MauledAgain

As reported by many sources, including the Wall Street Journal, “When Mrs. Clinton said there were years when Mr. Trump paid no taxes, he replied, ‘That makes me smart.’” The reference to taxes was in the context of federal income taxes. So, does paying no federal income taxes means, as Trump claims, that the taxpayer is “smart”? The answer is “No.”

Why is the answer “no”? Because even if paying no federal income taxes is a smart thing, in and of itself it doesn’t make the taxpayer smart.

First, if the smart thing or things that are done in order to reduce federal income taxes to zero are the product of the taxpayer’s advisers and return preparers, then the taxpayer ought not take credit for anything other than retaining those advisers. And even that act isn’t necessarily a measure of a person’s “smartness.”

Second, whether what is done to reduce the taxpayer’s federal income tax is a “smart” thing depends on what was done. Using the word “smart” is misplaced if the reason for not paying federal income taxes is tax fraud, business failure causing losses, mistakes in filling out the return, or engaging in activities that prevent the taxpayer from generating income.

So is Donald Trump “smart” because there were taxable years in which he paid no taxes? Suppose the reason Donald Trump did not pay federal income taxes is because he lost so much money in businesses that ended up bankrupt that his income was more than offset by business loss deductions. Suppose the reason constitutes tax fraud. If either of those is the reason, perhaps something other than “smart” was underway.

Until and unless Donald Trump’s federal income tax returns are available, it is impossible to determine whether “smart” things were done or whether “smart” decision were made. Whether Donald Trump is “smart” or “not smart,” or in between, it’s because of all sorts of things, only one of which is his federal income tax return situation. Even if not paying federal income taxes is a smart thing, it does not necessarily mean that the person doing the smart thing – or finding advisers who do a smart thing – is a smart person. Sometimes smart people do stupid things, and sometimes not-so-smart people do smart things.

Finally, being smart, in and of itself, ultimately means nothing. How does a person who is “smart” use his or her “smartness”? When I was a child I was told, by my mother, that being intelligent meant nothing. Why? I remember her words to this day: “There are plenty of intelligent people in prison.”

According to this story, the owner of several Atlantic City businesses admitted in federal court that he and his associates in one of the businesses deliberately hid profits in order to avoid paying more than $100,000 in federal taxes. He also admitted that he knew the business kept two sets of books, one that recorded the actual profits and one that reduced income for tax purposes. Accordingly, he pled guilty to tax evasion.

His attorney explained that the is client “got involved in a business” and owners, including the taxpayer, “were not very careful in recording tax receipts and including them in company and personal tax returns.” Prosecutors had described the arrangement as a structured scam in which two of the taxpayer’s partners, one of them the bookkeeper, deliberately failed to report revenue.

The taxpayer’s attorney hopes that his client’s philanthropic work will bring a sentence of probation rather than prison. The judge probably will take into account the fact that seven years ago the taxpayer was placed in pretrial intervention after being charged with blackmail.

What I don’t understand is how a deliberate plan to keep separate books in order to hide income and evade taxes is a matter of being “not very careful.” Carelessness in keeping tax-related information and carelessness in filling out tax returns is not uncommon. When identified, it can cause a taxpayer to incur civil penalties and additions to tax for negligence. It does not result in criminal prosecution. Tax evasion is not a matter of carelessness. Words matter.

Most people have heard at least one anecdote about a student who attempts to take a final exam in a course, only to discover that failure to have enrolled in the course shuts the door to the opportunity to earn a grade in the course. Most people have heard at least one anecdote about a student whose failure to enroll in a course causes the student to have insufficient credit hours to earn the desired academic degree. How many people realize that failure to enroll for a course can create adverse tax consequences?

In a recent case, Pilmer v. Comr., T.C. Summ. Op. 2016-59, the United States Tax Court held that IRS denial of a taxpayer’s claimed American Opportunity Tax Credit (AOTC) was correct, because the taxpayer failed to enroll in a course. The taxpayer was a student at Saddleback College, a community college offering two-year associate’s degrees and courses for credit transferable to four-year institution. During the spring 2012 semester, the taxpayer enrolled in a five-credit physiology course, and attended a three-credit health course on an “informal” basis. The taxpayer did not enroll in the latter course, and stopped attending after approximately eight weeks.

The taxpayer and her husband filed a joint federal income tax return. On that return they claimed an AOTC credit based on the taxpayer’s education expenses. The IRS disallowed the credit, and the dispute eventually ended up in the Tax Court.

The AOTC is available to eligible students. An eligible student is a student who satisfies two conditions. First, the student must be enrolled or accepted for enrollment in a degree, certificate, or other program leading to a recognized educational credential at an institution of higher education that is an eligible institution. Second, the student must carry at least half the normal full-time workload for the course of study the student is pursuing. The IRS did not dispute that the taxpayer satisfied the first condition. Whether the taxpayer satisfied the second condition was in dispute.

The taxpayer argued that her enrollment in the five-credit course combined with her informal attendance of the three-credit course constituted carrying at least a half-time workload. The Tax Court disagreed. It explained that under the regulations, a student carries a half-time workload if “[f]or at least one academic period that begins during the taxable year, the student enrolls for at least one-half of the normal full-time work load for the course of study the student is pursuing. The standard for what is half of the normal full-time work load is determined by each eligible education institution.” The IRS and the taxpayer agreed that in 2012 Saddleback defined a full-time workload as 12 academic credits and a half-time workload as 6 academic credits. The Tax Court pointed out that during the spring semester the taxpayer was formally enrolled in only the five-credit physiology course, and had never formally enrolled in or
received academic credit for the three-credit health course. Because the taxpayer was enrolled in only a four-credit course in the fall 2012 semester, qualification for the AOTC depended on the spring 2012 semester. Thus, because the taxpayer was enrolled only in a five-credit course during the spring 2012 semester, the taxpayer did not carry at least a half-time workload during either semester and was not entitled to the AOTC for 2012.

It is not clear why the taxpayer did not enroll for the three-credit health course. The taxpayer explained that the professor permitted her to attend and add the course later if there was room. Why did the taxpayer not add the course? Was there insufficient room? If so, why did it take eight weeks to make that determination? Was it a lack of money? Was it failure to add within the drop-add period? Was there sufficient room? If so, did the taxpayer lose interest in the course? Without knowing why the taxpayer did not enroll in the course, or in any other course in order to meet the six-credit-hour requirement for the AOTC, it is difficult to identify what the taxpayer could or should have done.

