MauledAgain

Stephen J. Friedman, dean of Pace University School of Law, has published an essay in which he asserts that "legal education has not evolved to meet the demands of a rapidly changing profession." Much of what he says repeats what I, a few others in legal education, and legions in practice have been saying for many years. His essay, though, is so diplomatic that he doesn't address a recent phenomenon in legal education that, if left unchecked, will exacerbate the problem. That phenomenon is the change in the preferred background of individuals hired to teach at American law schools.

At the core of Dean Friedman's analysis is his conclusion that "the educational goal of an American law school should be to educate and train effective new lawyers." He addresses how law schools should attain this goal, but for me that's a matter of dealing with a symptom rather than the problem. The problem is that many law faculty do not agree with Dean Friedman. I do. Whenever I make an argument that rests on the premise that the goal of legal education is to educate law students so that they can become legal practitioners, I am met with disagreement from many of my colleagues, not only where I teach, but elsewhere. One colleague put it as succinctly and openly as possible. Law schools, she explained, exist to train legal philosophers. I am grateful she was so direct, because it spared me the effort frequently required to get past the slogans often used to mask that perspective.

My practical reaction is, "Who's going to hire legal philosophers?" Apparently the answer is, "Law schools." What has been happening in law school faculty hiring is a rush to find candidates with Ph.D. degrees. A debate is underway in the legal blogosphere on the question of whether a Ph.D. is "necessary" or "essential" for teaching interdisciplinary courses in law schools. These are courses involving the relationship between law and economics, law and sociology, law and philosophy, and similar "law and" topics that look at law from a theoretical perspective.

Before turning to the question of whether law school graduates, after seven years of post-high-school education, are bringing to their employers as much as those with degrees from graduate programs in other disciplines, it helps to examine how legal education has evolved to the point that as long as thirteen years ago the American Bar Association MacCrate Commission issued a report criticizing the disconnect between legal education and law practice. Though many law schools have responded by creating and enlarging legal clinics, externships, practice simulation courses, and other experiences that mirror, to a greater or lesser extent, what happens in law practice, those efforts remain on the margin in all but the very few law schools that make legal practice experiences the centerpiece of student academic activity.

Legal education suffers from a flaw that does not afflict other disciplines. It awards doctoral degrees to students who do not have bachelors or masters degrees in the subject and who have not been required to pursue a program of prerequisite courses as is the case with the M.D. degree. A wee bit of history is most enlightening. Before the 1960s, a student graduating from an American law school earned an LL.B. degree, namely, a bachelor of laws. It was the student's first law degree. Awaiting those students who chose to continue their legal studies, though at the time few did, were the LL.M. and S.J.D. degrees, which are, respectively, the masters and doctoral degrees in law. During the 1960s law students pressured law schools to award doctoral degrees, because their college classmates who continued their studies were earning doctoral degrees. Rather than rebutting the request by pointing out that the person earning a Ph.D in, say, history, already had a bachelors and masters degree in history and thus had invested as many as 8 or 10 years in studying the subject, law schools accepted the simplistic, logical and yet misleading argument that "seven years of post-high-school education entitles the student to a doctoral degree." Hence, the invention of the J.D. degree to replace the LL.B. Law schools offered their existing graduates the option of replacing their LL.B. diplomas with J.D. diplomas. I personally know attorneys who chose not to do so because, having been in practice, they understood the superficiality of the change.

So, today, legal education is a weird world in which a lawyer who seeks admission to a Graduate Tax Program to earn an LL.M. in Taxation must demonstrate that he or she already has a doctoral degree in law. Wow....a doctoral degree as a prerequisite to a masters degree in the same discipline. Is this upside-down or just goofy? Perhaps both, but more importantly it is a warning. The so-called three years of law study for which a student is awarded a J.D. degree are so insufficient that two more programs of law study await the person who wishes to "run the table" in the discipline. Market forces, particularly in specialized areas such as tax and international law, have generated a substantial increase in the number of students enrolling in the one-year LL.M. programs. Few continue to seek the S.J.D. degree, the only market value of which is a slight boost in the chances of being hired to serve on a law faculty. In recent years, the Ph.D. has eclipsed the S.J.D. as the "terminal degree" favored by many if not most law school hiring committees.

Of course there is an abundant supply of candidates with Ph.D. degrees, especially when compared with the number holding S.J.D. degrees. Everything else being equal, a candidate with a Ph.D. degree will hold an advantage over a candidate without one. In some instances, there is no doubt that the Ph.D. degree is essential. When a law school offers a joint program, such as one in law and psychology, the nature of the program usually demands that there be faculty who hold both a J.D. and a Ph.D. degree in the subject matter of the program. Packing the faculty with Ph.D. holders, as I saw in a brochure yesterday from a law school announcing its new hires, all but a few of whom held Ph.D. degrees, ultimately will turn law schools into philosophy schools, much to the detriment of the legal profession and the clients who rely on it to solve their problems and help them plan to avoid problems.

Is the Ph.D. essential, or even helpful, with respect to law curriculum not wrapped into a joint program? More importantly, does having a law faculty rich in Ph.D. degrees somehow make law schools more likely to prepare law students for law practice? My answer to that question is not only "no", it also includes the assertion that a Ph.D.-rich faculty makes it less likely. Law faculties are rapidly becoming the paradigm for S.J.D. degree faculties (though few law schools offer that degree), with a concomitant distancing from the traditional goals of the LL.B. (now masked as J.D. doctoral degree) first level program in law. Those who claim that "having some Ph.D. holders on the faculty is good" may be overlooking the natural selection process by which another is added, then another, until only Ph.D. holders are hired. Eventually the entire faculty becomes one on which no one serves without a Ph.D. It is a phenomenon not unlike the one by which most institutions of higher education in America have become politically homogenous. What does this "Ph.D. trend" foretell for legal education? The analysis should begin with the needs of those to be educated.

One of the biggest challenges faced by law students enrolled in most traditional law school courses is unfamiliarity with the underlying subject matter. Law, of course, does not operate in a vacuum and is not, at least to me and some others, an abstraction in its own right. Law is necessary because people do things, say things, write things, and disagree about things. Law exists in the context of conversations, agreements, accidents, thefts, murders, waste dumping, war, marriage, adoptions, and just about everything that people do. Thus, when a first-year law student encounters torts and criminal law, there is a higher comfort level than there is with contracts and civil procedure, because most first-year law students have a pretty good idea of what car accidents and murders involve but don't recognize much that is involved with concepts such as answers and exculpation clauses.

Consequently, (too) much time is invested in law school courses getting students up to speed with respect to the underlying transaction or event. Years ago, law students had to struggle on their own to get up to speed. In recent years, a variety of factors have coalesced to shift much of that remedial work into the classroom, at the price of topic coverage. Those factors, which include student resistance to self-teaching, student expectations of "three more years of college," the use of student evaluations in making tenure and compensation decisions with respect to faculty, and even the need of some faculty to be "liked" by their students, have caused overcompensation in attempts to blunt the severity of the generation-ago law school experience illustrated in tales such as "Paper Chase" and roundly criticized by many current law faculty as "unnecessary" or "not conducive to learning." I'm not talking about eliminating the practice of insulting, yelling at, or traumatizing law students. I'm talking about practices that let 90% of the class know that they can coast while the "principally responsible row" has responsibility for preparing the next day's class, or that reduce reading load to several pages a night because students do not prefer "demanding" courses.

At the same time that these adjustments have put pressure on faculty to reduce topic coverage so that familiarity with underlying transactions can be incorporated into the course rather than left to student self-learning characteristic of most other graduate programs, three other developments have put even more constraints on the depth of student experience with legal topics. One change is that the law has grown in scope and quantity, as areas of practice unknown or relegated to a distant corner thirty years ago have moved to center stage. Environmental law is perhaps the most widely suggested example, but there are others, such as employment discrimination and international trade law. The second change is that within each area of the law, rules, cases, and administrative pronouncements have issued forth in torrents of words. Though I am often heard to gripe about the "doubling" or "tripling" of tax law during the time I have been teaching, the same can be said by my colleagues who teach courses such as corporations, bankruptcy, international law, or just about any other area of the curriculum, with few exceptions. The third change is that by adding and expanding legal clinics, externships, and similar experiences into the curriculum, law schools have made it necessary for students to cut back the credits invested in traditional courses. After all, any proposal to resolve this problem by expanding law school to four years, matching, for example, medical school, are met not only with predictions of student resistance, but also with simultaneous proposals to reduce law school to two years on the justification that little is accomplished during the third year and third-year students claim to be, or are, "bored."

Because of these pressures, increasingly more students are graduating from law school without having taken courses in tax, decedents, corporations, domestic relations, or other long-considered "bread and butter" courses of the legal profession. They hope and try to fill in the gaps when they sit through the bar review "cram" courses after graduation. Those courses, as everyone knows, are no substitute for the law school experience. It comes as no surprise, then, that practicing lawyers are frustrated with what law graduates cannot do. Dean Friedman points out the commonly-known fact that the pressure to rack up billable hours leaves little or no time for partners and senior associates to take newly hired law graduates through the apprenticeship-like experiences that were common a decade or more ago. Clients understandably do not want to be billed for, or pay for, the training of newly hired graduates who are uncertain of what they are to do. Students who have been through a clinic and who are hired to work in the same or a related area of the law are among the few exceptions to this phenomenon. Even today, though, fewer than half, and probably fewer than a third, of law graduates have had the opportunity to "do a clinic." Though some large law firms have instituted substitute processes to bridge the gap, medium and small firms are economically compelled to leave that task to Continuing Legal Education providers. A dangerous trend, the shifting of legal education from law schools to CLE providers, is looming on the horizon.

