MauledAgain

Anyone who teaches a tax course, most students who have been in a tax course, and a few faculty who have not taught tax courses, have experienced the consequences of the continous and eternal parade of tax law changes that impact not only tax practice but the design and teaching of a tax course. Although the steady stream of tax legislation gets much of the attention, the IRS does its part by issuing regulations and other administrative documents, and the courts decide case after case. Most courses share with tax courses the impact of the occasional case that turns part of the course on its head. Some courses are afflicted by serial administrative rulings. A few occasionally experience what tax law teachers consider part of the routine. For example, the recent bankruptcy law revisions will required bankruptcy law teachers to do some major revisions of their courses, but they don't get to to this every year as do the tax law teachers.

The constant changing is both an advantage and a disadvantage. The advantage is that new legislation or regulations require the teacher to re-examine that area of the course, to prepare new or revised notes, new or revised problems, new or revised problem solutions, new or revised powerpoint slides (if used), new or revised graded exercises, new or revised examination questions, new or revised student response pad questions (if used), and at times a new or revised syllabus. The advantage is that it transports the professor back to the first time a course was taught, namely, a time when the "newness" of things contributed to an enthusiasm and energy that sometimes is lacking when the notes haven't changed much for many years because the course hasn't changed much. The running joke is that the easiest task set belongs to someone teaching Law of the Middle Ages. To the best of my knowledge, there is no such course. But some come frighteningly close, at least in practical application. The disadvantage is that it takes time, often a lot of time, to revise the course. Sometimes schools and their administrations recognize this additional workload and its impact on other professional endeavors. Sometimes they do not. Sometimes it means the professor needs to make time to bring the course up-to-date by, gasp, working on weekends or evenings. When people react with "what a cushy job" when I explain that on average I have 6.5 hours a week in the classroom, I'm almost automatic explaining that each hour in the classroom requires at least several hours of preparation, and that after tossing in preparation and grading of examinations and other evaluative exercises, it's not what it appears to be. Unless, of course, one can simply transfer a course from one year to the next with little or no change. There's another running joke on this one, that of the faculty member who forgot to change the year on the syllabus. Except it's not a joke, it's a story, and I'll not tell it, and, no, it was not me.

I'm inspired to share this explanation because the IRS has just issued new proposed regulations on the transfer of partnership interests in exchange for services rendered to the partnership. If adopted, these regulations will not only clarify the treatment of transactions that did not exist when I first started teaching the course (such as the issuance of options for partnership interests) but also will change existing law and application of existing law by analogy to transactions for which there was no direct authority. To put it simply, the answers to the problems used in the Partnership Taxation, and Introduction to Taxation of Business Entities, courses with respect to the receipt of a partnership interest for services, will change. I had warned my students during the past few semesters that this was going to happen. What makes this more fun is that the publisher of the books I use in these courses is revising them, and has the book at the printer. (I know because I called and asked for page proofs so I can get started on the preparation of the fall courses. Yes, it's "only" May, but I learned years ago not to leave course preparation until two weeks before classes begin because something always happens, and it takes more than two weeks to prepare courses when all these revisions need to be made.) So the new editions are out of date before they are distributed.

So here's the segue from a posting on education to a posting on tax. I'm going to share some of the highlights of the proposed regulations, pointing out that on more than a few of the issues, the IRS has requested comments and suggestions from practitioners. It's a sure sign of the mess subchapter K is in when the IRS notes the practical administration problems and other challenges of getting two or more partnership tax law principles to reconcile. We continue to pay the price for that "make everyone happy" compromises that generated subchapter K, as it turns out it was a "make everyone think they are happy but wait until they see what a mess compromises are" compromise.

The regulations propose that transfers of ALL partnership interests, not just capital interests, be treated as property for purposes of section 83. That means the recipient would not be taxed until the interest vests unless the recipient elects to be taxed at the time of receipt. Under a special rule, the partnership and all of its partners would be permitted to elect determination of the fair market value of the interest using a liquidation value. Commentators had speculated, and courts had suggested, that section 83 applied to transfers of partnership interests, but the extension of section 83 to profits interests is an interesting foray into new territory, even though, as a practical matter, most transfers of profits interests were not subject to taxation by virtue of IRS administrative fiat.

The regulations propose that the general rule taxing a property transferor on the gain or loss realized from using property to satisfy a debt or to pay compensation, including its application to section 83 transactions, will not apply to partnerships transferring capital or profits interests in exchange for services. The preamble to the regulations explains that the nonrecognition concept of section 721 should trump the general rule. Even though the IRS notes that reverse section 704(c) principles in the section 704(b) regulations will ensure that the gain eventually is taxed to the transferring partners, and even though the rule would be good news for most taxpayers, it nonetheless is, in effect, an amendment of section 721, extending nonrecognition from property transfers by a partner to property and services transfers by a partner. Yes, a good argument can be made that section 721 should have been so drafted or so amended, and I tend to agree, but why is the IRS doing what Congress should be doing? The easy answer is that if the IRS doesn't "rescue" the taxpayers, who will? Surely not a Congress inattentive to a lot of important stuff (and not just tax). I understand that answer, but what is disturbing is that somehow the IRS needs to reply to those millions of taxpayers unintentionally afflicted by the alternative minimum tax who suggest ways the IRS can "rescue" them as well.

To synchronize all of this with other areas of partnership taxation, the regulations propose that the service partner's capital account be increased by the amount included by the service partner as compensation income, when that inclusion in fact occurs. It will occur when it is substantially vested, or, if the section 83(b) election is made, when received. And, of course, if there are no substantial restrictions, the vesting occurs on receipt. Similarly, the regulations propose that recognition of income by the services partner is an appropriate time for capital account revaluations.

Similarly, the regulations propose that if a section 83(b) election is made, opening the door to the possibility that the partner would forfeit the interest, the partnership nonetheless may allocate income and other items to the services partner despite the possibility of forfeiture. This is done through the addition of another "deemed to have substantial economic effect" rule because the allocation cannot have substantial economic effect because of the forfeiture possibility. But to qualify for the allocation, the partnership agreement would need to require "forfeiture allocations" if forfeiture occurs, and the usual "all other allocations must be valid" requirement is imposed. A "forfeiture allocation" is an allocation to the services partner, in the year of forfeiture, of items that in effect offset that partner's track record of allocations, contributions, and distributions up to that point. Note that I am paraphrasing a long, convoluted, arithmetic formula in the proposed regulations that I'll leave to the diehard partnership taxation fans to read on their own. This portion of the proposed regulation caps things off with a denial of allocations to the services partner if the forfeiture is planned. This is simply the IRS nipping abusive planning in the bud before it can blossom into something more devious, but I'm sure the artful planners will be culling the proposal looking for any hint of a tax shelter opportunity.

If you want to have a lot of fun, take a look at the proposed example. It's almost as long as one of my blog posts!

Are we done? NO!!!!!

Next, the regulations propose that the "transfer of property subject to section 83 in connection with the performance of services is not an allocable cash basis item within the meaning of section 706(d)(2)(B)." That means the daily proration rules are not mandatory, and the partnership can use interim closing in determining allocations to the service partner who arrives during, rather than at the end of, a taxable year. The regulations also propose that forfeiture allocations can be made out of partnership items arising at any time during the year even if the forfeiture takes place during the year.

The regulations then propose that amounts transferred in connection with the provision of services by the services partner, even if characterized as guaranteed payments, are included in the the service partner's income for the year in which section 83 requires inclusion, and not in the taxable year of the partnership's deduction as is the case for guaranteed payments generally.

Finally, the proposed regulations preclude treating as a partner someone to whom an interest has been transferred if that interest is substantially nonvested, unless the section 83(b) election is made. This makes sense, because it says, in effect, "wait until you really are a partner before expecting to be treated as one."

Back, now, to the education component of the post. There will be more for the students to read. They will need to read the regulations. They will need to read an explanation of the regulation, probably the preamble. Class time is needed to deal with the issues. What can be removed from class coverage without removing it from the course? These regulations, after all, do not make any of the other topics or subtopics any less important. If I take an "easier" topic and leave it to students to learn on their own, I do hear about it. But isn't it good practice to learn how to learn on one's own? After all, the many hundreds, if not more than a thousand, students who sat through Partnership Taxation or Introduction to the Taxation of Business Entities between January 1981 and two weeks ago must learn these new rules "on their own."

I will close with something else that causes anguish for students. These changes, if implemented, obsolete portions of "old student outlines" circulating in the dark corners of the student academic materials exchange alleyways. You can tell I'm not a fan of using old outlines, for the same reason I'm not a fan of trying to get into shape by watching someone else workout. This obsolescence means next year's students must create this portion of the outline for themselves. YAY! It also means I have some GREAT examination material, because students carelessly using old outlines don't do well with "new law" questions. And it makes it so much easier to shut down sympathy when a student inquiring about an undesired grade can be told, "I can tell you used an old outline." Fortunately, there's much less of that in my elective J.D. Introduction to the Taxation of Business Entities course because my warnings drive away students looking for the easy path. After all, according to the J.D. student grapevine, it's the most difficult course in the J.D. Program. As for the Partnership Taxation course in the Graduate Tax Program, the fact it is required means that at least some of the involuntarily enrolled students, unable to grasp the pervasive nature of partnership taxation in a tax practice, try to get by on the "quick and easy" and end up instead with "crash and burn." Yes, the Graduate Tax Program rumor mill describes Partnership Taxation as the most difficult course in the program.