The lesson, though, for taxpayers generally who want to claim the AOTC is easy to discern. Determine how many credits are required for full-time status, multiply by 50 percent, round up, and be certain to enroll in, and remain enrolled in, enough courses to meet that requirement. Of course, considering how many students fail to enroll for courses and thus end up precluded from taking final exams or from earning a degree, it would not be surprising to learn that failures to qualify for the AOTC continue to afflict students in the future.

Supply-siders like to argue that by reducing tax rates, people and businesses will engage in economic activity squelched by higher tax rates, and that taxes on that increased activity will increase tax revenues. Not only have supply-siders argued this theory, they have managed to persuade voters to elect politicians who subscribe to the theory that reducing tax rates increase tax revenue. Of course, when this theory meets practical reality, its shortcomings are evident. The beneficiaries of the tax cuts benefit, at least in the short-term, and everyone else deals with the fallout.

Philadelphia officials subscribed to this supply-side strategy. It cut taxes and has plans to cut more taxes. Supposedly, businesses and people would flock to the city, generate economic transactions, and thus increase tax revenues. Though activity in the city has increased, it is unclear how much was driven by tax rate reductions, how much was driven by the national economic recovery during the past eight years, and how much was driven by the cultural behavior pattern of younger people wanting to live in urban settings. No matter what caused the increase in economic activity, the increase wasn’t enough to generate tax revenues to offset the price of the tax rate reductions. According to this story, the combination of the rate reductions and increased spending based on the anticipated tax revenue increases, the city’s general fund balance is at risk of disappearing. It could happen within a year, and when it does, the consequences will be the usual awful outcome. First, the city’s credit rating will be reduced, increasing its cost of borrowing, which in turn worsens the fund balance and increases deficits. Second, essential services will be cut, and the city might even be compelled to raise taxes, though the people hit by the tax increases are unlikely to be the people and businesses benefitting from the previous rate reductions. For example, the soda tax enacted by the city will generate less revenue than the revenue loss over the next five years from the rate reductions, and those paying the soda tax aren’t necessarily those benefitting from the tax rate reductions.

So now financial experts are advising the city to freeze the planned future tax rate decreases, or increase property taxes. Others suggest cutting spending, though none have identified specific programs to be jettisoned. They know that if they do, it will trigger an outcry. In the meantime, the city’s finance director argued that the best way to solve the problem is to “grow the economy” and that to do so, the city needs to “keep reducing tax rates.”

Perhaps it would be helpful for those dealing with this issue to invest a few moments and check out When a Tax Theory Fails: Own Up or Make Excuses? Though I’ve written numerous posts explaining why supply-side economic theory is inadequate, I selected that post from March because it explores one of the worst supply-side experiences in the nation, specifically, the mess in Kansas. There are lessons to be learned about what not to do, and how not to try to dig out of the consequences of doing what ought not to have been done. Perhaps inviting some Kansas officials to visit the city will raise revenue, and not just from the taxes collected on their hotel and restaurant bills.

An attorney is retained to represent a plaintiff, and agrees to be compensated with a contingent fee. While the case is ongoing, the attorney and his wife end their marriage. They enter into a marital separation agreement. A section of the agreement titled “Spousal Support” provides that he is to pay her $7,000 per month and that the payment would end with either his or her death. Another section of the agreement titled “Division of Community and Co-owned Property” provides that she will receive some rental properties, along with ten percent of whatever contingent fee the husband receives from the ongoing litigation. No mention is made of whether that payment is made if he or she dies. The agreement also states that her ten percent interest in the fee “is a spousal support award from a contingent liability, the amount of which could not be definitely set at the time of the agreement, and that it “is taxable to [the wife] and
deductible to [the husband] as spousal support. This section of the agreement also provides that if the husband receives the contingent fee, he will pay a lump sum of $355,000 to the wife, and the agreement describes the sum as spousal support that would terminate on the wife’s death. Shortly after the couple’s divorce, the litigation settles, and the husband receives a $55 million fee spread out over several years.

Is this a law school hypothetical? No. It’s an actual case. It’s part of what happened in Leslie v. Comr., T.C. Memo 2016-171. There were other issues, and facts relevant to those issues, but those are left to other commentaries, including this excellent analysis from my colleague Les Book at Procedurally Taxing.

Essentially, the wife did not report the payments arising from the contingent fee as alimony. It is unclear, but one’s best guess is that the husband deducted the payments. The wife argued that test for determining whether the payments were alimony gross income is the seven-factor test of Beard v. Comr. The IRS argued that the enactment of section 71 made the Beard test obsolete. The IRS agreed.

The Tax Court looked at the language of section 71 and determined that the payments were alimony. There was no dispute that the payments were in cash, were made under a divorce or separation agreement, were made under an agreement that did not designate the payments as not includible in gross income nor deductible, were made by parties not members of the same household, and were not required if either party died. It was this last statutory requirement that generated additional disagreement. The wife argued that the obligation to make the payments did not end with her death. The court explained that although the agreement did not contain language that terminated the husband’s obligation to pay over part of the contingent fee on the wife’s death, and although the agreement did provide that payment of the $355,000 lump-sum was contingent on her not dying, applicable state law provided that amounts paid for support terminate on the death of either party.

The fact that the provision for payments based on the contingent fee were in a section of the agreement titled “Division of Community and Co-owned Property” does not matter. What matters is the language of the agreement, the language of the Internal Revenue Code, and the language of the applicable state law. Granted, the issue would have been even easier to decide, and perhaps would not have even made its way to the Tax Court, had the drafters of the agreement put the provision in the section of the agreement titled “Spousal Support” and included specific language providing that the payments would not be made if the wife died. It didn’t happen in this case, but hopefully those dealing with these issues in the future will fix the placement and include the language.

Yes, this is another MauledAgain post based on a television court show. The list is getting longer, and includes posts such as Judge Judy and Tax Law, Judge Judy and Tax Law Part II, TV Judge Gets Tax Observation Correct, The (Tax) Fraud Epidemic, Tax Re-Visits Judge Judy, Foolish Tax Filing Decisions Disclosed to Judge Judy, So Does Anyone Pay Taxes?, Learning About Tax from the Judge. Judy, That Is, Tax Fraud in the People’s Court, More Tax Fraud, This Time in Judge Judy’s Court, You Mean That Tax Refund Isn’t for Me? Really?, and How is This Not Tax Fraud?.

Almost thirty years ago, early in my teaching career, I read a case that reinforced my growing conviction that law faculty need not invent hypotheticals to get their students to think. It is not unusual for law faculty to make the hypotheticals outrageous in order to get students’ attention and to make what might otherwise be “boring” rather interesting. For example, though many consider tax classes to be “boring,” they often leave with the realization that tax practitioners often encounter fact situations no less eyebrow-raising than those encountered by those dealing with other areas of the law.

