MauledAgain

An article in Sunday’s Philadelphia Inquirer asked an important question with its headline: More taxes on worn buildings, vacant land? The article was inspired by a 16-year-long dispute involving Philadelphia properties owned by the estate of Sam Rappaport, once a prominent Philadelphia landlord. The estate’s executor is a New Yorker, Richard Basciano. One of the problems is that the properties have not been put to their best use, thus causing them to be valued for real estate tax purposes at amounts lower than presumably would be assessed if they were developed beyond their current state. Philadelphia builders claim that they have tried to purchase the properties from Rappaport’s estate, but that Basciano wants them to “charge New York prices for Philadelphia lots.” Basciano’s attorneys explained that many of the properties were tagged with violations of the building code, and that the properties were severely encumbered with debt. They also explained that the estate indeed has sold some of the properties to Philadelphia developers. Apparently, though, those sales took place more than ten years ago.

The article asked another question. “If Basciano can afford to hold the properties in search of higher profits, what’s to stop him?” and answered it by proposing “Maybe Philadelphia’s tax assessment system.” It is undisputed that under the current system, an empty lot is assessed at a lower value than would be the same lot with a commercial or residential building on it. A lot used as a parking lot carries a lower assessment than the same lot with an office building on it. The chief of Philadelphia’s Center City District suggests that the real property tax system be changed so that properties are assessed at their highest and best use. The theory is that by being taxed at the best-use value, property owners would be encouraged either to develop the property or to sell it to someone who will. The practical impact, however, could be destructive.

The suggestion that the tax assessment system be changed to value properties at best-use value poses a serious threat to owners of properties that are more than empty lots or parking areas but that are not the best use of the property. Consider the number of properties in the city with buildings that, if resources were available, could be torn down and replaced with more efficient, more functional, and more attractive, in other words, buildings that would have a higher value. This sort of valuation process would adversely affect owners of properties with older, functional yet aging, adequate yet not modern-looking buildings.

The article notes that the idea that the property tax should be imposed on land, not buildings, is a very old idea, and is one that ensures “property owners feel pressure to erect buildings as valuable as their neighbors’ instead of leaving them speculatively vacant.” There are several serious flaws in this approach. First, this approach would encourage the disappearance of green space within the city and would discourage property owners from devoting some portion of land to something other than concrete and steel development. Second, any attempt to mitigate the effect by restricting best-use valuation either geographically, such as the center city district, or by limiting it to empty lots, would violate a variety of state, if not federal, constitutional and statutory provisions. Third, this approach opens up the need to determine, and thus to dispute and litigate, the question of what is the best use and the question of what value should be assigned to a hypothetical best use.

A proponent of the best-use approach explains, “But I have a fundamental issue with someone saying, 'For tax purposes, it's worth $1 million, but when I want to sell, it'll be $20 million." So do I. The problem isn’t one that can be solved only by shifting to a best-use system. The problem is that a property that sells for $20 million, barring an absurd surge in market values the day before the sale, ought not be “worth $1 million” for tax purposes. The problem is the same one that has afflicted the Philadelphia real property tax for decades, namely, erroneous assessments. I have previously commented on the Philadelphia real property tax system, and its flaws, in a long series of MauledAgain posts, starting in An Unconstitutional Tax Assessment System, and continuing in Property Tax Assessments: Really That Difficult?, Real Property Tax Assessment System: Broken and Begging for Repair, Philadelphia Real Property Taxes: Pay Up or Lose It, How to Fix a Broken Tax System: Speed It Up? , Revising the Board of Revision of Taxes, How Can Asking Questions Improve Tax and Spending Policies?, This Just Taxes My Brain, Tax Bureaucrats Lose Work, Keep Pay, Testing Tax Bureaucrats Just Part of the Solution, A Citizen Vote on Taxes, Freezing Real Property Tax Reassessments: A Nice Idea, The Tax Price of a Flawed Tax System, Can Bad Tax Administration Doom the Tax?, Taxes and Priorities, R.I.P., BRT, and A Tax Agency Rises from the Dead. Getting assessments done properly poses the same challenges whether the assessors are trying to determine current market value or a theoretical best-use value, although one could safely assume that assessors are more likely to miss the mark when trying to determine best-use value than when trying to determine current market value.

The same proponent also advocates a “flipper’s tax” on passive property investors. His argument is that people who improve a property pay “a lot more tax” than do people who simply buy land and hold it, or buy land with run-down buildings and let it “rot” while waiting for the value to increase. Are there not laws already in place that impose penalties on property owners who let their properties “rot”? If there is a tax on people who hold property such as a parcel of land waiting for the best time to sell or develop, will there also be a tax on someone who owns a residence but who doesn’t install a deck that would increase its value? Yet does this sort of thinking not lead to a tax on employers who fail to hire more employees?

It’s not permissible for a government to tell the owner of a vacant lot to build a building on it, even though it is permissible for the government to tell the owner not to dump toxic waste on it or to tell the owner to clean the trash piling up on it. The tax law ought not be used as an end-around subterfuge to accomplish the impermissible.

One of my favorite classes in the basic federal income tax course is the one that deals with the tax treatment of items that a person finds. The point of the discussion is to give students a chance to understand the scope of gross income, and to appreciate the fact that not every specific instance of gross income is set forth in the statute. The course book that I use includes a case dealing with a taxpayer who finds cash in a piano that was purchased. In my supplemental materials, I provide them with newspaper articles about a person who found a copy of a first printing of the Declaration of Independence inside a painting purchased at a flea market for $4, another couple who found cash – in this case $140,000 – in a piano purchased at an estate sale for $70, and a person who found valuable autographs inside a table purchased for $3 at an auction. I share with them other stories, noting that most semesters I hear or read about a new one in the news about the time we discuss the topic. The stories are fun. After learning of someone who purchased a used violin only to discover it was a Stradivarius, I ask the class why these sorts of things don’t happen to me or to them.

One of the attributes of all the stories and hypotheticals is the ease with which the person discovers the valuable item. Someone purchases an item at some sort of sale and, presto, it’s a Ming Dynasty vase. Or someone is walking down the street and sees a diamond ring, or a Rolex. In some examples, I have the person identify the owner and return the property, in order to get across some aspects of realization and increase in economic wealth.

Now comes a Philadelphia Inquirer story about another way in which people find things. The title alone says almost everything: Hidden Treasure in Philadelphia-Area Sewers. That’s right. Sometimes to find a treasure one must do more than go to an auction or watch the ground carefully while walking. Sometimes one must get down into the muck and get dirty. All that advice about keeping out of the gutter and staying out of the sewer turns out to be misleading when it comes to finding valuable things.

The tax side of the story is what gets my immediate attention, but there’s so much more to the article. So if you’re interested in the details about “guns recovered after a burglary,” “[k]ids will throw anything down a hole,” “We’ve had ducks,” “Are there alligators?,” “catfish,” “Curly . . . the ball python,” and the hundreds of Nerf footballs from a “marketing attempt gone bad,” read the story. Even if you don’t get a chance to drop some fun trivia on a first date, it’s a fun read.

