate in their willingness to let the social security tax cut expire. Representative Jeb Hensarling claims that although lower taxes are better than higher taxes, “not all tax relief is created equal.” In other words, for these anti-tax Republicans, tax relief for the wealthy apparently is much more important than tax relief for low and middle income wage earners. Representative David Camp, who chairs the Ways and Means Committee, explained that tax reductions, “no matter how well-intended,” will increase the deficit and make the task of reducing the deficit “that much harder.” Camp gets points for that obvious bit of wisdom. If tax reductions, however, are a problem, then are not the Bush tax cuts even more of a problem, considering that they dwarf the social security tax cut? Where was Camp when those cuts were scheduled to expire and his colleagues went all out, in the face of spiraling deficits, to extend those tax cuts? Do we sense a double standard?

According to anti-tax Republicans, there is consistency in opposing a tax cut extension for ordinary Americans while heaping tax reductions onto the mega-rich. It is better, they say, to reduce corporate taxes and the tax burdens of the wealthy than it is to extend the social security tax cut. A spokesperson for House Majority Leader Eric Cantor claims that Cantor “has never believed that this type of temporary tax relief is the best way to grow the economy.” If he means that temporary tax cuts are not the answer to economic growth, then why the support for the extension of the temporary Bush tax cuts? If he means that temporary tax cuts for low and middle income individuals is not the answer, but that tax reductions for corporations and upper income individuals is the solution to the nation’s economic problems, can he please explain why the Bush tax cuts, rather than helping the economy, contributed to its downturn?

The answer might not be an extension of the social security tax cut. After all, the social security trust fund needs to be maintained and expanded to cover the benefits that are due to retirees in future years. The answer is to let the Bush tax cuts expire, and, ideally, to recoup the tax breaks from those who took them under the pretext of creating jobs that they had no need to create and no intention of creating.

So is there a double standard? Indeed there is. Perhaps a better word is hypocrisy. It’s interesting to watch the anti-tax group get painted into a corner as they are compelled to confess that they are not anti-tax across the board, but opposed to taxation of corporations and wealthy individuals. That does make sense from one perspective. Consider who contributes to the cost of acquiring elective office.

Taxation and the Descendants of Thomas Maule of Salem, Mass., Part X

2011-08-24T08:01:00.000-04:00

This is the tenth in a series of posts that highlight descendants (and in several instances, spouses of descendants) of Thomas Maule of Salem, Massachusetts, one of my 512 7-great-grandfathers, who have been involved, one way or another, in taxation or tax policy other than in their capacity as taxpayers. The short biographies that I present are, in most instances, just a slice of a much fuller life. The full biographies can be accessed through the index on the Maule Genealogy Homepage by using control-f to search for the person [Warning: the index page is huge and takes a minute to load] or by going to the sources mentioned in the posts.

Today I close the series with a Supreme Court tax case involving a Thomas Maule descendant.

Sarah Prudence (Sally) Ordway (1910-1997), 7-great-granddaughter of Thomas Maule of Salem, Mass., and my 8th cousin: Sarah’s interest in a trust set up by her father, John Gilman Ordway (6-great-grandson of Thomas Maule of Salem, Mass.) was the subject of a gift tax disclaimer case, U.S. v. Irvine, 511 U.S. 224 (1994).

Taxation and the Descendants of Thomas Maule of Salem, Mass., Part IX

2011-08-22T08:01:00.001-04:00

This is the ninth in a series of posts that highlight descendants (and in several instances, spouses of descendants) of Thomas Maule of Salem, Massachusetts, one of my 512 7-great-grandfathers, who have been involved, one way or another, in taxation or tax policy other than in their capacity as taxpayers. The short biographies that I present are, in most instances, just a slice of a much fuller life. The full biographies can be accessed through the index on the Maule Genealogy Homepage by using control-f to search for the person [Warning: the index page is huge and takes a minute to load] or by going to the sources mentioned in the posts.

Today I continue with two members of the single tax movement.

Louis Blaul (1854-1909), married to Mary Conard Clendenon, 3-great-granddaughter of Thomas Maule of Salem, Mass., and my 3rd cousin four times removed: According to the Single Tax Review (1910), on googlebooks, “The death of Louis Blaul of West Philadelphia, robs that city of an earnest and devoted Single Taxer.” His funeral, we are told, was conducted “as he had desired, not according to the rites of any church, but by officiating Single Taxers.” One of many explanations of the single tax, and its chief advocate Henry George, can be found in this article.

