MauledAgain

Here’s a question for NFL fans. Can you identify the only NFL stadium built without any public funding? The answer is provided in this article. The point of the article is that all sorts of private enterprise sports businesses grab funding from the government revenue streams that many of their owners attack as unwarranted. The article, for instance, notes the Bloomberg News analysis showing that $4 billion of taxpayer subsidies have been pumped into sports stadium and arena construction since 1986, through tax exemptions and subsidized bonds. One example provided by the article is the property tax exemption granted to the owner of the Dallas Cowboys franchise for its stadium.

The point made by the article isn’t new. Eight years ago, in Tax Revenues and D.C. Baseball, I explained why, given the finite limits of government revenue and spending, private sports franchise owners ought not be grabbing for public financing when so many other more basic needs, such as food and shelter, are unmet. Earlier this year, in Putting Tax Money Where the Tax Mouth Is, I again explained the problem: “Private enterprise, which for the most part rejects taxation and government regulation, is quick to find ways to tap into public funding that is financed by the very tax systems that private entrepreneurs detest.” These are but two of the several posts that I’ve shared focusing on the misdirection of tax revenues from the hands of the average taxpayer into the wealthy owners of private enterprise.

It amuses me to listen to the private sector claim that “we built it.” Surely the private sector has built things, but the public funding of sports arenas and other private enterprise facilities, such as warehouses, factories, and office buildings, makes it impossible to consider the private sector claim as anything other than, at best, a gross exaggeration, and at worst, a calculated lie. Perhaps what is lost on the folks making this argument is the irony of the location selected by the Republican Party for its convention. The Tampa Bay Times Forum was built by, and is maintained with, public funds, as described on its website. Perhaps the solution is to cut taxes and simultaneously cut all tax breaks for the “we can build it ourselves without any government help” private sector. What better way to bring the anti-tax crowd out to show its true vision of tax policy.

Six months ago, in Taxes, Citizenship, and Shame, I reflected on the effectiveness of publishing the names of tax scofflaws, noting “We live in an age when shame does not have the effect it once did.” A month later, in Cheating, Taxes, and Shame, I reacted to a survey showing that being caught cheating on one’s taxes did not generate as much shame as three other behaviors. With almost half of Americans, according to the survey, unashamed about cheating on their taxes, some other incentive is necessary.

One of my readers brought to my attention something that California is doing with respect to tax cheaters. He pointed me to this article, which describes how California Assembly Bill 1424, enacted a year ago, will allow the Medical Board of California to deny an application for licensure or to suspend the license of any licensee owing more than $100,000 in California taxes. The article referred to a press release from the Board.

The reader asked, quite understandably, “Do certain occupations or professions have a higher duty to pay their taxes in full and on time?” In other words, why pick on doctors?

Curious, I dug up Assembly Bill 1424. Among the many things it does, it requires the State Board of Equalization and the Franchise Tax Board to publish a list of the 500 largest tax delinquencies. It requires the Franchise Tax Board to include additional information on the list with respect to each delinquency, including the type, status, and license number of any occupational or professional license held by the person or persons liable for payment of the tax and the names and titles of the principal officers of the person liable for payment of the tax if the person is a limited liability company or corporation. Assembly Bill 1424 also requires a state governmental licensing agency that issues professional or occupational licenses, certificates, registrations, or permits, to suspend, revoke, and refuse to issue a license if the person’s name is on the list of delinquents.

So it turns out that California is not picking on doctors, though it appears to be picking on tax delinquents engaged in a business or activity that requires any sort of state licensing. But, not surprisingly, there are exceptions. The provision does not apply to the Department of Motor Vehicles, the State Bar of California, the Alcoholic Beverage Control Board, or the Contractors’ State License Board. So, it turns out after all that California is singling out some professions and occupations, but not all, for this income-jeopardizing consequence. For most licensed professions and occupations, loss of license is tantamount to loss of income.

The first set of questions addresses the scope of the provision. Why not permit the revocation of law licenses held by lawyers who are delinquent in their taxes? Why not revoke the licenses of bars and restaurants that are delinquent? What about contractors who aren’t current in meeting their tax liabilities? And why limit this approach to licensed professions and occupations? Why not pull the driver’s license held by a delinquent taxpayer?

The second question addresses the effectiveness of the provision. If losing one’s license to practice a profession or occupation reduces or eliminates the person’s income, would that not also reduce state revenue by reducing the tax base? I suppose that the answer is an expectation that the business would be taken to another professional or entrepreneur, who thus would earn more income and pay more taxes to offset the revenue loss incurred by the income reductions afflicting those whose licenses have been revoked.

Assembly Bill 1424 also prohibits California state agencies from buying goods or services from a contractor whose name is on the delinquent taxpayer lists. Though this cuts back to some extent the exception made in favor of contractors, it doesn’t have any impact on contracts not involving California.

The new law appears designed more as an incentive to compliance than as a punishment for noncompliance. Yet something more than mere shame is involved when a person not only sees his or her name appear on a tax delinquent list but also sees his or her license to practice or engage in an occupation revoked and watches that revocation receive state-wide publicity. The question is whether this “something more” is enough.

It is understandable why do-it-yourself lawyering has become popular. Although there always have been a few people who, for reasons of thrift or to prove to themselves that they were no less capable of handling their own legal matters than an educated lawyer, decided to be their own lawyer, in recent years do-it-yourself lawyering has become ever more commonplace. Part of the reason is that the cost of retaining an attorney has become increasingly less affordable for growing numbers of people in a shaky economy, and part of the reason is the proliferation of web-based do-it-yourself lawyering kits.

A recent Tax Court case, Larievy v. Comr., T.C. Memo 2012-247, demonstrates the adverse tax consequences of venturing into do-it-yourself lawyering. Acting as one’s own lawyer without the appropriate training can pose all sorts of other adverse outcomes aside from tax, but I leave those issues aside. In Larievy, a husband and wife decided to divorce. In 2004, they agreed to separate. Without consulting an attorney or any other professional, they reached an oral agreement that the husband would pay $2,605 each month for the living expenses of his soon-to-be former wife and for their children. Four years later, in May 2008, they filed for divorce, again without consulting an attorney or other professional. On December 1, 2008, the court entered a divorce decree, which included a provision that the former husband would pay $1,400 each month in alimony to his former wife, to continue until either one died, but that beginning on June 1, 2009, the amount would be reduced to $1,100 through June 1, 2013. The husband made the $2,605 payment each month, except for one month in which he wrote a check for $2,600. In the papers filed with the court in 2008, the former spouses included a document that recited the history of the payments made since 2004 but did not indicate how much of the $2,605 was for spousal support and how much was for child support. Apparently the husband and wife had an understanding of how the $2,605 was split but they did not reduce that understanding to writing until it was set forth in the December 1, 2008, divorce decree.

The former husband deducted the payments as alimony. However, no deduction is allowed for alimony unless the amount that has been determined is in writing. The statute, the regulations, and previous case law establishes that principle. Even if the agreement to pay $2,605 per month had been put in writing, the failure to designate the portion that was child support also would have precluded the deduction. In this instance, as the court explained, “no qualifying written divorce or separate agreement existed until December 1, 2008.”

