MauledAgain

Recently, as explained in New York State Sales Tax Technical Memorandum TSB-M-12(3)S, the New York sales tax exemption for clothing and footwear costing less than $110 is restored as of April 1, 2012. When I read a news alert about this change, the first question that came to mind was whether the limitation was applied on a per-purchase basis or a per-item basis. By looking at the Technical Memorandum itself, I learned that the limitation is applied per item of clothing and per pair of footwear. That simply led to the next question. What is an item? Specifically, if a person wanted to purchase a suit costing $205, could they avoid the sales tax by turning the transaction into two separate deals, one for the jacket at $105 and the other for the trousers at $100?

To find an answer, I followed the Technical Memorandum’s reference to yet another Technical Memorandum, New York State Sales Tax Technical Memorandum TSB-M-06(6)S, which addresses “Year-Round Sales and Use Tax Exemption of Clothing, Footwear, and Items Used to Make or Repair Clothing.” Though the Technical Memorandum addresses a variety of issues, including the treatment of clothing and footwear purchased through mail and telephone orders, the treatment of rain checks and coupons, the application of the exemption to shipping and delivery charges, and the definition of clothing, it does not address my question. The closest example involves the sale of a combination package. The Technical Memorandum explains:

If exempt clothing or footwear is sold with other taxable merchandise as a single unit, the full price is subject to sales or use tax, unless the price of the clothing or footwear is separately stated. For example, a store has a boxed gift set for sale that has a French-cuff dress shirt, cufflinks and a tie tack. The gift set is sold for a single price of $50. Although the shirt sold by itself would be exempt, the full price of the boxed gift set would be taxable because the cufflinks and tie tack are taxable and the selling price of the shirt is not separately stated.

In other words, the exemption can be obtained by splitting the combination package into separate items. Although this approach suggests that splitting a suit, which can be considered in some ways to be a combination package, into separate items each costing less than $110, qualifies for exemption, it can be distinguished using a very technical analysis, by classifying it as a situation involving the dividing of a package between exempt and non-exempt items, something technically different from dividing a package of exempt items into multiple exempt items.

The policy question is interesting. If the suit cannot be broken into two transactions that separately qualify for the exemption, then the sales tax will apply to the purchase of the suit. On the other hand, a person who purchases trousers and a blazer, each of which costs less than $100, would not be subject to the sales tax. Should this outcome be translated into some sort of “anti suit” policy of New York State? Or, to put it affirmatively, is New York State using tax policy to encourage the jacket-and-slacks dress code? My guess is that the legislature did not give any thought to this question.

This particular question demonstrates once again that the application of a simple concept to a world that is increasingly complicated generates complexity that should not be attributed to the law. Though many laws are in and of themselves complicated, on their face, a substantial amount of the complexity afflicting people in tax situations, as well as in other situations, arises from the complexity of the facts or from the complexity of applying the law to the facts, in contrast to the complexity of the law.

The rapidly growing legal education crisis (which I explored seven years ago in The Future of Legal Education and Law Faculty Activities) has inspired lawyers, judges, law faculty, politicians, and clients to toss out all sorts of ideas for fixing the problems and making legal education relevant for the twenty-first century. Recently, Brian Leiter weighed in with Four Changes to the Status Quo in Legal Education That Might Be Worth Something. One of the ideas that he highlighted is borrowed from the judiciary:

2. Judge Posner suggested some time ago that law school be shortened to two years, with a third year optional depending on a student's career goals. Those who want to be tax lawyers could do what is, in effect, the LLM in tax in the third year; those who want to be legal scholars could devote the third year either to cultivating scholarly skills or teaching skills, depending on their academic goals (per #1); those who haven't secured permanent employment after two years could use the third (at some appropriately reduced cost) in externships designed to enhance marketability, with some supervision from academic or clinical faculty; and so on. Of course, this dramatic change would only work if many legal employers would be prepared to hire students for "summer jobs" after the first year, so that they'd have the kind of 'hard' evidence they most value about suitability for the job (as well as collegiality, which is often more important). And, of course, in the short-term, shortening law school would have the perverse effect of increasing the supply of new lawyers in an already depressed legal job market.

Aside from the two disadvantages that Brian notes, namely, a transitory increase in the number of law school graduates and the need to find summer experiences for first-year law students, there is at least one other significant disadvantage to shortening a student’s time in law school.

My focus this morning is on the example of structuring legal education so that “[t]hose who want to be tax lawyers could do what is, in effect, the LLM in tax in the third year.” This is not my first exploration of the question of how long a law school education should be, a topic I addressed in Beer, Softball, 4-Day Weekends: Is This Any Way to Learn Law?. Though it may not please law students or law faculty to read this, there’s no escape from the reality that is encountered in LL.M. (Taxation) programs. Though many LL.M. (Taxation) students have had three years of law school and most of the others are in joint programs structured so that they will have completed three years of law school before taking the second half of their LL.M. courses, too many LL.M. (Taxation) students continue to struggle with basic legal concepts that form the foundation for study in tax law or any other area of the law. Too many are unable to write clearly, to identify issues, to work their way methodically through a checklist, to appreciate the interrelationships among tax concepts and between a tax concept and an associate legal concept, or to understand source of law differences. Far too many have had insufficient exposure to specific areas of law that are pervasive in tax practice, such as international law, wills and trusts, business entities, labor law, and administrative law. Just as law schools pay no attention to the array of courses on an applicant’s undergraduate transcript when making admissions decisions, so, too, LL.M. (Taxation) programs, and perhaps other LL.M. programs, are far less interested in the specifics of an applicant’s J.D. course array than they are things like GPA and identify of J.D.-granting school.

LL.M (Taxation) programs bank on J.D. graduates having had exposure to, and intellectual practice with, enough of the basic law courses that one or two missing ingredients can be overlooked. I don’t think that works very well but perhaps it’s better than nothing. The alternative, requiring certain prerequisites, poses the same economic survival risks to LL.M. programs as it does to J.D. programs. The problem with reducing law school by one-third is two-fold. First, barring changes in the J.D. program, students who struggle mightily because of the deficiencies in their J.D. experience will struggle even more. Second, at least some of the students who don’t struggle because they arrive with a solid J.D. experience will be disadvantaged when one-third of that experience is removed. In short, the number of students struggling will increase, and the reach of the struggle will deepen.

Reducing the law school experience to two years provides several advantages, not the least of which is a presumed one-third reduction in the cost of attending law school. I say presumed because I think law schools will make up the lost revenue in other ways. But at a time when law school easily could be expanded to four years considering the meteoric growth the scope, depth, and breadth of law during the past century-plus, a reduction would be counter-productive unless it were offset with an increase in intensity, an increase in rigor, and serious changes to what transpires in the educational experience. There is room to improve the efficiency of legal education. Though repetition is a helpful learning device, it is wasteful when credit hours are scarce and even more wasteful if credit hours are cut by one-third. Though Socratic and quasi-Socratic discourse is helpful in many ways, it the time that it consumes – in contrast to other pedagogical methods – does not provide concomitant benefits. When students complain that my three-credit courses cover four credits worth of material, they are correct in terms of class hours – which usually are tied to credit hours – but I jokingly ask whether perhaps some of their other three-credit courses in which they are enrolled aren’t covering enough. Students could accomplish more learning in the classroom if they do more preparation outside of the classroom and more assimilation after they leave the room. Some of the most productive experiences for law students involve academic activities that occur outside the classroom, and in this respect I am thinking of well-supervised clinics, externships, and directed research efforts.

Perhaps reducing law school to two years – less than one-half of the total time physicians invest preparing themselves for professional practice – would be effective if students enrolled in courses during the summers before each of those two years. Perhaps reducing law school to two years would be effective if the number of credit hours required each semester were increased from the usual 14 to 16 to something on the order of 20 to 24. Perhaps reducing law school to two years would be effective if in addition to intensifying the experience, there was a change in what happens in courses and what students are required to do, as I explored in Is the J.D. Degree Merely a Ticket to More Training?

Five years ago, in Law Grads: Time to Start Reading Lots of Tax and Law Books, I commented:

The more I think about Larry's question and the reader's experience, the more I wonder what is happening in the law schools. To those who claim that there is no way three years of law school can prepare a person for the sort of situation in which the reader, and many other law graduates, were put, I suggest that law school be expanded so that sufficient years are available to provide time to do the course work required for the underlying LL.B. and the J.D.

