MauledAgain

A National Law Journal story reports that "Bar Exam Failures Are on the Rise." As a member of a law school faculty, I pay close attention to the question, because it is disappointing to learn that students who have graduated from the law school have failed the bar. According to the story, the national pass rate has fallen from 70 percent in 1995 to 65 percent in 2000, and to 64 percent in 2004. Perhaps it's not enough to be a trend, but it certainly warrants attention. Another perspective makes the situation more alarming. Despite an increase of only 6.4 percent between 1995 and 2004 in the number of people sitting for bar exams, there has been a 28 percent increase in the number of people who have failed. The situation is downright scary when one considers the reported suicide threats made by graduates who have failed the bar one or more times, the reports of nervous breakdowns, the conclusions that attending law school was a mistake,

The bar pass rate varies from state to state. In some states, the bar exam is more difficult than average. In other states, it is less challenging. That's not so much a matter of whim on the part of the examiners, but a reflection of the complexity of a state's law. California's complex maze of legislation and regulations, almost matching the volume and depth of federal law, must be a contributing factor to its low 44 percent pass rate.

The consequences of failing are severe. Jobs are on the line. When I was hired by the Chief Counsel to the Internal Revenue Service, I was told I had 14 months in which to pass a bar examination. At best, I would have had three tries. The National Law Journal reports that many employers are giving new hires only two tries, and if the graduate doesn't pass on the second try, he or she is shown the door. Considering the levels of debt carried by some graduates, this is more than a mere inconvenience.

Why is the percentage of failing scores increasing? Sometimes it's simply a bad day. I recall a very bright, accomplished graduate who failed the bar exam, to the surprise of everyone. When her story became known, it made sense. She and her husband attended law school at the same time. They had two young children. One became ill the night before the first day of the bar exam. Guess who stayed up with the baby? There's absolutely nothing that can be done about those sorts of situations. Fortunately, they're not too prevalent. But that means the explanation lies elsewhere.

Is it simply a matter of bar examiners raising the score required to pass? Is it caused by the switch from being required to score above a certain level for the exam as a whole to being required to score above a certain level on each part of the exam? The latter is more difficult to do, because it prevents a very high score on one part of the exam from offsetting low performance on another part. Perhaps this is a reason. But perhaps by raising the passing grade the bar examiners are making a statement about the need to reduced the number of ill-prepared lawyers hanging up their shingle and seeking clients.

Is the lower passing percentage caused by an increase in the number of students graduating from unaccredited law schools? During the past decade, several law schools have opened, and traditionally, new law schools attract students who can't get admitted to existing schools but who are willing to take the chance that the new law school will earn accreditation before they graduate. If this is the reason, surely statistics showing the pass rates for graduates of these schools would provide proof. The statistics do show that graduates of unaccredited law schools don't do as well on the bar exam as do graduates of accredited law schools, but it does not appear that removing all graduates of unaccredited law schools from the statistics would reverse the downward trend in the overall national pass rate.

There are some commentators who think that the reason bar pass rates are dropping is a deficiency in legal education. The fact that some law schools have added credit-earning bar review courses into their curricula is telling. But it ought not be necessary if the existing curriculum is properly taught and students are held to the appropriate performance standards.

My analysis is simple. Law schools are not holding students' feet to the fire when it comes to performance. Inflated grades send a message of inflated accomplishment. Students need to be held to the standards to which they will be held in practice. Can this be done?

Students get a taste of what practice (and the bar exam) demands when they are challenged in the same manner. Students claim that I am a very demanding teacher. I agree. Why am I that way? Because, as I tell my students, their employers, their clients, and the judges in front of whom they appear will be even more demanding. If students do the work that is required, they succeed. If they ignore their responsibilities, their grades will fall.

Fortunately, at least at this law school, there is a plan to assist students whose grades are low even in a grade-inflated environment. An excellent academic support program has been established. When students avail themselves of its services, they improve. The principal obstacle is that it is not possible to compel a student to accept the assistance or to follow the advice that is given.

There is no substitute for hard work. Students who "got by" with minimum effort in high school and college, even earning high grades, discover that law school is much more challenging, even if the faculty is less demanding than faculties were several decades ago. I tell my students that they are in graduate school, matriculated in a doctoral program, and preparing to enter professional practice. What is expected of them exceeds what was expected in college, by at least an order of magnitude. Some get the message. Some don't.

When the envelope arrives from the bar examiners, every recipient gets the message. But then, unfortunately, for some of them, it's too late. That is why I think it is better to dish out the bad news, namely, low grades, earlier in the process, if those low grades are deserved. Then, perhaps, more students will take advantage of academic support programs and take steps to change their study patterns and the priority to which they give their academic responsibilities.

So, aside from good students who have bad days, I'm not ready to lament increasing bar exam failure rates or to put blame on bar examiners. The clients-to-be of law school graduates in training deserve the best.

It looks so inviting. To the untrained eye and uninformed mind, that is. What is it? It's one of those messages designed to appeal to human greed, sent by someone thoroughly bereft of integrity, fair play, and respect for law. Here's what it says:

After the last annual calculations of your fiscal activity we have determined that you are eligible to receive a tax refund of $63.80. Please submit the tax refund request and allow us 6-9 days in order to process it.

A refund can be delayed for a variety of reasons. For example submitting invalid records or applying after the deadline.

To access the form for your tax refund, please click here

Regards,
Internal Revenue Service

To someone not familiar with how the IRS operates and not attuned to the antics of phishers, this message, wrapped in imitation graphics and thus looking "official," surely will lure some people into its trap. Even if only one-half of one percent of the recipients falls for the deception, that's one-half of one percent of tens of millions of people. Under those circumstances, or any circumstances, that's one-half of one percent too much.

A person who knows how the IRS operates knows that it does not send these sorts of emails. A person who has the good sense to refer all tax correspondence to their tax advisor hopefully has retained a tax advisor who knows that this email is fraudulent. A person who does not know if the IRS sends these sorts of emails but who understands what phishing involves would look more closely, search the Internet for information and warnings on the specific message, and avoid problems. Someone with some fair amount of understanding with respect to sentence structure, grammar, and vocabulary would recognize the content of the email as something even a raw bureaucrat probably would not write.

Unfortunately, not everyone knows to do these things. Not everyone knows how to protect themselves. Not every tax advisor is up-to-speed with tax practice in the twenty-first century, which includes the ability to spot the digital version of con games.

What's particularly galling is that the criminals behind this particular scam are messing with tax. They have a history of impersonating banks, credit card companies, life insurance companies, utilities, hospitals, and just about every other sort of organization. Their chances aren't quite as high with those entities because not everyone banks at Bank X or buys water from Water Company Y. But almost everyone deals with the IRS. And at this time of the year, people are focused on taxes, distressed by taxes, worried about taxes, and eager to get good tax news. In step the criminals.

So what to do?

The first thing to do is to spread the word. Educate the public. Pass along the URL to this posting. Tell your friends and family to ignore this message that is NOT from the IRS.

The second thing to do is to improve the ability of people generally to spot and ignore these phishing attempts. It's popular to point the finger at software companies or some other "other" and expect them to protect people or design something that does so. Ultimately, though, the best protection is for each of us to be informed, educated, and alert.

The third thing to do is to act in ways consistent with the devaluation of human greed. Too many phishers and other digital crime perpetrators find their efforts easier to pursue and more likely to succeed because greedy people make easy marks.

This time, we can't blame the educational system, because phishing didn't exist when most people were in school. Yet for those now in school, it makes sense for them to have instruction in the recognition of digital fraud schemes, just as they presumably get instructions on rejecting offers of candy from strangers. Hmm. In some ways, the fraudulent IRS refund impersonation scheme isn't all that different from the offering of candy to someone the schemer hopes is gullible.

But what about all the people no longer in school? Some would propose huge government programs to deal with the problem. Others would suggest some sort of tax deduction or tax credit for doing things to prevent or avoid falling for the fraud. Nonsense. This situation is a wonderful example of how people can help themselves and each other. Simply spread the word, and put pressure on prosecutors to find and bring charges against the perpetrators.

Lest anyone fall for the "we can't find them" excuse, rest assured that most of these digital con artists can be found. The question is whether government is willing to invest time and money to do so. That issue involves a broader policy question of how the government should allocate resources devoted to protecting its citizens. Even though at least some of the perpetrators are physically beyond the United States, there is no reason that this nation does not have in place treaties that impose on the host nation an obligation to arrest, prosecute, and even hand over to the United States those of its citizens who are engaged in attempts to commit crimes in the United States against United States citizens. For all we know, the process of identifying and prosecuting phishing perpetrators, including those operating in foreign territory, would yield benefits in the planning and implementation of procedures to identify and neutralize the efforts of other criminals to perform other sorts of digital crimes, such as hacking, taking over computer systems, and bringing down the Internet.

Perhaps to get this started, each person who receives these Fake IRS Refund Phishing Scams (FIRPS?) should forward it, with the question, "Is this REALLY a fake as alleged by Jim Maule?" to their federal Senator and Representative, state governor, and state legislators. I wonder how long it would take legislatures to act, to direct executive branch officials to step up enforcement efforts, and to stiffen the penalties that courts can and should impose on those convicted of engaging in these scams.

