MauledAgain

Most of the time, when someone complains about tax being complicated, the reason is on account of what lawyers call the substantive law. In other words, the rules for computing tax liability are complex. Not only are computations sometimes reminiscent of those long-ago algebra classes, but determining how transactions are classified requires digging through general rules that are curtailed by exceptions, exceptions to exceptions, exceptions to exceptions to exceptions, special rules, and transitional rules. Fortunately, computer software can assist with much of the computational frenzy, assuming the programmers understand what needs to be done.

On the other hand, sometimes the complexity of tax arises from what can be confusing procedures. One might expect that the more complex the substantive tax law, the more complex the tax procedure. But that’s not the case. Some of the most vexing procedural snags can arise with respect to taxes that are computed rather easily.

For example, real property taxes are computed by multiplying the assessed value of the property by the tax rate. Sometimes a special rule permits reducing the assessed value. Sometimes a person qualifies for a reduced rate. Not infrequently, a property owner qualifies for a flat dollar reduction of the tax computed after multiplying the assessed value of the property by the tax rate. In almost every instance, the taxing authority almost always computes the tax and sends a bill to the property owner.

The fun begins when assessed values are increased and the property owner wants to appeal. If the property owner files the appeal before the bills are sent, in some jurisdictions taxing authorities can adjust the bill so that the old assessed value is used pending the outcome of the appeal. But in some instances the news that the assessment is being appealed doesn’t reach the folks who send out the property tax bills, and the bill that is sent reflects the newly assessed value. A property owner who is appealing the assessment is, in some jurisdictions, permitted to pay an amount reflecting the old assessment. But the property owner who is unaware of how the procedure works is apt to write a check for the amount shown on the bill and then go about trying to get the new assessed value reduced, expecting a refund if the appeal is wholly or partly successful.

According to this Philadelphia Inquirer story, things aren’t working out well in Philadelphia. It seems that most property owners who are appealing their new assessments are unaware that they can pay a real property tax computed by using the old assessment. Apparently the bills for at least 24,000 properties whose assessments are under appeal were sent out with tax amounts reflecting the new assessment. The cause, an official explained, was that the people sending out the bills did not get a list of properties for which appeals had been filed until it was too late to revise the bills. Another official used the word “confusion” to describe the situation. Indeed.

It’s worse. It seems that the owners of roughly 4,600 properties filed appeals even though the assessments on their properties were the same or even less than what they had been. In other words, taxpayers are filing appeals to complain that their taxes have been reduced.

The bottom line is that when a tax bill arrives, whether it is for real property taxes or any other sort of tax, the taxpayer needs to review the bill. In other words, the taxpayer needs to do what an auditor would do when examining financial statements. Look at each number. What is its origin? For a real property tax, look at the assessment notice and compare it to the assessment on the bill. Check the arithmetic. The bill probably is generated by computer software, but computer software is far from infallible. If unsure, get help.

About two months ago, in in If They Use It, Should They Pay?, and its follow-ups, The See-Saw World of Legislating Infrastructure Funding and Noticing a Tax, I described the long and twisted path taken by a simple proposal to raise tax revenues in Pennsylvania to fund transportation infrastructure repairs and maintenance. I pointed out that in the long run, the tax increase would be less than the vehicle repair costs incurred if the infrastructure repairs and maintenance were not pursued.

Now comes news, as reported in this story, that the governor of Delaware has proposed a 10-cent-per-gallon increase in that state’s gasoline tax. The revenue would be used to provide an additional $500 million to fund repairs and maintenance on the state’s transportation infrastructure. The average driver would pay an additional $57 per year, certainly far less than the cost of hitting just one unrepaired pothole. In addition to improving transportation safety, the work would create jobs.

It takes only one transportation catastrophe, such as the one last week in the nation’s southeast, to demonstrate the need for government and the need to fund government. The efforts to portray taxes as evil, though initially resonant with too many people, are being exposed as simplistic, misleading, and dangerous.

The People’s Court, with Judge Milian, has been the subject of two previous MauledAgain posts, The (Tax) Fraud Epidemic, and TV Judge Gets Tax Observation Correct. I have highlighted the importance of retaining records has been highlighted in more than a few posts over the years, including The Importance of Tax Record Keeping, The Aggravation of Tax Paperwork, and Failing to Keep Those Records Can Increase Taxes. Aside from the need to keep records, I discussed the question of how long records ought to be retained in Why the “Toss Tax Records After Three (or Seven) Years” Advice is Bad.

Several days ago, another episode of The People’s Court put the record keeping issue in front of however many viewers were paying close attention. The case involved a car owner who was unhappy with a body shop’s work in fixing a window in the car. As the case progressed, one of the questions that surfaced was the delay experienced by the plaintiff, who brought the car to the body shop many months before the window was replaced. The plaintiff alleged that the body shop repeatedly claimed that the reason for the delay was the supplier’s failure to supply the window in a reasonable period of time. The defendant disagreed, and tried to put the responsibility for the delay on the plaintiff. The defendant explained that the window arrived at the body shop within two days of when the plaintiff brought the car to the shop. Judge Milian asked the defendant for evidence that the window ordered for the plaintiff’s car had arrived within two days as defendant claimed. The defendant replied that he did not have any records because he doesn’t keep records for transactions that occur as long ago as two years. Judge Milian expressed surprise, pointing out that, as a business, he is required to retain records supporting income and deductions for at least three years. The defendant explained that because he did not make any money he didn’t need to retain records, and then claimed that he did not make any money on the particular job in question and so didn’t need to keep records of that job.

Two points need to be made for the benefit of all taxpayers, including business owners. First, records must be maintained for all the transactions during the year that affect tax liability computation, regardless of the income or loss computed with respect to a specific job, task, client, or customer. Second, even if a taxpayer loses money for a taxable year, records need to be kept in order to prove that the deductions exceed the gross income. Put another way, losing money is not a justification for not keeping records or for tossing out records too soon. In this particular case, the defendant’s business practices reflected other record-keeping deficiencies, such as a receipt for the customer that simply described the make and model of the car, with no notations referring to why the car was in the shop or any other details of the job.