The case that caught my attention, Blackman v. Comr., 88 T.C. 677 (1987), involved a taxpayer who became angry with his wife. His employer had transferred him from Baltimore, Maryland, to South Carolina, and so he, his wife, and their children moved there. His wife did not like it there and returned with the children to Baltimore. During Labor Day weekend, in an attempt to persuade her to give life in South Carolina another chance, the taxpayer returned to the Baltimore home, which apparently had not yet been sold. He discovered that another man was living there with his wife and children, and the neighbors filled him in on the frequency of the man’s presence in the home, even before he and the family had moved to South Carolina. When he returned, his wife was having a party and her guests refused to leave when the taxpayer asked them to do so. He returned several times, he repeated his request, and he broke windows. The guests did not leave until 3 in the morning the next day. Later that day, he returned again, asked his wife if she wanted a divorce, they fought, and she left. After she left, the taxpayer took some of her clothes, put them on the stove, and set them on fire. He testified that he then dumped pots of water on the fire and put the fire out. However, the fire spread, the fire department arrived, but it was too late, and the house and its contents were destroyed.

When the taxpayer attempted to deduct the loss as a casualty loss, the IRS disagreed, and the Tax Court explained that even though negligence does not bar a casualty loss deduction, gross negligence does. In this instance, the fact that the fire fighters discovered the clothes still on the stove caused the court to disregard the taxpayer’s claim that he had extinguished the fire. In addition, the court concluded that allowing the deduction would violate Maryland’s public policy against arson, as it is a felony in Maryland to burn a residence while perpetrating a crime. Setting one’s spouses clothes on fire is a crime. In one of my many favorite sentences from the Tax Court, the opinion told us, “We refuse to encourage couples to settle their disputes with fire.”

For all the years I taught the basic federal income tax course, I included this case in the supplementary materials I provide to the students. I recall from time to time, though not every semester, I would point out, “Though this is an isolated instance, the lesson can be extended to other situations in which a person acts with gross negligence.” I might ask the class to think of situations not involving fire but that might far less unusual and that would involve gross negligence or intention. I wrote about this case more than ten years ago in Why Tax Law Can Fire Us Up.

It turns out that the clothes burning reaction to anger-provoking events is not as uncommon as I thought. On a recent Judge Mathis episode, the defendant admitted to coming home, finding her boyfriend cheating on her, and setting his clothes on fire. According to the defendant, “things got out of hand,” though it wasn’t revealed if the house burned down. The facts were incidental to the issues in the case, and there was no indication of what impact the events had on anyone’s tax returns. What is it with angry people burning clothes? Why clothes? Why fire?

And though I described the Judge Mathis episode as “recent,” I used that word as shorthand for “a Judge Mathis episode I recently viewed even though it is older.” I tend to catch these episodes haphazardly long after their original broadcast date. I’m sure I’ve missed hundreds of episodes that would supply this blog with years of material. I doubt I will ever see all of them, but it’s likely at least a few more will find their way to this blog.

In Pennsylvania, public K-12 education is financed through real property taxes. Not long ago, the state legislature imposed a limit on the annual increase that a school board could approve. To stem the adverse consequences of real property taxes that were increasing at rates exceeding inflation, the legislature limited annual increases to 2.4 percent. Of course, there are exceptions. One is to put a referendum to the citizens of the district for a higher increase. Another is to obtain approval from the state for exceeding the limit.

Recently, a Common Pleas judge, issuing a decision in a lawsuit brought by some taxpayers in Lower Merion Township, ordered the Lower Merion School District to revoke a 4.4 percent increase it had approved for 2016-2017. The judge agreed with the plaintiffs that the district had overstated deficits in order to justify the tax increases when it sought state approval. The judge determined that since 2006, the school district had cumulatively raised taxes by more than 53 percent, even though at the end of each fiscal year, it had a surplus in its account. The judge also noted that although the board could impose a 2.4 percent increase under the law, he didn’t think an increase of that magnitude was necessary.

According to this story, when the school board held its first meeting of the school year, people took sides. What I found interesting is how people bring totally different perspectives to the same set of facts.

Most of those who spoke were critical of the board’s decisions. They expressed unhappiness at the lack of transparency in the budget process, and they were dissatisfied with the misrepresentations about deficits that were in fact surpluses.

The board tried to justify its actions on account of “staggering enrollment growth.” Enrollment growth of that magnitude suggests an increase in the number of taxpaying entities in the district. In turn, that would dampen the percentage increase necessary to fund the district. The board also claimed that the courts had no jurisdiction to judge the appropriateness of its actions.

Some of those in attendance were delighted that the board did “whatever it took . . . to provide a top-notch education for Lower Merion children.” The district’s per-pupil expenditure, more than $31,000 per student, is the highest in the state. Yet the district ranks 480th in the state. Another district, which like Lower Merion geographically abuts the school district in which I live, spends $16,000 per student and is “consistently ranked higher than Lower Merion in state and national surveys.” The lawyer who filed the lawsuit also noted that the district had overstated special education and pension costs when it sought and obtained state approval for increases exceeding 2.4 percent.

Others who supported the board claimed that they “never had to wonder” what was being done with the tax revenue. Yet another speaker had pointed out the board’s refusal to explain an unidentified $3 million expenditure in its budget.

Though people can disagree on whether a school district should build up reserves, or how much those reserves should be, there ought not be disagreement about the inappropriateness of claiming that deficits exist when in fact there are surpluses. Nor should there be disagreement that misrepresenting expenditures to the state when seeking permission to increase taxes beyond the mandated limit is wrong.

Some Pennsylvanians advocate eliminating the real property tax as a school funding source and replacing it with something else. But no matter what type of tax is used to fund public education, the expenditure side needs to be reviewed carefully. A district that spends the most per pupil in a state ought to come out better than 480th. Perhaps its officials can have a conversation with those who manage the district that spends half that amount per student.

Too many people are ignorant about taxes. Finding it difficult to complete a tax return is not tax ignorance. Tax experts find tax return preparation to be challenging. Tax ignorance in the form of not understanding general principles about taxation and not comprehending the significance of tax policy has repercussions far beyond the ability to fill out properly a tax return.

In posts such as 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, More Tax Ignorance, With a Gift, Tax Ignorance of the Historical Kind, A Peek at the Production of Tax Ignorance, and Another Reason We Need Better Tax Education, I have lamented how poorly Americans, to say nothing of legislators, fare when dealing with tax issues.

The latest example that I’ve encountered comes from a comment on an OpenVote page:

Im [sic] waiting for the next FBI investigation into Clinton's "illegal for you and I but not for her" situation to pan out before I vote. I honestly can barely afford to live now. I can't afford her tax increases.

