MauledAgain

Time to pick up on some news from last month that's been sitting in my "get around to blogging this" digital pile. Last month, according to several reports, including this one, France is ready to impose a tax on airline tickets. That's not news. Many countries and states impose taxes on airline tickets or otherwise tax air travel. The proceeds almost always are used to pay for the cost of operating the airports and to pay off the bonds floated to finance construction of airports and airport improvements. In that respect, these taxes are user fees. What's new with the French proposal is that the government plans to use the proceeds of the tax to fund the purchase of medicines for people afflicted with HIV, AIDS, tuberculosis, and malaria.

Support quickly came from Kofi Annan, Secretary General of the United Nations. Reportedly, the governments of Algeria, Brazil, Chile, Germany, and Spain plan to advocate an international airline tax administered by the U.N. Other countries have not responded with enthusiasm. Some oppose the idea. The U.S. opposes the idea but has promised not to block it. According to this report, 44 countries are involved in pushing the idea but only 18 are ready to implement it. Needless to say, the airline industry and the travel industry oppose the idea.

Initially proposed by French President Chirac, the tax is hailed as sensible because it would be easy to impose and allegedly "economically neutral," whatever that means. Here are a few of my reactions:

1. A tax should not be enacted simply because it is easy to impose. Protection money is easy to impose. That doesn't make it appropriate.

2. Air passengers, who ultimately would pay the tax, ought not be subjected to a user fee unless the proceeds are used to ameliorate the societal burdens created or increased by air travel. It would make sense to use the proceeds of such a tax to pay for the medical costs of dealing with hearing loss and diseases caused by jetliner air pollution.

3. Letting the U.N. have any role to play in taxation is as unwise as letting the U.N. have any role in the many projects it has undertaken without success. Which, unfortunately, is most of them. Note that I'm not opposed to a United Nations. I'm simply unimpressed by the track record of a United Nations that is more efficient with corruption than it is with peace-making, peace-keeping, and the other lofty goals that justified its creation.

4. A user fee to cure diseases ought to be imposed on the activities that cause or exacerbate those diseases. So, consider these:

a. Why not a tax on incompetent producers and workers whose failures cause stress (which in turn harms health). Perhaps one cent on Microsoft for each time a blue screen of death appears, and ten cents each time a flawed operating system security hole opens confidential data to hackers. Perhaps ten cents on every light fixture manufacturer whose product fails within one year?

b. How about a tax on contractors who promise to show up and work or promise estimates but fail to follow through? The stress that these no-shows generate surely accounts for all sorts of ill health.

c. Why not a tax on restaurant workers and food service employees who don't wash their hands and thus spread disease? Think spinach and e-coli.

d. Why not high taxes on industries that pollute, letting the marketplace decide if the industry will survive by passing through the taxes to consumers who are willing to pay because they want the product or service (e.g., coal burning electric generation plant) or will die because the real cost as reflected by the tax demonstrates the economic inefficiency of the product (e.g., imported toys containing lead)?

e. How about a tax on developers who build yet another unnecessary shopping mall or other construction project, leaving the resulting traffic congestion, and attendant pollution, and local infrastructure burden costs to fall on whomever happens to catch the fallout of yet more paved-over farmland?

f. How about a tax on politicians, government officials, and business executives whose lies, coverups, and thefts damage property, destroy lives, eviscerate pensions, or otherwise harm society?

g. How about a tax on people whose eating habits and failure to exercise contribute to poor health and disease and thus increase health care costs?

h. How about a tax on companies that sell food and other products that damage the health of U.S. citizens?

5. On the other hand, is it possible that the countries in question have nothing to tax other than airline passengers arriving and departing because the country has nothing much else in its economy that can pay taxes? If that's the case, what happens if the tax causes a decline in tourists and thus a decline in tourist revenue? There's this story about the golden goose.....

Now I have one more item to add to what once was my "Ten Reasons Not to Fly Commercial Airlines" list. Maybe I'll write that story some other day.

There is a gubernatorial race underway in Pennsylvania. Well, it's as much of a race as there would be if I tried to compete with Olympic-class sprinters in the 40 yard dash. The latest Quinnipiac University Polling Institute numbers put incumbent Ed Rendell ahead of challenger Lynn Swann 55 percent to 39 percent.

Last night, the two candidates faced off in a debate. High on the list of items tackled by the duo was the issue of tax reform in Pennsylvania. Ten months ago, in "Legislatures Take a Holiday From Taxes", I explained and commented on the Pennsylvania legislature's inability to reach a tax reform agreement. In June, after the legislature cobbled together a reform plan in which few have much confidence, I expressed my dismay in "New Pennsylvania Tax 'Reform' Doesn't Add Up." It didn't require all of my brain cells to suggest "Taxes the Highlight of This Year's Pennsylvania Gubernatorial Campaign?"

It's no surprise that Rendell pounded Swann on the latter's tax proposals. As I pointed out in "Taxation Swann Song Should Be Tackled for Loss," Swann's tax plan is "nonsense" and a "gadget ploy." Rendell's reaction to Swann's proposals was summed up in this quote: "It's not that he has no ideas, it's that he has bad ideas." I'd like to think Ed Rendell has been reading my blog. I doubt it.

Swann's performance in last night's debate did nothing to change my opinion of his tax proposals. Worse, it added to the list of reasons I don't think he's right for the job. Swann took Rendell to task, claiming that Rendell had backed off his 2002 campaign promise to reduce property taxes by 30 percent. Had Swann been careful in his reading and articulation, he would have understood that Rendell promised to push for that reduction. What Rendell understood, then and now, and Swann apparently doesn't, is that a reduction in property taxes requires action by the legislature. In his debate response, Rendell explained to Swann that the governor is not a monarch. His quote, "Well, Lynn, you'll learn that the people of Pennsylvania don't elect you king," is marvelous, because it shines some light on an attitude that is strengthening among some of those who hold public office in this country. What part of the civics course does Swann, like some of his like-minded political compatriots, not understand?

The notion that the executive branch should simply change tax law by decree also showed up earlier this week in a Wall Street Journal editorial that advocated implementation of inflation-adjusted cost basis through Presidential Order. Aside from the technical issues that cannot be solved in this manner, the idea that the Congress be bypassed, no matter how appealing the thought, is frightening. A good idea shows its strength by the power of the arguments its advocates make in its support. The notion of indexing basis for inflation, which I support despite the arguments to the contrary, is one that should be adopted only after the arguments in its favor and against the idea are set forth in a public forum that allows for the debate that characterizes a democratic political process. I suppose the folks who think the President can change the tax law by fiat adhere to the same philosophy as those who are telling Swann that as governor he simply could order a reduction in property taxes as he claims Rendell should have done. As I commented several months ago, Swann isn't getting good coaching. Neither is his D.C. counterpart, but let me not stray too far from the topic.

It's no surprise that the key to Swann's tax proposal, as I pointed out earlier, is his hope that the general fund can be raided to fund his plan. Cutting revenue while letting deficits pile up is something at which those presently holding power in Washington do with no apparent consternation, and at least one disciple wants to bring that short-sighted vote-collection game plan into Pennsylvania. It might not be the principal reason Swann is trailing so badly as the campaign enters its fourth quarter, but surely most Pennsylvanians are sharp enough to see through the play fake.

This time around, for me, dedication to higher principles trumps loyalty to party. Competence means more than political affiliation. Responsibility in making tax policy must not be shirked.

About a year ago, in "Hi, I'm from the Government and I'm Here to Help You ..... Do Your Tax Return", I criticized the California Ready Return project, characterizing it as not ready for prime time. Five months later, in ReadyReturn Not a Ready Answer, I renewed my criticism in an even more extensive analysis of the disadvantages of the program.

Now comes news relayed by Paul Caron's TaxProf Blog, that the California Franchise Tax Board has terminated the Ready Return program. Surely the debate over the merits of the program will transform itself into discussions of the reason. Was it the product of careful analysis by the Board not unlike what I, and others critical of the program, had undertaken? Was it simply a surrender to vested interests? Did members of the Franchise Tax Board read my posts on the topic and become convinced of the program's shortcomings? I doubt it. Though we probably will never know with certainty whether the decision was the result of analytical processes or lobbying by interest groups, I do predict that this development significantly decreases the odds of any proposed federal ready return program taking hold. At least not for quite a while.

Oh, how twisted politics has become. In a story released on Friday, NBC News Producer Joel Seidman spotlighted the depth of the relationship between lobbyist Jack Abramoff and White House Political Director Ken Mehlman, who now serves as chair of the Republican National Committee. Of course there is a tax angle.

In June, the Inspector General of the Department of Justice released a report that discussed the extent to which Abramoff was being fed information by Mehlman on U.S. Pacific Territories, two of which were clients of Abramoff's firm. In an exchange of emals concerning Abramoff's attempt to get the President's endorsement of Republican candidates in Guam, Abramoff refers to a conversation he had with Karl Rove.