Sometimes tax practitioners can learn from the experiences of people working in other industries who handle client financial information. Sometimes what appears to be good news for someone is more valuable as a warning than as a sigh of relief.

Last month, a federal district court in Minnesota dismissed with prejudice a complaint brought by a student loan borrower against a student loan servicing company. in Guin v. Brazos Higher Education Service Corporation, Inc., Civ. No. 05-668 (RHK/JSM) (D. Minn. 7 Feb 2006), the borrower sued after receiving notice from the company that the borrower's personal financial information might have been on a laptop computer stolen from the home of one of the company's employees. As I read the case, I kept thinking, "This could be about the theft of a laptop from the home of a tax practitioner's employee, an accounting firm's employee, or a law firm's employee." Thus, it is important to review the facts before exploring the court's reasoning and decision.

The loan servicing company, Brazos Higher Education Service Corporation, originates and services student loans. Among its 300-plus employees was a fellow named John Wright, who did financial analysis, principally analyzing loan portfolios, including the purchase of loans from other lenders and selling bonds financed by student loan interest payments. He worked out of his home, receiving financial data by electronic transmission from Brazos' finance department in Texas. Some of Wright's work requires him to have loan information such as the borrower's financial information. During a September 24, 2004, burglary at Wright’s home, the laptop on which he did his work was taken. Even though police were notified, neither the perpetrator(s) nor the laptop could be found. A private firm hired by Brazos also was unsuccessful in its efforts to recover the laptop.

Federal Trade Commission (FTC) guidelines regulating the student loan service industry recommend that when "deciding if notification [to customers of an identity theft threat] is warranted, [a company should] consider the nature of the compromise, the type of information taken, the likelihood of misuse, and the potential damage arising from misuse." California has a rule that requires such notification rather than leaving the decision to the discretion of the company.

Accordingly, Brazos tried to identify the borrower information that would have been on the hard drive of the stolen laptop and whether the thief or some other person could access it. Brazos determined that Wright had received seven data downloads before the laptop was stolen, but Wright did not track which databases were saved to the hard drive and which were not. Brazos concluded that it could not identify the borrowers whose data was on the laptop, so it sent a letter to all of its roughly 550,000 customers. The letter explained that "some personal information associated with your student loan, including your name, address, social security number and loan balance, may have been inappropriately accessed by the third party." and recommended borrowers put "a free 90-day security alert" on their credit bureau files and review consumer assistance materials published by the FTC. Brazos also set up a call center to answer borrowers' questions and to track reports of identity theft.

The plaintiff, Stacy Guin, who had taken out a student loan through Brazos several years earlier, received a copy of the letter. Guin contacted the Brazos call center to ask followup questions, and ordered and reviewed copies of his credit reports from the three credit agencies listed in the letter. Guin did not find any indication that a third party had accessed his personal information and, as of the time of the court's decision, had not experienced any identity theft or any other type of fraud involving his personal information. Brazos informed the court that to the best of its knowledge, none of its borrowers had experienced identify theft or other problems because of the laptop theft.

Guin sued Brazos, resting his case on three claims, breach of contract, breach of fiduciary duty, and negligence. Subsequently, Guin voluntarily dismissed his breach of contract and breach of fiduciary duty claims. Guin brought the negligence claim on behalf of "all other Brazos customers whose confidential information was inappropriately accessed by a third party."

Guin alleged that "[Brazos] owe[d] him a duty to secure [his] private personal information and not put it in peril of loss, theft, or tampering,” and that "[Brazos’s] delegation or release of [Guin’s] personal information to others over whom it lacked adequate control, supervision or authority was a result of [Brazos’s] negligence . . . ." Guin asserted that this conduct caused Guin to suffer "out-of-pocket loss, emotional distress, fear and anxiety, consequential and incidental damages."

After reviewing Minnesota law, which requires the plaintiff in a negligence action to prove the existence of a duty of care, a breach of that duty, an injury, and that the breach of the duty was the proximate cause of the injury, the court considered Brazos' response. Brazos argued that it did not breach any duty owed to Guin, that Guin did not sustain an injury, and that Guin could not establish proximate cause.

With respect to breach of duty, the court explained that the duty can be established by the traditional reasonable person of ordinary prudence standard or by statute. Guin's argument that the Gramm-Leach-Bliley Act (GLB Act), establishes a statutory-based duty for Brazos "to protect the security and confidentiality of customers’ nonpublic personal information" was rejected. The court pointed out that the GLB Act requires financial institutions to "[d]evelop, implement, and maintain a comprehensive written information security program that is written in one or more readily accessible parts and contains administrative, technical, and physical safeguards that are appropriate to your size and complexity, the nature and scope of your activities, and the sensitivity of any customer information at issue; [i]dentify reasonably foreseeable internal and external risks to the security, confidentiality, and integrity of customer information that could result in the unauthorized disclosure, misuse, alteration, destruction or other compromise of such information, and assess the sufficiency of any safeguards in place to control these risks; and [d]esign and implement information safeguards to control the risks you identify through risk assessment, and regularly test or otherwise monitor the effectiveness of the safeguards’ key controls, systems, and procedures. Guin's contention that Brazos violated the GLB Act by "providing Wright with [personal information] that he did not need for the task at hand," by "permitting Wright to continue keeping [personal information] in an unattended, insecure personal residence," and by "allowing Wright to keep [personal information] on his laptop unencrypted." was countered by Brazos with an assertion that Guin did not have sufficient evidence to prove Brazos breached a duty by violating the GLB Act. The court noted that nothing in the GLB Act addresses the FTC routine warning to businesses to provide secure data transmission through encryption, and that FTC regulations do not address, let alone require, encryption of data stored on a hard drive. The court concluded that at the time of the theft Brazos did have in place "written security policies, current risk assessment reports, and proper safeguards for its customers’ personal information as required by the GLB Act." Wright's access to the data, according to the court, was within the scope of the business duties that he had. Nothing in the GLB Act, according to the court, prohibits "someone from working with sensitive data on a laptop computer in a home office." Failure to encrypt the data, according to the court, does not violate the GLB Act.

Guin also argued that Brazos failed to comply with the self-imposed reasonable duty of care in its privacy policy, namely, that Brazos will “restrict access to nonpublic personal information to authorized persons who need to know such information.” Brazos conceded that under this policy, it owed Guin a duty of reasonable care, but argued that it acted with reasonable care in handling Guin’s personal information. The court concluded that because Brazos had policies in place, trained Wright about those policies, and followed those policies when transmitting data to Wright, it had complied with the policies. The court treated Wright's inability to foresee and deter the burglary and loss of the laptop as not a breach of duty.

With respect to injury, the court explained that "The threat of future harm, not yet realized, will not satisfy the damage requirement." Guin's assertion that he had been injured by identity theft was rejected because he could not prove anyone had stolen his identity. The court relied on an Arizona case (Stollenwerk v. Tri-West Healthcare Alliance, No. Civ. 03-0185, 2005 WL 2465906 (D. Ariz. Sept. 6, 2005). in which customers sued a corporation after computer hard drives containing customer financial information were stolen from the corporation's office. Testimony of an expert, who claimed that the plaintiffs' injury was "“an increased risk of experiencing identity fraud for the next seven years" was rejected because the expert did not quantify any increase in risk of identity theft because of the burglary. Guin had a similar expert's affidavit to offer, but the court treated it as similarly flawed.

With respect to causation, the court held that Guin could not show proximate cause because "the criminal act of a third party is 'an intervening efficient cause sufficient to break the chain of causation,' provided that the criminal act was not foreseeable and there was no special relationship between the parties." This question should go to a jury only if there is a reasonable difference of opinion, which the court decided did not exist. Even though Guin argued that leaving information unencrypted on a hard drive increases the risk that the information would be stolen, and even though Guin claimed that thefts of laptops and hard drives are occurring more frequently during an era of escalating identity theft problems, the court concluded that the theft of the laptop from Wright's home was not reasonably foreseeable by Brazos. According to the court, the facts that Wright lived in a relatively low-crime neighborhood, was unaware of any previous burglaries in his immediate neighborhood, and took reasonable precautions to secure his home made inapplicable the principle that high crime and a history of similar offenses can establish foreseeability.

So what does this have to do with tax practitioners, accountants, and law firms? Simple. These professionals maintain client information on their computer systems. Although they are not subject to the GLB Act, negligence can be proven in other ways if that information falls into the wrong hands. Even though the court analyzed all three defenses raised by Brazos, what made the case easy was the fact that Guin had not suffered identity theft. But Guin's good fortune in this respect is no assurance that a tax practitioner's client will similarly escape after his or her information is stolen or otherwise obtained from the tax practitioner's office.

It is not unreasonable to disagree with the court's analysis of the foreseeability and causation issues. Thefts of computers and digital information is common-place. Identity theft is an epidemic. Thieves who in pre-digital days could not be bothered with removing file cabinets of paper know that in a digital world a piece of equipment one-ten-thousandth the size of a file cabinet can hold thousands of file cabinets's worth of very valuable information.