I included the first sentence to put into context the second and third sentences, which are the ones that widened my eyes.

I tried to figure out who would be upset with proposed tax increases on high incomes. Could it be a very wealthy person living an outrageously expensive lifestyle? Could it be a poor person who has no clue as to why his fears are unfounded?

The comment triggered several replies, including this one:

If your [sic] thinking that she is going to raise taxes on the poor or middle class your [sic] not paying attention. I'm middle class and I have been taxed to death by the city and county I live in because the state has pretty much quit taxing the rich and wealthy corporations. Hillary only want to tax the millionaires and billionaires and the corporations that pay almost nothing because of loopholes put in place by republican policy at the state and federal level. Vote democrate [sic] if you want things to improve in this country. Go on line [sic] and read some of her economic policy proposals.

Though I included the entire comment, the key sentence is the final one. It boggles my mind how many people profess to know something though they haven’t examined the original source. Too many people are willing to repeat what another person says, without checking for themselves.

So how is it that proposals to restore taxes on the wealthy to what they were before the unwise tax cuts of 2001 get interpreted as tax increases on the poor and middle class? The answer is simple. The poor and middle class are fed misinformation so that they vote against their own economic interests. Why does that happen? The answer is simple. Those who dish out misinformation know that there are millions of people willing to buy into the nonsense. Why are they so willing? The answer is simple. It is much easier to listen to someone’s short sound bite, deceptive as it is, than to take the time to do some reading, analysis, and thinking.

My point isn’t to endorse a particular candidate. There are many other issues, besides tax policy, that enter into the electoral calculus. My point is that the nation suffers when people make voting decisions based on misinformation. Tax ignorance is dangerous, as is every other sort of ignorance, and the combination is deadly. Ignorance is not bliss.

Excuse the sarcastic blog post title, folks. It isn’t a secret that I am a fan of education, a critic of people having responsibilities beyond their skill set, a campaigner against grade inflation, and an advocate for standards matched to the task being undertaken.

So it boggled my mind when a colleague passed along to me, and others, a link to an alarming story. No, it’s not from The Onion or some other satirical site.

At Ohio State, supposedly one of America’s finer institutions of higher education, ranked fifty-eighth, a member of the faculty teaching organic chemistry decided that the best way to assign grades to the semester’s first quiz was to use a skill unrelated to the course material. The class was told that if a student could make a long-range shot into a trash can – he threw a paper ball that the instructor had tossed out to the classa – then the student and all his classmates would receive a score of 100 on the quiz. He made the shot. His classmates think he is “the real mvp.”

What a joke. An opportunity to determine which students understand or know what the quiz was testing is thrown into the trash, no pun intended. Instead, student scores are inflated by an accomplishment that has nothing to do with what the students supposedly are being prepared to do. Organic chemistry is one of the most challenging courses on an undergraduate campus. The quip when I attended Penn was that a quiet weeknight on campus meant that an organic chemistry quiz was happening the next day. Every student with hopes or thoughts of attending medical school enrolls in organic chemistry. It’s not a course in which a student’s qualification to move on and study medicine should be measured by the ability of one student to play well at trash can basketball.

It’s unclear what would have happened had the student missed the shot. Would there have been a quiz with earned scores? Or would every student have received a zero? Was the offer to the student simply an excuse to avoid giving and grading a quiz?

Occasionally I receive emails from educational advisory groups suggesting that I “gamify” my courses. Though many people treat life as though it were a game, thinking there is a “reset button” if someone happens to be killed, life isn’t a game. Nor should education designed to prepare people for life be treated as a game. Letting students earn education points for successfully tossing a paper ball into a trash can makes sense when it’s the basketball coach preparing the team for its next match, and perhaps in some other instances in which long-range throwing accuracy is relevant to the skill being learned and evaluated. Just imagine being told, as you are wheeled into surgery, that the operation is being performed by someone who earned perfect scores in the surgery course, without realizing that it’s because classmates hit long-range trash can shots, recited an entire Walt Whitman poem by rote, named the last ten winners of the Oscar Award for Special Effects, and correctly answered a question about the batting average of the 1934 American League home run champion.

The drop in sales and use tax revenue experienced by states because online purchases keep growing continues to stymie state governments seeking a way to reverse the trend. The problem isn’t new, it was predicted in the 1990s, and I’ve been writing about it from time to time since 2004, in posts such as Taxing the Internet, Taxing the Internet: Reprise, Back to the Internet Taxation Future, A Lesson in Use Tax Collection, Collecting the Use Tax: An Ever-Present Issue, A Peek at the Production of Tax Ignorance, Tax Collection Obligation is Not a Taxing Power Issue, Collecting An Existing Tax is Not a Tax Increase, How Difficult Is It to Understand Use Taxes?, Apparently, It’s Rather Difficult to Understand Use Taxes, and Counting Tax Chickens Before They Hatch, and A Tax Fray Between the Bricks and Mortar Stores and the Online Merchant Community.

For those who are unfamiliar with, or who have forgotten, the issue, here is a brief summary. When a resident of a state with a sales tax makes a purchase in another state and brings the item back into the state, that resident must pay a use tax. Of course, compliance is unsatisfactory. The only items with respect to which states manage to collect most of the use tax that is due are items requiring title, such as vehicles, boats, airplanes, and a few similar items. The rise of Internet commerce has made it even more difficult for states to collect the use tax, because the number of people who crossed state lines to make purchases to bring home is dwarfed by the number of people who can make out-of-state purchases without leaving their home or business. So, of course, states want out-of-state retailers to collect the use tax on their behalf, even if the retailer has no physical presence with the state.

A variety of suggestions to fix the problem have been made. In Our Online Sales-Tax Loophole, Robert Verbruggen describes a proposal now getting a good bit of attention. Representative Bob Goodlatte of Virginia offers the following plan. An online retailer would collect a sales/use tax based on the sales tax rate applicable to the purchaser’s state of residence, but using the exemptions in the sales tax law of the state in which the retailer is based. The amounts collected would be distributed to the various states through a clearinghouse. Verbruggen points out, correctly, that there are pitfalls. Some states might refuse to participate. Retailers in states without a sales tax would need to use the exemptions set forth in the laws of some other state, perhaps the state where the online retailer has the highest revenue. Alternatively, the retailer could simply report the transaction to the purchasers’ “home state.”