It is unfortunate that because, for whatever reason, the former spouses did not have the benefit of professional advice, the former husband lost significant deductions and thus paid more federal income tax than would have been payable had the simple task of putting in writing the agreement and the specific alimony and child support amounts. The taxpayers were not trying to game the system. They were not trying to hide income in overseas bank accounts. They were not trying to make use of offshore tax shelters. They simply did not understand the technical requirements of the tax law.

How can similar outcomes in the future be prevented? Although simplifying the tax law is one quick response, it isn’t applicable in this situation because the whole point of requiring a writing is to provide the requisite proof of the agreement. In this instance, the taxpayers were derailed by failing to put an agreement in writing, a wise move in most transactions in life, and not just for tax purposes. Somewhere along the line, the taxpayers either did not hear or did not get the message, put it in writing. Lawyers often are accused of slowing down transactions or complicating deals when they insist on a writing, and even face charges of being unromantic when advising couples to sign ante-nuptial agreements, but there are too many situations in which the lack of a writing worked to the detriment of someone. Under the circumstances at issue in Larievy, the risk of being unromantic surely was not a concern. It’s just that there was no one, lawyer or otherwise, reminding the taxpayers that a written document is a wise choice even when not required by law.

Last week, in Using Taxes to Measure Generosity, I made the point that using tax information to determine the relative generosity levels of states whose electoral votes went one way or the other in the last presidential election is unwise for three reasons. First, using the charitable contribution deduction as a determinant of charitable giving ignores the donations made by taxpayers who do not itemize. Second, the charitable contribution deductions in a state of any given “color” are not necessarily proportionately attributable to taxpayers who vote a particular “color.” Third, failure to remove contributions to religious organizations for activities and facilities that benefit the donors skews the results.

An alert reader pointed out a fourth flaw in the study that was the subject of Using Taxes to Measure Generosity. The charitable contribution deduction does not reflect contributions of time. The IRS does not collect any information that shows how many hours a person volunteers for charitable purposes. The reader correctly pointed out that most charities would not survive solely on the monetary contributions they receive if they were not the beneficiaries of unpaid volunteer labor. Even if the IRS could get past the legal and practical barriers to collecting and disclosing information on a taxpayer’s voting record and the identity of the taxpayer’s charitable contribution recipients, it would not necessarily have any information about volunteers’ time contributions.

I pointed out to the reader that collecting information about volunteer hours through a survey runs the same risk of using surveys to identify contributions of money. The risk of over-reporting is very real. I also pointed out that in measuring generosity, limiting the analysis to contributions of time and money to charitable organizations still falls short. Is there not generosity when a 5-year old shares a cookie with a friend? Or when an adult opens the door for an older person? Or when a teenager helps someone pick up the groceries she has spilled?

Perhaps the true flaw in the study examined in in Using Taxes to Measure Generosity is the attempt to quantify a moral value with dollars. As questionable as it might be to try to quantify a moral value with any sort of number, the use of dollars reflects the extent to which money addiction has permeated present-day culture. For too many people, all that matters is money and money equivalent. Turning to money as the measure when trying to evaluate generosity might be the poster child for what ails this nation. As I try to entice my basic federal income tax students to comprehend and express, the value of a stranger’s smile is not included in gross income.

Readers of this blog know that I do not like tax ignorance. That dislike is one of the many reasons I teach and write about taxes. In posts such as 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, More Tax Ignorance, With a Gift, and Tax Ignorance of the Historical Kind, I have lamented the sorry state into which the collective understanding of the body politic has fallen when it comes to taxation.

Though I think I have a pretty good idea of how and why tax ignorance has spread throughout the nation in a frightening exhibition of an intellectual pandemic, I read an article several weeks ago that highlighted the danger of sound bites and misleading headlines. The story described the decision by a retail chain to open a store in Delaware. The headline proclaimed, “Tax-free Cabela’s planned for I-95 site.” What’s a reader to think if the reader does not know or understand taxation? It is not unlikely for the reader to think, “Oh, I can shop there without being taxed.” But that’s not true. About a year ago, in Collecting the Use Tax: An Ever-Present Issue, I explained that residents of states surrounding Delaware who make purchases in Delaware without paying a sales tax are obligated to pay a use tax to their state of residence. As states become more immersed in the challenge of balancing budgets, increasing attention will be given to use tax payment shortfalls. That effort is already well underway in many states. So is it helpful when a taxpayer’s ignorance of use tax responsibilities is bolstered by a headline suggesting that the taxpayer’s outlook is correct?

As I wrote in Tax Ignorance of the Historical Kind:

Yet every time I hear or read tax misinformation, and realize how many people are making decisions based on erroneous premises, I shudder at the outcome. From pockets of tax ignorance, the educational deficiency now grips the nation from village schoolhouse to the halls of Congress. I wonder if some future historian – if there are any – will caption the chapter dealing with the early twenty-first century as “The Triumph of Ignorance.”

If watching tax legislation is like watching sausages get made, what does watching tax ignorance being fertilized resemble?

If asked to define “tax labor,” many taxpayers would think of a tax on labor, such as the inclusion of wages in gross income. Others would probably think of the effort required to fill out income tax returns and to file them with the IRS or appropriate revenue department. Business entrepreneurs would add to the list the many other returns that are required.

But tax labor involves more than filling out returns. It includes the effort required to gather up the records from which information is extracted that permits the entry of numbers and text on a tax return. But it also includes the creation of the records at the time that the event occurs which has an impact on the taxpayer’s tax situation.

A good example of how failure to generate records works to the taxpayer’s disadvantage is presented by Watley v. Comr., T.C. Memo 2012-240. The Watley case presented four issues, specifically, whether the taxpayer was entitled to a dependency exemption deduction for her sister’s two children, whether the taxpayer was entitled to file as head of household, whether the taxpayer was entitled to additional child tax credits related to the two children, and whether the taxpayer was entitled to an earned income credit. Because the taxpayer failed to prevail on the first issue, the unfavorable outcome with respect to the other three issues was unavoidable.

There were two alternative avenues for the taxpayer to take to qualify for the dependency exemption deduction for the two children. One was to show that each child was a qualifying child. The other was to show that each child was a qualifying relative.

One of the requirements that must be satisfied to show that someone is a qualifying child is that the person and the taxpayer have the same principal place of abode for more than one-half of the taxable year. In Watley, the taxpayer and the IRS stipulated that the children lived in the home of the taxpayer’s sister from January 1, 2009 through September 9, 2009. At trial, however, the taxpayer claimed that the children started living with her in July 2009. According to the court, her testimony was unclear, because at another point in the trial she testified that the children had been in her care since August 2009. The court noted that the taxpayer “did not introduce documents that showed the children lived with her before September of 2009.” But even if the taxpayer could produce documentary evidence supporting her claim that the children moved in with her in July of 2009, it would have been insufficient to meet the one-half year abode requirement. The taxpayer offered into evidence a letter from a real estate company stating that the taxpayer had taken possession of her mother’s apartment and would reside there with two minors, but the taxpayer testified that she moved into the apartment after her mother died in April of 2010. The taxpayer conceded that the date on the letter was wrong, and the court excluded the letter as hearsay.