Although some might read Guin, coupled with the inapplicability of the GLB Act to lawyers, as a comforting protection of tax practitioners against lawsuits brought by clients whose information is stolen, I read it as a word of warning. Guin illustrates the need for tax practitioners to understand what digital information is, how it is stored, how it can be accessed, why encryption is no less important than locking the office door, and why employees must not only be taught but required to follow data protection practices. It's not only theft of laptops from the practitioner's office or the employee's home that poses the risk. It's the data inadvertently sent in an email. It's the information hidden in a word processing or other file, as I discussed a little more than a month ago. It's the bad habit of leaving passwords written on post-it notes stuck onto the computer monitor. It's the employee who walks away from his or her desk without blocking access by logging out or locking the system. It's the lack of supervision of outsiders who enter into work areas. It pretty much is the failure to bring digital security experts in to analyze the operation, recommend a plan, and establish employee training programs for present and future use.

There are data protection failure cases waiting in the wings. Guin does not preclude a finding of liability in any of those cases if identity theft does occur. Do you want your client to be the named plaintiff in the case that proves Guin is not a blanket dispensation of tax practitioners from the ill effects of data protection mismanagement? I surely hope not.

Last month National Taxpayer Advocate Nina Olson presented a written statement addressing the federal tax gap. Considering that the tax gap, after taking into account IRS efforts to chase down unreported and unpaid taxes, is somewhere between $250 to $300 billion, the explanations and solutions provided by the report deserve careful attention. When the Taxpayer Advocate points out that an average of $2,000 per year is paid by compliant taxpayers to offset the tax gap, everyone should be listening. At least, I am.

The tax gap fascinates me and frustrates me. I discussed it several months ago when the data for 2003 was released. That data, computed from different sources, and two years more recent that what Nina Olson used, makes my fascination and frustration even sharper. I'm both fascinated and frustrated by the willingness of people to avoid their legal responsibilities. Of course, that fascination and frustration is not limited to tax avoidance devotees but also the behavior of those who violate a variety of rules and regulations.

I also visited the tax gap almost a year ago when the data used in Nina Olson's report was released. As I re-read my two posts I started to think that I had landed in a deja vu world, or perhaps a parallel universe. And that's without getting into a visit to the same topic about TWO years ago. If I were a magazine I might need to start publishing "The Annual Tax Gap Issue." Somehow I doubt it would get the attention Sports Illustrated gets with its "not quite on topic" annual issue.

Nina Olson's report points out that when taxable transactions are properly reported to the IRS, the rate of tax collection exceeds 90 percent, but when payments are not reported compliance drops to a range of 20 to 68 percent, depending on the type of transaction. Sometimes reporting does not occur because people are noncompliant. Sometimes reporting does not occur because it is not required. Though it may be a surprise to many, not all taxable transactions must be reported to the IRS. Olson estimates that about one-third of the tax gap arises from unreported transactions. What accounts for the rest of the tax gap? Olson doesn't get into this, but I would offer candidates such as improperly claimed deductions and credits, reported but unpaid tax liabilities, impermissible tax shelters, and similar devices that move transactions out of the reportable category.

Olson recommends expanding the list of transactions that must be reported. This is the sort of suggestion that makes one wonder why it wasn't done decades ago. The answer is easy. As Olson points out, tax revenues would climb if every taxable transaction was subject to reporting requirements. That, however, would be an onerous burden. Olson suggests that the nation could not tolerate reporting every payment to a cab driver, every payment to a lawn mowing neighborhood teen, and every payment to an independent contractor who comes to the home to make a repair.

I add that compliance is enhanced when withholding takes place, because withholding shifts the tax payment and not just information to the Treasury. A tale from the past explains why resistance to additional reporting requirements is likely to be no less strenuous as it was when additional withholding requirements were imposed. Some years ago, when the Congress enacted a law requiring banks and corporations to report interest and dividend payments, there was a huge outcry from banks and corporations, even though data processing made such reporting far easier than it would be for taxi riders to report their payments. Congress backed down after banks included flyers in their monthly statement mailings, accusing the IRS of enacting a new tax. The f word on this one for me wasn't frustrated or fascinated; it was furious. After all, compliance with respect to the reporting by RECIPIENTS of dividends and interests was, and to a great extent, still is, significantly less than compliance with respect to wages; in other words, mere reporting by the payor did not guarantee reporting by the payee though in recent years IRS computer matching has been digging out the recalcitrant taxpayers. Eventually, a "compromise" was adopted that installed a system of backup withholding, triggered with respect to specific taxpayers after they were identified as noncompliant. When filling out a form that asks, "Has the IRS notified you that you are subject to backup withholding?" is the noncompliant taxpayer likely to switch gears and be honest when answering?

Olson's report does not identify all of the candidates for admission to the reporting club. It suggests a process of studying each type of transaction to determine whether reporting for those types of transactions would be cost-beneficial. It provides, though, some examples, such as extending the reporting requirements applicable to payments to sole proprietors to payments to certain corporations. I ask, why not all corporations? The report also refers to the proposal to require brokers and dealers to report their customers' bases in stocks and other financial instruments.

An interesting idea floated in the report is encouraging taxpayers to schedule monthly estimated tax payments through automatic debits to their checking accounts. That idea flows from another one, quarterly reminders mailed by the IRS to taxpayers subject to estimated tax filing. Putting tax paying for self-employed individuals on a path similar to that applicable to employed individuals makes sense. My reaction to this proposal is "why not?" but my instinct is that it would not do much to bring the deliberately noncompliant into the fold. At best, it would reduce the risk that a taxpayer who made insufficient estimated tax payments and finds herself in a cash flow bind would try to escape the consequences by contributing to the tax gap.

The report proposes that the IRS be permitted to enter into voluntary withholding agreements under section 3402(p)(3) with industries or trades that have established payor-payee mechanisms, such as the travel industry, and hair stylists. The IRS, it is suggested, could provide safe-harbor worker classification if such an agreement is reached. The report suggests that self-employed individuals who establish a track record of noncompliance be compelled to have taxes withdrawn by automatic debit. My question is simply, "What about the noncompliant individuals who do not use banks?" Overall, this is the sort of process I figured already would have been in place. Backup withholding, even as enacted in the "compromise" that let corporations and banks off the withholding hook, is itself too limited.

The report recommends regulation of tax return preparers who are not subject to oversight under existing licensing of attorneys, CPAs, and enrolled agents. The report suggests that these unenrolled preparers be required to register, take a basic examination on substance and ethics, and participate in ongoing education. How, though, will the IRS identify the least compliant of these preparers if they are not signing the returns? The report admits that "The IRS does not know how many unenrolled return preparers are actively preparing returns for a fee in the United States." But it's worth a try, as much as I dislike government regulation. What I would like to see are tax courses in the nation's high schools and technical schools so that taxpayers are more likely to spot inept preparers (and more likely to demand tax reform).

Olson's report suggests that the IRS use more data from state and local governments. It appears that the IRS has access to this information but is using "very few" of the available resources. Why? Does it really require action by Congress to make this happen? No, but there is other information, such as gross receipts filings, that the IRS presently does not access, and perhaps the assistance or approval of Congress is required to open up these information exchanges. I say exchanges because state and local governments surely will seek data from the IRS for their efforts to increase compliance. Surely there are state and local tax gaps.

Finally, the report points out a need to research the reasons for noncompliance. Identifying approaches to reducing the tax gap would be enhanced if the reasons were understood. I'll get this started by sharing what I wrote several months ago:

One must wonder what motivates noncompliance. Perhaps some psychologists will conduct surveys to determine if it simply greed, or a growing rebellion in which people are "voting with their feet" by appropriating unto themselves their own special tax break that they cannot get through the Congress because they lack the clout of the lobbyists who have managed to reduce the tax on capital gains to extremely low levels. How much of the noncompliance is simple ignorance, stupidity, carelessness, or confusion? How much of the gap arises from people trying to hide information about the activities generating the income?

I provided one possible reason almost a year ago:

Most complexity in the tax law arises from the insane flurry of legislation enacted during the past 15 years that reflects the "I'm special" (or "my project is special") bleatings of the lobbyists and their clients. The "it would be nice/just/fair/smart/wise/sensible/good/ to create this special rule" argument too often is "it would be expedient to enact this special rule because it gets us votes" politics. Taxpayers know this, and thus feel justified in creating for themselves
the equivalent of the exception for which they did not have the money or connections to get for themselves directly.

Thus, I think that noncompliance increases in direct correlation to the extent taxpayers perceive the tax law as unfair. The more disproportionate a tax law's complexity is to the complexity of the context in which the law applies, the more unfairness will be perceived by more taxpayers.

And I agree, the answer is not simply a matter of changing the type of tax. It's a matter of changing the mentality that spawns the tax law.

I'm a tax teacher. I'm supposed to have the ability to change people's tax mentalities. I'm working on it.

I'm still working on it. Here's hoping that Nina Olson's report inspires more people to find themselves working on it.

But perhaps it can be put to rest.

Two weeks ago I followed up on my previous analysis of the National Association of Enrolled Agents' letter in which it presented and analyzed several hypotheticals illustrating problems with the new rules concerning the dependency exemption deduction,
with a reformulation of my thoughts about one of the NAEA hypotheticals.