Earl Harrington Foote (1882 - ?), 6-great-grandson of Thomas Maule of Salem, Mass., and my 7th cousin once removed: In 1920, Earl was a candidate for governor of Ohio on the single tax party ticket. According to Our Campaigns, he received 1407 votes, 0.07% of the total. In the 1930 census of Ohio, his occupation is listed as real estate agent. Earl was a 4th cousin three times removed of Louis Blaul’s wife Mary Conard Clendenon, but it is not known if Louis and Earl knew each other or knew of each other, though both were adherents of the single tax.

Taxation and the Descendants of Thomas Maule of Salem, Mass., Part VIII

2011-08-19T08:01:00.001-04:00

This is the eighth in a series of posts that highlight descendants (and in several instances, spouses of descendants) of Thomas Maule of Salem, Massachusetts, one of my 512 7-great-grandfathers, who have been involved, one way or another, in taxation or tax policy other than in their capacity as taxpayers. The short biographies that I present are, in most instances, just a slice of a much fuller life. The full biographies can be accessed through the index on the Maule Genealogy Homepage by using control-f to search for the person [Warning: the index page is huge and takes a minute to load] or by going to the sources mentioned in the posts.

Today I continue with a tax return preparer.

Evelyn Newton (1919-2002), 7-great-granddaughter of Thomas Maule of Salem, Mass., and my 8th cousin: Among the many careers juggled by Evelyn was tax return preparer employed by H&R Block. Her interests and skills reached beyond taxation, as she was employed by Utah Power and Light, and the Bureau of Reclamation. She also was an Herbal Life and Vanda Make-up distributor for more than a quarter of a century. (Primary source: her obituary in the 5 July 2002 Salt Lake City Deseret News)

Taxation and the Descendants of Thomas Maule of Salem, Mass., Part VII

2011-08-17T08:01:00.001-04:00

This is the seventh in a series of posts that highlight descendants (and in several instances, spouses of descendants) of Thomas Maule of Salem, Massachusetts, one of my 512 7-great-grandfathers, who have been involved, one way or another, in taxation or tax policy other than in their capacity as taxpayers. The short biographies that I present are, in most instances, just a slice of a much fuller life. The full biographies can be accessed through the index on the Maule Genealogy Homepage by using control-f to search for the person [Warning: the index page is huge and takes a minute to load] or by going to the sources mentioned in the posts.

Today I continue with tax accountants.

Willard Clinton Warren (1922-2009), 5-great-grandson of Thomas Maule of Salem, Mass., and my 3rd cousin twice removed: Willard ended his long career as senior tax principal of KPMG Peat Marwick’s Boston office. After serving in the Army Air Corps during World War II, he returned to Bowdoin College to complete his degree, and then joined the family business, Warren Publications. After a few years as manager of Pro-Con, he joined Mount and Carter, a Boston accounting firm, which through a series of mergers, became part of KPMG Peat Marwick. (Primary sources: his obituary in the 16 April 2009 Portland (Maine) Press Herald, in the Bowdoin College Magazine, and in the Conway Daily Sun.

Charles Banks King (1927-2008), 6-great-grandson of Thomas Maule of Salem, Mass., and my 5th cousin once removed: Charles as a CPA, educated at Principia College and the University of Miami Graduate School of Business Administration. He was director of the Estate Planning Council of Greater Miami, was a member of committees of the Florida Institute of CPAs, and served in leadership capacities at many other civic and professional organizations. He was a director and treasurer of the Miami Beach Taxpayers Association. (Primary source: his obituary in the 21 Dec 2008 Miami Herald)

Taxation and the Descendants of Thomas Maule of Salem, Mass., Part VI

2011-08-15T08:01:00.001-04:00

This is the sixth in a series of posts that highlight descendants (and in several instances, spouses of descendants) of Thomas Maule of Salem, Massachusetts, one of my 512 7-great-grandfathers, who have been involved, one way or another, in taxation or tax policy other than in their capacity as taxpayers. The short biographies that I present are, in most instances, just a slice of a much fuller life. The full biographies can be accessed through the index on the Maule Genealogy Homepage by using control-f to search for the person [Warning: the index page is huge and takes a minute to load] or by going to the sources mentioned in the posts.

Today I continue with members of local tax boards.