Based on an electronic calendar entry, it appears that the conversation took place at a "Tax Policy Dinner" hosted at Grover Norquist's home. So, wrapped up in this morass of favors, endorsements, deals, and other shadowy transactions is a thing called a "Tax Policy Dinner." Hosted, no less, by one of the staunchest opponents of taxation to come along in a long time.

It is simply wrong for tax policy to be worked out at a private dinner to which only a select few are invited. When the deal is done before the vote is tabulated, what's the value of the vote?

Years ago, when I served as an attorney-advisor at the U.S. Tax Court, a group of us decided that we would not talk about tax issues during lunch. We wanted a break. A break from tax analysis, tax thought, tax writing, and tax ideas. The last thing I want to discuss during a meal, dinner or otherwise, is tax. Why ruin good food and wreck one's appetite?

Apparently the movers and shakers with the money and power, who make decisions in the back rooms, corridors, and dining salons, think I'm wrong, and that tax and food go well together. To me, a "Tax Policy Dinner" packed with lobbyists is certain to generate more of what we've seen during the past two decades, things that grill the average citizen, slice and dice paychecks, and sweeten the tax rates for the wealthy. If the trend continues, the tax system will be toast.

The question posted to the listserv was described by the person posing it as "obvious," but I immediately recognized it as a symptom of one of the many reasons tax law is complicated and intimidating to students trying to learn it. The question? "Would meals en route during a move meet the qualified moving expense definition? The Code at IRC 217 suggests not but the regs and the applicable Pub. say yes; at least, that is my initial take on it."

When there is a discrepancy between the Code and the IRS regulations, rarely is it an error. Almost always it arises from the delay between the time changes are made to the Code and the time regulations are issued by the IRS. In the case of the moving expense deduction, the Code was amended in1993 to remove meals as a qualified moving expense. The Regs were last amended in 1972, and have not been amended since that time. Why? The Congress dumps hundreds of tax law changes on us every year. The IRS lacks the staff to push out regulations sufficient in quantity and quality to interpret the steady flood of Congressional tinkering with the tax law. So the lowest priority is assigned to regulations that would say what one expected. In this instance, the change to the regulations would be a tedious and intricate removal of all references to meals as qualified moving expenses.

Check out the personal and dependency exemption amount in the regulations under section 151. It's the very old $600 amount. It drives my students crazy. They ask, "Why do you make us read it?" I reply, "Because aside from the number change everything else in the assigned portion is relevant." They understandably rejoin, "Why hasn't it been changed?" That opens the door for me to explain that it's not as high of a priority for the IRS because it presumes taxpayers and tax professionals can replace the $600 with the appropriate exemption amount while they are reading the regulations.

Another time-lag discrepancy between the Code and the regulations involves the standard deduction and personal exemption. Many years ago, people who had attained the age of 65 or who were blind qualified for an additional personal exemption. The IRS duly issued regulations under section 151 defining blindness. Twenty-some years ago, Congress replaced the additional personal exemption for these individuals with an additional standard deduction, which is in section 63. The IRS has not yet moved the definition of blindness from the section 151 regulations to the section 63 regulations. Students in the basic tax course find that dealing with this discrepancy adds one more aggravation to what already is the most challenging basic course in the curriculum. Eventually, tax practitioners get accustomed to some of the nonsense caused by the lag, but too often something can be overlooked. That's when serious problems can emerge.

As for why the IRS Publication on the moving expense deduction is out of date, I have no answer. The IRS is usually pretty good about updating those very quickly, just as it is, and must be, prompt in updating tax forms to reflect tax law changes. With all the changes getting tossed into the IRS in-box, it's surprising that there aren't even more things that get missed.

As I tell my students, the tax law is dynamic. It's not static. One must learn not only the rules, but the analytical process, because the rules change. What I also must explain to my students is that because the different parts of the tax law change at different speeds, the course can be compared not only to quantum physics, as some students suggest, but to chaos theory.

I have no high regard for the members of Congress who participate in, and have participated in, the repeated scrambling of the tax law. I cannot escape the impact of their bad judgment. In the space of two days, I saw and responded to the question about the discrepancy between the Code and the regulations, I took the basic tax course students through the social security gross income computation nonsense in section 86, and worked my way through the numerous changes to section 170 enacted by the Pension Protection Act of 2006 so that I could update the Charitable Contribution Deduction portion of Tax Management Portfolio 503. If Congress wants to earn my tax respect, these experiences aren't going to suffice. Of course, I doubt Congress cares very much whether I, or perhaps anyone else, has tax respect for it. We are so well served, aren't we? Only as I wrote that question did I remember the topic of my last post, "So Explain Again What It Is That Taxes Are to Provide?" If this is the best the species can do, someone had best revoke the "sapiens sapiens" nomenclature. Maybe the dolphins can do better.

In the great debate about taxation and its purposes, one of the justifications and explanations for the imposition of revenue collection by governments is that governments provide services to their citizens. In effect, taxes provide a means for a society to distribute costs of government activities that benefit citizens in a manner that cannot be determined, or at least cannot easily be determined, by a marketplace. Usually, defense spending is proposed as an example of why user fees, for example, cannot totally replace income, sales, consumption, and similar taxes.

Three stories that emerged during the past week compelled me to wonder whether the realities of taxation are drifting even further away from the theories. It might be worthwhile requiring every high school and college student to study and discuss these stories for several hours before the end of the calendar year.

The first story consists of at least a half dozen articles published earlier this week by the Philadelphia Inquirer, in which several reporters analyzed the National Flood Insurance Program, a flood insurance enterprise funded by taxpayers. According to one of the stories, the program is $20 billion in debt, and would be bankrupt if it were a private enterprise. One of the principal reasons for its financial distress is the practice of providing flood insurance to properties that are in flood-prone areas. In some instances, property owners have collected flood insurance more than four times during a two-decade period. The program operates without financial reserves, something no private insurance company is permitted to do. Why? In theory, premiums would cover costs, and in years of high losses, the Treasury would lend money to the program. This is the Treasury that borrows from China and from the social security trust funds. Hmmm. Worse, the program provided huge discounts to properties on which construction took place before flood plain mapping became common, losing more than $1 billion a year in premiums. That alone accounts for most, if not all, of the program's debt. Why does the government continue to finance flood insurance for properties certain to be flooded? Why do the owners not leave? One owner explained that he does not want to leave the spectacular river views, and stated he is "thankful" for the federal flood insurance program. No kidding. With annual premiums of $1,000 or less, and payoffs in five and six digits, there's no financial incentive to depart. There's even less reason for developers to avoid building in flood-prone areas. One of the geologists quoted in the article put it nicely: "I see little reason for the public to subsidize private folly. If people want to live in floodplains, let them do it at their risk, not the public's risk."

The second story is the news that more than 1,000 taxpayer-financed laptop computers have vanished from the Department of Commerce during the past five years. That's just one department. Aside from the need to spend tax dollars to replace the stolen computers, all sorts of private personal information has found its way into the hands of those who have the laptops. Why am I not comforted by the words of the member of Congress who chairs the House Committee on Government Reform? Who agrees with him when he says, "We don't know exactly how many computers were lost or whether personal information was compromised. The secretary has assured me that getting that information is priority number one, and I'm confident he'll get his arms around the problem." We should rest easy? Not. Consider the next bit of information. The number of missing computers at the Department of Commerce could "increase significantly" once the inventory of handheld computers is undertaken. Toss in the loss of a computer a few months ago by an employee of the Department of Veteran Affairs, the loss of laptops by the Federal Trade Commission that contained individuals' account numbers, and the loss of computers at the Department of Agriculture, and then decide how well served citizens are by this pattern of behavior.

The third story comes out of California, just to prove that it's not only federal taxes that are put to questionable use. The California Franchise Tax Board has had to notify more than two hundred corporations that their tax information was emailed by an employee to a distribution list that included journalists, reporters and other media employees. It was an accident, we're told. One media outlet which received the list, explained that it contained names of taxpayers and their identification numbers. The official position? "Clearly, this is an unfortunate incident." That's the reaction of a spokesperson for a member of the Board. Wow, we wouldn't have been able to figure that out for ourselves.

Though some might explain away these examples of the chasm between justification and practice as mere manifestations of unavoidable inefficiencies in taxation, I disagree. Inefficiency is one thing. Stupidity and carelessness is another. Citizens who pay taxes have every right to expect that the government collecting and using them does so appropriately. Throwing dollars down the flood drain and financing the unwise location decisions of a select few individuals and businesses is not appropriate. There is no benefit to society when people park their possessions in the certain path of raging floods. Spending millions on computers and not taking steps to account for their whereabouts and secure them is not appropriate. It's wasteful. Failing to train employees to use great care when handling citizens' personal information and failing to implement safeguards to prevent deliberate and accidental release of confidential data is not appropriate.

