MauledAgain

One of the benefits of my regular attendance at the gym, aside from the obvious health advantages, is that I have an opportunity to address tax-related questions in an environment outside the law school and law practice worlds. I’ve shared some earlier experiences of this sort in Flat is Not Simple, At Least Not with Taxes, Tax Talk at the Gym, A Zero Tax, A Zero Congress, and Being Thankful for User Fees and Taxes.

The latest episode opened when one of the regulars at the gym said to me, “So have you ever heard of Grover Norquist?” I kept my reply simple. “Yes.” “Did you see 60 Minutes last night?” This required another simple answer. “No.” That brought an interesting question. “So what is it with this Norquist guy and his anti-tax pledge?” My response this time wasn’t so simple. “He doesn’t like taxes and he likes to get politicians to sign onto his anti-tax pledge.” I was not surprised when I heard in turn an unambiguous criticism of Norquist and his anti-tax campaign. Among the reactions was one that stood out. “It’s dangerous.” Of course it is.

As I drove home from the gym, I wondered, “So who is Grover Norquist? Why does he have so much influence? How does he manage to turn so many politicians against taxation even when anti-tax policies threaten the nation’s survival?” It is no secret that in 1985 Grover Norquist founded Americans for Tax Reform. Though the name of the organization suggests one thing, the actual goal is not reform in the sense of making the tax system more efficient, but elimination taxation by opposing tax increases while advocating tax cuts. Norquist was a principal player in the design of the Bush tax cuts.

Norquist, though, does not oppose tax increases simply because he advocates maintenance of the tax status quo. He opposes not only tax increases, but taxes. He has not cloaked his goal behind smoke and mirrors. As Norquist explained, "I do not want to abolish government. I simply want to reduce it to the size where I can drag it into the bathroom and drown it in the bathtub.” So the leader of the anti-tax movement is not only anti-tax, but anti-government. So much for the claims that my likening of the tax-cut movement to a bring-back-the-Wild-West movement is off base.

Yet Norquist, though active behind the scenes, has not been elected to public office. Americans have not been given any choice when it comes to his influence over tax policy. So how did he maneuver himself into this position? It’s another simple answer. Money. Norquist’s father was a vice-president of Polaroid Corporation. According to Americans for Tax Reform’s Form 990, Norquist was paid $222,419 for a 24-hour-per-week job. Norquist was not and is not poor, has not experienced deprivation, and has not suffered through the trauma of being laid off hunting for work. He comes from, and lives in, the ranks of the privileged few. Roughly $4 million in contributions are collected by his organization, and it is doubtful that the money is coming from people with little or no income, or even from people trying to get by on middle-class salaries. The people paying for anti-tax advocacy are people who benefit from that advocacy. According to this article from eight years ago, the tobacco, gambling, and liquor industries lead the way in funding Americans for Tax Reform.

What makes Norquist so zealously anti-government? Considering his claim that “nobody learned anything about politics after the age of 21,” it is likely that something happened when he was young. Something, some event, some person’s experience turned him into a zealot for abolition of the IRS, the FDA, and every other piece of government, a champion for dismantling of public pensions and public schools, and a diehard for privatization of social security. Perhaps the answer lies in a story such as this one, in which Norquist explains how his father would deprive him of some of his ice cream cone. One must wonder whether Norquist's anti-authoritarianism and his rejection of partisanship and support of bitter partisanship has its roots in the psychological abuse suffered at the hands of a cruel parent.

Norquist has acquired sufficient power that, as I described in Food for Tax Thought, he can host a “Tax Policy Dinner” at his home, so that people like Jack Abramoff and Karl Rove can arrange how they are going to direct the representatives of the American people to make tax policy decisions. In 2006, released Senate documents “shed light on how [Abramoff] secretly routed his clients' funds through tax-exempt organizations with the acquiescence of those in charge, including prominent conservative activist Grover Norquist.”

When unelected power brokers control the nation, especially when they use tactics and strategies that border on, if not cross, the line of what is appropriate, it makes a mockery of the ballot box. As I predicted in Food for Tax Thought, “To me, a ‘Tax Policy Dinner’ packed with lobbyists is certain to generate more of what we've seen during the past two decades, things that grill the average citizen, slice and dice paychecks, and sweeten the tax rates for the wealthy. If the trend continues, the tax system will be toast.”

Five years ago, in Maybe There is A Dependency Exemption Problem After All , I re-examined a dependency exemption hypothetical that was one of several raised in a National Association of Enrolled Agents (NAEA) letter to the Commissioner, asking for clarification of what then were new provisions affecting dependency exemptions, and that I had examined in Defining Dependents: Is it Any Easier?. Now, an alert reader has pointed out to me that the issue raised in the hypothetical was addressed by the Tax Court in a Summary Opinion in July of this year, Abdi v. Comr., T.C. Summary Op. 2011-89 (July 13, 2011).

It is worth repeating enough of the discussion to put the analysis in context:

Recall the hypothetical:

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

I had analyzed the facts in this manner:

I agree that Alice is the qualifying child of Mom and Dad. She is their child. She has the same principal place of abode as they do. She is under 19. She does not provide more than half of her own support. Alice also appears to be the qualifying child of Joe. She is his sibling. She has the same principal place of abode as he does. She is under 19. She does not provide more than half of her own support. But in this instance the Code provides a rule to break the impasse. Under section 152(c)(4)(A), an individual who may be claimed as a qualifying child by two or more taxpayers is treated as the qualifying child of the individual's parent if one of the taxpayers claiming the individual as a qualifying child is the individual's parent. The fact that the amount of the exemption for the parents is zero because their AGI is high enough to trigger total phase-out of the exemption amount does not change the definition of qualifying child.

Frank Degen [who had signed the NAEA letter] explains that the NAEA considers phrase "and is claimed" in section 152(c)(4)(A) as precluding the parents from entering the tie-breaking competition. Literally, this would make sense. The parents, not needing a dependency exemption the amount for which has been phased down to zero, do not enter Alice on their return. Thus, as Frank concludes, the son is the only person claiming Alice and there is no tie to break under the tie-breaking rules.

What happens if the statute is interpreted in this manner? First, taxpayers in the situation that Alice's parents and brother find themselves are left to work out a suitable tax-favorable arrangement. Only one "claims" the child in question and the others fail to "claim" the child. Perhaps Congress intended this flexibility. Under this interpretation, the only time that the tie-breaker would be triggered is when two or more taxpayers both claim the dependency exemption, prompting the IRS, which most likely would notice the double dipping, to apply the tie-breaker. Is the tie-breaker intended only as a remedial tool for the IRS to use when multiple taxpayers with "claims" to the child fail to settle on one claimant? Although figuring out what Congress intends is more a guessing skill than an analytical one, it's safe to suggest that Congress intended for the tie-breaking rule to apply as soon as multiple taxpayers became eligible to claim the child.

Interpreting the "and is claimed" language so that it gives the taxpayers a planning option is inconsistent with how Congress treats failure to claim the dependency exemption when doing so opens up a personal exemption for the dependent. Persons for whom another taxpayer can claim a dependency exemption are not permitted to claim their own personal exemption. Technically, they have a personal exemption but its amount is zero. Taxpayers whose adjusted gross income is sufficiently high to trigger a phase-down of the dependency exemption amount to zero have nothing to lose by omitting the dependent from their tax return. The statute, however, eliminates the dependent's personal exemption even if the eligible taxpayer neglects the dependency exemption.

But it's not so simple. In several other provisions, Congress bases eligibility on whether a dependency exemption has in fact been taken rather than looking to see if one could have been taken. For example, the Hope and Lifetime Learning credits are disallowed to a person if a dependency deduction with respect to that person "is allowed to" another taxpayer. Thus, the other taxpayer can forego the dependency exemption and leave open the credit door for the person in question, which is something that the taxpayer would want to do if the dependency exemption was phased down to zero or close to zero.

Why the difference? No one has any idea. In fact, some have argued that the credit should be disallowed to the person if the other taxpayer is eligible to take the dependency deduction even if the other taxpayer fails to do so. But the language of the credit provision undercuts that argument.

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

In the Abdi case, the taxpayer in 2008 was a 21-year-old who lived with his mother and three siblings, including his 11-year-old sister. The taxpayer’s mother did not claim him as a dependent, and though she claimed exemptions for the two youngest siblings, she did not claim one for the taxpayer’s sister. The taxpayer had three jobs and used most of his earnings to contribute to the support the family. The taxpayer claimed a dependency exemption for his sister in 2008, and the IRS disallowed it. The Tax Court concluded that the sister was the taxpayer’s qualifying child and also the qualifying child of the mother. The sister was the daughter of the mother and the sister of the taxpayer, satisfying the relationship test. The principal place of abode test was satisfied because all three resided in the same house. The sister satisfied the age test because she was eleven years old. The sister also satisfied the support test because she did not provide more than half of her own support.

