MauledAgain

A recent tax case, not unlike many other tax cases, provides a disappointing insight into human nature. Unlike cases involving improper exclusions and unjustified deductions, this case poses the question, “What should I do if someone makes a mistake in my favor and pays me twice?” In Willson v. U.S., No. 14-1109 (D.C. Cir. 6 Nov 2015), the Court of Appeals for the D.C. Circuit provided the answer that most people would give.

The problems for the taxpayer began in 2005. When filing his 2004 federal income tax return, the taxpayer determined that he overpaid his taxes by more than $28,000. He applied the overpayment as a credit on his 2005 return. A year later, that credit was more than enough to cover his 2005 liability, so he applied the remaining $13,193.55 overpayment to his 2006 return. In 2007, when filing his 2006 return, the taxpayer computed a zero liability, qualified for a refundable $30 credit, and ended up with a $13,223.55 overpayment. This time, the taxpayer requested a refund of $10,000 and applied the remaining $3,223.55 as a credit for subsequent returns.

As simple as that is, the IRS made a mess. When it processed the taxpayer’s 2006 return, it did not apply the $3,223.55 as a credit for future years. Instead, it send a check for $13,223.55 rather than the $10,000 that was requested. When the taxpayer filed his 2007 return, the IRS applied $13,223.55 as a credit from the 2006 overpayment. In other words, the IRS somehow managed to take one $13,223.55 overpayment and turn it into a $13,223.55 refund AND a $13,223.55 credit. The IRS increased that credit by a $600 tax relief credit and $85.48 in interest, applied $3,223.55 as a credit for 2008 and thereafter, and made a direct deposit of $10,685.48 to the taxpayer’s bank account.

When the IRS figured out it had done something wrong, it reversed the overpayment credit for the 2006 taxable year, which created a $13,193.55 tax liability for that year. In March 2011, the IRS sent the taxpayer final notice of intent to levy on his property to recover that amount. The taxpayer requested a collection due process (CDP) hearing. As that procedure moved along, the IRS processed the taxpayer’s 2009 return, which reported an overpayment credit, from 2007 and 2008, of $2,206.55. Because the taxpayer, in March 2010, had paid $100 applied to his 2009 liability, the IRS increased the 2009 overpayment to $2,306.55. The IRS did not refund this amount, nor did it apply it as a credit for subsequent years. Instead, it applied it as an offset to the $13,193.55 2006 liability created by the overpayment credit reversal.

It was at this point that the taxpayer realized he had received his expected refund twice. On May 24, 2011, he sent a letter to the IRS acknowledging he had received more than he was due, estimated the overpayment to him was about $10,000, and enclosed a check for $5,000 “not as payment for the 2006 demands which are clearly errors but as an immediately affordable amount to being returning an overpayment made entirely as an IRS error.” He offered to pay another $6,000 over three years.

On July 6, 2012, the IRS Appeals Office issued a final notice of determination sustaining the proposed levy. The $13,193.55 had been reduced by the $5,000 payment from the taxpayer and the $2,306.55 2009 overpayment, to $5,887. The taxpayer appealed the IRS determination to the Tax Court. The IRS conceded it was not permitted to collect the duplicate refund by creating a new assessment for 2006. Its options were to pursued an erroneous refund action, for which the statute of limitations had expired, to accept the taxpayer’s voluntary repayment, or to exercise its common-law right to offset a debt owed to the government with a debt owed to the taxpayer provided it did so within two years of the date of the erroneous refund. Because the assessment for 2006 was improper, the IRS abated the assessment, leaving a zero balance on the taxpayer’s 2006 liability. It determined it was barred by the statute of limitations from applying the 2009 overpayment to the refund, and refunded that amount to the taxpayer.

At that point, because there was no unpaid liability and no pending levy, the IRS moved to dismiss the case as moot. The taxpayer objected. The IRS had not refunded the $100 tax payment made in March 2010, which was within two years of the erroneous refund. The IRS did not return the $5,000 the taxpayer paid voluntarily in May 2011. The taxpayer requested that those amounts be returned and that the Tax Court had the power to order the requested repayment. The Tax Court disagreed, and the taxpayer appealed.

The Court of Appeals affirmed the decision. It held that the Tax Court’s jurisdiction was limited to the tax liability underlying the proposed levy. The underlying tax liability had been abated. The $5,100, according to the court, was not held against an underlying tax liability but was retained to recover an erroneous refund. The debt created by an erroneous refund is not a tax liability. Instead, it is an amount owed to the government by reason of unjust enrichment. The Court dismissed the taxpayer’s other arguments contesting the levy because the proposed levy would not occur due to the abated assessment.

It is unclear why the taxpayer sought the return of the $5,100. What makes it even more puzzling is that the taxpayer acknowledged he had received a double refund, had returned part of it, and proposed paying back the rest. Once the IRS abated the 2006 liability, the taxpayer was no longer at risk of losing property to levy, and thus had the choice of paying back the rest of the erroneous refund, doing nothing, or seeking a return of the $5,100. Rather than paying back the balance, and rather than doing nothing and taking the benefit of a windfall caused by an error, the taxpayer went for a much bigger windfall. In other words, the taxpayer argued for an outcome that amounted to a right to keep a duplicate refund. Whatever the law might provide or require, the decent thing to do is to return the money.