As with almost every proposed solution, Goodlatte’s plan is a band-aid that might slow the revenue hemorrhage, but doesn’t get down to the underlying causes. Sales and use tax avoidance pre-dates the internet. The internet simply took a loophole and made it huge. Goodlatte’s plan does not address, for example, the sales and use tax revenue loss experienced by Pennsylvania, New Jersey, and Maryland when their residents drive to Delaware to make sales-tax-free purchases. Nor does it address the scheme through which a resident of, say, New Jersey, uses a prepaid debit card to make a purchase that is delivered to a friend or relative who lives in Delaware. A variation on the scheme is to have the Delaware friend or relative make the purchases, with reimbursement taking place out of the sight lines of the revenue department and the retailer.

Verbruggen concedes that the problem needs to be “handled at the federal level.” For those whose political philosophy includes reducing the power of the federal government and minimization of federal regulation, the idea of state tax collection shifting to a federal clearinghouse must be anathema. Verbruggen also points out that attempts to shut the door on tax avoidance and tax evasion arrangements are too easily seen by some people as “tax increases,” though I suppose those folks might consider the receipt of a speeding ticket as a “reduction in the legal speed limit.” Needless to say, I do not admire the intellectual shortcomings of those who think enforcement of an existing tax is a tax increase.

Short of imposing a federal sales tax in place of state sales taxes and sharing the revenue, an idea fraught with its own problems, what’s the answer? I proposed a solution in Tax Collection Obligation is Not a Taxing Power Issue:

Perhaps a better approach is for states to seek voluntary contracts with out-of-state retailers, compensating them for serving as tax collectors. There may be state Constitutional provisions or legislation that prohibits contracting tax collection to out-of-state individuals or entities, though I doubt that is the case. For some businesses, being compensated to engage in use tax collection might help the bottom line.

Though taking this route doesn’t shut down, for example, the “use a friend or relative in a state without a sales tax” scheme, it is more consistent with free market principles than is converting out-of-state businesses into involuntary workers or setting up another federal bureaucracy with an additional layer of transactional transmission and another set of opportunities for errors, fraud, and complications.

Running for office presents candidates with numerous opportunities to slip up. This is particularly a problem when the issue is a complicated one. Taxation, for example, can present traps for candidates who are not careful with how they articulate their position.

Recently, there has been a call for exempting the value of Olympic medals from gross income. Some people think it’s wrong to require winning athletes to pay taxes on pieces of metal symbolizing their achievements. I disagree, but the point of this commentary isn’t whether an Olympic medal exemption makes sense. It’s to point out what happens when that issue becomes campaign fodder.

Senator Charles Schumer of New York, a Democrat, has introduced legislation that would add an Olympic medal exemption to the Internal Revenue Code. According to this news story, his Republican opponent, Wendy Long, criticized both Schumer and the proposal. She called the proposal “another example of cronyism in the tax code.” She added, “It makes no sense. My contention is that giving tax breaks as he does to his favored ones – the Broadway stars, the Olympic medalists, the hedge funders – means that a greater burned is placed on the average New Yorkers who toil in obscurity but work just as hart and are as deserving of a tax break.” She referenced members of the military, asking “Where’s the tax break for them? Even if they come home victorious and have won a war, instead of the 400 meter freestyle, no tax break for winning?”

Three thoughts crossed my mind when I read this. All three fit within the general reaction, “It makes no sense.”

First, the Broadway tax break to which Long apparently was referring is not a tax break for Broadway stars. It is a tax break for those who invest in live theater productions, making available to them the same tax break already in existence for television and movie productions. And the measure in question was the extension of the tax break, which had been enacted previously with an expiration date. I’m no fan of this tax break, but I’m even less of a fan of a tax break that treats television and movie productions more favorably than live theater. What matters is that this tax break accelerates tax deductions for investors, who are not members of “the middle class that Long claims Schumer pretends to champion.” And thus it is a tax break pretty much for the wealthy, a tax break in line with many others supported by the political party under whose flag Long is running. It would be great if she made it clear that she opposes the long-standing pattern of Republican tax breaks for the wealthy, but if she is elected she might find herself at odds with at least some of her political colleagues in the Senate. Still, describing the tax break as one for the actors casts the issue in the wrong spotlight.

Second, the tax break for hedge funds has been attacked primarily by Democrats and although some Republicans have joined in the criticism, perhaps seeking something that dresses them in populism, most Republicans and their supporters have opposed any attempt to change the tax break. Some even demand lower taxes for carried interest, as described in this article. Again, it is great to see another tax break for the wealthy coming under attack from a Republican, but what happens to Long’s Senatorial career if she is elected? And what happens to Schumer, a Democrat, who breaks ranks with his party and opposes elimination of the tax break for carried interests? Politics is a strange world, and in this instance, the two candidates are taking positions contrary to their labels. Perhaps they ought to switch parties?

Third, there exist a variety of tax breaks for members of the military. Long is playing on emotions when she suggests there are no tax breaks for them. Section 112 excludes from gross income compensation paid to members of the Armed Forces for serving in a combat zone, or was hospitalized on account of injuries incurred while serving in a combat zone. Section 122 excludes from gross income certain portions of retirement pay far too complex to describe in one sentence. Section 134 excludes from gross income the value of most allowances or in-kind benefits provided to a member or former member of the Armed Forces. I am unaware of any instance in which the IRS has required a member of the Armed Forces to include in gross income the value of any military honor, medal, badge, bar, or ribbon awarded to that person. Making it appear as though there are no federal tax breaks for members of the military does not nurture confidence in a candidate’s tax policy prowess.

There are far better ways to criticize an exclusion for Olympic medals than to confuse the issue with references to tax breaks for Broadway stars, hedge funds, and members of the military. The merits, or lack thereof, of an Olympic medal exclusion are a separate matter.

Perhaps it’s fortuitous that on labor day I share some thoughts about the prospect of even more jobs disappearing. According to this recent article in an Australian newspaper, robots using artificial intelligence could be preparing tax returns for Australian taxpayers.

Though I have always been eager to read about, play with, and even adapt technological advances, I have always done so carefully and with the imposition of a high standard. The standard is simple. The technology needs to generate results that have at least the quality they would have if an expert did the work. Because I understand technology, I understand how it can fail. And I understand that failure can be at least as bad, if not worse, than the outcome when an expert fails.

For me, until a technological “advance” is ready for prime time, it needs to remain in the world of testing and experimentation. It ought not become mandatory or widespread until it proves its superiority. It’s for that reason that I remain skeptical of self-driving vehicles, and my reluctance to embrace that technology has been affirmed by the unfortunate series of accidents, some fatal, generated by failures in the technology being used. Similarly, I remain hyper-critical of traffic signal software that leaves one vehicle sitting a red light for a minute and a half early on a Sunday morning when there are no other vehicles within half a mile of the intersection. The same disapproval exists for the systems that turn the light green for three seconds.