Now folks can see why I make friends quickly when I meet people who teach quantum physics. Somehow, though, it seems as though they've got it easier because Congress doesn't change the laws of physics the way it changes tax law. Sure, Congress probably will try someday, but by then we'll be dealing with more serious problems.

Happy Monday. I'm off to get a root canal and eventually another dental crown. This tax stuff is bad for one's teeth, I guess.

Once again it's graduation day, and I could simply repeat what I said last year. But that would be boring. As far as I know, the "do they all have jobs?" question gets pretty much the same answer. Many do, some don't, and many of the latter will find something after the bar exam.

It's a big day for the students who are graduating, and their families. I'd like to see all of them return five years from now, not merely to attend the evening social event called a Reunion, but to participate in a day-time symposium attended by law students in the Classes of 2010, 2011, and 2012. At this symposium the alums would describe how their law school experiences did and did not contribute to their successes and shortcomings in practice. Perhaps, one hopes, hearing words of advice and caution from those a few years older, rather than from the chronologically distant faculty, will nudge some of them away from the bad habits and bad decisions that make law school, and practice after law school, tougher than it needs to be.

This might be the biggest class to have graduated. A few more than 250 is what I've heard. That's not counting the LL.M. (Taxation) graduates. It is a tradition that has survived from the beginning of the school's history to read the names of the graduates as the proceed across the stage to receive their diploma (or, honestly, a rolled up piece of paper that they turn in for their diploma at the Registrar's office). So we'll be there a little longer than usual.

This year, 8 of the 23 students in the top ten percent were enrolled in one or more of my classes, and of those 8, 5 were in one or both of my tax classes. That's as high as it has been for many years. The top ten percent avoid my class, chiefly because they dislike the "during semester" workload that comes with the course. They did well with the "wait until the end" approach used for first-year courses, so why let go of a familiar and successful approach? I'll answer that question next week, if I remember. Of course, if the other 18 enroll in another section of the basic tax course, fine, but how can they, when those faculty also impose "during semester" workloads? What's even more disturbing is the percentage who took the Decedents' Estates course (approximately 60%) and the estate tax and family wealth planning courses (at best 5%), and the percentage of graduates who report that they engage in will drafting and estate planning (far more than 5%). I wonder how many clients ask their attorneys whether they've taken courses in the area of the law applicable to the client's issues.

And, yes, it is raining. It seems it always rains on graduation. The ceremony is indoors, but one has to get there. I like to walk from the law school to the Pavilion because it's faster than driving, good exercise, and a pleasant stroll. Not today. One year a thunderstorm came in with those "sideways" rains that make umbrellas useless baggage. I have never seen so many people just drenched from head to foot while dressed in suits and other dressed-up attire. I do recall a few sunny graduations, and some with breaks in the rain that came at the right time.

This is my twenty-second, yes, twenty-second, graduation at Villanova (other than my own). Add in three at Dickinson, and today is the 25th graduation in which I have participated as a member of a law school faculty. There are few things I've done for as long. Other than life itself, and other than being my parents' child for far more than 25 years, there's being a member of the bar (29 years), the family history addiction (32 years), knowing how to ride a bicycle (almost 50 years), having a drivers' license (35 years), and a few other, well, boring things. Fewer than 25 years? That list is long. I guess that demonstrates I'm young, ha ha ha.

Thanks for rolling down this stream-of-consciousness reflective moment with me. When I mentioned that it was a big day for the graduates and their families, I didn't mean to imply that it wasn't a big day for anyone else. For the faculty, it's similar to sending one's children off to college. It's time for them to fly, though using the phrase "kicking them out of the nest" might be a bit harsh. I know that I will see a few of the J.D. graduates, especially those who come back to enroll in the Graduate Tax Program. I know that I will get email or phone calls from some, usually when they encounter a situation in practice that reminds them of my courses, either to ask me "hey, how did you know this would happen?", to add to my collection of practice lessons for future students in response to my standing invitation to share their experiences, or to ask for guidance in unraveling an issue. But I also know that I will never again see or communicate with many, perhaps most, of the graduates. I'll read about some of them. I'll hear about a few of them. I'll be asked about one or two of them. So the comparison to sending one's children off to college isn't sufficiently precise. It's much more a valedictory event than an "au revoir" moment.

Good luck to all.

The ongoing dispute concerning New York's practice of taxing nonresidents on their entire income derived from employment with companies located in or doing business in New York has taken an interesting turn, according to this report. As I explained in this post and followup, New York has succeeded, to this point, in taxing a Tennessee resident, who is not a New York resident, on all the income he earns in Tennessee doing computer work for a New York organization even though he spends about 25% of his time in New York. So after getting ahead in the count, New York has taken a strike. Swinging.

New York's theory is that it can tax all the income of a nonresident who works for a New York company except to the extent the employee does work outside of New York because the employer deems it necessary for the employee to work out of state. Thus, in the previous case on which I commented, the Tennessee resident was not permitted to exclude any of his income from New York taxation because his decision to tele-commute from Tennessee was not required by his New York employer. Whether that approach, as advocated by New York, is an appropriate or permissible test continues to be debated, and we wait to see if the promise of a further appeal by the Tennessee resident materializes.

In the most recent case, a New York company who employed, among others, a Connecticut resident, moved most of its operations to Viriginia. The New York resident continued to do work by tele-commuting from the company's New York office. At that point, there is no question New York can tax the employee's salary. Several years later, however, the company told the employee either to relocate to Virginia or to tele-commute from home. The company terminated his building pass for the company's New York site and reassigned his office to another employee. It changed the employee's status from New York employee to member of a technical group in Virginia. The employee chose to tele-commute from Connecticut. He no longer worked in New York.

So even though this person no longer had any employment contact with New York, other than being employed by a company that had New York employees, New York insisted it had a right to tax him. An administrative law judge held that because the employee was required to work from Connecticut and did not have the option of working in New York, it was improper for New York to subject him to income taxation. There's no news on whether New York will appeal.

The idea that New York thinks it can tax a person who has no employment contact with New York other than being employed by a company with contacts in New York is startling. Theoretically, what's to stop New York from trying to impose income tax on all the employees, no matter where located, of Citibank, NBC, or any other company with New York employees or even just New York contacts? The previous case involved someone who took 75% of his work out of the state. This case involves someone who took all of his work out of state. Will the next case be someone who never did work in the state? If New York does not go that far, is New York contending that once a person works in New York the person cannot ever escape taxation even if moving away? Suppose the fellow in the most recent case had decided to end employment with the company, stay at home, and begin working from home for Morgan Stanley, which happens to have some New York employees. Would New York try to continue taxing him? What if his neighbor, who never worked in New York, also took a job working from home for Morgan Stanley? Would New York try to tax her? If not, how can New York justify taxing him but not her if the only difference is the fact that in the past he, but not she, worked in New York?

New York has its budget problems. So, too, do many other states. However, the need for money ought not be permitted to encourage state taxation officials, or their attorneys, to get so "creative" that they make unwise decisions. Just as federal and state revenue officials decry the "creative" activities of tax-avoiding taxpayers and their lawyers, so, too, those same officials should set the standard to which they want taxpayers to aspire, and refrain from "creative" but unsustainable revenue collection theories.

After all, whatever might be argued in the case of the Tennessee resident who is in New York for 25% of his employment efforts, there's no way New York can justify taxing a Connecticut resident who tele-commutes from home and never sets an employment foot in the state. That Connecticut resident imposes no financial burdens on New York, and gets no benefits from New York. I'll go so far as to claim that there is a serious Constitutional issue lurking in this case, and that's why I'll predict that New York will not appeal. It has way too much to lose than just the revenue in the case.

It is said that imitation is the sincerest form of flattery. Perhaps that's also true of literary imitation in the form of substantial quotation. Yesterday, while amusing myself by googling my full name, I discovered that my April 20, 2005 post on the increase in the number of taxpayers with incomes of $200,000 or more who pay no taxes had been republished, in full, on the Quatloos Tax Practice and Policy and Tax Shelter forum.

Other than "# posted by James Edward Maule @ 10:08 AM" at the end, there is nothing to indicate that the post is a quotation-in-entirety of a MauledAgain post, and, most disappointingly, there's no link to the MauledAgain blog. Easily done, of course, so I'm not sure why it's not there. It could be a problem with incorporating "a href" links, because the links in my post also disappeared, causing another Quatloos poster to provide the URL for the report that I cited in the post.

Attribution concerns aside, the comments made in response to the message of the posting deserve some attention. Rather than responding on Quatloos I decided to drive some traffic to MauledAgain by sharing my reactions here.