Recall the hypothetical:

Mom, dad, Alice (14), and Joe (22) live in the family house. Mom and dad file a joint return with an AGI of $400,000. Since Alice is a qualifying child of mom and dad, they could claim her as a dependent but would receive no tax benefit as their personal exemptions are phased out and the child tax credit would not be available to them. Joe is not a full-time student and his only income is a W-2 with $15,000 in wages. Under §152, Alice is a qualifying child of Joe, so he claims her as a dependent and thus gets the child tax credit and yes, even the earned income tax credit. Assuming Joe had no tax withheld, he goes from a balance due of $683 to a refund of $3,158.

I concluded that Alice is the qualifying child of Mom and Dad, because (1) she is their child, (2) she has the same principal place of abode as they do, (3) she is under 19, and (4) she does not provide more than half of her own support. I also concluded that Alice is the qualifying child of Joe because (1) she is his sibling, (2) she has the same principal place of abode as he does, (3) she is under 19, and (4) she does not provide more than half of her own support. Because a person can be claimed as a dependent by only one taxpayer, the question is whether Mom and Dad can choose to omit Alice from their return, letting Joe take the deduction. I had initially applied the tie-breaking rule in the Code that would have made Alice the dependent of her parents. The NAEA interpreted the phrase "and is claimed" in section 152(c)(4)(A) as permitting Mom and Dad to stay out of the tie-breaker, letting Joe win by default. After pondering the NAEA position and analyzing analogous situations in the tax law, I concluded that:

there is something to be said for the NAEA's interpretation of the "and is claimed" language. After all, to reach the sensible policy and practical application result, Congress should, and could, have used the phrase "and could otherwise be claimed" in lieu of "and is claimed." Congress did not do so. Thus, to the extent the NAEA is asking for clarification, it is a problem that should be mentioned, even though I'd be reluctant to advise Alice's brother to take the dependency exemption deduction and would insist he make his decision after listening to, or reading, a full explanation of the issue and the risks involved in making a yes or no decision.

But now news from the IRS, in the form of Volunteer Quality Alert 2006-04 – Guidance for Determining a Qualifying Child, Qualifying Relative, and Qualifying Person (March 2, 2006), the IRS makes it clear that the tie-breaking rules won't apply unless Alice is claimed on both the joint return of Mom and Dad and the return filed by Joe:

Sometimes a child meets the tests to be a qualifying child of more than one person. However, only one person can treat the child as a qualifying child. If the taxpayers have the same qualifying child, they may decide among themselves who will claim the child. If they cannot agree, and more than one taxpayer files a return using the same child, the IRS will use the tie-breaker rules...

Thus, as I explained in the reformulation post:

First, taxpayers in the situation that Alice's parents and brother find themselves are left to work out a suitable tax-favorable arrangement. Only one "claims" the child in question and the others fail to "claim" the child.

And to my question "Is the tie-breaker intended only as a remedial tool for the IRS to use when multiple taxpayers with "claims" to the child fail to settle on one claimant?" the IRS has said, "Yes."

However, to my question "Why the difference?" which I asked after contrasting the rule that prohibits parental failure to claim an otherwise allowable dependency exemption for a child from letting that child claim a full personal exemption, the IRS gave no answer. How could it? How could it possible divine the presumed intent of a Congress that said nothing to reveal the inner workings of the minds of those drafting the provision. Of course, "Why the difference?" is a question of greater concern for the policy maker than for the tax return preparer trying to provide the best service to his or her clients.

It is just downright disappointing that something as simple as the dependency exemption deduction can be so confusing and trigger so much commentary. No wonder when the tax world turns to things such as partnership taxation or subpart F that the complexity becomes agonizing. The patient is screaming in pain, and Dr. Congress thinks a little more morphine is the cure.

If March roars in like a lion, which it did here, surely tax season debuts each year with the usual scavenger hunt for deductions. This year is no different. What is particularly annoying is that with the tax law so complicated, no one benefits when erroneous information further complicates taxpayer attempts to comply and tax return preparer attempts to be of service to their client. I confess to being easily annoyed when bad tax advice makes the rounds. The latest entry, or should I say re-entry, into the find-a-deduction sweepstakes is the "personal grooming expense deduction."

The February 2006 issue of "Costco Connection" has a tax-savings article in which the author, Howard Scott, in a paragraph headed "Seek out other expenses" writes: "Do you incur personal grooming expenses because image is important?" [To get to the page, after clicking on the URL, click on "Smart Tax Tips" at the bottom left, and then click on "15 Tax Talk" on the right-hand side.] My thanks to Greg Stewart of Spokane, Washington, for bringing this to the attention of the ABA-TAX listserve's subscribers.

There is no such deduction. There is a long list of cases denying deductions for personal grooming, no matter the connection it might have to the conduct of a trade or business. For example, in Thomas v. Comr., T.C. Memo 1981-348, the Tax Court wrote: "Whether or not petitioner was required as a condition to her employment to be neatly coiffed, the expenses she incurred for this purpose are inherently personal in nature and cannot be considered as business expenses."

Technically, Scott has done nothing more than to ask a question. But considering that it follows a list of other questions, all focusing on deductions that would be available if the answer is yes, the inference is that a "yes" to the question would trigger a deduction. The inference surely is intended, considering the litany of items covered by the list of questions. After all, if the intent simply is to get taxpayers thinking about anything, why not ask questions such as "Do you have a pet dog?" or "Did you go to the movies?" Answering "yes" to these questions would not generate a valid tax deduction.

Is it fair to suggest that the question claims a personal grooming expense deduction exists? In light of other advice in the article. yes. Scott explains that even if a taxpayer has an accountant, the taxpayer knows his or her business better than the accountant does. In most cases, that's true. Scott then writes that the accountant might be "conservative." Perhaps. I'm sure he means conservative in the cautious and not political sense. Being conservative, Scott concludes, "often translates into a reluctance to implement new stratagies." So does this mean claiming a deduction for personal grooming expenses is simply a new strategy? I don't think so. Claiming impermissible deductions is a strategy almost as old as the income tax law. Refraining from doing so is not my definition of conservative. It's my definition of sensible, law-abiding, and prudent.

It may appear that I'm "picking on" Howard Scott. That's not what I'm trying to do. I didn't seek him out. He put his article into the public spotlight, and many taxpayers have read or will read it. All I want to do is to alert people to two simple things. First, there is no deduction for personal grooming expenses. Second, beware of what you read about taxes and rely only on advice from people whose tax-advice-giving reputations you can and do trust. Before relying on advice from Scott, I'd want to know more about him.

One place to start is the Costco article. Someone pointed out an error in the article which I did not notice when I looked for the reference to personal grooming expenses. In another paragraph, discussing the benefits of hiring one's children, Scott uses $4,850 as the amount below which the children can use a standard deduction to shelter income from taxation. For 2005, however, the amount is $5,000. It's too late, however, to hire one's children for 2005. That year is past. So in giving advice for 2006, the amount to use would be $5,150.

Standing alone, the use of the wrong amount would generally be nothing more than an error. All tax practitioners make errors, though most are caught before damage is done. When an article contains an error, advice to push one's "conservative" accountant into new stratagies, and a suggestion that personal grooming expenses are deductible, red flags begin to flutter. The odds that the suggestion of a personal grooming expense deduction is the consequence of an editor's change unreviewed by the author fade to zero under these circumstances.

Following up on someone else's research, I looked around, and here is what has been found. The Costco article describes Scott as a "longtime writer and tax preparer specializing in small businesses" and explains he "has published more than 1,700 magazine articles and three books." Among those 1,700 articles must be the one appearing in Pizza Today and the two-paragraph "Avoiding an Audit" advice in Remodeling Online. According to this report, Scott not only is a free-lance writer and tax consultant, he also is a beekeeper.

Why have I invested my time in this story? Because umpteen million Costco customers will read the article. Tax practitioners are bracing themselves for clients arriving with a copy of the Costco article, along with grooming expense receipts, ready to argue that Costco's expert says that a deduction is available. No sooner had someone wondered aloud if people would take Scott's advice to heart than someone else answered affirmatively. A client arrived with a copy of the Costco article and announced she should be allowed to deduct the cost of her pedicures. Why? She often wears sandals and her toes need to look nice. The client's job? She sells carpets. Turned out the client was sufficiently informed about taxes and after a few minutes, let on that she was rattling her tax practitioner's cage. Most clients are not so savvy. Several years ago, another subscriber reported, clients asked about the "$5,000 vacation deduction." I wonder where that idea originated. Wherever it did, like the new ones that are popping up, they need to be discredited before innocent taxpayers get into trouble relying on them.

But for every client with some understanding of basic tax law, there are a dozen who grab onto the idea of a tax-savings deduction with the grip of a drowning person reaching for the life preserver. Add in the vanishing breed of people who do their own returns, some of whom surely will take the grooming expense question's intended inference to its logical conclusion, and there's real reason to worry about the impact of bad tax advice in an age when bad advice can circle the globe in minutes.

Speaking of circling the globe, there is a place where personal grooming expenses can be deducted. Where? In Australia, as explained on H&R Block's Tax Tips for Australian taxpayers. The Australian deduction, by the way, is permitted if it is "incidental" and "relevant to the taxpayer's occupation." So, want a deduction for personal grooming deductions that enhance your image? Move to Australia.

And here's hoping no one gets stung by claiming a deduction for personal grooming expenses.