Most people don’t end up with duplicate refunds from the IRS. But many people have experienced store clerks handing them too much change. I have had that experience. What have I done? What I have done has brought gasps of “thank you” from store clerks who would have been held accountable personally for the error. And that just would not have been right. The sad part is that there are people who disagree with me. And they have told me so. The happy part is that they are outnumbered by those who agree with me. So what would you do if you happened to receive duplicate, or, can one imagine, triplicate, refund checks?

Tom Giovanetti, of the Institute for Policy Innovation has released a commentary criticizing the myRA, Treasury’s latest retirement savings opportunity. He makes several good points, including the fact it doesn’t offer anything more than existing Roth IRAs, the fact it invests only in Treasury securities, and that the rate of return is on the low side.

Had he stopped at that point, the commentary would not have inspired me to write anything. But Giovanetti then proceeded to offer this claim:

Workers don't have money to save because of 1) the increasingly anemic Obama economy, 2) skyrocketing health insurance premiums mandated by Obamacare, and 3) the Social Security payroll tax, which comes out of the first dollar of a worker's earnings and funds a Social Security benefit that doesn't even keep up with inflation for most recipients.

He couldn’t be more wrong. Workers don’t have money, to save or spend, because the oligarchs are jacking up corporate CEO salaries while cutting the pay of rank-and-file employees, with more than 95 percent of economic gains over the past seven years benefitting the top one percent. The economy has grown, but only to the benefit of the oligarchs, and to the extent it is anemic, it is because consumers lack money to make purchases, in turn a consequence of stagnant rank-and-file wages, the trimming of worker hours to spare the oligarchs the cost of paying for worker benefits, and the laying off of employees as huge corporations gobble up other businesses and sack the employees of the acquisition. Health insurance premiums are skyrocketing because private companies, which exist to make profits, are doing what profit-seekers will do in the absence of any countervailing pressure, namely increase revenues by increasing prices. And as for the social security tax being a problem, that tax has existed when the economy was robust and rank-and-file shared in the nation’s prosperity, and it has existed when the economy has stagnated or regressed. Thus, if it is to be blamed for stagnation in the economy it also should be credited with economic prosperity.

Isn’t it time for those who have created the economic mess to admit that there is a mess and that what was done has failed? Isn’t it time for those who keep singing the praises of those who messed up the economy to admit that they are fans of losers, and to shift their allegiances and advocacy to what worked in the past and ought to be revived?

Everyone who reads MauledAgain knows that I consider the increasing income and wealth inequality in this country to pose serious short-term and long-term effects on its economy. In the long run, income and wealth inequality makes it quite likely that there won’t be any income or wealth. In other words, income and wealth inequality sows the seeds of income and wealth destruction.

Now comes news that income inequality is “transforming the chocolate business.” According to Hershey Co., the “growing gap between low and high-income households .. . has changed buying patterns.” High-income consumer are shelling out big bucks for premium brands, and low-income consumers are making fewer shopping trips, thus reducing the impulse purchase of chocolate (and other items).

Hershey calls it “consumer bifurcation.” In other words, those who share in the new prosperity exist in a market close to those who have been shut out of the new prosperity. Hershey is not alone, as other companies, such as Campbell Soup, have experienced the same consumer bifurcation.

I doubt that those who consider income and wealth inequality to be a good thing care one whit about its effect on chocolate consumption or, for that matter, the availability of any other sort of consumer product. But eventually they will, as they discover, just as these food companies are discovering, that a healthy economy is demand-driven. Demand drives supply because it creates a market. Supply does not drive demand because demand cannot exist when income and wealth are concentrated in a few. Perhaps now that people are finding chocolate to be more expensive and are consuming less, they might devote some serious time to thinking and learning about economics. Part of me, though, thinks it won’t happen until consumer bifurcation reaches the coffee market. Then we might see some very angry consumers.

According to a recent story from Finland, authorities in that country are cracking down on restaurants that sell pizza for less than six Euros. Their rationale is that in order to sell pizza at that low of a price, the sellers must be evading the taxes that are due. So they are asking customer to report restaurants selling pizza for less than that price. This presents several questions.

First, would people not be tempted to avoid reporting places where they can get good deals on pizza? Knowing why they’re being asked to provide information to law enforcement officials, are they not likely to conclude that doing so would cause closure of their favorite pizza shop?

Second, is it not possible to question the reasoning of the authorities that brought them to the conclusion that cheap pizza equals tax evasion? According to the authorities, roughly one-third of the cost of a pizza covers ingredients, another one-third covers labor, and the rest is split among rent, miscellaneous fees, and taxes. Is it not possible for a pizza seller to find a good deal on rent or ingredients? Of course, perhaps there is some law-breaking underway but it’s not necessarily tax evasion. Are they skimping on wages? Are they obtaining cheap ingredients from an unsafe or unregulated source, or perhaps on a black market? Or perhaps some pizza shops are bringing in other revenue under the table. Are pizzas being sold as a cover for the sale of other items? Or perhaps an effort is underway to take over competitors by pricing them out of the market.

