MauledAgain

A recent Tax Court case, Haag v. Comr., T.C. Summ. Op. 2016-29, sheds some light on how metropolitan areas are defined for tax purposes. More specifically, the case tells taxpayers how not to define metropolitan area.

Both of the taxpayers, a married couple, were electricians and members of the International Brotherhood of Electrical Workers. They belonged to Local 150. They lived in Lake County, Illinois. Both taxpayers worked for several employers at different sites in the Chicago area, and the husband also did work in Joliet, Illinois, in Champaign, Illinois, and in Florida. Both taxpayers drove their personal vehicles to and from work. The taxpayers recorded only the miles he drove beyond Lake County, relying on conversations the husband had with other union electricians.

The IRS agreed that the husband had driven 330 miles round-trip to Champaign, Illinois, and conceded that a deduction was allowable for that mileage. The Tax Court also allowed a deduction for the cost of round-trip miles driven by the husband to Chicago Midway International Airport in connection with a trip to Florida to perform work.

The IRS argued that the other miles driven by the taxpayers were personal commuting transportation and thus not deductible. Because the IRS permits the deduction of expenses incurred in traveling to work locations outside the metropolitan area where the taxpayer lives and normally works, the taxpayers argued that the expense of driving beyond Lake County was deductible. They contended that because the jurisdiction of Local 150 was limited to Lake County, Illinois, Lake County was their metropolitan area. The Tax Court disagreed with the taxpayers. The court noted that the taxpayers usually worked in Chicago or Joliet, roughly 65 miles from their home. The Court explained, “Without suggesting the adoption of any rigid definition of the term ‘metropolitan area’ for this purpose, we conclude that Lake County and petitioners’ work sites in Chicago and Joliet fall within the Chicago metropolitan area. The distances that petitioners routinely traveled to work were not so unusually long as to justify an exception to the general rule that commuting expenses are nondeductible personal expenses.”

For most people who think about the meaning of metropolitan area, what comes to mind likely is the statistical metropolitan area defined by the Office of Management and Budget, for various purposes, including the census and resulting statistical information. A closer look at the definitions reveals that ascertaining a metropolitan area is not as simple as looking at a map. There are overlaps, gaps, and variations in boundaries. As the author of this explanation put it, “In practice, the parameters of metropolitan areas, in both official and unofficial usage, are not consistent.”

Taken narrowly, the Tax Court decision simply tells us that the jurisdictional area of the union to which a taxpayer belongs is not necessarily a metropolitan area. If it is, it’s happenstance that the union’s jurisdictional area matches a metropolitan area. The resolution of the question appears to be one that rests on the facts and circumstances of each case.

Pennsylvania localities have a tax problem. They’re not good at sharing taxes, and the rules imposed on them by the state give Philadelphia special treatment. According to this article, localities in the Philadelphia area are pushing back. Legislation has been introduced to change the rules.

The current system, though easy to describe, isn’t easy to explain or justify. Generally, when a locality imposes an earned income tax on a nonresident, it remits the tax to the worker’s locality of residence. Thus, as the article explains, if a person lives in Cheltenham but works in Lansdale, Lansdale collects an earned income tax but sends it to Cheltenham. The exception is Philadelphia. If a resident of Cheltenham works in Philadelphia, Philadelphia collects its city wage tax, and keeps it. In Pennsylvania, localities are permitted to enact earned income taxes, not to exceed one percent. Philadelphia’s wage tax is 3.5 percent. Localities are supporting legislation that would require Philadelphia to remit to the localities an amount equal to one percent of the wages taxed by Philadelphia that are earned by nonresidents who live in other Pennsylvania localities.

The structure in Pennsylvania is strange with or without the Philadelphia exception. It is inconsistent with how income-based taxes generally are shared. For example, if a Pennsylvania resident works in New Jersey and pays New Jersey income tax, the Pennsylvania resident is permitted to claim a credit for the taxes paid to New Jersey, limited to the amount of Pennsylvania income tax imposed on those wages. For example, if the Pennsylvania resident earns a $100,000 salary in New Jersey and pays an income tax of $5,000 to New Jersey, the Pennsylvania resident is permitted to claim a $3,070 credit against Pennsylvania tax liability. This eliminates double taxation. It leaves the tax in the hands of the state where the income was earned.

In Pennsylvania, the earned income tax ends up in the hands of the locality where the taxpayer resides, unless the taxpayer works in Philadelphia. In that case, it ends up in Philadelphia’s hands. So, in some respects, the treatment of Philadelphia is not what is out of line with general practice. It’s what happens among the other localities that is out of step.

The question comes down to which locality should end up with the tax on earned income. What is not permitted, and what would be unfair, is for both the locality of residence and the workplace locality each to impose a one percent tax on the taxpayer. That would discriminate in favor of the taxpayer who lives and works in the same locality.

Localities offer excellent arguments for the current system, and Philadelphia offers excellent arguments for its special status. All point out that they are delivering services to the taxpayer, in the form of roads, police protection, and similar services. It is in these arguments that a solution can be found.

The earned income tax should be split into two components. One would be called the resident earned income tax and the other would be called the worker earned income tax. Each could be set at a rate of 0.5 percent, or each could be set a different rate that attempts to approximate the relative level of services provided to the taxpayer. For example, because a worker spends roughly one-fourth of a week’s hours at the workplace, perhaps the worker earned income tax would be .25 percent and the resident earned income tax .75 percent. Because that is a rather crude computation, some other ration could be found. The key would be limiting the total of the two percentages to one percent. Under this plan as applied to the earlier example, Lansdale would remit to Cheltenham a portion of the earned income tax that it collected, as would Philadelphia. Similarly, the portion of any earned income tax collected by Cheltenham on a Philadelphian working in Cheltenham would be remitted to Philadelphia.

Would this work? I think so. Why not try?

When taxpayers decided to purchase rental real estate, one of the factors that affects selection of property and the amount to offer for purchase is the anticipated deductions arising from interest payments on loans secured by mortgages on the purchased property. The best-designed plans, however, can fall apart if anticipated income does not materialize. The resulting inability of the taxpayers to make the interest payments causes them to lose the anticipated interest deductions.

The taxpayers in Slavin v. Comr., T.C. Summ. Op. 2016-28, found themselves in financial difficulties when they were unable to generate sufficient income from rental properties purchased several years before the economic collapse of 2007-2008. In 2004, the taxpayers purchased rental property, borrowing $975,000 on a promissory note, on which interest at six percent would be due annually until the note was due in 2034. The note was secured by a mortgage on the property. During 2008 and 2009, the taxpayers did not pay the interest that was due because the property did not generate sufficient income. Instead, the taxpayers and the creditor added the unpaid interest to the principal balance of the loan, on June 10, 2008, and again on October 15, 2009. The interest rate was unchanged. On January 8, 2010, the taxpayers and the creditor modified the loan by reducing the interest rate from six percent to three percent. The taxpayers, who use the cash method, deducted the amount of unpaid interest that was added to the loan balance. The IRS disallowed the deduction.

Citing established case law, the Tax Court explained that the taxpayers were not entitled to deduct the interest because they were cash method taxpayers who had not paid the interest. The modifications adding the unpaid interest to the loan balance did not constitute payment of the interest.

The taxpayers argued that the modification was a “substantial modification” under regulations section 1.1001-3, but the Tax Court rejected the argument. The court concluded that the substantial modification rules apply to recognition of gain or loss on dispositions and exchanges of debt, and have no relevance to the determination of whether interest has been paid. The court also concluded that there had not been a substantial modification.

The risk with tax shelters is that when financial problems reduce or eliminate the viability of the shelter, the tax benefits also disappear. In other words, the financial problems compound the adverse after-tax consequences. When taxpayers are considering the purchase of rental real estate, the computations ought to include the possibilities not only of financial downturns but also of disappearing tax benefits.

So Philadelphia now has a so-called “soda tax, though legal challenges could postpone or eradicate the enactment. And, as I pointed out in Bait-and-Switch “Sugary Beverage Tax” Tactics, the tax applies to products other than soda, and although justified as an anti-sugar-consumption measure, doesn’t touch most sugar-containing items. Worse, it is imposed on products that do not contain sugar. I have explained these flaws in What Sort of Tax?, 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, The Realities of the Soda Tax Policy Debate, Soda Sales Shifting?, Taxes, Consumption, Soda, and Obesity, Is the Soda Tax a Revenue Grab or a Worthwhile Health Benefit?, Philadelphia’s Latest Soda Tax Proposal: Health or Revenue?, What Gets Taxed If the Goal Is Health Improvement?, The Russian Sugar and Fat Tax Proposal: Smarter, More Sensible, or Just a Need for More Revenue, Soda Tax Debate Bubbles Up, Can Mischaracterizing an Undesired Tax Backfire?, The Soda Tax Flaw in Automotive Terms, Taxing the Container Instead of the Sugary Beverage: Looking for Revenue in All the Wrong Places, and Bait-and-Switch “Sugary Beverage Tax” Tactics.