The Tax Court examined section 152(c)(4)(A) as in effect for 2008. The applicable language provided, “. . . if (but for this subparagraph) an individual may be and is claimed as a qualifying child by 2 or more taxpayers for a taxable year beginning in the same calendar year, such individual shall be treated as the qualifying child of the taxpayer who is – (i) a parent of the individual . . .” The court simply concluded, “However, as herein pertinent, this rule comes into play only if petitioner’s mother had claimed [the sister] as her qualifying child. The record shows that petitioner and his mother carefully arranged their tax affairs; petitioner’s mother claimed her other two sons as her qualifying children and petitioner claimed [his sister]. . . Because [the sister] is petitioner’s qualifying child for 2008, petitioner is entitled to the claimed dependency exemption deduction for [his sister] for 2008.” The Court did not examine the inconsistency between the provision in question and other provisions dealing with the dependency exemption, most likely because neither party raised the question. The Court applied the statute as written.

Long before the case reached the court, Congress had amended the provision, effective for taxable years beginning after 2008. Section 152(c)(4)(A) now provides, “. . . if (but for this subparagraph) an individual may be claimed as a qualifying child by 2 or more taxpayers for a taxable year beginning in the same calendar year, such individual shall be treated as the qualifying child of the taxpayer who is – (i) a parent of the individual . . .” The words “and is” were removed. In addition, Congress added, also effective for taxable years beginning after 2008, the following new provision in section 152(a)(4)(C): “If the parents of an individual may claim such individual as a qualifying child but no parent so claims the individual, such individual may be claimed as the qualifying child of another taxpayer but only if the adjusted gross income of such taxpayer is higher than the highest adjusted gross income of any parent of the individual.” If the Abdi case had arisen in 2009 or thereafter, the taxpayer would not have prevailed unless his adjusted gross income was higher than the adjusted gross income of his sister’s mother or father, whichever was higher. There are insufficient facts in the opinion to resolve the question.

Because of the 2008 legislative amendment in Public Law 110-351, the issue raised in the hypothetical has disappeared. Congress decided to eliminate the tax planning opportunity available before 2009. I close with the same words I used to close Maybe There is A Dependency Exemption Problem After All : “It is, though, a wonderful lesson in how the Internal Revenue Code, and tax law generally, becomes more complicated as each year passes. And this is with respect to a fairly simple concept and rule, as tax law concepts and rules go. Imagine what it's like parsing the subchapter K partnership regulations.”

A reader wrote to me recently, asking an interesting question and demonstrating how taxes can pop up anywhere, anytime. After watching what he described as one of his favorite movies, The Exorcist, he asked “what are the tax consequences of an exorcism on the exorcist and the family of the victim?” He further asked, “If the exorcist is a priest or doctor and operates as a sole proprietorship , what expenses could be deducted? What are the ordinary and necessary expenses of an exorcist? Would the IRS classify the activity as not for profit {hobby Loss} ? Could a home office deduction be possible? What would be his business code? How would the family deduct these costs ? Could the costs be deducted as an itemized medical expense? What are medical expenses? If the parents are divorced or separated , which parent could claim the medical expenses of a qualifying child? If the parent or parents have an employer provided medical reimbursement plan, would the costs be reimbursable? If the priest or doctor injures the victim, could the family sue for damages?”

The answer is not so much one of applicable legal principles, but the application of legal principles to facts that makes law school, for example, even more challenging for those who think the object of learning to be a lawyer is simply a matter of learning the rules. It’s in the application of legal principles to facts that the challenges of law, tax or otherwise, are most pronounced.

First, the exorcist. If the exorcist is paid, the exorcist has gross income. I don’t know enough to conclude if all exorcists are paid. Some, I assume, perhaps in error, do their work as part of their overall responsibilities as, for example, a priest, and are reporting a salary as gross income. But perhaps there is some bonus pay for doing exorcisms. If the exorcist is conducting a trade or business, section 162 applies. What are the ordinary and necessary expenses of carrying on the trade or business of exorcism? Again, what matters are the facts, and I simply don’t know what the full list of expenses would be. It’s easy enough to identify some, such as travel and transportation expenses, which would be deductible to the extent the exorcist traveled from one place of business to wherever the client is. Does the exorcist pay for some sort of liability insurance? If so, the cost of the premiums would be deductible, except to the extent they covered a period longer than a year, which would trigger the capitalization requirements. If the expenses are paid by the exorcist’s employer, which probably is what happens in the case of Roman Catholic priests, there is no deduction. Similarly, if the expenses are reimbursed, the reimbursement reduces the deduction. Are there independent exorcists operating out of their home? I have no idea, factually. Presumably it’s possible, and so the usual rules applicable to the home office deduction would apply. Are there exorcists who engage in that activity for purposes other than making a profit, thus causing their activity to fall within the limitations of the section 183 “hobby loss” limitations? Once again, I don’t know. My guess is that because people dabble in every sort of activity, for every activity there are people who take it to the level of a trade or business and people who do not move it past the hobby or not-for-profit stage. That happens with stamp collecting, horse raising, dog breeding, and surely exorcism. As for business code, I have no idea. Presumably a physician would use the appropriate code for the practice, and non-physicians would use either “All other professional, scientific & technical services” or “All other personal services.”

Second, the client. The primary question is whether the amount paid for the exorcism qualifies as a medical expense deduction, as I cannot think of any other deduction for which it might even remotely qualify. The legal principles sort out as follows. There are two major issues. The first is whether the services must be provided by a physician. The answer is no. Medical expense deductions have been upheld for services provided by licensed and unlicensed chiropractors and osteopaths, by naturopathic doctors, and by Christian Science practitioners. The second is whether the nature of the services qualifies as medical. The IRS takes the position that the cost of psychiatric, psychotherapeutic, and psychological treatment is a medical expense, but that payments to religious science practitioners for spiritual guidance and counseling are not. The IRS has concluded that the cost of deprogramming a person who is in a cult is not a medical expense. The Tax Court has held that amounts paid to Navajo medicine men for healing ceremonies called sings are deductible. So where does exorcism fit? Factually, the better argument probably is that exorcism more resembles a Navajo medicine man sing than does spiritual advice-giving or counseling by a member of the clergy.

As for who claims the deduction, if there is one, the answer is found in applying the usual rules dealing with that issue. The costs are reimbursable under a medical reimbursement plan if the terms of the contract so provide. Whether there are damages available if the exorcist injures the victim demands on the application of tort law principles to the situation, a discussion I will let others pursue. Exorcists have been sued, as evidenced by this report.

If I recall correctly, in the movie there was a good bit of collateral damage. I don’t know if that’s the case in exorcisms generally or whether that was worked up for purposes of making the movie more entertaining. In any event, an issue that was not raised by the reader is whether damage from an exorcism attempt qualifies for the casualty loss deduction. That damage seems no less “sudden, unexpected, and unusual” than damage from high winds, a meteor impact, or a lightning strike, suggesting that a deduction, within the applicable limits, would be allowable.

Usually when there is a manifestation of tax ignorance, it leads to bad tax policy, ill-advised votes, or some other sort of economic problem. One or more of those outcomes is still possible with this latest incident of ignorance, but at least the event brings a silver lining. It is now a bit easier to understand why the Congress is unable to do what needs to be done to fix the nation’s economy. Why? Because the nation is being poorly educated by imprecise reporting.

When I read a Philadelphia Inquirer article on the Deficit Commission’s lack of progress, I concluded that someone had made some sort of reporting error or typographical error or some sort of error when I read the following statement attributed to Senator Tom Coburn. Reacting to the debate swirling around proposals to increase tax revenues, to quote the article, “Coburn, a vocal opponent of any tax increase, said he could stand the idea of increasing government revenue if the money comes from restructuring entitlement programs.” I read the sentence again. Was he really claiming that a reduction in spending on Medicare, Medicaid, and Social Security would increase revenue?

Unwilling to dissect the statement without clarification, I did some internet searching and discovered that the precise words had come from the Associated Press and were being reported all across the country. If there was an error, it was not at the Philadelphia Inquirer. From another report, I learned that Coburn had made his statement on CNN’s State of the Union. When I dug up the CNN State of the Union episode on which Coburn allegedly made his statement and listened to it twice, I could not find the statement that Coburn supposedly made. Yes, he did point out that restructuring entitlement programs was necessary to reducing the deficit, but somehow someone’s summary of what he said transformed that statement into a claim that restructuring entitlement programs would raise revenue. Coburn did say, “You can call it a tax increase or you can call it a revenue increase” but that’s an almost accurate statement, though perhaps some people, including some members of Congress, might think that by voting for something called a revenue increase they are not voting for a tax increase. It is possible to increase revenues without increasing taxes, but that requires increasing either fees or other revenue such as income from the rental of government property. As a practical matter, those sorts of revenue pale in comparison to tax revenues, and no deficit reduction can be accomplished by playing only with insignificant fees and items such as rental income. The bottom line is that a reduction in spending on Medicare, Medicaid, and Social Security would not increase revenue, though it would decrease the deficit.