During one of the breaks, the show’s host asked two spectators what they thought about keeping records. One of them replied that business owners need to retain records, if for no reason other than tax purposes. The other spectator simply said, “What she said.” It is refreshing that these two spectators understood the significance of record retention. Later, the show’s host advised viewers to keep records for six years. As readers of MauledAgain know, I think that six years is too short. As I stated in To E-File or Not to E-File: That is The Question:

Though some people don't hold onto their tax returns for more than say, 3 or 7 years, relying on the statute of limitations, I recommend holding onto all returns, if for no reason other than to maintain records of basis and to guard against the strange day when the IRS claims a return from some years ago was not filed, which would open the statute of limitations, and which can be rebutted quite easily by providing a copy of the return.

And if the tax reasons for keeping records isn’t sufficiently convincing, the prospect of coming up short in litigation when asked to produce evidence supporting one’s allegations should settle the matter.

Julian Block has a problem. He’s not the only one afflicted with it. It hovers over me, and many others. The problem? When we write things, in the back of our minds is the ever-present awareness that the next hour, the next day, the next week, the next month, can bring one or more changes that makes our words wrong. Tax law affects so many activities, and changes so often, that keeping up with it poses a challenge to taxpayers, tax professionals, and those who write about it. When someone is as prolific a writer as Julian is, a condition with which I can relate, keeping an assortment of tax books up to date is a never-ending task. Not unexpectedly, Julian rises to the occasion.

And so it comes to pass that eight months after reviewing the 2013 edition of Julian Block’s “Tax Tips for Marriage and Divorce” in Julian Block Looks at Marriage, Divorce, Affairs, Engagements, and Cohabitation in the Shadow of Tax, I have been given the opportunity to look at his 2014 edition. Once again, Julian gives his readers good reason to replace the book currently on their shelves, and provides those unfamiliar with his books a reason to make room for his latest effort. Though it is a tax book, it’s a fun read. Julian has dug up all sorts of tax cases involving marriage, divorce, and an assortment of other transactions that offer stories just as easily at home in the scripts of soap operas and reality shows. There are cheaters and thieves, engagement breakers, mistresses and prostitutes, liars and shoplifters, sick children and cash hoards, and a variety of other tales of joy and sorrow.

As usual, Julian has produced a book that is practical, easy to read, and interesting. He gets many of his points across by using the question-and-answer technique, with the questions being easily envisioned as inquiries handed up by someone next door or in the next cubicle at the office. Julian deals with just about every tax issue that pops up when people create and end all sorts of relationships. He explains the marriage penalty and marriage bonus, filing status, alimony, property settlements, child support, death of a spouse, bad debt deductions for loans to spouses that aren’t repaid, legal fees, the impact of divorce and separation on dependency exemptions and the child tax credit, the tax consequences of residence sales by married couples, and the impact of social security benefits. Julian explains how tax returns can open the door to discovering assets hidden by a spouse before or during the deterioration of a marriage.

The book concludes with a chapter on withholding computations, a chapter on amending returns, and a chapter on using IRS publications. He addresses these concerns not only in the context of relationships but also as issues facing taxpayers generally no matter their relationship status.

As I noted with respect to the previous edition, the title of the book is misleading. It’s difficult to make the title of a tax book, or for that matter, a tax course, technically correct and yet succinct. Julian does not limit himself to marriages and divorces. For example, he examines the tax challenges faced by cohabiting individuals. He considers whether an unmarried woman can deduct the cost of contraception, and whether the cost of gender reassignment surgery is a deductible medical expense. But as I tried to construct a revised title for Julian’s book, I found myself wallowing in painfully long captions, so I gave up! But don’t give up the chance to acquire this book.

Recently I’ve been asked, by people expecting federal income tax refunds, why it is taking so long for the tax filing season to get started. The answer is easy. As reported in this and similar stories, the delay is a direct consequence of the government shutdown last fall. Originally scheduled for January 21, the tax filing season opening day has been pushed back to January 31. Considering that the shutdown spanned 14 days, it is worth noting that the IRS managed to trim four days from the delay.

Why does it matter? There are, of course, those folks who will be waiting for at least an additional 10 days to receive their refunds. Because the April 15 date cannot be changed by the IRS, it also means tax return preparation work will be squeezed into a shorter period of time. In some instances, taxpayers will decide, perhaps at the urging of their preparers, to file extensions and submit tax returns later in the year. For some taxpayers, that’s not necessarily an advantage.

This is not the first year in which a tax filing season has been delayed. There have been times when the delay was caused by last-minute tax law changes enacted by Congress late in the preceding calendar year. It takes time for the IRS to prepare forms, update instructions, rewrite its publications, revise computer programs, and train employees, to mention just a few of the many tasks triggered by tax law changes.

Life for taxpayers would be much easier if the Congress would act responsibly when dealing with the tax law. Not only would taxpayers find it easier to plan and easier to file tax returns, the reduction of time pressure on the IRS would free the agency to provide more assistance to taxpayers. Waiting until the last minute to enact tax law changes gives politics priority over fiduciary duty. That’s wrong. Shutting down the government also give politics priority over fiduciary duty. That’s wrong.

Americans deserve better. When are they going to insist on it? Better yet, when are they going to vote for it?

A recent Tax Court case, Elder-Douglas v. Comr., T.C. Summ. Op. 2014-7, illustrates how not to compute a casualty loss deduction. The taxpayer’s vehicle was involved in an accident, and the insurance company determined that it was unsalvageable. The insurance company paid the taxpayer $47,950 for the vehicle, after subtracting a $50 deductible. The taxpayer claimed a $12,020 casualty loss deduction on account of the loss of the vehicle. The taxpayer computed the deduction by subtracting the $48,000 from $60,020, the original value of the vehicle. However, the first step in computing the amount of a casualty loss deduction is to subtract the insurance recovery from the difference between the value of the property immediately before the casualty and the value of the property immediately after the casualty, unless the taxpayer chooses to use cost of repairs as a substitute measure, though that was not relevant in this case. Because the taxpayer did not provide evidence of those values, and because the Tax Court was unwilling to assume that the vehicle’s value immediately before the accident was the same as its value when it was new, it upheld the determination of the IRS that the taxpayer was not entitled to a casualty loss deduction.