So perhaps reducing law school to two years would be effective if law students arrived with an undergraduate education that prepared them for the study of law without the need for remedial courses or for remedial instruction in law courses. To quote one of my colleagues, “It is shocking how many law students don’t know what present value is.” Indeed. Shocking.

One thing to consider is that devoting one of the three years of law school to externships or clinics is not a reduction in the length of law school from three years to two years. Aside from the question of whether that sort of shift would reduce the overall cost of law school, that change is something far more overdue. The issue isn’t so much the length of law school but what is being done in law school. Once the latter question is resolved, the former question can be answered. Deciding that something can be accomplished in two years when two years is insufficient time merely increases the risk that what is accomplished in two years will be insufficient.

[Reposted from January 2005 because it no longer appears in the monthly archive because of blogspot page length restrictions]

Time to wander from tax into another area of interest (and one in which I also teach), that of wills and trusts. Specifically, time to explore the application of superficially simple legal principles to practical application in a context often overlooked by people when they are looking at their estate planning and setting things in order.

Last month, the medial outlets lit up momentarily on a story that quickly faded into the background as other, more pressing and serious developments moved onto center stage. The story involves the family of an American soldier who was killed in Iraq and who want Yahoo to turn over his emails. The soldier had used Yahoo to send emails to members of his family.

Yahoo refused, citing language in the contract that the soldier had with Yahoo. It states: "No Right of Survivorship and Non-Transferability. You agree that your Yahoo! account is non-transferable and any rights to your Yahoo! I.D. or contents within your account terminate upon your death. Upon receipt of a copy of a death certificate, your account may be terminated and all contents therein permanently deleted." This language, and the entire contract, can be found at Yahoo's web site. Yahoo risks all sorts of legal problems, including actions by the FTC or a state's attorney general, if it violates these privacy provisions. The soldier's family could seek a court order directing Yahoo to turn over the emails, and that would absolve Yahoo from the risks it sensibly has tried to avoid.

There is, though, a lesson for all uf us in this unfortunate situation. Whether one's correspondence is digital (email) or pre-digital (paper letters), a person needs to consider what happens to that material when the person dies.

One view is that the correspondence is property, and as such becomes part of the decedent's estate. In the case of the Yahoo email, the contractual provision does not so much make the email Yahoo's property as it prohibits Yahoo from releasing the property to anyone (because there is some question as to the ownership of the property). Of course, emails and letters in the possession of recipients are not the decedent's property, and thus could not be the estate's property, but those items raise a totally different issue that transcends death. After all, a recipient of a letter or email who is not otherwise bound to confidentiality faces few legal obstacles to releasing the correspondence (and as a practical matter, the biggest obstacle is that the recipient usually has little to gain and much to lose by doing so, but if that's not the case, the tabloids and others can have a feeding frenzy).

If this view is correct, then the decedent's will dictates the disposition of the letters, subject to some restrictions. How many people deal with this issue in their wills? Few. If there is no will, the intestacy law applies. Does intestacy law deal with this issue? Not really, other than through some tortured analogies that are great efforts to deal with an overlooked problem. So what is the executor to do? Technically, absent a provision in the will, the correspondence goes to the residuary beneficiary. What if the residuary beneficiary is a charity? Or a distant relative? Or a casual friend? The information in the correspondence could easily be on the market within weeks.

Can the executor claim that the fiduciary obligation imposed on executors require or permit destruction of the emails and letters? No. In fact, even if the decedent directs the destruction of the correspondence it is questionable whether such a command will be followed. The law in this area is confusing and fascinating.

Courts have long held under principles of public policy, that a decedent cannot direct the destruction of property after death. Thus, even though a person, while alive, can light a proverbial cigar with a proverbial rolled up $20 bill, one cannot order one's cash burned after death. Nor, according to several cases, can one order the razing of one's home (even if one could do so during lifetime), and this is an issue aside from permits and environmental concerns.

So in the classic hypothetical, when the decedent dies, love letters written to the decedent are found. Make the hypothetical interesting by identifying the writer as either a famous person or, better yet, someone whose position and status makes those letters scandalous (as if today there's much left that can fall within that term). So, however one wants to set up the facts, do so in a way that gives the love letters value. In our world of Warhol minutes, reality TV, and gossip run amok, it's unlikely that any love letters would lack value. The same is true of any other sort of letter (though love letters makes the hypothetical more interesting and gets the students' interest). The more secrets, the deeper the secrets, the more widespread those impacted or interested in the secrets, the higher the value of the email or other correspondence. I suppose that for celebrities' correspondence, the value reaches a peak and the issue is more likely to be litigated.

So if a decedent cannot order the burning of cash or the razing of a home, should a decedent be permitted to order the destruction of correspondence that has value? If the answer is yes, then those carving out an exception need to define the line, and I'm not convinced that the line can easily be drawn. Would it extend to home movies? Audiotapes? Photographs? Art work?

Surely one can think of reasons that the decedent would want the material destroyed, but then again, the decedent could have destroyed the material while alive. Except that destroying email on the email server of a commercial internet provider isn't easily accomplished, and might not be possible with emails less than 30 or 60 or 90 days old. But one also can think of reasons OTHER people would want the decedent's email and other materials destroyed: as one person pointed out (archived at Politech), "the emails might reveal the secret abortion of the sister or the secret first marriage of the father."

Digital technology puts yet another wrinkle on the issue. Paper correspondence sent to another person is in that other person's hands, and unless a photocopy was retained, it is beyond the reach of the decedent. The decedent cannot destroy it. Nor do the decedent's executor and beneficiaries have access (though, of course, the recipient's executor and beneficiaries might get their hands on it). With email, not only is the incoming correspondence on the server or computer, so too is the outgoing correspondence, or at least some of it is. Keep in mind that email is far more voluminous than is paper correspondence, perhaps by an order of magnitude.

Putting a direction in a will to destroy "love letters" could be counterproductive because wills aren't private. They become public when probated. "Destroy the love letters ....." or "Burn the letters received from ...." language would create all sorts of an uproar, and even if the contents never became public, the existence of the material would fuel the rumor mill for a long time, even if the decedent was not a national or international celebrity. After all, each one of us is a celebrity in our own little world. And, of course, "burn all correspondence" is overkill that by reaching legitimately retained financial and other information necessary for tax return and other compliance would give a court even more reason to hold to the principle that one cannot order the destruction of property after death.

It makes more sense to direct all property to a pre-existing trust and to give direction to the trustee (assuming, of course, that there is a right to order destruction of property). If the will inadvertently or deliberately incorporates the trust by reference, all bets are off because the trust is part of the probated will rather than a separate entity.

This is a huge issue for estate planners, but I don't think it gets enough attention. Perhaps, in days long gone, it wasn't an issue because there wasn't as much material, it was confined to letters, destruction could take place without anyone's knowledge except the executor or close family member, and the world wasn't as interested in the information. The digital world of email bring internet service providers into the picture, technology has opened the door to audio and video, the culture has become one very interested in the doings of other people, and the lure of money has become even stronger. All of those factors combine to make this issue one of growing, not lessening, importance.

Let me prove my point this way. When I teach this issue (and unfortunately it gets about 10 minutes), I ask my students to think about a possible premature death and the contents of their laptops and email accounts. A hush settles over the room, broken by sighs and groans. Clearly I have disturbed them, or at least their comfort zones. Then I point out that deletion of a file on a computer really isn't deletion (proving yet again why it is extremely difficult to practice or teach law effectively without having a good grasp of current and future technological developments).

I will close with a bit of theological insight that I don't share in my class (not only because of time constraints but also to spare taking the students on too wide of an analogy). In some of the theologies that include belief in an after-life, knowledge is universal. In the afterlife, everyone knows all things and all people, because everyone fully knows God, and by knowing God one knows all God knows. I don't profess an ability to explain this, though I can aver it was taught to me though not in those precise words. So if it does turn out that way, the only advantage to hitting the shred (not delete) function, and burning letters, is an information delay in the present temporal sphere. None of that, however, is going to reduce the tribulations of those whose secrets and private goings-on end up publicized among a small or wider audience because someone's email or letters were property with value that could not be destroyed.

Though I cannot give an "answer" to these questions, I can return to the tax world and share this conclusion: if the executor destroys the correspondence, there is no casualty loss deduction for the estate. Query whether the beneficiary who fails to recover damages from the executor for an unauthorized or illegal destruction has a casualty loss deduction.

So, estate planners and will drafters, what have your clients been asking you to do? And, for everyone, if you've thought about this question, what have you decided to do?

One of my readers alerted me to a story of which I had been unaware. It involves a tax return preparation enterprise that has created nightmares for its clients.