One of the requirements that must be satisfied to show that someone is a qualifying relative is that the taxpayer provide more than one-half of the person’s support for the taxable year. The court noted that the taxpayer failed to “introduce documents showing that she paid expenses related to” the children. She “also did not show the total amount of child support furnished to [the children] by all sources for 2009.”

The Court held that the taxpayer was not entitled to a dependency exemption deduction for either child. With that outcome, the taxpayer lost on the other issues.

For most issues, the tax law is quite demanding that the taxpayer offer evidence to support the taxpayer’s claims. What may seem obvious to the taxpayer isn’t necessarily obvious to the IRS or a court. The taxpayer’s testimony almost always must be taken with a grain of salt because it is self-serving. Valuable evidence includes documentation. Yet how many people, when engaging in a transaction, think of creating or retaining a document? In the Watley case, the taxpayer’s nieces and nephews were found alone after the taxpayer’s sister headed off to another location. In the turmoil of dealing with what appears to have been an emergency, in the uproar of relocating children, it is highly unlikely that anyone would be aware of the labor that needed to be expended to preserve any sort of tax benefit. True, in Watley, if the children did not, in fact, move into the taxpayer’s abode until July, there would have been no point in gathering evidence, but the lesson is there to be learned by taxpayers in other situations. If the taxpayer waits until the tax return is being filed, it might still be possible to find and safeguard the evidence, but even more labor and effort must be undertaken.

Tax is work. Work is taxed. Tax is laborious. It is laborious to learn, and it is laborious to apply, whether planning or complying with return filing requirements. In the tax world, as in some other worlds such as raising children, every day is a labor day.

Most retired people, and many not-yet retired people, know that social security benefits are subject to federal income taxation. Describing the principle in simple terms is challenging, because the computation of how much of a taxpayer’s social security benefits is included in gross income is complex. One can say that a portion of social security benefits, ranging from zero to 85 percent, is included in gross income, but even that statement fails to convey the reality and it also presumes that identifying social security benefits is easy. I have previously described the complexities in The Joys of IRC Section 86 and More Joys of IRC Section 86. Suffice it to say that law professors who teach the basic federal income tax course do not agree on the depth to which law students should be required to go when studying section 86. It ought to be no surprise that I take my students on the grand tour, not with the purpose of turning them into computational automatons but so that they can understand the concept of the bubble and how marginal tax rates are highest in the lower and middle, and not top, income ranges.

When I teach section 86, one issue on which I do not dwell is the determination of social security benefits. That amount is one of many elements in the computation of the gross income amount. Because of time constraints, the complexity of section 86, and the fact that I can make the points I want to make without getting into the determination of social security benefits, the situations we examine simply reflect some dollar amount of social security benefits.

Yet the determination of social security benefits for purposes of engaging in the section 86 computations is more than an abstract conceptual theory in the lives of taxpayers. A recent case, Moore v. Comr., T.C Memo 2012-249, illustrates the significance of the issue. The taxpayer received social security disability benefits of $11,947.20. Of that amount, $5,844 was paid by check to the taxpayers, $1,388.40 was deducted and transmitted for the payment of Medicare Part B premiums, and $4,714.80 was offset because the taxpayer received state workers’ compensation benefits in that amount. The taxpayer’s computation of social security gross income began with $5,844, not with $11,947.20. The taxpayer contended that because workers’ compensation benefits are not included in gross income, it would be unfair to require them to include them in gross income by starting the social security gross income inclusion computation with an amount that included the workers’ compensation offset. The taxpayer did not explain why the portion used to pay Medicare Part B premiums had been omitted from the computation, and at trial did not contest the IRS adjustment with respect to that amount.

Section 86(d)(3) provides that “if, by reason of section 224 of the Social Security Act (or by reason of section 3(a)(1) of the Railroad Retirement Act of 1974), any social security benefit is reduced by reason of the receipt of a benefit under a workmen’s compensation act, the term ‘social security benefit’ includes that portion of such benefit received under the workmen’s compensation act which equals such reduction.” In other words, social security benefits for purposes of the section 86 computation include the amount of workers’ compensation benefits to the extent they reduce or offset the total social security benefits to which the recipient is entitled.

It does not matter that the taxpayer does not receive the entire amount of the social security benefits. This is not an outcome limited to social security payments. For example, ignoring tax-deferred and tax-excluded contributions to retirement and other plans, an employee whose salary is $1,000 each week but whose weekly paycheck is less than $1,000 because of federal income tax withholding, state income tax withholding, FICA withholding, medical premium withholding, and similar payroll deductions, nonetheless must report $52,000 of compensation gross income for the year. The principle is that a taxpayer’s gross income computations include amounts that are not received by a taxpayer but that in some way inure to the taxpayer’s benefit.

In a previous case, the taxpayer had raised the same issue. However, that case was settled by a stipulated decision in which no opinion was issued by the court. Although the taxpayer contended that in the earlier case the court suggested that the taxpayer was correct. However, in the case under discussion, the court rejected any reliance on the previous case because it had been settled, no opinion had been issued, and no precedent had been established. At best, it would help the taxpayer escape a section 6662(a) penalty, but the IRS had withdrawn its initial suggestion that the penalty apply.

Law students, who rank among the nation’s brightest, struggle with section 86 even when not asked to do computations. It is no wonder that taxpayers generally stumble when dealing with section 86. Yet in this instance what tripped up the taxpayer wasn’t the calculations, but the selection of the starting number. That amount is clearly stated on the Form SSA-1099 that the taxpayer receives. Even if section 86 had been simplified, this taxpayer almost surely still would have reduced the benefits amount improperly. There’s only so much that simplification can do, but that’s no reason to abandon efforts to attain a simpler federal income tax law.

After my post in which I asked Where Are You, Income Averaging?, an alert reader pointed out that a type of income averaging was revived for farmers, and a few years later for commercial fishermen. What was revived isn’t quite what was repealed. The original income averaging taxed income by computing a tax equal to 3 times the tax that would be due if the taxpayer’s taxable income were 1/3 of what it actually was. It applied to all income. The special rule for farmers and commercial fishermen in effect permits the taxpayer to carry back 1/3 of farming and fishing income to the second preceding taxable year and compute tax as though it was earned in that year, and to carry back another 1/3 of farming and fishing income to the preceding taxable year and compute tax as though it was earned in that year. This income averaging is beneficial only if the rates applicable to the preceding two years are lower than those applicable in the current year. The repealed version of income averaging reduced taxes regardless of the status of rates in other years.

I did not mention the special farming and fishing income rule because it has no relevance to the plight of the taxpayer described in Where Are You, Income Averaging?. When the carryback method of income averaging was enacted for farming income, the committee report described the rational as appropriate because “income from a farming business can fluctuate significantly from year to year due to circumstances beyond the farmer’s control. Allowing farmers an election to average their income over a period of years mitigates the adverse tax consequences that could result from fluctuating income levels.” It didn’t take long before the fishing business lobbyists weighed in. But what about other businesses in which income fluctuates over the decade or half decade, as I described in Where Are You, Income Averaging?? Are their lobbyists less effective? Do they have lobbyists?