It's no wonder that there are anti-tax movements, and efforts to shrink or even eliminate government. These stories make it difficult to defend the concept that taxes are collected so that society can protect itself, better itself, and improve the condition of its members. These stories make it too easy for people to argue that they're tired of paying taxes to fund stupidity and carelessness. Others might reply that taxes have been funding stupidity and carelessness since the dawn of human history. That's probably true, but it's no excuse to tolerate its survival. Unless, of course, legislatures enact user fees imposed on government officials and employees who do stupid or careless things. Wouldn't that tax code be fun to draft?

It didn't take long for Andrew Mitchel to show that he is not going to rest on his laurels as the unchallenged champion of tax chart web publishing. Still another batch of charts has been added to his growing collection of visual aids to understanding Code provisions, cases, rulings, and other tax concepts. The total is now 330. Here's the list of the new additions:

Cases

1. Arrowsmith (Relation Back Doctrine)
2. Dover (Check the Box & Sell)
3. Falkoff (Return of Capital Distrib'n in Anticipation of Future Profits)
4. Handfield (Canadian Manufacturer Had a Perm. Establishment in the U.S.)
5. Lessinger (357(c) & Basis in Taxpayer's Own Note)
6. Mills (B Reorganization: Cash in Lieu of Fractional Shares)
7. Peracchi (357(c) & Basis in Taxpayer's Own Note)
8. H.K. Porter Co. (Worthless Stock: Liquid'g Distrib'n Only On Pfd Stock)
9. Spermacet Whaling (Whaling Exped. Not Engaged in a U.S. Trade or Bus.)
10. Woodsam Assoc. (No Gain Recog'n on Debt Conver. from Recourse to Non-Recourse)

Revenue Rulings

11. Rev. Rul. 54-105 (Indiv. Purch. & Sale of Prop. in Foreign Currency)
12. Rev. Rul. 55-440 (368(c) Control - Pfd Shs Called But Not Surrendered)
13. Rev. Rul. 56-184 (Pre-B Reorganization Cash Dividends)
14. Rev. Rul. 57-518 (C Reorganization Substantially All of the Properties)
15. Rev. Rul. 58-93 (A Reorg With a Drop (But Drop Precedes Merger))
16. Rev. Rul. 66-112 (B Reorganization with Contingent Consideration)
17. Rev. Rul. 66-224 (Cont. of Int. with Diff. Consideration to Diff. S/Hs)
18. Rev. Rul. 68-43 (Deemed Stock Dividend on 351 Exchange)
19. Rev. Rul. 68-298 (351 Exchange & Distribution to Shareholder)
20. Rev. Rul. 70-269 (B Reorganization: Substitution of Options)
21. Rev. Rul. 72-135 (Nonrecourse Loans Rechar'd as Contrib'ns to Capital)
22. Rev. Rul. 72-350 (Equity Advance Creates No Partner Debt Basis)
23. Rev. Rul. 89-101 (355 Spin-Off To Reduce Foreign Withholding Taxes)

Section 902 & 904 Examples

24. Effect of Liq'n on Pre-1998 Foreign Taxes Paid by 4th Tier Corp
25. Section 902 Deemed Paid Credits & Section 904(d) Look-Thru
26. No Look-Thru for Interest (40% Ownership)
27. Look-Thru for Dividend (40% Ownership Between CFCs)
28. Look-Thru for Dividend & Interest (80% Ownership)
29. Look-Thru But No Section 902 Credits
30. Look-Thru for Dividends Between Members of Qualified Group
31. Commissioner's Reconstruction of 10/50 Corp's Histor. Earnings & Taxes
32. Commissioner Unable to Reconstruct 10/50 Corp's Historical Earnings & Taxes

Subpart F Income - Pro Rata Share Regulation Examples

33. One Class of Stock
34. Common and Preferred
35. Two Classes of Common Treated as One Class
36. Two Classes of Common & One Class of Preferred
37. Common & Preferred: Discretionary & Non-Discretionary Distrib'n Rights
38. Restriction on Common Dividends is Disregarded
39. Redeemable Preferred
40. Common and Preferred
41. Certain 304 Transactions

Section 1248 Proposed Regulation Examples

42. Sale After 351 Exchange of Property
43. Sale After 351 Exchange of CFC Stock
44. Sale After 351 Exchange of CFC Stock to U.S. Subsidiary
45. Sale After Foreign to Foreign C Reorganization
46. Sale After Triangular C Reorganization
47. Sale After Triangular C Reorganization
48. Sale After B Reorganization
49. Sale After Upstream C Reorganization
50. Sale After 332 Liquidation

For those needing cross-references to my previous commentary on Andrew's chart work, look here, here, here, here, here, here, here, here), here, here, here, here, and here.

Andrew continues to welcome comments on his charts. You can contact him through his web site. For direct access to the charts, you can enter by Topic, by Alpha-numeric order, or by Date uploaded . If you don't see a chart you think should be in the collection, send Andrew a nomination for another chart. Three hundred thirty may sound like a lot, but there are more than three hundred thirty code sections, regulations sections, cases, and rulings. I think the tax law is sufficiently voluminous that Andrew will be busy for at least a few more years, and probably many more.

In this morning's Philadelphia Inquirer, Andy Cassel enlightened his readers on the Growing Market for Euphemisms. His column is a must-read. Usually Andy makes me think. This morning he had me thinking and then laughing. Andy points out that euphemisms are designed to blunt the impact of the message that could be carried with more descriptive words, that euphemisms have a limited shelf life, and that they originate in the "basic human need to fudge."

Years ago, after I commented in class that compliance with political correctness made speaking in a grammatically correct manner more difficult and that it often hid the reality of the situation, a student brought me a present: "The Official Politically Correct Dictionary and Handbook" by Henry Beard and Christopher Cerf. I learned that I was hair disadvantaged, optically challenged, and according to some, differently interesting (i.e., boring). The first section of the book begins with the definition of Ableism (coined at the college my daughter attends, and referring to the "oppression of the differently abled, by the temporarily able.") The third section tells us that some feminists reject words derived from Greek or Latin because those languages can "be seen as accoutrements of male privilege" (quoting Francine Wattman Frank and Paula A. Triechler in "Language, Gender and Professional Writing") but notes that in earlier centuries these languages were "denounced ... as feminizing influences threatened to destroy the robust masculinity of Anglo-Saxon English." Take away all the words in English with Latin and Greek origins, and what's left? The words of the Vikings? And they lacked accoutrements of male privilege? Right.

Though some of the words in that book continue to be used by some people, it's time for me to get John Walston's "The Buzzword Dictionary," which Andy reviews in today's column. Of particular interest to tax folks would be the term "negative profit," which means nothing more than the simple, shorter word "loss." A phrase with "negative" in it cushions the impact of the word loss? I do like, though, the phrase "percussive maintenance," which refers to the centuries old practice of giving something a whack to get it going again. Sometimes I need percussive maintenance on my brain when I awake in the morning.

For the teachers, the new cover phrase for "failure" is "deferred success." Apparently it replaces the phrase defined in "The Official Politically Correct Dictionary and Handbook": incomplete success, a term brought to us by Jimmy Carter in 1980 to describe the outcome of the Iran hostage rescue attempt. Another new term, of interest to teachers and parents alike describes what school children are watching when they get home rather than doing their homework: zitcom. I'm sure, though, that somewhere in "The Official Politically Correct Dictionary and Handbook" is a term that redefines acne, so zitcom might be even more transitory than most euphemisms.

The one that made me laugh was "information architect." I have a friend who is, so it appears, an information architect. I've never referred to her in that manner, nor has she ever described herself with those terms. We're content with the word "librarian." It's a fine word. Can you imagine Meredith Wilson trying to pen the lyrics to "Marian the Information Architect"? Nah, wouldn't have worked.

There's more news on the refund anticipation loan front, which I addressed last month in Should Tax Refund Anticipation Loans Be Blocked? and Tax Refund Anticipation Loans: Part II. John Flanagan passed along a tip to a report about the formation by H&R Block of H&R Block Bank.

The new bank will offer low-cost and free bank accounts and related services to its clients. H&R Block will arrange for direct deposit of tax refunds into the taxpayers' Block Bank bank accounts. This should eliminate fees for refund anticipation loans and the charges incurred by people who cash checks at check cashing services because they don't have bank accounts. What isn't clear is what will entice people who avoid banks to overcome whatever it is that gets in the way of using banks.

Perhaps it will be the shorter wait for tax refunds using direct deposit. Perhaps it will be the lower fees. Perhaps it will be the H&R Block Emerald Pre-Paid Card. Or the lack of no overdraft fees and the absence of a minimum balance requirement.

H&R Block also announced that the fees for a refund anticipation loan will be reduced. The average APR will be reduced in many instances to 36 percent, which seems high but is lower than what has previously been charged.

It appears H&R Block has been listening while the critics have been talking. Only time will tell if Block Bank cashes in with its intended clientele.