Yet this tax contains within its provisions a road-map for evasion. Aside from the obvious tactic of purchasing items outside the city, the wholesalers and distributors who are responsible for paying the tax have been presented with an avoidance mechanism. As explained in the city’s summary, the tax does not apply to “[u]nsweetened drinks that the purchaser or seller can add sugar to at the point of sale.” Aside from being another example of the hypocrisy of the justification for the tax, this exemption provides a pathway for escaping the tax. Though it won’t work for all of the taxed items, it will work for many of them.

Here is an example of what distributors could do, if they conclude that the cost of implementing this approach is worth it. It might not be cost effective at the moment, but if other cities and localities follow Philadelphia and the “soda tax” becomes a national phenomenon, this avoidance technique probably will get close scrutiny by the manufacturers and distributors. Beverages that are sold in bottle could be sold in unsweetened form, just as coffee is sold in unsweetened form. The beverage would thus not be subject to the tax no matter where it is sold or consumed, because the tax does not apply to unsweetened beverages. Purchasers could then add their own sweetener, re-cap the bottle, shake it, and find themselves with a sweetened drink. In fact, purchasers could adjust the amount of sweetener that they add, satisfying their own preferences, and ending up with a beverage that is sweeter or less sweet than what was originally being sold. Of course, this won’t work well with beverages that are sold in cans under pressure, such as soda, and might not work with soda sold in bottles. The shaking of those bottles after adding a sweetener to unsweetened soda probably would make a mess.

Eventually, the jurisdiction imposing the tax would realize that a sugar tax doesn’t work when applied to sweetened beverages, because actual revenues would be far less than those anticipated. Jurisdictions would then attempt to tax sales of sugar at wholesale and retail levels, which would spread the incidence of the tax over so many items that its impact would be different and perhaps less noticeable. At the same time, extending the tax to non-sugar sweeteners would be such an obvious revelation of the hypocrisy behind the claim that the tax is health beneficial because it encourages the reduction of sugar consumption that attempts to tax items containing non-sugar sweeteners would fail.

If that is the eventual outcome, it is disappointing to see politicians learning by making a mess of things instead of sitting down and using their intellectual skills to figure out in advance that the sort of tax enacted by Philadelphia is a product of emotions and not rational thought, afflicted by politics. What a bitter way for the people of Philadelphia to learn that they’ve been the target of a bait-and-switch game that so easily can backfire.

As the nation’s infrastructure, particularly roads, bridges, and tunnels, continues to deteriorate thanks to tax hate, states and localities are trying all sorts of approaches to finding revenue to fulfill their obligations to protect citizens who travel or commute. I learned recently, thanks to this article, that several towns in Indiana have enacted a “wheel tax” under authority granted by the state legislature. Unlike a liquid fuels tax, which badly approximates road use, or a mileage-based road fee, which much more closely approximates road use, the wheel tax does not distinguish between the car that is driven 10,000 miles annually and a similar car that is driven 2,000 miles annually, even though the former imposes five times as much wear-and-tear on the road as does the latter.

The wheel tax is not based on the number of wheels attached to a vehicle. The tax on passenger vehicles, which almost always have four wheels, is $25. The tax on motorcycles, which have two wheels, is $12.50. My immediate reactions was, “That’s $6.25 per wheel.” But I was wrong. The tax on commercial vehicles, which can have as few as four and as many as eighteen, or perhaps more, wheels, is $40. I would have expected some sort of sliding scale, so that a ten-wheeled truck would be subject to a $62.50 tax. And what about recreational vehicles, which can have as few as four, or as many as ten wheels? The tax is only $12.50. And personal trailers, which usually have two, but sometimes four, wheels? Again, $12.50.

It seems to me that some wheeling and dealing was in play when this tax was authorized and enacted. The big clue is simple. When logic is missing, something isn’t quite right. Some people might tire of hearing me write the praises of the mileage-based road fee, but the wheel tax does nothing to change my mind. Nor should it. Nor should it be called a wheel tax, because it has nothing to do with the number of wheels on the vehicle.

A recent New York Times article focusing on tax compliance by small businesses shared information from a several-years-old IRS Taxpayer Advocate report that I had not noticed when it was published. The report, Factors Influencing Voluntary Compliance by Small Businesses: Preliminary Survey Results, addressed various aspects of tax compliance among small business owners. One set of survey results stood out.

One of the survey’s findings is not surprising, at least to me. According to the report, “Taxpayers in the low-compliance communities appeared in more concentrated geographic clusters across the country, especially in the South and West.” Those areas of the country have higher proportions of individuals who dislike national government and cling to fierce independent individuality.

Other findings were surprising, at least to me. For example, “Respondents from the high-compliance communities most frequently clustered in ‘other services’ . . . , whereas those from the low-compliance communities most frequently clustered in “professional, scientific, or technical services. . . . Those from the high-compliance communities were more than twice as likely to speak a language other than English at home.” Had I been asked, before seeing these results, whether compliance was higher or lower among those for whom English is not their first language, I would have answered, “lower,” and I would have been wrong. As another example, “Low-compliance community respondents were more likely than high-compliance com¬munity respondents to belong to a trade association . . . , volunteer organization . . . , or church or other religious congregation . . . and to vote . . . or send children to local schools.” I would have expected people active in their community, particularly church-goers, to be more cognizant of, and more compliant with, tax compliance obligations.

The finding that surprised me the most? “Both groups responded without significant difference to questions about how complicated the tax rules are (64 percent of the highly-compliant vs. 63 percent of low-compliance respondents) and the clarity of income reporting rules (73 vs.68 percent).” I would have expected more than 95 percent of respondents in any category to characterize tax rules as complicated. I find it amazing that if three people are asked if the tax rules are complicated, one would respond in the negative.

Almost every person teaching a basic federal income tax course requires students to learn the income tax consequences of divorce. In addition to the rules dealing with alimony, there is a seemingly simple provision in section 1041 that affords nonrecognition treatment to spouses when they separate their marital property. A recent case, Belot v. Comr., T.C. Memo 2016-113, demonstrates how application of a simple rule to a seemingly simple set of facts can generate complexity.

The taxpayer and his former spouse had formed and jointly owned three businesses while they were married. In 2007, they divorced. In their settlement agreement, they agreed to own and operate the businesses as equal partners. Because their interests in the businesses were not equal, they engaged in several transfers in order to bring their sharing ratios to 50-50. It did not take very long for them to discover that they were unable to function as business partners, and the taxpayer’s former spouse sued the taxpayer to obtain full ownership of the businesses. In 2008, sixteen months after the initial settlement, the taxpayer and his former spouse entered into another agreement, under which the taxpayer transferred his interests in the businesses to his former spouse in exchange for a cash, some paid immediately and some to be paid over ten years as evidenced by promissory notes. The taxpayer did not report any gain or loss from the transfer, relying on section 1041.

Section 1041(a) provides that “No gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of) -- (1) a spouse, or (2) a former spouse, but only if the transfer is incident to the divorce.” Section 1041(c) provides that “For purposes of subsection (a)(2), a transfer of property is incident to the divorce if such transfer -- (1) occurs within 1 year after the date on which the marriage ceases, or (2) is related to the cessation of the marriage.”

Temporary regulation section 1.1041-1T(b), Q&A-7 includes five sentences explaining how Treasury interprets section 1041(c):

First, “A transfer of property is treated as related to the cessation of the marriage if the transfer is pursuant to a divorce or separation instrument, as defined in section 71(b)(2), and the transfer occurs not more than 6 years after the date on which the marriage ceases.”

Second, “A divorce or separation instrument includes a modification or amendment to such decree or instrument.”

Third, “Any transfer not pursuant to a divorce or separation instrument and any transfer occurring more than 6 years after the cessation of the marriage is presumed to be not related to the cessation of the marriage.”

Fourth, “This presumption may be rebutted only by showing that the transfer was made to effect the division of property owned by the former spouses at the time of the cessation of the marriage.”