The tax questions arise from several revelations on the part of the sewer workers. One worker explained that the “crew’s payload is about $10 in change every month,” and that “once every two months a worker will find a piece of jewelry – though mostly costume.” We’re told that “Most sewer departments have a finders-keepers philosophy. If the guy is willing to reach in and grab it, it is his.” As for small amounts of money, “The found money gets spent treating coworkers to lunch,” but “sometimes, [found coins] are just spent in the vending machine.” Rings and other jewelry often are so damaged that they are “sold to jewelers as scrap.” Old coins are taken in for appraisal. On one occasion, a worker was able to identify the owner of a 40-year old class ring, and returned it. See where this is going? The tax questions are jumping out at us. Does the worker who finds something of value and keeps it have gross income? Do the coworkers have gross income when they receive lunch courtesy of money found in the sewer pipes? What is the tax treatment of the worker who found the class ring and returned it to its owner?

These questions have fairly easy answers. I’m not going to provide them, because I or my tax professor colleagues across the country might turn this into an exam question or something to raise in the classroom. But perhaps the answer to my question about why these sorts of things don’t happen to me or to my students comes from one of the sewer workers interviewed for the story. “You have to be at the right place at the right time.” How true. When’s the last time you’ve been in the sewer? And digging through the tax law doesn’t count.

An unusual event has occurred in the tax world. The IRS issued Revenue Ruling 2010-25. The issuance of a Revenue Ruling, though something that happens much less frequently than it did twenty years ago, is not the unusual event. Nor is the conclusion reached by the IRS. What is unusual is that in the revenue ruling, the IRS concluded that the outcome in two cases in which it had prevailed was wrong. In other words, the IRS has decided not to continue taking the position that it had taken and that the Tax Court had upheld. Though from time to time the IRS announces that it does not plan to follow a Tax Court decision in which it lost, it is a rare occasion when the IRS wins, wins again, and then decides it should have lost.

The issue, on the surface, is fairly easy to set forth. How much of the interest paid by a taxpayer on a mortgage loan undertaken by the taxpayer to purchase a principal residence is deductible? The analysis is a bit more challenging.

Section 163(a) permits a deduction for all interest, but for individuals section 163(h)(1) disallows deductions for personal interest. Personal interest is all interest, other than trade or business interest, investment interest, passive activity interest, qualified residence interest, certain interest in deferred estate tax liabilities, and education loan interest. The relevant exception is the provision that allows a deduction for qualified residence interest.

Qualified residence interest consists of two components. One is interest in acquisition indebtedness with respect to a qualified residence. The other is home equity indebtedness with respect to a qualified residence. A qualified residence is the taxpayer’s principal residence and one other residence owned by the taxpayer that is selected by the taxpayer as a qualified residence. Acquisition indebtedness is any indebtedness “incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer” and that is secured by the residence. No more than $1 million of indebtedness can be treated as acquisition indebtedness. Home equity indebtedness is any indebtedness “other than acquisition indebtedness” secured by a qualified residence to the extent that it does not exceed, in effect, the lower of $100,000 or the excess of the residence’s fair market value over the acquisition indebtedness with respect to the residence.

So assume a taxpayer purchases a principal residence for $1,500,000, by using $300,000 of cash and borrowing $1,200,000 secured by a mortgage on the residence. The taxpayer owns no other residences. The taxpayer pays interest on the $1,200,000 loan. How much of that interest is deductible.

In Pau v. Comr., decided in 1997, the Tax Court agreed with the IRS that only the interest on $1,000,000 could be deducted, reasoning that there is $1,000,000 of acquisition indebtedness but no home equity indebtedness because the taxpayers did not prove that any of the debt was not incurred in acquiring, constructing, or substantially improving the residence. Three years later, the Pau decision was followed by the Tax Court in Catalano v. Comr.

The difficulty with the Tax Court’s reasoning is its conclusion that indebtedness cannot be home equity indebtedness if it was used to acquire, construct, or substantially improve the residence. But that is not what the statute says. The statute defines home equity indebtedness as indebtedness “other than acquisition indebtedness” secured by a qualified residence to the extent that it does not exceed, in effect, the lower of $100,000 or the excess of the residence’s fair market value over the acquisition indebtedness with respect to the residence. Thus, one must first identify acquisition indebtedness. The taxpayer used $1,200,000 of indebtedness to purchase the principal residence, but the statute treats only $1 million of this amount as acquisition indebtedness. In other words, the other $200,000 of indebtedness is NOT acquisition indebtedness. If the $200,000 is not acquisition indebtedness, then $100,000 of it can be home equity indebtedness provided the fair market value of the residence is at least $1,100,000. The Tax Court treated the statute as though it defined home equity indebtedness as indebtedness “not used to acquire, construct, or substantially improve a residence” that is secured by a qualified residence to the extent that it does not exceed, in effect, the lower of $100,000 or the excess of the residence’s fair market value over the acquisition indebtedness with respect to the residence.

Though it took ten years, the IRS finally decided that the conclusions reached on this point in the Pau and Catalano decisions are wrong. It issued Revenue Ruling 2010-25 to set forth the explanation that had been provided years ago by those who disagreed with the approach advocated by the IRS and adopted by the Tax Court in Pau and Catalano.

The IRS should be commended for giving up on an erroneous position. One wonders whether the IRS is prepared to give up on its erroneous position with respect to section 280A apportionment of interest and taxes that was first rejected by the Tax Court in Bolton v. Comr., rejected in every subsequent case, and rejected by every Court of Appeals that has considered the issue. There are similar issues ready for a similar admission of error by the IRS. The answer to why the IRS has not moved on those cases might lie in the answer to why the IRS challenged the taxpayer’s deductions in the Pau and Catalano cases. Could it be that not every IRS employee or Chief Counsel attorney fully understands the tax law? I wonder whose fault it is that the tax law is so difficult to understand because it is so confoundedly and needlessly complicated.

Efforts by the Pennsylvania legislature to deal with proposals to tax Marcellus Shale natural gas have, to borrow from the headline of this Philadelphia Inquirer story, reached a stalemate. The suggestions I made two weeks ago to prevent or break a stalemate, discussed in Tax? User Fee? Does the Name Make a Difference?, apparently have not been invited to Harrisburg. Nor have I. It only takes one read of the the Philadelphia Inquirer story to understand why. I’m more interested in getting things done, whereas the legislators are more interested in finding political advantage.

One of the reasons that a stalemate exists is the contradictory evidence generated by the pollsters. According to another Philadelphia Inquirer story, in one poll, only 35 percent of Pennsylvanians supported a tax on natural gas extraction, while 49 percent were opposed. Five months later, in a different poll, 78 percent of Pennsylvanians approved the idea of a gas severance tax, and 14 percent were opposed. Was there a sudden shift in voter attitudes? No.

The difference in the poll results are caused by the manner in which the poll question is framed. Consider the poll generating 49 percent opposition. After asking questions with respect to proposals to increase the tax on cigars and smokeless tobacco, and to impose tolls on I-80, the poll asked whether those questioned supported “increasing taxes on companies that extract and sell natural gas.” On the other hand, the poll generating 78 percent support asked a 123-word question – and, no, I did not write it – that explained what Marcellus shale natural gas is, that “large multinational gas-drilling companies from other states and other countries are coming here to lease land and extract this gas,” that “This discovery holds the promise of significant economic development and the creation of new jobs, but it has also placed new an difficult stresses on local services, harmed water supplies, and destroyed local roads,” and that “In other states, these companies pay a special tax to fund programs that will protect our environment and help local governments handle the increased demand on their services” before asking “Would you favor or oppose a special tax on these multinational gas companies for that specific purpose?”

