MauledAgain

Kay Bell, of Don't Mess With Taxes, has posted Tax Carnival #9: Welcome to Tax Season 2007. With links to stories and commentary about the start of the tax filing season, tax preparers, tax deadlines, paying taxes electronically, changes in the tax laws, tax software updates, and more, it's a posting worth a visit from tax practitioners no matter their location or specialty.

OK, it's not tax, or chocolate chip cookies, or model trains. It might be related, tangentially, to genealogy and perhaps even law school teaching. What is it? It is how I talk.

According to the What American Accent Do You Have Quiz, I speak like a, surprise, Philadelphian:

What American accent do you have? Your Result: Philadelphia   Your accent is as Philadelphian as a cheesesteak! If you're not from Philadelphia, then you're from someplace near there like south Jersey, Baltimore, or Wilmington. if you've ever journeyed to some far off place where people don't know that Philly has an accent, someone may have thought you talked a little weird even though they didn't have a clue what accent it was they heard.
The Northeast
The Midland
The Inland North
The South
Boston
The West
North Central
What American accent do you have? Quiz Created on GoToQuiz

Yet, for me, a Philadelphian is someone who says Iggles rather than Eagles, or whadduya? rather than what do you? Decades ago, Philadelphia magazine ran a story, and then a followup, "How to Speak Like a Philadelphian." The authors pointed out that there are many Philadelphia dialects, and provided quizzes from which one could identify not only the neighborhood in which a person grew up but the decade during which they were a child. It would be nice to see those quizzes go online.

So how good is this What American Accent Do You Have Quiz? Let me know.

At the end of December I shared A Proposed Congressional New Year's Tax Resolution. I proposed that Congress "[j]ettison the dozens of exclusions, deductions, and credits directed toward special interests, put an end to special low tax rates, remove the working poor from the tax rolls, and restore progressivity so that someone with $30,000,000 of taxable income is taxed at meaningfully higher rates than someone with $1,000,000 or $400,000 of taxable income." I noted that if Congress properly fixed the income tax, "a genuine reform would permit reduction of tax rates so that there would not be as much incentive for special interest groups to seek special tax breaks and would permit repeal of the AMT."

In yesterday's Philadelphia Inquirer, Jeff Brown shared his Readers' wish list to Congress. The ones focusing on the income tax -- several dealt with the social security system and the estate tax -- provide an interesting insight into how people "think" about the tax law.

Suggestion #1: Eliminate the tax on social security benefits because that constitutes "sticking it to the middle class!" How's that? Every social security recipient escapes taxation on 15% of the receipts, and most escape taxation on much more than that, in some instances escaping taxation on all of their social security receipts. The suggestion is an emotional one. Carefully analyzed, the taxation of social security benefits should reflect two concepts. First, receipts in excess of contributions, constituting economic gain, should be included in gross income. Second, a genuinely well-designed income tax rate structure would ensure that the very rich who receive social security are taxed at higher rates, whereas those whose gross income is on the low side even with social security profits included in it would be taxed a low rates or not even taxed. It is understandable that folks receiving social security on which they are taxed are upset when there are much wealthier people finding ways to receive income free of tax. The solution isn't to expand the nonsense but to curtail it.

Suggestion #2: Capital gains distributions from mutual funds that are reinvested in more shares of the fund should not be taxed until the money is withdrawn from the fund. In other words, a deferral of tax similar to that permitted for like-kind exchanges should apply to mutual funds. The sense of this proposal is simple, namely, whatever justifies deferral of tax when there is a like-kind exchange applies no less to mutual fund reinvestments. But why stop there? Why not permit deferral of all gain (rather than excluding $250,000 or $500,000) when a home is sold and replaced, or when stock is sold and replaced, or when appreciated personal artwork is sold and replaced? There are two answers. First, it would pretty much leave the income tax as a tax on wages (which some people want to see happen), and to prevent revenue loss the tax rate on wages would soar. Second, deferral is an idea has been increasingly restricted, from the repeal of the home sale and replacement deferral in favor of an exclusion to the growing list of transactions not eligible for like-kind exchange treatment. Been there, done that, don't work.

Suggestion #3: Index the AMT for inflation. If all else fails, this is a quick and acceptable, though far from ideal, fix.

Suggestion #4: Repeal the AMT. I'd vote for that if the regular income tax were cleaned up so that the reasons for an AMT were eliminated. Simply put, the regular tax would look much like the current AMT, in terms of fewer exclusions, far fewer deductions, and even fewer credits.

Suggestion #5: Raise the age at which money in retirement plans must be withdrawn. Under current law, distributions must start by the time someone is 70 and a half. The suggestions rests on the idea that leaving money in these accounts permits it to grow tax-free for a longer period of time. So long as the whatever taxable amounts remaining in the account are taxed when the account owner dies, the proposal could be seen as another request for deferral. It makes sense if someone has not retired by age 70 and a half, and perhaps folks who are still working should be permitted to delay withdrawals. Otherwise, the proposal makes little sense.

Suggestion #6: Index capital gains for inflation before applying the special low tax rate. Whoa! A significant justification for the special low tax rate on capital gains is that some of the gain reflects inflation and not real dollars. For years, I've advocated indexing basis for inflation. Once that is done, there is no reason for special low tax rates. The idea of indexing basis while retaining a special low tax rate is another proposal fueled by emotion, the one called greed.

Jeff Brown concludes his article with a wish: "To this reader and all the others who wrote, thanks. Let's hope the new Congress is as wise and fair-minded as you are." Let's hope not. Surely the first and last suggestion are unwise, and two of the others are dubious at best. The third and fourth suggestions, which are two of several alternative solutions to the AMT mess, are the only ones deserving of further consideration. Ironically, what's missing from the readers' suggestions that were shared are some changes that are sorely needed: eliminating the joint return, raising the standard deduction and personal exemption so that they match the poverty level threshold, ditching most credits and deductions, cleaning up the at-risk and passive loss rules, and ending off-shore income evasion mechanisms. Browse MauledAgain and I'm sure there are other suggestions that were overlooked.

I'm beginning to think that the tax law is complicated principally because people think they are special and others aren't. So we see the addition of tax law provisions written in convoluted terms that are designed to direct the tax breaks to a select few. In other instances, we see complicated statutes and even more complex regulations crafted to preclude the various games that are played to avoid taxes.

Last week a question was posed to the ABA-TAX list. A subscriber described situation involving an S corporation whose shareholders entered into an agreement stating "that the Board of Directors can arbitrarily decide who the profits of the corporation are distributed to." The agreement contained a "set formula" and "some 'bonus based on performance' provisions." Under the formula, the profits would be used to pay the "owner's taxes and to pay enough to
the younger owner to finance his buyout of the older owner."

The attorney who drafted the agreement explained "that the plan allows the ownership percentage to be adjusted to however we want it, thus moving income from the high tax bracket owner to the low tax bracket owner even though the profits were not distributed that way."

The question: "Can they do this?" Stated differently, " Is a corporation allowed to arbitrarily decide annually who is getting and reporting the profits?"

The answer is, "Yes, they can do this but they're going to have a pile of tax problems."

If the profits are distributed disproportionately to stock ownership, the S corporation will have a second class of stock and the S election will terminate. Without going into details, suffice it to say that termination of the S election is bad news.

In addition, if they start changing ownership percentages there's going to be an interesting array of gift tax, stock transfer tax, and income tax (disposition) issues. Unless the stock is worthless (which would make the profit allocation question moot), the outcomes will not be welcomed by the shareholders.

What they're trying to do can be explained in simple terms: A takes the income, B gets taxed. Any student who understands basic tax principles knows that this game was played decades ago and the taxpayers lost. Of course, taxpayers keep trying to find new ways of making B pay the tax on A's economic gain. One has to wonder if the attorney who drafted the shareholder agreement understands the basics of federal taxation, let alone S corporation tax rules.

The subscriber who posted the original question replied that the attorney claims that "the actual stock doesn't transfer ... but the 'phantom stock' plan allows the stockholders to manipulate who
reports what, even if the stock does not change hands." Wow.