Someone using the screen name "Investor" asked, "Are you suggesting that a tax system that allows 0.112% (which is roughly .0001% of the US population) of the high income taxpayers to escape income tax* needs "a major overhaul"?" and responded to his or her own question, "I would say that this indicates that a minor tweak is needed (maybe a phase-out of investment interest deductions for high AGI), not a major overhaul. There are other issues that lead me to believe that a major overhaul is needed, but not this one." Because of the attribution omission, it isn't clear whether Investor was querying ME or the Quatloos poster who posted my post. In any event, I'll respond. The point isn't that there is a gaping hole that demands a major overhaul. The point is that when an elite few can create for themselves, or have created for themselves, rules and contextual application that puts them in a "not tax paying" us versus everyone else who is the "taxpaying them," a serious erosion of taxpayer morale is planted like a cancer among the "taxpaying them." Another tweak is simply a further gaming of the system. The need for the major overhaul isn't the extremely small percentage of lost revenue. It's the need to restore taxpayer morale, and compliance, by junking a system that fertilizes "we'll find one way or another to avoid paying taxes no matter what tweaks what" cancers such as those that create the problem I blogged and that was then shared on Quatloos. Overlooked in Investor's analysis is another important fact, namely, the number of people with incomes over $200,000 who avoid paying tax is increasing at a rate that threatens to spread as does a rapidly metastizing cancer.

The next Quatloos poster, Levendis, pointed out that the alternative minimum tax was enacted in response to tax-avoidance abuses in which far fewer taxpayers engaged than currently escape taxation despite having more than $200,000 of income. What Levendis did not mention, but perhaps intentionally left unspoken, is the manner in which the AMT "remedy" has become an affliction on a huge number of taxpayers never intended to be caught by its net. That's the problem with tweaking a complex structure, as I pointed out some time ago in my Pleiotropy post. Investor replied, decrying the spread of the AMT to middle-class taxpayers, and characterizing complexity as the biggest problem affecting the tax system. Yet Investor had just finished suggesting another "tweak" rather than overhauling the system. Tweaks, or more precisely, bundles of tweaks and tweaks of tweaks, is what creates the hated complexity.

The Quatloos discussion then turned to two causes of the "over $200,000 tax escape," namely, the fact that the investment interest deduction and the medical expense deduction, which are not added back for AMT purposes, and which are not phased out as income increases, are the primary tax reduction factors in 23.1% and 8.6%, respectively, of the returns showing no income tax. Investor then raised an important consideration: "You may say that a system in which a person can have income of $200K and pay no taxes is unfair, but there are also a variety of other policy/economic considerations here. If someone has so much margin interest that it is completely eliminating their taxable income at the $200K AGI level, they obviously have huge investments. I would venture a guess that if you looked at these "zero income tax payers" over a span of 5-10 years, they pay more income taxes in the aggregate than the average American earns over that same period, and at a much higher effective rate. To look at one year and scream, 'this is unfair' is very narrow minded (I assume that this report does not imply that it is the same individuals year after year with $200K AGI and no tax liability)."

It is true that the report does not identify the taxpayers, and thus prevents the sort of 5-10 year analysis that would be more helpful in understanding the underlying economics. If, however, a person has no tax liability because of the investment interest deduction, it means not only does that person's investment interest expense equal or exceed investment income, that person also has little or no other income. So how are they paying their bills? Dipping into investments? But why would their investment interest expense exceed investment income? What's the sense in borrowing $5 in order to earn $4? The answer is that these folks may be "speculating" (translation: gambling) with investments. Should the tax law be "financing" that sort of "enterprise"?

Yet this discussion is too narrow. The investment interest expense and medical expense deductions account for 31.7% (and only 31.7%) of the situations in which no tax is paid by taxpayers with adjusted gross incomes equal to or exceeding $200,000. If one turns to taxpayers with expanded income equal to or exceeding $200,000, the single-most cause of no tax liability is the exemption from taxation of interest on state and local debt obligations. In the first group, miscellaneous deductions (at 21.4%) and "all other tax credits" (at 21.0%) are for all intents and purposes equally responsible for the non-taxation status of these returns as is the investment interest expense deduction. In fact, that latter deduction doesn't even show up as a separately identified cause of non-taxation on the returns with expanded income of $200,000 or more. So there's a lot more involved than simply the investment interest expense and medical expense deductions, and a "tweak" would need to be far more complicated than simply playing with those two deductions.

So long as specialty groups and their advocates continue to persuade the Congress that a dollar of one type of income is different from, and should be taxed differently (or not at all) than is a dollar of some other type of income, so long as those groups and their advocates continue to persuade the Congress that expenditures for some purposes should cause a reduction of tax liability, and so long as special interest groups and their advocates continue to push for direct tax liability reductions in the form of credits for every sort of favored activity, the tax burden distribution will be skewed in favor of the influential and powerful who use their energies to lobby for an unfair (and thus complicated) tax system. In turn, the number of wealthy who avoid taxes will increase. Similarly, the tax-disfavored will seek, in increasing numbers, a way to jump on the "tax reduction bandwagon." Some will fall prey to the hawkers of illegal tax shelters and off-shore schemes. Others will drop out of the system, or at least try. Still others will turn increasingly to "pay cash, pay less" arrangements. The corrosive effects of the "tax avoiding us" and the "tax paying them" cancerous divide will accelerate, and the tax system will begin to fail. Already, more than $300 billion a year goes unpaid, much of it unreported. The impact is far more serious than a million marchers parading down the Mall on a Sunday afternoon protesting this, that, or the next thing.

The Congress is losing touch with the overwhelming majority of taxpayers, who want to be law-abiding but who cannot help but think they are gullible fools for complying with laws that, to them, appear to be ignored or twisted by (or written to the advantage of) others who are more influential and powerful. Why Congress thinks it can fend off the problem by enacting tax cuts that reduce a person's taxes by several hundred dollars, while billions of tax dollars go uncollected baffles me. I suppose Congress thinks that throwing some bread to the masses will distract them, or sufficiently ease the disgruntled, while the rate on capital gains plumments toward zero, while the credits, deductions, and special exceptions for the influential and powerful grow in number and value, and while the quietly increasing "nibbling at the edges" noncompliance by the not-so-powerful replicates the impact of those silent termites lunching in the support beams. After all, who cares if a termite eats 0.112% of the wood? Each year. I've yet to meet a pest control technician who simply "tweaks" termites and stays in business.

The federal income tax law is groaning under the weight of ever increasing numbers of credits and deductions inserted in hopes that one or another of someone's worthy cause will be advanced by the supposed impact on taxpayer behavior of a tax incentive to behavioral change. Almost a month ago, I noted, in a somewhat mocking post that the Tax Reform Panel was "discovering" what everyone else has known for years when it issued an interim report that inspired this newspaper headline: Too many deductions, credits fill U.S. tax code, panel finds.

Everyone knows how this has come to be. Everyone agrees it must stop. Everyone understands the negative impact on tax compliance of these "my cause is so special it deserves to be in the tax law" provisions. Everyone knows the impact of these complexities on the rising cost of tax compliance. OK, maybe not everyone. Perhaps someone living under a rock missed out on the news.

Of course, not everyone will state publicly that he or she knows and understands the corrosive effect of using the tax law to try altering people's behavior. But that doesn't mean they don't know and understand those effects. The lemming mentality that grips politicians under pressure to do for their favored groups what some other legislator did for his or her devotees pervades legislatures.

If any of us thought that the Tax Reform Panel's warnings would change behavior, we were mistaken. Perhaps there ought to be a tax credit for legislators who refrain from introducing social engineering provisions into the tax code, with an additional credit for those who refuse to vote in favor of such measures. JUST JOKING. No, uh, maybe I ought to be serious about that.

Instead, the parade of tax goodies continues. So here we go again.

This time it's a dual-pronged tax proposal wrapped into wider-reaching proposed legislation that aims to accomplish a goal against no one with any degree of sense can speak negatively. Last week, Representative Carolyn Maloney re-introduced the Breastfeeding Promotion Act that has been introduced in at least two previous Congresses. In fact, it's been around so long that the Internal Revenue Code section that it proposes to add (section 45G) was used for another credit, as has been the next one in line (section 45I).

Quoting from the Representative's press release, "The purposes of this act are to promote the health and well-being of infants whose mothers return to the workplace after childbirth, and to clarify that breastfeeding and expressing breast milk in the workplace are protected conduct under the amendment made by the Pregnancy Discrimination Act of 1978." That it makes sense to encourage breastfeeding is undeniable, as painstakingly detailed in the 2003 Congressional Research Service Report, Breast-feeding: Impact on Health, Employment and Society. It's the use of the tax law, and the correlative complexity, rather than a more direct approach that injudiciously adds to the current crisis in tax law.

Again quoting from the Representative's press release, the bill covers four purposes: (1) to amend the Civil Rights Act of 1964 to protect breastfeeding by new mothers,(2) to provide tax incentives for businesses that establish private lactation areas in the workplace, (3) to provide for a performance standard for breast pumps, and (4) to allow breastfeeding equipment to be tax deductible for families."