Last week, in Tax Law Professor Aiming for the Senate, I asked whether any tax law professors had served in Congress before or after teaching law. I had two responses.

Jeff Jacobs pointed out that Tom Campbell had served in the Congress after teaching at Stanford Law. Jeff wasn't sure whether Tom taught tax courses. I cannot find any information on what he taught while on the law faculty. He's now on the business school faculty. His listed scholarship includes labor law, antitrust, and economics, but not tax law.

Linda Galler responded with a reference to Hilary Clinton, who taught law at the University of Arkansas, apparently for one year. I haven't been able to find anything listing tax as one of her subjects.

My post asking Should a Tip Be Excluded from Taxation as a Gift?, in which I concluded that answer is and should be "no", prompted a response from Jeff Jacobs. His comments are so well articulated that I repeat them here, with his permission:

Jim,

Thanks for the insightful comments, as we have come to expect from you and your blog, about the income tax consequences of the recent $10,000 tip to the bartender. Yes, I agree with you that it will be difficult for Cindy Kienow - even in the aftermath of Marrita Murphy's successful attack on the constitutionality of income taxation - to characterize the $10,000 she received from a customer as a gift. Tax advisers should counsel her to include the full amount of the tip in her gross income, based on the Ninth Circuit's decisions in Olk (1976) and Roberts (1949) as well as the Supreme Court's opinion in Duberstein (1959).

But I believe the 'real' tax controversy in this situation involves JS Enterprises, owner of the Applebee's in Hutchinson, Kansas, where Ms. Kiernow tends bar. There is no question that tip income - while often paid directly to the employee from a customer - is, in fact, imputed wages. As a result, since January 1988, employee tip income has been treated as employer-provided wages for purposes of the Federal Insurance Contributions Act (FICA), as if those tips were wages paid directly to the employee from the employer.

In other words, one-half of the FICA tax burden on the $10,000 tip is borne by the bartender, while the other one-half of the tax (7.65%, or $765 in this instance) is a "contribution" by the employer. Of course, I have no idea about Ms. Kiernow's annual wages. But, after preparing taxes over several years for well-compensated bartenders and waiters at expensive restaurants (such as Le Cirque in Manhattan and Bookbinder's in Philadelphia), I can observe that it may be possible that she has exceeded the taxable wage limit for the Social Security portion of the FICA tax (OASDI; $94,200 in 2006). Which means that she - and her employer - will "only" be subject to the Medicare portion (1.45%) of the FICA tax.

The employer's tax liability is slightly mitigated - and is greatly complicated - by the fact that Congress was somewhat sympathetic to the plight of restaurant employers, when it enacted the Omnibus Tax Reconciliation Act of 1993 (P.L. 103-66). You will recall that, instead of repealing the employer-paid FICA tax on tips, Congress added IRC sec. 45B to the Code, providing those employers operating food and beverage establishments - such as JS Enterprises - with an INCOME tax credit to offset the employer's already-paid FICA tax on any reported tips in excess of tips used to support a tip credit. As a result, it is even more difficult to calculate JS Enterprise's potential tax liability resulting from the tip that Ms. Kiernow received.

Yet, it is worth noting that the restaurant owner's liability:

a) would not need to be allocated among the other "tipped" employees, so long as it exceeded 8% of gross receipts.

b) probably falls within the special rules of IRC sec. 6053(c) for so-called large food and beverage establishments, where tipping is customary and where more than ten "tipped" employees were employed on a typical business day in the preceding calendar year; and

c) is unaffected by the line of cases culminating in the Supreme Court's 2002 decision in Fior D'Italia, 536 U.S. 238, since those controversies involved UNREPORTED tip income.

Bottom line: the other blogs have taken up the cry of "stealth tax" on behalf of bartender Kiernow. Who will take up the cudgel for her employer, if not you?

Regards, Jeff

Yes, I totally missed this aspect of the $10,000 tip event. Apparently everyone else save Jeff also missed it. He's correct, that trying to figure out if the section 45B income tax credit offsets the employer's FICA tax on the tip (somewhere between $145 and $765) is impossible without additional facts. Check out, for example, how the section 45B credit is calculated. Section 45B(a) provides that the employer social security credit equals the excess employer social security tax paid or incurred by the taxpayer, that is, the employer, during the taxable year. Turning to section 45B(b), we learn that the excess employer social security tax is any tax paid by the employer under section 3111 (the employer portion of FICA) with respect to tips received by an employee during any month, to the extent the tips satisfy two conditions. First, under section 45B(b)(1), they must be deemed to have been paid by the employer to the employee under section 3121(q), without regard to whether they were reported under section 6053. Section 3121(q) provides that tips received by an employee in the course of employment are considered remuneration for that employment and are deemed to have been paid by the employer for purposes of section 3111. Section 6053 is the provision requiring employees to report tips to employers. Second, under section 45B(b)(2), the tips include only the portion that exceed the amount by which the wages paid by the employer to the employee for the month, aside from tips, are less than what would have been payable at the applicable minimum wage. That's a bit simplistic. Technically, the benchmark is the wages that would have been payable "at the minimum wage rate applicable to such individual under section 6(a)(1) of the Fair Labor Standards Act of 1938 (determined without regard to section 3(m) of such Act)."

What were the bartender's non-tip wages for the month? Will her income exceed the OASDI limit for 2006? Does JS Enterprises have sufficient income tax liability to make use of the section 45B credit this year? Depending on the answers to these questions, the employer may receive a credit that fully offsets the employer's FICA tax on the tip. Or it might not.

As students learn in the basic federal income tax class, what seems to be a simple transaction can trigger one or more complex tax law analyses. In this instance, a $10,000 tip requires analysis of the employee's gross income for income tax purposes, the employee's wages for FICA purposes, the employer's FICA tax liability with respect to the tip, and the computation of the employer's section 45B credit. Each of those analyses requires further determinations, such as the applicable minimum wage rate and the employee's total wages. And all of this hardly speaks to the procedural and reporting aspects, such as the employee's obligation to report tips to the employer, the employer's obligation to furnish statements to the employee and the IRS, and the filing of a variety of forms by all involved.

I tell my students that there is little, if anything, one can do in life that escapes taxation. Tax, I remind them, is everywhere. Fortunately or unfortunately, only a few of us are pondering tax ramifications as we engage in a conversation, activity, or event. As I noted in Looking for Tax in All the Wrong Places?, it has been said of me, "Maule himself not only understands the tax structure, he sees evidence of it pretty much everywhere." Indeed.

Rather than jamming five or six posts into one day's worth of blogging, I let the ideas line up and wait their turn. I juggle the sequence, and followup posts sometimes go to the back of the line if they don't emerge within a day or two of the original post. Today I look back at Labor Day: (Almost) Everyone Gets a Chance to Work ... In Law School, considering some thought-provoking comments and inquiries, including some from Andrew Oh-Willeke. His observations, in particular, encouraged me to clarify my advocacy of opening the first-year of law school to all applicants save those with serious practice admission impediments, such as criminal records, and to raise the standards for letting students move to the second year of study.

1. I recognize that there are physical limitations to the number of students that a law school can admit. Absent expansion of the building facilities, there are only so many classroom seats. I expect that reduced numbers in the second and third year classes will open some spaces, and I also expect that scheduling classes throughout the day and throughout the week will maximize use of the facilities. Most law schools can handle larger classes than they plan to have present, as demonstrated by the many instances in which yield increases so that the number of enrolled admittees exceeds expectations. Eventually, the law school market would sort itself out, with some schools opting to add several classrooms to accommodate larger first-year classes, and other law schools maintaining or shrinking their enrollments.

2. Andrew's point about the impact of open (or near open) admissions on state school budgets is an important one. He explains that state subsidies ought not be invested in the education of students who are less likely to become lawyers. I wonder, though, if there also is an obligation for a state that subsidizes legal education to provide a genuine opportunity for more applicants because among those applicants are some who will excel and become excellent lawyers. Unfortunately, among those who graduate from state-supported, and other, law schools under the present system are too many who fail miserably at law practice or who leave when, having been cushioned by the less rigorous and demanding experiences of most late 20th and early 21st law school courses, they discover that the practice of law is more difficult and challenging than the toughest law school course. All of this aside, I think that a state-supported law school could increase admissions by some quantum amount without increasing its costs beyond the net additional tuition revenue. Reflecting economy of scale, the arrival of another x students would not increase certain expenses (heat, air conditioning, faculty salaries) and could defray other expenses (adding, for example, one new faculty). I wonder if there is a high subsidy cost to the state when more students are given the chance. I doubt it. Those who can't cut it will leave, perhaps late in semesters when they will get little or no tuition refund. At the same time, with appropriate evaluation of students, the state subsidization of students who aren't qualified will be reduced, as the present culture of "once in law school you graduate barring some outrageousness" is retooled. In other words, it cuts both ways, and I think it is possible to do this without raising the cost to the state. The state, in subsidizing these legal educations, has just as much interest in seeing the most capable be subsidized, and that interest dovetails with the principle of giving everyone a chance and then letting those successful in the first year continue.