Fifth, “For example, the presumption may be rebutted by showing that (a) the transfer was not made within the one- and six-year periods described above because of factors which hampered an earlier transfer of the property, such as legal or business impediments to transfer or disputes concerning the value of the property owned at the time of the cessation of the marriage, and (b) the transfer is effected promptly after the impediment to transfer is removed.”

The IRS did not argue that the division of property under the second settlement agreement was not “made to effect the division of property owned by the former spouses at the time of the cessation of the marriage.” Instead, the IRS argued that the transfer under the second settlement agreement did not qualify under the regulations because the transfer did not relate to the divorce instrument.

The Tax Court rejected the IRS argument. It explained that the IRS argument that the division of marital property must relate to the divorce instrument is based on the first, second, and third sentences of the regulation, which refer to the divorce instrument, but overlooks the fourth sentence. The third sentence of the regulation provides that there is a presumption that section 1041 does not apply to “[a]ny transfer not pursuant to a divorce or separation instrument.” The Court decided that the taxpayer had rebutted that presumption consistent with the provisions of the fourth sentence “by showing that the transfer was made to effect the division of property owned by the former spouses at the time of the cessation of the marriage.” The IRS, however, claimed that the taxpayer did not rebut the presumption as provided in the fourth sentence because his transfer of the business interests to his former spouse was not due to “legal or business impediments that prevented a transfer called for by the divorce decree”. To support this analysis, the IRS relied on the fifth sentence of the regulation. The court, however, set that argument aside because the fifth sentence merely provides examples and does not create a requirement that petitioner must satisfy to
rebut the presumption.

The IRS also argued that the 2007 settlement resolved all of the marital property issues between the taxpayer and his former spouse, but the Tax Court noted that nothing in section 1041 or the temporary regulations limits section 1041 to one, or only the first, property settlement or property division. The IRS then argued that the 2008 settlement was in substance a sale, but the court explained that exchanges of cash for property are not excluded from section 1041 by its own terms or by the regulations. The IRS further argued that the former spouse’s dissatisfaction with the 2007 settlement was a business dispute, but the court noted that section 1041 and the regulations apply to marital property that consists of business-related property. The IRS offered another argument, that when the former spouse sued the taxpayer in 2008, she brought her action in the superior court civil division rather than family court, but the Tax Court rejected this distinction because section 1041 has no restrictions on the forum in which spouses seek to resolve their marital property disputes.

The IRS attempted to distinguish an earlier case permitting section 1041 to apply to multiple property settlements by arguing that, unlike the earlier case, the 2008 dispute did not involve disagreement over the terms and obligations of the 2007 agreement. The Tax Court disagreed, pointing out that in both the earlier case and the one under consideration, the former spouse alleged problems in implementing the first agreement, and negotiated a revised agreement with the other spouse that caused a different division of the marital assets. The court concluded that the transfers under the second agreement in both cases were made to “effect the division of property owned by the former spouses at the time of the cessation of the marriage” and were “related to the cessation of the marriage.”

Accordingly, the Tax Court concluded that section 1041 applied to the transfers made under the 2008 agreement. That outcome is not surprising. It’s the outcome that any teacher or student of section 1041, and its regulations, would reach if presented with the facts of the case. What is surprising is that the IRS, for unknown reasons, chose to take the position that section 1041 did not apply. In order to do so, it had to invent eight rationalizations in a failed effort to persuade the court to disregard previous decision that made clear the outcome. Though there are various reasons tax law is complicated, one of the more easily avoided causes is the proliferation of arguments, by taxpayers and by the IRS, that try to make distinctions where none exist, thus making the analysis more complicated than is necessary. Though it is fairly easy to understand why taxpayers, especially pro se taxpayers, engage in this sort of approach, it is baffling why the IRS would try to prevail in a case that could easily be resolved by a student who has successfully completed a basic federal income tax course or at least the portion that deals with section 1041. Just because there was a second agreement, or cash involved in the transfers, or marital assets involving a business is no reason to disregard the clear and simple language of section 1041 and the temporary regulations. The resources of the IRS would have been better utilized dealing with other taxpayers who in fact have failed to comply with the tax law.

My objections to so-called “soda taxes” are well known. The stated goal does not match the scope of the tax, which is touted as a means of reducing sugar consumption but which fails to tax every form of sugar consumption other than certain beverages. Even if the revenues are dedicated to worthwhile purposes, the tax is flawed. I have explained why this particular tax is flawed in a series of commentaries, beginning with What Sort of Tax?, and continuing through 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, The Realities of the Soda Tax Policy Debate, Soda Sales Shifting?, Taxes, Consumption, Soda, and Obesity, Is the Soda Tax a Revenue Grab or a Worthwhile Health Benefit?, Philadelphia’s Latest Soda Tax Proposal: Health or Revenue?, What Gets Taxed If the Goal Is Health Improvement?, The Russian Sugar and Fat Tax Proposal: Smarter, More Sensible, or Just a Need for More Revenue, Soda Tax Debate Bubbles Up, Can Mischaracterizing an Undesired Tax Backfire?, The Soda Tax Flaw in Automotive Terms, and Taxing the Container Instead of the Sugary Beverage: Looking for Revenue in All the Wrong Places.

In recent days, the Philadelphia soda tax proposal has been modified in several ways. As reported in many news stories, including this one, the tax has been modified to include diet soda. Someone please explain to me how sugar consumption is reduced by imposing a sugary drinks tax on drinks that do not contain sugar, while leaving drinks containing sugar, such as coffee purchased at Starbucks into which all sorts of sugar and sugar-based substances are added free of taxation. As also reported, not all of the revenues from this tax will be devoted to the wonderful projects paraded in front of City Council and citizens as justification for the tax, because some of the revenues will be added to the city’s general fund. Neither of these changes does anything to generate more support for the tax, and they certainly make it easier for opponents to demonstrate the flaws of the tax.

What makes this particularly annoying is the manner in which the tax has been championed by its supporters. Advertised as a necessary evil to fund pre-kindergarten programs, community schools, parks, and recreation centers, at the eleventh hour, actually fifteen minutes before the Council vote, the city’s finance director announced that some of the revenues would be used for the general fund. If a business operator in the private sector did something like that, bait-and-switch charges would be hovering nearby. As one critic put it, the city “administration misled the public.”

In The Russian Sugar and Fat Tax Proposal: Smarter, More Sensible, or Just a Need for More Revenue, I wrote:

One of the arguments I offer in rejecting a tax limited to soda or soda and some sweet drinks is that such a limitation is inconsistent with the avowed goal of improving health. I have suggested that these taxes are not much more than an attempt to raise revenue, with lip service paid to issues of health. I have contended that if health improvement is a serious goal, and assuming that a tax would actually change eating habits, the tax needs to reach more than soda, and should extent to include items such as cookies, cakes, donuts, candy bars, and junk food.

The fact that the Philadelphia tax applies to beverages that do not contain sugar puts into the spotlight the absurdity of the entire soda tax movement. If, and I emphasize if, society is in favor of a “sin tax” on sugar, then advocate a tax that applies to all sugar-containing items and only sugar-containing items. What is happening in Philadelphia is counterproductive to the claimed health goals of the soda tax lobby.

A reader, after reading this article, contacted me with several questions. Before turning to the questions, I summarize the article.

Because of the Surgeon General’s initiative to reduce the incidence of skin cancer, sunscreen dispensers are being installed in places like beaches, golf courses, fishing piers, water parks, pools, hiking trails, and similar locations. Non-profit public health organizations are covering most of the cost. The installations generally occur under programs approved by city and local governments. It started in Boston, then Miami Beach, and then was picked up by several West Coast localities. Health and wellness advocates and skin cancer experts are encouraging cities and towns throughout the country to join in the effort to reduce skin cancer.

The reader asked, “Is the providing of dispensers with sunscreen a tax subsidy?” and “Are public health nonprofits a tax subsidy?” The reader prefaced his questions by remarking, “The use of the word ‘free’ in this article is misleading and/or incorrect . I was taught by my parents there is no such thing as a free lunch.”

First, the appropriate use of the term “free” depends on the context. If nothing is expected in return, then the recipient of something for which nothing is paid can consider the item “free.” On the other hand, it is not unusual for a person who receives a “free” item to encounter a request or demand for something in return. Consider a food manufacturer who distributes “free samples” of a new item to shoppers in a grocery store. Are the items truly free? For the recipient, yes, because there is no obligation to purchase the product. For the purchasers of the product, or of the food manufacturer’s other products, there is a cost, because the manufacturer needs to purchase the materials and labor to produce the free samples.