The story involves a business called Mo’ Money Taxes, which is based in Memphis, Tennessee. The company is a lender and offers tax return preparation services. It has been sued by several state attorneys general. For example, according to this report, the Illinois Attorney General sued the company, charging it with filing inaccurate returns without client authorization, and with hitting clients with almost a million dollars in hidden fees. The attorney general explained that many clients had not received refund checks.

Illinois is not the first state to file charges. According to this article, two Virginia legislators have asked a crime subcommittee of the Virginia House to hold hearings into the activities of Mo’ Money Taxes. Not only have some of the company’s clients in Virginia not received promised refund checks, other clients who did receive checks discovered that the checks either were less than anticipated or could not be cashed. One of those legislators, teaming up with a different colleague, has asked the U.S. Attorney General, the FBI, and other agencies to initiate a probe into the company’s transactions.

It gets worse. According to this story, thousands of tax documents related to the company’s clients in Tennessee, its home state, were found in dumpsters behind an office building from which the company had been evicted for failure to pay rent. The documents contain clients’ personal information, ranging from income and expense information to addresses, driver license numbers, and social security numbers. The company claims the landlord put the documents into the dumpster, but the landlord asserts that it did not do so.

Yet another story sheds some light into what might be at least part of the reason for what has happened. The owner of Mo’ Money Taxes, Markey Granberry, is in the middle of a nasty divorce proceeding. Amidst claims of physical assaults, adultery, unfit parenting, and drug use, the litigation revealed that the couple is fighting over a significant amount of assets. They own a $1.3 million home, which Granberry’s wife wants, along with their luxury automobiles, which include at least five top-end models. She also wants $800 a month for housekeeping and, shades of the disallowed deduction discussed in Tall Tax Tales, $200 a month for “fish tank maintenance.” According to the divorce papers, the owner of Mo’ Money Taxes owns 11 businesses and 19 properties. It is easy to speculate that the combination of being in over one’s head financially while distracted from business operations by difficult personal matters can lead to business failures, though it does not excuse the abhorrent conduct that has been alleged nor justify the imposition of similarly difficult financial and personal burdens on thousands of innocent clients.

According to the report from Illinois, the attorney general is working with the legislature to enact laws that would increase required disclosures with respect to refund anticipation loans and similar offers, and that also would put limits on the high fees charged by companies dealing in these products. It is a safe guess that those who oppose government regulation and complain about the growth in government will provide the usual objections to this sort of legislation, but it would not be necessary if the private sector was not so infected with unscrupulous practices. Similarly, those who complain about the regulation of compensated tax return preparers, though raising understandable concerns about the details of how it has been implemented, are saddled with the reality that the tax return preparation industry, though predominantly above-board and competent, is tainted by the existence of enterprises that give the profession a very bad name.

My advice to taxpayers is that they ought not retain a tax return preparer until they have done due diligence and research, particularly opinions from existing clients, about the reputation and quality of the potential preparer. My concern is that the people most often victimized by the unscrupulous companies are those least able to check out the business. That is why the idea of requiring tax return preparation be done by preparers who have earned an IRS-issued “seal of approval” is so tempting. Given the choice between a bigger government or thousands of victimized taxpayers, I’m compelled to choose the former, even though ideally I’d prefer to purge the marketplace of the perfidious businesses. Oh, wait, considering the terrible job the market itself and the private sector has done policing itself, we need ourselves, that is, the government, to step in. Eventually the private sector will figure out that government regulation of tax return preparers, or any other industry segment, can be rendered unnecessary if the market polices itself properly. If the idea of an IRS-issued “seal of approval” is so frightening, what about a “seal of approval” by a private sector self-policing group that is given teeth by private enterprises willing to sue miscreant preparers?

For many years reaching back to long before MauledAgain existed, and in many postings on that blog, I have rejected the use of tax law to accomplish indirectly what should be handled directly by government agencies other than the IRS and state revenue departments. In posts such as The Problem with Income Tax Vehicle Credits, Congressional Mis-delegation Endangers Tax Collections, and More Criticism of Non-Tax Tax Credits, I have pointed out the disadvantages of having the IRS administer programs designed to achieve national policy goals with respect to energy, environmental protection, employment, health care, education, and other matters that are within the purview of agencies established and operated to deal with those issues.

Now comes corroboration in the form of survey results that suggest the futility of tax incentives designed to influence behavior. A few days ago, Bloomberg BNA and Bloomberg New Energy Finance released the results of a survey in which participants, mostly tax professionals, were asked if they were familiar with particular tax incentives. The results are astounding.

Of the participants, 65 percent replied that they were “mostly or completely unfamiliar” with the production tax credit for wind projects. Only 7 percent described themselves as “extremely familiar.” When those who had not made or whose clients had not made a clean energy tax equity investment, 21 percent explained that they were unaware that they had such an option.

The chief executive of Bloomberg New Energy Finance put it succinctly. He stated, “These results suggest an information disconnect,” and added “Apparently though, many in the tax community have failed so far to spot the opportunity for their clients.”

If energy departments handled energy, and education departments handled education, and housing departments handled housing, the tax agencies could focus on collecting revenue. Financial rewards for complying with energy, education, housing, or other incentives would be disbursed through the respective agencies. In addition to matching administrative expertise with legislative goals, and in addition to increasing the likelihood of an incentive being publicized by the department responsible for the area in question, this approach would make visible the hidden spending buried in the tax law that most taxpayers don’t see and that legislators refuse to admit exists. One wonders whether the use of the tax law for purposes other than revenue collection is nothing more than a ploy to hide spending that the anti-spending crowd wants to preserve, a possibility mentioned and criticized in In Tax, as in Life, Just One Word Can Matter (“Let’s turn the nation’s attention to the federal spending that, until recently, has gone unnoticed by the public because it is hidden in a labyrinth of badly drafted and deliberately obfuscated tax law.”)

So, in addition to the disadvantages of burying expenditures in the tax law in the guise of incentives, the supposed advantage of this approach to tax and economic policy turns out to be far more theoretical than real. Purging the tax law of this hidden spending is long overdue.

Tax professionals, tax educators, school board members, high school principals and teachers, and taxpayers generally ought to set aside several minutes to view a heartening story about high school students learning to prepare, and preparing, income tax returns. The students participate in the Volunteer Income Tax Assistance program, but to do so they must pass a tax preparer exam. At the high school featured in the story, the students begin learning about taxes in a course that is part of the business curriculum. The course begins in January and by the end of February students are helping lower income individuals with their tax returns.

The people who put this program in place, including the teacher featured in the story, the school administrators who gave him the go-ahead, and the school board that approved the effort, deserve a commendation for taking this important step. It’s possible, of course, that similar programs have been put in place at other high schools. Perhaps somewhere there is a web site that lists the high schools that are doing this. If you know of such a site, let me know.

This program is promising not only because it teaches high school students about taxes, but also because it teaches them much more. They become aware of the world in which they will live, one in which they have responsibilities as citizens, including tax return filing. They learn to help people who are in need of assistance. The learn responsibility, by taking ownership of the tasks carried out under the program. These are values that will enhance their lives no matter what career path they choose. Of course, it was nice to hear one student suggest that he was headed for a career in taxation.

Over the years, I’ve shared more than a few commentaries about the need to introduce students to taxation before they leave high school. For example, five years ago, as I explained in Congress Invites My Ideas for Improving Tax Compliance and Of Course I Respond, I suggested to Senators Baucus and Grassley that “Making tax education a part of high school curricula throughout the nation would go a long way in reducing noncompliance.” More than a year later, in The Tax Fraud Environment: Sniping at the Congress, I noted, in connection with one of my discussions about the tax woes of Wesley Snipes, that, “Because an educated citizenry is less likely to believe the twisted logic of those trying to sell tax fraud plans, it makes sense to require high school students to take a course in basic rules of taxation.”

Thus, it is important for me to acknowledge that, at least in one high school, this is being done for some of the students. Progress!

The other day I heard a commercial on the local news radio station. A jewelry store chain was singing the praises of its business, and closed the advertisement by advising potential customers that if they went to the chain’s Delaware store, they could avoid Pennsylvania sales tax. This nugget of “wisdom” followed other claims designed to demonstrate the superiority of this enterprise over its Pennsylvania competitors.