3. Much of the change revolves around the concept of "chance." Admissions offices admit students using data, mostly numbers, that suggest an applicant's odds of successfully finishing the program. Advocates of current admissions policies argue, sensibly, that students with a greater chance of success should have priority over those with less of a chance. But because we're dealing with "chance" I prefer dealing with genuine law school examination and test results rather than with scores from tests for which applicants cram, and that accordingly do not reflect a law student's true diligence, academic maturity, and professionalism. If law faculty were more dedicated to evaluating students throughout the semester, and not just at the end with one "sink or swim" examination, the culling process could begin early, and the identification of students who have what it takes even though they don't score well on standardized tests or had a difficult sophomore year in college for unavoidable legitimate reasons (such as death in the family) would be easier to accomplish.

4. Whether a law school applicant projects to be someone who can pass the bar examination ought not be a factor. Currently, law schools try to predict who will succeed in law school, and presume that success in law school corroborates with passing the bar exam, even though law schools know that a significant percentage don't pass that exam. By opening admissions and letting students prove themselves, the odds of finding the most successful increase significantly because instead of guessing (educatedly or otherwise), the schools get to see what the student can do "on the field." If some students still fail the bar, that's another question, chiefly, whether legal education matches up well with the demands of the profession as manifested by bar exams (and the other fun question, of whether bar exams are properly designed and scored to evaluate whether a bar candidate is prepared to practice law). Both of these questions bear on the mismatch between law school/bar exam and practice, a point that Andrew raised and that readers of this blog know I have also made.

5. Andrew suggested that because there is a public need for people credentialed to practice law in a restricted specialty area, people unable to risk the time and cost of law school could "make a safer bet" while finding another path to a career in law. I disagree. I think that evolving business and other practices makes it impossible to restrict one's practice to a narrow area. Domestic relations not knowing tax, torts, privacy, and criminal law? Estate planner not knowing tax, domestic relations, and business organizations? And so on. Toss in subjects such as procedure and, ethics, add in some writing and advocacy courses, and we're back to at least a three-year curriculum. Many malpractice situations arise because lawyers narrow themselves, don't pay attention to what they think were the "extraneous" law school courses by not getting good CLE in those areas, and then get hit by the peripheral issue. I do think that paralegals fulfill the objectives you describe, and they are very prevalent in some areas, such as estate administration, litigation preparation, and some others. I do agree that there is room for expansion by paralegal institutes.

6. Ironically, my proposal is totally at odds with what some law schools now do in order to manipulate the numbers used in one or more of the various ranking systems in place to rate law school quality. Schools limit initial admissions so that they end up with a first-year class with high numbers. Then they generously admit transfer students to recoup the tuition dollars lost by limiting their first-year classes. One school does this to a degree that is unconscionable. It is deceptive, causes problems for other schools, and considering the identity of the school most engaged in this practice, inconsistent with its stated mission. Ironic, isn't it, that yet one more proposal to reform legal education would be unacceptable to many law schools because they're grubbing for the rankings money.

There are times, when the enrollment cycle is "down," that in theory anyone who wants to go to law school can do so by attending a very low-tier school. When the enrollment cycle is "up" there are applicants who are rejected by all the accredited schools to which they apply. No matter where the cycle is, in practice many people cannot go to any law school because of geography, money, or some other factor. Law schools have an obligation to widen the door of opportunity and to raise the standards for advancement to the second and third years. Not only is there a public benefit in casting the net wide in search of good lawyers, admitting students that would otherwise be put on a wait list and then cast adrift might bring the law school a star. As crude as it sounds, that star may end up as the typical "C student makes the money" graduate who in later years becomes a benefactor. Not that this should be the driving force, but it does indicate that law schools sometimes cut off their noses to spite their faces.

The news wires, blogosphere and even discussion boards are all abuzz about the bartender who received a $10,000 tip. Most of the stories, such asthis one and this one provide the same facts. Unfortunately, for those whose angle on the tale is an inquiry into the tax consequences, there's probably not quite enough for some tax practitioners to resolve the tax question. Does the bartender have $10,000 of gross income?

The basic black-letter tax principles are simple enough. Under section 102, gifts are excluded from gross income. There is case law that suggests tips are gross income as a matter of law, and there is case law that suggests there could be circumstances in which tips are not gross income, but no case has ever so held. The Tax Court, in Bevers v. Comr., 26 T.C. 1218 (1956), stated:

What is material, however, is the fact that the sums in question were received [*1221] by him as an incident of the services which he performed. They were obtained as the direct result of his employment. Had he been merely an observer, taking no active part in these games of chance, he would not have received the side money. It came to him in his capacity of dealer, and therefore we can only conclude that it represented gains derived from his labor as a dealer.

In Olk v. United States, 536 F.2d 876 (9th Cir. 1976), rejected two "findings of fact" by the district court, namely, that "The tokes are given to dealers as a result of impulsive generosity or superstition on the part of players, and not as a form of compensation for services." and "Tokes are the result of detached and disinterested generosity on the part of a small number of patrons."

The reference by the district court to "detached and disinterested generosity" is a reference to language offered by the Supreme Court in Commissioner v. Duberstein, 363 U.S. 278 (1959), in which it explained:

The course of decision here makes it plain that the statute does not use the term "gift" in the common-law sense, but [*878] in a more colloquial sense. This Court has indicated that a voluntary executed transfer of his property by one to another, without any consideration or compensation therefor, though a common-law gift, is not necessarily a "gift" within the meaning of the statute. For the Court has shown that the mere absence of a legal or moral obligation to make such a payment does not establish that it is a gift. Old Colony Trust Co. v. Commissioner, 279 U.S. 716, 730, 73 L. Ed. 918, 49 S. Ct. 499. And, importantly, if the payment proceeds primarily from "the constraining force of any moral or legal duty," or from "the incentive of anticipated benefit" of an economic nature, Bogardus v. Commissioner, 302 U.S. 34, 41, 82 L. Ed. 32, 58 S. Ct. 61, it is not a gift. And, conversely, "where the payment is in return for services rendered, it is irrelevant that the donor derives no economic benefit from it." Robertson v. United States, 343 U.S. 711, 714, 96 L. Ed. 1237, 72 S. Ct. 994. A gift in the statutory sense, on the other hand, proceeds from a "detached and disinterested generosity," Commissioner Of Internal Revenue v. LoBue, 351 U.S. 243, 246, 100 L. Ed. 1142, 76 S. Ct. 800; "out of affection, respect, admiration, charity or like impulses." Robertson v. United States, supra, at 714. And in this regard, the most critical consideration, as the Court was agreed in the leading case here, is the transferor's "intention." Bogardus v. Commissioner, 302 U.S. 34, 43, 82 L. Ed. 32, 58 S. Ct. 61. "What controls is the intention with which payment, however voluntary, has been made." Id., 302 U.S. at 45 (dissenting opinion).

So, ultimately, whether the $10,000 is gross income or excluded from gross income as a gift is a question of fact.

What facts relevant to the tax issue are known? The customer has always tipped well, according to the bartender, usually leaving $15 on a $30 tab. Two weeks ago, the customer left the bartender a $100 tip on a tab of under $50. Then came the $10,000 tip. The customer put the tip on a credit card. Rather than following his usual practice of turning the credit card receipt upside-down after signing it, he kept it facing up and said to the bartender, I want you to know this is not a joke." During an interview, the bartender said, "I hate to say it, but I really don't know him. You become friends with your customers ... I think he just appreciated the fact that I took the time to talk with him."

Assuming the customer's intention matters, does any of this disclose customer's intention? Yes and no. He did not say, "Here is a gift." He put the $10,000 on the credit card receipt, presumably on the line that is left there for tips. Where else would he have added it in? He is a generous tipper. Fifty percent is generous. So, too, are the $100 and $10,000 tips. It looks like a tip, it walks like a tip, it talks like a tip, so is it or any part of it an excludable gift? The burden would be on the bartender to prove it is a gift. The restaurant withheld federal income tax. I predict the $10,000 will be reported on the W-2 it provides to the bartender next January. That creates a very challenging burden. Can the bartender show they were friends after saying she doesn't really know him? Was it her birthday? Did they interact outside of the restaurant? Was there any communication outside of her employment activities? There are no facts so indicating. Looking to the transferor's intent poses problems, because the taxpayer may not ever have the opportunity to ascertain the intent or to present it in some way as evidence during an audit or in litigation. It wasn't a joke, but that doesn't mean it was a gift. Or was not a gift. When we think of gifts we think of birthdays, anniversaries, get well wishes, and similar transactions between people who have something more than a business relationship. I don't think the $10,000 was a gift. There's no evidence that it was, and what evidence there is suggests that it is not.