The attorney reportedly also explained that, "[a]s for pushing tax to the lower bracketed owner, the agreement says all taxes of the shareholders will be paid by the corporation, so he says
that doesn't matter." Sorry, but it does matter. Because the shareholders are in different tax brackets, the tax paid on behalf of one shareholder's share of the profits will be disproportionate to the tax paid on behalf of the other shareholder's share. This creates a second class of stock. It is an issue specifically addressed in the regulations because some states permit, or require, S corporations to pay state income taxes on behalf of shareholders, in some instances, the non-resident shareholders. Corporations must be careful to make payments in a way that maintains the proportionality characteristic of one class of stock.

It was also reported that the attorney in question is "a pretty renowned tax INSTRUCTOR part time at a university." Oh, my.

The discussion was taking such a strange turn, I had to clarify things. So I asked:

So let me see if I have this.

A owns, say, 30%. B owns, say, 45%. C owns 25%.

The S corporation has profits of $100,000. They want A to get, say, $72,000, but to pay the tax on $30,000?

So if A takes a distribution of $72,000, it's disproportionate and the S election does down the tube.

Oh, wait, so they'll claim that $42,000 of what goes to A is really B's and C's. And what is that? Seems to me there's a gift from B and C to A. Or some sort of taxable event. Either way, big problems.

Oh, no, it is claimed. A owns 72 of the 100 pretend shares. So A can take $72,000 and it won't be disproportionate.

Yes, but what about the attempt to have $42,000 of the $72,000 taxed to someone else? Isn't that assignment of income?

No, comes the reply. We're special. We don't worry about that. That's because we'll pretend that A is paying pretend taxes on the $72,000.

Better yet, we'll have the corporation pay the taxes. There's no deemed distribution there, is there? Oh, no, not more disproportionate distributions? Goodness, we're in an algebraic computational time loop.

What nonsense.

As [another subscriber] pointed out, the only way to split the corporation's earnings in a way that comports with tax law is to pay compensation. It's not a problem measuring it with phantom this or that. There are people who earn compensation based on phantom work. But that compensation must be taxed to the person to whom it is paid, and if the corporation pays the income tax, there's even more compensation. Old Colony Trust ... a case reached very early in the basic tax course, even before the assignment of income cases.

But I doubt such an approach will be satisfactory to shareholders who are trying to do the "I get the money, you pay the tax" routine. It's a routine almost as old as the tax law itself.

So I wonder how long it takes before umpteen dozen students are offering this "phantom plan" to *their* clients, tagging it as renowned. Gee, if enough S corporations do this, maybe it becomes tax law de facto?

Yes, there's more than a wee bit of sarcasm in my inquiry, but why do people insist that somehow they can find a way around a very simple, basic rule? If A owns x% of the S corporation stock, A must pay tax on x% of the S corporation's profits. Any attempt to distribute something to A other than x% of the profits, or to have some other shareholder taxed on some or all of A's share of the profits simply isn't permissible. What's so difficult to understand about that principle? Why are some folks so intent on disregarding it? Do they really believe that they are so special that a different set of rules should apply to their situation?

It gets worse. When another subscriber pointed out that this issue, and similar if not identical plan, had been discussed a few months ago, the subscriber who posed the recent question explained that the previous topic had also been generated by his question, dealing with a different client, same attorney. Apparently the earlier client chose to ignore the attorney's plan. Good move.

So in addition to asking why some people are so intent on trying to create a special set of tax rules that work to their advantage, I also ask why there are tax practitioners who so willingly offer to those people "plans" that supposedly do what those folks want to do? Is the desire for money so strong that people will set aside logic, reasoning, common sense, statutory language, others' bad experiences, and honesty in order to drum up business?

The response to these ploys will be yet more pages of tax law. Tax laws that say "we really mean it." Tax laws that use 30-word phrases instead of a word so that the masters of deception find it even more difficult to peddle the tax snake oil to unsuspecting, though perhaps greedily gullible, taxpayers.

The rule is simple: If A owns x% of the S corporation stock, A must pay tax on x% of the S corporation's profits. It's too bad some people just cannot take it for what it is.

Last week, Paul Caron's TaxProf Blog directed me to a Wall Street Journal editorial advocating a cut in corporate tax rates. Why? Because, according to the editorial, if corporate tax rates are cut, the wages of corporate employees will increase. The editorial claims that jobs migrate to nations with the lowest corporate tax rates.

The arguments advanced by the editorial aren't new, and they're plausible. But, for all intents and purposes, they are theoretical. They are based on data that is isolated from context, and disconnected from the many variables that enter into wage determination. Farm jobs exist where crops can be grown. Mining jobs exist where the ores are in the ground. Jobs disappear in war-torn areas. It's not so simple as accepting the plea of starving shareholders, "Give us more money by cutting corporate taxes and we promise we'll hire more people. Honest." More people being hired? At minimum wage? "No, wait," say the shareholders, "we'll increase wages of current employees." The WSJ editorial notes that "the real average wage for non-supervisory employees has risen 2.8%" during 2006. Big whoop. That's $1,200. Does the editorial mention what has happened to the wages of CEOs, CFOs, and other high-level supervisory employees? The editorial claims that employee non-wage benefits have increased, but it's unclear if the editorial is referring to the many stock option and similar deals available to top hat employees.

The editorial also advocates making the "Bush tax cuts" permanent, suggesting that those tax cuts created capital that was translated into those marvelous 2.8% wage hikes. The editorial overlooks the fact that the same fiscal policy caused state and local governments to find tax hikes inescapable, so that some of the wage hikes were diverted to increases in state sales taxes, local property taxes, state income taxes, and similar exactions. Would it not be better to eliminate the special low tax rates for the capital gain and dividend income of the wealthy, increase the progressivity of the tax rates for taxable incomes above $500,000, fix the regular tax so that the AMT could be jettisoned, and then reduce taxes overall so that folks at the low end get a meaningful tax break? Perhaps that would drive down the upward pressure on wages, and bring more workers into the job force so that the cost of labor to corporate and other employees would be mitigated. If all taxes imposed on a person earning $60,000 a year were cut in half, the pressure for a 3% wage increase in 2007 might soften into a demand for a 2% increase, even though purchasing power would continue to increase. Unfortunately, what's really at work here is an arrangement by which the very wealthy control the nation's tax revenue and most of its other income, and dictate who gets what. A very few determine which jobs exist, where they will be, who will fill them, and how much salary they will generate. Their ability to set terms would be constrained if they weren't living with effective 10% tax rates. To suggest that the corporate executives of the Fortune 500 should have even more after-tax money with which to control the economy is the very antithesis of a "free" market. I wonder if the Wall Street Journal realizes that its editorial is in some ways very inconsistent with its alleged core philosophy.

A tax colleague at another school suggested that the solution should be an income tax credit "based on the increase in wage rates for the lowest paid 10% of the workforce in excess of inflation, or the rate of increase in rate of compensation of the five highest paid employees." Though I detest the addition of another credit to the tax code, I much prefer this idea to the one floated by the WSJ editorial. It forecloses the risk that the savings from corporate tax cuts would be plowed into high-end salaries. Perhaps the answer to my "no new credits, please" request is to jettison the other wage credits in the Code and wrap their concepts into this one.

Ideally, corporate profits should be taxed to the true earners of corporate income, namely, shareholders. I have no conceptual disagreement with abolishing the corporate income tax, though I fully appreciate the logistical challenges. In turn, those profits must be taxed at realistic tax rates that treat dollars as dollars regardless of source and that reflect a genuine progressivity that does not treat a person with $400,000 of taxable income as deserving of the same tax rate as someone with taxable income of $4,000,000 or $40,000,000.

One last point deserves attention. So many corporations have structured their dealings in such a way that they do not pay corporate income tax. For those corporations, a cut in the corporate tax rates would be useless. So, too, would be the credit proposed by my colleague, unless it were a refundable credit, and I do not think he had a refundable credit in mind. Thus, the corporate tax rate cut proposed by the editorial would simply eliminate, or come close to eliminating, the corporate income tax without shareholders paying the price for that arrangement. It's not unlike the goals of those who want to eliminate the estate tax without paying the price of taxing unrealized appreciation at death.