It is possible, though perhaps not likely, that the taxpayer’s vehicle was worth more than $48,000 immediately before the accident. If the taxpayer had acquired and presented proof of such a value, the taxpayer might have been entitled to a casualty loss deduction, depending on how the other limitations, especially the ten-percent-of-adjusted-gross-income reduction, played out. Obtaining that information is not difficult, but is something that most people don’t think of doing at the time. However, it is not impossible to acquire that information after the fact. As I tell my students, facts matter, disputes over facts are at the core of far more cases than are disputes over the law, and getting facts is something lawyers need to spend a good bit of time doing. So, too, should taxpayers, especially with respect to facts that only they can produce.

In previous posts, I have pointed out that the cost of failing to raise taxes or user fees can exceed the increase thereby avoided. In Liquid Fuels Tax Increases on the Table, I wrote, “Leaving gasoline taxes at their current levels guarantees more bridge collapses, and pothole-caused front-end alignment repair costs that will take more out of motorists’ pockets than the proposed tax increases.” I made the same point in You Get What You Vote For, when I predicted that “front-end alignment spending will skyrocket past the small amounts that would have been paid if the [highway repair tax funding] proposal had been enacted.” In Zap the Tax Zappers, I explained why tax evaders need to face the consequences with these words, “Lest this be thought too rough, think of the person who dies when their vehicle hits a pothole and goes out of control, a pothole not repaired because of revenue shortfalls and spending cuts triggered by the actions of a group of people who refuse to pitch in and fulfill the obligations of citizenship.” In Potholes: Poster Children for Why Tax Increases Save Money, I shared news from the United Kingdom that the cost of damage caused by potholes exceeds the tax or user fee necessary to fix the pothole, and news from Los Angeles that potholes cause $750 of damage annually for each vehicle.

Now comes news about the scope of pothole damage in the United States, much of it caused by potholes either left unrepaired or fixed only after long delays on account of revenue shortfalls. In this Philadelphia Inquirer article, Ben Finley reports that each year, according to Independent Insurances Agents and Brokers of America, drivers file roughly 500,000 insurance claims for pothole damage and spend almost $5 billion on repairs. As best as I can tell, those numbers do not include hours lost driving the vehicle to and from the repair shop, the inconvenience of cancelling or rescheduling other events, and the overall negative impact on the economy. Nor is it clear if those numbers include medical expenses and other collateral damage arising from the consequences of hitting a pothole. The cost would be even higher if states barring lawsuits against highway departments for failure to repair potholes eliminated those legal barriers.

There are times when it makes sense to increase taxes or user fees in order to prevent even higher costs. Given the choice between paying an additional $150 in highway user fees or $750 in pothole repair costs, rational people would choose the former. Yet most people are willing to gamble, thinking that they are immune from pothole collisions or that they are in some way sufficiently special to have the ability to avoid potholes. The anti-tax crowd plays on this limbic system reaction to reality, parlaying people’s emotional weakness into political gains for those who benefit from tax reductions. Certainly the person who avoids a $150 tax or user fee increase only to incur a $750 repair bill had not received a benefit, but understanding that outcome before the fact appears to be a significant challenge for a huge number of voters.

As I concluded in Potholes: Poster Children for Why Tax Increases Save Money, “[T]he ultimate conclusion is that the anti-tax folks are working at cross-purposes with themselves. That comes as no surprise to me. Hopefully it comes as a wake-up call surprise to those seduced by the pied piper claims that people save money when they pay fewer taxes. The choice is easy to understand. Pay a little bit now or pay much more later.” I wrote that seven months ago. Later has arrived, and people are paying, paying much more.

Last week, a tax colleague at another law school pointed out the use of the term “IRS Code” in a Wall Street Journal story. This misleading reference, though common, surely cannot be accidental every time it occurs. On at least two previous occasions in Is Tax Ignorance Contagious? and Code-Size Ignorance Knows No Boundaries, I have criticized the use of the term “IRS Code” by people from whom I expected better.

Though sometimes the use of IRS Code is accidental, and in most of those instances probably a matter of someone uneducated in tax picking up the term from someone else, in too many instances the use of the term “IRS Code” is intentional. Why would someone intentionally make an error? The answer is simple. Someone who intentionally uses this term, knowing full well that the proper term is “Internal Revenue Code,” does so in order to sucker people into thinking that the IRS is responsible for what is in the Internal Revenue Code. Who benefits from shifting public unhappiness with the tax law to the IRS? Why, the people who are responsible for the Internal Revenue Code, specifically, members of Congress, their staffs, and the lobbyists who have procured much of what pollutes the tax law.

Unfortunately, the term “IRS Code” is going viral. More than 350,000 hits appeared when I put the term into a google search. The faster this nonsense spreads, the more difficult it becomes to eradicate its use. Unlike some errors, which are annoying but not particularly harmful, this error causes great harm and is particularly nefarious because it is the product of deliberate attempts to manipulate people. Until Americans get themselves educated about what matters, they will continue to be played and continue to complain about afflictions within their ability to eliminate. It is time to speak up and object whenever someone uses the misleading “IRS Code” term.

Last week, before the Senate vote on the extension of unemployment benefits, Pennsylvania’s Senator Pat Toomey, released a statement explaining his position and why he intended to vote against the bill. According to this story, Toomey said, “I have voted to extend unemployment benefits beyond the 26 weeks in the past. Unfortunately, this bill does not address the underlying problem. It does nothing to boost economic growth or spur job creation. A better approach would be to address the Administration's job-killing policies, such as Obamacare, the War on Coal, and our overly complex tax code.”