I'm not sure that the bartender plans to do anything other than report the $10,000 as gross income. Yet throughout the blogosphere and even among tax practitioners one finds suggestions that she ought to take the position it is a gift. This has triggered discussions of whether it would be appropriate for a tax return preparer to so advise, and whether tax law professors ought to encourage students to proceed in that manner when they reach practice. Perhaps a case will arise where the facts make a finding of a gift plausible. This is not one of them.

It's interesting to read the blog comments to get the view of the folks on the street. Two major concerns show up. One is whether she must share the tip with other employees. In this instance, the answer appears to be no, because she talks about how she will use the money as though she has all of what was not withheld for taxes. If she were required to share it, that would generate more tax questions, which are best left for some other day because there's enough to discuss with the situation as it is. The second concern is a dislike of the fact that taxes are withheld (although a few people seem to think that the restaurant withheld to benefit itself, which demonstrates a total misunderstanding of how the tax system works, something that could be alleviated if high schools would return to teaching civics, government, and tax basics, which is yet another topic left alone today). This comment is an interesting insight into the chasm between law and habit:

Speaking as someone who has worked as a bartender and server for (too many) years, I'll say this -- she'll hafta declare it to Uncle Sam, because it was left on a credit card. Had it been in cash...well, that's a different story. One must declare 8.5 percent of total sales as tip income, so if he'd slipped her 10K in cash, she'd be declaring....oh, let's see...about $2.25.

The comment generated this riposte: "The jerk put it on his credit card...paper trail=TAXES. She must be pretty hot!" And this one : "A thoughtful patron would tip in cash." The notion that a generous person is a jerk because they don't aid and abet tax avoidance (or evasion) is a telling commentary on the state of values in the nation. But my favorite is a third response to the initial comment: "i say blackmail. she knows something he doesn't want her to say lol. when is the last time that a rich person tipped so well just for kicks? or maybe he's in love with her." Perhaps. But will we ever know?

If the bartender, contrary to my expectations, decides to take the position that the $10,000 is a gift, she has two options. She can leave the $10,000 off her return, which almost certainly would trigger an audit because of the mismatch between her return and the W-2. If she sticks to her position she'd receive a notice of deficiency, at which point she could take the matter to the Tax Court or she could pay the deficiency and sue for a refund. Alternatively, she could file her return with the $10,000 reported as gross income, file a claim for refund, and when it is rejected, as I am sure it would be, she could sue for a refund. If she ends up in the Tax Court, I am 99.9% convinced that she would lose. If she ends up in district court, she stands a very good chance of winning if she gets a jury filled with folks such as those who have been posting the sort of comments mentioned in the preceding paragraph. If she chooses a non-jury trial, she still has some chance of prevailing, because there's no telling what a district judge, untrained in the tax law, would do with the case. If whichever party loses in the Tax Court or district court decides to appeal, it is very likely that the IRS would prevail, but, again, the Murphy decision demonstrates that even appellate judges aren't necessarily expertised in tax law.

What is needed is legislative, or even regulatory, guidance along the following lines. Transfers between family members or friends are presumed to be gifts unless there is evidence that business, employment, or similar circumstances bring the transfer outside of the gift arena. Transfers between employers and employees in the context of the employment relationship are not gifts, as provided in current law. Transfers between people in any other relationship are presumed not to be gifts unless there is evidence to the contrary. The tax law already defines family, although in several different ways, so it would simply be a matter of picking the most appropriate definition. There is no definition of friends in the tax law, but proving that two people are friends or not friends is a much more objective, and thus easier, task than proving whether something is a gift. In keeping with my advocacy of a shorter tax code, I'd make up for the new section 102(d) by eliminating the nonsense currently in section 74(c). As for the proposals to repeal the gift exclusion, or at least to repeal the gift exclusion for transfers of money, I suggest that the necessary record keeping and reporting would be so onerous as to make such a provision ineffective.

Don't misread the headline. It has nothing to do with guns, although I could have written "Tax Law Professor Gunning for the Senate." Ouch. "Tax Law Professor Running for the Senate" might work.

In a three-way race for the Republican Party nomination for Senator from the State of Delaware, Temple law professor Jan Ting received 42.5% of the vote, edging Michael Protack who received 40.1% and Christine O'Donnell, who received the other 17.4%. The complete results can be found on the Delaware State Elections website.

If Italy's lead in realignment of political parties, mentioned in my post of a few minutes ago, is followed, perhaps a Tax Law Professor party will gather momentum. Considering the mess that the Congress has made of the tax law, giving tax law professors a chance to fix things might make sense. There have been tax experts in the Congress, but they are outnumbered and their message is drowned in the cacophony of lobbyists bleating for their newest handout.

What I don't know is whether any tax law professors have served in the Congress, either before or after teaching law. If you know, share the information and I'll post it. Perhaps there's a new web page in the offing.

BNA reports, in a subscription article, that Italy plans to increase capital gains taxes and lower rates on bank interest. Under the plan, the same tax rate will apply to both types of income. During the past few years, Italy has lowered capital gains tax rates and enacted other changes not unlike those made to the federal income tax in this country. One must wonder whether this modest elimination of at least part of the special low tax rates for capital gains in Italy foreshadows similar changes in American tax law. These changes come on the heels of electoral change in Italy. Electoral politics in Italy underwent a huge upheaval a few years ago, with several political parties, including a major one, dissolving, and new political parties emerging and securing substantial voter support. Could that development also foreshadow the course of political behavior in this country? Perhaps more attention should be given to Italian taxation and politics. Perhaps something could be learned.

Early during the Saturday evening newscast on the local ABC station, the words "tax preparation business" were spoken, and my attention ratio turned from 80% computer/20% television to 100% television. Having missed the beginning of the story, I went to the station's web site to find the story, but what I found was a condensed version of what was read on the newscast. But I had heard enough to fill in the missing pieces using google, and that sealed my decision to comment today on an unusual connection between taxation and September 11.

Most tax practitioners are familiar with the many tax provisions that were enacted in the wake of the September 11 attacks. Special credits and depreciation allowances, for example, were put in place for what the tax law calls the New York Liberty Zone. These statutory provisions, however, focus on the rehabilitation and restoration of the New York economy. They don't address memorialization. That's where Elsie Caldwell, a Philadelphia accountant who runs a tax return preparation business enters the spotlight.

Elsie, who lost her son Kenny in the World Trade Center destruction, spearheaded an effort to have a September 11 memorial for the Philadelphia people who died that day. She not only did fund-raising, she made available for the mural the outside wall of the building in which she practices her profession. Sometimes tax return preparation practitioners get criticized or find themselves the subject of bad press, but Elsie Caldwell deserves accolades from the rest of us in the tax profession. She stepped up, beyond the call of professional duty, and as was apparent from the newscast, has brought much healing and joy to more than a few people.

Elsie not only had to cope with the loss of her son, she had to withstand the aggravations of litigation stemming from the appearance of her former husband, who had abandoned Elsie and her two sons 30 years earlier. His efforts to become executor of her son's estate were thwarted, but a New York appeals court held that he could collect half of the workers' compensation death benefit because the statute did not exclude parents who had reneged on paying child support from sharing in these awards even though another statute precluded them from sharing in distribution of the child's estate. Wisely, the court then offset his portion of the award by the amount of the delinquent child support payments.

Perhaps other people, under these circumstances, would have folded. Or perhaps turned their anger and grief into something destructive. Elsie Caldwell did not do those things. She found a positive in the sadness and undertook a challenging project for the sake not only of her own loss but those of many others, who, until a few years ago, were strangers to her. And her efforts have created a memorial mural that is a genuine gift to the people of Philadelphia and the visitors from elsewhere who take a look.

I've never met Elsie Caldwell. Perhaps someday I will. In the meantime, I'll say here what I'd say to her if I met her: "What you've done is outstanding, a tribute to your courage and determination, a gift to many, and a reminder that as geeky as people might think tax folks are, you've made it unquestionably clear that immersion in tax does not shut down the heart. Thank you."

On a day like today, when the world is reminded of the power of evil, I prefer to remind myself that there is goodness on the earth, too. The planet needs more people like Elsie Caldwell.

Lots of tax things have been happening recently, so I don't get to all the stories right away. I try to put the tax news items into a sequence reflecting urgency, and sometimes stories drop off the bottom of the list because too much time has passed by. That's not the case with today's topic. About a week ago the IRS announced how it would generate refunds of the telephone excise tax.

Taxpayers will have a choice. They can select what I will call the standard refund, or they can itemize from their bills. The standard refunds are $30 for a tax return with one exemption, $40 for one with two exemptions, $50 for one with three exemptions, and $60 for a return with four or more exemptions. For an itemized refund, taxpayers add up the tax paid for services billed after February 28, 2003, and before August 1, 2006.

So, of course, being curious, I sat down and looked at my telephone bills. Yes, I kept them. Don't make me tell you how far back the file goes. Please.

So I added up the federal tax charges. The total? $26.07. Oh, well, I guess I'll take the standard $30 refund.

But that's the residence phone line.