It never ceases to amaze me how many people think they have the right to go straight out of the left-turn lane because they're special. It never ceases to amaze me how often some folks come back to the public feeding trough. Corporate shareholders in this nation surely are starving if their trips to the tax food bin are any indication. Hopefully, the new Congress understands that voters aren't willing to take 2.8% wage hikes that are consumed by state and local tax increases in exchange for letting the privileged few enjoy special low tax rates on capital gains and dividends, and regular tax rates short on progressivity. Lest the wealthy think I'm picking on them, perhaps they'd like to think where their incomes will be when the foreign creditors to whom America owes trillions of dollars borrowed to finance the Bush tax cuts arrive to collect their due and take over American businesses. Then who will be taking the high-end salaries? Hopefully these folks' economic roads to Damascus won't come too late.

The family holiday gathering was delayed until yesterday, New Year's Day. Among the gifts I received was one that focused on taxes. There were worries that I already owned it. I didn't. Now I do.

What is it?

It's the "Death and Taxes poster," available from The Budget Graph, and visible in this very large jpg file of the poster. Mine came framed, ready to hang, and so now I must find search my house for an appropriate place in which to hang it. There's no room next to the framed replica of the very first federal individual income tax form. Plus there's a limit to how much tax wall art should be in one room. It could be too overwhelming for guests and visitors. On the other hand, perhaps putting all of these things in one place could provide a litmus test: if you can survive the tax room, you can survive Maule.

As best as I can tell, this particular item wasn't on Paul Caron's list of Christmas Gifts for that Special Tax Person. No link because there are so many of them on TaxProf Blog, so just visit TaxProf Blog and search for "Christmas Gifts for that Special Tax Person."

But where, oh where, are my IRS chocolates?

Readers of MauledAgain have emailed me. Reporters have called me. Paul Caron's TaxProf blog alerted me. The news is now a week old. For it was last Friday that the United States Court of Appeals for the District of Columbia Circuit issued an order vacating the judgment in Murphy v. United States, and setting a date and time for briefs and oral arguments in front of the same three-judge panel that rendered the decision in August.

It's not time to repeat my position on the decision. In terms of the analysis, nothing has changed since I shared my thoughts in Why Hold Section 104(a)(2) Unconstitutional When There's No Need to Do So?, It Didn't Take Long: Negative Reaction to My Criticism of the Murphy Decision, The Murphy Opinion and Tax Protesters, and En Banc Hearing in Murphy? Will It Happen? What Will Happen?. The short version is that it is a bad decision. My prediction that the entire D.C. Circuit Court would not permit it to stand seems even more likely to pan out. Of course, I'm far from alone in my opinion or my prediction.

What's interesting is that the case has been set for hearing in front of the same three-judge panel that issued the decision, and not in front of the court en banc. The government had requested an en banc rehearing, and not a panel rehearing. It's unclear how the case ends up as a panel rehearing, though one might guess that the court deemed the request for en banc rehearing to include a request for a panel rehearing. Why not simply grant the motion for an en banc rehearing? My guess is that the full court does not want to embarrass the three-judge panel, and that it is being given an opportunity to change its decision and rewrite its opinion. If the entire court agreed with the three-judge panel, the logical choices would have been to deny the government's motion for an en banc rehearing, or to have granted it and emphasized the full court's agreement with the three-judge panel. The only reason, it seems to me, to put the case in front of the three judges once again is what my children called "do over." I suppose I was wrong when I told them that in real life "do over" isn't an option. It is, this time, for three judges who have a great opportunity to set things to right. I'm also going to guess that most, perhaps all, of the judges on the D.C. Circuit have been reading the commentaries by tax practitioners, tax law faculty, constitutional law experts, and others.

Do I dare predict the outcome? I'm tempted. I think the three-judge panel will revise its opinion. It might, for example, try to remove any suggestion that it supports the position advocated by tax protesters that wages do not constitute gross income. It might, for example, clean up the language that treated section 104 as an inclusion provision. I'm not certain, though, that it will reach a different conclusion.

With oral argument scheduled for near the end of April, it is unlikely there will be anything from the court before June at the earliest. Surely there will be many other tax issues to contemplate while the briefing process and oral argument in Murphy is underway. And we know there will be some more Murphy stories to blog as 2007 moves along.

Speaking of 2007, Happy New Year. Yes, it's a bit early, but I doubt I'll be back with a MauledAgain posting in 2006.

With each passing year, the number of taxpayers subject to the alternative minimum tax (AMT) grows, as does the attention given the issue in mainstream media. It is a popular tax topic for journalists, as evidenced by reports such as this one, particularly because its growing reach does not sit well with those who are brought within it on account of the way the AMT is structured.

Though Congress has tinkered with the AMT to offset some of its growth, the fixes are temporary. When those fixes expire, assuming that they are not extended, as many as 30 million taxpayers may find themselves subject to a tax that was designed to prevent wealthy taxpayers from using tax breaks to reduce their income tax liability.

Some reformers call for repeal of the AMT. Others think that further polishing will solve the problem. For example, one proposal is to make capital gains and dividends that otherwise are taxed at special low rates subject to the AMT. Take a look at Linda Beale's "Congress Fiddles While Middle America Burns: Amending the AMT (and Regular Tax)". Others suggest permanent increases in the threshold amounts below which the AMT does not apply. A few have advocated repealing the regular income tax and letting the AMT be the structure used to compute income tax liability.

I take a very different approach, though I doubt I am the only one to consider it or even to adopt it. To me, the AMT is nothing more than a patch on a very flawed regular income tax. In other words, if the regular income tax were properly designed, there would be no need for a "fix" to deal with the consequences of taxpayers whose regular income tax liabilities are reduced because they take advantage of the deductions available in the tax law. If the regular income tax causes some taxpayers' tax liabilities to be less than what people think they ought to be, and yet those tax liabilities are computed properly, then the problem is in the design of the regular income tax. In other words, the existence of the AMT is proof positive of the flaws of the "regular" tax. Fix the regular tax and there's no need to fix the fix.

The most frequently heard or read disagreement with my approach is a political one. Succinctly, it is easier for a politician to tinker with the AMT than it is to fix the regular income tax mess. It takes far more courage, far more vision, and far more technical savvy to heal the wound than it does to change the color of the band-aid.

Sadly, it probably is true that the Congress, whether controlled by Democrats or Republicans, will not do what needs to be done. Whether it will adjust the AMT remains to be seen, but surely the eternal quest for votes will trigger some sort of relief lest the next electoral results exceed a simple turning out of the incumbents.

The intrusion of politics is unfortunate. Service to country and fellow citizens has taken a back seat to loyalty to party and party bosses. Crafty publicists hawk tax breaks in a superficial manner, leading taxpayers to think they are getting a tax break even though the AMT blocks that tax break from having any real effect. How is this possible? The tax law is so complicated that most taxpayers don't understand that they are being conned. Perhaps it is not a mere oversight that tax law is not taught in the nation's high schools.

What's worse, some people prefer a flawed regular income tax system. They have more to gain by it than from a transparent, honest, efficient, sensible and fair income tax system. The advantage of a flawed tax system is that it permits the folks who think they're entitled to go straight from the left turn lane and to cut in front of everyone who have been waiting patiently to sneak in a special break without anyone noticing, while also tossing in symbolic tax reductions that end up vaporizing under when the AMT is applied.

Nonetheless, I offer this challenge to the newly elected Congress whose members have assumed a mandate of "leading this country in a new direction" to back up their promises with action. Rather than wasting time and intellectual capital arguing over the trivial stuff, take the opportunity to clean up the income tax mess. Jettison the dozens of exclusions, deductions, and credits directed toward special interests, put an end to special low tax rates, remove the working poor from the tax rolls, and restore progressivity so that someone with $30,000,000 of taxable income is taxed at meaningfully higher rates than someone with $1,000,000 or $400,000 of taxable income. Done properly, a genuine reform would permit reduction of tax rates so that there would not be as much incentive for special interest groups to seek special tax breaks and would permit repeal of the AMT. The Pennsylvania individual income tax, with few exclusions, almost no deductions, a handful of credits, a prohibition against using a loss in one category of income to offset income in another category, and a rate of just over 3 percent, simply doesn't attract the sorts of power brokering, back room dealing, hideaway dinner meetings, and disguised lobbyist favors that have infected the federal income tax.