The Philadelphia Inquirer story suggests that the difference is “all in how the question is asked.” That’s true, but it glosses over the meaning of “how.” To me, the differences in the poll results illustrate the differences in outcome when someone who is educated about an issue is answering a question and when someone who is not educated about an issue and is answering a generic sound bite question is answering a question. The director of the poll generating the 49 percent opposed outcome, which asked a short question without providing background information, agreed, saying, “I think it is not exactly the residents of the state know much about or are very much concerned about, despite the fact it’s a huge policy and political issue in the state.” I wonder how his poll would have turned out had he provided educational information before asking the question. Perhaps the answer can be found in a third poll, administered after the first poll and before the second one, that simply asked, “Do you support or oppose increased taxes on America’s oil and natural-gas industry?” and obtained a 31 percent favor, 61 percent opposed result. Notice that the question mirrors the current “don’t tax us” advertising campaign being waged by the fossil fuels industry.

The inconsistent poll outcomes demonstrate not only the need to educate the public, but the need to put the issue in terms that make sense to people. That’s why I suggested that what should be under consideration are user fees. Imagine a poll question that asked, “Should natural gas extraction companies be charged a fee for polluting underground water or should that cost be paid by taxpayers and homeowners?” and “Should natural gas extraction companies be charged a fee to pay for fixing the damage their large vehicles do to local roads, or should local taxpayers pay?” It would be shocking if people replied that they were willing to pay taxes and other costs to bear the burdens that generate benefits for the extraction companies and their owners.

The irony of the stalemate is that the governor and legislators are battling over rates. The Senate Republicans favor a 1.5 percent tax on natural gas extraction, House Democrats favor 9.8 percent, and the governor suggested 6.2 percent. If principle is going to stand in the way of compromise on a rate, perhaps principles can be unified to go the user fee route. There’s much less arbitrariness in selecting a fee based on actual costs than in selecting a rate that focuses on revenue generally rather than on costs and expenses.

A recent opinion piece with respect to IRS regulation of tax return preparers, which came to my attention thanks to Paul Caron’s TaxProf Blog, has caused quite a stir. In the opinion piece, Dan Alban attacks the IRS proposal to regulate tax return preparers on a number of grounds. First, he claims that by exempting attorneys and CPAs from the requirements, the proposed rules will “create an anti-competitive barrier to entry in the market for tax return preparation that benefits large tax preparation firms as well as attorneys and CPAs. Second, the proposed rules, by giving the IRS more control over preparers, will make preparers “dependent on the IRS for their livelihood” and thus “give the IRS increased leverage in disputes . . with preparers.” Third, the proposed rules are not necessary because there already are in place criminal and civil penalties applicable to preparers who violate the law, and because preparers face possible civil litigation filed by misrepresented clients. Fourth, the proposed rules will increase the cost to taxpayers of tax return preparation. Alban points out that as a Harvard Law School graduate who has passed the bar, he would not be subject to the proposed rules even though he “has never so much as taken a law school class or continuing legal education in tax law” and who doesn’t even do his own tax returns. Alban is a staff attorney for the Institute for Justice, where apparently he deals with legal issues other than taxation.

To the extent Adler considers regulation of tax return preparers by the IRS to be a bad idea, I disagree. Tax return preparation is no different from any other industry whose participants have the power to help or hurt its clients or customers. Existing penalties are not preventing the unethical behavior of a few “bad” preparers whose actions end up tainting the entire industry’s reputation. Some taxpayers have been ill served by their tax return preparers, and “some” is too much. When one considers the various industries that are properly regulated, in every instance clients and customers are better off than they were before regulation, and when one considers the various industries that are not regulated or that are inadequately regulated, clients and customers end up on the short end of the deal. Aside from the ethical issues raised by preparers who file fraudulent returns, steal refund checks, or otherwise cheat their customers, the bigger issue is one of competence. When Money Magazine ran its individual federal income tax return preparation test promotion, the outcome always produced as many different versions of a tax return from the same set of facts as there were preparers trying to win the prize. The prize, incidentally, was creating the following year’s set of facts for the next contest. The participants, as best as one can tell, were ethical. All but one, and in most instances, all of them simply lacked what it takes to complete an individual federal income tax return properly. That, of course, is a consequence of Congressional mismanagement of the tax law.

To the extent that Adler objects to the proposed exemption from regulation for attorneys and CPAs, I wholeheartedly agree. The notion that attorneys and CPAs are somehow per se lacking the need for regulation is nonsense. Even if unethical behavior occurs among a smaller proportion of attorneys and CPAs than among tax return preparers, that difference does not justify a blanket exemption. True, attorneys and CPAs are regulated as such by state licensing boards or their equivalent, but those entities do not focus on tax return preparation ethical issues in contrast to ethical issues generally. When it comes to competence, there are tax return preparers not blessed with a J.D. degree or a C.P.A. certificate who can run circles around most lawyers and CPAs, including some of those who specialize in taxation. It is dangerous to assume that attorneys and CPAs do not need regulation when it comes to preparing tax returns.

Though much of the attention has been focused on preparers who handle individual returns, thus bolstering arguments that the CPAs and the few attorneys who do engage in tax return preparation are likely to be adequately skilled, the competency issue reaches far beyond individual returns. The error rate for tax returns of corporations, partnerships, trusts, estates, REITs, tax-exempt organizations, and other taxpayers is frighteningly high. Almost every semester, one or two students in my Graduate Tax Program courses tell me that after the courses open their eyes to the fact that what they and their firms have been doing is inconsistent with the law. Every week, I hear stories from friends and former students in practice who describe the sloppy condition of returns prepared by their clients’ former tax advisors and preparers. Every week, I read stories about ill-prepared returns generated by lawyers and CPAs. Every day I read posts on listservs that suggest a surprising lack of understanding of one or another tax law issue by lawyers and CPAs, including some who specialize in taxation. The need for education, examination, and licensing of attorneys and CPAs is no less urgent than it is for other preparers.

Defenders of the attorney-CPA exemption point to CLE and CPE requirements as a distinction that sets them apart from other preparers. That suggestion is more nonsense. Attorneys are not required to enroll in CLE courses that address tax as a precondition to practicing tax law or preparing returns. Worse, attorneys are not required to demonstrate that they learned anything from sitting through a CLE session because there are no examinations. When CLE was initiated in Pennsylvania, I urged the adoption of a testing mechanism, but the idea was rejected, ostensibly for logistical reasons but primarily because attorneys would balk at the idea. So even if attorneys were required to take tax courses and tax CLE classes before preparing tax returns, and they’re not, there’s no way of knowing if they’ve learned what they need to learn until they slip and fall on an actual tax return. Attendance at CLE and CPE classes does not guarantee the acquisition of knowledge and understanding, let alone expertise.