Second, whether a tax subsidy is involved depends on how the sunscreen and dispensers are being funded. Certainly if they are being purchased by the state or local government using tax revenues, then they are not free for the town’s taxpayers even though they might be free for visitors who are not taxed or otherwise charged for the sunscreen. If the cost is borne by nonprofit tax-exempt organizations, the question of whether a tax subsidy exists is answered depending on how one views tax-exempt status. For decades, arguments have been delivered from those claiming that it is and those claiming that it is not. The cost of tax-exempt status is that additional taxes are paid by taxable persons and entities in order to make up the revenue not received from the tax-exempt organization, and to some, this is a tax subsidy. To others, a government is not giving anything to a tax-exempt organization when it refrains from taking some of its income or assets in the form of a tax. The concept of tax-exempt status, at a theoretical level, is that the monies not paid in taxes are used by the organization to provide services and assistance that otherwise would burden society and government. At a practical level, of course, it doesn’t work quite that way.

Would the analysis change if users of the sunscreen were required to pay, through an iPhone app, the swiping of a debit card, or other payment mechanism? It would remove the reader’s questions, because it would no longer be free in any sense. Why have the providers of the sunscreen elected not to charge? Because, as one spokesperson pointed out, “[s]unscreen is expensive, and for some people, it’s just not in their budget.” If those who cannot afford to pay don’t use sunscreen, many will develop melanoma, and in turn put economic costs on society, through a combination of higher health insurance premiums for everyone, that far exceed the cost of the sunscreen. Just as the food manufacture hopes to recover far more than the cost of the free samples through increased sales, the providers of sunscreen hope to recover far more than the cost of the sunscreen through decreased health care cost expenditures.

So what’s free? Perhaps not lunch, but the wisdom of planning ahead and paying a little now in order to receive or save much more in the future. Of course, with the current trend of monetizing everything, unless the trend changes, perhaps ultimately nothing, even the air we breathe, will be free.

A recent Tax Court case, McAuliffe v. Comr., T.C. Summ. Op. 2016-25, demonstrates the importance of creating and maintaining proof that tax returns are filed, and when they are filed. Though the case involved whether refund or credit of an overpayment was barred by the statute of limitations, the preliminary issue was whether the taxpayer filed a federal income tax return for 2003, and if so, when.

The taxpayer, an attorney, lived in Ohio, where he served as a municipal court judge. On April 23, 2003, he was indicted for mail fraud and money laundering offenses. He was charged with burning down his house and seeking insurance proceeds. He was taken into custody by April 28, 2003, held without bail, and convicted by a jury in February 2004. In December 2005, he was sentenced to 156 months of imprisonment. He was incarcerated in West Virginia when the petition was filed with the Tax Court. After he was released in August 2014, he moved to Florida. The taxpayer’s appeal of the conviction and his collateral attacks on the conviction failed. The Supreme Court of Ohio disbarred him from the practice of law.

The taxpayer received approximately $80,000 of gross income in 2003, and $12,156 in federal income taxes was withheld from his pay. The record of the IRS do not reflect a timely filed return for 2003, but do reflect the timely filing of a request to extend the due date for the 2003 return to August 15, 2004. The IRS records reflect the receipt of a return for 2003 filed in November 2008 while the taxpayer’s case was pending before the IRS Appeals Office.

The taxpayer testified that after his arrest, his tax affairs were handled by his attorney-in-fact, Craig Maxey, and by Cindy Grimm, a full-time parole officer and part-time, seasonal, return preparer for H&R Block. The taxpayer testified that after his arrest he was not thinking about taxes and had no involvement in them. Grimm obtained the request for extension of time to file, and Maxey provided her with the taxpayer’s 2003 tax information. Though neither Maxey nor Grimm testified at trial, the parties stipulated that she did not recall whether she filed the taxpayer’s return or sent it back to Maxey for filing. They stipulated that Grimm stated that if she filed the return, she would have done so electronically. They also stipulated that Maxey stated he did not mail the 2003 return to the IRS.

In or about 2007, the IRS commenced an examination for the taxpayer’s 2003 taxable year. There being no return, the IRS created a substitute for return, and proposed a deficiency in tax and additions to tax.On May 5, 2008, the IRS sent a notice of deficiency to the taxpayer in prison. The taxpayer filed a petition on July 14, 2008. Thereafter, the IRS requested from the taxpayer a copy of the 2003 return. In November 2008, the taxpayer sent a copy of the 2003 return, explaining that the first time he had seen the return was when he received a copy from Maxey a few days earlier. The return provided by the taxpayer did not have his actual signature but had a stamped signature. At trial, the taxpayer testified that Grimm possessed his signature stamp and used it for tax and nontax purposes. The return had Grimm’s actual signature as preparer. The return showed zero taxable income, zero total tax, and an overpayment equal to the amount of withheld tax. Also in evidence were incomplete extracts from a transcript dated May 30, 2012, from the Ohio Department of Revenue for the taxpayer’s 2003 Ohio taxable year. The extracts did not definitively establish when the Ohio return was filed, nor whether a federal income tax return was filed for that year, although they refer to the amount of the taxpayer’s AGI as reported on the return provided to the IRS Appeals Office in November 2008.

The Tax Court concluded that the record demonstrated the taxpayer himself never prepared or signed a return for 2003. The taxpayer did not know whether Maxey and Grimm did what he thinks they were supposed to have done. He surmised that they did, because the Ohio income tax return for 2003 was filed. But nothing in the abstracts from the transcript indicate whether or when a federal income tax return was filed. Based on Grimm’s inability to remember whether or not she filed the return, and Maxey’s testimony that he did not mail a return, the court decided that it could not conclude that either Grimm or Maxey filed the return.

The best proof that a tax return has been filed depends on how it is filed. If it is filed in paper form through the mail, a return receipt is proof not only of transmission but also of receipt by the relevant tax office. If a return receipt is requested but not received, the taxpayer has an early warning that the return probably was not received, and can begin to track it down. If the return is filed electronically, the software generates a receipt, and thereafter provides a notification that the return was accepted by the relevant tax office. It is unclear whether Grimm or H&R Block received such a confirmation, but presumably a search was made for it and it was not found.

Though advice to obtain receipt for the mailing or filing of a return is easy enough to give to a taxpayer who is preparing his or her own return, or who is working with a preparer, it is of much less help for taxpayers who are not involved in the preparation of their return because they are in prison, in a coma, or otherwise in a position that prevents them from being involved in the return preparation. At that point, it becomes the responsibility of the person handing the taxpayer’s tax matters to obtain a receipt for filing the return. Though it might be easy to wonder why Grimm did not do so, considering that she was a tax return preparer, it is unclear what responsibilities Grimm undertook with respect to the taxpayer’s return. Even if the taxpayer had made direct contact with Grimm and requested her to file his 2003 return as he was being led off into the criminal justice system, it’s a bit much to expect him to provide a checklist of what ought to be done or to request specifically that a return receipt be obtained. Perhaps that request should have been made by the attorney-in-fact.

We now live, fortunately or unfortunately, in which assertions of actions taken and not taken, of things said and not said, are easily offered and more easily circulated. The best protection is to keep good records, obtain receipts, and retain evidence of what has and has not happened. The cost of not doing so can be steep, and can be more than a lost overpayment.

Several weeks ago, in Taxation of Androids and Robots, and Similar Pressing Issues, I commented on discussions at a science fiction conference that focused on the question of who would qualify as “people” for purposes of taxation. The participants addressed the tax status of androids, robots, sentient non-human aliens, and zombies. Though the question of whether a zombie is subject to taxation might seem far-fetched and irrelevant to current tax practice, the treatment of what could be characterized as a “zombie corporation” arose in a recent Tax Court case.

In Allied Transportation, Inc. v. Comr., T.C. Memo 2016-102, the Tax Court considered whether it had jurisdiction to consider a petition filed in response to a notice of deficiency. Allied was incorporated on August 23, 2001, by Sukhjeet Singh Gill. It was issued a taxpayer identification number by the Maryland Department of Assessments and Taxation, Corporate Charter Division. On October 8, 2004, the department revoked and annulled Allied’s corporate chapter for failing to file a required property tax return. On February 12, 2007, Gill attempted to file articles of revival on behalf of Allied, but on March 6, 2007, those were declared void for nonpayment.