The incoming Congress has a golden opportunity to make a genuine difference. Let's see what it can, and cannot do.

The other day I commented on IRS chocolate and pointed to it as a gift suggestion. Now comes a much longer-lasting gift. It's in the form of news, described in an article with a fun headline: Chocolate Can Do Good Things for your Heart, Skin and Brain.

Indeed. According to the report, chocolate also increases blood flow, reduces clotting, reduces platelet stickiness, decreases bad cholesterol, prevents cell damage, reduces inflammation, reduces blood pressure, assists muscle recovery after exercise, promotes smoother and moister skin, helps memory, lengthens attention span, reduces reaction time, and sharpens problem-solving ability. But there's no proof it functions as an aphrodisiac.

It has to be dark chocolate. White chocolate doesn't provide the benefits because the flavonoids, the source of the good health, have been removed.

Yes, folks, as I've been saying for years, chocolate is medicinal. Just don't overdose. The good news is that we can drive and operate heavy machinery after taking our daily allotment.

Yesterday, on his TaxProf blog Paul Caron directed our attention to a New York Times story that suggests the recent increase in December births is a consequence of tax law changes. Paul was alerted to the story by none other than Villanova's dean, Mark Sargent. It's always good for law school deans to know how pervasive tax law can be, for it lets them understand the value of tax law professors. Ha ha.

In the story, To-Do List: Wrap Gifts. Have Baby, David Leonhardt provides an interesting array of observations:

1. Modern medical technology has made it easier for women to select a day for their child's birth.
2. For four of the seven years from 1997 through 2003, December has pushed September aside as the month with the highest number of births; data for years since 2003 has not been released.
3. Since the early 1990s, the tax code has provided an increasing number of tax benefits based on the existence of, and number, of a taxpayer's children.
4. The tax value of a child being born before the end of the year, in contrast to after the beginning of the next year, is in the thousands of dollars.
5. Among the tax breaks are the dependency exemption deduction, the child tax credit, the earned income tax credit, and the medical expense deduction.

From these observations, Leonhardt concludes that the tax law is encouraging people to have children in December. He acknowledges that this conclusion isn't easy to accept. He quotes one economist who describes the spike in December births as "astounding." Because there are other reasons people might prefer having their children in December, several economists ran some tests and determined that there was a correlation between tax breaks and birth timing. Leonhardt concludes that of the 70,000 children who would otherwise be born during the first week of January, 5,000 have their births "accelerated" into December "partly for tax reasons." One of the economists thinks Leonhardt's estimate is "conservative."

Two salient concerns jump out at me. The first is whether people ought to plan their child's birth dates with deference to the tax laws. The second is whether people ought to take steps to "accelerate" a child's birth in order to obtain tax benefits.

Perhaps I am naive, or perhaps I am a cynic. I don't think people ought to do things that they otherwise would not do because there is a tax advantage for doing so. The tax law ought to be a factor only when it influences the taxpayer to select one of two or more choices any of which would be acceptable to the taxpayer. Thus, the tax law encourages taxpayers to select a particular form of business entity but it ought not cause a person to operate a business in the first place that the taxpayer would not otherwise choose to own. I've always wondered, and half-jokingly ask my tax students, if people sit around and decide to adopt a child because the Congress enacted or increased the adoption credit. Now I'm beginning to worry that perhaps people do think in those terms. Can you imagine a child being told that he or she was adopted because the tax laws induced the parents to do so? Perhaps I am wrong in thinking that the days of having as many children as possible because there were many acres of farmland to till are behind us. Leonhardt thinks that "[u]nless you’re a cynic, or an economist," it might be too much to think that the tax law has intruded on something so personal as the decision to have a child. I share his astonishment.

But even if one accepts the idea that people who might otherwise not have children decide to do so because of the tax law, or choose to have more children than they otherwise would have because of tax advantages, it is even more difficult to accept the notion that medical technology ought to be used to bring a child into the world before nature says it is time to do so. Aside from medical necessity that demands earlier birthing, doing Caesareans or pumping up the pitocin in order to make certain the child arrives before the ball falls on Times Square is dangerous. Leonhardt points out studies that show infant mortality increases when Caesareans are performed. I'm going to guess there is more risk to the mother as well. Compounding this approach is the increased cost of accelerating a birth. Leonhardt asks if the "health care system should be subsidizing parents' desire for a smaller tax bill." Good question. Easy answer. No. According to Leonhardt, some health care systems are now discouraging voluntary birth acceleration.

Leonhardt suggests a solution, and his suggestion makes sense. The tax advantages pegged to a child should be prorated, so that having a child in December would qualify a taxpayer for a small fraction of what's at stake. The significance of "out before the ball drops" would disappear. Of course, the proration also should apply to other instances where the tax law currently puts a premium on making a personal decision by midnight of December 31. Thus, for example, two individuals who marry on December 31 would be entitled to use joint return rates for 1/365 of their income rather than for all of it.

I doubt Congress will take the suggestion seriously. It's too easy to win votes by proclaiming one's self as pro-family and by proving one's status as pro-family by voting for enactment and retention of tax breaks that reward the acceleration of marriage and births. Never mind that the tax breaks are doing damage to children and mothers.

I don't understand why people who are planning to have children don't simply just have them. So what if the child arrives in September or October? What's the point in delaying the child's arrival until December and then resorting to Caesareans or pitocin to avoid a January birth? The cost of raising the child isn't reduced, and probably increases because inflation will make the cost of raising a child born in December of 2006 slightly higher than the cost of raising a child born in September of 2006. Could people be factoring time value of money into the computation and determining that the highest internal rate of return on having a child occurs when the child is born on December 31? Yikes, I cannot imagine how people whose decisions are based on that sort of reasoning determine how much to spend on an engagement ring or when to present it. "Excuse me, dear, but please stop complaining that you didn't get a ring on Valentine's Day. My financial adviser tells me it's best to pop the question next Thursday." OK.

Yesterday, I closed a commentary posted to a tax professor listserve with this observation: "The sad aspect of the story is that people should have children for every reason other than tax savings. What's next? Investing in a partnership that purchases children instead of oil and gas or real estate investments?" A tax colleague on the West Coast replied, "In many cases, leasing provides greater flexibility and superior discounted cash flow." He got me.

Paul Caron, over at the TaxProf Blog has started a series on "Christmas Gifts for that Special Tax Person." His first suggestion, he presents the framed exact reproduction of the original 1913 Form 1040. Oh, well, I already have one of those, a gift from family some years ago. It hangs in my dining room, catercorner to a framed blowup of the BNA Tax Management advertising copy with my portrait on it. Now that is something one won't find in stores. As far as I know, only one other print of that size exists, and the last time the other copy was in front of my eyes was when I walked through the lobby to Tax Management's offices. Considering that a few years have passed, perhaps it has been supplanted and consigned to storage or worse. I hope not. When they decide to toss it, I'd love to have it. Then each of my children can have one when I move on!

It's Paul's second suggestion that has me mesmerized. Did you know there are IRS chocolates? What an unexpected combination. Chocolate and the IRS. Perhaps what makes them good partners is that both operate with bean counters. OUCH, that was really bad. Sorry. Go take a look at Paul's blog, because the photos alone are worth the visit. They come in cases of 50 (though one version comes in cases of 20). Let that not stop anyone who wants to buy me a gift and doesn't know what to get. Don't worry, I'll share. Apparently Linda Galler brought these to Paul's attention. I don't know if Linda sought these out or came upon them by happenstance. Perhaps she, too, has a nose for chocolate. No matter, thanks to Linda for alerting the tax world, and I'm doing my best to spread the news. I know members of my family read this blog. OK, don't complain this year that I never give anyone suggestions. It's true, usually I say, truthfully, that I don't want anything. But this year, aha, these are too good (ouch again) to pass up. The fun question is whether they melt in your hand or in your mouth.

The serious question is whether there is a tax credit for purchasing IRS chocolate. There's a credit for almost everything else. What this country needs is a good chocolate purchase credit. Happy Holidays!