Defenders of the attorney-CPA exemption also point out that attorneys carry malpractice insurance whereas preparers do not, though I wonder if that’s true of the large tax return preparation enterprises. They also point out that attorneys have as much as seven additional years of education than do tax return preparers with high school diplomas. The existence of malpractice insurance ought not be a ticket to unregulated tax return preparation activities. If the IRS were to require malpractice insurance by all tax return preparers, it would simply mean that attorneys would already be in compliance. As for those additional seven years of education, there’s no guarantee that it does much of anything to make a person more competent as a tax return preparer.

Defenders of the attorney-CPA exemption also argue that with limited resources the IRS needs to focus on preparers who are much more likely to present problems in terms of ethics and competence. One difficulty with this argument is that it presumes attorneys and CPAs to be per se less likely to present problems. That may or may not be the case. Another, more important, difficulty is that the exemption is a flat-out exemption, whereas the better response to limited resources would be to implement the preparer requirements in stages, without absolving any one group in perpetuity. Letting attorneys and CPAs wait until other preparers have been examined is acceptable as a practical matter even if it means competent preparers who are not attorneys or CPAs are brought into a preparer regulation system before attorneys and CPAs who lack competence. But that’s much different from letting attorneys and CPAs off the hook.

Defenders of the attorney-CPA exemption suggest that states are in a better position to regulate attorneys, CPAs, and even other preparers. The problem with state regulation is that preparers of a nation-wide federal tax should be subject to one standard, not fifty-plus differing systems. This is particularly a practical problem because many preparers do not limit their clientele to the residents of just one state. Does the SEC rely on state regulatory boards to determine who has sufficient expertise to practice before the SEC or represent clients in SEC matters? The same question can be asked of the NLRB, the EPA, and a long list of federal agencies dealing with federal law.

It also has been pointed out that several federal statutes might preclude the IRS from requiring attorneys and CPAs to satisfy testing and continuing education requirements. For example, 5 U.S.C. §500(b) provides:

An individual who is a member in good standing of the bar of the highest court of a State may represent a person before an agency on filing with the agency a written declaration that he is currently qualified as provided by this subsection and is authorized to represent the particular person in whose behalf he acts.

Similarly, 5 USC §500(c) provides:

An individual who is duly qualified to practice as a certified public accountant in a State may represent a person before the Internal Revenue Service of the Treasury Department on filing with that agency a written declaration that he is currently qualified as provided by this subsection and is authorized to represent the particular person in whose behalf he acts.

Finally, 5 USC §500(d)(2) provides:

This section does not . . . authorize or limit the discipline, including disbarment, of individuals who appear in a representative capacity before an agency

Do these statutes indeed protect attorneys and CPAs? It depends on the meaning of “represent a person before an agency” and “represent a person before the Internal Revenue Service.” If those phrases includes tax return preparation, then the IRS enrolled agent requirements, that limit representation by non-attorney/non-CPA individuals before the IRS but that do not limit the preparation of returns to attorneys and CPAs, suggest that “represent a person before the Internal Revenue Service” means “act as an advocate in an adversarial proceeding” and not tax return preparation. But even if the cited statutes prohibit testing, licensing, and imposing CE requirements on all preparers, including attorneys and CPAs, 5 USC §500(d)(2) permits the IRS to impose the “discipline” of examination and CE on every preparer who violate the disciplinary standards of correct returns coupled with ethical behavior. It would take but a few years before every preparer was subject to discipline. Are there any preparers with a perfect track record over a three or four year period? I doubt it. Consider those Money Magazine “tax return preparation contests.”

If the goal of preparer regulation simply is to stop preparers from stealing refund checks, then limiting examination and certification to preparers who are not attorneys and CPAs might be defensible. But if the goal is to produce more accurate returns, and thus improve revenue and compliance across the board, as it ought to be, I maintain that most lawyers and many CPAs aren’t as expertised as they need to be. In all fairness, Congress has created a tax law that rivals quantum physics in terms of difficulty, which surely makes attaining competence just that much more elusive, but that does not diminish the need for tax competence by all preparers. Demonstrating that competence ought to be accomplished by actual testing and not by erroneous presumption.

My Friday post, Mileage-Based Road Fees Gain More Traction brought a comment and question from a reader:

I've skimmed all the posts about the per-mile fee idea. It's logical to believe that fewer people would drive if they knew they were being charged for every mile they drove regardless of their vehicle's fuel efficiency. Wouldn't this have a discriminatory effect on the disabled, and yes, overweight people, who essentially have no choice but to drive to work every day. The rest of us may have the choice of walking, carpooling, or public transportation, but some may not. I know they would driving the same amount they do now, and they are also paying taxes on the fuel/gas they use now, but at least they can choose to lessen the burden by buying more fuel-efficient vehicles.

The reader focuses attention on several matters that deserve more elaborate examination. My response, re-arranged somewhat, was as follows:

It’s possible that a mileage-based road fee would would cause a reduction in driving, even to the point of causing a few people to reduce their driving to zero miles. If the fee has the effect you think it will – and it might – then the reduction of miles driven is a nice side effect of the primary purpose of per-mile fees, which is to pay for the roads on which people are driving. It might cause people to “bundle errands” for example. The fee would be consistent with the overriding goal to reduce consumption of energy from finite resources. Until efficient means are found to make use of renewable and infinite sources (solar is infinite as a practical matter), it’s a matter of finding ways to reduce fossil fuel consumption. So a reduction in the number of miles being driven is not necessarily a bad thing. The issue is whether it is a bad thing if it compels certain people to abandon driving. That brings us to the discrimination question.

Will a per-mile fee cause discriminatory effects? Yes, it will hurt those who drive fuel-efficient vehicles, because instead of paying lower fuel taxes (because they use less fuel), they’ll be paying the same mileage rate as someone driving a fuel-inefficient vehicle. That’s ignoring the possibility of adjusting per-mile fees for the weight and other characteristics of specific vehicles (though that would happen, and has happened, with large trucks, which cause disproportionately more damage to roads). On the other hand, an adjustment for specific vehicles would make more sense if based on weight and other factors affecting impact on road condition than if based on fuel efficiency. I’ve not seen anything suggesting an adjustment for the weight of the driver or the passengers, nor do I think the variation is significant when compared to vehicle weight variations.

On an individual level, whether someone is better or worse off paying a per-mile fee rather than a gasoline tax depends on a variety of factors, including vehicle fuel efficiency, the gasoline tax rates in the state of residence, the relative amount of fuel purchased while driving in other states, etc.

As for choosing between driving and alternatives, again, the effect of the per-mile fee depends on what the person is driving, how many miles they drive, etc. For some people, the per-mile fee will be cheaper when compared to the baseline.

What makes the analysis a bit challenging is that the comparison should be made between current gasoline taxes and the one-cent-per-mile fee required to replace the gasoline tax revenue. If a higher per-mile fee is imposed to permit deteriorating roads to be repaired before more people die as happened in Minneapolis several years ago, then the comparison must be made to the alternative, which is an increased gasoline tax.

In any event, if the true cost of using the highways is x pennies per mile, why should we pretend that the nation as a whole can get highway use for less, or even for free? It may be that an “in your face” fee – not unlike a toll – would cause people to drive less, in contrast to the “hidden in the price per gallon” gasoline tax. On the other hand, toll roads in this country are far from deserted.