On August 14, 2014, the IRS issued a notice of deficiency to Allied for taxable year 2010. It alleged a federal income tax deficiency of $79,812 along with additions to tax of $18,000. On October 14, 2014, Allied filed a petition with the Tax Court, signed by Gill. On October 14, 2015, the IRS filed a motion to dismiss for lack of jurisdiction, arguing that the petition was not filed by a party with capacity to sue. Counsel for the IRS explained in the motion that he had discussed the motion with Gill, who stated he no longer had any involvement with Allied and did not intend to proceed any further with the case. On October 20, 2015, the court issued an order to Allied directing it to respond to the IRS motion to dismiss. Allied did not respond.

Rule 60(c) of the Tax Court Rules of Practice and Procedure provides that the capacity of a corporation to litigate in the court is determined by the law under which it was organized. In Maryland, when a corporation forfeits its charter, the powers conferred on it by law are inoperative, null, and void as of the date of forfeiture. The power to sue or to be sued is extinguished. In other words, the corporation is dead. However, the corporation is treated as continuing to exist after the forfeiture, for purposes of litigating matters that have a rational relationship with the legitimate winding up of the corporation. This post-forfeiture existence is limited to the completion of corporate business existing at the time of the forfeiture.

The Tax Court pointed out that Allied filed the petition more than ten years after the forfeiture. It held that ten years is an excessive period within which to conduct winding up activity. It also noted that the tax liability in question was for 2010, six years past the forfeiture. The court commented, “The notice of deficiency determined, on the basis of a bank deposits analysis, that Allied had unreported gross receipts of $247,595 for that year. Given that Allied had forfeited its charter six years previously, it seems unlikely that it (as opposed to a related party) could have earned those gross receipts.” The court concluded that litigation concerning income arising in 2010 would not seem to have a rational relationship to the winding up of corporate business that existed in 2004.

From this case, it is easy to conclude that zombie corporations exist. These are corporations that die when their charters are revoked or otherwise terminated, but that are treated as alive for limited purposes related to the winding up of the corporation. The case also demonstrates that a dead corporation cannot have gross income. The case does not answer the question of whether a zombie human can have gross income. When and if that case arises, hopefully after I’ve left the planet, there might be some basis for arguing from analogy from the principles illustrated by this case. I have no intention of returning as a zombie to obtain first-hand experience with respect to the question.

Those television court shows continue to supply material for MauledAgain. The tax aspects of these television cases have inspired me to write posts such as Judge Judy and Tax Law, Judge Judy and Tax Law Part II, TV Judge Gets Tax Observation Correct, The (Tax) Fraud Epidemic, Tax Re-Visits Judge Judy, Foolish Tax Filing Decisions Disclosed to Judge Judy, So Does Anyone Pay Taxes?, Learning About Tax from the Judge. Judy, That Is, Tax Fraud in the People’s Court, More Tax Fraud, This Time in Judge Judy’s Court, and You Mean That Tax Refund Isn’t for Me? Really?. This time, the inspiration comes from an episode of Hot Bench, which previously gave me the material for Law and Genealogy Meeting In An Interesting Way.

The plaintiff bought a car from the defendant, who claimed to be an independent car wholesaler. The plaintiff did not get title to the car. Title had been transferred from a third party to an auction house, and from the auction house to one of the defendant’s companies. The defendant explained that his attempt to transfer title to the plaintiff hit a snag with the Missouri Department of Motor Vehicles because it considered him to be a dealer rather than the independent car wholesaler he claimed to be.

The plaintiff paid $2,300 for the car. She was given a receipt for $800. The receipt was issued in the name of another of the defendant’s companies, and not the one that purchased the vehicle at the auction. When asked why the receipt was for $800 and not $2,300, the plaintiff responded that the defendant issued her a receipt for $800 so that she pay state sales taxes on $800 rather than the entire $2,300.

The court did not look favorably upon the defendant’s behavior. It held for the plaintiff, awarding her return of the $2,300, and giving possession of the car back to the defendant. Nothing was said about the sales tax fraud, nor was it clear whether the plaintiff had any part in it.

This is not the first television court case involving sales tax evasion. A similar case was the inspiration for The (Tax) Fraud Epidemic. I wonder how prevalent this particular style of sales tax evasion has become. There’s no avoiding the conclusion that it is fraudulent to say to a customer, “I’m selling this to you for $2,300, you will pay me $2,300, but I will issue a receipt that can be used in support of the lie that I sold this to you for $800.” The question is whether the buyer should be held accountable for not saying, “No, I want a receipt for $2,300 and I will pay sales tax on that amount.” My guess is that, in this case, even if the plaintiff had said that, the defendant would have had a plausible explanation for why “This is the way it is done.”

Each year, the underground economy accounts for hundreds of billions of dollars of evaded federal income taxes. This “tax gap” gets a good bit of attention. I wonder how much tax gap exists for state and local non-income taxes. I suspect that it’s not in the hundreds of billions of dollars. It’s probably in the tens of billions of dollars. That’s a lot of unrepaired roads, delayed emergency services responses, and education gaps.

Some members of Philadelphia’s City Council who are opposed to the sugary beverage tax proposed by the mayor have offered an alternative. The Non-Reusable Beverage Container Tax would apply to non-reusable beverage containers supplied to, acquired by or delivered to retailers. A non-reusable beverage container is any individual, separate, and sealed glass, metal, or plastic bottle, can, jar, or carton, not ordinarily collected from consumer for refilling, that contains a beverage of more than seven fluid ounces and that is intended for consumption off premises. A beverage is any soft drink, water, ready-to-drink tea or coffee, fruit juice, vegetable juice, or energy drink, but not baby formula, products with milk as the primary ingredient, and milk substitutes. The preceding summary does not do justice to the complexity of the proposal, particularly the collection and procedural requirements.

In terms of how I analyze taxes and user fees, the beverage container tax fares no better than does the soda tax. I have analyzed the latter in numerous commentaries, beginning with
What Sort of Tax?, and continuing through 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, The Realities of the Soda Tax Policy Debate, Soda Sales Shifting?, Taxes, Consumption, Soda, and Obesity, Is the Soda Tax a Revenue Grab or a Worthwhile Health Benefit?, Philadelphia’s Latest Soda Tax Proposal: Health or Revenue?, What Gets Taxed If the Goal Is Health Improvement?, The Russian Sugar and Fat Tax Proposal: Smarter, More Sensible, or Just a Need for More Revenue, Soda Tax Debate Bubbles Up, Can Mischaracterizing an Undesired Tax Backfire?, and The Soda Tax Flaw in Automotive Terms.

So what’s the justification for the beverage container tax? According to this report, the member of City Council introducing the bill stated, “This tax needs to be shared by all, from soda to Perrier.” Of course, the beverage container tax does not ensure that the revenue burden is shared by all. Some people will have the ability to purchase beverages outside the city, whereas others do not have that opportunity. The flat 15-cents-per-container tax is regressive, because a person who purchases beverages 500 times during the year would pay $75, which might not be much for a wealthy or economically comfortable individual but which would be a big dent in the wallet of a poor person.

Just as the soda tax has no rational connection to the programs its revenues are intended to finance, so, too, there is no rational connection between a beverage container tax and the programs its revenues are intended to finance. As a practical matter, both tax proposals are designed to finance the same bundle of programs. It’s not that those programs are bad ideas. It’s the lack of a rational funding connection that underscores the flawed nature of both proposals.

The soda tax is designed to cut sugar consumption. But it fails to reach its intended target because it does not apply to most sources of sugar. It’s unclear what the beverage container is intended to target other than containers as containers. Perhaps some sort of justification could be offered in terms of reducing the proliferation of containers filling landfills, polluting the ocean, and contributing to street trash. However, the nature of such an argument as pure pretext would be obvious because the proposed beverage container tax would not apply to most sources of detrimental containers. Worse, it would apply to containers that are recycled, even though those containers create far fewer environmental disadvantages than do containers that are not recycled. Even worse, it would not apply to those styrofoam containers used to deliver food and other items. Inexplicably, it would apply to container filled with beverages intended for off-premise consumption but not containers filled with beverages intended for on-premises consumption, even though both containers contributes to pollution and landfill overflow if they are not recycled.

The beverage container tax is nothing more than the soda tax expanded to cover other beverages, some healthy and some not-so-healthy. Designed in that way, the tax no longer can be justified as a means of reducing sugar consumption. It cannot be justified as environmentally sensible. It’s nothing more than a matter of looking for revenue in all the wrong places.

It’s official. Today is the first day, since January 2, 1981, that I am not a full-time member of a law school faculty. After three years in a “staged retirement” plan of my design adopted by the law school, I retired as of May 31, 2016. Staged retirement permits a faculty member to reduce teaching load to one semester, and to be relieved of committee assignments and scholarship expectations (though the latter was irrelevant to me as I continued to write).