Monday's post, Tax Planning Challenges When Congress Dilly-Dallies brought a most interesting response from Andrew Mitchel, the tax chart guru. He points out that delays in dealing with expiring provisions are not the only snags to productive tax planning. Sometimes a provision that is enacted with an expiration date does not get used because of the uncertainties about its continuation. To quote Andrew, with his permission:

I liked your recent blog about people not acting because certain tax provisions expired and they weren't sure if they would be renewed. In a similar vein, I know that I personally have not made any contributions to 529 plans in the past because the law exempting distributions used for educational purposes was to sunset prior to my children reaching college age. This year the exemption was made permanent. I have now made a contribution to a 529 plan and I know of others that have done the same (for the first time).

Not only do expired tax benefits have distortions on intended behavior, but sunsetting provisions have similar effects.

I wonder if the experts who predict how taxpayer behavior will change in response to legislative enactments take this practical information into account. Perhaps their analyses are limited to the theoretical, a trend that is becoming far too prevalent. The famous question, "If they build it, will they come?" can be rephrased, "If they enact it, will taxpayers use it?"

Yesterday I was at lunch with some members of my family when the conversation turned to teaching, specifically, a tale of a class taught by a soon-to-retire professor whose incompetence caused all but 2 students to withdraw from the course. Essentially, he was not teaching the course as described, but another course. The concern was the removal of the withdrawals that the school put on the transcripts of the students who thought they were in an introductory course. On another day I'll comment about the inability of some higher education administrators to make education what it needs to be, in many instances because of constraints beyond their control.

The discussion about teaching continued with some comments about a teacher's responsibility to stay current with the subject matter. Someone at the table looked at me and commented that at least it would be easier this year in my tax courses because Congress hadn't done anything with the Code. Within a microsecond I explained that Congress indeed had made a slew of changes, as I discussed in last Friday's post, On the Way Out, They Grabbed Tax Breaks by the Hundreds. Trying to think of examples, I turned to the teacher at the table and explained that the preferred (above-the-line) deduction for certain expenses paid by school teachers for classroom supplies, which had expired on December 31 of last year, had been extended. Wasn't that good news?

No, was the response. The teacher explained that she had not made any classroom supply purchases this year because the deduction had expired. Suddenly, I wondered if there was more to the inability of Congress to do things in a timely and sensible fashion than simply my complaints, as exemplified by last Friday's post, about the tardiness, inefficiencies, unfairness, obfuscation, and irresponsibility of the Congress. Could it be that the failure to extend the teacher deduction before the beginning of taxable year 2006 had an adverse impact on the contributions teachers make to the experiences of their students, particularly in impoverished school districts, when they purchase the supplies that students otherwise would not have? So I asked whether the teacher's colleagues had reacted in a similar manner. I was assured that indeed they had. That's too bad. Is this simply the experience of teachers in one school district or is it a nationwide phenomenon? How would I find out? Has anyone surveyed teachers nationally? If you know, drop me an email.

It's bad enough that there are students whose schools cannot provide the required supplies and materials. It's unfortunate, yet a blessing, that teachers will step up to help where society generally fails our children. It's particularly impressive that teachers often make financial sacrifices to do this. In all fairness, though I am critical of the bad teaching that is tolerated in some schools, and even more critical of school administrations that are more political than pedagogical, I also know there are a lot of good teachers in our schools and that some of them are responding beyond the call of duty. And yet the Congress, by hemming and hawing all year playing politics with the so-called extender provisions in an effort to make permanent the estate tax repeal, seems to have done a disservice to education generally.

Yes, it's a small deduction as far as revenue costs go. Understand that it's not a matter of whether there is a deduction, but whether it can be deducted in computing adjusted gross income rather than being washed out by the limitation under section 67 that eliminates these employee business deductions to the extent they do not exceed 2 percent of adjusted gross income. But it's a big issue in terms of impact on our students and their education. Unless, of course, it turns out that the seeming expiration of the deduction did not affect teachers as my conversation suggests.

There is a lesson here. People need to plan. People need to know on January 1 what the tax landscape will be during the year so that they can make informed decisions. December is too late in the year to let people know what the tax rules for the year are going to be. It's not as though the Congress is suddenly presented with a problem. Everyone knew that provisions were expiring in December of 2005 long before the end of 2005. If a person ran a business the way the Congress runs this country, that person would be bankrupt in short order. Oh, wait, the Congress has also managed to rack up huge deficits, but I also will leave that topic to another day.

It's a game that has been played many times. It's late December. The IRS, facing deadlines for a variety of reasons, such as printing and web page re-design, has put together tax forms and instructions for the taxable year 2006. Taxpayers, facing last-minute end-of-year tax planning, make decisions based on the tax law as it exists in early December. Tax practitioners, asked for assistance in this year-end planning, deal with the same situation. Students, preparing for final exams in fall-semester tax courses, assimilate and shape their thinking around provisions in the tax law studied throughout the fall semester.

And then the rug gets pulled out from under these folks. By the Congress, of course. What other institution excels at crisis generation to the degree as does the one whose members inhabit the hallowed halls of the U.S. Capitol?

It's not that the IRS, taxpayers, and tax students did not foresee the possibility. Chatter about pending tax legislation has been underway for months. Yet, for all the predictions and guessing, no one knew with any degree of certainty if the legislation would be enacted, what provisions that were in the introduced bills would survive, what last-minute additions would find their way into the package, and how late in the year the legislation would be signed into law and made official. Topping off this array is the certainty that there are mistakes in the legislation.

If you have several days with nothing to do, take a look at the Tax Relief and Health Care Act of 2006. [Note: if the page does not load, go to the Library of Congress web site and search for Tax Relief and Health Care Act of 2006.] Why a few days? It's hundreds of pages long. Or do what most people do, namely, find a summary that someone else has prepared. The IRS cannot do that. Its personnel must comb through this monstrosity, examining each provision to determine if it requires a change in one or more tax forms or a revision to tax form instructions. The Chief Counsel's office and Treasury must generate a list of regulations projects required by this most recent tax act, and they must identify existing projects needing revision on account of it. Taxpayers must hope that their tax advisors have caught wind of every little provision, especially those stealthily inserted into the legislation at the last moment, items about which there had been little or no precedent chatter. Students might have the easiest time of it, for only the most brutal of tax law professors would expect a student taking an exam on December 16 (as mine are) to take into account changes made during the preceding week. Even I, the advocate of making law school education resemble tax practice rather than a philosophical symposium, don't push my students that close to the cliff of reality. Perhaps I should, but they've got more than enough tax insanity with which to cope.

This year, unfortunately, the IRS forms and instructions process is so far along that the IRS has told taxpayers that they will be using forms and instructions that do not reflect the changes. Taxpayers, and tax practitioners, will need to figure out independently how to modify the instructions in order to incorporate the changes. How seamless will this be? The IRS may issue supplemental instructions, but if the manner in which my tax students, among the nation's best and brightest, have assimilated mid-stream changes over the past two decades is any dedication, confusion will run rampant. One interesting example of what the IRS must do involves the sales tax tables for the revived sales tax deduction. The IRS plans to do another mailing to taxpayers to distribute the tables. Will the Congress step up to the plate and provide the IRS with funds to pay for this mailing, or will the IRS be expected to make cuts in some other program area? Does Congress want less taxpayer service? Of course not, because Congress harps on that issue every week. Does Congress want fewer audits? Wouldn't that make a great headline? Has Congress thought about the impact of the inefficient manner in which it does business?

So what does this legislation do to the tax world?

First, it takes some provisions that seemingly had expired at the end of 2005, and breathes new life into them. Called "extenders," these provisions change the termination date from December 31, 2005, or something like that, to December 31, 2007 or some other date in the future. Credits and deductions that taxpayers thought were dead have been revived. For some taxpayers, it's too late to turn back the clock and reshape business plans or undo personal decisions to take advantage of these revivals. Other taxpayers, having gambled, can chalk up last minute success, though had the particular provision in question not been revived, they would have been in deep financial trouble. Among the provisions that have been extended are the state and local sales tax deduction, the deduction for college tuition, the preferred status of the deduction for classroom supplies purchased by teachers, the research and development credit, the new markets credit, the Indian employment tax credit, the welfare-to-work credit, the benefits accorded qualified zone academy bonds, expensing for brownfields remediation costs, incentives for investing in the District of Columbia, several depreciation provisions, and an array of other provisions with which few taxpayers are familiar and which affect even fewer.