The confusion with respect to revenue, taxes, spending, and deficits is simply another piece of evidence demonstrating how deficient Americans and their representatives have become in terms of understanding economics and government policy. It is the same sort of misunderstanding that causes many people to consider tax credits to be tax reductions rather than the disguised spending programs that almost all of them are, and to resist cutting or repealing them because doing so appears to them to be the same as increasing taxes rather than cutting spending. To the credit of Coburn, and Senator Warner who appeared on the show with him, they have pointed the finger at the politicians who are putting partisan politics above the best interests of the nation. One must hope that the reporting of a statement that was not made indeed is ignorance and not something worse.

Headlines, like sound bites, can be so misleading because they are so short. Sometimes succinctness is not a virtue. Consider this headline: GOP Aides: Super-Committee Republicans Open to Tax Increases. Does that mean some Republicans, perhaps some anti-tax-increase Republicans, have changed course? No.

A better headline would have been: “GOP Aides: Super-Committee Republicans Open to Tax Increases and Benefit Cuts for Middle-Class Citizens While Advocating More Tax Cuts for the Wealthy.” Yes, I know, it’s too long for a headline. Making it shorter makes it more volatile. Perhaps “GOP: Tax Middle-Class More to Fund Tax Cuts for Wealthy” gets the point across. But what politician advocating that approach has the courage and dedication to integrity to step up and declare support for that goal? Instead, the complexity of the tax law provides camouflage behind which lawmakers can hide.

Republicans on the deficit-reduction panel want to cut back itemized deductions and credits that primarily benefit middle-class taxpayers, while cutting the tax rate on high incomes from 35 percent to 28 percent. They also seek to cut back on Social Security, Medicare, and Medicaid benefits. The net effect of these proposals would be to worsen the economic position of the middle class, while leaving the wealthy with even more after-tax dollars.

Here’s the first part of a plan for dealing with the federal budget crisis that makes sense. Put the tax rates back where they were before they were foolishly reduced at the same time the nation went to war (as discussed in When Tax Cuts Are Part of the Problem, They Ought Not Be Part of the Solution, and the posts cited therein). Impose a user fee on entities that receive or received federal bailout or other funds and fail to increase the number of employees hired and working in the United States. Enact a mileage-based road fee to fund transportation infrastructure repair (as discussed in Toll One Road, Overburden Others? and the posts cited therein). Remove from the Internal Revenue Code all spending programs, and then put each one up for a vote in Congress as a spending outlay, thus putting an end to the spending increases that have been enacted disguised as tax credits, to bring front and center a serious budget problem discussed in More Criticism of Non-Tax Tax Credits and the posts cited therein. Provide corporations a deduction for dividends paid, and impose a tax on corporate accumulated earnings that exceed five percent of the fair market value of assets reported for financial accounting purposes, thus reinvigorating a rarely enforced existing tax (as discussed in Taxing Capital to Help Capital). Repeal the depreciation deduction for buildings and building components (as discussed in Abolish Real Estate Depreciation Deduction? An Idea Gathers Attention, and the posts cited therein). Repeal section 168(k) and section 179 (as discussed in If At First It Doesn’t Work, Try, Try, Try Again, and the posts cited therein). Repeal the special low rates for capital gains and dividends, and index the adjusted basis of assets (as discussed in, among other posts, Special Low Capital Gains Tax Rates = More Tax Revenue? Hardly.). Remove the limitation on the deduction of capital losses. Subject Social Security benefits to means testing, making relevant the “I” in FICA (as discussed in FICA, Medicare, and Payroll Taxes). Clean up the Medicare and Medicaid programs. Eliminate subsidies to any individual or entity that has positive taxable income or reports income for financial accounting purposes.

Guaranteed, no politician is willing to advocate such a plan. Why? It pretty much chops away at the benefits available to the most of the politician’s fund-raising base. We know who populates that base, and we know who generates the bulk of the money flowing into campaigns. We know that they will not tolerate interference with the good thing they have going. So long as the wealthy and powerful are permitted to exercise their power and utilize their wealth for their own benefit, to the detriment of the nation and everyone else, tragedy looms.

Jobs are created when there is a need for work to be done. If every owner of property with a lawn did the lawn mowing, there would be no lawn mowing jobs available.

Jobs are not created when someone has money to burn unless there is a need. So in a world where every lawn that needs to be mowed by someone other than the property owner is being mowed because there are sufficient lawn mowing service employees available to do the lawn mowing, a millionaire who decides to hire people to mow the lawns of other property owners isn’t creating jobs. At best, if jobs are created, it’s because someone with a job currently mowing lawns loses that job.

Even if there are lawns that need to be mowed, but that are on properties whose owners cannot do their own lawn mowing, this is insufficient to create a market for the millionaire to exploit. The owners who need lawns mowed but who cannot do the work themselves must have resources to pay for lawn mowing services.

It is quite likely that almost all of the owners who need lawn mowing services are not millionaires. Over the past decade, their real incomes have stagnated. So that leaves very few people able to pay for the services offered by the millionaire with newly hired employees. In turn, the lack of customers means that those employees will quickly find themselves out of a job. This is one reason why tax reductions benefitting the wealthy have not created jobs.

On the other hand, if the resources available to the people who need lawns mowed are increased, the market ramps up. The millionaire in the story finds customers able to pay, and gets a tax deduction, and thus a tax reduction, for paying salaries to the newly hired employees. The current system generates tax reductions for millionaires without the need for tax rate reductions. In fact, restoration of the ill-advised Bush tax cuts for millionaires would be even more incentive for the wealthy to spend their money hiring people, because the resulting deductions would push their taxable incomes down, perhaps into lower tax brackets.

There’s another reason tax cuts for the wealthy do not create jobs. Many of the jobs that could be created require skills that don’t exist in the workforce. As reported by Joseph N. DiStefano in Millions of U.S. Jobs Vacant, But Millions More Americans Out of Work, there is a gap between the jobs that are available and the skills in the labor pool. Though some of the disconnect might reflect unwillingness to do certain work, such as crop picking, landscaping, and lumberjacking, there are all sorts of jobs for which Americans lack the requisite training and skills. That’s not a surprise, considering the mismatching of students and education choices, the failure of American education to provide the sort of education and training that the nation needs, and the cultural phenomenon of most parents thinking that their children are too gifted to take on certain jobs or pursue certain careers. Consequently, as DiStefano explains, employers aren’t hiring “young, entry-level U.S. workers” because older workers and “reliable, desperate immigrants” are more attractive to companies unwilling to train “people likely to leave,” a situation compounded by worker mobility and corporate mergers and consolidations, to say nothing of outsourcing. So all the tax breaks in the world piled onto millionaires won’t make a difference, because, assuming they are in fact job creators, they don’t want to hire, and won’t hire, from the largest segment of the unemployed.

Yet, despite this reality, we continue to hear not only objections to termination of the Bush tax cuts, but cries for even more tax rate reductions for the millionaires and cutbacks in benefits for everyone else, on the specious grounds that this is the solution to the job creation dilemma. The only outcome of more tax cuts for the wealthy and fewer benefits for everyone else is that the people needing lawns to be mowed continue to lack the ability to pay for those services, and the millionaire ends up with even more money that cannot be put to use creating jobs because there’s no one to pay for the services or goods that could be provided by people hired to provide those services and goods. And even in segments of the economy where there is demand, employers cannot find employees because the nation’s education and training system has failed. Instead of pumping more money into the hands of millionaires, why not pump that money into quality training to provide the labor pool that employers claim they need and haven’t found?

So are additional tax cuts for the wealthy really about creating jobs? Or is that just some nice sound bite material being used for other purposes?

In an article in Monday’s Philadelphia Inquirer, Small Matters: Don't Make the Mistake of Overtaxing Wealth, Bill Dunkelberg tries to make the case for a flat tax, claiming that it would “be a boon for millions of small businesses, reducing the amount of time and money owners had to spend to deliver tax revenue to the government.” His definition of a flat tax is this: “There would be no deductions for anything - not charity, mortgage interest, or a host of other special stuff in the tax code today. There would be only personal exemptions (like now), say $30,000 for a family of four, less for single individuals. Your tax would be a percentage of your income in excess of the exemption.” He gives two examples, using his proposed $30,000 exemption and a 20 percent rate, and concludes that someone earning $31,000 would pay $200 in tax while someone earning $1 million would pay $194,000.

Dunkelberg offers this version of the flat tax in response to the unassailable claim that, “The tax code is a mess,” and as a solution to the not surprising claim that taxpayers invest six billion hours annually filling out tax forms and keeping records. He begins his argument with a plea to ignore the calls for restoration of the tax rates in effect before the Bush tax cuts were enacted, alleging that wealth produces “investment and job creation.” He raises the shop-worn argument that the top one percent earns 20 percent of income but pays 40 percent of income taxes.

The first problem is that the statistics concerning the percentage of income earned by the wealthy are flawed because the definition of income is flawed. A good chunk of the wealthy’s income doesn’t show up in IRS statistics, because it consists of tax-exempt interest, unrealized increases in wealth through the untaxed appreciation of assets, postponed income on account of deferral techniques and nonrecognition provisions, and shifting of income offshore. Thus, when institutions such as Kiplinger describe what percentage of income is earned by the wealthy, or provide calculators to permit visitors to determine which percentile they inhabit, they use adjusted gross income, which is about as good a measure of true income as the wild guess of a child as to the height of a skyscraper. This point is important not only for showing that the wealthy have a much higher percentage of overall income when the quirks of the tax definition of gross income are set aside, but also to set the foundation for one of the flaws in the so-called flat tax solution.