What would be helpful, and I don’t think I’ve seen this yet, is a web site where people can input the type of vehicle they drive, the number of miles they drive, the state (or area) in which they live, and the type of mileage-based fee with which they want to make comparisons. In other words, someone could input that she drives 12,000 miles a year, lives in eastern Iowa, and drives a Dodge minivan, and receive output that shows an estimate of the gasoline taxes she currently pays and the mileage-based road fee that she would pay if the fee were set at one cent per mile (gasoline tax replacement rate) or two cents per mile (road and bridge restoration rate). If I had the time and know-how I would create the page, but I’d rather see those who are more knowledgeable about specific vehicles, fuel efficiency, and the other required information generate something along these lines. Perhaps the folks at the Texas A&M University Texas Transportation Institute’s University Transportation Center for Mobility would find this a useful project for some students to undertake. Hint. Hint. It’s important for drivers and vehicle owners to have this sort of information so that they can contribute useful feedback during the inevitable upcoming debate.

Back in 2009, the University of Virginia’s Miller Center of Public Affairs held a transportation policy conference. One of the major topics on the agenda was “funding sources.” More than six dozen transportation experts from both the private sector and government agencies attended. As often is the case with conferences and symposia, the report was not issued for many months. According to the report, Well Within Reach: America’s New Transportation Agenda, the best option for dealing with the inefficiencies of the gasoline and other liquid fuel taxes is to adopt a per-mile fee. Is this surprising? No. Several weeks ago, in Making Progress with Mileage-Based Road Fees, I noted the work of the Texas Transportation Institute at Texas A&M University, particularly its University Transportation Center for Mobility, which presents a growing collection of information and research on the topic. Private sector experts and government agency officials are studying the assorted road mileage fee proposals, but as I lamented in Pennsylvania State Gasoline Tax Increase: The Last Hurrah?:

“What I support is the mileage-based road fee, a 21st century concept that seems to elude legislatures and politicians still living in the 19th and 20th centuries. It is time for them to sit down and read Tax Meets Technology on the Road, Mileage-Based Road Fees, Again, Mileage-Based Road Fees, Yet Again, and Change, Tax, Mileage-Based Road Fees, and Secrecy, and the articles and studies cited therein.

Though my suggestion and my analyses of the proposals did not see the light of day at the Miller Center conference, it’s encouraging to discover yet more support slowly but surely taking shape and gaining strength across the country. It is, I hope, just a matter of time.

The conferees also concluded, to no one’s surprise, that more spending is required to shore up the nation’s transportation infrastructure. It’s crumbling, in part because the gasoline and other fuels taxes being used to fund repairs and improvements have lost one-third of their purchasing power because they have not been increased for 17 years. Added to that is the decline in fuel use arising from the manufacture and sale of more efficient vehicles and shifts to motive power generated by means other than taxable liquid fuels. The shortfall in current spending is approaching $100 billion a year. When the time comes to pay the price for this shortfall and short-sightedness, the outcome will be no less catastrophic than the price to be paid for engaging in war while reducing taxes. The conferees calculated that a one-cent-per-mile fee would replace the revenue currently raised by the gasoline tax, and that a two-cent-per-mile fee would permit repair and maintenance of a crumbling infrastructure.

The conferees also recommended something that I’ve advocated for many years, not only with respect to transportation infrastructure but other government-funded projects as well. Investment in transportation infrastructure ought to be treated as just that, an investment, and not spending. If this approach were to be taken across the board, putting government accounting on an equivalence with enterprise accounting would provide a much more useful data set for policy makers, civic discourse, and voter decisions.

A question posed last week on the ABA-TAX listserv concerning the reporting of LLC transactions presents not only an opportunity to set forth a rule but also a chance to understand why the rule exists. The facts are fairly simple. A limited partnership is the sole member of a limited liability company. The partnership does not elect to treat the LLC as a separate entity, and thus the LLC is disregarded. The LLC engages in transactions. How should those transactions be reported? One choice, which has been followed in at least one instance, is for the partnership to report the LLC’s net income as one item on the “other income” line on the partnership’s tax return. Call this the “first method of reporting.” Another choice is for the partnership to treat each transaction of the LLC as its own transaction. Call this the “second method of reporting.”

The instructions require that all income, losses, gains, and other items must be reported as items attributable to the sole owner of the LLC. In the case of LLCs owned entirely by one individual, the common practice is to put the LLC’s transactions on a Schedule C (or in some instances a Schedule E) as though the individual had engaged in the transactions which the LLC undertook.

Partnership returns do not include a Schedule C because the return itself provides places to report the items that are reported on an individual’s Schedule C. What must happen is that each item arising from the LLC’s transactions needs to be combined with its counterparts from the partnership’s activities, and the aggregate for each type of transaction reported on the appropriate line or schedule of the partnership return. In other words, the second method of reporting is the correct method.

An example illustrates how the rule works and why it makes sense. The example is an elaboration of one that I posted in response to various replies that had been shared with respect to the original question.

Assume that the LLC has transactions generating gross income of $2,000,000. Assume it has advertising expenses of $100,000, salary expenses of $650,000, repair expenses of $150,000, and utility expenses of $200,000. Also assume that the LLC purchases section 179 property for a cost of $400,000, and purchases no other property. The property is 5-year property.

Assume that the partnership has transactions generating gross income of $3,000,000. Assume it has advertising expenses of $300,000, salary expenses of $1,150,000, repair expenses of $250,000, and utility expenses of $400,000. Also assume that the partnership purchases section 179 property for a cost of $300,000, and purchases no other property. The property is 5-year property.

Under the first method of reporting, the LLC would compute a section 179 deduction of $400,000, add it to the $1,100,000 of other deductions, subtract the total of $1,500,000 from the gross income of $2,000,000, and report the “net income” of $500,000 on the partnership’s return. The partnership would compute a section 179 deduction of $300,000, add it to the $2,100,000 of other deductions, and subtract the total of $2,400,000 from the combined gross income of $3,000,000 and LLC net income of $500,000 to show partnership taxable income of $1,100,000. That amount would be allocated among the partnership’s partners.

Under the second method of reporting, the LLC would do nothing but hand off its transactions to the partnership. The partnership reports gross income of $5,000,000. It has advertising expenses of $400,000, salary expenses of $1,800,000, repair expenses of $400,000, and utility expenses of $600,000. It is treated as having purchased section 179 property for a cost of $700,000, and as having purchased no other property. The property is 5-year property. The partnership’s section 179 deduction is $500,000. Its section 168(k) deduction is $100,000 (50% of the remaining $200,000). Its section 168(a) deduction is $20,000 (20% of the remaining $100,000). Its deductions on account of purchasing the property total $620,000. Its total deductions are $3,820,000. Its partnership taxable income is $1,180,000. That amount is allocated among the partnership’s partners.

The $80,000 additional partnership taxable income under the correct method of reporting is the $80,000 portion of the cost of the section 179 property that is not allowable as a deduction under section 179 and that is not allowable as a deduction under section 168 for the first year of use. This illustrates why the combination of gross income and deductions for the LLC is not permitted at the LLC level, because by doing so, the $500,000 section 179 limitation is avoided. In effect, the first method of reporting would permit the partnership to have the benefit of two $500,000 limitations, one with respect to the LLC and one with respect to itself. That is inconsistent with the concept of a disregarded entity because disregarded entities have nothing to report independently and thus do not have separate limitations.