The second tax prong, making breastfeeding equipment tax deductible, cannot be criticized so long as there is a medical expense deduction in the tax law. Breastfeeding equipment is medical equipment just as eyeglasses, hearing aids, and similar items, and so I would have responded "yes" to a question about its deductibility had I been asked this question before this bill prompted me to explore the question. But I'm not certain that the IRS would agree with me, because in one private letter ruling (PLR 8919009), it concluded that medical expenses did not include the cost paid by a pregnant woman for instruction with respect to "(g) Breast feeding/bottle feeding; and (h) Newborn care and the adjustments of becoming a parent." There is no other guidance from the IRS, and I could not find any cases addressing the issue. So, to the extent the bill clarifies that the medical expense deduction should cover breastfeeding equipment then this particular amendment to the tax law makes sense. In any event, it adds a five-word subparagraph and a one-sentence definition to the Internal Revenue Code, in language that doesn't defy comprehension.

It's the first tax prong, establishing a credit to encourage businesses to set up private breastfeeding areas in the workplace, that not only unnecessarily complicates the tax law but also falls short in accomplishing the goals of the bill's sponsors. The complication to the tax law is not only an entire Code section, consisting of five subsections, layered with dollar limitations, definitional challenges, the computational requirements of a recapture provision, the incorporation of other, existing, tax law rules, and an array of conforming rules with respect to such things as basis and double benefits, but the need for taxpayers to maintain additional records, pay return preparers additional fees to fill out forms, and to certify the qualification of expenditures and policies with respect to the matter.

Don't get me wrong, and don't take my objection to the proposed tax credit as an objection to the goals of Representative Maloney. I'm all for breastfeeding of infants. I agree that the practice is good for infant, mother, and society. If, and that's a big "if" on which I reserve judgment, it is appropriate and necessary for the FEDERAL government to step into the arena of how parents nurture and nourish their children (and I understand that some reasonable arguements can be made to that effect, as well as to the opposite conclusion), then the sponsors should be proposing a law that requires government and employers to accommodate the breastfeeding of infants. It ought not leave mothers at the mercy of whether their employer decided it did or did not need a tax credit. For example, employers that presently are in financial difficulties are swimming in deductions and credits, and thus the proposed bill gives them no incentive to accommodate nursing mothers.

So what to do? Make it a law. Make it mandatory. After all, the minimum wage is mandatory for covered employees. Employers aren't thrown a "take it or leave it" tax credit as an incentive to do something that they're left with a choice to do or not do. Federal law requires airline passengers to submit to pre-flight inspection. It doesn't leave the success of this security measure to the whims of people deciding whether to take an optional tax credit for choosing to undergo the inspection.

At best, tax incentives for behavior should do no more than to encourage behavior which society thinks is nice but not essential. Even so, I disfavor tax incentives for behavior, but I can understand the arguments made by their supporters when the behavior in question is something desirable but not within the scope of a government to command. If tax incentives must be used to entice people to do what they must do, then government has sunk to the level of bribing its citizens to behave. That, in a political world controlled by the under-taxed wealthy and their lobbyist allies, is not government but organized corruption.

The sponsors of this bill should be saying, and perhaps are trying to say, to employers, "You must accommodate nursing mothers." If an employer gets a reward for doing so, in the form of a tax reduction, then why not similar rewards to people who comply when told, "You must stop at stop signs," "You must put your clients' funds into escrow," or "You must report all outbreaks of mad cow disease in your herd." To the extent society is becoming a "what's in it for me" and "show me the money" culture, Congress is contributing to this degradation of civilization by enacting tax legislation that pays certain citizens to do what they ought to be doing aside from legal compulsion, let alone when required to do so by law.

If it doesn't stop here, where and when will it stop? When there are 43,583 tax credits for every imaginable cause, and the entire country shuts down because everyone is swamped with the task of identifying which 1,304 credits apply to their specific situations, while investing hundreds of hours into compliance?

Yes, Representative Maloney got herself some good press re-introducing this bill on Mother's Day. But she, and her co-sponsors, could do the country an even greater service by ditching the credit, making the accommodation of nursing mothers mandatory, and leaving it at that. After all, if the nation's employers need to be bribed to accommodate our mothers, we've reached a most pitiful sad condition such that more than the tax code needs to be ripped out by the roots.

Anyone who wonders how the tax law can become complicated can get a glimpse into the process by reading through this explanation of how one well-intentioned new deduction has opened up a debate the answer to which isn't as obvious as either side seems to think that it is. Though I know what I would do if I were writing the statute, that's irrelevant, because the statute, as written, doesn't provide enough guidance to resolve the issue. So there's complexity-causing step number one: Congress fails to provide a sufficiently specific direction. In many ways this is not only step number one, it's the only step. It isn't fair, is it, to treat the next steps in the process as "complexity-causing"?

The provision in question is the new section 199. Section 199 allows a deduction equal to a specified percentage (it increases over the next few years) of the lesser of something called "the qualified production activities income of the taxpayer for the taxable year" or taxable income for the taxable year. The second element can be ignored, as it is designed to prevent the deduction from generating a negative taxable income, an issue not germane to this discussion. But what is "qualified production activities income" or QPAI as it has come to be known? The statute provides that it equals any excess of the taxpayer's "domestic production gross receipts" for the taxable year, over the sum of the cost of goods sold allocable to those receipts, other deductions, expenses, or losses directly allocable to those receipts, and a ratable portion of other deductions, expenses, and losses not directly allocable to those receipts or to another class of income. Whew. Fortunately, the issue requires a focus on "domestic production gross receipts" or, to use the rapidly emerging acronym, DPGR. What is DPGR?

The statute tells us that DPGR means the taxpayer's gross receipts derived from any one or more of three major areas of activity. The first major area is any lease, rental, license, sale, exchange, or other disposition of any of three types of property. The first type of property is any qualifying production property manufactured, produced, grown, or extracted by the taxpayer in whole or in significant part within the United States. The second type of property is any qualified film produced by the taxpayer. The third type of property is electricity, natural gas, or potable water produced by the taxpayer in the United States. The second major area of activity is construction performed in the United States. The third major area of activity is engineering or architectural services performed in the United States for construction projects in the United States. The statute also tells us that DPGR does not include the taxpayer's gross receipts derived from the sale of food and beverages prepared by the taxpayer at a retail establishment, or from the transmission or distribution of electricity, natural gas, or potable water.

Anyone with experience reading tax statutes, or the sort of paraphrasing I've shared, and even folks who've never seen a tax statute can figure out that Congress engaged in some picking and choosing in designing the deduction. The limitation to activities in the United States is at the heart of the deduction, which is designed to give U.S. enterprises an incentive to generate product and to sell it (hopefully overseas so as to reduce the trade deficit, but no one really wants to say that because it re-opens the door to the mess that Congress tried to solve with the deduction and some associated provisions). But why distinguish between food prepared at a retail establishment and food prepared elsewhere? I explored this in my first analysis of this new deduction and I'll let those who missed it go take a look when they're finished with the present concern.

Because we're going to focus on "construction performed in the United States" there's no need to analyze the definitions of qualifying production property, qualified film, or the words "manufactured, produced, grown, or extracted." Suffice it to say many paragraphs could be written on each of those. Beginning to get a sense of why tax law becomes so complicated?

The statute does not define "construction." Should it? After all, don't all of us know what "construction" is? It means to build something, right? Well, maybe.

So the IRS had to step forward and define the term. In Notice 2005-14, a long document that parses much of the statute, the IRS (in section 3.04(11) of the Notice) said more about construction than one might have guessed (other than those who know me and know that I can speak or write for long periods of time based on one key word or key phrase).

The IRS began by defining construction as the construction of real property, and then defined real property as "residential and commercial buildings (including items that are structural components of such buildings), inherently permanent structures other than tangible property in the nature of machinery, inherently permanent land improvements, and infrastructure)." The IRS points out that local law is not controlling in determining whether property is real property for these purposes, citing the Conference Report to the legislation. OK, so there's complexity-causing step two, namely, the writing of rules by the staff of the Joint Committee on Taxation to fill in the gaps in the legislation that come to its attention after the legislation is too far along to be changed but before too much time goes by. The IRS also notes, not surprisingly, that tangible personal property such as appliances, furniture and fixtures, sold as part of a construction project is not real property for purposes of the decution. But then the IRS throws in a reference to another rule in its Notice, concluding that if more than 95% of the total gross receipts derived by a taxpayer from a construction project are attributable to real property, ALL of the total gross receipts derived by the taxpayer from the project are treated as DPGR from construction.

Having defined construction as the construction of real property, the IRS then turned to the definition of "construction" in the phrase "construction of real property." If this seems a bit weird to those of you not immersed in the reading of tax (or other statutes), understand that it is "normal" in the world of statutory legal analysis. Hmmm. No wonder lawyers are sometimes seen as being a bit "cagey" with their words. So, the IRS explains that it and the Treasury Department (of which it is part) "believe" the term "construction" includes "most activities that are typically performed in connection with the erection or substantial renovation of real property, but does not include tangential services such as hauling trash and debris, and delivering materials, even if the tangential services are essential for construction." But, it also notes, "if a taxpayer performing construction also, in connection with the construction project, provides tangential services such as delivering materials to the construction site and removing its construction debris, the gross receipts derived from such tangential services are DPGR." The IRS explains that "[i]mproving land (for example, grading and landscaping) and painting are activities that are considered 'construction,' but only if they are performed in connection with other activities (whether or not by the same taxpayer) that constitute the erection or substantial renovation of real property." And, because of how the statute is crafted, the IRS excludes from the definition of "construction" any activity within the definition of "engineering and architectural services."

