MauledAgain

In a Room for Debate commentary, Ryan Alexander questions the need for, and the appropriateness of, the tax-exempt status of the National Football League. The NFL qualifies, not because it fits within a definition, but because the Internal Revenue Code specifically exempts professional football leagues. No such exemption exists for the NBA or major league football, but somehow the NHL and the PGA also managed to get this treatment.

According to Alexander’s sources, the NFL collected roughly $327 million in 2012. Those uninitiated in how the income tax functions, as demonstrated by some of the comments posted to the article, might think that tax rates ought to apply to that amount. However, the NFL turned around and spent some amount of money to pay its employees, pay rent on its offices, and to fund other business expenses. Those amounts should be deductible. In theory, the dues paid by NFL teams to the NFL ought to be enough to cover expenses, and the NFL should break even, or come within some de minimis amount of doing so. The Joint Committee on Taxation estimates that roughly $11 million of tax revenue is lost each year, which suggests that the NFL is collecting more in dues from its member teams than it is spending on its behalf. It seems to me that more information is needed to get a better picture of why and how this tax-exempt benefit was sought and is being used. An organization that collects dues from its members and spends those dues on behalf of those members, thus breaking even, doesn’t need tax-exempt status. If the NFL is making money, why should it be exempt from income taxation?

In a letter to the editor of the Philadelphia Inquirer, titled Rewrite, Don't Blame, Michael Colgan, chief executive officer of the Pennsylvania Institute of CPAs, claims that President Obama “missed the mark” by placing “blame for corporate inversions on ‘accountants going to some big corporations . . . and saying we found a great loophole.’” Colgan asserts, “The real blame lies at the feet of the president and Congress for not tackling the long-overdue rewrite of the U.S. tax code.” Though Colgan is correct that inversions are not illegal, including the president, or any president, among those deserving of blame for the mess that is the Internal Revenue Code totally misses the mark.

Colgan should know and understand that the Internal Revenue Code is a product of the Congress. The President cannot enact, declare, create, or amend the Internal Revenue Code. Yes, a President can make suggested changes, as every President, including the current one, has done. But Congress is free to accept, reject, or modify those rejections. In the case of the current President, the Congress has demonstrated no inclination to do much of anything with his or anyone else’s suggestions with respect to reforming the tax law. The Congress is too busy listening to the tax wish lists of the mega-millionaires and billionaires who fund their campaigns and tell them what to do.

Colgan lets us know that the Internal Revenue Code needs to be fixed and that doing so is a “monumental, yet critical, initiative.” He’s correct. He concludes, “[T]he CPA community stands ready to assist in this enormously important endeavor.” The CPA community can begin its assistance by joining in efforts to clean up and reform the Congress. That means putting an end to lobbying for the clients and, instead, advocating for the public common weal.

On Sunday, Mark Zandi published a commentary in the Philadelphia Inquirer in which he shared some thoughts about corporate inversions. A few weeks ago, in Spinning the Inversion, I criticized those who defend inversions by relying on claims that inversions are good for the economy and that shareholder profits trump all else.

Zandi, on the other hand, tries to get at the root of the problem. He concludes that “the U.S. corporate tax code . . . is a mess.” He’s right. So, too, is the tax law for individuals, trusts, estates, partnerships, and tax-exempt organizations.

Zandi points out, “Some companies pay little tax because of loopholes in the code designed just for them.” Again, he is right. The issue isn’t the nominal tax rate, but the effective tax rate, and the problem is that corporations are not taxed at a uniform effective rate. Zandi notes that “[f]inancial institutions, energy companies, and some manufacturers” benefit from tax breaks. I’ll add that in some way those companies managed to “persuade” Congress to cut their taxes, not by playing with the rates, but by enacting narrowly applicable deduction and credit provisions of use only to those who hired the “lobbyists” who “persuaded” Congress to make the tax laws messier on behalf of those companies or industries.

It would be helpful to look at the list of companies going the inversion route, determine their effective tax rates, and then compare those rates with those incurred by corporations that are not inverting. There’s a research project in that proposal for some enterprising LL.M. (Taxation) or M.T. student who is about ready to ask for paper topic suggestions. My guess is that those corporations paying taxes at effective rates of fifteen, ten, and even zero percent have no reason to spend money doing an inversion.

The lesson here is simple. Let’s stop with the special treatment for a favored few. Though those favored with special tax breaks can throw together arguments why they are so much more important to the economy than anyone else, careful consideration and thought generates the conclusion that they’re no special than anyone else. If the citizens of this nation stand up to demand an end to the economic bullying that afflicts federal, state, and local tax systems, as well as the not-so-free free market, the nation will thrive in ways that presently are unattainable.

As Zandi points out, eliminating the special breaks permits a reduction of the corporate tax rate for all corporations. That sort of fairness might be objectionable to those presently doing well as a result of the economic bullying, but that sort of fairness is a core ingredient in what makes the American economy prosper. When fairness is compromised, everything else will collapse, sooner or later.