In April of this year, I discussed, in Don’t Like This Tax? How About That Tax?, a proposal to revamp Philadelphia’s business privilege tax. At the time, I noted that “Details are scant, so it’s unclear precisely what the proponents plan to suggest.” Nonetheless, the understanding was that “The proposal to change the business privilege tax is to repeal the net income component and to increase the gross receipts component.” I criticized this approach, because unprofitable businesses would face a tax even though their other expenses exceeded their gross receipts. I shared this insight:

Conventional wisdom, we are told, is that the gross receipts component of the business privilege tax curtails or eliminates job creation. Of course it does, because when those low-gross-profit-margin enterprises leave, they take their jobs with them. The City Council members advocating the change claim that their idea would “help small businesses, since the majority of their tax liability is on the net-income side.” If by small business, they mean those with low levels of sales, but high profit margins, they may be correct. I wonder, though, how many businesses with low levels of sales, particularly during this economic downturn, have high profit margins. I suspect that the businesses standing to gain from the proposal are those with very high net profit margins, many of which are unlikely to be found among small businesses.

My musings turned out to be prophetic, as it was not long thereafter that news broke concerning the city’s imposition of the business privilege tax on bloggers and other small-time entrepreneurs with negative income and minimal gross receipts, sometimes less than the minimum business privilege tax amount. That development was discussed in A Tax on Blog Writing or on Blog Business?.

According to a Philadelphia Inquirer story on Friday, two members of city council have introduced a bill to phase out the net income component of the business privilege tax, and simultaneously increasing the gross receipts component, which would be the only component, to 0.53 percent. The shift would take place over a five-year period. The bill deals with the small business problem by excluding the first $100,000 of gross receipts from the tax. Because the Philadelphia business community has not yet reacted to the proposal, it remains to be seen what contours will shape the debate or whether the proposal has any chance of moving forward.

When I discussed the issue in Don’t Like This Tax? How About That Tax?, the lack of specific information caused me to guess that the gross receipts tax rate would be roughly one percent. Now that the specific 0.53 percent figure is available, I will recast the examples I provided in that earlier posting, noting the changes in strikethrough and bold:

The Philadelphia business privilege tax equals the sum of two amounts. The first equals 0.14 percent of gross receipts. The second equals 6.45 percent of profits. Thus, a business that fails to make money nonetheless is taxed. A business with high gross receipts and high cost of goods sold, thus incurring a low gross profit percentage and profits that are a small fraction of sales, pays a disproportionately higher tax, when compared to profits, than does a business with a high profit margin. For example, a grocery store that has $100 of sales receipts, $95 of cost of goods sold, and $4 of operating expenses, thus making $1 of profit, would pay a business privilege tax of 20.45 cents (0.14 percent of $100 plus 6.45 percent of $1). A law firm with $100 of sales receipts and $60 of operating expenses, would pay a business privilege tax of $2.72 (0.14 percent of $100 plus 6.45 percent of $40). As a percentage of profits, the grocery store’s business privilege tax is 20.45 percent (20.45 cents out of the $1 profit). For the law firm, it is 6.8 percent ($2.72 out of $40). Something’s not quite right when the business with 40 times as much profit pays at a rate that is less than 1/3 the rate paid by the other business. Is it any wonder there are few grocery or similar stores in Philadelphia?

The proposal to change the business privilege tax is to repeal the net income component and to increase the gross receipts component. Though it’s unclear by how much the gross receipts percentage would need to be raised to offset the loss of the business profits component and to raise the additional revenue that the city needs, let’s take a wild guess and assume it would need to be raised to 1 percent.Under the proposal, the gross receipts percentage would be 0.53 percent. What does that do to the grocery store and the law firm, treating the dollar amounts as tens of thousands to avoid the $100,000 exclusion? Both would face a tax of $1 53 cents. For the law firm, this would reduce its business profits tax from $2.72 to $1 53 cents, and reduce the tax as a percentage of its $40 profit from 6.8 percent to 2.5 1.325 percent. For the grocery store, it would increase its business profits tax from 14 [20.45] cents to $1, and would increase the tax as a percentage of its $1 profit from 20.45 percent to 100 53 percent. The proposed change would drive every business with gross receipts exceeding $100,000 and with a low gross profit margin out of the city. I wonder what that would do to tax revenue.

This will be an interesting story to follow. Surely there will be more developments.

The Pennsylvania House is debating, yet again, the wisdom of imposing a tax on Marcellus Shale natural gas. According to this story, House leaders expect the legislation to pass, setting up negotiations with the State Senate and the governor. Under the House legislation, a tax of 39 cents would be payable on every 1,000 cubic feet of natural gas extracted from wells, which at current prices is the equivalent of an approximately ten percent tax. The House legislation would direct 60 percent of the revenue to local governments and environmental programs and leave the other 40 percent for the state’s general fund.

Not surprisingly, reaction to the legislation splits along partisan lines. Supporters of the tax, principally Democrats, point out that the extraction of Marcellus Shale gas imposes significant burdens on the environment, and also puts stress on local governments and infrastructure in the mainly rural areas of the state where extraction is underway. Republican opponents characterize the tax as “unreasonably high,” as “job-crushing,” and as a “wasteful windfall” that would fuel “big government.” They have also characterized the tax as something that would put the state at “an economic disadvantage” and have “a chilling effect on capital development.”

Perhaps the legislative process would move more efficiently if instead of levying a tax, the legislature opted for a user fee. There is no doubt that rural local governments in the extraction area face significant cost increases sparked by the arrival of an industry putting demands on government services and on the environment. Increased traffic, increased need for police and fire protection, increased need for testing ground water and wells, increased stress on bridges and highways caused by heavy equipment, increased services necessitated by the arrival of temporary workers, and other expenses incurred by local governments lacking the sort of tax base enjoyed by more developed areas of the state. Should the residents of these rural counties be hit with higher local property taxes so that companies owned by nonresidents can extract a profit without bearing the full cost of generating that profit? Does it not make more sense for the state to impose an array of user fees so that the extraction industry bears all the costs of extracting the natural gas? It might require designing the fee in a manner requiring more precision than a simple cents-per-cubic-feet arrangement, but that should be possible with just a little more effort. Does it make sense to charge fees for transporting equipment over state and local highways based on weight, frequency of travel, and mileage? Does it make sense to charge fees based on proximity to groundwater and wells, multiplied by production activity as measured by the number of feet drilled? Does it make sense to charge another fee based on quantity of extracted waste dumped onto land adjacent the wells? Does it make sense to charge a wildlife habitat disruption fee? Does it make sense to charge a clean air replenishment decrease fee on account of trees cleared to make room for wells and other extraction activity? Perhaps companies unwilling to deal with a wide range of fees addressing the various social, environmental, and economic costs triggered by the extraction activity could be given the option of paying 39 cents per 1,000 cubic feet of extracted natural gas in exchange for being relieved of all those fees.