Hang on. We're almost there. Because it doesn't bear on the issue under discussion, we can skip over the definition of infrastructure, which was used in the definition of construction as "construction of real property," and the definition of substantial renovation. Those are two tangents that lead to paths we will not travel today. Those who have never been in one of my classes can see glimpses of how I construct coverage of a topic, shunting to the side deeper analyses of terms and issues that distract from the bigger picture.

But it is important to consider one more term before turning to the issue. The IRS defined the phrase "derived from construction" as including both the proceeds from the sale, exchange, or other disposition of real property constructed in the United States, whether or not sold immediately after construction is completed, assuming all other requirements are met, and compensation received for construction services performed in the United States, assuming all other requirements are met). However, the IRS concluded that DPGR does not include gross receipts from the lease or rental of constructed real property. And the IRS concluded that DPGR does not include gross receipts attributable to the sale or other disposition of land.

It didn't take long before representatives of "a coalition of U.S. firms engaged in the residential land development and homebuilding businesses" responded (in this document) to the IRS invitation to comment on Notice 2005-14 and objected to the exclusion from DPGR of gross receipts from the sale or other disposition of land. They took a two-part approach in their criticism of the IRS rule.

First, the coalition representatives pointed out that the statute does not exclude land, and that because Congress did identify certain activities or products as ineligible for the deduction, it would have excluded land had it intended to do so. Of course, no one really knows what Congress, or any individual member of Congress intended, or even if they intended anything considering few, if any of them, read their legislation, but I'm being picky in terms of how the coalition representatives make their point. A stricter reading yields the simple argument that there is nothing in the statute excluding land proceeds from DPGR, period. The coalition representatives pointed out that although Notice 2005-14 contains no explanation for the exclusion, IRS and Treasury officials have expressed publicly concerns that land speculators will engage in minimal construction activities in order to get a deduction, something that the coalition's members would not be doing because they are engaged in construction development and not land speculation. Of course, the line is not that bright, but the coalition representatives, borrowing from a similar provision in another area of the income tax law, proposed an alternative approach that would weed out land speculators from construction project developers. They also argued that land is a raw material in the construction of a building just as coal and gold are raw products used in the manufacture of products made from them. Finally, they argued that it makes no sense to treat land as a different sort of real property when it comes to defining proceeds derived from construction of buildings that necessarily are built on land.

Second, the coalition argued that compliance with the rule in Notice 2005-14 would be difficult, if not impossible, to achieve. Separating gross receipts, cost of goods sold, and deductions into those attributable to the land and those attributable to the buildings and other qualifying property would require accounting in which developers currently don't engage. Worse, they explain, "[t]he exclusion would therefore force land developers and homebuilders to undertake both sampling and valuation methodologies that would engender substantial controversy upon subsequent examination by the Internal Revenue Service." Anyone familiar with the issues and disputes arising when purchase price is divided between nondepreciable land and depreciable buildings can envision the sort of audit and litigation that would be generated by even more complicated apportionments of not only purchase price, but construction costs, and sales proceeds.

If it weren't for the fact that huge amounts of money flow into and out of land development and building construction each year, this analysis might not be more than an academic exercise in the study of tax complexity origins. However, the dollar amounts involved make this an issue of great practical importance, and one that needs to be resolved sooner rather than later.

What's at stake is the profit that, however measured, is attributable to the land component of the construction project. If the coalition is correct, and the proceeds attributable to the land should not be taken out of the computation, then the cost of the land also should not be taken out. Because the deduction is based on QPAI, and because QPAI is computed by subtracting costs from receipts, it is the profit on the land that is at issue. Because it can take as many as 10 years from the time the project begins with the acquisition of the land or an option to purchase the land until the final building on the property is sold, the profit attributable to the land can be considerable.

So who's right?

Technically, I think the coalition is correct because its representatives rely on a statute that does not exclude land from the picture. I think IRS and Treasury Department concerns about abuse can be handled not only by something along the lines of the proposed anti-abuse provision (which would deny the deduction if non-land construction costs were less than 10% of the total project cost), but also by the Notices' use of construction industry standards in identifying eligible taxpayers and by the W-2 wage limitation, which would limit or eliminate the deduction for land speculators because they pay little or no wages in connection with their investment.

On the other hand, the deduction focuses on "production" and although construction companies "produce" buildings, roads, infrastructure, and similar land improvements, they don't "produce" land. Unlike processors of coal and gold, who remove the substances for use in other places, the land is there when the construction company arrives, and it is there when they leave. They don't leave behind exhausted coal fields or empty gold mines. Actually, many developers do scrape off the topsoil and sell it, a practice that annoys me no end for several reasons (e.g., environmentally unsound, requires new homeowner to replace the topsoil perhaps by purchasing it from the construction company's purchaser) and now that they'll get a deduction for a percentage of their topsoil extraction profit, it's even more annoying. But the upshot is that the statute doesn't restrict the deduction to "qualifying construction" the way it restricts the deduction in the manufacturing, extraction, growth, or production areas. If Congress had used the adjective "qualifying" then the IRS would have a much firmer foundation (sorry!!) on which to rest its conclusion.

Those who wish to micro-manage the interface between tax and the economy would limit the deduction to the portion of the profits attributable to the land that arise from the impact of the construction activity but not the portion arising from general price increases or developmental sprawl in general. In other words, the land developer's deduction would reflect the contribution made by the developer's activity to the value of the land as a part of the economy. After all, any land developer willing to tell it as it is must admit that there remains an element of land value speculation even as the construction project moves along from zoning changes to ribbon-cutting.

Observe how a tax expert must understand the land development and construction business in order to begin analyzing the issue. Fortunately or unfortunately, depending on how I look back at life, I've had more than the average person's share of building construction experience, as plumber's assistant one summer way back in my high school days, to purchaser of new homes built under my watchful (and, to the contractors, annoying) eye. Perhaps some members of Congress have had similar experiences. Perhaps they thought about and envisioned the "construction" process when they were writing (oops, they don't write) and voting for the legislation enacting the deduction. Nah. Didn't happen that way.

So for want of a conscious decision by the Congress, necessitated by the practical realities of the construction business, the IRS and taxpayers must expend time and money resources trying to resolve this matter. Perhaps it will be resolved in a revised Notice or other administrative issuance. Perhaps it will be resolved through audits that end up in litigation. Perhaps it will be resolved when the Tax Court's decisions are uniformly affirmed, or reversed, by the Courts of Appeal. But perhaps it won't be resolved until conflicting Courts of Appeals decisions end up compelling the Supreme Court to take on the issue, probably late in the decade. Yes, indeed, if enough steps are taken on the tax-law-as-a-complexity journey, that's where the question ultimately will land. Oh, that was awful.

Oh well. Perhaps for some this post broke new ground.

The grading marathon continues, and I take occasional breaks to let my brain rest. During one break, I took a look at incoming email from one of the law lists to which I subscribe. It contained an abstract of an article by Tom Alleman originally published in Texas lawyer. It's an article well worth reading. Here's the part that captured my attention and should encourage others to read his take on pro se litigants. He describes what it was like in his first post-law school job, one that he held at the federal court house in Kansas City:

As time went on, I met all manner of people who had business for the court. We met several people who complained that some government department or other was beaming invisible rays at their heads. One of these poor souls came in on a quiet Friday afternoon, so another clerk and I took him over to the Lexis terminal, at that point an imposing stand-alone console about the size of a small desk. We turned it on, typed in "Stop beaming rays at John Doe's head," hit "enter" and turned it off. Doe left happily, the voices in his head now silent, and we returned to our duties, knowing that we had helped one American citizen obtain justice in an imperfect world.

I remember those Lexis terminals. Maybe I can dig one up and keep it on standby in my office. It might come in handy someday.

OK, I'd better get back to grading. Before my students start beaming subliminal A messages to me.

When I first started teaching law school, I was "warned" by older colleagues that the most burdensome part of being a law professor is examination grading. I can understand why some law (and other) faculty feel that way, but I'm not convinced it's the most burdensome.

I mention this because I have three examinations to grade this semester. One was administered Monday evening, with some rescheduled for last night. All have been graded. Another examination is being administered as I write, and the third will be given tomorrow morning. Grades are due by mid-week so that they can be processed and graduation information prepared. So this post will be short, as will be Monday's.

CREATING an examination is the tough part. It is challenging. One must find questions "that work" but that don't invite students to do no more than write "all they know" about a subject. Law school is a graduate school, and it would be more effective, but inefficient, to have students take oral examinations in front of three-person or five-person faculty panels. Ideally, they would be comprehensive rather than limited to specific courses. That would put an end to the "write all you know and hope the professor finds worthwhile information in the dump" approach. My examinations deter and penalize that behavior, which is why they are so challenging to design.