Dean Friedman's proposal is not unlike one that I continue to advocate. He suggests that students have "a law school experience that comes as close as possible to an integrated combination of skills, knowledge and substantive law in one broad area -- such as litigation or corporate transactions -- than with a smorgasbord of unrelated courses." For years, I have advocated abandonment of the doctrine-focused law school subject breakdown to make room for transaction-based courses. For example, a first-year course in "residential leasing" would combine the relevant aspects of contracts, torts, property, tax, consumer protection, dispute resolution, litigation procedure, drafting, and all the other areas and skills of law that bear on the consequences of signing a lease and the planning factors that ought to be considered before doing so. Any seasoned lawyer will explain that in practice clients arrive with problems, to be solved or avoided, and not with doctrinal questions. Similar courses could be developed for "taking a job," "starting a business," "entering into a relationship," "having children," and so on. The primary benefit of this approach is that it integrates doctrine in a practical context, a benefit that is particularly useful considering the absence of the fourth year of law school in which this could be done. A secondary benefit is the efficiency of eliminating overlap, in which the same case or legal principle is covered in multiple courses, "boring" students who have already encountered it, but necessary because some students in the course haven't yet learned it.

Interestingly, Dean Friedman suggests that "While we don't need radical changes in a law curriculum that has worked for a long time, legal education must be brought into closer alignment with the need of law students to hit the ground running when they begin to practice law." I disagree. I DO think we need radical changes in a law curriculum that dates back to the end of the nineteenth century. My guess is that Dean Friedman, being a dean, is being necessarily diplomatic. After all, the principle disadvantage to my proposal is that it would require a huge amount of adjustment and remedial learning by law faculty. It is no wonder that they almost universally oppose my plan. Someday a law school, most likely a new one, will decide to forego "imitation of the elite 25" and set out to do what Langdell did some 125 years ago, and that is to change law school so that it is congruent with the world in which its graduates will practice. I doubt it will happen in my professional lifetime else I'd be hanging my phone number and email address on the end of this paragraph.

The likelihood, though, of this happening at any law school is decreasing rapidly. Trends in law school hiring are widening the gap. At one time, practice experience, whether in a law firm, corporate legal department, or government agency, was considered essential in the background of a faculty candidate. Now, the Ph.D. degree or some academic experience, is at least as desirable if not preferred. The intense pressure to publish "scholarly" pieces has given the edge to applicants who already have published. Considering the time pressures of law practice, it is less likely that a practitioner will carry to the interview the resume filled with publications as will the person who hasn't left the academy. Law faculties that evolve to become islands of academics researching and publishing in theoretical areas will be far less sensitive to the needs and realities of legal practice. In some instances, some traces of hostility to the practice world have been, and will be, detected.

Thus, when Dean Friedman writes, "A more focused approach to legal education would recognize that law schools are professional schools, designed to prepare students for entry into a specific profession," he expresses a perspective that conflicts with some of the trends that have been underway in legal education for the past 5 or 10 years. I am sure he is aware of these trends. It will be interesting to observe the outcome of the several changes he describes that have been made to the curriculum at Pace, though it will take another 5 or 10 years to measure that outcome by evaluating the experiences in practice of the students currently enrolled at his school. I wonder, though, if American legal education has that much time. I wonder if the legal profession can wait that long before deliberately or inadvertently changing its relationship with the legal academy.

Jim Counts of Hemet, California, passed along to the ABA-TAX listserve some URLs pointing to interesting material newly posted on the IRS web site. One of these, Findings from the 2004-05 Taxpayer Communications Tracking Study is one of those typically numbers-packed, almost-all-questions-asked survey results reports that has something interesting for (almost) everyone. The purpose of the study was to measure the effectiveness of IRS communications intended to persuade taxpayers to file their returns electronically. Survey questions ranged from those designed to measure the memorability of particular public service announcements to identification of taxpayers who had filed electronically in an earlier year but then returned to paper filing.

Some of the results match the impressions one can get by communicating with tax professionals about their clients. Others include small tidbits that are puzzling or enlightening. Here are a few that caught my eye.

When asked about IRS communications touting electronic filing, 74% of the respondents found them interesting, and 62% thought they provided interesting information. Those sorts of results aren't all that surprising. Yet 44 percent (up from 41% the previous year) considered the messages to be "boring." Indeed! How could a message about tax return filing be boring? Just kidding. Only 26% claimed that the messages had the intended effect of leading them to try electronic filing, but although this appears to be a small number, consider that many already were using electronic filing. One in five said that the messages prompted them to visit the IRS web site, which suggests to me that some sort of MauledAgain public service announcements might be appropriate for network and cable television. Again, just kidding.

How successful is electronic filing? For the 2005 filing season (2004 returns), slightly more than half (54%) of taxpayers used it. Electronic filing finds more of it adherents among earlier filers, and they are more likely than those not using electronic filing to claim the earned income tax credit, the child tax credit, and educations credits. Of those using electronic filing, 68% use a paid preparer, and 96% of these taxpayers report that their preparer offers an electronic filing option. Interesting. I wonder what the preparers servicing the other 4% are offering?

Only 2% of taxpayers have used electronic filing but assert that they will not use it again and do not want to use it again. A larger group, 13%, used it previously, did not use it in 2005, and admit they'd consider using it again. Of the 31% who have never used electronic filing, many are relatively "older" and tend to file later. Interestingly, of the 52% of this group who use paid preparers, only 31% report that their preparers offer an electronic filing option. Hmmm. Either there are two distinct universes of paid preparers, or there are a lot of paid preparers who elect to avoid bringing up the option because they know or sense that it would simply disturb their clients. It is also surprising that the term "older" does not mean, as one might expect, those who are retired, but a much younger group with an average age of 48.

Using data reported by the respondents, the survey consultants grouped all but 6% of taxpayers into four categories:

* Fifteen percent fall into the category of those who prepare their own returns and who have complex returns. These taxpayers are older, usually married, have higher incomes, and more education. They are among the those who file much later in the filing season. Only 47% file electronically. My guess is that the complexity of the return, including the need to wait for more Forms 1099, Schedules K-1, etc., is a contributing factor to the relative late timing of their filing. Nor is it surprising to find that self-preparation is more common among those with more education, or that higher incomes correlate with more complex returns.

* Twenty-one percent fall into the category of those who prepare their own returns and who have simple returns. This group is disproportionately female, younger, and with lower income and less incidence of marriage. Only 41% use electronic filing, making this the category that uses the option the least.

* Twenty-six percent fall into the category of those who use a paid preparer and who have simple returns. This group also is disproportionately female, is younger than the other categories, has a lower incidence of married taxpayers, but has the highest proportion with children. It is the least-educated group, and is the group that uses electronic filing the most.

* Thirty-two percent fall into the category of those who use a paid preparer and who have complex returns. It is the category with the oldest and most likely to be married taxpayers.

The report also separated respondents into four categories in terms of when they file their returns:

* The "as soon as I get my W-2 Forms" or "as soon as possible" folks. They file in January or early February, want to "get it over with" or expect a refund. They are the youngest of the groups, have the lowest income, and are the least-educated. They are most likely, not surprisingly, to use a paid preparer. They are the group with the highest proportion of simple returns, and 62% use electronic filing.

* The "when I get around to it" crowd. This is the ones who generally file later in February and during March. Other than being slightly disproportionately male, it's a group that mirrors taxpayer demographics generally. Of this group, 40% have simple returns and 52% use electronic filing.

* The "as late as possible but not last-minute" people. These folks file in later March or early in April. The are slightly disproportionately male and older, are the most educated, and have the highest proportion of taxpayers who have a balance due to pay. Many of them have complex returns and only 42% use electronic filing.

* The "last possible minute" adherents file after April 1, mostly because they owe money or are die-hard procrastinators. This group is older, only 51% use a paid preparer, and only 39% use electronic filing. Of this group, 66% have complex returns. I wonder if another reason that some people fall into this group is because they are waiting for Schedules K-1 to arrive, which would correlate to the higher number of complex returns in the group.

I saved the best until last. When asked to characterize the IRS, 64% (down from 71% a year earlier) called it up-to-date or modern, 64% characterized it as dependable, but only 55% called it helpful. Can it be trusted? Yes, say 47%, but 63% say that one needs to be wary of the IRS. Is it interesting? No, say 65%. In fact, 52% call it boring. Only 26% (down from 33% the previous year) call the IRS "a friend." Wow, some people are very, very lonely. A whopping 65% claim the IRS is "difficult" and 59% tag it at "high-strung and uptight." Somehow, 14% reach the conclusion that the IRS is "easy-going and laid back" and 8% call it "shy and introverted." When Jim Counts directed the ABA-TAX listserve subscribers to examine this report, he noted those last two percentages and asked, "[are] these people seeing the same IRS people I am?" Jim, I'm still wondering about the folks who see the IRS as "a friend."

This short summary merely touches on some of the data in the report. It's easy to read, filled with graphics that are highlighted in color and peppered with small notations that draw the reader's attention to significant year-to-year changes. Here, for example, you can find information on what percentage of paid preparers doing simple or complex returns are CPAs. You can also discover data on taxpayer perceptions of electronic filing. Anyone interested in the psychology of self-compliance or in the efficiencies of IRS return management and filing advocacy should consider looking at this report more thoroughly.

A recent split decision by a three-judge panel of the Pennsylvania Commonwealth Court not only opens the door to state sales taxation of software downloaded by Pennsylvanians but also illustrates the chaos that arises when courts undertake to do what legislatures have not done. Understanding the significance of this case requires an appreciation of existing law, the facts of the case, and the differing approaches courts can take to resolving disputes that are the subject of statutory rules.

The case is Graham Packaging Company, LP v. Commonwealth of Pennsylvania, No. 652 F.R. 2002, argued on June 9, and decided on September 15. The opinion can be found in the usual places, including this site.

Graham Packaging, the taxpayer, was charged sales tax when it paid to renew licenses for using canned software that it had previously purchased. The statute defines canned software as "Computer software that does not qualify as custom software." In turn, "custom software" is defined as “[c]omputer software designed, created and developed for and to the
specifications of an original purchaser." Most, if not almost all, consumers purchase canned software. Custom software generally is limited to businesses with needs so specific that existing canned software doesn't address the requirements of the business.

The Facts

The taxpayer designs, manufactures, and sells customized containers used for food, beverages and household products. It uses various software to do its work. In 1999, the taxpayer paid roughly $400,000 to Dell for a two-year renewal of multiple licenses to use various canned computer software programs, such as Windows NT and Office Pro 2000 that it had purchased previously from Dell. The taxpayer paid sales tax of approximately $22,000, and then petitioned for a refund. The Board of Appeals and the Board of Finance and Revenue denied the petition, and the taxpayer appealed to the Commonwealth Court.