A little more than two years ago, in The Frequent Flyer Flap, I discussed the tax consequences of receiving frequent flyer miles. The discussion included consideration not only of miles received from the airline, but also miles received from third party vendors in connection with the making of a purchase or the opening of an account. I explained how the IRS positions with respect to the receipt of frequent flyer miles for tickets purchased on employer accounts and miles received from banks for opening an account could be reconciled. I also pointed out that all sorts of questions remained to be answered.

Last week, in Shankar v. Comr., 143 T.C. No. 5 (2014), the Tax Court held that the value of frequent flyer miles received by the taxpayer for opening a Citibank account was includable in gross income. The taxpayer’s testified that he knew nothing about the miles and did not receive an award from the bank. Thus, the court was left with the IRS determination of when the gross income occurred and the value of the tickets. The IRS produced evidence from the bank that the miles had been redeemed in 2009 for tickets worth $668, the price that otherwise would have been paid. This was the amount that the bank included on a Form 1099 sent to the taxpayer. The taxpayer did not include this amount on his return. The facts played out as I had predicted in in The Frequent Flyer Flap:

Citibank, which transfers frequent flyer miles to customers who open an account with the bank, issued Forms 1099 to its customers, reporting the value of the miles – that is another issue – as miscellaneous income. The practical effect is that failure by the customer to report the income will cause the IRS computers to make an adjustment because there is no entry on the customer’s income tax return matching the Form 1099.

The court treated the miles received from the bank as interest, that is, an amount provided to the taxpayer for depositing money into an account available to the bank for its use. The court did not discuss why the valuation was based on the price of the tickets at the time of redemption rather than the value of the miles at the time of receipt. Nor did it discuss why the gross income occurred in the year of redemption rather than the year of receipt, though it is unclear from the opinion when the account was opened and the frequent flyer miles provided to the taxpayer, and if that transaction also occurred in 2009, it would not have been an issue worth discussing in this case. In a footnote, the court simply stated that the parties had not addressed, nor was it considering, whether award of the frequent flyer miles was the taxable event. The taxpayer appeared pro se, which explains in part why the issue was not presented.

The narrow holding of the case simply confirms a position the IRS expounded several years ago, namely, that frequent flyer miles received for opening a bank account were taxable. Other questions remain to be answered. For example, what if the taxpayer already had frequent flyer miles, and those received from the bank were added to the ones he already had, perhaps from making previous ticket purchases? How would it be determined if the taxpayer used the miles from the bank, the previously accumulated miles, or some combination, to purchase the $668 tickets? Would some sort of specific identification method be used, such as determining if the coupon or other document from the bank was transferred to the ticket agent? If so, who is responsible for keeping track of the transaction? In this case, the redemption apparently was processed somehow through Citibank, which issued the Form 1099. But apparently not all redemptions are processed in this manner.

The decision does not apply to all incentive rewards. As I explained in The Frequent Flyer Flap, the law is more complicated:

Does the IRS position mean that all items received as an incentive to doing business with a company includible in gross income? No. If the incentive is in the form of a rebate, it is not includible in gross income. Nor should there be gross income if the incentive is part of a package. For example, a buy-one-get-one-free promotion is nothing more than a reduction of the market price to half the stated price. Similarly, a buy-three-suits-get-a-free-tuxedo arrangement falls into the same category. On the other hand, if no purchase is involved, such as opening a bank account, there is no transaction to which a rebate can be connected. There is gross income. As the IRS spokesperson put it, whether something received for doing business is taxed as a prize or award "depends on the nature, value, and other facts and circumstances." That's a way of generalizing what I just explained in the preceding sentences. When the author of the story claims that the IRS explanation is "a fancy way of saying the IRS doesn't know," he is falling into the trap of wanting a definitive answer for a range of situations that cannot be bundled together for analytical purposes.

For example, how should frequent flyer miles or similar incentives or points provided by credit card companies be treated? Clearly they do not represent interest paid to the taxpayer was the case in Shankar. Are they rebates from the vendor selling the product or service charged on the credit card, and thus simply a reduction of the purchase price? Are they compensation payments from the credit card company for using its credit card? It’s not a reduction of the interest charged by the credit card company because they are awarded even if the cardholder pays all balances and thus is not charged any interest. Is it a rebate to the merchant for using the credit card company’s system which the merchant chooses to share with the customer by having the credit card company make the payment on its behalf? Is it simply a rebate of the purchase price along the lines of the auto manufacture rebates to customers of automobile dealers, which the IRS concluded were not gross income and reduced the purchase price of the vehicle? The IRS did not grace us with its reasoning for its conclusion with respect to the manufacturer rebate. Why is a payment from a third-party to a buyer of something a reduction in the purchase price? There needs to be some sort of underlying rationale – constructive this or that, agency, something – to limit the scope of the conclusion. The incentive to the manufacturer and the relationship between the manufacturer and dealer are fairly easy to see. The relationship between the credit card company and the merchant isn’t quite so clear. Some sort of rationale is needed to explain how far the Revenue Ruling conclusion can be taken.