Frederick William Savory (1927-2004), 7-great-grandson of Thomas Maule of Salem, Mass., and my 8th cousin: Frederick was a dairy farmer and crop supply company owner who served for many years on the Town of Greene (N.Y.) Tax Grievance Board. (Primary source: his obituary in the 11 August 2004 Binghamton Press & Sun Bulletin)

Richard Edgar Hewitt (1920 - ?), 5-great-grandson of Thomas Maule of Salem, Mass., and my 5th cousin twice removed: According to a 1982 clipping in an Evansville newspaper archive, Richard, who was president of the Hoover Abstract Corp., served on the Vanderburgh County Tax Adjustment Board as well as on several other civic and governmental boards and commissions.

Taxation and the Descendants of Thomas Maule of Salem, Mass., Part V

2011-08-12T08:01:00.000-04:00

This is the fifth in a series of posts that highlight descendants (and in several instances, spouses of descendants) of Thomas Maule of Salem, Massachusetts, one of my 512 7-great-grandfathers, who have been involved, one way or another, in taxation or tax policy other than in their capacity as taxpayers. The short biographies that I present are, in most instances, just a slice of a much fuller life. The full biographies can be accessed through the index on the Maule Genealogy Homepage by using control-f to search for the person [Warning: the index page is huge and takes a minute to load] or by going to the sources mentioned in the posts.

Today I continue with two local tax officials.

George Perry Worrell (1863-1942), married to Mary Louisa Ogden, 4-great-granddaughter of Thomas Maule of Salem, Mass., and my 4th cousin 3 times removed (in addition to being a cousin through my Ogden ancestry): In the 1930 census of Pennsylvania, George’s occupation is listed as tax collector. On the three previous census enumerations, he had been listed as a salesman for a grocery store, but it’s not known if the tax collector position followed a career path change or a second job. I haven’t been able to learn anything more about his public service as a tax collector.

Joseph M. J. Flaig (1882-1933), married to May P. Neave, 4-great-granddaughter of Thomas Maule of Salem, Mass., and my 4th cousin 3 times removed: In the 1930 census of Missouri, Joseph’s occupation is listed as tax assessor for the city of St. Louis. According to his death certificate, at the time of his death he was deputy assessor for the city of St. Louis. I know nothing else about him.

Taxation and the Descendants of Thomas Maule of Salem, Mass., Part IV

2011-08-10T08:01:00.000-04:00

This is the fourth in a series of posts that highlight descendants (and in several instances, spouses of descendants) of Thomas Maule of Salem, Massachusetts, one of my 512 7-great-grandfathers, who have been involved, one way or another, in taxation or tax policy other than in their capacity as taxpayers. The short biographies that I present are, in most instances, just a slice of a much fuller life. The full biographies can be accessed through the index on the Maule Genealogy Homepage by using control-f to search for the person [Warning: the index page is huge and takes a minute to load] or by going to the sources mentioned in the posts.

Today I continue with two IRS employees.

Juanita Maude Tucker (1922-2006), 4-great-granddaughter of Thomas Maule of Salem, Mass., and my 3rd cousin three times removed: According to her obituary, Juanita “retired in 1988 after an exemplary 20-year career with the IRS.” Before working for the IRS, she was a co-owner and operator of the Powder Puff Beauty Shoppe in Bloomington, Texas, a business she started after raising her children. I do not know in what capacity she worked at the IRS. (Primary source: her obituary.

Rose Marie Randolph Agnes Maule (living), 6-great-granddaughter of Thomas Maule of Salem, Mass., and my aunt: After raising her and uncle Joe’s children, aunt Rose worked for many years as an IRS tax examiner in Philadelphia before retiring some years ago. I’ve never tried to pry into the details of what she did, respecting the confidentiality restrictions to which she was subject. My career with the Chief Counsel to the IRS began before I had learned that Aunt Rose was a tax examiner, though shortly after she had taken the position.

Taxation and the Descendants of Thomas Maule of Salem, Mass., Part III

2011-08-08T08:01:00.001-04:00

This is the third in a series of posts that highlight descendants (and in several instances, spouses of descendants) of Thomas Maule of Salem, Massachusetts, one of my 512 7-great-grandfathers, who have been involved, one way or another, in taxation or tax policy other than in their capacity as taxpayers. The short biographies that I present are, in most instances, just a slice of a much fuller life. The full biographies can be accessed through the index on the Maule Genealogy Homepage by using control-f to search for the person [Warning: the index page is huge and takes a minute to load] or by going to the sources mentioned in the posts.