I also have a business phone line. The IRS will require businesses and nonprofit organizations to calculate the actual amount of tax paid, but it also is considering coming up with some sort of estimation method. So I added up the federal tax charges for that phone line. The total? All of $16.01.

Now, if get a refund of the $16.01, am I not required to include the refund in gross income under the tax benefit rule? Of course. Unless the IRS comes up with some estimation method that lets me claim a larger refund, the after-tax benefit of the refund for the business phone line probably would not let me buy a decent dinner.

And if I take into account the presumed value of 20 minutes of my time, which is what I expended to go through the old phone bills, this entire adventure does not go down as a financial success. But it was intellectual fun. No wonder a good friend called me a geek yesterday evening (when I commented I had diminished my non-tax reading because I was updating another tax book). Yes, only a tax geek would sit down and rummage through old phone bills. And only a good friend could smile when identifying me as a geek.

So all that phone bill analysis would have been pretty much for naught but for the fact it generated a blog post. A blog post that's certain to trigger a stampede of readers. Seriously, I wonder if anyone has tallied up the federal tax on their long-distance phone bills and generated a total exceeding the standard refund. Let me know.

Suppose you know that someone is committing tax fraud. Or suppose you have very strong evidence that tax fraud is taking place. What should you do?

The answer, of course, depends on who you are and who the other person is. Goodness, if you are the other person, the answer is obvious. Stop committing fraud. Suppose that the other person is a spouse, a business partner, a parent, a child, a professional colleague, or a neighbor. Then what?

The answer to this question isn't something that can be taught in law school. It requires a blend of wisdom, experience, judgment, knowledge, and understanding. A variety of factors comes into play. How was the information obtained? How strong is the evidence? What risks, such as the risk of retaliation, arise if you approach the IRS? Is it better to look the other way and to let the IRS discover it on its own?

An interesting discussion is underway on the ABA-TAX listserv in response to a question posed by a tax practitioner. The initial question was proof that law professors don't invent hypotheticals:

Would I have potential for liability of any kind (to IRS under Circular 230, to state CPA boards for ethics violations, to the person accused of tax fraud) if I assist a third party (who I'll call Jane Doe) with the filing of Form 3949 A Information Referral?

Jane Doe (100% credible and with documentation) has asked me if I would submit to the IRS the Form 3949 A Information Referral regarding the ex-spouse. The Form 3949 A would be prepared based on information supplied to me by Jane Doe. The documentation was acquired over several months during family litigation issues with the ex-spouse. Her attorney obtained copies of tax returns and other documents that support the suspicion of income tax fraud.

My plan is to prepare and submit the Form to IRS, stating that I am doing so on behalf of Jane Doe who desires to remain anonymous. For valid personal reasons, she doesn't want to be the one who contacts the IRS. Neither Jane Doe nor her ex-spouse are, or ever were, clients of mine.

What are your comments and suggestions?

Those who responded agreed that the tax practitioner ought not be the informant. After all, the tax practitioner has no first-hand knowledge. The tax practitioner's judgment that Jane Doe's documentation and credibility makes a strong case can inform his decision to represent her but does not transform him into the informant. It was pointed out that if the practitioner becomes the informant, the practitioner risks acquiring the reputation of being someone who turned a taxpayer in to the IRS. Another comment explained that although the Form 3949 (yes, there's a form!) does not require identifying information about the informant, the ex-husband nonetheless will have a pretty good idea as to who blew the whistle. If Jane Doe is trying to position herself to state truthfully that she did not turn in her ex-husband, that should not persuade the tax practitioner to take her off the hook. A more interesting question is whether she is trying to find someone else to be the informant. Is she trying to sidestep a confidentiality restriction? If so, I don't see the difference between her giving information directly to the IRS or giving it to the tax practitioner to pass along. Either way, she is breaching any such confidentiality restriction.

Another subscriber made a point that illustrates the benefits of looking at problems through a wide, rather than narrow, lens. In this instance, the subscriber noted that Jane Doe could be implicating herself, or at least creating a problem for prior year tax returns, especially those filed jointly with the now ex-husband. Another subscriber noted that the ex-husband could have amended his tax returns.

One of the reasons given for advising the tax practitioner not to become an informant for Jane Doe is that tax practitioners are retained by taxpayers and don't work for the IRS. This comment resonated with me: "I also think we have a duty to respect the law and to consider what our duty is when we become aware of someone else's illegal activities that evade their fair share. After all, every dollar they don't pay is another dollar the rest of us, and our clients, have to pay."

For those who are interested, here is what I had to say on the matter early in the discussion:

High on the list of situations in which taxpayers are reported to the IRS are disclosures by former (or soon to be former) spouses. (Also high on the list are disgruntled employees and nosy neighbors). If Jane Doe wants to report her former spouse's alleged fraudulent activities, she can do so. If she chooses to retain someone to assist her, she can do so. At that point, isn't the retained advisor working for her? Isn't she a taxpayer whose taxes are higher than they ought to be because of the fraud committed by other taxpayers? How does assisting Jane Doe make her advisor someone who works for the IRS?

The question was whether the advisor is opening himself to risk for taking Jane Doe as a client and assisting her. (Note: Jane Doe may not have been the advisor's client, but once the advisor starts advising and assisting, she becomes a client.) If the advisor knows or has good reason to know that Jane Doe herself is being untruthful, or has doubts about the prima facie validity of her allegations, the advisor ought not take her on as a client because there would be some risk. If Jane Doe is revealing information obtained under circumstances that obligated her to keep it confidential, there also would be some risk. If the information she has was obtained illegally or in an improper manner, then again there is some risk.

The question ought to be whether the advisor should become the informer. That, I think, is unwise. As someone pointed out, there are ways for the person with the information to remain anonymous. The advisor does not have first-hand knowledge and by making the assertions moves from the somewhat protected role of advisor to a more visible, and much riskier, position as an informer. I suppose that might be the crux of the idea that the advisor ought work for the client (advise and assist Jane Doe) and not the IRS (don't become an informer on matters of second-hand information).

As for tax practitioners, they ought not be informants for second-hand situations. As for first-hand situations, as someone put it, ultimately each person must decide for himself or herself what he or she will do. In these instances, a tax practitioner is in the same position as is anyone else, though perhaps the tax practitioner's understanding of the tax system makes the situation a bit less intimidating.

I've long been a proponent of an open admissions policy for law school. Rather than selecting future lawyers on the basis of undergraduate cumulative averages, post-college careers (if any), and standardized entrance examinations, I would open the doors to anyone who expressed an interest in attending law school, save for those few who carry criminal records or psychological disorders of a pathological nature, or those lacking an undergraduate degree from an accredited college or university. The best test of a person's ability is administered when the person is given an opportunity.

This position is one I adopted years ago. The defining moment may have been the time when a student admitted from the wait list on the first day of class graded onto law review. That means the person finished in or near the top ten percent, even though the usual admissions guidelines had the person sitting out on the front lawn waiting for the Registrar to tell the Admissions Committee that this or that admitted applicant had failed to show up, thus making room for one or two or three more students. The slots are filled as they open because law school budgets count on a certain number of "tuitions" as they're called in financial discussions.

My position has been solidified as I watch students with numbers "predicting" average accomplishment do well and students with outstanding "predictors" wobble along and drift to the bottom of the class. I suppose it's because the predictors don't measure heart, and willingness to work. Work. That's what we celebrate today, those who work. Or, as I prefer to think of it, those who work hard.

So how would open admissions work? [Ouch, I'm going to hear about that one!] Simple. Open the doors. Something not unlike Dick Vermeil's open tryouts for the Eagles several decades ago now getting attention in the movie "Invincible." There are some gems out there who might otherwise pass unnoticed. It's true in football, and I'm convinced it's true in law school admissions. Of course, open admissions means there will be more students who don't perform at a satisfactory level. That means more students who don't move into the second year, but are instead asked to turn in their playbooks, clean out their lockers, pack up, and go. Don't laugh. There are lockers in this law school. It wasn't just a football analogy.

Is this sort of competition healthy? Yes. Open admissions means a return to the days of "look to your left, look to your right, at least one (or two) of the three of you won't be here next year." In our post-modern world, the idea of failure seems so horrible that too often too many try to make failure obsolete. Sometimes failure is good. It means we tried, and learned what we can and cannot do. Better to have tried and failed than not to have tried at all. [I think I'll hear about that one, too.] Knowing that admission isn't a "ticket" to a "purchased degree" might shake up those students who think the game is won when the acceptance letter arrives. After all, few law students fail to graduate, and those who do fail almost always have done something outrageous or have been afflicted with some sort of catastrophe outside of their academic lives, such as health setbacks, family troubles, or serious financial problems.