Seems to me that the best way to figure out if taxes are being evaded is to audit the pizza shops. Compare the volume of observed and reported transactions, and the taxes due on them, with the actual taxes being paid. Otherwise folks in Finland will end up being asked or required to report every transaction that they think is a “good deal.”

It’s a familiar story. A private sector business asks for special tax breaks and taxpayer funding for an enterprise that already is extremely profitable and that will continue to be profitable. The justification is that the business generates economic benefits for the public at large. Some of the most egregious instances of this money grab occur in the professional sports industry. I wrote about this eleven years ago in Tax Revenues and D.C. Baseball, and three years ago in Putting Tax Money Where the Tax Mouth Is, Taking Tax Money Without Giving Back: Another Reality, and Public Financing of Private Sports Enterprises: Good for the Private, Bad for the Public.

Now comes a report that the taxpayers of St. Louis are going to be on the hook for financing a good chunk of the cost of building a new football stadium in that city for the St. Louis Rams. The proposed legislation, which the politicians hope “is generous enough” for the impoverished folks of the NFL, would give to the team two-thirds of taxes generated by the stadium. The city and the state would be required to come up with $390 million of the cost of the $1 billion stadium, in addition to giving up two-thirds of the tax revenue. Allegedly an NFL executive considered tax dollars used to finance the city’s share of the construction costs to be “private dollars, not public.”

It is unclear, according to several city officials, how the numbers add up. Under the current arrangement for the existing stadium, the city collects $4 million a year in tax revenue from the team but pays $6 million each year to pay down construction debt. An assistant to the mayor projects that under the proposed deal, the city will continue to pay $6 million annually but receive only $2 million in tax revenue. Supporters of the proposal claim that the city will receive additional revenue from the construction and that the tax revenue might grow more than is expected.

As I asked in Where’s the Promised Trickle-Over?, where is the guarantee that this will work for the taxpayers as promised? Why are those who so intensely claim that the latest giveaway to the wealthy will benefit everyone else so reluctant to ensure that if it doesn’t work out as promised that they will step up and make up the shortfall? The answer is that they know that these deals do not deliver as promised, but they’ve learned the tricks of selling bad deals.

The same people who are quick to complain about spending and tax breaks that help people in need are just as quick to insist on spending and tax breaks that enrich the rich. The claim that it helps those in need has been disproven repeatedly. When people complain that a state or local government fails to support highway maintenance, education, environmental protection, and public health, do they ever consider that the shortage is attributable to giveaways to those who are the first to condemn “takers”? The perspective that taking is good when it benefits the wealthy but is bad when it benefits those in need reflects a deeper outlook. The notion that those in need are in that condition because they are lazy, and that those who have wealth and deserve even more because they are hard-working flies in the face of reality. There are plenty of people who want to work but cannot for a variety of justifiable reasons, and there are too many people who are wealthy simply because of the accident of birth or other incident of sheer luck. It is time for the self-designated “makers” to make something more than increased wealth for themselves.

The NFL and its teams, as well as the other professional sports leagues and franchises, do not need financial assistance from the public. They do not need, and ought not seek, additional funds that require increased taxes for others or reductions in public benefits for everyone else. If a professional sports league or one or more of its teams cannot survive on its own revenue and must go out of business, so be it. People who want these enterprises to succeed can patronize them, and find other ways to support them financially without shifting that burden to others.

From the outset, I have made it a point to work Halloween into MauledAgain, usually looking for the silly or goofy but occasionally taking a more serious approach. The posts began with Taxing "Snack" or "Junk" Food (2004), and have continued through Halloween and Tax: Scared Yet? (2005), Happy Halloween: Chocolate Math and Tax Arithmetic (2006), Tricky Treating: Teaching Tax Trumps Tasty Tidbit Transfers (2007), Halloween Brings Out the Lunacy (2007), and A Truly Frightening Halloween Candy Bar (2008), Unmasking the Deductibility of Halloween Costumes (2009), Happy Halloween: Revenue Department Scares Kids Into Abandoning Pumpkin Sales (2010), The Scary Part of Halloween Costume Sales Taxation (2011), Halloween Takes on a New Meaning and It Isn’t Happy (2012), Some Scary Halloween Thoughts (2013), and The Inequality of Halloween? (2014).

Now we learn that the issue I noted in Halloween and Tax: Scared Yet? (2005), the different sales tax treatment in some states between candies made with flour and those that are not, has caught the eye of the consumer. Flour is used in candies such as licorice, KitKats, and Nestle’s Crunch. In a Napa Valley Register commentary, Jill Cataldo describes the bewilderment faced by her sister when her sister noticed that the sales tax on Twix bars was much lower than the sales tax on Snickers purchased for the same cost. Cataldo did some research and discovered what I had described ten years ago, that in her sister’s state and in many others, the presence of flour in an edible item causes the item to be classified as “not candy” and thus subject either to a lower sales tax or no sales tax. So, as she points out, chocolate covered cherries are candy and thus receive less favorable sales tax treatment. Chocolate covered pretzels are treated as “food” and either escape sales tax or are taxed at a more favorable rate.