The second problem is that eliminating deductions removes only some of the complexity. Even eliminating credits, which perhaps is part of Dunkelberg’s suggestion to remove “other special stuff in the tax code,” would remove only some more of the complexity. When it comes time to discuss gross income exclusions, what happens? One choice is to eliminate all of them. The other choice is to retain some of them. The latter choice, of course, preserves an arena for the development of complexity. The former choice means that gifts, scholarships, inheritances, life insurance proceeds, employee benefits, and, yes, even municipal bond interest and unrealized asset appreciation, would be taxed. Does Dunkelberg want a student who receives a $50,000 scholarship to be hit with a $8,000 tax (which presupposes a $10,000 exemption for a single person, based on the $30,000 exemption for a family of four)?

The third problem is that eliminating all exclusions, deductions, and credits other than credits for taxes withheld or paid in advance does not simplify the tax system sufficiently. Upper income salaried taxpayers have the advantage of being able to defer income, and their tax liabilities on that income, to a future year, which in present value terms, is a tax savings. Lower income salaried taxpayers cannot afford to play this game because they need their meager salaries to pay the bills and put food on the table. What happens to nonrecognition provisions, a source of much complexity but also a source of tax avoidance that lowers the effective tax burden on taxpayers in a position to take advantage of those provisions? The tax law would be simplified if these provisions were removed, but that would generate all sorts of liquidity issues for taxpayers trying to move assets from one entity to another for business purposes.

The fourth problem is that a flat tax as Dunkelberg advocates, that is, a flat tax with an exemption and the elimination of deductions, would increase taxes on lower income taxpayers and further reduce taxes on upper income taxpayers.

This is not my first attempt, nor my second, nor my third, to explain why the flat tax does not simplify tax law nor deal adequately with the things that generate complexity. Six years ago, in The Revived Forbes Flat Tax Plan, I dissected the proposal to tax all income at 17 percent with a zero percent rate applicable to capital gains, and revealed the complexity generated by taxing capital gains, to say nothing of the unfairness of leaving the primary source of wealthy individual’s wealth accumulation free of taxation. Three years ago, in Flat is Not Simple, At Least Not with Taxes, I explained that a true flat tax, namely, a one-rate tax, does absolutely nothing to simplify the tax system, and revealed that most plans tagged with the label are nothing more than disguised attempts to impose income tax on workers while letting people who live off of trust income and investments off the hook. Two years ago, in Fighting Tax Ignorance, I took apart, among other things, Paul Ryan’s claim that reducing the tax rate schedule to one or even two rates would simplify the tax law. Four months ago, in The Flat Tax Myth Won’t Die, I explained why, although I agree with those who want to remove special interest tax breaks from the Internal Revenue Code, and transform spending plans disguised as tax credits into actual expenditure programs that the public can see for what they really are, I object to retention of special interest treatment for capital gains and other sorts of income leaving wage-earners as the people on whose back the nation is financed.

Because I think that the plans masquerading as “flat tax” plans are designed for the purpose of shifting tax burdens from the wealthy to the poor, I think that the phrase “flat tax” ought to be put out to pasture. That won’t happen, because use of more precise labels would show the plans for what they really are. It’s not surprising to me that advocates of taxing nothing more than wages keep hiding behind the phrase “flat tax.” But it will be to the people who sign on to a flat tax plan as the answer to tax complexity and then discover that the Pied Piper has struck again.

The nation’s bridges and highways are falling apart. I’ve not seen or read anything to the contrary, certainly no one claiming that the transportation infrastructure is in tip-top condition.

That’s not the only problem afflicting the nation. Far too many Americans, including many in the construction trades, are out of work.

The Administration develops a plan to kill two birds with one stone. Hire unemployed construction workers to fix the nation’s transportation infrastructure. Actually, a third bird gets killed with this stone, because the impact of hiring the construction worker and initiating construction projects will give a secondary boost to the local economies of the areas where the work will take place.

So what does the Senate do? According to many reports, including this one, it rejected the Administration’s $60 billion proposal. Why did all of the Senate Republicans, a Democrat, and an independent oppose the plan? Republicans provided two reasons. First, it is funded with a tax on the wealthy. Boo hoo for the wealthy. If they would have used their tax breaks to hire people instead of financing off-shore tax shelters that don’t benefit America, perhaps this nation’s infrastructure would not have fallen so deep into disrepair. Second, claim these wizards of economics, $60 billion is too much to spend. Hello? The amount needed to fix the nation’s roads and bridges is multiples of $60 billion. Perhaps it is cheaper to let bridges collapse, leading to the sort of deadly consequences of infrastructure funding shortfalls I discussed in Funding the Infrastructure: When Free Isn’t Free? Brilliant thinking. These are the same Republicans who voted down an effort to keep the nation’s firefighters and teachers on the job.

In turn, the Senate’s Democrats then caused the failure of the Republican plan to spend $40 billion to repair bridges and other infrastructure using funding taken from other programs. The Republican plan also included provisions intended to make the nation’s air quality worse than it is, under the pretext that less regulation means better lives for, oh wait, more money for those already with plenty of it.

After telling the nation that it doesn’t deserve quality highways and bridges, the Senate Republican leader claimed that “Democrats are more interested in building a campaign message than in rebuilding roads and bridges.” Hello? What better way is there to rebuild roads and bridges than to offer legislation that provides funding for the repair of roads and bridges? McConnell’s comments are equivalent to claiming that a person riding a bicycle is not trying to ride a bicycle.

The Senate’s majority leader has this one right. “[The Republicans’] goal is to do everything they can to drag down this economy, to do anything they can to focus attention negatively on the President of the United States in hopes that he can get my job, perhaps, and that President Obama will be defeated. So let's not talk about campaign speeches here on the Senate floor. Let's talk about reality." Exactly. Some of the Senators who voted against the legislation previously voted for highway repairs and the requisite funding. It is so unavoidably obvious that the nation’s transportation infrastructure needs have been put in the back seat so that partisan politics can ride up front.

When partisan loyalties mean more than the nation’s well-being, when money means more to wealthy “world citizens” than does the long-term physical security of the nation, and when protection of millionaires who fund campaign treasure chests means more than the lives and safety of the rest of America, the literal physical survival of the nation is imperiled. Without a high-grade transportation network, the economy becomes even worse. There are times one must wonder if the wealthy “world citizens” see that sort of outcome as more conducive to their plans than the sensible approach of spending money to keep the nation intact.

So, yes, as long as this absurd tax and spending stalemate continues, where decisions are not made on the merits of the issue but on the partisan attachments of supposedly public servants, the nation and its infrastructure, the nation and the health of its citizens, the nation and its economy, will continue to stagnate, deteriorate, and crumble. The question now is how close we are to the point of no return.

In response to my recent Halloween post, The Scary Part of Halloween Costume Sales Taxation, Thomas A. Haines, CPA, of Tax Matrix, offers some helpful information about the sales taxation of costumes and accessories, for which I thanked him. He writes:

In contrast to your recent blog, I believe that there is general agreement among the states as to the definition of “clothing” and “costumes.” Our firm specializes in sales & use tax. We advise our clients—generally larger retailers—as to items subject to or exempt from state sales tax.

There are only seven states that provide an exemption for clothing: Massachusetts, Minnesota, New Jersey, New York, Pennsylvania, Rhode Island, and Vermont. Among these states, four have adopted the definitions provided in the Steamline Sales Tax Agreement: Minnesota, New Jersey, Rhode Island, and Vermont. These four define clothing as “human wearing apparel suitable for general use” (see M.S. 297A.67, Subd. 8; N.J.S.A. 54:32B-8.4; R.I. Gen. Laws § 44-18-7.1(f); and, 32 V.S.A. § 9701(24), respectfully). You will note that Minnesota and Vermont laws include a list of examples of “clothing” which includes “costumes” (see M.S. 297A.67, Subd. 8(b) and 32 V.S.A. § 9701(24)(A)(ix), respectfully). Minnesota, New Jersey, and Rhode Island has issued publications or regulations specifically stating “costumes” are “clothing” (see Minnesota Sales Tax Fact Sheet 105, Clothing; Bulletin S&U-4, New Jersey Sales Tax Guide>, and Rhode Island Regulation SU 07-13, respectfully).

Massachusetts provides a sales tax exemption for clothing under G.L. c.64H § 6(k). As you can see, this is a rather broad definition; however, they have provided guidance in their publication, A Guide to Sales and Use Tax. Under “Apparel and Fabric Goods,” they specifically state “costumes” are an exempt item.

New York provides an exemption for clothing under Tax Law § 1105(a). “Clothing and footwear” is defined in Tax Law § 1101(b)(15). You will note that this definition specifically
excludes “costumes.”