This case supports three observations about tax law. First, contrary to the misguided beliefs of many, tax law does not always involve numbers and in fact often does not. Second, there do not exist answers to every tax question. Third, tax law and tax analysis is convoluted because the business world has become convoluted. In The Frequent Flyer Flap, I shared this thought:

The author of the follow-up article [in 2012, describing reaction to Citibank’s issuance of Forms 1099] notes that “this whole thing is a perfect illustration of why our tax system is so messed up.” Perhaps the tax system is so messed up because business transactions are so messed up. Once upon a time, a person paid a price for an item and that was it. Then the marketing gurus jumped in with all sorts of gimmicks, incentives, cross-arrangements and other “deals” that appear to be price breaks but in the long run cost the consumer. When Citibank buys frequent flyer miles, it incurs a cost, and to maintain profits, it must reduce the interest it pays on its accounts. . . . So if people want a simple tax system, simplify the unnecessarily complicated business arrangements.

Don't hold your breath.

A recent Tax Court decision, Oxford v. Comr., T. C. Summ. Op. 2014-80, delivers an interest insight into the intersection of the first-time homebuyer credit and the meaning of principal residence. Though the taxpayer argued that she was entitled, alternatively, to the credit as either a “first-time homebuyer” or as a “long-time resident,” the court did not reach the latter possibility because of how it analyzed the former.

The taxpayer purchased a home in 1998 in Wichita, Kansas, and used it as her principal residence until 2004, when she sold it because she became unemployed. She put her furniture into storage and moved into a mobile home owned by, and on the property of, her daughter. In 2005, the taxpayer started a new job in Palmdale, California, while continuing to live with her daughter, traveling not only between Wichita and Palmdale, but also between Wichita and employer sites in Texas and Georgia. When in Kansas she continued to live in the mobile home on her daughter’s property.

In 2007, the taxpayer purchased a fifth-wheel trailer, which she placed in an RV park in Palmdale. The trailer was hooked up to utilities in the park, but every six months, in accordance with park rules, the taxpayer moved the trailer to a different site within the park. The taxpayer had a car in Palmdale, registered it and the trailer in California, had a post office box near the park, filed California income tax returns using her California address, and had third-party information returns mailed to that address.

In March 2009, the taxpayer entered into a contract to build a house in Wichita. She moved into the house in November 2009, and began to use it as her residence.

The Court explained that the first-time homebuyer credit is available to a first-time homebuyer, which is an individual who had no present interest in a principal residence during the three-year period ending on the date of the principal residence in question. For constructed property, the purchase date is the day that the individual first occupies the residence. In this case, that took place in November of 2009. Thus, the question was whether the taxpayer had a present interest in a principal residence during the three years ending in November of 2009.

The IRS argued that the taxpayer owned a present interest in a principal residence during the three years ending on the day she moved into the residence constructed in Kansas, because she owned the trailer in which she lived in California. The taxpayer argued that although she owned the trailer, it was not her principal residence because her principal residence was on her daughter’s property in Wichita.

The Court sidestepped the dispute between the IRS and the taxpayer by first focusing on whether the trailer could be a principal residence. Because section 36 incorporates the definition of principal residence in section 121, the court applied the definition in the regulations under section 121. Those regulations provide that property used as a residence does not include personal property that is not a fixture under local law. Under California law, personal property is all property that is not real property, and real property is land, property affixed to land, property incidental or appurtenant to land, and property that is immovable by law. California law provides that something is affixed to land when it is attached to it by roots, imbedded in it, or permanently attached to something that is permanent. The Court explained that whether the trailer was affixed to the land depends on the facts and circumstances. The Court concluded that the trailer was not affixed to the land, despite being hooked up to utilities, because it did not sit on a foundation, it was supported by its wheels, it was required to be moved every six months, and it was moved every six months. Accordingly, the trailer could not be a principal residence, which meant that the taxpayer did not own a present interest in a principal residence during the three years ending in November of 2009. And with that conclusion, the other issues did not need to be addressed.

Had the taxpayer sold the trailer at a gain, the taxpayer would have had reason to try to persuade a court that she had sold a principal residence and was eligible for section 121 gain exclusion. Of course, she would not have prevailed. Yet in this situation, the fact that the trailer was not a principal residence was a good thing for the taxpayer. As I tell my students, sound bite generalizations and 140-character tweets oversimplify things. Though it might appear that characterizing a residence as a principal residence is an overriding tax planning goal, there are times when it is better not to make or win that argument.

Not quite a year ago, in Tolls, Taxes, and User Fees in a Public-Private Context, I wrote about a decision by the Supreme Court of Virginia rejecting a citizen’s claim that he could not be compelled to pay a toll for use of a previously toll-free tunnel that had turned over to a private company to which the state legislature had given toll-setting authority. The Court concluded that the legislature’s grant of toll-setting authority to the private company was not the unlawful delegation of the legislative power to tax, because the toll was not a tax.

Now the tide has turned. This time, it’s a matter of local jurisdictions trying to impose property tax on privately-owned bridges in the same area of Virginia. According to this article, the city of Portsmouth wants the owners of the South Norfolk Jordan Bridge to pay property taxes.

The bridge owners argue that the bridge is exempt from taxation because state law exempts from taxation any bridges and tunnels in Chesapeake Bay, its tributaries, or the Atlantic Ocean. They point to an amendment to recent budget legislation that declares, as a matter of restating existing law, that any bridge constructed and operated under specific statutory provisions “shall not be deemed to be within any locality to which it is attached,” without naming the Jordan Bridge.