The parties agreed on the facts:

* software users do not own the software program, but merely purchase the right to use the program in accordance with the licensing agreement and copyright law

* computer disks are often provided free of charge to multiple user license holders

* computer disks do not give the users any right of ownership to the software

* the computer disks remain the property of the licensor of the software program

* the physical delivery of the software can be accomplished without transferring a computer disk and a computer disk is not necessary to use the program

* the physical quality of the computer disk does not affect the price of the software

* the taxpayer paid for two-year license renewals of software licenses previously purchased by the taxpayer

* the delivery of the software was originally accomplished by disk

* the license renewals did not involve computer disks

* the original computer disks were obsolete when the licenses were renewed.

The Applicable Law

Under the statute, a 6% sales tax is imposed on "each separate sale at retail of tangible personal property or services, as defined herein, within [Pennsylvania]." A sale at retail is "[a]ny transfer, for a consideration, of the ownership, custody or possession of tangible personal property, including the grant of a license to use or consume whether such transfer be absolute or conditional and by whatsoever means the same shall have been effected." Tangible personal property is defined, in part, by the statute as "[c]orporeal personal property including, but not limited to, goods, wares, merchandise, steam and natural and manufactured and bottled gas for nonresidential use, electricity for non-residential use, prepaid telecommunications, premium cable or premium video programming service, spirituous or vinous liquor . . . interstate telecommunications service originating or terminating in [Pennsylvania] . . . ." Thus, if canned computer software programs are tangible personal property, then the amounts paid to renew the software licenses are properly taxed because grant of a license to use tangible personal property for a fee is considered a sale at retail.

Before July 1, 1997, the statute expressly included in the definition of sale at retail the "rendition for a consideration of computer programming services; computer-integrated systems design services; computer processing, data preparation or processing services; information retrieval services . . . [and] other computer-related services." Computer programming services were defined in the repealed statute as "Providing computer programming or computer software design and analysis. Such services include, but are not limited to, services of the type provided by or through computer programming services, customer computer programming services, computer code authors and freelance computer software writers, software codification, custom software programming, custom computer programs or system software development, custom computer software systems analysis and design, custom applications software programming, computer code authors or free-lance computer software writers." Canned software did not fall within the definition of computer programming services. or within the defintion of "other computer-related services," defined as "Supplying computer-related services not described elsewhere in [this statutory provision]. Such services include, but are not limited to, computer consulting services; data base development and data processing consulting services; disk, diskette or tape conversion services; disk, diskette or tape recertification services; computer hardware and software requirement analysis services; software documentation services; software installation services; software training services if provided in conjunction with the purchase of software; or reformatting or editing services."

The Department of Revenue had a statement of policy in effect until June 30, 1997, when the preceding statutory definition was repealed. The policy stated that the performance of computer services, which was defined to include writing or modifying computer programs and customized computer software programs, was a service or tangible personal property transferred to the purchaser. The statement of policy provided: "(1) The following are examples of taxable computer programming services: . . . (iii) The sale of a license to use canned or custom software applications. Canned software is tangible personal property. Custom software is a computer service." Thus, before the 1997 legislative changes, canned software was treated as taxable tangible personal property and custom software was expressly identified as a taxable computer programming service.

After the 1997 legislation that deleted custom computer-related services from the definition of sale at retail, the Department issued a new statement of policy, effective July 1, 1997. This statement provided that "the rendition of computer programming, computer integrated systems design, computer processing, data preparation or processing, information retrieval, computer facility management and other computer-related services, as defined under [the] repealed [statutory provisions] are no longer subject to Sales or Use Tax. The sale-at-retail or use of computer hardware and canned software, as well as services thereto, remains subject to sales and use tax as the sale-at-retail or use of tangible personal property and is not
affected by the repeal...... The sale at retail or use of canned software, including updates, enhancements and upgrades is subject to tax. Canned software includes custom software that is transferred pursuant to a sale at retail to a person other than the original purchaser. Computer software designed, created and developed to adapt or modify canned software
to the specific needs of a particular customer does not convert the canned software to custom software. . . .A vendor’s transfer for consideration to a purchaser of the temporary ownership, possession or custody of a storage medium containing canned software for the purpose of being used or recorded by either the purchaser or vendor on the purchaser’s computer hardware is subject to tax. The sale at retail or use of custom software is not subject to tax. The sale at retail or use of custom software constitutes a purchase of a
non-taxable computer programming service. The sale at retail or use of multiple copies or licenses of custom software to the original purchaser is not subject to tax. The sale at retail or use of custom software installation, custom software repair and maintenance, custom software updates, enhancements and upgrades that constitute custom software is not subject to tax." The upshot of all this language, shared so that people unfamiliar with tax law can appreciate the maze that must be created to fine-tune a tax system, is that canned computer software is treated as tangible personal property subject to sales tax and custom computer software is treated as a nontaxable computer programming service.

But then in February of 2000, the Department of Revenue issued a ruling in which it ruled indicated that the purchase of canned software transmitted electronically is not subject to sales tax but that purchase of the same software, recorded and delivered on tangible media, is subject to sales tax because it has a physical material body. The ruling also stated that "charges for canned software updates that are part of a maintenance contract, and that are delivered electronically, are also not subject to tax." The Department's analysis was that it "taxes the sale of canned computer software for the same reason that it taxes the sale of books, prerecorded audio and video tapes, and any other type of information recorded on a tangible medium: they all qualify as corporeal personal property. Canned computer software that is delivered electronically does not have a physical material body; it is not corporeal.” Though the ruling, which appears to conflict with the post-1997 statement of policy, appears no longer to be in effect, the Department continues to maintain the position expressed in the ruling, as evidenced by a another ruling issued in January of 2003. Confused? We should be.

The Arguments

The taxpayer argued that the amounts paid for the renewal of the licenses to use the canned software are not taxable because the 1997 legislation was a comprehensive repeal of the tax on computer programming services, which the taxpayer concluded covered canned software. It argued that considering the pre-1997 statement of policy expressly provided that the sale of a license to use canned software was a taxable computer programming service, and because computer programming services were removed have now been deleted from the definition of sale at retail, a license to use canned software is no longer taxable. The taxpayer pointed out that the post-1997 statement of policy does not address the treatment of licenses to use canned software. The taxpayer concluded that no statutory or regulatory authority exists to authorize a sales tax on licenses to use canned software.

The taxpayer also argued that because computer disks are not used for the license renewals, there is no corporeal tangible personal property that can be taxed. It relied on the 1999 revenue ruling in which the Department of Revenue concluded that electronic transfer of canned software unaccompanied by a disk is not taxable event.

The Department argued that canned software delivered by disk DOES constitute tangible personal property, making the the license renewals taxable. It stressed that the repeal of the sales tax on computer programming services in 1997 did not affect the continued taxability of purchases of canned software transferred on a disk, which always were and continue to constitute tangible personal property. It looked solely to the form of the delivery to determined if the transaction involved tangible personal property. The Department conceded that if a program is transferred to the purchaser electronically, through email or downloading, without the use of a disk, the transaction is not taxable. The Court noted that the Department appeared to have taken two inconsistent positions on the issue. Still confused? So am I, but at least we're not alone.

The Court's Analysis

The Court disagreed with both parties. It explained that no Pennsylvania appellate decision could be found that defined tangible or corporeal personal property, or that determined if canned software is tangible or corporeal personal property. The Court then described what other jurisdictions have done with the issue, pointing out that one reason for so different approaches is that "software and other forms of current technology do not fit squarely into our less than modern, traditional concepts of tangible property," and that "the various statutes ... are not identical."

Some states have enacted legislation that specifically treats canned software as tangible property, or that specifically treats all software as tangible property. Other jurisdictions take the approach that the Department of Revenue advocates, requiring the existence of some physical matter in order for there to be tangible or corporeal personal property. Still others apply an "essence of the transaction" or "true object" test, which focuses on whether the essence or object of the sale is property or a service that uses property as the means of delivery. But similar transactions have generated conflicting results among the states using this test. So although some courts considered the essence of the transfer to be intangible information, other courts treat the software that is on the disk as physical property and not just intangible knowledge. Yet other jurisdictions apply an "incidental to service" test, under which the existence of tangible personal property is disregarded if it is incidental to the transfer of a service. Another group of jurisdictions treate canned and custom software differently, because custom software involves the transfer of specifically requested services peculiar to the purchaser's needs whereas canned software is prepared for general and repeated use.

The Court determined that for purposes of the situation it faced, as a practical matter there was little practical difference between the essence of the transaction test and the incidental to service test. Both test make the mechanism of transfer irrelevant. For the essence of the transaction test, the subject of the sale is the software. For the incidental to service test, the physical transfer is incidental to the purchase of the ability to use the software. The Court then adopted the essence of the transaction test as "the most logical and practical."

Rejecting the Department's approach, which focused solely on the medium of transfer, the Court preferred the essence of the transaction test because it doesd not exalt form over substance, requires uniform tax treatment of all canned software, and reduces or eliminates the opportunity to avoid tax liability by selecting one form of delivery over another. The Court explained that the essence of the transaction test resolves the treatment of renewal licenses for software originally transferred on a disk but subsequently updated by downloads.

The Court described as "difficult" the task of determining the nature of the software and accompanying license as tangible or intangible. The Court decided that the legislature, although using the word "corporeal," did not intend to limit tangible property to that which can be seen and held because the statute's list of covered property includes electricity, cable, video programming and telecommunications services. Thus, the Court agreed with those jurisdictions that have held a software purchaser acquires "more than incorporeal knowledge or an
intangible right" but acquires "an electronic copy of a computer program that is stored on a computer’s hardware, takes up space on the hard drive and can be physically perceived by checking the computer’s files[, and that] remains in the computer and operates the program each time it is used."

The Court found support for its conclusion in the 1997 amendments. Before those amendments, the statute defined sale at retail to include computer programming services, which expressly included custom computer software programs and programming, but did not mention canned software. "Unlike custom software, canned software is generally marketed at retail, it is not created for a specific user and is sold in mass quantities. In the 1980s and 1990s, canned software was typically purchased in tangible form, in a box and 'off-the-shelf.'" There is no doubt that in 1997 canned software was taxable. Thus, the court reasoned, "Since the legislature did not include prewritten or canned software programs when defining computer programming services, nor otherwise specifically mention it as a taxable item, we must infer that the General Assembly deemed canned computer software to fall within the general definition of tangible personal property. Otherwise, we would have to conclude that the legislature intended to impose a sales or use tax on custom but not canned software, an absurd result."