Pennsylvania defines clothing under 61 Pa. Code § 53.1. Costumes are deemed “Ornamental wear” as defined under 61 Pa. Code § 53.1(a)(5) and provided via examples under 61 Pa. Code § 53.1(c)(6)(i). “Ornamental wear” is subject to tax pursuant to 61 Pa. Code 53.1(b)(2).

With regard to tuxedos and other formal apparel, they are exempt as “clothing” in Streamline states. They are deemed “formal day or evening apparel” in Pennsylvania and are subject to sales tax (see 61 Pa. Code § 53.1(a)(3)). Massachusetts and New York each impose limits of $175 and $55, respectfully, on exempt clothing. A tuxedo would be exempt should the cost fall below the aforementioned limits.

Accessories, too, have not been a problem. The only exceptions are Santa hats, Santa gloves, and witches hat. These three items are classified these as costumes; however, any thing else is classified as accessories even if worn (e.g. masks, wigs, hand coverings, etc.). To date, we have not received any complaints (from clients or state regulators) regarding the classification of items.

Though progress is being made, there remains a lack of uniformity. Seven states provide a clothing exemption not found elsewhere. Four of the seven agree on a definition but the other three are not yet on board. Costumes are taxed in some of these states but not in others, and similar disparate treatment is afforded tuxedos. Two states impose limits on the clothing exemption, but the others do not.

In an increasingly interdependent world, let alone interdependent union of states, lack of uniformity poses risks. Imagine if states used different shapes, colors, and words for stop signs. Imagine if states decided to use different colors for traffic signal lights. Though the disadvantage to states of doing so – increased accidents, deaths, and injuries – is more readily apparent, states are losing revenue because of variations in tax definitions. It is too easy for someone accustomed to a tax exemption for clothing or to the sales taxation of clothing to take the same approach no matter where they happen to be. States face so many problems, though, that getting them to focus on the technical definitions that may or may not bring Santa hats, tuxedos, and Halloween costumes into the sales tax regime is quiet unlikely. So, buyer beware! Sellers, too.

About a year and a half ago, in Don’t Like This Tax? How About That Tax?, I criticized a proposal to revamp Philadelphia’s business privilege tax because it would eliminate the income component and measure the tax based on gross receipts, causing enterprises without net income to pay the tax. Six months later, as more details emerged, I returned to the question, updated the examples of how the changes would impact businesses, and in Better to Tax Gross Receipts, Net Income, or a Combination?, predicted that the proposal, if enacted, “. . . 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.” Two months later, in Taking Time to Construct Viable Tax Proposals, I explained that hearings on the proposal had been postponed, and that negotiations were underway to phase out the gross receipts portion of the tax so that in effect it would transform into a 6 percent net income tax.

Now comes news that the city’s mayor and council have agreed to modify the business privilege tax. There would be a $100,000 exemption of the gross-receipts portion, and exclusion of the first $100,000 in sales from the net-income portion of the tax. Businesses would be taxed only on sales made in Philadelphia. The bill has not yet been enacted into law.

About six months ago, in connection with a different tax issue, I let the title of a post ask a question: Revenue: Is It All in The Name?. The answer can be debated, but in Philadelphia’s case, according to its mayor, the answer is yes. As reported in this story, the mayor wants to change the name of the business privilege tax to the business income and receipts tax. Why? The mayor said, “But it is not necessarily a privilege to pay taxes,” explaining that attaching the word “privilege” to a tax bothers businesses and even some elected officials.

Is it a privilege to pay taxes? Some people think so. Here’s a blog post titled “Paying Taxes is a Privilege.” Here is another, and yet another. Lest one conclude that the argument is made only by those who are incorrectly accused of benefitting from the tax system, the chairman and CEO of Phillips Beverage Co. agrees. Theological justification for the goodness of paying taxes is explained in this post written from the perspective of Christian humanism. Others, of course, disagree. To see an example of this position, check out dakota99’s comments at this site.

It is not my goal today to resolve the question of whether paying taxes is a privilege. I think so, but clearly others disagree. That much can be confirmed by dropping the terms paying, tax, and privilege into an internet search engine. My goal today is to focus on whether changing the name of a tax by removing the word privilege makes a difference. I doubt it. The word tax remains.

The word that bothers most people is not privilege but tax. That’s one of the points I raised in Revenue: Is It All in The Name?. Perhaps entrepreneurs would react in a less unfavorable manner if the amount in question were called a “publicly-provided services and benefits fee.”

Two years ago, in Unmasking the Deductibility of Halloween Costumes (2009), I examined the deductibility, for federal income tax purposes, of the cost of Halloween costumes. Usually, my Halloween posts, which apparently have become a tradition, involve candy and other treats, such as Taxing "Snack" or "Junk" Food (2004), Halloween and Tax: Scared Yet? (2005), Happy Halloween: Chocolate Math and Tax Arithmetic (2006), Tricky Treating: Teaching Tax Trumps Tasty Tidbit Transfers (2007), Halloween Brings Out the Lunacy (2007), and A Truly Frightening Halloween Candy Bar (2008), though last year, in Happy Halloween: Revenue Department Scares Kids Into Abandoning Pumpkin Sales (2010), I focused on a different sort of edible that surely is not candy and for many is not a treat. Now it’s time for another Halloween item that is not candy, and though it may be a treat, the tax aspects are somewhat tricky.

Not too long ago, I had occasion to notice that Halloween costumes were subject to sales tax in some states but not others. In some states, such as New Jersey, costumes are considered clothing and are exempt from sales taxation because clothing is exempt from sale taxation, though before the law was amended adult costumes were not considered to be clothing though children’s costumes were so treated. In Florida, there is no exemption for costumes. Some states, for example Mississippi, exclude costumes from sales taxation if they are purchased for purposes of making a film for which a film production income tax credit is available.

In just about every states, costume accessories, such as masks, are subject to sales taxation. That is the case, for example, in New Jersey. The same principle applies to accessories such as wands, swords, baskets, and broomsticks.

What is scary is that the nation’s legislators cannot agree on whether a costume is clothing, an alarming prospect even aside from the inability to agree on whether clothing should or should not be subject to sales tax. A costume is something that is worn. Clothing is something that is worn. The difference is that a costume is worn only for special occasions. A tuxedo is clothing even though it is worn only on special occasions, and surely there have been men wearing tuxedos who have called the thing a costume. To use a common definition, clothing is something that covers. Costumes cover. The same definition also uses the word “garment” to describe clothing. From the same source comes a definition of costume that uses the terms dress and garment. Some costumes so resemble everyday wear that drawing the distinction becomes arbitrary and nonsensical. Truly horrifying.

It is easy to understand why accessories such as wands and broomsticks do not fall within the clothing exemption. These are not items that are worn, they are not garments, and they do not cover. On the other hand, a mask is worn, and it covers. Why is it classified as something not clothing? It should be terrifying that tax policy rests on analysis devoid of logic, common sense, and consistency. The only logical explanation, aside from the simple expedient of increasing sales tax revenues by narrowing exemptions, is the notion that exempt items are “necessaries” and that costumes and masks, unlike clothing, are not “necessaries.” The difficulty with this analysis is that tuxedos, ballroom gowns, and someone’s fiftieth pair of shoes or thirtieth cocktail dress, are not “necessaries” and yet they are exempt. Frightening, isn’t it? For most people, tax always is, no matter how the rules sort out, but when it comes to the sales taxation of Halloween costumes, it’s simply ghastly.

One of my readers, noting that I had disclosed having read the Internal Revenue Code, asked if I agreed that all of the Code, and even the regulations, are “complex and hard to decipher.” He asked, “Can complexity be measured? Would some of the criteria be the number of pages, number of interrelated sections or regulations, number of topics covered in the section, etc. Is there a top ten list of complex code sections?”

My response added questions. The primary question was simply, “How does one measure complexity?” I elaborated on my question: “Number of words? Not necessarily. There is something somewhere floating about that deals with ‘What is the longest Code section?’ but I don’t have a cite offhand. Number of challenging computations? Number of difficult definitions? Number of exceptions? Number of exceptions to exceptions? Difficulty of application? The black letter law ‘gifts are excluded from gross income’ is simply stated, but the question ‘What is a gift?’ requires complicated analysis to come up with something that separates gifts from payments for services. Does it matter if the provision affects 10 people or 1000 people? In other words, is something with a complication level of 6 (whatever that means) affecting 200 people (1200 points) more complicated than something with a complication level of 8 affecting 5 people (32 points)? Some of the most complicated things are the transition rules and effective dates, which technically are in the amending act and not in the Code itself.”