The city argues that the legislation does not address taxation but simply deals with boundaries, as the amendment does not affect the state’s tax code but only its boundary-setting statutes. The city points out that the owners of the bridge rely on public services that are provided by the city, such as emergency response to accidents.

The dispute may end up in court. Or perhaps the legislature will address the situation. The author of the amendment in question claims that he and others in the state capital did not know the issue existed, and would have discussed the matter with legislators from the city had they known.

The deadlock demonstrates another reason why public services ought not be put into the hands of money-seeking private enterprises. Taking a position that public services ought to be made available to a private enterprise that doesn’t pay for those services is emblematic of the problems presented by post-modern capitalism. It would not be surprising to discover that the owners of private structures have paid lobbyists to “persuade” state legislators to exempt them from paying their fair share of the cost of the services that they use.

Perhaps the city should announce that it will accept the bridge owners’ argument that the bridge is not within the boundaries of the city, and that, accordingly, the city will continue to provide public services to those people and structures within its boundaries. What will happen when people realize that if they use the bridge and have an emergency, no help will be forthcoming? Perhaps they will stop using the bridge, which in turn would cut down bridge revenue. Post-modern capitalists need to understand that one needs to spend money to make money, and the idea of getting free public services is akin to trying to run a business on unwaged labor.

Earlier this month, in Philadelphia Lap Dance Tax Effort Bumped Up to Court, Which Grinds It Down, I continued the saga of the attempt by Philadelphia to impose its amusement tax on lap dances, a commentary started in Lap Dance Tax? and continued in Tax Review Board Strips City’s Lap Dance Tax Attempt. Now comes another development in the tale, in an article that prematurely suggests the final chapter has been written, “Court fight over lap-dance levy won't grind on.” To the contrary, a sequel may be waiting in the wings.

According to the story, the city of Philadelphia, which lost its appeal of the Tax Review Board’s adverse decision, has let the deadline for appealing the judge’s decision pass by without taking any action. A representative of the mayor confirmed that no appeal would be taken, but added no additional information. It has been suggested that the city may attempt to raise the revenue by amending the amusement tax statute to make it cover the dancers. If legislation of this sort is introduced, rest assured that it will be debated and the lobbyists will be busy. The lawyer for the entertainment venues in question suggested that there are First Amendment issues, and also pointed out that this sort of legislation could reach other activities, such as karaoke singing.

Though the entertainment venues prevailed in this dispute, even if no legislative action develops, they incurred what their lawyer called “a small fortune” in resisting the city’s taxation attempt. Hopefully their tax advisors remember that there could be a deduction to offset part of the cost.

Somehow, I don’t think we’ve heard or read the last of this. Sequels are produced because someone thinks there’s money to be made. It only takes one member of City Council to propose legislation.

Though the report of the U.S. Treasury Inspector General on the collection of the medical device tax carries a July 17 date, it was issued just a few days ago. The report explains that the tax is not yielding as much revenue as was predicted, nor are as many companies filing returns as had been anticipated. The tax, which is controversial, probably is being ignored by some businesses that are required to pay it.

According to the report, the IRS lacks the ability to identify the companies that should be paying the tax. Nor does the IRS, according to the report, have the appropriate systems in place to ensure that the amount of tax being paid is correct.

To identify taxpayers and compute the appropriate tax, the IRS needs resources. Because the Congress continues to short-change the IRS, the resources must come from other tax enforcement programs. For all we know, the IRS shifted funds from other programs, but the amount that it was able to shift was insufficient to identify all of the taxpayers required to pay the tax.

When the Congress enacts a tax but fails to provide funding to collect the tax, the enactment of the tax is nothing more than window dressing. This approach probably is intended to make those favoring the tax pleased that it has been enacted while also pleasing those who oppose the tax by ensuring that some, most, or all of it will not be collected. When the tax was enacted, I considered it to be counter-productive, because it does not contribute to the diminishment of health care costs. For example, medical devices that screen for diseases and permit remediation before the disease generates a more expensive health problem ought not be taxed. What should be taxed are processes, habits, performances, and items that contribute to health care cost increases, though this sort of tax needs to be applied across the board and not just to a few items.

For me, this situation is just another example of how ineffective Congress has become. In time, if the trend continues, Congress will become irrelevant, and that’s not a good outcome.

Almost two years ago, in Public Financing of Private Sports Enterprises: Good for the Private, Bad for the Public, I pointed to the fiasco surrounding the financing of the Yankee Stadium parking garages as yet more proof of why public money should not be spent, either directly or through tax subsidies, to defray some or all of the cost of a private undertaking. To refresh the collective recollection:

When the new Yankee stadium was built, the owners managed to extract all sorts of public benefits to assist them. New York City waived $2.5 million in taxes. New York State waived $5 million in taxes. Federal tax breaks amounted to $51 million. New York City dished out $32 million to replace public parks seized by the state legislature. The state’s Empire State Development Corporation contributed $70 million. Some claim that public investment in the stadium and its parking garages comes in at $1.3 billion. Critics has opposed the garages because sufficient public transportation existed in the area, and because the garages are not what is needed to revitalize the neighborhood. Critics predicted that the garages would not be economically feasible.