Today I continue with two employees of predecessors to the IRS.

Roy Levi Maule (1889-1940), 4-great-grandson of Thomas Maule of Salem, Mass., and my 4th cousin three times removed: In the 1930 census of Oregon, Roy’s occupation is listed as deputy collector for the Bureau of Internal Revenue. Many years ago, his cousin and son described his occupation as a public accountant, making no mention of his career with the BIR. In the 1920 census his occupation is listed as bank teller and in the 1910 census he is listed as a confectionary salesman.

Joshua Clendenon (1813-1892), great-great-grandson of Thomas Maule of Salem, Mass., and my 2nd cousin five times removed: During 1865 and 1866, Joshua was employed as a clerk by the Office of Internal Revenue, Department of the Treasury, in Washington, D.C. According to the 1860 census of Pennsylvania, he was working as a conveyancer before he moved to Washington. He eventually returned to Philadelphia, presumably after he retired. (Primary source: Congressional Serial Set, Issue 1293)

Taxation and the Descendants of Thomas Maule of Salem, Mass., Part II

2011-08-05T08:01:00.001-04:00

This is the second in a series of posts that highlight descendants (and in several instances, spouses of descendants) of Thomas Maule of Salem, Massachusetts, one of my 512 7-great-grandfathers, who have been involved, one way or another, in taxation or tax policy other than in their capacity as taxpayers. The short biographies that I present are, in most instances, just a slice of a much fuller life. The full biographies can be accessed through the index on the Maule Genealogy Homepage by using control-f to search for the person [Warning: the index page is huge and takes a minute to load] or by going to the sources mentioned in the posts.

Today I continue with an IRS and a Treasury official.

James Albert Mackey (1943-1999), 6-great-grandson of Thomas Maule of Salem, Mass., and my 7th cousin once removed: From 1971 through 1980, Jim was an assistant commissioner of the IRS. He had worked at Deloitte and Touche after completing military service, and after his departure from the IRS he founded the accounting firm of Mackey and Kirkner in Newtown Square, Pa., where I grew up. His son Jim was a student of mine at Villanova’s Law School in the 1990s. (Primary source: his obituary in the 23 Nov 1999 Philadelphia Inquirer)

Lorin Blodgett (1823-1901), 3-great-grandson of Thomas Maule of Salem, Mass., and my 4th cousin four times removed: Among Lorin’s many careers were positions as manager of the Treasury Department’s financial and statistical reports, as appraiser-at-large of customs, and as special assistant in the Treasury Department. When not busy with Treasury matters, he made time to found the U.S. Weather Bureau, serve as assistant at the Smithsonian Institution in charge of climatology research, present papers on atmospheric physics, direct the surveying and determination of gradients and altitudes for the Pacific railway, work in the War Office, write at least 150 books, 350 pamphlets, thousands of editorial articles, and countless reports, edit newspapers, serve as secretary of the Philadelphia Board of Trade, and take the industrial census of Philadelphia four times. His “Commercial and Financial Resources of the United States” was reprinted in Germany and was a significant factor in maintaining the nation’s credit in European money markets. (Primary source: Famous Americans)

Taxation and the Descendants of Thomas Maule of Salem, Mass., Part I

2011-08-03T08:01:00.002-04:00

This is the first in a series of posts that highlight descendants (and in several instances, spouses of descendants) of Thomas Maule of Salem, Massachusetts, one of my 512 7-great-grandfathers, who have been involved, one way or another, in taxation or tax policy other than in their capacity as taxpayers. Why this 7-great-grandfather and not one of the other 511? In part because I carry his name and his y-DNA, in part because I have not identified all of the other 511, and in part because I have not done similar research for the descendants of the other 511 whom I can identify. The short biographies that I present are, in most instances, just a slice of a much fuller life. The full biographies can be accessed through the index on the Maule Genealogy Homepage by using control-f to search for the person [Warning: the index page is huge and takes a minute to load] or by going to the sources mentioned in the posts.

Today I begin with a legislator.