Cataldo made the point that consumers looking to save a few pennies on Halloween candy purchases should look for those items that contain flour. I wonder how many people can make a list, without looking it up, of so-called candy that is treated as food under sales tax laws because they contain flour. However many people can do so, I’m confident that the number of people who can explain why this difference exists is far fewer. I can guess, but it really makes no sense to conclude that the inclusion of flour makes the item sufficiently nutritious to deserve more favorable sales tax treatment.

The most important question, though, is how many people are going to hand out Kit Kat bars or Nestle’s Crunch and tell the children, “This really isn’t candy.” My guess, and hope, is zero, because I can’t imagine anyone wants the youngsters running through the neighborhood shouting, “Those people gave us something that they said isn’t candy,” or, worse, “Those people have problems, because they gave us candy and said it wasn’t candy.” I prefer to have a repeat of what the children exclaim when they leave my front door, “He’d giving out Reese’s Peanut Butter Cups.” Indeed. Truly nutritious food. How scary is that notion? Happy Halloween.

There is a tax parade, and apparently the poor and middle class haven’t been invited. For those struggling to get by, if they can get into this parade there are some dollars at the finish line. Lots of dollars.

Where is the parade? The one that has my attention is in New Jersey, but there are similar parades all over the nation. The New Jersey parade gives away tax dollars to prosperous corporations. Why? Because those corporations threaten to leave New Jersey or to refrain from coming to New Jersey even though at least some of them don’t have much of a choice. Here are some of the featured participants:

• The Philadelphia 76ers, as described in In When the Poor Need Help, Give Tax Dollars to the Rich.
  
• Lockheed Martin, as described in Fighting Over Pie or Baking Pie?.
  
• Subaru, as described in Why Do Those Who Dislike Government Spending Continue to Support Government Spenders?.
  
• Berry & Homer, as described in When Those Who Hate Takers Take Tax Revenue

And now comes news that the parade has lengthened. This time, it is Eggo Co., a subsidiary of Kellogg, and Clean Green Textile Service. As was the case with the other handouts, there is nothing to ensure that the promised jobs and other economic benefits will accrue to residents of Camden or others in economic distress. Policy analysts contend that no matter how long these corporations remain in their new locations, the state loses money. Considering that the previous entrants in the parade have not generated jobs or economic benefits anywhere near what was promised, it is understandable that those who look closely at the arrangements can see that the only winners are the corporations getting these tax breaks. In When Those Who Hate Takers Take Tax Revenue, I wrote:

One of the arguments put forth by the anti-government-spending folks is that it is bad morally, socially, and politically to collect taxes from one group and to disburse the receipts to another group. These folks like to brand the first group as “makers” and the second group as “takers.” Yet when the takers are their friends and allies in the movement to feudalize America, not a peep is heard from them.

New Jersey, governed by a member of the political party that is trying to consolidate its power by demonizing “takers,” provides an excellent example of the hypocrisy entrenched in this modern reverse Robin Hood philosophy. * * *

Though this tax revenue giveaway game has been underway for several years, there is no sign that the economic condition of Camden’s residents have improved. The folks in Trenton who rail against government spending cut education spending, job training spending, social welfare assistance, and a variety of other expenditures denounced as enabling “takers” to feed at the public trough. Yet in the meantime, a state that faces deficits in its transportation infrastructure budget continues to funnel taxpayer dollars into the hands of companies with sufficient political connections to snag some funds for themselves. * * *

At what point will enough voters see through the con game and send packing the takers who took over political control by demonizing takers? When will political hypocrisy disappear? At what point will people realize that economic growth consists of creating something of economic value and not simply moving jobs from one place to another?

Previously, in Why Do Those Who Dislike Government Spending Continue to Support Government Spenders? I had written:

There’s something not quite right in the collective psyche of the anti-government-spending crowd. Enraged by high taxes, they manage to put into office, and keep in office, people who dish out tax revenues as though there were no limits on taxation. Of course, the tax breaks go to those who are in least need of economic assistance. Their excuse, that they will use the tax breaks to help those in need, is hilarious, because the best way to help those in need is to direct assistance directly to them so that they can infuse those dollars into the economy. That makes the economy grow. Handing tax dollars to those who don’t need financial assistance is nothing more than helping some people grow their Swiss bank stash.

These words have not reached the eyes of those lining up their corporate friends for parade entry, and in the off chance they are aware of the criticism, from myself and others, they are overwhelmed by the focus on monetized power politics.

So could it be time for “if you can’t beat them, join them”? Not for those of us who lack the resources to sign up for the parade, or perhaps what should be called the corporate gravy train. That is the essence of what is wrong with this nation’s economic condition. Those with more than sufficient money can afford to get more money, and those with insufficient funds are too poor to get more money from the legislative handout machine. Eventually they will have everything and the rest of us will have nothing. By then, it will be too late. The parade will be over, and almost all of us will have been left out.

Section 280E of the Internal Revenue Code prohibits the deduction of “any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.” The Tax Court has held that marijuana is a schedule I controlled substance and that the sale of medical marijuana pursuant to California law constitutes trafficking within the meaning of Section 280E. Olive v. Comr., 139 T.C. 19, aff’d, 792 F.3d 1146 (9th Cir. 2015); Californians Helping to Alleviate Med. Problems, Inc. v. Comr., 128 T.C. 173 (2007). Thus, if the taxpayer is carrying on the trade or business of distributing medical marijuana in California, the otherwise deductible trade or business expenses are not deductible.