In a follow-up, the reader shared the link to Janet Novack’s Forbes article, The Most Confusing Part of the Income Tax Code, which describes ten areas of tax law that are complex. The reader then asked, “Should you consider the number of tax cases litigated regarding a particular section? Should you consider the National Taxpayer’s Advocate Report 2010 stating that 80 million taxpayers are affected by family status issues such as earned income credit, marital status, child tax credit, and child and dependent care credit? Should you consider if you are wrong about filing status the taxable income and total tax owed or refunded is affected? Should you consider if section 107 parsonage allowance with only 81 words is extremely complex because it has resulted in hundreds of tax cases about the law and whether the section is constitutional?” In yet another follow-up, he asked, “Should you consider the [flush language] sentence from Section 509(a)(4) [509(a)]? Should you consider the premise that if tax experts or AICPA argue for simplification of particular tax codes [sections] then those tax codes [sections] are too complex?”

I don’t agree with the proposition that every code section and regulations section is complex. For example, section 701 provides, simply, that partnerships are not subject to the federal income tax. But I think there is unanimous agreement that many, perhaps most, Code sections are complex. And I think it is safe to conclude that there is unanimous agreement that too many Code sections are complex.

In addition to the issue of deciding which factors should enter into the determination of complexity and the issue of determining how much weight should be assigned to each factor, there is the further, sorry, complication caused by the existence of different types of complexity. For example, some Code sections are complex primarily, or even solely, because of computation complexity. Section 82, prescribing the calculation of social security gross income, falls into this category. Another sort of complexity is interpretational complexity. For example, the flush language of section 509(a), noted by the reader, surely qualifies, as it reads, “For purposes of paragraph (3), an organization described in paragraph (2) shall be deemed to include an organization described in section 501(c)(4), (5), or (6) which would be described in paragraph (2) if it were an organization described in section 501(c)(3).” Still another type of complexity is technical complexity, when redundancies, ambiguities, poor drafting, and slipshod organization complicate the task of trying to determine what the words mean. Often this sort of complexity arises not from any Code section in and of itself but from the intersection of multiple code sections. Yet another type of complexity is revision complexity, the confusion that results from constant changes to the provision, with effective dates, exceptions to the effective dates, grandfather provisions, and other special rules, many of which remain in the amending act but don’t end up in the Code itself.

Should the analysis be limited to entire Code sections? Or is it acceptable to tag particular subsections, paragraphs, subparagraphs, clauses, and subclauses? It is not uncommon to find a Code section with a very simple subsection (a), only to discover that it’s (b), (c), and (d) that cause eyeballs to spin around in a person’s head. Should provisions that are in amending acts but not in the Code qualify? I think so, though that technically makes the question something different from “What is the most complex Code provision?”

If the only requirement to win the complexity contest is number of words, the victor is section 341(e)(1), as described in this web page:

Internal Revenue Code Section 341(e)(1) - Its a 455 word sentence about "Collapsible Corporations"

(1) Sales or exchanges of stock for purposes of subsection (a)(1), a corporation shall not be considered to be a collapsible corporation with respect to any sale or exchange of stock of the corporation by a shareholder, if, at the time of such sale or exchange, the sum of - (A) the net unrealized appreciation in subsection (e) assets of the corporation (as defined in paragraph (5)(A)), plus (B) if the shareholder owns more than 5 percent in value of the outstanding stock of the corporation the net unrealized appreciation in assets of the corporation (other than assets described in subparagraph (A)) which would be subsection (e) assets under clauses (i) and (iii) of paragraph (5)(A) if the shareholder owned more than 20 percent in value of such stock, plus (C) if the shareholder owns more than 20 percent in value of the outstanding stock of the corporation and owns, or at any time during the preceding 3-year period owned, more than 20 percent in value of the outstanding stock of any other corporation more than 70 percent in value of the assets of which are, or were at any time during which such shareholder owned during such 3-year period more than 20 percent in value of the outstanding stock, assets similar or related in service or use to assets comprising more than 70 percent in value of the assets of the corporation, the net unrealized appreciation in assets of the corporation (other than assets described in subparagraph (A)) which would be subsection (e) assets under clauses (i) and (iii) of paragraph (5)(A) if the determination whether the property, in the hands of such shareholder, would be property gain from the sale or exchange of which would under any provision of this chapter be considered in whole or in part as ordinary income, were made - (i) by treating any sale or exchange by such shareholder of stock in such other corporation within the preceding 3-year period (but only if at the time of such sale or exchange the shareholder owned more than 20 percent in value of the outstanding stock in such other corporation) as a sale or exchange by such shareholder of his proportionate share of the assets of such other corporation, and (ii) by treating any liquidating sale or exchange of property by such other corporation within such 3-year period (but only if at the time of such sale or exchange the shareholder owned more than 20 percent in value of the outstanding stock in such other corporation) as a sale or exchange by such shareholder of his proportionate share of the property sold or exchanged, does not exceed an amount equal to 15 percent of the net worth of the corporation.

If there were a way to measure the amount of money expended in an effort to understand and comply with specific Code sections or components thereof, perhaps that would be the best measure of complexity. I don’t think information of that sort is available.

Some complexity, however, is attributable to the transaction under consideration and not to the tax law. If a taxpayer, in an attempt to end-run the system, sets up a business or investment enterprise by using hundreds of entities located throughout the world, cross-linked in complicated ways and engaging in roundabout interactions, the challenging task of applying tax law principles to the arrangement is not the fault of the Code. There also is the reality that what one person finds complicated another person understands with little effort. That, in turn, raises the question of who should be the judge of complexity. Should it be the practitioners who collaborate on ABA and AICPA commentary and proposals for simplification? Should it be taxpayers generally? I think it should be anyone who works with the tax law. So I invite readers to nominate candidates for tax law complexity, specifically Code and Regulation provisions, whether entire sections or specific components, or intersections of multiple provisions. To keep things manageable, readers should select their one candidate for “most” complex. I understand that all of us could easily list ten or twenty or even a hundred complex provisions but the question is “most” complex. If there are sufficient nominations (and am I setting myself up for colossal embarrassment if only two or three readers submit entries?), I will then try to learn how to set up an online poll that permits everyone to vote (and I welcome suggestions on how to do that, and, at the risk of making this complicated, ha ha, on whether the winner needs a majority or simply a plurality). Oh, nominating speeches are not required, as complex provisions speak for themselves!

Though it sounds good at a theoretical level, the practical problem with cutting taxes in order to force a cut in government spending is that the health and safety of citizens is what gets cut. I pointed this out in The Price of Insufficient Tax Revenue, explaining that the combination of additional tax cuts and the refusal to restore revenue lost through previous tax cuts had compelled the city of Camden, New Jersey, to make huge cuts in its police and fire fighting forces. I returned to the same point in Cut Taxes, Cut Spending, Cut Safety?, explaining that the short-term savings predicted from cutting vehicle inspections would end up being swamped by the long-term economic costs of damages caused by uninspected but dangerous vehicles. I questioned the validity of the cut-spending rationale in Whether There Is Money Depends on Who’s Asking, criticizing the decision to pour taxpayer money into the hands of a shopping and entertainment center developer. Not a peep was heard from the anti-government-spending crowd when the spending flowed to their political allies.

Now comes more news of cutbacks in citizen protective services on account of tax revenue shortfalls. In a story appearing a few days ago, readers of the Philadelphia Inquirer learned that Pennsauken Township, in New Jersey, gave notice that they would release 12 police officers at the end of the year. Last year, when a similar notice was given, some police retired, averting the need for pink slips, but reducing the township’s police force. The mayor of the township stated, “We’re very concerned. This is a reduction in force that’s unprecedented.” No kidding.

According to the story, almost 1,400 police officers and fire fighters were laid off in New Jersey during 2010. Even more would have been dismissed but for retirements, compensation reductions, or redirecting state funds to re-hire some police and fire fighters.

The issue has become a political football. Charges of fiscal mismanagement have been tossed about. Questions are being asked, particularly why township workers received raises if there is insufficient money to retain all the members of the township’s police and fire fighting forces. The answer to that question surely is in the simple fact that the raises are a contractual obligation, and do nothing more than maintain the real dollar value of salaries. The question that needs to be answered is why are tax revenues insufficient to cover the township’s spending. A related question is whether the township’s citizens enjoy the choice that is being presented, the choice being one of paying the price of more taxes or the price of reduced police and fire protection.

Is it simply a matter of the citizens of a town being unable to afford what they want? In that case, the town needs to learn to live without the things that cannot be afforded, though the price may be a town wracked by fire and crime. Or is it a matter of the citizens of a town being unwilling to pay for what they want? Or is it a matter of funds that should be used for what citizens want being used for what citizens don’t want? Or is it some combination of affordability, resistance, and diversion?

It has been said that the low must be reached before the climb back to the heights can begin. But for that to be true, there must be knowledge that the low has been reached, and it needs to be reached at a local level. As the Pennsauken Township, Camden, and other New Jersey municipal layoff stories repeat themselves throughout the nation, perhaps attention will turn from the sound bite nonsense being spewed by political candidates to serious fiscal and economic analysis of reality.

A few readers have suggested to me that I dislike, or worse, hate the wealthy. That’s not true. I dislike what many, not all, wealthy do in terms of co-opting Congress and dictating tax policy that favors the wealthy and that has brought the nation’s economy to its knees. Indeed, there are wealthy individuals who advance economic arguments similar to the ones I make, but they quickly become the target of other wealthy individuals and those who are devotees of the agenda that has brought us so much economic misery.