The American Bar Association, which accredits law schools, requires that "A law school shall not admit applicants who do not appear capable of satisfactorily completing its educational program and being admitted to the bar." This is in Standard 501(b). In its Interpretation 501-1, the ABA states: "Sound admissions policies and practices may include consideration of admission test scores, undergraduate course of study and grade point average, extracurricular activities, work experience, performance in other graduate or professional programs, relevant demonstrated skills, and obstacles overcome." In Interpretation 501-3, it explains: "Among the factors to consider in assessing compliance with Standard 501(b) are the academic and admission test credentials of the law school's entering students, the academic attrition rate of the law school's students, and the bar passage rate of its graduates." Nothing makes test predictors the sole criterion, and nothing precludes admitting anyone who has managed to earn a degree from an accredited undergraduate school.

The ABA Standards and Interpretations reflects the following concern. Is it appropriate to charge a student tuition if that student does "not appear capable of satisfactorily completing" law school? Is it wrong to hold out false hope? Is it improper to fleece dollars from someone who lacks the prerequisite skills?

No. Yes. Yes. But what does it mean to hold out false hope? It means law schools ought not send the message, "If you're admitted, then you'll be a lawyer barring some highly improbable turn of events." Yet that's what happens, isn't it, when admission becomes almost a guarantee of graduation. The incentive to work, and work diligently, erodes when that message meets up with mandatory curves and rankings. Is it any wonder so many upperclass law students ease back? And what does it mean to fleece dollars from someone who lacks the prerequisite skills? It means law schools ought not admit students and take their money without making it unquestionably clear that law school requires an amount of work that the student most likely has not achieved at any time in his or her life. That's the nature of a graduate program designed to prepare students for a professional career once they earn their doctoral degrees. What better way to make that clear than to point out the odds of making it to the second year?

So my attention was grabbed on Friday when I saw the National Law Journal article with the eye-opening headline "Law School Sued for Expelling Students" and the even more eye-stopping byline: "Suit alleges St. Thomas cut 25 percent of first-year class to bolster bar pass rates." I brought the article to the attention of my faculty colleagues early Friday morning, along with a few comments. Some of what I said I've already written. Here are a few more points, elaborating on the relatively short email I sent around to the faculty.

1. Some schools that do the opposite are probably doing more long-term harm to the legal education system. In an effort to rack up rankings points, some schools are restricting their first-year admissions to a very select few with "high numbers" and then make up the lost tuition by "raiding" the top students from other law schools. Never mind the difficulty of adjusting to a new law school one year after adjusting to law school. There always have been a few transfers on account of personal or family issues, but when the average of 2 or 3 departures becomes 10 or 15, or more, something's not right. Thank you, U.S. News and World Reports. My three most recent posts on rankings (here, here, and here) don't disguise the fact that I'm no fan of the rankings game as currently played, and this "false exclusivity" phenomenon is just another reason for my dislike of the game.

2. The attorney for the student who is suing claims that the school is "culling" students it should not have admitted in the first place, and adds, "They're not supposed to accept students who don't have a reasonable prospect of completing law school." The standard is "appears capable" and not "have a reasonable prospect of completing" law school. I have not seen the admissions letter and other information made available to the student, so I don't know whether the student was told that he was not guaranteed success. The student, in my view, paid for the chance to perform well enough to move on to the second year. The view that payment of tuition guarantees graduation and its accompanying degree is one that has become widespread among many students, and perhaps fuels the current litigation. I hasten to add that there is another bit of factual confusion, namely, whether the applicable standard was changed before or while the student was enrolled, because the student's reported grades are sufficient to meet one described standard but not another. Perhaps when the facts are sorted out the issue will be somewhat different from what it appears to be.

3. Provided a student is given timely notice of what must be done to advance and graduate, what's so wrong with dismissing students who, given the chance, cannot perform? I wonder if the law student in question would have sued on some other basis had the law school denied admission because it thought he lacked the requisite ability. There's a bit much of "heads the student wins, tails the student wins" in the situation.

4. It is essential, therefore, that in an open admissions system, the applicant be sent something along these lines, "We don't think you have much of a chance, though you appear capable if you put your mind to it, and because one never knows, we'll let you in if you're willing to pay for the chance. With the chance, you have the opportunity to become a lawyer if you do all that is required with diligence, faithfulness, and maturity. Without the chance, you have no chance of being an attorney."

5. The allegation that the school violated its mandatory grading curve is significant if it flies. Not only do mandatory grading curves (and even strongly recommended curves) disadvantage students who do well but are matched with other students doing well, they also compel (hence the allegation in the lawsuit) giving higher grades to poorly performing students because, reversing the curve in question, 85% of the students must earn a C+ or higher. Sorry, if 40% of the students do C and D work, law schools ought not pretend they've achieved a C+ or higher. That's why measuring against a standard makes more sense.

6. This is a case worth watching if it proceeds. I wonder if the law school will seek discovery of the academic work habits of the students in question. "How many hours a week did you study?" "Did you attend class?" "Were you prepared for class?" "Describe how you prepared for class." "Did you work during the semester or cram at the end?" "Did you participate in class?" "Did you create your own outline, charts, and graphs or did you use someone else's work?" This is important because the law school cannot be at fault for dismissing a student whose failure to progress is caused by the student's inadequate work habits and academic immaturity rather than underlying intellectual deficiencies. It has always amused me to read the answers that Graduate Tax Program students give to the question on the course evaluation that asks how many hours a week outside class they invested in the course. Surprisingly, even though they should be investing six to eight hours a week outside of class, there are students who honestly answer "one," "two" or some other deficient number. I am convinced that the students with the most complaints about the work load and high expectations of the instructors and course are among those who invest so little time. Why we don't ask this question of J.D. students remains a mystery to me. I can't imagine why we wouldn't want to know.

So here is hoping that everyone celebrating Labor Day however they celebrate it can look back and forward to their contribution to working. Working hard.

Happy Labor Day.

The Murphy case is creating quite a stir. Considering what the court said, it's not a surprise. When I commented on the opinion last Wednesday, I focused on the technical deficiencies in the opinion, something that triggered a response to which I replied the next day. This afternoon I was interviewed by a reporter for Tax Notes, whose article should show up next week.

Like many others, both within and without the tax profession, I am riveted by this case. Why? It's not just the technical flaws. Those aren't infrequent when tax cases reach the courts, particularly when the tax expertise isn't quite what it ought to be. It's also the inspiration that the opinion is giving to the tax protest movement. Specifically, the folks who have argued that wages are not gross income because they are not income have relied on the idea that wages are received in return for "human capital" and thus cannot be "incomes" within the meaning of the Sixteenth Amendment.

So what does the Murphy opinion do for these folks? Consider these two excerpts from the opinion, and understand that tax protestors love to take pieces of judicial opinions and connect them together:

Broad though the power granted in the Sixteenth Amendment is, the Supreme Court, as Murphy points out, has long recognized “the principle that a restoration of capital [i]s not income; hence it [falls] outside the definition of ‘income’ upon which the law impose[s] a tax.”

* * * * *

According to Murphy, the Supreme Court read the concept of “human capital” into the IRC in Glenshaw Glass. * * * * In Murphy’s view, the Court thereby made clear that the recovery of compensatory damages for a “personal injury” -- of whatever type -- is analogous to a “return of capital” and therefore is not income under the IRC or the Sixteenth Amendment.

Under tax protestor logic, because Murphy won her appeal, the court accepted her arguments as valid. Of course, a court that is aware of the "wages are not gross income" tax protester movement easily could put into its opinion language that restricts its opinion to the specific issue in front of it, but considering that the court was so quick to hold unconstitutional a Code provision that isn't "responsible" for the taxation of which Murphy complained it's no surprise that the court was not considering the impact of its opinion on the administration of the tax law.

Will these sentences be cobbled together by the "wages aren't income" crowd? Undoubtedly. Don't believe me? Or the others making the same prediction? Take a look at the way bits and pieces of legal authorities are mixed and matched in an attempt to prove that the Constitution prohibits the taxation of wages. It takes deep concentration to make it through this explanation. Someone named "bonked" shares this thought: "You see, a tax on wages is not authorized by the constitution, unless it is apportioned..." I could have fun with this one, but I'll restrain myself. And the comments following this LibertyPost article, which proclaims that "Court ruling shakes ground under IRS," are worth reading, but don't be distracted by the references to things such as "Section C of the Tax Code."

What happens if these arguments are made in front of a judge who analyzes the tax law in the same manner as did the three-judge panel of the D.C. Circuit in Murphy? Imagine how small the jump from "unconstitutional to tax damages from human capital" to "unconstitutional to tax wages" looks to someone who doesn't quite grasp the nuances and accepts the language of the Murphy opinion on its face. It will take only one such case. Just one. What will Congress do? Start the process for a constitutional amendment? Hope for a Supreme Court reversal? How long will either of those reactions take? Remove wages from the income tax base and tax revenues plummet.

A footnote: As I wandered the Internet last night, I came across an interesting commentary on a post that quoted part of my first commentary on Murphy. The sentence begins "Maule's of course right that". How could I not keep reading?