In a recent case, Canna Care, Inc. v. Comr., T.C. Memo 2015-206, the Tax Court rejected the taxpayer’s claim that it was not engaged in a trade or business because California law prohibits the distribution of marijuana for profit and the parties stipulated that the taxpayer was not operated for profit. The Tax Court explained that the fact the taxpayer was operated in accordance with California’s restriction on profiting from distributing marijuana did not affect its finding that the taxpayer was engaged in the business of distributing marijuana for purposes of section 280E. The court noted that the salaries paid to the taxpayer’s owners were “well in excess” of those paid to its other employees, an indication that the taxpayer had been formed to generate income.

According to the court’s recitation of the facts, the taxpayer was owned by a married couple who had six children and were facing financial hardship compounded by increased tuition expenses for those children. The husband “turned to his faith for a solution. After much prayer, [he] was convinced that God wanted him to open a medical marijuana dispensary to solve his family’s financial woes.” Because the husband’s prayer was motivated by a desire “to cure his family’s financial difficulties,” the claimed divine inspiration did not absolve the taxpayer of the restriction imposed by section 280E.

When the wealthy, or at least the tax-hating segment of the wealthy, and their advocates push for tax cuts that benefit the wealthy, their justification essentially boils down to a claim that the outcome will be good for all Americans because tax cuts create jobs, stimulate the economy, and advance the cause of freedom. Anyone who reads this blog knows that I think that claim not only is nonsense but is intentionally deceptive.

Now that the tax-haters have control of Congress and most state legislatures, their need to be deceptive has diminished. Because of gerrymandering, even if the majority of Americans voted in favor of undoing the damage, it would have no effect. Controlling the White House or a governor’s house means little when legislatures – such as the Congress and the crew in Harrisburg, Pennsylvania – refuse to act unless the elite who control them get their way.

And it is in that setting billionaire Carl Icahn has threatened the Congress with his money. He has set up a $150 million political action committee, and if the Congress does not enact more corporate tax breaks he will use that money to re-constitute the membership of Congress to a group that does what he wants. Specifically, Icahn wants American corporations that made money but avoided paying taxes by shifting the profits overseas to be permitted to bring that money back to this country without paying the taxes that otherwise would apply. One of the companies that has engaged in this scheme is Apple, in which Icahn is one of the largest investors. Apple has stashed $181 billion overseas, more than any other American corporation.

The president of Every Voice Center, an advocate of campaign finance reform, points out that Icahn’s threat demonstrates “what politics has come to be, which is an argument among billionaires.” In other words, if you’re part of the 99 percent that cannot afford to purchase or threaten Congress, you don’t count. That is, I suppose, what democracy means to the oligarchs. Democracy for them, not for anyone else. So billionaires like Icahn, the Koch brothers, Tom Steyer, and Sheldon Adelson call the shots and use their money to dictate public policy, one pillar of which is to attack the rest of the nation’s citizens by crushing them economically, cutting their benefits, reducing their work hours, curtailing their voting rights, and letting public infrastructure rot away. So now we know what the tax cut beneficiaries have been doing with their tax cuts.

Back in 2004, a similar provision was enacted that permitted corporations to repatriate their overseas profits. It was advertised as a job-creating no-brainer. According to a Senate study seven years later, the provision did not create jobs. Instead, corporations stashed more profits overseas, and, of course, the economy fell apart a few years after the 2004 provision was enacted. But, as has been the case with every other failed economic ploy enacted or proposed by the anti-tax lobby, the failed provision is offered up again and again. Clearly, the ability to learn from one’s mistakes is not a skill possessed by these folks. Icahn’s announcement pretty much underscores his intention to use his wealth to mis-educate the public by saturating the airwaves and internet with more false claims about the job-creating benefits of creating even more tax breaks for the people least in need of tax breaks or any other sort of economic relief.

For whatever flaws there are in government, there is an even bigger flaw in letting oligarchs run the country. There is no voting booth or polling place to which one can go to vote out the oligarchs. The window for fixing the problem is closing quickly.

Recently, a Philadelphia Daily News reader posed a question to the paper’s personal financial columnist. The reader’s mother owns a home on which there is a mortgage loan. The loan balance is $100,000. The reader is a co-signer on the loan but is not on the deed. The mother is selling the home, and buying another one. The reader will not be on the deed to the new home. Apparently the mother needs financial assistance, because the reader has offered to help. The reader listed two alternatives. One is to pay off the mortgage on the existing home and to be repaid when it is sold and the new home acquired. Another is to provide the $100,000 for the new home, thus reducing the mother’s monthly payments on that property.

The reader suggested there might be adverse tax complications. The columnist stated that paying off the mortgage on the existing home would have no tax effect. At first glance, it appears that the reader is doing nothing more than lending money to the mother. Similarly, lending the money to the mother so that the mortgage on the new home is lower would appear to be nothing more than a loan. Generally, the making of a loan does not trigger income tax consequences because the lender is replacing one asset, cash, with another, loan receivable, and thus is not economically wealthier or poorer, and because the borrower is adding an asset while also adding an offsetting liability, and thus also is not economically wealthier or poorer.