Technology is no better than the programmers who design the hardware and software. Sometimes I wonder if the advantages of multiple sets of eyes and brains reviewing the product are being lost on account of cost-cutting goals that misperceive the difference between long-term and short-term success.

The folks who think that artificial intelligence, which is nothing more than complex software, can replace tax return preparers face a stark reality. For some taxes, surely artificial intelligence has advantages. But for any tax preparation that requires judgment, wisdom, experience, and intuition, artificial intelligence fails. Perhaps decades from now, when neuroscientists have figured out how judgment, wisdom, experience, and intuition are reflected in the biochemical and electromagnetic functions of the human brain work, and software engineers have figured out how to translate those functions into computer code, the idea of robots doing federal income tax returns might come to a worthwhile fruition. Until then, the likelihood of crashes that weren’t supposed to happen and time wasted at badly programmed traffic signals will make the robot tax return preparer a fine wine that no one should drink before its time.

In a recent opinion piece, Catherine Rampell predicts, “Tax cheating is about to rise in the United States.” Is she correct?

Rampell gives six reasons for her conclusion. Each deserves attention.

First, Rampell notes that “Congress has gutted Internal Revenue Service enforcement.” This is true. Will the attempt by certain members of Congress to hamper or destroy the IRS encourage more cheating? I think so.

Second, Rampell notes that “Budget cuts have also hurt IRS customer service.” This, too, is true. Will the decline in IRS assistance cause more cheating? I don’t think so. Those who call the IRS for help want to do the right thing. They pretty much are people who, without IRS help, will do their best to do the right thing. Will they make more mistakes? Certainly. But making mistakes while trying to comply with the law does not constitute cheating.

Third, Rampell points to “The growing perception that everyone else is doing it.” Is there a growing perception that everyone else is cheating? Probably. Does that mean that more people will cheat? Probably, though there are many people who have been raised properly and understand that just because “everyone else” is doing something is no reason to follow suit, particularly if what “everyone else” is doing is illegal or just plain stupid. The “everyone else is doing it” mantra is a characteristic of adolescence. Though some people don’t get past that stage, most people do.

Rampell calls attention to “Declining trust in government.” In one sense, with approval ratings of Congress almost as low as they can go, it’s challenging to think that trust in government can decline any further. In another sense, though, willingness to comply with the tax law is declining. However, a person who is less willing to comply is not necessarily cheating. Laziness in obtaining accurate information isn’t quite the same as inventing false information or hiding true information. On balance, taxpayers’ understandable distrust of many politicians and government officials, which is not quite the same as distrust of government, will create an environment more conducive to cheating.

Rampell reminds us that “The tax code gets more complicated every year.” This is so true. Complexity, though, is just as likely to encourage laziness and carelessness as it is to trigger active pursuit of fraudulent schemes and other tax cheating devices. Yet complexity alone is not a cause of noncompliance. Many laws and rules are particularly simple and yet are the object of overwhelming noncompliance. Speed limits, littering regulations, and restrictions on shoplifting are easy to understand, and yet are violated regularly by a higher percentage of the population than commits tax fraud.

Rampell notes “The rise of the ‘gig economy.’” She explains that the increase in jobs not subject to third-party reporting and withholding correlates with an increase in noncompliance. This is true. The question, though, is whether the increase in the “gig economy” is accompanied by a disproportionate increase in transactions not subject to third-party reporting. Rampell concedes that fewer business transactions are being undertaken for cash payments, and the increase in data collection generally gives the IRS more places to look for unreported income.

Rampell does not mention factors that I consider to be significant contributors to tax cheating. It is the increase in self-focus, the increase in greed, and the increase in harsh economic conditions that coalesce to tempt people to cheat on their taxes. It is the weakening of concerns for integrity and responsibility that make it possible for increasing numbers of people to succumb to that temptation. These are problems that will not go away with a simplified tax law and adequate IRS funding, as Rampell advocates. Of course I support simplifying the tax law and adequate funding of the IRS, but I also support increased attention to tax education in middle and high schools, and a broader dissemination and explanation of what happens with tax revenue. And somehow, some way, the sense of integrity and responsibility that was once a core value of the culture needs to be reinvigorated. That, however, is more than just a tax compliance problem.

So is tax cheating going to increase? Yes. The rate of increased noncompliance is debatable and subject to guessing, and the causes of tax cheating can be argued, but there’s no denying the trend lines.

Recently, the Treasury Inspector General for Tax Administration (TIGTA) released a report with the tongue-twisting title, “The Integrated Production Model Increases Data Access Efficiency; However, Access Controls and Data Validation Could Be Improved.” What does THAT mean?

The report contains the result of an audit that TIGTA conducted, examining the IRS Integrated Production Model (IPM). The IPM provides one point of access to taxpayer data contained in a centralized database. In other words, rather than accessing multiple databases, IRS employees can “pull up” relevant taxpayer data from one gateway. TIGTA explains that the reduction of redundant databases “has improved the efficiency of data access.”

However, the report also explains that “access controls were not documented,” and that it was “unable to definitively verify that the IPM pulls data from only designated source systems.” In other words, there is insufficient control over what goes into the centralized taxpayer information database. Worse, of the 18 source systems that TIGTA was able to examine, 14 had “no validation of data for accuracy, completeness, and reliability.” Put another way, “The IPM database acts as a data repository, and there are no controls to validate received data.” That means erroneous information can find its way into the database and no one knows that it is there. So when IRS employees look at what they think is data on a particular taxpayer, that data could be incomplete or, worse, erroneous. For example, when a malcontent files a false Form 1099 in the name of a particular individual or business for spite, revenge, or other reasons, it’s possible that the false information will find its way into the centralized database.

TIGTA made three recommendations to the IRS to fix the problem The IRS agreed with two, and disagreed with one. Even if the IRS manages to implement the two recommendations it accepts, there still will be reasons for taxpayers to be nervous. And imagine, there are folks who want the IRS to take the data in this repository and use it to prepare tax returns on behalf of taxpayers.

What was not mentioned in the report is the cost of implementing the recommendations. I wonder if Congress will provide the funds. I wonder if Congress understands the problem. I wonder if the Congress cares. TIGTA does. The IRS appears to care. Do you?

A recent letter to the editor of the Philadelphia Inquirer illustrates why taxpayers are more confused than they need to be when it comes to understanding the tax law. According to Jodine Mayberry, she purchased a home and paid a real estate transfer tax, as do all purchasers and sellers of real estate in Pennsylvania. She told her accountant she wanted to deduct the transfer tax. The accountant told her that it was not deductible because it was not a tax but a fee. Jodine explained that it “sure felt like a tax.”