Second, the new legislation takes some provisions that were scheduled to expire at a future date and extends the expiration date even further into the future. For example, a variety of recently enacted tax breaks for assorted energy-saving activities have been given this treatment. Though this might make planning a bit more predictable for taxpayers considering investments and purchases involving energy equipment, there's no guarantee that the 110th Congress won't remove these provisions or turn back the termination date to what it was before the enactment of the Tax Relief and Health Care Act of 2006.

Third, the health savings account provision of the tax law was amended to increase the limit on the tax-free contributions that can be made to those accounts. According to the Washington Post, the changes were "quietly added" by Republican lawmakers "with little public debate" at the "urging of several major business lobbies eager to reduce their medical-insurance costs." The expansion of HSAs does nothing to help the 600,000 children whose health care is imperiled because a funding patch for the State Children's Health Insurance Program was removed from the list of extenders.

Fourth, the new law tosses in a potpourri of changes. The section 199 deduction is widened to include certain activities in Puerto Rico. The credit for prior year minimum tax liability is made refundable if, after three years, there is insufficient minimum tax liability to be offset. There is a new deduction for advanced mine safety equipment in the year of acquisition. There is a new credit for mine rescue team training. The ill-advised special low tax rate for musical compositions is made permanent. Mortgage insurance premiums are treated as deductible interest, for certain taxpayers, through the end of 2007. So if there's a question on the tax exam asking for a True or False answer to the statement "Mortgage insurance premiums on personal residence mortgages are deductible," should it be tossed out? The simple answer "no" has become a more complicated "sometimes." I have previously commented on the ill-advised nature of the mine safety tax breaks and the outright inappropriateness of the tax break for income earned by writing music in contrast to the higher rates on income earned by performing other services.

Fifth, all sorts of changes are made to tariffs and excise taxes. In the interest of brevity and in acknowledgment of my limited familiarity with the details of tariffs and excise taxes generally, I'll let someone else opine on their significance. What needs to be noted is the report in the Washington Post that 520, yes five hundred and twenty, tax breaks were added to the legislation in the tariff area alone.

Sixth, the legislation contains boatloads of changes to Gulf of Mexico energy policy, a premium array of modifications to Medicare, and a long list of tariff changes. Did you know that there was a tariff on N-Cyclohexylthiophthalimide that has been suspended? Did you know there was something called N-Cyclohexylthiophthalimide? According to this site, "Cyclohexyl thiophthalimide is the primary retarder used to prevent premature vulcanization of rubber compounds during mixing, calandering, and other processing steps." Take a look at the legislation's table of contents beginning with section 1111 and ending with section 1493. Tell me how many of the terms you can define without doing any research.

Seventh, the law makes a variety of technical corrections to earlier enactments. That ritual has become habitual, unfortunately. Is it any wonder that corrections are required when the Congress waits until the last minute and then crams all sorts of things into the bill without giving itself or its staff time to do some careful drafting, let alone giving the public a chance to review the proposals and provide comments?

Eighth, this "Tax Relief and Health Care" bill makes changes to the trade law. Particular attention is given to trade with Vietnam, Haiti, parts of Africa, and areas in the Andes. It's amazing how much stuff that isn't tax gets jammed into tax legislation. In this instance, it was mostly a matter of blackmail, though politicians like to call it "leverage." Sorry, changing the word doesn't mask the inappropriateness or inefficiency of such a process.

Something still isn't quite right with the legislative process. A lame-duck Congress has grabbed for its friends and supporters all sorts of financial and tax breaks as its members leave the chambers. Politically, the losers have put the next Congress into a tough spot, because attempts to undo this pork rolling will meet with cries of "insensitive tax raising" from those who are unhappy that someone else is sitting at the public trough. No matter that uncertainty and confusion clouds year-end tax planning, that aggravation and inconvenience, to say nothing of extra work, will afflict the soon-to-start tax filing season, or that students of tax once more find that some of what they have learned has become obsolete before it leaves the starting line. No, somehow the economic wants of the financially powerful that run the country take precedence over the needs of the people. Of course, this flaw in the system is nothing new, as is evident from the many times it has factored into an analysis of tax legislation. For example, during the past 18 months alone the effects of this flawed system have surfaced too many times: There Are Some Things Tax Break Money Cannot (and Should Not) Buy (May 22, 2006); Call the New Tax Bill TROFTHOWT. Why? Read On (May 15, 2006); I Sing a Song of Taxes, a Pocketful of Cries (Nov. 30, 2005); "They" May Be Reading the Tax Analysis, But Are "They" Listening? (Nov. 18, 2005); How Much Energy Does It Take? (June 20, 2005).

The vice-chair of the House Republican Congress put it best: "A lot of members of Congress are just clueless as to what is going on." No kidding. The Constitution imposes minimum age and citizenship requirements for members of Congress, but unfortunately says nothing about intelligence, education, or common sense. The drafters of the Constitution probably assumed voters would take those factors into account when making their electoral choices. Hah.

What's next? A very easy-to-articulate and difficult-to-answer question: Will the 110th Congress restore sanity to the legislative process and to the tax law? Or will it be more of the same?

Julian Block has a tax book hat trick for 2006. Earlier this year, in Tax and Relationships: A Book to Read and Give, I described his "MARRIAGE AND DIVORCE: Savvy Ways For Persons Marrying, Married Or Divorcing To Trim Their Taxes - And They’re Legal." Several months ago, in A New Book on Taxation of Residence Sales: Don't Leave Home Without It, I reviewed Julian's "THE HOME SELLER’S GUIDE TO TAX SAVINGS: Simple Ways For Any Seller To Lower Taxes To The Legal Minimum." Now he brings us "TAX TIPS FOR SMALL BUSINESSES: Savvy Ways For Writers, Photographers, Artists And Other Freelancers To Trim Taxes To The Legal Minimum."

As I mentioned in the two previous reviews, Julian's titles suggest that he is collecting gimmicks, tricks, and ploys with respect to the tax treatment of the selected subject, but the actuality is quite the opposite. What Julian does is to put the spotlight on tax provisions that easily can be overlooked by someone not expertised in taxation. In addition to reminding taxpayers of deductions and credits of which they should be aware, he also spells out in careful detail the common mistakes that taxpayers often make, and why trying for more than the tax law allows is counterproductive. Thus, in his latest effort, Julian begins with an explanation of how difficult it is to demonstrate that activities such as writing, photography, and art constitute trades, businesses, or for-profit activities rather than hobbies.

In this new book, Julian devotes chapters to small business depreciation, health insurance and vehicle deductions for the self-employed, home office deductions, self-employment taxes, net operating losses, and section 1244 stock. He describes the narrow circumstances under which travel expenses for an entrepreneur's spouse can be deducted. He explores the circumstances under which employed of children in a parent's business can be advantageous, and those in which it is not. Practical tips about making payments at the end of the year, keeping records, sending checks to the IRS, extensions of time to file, and making refund claims are covered in five chapters. Julian warns self-employed individuals who hire employees about the risks of failing to withhold and remit employment taxes, a problem that seems to afflict far more people than one would expect.

As with his earlier works, Julian's most recent effort is more suited for the person not schooled in tax law. The many people who start doing business without getting any tax advice, and who for whatever reason do not seek that advice at the outset, would be well advised to buy this book and become acquainted with the tax law parameters affecting writers, photographers, and artists. Doing so would reduce the likelihood of making decisions that generate adverse tax consequences that could have been avoided.

To order a copy, contact Julian Block at 3 Washington Sq., #1-G, Larchmont, NY 10538 or go his website, julianblocktaxexpert.com. Or, as was the case with the previous books, email Julian at julianblock@yahoo.com.