Francis E. Holman (1915-1991), 7-great-grandson of Thomas Maule of Salem, Mass., and my 8th cousin: Fran Holman, judge, state senator, and member of the state house in Washington, built his reputation as an independent legislator who “served the public rather than special interests” and was free from political influence. Former governor Dan Evans remarked, “Mr. Holman couldn’t be budged even by The Boeing Co., taking a stand involving taxation that Boeing opposed.” Reportedly that stand cost him his partnership in one of the state’s largest and most elite law firms. While in the state legislature, he was active in tax reform, “making [the issues] understanable to the public.” (Primary sources: his obituaries in the 11 June 1991 Seattle Post-Intelligencer and the 6 June 1991 Seattle Times)

Tax Complexity: Why?

2011-08-01T08:01:00.002-04:00

It is no secret that I find the complexity of the Internal Revenue Code to be unjustified, oppressive, counter-productive economically, and the consequence of politicians creating new provisions rather than expanding existing ones, because the former is more advantageous to incumbents concerned about the source of their next campaign funding dollar. Last week I had the opportunity to gather some facts illustrative of this problem. After I finished writing the analytical portion of the next edition of Tax Management, Inc’s 597 T.M., Tax Incentives for Economically Distressed Areas, I turned to what is called the Portfolio Description Sheet. I counted up the number of issues that are discussed, and then, out of curiosity, I compared the results with their counterparts in the first edition of the Portfolio, written in late 2004 and published in early 2005. The Portfolio analyzes tax provisions that pump money into economically distressed areas, an approach that began in the 1990s as Congress chose to ignore direct grants that constitute spending and decided to use tax breaks that are, in effect, spending, though the beneficiaries of these provisions and their Congressional protégés refuse to treat them as spending and thus consider any reduction or elimination of these tax breaks to be tax increases rather than spending cuts.

The first edition dealt with six types of what I call qualified distressed areas. Early in the “use the tax law rather than spending grants” game, Congress created things such as empowerment zones, enterprise communities, renewal communities, and the District of Columbia Enterprise Zone. By 2011, the six had grown to 14, with the addition of an array of disaster areas, economically distressed production areas, and recovery zones. Though each of the 14 share the characteristic of being an area that has suffered or is suffering from economic set-backs, each one is defined differently.

The first edition of the Portfolio discussed 11 types of qualified assets, including enterprise zone businesses, renewal community businesses, qualified zone property, qualified renewal property, and DC Zone assets. The number of qualified asset types addressed by the second edition grew to 17. Added were things such as qualified equity investment and recovery zone property. Again, though these assets share the characteristic of being used in a qualified distressed area in some manner, the technical details buried in the definitions can make eyeballs spin. For example, try to imagine the differences among these types of property: qualified recovery assistance property, qualified section 179 recovery assistance property, qualified disaster assistance property, and qualified section 179 disaster assistance property.

The first edition analyzed 19 specific tax benefits available to taxpayers who meet the requirements for operating a business or making investments in a qualified distressed area. By 2011, the number had grown to 93. You read that correctly. From 19 to 93. Sounds like the title to the biography of someone’s adult life. The number of exclusions and deductions grew, and to that list were added more than a dozen credits. For example, there is a deduction for qualified disaster expenses and special rules for federally declared disaster area casualty losses.

Finally, the first edition described 12 tax detriments imposed on taxpayers who claimed one or more of the tax benefits. For example, amounts for which a deduction is provided cannot be used to increase basis, and in some instances, if property ceases to be a qualified asset, some sort of recapture applies. In the second edition, there are 51 tax detriments that need attention.

If that doesn’t demonstrate the unchecked growth of the tax law, try this. The manuscript for the first edition consisted of 172 single-spaced pages, with 1,708 footnotes. Using the same margins, font, and other parameters, the manuscript that I completed last week consists of 325 single-spaced pages, with 3,916 footnotes.

Isn’t it time that people get a handle on how much spending has been enacted in the tax law? Ought not economic benefits be treated in the same manner, whether they are direct grants or disguised grants hiding in complex Internal Revenue Code provisions? Is it not possible to create one set of rules for economically distressed areas? Why was it not enough to have empowerment zones? Why add renewal communities? And enterprise zones? Why are some tax benefits available to the Kansas disaster area but not the Hurricane Ike disaster area? Why are the special rules for the Midwestern disaster area different, and in some instances slightly different so as to catch the unwary off-guard, than those applicable to the Rita GOZone? Why are there different rules for the Hurricane Katrina disaster area and the GOZone, considering that the former is pretty much the latter? It’s not as though each time around, Congress refined the provisions and made them better or easier to understand. To the contrary, each of the many dozens of times Congress has added, modified, twisted, or tinkered with the provisions, the language became denser and longer. Why?