So what happened? As predicted, the garages are an economic failure. Not surprisingly, the Bronx Parking Development Company has defaulted on $237 million of bonds that qualified for tax-exempt status under three tax systems, city, state, and federal. New York’s mayor has proposed that, “If the owners of the parking garage can’t make money, that’s sad. We’ve got to find a way to help them.” Really? What about the people who can’t make money because the jobs for which they are educated and qualified have been shipped overseas? Should “we” help them? If welfare is so bad, as the anti-tax and anti-government forces claim, why do we find the same folks supporting public assistance for millionaires and billionaires? Why?

Now comes news that the parking garages are helping themselves. According to the report, some Yankee fans who use the garages are being required to pay twice, first to a ticket machine that fails to generate a validation ticket and then again to an attendant who refuses to accept as payment the time-stamped receipt generated by the ticket machine. It happens frequently, and a police officer told one disgruntled fan, “They do it to everybody. It’s a scam.” Another police officer explained, “This happens all the time. They’re not going to budge.” I’m no expert in criminal law but it seems to me that some arrests are in order.

New York City’s Department of Consumer Affairs has handled 45 complaints against garages operated by the company in question. It earned an F from the Better Business Bureau.

Of course neither the development company that built the garages nor its partner company that operates the garages have commented. The development company benefited from $237 million in tax-exempt bonds as part of the deal that was described in Public Financing of Private Sports Enterprises: Good for the Private, Bad for the Public. Worse, it has racked up $48 million in unpaid rent, taxes, and other fees owed to the city.

There were those who said, “Cut out taxes and we’ll create jobs.” We know how badly that turned out. There were those who said, “Use public resources to fund private enterprise and it will do wonderful things for the citizens.” Now we’re seeing how that is turning out. Yet these are the folks who dare to label the disabled, the poor, the injured veterans, and the furloughed workers as “takers.” We know who’s doing the taking. It’s time for those who have been supporting these takers because they don’t like takers to figure out how ridiculous their thinking has been when they enter the voting booth.

Last week, on a visit to my son and daughter-in-law in Rhode Island, we drove past a campaign billboard on which the candidate’s promise was proclaimed. If elected, he would lower gasoline prices to $2.50 per gallon. I asked, “What’s the story with this guy?” I was told that Leon Kayarian had made that promise not only the highlight of his campaign but the only issue of his campaign. I was assured he almost certainly would not win.

Rhetorically, I asked, “How would he do that? Repealing the state gasoline tax would not lower prices that much.” To find the answer, I went to his web site, where he advocates adherence to the “Pickens Plan.” The gist of the Pickens Plan is that America needs to be energy independent. The Plan consists of using natural gas for fleets and heavy-duty trucks, modernizing the electrical transmission grid, developing renewable energy sources, and increasing energy efficiency in buildings. Those are all excellent goals, but how would achieving them reduce the price of gasoline? The Pickens Plan doesn’t appear to address that question.

Kayarian, however, claims that “THE KEYSTONE PIPELINE APPROVAL COULD BRING GASOLINE PRICES DOWN TO $2.50 A GALLON, OR AS LOW AS $1.87 A GALLON, LIKE IT WAS IN 2008.” The pipeline would move Canadian tar sand oil to the United States coast for export. It does not appear to have any effect on the refining of gasoline. Gasoline prices are affected by both supply and demand, and the reason for the low price in 2008 was the Bush Recession that drove down demand as the economy suffocated.

But Kayarian’s campaign puts the proposition in terms of a promise. If elected, how would he keep that promise? What power does he have as a state governor to affect the prices charged for a commodity traded on a global market? Would he dictate a price limit? All that would do is to drive the gasoline suppliers out of the state.

Yet the Pied Piper promises of cheap gasoline, $5 per month mortgage payments, nickel candy bars, three-dollar dinners, and zero taxes resonates with those whose inability to bring rational analysis to their decision making also prompts them to invest in the “guaranteed 40 percent annual return” and “triple your money in a week” investment offers. The number of people afflicted with this psychological impediment is much more than a few, which is why I wonder if perhaps Kayarian just might gather enough votes to win in a multiple-candidate election. Consider what similar campaign tactics have done at the national level. Not that it’s desirable, but it’s a genuine possibility. And a dangerous one.

A recent case, Chapel v. Comr., T.C. Memo 2014-151, illustrates why the “tax is numbers” mentality that convinces too many law students to ignore tax courses is so wrong. Though numbers matter, much of tax analysis involves words. In Chapel, a divorce decree incorporated a separation agreement into which two spouses had entered. The agreement provided that the former wife would receive “[a]n award of property settlement in the sum of $63,500.00, which amount shall be paid within thirty (30) days” of June 6, 2008. The agreement also provided the former wife an additional property settlement of $85,723. The agreement contained separate provisions under which spousal support would be paid to the former wife until she remarried or died or the former husband died.