The grading itself can be tedious. Not that I have any right to complain, but handwriting has become very difficult to read as a general proposition. I'm waiting to find out if the software that permits students to do examinations on computers comes in a version that prevents them from "taking" a digital copy of the examination. That's important because I do not make previous examinations available. Especially in tax, once I design a good set of facts, I can spin all sorts of questions off that fact situation. I do not want to coach students on those specific facts, which is what they would want to have done for them if they had those facts. Nor do I want to go through what I had to do when I did publish old examinations, which was an explanation of why a particular question made no sense, or had useless information, or lacked information, because the tax law had changed. Now that tax law changes every year, it is easier to design new questions by adapting older ones, but that is not where I want student focus to be.

What is most burdensome with examinations is coping with the disappointment that comes from discovering one's students, as a group, have learned some very strange things about the law. This is, of course, offset by the glee of discovering a student who was apprehensive about their course grade has done well. It varies from semester to semester and from course to course. Sometimes, classes as a whole write great exams. Other times, it isn't so great. There almost always are students with excellent grades. It's when some students begin to populate the lower grade regions that it's time to contemplate if this reflects deficiencies in the course. Almost always, the reason is either the student's inattentiveness to and absence from the course, or some sort of outside distraction afflicting the student during the examination period.

Part of the problem is that student anxiety increases when the entire course grade rests on one end-of-semester examination that is packed in with other examinations. Students who are in both of my J.D. courses this semester have examinations on back-to-back days. Their brains will be tired tomorrow morning. I have tried to offset this "sink or swim, never have feedback" approach still prevalent in many law school courses by giving assignments during the semester that count for a portion of the grade. Some of the assignments are done out of the classroom, and others are in-class exercises that are unannounced.

For students, the primary benefit of these exercises is feedback. They can determine if they are on the right track. They can make adjustments before it is too late. It is superior to finding out AFTER the examination period that one has a particular study, testing, or writing flaw that poisons all one's exam performances. It builds up self-confidence where and when it ought to be nurtured. For me, it lets me know which students need to be reminded to refocus. It tells me if I am "losing" a substantial portion of the class such that I need to make adjustments. Although students sometimes complain about being graded throughout the semester, almost all come to appreciate what the Dean calls "huge amounts of work" by me. After all, in courses such as Trial Practice and those meeting the practical writing requirement, along with Clinic experiences, students are evaluated constantly rather than at one time. The misleading attractiveness of the "one exam at the end" approach is that it is easier, but when I can give a much shorter examination because some of the scoring already has been done, I endure much less "burdensomeness" than do many of my colleagues as they test their endurance grading everything at once.

In the J.D. courses, students drop the lowest 2 of 10 scores (so that I don't need to deal with whether class absence was or was not justified). In the Graduate Tax Program course, students drop the lowest one of 4 scourse, even though all 4 are, at the moment, out of classroom exercises. The J.D. total exercise score counts for 1/3 of the grade, but in the Graduate Tax Program it counts for 1/5.

I want to find a way to shift more of the scoring into the semester. Doing that in the J.D. program will be a fairly simple matter. The use of student response pads ("clickers") means that I can count more in-class question responses toward a grade, and I am pondering making 40%, rather than 1/3, of the grade dependent on semester work. Perhaps even 50%. In the Graduate Tax Program, it is more difficult. Students attend only 14 100-minute classes rather than 42 50-minute classes. Thus, it is far more likely students will be absent when an in-class exercise is given. The limited 2-credit course and the nature of the material (Partnership Taxation) already puts a huge time pressure on adequate coverage, and in-class exercises simply would increase that time constraint problem. I've not yet introduced clickers into my Graduate Tax Program course. I'm still trying to get Graduate Tax Program students to check the on-line Blackboard classroom as often as they should. Some do, but far too many do not, even with the help of the Program's staff who take time to teach the students the very easy 3 steps for accessing Blackboard.

So, back to grading I go. And I'll let others wonder if it is really true that no matter how challenging it is to take an examination, it is even more challenging to create and grade them. It's true of crossword puzzles. That's the clue.

The debate over Social Security reform has taken a turn that is getting much-deserved attention, no matter how one stands on the substance of the proposal. By advancing the concept of "progressive indexing," the President has championed putting into the social security benefits equation the concept of needs-based determination. Of course, progressive indexing is a far cry from genuine needs-based benefits determinations, but at least it opens the door to the hallway that leads back to the word INSURANCE in the official name of the social security system.

Currently, social security benefits are indexed to increase based on increases in the wage index. Some reform proposals have suggested that all social security benefit increases should reflect price index increases. If the goal of social security is to ensure that retired folks have enough income to pay their bills, then the price index increase is the better measure of adjustment than is the higher wage index increase. On the other hand, those who turned social security into an entitlement program characterized as a savings plan, which, of course, it was never intended to be, then it is easier to understand how and why politicians decided to use the more expensive wage index increase as the benchmark for determining social security benefit increases.

The President's proposal would limit social security benefit increases to the more slowly climbing price index only for so-called high and middle income workers. It remains to be seen what dollar amount will define those categories. People with some sense of what might develop are suggesting amounts such as $25,000 and $100,000 as the thresholds. Of course, with you-know-who in the details, a change of $10,000 one way or another in the boundary can make a huge difference in the total dollars involved in the reform computations. It would make sense, would it not, to scale the adjustment so that a $5 change in income level doesn't trigger a huge difference in benefits.

The challenge to accomplishing reform is that people who think they have vested interests and people with vested interests reject any attempt to make the system more equitable, even if the vested interest is not equitable. The major flaw in social security is that an insurance program was morphed into an entitlement program, subsequently justified by claiming that it is a "savings" program. It is not a savings program, and anyone designing a savings program would not suggest the convoluted mess that social security has become. Why did it become an entitlement program? Simple. At the time, with high worker-to-retiree ratios, it posed low short-term costs for the accumulation of high numbers of votes. Now that the piper has come to be paid, with low worker-to-retiree ratios, longer life expectancies, and benefit increases reflecting the higher wage index rather than the price index, a financial catastrophe looms.

Any genuine reform must roll back the baggage that has been piled onto the system. The tough challenge is accommodating those retirees and soon-to-be retirees who relied on the system with expectations of coverage. The President promises that they will not be disadvantaged. But someone will be disadvantaged. Easily $8 trillion of social security benefits have been paid over the years to retirees in excess of contributions. Even with increases in the payroll tax rate and the wage cap, the deficit for all current and past participants, including current workers, is on the order of $11.2 trillion. Wow. If someone other than the government set up such a plan, they'd be charged with operation of an illegal Ponzi or pyramid scheme. Social security has come to represent the flaws of handing out entitlements without acknowledging, knowing, or understanding that when there are only 10 cookies, it's impossible to give each of 30 children an entire cookie.

Private accounts don't solve the problem. Certainly not unless workers are required to put into the accounts amounts sufficient to fund the retirement income that they wish to have, or that the "government" decides they should have. Hmmm, that latter bit sounds like a Soviet five-year plan to me. Anyhow, it's quite easy to figure out what someone needs to save each month in order to have a retirement income of a specified number of dollars, and the amounts being put into social security, whether plowed into private accounts in a volatile stock market, or, as presently is done, loaned to the government to finance huge deficits in the budget, won't do the job.

On the other hand, as INSURANCE, the premiums that are being paid are more than adequate. It makes no sense to tell a person who retires with a $5,000,000 annual pension (plus severance payments, golden parachutes and all other sorts of goodies) or with a $150,000 annual pension that they are not expected to be able to get along in life without some government payments. To those who insist that the payments are a return to the retiree of his or her contributions, check again. Only if the person dies within a few years of retirement with no survivors is that true. How else did the huge deficit between contributions and benefits get generated? Clearly, when seen as insurance, a claim for a return of premiums or for a payout makes about as much sense as a homeowner, after 30 years of living in a home that didn't burn down or otherwise suffer a casualty, suing an insurance company for breach of contract because the homeowner "didn't get anything out of it" and "wants their money to which they are entitled." What makes insurance work is that only a few, or some, of those who purchase the insurance end up getting something back, and usually they really don't want to have the experiences that justify the payment. A huge exception is life insurance, which ranges from very expensive whole life insurance (because one must pay the true cost), to time-limited but cheaper term insurance (which is cheapest for those least likely to die and extremely expensive, even if available, for those nearing the end of their life expectancies).

The key to social security reform, then, is undoing the mindset such as the one found in this government advertising, which emphasizes the absence of a needs test and the entitlement quality of social security. Consider this explanation of social security as an earned right: "Social Security is more than a statutory right; it is an earned right, with eligibility for benefits and the benefit rate based on an individual's past earnings." Written with full disclosure, it would read "Social security sets benefits at varying levels depending on an individual's past earnings, but in all events other than early death by a retiree with no survivors, the benefits paid exceed the amounts contributed and the earnings on those amounts, with the difference being made up by imposing increasingly higher taxes on those still working, a ploy which will no longer be available in a few years because there will be two workers for every retiree instead of 20 workers for every retiree as there was when this pyramid scheme was turned into an entitlement program."