The Court also concluded that nothing in the history of the 1997 legislative changes indicated that the legislature intended to or did in fact change the taxation of canned software. Removing computer programming services and custom computer software from the definition of a sale at retail did not affect the continued taxation ofcanned software. All that has changed is the way canned software is delivered, not its nature. The Court agreed with the Department's statement of policy and disagreed with its issuance of revenue rulings arguing that the manner of conveyance determines tax liability. Summing up, the court announced, "We conclude that the sale of all canned software, whether transmitted electronically or on a physical medium, is taxable as the sale of tangible personal property."

One of the three judges dissented, pointing out that the sales tax does not apply to sales at retail of personal computers and single-user licensed software purchased with a personal computer, but that this exclusion does not apply to the sale at retail of multiple-user licensed software. He concluded that the taxpayer's multiple-user renewals are beyond the statutory definition of tangible personal property, and only the legislature can change that definition. The Department, he contended, has no authority to impose sales tax on renewals of multiple-user software licenses. There is no need to consider what other states do, because the statute explicitly excludes the renewal of multiple-user licenses to use canned software from the definition of a transfer of tangible personal property or a license to use tangible personal property.

So What?

There are several "so what?'s" in this case. The first is that it may not matter. It is almost certain that the taxpayer will appeal, and it is possible the decision will be reversed. The second is that the court took a position for which neither side argued. When neither side argues a position, the court is left without the benefit of the parties' views on what it independently chooses to do. The third is that, assuming the decision stands, the consequence of far from superior legislative drafting will disadvantage a substantial number of consumers. Unless consumers and software vendors press the legislature to make sense of the law and enact clearly-written rules, the matter will continue to evolve in unpredictable ways as the technology continues to develop, moving past software downloads to the use, for example, of programs running on servers rather than on the user's computer. The fourth is that the existence of so many different approaches to the same issue imposes a higher transactional cost of business on vendors, because they need to figure out how to comply with many different laws, rather than one uniform, law. It is time for states and their legislatures to act globally rather than as medieval fiefdoms. The fifth is that the "education gap" between the world affected by legislators and what legislators carry to the floor of the legislature from their education is widening. It is never good that those who rule do not understand what is being done by those who are ruled. In a democracy, it is even worse that those who select those who rule are in turn blissfully ignorant of the gap that is perpetuated when attention is not paid to qualification.

Wider questions, such as the wisdom of having a regressive sales tax, remain but are beyond the scope of this particular case. On what basis does a state contend, as a matter of policy, that the transmission of software to a user justifies imposition of any kind of tax on that transfer? If the transfer burdens a particular state facility, such as a highway or a telephone line, then the tax ought to be in the nature of a user fee for that burden. The manner of transmission does matter. If taxing physical delivery while not taxing electronic downloads ends up as the long-term outcome, it will have the benefit of encouraging delivery that does not require the energy consumption of delivery vehicles such as airplanes and trucks. This wide-angle view of the issue seems to escape legislatures. Nor did the court, having decided to redefine tangible personal property, look to the long-range and broad sweep policy impact of its decision.

Among the tax practitioners I know are some who claim they ignore reports about pending legislation until the changes are signed into law. Their philosophy is that it makes no sense to invest time and effort learning about a proposal that might not make it into the statute. In many respects, I agree. There are hundreds, if not thousands, of tax law amendments introduced by members of Congress each year, almost all of which have as much chance of crossing the President's desk for signature as I do of being signed as a replacement kicker for the Philadelphia Eagles.

Sometimes, though, it is necessary to look up from the present and listen for the low, soft rumble of the approaching train. This is especially true for tax legislation that, once enacted, takes effect immediately, or as of an earlier date representing when the bill was approved by Committee, rather than at some future date. The Hurricane Katrina tax relief package, introduced as H.R. 3768, has moved through the House, and the Senate faster than it took Katrina to form and reach New Orleans. Late yesterday negotiators from the House and Senate met to reconcile the differences between the two versions, and approval by both houses of Congress is expected by sometime this evening, tomorrow at the latest.

So it's time to look at what this legislation, to be called the Hurricane Katrina Tax Relief Act of 2005, does. Here are the major provisions.

Transactions Involving Qualified Plans

* It will permit penalty-free distributions, up to $100,000, from tax-qualified retirement plans to individuals who have sustained a loss due to a federally-declared natural disaster if the distributions are made within one year after the disaster declaration, and will allow repayment of a disaster-related distribution to a tax-qualified retirement plan if made within three years after an initial distribution.

* It will permit individuals receiving a disaster-related distribution from a tax-qualified retirement plan to spread the distribution ratably in income over a three-year period, which keeps the income inclusion from being bunched in one year subject to a higher rate.

* It will permit individuals to recontribute as a rollover any withdrawals from qualified retirement plans that had received after February 28 and before August 29, 2005, to purchase or construct a principal residence in a Hurricane Katrina disaster area that was not purchased or constructed due to Hurricane Katrina.

* It will increases from $50,000 to $100,000 the amount which a tax-qualified employer retirement plan may loan to a plan participant affected by Hurricane Katrina, and it will extends the repayment period for such loans.

Charitable Contributions

* It will suspend limitations on individual and corporate tax deductions for cash charitable contributions to charitable organizations made between August 28 and December 31, 2005, for Hurricane Katrina relief efforts.

* It will increase the mileage rate for determining the tax deduction for the charitable use of an automobile to provide Hurricane Katrina disaster relief to 70% of the standard mileage rate in effect for business usage.

* It will extends to individual taxpayers and pass-through entities the deduction currently available only for C corporations for contributions of food inventories made anywhere in the country from August 28, 2005, through December 31, 2005.

* It will increase the allowable amount of the tax deduction for charitable contributions of book inventories made after August 28, 2005, and before January 1, 2006.

Personal Exemptions and Credits

* It will allow individuals who provide free housing to persons displaced by Hurricane Katrina for 60 consecutive days an additional personal exemption of $500 for each displaced individual, up to $2,000 annually, but family members do not qualify for this additional personal exemption, which means that they would need to satisfy the tests for being a qualifying relative that is in current law.

* It will allow taxpayers in Hurricane Katrina disaster areas to use earned income for the previous taxable year to compute the earned income and child tax credits for the taxable year which includes August 28, 2005.

* It will authorize the IRS, in taxable years beginning in 2005 or 2006, to apply the tax laws to ensure that taxpayers relocated due to Hurricane Katrina do not lose dependency exemptions or child tax credits or experience a change of filing status due to their relocation.

Employment Provisions

* It will designate employees hired in a Hurricane Katrina disaster area as members of a targeted group for purposes of the work opportunity tax credit, it will waive the termination date of the credit for these employees, and it will not require certification. The credit will be available for hiring someone who was unemployed before the hurricane struck. It will also permit the credit for a three-month period for hiring of employees outside the disaster area.

* It will make the employee retention credit available to employers in the disaster zone who have less than 200 employees, effective until December 31, 2005.

Other Provisions

* It will extend from two to five years the mandatory replacement period for property involuntarily converted due to Hurricane Katrina for purposes of provisions allowing nonrecognition of gain from property involuntarily converted

* It will exclude from gross income certain nonbusiness cancellations of indebtedness for victims of Hurricane Katrina.

* It will suspend the $100 floor and 10%-of-adjusted-gross-income limitations on personal casualty losses incurred by victims of Hurricane Katrina.

At the time of this writing, the full account can be determined by comparing the summary of the House bill with the summary of the Senate bill, reconciling the two using the reports that have made their way through the mainstream media or tax reporting services. If the links don't work, go to the Library of Congress legislation tracking site and enter HR 3768 in the search box, remembering to click the bill number radio button. From there, work your way to the summaries.

Because some of these provisions are short-lived, taxpayers and their advisors will need to make decisions very quickly once the bill is signed into law. If decisions are made expeditiously, then implementation can be arranged within what for many provisions is a short window of opportunity. To the extent that the language of these provisions encourages quick action, it is consistent with the notion that the relief needs to be speedy and soon.

Beware that by the time the final language is put together later today, there may be additional changes or there may be modifications that slightly alter some of the descriptions I've provided. I'm not attempting to analyze yet-to-be-enacted law but to give people a chance to think about the extent to which they or their clients might need to move quickly with respect to certain types of transactions.

Sadly, if the weather forecasters are right, we may see another edition of this legislation, or at least something that extends it to relief for the disaster zone Hurricane Rita seems intent on creating.

He's back at it. The TaxChartMaker, which is the nickname I've given Andrew Mitchel, he of the tax charts collection. It continues to grow.

This time, if I'm correctly keeping score, he has issued his fifth update. In four previous posts (here, here, here, and here), I tossed in my praise for his efforts. I do so again.

This time he has added charts for cases such as Chamberlin (Preferred Stock Bail-Out), Chisholm (Transfer to Partnership and Partnership Sale - Form Respected), and Old Colony Trust (Employer Payment of Employee Taxes), rulings such as Rev. Rul. 59-296 (Upstream Merger of Insolvent Subsidiary), Rev. Rul. 78-330 (Avoiding Sec. 357(c) in a D Reorganization), and Rev. Rul. 2001-46 (Multi-Step Tax Free Reorganization was Not a Qualified Stock Purchase), statutory provisions such as Triangular B Reorganization, Triangular C Reorganization, the 338(g) Election, the 338(h)(10) Election, and a regulatory provision, Reg. 1.302-2(c), Example 2 (Husband's Stock Redeemed - Basis Transfers).

According to Andrew, the site "now has a total of 104 charts (29 cases, 37 rev. ruls., 12 tax free reorgs, 21 indirect stock transfers, and 5 others)." They "welcome feedback on how to improve the clarity and/or accuracy of any of the charts."