In each of the first seven months of 2008, the former husband wrote checks to the former wife. The first five were for $4,300, the sixth for $4,944.33, and the seventh for $321.34. He also wrote a check, on July 23, 2008, for $63,500. The words “spousal support” were handwritten on the check and then crossed out. The former husband deducted $90,264 as alimony on his 2008 federal income tax return, with no explanation for the $1.67 discrepancy between that amount and the $90,265.67 total of the eight checks. The amount of another check, written in September for $3,761, was not deducted.

The IRS issued a notice of deficiency, determining that $63,500 of the payments was not deductible because it was a property settlement payment and not alimony. The Court concluded that the payment failed the requirement of section 71(b)(1)(B), which provides that, among other things, a payment is not deductible alimony unless “the divorce or separation instrument does not designate such payment as a payment which is not includible in gross income under this section and not allowable as a deduction under section 215.” Because property settlement payments are not alimony, designating a payment as a property settlement is the equivalent of designating it as not includible in gross income and not deductible. The Court relied on several facts. First, the agreement stated that the former husband was required to make a $63,500 property settlement payment. Second, the $63,500 was provided in one category of issues addressed by the agreement, and spousal support, or alimony, was addressed in another category. Third, the July 23, 2008 payment was the exact amount of the property settlement specified in the agreement.

The Court rejected the former husband’s argument that the July 23, 2008 payment was an alimony payment reflecting proceeds of his sale of stock, and that the $63,500 property settlement payment required by the agreement had been made in another transaction. The bank statement provided by the former husband to prove that the $63,500 payment was made in another transaction contained no information supporting that claim.

The former husband lost more than a deduction. The Court upheld the IRS imposition of the section 6662(a) accuracy-related penalty.

Words matter. The parties in Chapel could have arranged their financial settlement differently, reducing the property settlement and increasing the alimony. There are non-tax reasons why this might not appeal to one or the other of the parties. It is unknown whether they considered other options, but once they agreed that there would be a $63,500 property settlement payment, it was too late, when it came time to file the tax return, to characterize the payment as something other than a property settlement payment. Words matter. They tell us what we can do with the numbers.

Now that public attention is being turned to the corporate inversion tax-savings scheme, the spin doctors are coming out in full force. Nothing inspires the anti-tax crowd as fervently as any sort of criticism of, or legislative attack on, their inability to understand or accept the apportionment of social costs.

In Tax inversions help, not hurt, the economy, Diana Furchtgott-Roth argues that corporate inversions “have benefits for the American economy.” She claims that, “They make it easier for companies to invest in the United States.” She points to the 35 percent marginal rate as imposing a 35 percent cost on bringing overseas earnings back into this country. The flaw in that argument is that a variety of deductions and credits reduces the EFFECTIVE tax rate from the NOMINAL rate to a much lower rate. This is the same flaw in reasoning that underpins the claims that the wealthy pay more than 40 percent of their income in federal income taxes, when in fact that is a MARGINAL rate and not the AVERAGE rate. That’s why comparing nominal rates in various countries is irrelevant. In her example, if a company brought back earnings to construct a factory, it would reduce its taxes through depreciation deductions. Of course, that’s not what the shareholders want to do. They want to bring back the earnings to put into their pockets, for subsequent re-transfer abroad, and that sort of transaction would be taxed, as it ought to be.

She claims that inversions “raise profits for U.S. shareholders, who can channel more funds back to America.” If inversions raise profits, they do so by cutting taxes, not by increasing productivity. If those profits are paid to U.S. shareholders, yes, they CAN bring funds back to America, but the question is, will they? The answer is no. Just as the “cut our taxes, we’ll re-invest the increase in our after-tax income in jobs” promise turned out to be the cry of a Pied Piper, so, too, the promise of re-investment in America is simply a case of corporations and their shareholders taking a page out of the Bush tax cut playbook. And we know who lost that game. Not the people getting the tax cuts.

If, as she claims, foreign corporations have an advantage over domestic corporations when it comes to investing in America, the answer is easy. Increase taxes on the activities of foreign corporations in this country to the point where the advantage is negated. What she fails to mention is that these foreign companies are owned by shareholders not only abroad but also in the United States. The much better solution, one that is beyond this post and way beyond political possibility, is to tax corporations the way we tax S corporations, a solution that I can support. Furchtgott-Roth seems to endorse that sort of approach, but fails to mention the political roadblocks, which will be steeper than those effectively raised when Congress tried to do the simple thing of requiring withholding on dividends.

Another point to remember is that the reason other countries have lower NOMINAL rates on corporations is that they have higher rates on individuals. But the anti-tax advocates don’t want that. They want the elimination of taxes so the resulting failure of government opens the door to ownership and control of the citizenry by the self-appointed, non-elected one-tenth of one percent.

In Three Cheers for Tax Inversions, Ross Kaminsky makes similar arguments. Yet he, too, confuses NOMINAL rates with EFFECTIVE rates. Few, if any, American multi-national corporations are paying 35 percent of their income in federal income taxes, not with the variety of tax breaks provided by their friends in Congress.