Jodine’s instincts with respect to the character of the payment are correct. So, too, is the label placed on the payment on her settlement sheet. The transfer tax is a tax. It is not a fee. The accountant was wrong in calling it a fee. However, the accountant was correct in concluding that the tax is not deductible.

Jodine’s instincts with respect to the deductibility of taxes are incorrect. Her letter suggests that she considers all taxes to be deductible. That is not the case. To be deductible, the tax must be within the scope of section 164(a), which specifies which taxes are deductible, and also not be within the scope of section 275, which lists taxes that are not deductible. That is why the federal income tax is not deductible but state income taxes are, assuming the taxpayer itemizes deductions. That is why gasoline taxes are not deductible, unless paid in connection with a trade or business or for-profit activity, but real estate property taxes are. That is why inheritance taxes are not deductible but state and local personal property taxes are.

The flush language of section 164(a) specifically provides that the real estate transfer tax paid by a purchaser, and any other taxes paid in connection with the acquisition of property, are treated as part of the cost of the property, and become part of the property’s basis for tax purposes. When paid by a seller, the transfer tax, and any other taxes paid in connection with the disposition, reduce the amount realized on the sale, which is the starting point for computing gain or loss on the disposition of the property.

By telling Jodine that the real estate transfer tax was not deductible because it was a fee, the accountant implied that if it were a tax it would be deductible and that fees are not deductible. In fact, some taxes are not deductible, and some fees are deductible. It’s understandable that taxpayers who are not tax professionals would be confused. Assuming that Jodine is accurately repeating what the accountant said, it is not helpful for a person preparing tax returns, who should know how taxes and fees are treated for tax purposes, to add to a client’s confusion. It would have been helpful simply to explain that real estate transfer taxes not only fail to appear in the list of deductible taxes, they also are specifically described as non-deductible and as part of the purchase price or as a reduction of the sales price in computing amount realized.

Readers of this blog know that I am not a fan of targeted tax credits ostensibly designed to generate more tax revenue than they cost, in part because they do not generate the additional revenue their supporters claim will materialize, in part because they complicate tax laws, and in part because they are fueled by and fuel the dark side of special interest lobbying. One of the tax credits that states have dished out with reckless abandon is the credit for producing films and other productions in the state. I have discussed this problem in posts such as Using Taxes to Rescue a Non-Drowning Film Industry?, Do Profitable Companies Need Tax Breaks?, You’ve Gotta Give 'Em (a Tax) Credit?, and Another Problem with Targeted Tax Credits.

So it was no surprise when I noticed that a new study has reached the same conclusion that I, and others, have reached. The core of the abstract is worth noting:

This study evaluates the impact of motion picture incentive programs, an array of tax incentives employed by over 40 states to entice film and television productions out of California and New York, on labor and economic conditions from 1998 through 2013. Results suggest that sales and lodging tax waivers had no effect on any of four different economic indicators. Transferable tax credits had a small, sustained effect on motion picture employment levels but no effect on wages. Refundable tax credits had no employment effect and only a temporary wage effect. Neither credit affected gross state product or motion picture industry concentration. Incentive spending also had no influence.

So why do state legislators continue in their mad rush to throw taxpayer dollars at an industry that is far from impoverished and in no need of financial assistance? Anyone who stays current on current news knows the answer. As the author pointed out, “If it’s such a successful industry and a profitable industry, you shouldn’t need a subsidy.”

The only good news is that a few states have downsized, eliminated, or failed to renew these giveaways. Yet during the past several decades some states that have scaled back or eliminated these ineffective credits have reinstated them. It would be interesting to map this pattern against election cycles.

Fairfax County in Virginia imposes a personal property tax on motor vehicles (and some other items). To collect the tax, the county requires registration of motor vehicles. Getting the information isn’t very difficult when the vehicle is purchased from a dealer in the county or elsewhere in the state, because information is sent directly to the county. But if vehicles are purchased outside the state, the owner must register the vehicle. Many don’t. Because it is so close to Washington, D.C., Fairfax County experiences a high residential turnover rate. So to keep up with the influx of vehicles that are not registered, the county invites residents to report vehicles not bearing Virginia license plates. Though the country lists the categories of vehicles that are exempt, such as those belonging to members of the military temporarily assigned to the area, diplomats, and full-time college students, someone who decides to report an out-of-state license plate would not necessarily know the status of the vehicle’s owner. The web site permits those who report a vehicle with out-of-state tags to check on the status of the report and the vehicle.

It does not appear that rewards are offered for reporting motor vehicles that lack Virginia plates. The incentive, I suppose, is that the tax increases caused by failure of owners to register their vehicles in Virginia are avoided if those owners are reported and compelled to pay the tax. According to the web site, “within the last fiscal year, more than 1,800 previously unregistered vehicles were added to car tax records . . . which will yield more than $2 million in tax revenue to support the county budget.”

So, would you report your neighbor’s unregistered vehicle if a similar tax and reporting program existed in your locality? Will this question become obsolete as tracking technology permits revenue officials to determine where vehicles are garaged?

New Jersey has a problem, though I doubt it’s the only state with this sort of challenge. The federal government also faces a similar issue. Put simply, the state’s fund for maintaining, repairing, and improving highway and other transportation infrastructure is almost depleted. So what happens when there’s no money in the fund and a bridge collapses. According to this report, New Jersey Governor Chris Christie issued an executive order directing state officials to use general funds budgeted for other state services to deal with projects that threaten the “healthy, safety, and welfare” of residents. This action comes after he shut down construction and other nonessential work.

Why is the fund almost out of money? The state legislature has been unable to agree on a funding plan. Legislators agree that the state gasoline tax needs to be increased by 23 cents per gallon. But they disagree on how to “cushion” this change. Christie and some legislators want to reduce the sales tax from 7 to 6 percent and to increase the retirement income exclusion. The Senate president wants to repeal the estate tax, increase the retirement income exclusion, increase the earned income credit, and create tax breaks for commuters and veterans. The head of the Assembly supports both proposals. It has been suggested that the impasse could last for months.

Common sense tells us that taking money from other services means that to fund transportation infrastructure emergencies, the state will need to reduce state police protection, or debt payments, or some other service. Does that not also impair the “health, safety, and welfare” of New Jersey residents? And what highway repairs can be tossed aside as not endangering “health, safety, and welfare”? Try to think of a problem that can be ignored. Broken traffic lights? Potholes? Missing stop signs? Sinkholes? Bridge collapses?

Common sense also tells us that one must pay the price for what one wants. Residents of New Jersey, not unlike those of every other state, want safe highways and transportation infrastructure. If that requires a liquid fuels tax increase, and the legislature agrees that it does, then the answer is clear. But the idea of cutting back other taxes to “cushion” the cost simply means that services funded by those other taxes will be cut. Time and again, people seem to want a lot and want to pay little. Eventually, one gets what one pays for.