Look carefully at the last sentence. Toomey claims that the Obama Administration has job-killing policies. That may or may not be true. Toomey then provides three examples of what he considers to be the Obama Administration’s job-killing policies. The first is Obamacare. Perhaps Obamacare kills jobs. Perhaps it does not. The second is the so-called War on Coal. Perhaps that policy kills jobs. Perhaps it does not. The third is the complex tax code. Perhaps the complex code kills jobs. Perhaps it does not. What is manifestly absurd about Toomey’s statement is the description of the complex tax code as a policy of the Obama administration. The tax code is a creature of the Congress. Its complexity arises from legislation enacted before Obama became President. Though some of Obama’s economic proposals would add complexity to the income tax law, something for which I have been generous in criticism, those proposals have not been enacted and thus are not part of the complexity Toomey dislikes.

If Toomey truly dislikes the complexity of the tax code, he ought to know what to do. In case he does not, I’ll help him out. First, repeal the complex provisions that exist because special interest groups purchased the enactment of those complex provisions. Second, repeal the complexity that arises from using the income tax law for social policy purposes. Third, restructure, rewrite, and simplify what remains. Most of all, join with the other members of Congress in standing up and taking responsibility for what Congress has created. Stop with the feeble and disgraceful attempts to hold the executive branch responsible for the shortcomings of the federal legislature.

It’s inescapable. It’s the monster that will not die. I have complained about tax ignorance many times, 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, More Tax Ignorance, With a Gift, Tax Ignorance of the Historical Kind, A Peek at the Production of Tax Ignorance, When Tax Ignorance Meets Political Ignorance, Tax Ignorance and Its Siblings, Looking Again at Tax and Political Ignorance, and Tax Ignorance As Persistent as Death and Taxes, Tax Commercial’s False Facts Perpetuates Falsehood, and Tax Ignorance Gone Viral. Several days ago, another encounter with tax ignorance left me cognizant not only of how widespread this problem has become, but also of how pernicious it might be.

This time, it was a stranger posting a comment on a facebook friend’s page. When I read the comment, I had to shake my head. Anyone who knows anything about taxes should immediately spot the errors. According to the stranger, whose name I am not disclosing:

Social security has a max payout in benefits. A quick google shows it's at 3425 a month or roughly 41,100 a year. If somebody made 10,000,000 in a year and paid 6.7% in SS taxes, they would be paying 670,000 a year for something they would only see 41,000 of. Even at .7% they are currently paying more into a system than they would ever see in a return from that system.

In reality the rich are already subsidizing SS. The poor and the shrinking middle class are the ones who are taking more out of the system than they are paying in. You either want socialism or you don't.

The first error is that the combined rate is 7.65 percent, not 6.7 percent. The second error is that the old-age portion of FICA, setting aside the Medicare portion, is 6.2 percent, not 6.7 percent. The third error, one that goes to the heart of the absurd point that the strange was trying to make, is that a person who has wages in 2014 of $10,000,000, would pay the old-age portion of the tax only on the first $117,000 of wages. The person would not come close to paying $670,000 a year. The person would pay $7,254 in the old-age portion of the tax.

Of course, I posted a reply. I pointed out the major error, and explained that there is a $117,000 cap on the amount of wages subject to the old-age portion of FICA. And I noted that the entire point being made by the stranger “goes down the drain” and that the rich do not subsidize social security. I didn’t waste my time getting into the actuarial computations that factor in earnings on the amounts contributed by workers, the impact of amounts contributed by employers who, theoretically at least, would pay higher wages but for the employer portion of FICA, the fact that there are retirees who die before living long enough to losing out, and the financial stability of the system. When someone falls down trying to ride a tricycle, it’s not time to put them on a motorcycle.

The concern is that this misinformation, to use a kind word, will go viral, and hordes of unwitting people anxious to cast blame on people other than themselves will jump on the “the rich subsidize social security” bandwagon. The campaign to cast the middle class and the poor as the ones responsible for the sins of the evil elite is picking up steam, thanks to the increasing desperation of those whose misdeeds are increasingly coming to light.

How does this informational garbage get started? There are three possibilities.

The first is that the stranger, independently and on his own, conjured up his absurd statements, blindly tossing about facts without knowing the reality. Afflicted with ignorance, he tossed out conclusions too easily grabbed by others. Surely he did no or insufficient research. Was he the victim of inadequate K-16 education? Probably, but even if he could demonstrate that no one ever taught him the basics of social security that ought to be learned by every American, there is no excuse for his failure to educate himself or to seek assistance from those who are qualified.

The second is that the stranger, knowing full well the truth, nonetheless dished out lies in order to advance a political agenda important to that increasingly desperate group of tax and government haters. This sort of behavior is evil.

The third is that the stranger simply repeated something picked up somewhere else. Again, the stranger surely did not fact-check the assertions, because doing so would have revealed the truth. That the stranger refers to google, though not claiming to have used it himself, to prove what he claims is the maximum monthly social security benefit suggests that the stranger either failed to check the other information, or conveniently chose to ignore the truth. The person or persons from whom the stranger picked up the misinformation either themselves were ignorant or lied. At some point, though, the chain reaches back to the originator, and it is far more likely that the originator lied than simply manifested ignorance.

When people complain about the polarization of the country, when commentators lament the divide between citizens, and when politicians pretend to care about the erosion of the nation’s strengths, they need to understand that the gap is the product of a campaign that would not have succeeded but for the lies. Ultimately, the responsibility for the successful future of this nation is in the hands of the citizens, who have a moral obligation, and sometimes a legal obligation, to educate themselves before tossing off nonsense that can snowball into dangerous crowd-baiting.

If anything, this episode ought to convince Americans that it is time to stand up to, and call out, the liars, and to rescue the ignorant by bringing education back to what it once was, a feature of American democracy of which the nation once was proud. An uneducated citizenry is a breeding ground for tyranny.