The special income averaging for farm and fishing income is available regardless of the economic status of the taxpayer. In the meantime, the taxpayer in Francis v. Comr., T.C. Summ. Op. 2012-7, a member of the Armed Forces not counted among the ranks of the wealthy, is stuck with a disappointing tax outcome caused by circumstances beyond his control. Why the better tax treatment for farming and fishing income and not for military back pay? Something about this nation’s tax priorities isn’t right, but those who pay attention have known that for a long time.

A recent report about the level of charitable giving is certain to generate all sorts of debates about the meaning of its conclusions, but there are so many flaws in the study that its value is far less than has been and will be attributed to it. The report examined IRS statistics showing the total charitable contribution deductions claimed by taxpayers in each state, and then compared that number with income. The report divides states by color, reflecting the state’s presidential vote in the 2008 election, and concludes that the eight “most generous” states were states won by John McCain and the seven “least generous” states were ones won by Barack Obama. The report concludes that there are two primary reasons for the perceived discrepancies. One is the difference “in each area’s political philosophy about the role of government versus charity.” The other is that “regions of the country that are deeply religious are more generous than those that are not.”

The first problem with the study is that it uses the charitable contribution deduction as a determinant of charitable giving. This means that charitable contributions by taxpayers who do not itemize deductions are omitted from the analysis. Although there is no hard evidence, it is not unreasonable to conclude that taxpayers who do not itemize are principally lower-income taxpayers, and there is evidence suggesting that lower-income taxpayers are more likely to attend church. Though they almost certainly make small donations in absolute terms that, although not showing up in IRS statistics, add up, their giving as a percentage of income appears to be higher than average. So, in effect, the study ignores a significant chunk of data, data likely to alter the study’s outcome.

The second problem with the study is that it assumes that the charitable deduction information for taxpayers in a particular state reflect the philosophy of that state’s political majority in 2008, even if that majority is only 51 percent or 52 percent or some other marginal proportion of the population. It is possible, and perhaps even more than likely, that higher levels of giving among the state’s political minority makes it appear that the state’s political majority is more generous. The only two states that most likely do not fall within this flawed analysis are Utah and Idaho, where members of the Church of Jesus Christ of Latter-Day Saints, bound to tithe, make up a significant percentage of the population, cause the two states to dwarf other states in terms of charitable deduction percentage, and have a political majority that is far above the usual percentages in the low fifties. Making this problem worse is the fact that there are increasing numbers of voters and taxpayers who do not identify with either political party. There also is the interesting twist that states voting in favor of John McCain claim fewer members of the one-percent than do states voting in favor of Barack Obama.

The third problem with the study is that it does not isolate charitable contributions to religious organizations. A significant amount of charitable deductions reflects donations to religious organizations. Though some of that money is used for missions and other projects that assist third parties, much of it remains at home, so to speak, paying for buildings in which members meet and worship, paying for clergy and staff to minister to the donors, and paying for programs that benefit the donors. Treating these amounts as measures of “generosity” is misleading and taints the study. Looking solely at donations that benefit third parties without yielding the donors something more than the good feeling that comes with generosity would generate a much better measure of generosity.

It is easy to criticize the report’s authors for skimming some information from IRS reports and compiling a flawed and arguably misleading analysis. But in their defense, getting the information that is needed to make a more meaningful measure of generosity is pretty much impossible. One approach would require analyzing not only the identities of charities listed on specific tax returns, which would require a violation of federal tax privacy laws, but also some sort of means to tag each taxpayer as a member of a particular political party. This approach, therefore, not only would require law-breaking, but would require the virtually impossible tasks of tagging taxpayers and getting information from the huge numbers of taxpayers who do not report charitable contributions on their tax returns. Another approach would be to survey individuals. The problem with these sorts of surveys is that the self-reported information is misleading. People tend to overstate their charitable giving because, after all, few people want to appear selfish and miserly when answering these sorts of questions.

So when the campaign heats up with allegations about which party’s members are more generous, the allegations, from both sides, will be resting on flimsy foundations. But they make for good sound bites, from the perspective of campaign managers, and so we are certain to be assaulted with flawed conclusions about generosity. They will be dumped in with all the other flawed allegations that will assault our eyes and ears in the months to come.

Decades ago, when the federal income tax rate structure included as many as 24 different rates, with the highest reaching 91 percent, the tax law included a computational process known as income averaging. In effect, income averaging permitted a taxpayer whose income spiked in a particular year to avoid being pushed into the very high tax brackets by taxing the income as though it had been earned during the preceding three years, thus subjecting it to the lower rates to which it would have been subject had it in fact been earned somewhat proportionately over those years. Income averaging was complex. The first portfolio that I wrote for what is now Bloomberg BNA was devoted entirely to Income Averaging. It is the only one of the portfolios that I have written that I do not periodically revised, because it was withdrawn when Congress repealed income averaging.

In 1986, when Congress reduced the number of income tax brackets and reduced the top rate to 28 percent, in exchange for removing many exclusions, deductions, and credits, it eliminated income averaging because there ni longer was a possibility that a surge in income would push the taxpayer into very high tax brackets. Though there was still a possibility that someone usually in the 15 percent bracket would be pushed into the 28 percent bracket by a sudden spike in income, the impact was considered too small to warrant retention of a provision that contributed to tax law complexity.

A recent case, Francis v. Comr., T.C. Summ. Op. 2012-79, involved taxpayers who sought to obtain the benefits of income averaging in a different manner but who failed to persuade the Tax Court that they were entitled to do so. In 2008, the taxpayer received a payment of almost $25,000 representing backpay representing amounts that would have been received by the taxpayer in 1998 through 2002 had the taxpayer not been wrongfully passed over for promotion in 1998. The taxpayer failed to report the backpay on the 2008 return. In Tax Court, the taxpayer argued that the backpay should be allocated to, and reported on, their 1998 through 2002 returns, because the marginal tax rate applicable to their income for those years was lower than the rate applicable to their income in 2008. The taxpayer did not prove, and nothing in the record indicated, that the taxpayer constructively received the backpay in a year before 2008. Accordingly, under section 451(a), regulations section 1.451-1(a), and prior case law, the backpay was includible in the taxpayer’s 2008 gross income. In fact, a taxpayer in a previous case had unsuccessfully attempted a similar allocation of one year’s income to prior years.

The Tax Court noted that, “Although not clear from the record, it may very well be that petitioners would have paid less tax with respect to the promotion backpay if the promotion denial had never occurred. Under the circumstances we can appreciate petitioners’ dismay.” However, even if the taxpayers were permitted to compute tax as though the backpay had been received during the 1998 – 2002 period, the interest for period beginning with the year of inclusion and ending in 2008 would more than offset the tax savings obtained by computing tax using the presumably lower marginal rates applicable in those earlier years. But if the income spike had not been $25,000 but $2,500,000, the interest component most likely would not wipe out the tax savings.