During the 2005 tax filing season, the California Franchise Tax Board (FTB) administered a pilot program for a project called ReadyReturn. A group of taxpayers was invited to join the pilot program. Under the pilot program, the FTB prepared the taxpayer's return, and then gave the taxpayer the opportunity to verify the information, make any necessary changes, and sign and submit the return. According to the FTB report, approximately 50,000 taxpayers were invited to join the pilot program, of whom nearly 9,400 filed the return prepared by the FTB (5,600 by e-file and 3,800 using traditional paper). The ReadyReturn site provides slightly higher numbers: 11,620 participants (5,610 by e-file and 6,010 by paper).

The FTB prepares the taxpayer's return by "using wage and withholding information that is already reported to the state by employers." Accordingly, the taxpayers invited to participate were those "who file the most simple returns."

FTB surveys of the participants revealed that almost all of them considered ReadyReturn easy to understand, almost all of them concluded they saved time using ReadyReturn, and more than 90% also concluded it was more convenient than how they filed the previous year. Roughly 80% reported that ReadyReturn made them "feel less anxious about filing their tax returns." The survey also discovered that 99% of the participants were “Very Satisfied” or “Satisfied” with ReadyReturn, roughly 97% would use it again, and about 90% thought ReadyReturn was a service that the government should provide. Only 5% indicated they believed their personal information was not secure with ReadyReturn. Many of the taxpayers invited to participate who chose not to do so turned down the opportunity because they had already filed their return, though others expressed doubt about the security of using the Internet, were not comfortable receiving a pre-filled-in return, or preferred a non-government e-filing company. The FTB reported that ReadyReturns were less likely to fall out of processing because of errors, that ReadyReturn users were less likely to receive error notices, and that ReadyReturn introduced "thousands" of paper filers to e-filing, with more than half of the ReadyReturn participants who used e-filing having used paper filing for the previous year.

Based on these results, the FTB requested that the program be fully implemented. However, it would be limited to taxpayers who are single, have no dependents, claim the standard deduction, and have income derived solely from wages.

The project, however, is not without its critics. For example, the National Taxpayers Union (NTU) produced an issue brief, California's ReadyReturn Program: Fool's Gold in the Golden State, in which it pointed out numerous concerns. First, the NTU wondered why the FTB should "get into the tax return preparation business," considering that there are more than adequate numbers of tax return preparers available. Second, the FTB provides a free e-file service, which should mitigate concerns about private industry charging taxpayers for that service. Third, there is no guarantee that the FTB would make fewer computational mistakes than other preparers. Fourth, the FTB is unlikely to "scour the tax code for ways to reduce the filer's prepared tax liability." Fifth, changes in the taxpayer's status could change eligibility, posing the risk that taxpayers would not understand the need to switch to a private preparer. Sixth, there is a cost in generating FTB-prepared returns that end up in the trash because the taxpayer became ineligible to participate or otherwise chose to pass up the chance. Seventh, ReadyReturn makes it less likely that taxpayers will understand how much of their income is being withheld or otherwise paid in taxes because they will not look at the return or have a preparer explain it. Eighth, some taxpayers may see ReadyReturn as a new approach to increasing tax collections. Ninth, the service would not be free because its costs are borne by taxpayers generally. Ninth, ReadyReturn could lead to FTB offering bookkeeping services or estimated tax computation advice, and, at the very least, would justify requests by the FTB for more employees and more funding. Concerns from other critics echo these arguments.

The California State Senate Republican caucus has prepared a briefing report on ReadyReturn that devotes far more space to objections than to the advantages touted by its supporters. The Howard Jarvis Taxpayers Association released a commentary in which it called ReadyReturn a "prime example of California's long line of information technology boondoggles," claimed that "[i]n addition to the conflict of interest in having the tax collector also serve as the tax preparer, the program presents a myriad of accountability problems, and suggested "ReadyReturn should be returned to sender with a cancellation notice."

The project also has its supporters. Joe Bankman, a member of the law faculty at Stanford, explains in "Simple Filing for Average Citizens: The California ReadyReturn" that ReadyReturn offers a solution to the trials and tribulations of fling tax returns. He rejects the arguments made by its critics, and rues the effectiveness of those lobbying on behalf of the tax return preparation industry. He concludes with a call for consideration of a similar program at the federal level. A lobbyists for the California Tax Reform Association explained that ReadyReturn was good for taxpayer privacy because taxpayers would "know what kind of information is there. It's simple and straightforward and demystifies the process of filing taxes."

Five months ago, I concluded that ReadyReturn wasn't ready for prime time. In my analysis I weighed the arguments in favor of its use against the arguments that it is not the answer to the problems it purports to ameliorate. Recently, as the FTB's request for full implementation came under attack in the California legislative process, the debate resurfaced. New arguments have been advanced, principally to paint ReadyReturn as a program to save low-income taxpayers from fee-paying and sometimes predatory tax return preparers. After considering these new arguments, my conclusion remains unchanged.

ReadyReturn has been hailed as a "move in the right direction" to deal with increasingly complex provisions that directly affect taxpayers least likely to have the ability to handle them, such as the additional wrinkles added to the earned income tax credit (EITC) by the legislation providing tax incentives for recovery from Hurricanes Katrina, Rita, and Wilma. The concern is that even more low-income taxpayers will be driven to use fee-charging preparers because volunteer preparers cannot compete with the likes of H&R Block. Aside from the fact that California's ReadyReturn cannot do anything for people in the Gulf Coast region filing 2005 federal income tax returns, justifying the implementation of government-prepared tax returns by pointing to government-generated complexity is a bootstrap argument. All that would be accomplished is to make more and more low-income taxpayers wards of the state when it comes to tax compliance. The notion that these taxpayers will review the return "proposed" by a government is impractical. Low-income taxpayers would either accept the government proposal, even if it was incorrect, or go to a fee-charging preparer for help in deciding whether to accept it.

ReadyReturn has been defended because the only "realistic alternative to ReadyReturn is commercial tax return preparation services, which have a vested interest in complexity." Yet ReadyReturn would cement the complexity, because by sheltering taxpayers from its impact, it removes an incentive for taxpayers to press for genuine simplification. What better way to guarantee complexity than to make taxpayers think it doesn't exist because taxpaying has allegedly been "demystified" by letting the government decide what the taxpayer should pay? Simplicity in the form of marching in lockstep to government-dictated tax returns is a dangerously misleading attribute of ReadyReturn, and the theoretical proposition that taxpayers can reject the government's proposed return flies in the face of reality. Low-income taxpayers already are at the mercy of the government, and ought not think they are being befriended by an entity that by law is not set up to be the low-income taxpayer advocate. Consider, for example, the difficulties faced by low-income individuals when dealing with government-controlled child support and custody matters. Incidentally, almost every tax return preparer with whom I communicate abhors the complexity that has turned the tax law into an impenetrable mess. The suggestion, as has been made, that tax return preparers might have been involved in creating the absurd complexities of the hurricane relief EITC, ignores the fact that most complexity arises either from special interests seeking to hide a narrowly focused tax benefit or from theoretical solutions proposed by folks with little or no practical experience in dealing with taxes. Tax return preparers are busy enough and coping with more tax nonsense than they wish than to have encouraged the addition of more mazes into the tax law.

Ready return has been described as a good idea being plowed under by the tax return preparation lobby. That lobby is perceived as inimical to a free market, and as joining forces to conspire against the public. Yet, all things considered, tax return preparers and tax return preparation software don't carry prices that smack of monopolistic or conspiratorial
behavior. Consumer choice when it comes to finding a tax return preparer is orders of magnitude broader than when it comes, for example, to choosing a computer operating system. There is genuine competition among preparers and tax return software developers. The problem with applying market analysis is that it presupposes the government should be a player in the market. How, then, can a government protect the market when it's playing in it? Unless there is a reason for the government to monopolize a market (e.g., national defense), it ought to stay out of it.

ReadyReturn has been characterized as a move toward simplicity on the premise that a government employee has a vested interest in simplicity because it means less work. I disagree. I translate a desire for less work into a temptation to cut corners. And we know whose corner will be cut when that happens. Most government employees have a sense of "protect the revenue" built into their mind set by their training. The folks programming the computer aren't working in algorithms to determine if the taxpayer is claiming the correct number of dependents. Although the FTB request for full implementation would not include taxpayers with dependents, legislators who support the project want to expand it so that it does. All that the FTB could do is to list the dependents claimed on the previous year's return, because it does not have access to information about support, living in the abode, etc. But I wonder if its need for that information would open the door to government collection of even more information about every aspect of the taxpayer's life that affects taxes. Trust me, most things in life affect tax liability.