Two and a half-years ago, in Tax Complexity: Why?, I explained that in the seven years between the first and second editions of Tax Management, Inc.’s 597 T.M., Tax Incentives for Economically Distressed Areas, one of the tax portfolios I have written, the number of what I call qualified distressed areas increased from six to 14, the number of qualified assets grew from 11 to 17, and the number of tax benefits for taxpayers who meet the requirements for operating a business or making investments in a qualified distressed area grew from 19 to 93. Some years ago, Congress decided to classify certain areas as one or another type of zone, with the intention of using the tax law to jump-start the economies of localities in economic distress. The tax law has been complicated with empowerment zones, enterprise communities, renewal communities, the New York Liberty Zone, the Gulf Opportunity Zone, the District of Columbia Enterprise Zone, economically distressed production areas, recovery zones, and a variety of other zones.

Has all of this tax zoning worked? One perspective is that it has, which explains the creation of additional programs. The other perspective is that it has not, which explains the creation of additional programs. If the first type of zone worked, then why not simply add additional distressed areas to the list of places qualifying for its benefits? Actually, that was done with one of the zones. But, for the most part, Congress continues to create new types of zones, each a little different, each posing traps for the unwary, each wrapped up in hyper-technical vocabulary, conditions, tests, and exceptions. Aside from the inappropriateness of using the tax law for social policy purposes, which also shifts these spending grants from the spending side of the federal budget ledger, it is inefficient and unwise to continue creating variations on the theme. There is no reason that the Congress cannot create one type of zone.

And now the President has announced the first five Promise Zones. Just what the tax law and the nation need, yes? No. Why not simply add these areas to the list of empowerment zones, or enterprise zones, or renewal communities, or recovery zones? Why not keep it simple? The answer is simple. Special interest groups, lobbyists, and politicians all benefit from the creation of more complexity, with special breaks for their “special” friends. No longer is the question whether it is beneficial for the common weal. Instead, it is measured by what can be hammered out for those who are too special to be included within an existing group.

I close with the final paragraph from Tax Complexity: Why?:

Isn’t it time that people get a handle on how much spending has been enacted in the tax law? Ought not economic benefits be treated in the same manner, whether they are direct grants or disguised grants hiding in complex Internal Revenue Code provisions? Is it not possible to create one set of rules for economically distressed areas? Why was it not enough to have empowerment zones? Why add renewal communities? And enterprise zones? Why are some tax benefits available to the Kansas disaster area but not the Hurricane Ike disaster area? Why are the special rules for the Midwestern disaster area different, and in some instances slightly different so as to catch the unwary off-guard, than those applicable to the Rita GOZone? Why are there different rules for the Hurricane Katrina disaster area and the GOZone, considering that the former is pretty much the latter? It’s not as though each time around, Congress refined the provisions and made them better or easier to understand. To the contrary, each of the many dozens of times Congress has added, modified, twisted, or tinkered with the provisions, the language became denser and longer. Why?

Why? Because Congress doesn’t get it. At all. Nor, in this instance, does the Administration.

I continue to be amazed by the number of people who insist that the solution to the job creation challenge is to reduce taxes. More than three years ago, in Job Creation and Tax Reductions, I wrote:

Will they create jobs if their taxes are reduced or if their tax cuts are extended? Not necessarily. A person does not “create a job,” that is, hire a person for a position that previously did not exist, simply because the person’s tax cuts are extended. People do not hire other people for the sake of doing so. They hire other people if they have work that needs to be done. Extending tax cuts does not cause an increase in the amount of work that needs to be done.

Less than a year later, I returned to the issue, in Why the Tax Compromise is a Mistake, explaining:

If the job creators want a cut in their tax liabilities, they need to do what I’ve been advising them to do for quite some time. Hire people, take the compensation deduction, thereby reduce taxable income, and watch tax liability go down. It’s that simple. Corporations and wealthy individuals are awash in cash, but they’re not creating jobs. Nor will they create jobs as their cash hoards grow from continued tax breaks. I explained this, for example, in Job Creation and Tax Reductions. The promise of jobs is an empty promise. By the time America realizes this, it will be too late.

Though increasing numbers of economists and commentators are beginning to comprehend the adverse consequences of buying into the “tax breaks create jobs” nonsense, a vocal slice of Americans continue to chant the mantra of the very few who have done well on account of the tax breaks for the elite. I continue to wonder why those who are being economically disadvantaged by specific policies continue to support those policies.

Suppose, for a moment, that tax rates were reduced to zero. Would there be a rush by businesses to hire people? No, there would not be. There would be a rush to increase prices, as business owners calculate that their customers can afford to pay more. Inflation would increase, ultimately leading to more economic difficulties and more job losses. As I consistently point out, businesses do not hire people if there is nothing for those people to do. For those people to have something to do, there needs to be demand. Demand increases when a wide swath of the population has the resources to purchase goods and services. The shifting of wealth and income into the hands of an elite few who control the economy has reduced the resources of the consumer class, and that is why the economy continues to underperform. Until Main Street understands that it ought not to try piggy-backing on Wall Street or Wall Street’s tax policy arguments, Main Street will continue to die a slow economic death.

The focus on using the tax law to encourage people to create jobs is one side of a coin, and it’s the side that turns up flat when tossed. A little more than two years ago, in Taxing Capital to Help Capital, I shared a perspective on modern capitalism that is finding adherents across political and economic spectrums. Specifically, I tossed out this suggestion:

Perhaps another approach is to use the tax law not only to reward those who create jobs, as the current tax law supposedly does, but also to punish those who fail to create jobs. Two-edged swords are much more effective that one-sided blades. The mechanism for doing this already is in place. It’s the corporate accumulated earnings tax, which is avoided by companies that claim they are hoarding profits for “future growth.” Nonsense. Those who wish to avoid the tax can invest the profits in construction of productive facilities and hiring of employees. And the tax needs to be extended to all business entities. I can hear the howls now. “You will kill capital.” To the contrary, capital is killing itself by focusing on short-term profit at the expense of long-term investment in labor. Capital needs to be taxed to save itself.