Something doesn't add up, at least not when I try to do the math. As reported in numerous news stories, including this CNN article, when President Bush announced his proposals for a significant federal government role in the rebuilding of New Orleans and other devastated areas along the Gulf Coast, he did not put a price tag on his vision. Assorted consultants, experts, analysts, and others familiar with the details of construction and rehabilitation have floated a variety of estimates, with many being in the neighborhood of $200 billion. Some warn, however, that the price tag could be much higher. Although it is not clear, it seems that these estimates are for federal contributions, after taking into account amounts paid by private insurance companies and invested by the private sector. If indeed there are 250,000 homes that must be rebuilt, even at an average cost of $150,000 each, that's $37.5 billion. Toss in the cost of rebuilding and repairing commercial buildings and public structures. Add the price of reconstructing roads, bridges, dams, levees, utilities, railroad tracks and beds. Include the expense of replacing destroyed vehicles, equipment, and other items, both private and public. That's the quick list.

So I'm confident that the President's proposal carries a hefty price tag. I'm not alone in that conclusion. That's not the issue.

The issue simply is, "Where does the federal government get the money to pay for this work?" There are four possibilities, aside from various combinations of the four. The first is to raise taxes. The second is to cut other federal government spending. The third is to borrow, thus increasing the federal budget deficit. And the fourth is simply to print more money.

A person's political philosophy, economic beliefs, and fiscal perspective will influence the choice that the person makes. It is not unreasonable to expect a variety of opinions. All sorts of funding proposals can and probably will be floated. What is troubling is that the President's plan for coming up with the $200 billion, or more, is a generic campaign sound-bite carrying no specifics.

The President ruled out the first option. "We should not raise taxes," is about as clear an articulated position that one can take. Almost as clear as "Read my lips." You know the rest. To his credit, the President said taxes should not be raised, not that taxes will not be raised. Subtle difference. A nuance. Perhaps to the surprise of those who think nuance is a lost attribute in the current administration.

The President, saying nothing about the third and fourth options, hailed the second, "The nation will have to cut unnecessary spending." Nowhere, though, is "unncessary spending" defined. Instead, the President stated, I'm confident we can handle it and our other priorities."

Somehow that sounds to me as though he thinks 1 plus 1 plus 1 equals 2.

Although the current Administration prides itself on championing a legislative agenda designed to cut government spending, unncessary in its view and perhaps some of it necessary in the view of others, to admit that there is still $200 billion of unnecessary spending in the budget is too clever. Surely, the President would define appropriations for projects inserted into legislation in order to obtain votes, such as the bridge between Alaska and the island with several dozen inhabitants, as unnecessary. But I don't see legislators lining up to slice their pork barrel projects from the budget. A quick skim of the Energy Policy Tax Act, recently signed by the President, reveals more than a handful of questionable expenditures. Nonetheless, they don't add up to $200 billion. Not even close.

So what's to be cut? Military spending? Hardly, not with resources spread thin, existing cuts threatening the viability of the Navy and to some extent the Air Force and with additional funds required to induce enlistments and re-ups. Homeland security? After the current fiasco, no one valuing his or her political career would make such a proposal. Energy exploration? No, that won't be the target. The budgets of some small agencies? Perhaps, but cutting $100 million from a $150 million budget doesn't generate $200 billion even if there are 50 such agencies (and I doubt there are). Congress isn't going to vote to cut social security benefits. Note that I am trying to predict where the President and Congress will find $200 billion, not where I would find it. But I'm not a politician and I'm not out to make friends among the bureaucrats, hangers-on, lobbyists, and others who have misdirected the government's spending.

Let's face it. The history of the Congress, especially during the past several decades, suggests that when all is said and done, the federal deficit, now running slightly above $300 billion annually, will increase. Something on the order of $1 of spending plus $1 of spending plus $1 of spending somehow must equal $1 of revenue plus $1 of revenue.

I'm not going to regurgitate all the arguments of why the deficit poses a long-term threat. Most of those arguments are economic. I will emphasize a different one. The deficit threatens our national security. When the deficit is increased, the government must borrow money. From whom does it borrow? From people and institutions with dollars. Who has this sort of money? China. Yes, China. For a President trying to make his mark as a defender of national freedom and independence, it strikes me as short-sighted to let another nation, and one with visions of military glory at that, own this one.

Once the notion of letting China or other nations "own" this country is rejected, there are only two way of fixing $1 of spending plus $1 of spending plus $1 of spending somehow must equal $1 of revenue plus $1 of revenue, aside from combinations of the two. Cut spending. Increase revenue. The fourth option, printing more money, isn't going to happen on Alan Greenspan's watch and I doubt it would happen under the guidance of his successor.

Letting the deficit climb is as easy as cutting taxes, because the impact is in the future. Cutting spending, or refraining from enacting unwise expenditures, is a tougher choice, because the impact is immediate. Tomorrow's vote matters more to most of the Congress than do the votes that will be cast in 2012. In a world where long-term planning is essential, our government is hampered by a short-term poltical system. There's one for the Constitutional Law scholars to ponder.

Despite my general reluctance to let government make decisions unless there is no other viable choice, I also hold to a value of integrity that tells me to raise the appropriate revenue once that choice has been made. Where is the value in promising government assistance to those in need if those people or their descendants will be stuck with the bill? That sort of practice in the private sector can get attorneys general sniffing at the books of the business. It ought not be any more acceptable when government does it.

The defense of deficit spending, namely, that it is necessary when there is an emergency, is one that I can accept. Had there been no deficit spending during World War Two, when revenue was close to being maxed out, the outcome of that conflict could have been different or perhaps achieved at a greater cost in human life. The current difficulty, though, is that the existence of the Katrina emergency, which standing alone might justify deficit spending, comes at a time when the budget deficit already is out of control because of imbalances caused by non-emergency decisions. The huge capital-gains tax cut and the dividend tax rate reduction might be defensible in a time of peace and quiet on the military and weather fronts. But this is not such a time. Incidentally, the taxes that would have been paid by the investor community don't appear to have been channeled into projects such as energy independence, but appear instead to be chasing oil, gasoline and other energy futures. In other words, gambling. And we've seen how one great gamble, ignoring the improvement of the Louisiana levee system, brought the wrong sort of jackpot.

Sorry, Mr. President, but it's time to admit to another mistake, one that is more easily fixed. Bring back the revenue from capital gains and dividends. In the long run, that might be what makes your historical legacy something far better than what many people now think it's going to be.

For some reason, many people and businesses still live in a world of paper. According to a memo described here, a report of which I also received from another source, thirty thousand, yes, THIRTY THOUSAND, pieces of mail addressed to an IRS lockbox went into San Francisco Bay on Sunday, 11 September 2005, when an accident took place on the San Mateo Bridge in San Francisco, that involved a courier that was transporting the contents of the lockbox. Those contents consisted chiefly of 1040-ES estimated tax payments. The payments came from Alaska, California, Hawaii, Idaho, Montana, Nevada, Oregon, Utah, Virginia, Washington, and Wyoming.

What to do now (with thanks to Jim Counts of Hemet, California for the advice): Check with your bank (or have your client check with the bank) to see if the check cleared. If it has, fine. If it has not, call the IRS to see if the check has been posted to the taxpayer's account. If it has not, stop payment on the original check and send in a replacement. I add this cautionary note: include a statement that the check is being sent as a replacement for a timely mailed payment presumed lost on account of the 11 September 2005 San Mateo bridge accident. No one knows if the IRS will waive penalties. If it doesn't, that will surely generate an uproar.

What to do in the future: The IRS makes it possible to post estimated tax payments (and other payments) using the Internet. I haven't mailed a 1040-ES for several years. The same system can be used to make other tax payments. Many states have similar arrangements in place. I know that Pennsylvania does.

Decades ago, I mailed a monthly car loan payment but it never arrived. Fortunately, the lender was the credit union to which I belonged, back in the days when customers were known by face and reputation and financial institutions weren't gargantuan, so it was not a big deal to replace the check and avoid credit reporting issues. That experience surely contributed to my willingness to find other ways to communicate that are more reliable, easier to confirm, and less risky in terms of loss. I suppose now another 30,000 people will open themselves at least to trying a 21st century approach.

Although students usually react in disbelief when I tell them that one of the best ways to learn is to teach, eventually they come around to understanding the point that I am making. Frequently it takes months, sometimes years, before they acknowledge the validity of the statement. On rare occasions, I get the opportunity to show them an example while they are still enrolled in one of my courses.

That's what happened yesterday as we explored the section 117(a) exclusion from gross income of qualified scholarships. Many people, even those who are not tax practitioners, know that "scholarships are not taxed." Technically, what escapes taxation is "a qualified scholarship received by an individual who is a candidate for a degree at an educational organization described in section 170(b)(1)(A)(ii)." I include the tax treatment of scholarships in the basic tax course not only because it is something to which the students easily can relate (their responses to a "clicker" question revealing that an overwhelming majority had been scholarship recipients) but also because it provides an opportunity to explore cross-references and to understand how the definition of an educational organization for purposes of charitable contribution limitations becomes an ingredient in the analysis of the scholarship exclusion.

It's easy, when teaching the topic, to toss off the cross-reference as one that "picks up the typical college or university" and to turn to issues relating to the performance of services by scholarship recipients, the limitation of the exclusion to amounts expended on qualified tuition and related expenses, and to thrash out the treatment of athletic scholarships. But I pause for a moment with the "candidate for a degree at an educational organization described in section 170(b)(1)(A)(ii)" language because it's fun to ask the class what happens to the scholarship received by a student attending a private high school? It's fun because it shows the class yet another example of sloppy statutory drafting, and lets me see who has read the assigned regulations, where the IRS came to the rescue of Congress, once again, by defining primary and secondary school students as candidates for a degree. Don't believe me? Read Proposed Regulation section 1.117-6(c)(4)(A).

I then address the cross-reference to section 170(b)(1)(A)(ii). In addition to exploring how a statutory cross-reference works, it provides another opportunity to show students how something that they may have thought to be a simple concept before entering law school, in this instance, what is a college or university, becomes complicated. Section 170(b)(1)(A)(ii) describes "an educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on." After the bad jokes about irregular faculty and irregular curricula, I usually ask them to determine if a student who receives a scholarship to enroll at Concord University School of Law, which to the best of my knowledge does not have a campus for students, will end up being taxed because he or she is not a candidate for a degree at an educational organization that, among other things, has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on." This question is designed to get students to assert that "cyberspace" is the place where Concord carries on its educational activities. Sometimes students provide that response, sometimes not. Sometimes I have time to question whether Proposed Regulations section 1.117-6(c)(6) Example (4), which disqualifies scholarships received by students taking correspondence courses applies to an Internet school which operates in a cyberspace that extends throughout the world. Of course, I've never researched the question of whether students enrolled at Concord receive scholarships from anyone.