Finding this commercial on the internet either is impossible or is a task beyond my skill set. In the process of searching for the commercial, I came across a web site that, for all I know, could be the source of the ad writer’s claim. According to this article by an unnamed contributor, it is possible to avoid sales taxes by following these instructions:

1. Find out how to avoid paying sales tax. Nearly all states do not have sales tax on items purchsed [sic] via the internet when the company you are buying from does not have a physically presence in that state. For instance, items purchased from Amazon.com or Blue Nile have no sales tax because they do not have a physical store in the states they are selling.

2. If you do not want to buy over the internet, then you can also find a regular brick and mortar store (while you are travelling out of state) that doesn't have a presence in your home state. For example, if you buy a sweet new Rolex in Tourneau in New York and have the store ship it to to your home in Colorado (where the is not a Tournea), you pay no sales tax.

3. Finally you can buy the item in a state that doesn't have any sales tax to begin with and bring it home with you. States that do not have sales tax are: Alaska, Delaware, Hawaii, Montana, New Hampshire, New Mexico, and Oregon.

Though technically these are ways to avoid the sales tax, they are not ways of avoiding the use tax. The same article then offers some “tips and warnings” for its readers: Among the tips are two that are no less oblivious to reality as is the failure to mention the use tax. Readers are told that “This works best with small items that are expensive, i.e. use this for wedding rings but not for cars!” It doesn’t work at all for cars, because when it’s time to register the vehicle, proof that the sales tax has been paid will be requested, and if it is not produced, especially if title is being transferred from out-of-state, a use tax will be imposed. Readers are also told, “The IRS may still hold you liable for tax even if the company did not charge you, check with your accountant.” The only good advice is the suggestion that a phone call be made to, or an email sent to, an accountant, though other tax professionals also can be helpful. The IRS is not going to impose a sales tax with respect to the purchase, and the making of the purchase will not generate gross income for the purchaser.

I explained the use tax in, among other posts, Tax: Perspective Matters. That post was yet another in the long series of commentaries on tax ignorance, including Tax Ignorance, Is Tax Ignorance Contagious?, Fighting Tax Ignorance, Why the Nation Needs Tax Education, Tax Ignorance: Legislators and Lobbyists, Tax Education is Not Just For Tax Professionals, The Consequences of Tax Education Deficiency, The Value of Tax Education, Tax Ignorance of the Historical Kind, Is It Any (Tax) Wonder?, and Tax Myths, Tax Lies, and Tax Twisting. So here is another. It is frightening how much misinformation pollutes the nation. Genuinely alarming.

A recent story about yet another public figure running into a tax problem caught my attention not so much because it involved false tax returns but because of the size of the tax return preparation fee. Even though that’s part of the entire swindle, I wonder why it did not raise anyone’s eyebrows at the time.

According to the indictment, a former Philadelphia Eagles player allegedly joined up with two other people to file false federal income tax returns on which huge refunds were claimed. Freddie Mitchell, famous in Philadelphia sports lore for his outspokenness and his “fourth-and-twenty-six” catch, faces charges for targeting a professional athlete – identified only by the initials A.G. – as an unsuspecting avenue for a purported scheme of filing false tax returns in order to obtain unjustified refunds. Mitchell also has been charged with recruiting other professional athletes for the same purpose and with filing false tax returns for his company, Chameleon Enterprises.

Mitchell and the other two named in the indictment approached the professional athlete and persuaded him to retain them to do his tax return. They then doctored the return, to which they attached false Forms W-2 and false Schedules C showing losses, to generate a $1.9 million refund. They allegedly prepared five other false Forms 1040, but the indictment does not provide much in the way of details. They also prepared false returns for Mitchell’s company. Eventually the three defendants ended up with several million dollars of false refunds.

On top of all of this, Mitchell took a $100,000 down payment for tax return preparation. Was that not a red flag to the professional athlete? I’m confident that the tax return preparation fees paid by huge corporations with complex transactions, including international transactions, can run into the millions, but for an individual, even an individual with an array of investments and activities, a six-digit tax return preparation fee is orders of magnitude beyond what one would expect. According to the indictment, the fee charged by the three indicted individuals was computed as a percentage of the refund.

Perhaps what alerted the IRS to the scheme was the Form 8888 filed by the defendants. It requested that the $1.9 million refund be split three ways, with $638,288 being deposited into a joint account owned by the other two individuals and $280,000 being deposited into an account owned by Freddie Mitchell.

Red flags are everywhere. Ought not the education system teach every person that a tax return preparation fee based on the size of the refund is a warning sign that the preparer has incentive to jack up the refund, and that the temptation to falsify information in order to do so looms large? According to the indictment, A.G. did not know that his returns were doctored to generate huge refunds. I doubt A.G. looked at his returns, I doubt A.G. recognized the dangers of tax return preparation fees based on refund sizes, and I doubt that had A.G. looked at his returns that he would have noticed the disconnect between what was on those returns and reality. I also doubt that A.G. realized that a $918,000 tax return preparation fee is way out of line for an individual return. Way out of line. It’s too bad A.G. did not learn, somewhere along the line, about this aspect of the practicalities of life.

The recently issued opinion of the United States Tax Court in Martignon v. Comr., T.C. Summary Opinion 2012-18 (March 1, 2012) describes a taxpayer for whom the stars were not nicely aligned. The taxpayer went into business with an Alejandro Vargas when they opened a restaurant called Café Savannah. They formed a limited liability company taxed as a partnership, in which the taxpayer held a 40 percent interest and Vargas held a 60 percent interest. Vargas controlled the restaurant’s finances, and the taxpayer operated the restaurant, including cooking and waiting on tables. While working at Café Savannah, the taxpayer continued to work full-time at another restaurant where he had been general manager before going into business with Vargas.

Soon after they opened Café Savannah, the taxpayer and Vargas had some sort of falling out. Almost five years later, Vargas changed the locks, refused to communicate with the taxpayer, and ignored the taxpayer’s request for records of the business. The taxpayer retained an attorney, but it was not until 2011 that he managed to get access to the restaurant’s records.

For the restaurant’s taxable years 2003 through 2006, the taxpayer received Schedules K-1 that showed losses. The taxpayer did not receive any distributions. In the spring of 2008, the taxpayer received a Schedule K-1 that reported $22,544 as his distributive share of the restaurant’s income. The taxpayer retained an accountant to prepare his 2007 federal income tax return. The accountant listed Café Savannah on the taxpayer’s Schedule E as a partnership in which the taxpayer held an interest, but did not report any of the $22,544 shown on the Schedule K-1 from Café Savannah.

The Tax Court held that the taxpayer was required to report the income from the restaurant. The court pointed out that a partner’s distributive share of partnership income is taxed even if it is not distributed. This is one of the reasons I stress to students in my Partnership Taxation class that the term “distributive share” and the word “distribution” are different, have different meanings, and ought not be used interchangeably. The court also explained that the outcome does not change even if the reason for a partner not receiving a distribution is the wrong-doing of a partner.

The only good news for the taxpayer came when the Tax Court rejected the IRS attempt to impose on the taxpayer the accuracy-related penalty. The court concluded that even though there was a substantial understatement of income on the taxpayer’s return, there was reasonable cause for the understatement and the taxpayer had acted in good faith. What apparently impressed the court was the taxpayer’s attempt to determine if the Schedule K-1 was incorrect because unlike the previous ones it showed income, the taxpayer’s attempts to contact Vargas and obtain the restaurant’s records, the taxpayer’s retention of an attorney in an attempt to obtain the records, and the taxpayer’s retention of an accountant to prepare his tax return.

The taxpayer’s tale is an unfortunate one. He gives up a job as general manager at a restaurant to go into business with someone, and it doesn’t work out. His business partner locks him out of the restaurant and blocks his efforts to see the business records until compelled by a court order four years later. The taxpayer retains an accountant who doesn’t include on the tax return the amount shown on the Schedule K-1, an action that is almost guaranteed to get a reaction from the IRS. The taxpayer owes tax on a distributive share of income that, at least as far as the Tax Court opinion explains, the taxpayer has not received. On top of that, the taxpayer also has some interest to pay. About the only bright spot in the story is the taxpayer’s escape from the accuracy-related penalty.

It’s not unusual for tax troubles to pile on top of other difficulties. It happens in divorces, it happens in bankruptcies, it happens in employment terminations, it happens in some personal injury situations. Some of these events are unavoidable, but often what turns out in hindsight to have been a bad decision in terms of relationship, business, or other activity ends up being doubly bad because of the tax consequences. Good planning might help, and good planning includes considering the tax consequences that follow from a bad decision. In analyzing the risk of a decision turning out badly, the tax consequences deserve to be part of the mix.