Nothing in the ensuing 27 months has done anything to change my mind. Yet during that 27 months, too many people jumping on or staying on the elite bandwagon haven’t noticed the cliff at the end of the road. Those “cut tax” sound bites might sound appealing, but so did the pipes of the Pied Piper.

Last Friday, in Earn Property Tax Rebates by Shopping?, I pointed out that when visiting a friend, I had noticed a sign that promised property tax credits to residents who shop in town. Residents obtain a card from the township, and present it at participating merchants when making a purchase, earning rebate credits applied to reduce the property tax bill. I noted that I didn’t know how long the program has been in effect, how successful it has been, or what percentage of residents and businesses are participating.

Clearly I had more learning to do about this program. That’s not a surprise. A reader of MauledAgain sent me links to similar programs in two other New Jersey towns. So the tally at this point is three: Marlboro Township, Bayonne, and <"http://www.voorheesnj.com/shop-voorhees-info.php">Voorhees Township. According to a facebook post, the program is or was being considered in Caldwell, but the link in that post goes to a dead page. Digging around a bit, I found the program in effect in Highland Park, ready to be implemented in Pequannock, and under consideration in Washington Township and other municipalities. A more detailed explanation of how the programs work is in this report, which also asserts that the program in Marlboro Township may have been the first in the country. To determine whether a program exists in a particular town, shoppers can visit this web site. Using that site, I discovered that the Property Tax Reward Program was developed by Fincredit, Inc., according to this explanation.

A member of the New Jersey legislature, according to this news release has introduced legislation that “codifies current practice and retroactively validates any municipality that implements the property tax rewards credit program.” The legislator explains that the program is “a win-win for everyone and will, I believe, serve as a model for towns throughout the U.S.” What I haven’t figured out is why the program started in New Jersey before legislation was introduced, and why it did not begin elsewhere.

The program, however, is not without its critics. For example, a candidate for mayor of Bayonne, in this letter to the editor explains that local merchants must pay roughly $300 to FinCredit for a card reader, must offer a discount to shoppers, must agree to funnel a portion of the money received from a customer toward the customer’s property tax bill or rent, and pay 25 percent of the savings to FinCredit. The candidate claims that merchants had already lowered prices to compete with box stores, giving customers savings without the use of a third party company, and notes that nearly half of the four dozen merchants who signed up in Marlboro Township dropped out of the program. The candidate asserts that the sales growth achieved under the program could have been accomplished by spending the money instead on advertising. Similar criticism is offered in this editorial, which also notes that some towns have rejected FinCredit’s propositions. Coming in the context of political campaigns, the best that can be said is that the program is not without controversy.

It remains to be seen whether the program takes hold across New Jersey or across the country. At the moment, it’s not getting the sort of attention one might expect. I would not be surprised to see that change.

A recent posting on a tax listserv grabbed my attention. A tax attorney’s client told him that she was going through a divorce, and had no money. Her accountant told her that because she had no money, there was no reason to file tax returns. Later, when she learned that was not the case, she contacted the tax attorney.

Though the tasks facing the tax attorney are one question, what took center stage in my mind was not only the absurd idea that a person with no money is not required to file tax returns, but also the disappointing news that a professional would give this sort of advice. I’ve discounted steeply the possibility that the client lied, because the client’s action in seeking a tax attorney’s assistance once she learned that the prior advice was erroneous suggests veracity on her part.

There are a few taxes that are based on how much money a person has. There are a few taxes that are based on how much property a person owns, without regard to how much, if any, of that property is held in the form of money. But most taxes are based on factors other than how much money a person has, and this is something that anyone venturing to provide tax advice ought to know. It is not unusual to hear stories about individuals whose income tax withholding is insufficient, for whatever reason, and who spend all of their take-home pay, only to find themselves the following spring owing income taxes but having no money. The lack of money does not reduce the income tax that is due. This happened not too long ago to a graduate of an elite law school, and that story perhaps deserves its own commentary.

There are some basic tax concepts that everyone should know. At the very least, there are tax concepts that every tax professional should know. It is not only disappointing but dangerous for tax advisors to be dishing out clearly erroneous information about taxes.

I learned something the other day. I was visiting a friend and noticed several billboards encouraging people to shop in the township. The signs included a slogan, “Shop in Town, Earn Property Tax Credits.” My friend explained that residents can obtain a card from the township, and present it at participating merchants when making a purchase. The resident earns rebate credits that are applied to reduce the property tax bill. Merchants benefit from higher sales volume because the program encourages residents to shop within the township. I think what is happening underneath the transactions is that the resident is giving up what might otherwise be a purchase discount for what is a larger property tax rebate. The merchant, although losing some money on sales to regular customers, makes additional money from the increased volume. I don’t know how long the program has been in effect, because I didn’t ask. Nor do I know how successful it has been or what percentage of township residents and merchants are participating.

It’s an interesting and creative idea, though I’d like to know more about the program’s track record before forming a firm opinion. At least it wasn’t called the Frequent Shopper Rebate program, because that would provide too much of an excuse for the people who like to shop until they drop, line up for Black Friday starting on Thanksgiving afternoon, and need to hire youngsters to carry all their packages. Seriously, for towns trying to preserve Main Street businesses and discourage residents from journeying to large shopping malls in other locations, it might be worthwhile checking out this program in places where it has been implemented.

Whether bicycles should be taxed is a question raised by a headline earlier this week in a Philadelphia Inquirer report. The headline, “As City Cycling Grows, So Does Bike Tax Temptation,” not only raised that question but suggested that bicycles are not currently taxed. As a matter of fact, in states that impose a sales tax, bicycles are taxed in all or almost all of them. I don’t think there are exemptions for bicycles as there are in many states for items such as food and clothing, but perhaps there is a state that provides a bicycle exemption.