But yesterday, as I was engaging this question, the events of the past few weeks made something in my brain trigger one of those "think while talking" experiences. Because our law school, along with most others, have accepted law students from Tulane and Loyola (New Orleans), I had this "picture" of all the displace students from New Orleans area colleges and universities dispersed throughout the country. Knowing that those schools had collected tuition for the fall semester, and that the host colleges and universities were permitting the students from those schools to attend as non-matriculated visitors without charging tuition, I wondered what happens to the analysis when the law is applied to a scholarship received by a student at one of the New Orleans area schools. Those schools, for the semester, and perhaps for the entire academic year, do not have an operating campus. Those schools do not have a "place where its educational activities are regularly carried on." At least not for a while. Depending on how that phrase is interpreted in light of the current situation, the scholarship recipient may or may not be a candidate for a degree at an "educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on." The visiting student is definitely not a candidate for a degree at the school where he or she is visiting.

I suggested to the students in my class that the sensible interpretation is that "regularly" allows for temporary shut-downs beyond the now infrequent but once common summer and holiday break campus closures. Any other interpretation, no matter how reasonable and no matter how consistent with the statutory language, would generate an absurd result. The students agreed. No one raised a contrary argument. Gee, I'm persuasive.

After class, I did some research. I could not find anything addressing the question. Regulations section 1.170A-9(b), interpreting the phrase "educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried" says nothing about the issue. It's not as though it has never happened until now. There have been campuses closed because of flu or other quarantines, natural disasters, and similar emergencies, but I don't think the closures lasted for the semester or academic year, or longer, that threatens the New Orleans area schools. If there were long-term closures, they either occurred before the income tax was enacted or before the scholarship exclusion reached its present form (such as the "temporary" closing during the nineteenth century of what is now Pennsylvania State University Dickinson School of Law that plays a prominent part in the debate over the longevity rankings of American law schools). When schools close permanently, the issue does not arise because the student transfers to another school and thus is a candidate for a degree at a school meeting the definitional requirements.

Perhaps I have missed something. I hope that if I have, it's an IRS announcement that the campus closures compelled by Katrina will not disadvantage scholarship recipients and will not require them to include their scholarships in gross income. Considering that Katrina is not the last catastrophe to befall us, and that a future disaster may cause years-long closures, the IRS (technically, the Department of the Treasury) ought to amend the regulations. In effect, either my interpretation is correct, and they should say so, or it is incorrect, and they should say so. Then at least one more unforeseen consequence of a horrible tragedy can be resolved.

When I wrote my essay in yesterday's post, "What's Scarier? The Problem, or the Proposed Solutions, I did not realize that there were worse proposals than the ones I had criticized. It's bad enough that people are demanding a decrease in the price of a less available product, or that politicians are taking up the cause for unwise reductions in gasoline taxes. The things that ought to get done are getting little, if any, attention, though I did give kudos where kudos were due, much to my surprise, to the angry Philadelphia mayor who did something constructive.

In today's Philadelphia Inquirer, a letter to the editor from Morris W. Feldstein of Philadelphia proposes a solution that startled me. He begins with a call for "some sacrifice for the common good." He then proposes that "the governors of various states call for four no-driving days on one Sunday during each season. (They could be called "family days.") They might result in very little driving except for emergencies and law-and-order situations." He adds that "I have no idea how many gallons of gasoline we would save, but it might at least create some discipline about our individual driving."

Did Mr. Feldstein think for a minute about his proposal? He is, in effect, proposing that on four Sundays of the year, every citizen who attends a religious service on Sundays and who must drive to their church would be prohibited from doing so. Did Mr. Feldstein think about this and dismiss it as unimportant? Did he fail to think of it, period? Is the First Amendment wandering around here, somewhere?

Did Mr. Feldstein think about the impact on a local economy of an empty stadium on a summer Sunday when the baseball team is in town, on the autumn Sunday when the football team is playing, or the spring Sunday when the hockey team is scheduled? Are these "emergencies?" Perhaps Mr. Feldstein sits at home on Sundays and figures everyone else ought to be doing the same.

Mr. Feldstein's approach is seemingly simple, but it's simplistic. If we are going to find ways to cut back driving, let's eliminate driving that can be eliminated without impinging on people's right to worship or on jobs in the local economy. Although I think I see some of this beginning to happen, it doesn't hurt to get widespread adoption of sensible approaches to saving gasoline. First, rearrange school bus schedules so that high school students do not need to drive to school. During the past two weeks, I have seen more students on the school bus, and fewer busses carrying only 25 or 30 percent of capacity. Second, carpool, not just to work but to other events. On Tuesday, I noticed that most of the vehicles arriving at the Phillies game (including the one I was in) held three, four, or more people. Excellent. Third, fix the timing and control of traffic lights so that people aren't wasting gasoline while the light remains green for a road on which there is no traffic. I have a list of these intersections, but if my attempt to undo a gasoline-wasting change in line painting on Lancaster Avenue is any indication of success, I hold out little hope for the upgrading of traffic flow control. Fourth, as I've mentioned in previous posts, let the price of gasoline reflect its value and scarcity, and let citizens make individual decisions with respect to the cost of their discretionary driving. Fifth, if that doesn't work, then ration gasoline, which will reward those who have already adapted their lifestyles to a resource-conserving approach, and send the message home to those who continue to think that there are thousands of oil tankers sitting off the coast holding supplies from the market until the price gougers are finished charging Americans for what should be one-dollar-a-gallon gasoline.

This morning as I was getting ready to head to the gym, I heard a KYW News Radio report in which John Street, the mayor of Philadelphia, was described as "angry" about gasoline price increases. He sounded angry. His reaction to the gasoline price increase is ”I don’t like it. I think it is terribly unfair.” Most people don't like it. Is it unfair? Is it unfair when the price of something in short supply goes up?

To his credit, the mayor explained that his personal protest against gas prices was to give up the city-provided custom Chevrolet van and to use a PT Cruiser. Street informed the reporter that the PT Cruiser gets double the mileage. He also predicted that "this exploitation" will convince many people to change their gasoline-use habits. He's right, and wrong. People already are beginning to change their habits. Far fewer vehicles are zooming down the highways at 20 miles per hour over the speed limit, though there must be some folks indifferent to high gasoline prices or in some huge hurry. But the term "exploitation" remains to be evaluated as truth or emotional exaggeration.

On the way home from the gym, I heard an interview of John Corzine, Senator from New Jersey and candidate for governor of that state. Asked "what are you going to do about the rising gasoline prices?" he responded with a two-fold approach. The first, which makes sense, was described as encouraging the Federal Trade Commission to investigate the price increases to determine if there is any gouging or illegal practices involved. The second was a call for a gasoline tax holiday. What made me wonder about the struggle between rational thought and playing to the crowd was Corzine's comment, and I'm paraphrasing the best that I can, "There are refineries here in the Northeast and they're not damaged. You'd think with the gasoline prices we've seen that the only refineries in the country are in Louisiana." In fairness to Corzine, he did remind listeners that not much has been done to secure the nation's chemical plants.

Here we go again. Two politicians playing with emotion. The contrast is interesting. Street is emotional, using some very strong terms, and yet does a rational thing in response. He changes vehicles and predicts, perhaps implicitly urges, changes in gasoline-use habits. Corzine, calm and at ease, proposes an irrational and countereffective response and makes a statement so inconsistent with a rational understanding of the markets that one wonders how he did manage to succeed in the business world before entering politics.

Here's the core of the problem: there is a finite amount of oil remaining to be extracted. Many commentators think that more than half of what was available before the "petroleum age" began has already been extracted and consumed. Some point out that much of what remains is the oil that is more expensive to find and extract, because it is in such places as deep water oceans, and that the cost of extracting what remains will begin to climb even more sharply. A few commentators claim that the Saudi oil fields are past their prime, explaining why the Saudis have been ordering off-shore drilling rigs (which, incidentally, appear to be in short supply). I recommend visiting the Oil Drum and reading up on the news and commentary. There's a lot there that does not see the light of the mainstream media day.

Corzine's comment begs the question. If, for example, Louisiana refineries processed all gasoline consumed in domestic uses, the sort of damage that was inflicted would have generated such a gasoline shortage that per-gallon prices would be in the double digits, and I'm not talking $12. I suppose once again the question would be, "What are you going to do about it?" There are folks, I think, who have the impression that the government can command an increase in the oil supply. These same folks think food is grown in supermarkets. Perhaps they're among the 90 percent of American adults who do not know what radiation is, the more than two-thirds who cannot identify DNA as a key to heredity, or the twenty percent of American adults who think the sun revolves around the earth. No, I don't make this up, for it comes from Dr. Jon D. Miller of Northwestern, who thinks that this ignorance "undermines" the ability of citizens to participate in democracy in a meaningful way, as explained in this New York Times story. And people wonder why I keep griping about the miserable overall condition of the K-12 and undergraduate education system in this country, especially after we set aside the schools catering to the elite.

Perhaps John Corzine knows it is pointless to try to teach his constituents the truth about supply and demand. I'm ruling out the possibility that he doesn't understand those economic rules, because I am almost certain he not only studied them in school but also used them in his pre-politician careers. Perhaps John Street understands that joining in the emotional reactions of the populace to rising gasoline prices is more beneficial for a mayor than cold, calm analysis.

Under the current circumstances, reducing the pump price of gasoline by suspending the gasoline tax is precisely what ought NOT to be done. It will give Americans the false impression that gasoline is more plentiful, because that's what reduced prices say to consumers. Under the circumstances, treating the gasoline tax as the user fee that it really is, and raising it to reflect inflation since the last time it was adjusted, would be the best thing to do. The increase in pump price would encourage even more of the adjustments that Mayor Street of Philadelphia thinks would occur. And perhaps the decline of net oil availability would be postponed for enough time to permit development of alternatives. The increase in pump price would also make existing alternatives cheaper in comparison and thus more likely to be moved from development to production. To cushion the poor against the impact of the increase, a tax credit would make sense.