However, neither the reader nor the columnist asked about, or mentioned, whether the reader would be charging interest on the loan to the mother. If interest is not charged, or is charged at a rate lower than the applicable rate, section 7872 would come into play. The amount of foregone interest would be treated as a gift from the reader to the mother, with these consequences. The reader would be treated as making a gift for gift tax purposes in the amount of the foregone interest, and would be treated as having interest income in that amount for income tax purposes. The mother would be treated as receiving a gift, excluded from gross income, in the amount of the foregone interest, and would have a potential mortgage interest deduction in that amount. Because the loan in question does not exceed $100,000, the amount of foregone interest for income tax purposes would be limited to the amount of the mother’s net investment income, or zero if the net investment income is $1,000 or less.

It is likely, though not certain, that the mother’s net investment income is zero or very low. But it is possible that the mother has net investment income from assets that cannot be liquidated to provide funds for paying off the existing mortgage or applying to the cost of the new home. Though some might consider this question to be “theoretical,” it isn’t. It isn’t theoretical until and unless all of the necessary facts are known. The fact that it might turn out that the mother’s net investment income is $1,000 or less does not mean that it should be presumed to be so.

The reader’s question would find its way onto a basic federal income tax examination if I were still teaching that course. It provides an opportunity to identify students who understand the tax issues at a basic level, that is, those who earn points for describing the income tax consequences of paying off a loan or making a loan. And it would also provide an opportunity to identify students who would earn even more points for identifying the section 7872 trap that lurks in the background. It is the sort of question that could be asked in terms of “what additional facts do you need to know?” Many students don’t like those types of questions, being accustomed to the “tell me the facts and I will tell you the answer” approach, but in practice, as the reader’s question suggests, the clients usually don’t present all the facts, often do not know what facts they need to be presenting, and need the attorney or accountant to help them identify relevant information.

A recent case, WSK & Sons, Inc. v. Comr., T. C. Memo 2015-204, offers lessons on what not to do on a tax return with beachfront house rentals. The taxpayer was a corporation owned by three related individuals, William S. Karras and his two sons William B. and Robert J. The corporation rented a beachfront house from an unrelated corporation for December 26, 2008, through January 2, 2009, for $22,950, of which $5,000 was a refundable security deposit. The tenants were listed as “William & Shana Karras Family,” the lease covered 10 adults, and the “tenant print name” field on the firm was filled in as “William & Shan Karras/ W.S.K. & Sons, Inc.” William S. Karras provided his personal credit card information to secure the credit card authorization for the agreement. William B. Karras, his fiance, some of her family, and a few of his friends stayed at the house. On January 3, 2009, the day after the rental ended, he and his fiance married.

On its federal income tax return for its taxable year ending February 28, 2009, the taxpayer claimed an advertising deduction that included, among other things, expenses related to the wedding. On its general ledger, under advertising and promotion, the rental amount of $22,950 was listed as “PRUDENTIAL PROP RENTAL.” The IRS disallowed the entire advertising expense deduction.

The taxpayer argued that the $22,950 was deductible because it was for a “corporate retreat” held at the beachfront house, claiming that “the retreat served a legitimate business purpose by enhancing employer-employee relationships for future productivity and preserving and expanding” the taxpayer’s relationship with its primary client. The Tax Court determined that the entry in the general ledger, the lease, and the credit card authorization did not establish that the $22,950 was paid. William B. Karras testified that he was present at the beachfront house, that it was rented to hold the taxpayer’s weeklong company meeting followed by entertainment and that “just the vendors and the subcontractors * * * were invited, along with our employees.” He also testified that his fiance, some of her family, and a few of his friends showed up because “we ended up sponsoring a – hosting a fishing trip shortly after as well.” Though unsure of the number of employees who attended – between 5 and 10 – he testified that more than 30 people were at the meeting. He affirmed that his wedding was the day after the meeting ended. The Tax Court noted that the taxpayer had stipulated that the advertising expense deduction included payments made for the personal expenses of the wedding, but that William B. Karras did not clarify what part of the rent was not related to the wedding expenses.

The Tax Court concluded that the testimony of William B. Karras was vague, uncorroborated, and led by the taxpayer’s attorney. Thus, the expenses were not substantiated and the deduction was disallowed.

Was this simply a case of a taxpayer who neglected to substantiate a deduction by not hanging onto receipts that proved payment? Was this a case of a taxpayer whose shareholder was unable to remember facts that supported the deduction? Why were 20 to 25 people who were not employees at a corporate retreat designed to encourage employer-employee productivity? Why was the retreat during a holiday week? Why was it at a beach? Why was it just before the wedding of one of the shareholders? The Tax Court found a way to resolve the case without getting into these questions. How nice for the taxpayer. But, by the way, the Tax Court upheld section 6662 penalties against the taxpayer. That was not a surprise.