Whether William H. Gross is wealthy is information I do not know, though my best guess would be that he, as manager of a very large investment fund, probably is not in the “other 99 percent.” What I do know is that he has advanced an argument that ought to be given serious attention by his economic comrades. They may learn something about the benefits of long-term rather than short-term planning. In his analysis, Gross describes four factors that triggered the nation’s economic distress: falling interest rates, lower taxes, deregulation, and financial innovation. He notes that attempts to solve the problem focus on cyclical financial issues rather than structural policy solutions. He concludes, “[A]lmost all remedies proposed by global authorities to date have approached the problem from the standpoint of favoring capital as opposed to labor.” He explains that the reason attempts to stabilize banks, to push markets back to their previous peaks, to increasing debt by lowering interest rates have failed. The reason, he asserts, is that when “Wall Street” (capital) benefits at the expense of “Main Street” (labor), both ultimately will collapse.

Gross suggests that “Even conservatives must acknowledge that return on capital investment, and the liquid stocks and bonds that mimic it, are ultimately dependent on returns to labor in the form of jobs and real wage gains. If Main Street is unemployed and undercompensated, capital can only travel so far down Prosperity Road.” In other words, as I have contended, the past decade has seen a resounding growth in capital, translated, the assets and income of the wealthy, to use Gross’s words, “at a great cost to labor.” Fear of unemployment drives down spending, reduced spending drives down housing prices and in the long-run, business profits. To quote Gross again, “Long-term profits cannot ultimately grow unless they are partnered with near equal benefits for labor.” He adds, “The United States in particular requires an enhanced safety net of benefits for the unemployed unless and until it can produce enough jobs to return to our prior economic model which suggested opportunity for all who were willing to grab for the brass ring – a ring that is now tarnished if not unavailable for the grasping.” Over the past few years, in response to my inquiry as to why some who are not wealthy become so defensive when something as simple as repealing the Bush tax cuts is advocated, I’ve been told that failure to reduce even further the taxes on the wealthy will make it impossible for those who are not wealthy to attain the American Dream. Well, perhaps coming from someone like Gross the news carries more heft than when it comes from me. At the moment, folks, the American Dream is pretty much out of everyone’s reach except those who have already achieved it. Gross concludes with a warning that should alarm those who support the policies that have brought us to where we are, especially considering that he is an investment fund manager. He writes, “Investors/policymakers of the world wake up – you’re killing the proletariat goose that lays your golden eggs.”

Aside from feeling a bit vindicated after reading Gross’s newsletter, I began thinking, “How can the private sector adjust to forestall the inevitable crash pattern promised by current practices? Can the private sector do it alone?" Hardly. The private sector’s track record is abysmal in this regard. Many in the private sector resist outside intervention, specifically, government regulation and taxes, but that is the unsurprising reaction of those too proud to admit that their experiment failed. But how can the government intervene? If it orders the private sector to create jobs, the private sector replies that it doesn’t need workers. The government already imposes minimum wage laws in an effort to ensure that capital invests in labor, though ironically some of the unsuccessful economic experimenters are now crying for a reduction in the minimum wage and a narrowing of the situations to which it applies. Gross seems to suggest that higher and longer unemployment benefits is a or the solution, but from a productivity perspective, it makes more sense for the government, that is, society, to get something in return. In the 1930s, people were paid, not to “collect unemployment” while job-hunting, but to do things, such as cleaning up national parks, preserving archival records, and repairing infrastructure. The nation has things that need to be done, ranging from bridge repair to education of the young, and the nation has people capable of doing these things who need jobs, so it’s a match that works, except that just the other day the Senate, in all of its wisdom, said “no” to this sort of solution.

Perhaps another approach is to use the tax law not only to reward those who create jobs, as the current tax law supposedly does, but also to punish those who fail to create jobs. Two-edged swords are much more effective that one-sided blades. The mechanism for doing this already is in place. It’s the corporate accumulated earnings tax, which is avoided by companies that claim they are hoarding profits for “future growth.” Nonsense. Those who wish to avoid the tax can invest the profits in construction of productive facilities and hiring of employees. And the tax needs to be extended to all business entities. I can hear the howls now. “You will kill capital.” To the contrary, capital is killing itself by focusing on short-term profit at the expense of long-term investment in labor. Capital needs to be taxed to save itself. For example, the special low rates for dividends and capital gains need to go, and if there is to be a special low rate, it ought to be on wages, which would reduce the cost of labor. And if capital doesn’t want to be taxed, it can avoid the imposition by hiring people. Recall that I have argued that the best way for the wealthy to lower their tax burden is to create jobs and take a compensation deduction, thus reducing taxable income. For example, in Why the Tax Compromise is a Mistake, I wrote, “If the job creators want a cut in their tax liabilities, they need to do what I’ve been advising them to do for quite some time. Hire people, take the compensation deduction, thereby reduce taxable income, and watch tax liability go down. It’s that simple. Corporations and wealthy individuals are awash in cash, but they’re not creating jobs. Nor will they create jobs as their cash hoards grow from continued tax breaks.” This comment summarized the more detailed explanation in the earlier post, Job Creation and Tax Reduction. The answer is easy, and if the wealthy, including wealthy cash-bloated corporations, cannot understand this and figure it out, then society needs to give them a tax push. They will scream, but iIt’s tough to sympathize with people who reject such an easy approach to solve their alleged high taxation problem, an approach that also solves the jobs problem that afflicts the not-so-wealthy of the nation.

Almost five years ago, in A Tax Advice Book for People Who Write and Illustrate Books, I reviewed Julian Block’s “TAX TIPS FOR SMALL BUSINESSES: Savvy Ways for Writers, Photographers, Artists and Other Freelancers to Trim Taxes to the Legal Minimum. He has now released a new edition, with a modified title, “Julian Block’s Easy Tax Guide for Writers, Photographers, and Other Freelancers.” Once again, Julian has given tax practitioners and taxpayers with any sort of connection to the literary or artistic world a handy and helpful explanation of tax tips that they might otherwise neglect.

Julian opens the book with several questions posed by readers of the earlier edition. What are the tax consequences of writing a book for an agreed price, incurring reimbursable expenses only to discover that the publisher went out of business and did not pay? Are the tax consequences different if the writing business is a part-time one? How should an author react when one publisher sends a Form 1099 net of agent’s commissions and the other publisher sends a Form 1099 showing the gross royalty? Must expense reimbursements included in a Form 1099 be reported? Are the expenses incurred for a spouse who accompanies a writer to a conference deductible? What is the tax treatment of a speaking honorarium that the speaker asks be paid to a charity? What sort of charitable contribution is available for donating papers, original manuscripts, and correspondence to a charity? Is a charitable contribution available for an artist who paints a portrait and donates it to a church bazaar? There are more questions. Yes, there are answers, but to discover them, buy the book.

Julian then discusses, in succession, the hobby loss and for-profit rules, the tax treatment of awards received for writing and other accomplishments, depreciation deductions for writers and artists, how freelancers compute health insurance deductions, automobile expenses, travel expenses for spouses, the tax consequences of hiring one’s children, home office deductions, sales of homes for which home office deductions have been claimed, and clothing expenses. Julian then deals with some planning and compliance issues, including the timing of making payments near year-end, sending payments to the IRS, self-employment taxes, net operating losses, retention of tax records, extensions of time to file, amending returns, obtaining tax advice from the IRS and others. He deals with these topics in language suitable for those who are not familiar with the technical verbiage of the Internal Revenue Code.

Julian’s book was sent to the printer near the end of 2010 and was released later in 2011. Shortly after the book entered printing, Congress lowered the employee FICA rate and the self-employment rate for 2011. The book does not reflect this change. One of the challenges in writing tax books, and I speak from experience, is that the subject of the book too often becomes a moving target. If tax books were judged solely by this standard, no tax book of practical utility would qualify. There are sufficient disclaimers in the book, as there are in tax books generally, alerting readers to consult professionals and to check for the latest changes in the tax law.

Writers and other freelancers, especially those unfamiliar with the impact of tax law on their activities, should get themselves a copy of this book. I recommend it just as I recommended Julian’s previous books, "MARRIAGE AND DIVORCE: Savvy Ways For Persons Marrying, Married Or Divorcing To Trim Their Taxes - And They’re Legal," which I reviewed in Tax and Relationships: A Book to Read and Give (Feb. 2006), "THE HOME SELLER’S GUIDE TO TAX SAVINGS: Simple Ways For Any Seller To Lower Taxes To The Legal Minimum," reviewed in A New Book on Taxation of Residence Sales: Don't Leave Home Without It (Aug. 2006), "TAX TIPS FOR SMALL BUSINESSES: Savvy Ways For Writers, Photographers, Artists And Other Freelancers To Trim Taxes To The Legal Minimum," reviewed in A Tax Advice Book for People Who Write and Illustrate Books (Dec. 2006), "Year Round Tax Savings," reviewed in Another Tax Book for Tax and Non-Tax People to Read (Feb. 2007), "Travel and Moving Expenses: How To Take Maximum Advantage Of Every Tax Break The Law Allow," reviewed in Tax Travels and Tax Moves: Book It with Block (Sept 2007), "Ultimate Tax-Saving Resource '08," reviewed in Helping Tax Clients Understand Taxes (June 2008) and "Julian Block’s Tax Tips for Marriage and Divorce," reviewed in Julian Block Talks Tax with Married, Divorced, and Other Couples (Jan. 2011) and “Tax Deductible Travel and Moving Expenses: How To Take Advantage Of Every Tax Break The Law Allows!,” reviewed in Julian Block: On the Road Again (July 2011).