ReadyReturn has also been characterized as a program that would eliminate the business incentive of tax return preparers to understate tax liability in order to generate refunds, especially if being compensated with a percentage of the refund. Tax return preparer misconduct is not a situation running out of control; in contrast, at least one study has found that a "clear majority" comply with the highest tax return preparation ethical standards. That is not surprising, because there are in place sufficient incentives for tax return preparers to be honest. Penalties, prison, professional disbarment, and similar adverse consequences face the unscrupulous preparer. The problem is that the government has a miserable track record enforcing existing penalties against unethical preparers. Perhaps the FTB could stop trying to play tax return preparer and funnel some resources into helping law enforcement police the tax return preparation industry. Making the government the tax return preparer for low-income, and eventually middle-income taxpayers, on account of the misdeeds of the small number of preparers who act illegally is overkill. One question not asked by the FTB was, "Who do you trust more, the revenue department or your tax return preparer?" Somewhere in here I have visions of people being treated by government doctors, having their tax returns prepared by government employees, having their music censored by government bureaucrats, having their hair length set by government barbers, and so on. The words, "I'm from the government and I'm here to help you, uh, take over your life, because, after all, there are some not very nice people out there doing bad things preparing tax returns,." ought to send chills down the spine of every citizen. ReadyReturn increases dependency on government. That simply is dangerous.

Ready Return has been defended as protection against tax return preparers who advance refunds to low-income taxpayers at a very high rate of interest. Isn't usury illegal? Ought it not be? Ought not our government schools teach people not to borrow money at a high rate of interest and to report such transactions to the appropriate law-enforcement agencies? And if we are to worry about protecting taxpayers as consumers, why should revenue departments be presumed any better at protecting their customers (taxpayers) than are businesses in the private sector subject to all sorts of constraints and requirements designed to ensure consumer protection? It is rather ironic that ReadyReturn would be defended as protection against high-interest loans when governments think nothing of paying zero interest on overwithheld taxes that are refunded months after they've been collected. Casting government tax return preparation as the taxpayer's friend in setting appropriate interest rates makes little sense.

ReadyReturn has been hailed as a remedy for the difficulties faced by taxpayers when the preparer is "long-gone when the IRS asks for more information" or disallows a credit or deduction fraudulently obtained by an unscrupulous tax return preparer, because ReadyReturn provides the low-income taxpayer with more information with which to evaluate the analysis of their returns. Yet aren't these taxpayers perceived as needing the assistance of a ReadyReturn program because they cannot read, cannot deal with numbers, and cannot understand taxes? How are they going to do anything with the information supposedly provided by the FTB? How could the FTB possibly have more information than the taxpayer has? Users of ReadyReturn are put in the position of having a tax return prepared by the government that is presumed to be correct, and the burden of fixing an error is shifted to the taxpayer.

ReadyReturn has been described as a cost-savings rejection of "outsourcing" tax return preparation to the private sector, because it takes overhead and profit out of the cost of return preparation. The notion that there are no overhead costs to government programs makes no sense to me. Surely, ReadyReturn and the staff running it use electricity, water, and health plan benefits.

ReadyReturn removes third-party protection from taxpayer-revenue department relationships. Will one branch of the FTB audit the work of another branch? Isn't there a conflict of interest when the auditor is preparing the return to be audited? Absolutely. Has not a lesson been learned from Enron about the importance of independence? Apparently not.

ReadyReturn masks the problem. As I concluded in my October commentary on ReadyReturn, the solution to complexity is genuine simplification. To achieve that goal, complexity must be revealed for the economic and social drag that it is. The legislative addiction to special interests, of which complexity is a major symptom, requires withdrawal. Withdrawal needs to be discomforting. Enablers of complexity need to be identified, and should not be permitted to cushion the consequences of addiction that lull its victims into a false sense of security. Low-income taxpayers have no incentive to learn why the tax law has become such an agony to taxpayers unless they experience some of that agony. Sheltering low-income taxpayers, and eventually the middle class taxpayers the FTB and ReadyReturn proponents want to bring into the project, dampens criticism of the tax system, weakens the tax reform movement, and trims the number of citizens considering the tax law to be a problem.

Yet the advocates of ReadyReturn have a noble purpose. I think they genuinely want to help low-income taxpayers. I think some of them, at least, genuinely think that ReadyReturn is the answer. They mean well, and they have done society a service by bringing much needed attention to the dangers posed to society by tax complexity and to the aggravations afflicting taxpayers when they try to comply with those laws. Yet when reading reports that the taxpayers using ReadyReturn are happy, I wonder how much of that happiness is blissful ignorance? An informed and educated citizenry is essential to a democracy, and so long as the tax law is as it is, keeping citizens insulated from the reality merely guarantees perpetuation of the mess.
The urge to protect low-income taxpayers is not unlike the urge to protect one's child from falling off the bicycle while learning to ride. In the long run, the child must be allowed to fall.

I, too, deplore the increase in the need for paid preparers. The answer, though, is to make independent tax return preparation services available to all taxpayers who cannot afford those services, at least until the true need for tax preparation assistance is removed.

After arguing on a listserve that "The goal of helping low-income taxpayers can be achieved in less risky, more informative, and more effective ways," I was challenged to elaborate, and that if I've "got something better to offer," I should show my hand. Fair enough.

If there is going to be the expenditure of government funds to assist low-income taxpayers comply with the tax law, I'd rather see government pay the bill, thus keeping the third-party intermediary in the picture and thus keeping government honest and unconflicted. My experience with most (not all) state revenue department officials (and some IRS employees) is that they do not have the training or mind-set to prepare tax returns for low-income and middle class taxpayers as an advocate of the taxpayer. Paying the bill for independent preparers to do the job would keep the spotlight on the national disgrace (and threat to economic survival) that the tax law has become over the past three decades.

Therefore, the money and resources being expended by the State of California to program, design, implement, and operate ReadyReturn should be used to finance a "tax return preparation credit" to be claimed by low-income taxpayers (however defined) who pay tax return preparers to prepare their return (and perhaps by those who prepare their own returns though that raises a gross income issue). In this manner, the tax return is prepared by someone or some entity outside of government, which makes it less risky because it puts a second set (or maybe even the only set) of knowledgeable eyes on the return (assuming the low-income taxpayer isn't knowledgeable and assuming, as I do, that the government employees
programming, designing, implementing, and operating the program are insufficiently knowledgeable about the specific tax situation of each taxpayer to know what is best for the taxpayer and in at least some instances are not up to speed on the law). This approach is more informative because it lets low-income taxpayers remain aware of the complexity imposed on them by state legislatures and revenue departments (and if implemented at the federal level, by the Congress and the IRS). This approach is more effective because it would generate fewer situations in which the taxpayer return shows a tax liability higher than (or refundable credit lower than) what an independent tax return preparer would generate. The credit could be disallowed to taxpayers who use a state-funded volunteer tax return preparation service, such as VITA programs that do state returns.

Francine Lipman of Chapman University School of Law considered the tax return preparation credit in her article, "The Working Poor are Paying for Government Benefits: Fixing the Hole in the Anti-Poverty Purse." She rejected the idea because she concluded it "would encourage rather than discourage the use of paid tax preparers with more even benefits being shifted away from working poor families and their communities to paid tax preparers." So stated, that seems true, but from a different perspective the question is whether the FTB should use tax revenue to pay its employees to prepare returns or transfer those dollars to low-income taxpayers so that they can hire independent tax return preparers to prepare their returns. So viewed, the credit removes the conflict of interest, preserves taxpayer choice in selecting a preparer, and decreases the risk that the FTB prepared return would be accepted blindly by taxpayers.

I have as much faith in things working out well for individual taxpayers under any sort of "we'll take over, thank you, sit back and relax" government-run program as I do in things working out for the folks trying to make sense of the Medicare mess. In both instances people theoretically can get third-party assistance, but if they cannot afford it, they don't get it. That's why I prefer the credit. If it means more tax return preparers get more business, that's simply another symptom of the tax complexity mess. The solution is to fix the problem, and not put a leaky band-aid on a symptom.

During the past two months I have described some of the issues arising from a careful reading of the definition of qualifying child enacted by the Working Families Tax Relief Act of 2004. The original post, reflecting a step-sibling hypothetical I had crafted for my basic tax class, was followed by a discussion of other problems identified by the National Association of Enrolled Agents and an elaboration of one particular NAEA hypothetical with respect to which I backtracked and conceded that even where I had tried to define away the problem there indeed was one.

Frank Degen of the NAEA has alerted me to the fact that in the Treasury Department's "Blue Book" for the proposed 2007 federal budget, there is a proposal to deal with the qualifying child definition problem. After setting forth existing law, and then pretty much using the existing hypotheticals to explain why corrective action is required, the Blue Book describes the specific changes under consideration:

The proposal clarifies the definition of a qualifying child and who is eligible to claim these children.

Definition of Qualifying Child. The proposal would stipulate that a taxpayer is not a qualifying child of another individual if the taxpayer is older than that individual. However, an individual could be a qualifying child of a younger sibling if that individual is permanently and totally disabled. In addition, an individual who is married and files a joint return (unless that return is filed only as a claim for a refund) would not be considered a qualifying child for the child-related tax benefits, including the child tax credit.

Eligibility of Taxpayer for Child-Related Tax Benefits. If a parent resides with his or her child for over half the year, only the parent would be eligible to claim the child as a qualifying child. However, the parent could waive the child-related tax benefits to another member of the household who has higher AGI and is otherwise eligible for the child tax benefits. In addition, dependent filers would not be eligible for child-related tax benefits.

The proposal would be effective for tax years beginning after December 31, 2006.

Four quick comments:

1. I haven't yet examined the proposal to determine if it resolves all of the problems.

2. I note that the changes are more than clarifying, because they add some wrinkles that don't exist in the law as enacted by the Working Families Tax Relief Act of 2004.