A question that was posed last week presents an opportunity to explain how a student of taxation needs to learn not only rules but methods of dissecting a transaction to identify what is deemed to occur for tax purposes. The fact situation that my students see early in the semester involves an employer who persuades a valued employee to continue employment by transferring an automobile to the employee's spouse. At first glance, almost all students see a transfer from an employer to someone who is not an employee and begin thinking that the rules applicable to gifts would apply. But careful analysis reveals that the transaction, in substance, is a transfer by the employer of an automobile to the employee followed by a transfer by the employee to the spouse. Thus, the compensation rules apply to the employee, and the marital property transfer rules apply to the spouse. I tell my students that this hypothetical serves as a paradigm for many situations in which what appears to be one transaction ends up being treated as two or more steps.

Last week's question was described this way:

Sole owner of an S Corp wants to pay his top employees a bonus of land he owns personally instead of cash.

I assume this would be compensation and would be reported as such on W-2s. Is the amount to report the current FMV or the owner's basis?

One analysis concluded that the owner would be "entitled to a compensation deduction equal to FMV" and would be required to "recognize gain equal to the difference between owner's basis and FMV." This would give the employee an adjusted basis equal to fair market value.

Someone tactfully challenged this analysis by asking where the compensation deduction would be reported on the owner's tax return. Back came a response: "Wages." That, however, though describing the nature of the transaction, does not identify where the deduction would be taken. Schedule C? Schedule E? Schedule A?

Someone else pointed out that what appeared to be a transfer by the S corporation shareholder to the S corporation employee would be a "deemed contribution of the land to the corporation, with a carryover basis and a gain to the corporation when the land is transferred to the corporate employee as compensation for services rendered to the corporation." Bingo. It's a marvelous application of the "automobile transferred to employee's spouse" paradigmatic hypothetical that comes early and often in the basic tax course. Someone was paying attention. So, too, was another respondent, who explained that the deemed contribution of the property to the S corporation would be tax-free under section 351 and give the S corporation an adjusted basis equal to that of the shareholder, and that the deemed transfer to the employee would trigger a compensation deduction and also gain to the corporation because it was using appreciated property to pay an obligation.

At about the same time, I replied, in what turned out to be an incomplete answer. I asked, "Why is this not a deemed contribution of the land to the corporation and a payment by the corporation of compensation?" I overlooked the gain recognition that would fall upon the corporation. I turned too quickly to the "so what?" portion of the question. "Yes, the deduction will flow through to the owner," I noted, so that ultimately the shareholder would get a deduction, but in the form of a reduced amount of income pass-through or a larger loss pass-through from the corporation. So, ultimately, the answer to "where?" is Schedule E, in an oblique sort of way.

But then I pointed out one reason it mattered: "[B]ut (at least theoretically) the determination of whether the compensation is reasonable will be affected by bunching the bonus and regular salary, and the computation of FICA, etc., will differ." Otherwise, the employee's total compensation would be split between two payors, causing a variety of problems in the determination of its deductibility and the computation of taxes and limitations that are affected by total compensation.

This scenario demonstrates that one of the several complexities of tax law is transactional complexity. In this instance, what appears to be a simple transfer turns out to be two transfers, each triggering a variety of tax consequences. Knowing the rules is insufficient, because the first thing that must be accomplished is identification of the facts to which the rules are to apply. Identifying the applicable rules requires an understanding of the facts. This is one reason I reject the "IRAC" (issue, rule, application, conclusion) nonsense hailed by some law professors and bar review instructors as helpful. Sorry, but the first step is to identify the actual facts, because until that is done, there is no way to identify the issue or the applicable rules.

It is important to recognize that these sorts of factual analyses are not something over which tax law has a monopoly. In every area of the law, and in many areas of life, what appears to be a one-step transaction turns out, in substance, to be a two-step even multiple-step arrangement. Yes, the parties could have taken each step. The employer could have transferred the car to the employee and the employee could have transferred it to the spouse. The shareholder could have transferred the property to the corporation and the corporation could have transferred it to the employee. But other considerations must be given their due. Would there be multiple state and local transfer taxes? Would it generate problems with state regulation of the employer or the property? Would there be other transaction costs doubled by the doubling of the actual transfers?

It takes some practice and experience to become facile with the art of "splitting" one transaction into two or more steps for tax or other purposes. That's yet another reason someone who spends a mere three years in law school enters law practice with many unpolished skills and some hurdles to overcome. There is no magic rule or computer program that can parse a transaction. The folks who think tax is a mechanical discipline which provides "answers" to each problem can ponder these sorts of transactions as they try to understand why there are as many situations with no clear answer in tax as there are in other areas of the law.

Slightly more than two years ago, I commented on the tale of Arthur L. Farnsworth, who lost by a huge margin his campaign for Congress, during which he explained that he believed no one is obligated to pay federal income taxes and that he had not paid federal income taxes. Farnsworth's tactics caught my attention, in part, because, as I explained in that earlier post>

Unlike some tax protestor advocates, who encourage people to ignore their tax paying duties while filing their own returns because they don't really believe what they're preaching, this fellow apparently told the truth. At least the IRS and the Department of Justice believed him.

They believed him enough that he was arrested and indicted.

Now comes news that Farnsworth has been convicted of tax evasion. A jury rejected his argument that paying federal income taxes is voluntary and not mandatory. Farnsworth agreed he had gross income and taxable income, but claimed he had a good faith belief that compliance with the tax law is voluntary.

But the jury did not believe him. Taking less than two hours to return the guilty verdict, the jury accepted the prosecution argument that Farnsworth's motives reflected his tax-protester philosophy and not the "intense legal research" Farnsworth claimed he had undertaken to corroborate his position.

Apparently Farnsworth came across as "confident and combative" when he was testifying. Those are two characteristics of many politicians. Farnsworth also racked up a third, namely, extreme difficulty getting people to believe what is being said. It's ironic that the one thing he did say that was believed triggered the investigation, arrest, indictment, and conviction. He was telling the truth when he admitted he had not paid federal income taxes. So, perhaps Farnsworth is different from most politicians, because he had the courage to back up his philosophy with consistent action. Perhaps the judge should sentence him to holding seminars for the nation's politicos. Free of charge, of course, so that Farnsworth isn't confronted with the challenge of deciding whether to pay taxes on the income.

Several months ago, in Adding Up The Telephone Tax Refund, I described how I invested a bit of time adding up the long-distance excise taxes that I had actually paid, and determined that it made more sense to take what I call the "standard refund" offered by the IRS. I am guessing that unless a person spends an unusually high number of hours on long-distance calls, the outcome would be the same for others.

The IRS has now released guidance for organizations computing the telephone excise tax refund. The guidance applies to businesses and to tax-exempt organizations. Everyone has the option of sitting down and adding up the actual excise tax paid during the March 2003 - July 2006 period for which the refund is calculated. Depending on how an organization maintains and retains records, this could be a fairly easy task or a nightmare. The alternative is to use a formula.

Here's how the formula works. Take a telephone bill with a statement date in April 2006, and another bill with a statement date in September 2006. For each bill, divide the total telephone tax that has been paid by the total of the bill. Because the September bill includes only the tax on local service but not long-distance service, the difference between the two percentages generates what I will call the "long distance excise tax percentage." For example, assume that on the April 2006 bill of $200, the telephone tax is $3, and on the September 2006 bill of $100 it is $1. The April percentage is 1.5 and the September percentage is 1.0. Thus, the "long distance excise tax percentage" is 0.5%. Next, add up the telephone bills for the March 2003 - July 2006 period, and multiply it by the "long distance excise tax percentage."

Simple enough?

No!

If the organization has 250 or fewer employees, the "long distance excise tax percentage" is limited to 2.0%, even if the computation generated a higher amount. If the organization has more than 250 employees, the "long distance excise tax percentage" is limited to 1.0%, even if the computation generated a higher amount.

I understand the simplicity of calculating the April and September percentages, computing the difference, and applying that result to the bills for the March 2003 - July 2006 period. I don't understand why there is a limit, nor why the existence of a 251st employee should make the limitation half of what it otherwise would be. Perhaps it's a law of physics or a chemistry formula I failed to learn in college, or learned and have since forgotten. Perhaps it has something to do with time travel or teleportation.