Here we go again! More proof that chocolate is medicinal. Check out this report, forwarded to me by my sister, about the flavonoid epicatechin that is found in dark chocolate. How long until a proposal for a chocolate purchasing tax credit shows up? I ask that with a grin.

The practice of publishing the names of tax scofflaws has become commonplace. For example, Pennsylvania has been issuing this sort of list since 2006, with the latest list here. Last year, St. Tammany Parish published a list of tax delinquents, which included public officials. Recently, Greece published a list of roughly 4,000 taxpayers who owe about $19 billion to that economically ravaged nation. It’s unclear when California began its practice of publicizing the names of people who owe back taxes, but it would not surprise me if this approach, like many other things, originated in that state.

Those are but a few examples of what most revenue departments now consider essential to their responsibility of collecting taxes. There are at least three reasons for making this information public. First, it probably makes it a bit easier for revenue officials to track down delinquent taxpayers. Second, the public, especially compliant taxpayers, has a right to know. Third, a person whose name appears on a list ought to be, and sometimes is, shamed into compliance.

We live in an age when shame does not have the effect it once did. Yet tax officials explain that the published lists have had a positive effect on their tax collection efforts. And apparently the effect was enough to inspire a newly elected member of Philadelphia’s city council to publish a “bad neighbor map.” According to this KYW report, the map identifies property owners in Philadelphia – or at least in his district – who have let their properties become nuisances, afflicted with multiple license and inspection violations. According to a more recent report, the site has gained national attention, and ended up crashing from an overload of visitors. I can believe that, as every time I visit the site, it gets stuck loading the property markers.

Were I to have been asked, before seeing the results, whether publishing the names of delinquent taxpayers and noncompliant property owners would have any significant effect on triggering compliance, I would have said no. More and more people don’t care, and don’t care about being highlighted as an offender, perhaps because they think that the consequences are slight and the odds of having to deal with consequences are in their favor. Some people are so hungry for attention that they are tempted to violate laws because of the ensuing mainstream and social media coverage.

But I would have been wrong. Apparently there are enough people who prefer not to be highlighted as a tax scofflaw or as an owner of derelict property to make these sorts of lists work. So my easy prediction is that we will see more of them, not only with respect to unpaid taxes and poorly maintained properties, but also with respect to other sorts of violations.

I hope it is a joke. I think it is a joke. It probably is a joke. It might even be excellent satire. I fear that some people will take it seriously.

The American Moustache Institute claims to be lobbying for what it calls the STACHE Act, an acronym for Stimulus to Allow Critical Hair Expenses. According to the Institute’s explanation, the proposed legislation “would provide up to a $250.00 annual tax refund for Mustached Americans.” In another paragraph on the same page, however, the Institute quotes an advocate of the proposal, who claims that “Given the clear link between the growing and maintenance of mustaches and incremental income … mustache maintenance costs qualify for and should be considered as a deductible expense.” $250 refund? $250 refundable credit? $250 deduction?

The obvious confusion about what it is that the Institute seeks, coupled with the claim that “All Americans are invited to participate in perhaps the most important movement in the history of movements – to help ensure for the fair taxation of Mustached Americans,” is what gives me hope that this is some sort of hoax.

The proposal is based on a “celebrated white paper” by a “noted tax policy professor” named Dr. John Yeutter, an “Associate Professor of Accounting and Tax Policy at Northeastern State University.” The paper, titled “Mustached Americans and The Triple Bottom Line,” does exist. There’s no publication date on the paper, though “2011” appears in the URL. However, in searching for the paper, I came across a Huffington Post article from 2010 that described the paper and a similar tax proposal. And just the other day it surfaced on CNN.

Though at one level the paper reads like a serious proposal, at another level it is downright off-the-wall and absurd. Consider the items that would be deductible: “Mustache and beard trimming instruments, mustache wax and weightless conditioning agents, Facial hair coloring products (for men and women over 43 years of age), bacon, mustache combs and mirrors, DVD collections of “Magnum P.I.” and “Smokey & The Bandit,” mustache insurance (now required by state law in Alabama, Oregon, Maine, and New Mexico, and Puerto Rico), billy clubs or bodyguards to keep women away as a mustache increases good looks by an estimated 38 percent, little black books and jumbo packages of kielbasa sausage, Burt Reynolds wallet-sized photos.” To me it appears that the paper is poking fun at the long line of lobbyists who arrive on Capitol Hill with a long list of why their clients’ pet project is deserving of federal financing through tax expenditures.

If, as I think, the paper and the proposal are satire, their authors have done a fine job of highlighting the flaws of the tax policy process as it now exists. If, on the other hand, the proposal is serious, then the nation is in worse trouble than I thought. And if it is a serious proposal, perhaps I will start a movement for the deduction of all expenditures, favoring neither the bald nor the hirsute, the bearded nor the clean-shaven, the somber nor the jocular, the poor nor the rich, the educated nor the ignorant, male or female, old or young, or anyone else. Everybody deducts everything, and at that point lobbyists for deductions are out of business. Then perhaps I will turn to exclusions and credits. All income is excluded, and everyone gets whatever tax credit they want. As part of the deal I’ll throw in provisions that outlaw traffic lights and stop signs. Everybody’s special, and no one deserves to be hindered from doing what they want to do at an intersection. Sorry for the cutting sarcasm, and for working up a lather, but it’s time to shave and trim the narrowly tailored special interest provisions in the tax law. I’ll let the readers do their part and comb through them on their own.

Last week, I was reading an article about partnership taxation when I came upon something very disturbing. Rather than embarrassing the author of the article, I will paraphrase what I read, maintaining the words that caught my attention. “To deal with this problem, the IRS enacted rules to prevent doing certain things.” This sentence was followed by a citation to an Internal Revenue Code section, which indeed does contain the applicable principles. From what I can figure out, the author is not a lawyer, but when someone delves into writing about tax for a tax journal, that person has an obligation to understand tax law, not only in terms of substance, but in terms of sources of law.

The simple upshot of this can be summed up thusly: The IRS DOES NOT ENACT INTERNAL REVENUE CODE SECTIONS. It is the CONGRESS that enacts Internal Revenue Code sections. That’s very basic stuff. Extremely basic stuff. Understandably, many of the propaganda ministries have a not-so-hidden agenda of trying to persuade people that it’s the IRS that generates the tax laws, as part of the effort to discredit the IRS and taxes generally. But tax professionals know, or at least should know, better. Every semester, for the first out-of-class graded exercise in the basic tax class, I search the internet for the latest version of the “IRS enacts Code sections” myth, present it to the students, and ask them to comment on the statement. This helps me identify which students have been paying attention, and aside from driving home the point that paying attention matters, gives students the opportunity to engage in remedial education. For some reason, although all Americans over the age of, say, fourteen, should understand that statutes are enacted by legislatures, the teaching of what was once the ubiquitous Civics course has been shelved in most school districts. Answering the question why is a matter for another post. Perhaps something about an uneducated electorate being less likely to throw out incumbent legislators, especially the ones that try to blame others for the laws they enact. Consider, for example, the situation I explored in If Congress Says So, Don’t Blame the IRS (“So long as people view the IRS as the source of all that is wrong with taxation and the tax system, or the cause of anything they dislike about tax law and tax enforcement, and overlook the responsibility of the Congress for the tax law, tax policy, and tax administration deficiencies afflicting the nation, the problems will not be solved.”)

Similar misusages of precision terminology abound in articles, discussion board postings, student exam responses, newspapers, and all other sorts of communication media. Too often, one sees sentences such as "The IRS held that . . . "

The precise terminology is as follows. The Congress enacts statutes. The Treasury Department promulgates regulations. The Tax Court holds that one or another outcome is the appropriate result. The IRS rules or concludes or advises that its position is one thing or another; it does not hold. Courts issue opinions, the IRS issues rulings, the Treasury Department issues regulations, the courts explain things, the IRS explains things, the Treasury Department explains things.

One of the things that might contribute to the imprecise transposition of terminology that has negative effects is the message that I received years ago in an English literature class. It is a message that I think is being repeated throughout the years and throughout education systems. I was told, “Aside from common words such as articles and prepositions, don’t use the same word more than once, especially on the same page. Buy a thesaurus.” That might be good advice for a novelist or poet, but it is atrocious advice for those who write in technical areas. Lawyers, engineers, physicians, scientists, actuaries, accountants, and those in other technically-focused professions can create confusing and even dangerous if not fatal errors when they use different words to mean the same thing. If the word “basis” must appear several hundred times in a tax article, so be it. Using “capital account” instead of basis “just to change things up” in the style of the fiction writers is ill-advised.