There are two types of income spikes, but only one is deserving of income averaging. It is sufficiently uncommon that Congress decided to leave income averaging out of the Internal Revenue Code even when the top rate was increased from 28 percent to 39.6 percent and subsequently 36 percent. When a taxpayer has a business that generates little income in some years and significant income in other years, income averaging is warranted because the annual nature of income tax liability computations is detrimental to taxpayers whose business activities are pegged to a cycle that extends over more than one year. Just as some businesses are seasonal within a year, such as ski resorts or Christmas tree retailers, some businesses are seasonal within a decade or half-decade. On the other hand, if a taxpayer’s income spikes because the taxpayer wins a $100,000 lottery prize, the justification for treating that income as though it was earned over a period of years does not exist. In the Francis case, the income was attributable to a period of years. In that sense it was much more similar to the half-decade seasonal business rather than the one-time lottery win.

Though most half-decade and decade seasonal businesses have ways of spreading the income, such as using the completed contract method of accounting, the taxpayer in Francis did not have that opportunity. Even though the backpay was designed to put the taxpayer in the same position he would have been in had the promotion been made when it should have been made, it did not have that effect because the tax consequences were not taken into account. Certainly it is possible to work into the computation of the award the tax impact, with adjustments for the interest factor. The Francis case involved military compensation, and perhaps it was not permissible for the parties to take those factors into account. In that event, Congress needs to change the statutes regulating the computation of military backpay, but that is a topic beyond the scope of this blog.

The experience of the taxpayer in Beach v. Comr., T.C. Summ. Op. 2012-81, demonstrates how easy it is for a taxpayer to make errors when filing a federal income tax return. Compounding the situation was an error made by the IRS.

The taxpayer owns a 2001 Saleen Ford Mustang. On February 6, 2007, it was damaged in an accident caused by an uninsured motorist who was at fault. The taxpayer’s adjusted basis in the Mustang was $25,482. It was worth $28,500 immediately before the accident and $2,250 immediately after the accident. The auto body shop determined that the cost of repairs would be $18,772.79, and taxpayer’s insurance company, after subtracting the $250 deductible, paid $18,522.79 to the auto body shop. The insurance company then initiated attempts to recover $18,772.70 from the uninsured motorist. The auto body shop returned the repaired Mustang to the taxpayer on June 29, 2007.

The taxpayer claimed a $17,287 casualty loss on his 2008 federal income tax return. The taxpayer did not enter any amount on the line for insurance or other reimbursement.

On December 10, 2010, the IRS issued a notice of deficiency for 2008, because of the taxpayer’s failure to subtract the insurance reimbursement. After the taxpayer filed his Tax Court petition and the IRS filed its answer, the IRS moved to amend its answer in order to add a second reason for its determination of a deficiency, specifically, that the casualty occurred in 2007 and should not be reported on the 2008 return.

The Tax Court concluded that any casualty deduction should be deducted in 2007. In fact, at trial, the taxpayer admitted that he “filed in the wrong year.” In addition, the Tax Court concluded that even if the deduction was proper in 2008, it would amount to zero, because the $250 remaining after subtracting the $18,522.79 reimbursement did not exceed 10 percent of the taxpayer’s adjusted gross income.

The IRS also determined that the taxpayer was liable for the 20 percent accuracy-related penalty. The IRS, having the burden of proof, argued that the taxpayer was negligent or disregarded rules or regulations. The Court concluded that the taxpayer was liable for the penalty because the taxpayer failed to subtract the reimbursement, thus failing to exercise ordinary and reasonable care in the preparation of the return. Petitioner’s attempt to avoid the penalty by arguing that he had not received a reimbursement because the insurance company had not paid him anything failed, because reimbursement can occur when payment is made to a third party on behalf of the taxpayer, as happened in this instance when payment was made to the auto body shop.

It is not merely a tax law proposition that a person who is out of pocket $250 does not suffer a $17,287 loss. It is not merely a tax law proposition that a person does not suffer a $17,287 loss if an insurance company pays all but $250 of an $18,772.79 accident repair bill. Even if there had been a deduction, reporting the transaction on the wrong return compounds the error. It is unclear why the taxpayer waited until early 2009 to report a 2007 transaction. And yet the taxpayer was not alone. The IRS did not pick up on the improper year issue until after it had filed its answer in the Tax Court. The IRS, however, was not subject to any sort of accuracy penalty. It pays to be careful.

EDIT: Yes, it pays to be careful. I wasn't. It's now fixed, though this post is spreading through cyberspace faster than I can catch up. The repaired sentence: "The Tax Court concluded that any casualty deduction should be deducted in 2007." Somehow (well, I know how, it involves learning how to use new versions of software) I had the wrong year in that sentence. It pays to have a proofreader.

Over at Forbes Magazine, Nick Schulz brands Exxon-Mobil a “Tax Hero” for paying three times as much in taxes, to governments world-wide, as it made in profits. At first glance, that seems impressive. But, after the careful analysis so lacking in the post-modern sound bite world, it’s not.

First, 77 percent of the taxes are the equivalent of fees and expenses that are recovered by passing the tax through to the consumer. For example, if Exxon-Mobil sells a gallon of gasoline for $4.00, it collects that $4.00 from the consumer. Included in the $4.00 is, depending on the state, some amount of liquid fuels tax. If Exxon-Mobil makes a profit of 30 cents on that gallon, it can claim it has “paid” far more than 30 cents in taxes, but in reality, the consumer is paying the tax and Exxon-Mobil is simply passing it through to the particular governments imposing it. Retailers collect and pay over significant amounts of sales taxes, but those taxes are being paid by the purchasers.

Second, Schulz appears to have pulled his numbers from consolidated financial accounting statements. The amounts shown as taxes are not amounts that are paid, but, at least in the case of income taxes, consist in part of figures representing amounts that are “set aside” as potential future tax liabilities. There is no guarantee that these taxes ever will be paid, and there is a long history of amounts charged as reserves for taxes by corporations generally never being paid.

What is appalling about this perspective, though, is that it highlights the internal inconsistency in the approach taken by those who seek to reduce taxes on corporations and the wealthy. One of the arguments tossed about is the notion that half the population is not paying tax, a proposition I debunked in Tax Myths, Tax Lies, and Tax Twisting and debunked again in Lying About Tax Myths. When careful analysts point out that everyone pays taxes, they are denounced for drawing attention away from the income tax. Yet, advocates of corporations as “tax heroes” are quick to include all sorts of taxes other than income taxes because, as for example in the case of Exxon-Mobil, profits exceed income taxes, even when using the “reserve” rather than the actual payment amount. Why the double standard? Of course, what’s overlooked is that in 1913 the income tax was designed, not as a general revenue raiser – that didn’t happen until World War II (though it happened to some extent during World War I) when sensible people, unlike the Congress and Administration in 2002, acknowledged that one does not jack up military spending without increasing tax revenue – but as a mechanism to prevent the wealthy from continuing and enlarging its purchase of elections. It was enacted as a device to preserve democracy against its destruction by the oligarchy. When enacted in 1913, the income tax applied to fewer than half a million people in a nation with a population of almost 100 million. The same could be said of the estate tax. They were directed squarely at the wealthy elite who were turning the nation into their own private fiefdom.