Kaminsky brings up the “we’re good for you so don’t tax us” canard. He rejects the idea that corporations should pay taxes because they gain benefits from doing business in the United States. Instead, he spotlights the gains these companies bring to the United States. If he pushed his reasoning to its limit, no one should pay any taxes because everyone brings a benefit by being here. High-taxed middle-class workers surely bring benefits to this country on account of the goods they manufacture and the services they provide. Everyone who eats food brings benefits by injecting money into the economy by buying food. It smacks of the perspective that the one percent are far more valuable to society than the 99 percent.

Kaminsky then argues that “Companies don’t pay tax; people do.” But, the Supreme Court has said corporations are people. They contribute to political campaigns. They even have religious beliefs. So, as people, they can pay taxes. Yes, I’m being a bit facetious, but the “Companies don’t pay tax; people do” argument is a red herring.

Kaminsky reveals his underlying philosophy when he describes the paradise created by eliminating corporate income taxes. Money would go to consumers, workers, and shareholders rather than to “our wasteful and largely incompetent government.” Again, we saw what happened when this argument was pushed in favor of the tax cuts for the wealthy. His suggestion that corporations would raise worker pay flies in the face of what has happened since 2001. The increase in after-tax cash flow has poured into the overseas coffers of the wealthy, while the economic position of workers has declined.

On the other hand, eliminating the corporate income tax and taxing corporate income in the way S corporation income is taxed, as Kaminsky seems to suggest, makes sense and is an approach I can support. Kaminsky, like Furchtgott-Roth, doesn’t mention the opposition to that approach that would come from the anti-tax crowd. Also, like Furchtgott-Roth, Kaminsky claims that foreign corporations have an advantage over American corporations, but he doesn’t explain why that advantage cannot be eliminated by taxing those corporations when they do business in this country. If other nations want to cut corporate taxes and make up the difference by taxing individuals, so be it, though that, too, is an option that exist for this country though, again, the anti-tax crowd will oppose it because its goal is the elimination of all taxes.

Kaminsky is disturbed by the idea that the nation needs “a new sense of economic patriotism, where we all rise or fall together.” He finds this even more upsetting than the claim that “There is nobody in this country who got rich on his own.” In an attempt to spin around from reality, he claims that “There is nothing patriotic about being a slave to your country and unable to succeed on your own efforts, courage, and creativity.” Aside from the fact that a good chunk of the wealthy did nothing but emerge from their mother who happened to be wealthy or happened to have hooked up with wealthy, those who were not born into wealth but attained wealth status did not get there on their own. They used public infrastructure. They were protected by public military and public police. They were also protected by public social norms. They were enabled by customers and clients who tolerated their flaws. Those underlying structures cannot exist without government, because there is no such things as an unregulated free market. Without regulation, markets become the playground for economic bullies. When Kaminsky claims “I don’t succeed or fail based on whether my neighbor does,” he totally misses the point. If your neighbor cheats in the marketplace, steals your trade secrets, cyber-attacks your data, or damages the pubic infrastructure on which you rely, it not only can impede you, it can destroy your business. Ask the folks who dealt with Enron, Adelphia, Worldcom, and that wonderful parade of losers.

Furchtgott-Roth asks, “What is more American than doing what is best for your company?” The answer is, doing what is best for America no matter what it does to the company. That is what America did during World War II. If today’s generation of “capitalists” were the folks around back in the 1940s, we’d be speaking German or Japanese. The better question for these right-wing economists who think they know everything about money is one that determines if they understand the bigger picture. “What’s worse than godless communism?” The answer? “Godless capitalism.” And ultimately, that is what is wrong with twenty-first century global capitalism.

My recent post on the latest developments in the attempt by Philadelphia to subject lap dances to the amusement tax, Philadelphia Lap Dance Tax Effort Bumped Up to Court, Which Grinds It Down, inspired a reader to ask me if I had seen a recent story about the judicial decision treating strippers as employees for labor law purposes.

Though there are some differences between the tests used for labor law and for tax law purposes when trying to decide if someone is an employee or independent contractor, the analysis in the case is quite similar to that found in tax cases. It is reasonable to assume that when the tax aspects of these arrangements are raised, that the analysis will end up bringing a court to the same outcome.

According to the decision by a federal district judge in Philadelphia, the strippers are employees, and thus must be paid minimum wage, must be compensated for overtime work, and are entitled to retain all of their tips. The judge based this conclusion on these facts:

-- the club at which the strippers work determines the price paid by customers, and dictates the length of lap dances.
-- the club requires the strippers to share their tips with the club’s DJ, “house mom,” and “podium host.”
-- the club fines the strippers for arriving late, leaving early, using cell phones, chewing gum, entering and leaving the stage other than through the stairs, or not wearing their hair down.
-- the club specifies how the strippers are to make themselves appear physically, providing a salon on the premises for this purpose.
-- the club requires strippers to work at least four shifts a week to avoid paying shift fees.
-- the club keeps each stripper under management review.

The bottom line is that the club controlled the strippers’ work. That is the same principle that underlies the approach taken for tax purposes.

That the IRS and state revenue departments will be paying attention to this decision is evident from the amount of money involved. There’s quite a bit of FICA, unemployment compensation tax, worker compensation premiums, and withholding when an employee stripper can earn, according to the club, as much as $1,600 per shift. With a minimum of four shifts per week, the arithmetic suggests a stripper could bring in north of $300,000 in a year.