Through the years, though most of the faculty who have retired headed out to other pursuits, several returned to teach one or two courses. A combination of institutional need and individual desire to stay connected to the classroom has created admirable symbioses. For those two reasons, the plan is for me to return in the spring semester of 2017 to teach a course, and, perhaps, two. Two? To use one of my favorite phrases, it depends. Thereafter? Guess. Yes, it depends.

Another colleague who is retiring described the arrangement rather nicely when asking a question recently, “A bunch of us are heading out the door, though a couple are heading right back in.” It is a bit confusing, because it creates a relationship somewhere between full-time member of the faculty and fully retired no-longer-on-campus retiree. I’ve proposed a new designation but you’ll hear about that in the future only if it becomes official.

On the evening of May 12, the Villanova University Charles Widger School of Law hosted a retirement dinner for those of us who retired as of yesterday. When invited to speak, this is what I said:

Thank you.

Contrary to perception, my time here hasn’t been all about tax and numbers. So only a fraction of my remarks will involve integers.

I’ve been teaching or tutoring since I was in grade four. I have learned that it is true, the best way to learn is to be an effective teacher. Though that includes teaching one’s self, there is no good substitute for learning from and teaching others. That happens in this school, and I present four facets of how I experienced this.

First, when I joined the faculty, I was asked, “What’s it like now that you’re part of the faculty that taught you?” I answered, ‘They’re still teaching me.” I didn’t add that they were still admonishing me. Sometimes justifiably. Over the years, all but one of that group has departed, one way or another, and that colleague retires next year. As they left, others arrived, and I have learned from them as well. Though I have no time to describe what I learned, I appreciate the intellectual sharpening, the social banter, and the friendships. By my rough estimate, more than 100 teaching colleagues have shared this journey at one time or another. I thank my colleagues.

Second, faculty were not the only employees from whom I learned. Over the years, at least 200 administrators and staff taught me all sorts of lessons, from computer secrets to label printing, from library and research help to event planning tips. I thank the administrators and staff.

Third, the reason this institution exists, the students, taught me even more. I was told that when I graded exams, I would be astonished by what I would learn. I discovered the truth of that warning while grading 8.467 final exams in 21 different courses, taught over 87 semesters spanning 35 and a half years. I learned even more from those quizzes and exercises that I battled for permission to administer, and that have become a major component of the formative assessment process soon to be found throughout the curriculum. As I taught, I learned what my students were grasping and missing, in a process that had me read and grade, over the past 22 years, semester exercise and quiz responses totaling more than 52,000. I thank my students.

Fourth, even more learning came from colleagues who looked at manuscript drafts, student research assistants who dug up information, and staff who assisted in filling the mailboxes of lawyers and non-lawyers with 22 books and 33 revisions to 19 of those books, 22 chapters in books and 41 revision to 18 of those chapters, 33 articles, dozens of other publications, and 2,175 posts on the “will you ever tell us how it got its name” MauledAgain blog. The responses to those publications have been quite an education. I thank my helpers and my readers.

In closing, I have been asked, “So you’re retiring, why now?” The answer is in those numbers. Simply put, I do not want to burn out. Though Neil Young has claimed that it’s better to burn out than to fade away, I agree with John Lennon’s criticism of that advice. So I plan to fade away. Slowly, from 7 courses a year to 5 to 4 to 2, and now, yes, next year, 1 (or, maybe 2), I have tried to make retirement, for me, a gradual process and not an abrupt halt.

This evening has been a wonderful opportunity to pause, look around, share memories, and contemplate the future. It has been, and will continue to be, an extraordinary educational journey. Please understand, it’s not over. Though I am retiring, I am not leaving.

Some people have asked me what I will be doing now that I am “retired.” Others have noted that “your life will be so different.” I have explained why that will not be so. I will continue to teach, though only one course, or perhaps two. I will continue to write, though perhaps not as frequently. I will continue to share commentary on this MauledAgain blog. I will continue to research family history. I will continue the activities in which I engage at my church. I will continue to go to the gym. I will continue to visit family. I will continue to travel. I will continue to read. I will continue to do household and yard chores.

So to shift from visualizing doors to understanding the journey, I’m going down the same highway and perhaps spending a little more time in some lanes and a little less time in others. Perhaps I will slow down a bit, at first. But I will continue to learn. From that, I have no intention to retire.

Today is Memorial Day. It began as Decoration Day, intended to recognize those who died in war in service to their country, by placing flowers, wreaths, flags, and other “decorations” on gravesites. Purists will note that Veterans Day, in November, provides an opportunity to honor those who served and who are still with us.

Today, though, is a day to remember more than those who have died while serving our country in war. It is a day to remember those who served and suffered fates worse than death, those who served but who suffered physical and psychological injuries from which they have not fully recovered, those who served and fully recovered, and those who served though escaping death and injury. It is a day to remember that the horror of war extends far beyond gravesites and into the lives of millions of Americans, including the families and friends of those who have served.

Today is a day to remember the lessons that are taught by war, lessons that apparently are difficult to learn. War comes with a cost, and that cost must be paid. In recent years, this nation has short-changed its veterans, and Congress and individual politicians have trotted out all sorts of reasons for bringing corporate cost-cutting measures to bear on those who have paid a price too few appreciate. As I wrote ten years ago in A Memorial Day Essay on War and Taxation:

Wars consume resources. Wars divert resources. In other words, wars cost money. Wars destroy lives. A life lost is immeasurable, yet economists, lawyers, and juries put price tags on lives, however lost. It is not good for an economy, or for taxation, for lives to end prematurely.
. . .
War is such a collective expression of the ultimate essence of life and death that it ought not be undertaken half-heartedly, experimentally, impetuously, or foolishly. War requires commitment, and without it there ought not be war. War requires resources, and without a commitment to expend those resources, it ought not be undertaken.
. . .
Yet the current global war has not been managed in the same manner. Politicians have chosen to fight without increasing revenue, imposing rationing, or deferring projects and activities. In their defense, they argue that none of these things are necessary, that a nation can have its guns without giving up its butter. I disagree, and I happen to think that politicians are reluctant to do what needs to be done because they are more concerned about maintaining their position in office than in making the tough decisions that war requires. So our national leaders have chosen to put the cost of the current war on our children and grandchildren. Those who decry the huge deficits, triggered in part by war and in part by the almost insane concept of decreasing tax revenues (mostly for the wealthy) during wartime, pretty much focus on the economic impact. They ask if, or suggest that, our grandchildren will be facing income tax rates of 80 percent in order to reduce an unmanageable deficit. I think it will be worse. I think our children and their children and grandchildren will become subservient to our nation's creditors. The sovereignty of the United States of America is far from guaranteed, and is at risk. Were these considerations discussed when those in power decided that war can be done on the cheap?

War cannot be done on the cheap. War is not free. War ought not be purchased on a credit card. War is a national commitment. Hiding the true cost of war in order to influence a nation's willingness to engage in war is wrong. Ultimately, the price to be paid will be dangerously high. . . .

If I could travel back in time, I would amend that commentary to point out that our national leaders have chosen to put the cost of twenty-first century wars, declared or undeclared, as well as military actions, on our children, grandchildren, veterans, and military personnel. Those who benefit from the outcome of war have not been handed an adequate invoice.

Previous Memorial Day posts:

Gasoline and War

A Memorial Day Essay on War and Taxation

Memorial Day: How Important are Taxes Really?

Honoring Those That Serve

Memorial Day: Why a Holiday From Taxes?

Memorial Day, Taxes, and Remembering the Future

Free, Freedom, Fees, and Taxes

Paying Taxes: In Memoriam

A recent case, Aleamoni v. Comr., demonstrates the need for business owners to select carefully the entity through which the business will be conducted. In the mid 1980s, the taxpayer, a college professor, formed a C corporation through which he offered consulting and similar activities not part of his teaching and other university responsibilities. The taxpayer and his wife owned half of the shares, and their children owned the other half. Over the years, the taxpayer and his wife advanced money to the corporation, which the corporation recorded on its general ledger as loans from shareholders. In the mid-1990s, the taxpayer and his wife started attaching a Schedule C to their federal income tax return, deducting the money advanced to the corporation during the year as a business expense. No income was reported on the Schedules C. The corporation filed Form 1120 for each of its taxable years, reporting gross income and deductions exceeding the gross income. The balance sheets on those returns showed the advances from the taxpayers as loans from shareholders. The IRS disallowed the Schedule C deductions, and the taxpayers filed a petition for redetermination in the Tax Court.