Then it gets even more complicated for sole proprietors. A sole proprietor who reports gross income of $25,000 or less on Schedule C may use the standard refund amount or the long-distance telephone excise tax actually paid. A sole proprietor who reports more than $25,000 of gross income has three options: (1) use the standard refund amount for individuals and the formula for business, (2) use the formula for the business and the actual telephone excise tax paid on the personal bills, or (3) use the actual excise tax paid on both business and personal bills.

There's more. Special rules exist for trusts and estates. Analogous rules apply for farmers. And on and on it goes. Wait, don't hang up!

I wonder how long it will take someone in government to call the refund computation process something that has added 20,000 jobs to the economy, mitigated the downturn in the housing market, strengthened the dollar overseas, or reduced mortgage rates. And if that happens, how many Americans will see the disconnect?

In early October, I explained, in Ready It Was Not: The Demise of California's Government-Prepared Tax Return Experiment, that the California Franchise Tax Board had terminated the Ready Return program, which I had criticized in Hi, I'm from the Government and I'm Here to Help You ..... Do Your Tax Return and in ReadyReturn Not a Ready Answer. Without repeating two justifiably long analyses of the defects of the program, suffice it to say that conflict of interest permeates the arrangement, the track record of government employees in these sorts of situations is too far from ideal, opens the door to fraud, poses logistical problems, tricks millions of taxpayers into thinking that complicated tax laws are not their problem even though they continue to pose a threat to the national well-being, and puts taxpayer privacy at risk. Joined by many other critics, I tried to explain to the advocates of Ready Return why it was the typical "good idea in theory" that falls apart in the real world of tax practice.

In late October, I noted that opponents of Ready Return continued to lobby against it. In As Halloween Looms, Making Sure Dead Tax Ideas Stay Dead, I suggested that perhaps the reason a seemingly dead program was getting negative attention could be found in the many "horror flicks where the monster, the alien, the bad guy, or whomever it is that should be dead appears to be dead but isn't." Opponents of the program were contributing to the campaign of a candidate running for the office of state controller who supposedly did not favor Ready Return.

In my late October post I stated that, "Perhaps most folks think, as I do, that the ReadyReturn experiment is over."

Wow, was I ever wrong.

Along comes news that Ready Return has been resurrected. There is no way to paraphrase the first part of the opening sentence of the story: "State tax authorities defied lawmakers Monday by reviving ReadyReturn..." Yes, "defied." The outgoing state controller, and the incoming state controller, "engineered" the restoration of the theoretically ideal but pragmatically horrific arrangement. The legislature had let funding and authorization for the program expire earlier this year.

The incoming and outgoing controllers, along with the Director of the Finance Department, comprise the Franchise Tax Board, which reinstated the program after being assured by staff that the Board could act on its own despite the actions (or inactions) of the legislature. Yet legislative leaders explained that they would not try to stop the Board from taking this step. Why?

The justification offered by the outgoing controller is the high praise from taxpayers who used the program. But is high praise meaningful when the taxpayers do not know if their returns were properly prepared, if their privacy was protected, if their returns reflected all available tax breaks? Surely a drug dealer's new customers, getting some free "samples" on the corner, have nothing but high praise for their provider. Who gets to audit the returns prepared by the California government on behalf of these taxpayers? Oh, wait, the government will audit itself. Considering the developments of the past many decades, I have little confidence in government getting it right.

Twenty-one other states have taken a different approach. They are cooperating with private sector enterprises, with IRS assistance, in the Free File Alliance, to make available to low-income taxpayers the same software that middle-income and upper-income taxpayers can access directly or through paid preparers. Would citizens prefer food stamps or meals prepared by government employees? It's possible to assist citizens without taking control of their lives, a point too often lost on elected officials, and almost always ignored by appointed bureaucrats. Even so, some members of Congress and others have criticized the Free File Alliance, claiming it exploits taxpayers. I suppose that handing out food stamps exploits hungry citizens, whereas providing government-prepared meals doesn't?

If private enterprises challenge the actions of the Franchise Tax Board, it probably will not be litigation brought by one plaintiff. Not only should we expect Intuit and other software providers to oppose this government intrusion into the private market, other critics, such as the California Taxpayers Association and the California Chamber of Commerce, probably will join, together with other businesses and business groups representing one-person and small firm tax practitioners, to oppose the Franchise Tax Board's unilateral action. Of course, the Franchise Tax Board will not defend such a lawsuit by itself. Stanford University law professor Joe Bankman, who used $30,000 of his personal funds to hire a lobbyist to argue for restoration of ReadyReturn, almost surely will file an amicus brief in support of the program if it gets to that point. Considering reaction I've seen to the news of the program's re-emergence, he almost surely would not be alone.

As I argued in my earlier posts on this subject, would not the state of California, its citizens, and its taxpayers, be better off if the Franchise Tax Board would use its resources to work for simplification of what is one of the two most complicated state income tax systems in the nation? Rather than quieting the complaining voices of millions of taxpayers by doing their returns for them and masking what really is happening to them, the Board ought to confront the problem rather than paper over the symptoms. But because the Board, its members, and the politicians who run California have vested interests in complicated tax systems, they prefer to silence hordes of would-be critics by patting them on the head and telling them, "There, there, Uncle California has everything under control for you."

I cannot imagine why any of the low-income folks supposedly being helped by the government in this program should have any reason to trust the government any more than people do generally. According to this study, "The percentage of Americans who trust the government in Washington plunged from 76 percent in 1964 to 25 percent in 1996." A May 2006 poll indicates that 63% of the people do not trust government, and that 78% think the federal government has too much power. In California itself, according to this recent survey, 29% of those polled "say they trust the government to do what is right just about always or most of the time." I wonder what the other 71% think about the state government doing their tax returns.

There is something much deeper in this entire story than simply the elimination of tax return preparation burdens on low-income individuals. After all, the easiest and cheapest way to attain that goal is to remove low-income individuals from the tax rolls. Ah, but then the control factor isn't there. So what is it, really, that ReadyReturn represents? And though I run the risk of being as wrong as I was when I suggested ReadyReturn had found its appropriate place in the tax idea trash can, it's a foot in the door and a camel's nose in the tent. At what point will all taxpayers simply be told, "we figured out how much of your money we want, thanks for prepaying, see you next year"? Be afraid, be very afraid.

Paul Caron relayed an interesting rhetorical comment about the constitutionality of the Internal Revenue Code on his TaxProf Blog. The observation was triggered by news that Judge Audrey Collins of the Central District of California again struck down a portion of the Patriot Act on the ground that despite amendments to the provisions they remain "too vague" to be understood by "a person of average intelligence" and thus are unconstitutional. The Wall Street Journal Best of the Web commented:

So laws are unconstitutional if "a person of average intelligence" can't understand them? Someone ought to get the Internal Revenue Code before this judge.

Two thoughts occur to me. Neither is reassuring.

The first thought is whether vagueness should be attributed to the Internal Revenue Code. The Code has many faults. It is complicated. It gives multiple definitions to the same word or phrase. It changes so frequently that tax practitioners are compelled to empty portions of their brains and refill them at a faster rate than do many other professionals. It is loaded with special interest provisions that aren't necessarily of benefit to the public generally. It contains provisions reflecting bad policy. But vague? There's nothing vague about the application of the tax rates in section 1 or the rule that a pet cannot be a dependent. Yes, there are questions that the Code does not answer, but the Code itself provides for administrative interpretation.

The second thought takes the form of a question. If everything that could not be understood by a "person of average intelligence" were to be declared unconstitutional and removed from the planet, what would remain? Is there something wrong when a patient cannot understand a medical procedure used by a surgeon? Is there something wrong when a driver does not understand the engineering formulae used in designing the bridge over which the vehicle is crossing? Is there something wrong when someone enjoying a fine meal cannot understand the recipe?

I'm not taking any position on the merits of the case decided by Judge Collins. There is, however, something alarming about reducing everything to a least common denominator of "average" anything. That's not a defense of complexity. Complicated things aren't vague. To the contrary, they generally are very precise and quite the opposite of vague.

But even a constitutional ban on complexity would be no less counterproductive. If everything that was complicated were to be declared unconstitutional and removed from the planet, what would remain? Think about it.