It’s not as though the situation is a surprise. Sympathy for legislators facing an unexpected problem is understandable. But the highway funding crisis was predicted, it was avoidable, and it could have been handled months ago, if not years ago. The process of legislating requires making tough decisions. Those who cannot make tough decisions ought to stay away from jobs and offices that require tough decisions.

So how can the legislature be pushed into getting this problem solved? I think of a story I read when I was in my teens. In 1271, the College of Cardinals could not come to agreement on the election of a new pope. The debate dragged on for almost three years. At the time, the College met in Viterbo. Eventually, the people decided to lock the cardinals in the palace, and to limit them to bread and water until they selected a new pope. Supposedly, they also removed the roof from the palace. A new pope was quickly elected. Though I do not remember the name of the book in which I read the story, accounts are readily available, including this one. So is the solution to getting legislatures to do what needs to be done a dose of bread, water, and roof removal? It’s a tempting proposition.

A reader alerted me to this story and asked if voters can be given too many tax propositions. According to the story, voters in Amarillo, Texas, will be asked in November to vote yes or no on each of seven tax propositions. Each proposition is for the issuance of general obligation bonds to be repaid through a tax. The amount for each proposition varies, and the proceeds of each bond issue would be used for different purposes. For the curious, here are the propositions:

Proposition Number 1: "The issuance of $89,495,000 general obligation bonds for street improvements and the levy of a tax in payment thereof."
Proposition Number 2: "The issuance of $20,080,000 general obligation bonds for public safety improvements and the levy if a tax in payment thereof."
Proposition Number 3: "The issuance of $41,475,000 general obligation bonds for municipal buildings improvements, including a senior citizen center, and the levy of a tax in payment thereof."
Proposition Number 4: "The issuance of $22,250,000 general obligation bonds for neighborhood park and recreation facilities and the levy of a tax in payment thereof."
Proposition Number 5: "The issuance of $83,430,000 general obligation bonds for Civic Center improvements and the levy of a tax in payment thereof."
Proposition Number 6: "The issuance of $16,295,000 general obligation bonds for the fleet services department including equipment and vehicles therefor and the levy of a tax in payment thereof."
Proposition Number 7: "The issuance of $66,625,000 general obligation bonds for athletic facilities, including soccer, softball and baseball fields and gymnasium, basketball and aquatics facilities and the levy of a tax in payment thereof."

My response reflected my first thought, “It depends.” Surely if there were dozens or hundreds of propositions on the ballot, it would be burdensome for a voter to go through each one, though some might review the propositions ahead of time and walk in with a list of the propositions with a Y or N written next to each one. But seven? That’s not particularly burdensome. I also suggested in my response that it makes more sense to break each proposal into a separate proposition rather than bundling them into one. When bundled into one, objections to one of the proposal could doom the others, and in some instances strong support for an essential proposal would bring along one that does not otherwise deserve approval.

After I responded to the reader, two more thoughts popped into my head. I share them here.

First, would it not be ideal if legislatures acted in the same manner, rather than shoving into an essential piece of legislation a provision that would not pass if it stood alone? Granted, legislators need to deal with dozens and even hundreds of proposals, but they’re being paid to do that. If they stayed in the legislative halls for a sufficient period of time, they could work through even thousands over the course of a year, with each proposal standing alone and not hiding behind another provision.

Second, do not those who live in households that budget engage in a similar process? Does a person, or a couple, or a family not consider a series of decisions on spending, and whether to borrow to make an expenditure? Just as the voters in Amarillo need to examine each proposition, so, too, those who are making budget and financial decisions need to examine each proposed expenditure. My guess is that there are more than seven to be considered.

A recent Tax Court case, Cappel v. Comr., reminds taxpayers that tax danger lurks in every child support situation. Usually, divorcing couples avoid the consequences, but sometimes one of the two behaves in a way that makes a mess of the other person’s tax situation and leaves that person unable to dig out of it.

The taxpayer has three children, T, C, and P. T and C were born to the taxpayer and his first wife. P was born to the taxpayer and his second wife, with whom he is in divorce proceedings. During 2011, T, C, and P were 20, 16, and 12, respectively. In 2002, a Florida family court entered a child support order in the divorce
case between petitioner and his first ex-wife. The court ordered that the taxpayer “will receive the child dependency exemption for [T and C] each and every year beginning in 2001” but “only if he remains current from this point forward in his payments of child support.” The taxpayer credibly testified that he has been current in his child support payments at all relevant times, and the IRS did not contend otherwise.

The taxpayer timely filed a federal income tax return for 2011 on which he T, C, and P as dependents. Notwithstanding the Florida court’s 2002 order, the taxpayer’s first former wife also claimed T and C as dependents for 2011. The taxpayer’s second wife, the mother of P, claimed P as a dependent for 2011. Neither T nor C resided with the taxpayer during 2011, and he does not know where either of them resided. P resided with his mother in Pennsylvania for more than half the year during 2011; he did not reside with the taxpayer at any time during 2011. The taxpayer was the noncustodial parent of C and P during 2011. He did not obtain, from C’s mother or from P’s mother, an executed Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent.

The primary question before the court was whether the taxpayer was entitled to claim dependency exemption deductions for the three children. The answer to that question would determine whether he was entitled to head-of-household filing status and child tax credits.

The Tax Court analyzed whether each child was a qualifying child or a qualifying relative. None of the children were qualifying children because none of them satisfied the requirement that they have the same principal place of abode as the taxpayer for more than one-half of the taxable year. Neither C nor P was a qualifying relative because the taxpayer, though paying child support, did not provide evidence that he supplied more than 50% of their support, nor did he provide evidence that he supplied more than 50% of the support of T. Nor was the taxpayer within the exception for noncustodial parents because he did not file a Form 8332.

The court noted that the taxpayer “has acted honorably in paying child support for many years, but his ex-wife has apparently claimed two of their children as dependents in violation of a Florida court order. But while the result may seem harsh in these circumstances, the law is unfortunately clear. On the record before us, we have no alternative but to sustain [the IRS].”

So what’s the solution? The answer, I think, is for the taxpayer to sue his first former wife for breach of contract. Damages should reflect the increased taxes, interest, and penalties paid by the taxpayer on account of her failure to comply with the contract and the resulting court order. Going forward, it makes sense for divorcing couples to include in their divorce agreements a provision that concedes damages if either party breaches the agreement or violates the accompanying court order. That, too, might seem harsh when proposed, but in the long run, it’s best to insist on its inclusion.