Revision of the explanation of social security as "self financed" might help undo the entitlement mindset that politicians grafted onto the Federal INSURANCE Contributions Act system. The government advertising says "And, unlike many foreign plans, Social Security is entirely financed by dedicated taxes, principally those deducted from workers' earnings matched by employers, with the self-employed paying comparable amounts." Rewritten with full disclosure, it should read, "So far, and for another few years, social security is financed by dedicated taxes deducted from workers' earnings matched by employer contributions, or from comparable taxes on self-employed individuals, with the excess being loaned to the federal government to cover deficits, but eventually under the system as implemented by the Congress there will be more retirees with higher claims on payments such that the system will need to ask the federal government to repay the loans or significantly increase social security taxes, or both, causing a huge financial crisis with significant socio-economic and national security overtones."

The government advertising touting the lack of a means test deserves a full quotation: "In contrast to welfare, eligibility for Social Security is not determined by the beneficiary's current income and assets, nor is the amount of the benefit. This is a key principle. It is the absence of a means test that makes it possible for people to add to their savings and to establish private pension plans, secure in the knowledge that they will not then be penalized by having their Social Security benefits cut back as a result of having arranged for additional retirement income. The absence of a means test makes it possible for Social Security to provide a stable role in anchoring a multi-tier retirement system in which private pensions and personal savings can be built on top of Social Security's basic, defined protection." The problem with this analysis is that it has been disproven. The existence of social security has eased the consciences of corporate employers who have trashed their retirees' and employees' retirement plans, who have engaged in mergers disastrous to retirees, who have engaged in profiteering and fraud that has destroyed retirement accounts, and who have demonstrated that low public confidence in privately-operated (especially corporate) retirement plans is understandable. The government justification of "no means test" is equivalent to telling us that homeowners, secure in the knowledge that their casualty insurance will be there for them, can instead focus on using their homes in ways that pose greater risk of fire and other damage.

If the concern is that a means test would entice people to sit back and let the government support them because they failed to save for retirement, the solution is mandatory retirement savings, operated in a manner that precludes risky investment or mismanagement. Insurance companies know how to spot fraudulent claims (though they too often pay up because it's cheaper than litigating), and a well-managed mandatory retirement savings plan should be able to do the same. Of course, whether the government is in a position to filter out fraudulent claims after it has been operating the social security pyramid for decades is an interesting question. The answer, of course, is to remember that the government is of, by, and for the people, and that the pyramid scheme was a creature of politicians. Only by changing the political landscape can social security reform be accomplished. A pessimist would note that such a change is unlikely. A realist would add that, if true, the days of the "American Empire" are numbered, as were those of every previous empire. The optimist would respond that perhaps, just once, the citizens can demonstrate that they know how to put the national interest above the me-first mentality that permeated the politician playground in good government has been held hostage for too long.

A new survey from the National Council on Economic Education reinforces my expressed desire that K-12 education be revamped so that high school graduates enter society with the survival tools needed for life in the 21st century. Specfically, after interviewing and testing several thousand adults and students, the NCEE disclosed that:

*** Virtually all adults (97%) believe that economics should be included in high school education. However, only 50% of high school students say they have ever been taught economics in school (either in a separate course or as part of another subject).

*** On average, adults get a grade of 70 (C) for their knowledge of economics and personal finance, based on a 24 question quiz. Students’ average score is 53 (F).

*** 34% of adults and 9% of high school students get an “A” or “B” on the Economics Quiz.

*** Males are more likely than females to get an “A” or “B” (adults: 51% vs. 17%; students: 12% vs. 6%)

*** Economic understanding increases with age. Ninth – tenth graders are least likely to get an “A” or “B”, while adults 50 years and older are most likely to
get an “A” or “B”:
................ 8% of 9th – 10th graders get an “A” or “B”
................ 10% of 11th – 12th graders get an “A” or “B”
................ 25% of 18 – 34 year olds get an “A” or “B”
................ 34% of 35 – 49 year olds get an “A” or “B”
................ 38% of 50 – 64 year olds get an “A” or “B”
................ 42% of 65+ year olds get an “A” or “B”

*** College graduates are 4 times more likely than those with only a high school education to get an “A” or “B” on the quiz (61% vs. 15%). Twelfth graders
are just as likely as adults with only a high school education to get an “A” or “B” on the quiz (14% vs. 15%)

*** Most adults and students underestimate the impact of a college degree on earnings. Only two in ten know that adults who are college graduates earn about 70% more per year on average than adults who are high school graduates only.

*** Half of adults and even fewer students do not know that keeping savings as cash at home has the greatest risk of losing value due to inflation.

The good news is that student performance, compared with results in a similar 1999 survey, held steady or improved. Progress! But still a long way to go.

My tax teaching and tax blogging colleague Jack Bogdanski wishes everyone a Happy Statute of Limitations Week because on April 15, 2005, the three-year statute of limitations applicable to 2001 tax returns (due no later than April 15, 2002) expired.

So, Jack turned on the shredder and had at his receipts from 2001. He saved the tax returns themselves. He's hoping that an IRS audit letter dated April 14 doesn't show up in the April 17 mail. I'm sure it didn't. We'd have heard about it by now.

Jack carefully notes that the three-year statute is typical, and that if we haven't heard from the IRS about our 2001 returns by now we're "most likely" not going to hear from it. He chooses his words carefully. There is a six-year statute of limitations for 25% or more omissions of gross income, and the statute of limitations is for all intents and purposes eternal if there is fraud.

So when Paul Caron wrote up Jack's blog post, he called it Time for a Tax Bonfire. Before I looked at Jack's post, I had visions of Oregon's forests in flames because, well, there's a lot of stuff to burn when clearing out tax files. Fortunately, Jack wasn't burning anything.

But, folks, go easy with the shredder. DON'T SHRED anything that has to do with what you've paid for assets, or to improve those assets, because those amounts become part of adjusted basis, which is used to compute gain or loss when the asset is sold. Likewise, don't shred any information about the value of inherited property when the decedent died, or the donor's adjusted basis in property received by gift. Hang onto those contractor's invoices for the addition built onto the home. Keep all those investment records showing dividends plowed back into the stock through a dividend reinvestment program.

Why? Because a sale of property in 2006 can require the taxpayer to prove facts from 1996 or 1983 or 1964 or whenever, if those facts related to adjusted basis.

So, what to do? Be like me. Throw out the junk when it arrives (such as those bank privacy notice Jack mentions). Digitize what can be scanned with minimal effort. Buy a few more file cabinets. Build an addition onto the house.

Aha.... finally. We discover why the housing market continues to hum along, with so many families moving to bigger residences. It's to make room for all the tax paper.

Oh, if you've printed out this comment, don't burn it. Someday it could be worth a fortune and could send your great grandchildren to that $875,000 per-year private college.

As undergraduates approach the time of the year when they begin thinking about their course enrollments for the upcoming academic year and even about declaring majors, it's a good time to stop and consider the answer to this question: "I want to go to law school, so what should I select as my major?"

For many decades law schools have replied that it doesn't matter. The Pre-Law Committee of the ABA Section of Legal Education and Admissions to the Bar takes the position that it does not recommend, and it is impossible and undesirable to recommend, preferred undergraduate majors for students intending to attend law school. Instead, it suggests these students should seek educational, extra-curricular and life experiences that will enhance development of analytic and problem solving skills, critical reading abilities, writing skills, oral communication and listening abilities, general research skills, task organization and management skills, and the values of serving others and promoting justice. The American Association of Law Schools states that undergraduate education should be focused on "comprehension and expression in words; critical understanding of human institutions and values with which the law deals; creative power in thinking."

Unquestionably, selection of a major does not bear on the chances of getting into a law school, as indicated in this explanation from Peterson's on the Yahoo Education site: "Perhaps the most common misconception about getting into law school is that certain majors are looked upon more favorably than others in the admissions process. Also, since virtually no school has a "prelaw" undergraduate major, many students believe that political science is the prelaw major. Not so. Any rigorous program of study, from anthropology to zoology, is fine. You should major in an area you enjoy, since you'll do better in that subject than in any other. Engineering or physics majors often think that they cannot apply to law school because they lack a liberal arts degree. This is wrong! Law schools are happy to receive applications from engineers, chemists, physics majors or anyone who majored in any of the so-called "hard" sciences."

In one respect, the notion that undergraduate major does not matter is true. A student who is bright, motivated, and disciplined can do very well in law school no matter the undergraduate major. That's no guarantee, though, that the student can do well without investing far more hours than the student can or is willing to invest.

If, however, the question being asked masks a different concern, then the reply that it doesn't matter is misleading. Perhaps the undergraduate is asking, "I want to go to law school, and I want to arrive with a package of educational experience that enhances my chances of success and minimizes the avoidable academic struggles that might otherwise afflict me, so what should I select as my major?"

To that question, I suggest the answer is as follows: "Select a major that teaches you how to think, that compels you to solve problems, that rewards you for communicating effectively and efficiently, that demands you develop organizational skills, that requires you to be disciplined, and that encourages you to examine details in the framework of a larger contextual fabric." That's a positive response. A negative response is as follows: "Avoid a major that encourages mere memorization and recitation of information, or that emphasizes expression of feelings over careful application of logic and analysis." Most majors do the former, if the student takes his or her academic responsibilities seriously. Some majors are more demanding than others. I'm not going to provide a list of "not so helpful majors" because I'd rather students figure it out for themselves. After all, for me, good teaching is motivating and helping students to solve problems rather than handing them answers on a plate.