To claim that a corporation is a “tax hero” because it is so big that it collects huge amounts of taxes from its customers and passes them on to governments, and thus is a huge taxpayer, is total nonsense. It is “spin,” a buzz word for another word that I won’t type here but that would have brought out the soap had I said it as a child. It’s an attempt to mislead the tax-ignorant. It needs to be exposed for the chicanery that it is, which is what I have attempted to do.

A recent case, Alltel Communications Inc v. South Carolina Department of Revenue, No. 27156 (8 Aug. 2012), demonstrates yet again why the reduction of a theoretical concept to a practical application is what makes simple tax law concepts misleading. South Carolina has a corporate license fee – in effect a combination of a property tax and a gross receipts tax – that is computed at higher rates for certain types of companies, including telephone companies. The taxpayers in the case are in the business of providing wireless communication, or “cell phone,” services using radio waves. As the Supreme Court of South Carolina put it, the question is whether cellular service providers are telephone companies.

The administrative law court granted summary judgment in favor of the taxpayers, finding that they were not telephone companies for purpose of the license fee in question. Alternatively, the administrative law court concluded that if the statute were ambiguous, the taxpayers would prevail because ambiguities in a taxing statute must be interpreted in favor of the taxpayer. The revenue department appealed, and the Court of Appeals reversed and remanded for additional fact finding. The taxpayers applied for certiorari, and the South Carolina Supreme Court reversed, holding that “telephone company” is not a defined term, its application to the taxpayers is doubtful, and that this ambiguity must be resolved in favor of the taxpayers.

The parties had stipulated that the taxpayers were “radio common carriers” because they owned or operated in the state equipment or facilities for the transmission of intelligence by modulated radio frequency signal, for compensation to the public, that telephones and telephone companies transmit intelligence over a vast network of wires located in public rights of way and in easements over private property, that the taxpayers do not have facilities located in public rights of way, and that petitioners provide wireless voice and data communications using radio communication towers or facilities that the taxpayers own, lease, or license. Relying on these stipulations, the administrative law court concluded that the taxpayers were not telephone companies, but the Court of Appeals disagreed, concluding that additional facts were required to determine if the taxpayers were telephone companies. The taxpayers argued that because a “telephone company” is a company that uses landlines and wires, they are not telephone companies. The Supreme Court of South Carolina described this argument as having “ostensible merit,” buttressing its strength by examining the history of the license fee, and describing it as an excise tax imposed for the special privileges that had been granted to telephone companies to run their wires and install their poles in public rights of way. The court also noted that unlike the telephone company at the time the tax was enacted, the taxpayers were not a monopoly but participants in a competitive industry. Yet, despite the strength of this reasoning, the court also concluded that the lack of a definition of “telephone company” in the statute made the question ambiguous. It then proceeded to resolve the dispute in favor of the taxpayers because ambiguities in tax law must be interpreted in favor of the taxpayer.

To a tax neophyte, it probably is surprising that a statute imposing a higher tax on a telephone company does not contain a definition of telephone company. To the experienced – or jaded – tax practitioner, it is business as usual and work for tax litigators. The Supreme Court pointed out that the tax was enacted in 1904 and “yet more than a century later the term ‘telephone company’ remains undefined by the legislature.” What? A legislature not doing something it needs to do and procrastinating for more than 100 years? So the affliction has infected more than just the federal Congress. Though the legislature’s failure to act may have generated fees and income for some lawyers, it also imposed costs on the taxpayers that eventually will be passed on to its customers. A long time ago, someone said, “Let’s tax telephone companies at a higher rate.” Someone else said, “That’s a good idea.” Perhaps no one asked, “What is a telephone company?” Perhaps someone did and was rebuffed with, “Everyone knows what a telephone company is.” Over the years, as new technologies entered into the world of communications someone surely asked, “Is a cellular telephone company a telephone company?” but the legislature remained silent. Perhaps its members were too busy campaigning for re-election.

For as long as I have been teaching, students in my tax classes have been amused or frustrated by the frequency with which “it depends” surfaces as the answer to a question. Of course, many of the questions are designed to elicit responses to the follow-up question, “on what?” and to develop student’s fact-finding skills. Tax practitioners well know that some of the questions are simply the consequence of badly drafted tax laws that leave the answer up in the air until resolution arrives through subsequent legislation, a regulation, a ruling, or a judicial opinion.

Thus, it is not surprising that many statements about tax law begin with the ubiquitous “Generally,” or its variation, “In general.” It’s a rather obvious way of hedging one’s answer against the unknown exception. Unfortunately, in a world demanding absolute answers to questions within microseconds, any suggestion of a hedge earns demerits. In turn, absolute assertions spring up. This is true, and quite a problem, not only in the tax world, but for the moment, the focus is on tax.

Last week I received an email that contained a tax analysis that was replete with absolute statements. Though many were correct, two were wrong. The discussion, which can be found here, focused on the tax consequences of a project funding effort called Kickstarter. People in need of funds for a project, called creators, submit details of the project to Kickstarter, and if Kickstarter things it is worthwhile, the project and its details are posted on the Kickstarter web site. This permits anyone who likes the idea to “donate” money to help the project raise funds, and thus to become a backer. The creator submits a financial goal, and if the “donations” are sufficient the funds go to the creator, minus a 5 percent fee for Kickstarter. If insufficient funds are raised, the funds are returned and the creator gets nothing. If the project moves forward, backers “are rewarded with something in return, ranging from the backer’s name on a list of contributors, to a tee shirt, to a DVD of the documentary, to an invitation to the initial performance, to a signed photo of the work in progress by a famous photographer.”

Under the caption “What’s the tax angle?,” the description of Kickstarter provided the following propositions:

1. “Backers are not donating money in the way one donates to a charity. The money someone gives toward a project is just that, a gift. The gift is not deductible on the donor’s tax return. There is an exception: If the project is classified as a 501(c)(3) not-for-profit organization then the donation is a personal — not business — charitable deduction on the donor’s tax return.”

2. “The value of these rewards [the tee shirt, the DVD, etc.] are not taxable to the donor.

3. “The cost of the rewards is a business expense for the creators.”

4. Creators will be sent a 1099-k at year-end from Kickstarter. The money the [creator] receives is taxable income. It is included as part of business gross income.”

I take exception to the claim that the amounts contributed by backers are gifts. In some instances they are. But to the extent the backer receives something in return, the money, or at least part of it, is not a gift, but the purchase price of the item received by the backer. The word “generally” would have allowed room for this aspect of the transaction.

I also take exception to the claim that the value of the rewards are not taxable to the donor. Under some circumstances, and it depends on the language of the contract and the specific arrangements into which the parties have entered, gross income can be generated if the value of what is received exceeds the amount that has been paid. This is unlikely to happen other than in rare circumstances, but it is another instance for use of the word “generally.” It is tempting to think that if the circumstances are so rare it is acceptable to dismiss them as though they did not exist. Yet the tax law, as is the case with other areas of law and other disciplines, is highlighted by situations thought to be quite rare but which were very real to the people who experienced them.