The taxpayers argued that the advances were loans to the corporations, that the advances are deductible as business expenses, and that the failure of the IRS to disallow the deductions in audits of returns for earlier years precluded it from disallowing the deductions for the years in issue. The IRS argued that the advances are not deductible whether they are characterized as loans or as capital contributions.

The Tax Court concluded that the advances were not deductible under section 162 because they were not expenses. They represented investments by the taxpayers in the corporation and thus were not deductible. The court noted that if the advances were loans the taxpayers might be entitled to a bad debt deduction in the future to the extent the loans became worthless, and that if they were capital contributions the taxpayers might be entitled to a capital loss deduction in the future to the extent the stock became worthless. However, because the taxpayers explained that the corporation existed and doing business, because they expected the advances to be repaid in due course, and because they gave no suggestion that the stock was worthless, the bad debt and capital loss deduction possibilities were not in play.

The court suggested that the taxpayers might argue that the corporation was little more than the alter ego of the professor, but that a corporation formed for legitimate business purposes is an entity separate from its shareholders. Thus, the shareholders are not permitted to deduct the corporation’s expenses, even if financed by loans or capital contributions made by the shareholders.

The court pointed out that if the corporation were an S corporation the amounts advanced to the corporation would be deductible by the shareholders to the extent those amounts were used by the corporation to pay deductible expenses. That approach was rejected because the taxpayers had not formed an S corporation.

The court dismissed the taxpayers’ argument that the failure of the IRS to object to the Schedule C deductions in audits of returns for earlier years precluded it from doing so for the years in issue. It explained that the doctrine of equitable estoppel is not a bar to correction by the IRS of a mistake of law, even if the taxpayer relied on that mistake in filing returns for subsequent years.

When starting a business, selecting the form in which the enterprise is conducted is an essential consideration. There are advantages and disadvantages to each of the choices. Determining which form makes the most sense for a particular taxpayer depends on the particular characteristics of that taxpayer’s characteristics. It requires examination of the particular business, the market in which it operates, the long-term and short-term probability of success, the possibility of becoming a target for acquisition by another party, the tax situation of the taxpayer, the psychological and emotional constraints on the taxpayer’s business presented by third parties, the prospects of the taxpayer’s premature death, and dozens of other factors. Making the wrong decision, which is much easier to identify through hindsight, can have significant adverse consequences. It is worthwhile for the taxpayer to consult with a professional, to avoid relying on internet advice and sound bite bits of so-called wisdom, and to remain skeptical of decisions made by robots or other forms of artificial intelligence that disregard the factors not easily reduced to bits and bytes.

A little more than three months ago, as I explained in “Can a Clone Qualify as a Qualifying Child or Qualifying Relative?”, a reader asked me, “Can a clone qualify as a qualifying child or qualifying relative?” After sharing my thoughts about how the analysis could begin, I concluded by admitting, “I don’t know. I can guess, and you can guess, and it’s fun to share our guesses. But in the end, it’s that classic response, ‘It depends.’ Until then, think about it from time to time.”

The same reader has now pointed my eyes in the direction of an almost two-year old commentary, Die, robot. From androids to zombies: taxation of the undead. However I had missed this, perhaps because it was based on a science fiction conference held in London, I had to read it. Of course.

The conference focused on how people would save tax in the future. The discussion started with the question, “who will the people be?” In a series of questions worthy of law school trying to prepare its students for practice in the late twenty-first century, the participants wondered if an android or robot into which someone’s consciousness had been downloaded would be taxable as a person.

The suggestion that taxing authorities would TRY to tax the android or robot is not surprising. Of course the authorities would try. But would they be correct? Would, or should, their decision be upheld or struck down?

One line of analysis contended that a person would not escape taxation simply because he or she had an artificial leg, or an artificial leg and an artificial heart, or a prosthetic voice. Logically, therefore, why would a person not exist if a combination of artificial everything, including an artificial brain, was cobbled together? These ideas have populated science fiction literature for decades. But unlike past generations, or even those alive today who as children or young adults passed these imaginations off as fantasy, the possibilities are very real, if not today, then next week or next year, or next decade, that human-like androids and robots will exist.

Eventually, the panelists at the conference decided that if the android or robot could own property, it should be treated as a person, and thus taxable. Similarly, if it incorporated itself the resulting entity would be taxable. The author of the commentary decided that the test should be, “if it moves, tax it, if it thinks, tax it, if it earns, tax it.” That approach would make animals obligated to file tax returns in those instances when the animal earned money, something that does happen. Animals certainly make money for their earners, as this article explains, so certainly the owner of an android or robot would be taxable on that income. But what happens if the android, or the robot, or the animal, is treated as having independent existence with a right to retain its earnings? Laugh not, because there are chimpanzees and capuchins who have been taught to handle money, as explained in an article that explains not only how they learned to use money and to understand it, but what they then ended up doing with it. It’s well worth the read.

The commentary addressed other tax issues involving androids and robots, such as domicile, cloning, zombies, sentient non-human aliens, and, perhaps alarmingly, time travel. If the question of “tax and time travel” is getting this sort of attention, I might need to find a better example for use in warning law students about drifting from the practical into the theoretical when doing so is inappropriate.

These questions are, at the moment, focused on theoretical concerns. But, one by one, sooner or later, they will become very real. Perhaps none of us will face them, other than in blog musings and dinner party chit-chat. But our children, grandchildren, or more remote descendants will grapple with these issues. Perhaps they will come back to fetch us. Will we be required to pay a transportation tax when that happens? If I find out, I’ll let you know.

Usually, ascertaining a taxpayer’s motives is something on which practitioners and judges focus when the issue involves taxpayer intent with respect to a specific transaction. For example, in more than a few places, the Internal Revenue Code requires a determination of whether a taxpayer entered into a transaction with a purpose to avoid federal income tax. There is another set of situations, however, in which the focus on a taxpayer’s motives is a matter of understanding why a taxpayer chose to take a particular return position or to litigate an issue. A recent case, Santos v. Comr., T.C. Memo 2016-100, leaves me, and presumably others, wondering why the taxpayer contested a deficiency and advanced the arguments that he did.

The facts of the case are fairly simple. At an unspecified time in the past, the taxpayer earned a bachelor’s degree in accounting. In 1990, he began working as a tax return preparer. Five years later, he became an enrolled agent. In 1996, he earned a master’s degree in taxation. He expanded the scope of his services to his clients to include accounting and financial planning. At some point during or before 2010, the taxpayer enrolled in law school, and graduated in 2011. In that same year, he sat for the California bar examination. He was admitted to the California bar in 2014, and also was admitted to practice before the United States Tax Court. In 2015, he and his father opened law offices, offering legal representation, tax planning, accounting, and financial planning.

When the taxpayer filed his 2010 federal income tax return, he deducted $20,275 in law school tuition and fees. The IRS disallowed the deduction. The taxpayer filed a petition in the Tax Court. He lost. He lost because education expense deductions are not allowable if the education prepares an individual for a new trade or business, because the requirement that the taxpayer be carrying on the trade or business to which the deduction relates is not satisfied. This principle is set forth in the regulations under section 162. The regulations specifically include an example that explains why law school tuition is not deductible by someone who is practicing a profession other than law, such as accounting. Numerous judicial decisions have reached the same conclusion, and have upheld the regulations.

The taxpayer attempted to justify the claimed deduction by challenging the validity of the regulations. He argued that the Treasury Department failed to respond adequately to public comments received when the regulations were proposed in 1967, citing a 2015 decision involving regulations under a different Internal Revenue Code provision, and that analyzed the validity of the regulations based on empirical determinations and not statutory interpretation. The taxpayer also claimed the regulations violated the Regulatory Flexibility Act of 1980, but the court pointed out that the 1967 regulations were not subject to that Act because that Act, by its terms, applies only to regulations promulgated after 1980. The Tax Court also noted that the taxpayer did not raise his claim that the regulations are invalid until after trial, leaving the court bereft of any information about the comments offered in 1967 and without the ability to determine whether the Treasury Department responded adequately to those comments.

Apparently no additions to tax or penalties were asserted by the IRS. My guess is that the amount of tax liability in question was insufficient to trigger them, and that had the tax liability been sufficient, the taxpayer would have faced one or another addition to tax or penalty.