3. The proposed effective date pretty much makes the legislation non-binding for taxable years before 2007. Where does that leave people who are struggling to figure out the correct answer? They can treat the legislation as guidance on existing law. Perhaps they can be favored with an IRS ruling or announcement that interprets existing law in a manner consistent with the proposed legislation.

4. Perhaps the proposal will be enacted. Perhaps it will not. Perhaps it will be enacted in altered form, making reliance on it (see #3 above) somewhat of a gamble.

In early October, I shared an extensive analysis of why academic blogging will change academic, including legal, scholarship. The debate over the role of blogging in the professional life of an academic continues unabated. The debate over the role of blogging in the professional life of a law professor is getting at least as much attention. It's time to look again at the situation.

What inspires this review is a National Law Journal article carrying a title that solidifies my October 2005 prediction: "Blogging law profs assault ivory tower," and which came to my attention on Paul Caron's TaxProf Blog. The article's sub-title, "Is it scholarship, or a cyber chit-chat?" sums up the discussion rather nicely, if not starkly. From my vantage point, it appears that the so-called traditionalists are beginning to sense the threat to their way of academic life that blogs, and technology generally, pose. Understandably, they seem concerned that the foundations of the think/write/publish routine to which they are accustomed and with which they are comfortable are beginning to crumble. The irony is that the approach held so dear by traditionalists probably isn't old enough to qualify as a tradition.

Here's a blast from one side of the debate: "They have nothing to do with scholarship," according to a professor at the University of Texas School of Law. Thank you, Prof. Litvak. I'm certain you have never examined the posts on this blog. I'll admit that some of my writing on MauledAgain isn't legal scholarship and I don't pretend that it is. On the other hand, I have shared thorough analyses of specific tax law issues. Although these posts don't drown in footnotes, or their equivalent, there are sufficient links to sources of law and other commentary to inform the reader who needs additional material. Of course, your definition of "legal scholarship" probably requires approval by second-year and third-year law students who know less about tax than they know about the other areas of the law even though they purport to select for publication the most appropriate articles addressing those areas. What most of those students do is to look up authors' law schools in the U.S. News and World Report rankings, and proceed accordingly.

Here's another blast from the same commentator: "Blogging has the presumption that you write something thoughtful, important and valuable. I don't think the medium allows that." What nonsense. When I write one of my deeply analytical blog posts, I go through the same process I follow when I write one of my Tax Management, Inc. portfolios, one of my books, or one of my law journal articles. I begin by thinking. The medium, Prof. Litvak, has nothing to do with that. Well, wait. If by "the medium" you mean the internet, it has a lot to do with that. I find and learn about issues much more quickly than in the days when print advance sheets wandered onto my desk days or weeks after the event. I find and learn about transactions and events that did not come to my attention in pre-digital days. So "the medium" gives me more about which I can think. Then I analyze. Once again, I go through the same process. My brain cells function in the same way. If there is a difference, it's that I have almost instantaneous access to what others are thinking, ideas that would not see, and do not see, the light of day in the world of student-edited, paper format reviews that often are too late to be of use. Sometimes I seek feedback, and learn far more from listserv discussion than I would chatting with the one or two members of my faculty who have expertise in my area of the law. Then I write. The difference is that when I'm ready to publish, I publish. I don't go begging to second-year and third-year law students who have little if anything to add to the analysis, and whose focus on the technical insanities of the Blue Book or whatever citation format directive is in vogue adds weeks if not months to the process without adding anything to the message. In other words, at least some of what I (and others) write on our blogs indeed is thoughtful, important, and valuable.

I suppose it's an awful feeling watch the world rush by. Is it helplessness? Is it fear? Is it clutching the last remnants of the pre-digital world hoping that somehow the tide can be turned back? What is it that causes the "traditionalists" to resist change? As I mentioned in my October 2005 post, I understand the plight of the untenured faculty member whose professional future lies in the hands of tenure committees and faculties dominated by traditionalists. But I don't understand the tenured folks who cling to what they did ten, twenty, or thirty years ago with the same tenacity that they grip their chalk and scribble on their blackboards, blissfully ignoring anything that has happened in law school pedagogy since 1985.

Some of it, I think, is a conviction that learning, and adapting to, the new world of law school publishing (and teaching) is beyond one's ability. More nonsense. When given the opportunity, my educational technology mentor (Henry H. Perritt, Jr., now of Chicago-Kent College of Law) was exceptional in leading the self-doubting but adventuresome faculty member into the twenty-first century. I've had similar opportunities, and although I'm not as accomplished as Hank, I've had some success. So, for me, there's no doubt that lack of ability has nothing to do with "traditionalists" who fear, resent, oppose, and avoid scholarship by blogging. Perhaps it has something to do with a perception of inability, not with the technology, but with surviving in a publishing world where the competitive balance has shifted.

Even some law professor bloggers are critical. A member of the Chapman University School of Law faculty claims that blogging does not lend itself to intellectualism because "It's not very thoughtful." Why? Does thoughtfulness exist only for things that proceed at a snail's pace? One of my late colleagues was well-known for spending enormous amounts of time carefully crafting answers to student e-mails. I challenge anyone to demonstrate that because he sent an e-mail in reply that he lacked thoughtfulness. There are times I spend hours researching and writing a blog post. If that is thoughtlessness, how does the end result contain so much well-reasoned analysis?

Perhaps it's a matter of recognizing the thoughtlessness of some blogging. But why then paint all bloggers with the same broad brush? Isn't that totally inconsistent with the widely accepted view in the law professorate that one should not stereotype others? After all, just because some law review articles are horrendous, and they are, does not mean all law review articles are terrible.

Fortunately, I'm not alone when it comes to advocating the long-needed change in legal scholarship. Professor Ann Althouse of the University of Wisconsin Law School "calls law review articles 'bloated and pompous' and 'a dinosaur of a writing model.'" She makes her point well. She argues that law review publishing not only is slow, but its tendency to cram dozens of footnotes onto every page makes the material difficult to read. Part of the problem with the footnotes is the culture of circular citation, which highlights the narrow arena in which law reviews play. Author A cites author B, who cites author C, who cites author D, who cites author A. Douglas Berman, who teaches law at Ohio State, calls the process "incestuous."

Not surprisingly, the best comments come from a practitioner. After all, these are the people who are making law every day, touching the lives of clients, dealing with reality, facing deadlines, and getting things done. Stanley Bernstein, a senior partner with a securities litigation firm in New York, said, "I don't need a think tank, I need advocacy." Despite having been a law review editor while in law school, Bernstein explained that he rarely uses law review articles. His explanation is a condemnation supreme: "By the time you need to use them, they are generally a year or two out of date."

The tide is indeed turning. According to the National Law Journal article, "[a]t least four federal circuit court opinions and more than 10 federal district court opinions also have cited Prof. Berman's blog. The latest count of law professor blogs, surely understated, is close to 200. I know it's understated because the newest blogs at Villanova haven't yet been catalogued by the counting sites.

Admittedly, some of the blog-bashers are no less harsh in their critiques of the traditional system. But when they advocate things such as peer-reviewed journals, they are doing nothing more than suggesting a jump from the sinking ship of law publishing to the similarly endangered publishing vessels of other disciplines. Where is the creativity? Where are the new ideas to match new technologies? Why not a system by which law professors read, review, rate, and goodness, perhaps even rank, law blogs? Why not a peer-review system of awarding tags of "good," "very good," "excellent," and "superb" to law blogs, perhaps classifying them by their purpose (such as new information, analysis, political opinion, etc.)? Why not? It's an idea whose time has probably come. And if law professors don't get together and assume responsibility for this sort of valuable law blog vetting, others will. Can you imagine the outcry over the U.S. News and World Report law blog rankings? If that is to be avoided, the American Association of Law Schools and the American Bar Association Section of Legal Education had best get the ball rolling now, and it had best roll at a speed far surpassing that at which traditional law publishing moves. Time, folks, is of the essence.

Reader James Butler has brought to my attention a story about two women, each of whom is donating a kidney to the other's husband. They are not donating to their own husbands because of blood type mismatches.

The two women connected through the Paired Donation Consortium, which facilitates matching between living donors. So far, the Consortium has registered 80 pairs of donors and recipients, leading to 12 kidney swaps already in place.

James, who is a tax lawyer, reacted to the story as tax lawyers do. He immediately saw the tax issues. He wrote:

It would seem each women is "donating" a kidney to the
other's husband in exchange for a like donation. While the IRS may never dare raise the issue, could this create taxable income to each couple? They aren't gifts since something is expected in return. There isn't a like kind exchange since this isn't a business or investment type activity. Selling a kidney is illegal but swapping them seems ok.

Is it taxable? If it is taxable, would it be income to the wife or the husband? The husband gets something of value in exchange for something given up by the wife. Maybe they are constructive gifts to the husbands followed by an exchange?