Of course, undergraduate departments are not reluctant to nominate their major as ideal. The economics professoriate point to the higher than average results for economics majors on the standard tests, and on surveys showing that lawyers who majored in economics earn 10% more than the average lawyer (gee, I'm really messing up those statistics!). An interesting report comes from the economics program at Winthrop, and another from the program at Clarion. Similar invitations to major in a particular area come from philosophy departments (e.g, Clemson), history (e.g., "perfect preparation for law school", and "highest rate of admission to law school"), liberal arts generally (e.g., "students who graduate with a solid liberal arts preparation are among the most successful law school candidates"), political science (e.g, "one of the best undergraduate majors for students who want to go law school "), and, I am sure, others that I haven't found yet.

The issue, though, is not so much the selection of the major in terms of its substance, but whether the major is designed so that the student can find time in his or her schedule to balance the courses in the major with courses that broaden the student's educational experience. Because undergraduate students often lack the wisdom or experience to package course selections in ways that are beneficial for the long-term, they should be encouraged to consult with, and learn from, experienced course advisors whose outlooks are in tune with these principles. Selecting courses for reasons of ease in grading, schedule, or other purposes can cause the undergraduate to fall short, and to face remedial burdens while in law school. Quoting again from the Pre-Law Committee of the ABA Section of Legal Education and Admissions to the Bar, and I do love this statement, "Taking difficult courses from demanding instructors is the best generic preparation for legal education." They should add that doing the same in law school is the best preparation for law practice. Can I put that in bold? Paraphrased, "Taking difficult law courses from demanding instructors is the best generic preparation for legal practice."

Putting all of this together generates a conclusion expressed, for example, in these terms, by the folks at Collegeview. They advise, "In law school, students read, write, and think voraciously. As a result, undergraduate majors who work on these skills really include a broad base of possible majors. Consider a combination of courses, regardless of the major you select. For example, if you choose to be an English major (reading/writing), then make certain that you take courses in logic and math (thinking). If you major in history (reading/writing), similarly make certain that you take courses that require you to analyze information critically (computer science, philosophy, math). "

What matters more than major, in many respects, is undergraduate course selection. Students who take courses in a narrow field of study, without reaching out to other disciplines, do themselves a disservice. Even if the requirements of a major leave little room for electives, there no harm in taking more courses than are required for graduation. Schools that require students to take courses from a variety of schools and departments, as was the case with Wharton when I was an undergraduate, set a fine example. Earning a degree in economics while majoring in accounting with a business law minor, I took courses in English Literature, Physics, Anthropology, Roman History, Organization Theory, American Civilization, Sociology, and several others in addition to a long list of business courses. There were so many courses that graduation from Wharton required 120 credit-hours rather than the 90 required for the B.A. from the College of Liberal Arts. Hmmm. I confess that at the time I grumbled a bit, and yet now from the perspective of a few years (decades, really) of experience, I've come to appreciate the benefits of most of those non-business courses.

When it comes to undergraduate course selection, I have no doubt that certain courses are essential, unless the student has acquired a similar exposure through some other experience. Most law courses deal with the application of principles to facts arising in the course of a person's life or entity's existence. Thus, to understand how law is applied one needs to understand the underlying transaction or event. It's no surprise that first-year law students generally disfavor contracts, property, and civil procedure as much as they take to torts and criminal law. The transactions of the latter two courses are common, perhaps much too common, in people's lives, and thus it isn't difficult to visualize the automobile accident, the stop-and-frisk, the physical assault, or the high-speed police chase. In contrast, few law students are familiar with the details of life estates, exoneration clauses, or similar contractual or property matters. Amazingly, most law students have signed real property leases and engaged in bailments, and yet don't quite appreciate the legal significance of what they have done.

From my perspective of teaching tax and probate courses, there's no question that the Decedents' course is less challenging in some ways than is the basic tax course, because most law students have had acquired some awareness of wills, understand that people die and become disabled, and can envision the dynamics of family relationships that shadow these issues. They struggle more with trust concepts. In tax, they can absorb the principles dealing with scholarships, student loan interest, and dependency exemptions far more easily than those applicable to life insurance, annuities, and land purchase options, not so much because the law is less complex or easier to understand but because they've dealt with the former and have had little or no experience with the latter. Is there any reason, for example, why people with at least 16 years of education have not learned SOMETHING about life insurance and annuities, not because they might go to law school but because these are matters that affect everyone no matter what they do in life?

Thus, I suggest this to undergraduate students who are planning to attend law school:

Take a course in business basics, so that you understand the time value of money, the difference between a stock and a bond, the essentials of a corporation and limited liability company, the significance of interest rate changes, the purpose and function of life insurance and annuities, the definition of the trade deficit, the rules of supply and demand, and how to balance a checkbook. Why? Because lawyers deal with these things, and law students encounter them in many of their courses.

Take a course in American history, not so much as to learn events but to understand the significance and context of those events. If you have a chance to take a course in American Civilization, do so.

Take a course in French-Norman-English history. Why? These courses will expose you to the background against which American law developed. It will make it easier to understand the medieval property concepts that pop up in the Property and Decedents courses because they are the foundation of modern property, probate, and other areas of law.

If you haven't had Latin, and even if you have, take a year of French. Why? These are languages that have left their mark in American legal terminology, and not only does knowing some basic Latin or French assist in deciphering the word questions on the LSAT, it spares you interrupting your first-year reading 10 times an hour in order to look up "res ipsa loquitur" or "stare decisis" in your Black's Law Dictionary (which really does slow you down tremendously). Taught well, they also introduce you to appreciating other cultures, something that lawyers often need to do, considering the extent to which law, like many other things, has globalized. And, having a second (or third) language skill will be valuable in your career development (crass translation: job search success), and also give you the opportunity to do public service, as do some of Villanova's students who serve as translators in the School's Immigration Law clinic.

Speaking of looking up things, take an undergraduate law course, especially one that focuses on procedure. Why? Arriving at law school understanding basic legal process and the meaning of terms gives a student an advantage because it means less time need be spent coming up to speed in that regard. And you might get a better idea if law is something that appeals to you as an area of study.

Take a course that involves reading and understanding the Constitution. If you need to ask why, think again.

Take a course in understanding how something complex works and how its parts interrelate. In other words, take a course in one of the "hard" sciences, or engineering, or computer programming. Why? The sort of thinking that goes on in those types of courses is very much like the sort of thinking that goes on in many law courses.

Take a course that requires you to write. No, not necessarily English literature. A course that requires you to take something complicated and explain it. Why? Because that's what lawyers do, all the time.

Take a course that requires you to stand up in front of your classmates and explain something. Why? Because that's what lawyers do, much of the time. Perhaps the American History course, or another of the recommended courses, will require this of you. If so, you'll achieve a double benefit.

Take a course in psychology. Why? Lawyers are de facto psychologists. They deal with people, all of the time. And people bring to their lawyers loads of psychological baggage. Law students are surprised to discover that the human condition has as much to do with how one deals with a client, or opposing counsel, or any other person, and with what one recommends, than do the machine-like patterns of legal principles.

Many undergraduate schools are now putting together pre-law programs or packages. These generally are not majors as such, but bundles of suggested courses tailored to the resources and schedules of the particular school. It is not my intent to examine and critique the various course combinations that are required or suggested as part of these endeavors, though I do invite pre-law advisors and others who design the requirements to read my preceding suggestions and consider them when they next revise their programs and advisory materials. It is my intent to make students aware of the need to think about these issues when they arrive at college, not during their junior year when they decide to contemplate a rapidly arriving graduation.

There is one bit of advice sometimes given to undergraduate students thinking about law school that disturbs me. Because, unlike major, GPA is a significant factor in law school admissions decisions, students are told to take courses that maximize the GPA (in contrast to being told to set priorities so that GPA is maximized). This is a short-term logistical maneuver that leads to long-term strategic failure if it causes the student to enroll in undemanding courses that don't develop good law school skills. Aside from the fact law schools are getting better at distinguishing one A from another based on course description, entering law school with a high GPA earned on an easy path is like a high school graduate trying to play in the NBA after scoring 50 points a game playing against middle school competition. Do your best, put your academics high on your list of priorities, and let your GPA reflect who you are and what you can and cannot do.

I close with one last bit of advice: Major in life. Real life, not the "anything but classes or public service" fun times "life" students can find at most colleges and universities. Yes, there is much benefit in taking off a year or two between college and graduate school. "Life-hardened" individuals tend to do better in law school, and, though I'm no expert on the question, in other graduate programs. Why? First, they're in law school because they want to be in law school, not because they had no other choices and hopefully not because their parents "made" them go to law school. Second, they're more mature. Third, they've seen the reality of life and how it differs from what too often becomes the cocoon of college. Fourth, it's more likely they are paying their own way, and thus they're motivated to "protect their investment." Fifth, they bring life experience, as a paralegal, police officer, health care worker, telecommunications intern, whatever, back into academia, making it easier to understand at least some of the transactional backgrounds against which the law develops.