Almost four years ago, in Is Tax Ignorance Contagious?, which addressed a woeful reference to a so-called but non-existing “Tax Code 63-20,” I wrote:

It is not uncommon for law students to conflate legislation, regulations, and rulings. When I insist they demonstrate understanding, and push aside ignorance, some of them have argued that my call for precision is unwarranted, and that what they have done is acceptable. My rejection of imprecision, by students and by others, at times has been derided as picky or worse. But I usually quiet the complaints by asking if people want neurosurgeons operating on them, their children, or their parents to be imprecise. I wonder if people want engineers building bridges to be imprecise. I ask whether the folks making pet food, medicines, and other products should be imprecise. Perhaps speech references aren't as life-and-death as neurosurgery, bridge building, food manufacturing, or pharmaceutical formulation, but when dealing with billions of taxpayer dollars, precision is no less a sign of the care and attention to detail that should be demanded of public officials. If public officials are going to talk about taxes, they should make certain they know what they're discussing and take steps to make their words correct and precise.

At least some public officials can claim that they did not attend law school or any other educational institution that gave them the opportunity to learn something about precise language, but certainly those who are writing about tax in professional tax journals owe it to their readers to learn the language of tax and to use it properly.

For most people, trips to the gym generate benefits for their physical health. My gym visits not only improve my physical condition, at least in theory, they also provide opportunities to put my brain to work, especially when tax questions and discussions pop up. On at least five occasions in the past, conversations at the gym have produced MauledAgain posts. (See Flat is Not Simple, At Least Not with Taxes, Tax Talk at the Gym, A Zero Tax, A Zero Congress, Being Thankful for User Fees and Taxes, and Tax Policy, Elections, and Money.)

The other morning, as I walked in, one of my friends pointed to another person and said, “He has a tax question for you.” I turned, and was asked, “Is there a deadline for when people must send you the forms you need to do your tax return, like W-2s and 1099s.” Indeed there is. I pointed out that January 31 is the deadline for employers to mail W-2 forms and payors to mail 1099 forms, which means that some people won’t received these until early February. However, I noted, if an individual is a shareholder in an S corporation, the K-1 reporting the person’s share of S corporation items isn’t required to be sent until March 15, and that’s if the corporation does not file an extension. If the individual is a partner is a partnership or owns an interest in a limited liability company taxed as a partnership, the K-1 isn’t required to be sent until April 15, and, again, that’s without regard to any extension. The person who had asked the question commented, “Then these people are probably filing extensions.” Yes, they are. At that point, I could not resist the tendencies of law professors to pose hypothetical situations. “What if,” I asked, “the partnership is a partner in another partnership,” and as the person’s eyes widened, I added, “and that partnership is a partner in another partnership?” As my friend began to roll his eyes, I added, “and you can toss in some controlled foreign corporations for fun, too.”

As the conversation continued, I pointed out that the income tax rests on a set of theoretical notions that made sense when the world was much less complex than it is today. In the early and middle part of the last century, very few individuals were partners in partnerships that were partners in other partnerships, let alone in partnerships that were partners in partnerships that were partners in partnerships that were partners in partnerships, and so on. The inefficiencies of the current filing system are an inescapable product of the combination of an income tax with multi-layer business and investment structures. When making a list of arguments for and against some other sort of tax, these inefficiencies show up in the column holding the disadvantages of an income tax.

Years ago, a member of Congress introduced legislation that would require individuals to file their income tax returns on their birthdays. It was quite some time ago and I cannot find the legislation, and I don’t recall the specifics. For example, I don’t recall if special provisions existed for people whose birthdays would fall on a national holiday. In any event, imagine the challenges of implementing this absurd proposal. A person born on January 2 would not have the requisite information, unless the person were permitted to file on January 2 of the following year. The disadvantages of that delay include postponed government revenue and taxpayers even less likely to remember the details of transactions undertaken more than a year earlier.

Most of the timing problems illustrated by the partnership and S corporation examples arise from the flow-through taxation principles that apply to those entities. Perhaps it is time to rethink how those entities and their owners are taxed.

Adopting an approach taken in other states, Pennsylvania is adding to the income tax form a line on which people are expected to “declare ‘use taxes’ . . . or unpaid sales taxes on items from so-called ‘remote sellers.’” According to this KYW News Radio report, a state senator explains that this addition to the tax form “may come as a surprise to some.” I think it will come as a surprise to many.

State Senator Mary Jo White added, “When you now collect a tax that has never been collected before, the public perception is that it’s a new tax.” I agree. If an existing tax is not on someone’s radar, its appearance will cause the person to think that a new tax has been enacted. Public understanding of the use tax is woefully inadequate. Readers of MauledAgain know that eliminating tax ignorance is one of my goals, as demonstrated by my many posts on the issue, including Tax Ignorance, Is Tax Ignorance Contagious?, Fighting Tax Ignorance, Why the Nation Needs Tax Education, Tax Ignorance: Legislators and Lobbyists, Tax Education is Not Just For Tax Professionals, The Consequences of Tax Education Deficiency, The Value of Tax Education, Tax Ignorance of the Historical Kind, Is It Any (Tax) Wonder?, and Tax Myths, Tax Lies, and Tax Twisting).

Most Pennsylvanians living in the counties near the state of Delaware know that if they go to Delaware to make a purchase, they don’t pay sales tax, and that if they made the purchase in Pennsylvania they would pay the sales tax. What most Pennsylvanians making these “Delaware shopping trips” apparently don’t know is that under long-existing Pennsylvania law, they owe use tax on those purchases. The use tax simply is a substitute for the sales tax, to be applied to out-of-state purchases of items brought back to the state. Use tax compliance is so low that states try to find ways to compel out-of-state retailers to collect sales tax on the state’s behalf, even when there is little or no connection between the state and the nonresident retailer. A few years ago, several states began experimenting with putting a use tax line on their income tax returns, and other states, including Pennsylvania, have followed suit. Will it work? In a sense, it’s a no-lose proposition for the state. Adding a line to the return costs almost nothing. Even if the state collects only a small fraction of what is owed, the state is collecting more than it would in the absence of the change to the income tax return.

The income tax return solution for the use tax problem is insufficient. What is necessary is public education about the use tax. Why do Pennsylvanians, or residents of any state with a sales and use tax, for that matter, not know that the use tax exists? The answer is simple. No one has told them. How difficult would it be to include in the curriculum of the K-12 system an hour or two to explain state taxes in general, including the use tax? Most middle and high school students, if not all of them, understand the sales tax. Even some elementary school students have learned that saving one dollar to purchase a 99-cent item isn’t enough. I learned that when I was very young. It’s not rocket science, at least until an inquisitive child asks the dreaded question, “How do we know which items are subject to the sales tax and which aren’t?” Things have changed since the days of my youth, because now a student can be told to “look it up,” presumably on the internet, without worrying that the child would get lost in the library looking for statutes.

It will be interesting to watch what happens as increasing numbers of Pennsylvanians become aware of the use tax line on the income tax return. It’s an easy guess that there will be griping. What will hold my attention is the wait to see if some politician tries to benefit from this development by making loud noises about the “newly enacted tax.” After all, there’s nothing that says politicians are smarter about taxes than are people generally.

Back in December, when the Congress decided to extend the payroll tax cut by two months, I explained, in How Politics Generates Tax Complexity, that the legislation contained a new tax designed to prevent a two-month payroll tax reduction from becoming the equivalent of a full-year reduction. Because the tax that is reduced applies only to the first $110,100 of wages, taxpayers whose monthly income exceeds $18,350 were subjected to a new tax equal to 2 percent of wages and compensation exceeding that amount. I provided examples of why the new tax was needed and how it works in How Politics Generates Tax Complexity. In that posting I pointed out that if the payroll tax cut was extended through the remainder of 2012, “the additional tax should ‘disappear,’ but whether that happens depends on what the Congress does with the new tax.” Now that Congress has extended the payroll tax cut through 2012, it is time to examine what it did with the new tax.

The original payroll tax cut, for 2011, was enacted by section 601 of P.L. 111-312, The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. The reduction applied during the “payroll tax holiday period,” in turn defined as calendar year 2011. When the reduction was extended in December 2011 by section 101 of P.L. 112-78, The Temporary Payroll Tax Cut Continuation Act of 2011, the payroll tax holiday period was defined to be the “period beginning January 1, 2011, and ending February 29, 2012.” This was accomplished by having section 101 of P.L. 112-78 amend section 601 of P.L. 111-312. In addition, section 101 of P.L. 112-78 also amended section 601 of P.L. 111-312 to add a subsection (g) to section 601 that imposed the new tax previously described. The recently passed legislation, to be enacted when signed by the President, is called The Middle Class Tax Relief and Job Creation Act of 2012. It redefines the payroll tax holiday period to be “calendar years 2011 and 2012” and it repeals the new 2 percent tax.