I think James gets an A for describing the black letter law. The exchange is not a gift because they each get something in return. Each has a basis of zero in the exchanged kidney. Each has an amount realized equal to the fair market value of a kidney. The like-kind nonrecognition rules do not apply because it's not a trade, business, or investment activity. No other non-recognition provisions are relevant. There's no exclusion applicable to the transaction. The lack of cash is not an obstacle to the taxation of bartered exchanges. Though James didn't mention it, IRS rulings with respect to the sale of blood and blood products suggest that the income would be ordinary income and perhaps personal services compensation income. There's no charitable contribution deduction because no charity receives the kidneys. The substance over form doctrine treats the exchange as a swap of kidneys between the two women, each then making a gift to her husband. My guess is that there are medical expenses, which ought to be deductible to the extent they exceed the 7.5 percent adjusted gross income floor.

That's the easy part. The tough question is whether the IRS would require taxation. What a heartless (ouch) approach to take. The IRS does have a track record in this area. So, too, does the Justice Department.

The first case is that of United States v. Garber, 607 F.2d 92 (5th Cir. 1979). Dorothy Garber learned, after the birth of her third child, that her blood contained a rare antibody useful in producing blood group typing serum. At the time she was one of only two or three people in the entire world with the antibody. A manufacturer of diagnostic reagents, Dade Reagents, persuaded her to sell to them blood plasma. The process involved withdrawing a pint of her blood, putting it through plasmapheresis to extract plasma by centrifuge, and returning the red blood cells to her body. Each appointment lasted from 90 to 150 minutes, generated a pint of plasma from two pints of blood, required injection of an incompatible blood type to increase the antibodies, caused pain and discomfort, and posed the risk of blood clots and hepatitis. Garber was paid on a sliding scale reflecting the strength of the plasma obtained in the particular appointment.

Eventually, other reagent manufacturers lured her away from Dade Reagents by offering higher prices for her plasma. She began selling both to Associated Biologicals and to Biomedical Industries. Both paid money for each extraction, and Biomedical also provided a salary, a leased automobile, and a bonus. At one point Garber was doing six extractions a month.

Although she reported the salary, Garber did not report the other payments as income, even though she received a Form 1099 from Biomedical. She did not receive such forms from Associated Biologicals. Consequently, she was INDICTED for willfully and knowingly attempting to evade a portion of her income tax liability by filing false and fraudulent income tax returns. She was convicted with respect to one of the years in issue, and sentenced to 18 months in prison, all but 60 days of which was suspended, placed on probation, and fined $5,000 in addition to her civil liabilities and penalties.

On appeal, the Fifth Circuit held that the trial court's refusal to admit the expert testimony of a CPA retained by Garber, after permitting the government's witness, an IRS agent, to testify that the transactions generated unreported income, was reversible error and remanded the case. The appellate court noted that besides the disagreement over the characterization of the transactions as performance of services or sale of products, there was disagreement in the latter instance over the valuation of the plasma. The court then made a total mess of its explanation by confusing basis and value and making some rather bizarre assertions:

The cost of Garber's blood plasma, containing its rare antibody, cannot be mathematically computed by aggregating the market cost of its components such as salt and water. That would be equivalent to calculating the basis in a master artist's portrait by costing the canvas and paints. No evidence of any original cost exists in the case of Garber's unusual natural body fluid.

In such a situation it may well be that its value should be deemed equal to the price a willing buyer would pay a willing seller on the open market. [citations omitted] If this were the proper basis, the exchange would be a wash resulting in no tax consequences.

Sorry, but the basis in a master artist's portrait IS the cost of the canvas and paints. Moreover, setting basis equal to value makes no sense in the absence of taxation. Nor does setting value equal to the price at which something would exchange on the open market establish basis. And they wonder why I continue to insist that basic federal income taxation should be a required course. We're talking some very core concepts.

The concurring judge, though agreeing that the trial court's evidentiary decision was reversible error, stated, sensibly:

Because I conclude that the transactions under investigation constituted services and the income derived therefrom taxable under 61(a)(1), I should have preferred that the court say so in positive terms. The question would thus cease to be a novel one for those considering it in the future.

The dissent, in which three other judges joined, concluded that there was gross income, pointed out that Garber had spent for personal purposes the portion of her fees that the payor had put into a savings account earmarked for tax payments, had not been told by the IRS that the payments were not income, and had not sought professional advice. The dissent agreed, though, with the concurring judge that the majority opinion did not provide appropriate guidance on the legal question of whether the payments were gross income. It pointed out, accurately, that if the payments were not gross income, the case should be reversed and the indictment dismissed, but that by remanding the case, the majority implied that the payments were gross income.

The good news: After the remand, the government dropped the prosecution. There's no record of whether Garber paid the unreported tax.

A year later, the Tax Court addressed the deductibility of various expenses by another plasma donor, Margaret Cramer Green. Green v. Commissioner, 754 T.C. 1229 (1980). In this case, Green was paid by Serologicals, Inc. for generating plasma through plasmapheresis. Green reported the amounts she received as gross income, offset by claimed business expense deductions. The court's analysis is most interesting, especially in light of the Garber opinions issued a year earlier:

Both parties to this case base their respective arguments upon the implied assumptions that petitioner realized income upon receiving payment for her plasma and that this income should be characterized as ordinary. Although these assumptions may seem obvious, since this case presents some novel legal questions, we feel compelled to lay a firmer foundation for our conclusions herein.

Clearly, petitioner realized income. Section 61 states that "gross income means all income from whatever source derived.4 Such sweeping language must be broadly interpreted to fulfill the intent of Congress to implement a comprehensive income tax. [citations omitted] Congress intended "to use the full measure of its taxing power." [citations omitted] Fulfilling this intent, the well-settled test for income is that enunciated in Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955), which looks for "undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion." The Fifth Circuit, to which appeal in this case would go, has followed this test as a search for lasting economic gain realized primarily by the taxpayer personally, [citations omitted] See also the Fifth Circuit's general discussions of this and other matters as they specifically relate to blood plasma sales in United States v. Garber, 607 F.2d 92 (5th Cir. 1979), revg. and remanding, on rehearing en banc, 589 F.2d 843 (1979), a criminal fraud case. All of these gains are taxable, unless specifically excluded. [citations omitted] Petitioner received the payments for her plasma directly, without any conditions subsequent which might require repayment of the funds or might control her use of the funds. The payments were not subject to any exclusion from income. [footnote omitted] The payments were gross income to petitioner under section 61.

Next, we must determine the character of the income realized by petitioner for her plasma. This income was not capital gain. Capital gain involves the sale or exchange of a capital asset. Section 1222(1) and (3). If petitioner's activity is viewed as the sale of property held for sale to customers in the ordinary course of business, petitioner's blood plasma, the property held for sale, is not a capital asset. Sec. 1221(1). On the other hand, if her activity is viewed as a service, her blood plasma is an integral part of that service and is not part of a sale or exchange. [citations omitted] Therefore, regardless of how the activity is viewed, it is not the sale or exchange of a capital asset and the income realized therefrom is not capital gain.

Nevertheless, the identification of the activity as either the sale of a product or the performance of a service is important in determining gross income and the deductibility of certain items in the calculation of adjusted gross income and taxable income, which is the general issue before us. Under the facts of this case, we find that petitioner's activity was the sale of a tangible product. From petitioner, who did little more than release the valuable fluid from her body, the plasma was withdrawn in a complex process by the equipment of the lab. Petitioner performed no substantial service. She was paid for the item extracted by the lab. Except for the unusual nature of the product involved, the contact between petitioner and the lab was the usual sale of a product by a manufacturer to a distributor or of raw materials by a producer to a processor. A tangible product changed hands at a price, paid by the pint.

The rarity of petitioner's blood made the processing and packaging of her blood plasma a profitable undertaking, just as it is profitable for other entrepreneurs to purchase hen's eggs, bee's honey, cow's milk, or sheep's wool for processing and distribution. Although we recognize the traditional sanctity of the human body, we can find no reason to legally distinguish the sale of these raw products of nature from the sale of petitioner's blood plasma. Even human hair, if of sufficient length and quality, may be sold for the production of hairpieces. The main thrust of the relationship between petitioner and the lab was the sale of a tangible raw material to be processed and eventually resold by the lab.

So is there any difference between the extraction of plasma and the extraction of a kidney? In both instances, the taxpayer "performed no substantial service."

Not only do these cases affirm what James Butler and I think is the black letter law result, they suggest, at least to me, that the IRS probably would require reporting of the gross income by the kidney-swapping women. Are the cases different? If one tries to distinguish Garber and Green by characterizing them as motivated by economic gain, one can treat each kidney-yielding woman as motivated by economic gain, namely a kidney for her husband. If one tries to distinguish the kidney-swapping women by portraying them as altruistic and generous despite the kidney being received in turn, one can note that Garber and Green endured discomfort, pain, and risk in order to help all those unidentified individuals who benefit from medical science's use of the rare plasma.

If the IRS does so proceed, the outcry might be overwhelming. In that case, Congress can amend the Code if it so chooses, to provide an exclusion. The IRS should not arbitrarily add an exclusion to the tax law simply because it might be a good idea.

It is doubtful that the kidney-swapping women would be permitted to claim trade or business deductions. Unlike Garber and Green, who had been undergoing plasma extraction for years on a continual basis, the kidney-swapping women were engaged in a one-time transaction. It is highly unlikely the one-time transaction would rise to the level of a trade or business.

I wonder if the kidney-swapping women have consulted their tax advisors. If they did, I wonder what the tax advisors told them. I am most curious. If you were their tax advisor, what would you tell them?