So, for me, the question is, why did the taxpayer challenge the regulations? Why did the taxpayer argue that a statute applicable after 1980 should be applied to regulations promulgated in 1967? Why did the taxpayer fail to raise the validity arguments until after trial? Several thoughts cross my mind:

Did the taxpayer make this argument because someone in his law school basic tax class suggest that the argument should be made?

Did the taxpayer make this argument because there were no other possible ways to defend the disallowable deduction?

Did the taxpayer make this argument because another practitioner, or an internet commentator, put the idea into his head?

Did the taxpayer make this argument because somewhere in his legal or tax education he was taught, or somehow learned, that creativity or cleverness is commendable no matter the circumstances?

What motivated the taxpayer?

The controversy over the latest soda tax proposals in Philadelphia continues without respite. If I were to publish a reaction to every comment and news development concerning soda taxes, this blog would become immense, quickly. So I am selective when I see or hear soda tax information and opinions. I have been sharing my views on the soda tax for almost a decade, starting with What Sort of Tax?, and continuing through 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, The Realities of the Soda Tax Policy Debate, Soda Sales Shifting?, Taxes, Consumption, Soda, and Obesity, Is the Soda Tax a Revenue Grab or a Worthwhile Health Benefit?, Philadelphia’s Latest Soda Tax Proposal: Health or Revenue?, What Gets Taxed If the Goal Is Health Improvement?, The Russian Sugar and Fat Tax Proposal: Smarter, More Sensible, or Just a Need for More Revenue, Soda Tax Debate Bubbles Up, and Can Mischaracterizing an Undesired Tax Backfire?

Several days ago, Dr. George L. Spaeth of Philadelphia, sent a letter to the editor of the Philadelphia Inquirer, in support of the 3-cents-per-ounce soda tax proposal offered by the mayor, and in opposition to a one-cent-per-ounce counterproposal from the president of City Council. Dr. Spaeth justifies the soda tax as follows:

Many people do not understand the harmful effects of sugar, including weight gain and diabetes. There is an epidemic of obesity and diabetes in Philadelphia. People who are significantly overweight have a poorer quality of life, shorter life expectancy, and more illness. We all have needs and wants. Drinking beverages containing sugar is a want, not a need.

Though the doctor is correct in pointing out the disadvantages of being overweight, in asserting that sugary beverages are a want, not a need, and in identifying sugar as a cause of weight gain, he, like so many others, treats sugary beverages as though they are the only ingestible items containing sugar. Donuts contain sugar, donuts are a want, not a need, and yet donuts escape being a tax target of those promoting sugar-free health. The same can be said of cakes, cookies, pies, candy bars, and a long list of foods. The same can be said of coffee and tea to which a person adds sugar, because the tax would not apply to sugar sold in bags for use in adding to food and drink.

When, several months ago, another letter writer supported the revival of a soda tax proposal by the mayor of Philadelphia, I stressed the inequity of focusing on sugary beverages as one of the reasons the proposal was flawed. In Soda Tax Debate Bubbles Up, I wrote:

Another issue is whether a tax characterized as designed to improve health should be limited to just one of many allegedly unhealthy dietary items. The letter writer conceded this point by noting, “And evaluate your health status - and who will benefit from the tax.” The letter writer offered no proof that soda is more unhealthy than many of the other items, particularly those containing sugar, fats, and cancer-causing substances, that people ingest.

I’ve yet to see any explanation or justification for subjecting only certain sugar-containing items to a tax whose supporters claim is designed to reduce sugar ingestion. Reducing the consumption of sugary beverages is meaningless if those are replaced by other items containing sugar. If sugar is the problem, those craving it will seek it wherever they can find it.

Taxing only sugary beverages when trying to reduce sugar consumption is like requiring inspection of tire treads but not brake linings when trying to reduce automobile accidents caused by traction failures. Failing to look at all aspects of a problem is a major contributor to unwise legislative proposals and wacky legislation. If the problem is sugar, tax sugar. If the target of tax are beverages, what is the problem?

Sunday’s Parade Magazine included an interesting Ask Marilyn question. Randall Hancock wrote:

I once owned a house that was the second of 10 on a gravel road. The neighbor in the 10th house proposed buying new gravel, with each neighbor paying one-tenth of the cost. I disagreed as I used only two-tenths of the road, and he used the entire road. What should our shares have been?

Marilyn replied:

I think everyone should share the cost equally. The first neighbor needs to pay only for the first tenth of the road, but then the second neighbor needs to pay only for the second tenth (the first tenth is paid by the first neighbor), and so forth, with the last neighbor ultimately needing to pay only for the last tenth of the road.

Administrative issues aside, I disagree with the reasoning, and I question whether the result, though administratively simple, makes the most sense.

The person living in the first house uses one-tenth of the road. The person living in the tenth house used 100 percent of the road. The benefit accruing to the owner of the tenth house is ten times the benefit accruing to the owner of the first house. Put another way, the person living in the tenth house imposed ten times as much wear and tear on the road as does the person living in the first house.

Suppose, for example, that each homeowner was responsible to care for the portion of the road in front of the homeowner’s property. To keep things simple, assume that the houses are only on one side of the street, and that each has the same front footage on the road. The portion of the road in front of the first house will wear out more quickly than the portion in front of the tenth house. Over time, the owner of the first house will be paying ten times more for road maintenance than the owner of the tenth house. This, of course, ignores cost savings obtained by owners who get together to seek a “quantity discount” from the road repair vendor. Does it make sense to impose a disproportionately greater financial burden on the owner of the first house? Would that burden be reflected in the fair market value, and thus purchase price, of the house? Is the closer proximity of the house to the main road something that adds value to the house sufficient to offset any negative impact of the disparate road maintenance burden? Sharing the cost equally permits the owner of the tenth house to pay for one-tenth of the cost while contributing to roughly 18 percent of the wear and tear.

The preceding analysis assumes that the usage of the road is proportional to the distance to each house. Thus, it ignores the number of vehicles traveling to each house. Taking those into account presents a different alternative. In theory, the financial burden of maintaining the road should reflect volume of traffic generated by each house. That theory certainly falls apart in the face of practical reality, though I suppose someday we will hear that there is “an app for that.” A proxy for this measurement could be the number of vehicles registered to the address of each house. That alternative presents fewer practical problems of measurement, though it would still be difficult to measure because registration data doesn’t necessarily reflect the reality of vehicle ownership and garaging.

Consider, in comparison, the case of a shared driveway. Assume that one house is close to the street and the other house is behind the first house, further from the street. To reduce impermeable surfaces, the township refuses permission for a “flag lot” driveway for the house in the back, and instead requires builder to extend the driveway for the first house, so that it reaches the second house. Should the owner of the second house pay one-half of the cost of maintaining and repairing the entire driveway, while using the entire driveway and thus causing the front half of the driveway to deteriorate at a faster rate? Should the owner of the first house pay one-half of the cost of maintaining and repairing the entire driveway, though only generating one-third of the entire driveway’s use? Should the owner of the second house, who would have been saddled with the cost of a separate driveway as long as the extended driveway had the township permitted the usual “flag lot” driveway, reap a financial benefit that is, in fact, generated by the owner of the first house paying more than would have been paid had the driveway not been extended?

Generally, in these instances of shared private roads and shared driveways, the deeds, homeowner association documents, or similar contracts, specify the terms and conditions for maintaining common areas. So the question arises when the property is being developed, and the owners simply can live with the rules or choose not to purchase a home subject to those rules. When the question is transferred into the world of shared highways, police protection, and other public services, the analysis runs along the same lines but often generates different results. One of the hallmarks of society is that benefits and burdens end up being distributed in ways that do not match each other, and that do not match the specific benefits for, and burdens on, each taxpayer. Though, for example, a township might add a “street light fee” to the property tax bills of only those homeowners who live on streets with street lights, the cost of trash pickup might be imposed in proportion to property value, reflecting its funding through the real property tax, even though the amount of trash picked up at each home differs by orders of magnitude, one bag here, two bags there, and seven bags over there.

This simple example illustrates the challenges of designing taxes, and also demonstrates why user fees are easier to manage. Though not all public services can be funded through user fees because of administrative challenges or measurement obstacles, the user fee does present an opportunity to inject more fairness into public revenue determinations without unduly increasing complexity. If the costs of maintaining the gravel road or shared driveway are sufficiently small, equal division probably generates assessments for each owner that are not significantly different from what they otherwise would be. It’s not worth the effort to reduce one bill by $20 while increasing another by $20. But in the larger arena, with costs reaching tens and hundreds of millions, if not billions and trillions, user fees tied to benefit and burden are always worth at least full consideration and often deserve enactment.