What the story addressed was a proposal in Chicago to impose a $25 annual cycling tax. Proponents point out that the city spends money blowing snow from bike paths. What’s being proposed might fare better if it were called what it really is, a user fee. These sorts of fees are not unusual. The state of Hawaii requires a registration fee from bicycle owners not unlike the fee required from motor vehicle owners. Colorado Springs charges a $4 additional tax on the purchase of bicycles, and dedicates the proceeds to what it calls bicycle infrastructure. The $4 tax was enacted after being proposed by the cycling community.

Proponents of a bicycle user fee think that infrastructure construction and repair for the benefit of bicyclists should be funded, at least in part, by those bicyclists. They also think that registration assists in deterring and solving bicycle thefts, and makes it easier to enforce traffic laws often broken by bicyclists.

Opponents of a bicycle user fee question the feasibility of enforcing a user fee, and suggest that the cost of enforcement might consume some or all of the user fee. They highlight the benefits bicycles provide, such as less pollution, less traffic congestion, and healthier populations. They ask why pedestrians using sidewalks are not charged a user fee for shoes.

Aside from a few “sin” taxes on items that provide little if any benefit but enormous detriment, almost all user fees and taxes are imposed on activities or things that provide significant benefits, often outweighing the detriments. Without trains and trucks, goods could not be shipped to market, but using that sort of argument to prevent taxation of trains and trucks can be extended to the point at which little, if anything, is taxed or subjected to user fees. The better approach is to consider the costs imposed on the commons by an activity or an item, and to compute a user fee that reimburses that cost. At that point, those engaging in the activity or owning the item can decide whether it is economically feasible to continue with the activity or ownership.

Chicago’s response to the question was no, in the sense that the proposal was left hanging out to dry. Similar proposals during 2013 in Georgia, Oregon, Washington, and Vermont, made little or no headway. It remains to be seen what 2014 will bring. Surely more proposals. Perhaps a user fee or two.

When a taxpayer signs a contract, the terms of that contract quite often dictate the tax consequence. This point was highlighted in a recent case, Sharp v. Comr., T.C. memo 2013-290. The taxpayer sued her former employer because she contended that she had been compelled to resign because the employer and other employees made her life so miserable that she ended up with muscle tension, migraine headaches, fear of going to work, fear of people, nightmares, and depression, for which she was hospitalized. She sued the employer on at least two grounds. The first was a workers’ compensation claim. The second was a claim for the gross negligence of the employees. The taxpayer and the employer settled the litigation. In the agreement, the employer promised to pay $210,000 in each of three annual $70,000 installments. The agreement described the payments as for “emotional distress damages only.” When the taxpayer received the first $70,000 payment, she excluded it from gross income, attaching a statement to her income tax return explaining that the payment was excluded under section 104(a)(2). The IRS disagreed and issued a notice of deficiency, recomputing the taxpayer’s tax liability by including the $70,000 in gross income. The attorney who represented the taxpayer in the case against the employer also represented her in the Tax Court, and also was the attorney who advised her to exclude the payment from gross income.

The taxpayer argued that the section 104(a)(2) exclusion applied because the payment was received under a statute in the nature of a workers’ compensation act. The Tax Court disagreed, pointing out that the language of the settlement agreement made no mention of a workers’ compensation claim being paid. The taxpayer offered no other evidence of the employer intending to pay any portion of the $210,000 in exchange for settling a workers’ compensation claim.

The taxpayer also argued that the section 104(a)(2) exclusion applied because the $210,000 was on account of personal physical injuries or physical sickness. Again, the Tax Court disagreed, noting that the settlement agreement provided that the payment was for “emotional distress damages only.” Accordingly, none of the settlement proceeds could be on account of personal physical injuries or physical sickness. The court also explained that emotional distress is not a personal physical injury or physical sickness even if it is manifested in physical symptoms, citing several earlier cases that had reached the same result.

I wonder whether, in settling on a $210,000 amount, the taxpayer, and her attorney, viewed this amount as a tax-free amount. Had they understood that it would be taxed, would they have insisted on, and held out for, a higher amount so that the after-tax equivalent would have been $210,000? I also wonder, if non-taxability was important, why did they not insist that the settlement agreement contain language that characterized the payments as settlement of workers’ compensation claims or claims for negligence causing physical sickness? If the employer was adamant in not conceding a workers’ compensation claim, or negligence of the other employees, that position would strengthen the taxpayer’s resolve to receive more than $210,000 in order to cover the tax liability.

Unfortunately, section 104(a)(2) remains a trap for those who do not fully understand how it applies. In this instance, the taxpayer and her attorney got caught in the bizarre distinction between physical injury and emotional distress. As I noted in The Strangeness of Tax: When “Bodily” is Not "Physical":

The distinction between physical and non-physical injuries is, to me, rather outdated. When it comes to illness and disease, the distinction between “physical” and “mental” is disappearing, if not entirely gone. Emotional distress causes changes in brain chemistry, which clearly is a physical matter, just as a disease that changes blood chemistry is a physical matter. Perhaps an injury arising from slander or libel is not physical, in the absence of emotional distress symptoms, but the idea that emotional distress damages should be treated differently from those for a broken leg doesn’t make sense in the world of twenty-first century medicine. This is especially so considering that damages for emotional distress arising from a physical injury or illness are excluded.

Until Congress removes this artificial and questionable distinction from section 104(a), taxpayers and their attorneys need to be highly cognizant of the extent to which settlement contract language can affect income tax liability.

According to this story, an anonymous individual put a $3,500 diamond ring into a Salvation Army red kettle. This generosity follows a donation of $1,000 in cash last year, in the form of ten $100 bills, a donation of a gold nugget two years ago, and the donation of a gold nugget three years ago. Because the person calls the Salvation Army to alert the organization to look carefully at the contents of a particular red kettle, the Salvation Army knows that the donor is the same person.