Dealing with the many economic, tax, social, environmental, and other problems confronting the nation, its states, and its communities requires something more than reapplication of familiar taxation patterns. A bit of creativity is in order. User fees that make the justification for government revenue easier to see, and thus easier to understand, deserve more attention and present valuable opportunities.

On Monday, in the basic federal income tax class, it was time to explore how taxpayers acquire basis. The depth to which the exploration is taken in this course usually is such that the topic turns out not to be one of the mind-numbing experiences that pop up from time to time, such as the section 86 “bubble” to which the class had been introduced on Friday. But this year, the basis discussion became a frustration for both teacher and student. Why?

At the beginning of the decade, when the Congress voted to phase out the estate tax so that it disappeared in 2010, with a revival in 2011 absent any Congressional action, it also voted to replace the basis rules for property acquired through a decedent in section 1014 with a special set of rules in section 1022. Section 1022 would not become effective until 2010. So when it was enacted some years ago, I read it, appreciated the complexity it created, and decided that there was no point in teaching it because it might not even take effect. Many, including myself, supposed – wrongly, it turned out – that Congress would get its act together (sorry, pun indeed intended) and fix the estate tax repeal/section 1022 pseudo-carryover-basis mess before 2010 rolled around. As I told the students on Monday, even when 2010 arrived, I figured that because I teach the course in the latter part of the year, section 1022 would disappear before the semester began. Again, I was wrong.

The failure of Congress to do anything (see, e.g., Can a Zero Congress Exist Forever? and A Zero Tax, A Zero Congress) left me with a decision to make. What should I do with section 1022, itself a complexity that demands an amount of class time that would cut into the many other topics that are essential to acquiring an understanding of the subject? I made the decision to teach section 1014, which isn’t particularly difficult to teach or learn in this setting because we don’t get into the variations on fair-market-value-at-death general rule, and to illustrate how unrealized appreciation existing at death pretty much escapes income taxation. I also decided to mention the existence of section 1022, describe what it does in general terms – carryover basis, with a variety of exceptions that make the practical application difficult – and to explain why I was giving it short shrift. I told the students that they would not be responsible for section 1022 on any of the graded exercises or the exam.

I shared with the students my reasoning for giving section 1022 short shrift. After class, in response to a student question, I refined my reasoning. What follows is a combination of what I shared in class and what I shared with the student. I explained that although we don’t know what will happen, we do know that there are four possibilities with respect to section 1022. First, Congress does nothing and section 1022 expires by the terms of the enacting legislation after being in effect for one year. Second, Congress re-instates the estate tax retroactive to January 1, 2010, making section 1022 either totally ineffective or effective with respect to those receiving property on account of the death of a handful of decedents somehow excepted from the retroactive repeal of the estate tax repeal. Third, Congress re-instates the estate tax as of January 1, 2011, making section 1022 effective for only one year. Fourth, Congress extends the repeal of the estate tax into 2011 and beyond, presumably doing the same for section 1022 and giving it a life of more than one year. The only instance under which section 1022 has more than a year’s worth of effectiveness is the fourth, and the odds of that happening are between slim and none. The other three possibilities, which account, by my estimate, for 99.something percent of the odds, leave section 1022 either as nothing or, at best, a one-year wonder (or one-year insanity, depending on one’s perspective). Thus, it isn’t worth investing valuable class time and out-of-class preparation and assimilation time for what almost certainly will turn out to be a momentary blink in the history of taxation. True, I told the students, one or another of you may end up at a firm that has clients whose decedent died in 2010, or clerking for a judge who ends up with a case involving section 1022, but the odds are very, very high, if not 100 percent, that most of the students in the class will never deal with section 1022, even if they are heading into a tax practice.

The risk in explaining this to students is that the message will get jumbled. There is a danger that some students might emerge from their study of basis thinking that carryover basis at death is the long-time rule. There is a danger that some students might think the $1.3 million exception involves section 1014 rather than the one-year section 1022 deviation. Even those who choose to teach this topic from a tax policy perspective run the risk of students getting confused with current rules, proposed rules, expiring rules, temporary rules, sunset provisions, and all the other politics-trumps-good-policy detritus of the estate tax repeal mess. There also is the risk that the attempt to teach and learn the topic can turn into a wide-open discussion of Congressional ineptitude, and although that is beneficial in its own right, it would push even more essential course topics off the table.

For me, having to allocate even a few minutes, as I did, to explain what would not need any discussion had Congress acted responsibly is frustrating. Though students may not realize it (yes, another bad pun), I am not unaware of the frustration that afflicts them when they encounter what surely is one of the worst experiences to afflict those who are expecting a static set of definite rules. This is worse than the “it depends” situations that need to take into account facts, values, or other variables. This falls into the “we don’t even know what the rules are” torment that afflicts tax practitioners. And thus, I closed discussion of the section 1022 matter by letting students know what life is like, at this very moment, for tax practitioners who, as I put it, do not have the option of hiding in a tower and chatting about the theoretical advantages and disadvantages of estate tax repeal and section 1022. What I didn’t tell the students – and I suppose they have or will have figured it out for themselves – is that when they reach practice, almost surely with section 1022 a thing of the past, they eventually will be the practitioners to whom a tax law professor refers when describing to students of a few years hence yet another transitory tax rule that may or may end up having any applicability. I am more confident what Congress will bring us will be additional instances like the estate tax repeal insanity rather than some semblance of order, stability, clarity, simplicity, and wisdom. And I’m almost as confident that there will additional instances of frustration on account of Congressional failure to act.

In years past, those trying to encourage responsible decision making on the part of Congress have referred to the legacy we are leaving our children. Some of those who were children at the time are now sitting in my classroom, and many others are sitting in the classrooms of other tax law faculty. It is disheartening that we get to teach the legacies that were being prepared not so many years ago. Who enjoys being the bearer of bad news? I don’t. I doubt my tax teaching colleagues do. But, as they say, someone has to do it.

[republished from 1 Mar 2006 because blogspot archived page length limitations prevents all posts from appearing]

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Late last week, as reported in this Philadelphia Inquirer story and elsewhere, leaders of the Congressional majority decided to defer consideration of the many tax issues confronting the nation until after the election. At a minimum, 2010 will be 90 percent completed before there is any action on these pressing matters, and there still is no guarantee that anything will get accomplished before the end of the year. The stated reason is that the majority party has failed to reach a consensus. The majority whip was more forthcoming, explaining that “many lawmakers would prefer to be home campaigning.” A Senator from the minority party claims that the majority party is “in charge” and hasn’t “done anything” about the problem, but the majority party claims that it cannot do anything with bipartisan support and accuses the minority party of holding extension of middle-income and lower-income tax rate reductions “hostage” in an effort extend tax rate reductions for the wealthy. Yet the majority party seems reluctant to schedule a vote on the issue, perhaps worried that failure to extend tax breaks for the wealthy while providing them for the vast majority of taxpayers will get twisted into political campaign sound bites that make those uneducated in tax law conclude that their taxes have, in fact, been raised. How much easier it would be if politicians simply told the truth instead of trying to spin things from reality into campaign slogans. Yet the minority party has just enough votes to block the majority party from doing anything, because of the bizarre “you need 60, not 51, votes to get something done” rule in the Senate.