On Monday morning, while listening to KYW news radio, I heard a report that caught my attention because the reporter mentioned the word taxes. After listening through the 22-minute news cycle, I paid closer attention when the report ran again, and subsequently found the transcript on the KYW web site. The report focused on a familiar issue, specifically, the struggle that states face in trying to collect use taxes on purchases made by state residents from out-of-state retailers. According to the report, Pennsylvania’s Governor Corbett has joined the long line of state officials across the nation who are trying to deal with this thorny issue.

The problem is that when a Pennsylvania resident makes a purchase on-line from an out-of-state retailer, the resident often does not pay sales tax. Technically, because the purchase is not being made within the state, a use tax is due in lieu of the sales tax, though the use tax is computed at the same rate and on the same items as is the sales tax. Estimates for Pennsylvania’s lost use taxes are in the hundreds of millions of dollars.

What the report got wrong, though, is the applicable law. The reporter quoted Christopher Rants, the president of the Main Street Fairness Coalition, which argues, understandably, that out-of-state on-line retailers not collecting sales or use taxes have an advantage over in-state, bricks-and-mortars retailers. According to Rants, states “can only collect from out-of-state retailers on a voluntary basis.” That is true only if the retailer has no nexus with Pennsylvania. If the retailer has a Pennsylvania nexus, it is required to collect the tax. Though there are many retailers who avoid nexus with as many states as possible, there are far more than a few retailers that have nexus with a significant number of states.

The issue pre-dates the internet, though the emergence of the internet has exacerbated the problem. For decades, Pennsylvania residents have traveled to Delaware to make purchases, because there is no sales tax in Delaware. Anecdotes have been told about Pennsylvania revenue officials watching for vehicles crossing from Delaware into Pennsylvania that appear to be driven by people who have made substantial purchases, but I have my doubts that this sort of enforcement is efficient or effective. In contrast, Pennsylvania’s Liquor Control Board seems to have had better success dealing with attempts to avoid Pennsylvania alcohol duties.

The upshot of the issue comes down to a simple administrative problem. Technically, Pennsylvania residents who purchase items from retailers with no Pennsylvania nexus, whether by going to some other state or ordering on-line, owe a use tax. Very few residents pay that tax, because the state rarely knows about the purchases. When the state does know, for example, when a person brings into the state and seeks to register a boat or vehicle, the use tax is imposed as part of the titling process. Very few items, however, are subject to the sort of titling process required for vehicles and boats.

It is easier, of course, for a state to put the burden of use tax collection on retailers. Retailers bear the burden for sales tax collection, but that obligation is easy to enforce because it applies to in-state purchases and thus to retailers who are physically present in the state and whose in-state businesses are subject to a variety of regulations, including other business taxes, that bring their existence to the attention of the Department of Revenue. On the other hand, a retailer located in some other state, with no Pennsylvania connections, that sells an item to a Pennsylvania resident by way of the internet, is beyond the reach of Pennsylvania’s jurisdiction, just as a French farmer with no United States connections is beyond the reach of the federal income tax. Some states have placed a line on their income tax returns inviting people to report use taxes on out-of-state purchases, but what little evidence exists of the success of this approach doesn’t suggest it is the answer.

This is not my first commentary on use tax collection in an internet age. Seven years ago, in Taxing the Internet, I pointed out that “when it comes to taxing transactions and activities conducted on or through the internet, or taxing access to the internet, those transactions, activities and access should be taxed no differently from the way in which transactions and activities conducted through means other than the internet are taxed” and proposed that states should “tax retail transactions as catalog sales are taxed, imposing use tax collection responsibilities on those with sufficient nexus to the taxing state.” Three years later, in Taxing the Internet: Reprise, I reacted to the introduction of legislation allowing states to shift use tax collection responsibilities to merchants with no connection to the state, noting that despite the claims of advocates for this approach, state 1 has no “independent and sovereign authority” to impose a sales tax on a transaction that takes place in state 2, or to require a merchant in state 2 with no nexus in state 1 to collect use tax on behalf of state 1. I reminded readers that “What’s hurting states is their unwillingness to do what must be done to collect use taxes.” Three years later, in Back to the Internet Taxation Future, reacting to a reappearance of the proposal to permit state 1 to require retailers in state 2 with no state 1 connection to be taxed by state 1, I explained why progress had not been made, pointing out the inability of legislators and others to distinguish between sales and use taxes, the silliness of claims that internet retailers are not required to collect sales taxes at all for any state, the unwillingness of state legislatures and state revenue departments to identify and audit taxpayers not in use tax compliance, the mischaracterizations of the Supreme Court’s 1992 decision in Quill Corp. v. North Dakota, and the inability of legislators, state employees, and citizens to understand the limitations of the Due Process Clause. A week later, in A Lesson in Use Tax Collection, I took a look at California’s approach of requiring in-state business entities to register and report their out-of-state purchases, an approach not without flaws but a step forward in the correct direction.

States, such as Pennsylvania, trying to bring use tax collections closer to what they should be under current law, need to do something more than the cheap “shift the work to out-of-state retailers” approach that violates Constitutional safeguards. Instead, they need to examine what other states have done, to learn, for example, from California officials whether the California approach worked out, to invite businesses to offer their proposals, to start examining tax returns and other records to identify taxpayers most likely to be deficient in use tax payments in amounts making audit and collection procedures worth the effort, and to publicize these efforts in an attempt to educate other residents of their use tax obligations. Perhaps states might consider paying out-of-state retailers to act as collection agents, as it is likely that retailers would be willing to engage voluntarily in use tax collection if the cost of doing so was defrayed by the state with a wee bit of profit thrown into the payment. Surely there are other ideas that are efficient, effective, and within the bounds of Constitutional restrictions.

Anyone looking closely at the “Links to Other Tax Blogs” on the left side of this page will notice that I’ve added a link to Due Diligence. Though this blog includes commentary on white collar crime, legal malpractice, and several other areas where the lack of due diligence can get lawyers and others into trouble, it also includes a significant number of tax cases and other tax situations where the failure to exercise due diligence sparked adverse consequences. I’m particularly glad this blog exists because it is something to which I can direct students who respond favorably to my advice that those who find both tax and criminal law to be interesting can carve out a niche occupied by relatively few lawyers and that demands a confluence of analytical skills that transcend those used in tax and those used in criminal law analysis.

The Due Diligence blog runs a series of headlines, from which users can follow links to complete stories. The headlines remind me of the sound bite teasers aired by local television stations that are followed by “news at 11” or, for some, “news at 10.” Those teasers almost always are attention-getting descriptions of crimes, accidents, fires, and other ratings-making catastrophes. Consider not only these headlines but the cumulative impression they provide of the condition of the nation’s business sector:

* More Offshore Indictments – This Time Julius Baer Is Target
* Ed May: A Sentence That Ends a Dour Chapter
* Merrill Lynch Tagged Again – This Time for $800,000
* Merrill Lynch Fined $1mm For Fraud
* Lawyer and Client Indicted in Asset Protection Gone Wrong
* NBA Player Arrested for Alleged Ponzi Scheme
* Stock Traders More Reckless Than Psychopaths? Yes Says Study!
* Edward Jones Brokers Under FBI Scrutiny
* New Charges Against Milwaukee MD For Unreported Foreign Accounts

And that’s just the front page with the news from the past several weeks. Why was I not surprised to learn that stock traders are more reckless than psychopaths?

After reading the stories linked to these headlines, and others on Due Diligence, two thoughts popped into my head. First, those who sing the praises of the private sector might not realize how flat their tunes are when one considers that these headlines are but the tip of the iceberg. It’s a significant factor in my conclusion that the “choice” presented by the “free” market is a false choice, as I noted last week in From Fat Tax to Accountability: The Failure of Choice. Second, the resounding chorus from the anti-government, anti-tax crowd for a reduction and even elimination of laws, rules, and regulations protecting society from the rapacity of those who generate the sort of headlines featured in Due Diligence is another chant that fails to resonate with reality. Imagine how much busier the Due Diligence blog would need to be if the regulation bashers had their way. Sadly, it would be reporting the crimes, rip-offs, and scams but not investigations, indictments, convictions, fines, or sentences. I suppose there are some people who would find that to be a better world. I’m not among them.

Tax professionals, as well as other professionals, will find keeping tabs on Due Diligence to be worth the few minutes they invest. That’s why Due Diligence has been added to “Links to Other Tax Blogs.” Check it out.