Apparently, the anonymous donor does not care about the charitable contribution deduction that would be available if the Salvation Army issued the appropriate receipt for the donation. One reason for not caring about the deduction probably does not come into play, because it is unlikely that the donor’s itemized deductions are less than the standard deduction. Another reason also is improbable, because it is unlikely that the donor is buried in losses that generate zero or negative taxable income even without the charitable contribution deduction. Another possibility is that the items are stolen property and the donor is a thief trying to make good by finding a way to return the property, but would it not make more sense to deposit all of the loot at one time in an anonymous way with law enforcement authorities, who are capable of tracing the owners of recovered stolen property? The most likely reason is that the person does not want publicity.

So it remains a mystery, though a mystery that will bring some needed financial assistance to some people dealing with financial difficulties. It also brings a few dollars in tax revenue attributable to the unclaimed charitable contribution deduction.

When a snag in the tax law generates results for taxpayers that are undesirable in terms of policy, fairness, or computation, ought not any remedy enacted by the Congress apply to all taxpayers confronting that snag? One would think so, but that’s not how it works. When it comes to distributing presents, Congress is not necessarily even-handed.

Recent legislation provides a good example of the problem. Under section 501(c)(3), an organization cannot be tax-exempt, and under section 170 contributions to it are not tax-deductible, if, among other requirements, the organization benefits private rather than public purposes. Thus, when donors contributed to a fire company for the specific benefit of the families of two firefighters who had been killed in the line of duty, the fire company had to refrain from distributing the funds to those families because doing so would jeopardize its exempt status. The remedy was H.R. 3458, which was enacted last week and signed by the President on December 20. The bill does not fix the problem for all fire companies that find themselves in this sort of situation. Instead, it applies only to payments made with respect to “an emergency on December 24, 2012, in Webster, New York.”

Why is this a problem? The fire company in Webster, New York, has had to retain the donations until the legislation takes effect. That means the families have been waiting for financial assistance for almost a year. When the next emergency arises, in some other location, and firefighters are injured or killed, they and their families also will need to wait until Congress gets around to enacting legislation. How do we know this will happen? Because it happened to the Webster, New York, fire company. Unfortunately, it was not the first fire company to have members injured or killed in an emergency, for whom donations were made, and that had to hold the donations until special legislation was enacted permitting it to distribute the donations without losing tax-exempt status. It happened, for example, in 2007, in connection with donations made to assist the families of five firefighters who died fighting a Riverside, California, fire. Special legislation was required to permit distribution of donations made in the aftermath of the September 11, 2001, terrorist attacks.

It is not difficult to draft and enact legislation that would apply to all donations made for the benefit of emergency responders who are injured or killed in the line of duty while dealing with disasters, catastrophes, or other emergencies. That would permit fire companies and similar tax-exempt organizations to distribute expeditiously funds donated for the assistance of those who are injured and the families of those who are killed. It would eliminate the repetitive consumption of legislative resources moving bill after bill through the Congress and White House. It would be a nice gift to the nation and it would make sense. That’s why I doubt the Congress will do this for once and for all, the way it ought to be done.

The Reason Foundation has released a report, Unmasking the Mortgage Interest Deduction: Who Benefits and by How Much? in which the authors conclude: “We believe the most appropriate policy action would be a complete elimination of the mortgage interest deduction combined with reductions in marginal income tax rates to make the repeal revenue neutral.” The authors point out that the deduction is claimed on only one-fourth of individual income tax returns, and “almost exclusively benefits wealthy households and young Americans with large mortgages.” They argue that eliminating the deduction would “increase fairness and simplify the tax code.” This would permit reducing income tax rates.

Everything that the authors of the report argue makes sense. As an advocate of simplifying the income tax and not using it to accomplish purposes that are more appropriately achieved through other means, I support the conclusion. But it doesn’t go far enough. Everything that can be said about the mortgage interest deduction can be said about other deductions. For example, the charitable contribution deduction, the deduction for state and local income taxes, and the deduction for state and local real property taxes are claimed on less than half of income tax returns. These deductions benefit wealthier taxpayers because they benefit taxpayers who itemize deductions, most of whom are higher income taxpayers. See, for example, the Tax Policy Center report on deductions for state and local taxes.

What good reason exists to eliminate the deduction for mortgage interest but not the deductions for charitable contributions and state and local taxes? Unquestionably, advocates of the latter deductions have a list of reasons that they can offer, and that they have offered whenever someone suggests eliminating, or even scaling back, those deductions. The same can be said, however, of the mortgage interest deduction. Its advocates also have a list of reasons. For the most part, advocates of exclusions, deductions, and credits base their reasons on one common underlying claim, namely, that the tax break in question is essential because it does good things and because without it, the economy will collapse. The reality is that the economy will not collapse, generous people will continue to give to charity, and compliant citizens will continue to pay state and local taxes. The argument that removing the deduction reduces the incentive to give to charity, for example, is offset by the reality that reduced income tax rates will leave more money in the hands of taxpayers that can be used to offset the tax benefits lost by elimination of the deduction.

Simplifying the income tax by removing the hundreds of tax breaks that clutter the Internal Revenue Code makes sense. In fact, this approach makes so much sense that it was followed, though not as completely as it could or should have been, in 1986. Tax breaks were removed, and rates were reduced. So what happened? What happened is that the lobbyists showed up, arguing that the tax breaks benefitting their clients were so important, and so much more important than anyone else’s tax breaks, and persuading the Congress, ever in search of campaign contributions, to restore the tax breaks without bringing back the higher tax rates. Ultimately, this is a significant factor in the creation of annual budget deficits. What the lobbyists and Congress did is no different from what happens when one person agrees to pay for an item, the second person agrees to deliver the item, the first person pays, the second person delivers the item, and then the first person stops payment on the check. Breaking one side of the deal and not the other was and is wrong.

Perhaps the Reason Foundation has additional reports in the pipeline that will address other deductions. I certainly hope so. A quick check of its web site didn’t reveal if this is or will be the case, but sometimes things aren’t on web sites or are difficult to find. Though sometimes abandoned buildings need to be taken down brick by brick, sometimes it is more efficient and fair to knock the thing down with a wrecking ball. That is what should happen to the huge pile of tax breaks that benefit few and disadvantage many. There’s no point in picking on just one tax deduction.