There's another problem looming, and suspending the gasoline tax will have no impact. Natural gas supplies and the natural gas on-shore processing facilities were damaged or destroyed with greater adverse impact than crude oil supplies and gasoline refining capacity. Predictions of 70%, even 200%, increases in home heating costs when winter rolls around are making their way across the blogosphere, with only minimal attention in the mainstream media. As serious as is disruption in gasoline supplies and as annoying as is a gasoline price increase, home heating fuel shortages will be deadly, especially if there is unavailability at any price. As a practical matter, what will happen is that natural gas supply to heating will be given priority, thus cutting the supply to electrical generating plants. The ensuing brownouts and rolling blackouts won't be very good for folks who heat with electricity, or for those who use electric fans as part of a forced-air heating system.

Though I may sound like a disciple of Thomas Malthus, there is something bizarre about the way exploding populations and resulting increases in demand for all sorts of materials gets so little attention because perhaps it isn't quite up to the standards of the post-modern view of life. In a world filled with "pretend" and "say what they want to hear" the important news gets shoved into the corner. How many Americans, or for that matter, how many of the billions of people on the planet, understand supply and demand, or the impact of China's rapidly evolving economy on the price of cement, steel, and fertilizer? While the nation gobbles up PlayStations for the children to use during the next hour, few are thinking about life without PlayStations and all the other conveniences of a world so dependent on a few scarce natural resources that are destined to become even scarcer. I don't buy the "God will provide" message extracted from the lilies of the field parable. It's not that simple and it doesnt' work that way. (A theological aside: Though the parable is sometimes interpreted as "sit back, let God take care if it," has a different meaning for me, namely, stop fretting about the problem and try to do something about it, for only then will God put into your mind the inspiration to a solution.)

Long-term planning that should have been underway decades ago lies unattended, because long-term planning is so antithetical to an instant gratification culture that wants everyone to be happy and spared of inconvenience. Long-term planning is boring. It doesn't sell. It doesn't fit a tidy soundbite. It requires difficult, very difficult choices. It will not generate programs with which everyone will be happy. It will generate programs that easily could make everyone unhappy.

We have seen, at least on television and for some unfortunate victims and courageous relief workers, the impact of planning failures. It will happen again, because long-term planning cannot be accomplished in the few months or years before the next natural disaster, the next major terror attack, or the next disruption, for whatever reason, in the supply of something critical such as pharmaceuticals, zinc, or fresh water.

Suspending gasoline taxes is like putting a bandage on a hemorrhage. Saying "it will be ok" to the bleeding person doesn't quite get the job done. All those politicians quick to lament the lack of leadership, though speaking for understandable reasons, need to figure out how they will take the mantle of leadership voters have asked them to assume and to use it wisely. For the moment, John Street's allegedly anger-induced vehicle change is far more noteworthy than John Corzine's simplistic and countereffective "what they want to hear" gasoline tax suspension suggestion. Why? Because what John Street has done could become a long-term alteration in vehicle use. What John Corzine suggests does nothing to deal with the inevitable drying up of oil and natural gas supplies.

According to this Washington Post story, a tax relief proposal introduced in the Senate to assist in the recovery from Katrina includes "a tax credit to encourage employers to hire Katrina evacuees, and for companies in the disaster zone to temporarily retain evacuees on their payroll." About a week ago I predicted something quite similar:

I think the existing credits will be expanded. The temporary expansion for second-year wages will be extended beyond this year. I think a large area will be declared an empowerment zone, or perhaps be given a special category not unlike the New York Liberty Zone, generating special tax treatment for wages paid to individuals working in it, amounts paid to rebuild facilities located in it, money invested in enterprises formed to operate in it during or after reconstruction.

What I did not predict is interesting:

* A gross income exclusion on debt forgiveness related to the disaster.

* Waiver of penalties for early withdrawals from retirement plans to be used for recovery expenditures.

* A $500 personal exemption for each evacuee housed by a taxpayer who is not otherwise claimed as a dependent.

The last one is very interesting. Because it is late in the year, it is impossible to bring an unrelated evacuee within the definition of dependent. But $500? Why not a proportionate part of the current exemption amount, which would be on the order of $800?

It is estimated that the Senate package will cost between $3 billion and $7 billion. I wonder whether any attempt will be made to offset this cost, and the otherwise enlargement of the deficit.

There is no certainty that the House will pass the same provisions. The only certainty is that the House will pass additional provisions and leave out or modify one or more of the Senate provisions.

Stay tuned.

Prof. Ann Murphy of Gonzaga asked this question: "Does anyone know off the top of their head why the Hope Credit has a provision that bars the credit if the student has a felony drug conviction but the Lifetime Learning Credit does not?" It's one of those wonderful "why" questions that most law professors love, and law students dislike, because it goes beyond knowing black letter law and reaches to understanding the law.

Of course, the first thing I did was to check. Perhaps there was some complicated "deemed incorporation" provision, or a cross reference hidden in a maze of statutory spaghetti that made the rule applicable to both credits. No such luck in defusing the question. There is a difference. That energized my curiosity.

When Prof. Murphy asked her question, several other tax law professors responded. One speculated that the idea was to encourage high school students to "just say no." Another noted that she had read that the reason rested on the difference between the per-student character of the HOPE credit and the per-taxpayer character of the Lifetime Learning Credit.

These are valiant guesses. Nonetheless, if using the tax law to discourage drug abuse is something Congress thinks is effective and wise, there is no reason that both credits cannot be disallowed if the taxpayer whose expenses are generating the credit is convicted of a felony drug violation. Even though the Lifetime Learning Credit is per-taxpayer, there is no obstacle to prohibiting the taxpayer from taking into account expenses related to a convicted drug felon.

As one respondent noted, half seriously and admittedly with a cynical bent, was it to give tax professors another Code provision to ridicule in class? To that I add, was it to provide further proof that the tax law ought not be the vehicle for punishing violations of criminal law other than tax fraud? The warnings from those of us who have consistently objected to use of the tax law for social engineering or as a substitute for what should be done by government agencies other than revenue departments or the IRS are reinforced by this nonsense.

Though I may have missed something buried somewhere, there is nothing in the Committee Reports about the prohibition other than a paraphrase of the statute. No rationale for rule with respect to the HOPE credit is provided, though it ought to be obvious, I suppose. More importantly, no mention is made of the absence of the prohibition for the Lifetime Learning Credit appears, and so whether it was a conscious decision, with an undisclosed reason, an oversight, or a conscious decision whose reason was deliberately concealed is unclear. The last possibility is probably unlikely. As between the other two possibilities, I don't know. And, of course, there are no cases or rulings addressing the question. Unless a convicted drug felon challenges the prohibition on the HOPE credit because it doesn't apply to the Lifetime Learning Credit, a challenge surely to fail, I don't see how the issue would be one that a court would need to consider.

Finally, I have not seen any studies addressing the impact of the prohibition on illegal drug use. I wonder how many students think, "Wow, if I do this and get caught, a conviction jeopardizes my tax credit." So, being similarly cynical, I wonder if the prohibition is simply some sort of window dressing that lets politicians say, "See? We are doing things to reduce illegal drug use." But that still does not explain why a similar prohibition was not, and could not have been, inserted into the Lifetime Learning Credit provisions. For that matter, why not put it in all credit provisions. "Convicted of a drug felony? You don't get the adoption credit. After all, do we want to encourage drug felons to adopt children? Convicted of a drug felony? You don't get any other credits. THAT will make you think twice about using illegal drugs." Right. The illegal drug users are shivering with fear of losing tax credits.

Thanks to Prof. Gail Levin Richmond and Prof. Evelyn Brody for their comments. It always is nice to know I'm not the only tax professional who comes away from parts of the tax law muttering, "Huh?"

Here's an update to my post about the impact on annuity recipients if a charity goes under on account of Hurricane Katrina. I've been told that there is another type of annuity arrangement, which is not a CRUT, CRAT, or pooled income fund. A person essentially purchases an annuity from a charity, getting back less than would be received if the annuity had been issued by a commercial annuity company, with the remaining portion accruing to the benefit of the charity.

In these situations there is no trust. The charity's obligation to make the payments is secured by the charity's other assets. If the charity terminates, then the person who paid for the annuity stands in line with other unsecured creditors to get paid. And if something like a hurricane wipes out the charity, leaving it with uninsured losses, the annuitant loses. This is what happened to people expecting annuities from the Baptist Foundation of Arizona, a tax-exempt organization established to assist with advancing causes on behalf of Southern Baptists. Details of the Foundation's financial demise can be gleaned from this long list of articles. In another case, an organization was set up to sell these sorts of annuities, with the investors told that the excess would go to charity. At least one official of the organization embezzled the funds. Without getting into all the facts set forth in the SEC complaint, the would-be annuitants were left out in the cold. This situation, though, isn't one in which the charities themselves failed. Thanks to those who brought these cases to my attention.

Some states regulate these arrangements, subjecting them to rules that are the same or similar to those governing insurance companies selling annuities. Many states don't regulate them. A practitioner informed me that the charitable gift annuity "industry" of the sort just described is "quite large." It seems that many investor advisors push their use. Yet they are much riskier than CRUTs and CRATs, and don't have the protection, in many instances, afforded to commercial annuities. They also pose risk to the charity, because the annuitant can outlive life expectancy, and unless the charity is selling many of these contracts it lacks a sufficient base over which to spread the risk.

A good question is why charities are in the insurance business instead of in the business of doing charitable works. A better question is why charities are permitted to act as insurance companies but escape regulation. A tougher question is why people would go this route rather than set up a CRUT or CRAT. The practitioner who wrote me prefers the CRUT or CRAT, based on experience in the practice world, and I haven't heard or read any reason to ignore them. As students in my Decedents' Estates and Trusts course learn, "use a trust" becomes a good answer to very many of the "how could this problem have been avoided?" questions.

Once again, it is buyer beware. Even if the buyer is awash in noble purposes, such as assisting the charity.