And although Kickstarter explains that backers do not obtain ownership interests in projects, it is only a matter of time before a creator gets creative. Trying to summarize the tax consequences of establishing an ownership interest in an enterprise without using the word “generally” is, generally speaking, quite a challenge.

From a tax perspective, there’s a little something to be said about the value of those television court shows. Twenty months ago, in Judge Judy and Tax Law and Judge Judy and Tax Law Part II, I shared my reaction to several tax propositions that were articulated on Judge Judy’s version of television court. In the second post, I asked, “I wonder what sort of impact on the viewers this episode has made. Has it taught people that it doesn’t pay to commit tax fraud, . . .” Apparently the answer is no.

Last week, I found myself watching an episode of People’s Court. The facts were fairly simple. The plaintiff had purchased a used car from a used car dealer. For some reason, he did not test drive the car, nor did he take it to a mechanic for a pre-purchase examination. He admitted that he had made “a lot of mistakes.” Of course, the car turned out to be a clunker, so the plaintiff sued to get his money back. Judge Marilyn Milian asked for proof of how much he had paid. She asked for the bill of sale. The response? There is no bill of sale. The dealer noted that the price was $500. The plaintiff disagreed, claiming that the $500 was the price the dealer agreed to put down in order to save the plaintiff from paying sales taxes on the much higher amount that the plaintiff claimed to have paid. The judge asked, “And that was the dealer’s idea?” Of course, the plaintiff began to squirm. The judge then observed, “You know that is tax cheating, right?” She then remarked, rather sarcastically, that she likes the cases when someone sues for the actual purchase price even when there is a bill of sale that has a fabricated lower price designed to reduce the purchaser’s sales tax.

While trying to find a transcript of the episode – I failed – I discovered that a similar situation had arisen in at least two earlier episodes. One of those episodes was noted in TV Judge Gets Tax Observation Correct. In the other case, the dealer left blank the space for filling in the purchase price so that the purchaser could fill in a lower number for sales tax purposes. The parties in the more recent case either did not watch the earlier episode or, if they did, figured they were special enough to pull off the stunt without being caught. Judge Milian apparently does get more than a few of these sorts of cases.

I wonder if the revenue department for the states in which these transactions took place followed through with an audit. Is it any wonder that governments face revenue shortfalls?

It wasn’t that long ago that in Sometimes When It Comes to Tax Violations, Voters Get It Right, I asked, “What’s going on in the heads of people who think they can escape responsibility? Perhaps it reflects the tax fraud defense offered in Browning v. Comr., T. C. Memo 2011-261. In that case the taxpayer explained, 'I]t’s like running a red light or going the speed limit. You do things you shouldn’t while you can.' ” Every which way one turns, someone is trying to rip off someone else, whether it is society at large, individual consumers, voters, property owners, or some random victim. Using lies, scams, con games, fake smiles, fancy words, and every other tool known to the deceiver, these perpetrators are growing in numbers and in boldness. It’s no wonder, as it reflects the example being set by persons in position of authority, in both the public and private sector, and in for-profit and not-for-profit organizations. The tax fraud epidemic is part of a larger fraud pandemic that threatens more than the dollars purloined or the people victimized. It threatens to turn the nation into a den of thieves.

At the end of July, voters in Georgia had the opportunity to approve or reject, through a referendum, a one percent increase in the state sales tax to fund highway and transit improvements. For purposes of the vote, the state was divided into twelve regions, with each region having a list of improvements for that region. Presumably, one purpose of arranging the voting in this manner was to avoid the not uncommon, and frequently criticized, pattern found in many states of transportation taxes in one region being used for improvements in another region.

According to this report, voters in nine of the 12 regions rejected the tax increase. The discussion leading up to the vote generated some strange alliances and divisions. Business owners who usually support anti-tax Republicans supported the tax, whereas the so-called Tea Party, not surprisingly, opposed it. Some Democrats opposed the proposal because the project lists did not, in their view, include sufficient spending in African-American communities.

Reasons for the failure of the proposal in the Atlanta area are as varied as the voters. According to this report, some voters rejected the proposal because they don’t trust the government. Others voted no because they perceived that they would not benefit individually, or would benefit less than people in other areas of the region. Mass transit supporters voted no because some of the funds would benefit car drivers. Still others voted no because the project list included mass transit expansion, with almost one-half of those polled explaining that mass transit causes increases in crime.

There is no question that there are traffic and transit problems in Georgia, particularly in the Atlanta area. Some predict that with traffic woes becoming an impediment to business growth, “valuable young workers” and jobs would leave the region. As one supporter of the tax noted, when employers consider where to locate new jobs, traffic is a major factor in the analysis. So unless and until the voters of Georgia unite behind some sort of funding plan, congestion will increase, highways and bridges will continue to deteriorate, accidents and fatalities will rise, and front-end alignment spending will skyrocket past the small amounts that would have been paid if the proposal had been enacted. The business owners who supported the tax, despite their alleged anti-tax outlook, understood that the tax in question was a cost of maintaining and expanding the transportation resources necessary for their enterprises to thrive and grow. The inability of most people to understand the issue is reflected by the statement made by an opponent of highway funding increases in Texas, as shared in this report. “We don't want more taxes, especially to use roads we've already paid for with tax money.” The problem is that there are two aspects of paying for roads. One is to pay for construction of the highway. The other is to pay for the maintenance and repair of the highway. When teenagers begin to talk about purchasing a car, sensible parents explain to them that the cost of the car is more than the purchase price because they need to take into account fuel, insurance, and repairs. Similar advice is given to those seeking to purchase a home if they are fortunate enough to be exposed to wisdom, as the cost of a home includes not only the purchase price but utilities, insurance, maintenance, and repairs. The long-term effects of failing to teach financial common sense in the nation’s school systems is now threatening the well-being of the country’s physical infrastructure.

Regular readers can easily guess what went through my mind when I picked up the Philadelphia Inquirer and saw this report. Apparently Nadya Suleman, better known as Octomom, joined an online dating service that permits users to pay other users to go on a date. Users bid for the privilege of going out with someone, and Nadya has put the opening bid at $500.

Regular readers will remember that a little more than a year ago, in The Tax Consequences of Being Paid to Date, I addressed the income tax consequences, and touched lightly on the sales tax consequences, of transactions undertaken through that web site. Yes, it’s still in business. I concluded that the amount received by the person being paid to go on the date is gross income. I explained that it is not a gift, and that it is paid in exchange for the person’s time in the same manner as a psychologist, plumber, or painter has gross income when paid for his or her time, making it compensation for services provided.