At the end of last month, the Office of the Treasury Inspector General for Tax Administration issued a report on its audit of the IRS project to upgrade its server, desktop, and laptop systems from Windows XP and Windows Server 2003 to Windows 7 and Windows Server 2008 or 2012. The title of the report doesn’t quite convey the seriousness of what was discovered. “Inadequate Early Oversight Led to Windows Upgrade Project Delays” gives the impression that, at worst, delays caused inconveniences. What the audit revealed as the consequence of the delays is much more alarming:

As a result, the IRS does not have the latest ability to combat data breaches and remains at risk of hacking attempts and data loss or corruption due to malware. When the IRS’s data and network are not secured, taxpayer information becomes vulnerable to unauthorized disclosure, which can lead to identity theft. Further, security breaches can cause network disruptions and prevent the IRS from performing vital taxpayer services, such as processing tax returns, issuing refunds, and answering taxpayer inquiries. . . . We believe that running workstations with outdated operating systems pose significant security risks to the IRS network and data, particularly in the environment where a chain is only as strong as its weakest link. External hackers or malicious insiders need to locate only the one computer with security weaknesses, such as one with an outdated operating system, to exploit in order to steal data or further compromise other computers.

The report reveals that IRS management of the operating system replacement left much to be desired. Certain procedures were bypassed, and somehow there are more than a thousand computers that cannot be located.

Before casting full blame on the IRS, it is important to consider another finding by TIGTA: “In addition, budgetary constraints at the start of the Windows XP upgrade effort on April 2011 forced the IRS to upgrade old computers rather than purchase new computers, which would have made the upgrade process easier due to the compatibility of new hardware with new operating systems.” In other words, Congress made the task more difficult. Ultimately, responsibility for the IRS rests with the Congress, because it is an agency to which it has delegated particular tasks. Failure of the Congress to provide the IRS with the necessary resources and appropriate supervision is yet another indictment of the degradation of the American legislative process, particularly at the federal level.

Though it is tempting to some to use this news as another reason to criticize, attack, and shrink government, keep in mind that it is worse in the private sector. At least with the IRS, there is an audit and report. Has the public been the beneficiary of any such audit or report with respect to the thousands of private companies that acquire and retain sensitive customer and client information? As horrible as it is to have one’s tax and related financial information compromised, for many people it is worse when their health information or personal behavior is revealed without their consent. The underlying problem is much deeper, and involves an amalgamation of evil behavior with inadequate education and management. The solution will not be easy, but if one is not found, life for many people is going to become far more than inconvenience caused by delays.

Readers of this blog know that I am not a fan of a tax aimed solely at soda or soda and sugary drinks. I’ve written about this issue in a series of posts, beginning with What Sort of Tax?, and continuing in The Return of the Soda Tax Proposal, Tax As a Hate Crime?, Yes for The Proposed User Fee, No for the Proposed Tax, Philadelphia Soda Tax Proposal Shelved, But Will It Return?, Taxing Symptoms Rather Than Problems, It’s Back! The Philadelphia Soda Tax Proposal Returns, The Broccoli and Brussel Sprouts of Taxation, The Realities of the Soda Tax Policy Debate, and Soda Sales Shifting?. My criticism of soda taxes and sugary drink taxes is that there are all other sorts of food items that contribute to excessive sugar intake, and the obesity and adverse health effects that the advocates of these taxes claim to be trying to reduce. I have also criticized the disconnect between the tax and public health improvement.

Now comes a report that the enactment in Mexico of a soda tax that meets the demands of the soda tax advocates did cause a reduction in the consumption of soda, particularly among lower income individuals. This resolves the argument between those who claim a soda tax would reduce soda intake and the soda industry which claims that soda taxes would not deter soda consumption. I’ve never thought this issue deserved attention, because it doesn’t require rocket science or an experiment in Mexico to figure out that an increase in a tax on an item will reduce consumption of that item unless the item is an absolute necessity or unless the black market finds a way to provide the item while evading the tax.

What remains undetermined is whether a reduction in soda consumption will reduce obesity and other adverse health effects. It will take many years to figure this out. It will not be easy. Why? Because there are multiple variables in the causation of obesity and other adverse health effects. It is not unlikely that people who find soda to be too expensive because of the tax will spend their dollars on pies, cakes, candy, doughnuts, cookies, ice cream, and similar items. Because it is absurd to think that taxing soda consumption out of existence will cause significant decreases in obesity and other adverse health effects, any tax attack on bad health habits would need to be far-reaching. And, of course, making a tax attack that far-reaching would be counterproductive in many ways, and poses all sorts of policy concerns. Though advocates of the soda tax point to tobacco taxes as the reason for reduction in the use of certain tobacco products, it is far more likely that the “shock and horror” public service messages and advertisements, or the experience of watching someone die from tobacco-induced cancer, has a much stronger effect on behavior.

When I read this article by someone identified as “Dennis S” about a story published on the Brietbart web site, I was delighted to note that even those who have made shrinkage of government a part of their political platform acknowledge some of the unintended consequences of that policy. Dennis S suggests that the damage from the recent rainstorms that swamped South Carolina would not have been quite as catastrophic had the state government paid more attention to infrastructure. South Carolina has been beset by funding reductions in the maintenance of bridges, dams, and roads. Not long ago, the state’s legislature refused to enact a $400 million infrastructure protection and repair bill, and those supporting the bill predicted catastrophe when the next hurricane or intense storm hit. Sometimes being correct in one’s prediction is unpleasant, leaving “I told you so” as a quip that seems harsh. Yet it is true. This is what happens when taxes are cut for the sake of getting votes by cutting taxes, when revenue increases are touted as the reward for tax cuts, and government is condemned as an obstacle to freedom. Freedom isn’t worth much when dams break, rivers flood, roads wash out, drinking water is unsafe, electricity goes out, people die, and injuries abound.