There are practical problems to the delay. Treasury and the IRS need lead time to prepare withholding tables for 2011. It’s almost impossible to issue those tables if Congress waits, as it has in the past, until late December before acting. Estate planners trying to write wills for their clients are left in a position requiring them to draft clauses packed with alternative provisions, each geared to one of the many possibilities that exist for the scope of the estate tax in 2011 and beyond. Those managing the estates of individuals who died in 2010 are stuck, trying to hedge against the possibility of retroactive estate tax increases. Individuals and businesses trying to make decisions, such as whether to make purchases or to hire employees in 2010 or 2011, are in limbo waiting to see what the tax rules will be in 2011.

At the beginning of this year, in A Zero Tax, A Zero Congress, I wrote:

What I can offer is my condemnation of the Congress for putting America into yet another economic mess. Several commentators have noted, cynically perhaps, that members of Congress benefit from having the estate tax issue held open because it encourages lobbyists for the various positions to rustle up more cash for the campaign coffers of members of Congress. Far be it for me to criticize a cynical observation. Truth be told, I think these commentators are making a valid point. It's not unlike members of Congress to put personal objectives, including raising re-election funds and grabbing power, ahead of what needs to be done for the national economic good. One look at the bribery involved in crafting a health care bill tells us quite a bit about the value system in play on Capitol Hill.

This perspective is reinforced by the comments made by members of Congress that they prefer to be campaigning, rather than serving the nation’s interest by staying in Washington and handling their legislative responsibilities while the electorate watches and expresses its collective evaluation at the voting booth based on what Congress does rather than what it says on the campaign trail. In the same post, I also noted, in trying to find words to describe the Congressional inaction:

Irresponsible is my favorite. Short-sighted is another good one. Unwise, incompetent, and outrageous also come to mind. There also are some phrases that can be used. Derelict in its duty. A breach of its fiduciary obligation. . . . . There may not be any constitutional requirement that Congress do its job properly and in a timely manner, nor a provision that prohibits the Congress from creating the mess in the first place. Nor is there any statute that can be invoked to compel the Congress to live up to its responsibilities, particularly when the responsibility is one of its own making. But there is more to law than just a constitution and statutes, regulations and cases, rulings and decrees. There is a moral imperative, an overarching array of dedication to the national interest, respect for the citizens, decent treatment of the taxpayers, adherence to diligence, integrity, common sense, and fiduciary duty, and a deep understanding of the difference between the good and the expedient. Whether the Congress ever had or exercised this set of values is debatable, but what's not in dispute is the conclusion that the current Congress fails miserably in this regard. It is morally bankrupt. It earns a zero.

Nothing that has happened during the past week changes my mind. On this question of dealing with the tax law, the Congress earned a zero in January, it has earned zeroes throughout the year, and it earned yet another zero by announcing that it was going to go campaign rather than do its job. The answer to the question raised in the post title, can a zero Congress persist forever, is no. At some point, something or someone will yield. The question is when, and it won’t be soon. That’s too bad for the nation.

In May, after more than 70 percent of those voting in a Philadelphia referendum chose to send the reviled Bureau of Revision of Taxes to the scrap heap, I wrote, in R.I.P., BRT, that it would take several months for the mayor to set up the Office of Property Assessment and the Board of Property Assessment Appeals, thus splitting the BRT’s duties between two separate agencies. I also noted reports suggesting at least one member of the BRT would challenge the vote, and if successful, would accomplish not much more than a postponement of the BRT’s death.

For those not familiar with the BRT story, it was no shock that an overwhelming number of voters chose to end its existence. In doing so, they joined with the mayor, City Council, and other civic and political leaders in deciding it was time for the patronage-ridden, inefficient, and cumbersome agency to go. For several years, Philadelphia papers had revealed all sorts of problems with BRT operations. My commentary can be found in a long series of MauledAgain posts, starting in An Unconstitutional Tax Assessment System, and continuing in Property Tax Assessments: Really That Difficult?, Real Property Tax Assessment System: Broken and Begging for Repair, Philadelphia Real Property Taxes: Pay Up or Lose It, How to Fix a Broken Tax System: Speed It Up? , Revising the Board of Revision of Taxes, and How Can Asking Questions Improve Tax and Spending Policies?, This Just Taxes My Brain, Tax Bureaucrats Lose Work, Keep Pay, Testing Tax Bureaucrats Just Part of the Solution, A Citizen Vote on Taxes, Freezing Real Property Tax Reassessments: A Nice Idea, The Tax Price of a Flawed Tax System, Can Bad Tax Administration Doom the Tax?, Taxes and Priorities, and R.I.P., BRT.

But now, as reported by various sources, including this article, the Pennsylvania Supreme Court, hearing the BRT challenge on a fast-track system that bypassed the usual appeals process, has held that the city had no authority to terminate the BRT, but also concluded that the city had the authority to set up an Office of Property Assessment to take over the BRT’s assessment function. If the legislature does not act, this judicial conclusion will leave the BRT very much alive and responsible for handling property tax appeals. The BRT based its objections on two major premises. First, the statutory authority for the city to make changes is limited to the making of assessments but not the hearing of appeals with respect to assessments. Second, the city’s plan to abolish the BRT undercut the authority of state judges to appoint the members of the BRT. The City of Philadelphia presented a competing interpretation of the statute, but in its opinion, the Supreme Court agreed with the BRT.

At the moment, the City of Philadelphia can proceed with its plans to take over, and repair, the assessment process. That process, as described in the MauledAgain posts cited above, is woefully broken. But, for the moment, the BRT retains control of the appeals process, which poses the threat of the BRT undoing or overturning assessments for the same reason that it has been making inappropriate assessments for so many years. Those who were getting low assessments during the assessment process now must turn to the appeals process, and there is no guarantee that the BRT will do anything other than provide for the appealing, favored, taxpayer the low assessment that would have been provided during the assessment process. The statement by the city’s managing director that the Court’s decision to permit the assessment process to be taken away from the BRT takes away the BRT’s “opportunity to do a great deal of mischief” is very optimistic. The mayor intends to work with the judges to find suitable candidates for the BRT as the terms of those currently serving expire, but it remains to be seen how this will work out.

Thus, the partial victory by the City is not a practical victory. The system will not be fixed until the BRT is removed from all aspects of real property assessment, and this must be done by the legislature. Though the legislature has a history of dawdling, even with respect to important and time-constrained issues, it ignores the overwhelming voice of the city’s voters at great risk to itself. Yet even when moving at high speed, the legislature takes months, sometimes years, to get things done.

Unfortunately, a BRT attorney is trying to spin the Court’s decision into something it is not. The Court based its conclusion on statutory language. That language is plain and simple. The Court had no choice but to follow it. Despite this, the BRT attorney characterized the Court’s holding as vindication for the BRT, claiming that “It demonstrates they were doing the public a service.” Sorry, but the Court said nothing of the sort. It did not need to address, did not address, the merits of the quality of the BRT’s activities. For that, perhaps the BRT should be thankful.

Back in May, when I wrote R.I.P., BRT, I predicted that there would be more posts. That wasn’t a difficult prediction to make. Nor is it difficult to predict that there will be yet more posts about the BRT and Philadelphia’s real property tax. Like the BRT, it’s something that does not want to go away.