When Paul Caron picked up my post on TaxProf Blog, 23 comments were left by his readers. Some agreed it was gross income. Several argued that there was no profit, after taking into account the expenses of “prepping” for the date, but that doesn’t eliminate the status of the fee as gross income nor, turning to another aspect of the question, the requirement that it be reported. There also is some question about the wisdom of assuming that the prepping expenses are deductible, as many people are obligated to “look nice” for their jobs but that doesn’t transform their commuting, attire, or hair care expenses into deductions. Some of the more interesting comments highlighted practical concerns, such as the question, “How would the taxman know you got pay for your dates?” It is true, as someone else noted, that the income tax “‘really’ invades privacy.” Indeed it does, as I explain to my basic tax students every fall. I challenge them at the beginning of the course to be prepared to answer at the end of the semester the following question, “What aspect of your life is not affected by the income tax law?”

Some of those who commented expressed the opinion, shared by the writer of the most recent Philadelphia Inquirer report that the transactions are nothing more than escort services or prostitution arrangements. If that is so, the amounts received unquestionably are gross income. Yes, there are cases addressing this issue. As I noted in The Tax Consequences of Being Paid to Date, I did not go to the site in question. One of those commenting on Paul’s TaxProf Blog post, a person by the name of “anon,” wrote, “That site is terrible. I joined it yesterday and deleted my account only 1 hour later.” I have no intention of replicating anon’s research.

The Philadelphia Inquirer story that triggered last year’s post, The Tax Consequences of Being Paid to Date, revealed that the site in question has 50,000 members, and receives bids averaging $138. With that level of activity, surely it’s just a matter of time before one of these transaction ends up as the subject of a Tax Court or district court opinion.

Indeed, sometimes voters get it right but too often it takes way too long. This was demonstrated recently in the case of Philip Lewis Hart, a member of the Idaho legislature. Hart by profession is a structural engineer, he happens to think that the federal income tax is unconstitutional, and he has written a book explaining his position. He has fared no better in court than have any of the other tax protestors who make the same worn-out, illogical, misguided, and warped arguments. See, e.g., Hart v. Comr., T. C. Memo 2000-78.

Several months ago, with his tax debts heading north of half a million dollars, Hart filed for bankruptcy. According to this story, Hart also owes money to a law firm and is fighting a U.S. Justice Department attempt to foreclose on his home. According to another story, Hart has proposed to pay $12,000 over a five-year period to settle $600,000 of debt. One wonders if Hart noticed the absurd deal worked out for Ford T. Johnson, which I noted and criticized in From Tax Until Eternity. Johnson had complained about a deal permitting him to pay off a $2.5 million debt in $400 monthly installments.

What’s going on in the heads of people who think they can escape responsibility? Perhaps it reflects the tax fraud defense offered in Browning v. Comr., T. C. Memo 2011-261. In that case the taxpayer explained, “[I]t’s like running a red light or going the speed limit. You do things you shouldn’t while you can.” According to this story, the house that Hart is trying to save from foreclosure “was built in part with logs he illegally harvested from state school endowment land.” Despite his claim that citizens are permitted to take the logs for free, he repeatedly lost his appeals but never paid off the judgment. Some people interpret “freedom” and “rights” as licenses to do whatever they want, whenever they want, with no regard for the freedom or rights of anyone else.

Somehow, Hart got himself elected to the Idaho legislature and was re-elected three times. It’s unclear whether voters knew about his log acquisitions and his tax return behavior. Surely some of them did, but perhaps those who did were the ones who voted for the other candidate. Eventually, to avoid ethics sanctions, he stepped down from the Idaho House tax committee. But the good news is that several weeks ago he lost in the GOP primary and will not be serving a fifth term. Enough voters opened their eyes and ears, and used their brains. Why it took so long is unclear.

Suppose for a moment that the Bush tax cuts are extended for taxpayers with taxable income of less than, say, $250,000. Is it possible for taxpayers with taxable incomes of $250,000 or more to avoid the resulting increase in their tax liabilities? Of course. If they hire people to do work that is connected to the trades and businesses that they operate and the for-profit activities in which they engage, their taxable incomes will decrease because of the deduction for the salaries that they pay. Every taxpayer with a taxable income of $250,000 or more has the ability to bring their taxable income to less than $250,000 through lawful means. If they hire and spend wisely, they obtain full value for what they pay, so their wealth position is not compromised. In the meantime, their new employees will be paying taxes on their newly acquired incomes, permitting those new employees in turn to purchase goods and services. The section 162 compensation deduction is not the only existing incentive to help people reduce their tax liabilities by reducing taxable income. Perhaps the problem is that much of what those with incomes of $250,000 or more want to do with their money doesn’t generate a tax incentive. I wonder why.

Recently, in Carlebach v. Comr., 139 T.C. No. 1 (July 19, 2012), the Tax Court upheld the validity of a regulation dealing with the definition of a dependent that illustrates why tax statutes are long. Had the statute been even longer, there would have been no justification whatsoever to challenge the regulation because there would have been no need for the regulation.

The issue was simple. The taxpayers claimed dependency exemption deductions for their children. In some of the years in question, none of the children were citizens of the United States. In other years, some of the children were citizens but others were not. The Court first addressed the taxpayers’ argument that their children were citizens during the years in question but rejected the argument. The Court then turned to the core tax question.

Section 152(b)(3)(A) provides that a dependent “does not include an individual who is not a citizen or national of the United States . . .” Regulations section 1.152-2(a)(1) provides that “to qualify as a dependent an individual must be a citizen or resident of the United States . . . at some time during the calendar year in which the taxable year of the taxpayer begins.” The taxpayers argued that the requirement in the regulations that their children be citizens during the calendar year in which the taxable year of the taxpayer begins is invalid. They rested their contention on the argument that Congress enacted a statute that did not include the calendar year time requirement. The taxpayers argued that it was sufficient that their children were citizens by the time they filed their returns, though the Court pointed out that the logic of the taxpayer’s argument was equivalent to a claim that a person qualified so long as they became a citizen by some point before the return was filed.

The taxpayers argued that because Congress included “during the calendar year” language in other parts of section 152, and omitted it from section 152(b)(3)(A), Congress did not intend for the latter provision to be interpreted as provided in the regulations. The Court, however, noted that the language of the Code must be examined in context, and that the annual accounting system inherent in the federal income tax, as explained by the Supreme Court in Healy v. Comr., 345 U.S. 278 (1953) makes it clear that the requirements for status of a dependent must be determined with respect to an annual period. Even if the statute could be construed as ambigous, the Court explained, the regulation is a reasonable intepretation. Though not determinative, the Court noted that the interpretation in the regulation has been in place since 1944.

Certainly, it would be easier if section 152(b)(3)(A) provided that a dependent “does not include an individual who is not a citizen or national of the United States . . . during the calendar year in which the taxable year of the taxpayer begins.” Doing so would make the Code even longer, to the distress of those who think the Code is too long as it is. The problem is that a simple concept, specifically, the dependency exemption deduction, is transformed into an increasingly complex Code provision, interpreted by even longer and more complicated regulations, as a defense against mis-interpretation and gaming, and in response to mis-interpretation and gaming. Even if the Code were significantly shortened by removal of all special interest provisions and all credits, exclusions, and deductions substituting as spending programs belonging to other agencies, the tax law would continue to be more than a grouping of simple concepts. It’s in the application that concepts, no matter how simple, become complicated.