Dennis S also notes a behavioral pattern that isn’t new and hasn’t gone unnoticed over the past decade. When New Jersey and other Mid-Atlantic states requested federal aid to help rebuild communities devastated by Hurricane Sandy, anti-government, anti-tax legislators opposed spending the money. The entire South Carolina Congressional delegation voted against the aid bill. Now that South Carolina needs assistance, these anti-government, anti-tax advocates are demanding federal aid. The state that has collected the most federal emergency funding since 2009, Texas, is represented in Congress by a Senator who rails against pretty much every federal program. He relents, of course, when his state stands to rake in money paid by taxpayers in other states.

Then I picked up on a Glenn Reynolds USA Today commentary, in which he frets that Americans are moving from blue states to red states. Reynolds suggests that “people who earn enough money to pay taxes” are trying to escape the high taxes of blue states, whereas those “living on welfare benefits and [not] plan[ning] to change that” would not move to a low-tax state to escape taxes and, if they were to move at all, would select a blue state offering higher welfare payouts. Reynolds explains that the high-tax states eventually will end up with more people who live off benefits, and fewer taxpayers, whereas the low-tax states eventually will end up with fewer people who live off benefits, and enough growth in taxpayers that would permit more tax reductions. The high-tax states, he claims, will go bankrupt. He then notes two possible counter-trends. One, that the high-tax, high-benefit states might lower taxes and reduce benefits, though he considers this unlikely. The other, that taxpayers moving from high-tax states to low-tax states “might bring their political attitudes with them, . . . supporting the same policies that ruined the states they let.” Reynolds offers advice to “conservative billionaires,” suggesting that they pay for programs that explain to blue state residents moving to red states that they should change the way they vote. He admits he does not know if this would work.

As I read this, I kept in mind that South Carolina is a red state. I wonder what is going through the minds of people who moved to South Carolina in order to benefit from lower taxes by cutting benefits. Intact bridges, sturdy dams, functioning electrical power grids, drinkable tap water, and protection against death surely are benefits. I wonder how many South Carolinians, native or newly arrived, are wondering about the “cut taxes, cut benefits” mantra financed by those who need tax cuts simply to finance their purchase of, and subsequent tear-down, of governments. When they succeed – I fear it is not a question of if they succeed – those same benefits will be available to those capable of paying the private sector price, which I guarantee will make the tax cost of these societal needs pale in comparison. What, then, becomes of freedom? Freedom from abusive private sector behavior is no less important than freedom from abusive government. One does not attain that freedom by destroying the private sector or by destroying government. Freedom is attained by destroying greed.

According to this report, Louisiana Governor Bobby Jindal, one of more than a dozen individuals seeking the Republican presidential nomination in 2016, is revealing his tax plan. It seems every candidate has a tax plan, each one seems to be worse than the previous one, and Jindal is going for the prize. According to Jindal, the federal income tax system “must require that every American” have “skin in this game,” that is, pay taxes. Every American?

So, Mr. Jindal, does that mean the person with no income would be required to pay an income tax? How about infants who are not trust fund babies? Would they be paying an income tax? Are you serious?

Jindal’s prize-winning absurdities include elimination of the standard deduction, the deduction for personal and dependency exemptions, and most other deductions. The federal income tax liabilities of almost all lower-income and middle-income Americans would increase.

And what would Mr. Jindal do with the increased revenue? Would he reduce the budget deficit? No. Would he see to it that the nation’s infrastructure is spared becoming a competitor for worst in the world? No. He would eliminate corporate income taxes. And the federal estate tax. Anyone with even half a brain knows who would be stashing even more cash with those moves.

Jindal also proposes a credit for people with children under 18, though it is unclear whether this would be for all families or just those with small amounts of income. He proposes a similar credit for people older than 65 whose income is under $5,000. Imagine scraping by on $5,500 of annual income and being required to pay into an income tax system originally designed to reduce the income and wealth inequality of the late nineteenth century, which had plunged the nation into economic crisis time and again.

So after Jindal claims every American should be paying federal income tax, he proposes a plan that doesn’t accomplish that result. Brilliant. When he adds in the claim that by reducing federal tax revenue – which must mean huge reductions for the economic elite, because surely the 99 percent not in the top one percent would not be getting reductions – wages would grow at more than 8 percent, he demonstrates why he ought to be sitting in some tax classes. Again, anyone with half a brain knows what happened when a similar “cut taxes on the wealthy” stunt was pulled early in this century. There’s more to responsible tax policy than dishing out sound bites that play to the peanut gallery. There’s a reason I don’t blog about quilting, needlepoint, and welding.

Fortunately, there is very little chance that Mr. Jindal will be moving from Baton Rouge to 1600 Pennsylvania Avenue. Hopefully, no one else will take ownership of his daft tax ideas.