Those who have been reading this post carefully will have noticed that nowhere have I mentioned the Internal Revenue Code or any of its provisions. That’s because none of the legislation changed anything in the Internal Revenue Code. I will repeat what I emphasized in How Politics Generates Tax Complexity. The payroll tax cut legislation “provides another example of a lesson I try to get across to the students in my basic tax class, namely, there is much statutory tax law that is NOT in the Internal Revenue Code.” When critics of tax law complexity point out “the size of the tax code,” they are understating the point they are trying to make. Assuming that the number of pages of statutory provisions is a good proxy for tax law complexity, and it is in some ways but isn’t in other ways, highlighting the length of the Internal Revenue Code understates the point. One needs to add in the uncodified legislation that has no less of an effect on tax law complexity. In some respects, the uncodified material adds disproportionately more to tax law complexity.

Suppose a person owes $2.5 million to another person. How much would be an appropriate monthly payment to pay off the debt plus interest accumulating while the debt is being serviced? The answer depends on two factors. First, the interest rate makes a difference. Second, the term of the loan payoff matters. For example, with a 5 percent interest rate and a 30-year term, the monthly payment would be $13,420.54.

In a recent case, Johnson v. U.S., No. 8:98-cv-03050-WDQ (D. Md. Feb. 15, 2012), the court approved an installment payment arrangement proposed by the IRS for a taxpayer who owed roughly $2.5 million in unpaid taxes and accumulated interest. The taxpayer had objected, claiming that requiring him to make installment payments of his debt would be a hardship. The taxpayer did not dispute the existence of the debt, which arose from the taxpayer’s failure as responsible person to cause his corporation to pay employment and withholding taxes.

The taxpayer’s evidence showed that he had annual income of almost $64,000. It was in the form of payments from his corporation to the lessor of his family’s home. The taxpayer arranged to take income in this manner because it is not subject to garnishment. In addition, the corporation paid his wife, who is not liable on the debt, a salary of between $130,000 and $140,000. The corporation’s salary decisions were made by taxpayer as president. The taxpayer resided in a home with his wife, adult son, niece, and sister-in-law. No information was provided with respect to the income of, or contribution to household expenses by, the other three, aside from the taxpayer’s explanation that he supported his adult son who has Asperger’s syndrome.

The taxpayer argued that the amount requested by the IRS “would impose an undue hardship on [the taxpayer], and by extension, his wife and children.” He also argued that the amount requested by the IRS was unreasonable, but did not offer an alternative amount.

So how much was the IRS requesting the taxpayer remit under its proposed installment agreement? It was $400 a month. That amount is 7.5 percent of the taxpayer’s income, and 2.35 percent of the combined income the taxpayer and his wife were pulling out of the corporation. The court, not surprisingly, held for the IRS. The court noted that the taxpayer’s adult son is not the taxpayer’s dependent alone, that the taxpayer is not supporting anyone other than paying rent on the home, that the annual salary of the taxpayer’s wife is double the taxpayer’s income even though she works substantially fewer hours than does the taxpayer, that the taxpayer controls how the corporation’s money is paid out in salaries, and that the intent of the installment payment provisions cannot be circumvented by the structure the taxpayer adopted for compensation.

I agree with the taxpayer that the amount requested by the IRS was unreasonable. It was unreasonably low. The court, however, could do nothing more than approve the IRS request. I tried to use a loan amortization calculator to determine how many years would be required to repay the $2.5 million debt if the monthly payment is $400, using a 5 percent interest rate. The calculator replied: “Error: The loan cannot be repaid using the parameters that you provided, probably because the Payment Amount is not sufficient to cover the periodic interest that is due. Try increasing the Payment Amount, or perhaps increase the Balloon Payment.” It did, however, permit me to make the computation using a zero percent interest rate. It would take 521 years. Even at a 1 percent rate of interest, the loan would grow despite the $400 monthly payments. At 1 percent, annual interest, ignoring compounding, is $25,000. At 5 percent, the annual interest would be $125,000. Annual payments of $4,800 aren’t going to make a dent. The loan would continue to grow. It would grow infinitely. It would exist eternally.

Of course, someone else is paying off this taxpayer’s debt. Either other taxpayers are paying higher taxes to make up the difference, or the budget deficit is growing because of the unpaid debt, shifting the burden to whomever it is that ultimately pays the deficit. Surely, there are five-person families who know how to live on far less than the taxpayer and his wife are making. Surely there are households of five who manage to provide themselves with housing for less than $64,000 a year. Why the IRS did not push for something more realistic, along the lines of $2,000 a month, puzzles me. I wonder how many other eternal tax installment payments are on the books. What does not puzzle me is why this taxpayer had the audacity to complain about a meager $400 monthly payment. The answer to that one is easy. Very easy.

A question on the ABA-TAX listserve [list subscribers can access the discussion here] gave me a reason to look more closely at how the tax law counts days, at least for purposes of the limitation on vacation home and rental property deductions under section 280A. The person asking the question was engaged in a discussion with unidentified individuals about how many days a vacation home is treated as rented. Under section 280A, the number of rental days is important for several reasons. First, if the dwelling unit is used by the taxpayer and rented for fewer than 15 days, the gross income and deductions attributable to the rental, aside from deductions allowable in any event, are disregarded. Second, a taxpayer uses a dwelling unit as a residence, thus triggering the section 280A(a) limitation, if the taxpayer uses the dwelling unit for personal purposes for more than the greater of 14 days or 10 percent of the number of days the unit is rented at a fair rental. Third, the number of rental days and the number of days of use are elements in computing the actual limitation that applies under section 280A.

The question was posed as follows. The questioner took the position that if a person rents a vacation home to six different tenants of one week each, there are 42 days of rental use. Those with whom he was having the discussion claimed that when the tenant arrives on a Saturday and leaves the following Saturday, there are 8 days of use because there are two Saturdays and one day of each of the other days of the week. The questioner pointed out that this sort of counting would cause the six one-week rentals to be treated as 48 days of rental, which makes no sense to him.

Because treating six one-week rentals as 48 days of rental also makes no sense to me, I set out to ascertain whether there was any authority for counting days. I found the answer in Proposed Regulations section 1.280A-1(f), which provides:

For purposes of section 280A, this section, and section 1.280A-3, the term “day” means generally the 24-hour period for which a day's rental would be paid. Thus, a person using a dwelling unit from Saturday afternoon through the following Saturday morning would generally be treated as having used the unit for 7 days even though the person was on the premises on 8 calendar days.

Thus, arriving on Saturday afternoon February 11 and leaving on Saturday morning February 18 would be 7 days of use: the 24-hour period ending on February 12, the 24-hour period ending on February 13, and so on through the 14th, the 15th, the 16th, the 17th, and the 18th. That's 7 days, even though use exists on eight calendar days.

As I thought about the initial question, I understood the goal of the regulatory rule is to prevent double counting days, whether days of personal use or days of rental. Technically, though, double counting is possible under the regulations but a reasonable interpretation should avoid the pitfalls of a rigid application of the language. Consider an example. Renter1 signs a lease to occupy the dwelling unit from Saturday, February 11, 10 a.m. until Saturday, February 18, 9 a.m. This counts as a seven days of rental under the proposed regulation. Suppose that an emergency delays renter1’s departure until 2 p.m. on February 18, but that renter2, who has a lease for February 18, 10 a.m. until February 25, 9 a.m., is willing to, and does, accommodate renter1 by delaying occupancy. The best interpretation would be to treat each lease as 7 rental days. Though renter1 has continued occupancy into an eighth 24-hour period, it would not make sense to conclude that there are 15 days of rental, 8 from renter1 and 7 from renter2. Doing so would double-count Saturday, February 18.

So why would someone want to treat a one-week rental as 8 days, thus turning six one-week rentals into 48 rental days? The calculations for the deduction limitation reflect days of rental, and increasing the days of rental works to the taxpayer’s advantage. In this instance, with clear regulatory authority on how to count days, treating six one-week rentals as 48 rental days is flat-out wrong. And worse.