A question from an anonymous reader was posted on a tax listserv to which I subscribe. It's a good question, and worth consideration. The person wrote:

What happens when a person sets-up a charitable gift annuity to a college or university, and the university no longer exists? Maybe Tulane will no longer exist due to Hurricane Katrina. Maybe at some future point, UCLA will no longer exist due to a catastrophic earthquake.

Through a charitable gift annuity, the university or college promises to pay an annual income for---life. Life, your life and my life, is a long time. Obviously, if the university (Tulane/UCLA/ University of Miami) no longer exists-- the check will not be in the mail.

Somewhere, there's an elderly couple who may not be receiving their annuity check from Tulane for a long time--a long, long, time.

I am going to provide a longer answer than I sent back to the listserv.

The sort of annuity in question is created when a certain type of charitable gift is made. It is essentially a creature of the tax law. Generally, charitable contributions of less than all of the taxpayer's interest in the property do not qualify for a deduction. There are several exceptions. The relevant one, in section 170(f)(2)(A), provides that if property is transferred in trust, no deduction is allowed for designating a charity as the taker of the remainder interest, unless the trust is a charitable remainder annuity trust (CRAT), a charitable remainder unitrust (CRUT), or a pooled income fund. Though the question did not specifically describe what sort of arrangement was made, it is likely that it was a CRAT or CRUT, and not a pooled income fund. The question highlights a challenge I tell my students they will encounter repeatedly in practice and for which they don't get as much preparation as they should, namely, clients who do not provide sufficient facts in the question. And it isn't just clients. Tax practitioners, and lawyers in general, are not necessarily more attentive to spelling out all the necessary information. For example, on another tax listserv to which I subscribe, a significant number of the questions come with a less than bare-bones outline of the facts, requiring a series of clarification requests to avoid the "if this then that, but if something else, then some other thing, else yet something else" answers that branch into all sorts of possibilities. Fortunately, the question I'm considering can be analyzed without knowing whether it is a CRAT or a CRUT. What matter is that it is a charitable trust.

What happens is that money or property is transferred into the trust, and a trustee is named. The trustee can be a bank, trust company, some other professional trust service. It can be the donor or a family member, and it could be the board or trustees of the charity, though there are reasons that using a bank or trust company generally is preferable. The taxpayer, in setting up the trust, determines how much of an annuity will be paid to the taxpayer (or the taxpayer and spouse). For a CRAT, it can be a fixed amount or iIt can be a percentage of the trust's initial value. For a CRUT, it is a variable amount that reflects the investment success (or lack thereof) of the trust. The annuity almost always is paid for the life of the taxpayer (or the joint life of the taxpayer and spouse), but in some instances for whatever reason it can be a set term of years. When the taxpayer dies (or the last of taxpayer and spouse dies), or the specified term of years ends, the trust terminates and its assets are distributed to the charity that owns the remainder interest.

So what happens if the charity ceases to exist? Though we tend to think of charities as perpetual entities that have been around forever and that will remain until the end of eternity, the reality is that thousands of charities are created each year, and hundreds, if not thousands, go out of existence each year. Charities cease to exist for many different reasons. Sometimes they use up all their money. Sometimes they accomplish their goal, perhaps using up all their money in doing so. When a charity is the beneficiary of a trust, and ceases to exist, unless the trust instrument specifies a successor (replacement) charitable beneficiary, the trustee must turn to the courts to obtain a determination of what to do. Courts have general supervisory jurisdiction over trusts.

Centuries ago the courts developed the doctrine of cy pres to deal with this sort of question. It was so long ago that Norman French was still the official language, and so the term "cy pres" emerged from the longer phrase describing the doctrine. The full phrase? "Cy pres comme possible" It means "as near as possible" The pronunciation is fun. In Norman French it would be close to "see pray" but lawyers say "sigh pray" (an interesting look at how language evolves). In modern French "as near as possible" translates closer to "aussi pres comme possible." Go ahead. Put "cy pres comme possible" into this translator and see what happens!

Originally, what the cy pres doctrine provided, and still provides, is that when the purposes of a charitable trust have been accomplished or are impractical to attempt, and money remains, the court will find another purpose, as close as possible to the original purposes. Technically, in some instances, centuries ago in England, the crown could dictate the substitution once the court determined that the original purpose could not be accomplished, but that's not of any relevance to the question. In the United States, the leading case (Jackson v. Phillips, 96 Mass. 539 (1867), for those moved to read it) involved a trust established to support abolition and support for fugitive slaves. The court crafted a substitute goal of assisting the education of emancipated slaves and the alleviation of poverty among former slaves in the city where the trust donor had lived. Over time, the doctrine expanded to include resolution of the problem suggested by the question, namely, what happens if the charitable institution benefitted by the trust ceases to exist?

If a charitable organization that is the beneficiary of a CRAT or CRUT (or any other charitable trust) ceases to exist, the court will select a substitute. How does it do this? As in every cy pres case, it is a question of fact and judgment. The court tries to find another institution which resembles the defunct organization. It considers whether its goals are the same or close to those of the defunct organization. It can examine if it reaches to the same sort of population or one close to it as targets of its charitable works. It notes if it operates in the same or nearly the same geographic areas. There is no set list of things to examine, because the facts of each particular case will set those parameters.

Now for the wrinkle. There's always a wrinkle. What I described is trust law as it developed in England and was absorbed and refined in those areas of the United States whose law has its origins in the English common law. Louisiana, however, because it was founded by the French and under French rule for many years, has a law originating in French civil law. Unlike common law, which developed principally from judicial application of legal doctrine to facts, civil law has its roots in extensive codes, or statutes, which are applied to the facts. Think of an Internal Revenue Code equivalent for every possible aspect of the law. In recent times the distinction has blurred, because statutes and administrative regulations have come to dominate a substantial portion of American (and English) law. So does Louisiana have a cy pres doctrine? Yes. See In re Succession of Milne, 230 La. 729 (1956) (reviewing the origins and application of the doctrine), and it has been codified at La. Rev.Stat. 9:2331.

If an educational organization goes out of existence, my guess is that the court would try to find another educational organization in the same area, with the same (or nearly the same) sort of student demographics, with the same (or nearly the same) programs of study, etc. I'm in no position to make guesses as to specific institutions. But what is clear is that if Tulane or some other school ceases to exist, the trust will continue to exist and the donors will continue to receive their annuities.

Hopefully, this was an interesting academic question. It would be sad, and indicative of far greater upset, if any practicing lawyer had to deal with this issue. All of these institutions, not just Tulane, need to be sustained and need to return to full operations after their properties have been restored. Anything less would compound what already is a horrific tragedy into something unthinkably worse.

My posting yesterday that summarized the discussion to that point between Stuart Levine and myself on the substitution of an income tax at death on unrealized net gains for the estate tax brought a response from Ben Bateman of Amarillo, Texas. He wrote:

Your argument in favor of taxing capital gains is correct, but for the wrong reason. The proper argument is that current law encourages people to hold appreciated assets until death, rather than shift their holdings to something that's more economically efficient. The proper argument is economic distortion, not some socialist cliché about rich vs. poor and the importance of progressivity.

You also missed the real problem about determining basis after death. What's the difference between figuring basis one hour before death and one hour after? Simple: One hour before death, the person most likely to know something about the basis is still alive to tell us. Dead men tell no tales, and they aren't very good at explaining basis records, either. I completely sympathize with the goal of taxing gains at death, because current law creates the sort of economic distortion that tax professionals should abhor. But taxing those gains would also mean that the children pay tax based on their ability to produce information that they had no legal right to obtain before death. Your father didn't keep good records? That means you pay extra.

Granted, this situation already occurs in cases of extended incapacity. If your father becomes disabled and you need to sell some of his property, then the amount of gain will in fact vary based on the quality of records that you had no right to maintain. But taxing gains at death would turn that relatively rare unfortunate situation into a commonplace injustice.

Here is the reply I sent to Ben:

Your point about the lock-in effect of not taxing gains at death is a good one. It should get mentioned, and I'll do that in a follow-up post.

In my experience figuring out basis for a client when doing a return, almost always they had to retrieve paper. None of them remembered anything other than "roughly something" and those were wild guesses. Now, finding the papers might be easier for the "organized" clutter-making client, but eventually it will turn up. The Code has rules for determining donor basis when gifts are made of property that were gifts to the donor by an earlier donor, who often is long gone. So I don't think it's as big an issue as you do. And as more and more recordkeeping goes digital it may get easier across the board. Many items of property, including stocks, bonds, land, commodity investments, vehicles, boats, etc. can have a basis determined fairly easily if date of acquisition is known (something that may be apparent from tax return and other records such as local government land title records, vehicle registrations, information from stock and other brokers, etc.). Many of the items for which records of cost and purchase date are not maintained aren't worth enough to worry about (or are loss items) such as clothes, housewares, etc. The general exception would be those special items on homeowners' insurance: guns, jewelry, antique furniture. How much, though, in the context of the entire picture, are those worth?

As for penalizing children for failure of parents to keep good records, that already happens, in tax and other areas (what if dad has no record of the $10,000 loan to A? the estate doesn't get to collect an asset). One way of dealing with this, going forward, is to have taxpayers report purchases on their income tax returns so that the record is established when the transaction is fresh. It won't be perfect but it would be much better.

Here's a little more about the lock-in effect. Knowing that gains would be taxed if property is sold during lifetime, and knowing that the gains forever escape taxation if the property is held until death, many taxpayers choose to take the latter course, thus "locking" themselves into a "hold the property until death" position. This is especially true if the estate tax would not apply and impose a tax cost to holding the property until death. Thus, increasing the estate tax exemption or repealing the estate tax exacerbates the lock-in effect.

The lock-in effect is one of the arguments raised by supporters of lowering or eliminating the tax rate on capital gains. After all, they argue, if capital gains are not taxed when there is a lifetime sale, there would be no lock-in effect. That's true. However, the lock-in effect can also be removed by taxing gains at death. Both approaches make lifetime sales and holding until death equivalent (aside from the time value of money that might favor holding until death, although the risk of higher income tax rates being enacted shortly before death has a offsetting impact on the decision making analysis). None of the other arguments for eliminating or reducing the tax on capital gains persuades me that it is a superior approach to taxing unrealized net gains at death.

Ben is correct. I should have made this point, but overlooked it.