When it comes to politics, I dine at the buffet. My focus is on the nation, principles, and policies, rather than on policies, caucuses, or individuals. It is not unusual for me both to praise and criticize the same organization or person. Here is an example.

Just last week, in When Double Taxation Doesn’t Exist, I criticized the position taken in issue 9.04 of Tax Bytes, published by the Institute for Policy Innovation, with respect to whether the taxation of income earned by investing after-tax salary income constituted double taxation. Those reading my post carefully would have noticed that near the end, I expressed agreement with the position taken in the same issue 9.04 of Tax Bytes with respect to the ReadyReturn concept.

Shortly thereafter, I received issue 9.05 of Tax Bytes. In this essay, the Institute for Policy Innovation weighed in against the use of the tax law to “manipulate behavior and micromanage the economy” through an assortment of Internal Revenue Code provisions. On this point, we are in agreement. More than six years ago, in “Prof. Maule Goes to Washington”, in which, at the request of a former student, I outlined how I would reform the federal tax law, I wrote:

Also trashed are all the social policy provisions that ought to be in some other law, if indeed the citizens think that the federal government should be providing financial assistance to particular individuals or communities or to those who engage in particular activities. I understand that the Congress, which consistently criticizes the IRS, has a habit of demonstrating its true thoughts about that particular federal agency by putting into the tax law provisions that deal with matters that are within the purview of other federal agencies because the IRS appears to be more capable of administering these programs, but it's time for Congress to demand of the other agencies the same sort of competence that it attributes to the IRS when it turns to the IRS to handle its pet project of the week.

Two and a half years later, in Not to Its Credit, I revisited the issue after the Congress used the Heartland, Habitat, Harvest, and Horticulture Act of 2008 to add and expand all sorts of tax credits:

I object to the Internal Revenue Service being turned into a institution that is focused more on the technical requirements of energy production activities than on administering revenue laws. I wonder why financial incentives to produce and conserve energy aren't administered by the Department of Energy. Well, I know the answer. The Congress, though every now and then publicly trashing the IRS and characterizing it as harmful, then turns to the same agency to administer its favorite incentives programs. Which should speak more loudly to America? What Congress says when it grandstands or what it does when it overburdens the tax law and the IRS because it apparently doesn't trust other agencies to administer laws relating to agriculture, energy, employment, or health?

And about a year ago, in The Unintended Consequences of Tax Policy As a Social Tool, I focused on one of the many dangers of using the tax law as a means to encourage or discourage particular behavior:

In every instance where the Congress has used the tax law to encourage behavior, all sorts of people have crawled out from under the wood pile to claim that they were engaging in that behavior and thus entitled to the tax break, even though they were not engaging in that behavior. One need think only of the abuses with respect to the credit for new home purchases, the earned income tax credit, the plug-in electric and alternative motor vehicle credits, and the biodiesel fuel credit, to name but a few, to understand the inherent weakness of trying to use tax law to do what should be done through other means.

The Institute for Policy Innovation, in issue 9.05 of Tax Bytes, correctly notes that both parties have abused the tax law in this respect. Whether it is one side trying to use the tax law to encourage and subsidize child-rearing or domestic manufacturing, or the other side trying to encourage home ownership or energy conservation, “it’s this drive to manipulate and micromanage that drives the tax code toward such incomprehensible complication.” My only quibble is that I think it’s not a matter of being driven toward incomprehensible complication. I think the tax law has already arrived at that destination.

The Institute for Policy Innovation, in issue 9.05 of Tax Bytes, asks:

. . . “What is the purpose of the tax code?” Is it to drive social outcomes and to try to shape society according to the vision and preferences of whoever happens to control the tax writing committees at any given time? . . . Rather, shouldn’t the purpose of the tax code be to raise the necessary revenue to fund government while creating as few economic distortions as possible? If you were going to write a tax code for a free society, wouldn’t you foreswear using the tax code to manipulate people’s behavior, and choose instead to have everyone subject to similar low rates, and eliminate virtually all credits, deductions, exemptions and schedules in the process?

In the broad outline I presented in “Prof. Maule Goes to Washington”, I mapped out the basics:

Income would include income, with very few exclusions... As for outgo, there would be two basic deductions. One would be for the expense of producing the income... The other would be a deduction (or perhaps a credit) that would reflect the wisdom of not imposing a tax on those whose incomes were barely sufficient to live life...Perhaps, because all citizens ought to contribute something to the cost of government, a small ($10) tax ought to be imposed on taxable incomes under the cutoff, and a very low rate imposed on taxable income above the cutoff but below, say 125% of the cutoff... Of course, no surprise, when it comes to rates, all taxable income is taxed under a rate schedule...This approach permits lowering the tax rates. The base would be broadened, and thus rates could be reduced...Finally, there is the matter of credits. Of course the credits for taxes withheld (and I'd withhold on all income payments exceeding $500, not just wages and certain other payments) and estimated tax payments would be retained...

There might be disagreement about which path to take, but at least in this case we seem to be pointing in the same direction.

Every so often I make a prediction in one of my blog posts. Every now and then one of them comes true. Admittedly, this was a fairly easy prediction. And the fact it came true isn’t anything to cheer about. In fact, that it came true is simply more evidence of how sad a state the tax law is in.

In late 2010, in A Section 107 Puzzle: Is “A” Just “One” or “Any”?, I analyzed the decision in Driscoll v. Comr., 135 T.C. No. 27 (2010), in which the United States Tax Court, in a case of first impression, held that the exclusion from gross income under section 107 of a minister’s parsonage allowance is not limited to the portion used to provide the minister’s primary residence but also extends to the portion used to provide a second home, which happened to be located in a vacation area. The question of whether the term “a home” in section 107 meant “just one home” or “however many homes” divided the Tax Court judges. Ultimately, the taxpayer prevailed, with the majority supporting the conclusion that the word “a” did not mean “one.” As I wrote in A Section 107 Puzzle: Is “A” Just “One” or “Any”?, “The case is yet another example of how courts struggle to determine what Congress intended when examining statutory language the Congress almost surely enacted without thinking about the issue. The existence of majority, concurring, and dissenting opinions indicates the extent of the struggle.”

In the last paragraph of A Section 107 Puzzle: Is “A” Just “One” or “Any”?, I asked five questions:

What’s left are several questions for the future. First, will the IRS appeal, and if so, will it prevail? Second, will the IRS continue to issue notices of deficiency in these sorts of cases, knowing that it would lose in the Tax Court but hoping that it would prevail on appeal to a different Court of Appeals? Third, might the Supreme Court end up dealing with this issue? Fourth, will the Congress amend section 107 to respond to the Tax Court’s decision, and, if so, what will it do? Fifth, might the Congress repeal section 107, the existence of which is difficult to justify under any sort of tax policy analysis?

It was at this point that I went out on a limb and explained: “I’m willing to predict that at some point in the future, a subsequent development with respect to this issue will be the subject of a future MauledAgain blog post.”

Well, here we are. Last week, in Comr. v. Driscoll, ___ F.3d ___ (11th Cir. 2012), the Eleventh Circuit reversed the Tax Court. Relying on Webster’s dictionary, the court concluded that “a home” refers to one home. Webster’s Dictionary provides three definitions of home. The first is “the house and grounds with their appurtenances habitually occupied by a family.” The second is “one’s principal place of residence” and the third is “domicile.” I suppose everyone who has a home in one area and a vacation property in another location is speaking improperly when they refer to their “vacation home” because that would suggest they have two homes. The court rejected the taxpayer’s argument that Congress, by using the term “principal residence” in other Code provisions but not in section 107, did not intend to limit section 107 to principal residences.

Aside from the substantive legal principle that emerges from this case, which of course is subject to a similar case being decided differently by another Court of Appeals, there are two lessons to consider. One is whether this issue demonstrates that section 107 has outlived its usefulness. My many clergy friends won’t be happy with the suggestion that it be repealed, but it presents a long list of issues, with this particular “how many” question being one of the less pervasive ones. The other lesson is the disadvantage of gargantuan tax codes. The Internal Revenue Code is so big that almost no one has a comprehensive understanding of its vocabulary and style. Different terms are used for the same concept because different individuals draft the language. The days when someone doing drafting could remember all the places where the same concept was referenced are long gone. Every additional provision brings the opportunity for additional ambiguities, inconsistencies, and language reconciliation challenges.

When one considers the time, energy, and other resources expended on this issue by the IRS, the taxpayer, and the two courts, it is easy to see the adverse impact that careless legislating has on people, the nation, and its economy. Once again, the root of the problem is with the Congress. Once again, the Congress has failed.