Too often, those trying to make even more money, including schemes taking advantage of tax law provisions, are blinded by visions of short-term gain because they cannot see past the glittering buckets of gold. Thus, they fail to see what is waiting in the wings, or what is lurking behind the horizon. Savvy investors know that the long-term mattes no less than the short-term, because even with time value of money being taken into account, omitting long-term effects is a recipe for disaster. Of course, sometimes that disaster is foisted on unwitting investors who consider this shortcoming by others to be yet another opportunity to funnel wealth into their insufficiently-filled bank vaults.

Recently, the public and some politicians have had their attention drawn to corporate inversions, a technical tax-elimination ploy with which international tax practitioners have been familiar for more than the few months the topic has made headlines. Dozens of American companies, resting on the principle that their shareholders ought not ever pay taxes and deserve infinite rates of return on their investments, have resorted to the inversion trick, prompting outcries from politicians. But politicians are not a threat to the inversion game, because collectively they lack the willingness or ability to do anything about it, thanks to being owned by the very companies using the technique.

But the public poses a very different, and real, concern. Recently, reports began to circulate that Walgreen planned to move forward with an inversion. The news generated ripples of indignation across the country. According to this report, Walgreen decided not to undertake an inversion. The reason? According to the CEO, “hard-to-quantify but significant potential for consumer backlash.” Indeed. What happens to a company if, perhaps magically, most or all of its customers decide to turn elsewhere because they do not approve of the company’s policies? The answer should be obvious.

Of course, the boycott approach to dealing with companies that put infinite profit growth above all other concerns does not work if the product or service is necessary and there is no alternative source. This is the major reason the handful of people who own almost everything push for deregulation, repeal of antitrust laws, and creation of monopolies. People laughed when, decades ago, I began using “Megaowneverything Corp.” in some of my questions. “Won’t ever happen,” they claimed. It hasn’t happened yet, but we’re getting there.

Another challenge to corporations that want to consider long-term effects of a decision when analyzing the sense of making the decision is what the report called “pressure from investors.” Most investors, reflecting modern (or is it “post-modern”) culture, want instant gratification. They want to invest a dollar today and receive a bazillion dollars tomorrow. Rather than trying to make a living or make a good investment, they want to make a killing. They will, but what they kill won’t be what they expected to kill. Their investment, their revered golden goose, will end up in a grave. But unfortunately, the not-so-golden geese of hundreds of millions of people will go down just as well.

There are ways to put an end to the greed frenzy that is the root of this nation’s problems. But that won’t happen until people do more than simply suggest their boycott of one corporation. Until long-term considerations are given their due, short-term success remains nothing but a mirage.

About a year ago, in Lap Dance Tax?, I described the City of Philadelphia’s decision to impose its amusement tax on establishments that provide lap dances. The establishments argued that the tax applies only to the admission fee, a tax that they have been paying, and does not apply to the “separate experience” of the lap dance. I shared the opinion that the tax should apply to the lap dance fee if “in fact the lap dance is amusement.” I pointed out that that if the lap dance is amusement, the tax should be paid by the recipient of the lap dance fee, which could be the dance or the establishment, depending on how the fees are handled.

A few months later, in Tax Review Board Strips City’s Lap Dance Tax Attempt, I shared the news that the city’s Tax Review Board unanimously concluded that the amusement tax applies only to the cost of admission to an establishment. I pointed out that the Board “did not reach the issue that I think needs to be decided, which is whether the lap dances constitute amusement.” I explained:

If the tax applies only to admission fees, then why is the statute not phrased in those terms? The language “to attend or engage in” is broader than “to be admitted to,” but rather than focusing on dissecting the language in that manner, the city argued that the lap dance fee was the equivalent of a new admission fee, an argument rejected by the Board. Because the Board concluded that the amusement tax did not apply to lap dances, it did not reach the issue, raised by the establishments, of whether the lap dances are exempt from the tax on the basis of being theatrical performances.

Now comes news that a Common Pleas Court judge has upheld the Board’s decision. Because I cannot find the judge’s opinion, and I’m not sure there even is a written opinion, I cannot evaluate how the judge reached this conclusion. The reports do indicate that lawyers for the establishments pointed out that if the city prevailed, it could go into a restaurant and impose a separate amusement tax on account of the piano player or go into a bar and impose a separate amusement tax on account of each karaoke performance. The lawyers suggested that the city’s effort to expand the tax started with gentlemen’s clubs because “no one feels sorry” for them.

A lawyer for one of the establishments opined that the court decision “should be the end of it.” But though the city has not announced whether it will appeal, the city solicitor stated, "We believe we are legally justified." Unlike lap dances, which I’m told don’t last very long, this dispute over taxing them might become a dance tax marathon. My guess is that the lawyers will need to wiggle through a few more proceedings.

According to this report, the Pennsylvania House adjourned until September 15 without considering a proposal for a new Philadelphia cigarette tax designed to offset shortfalls in funding for the city’s schools. School officials suggested that the schools would not be able to open on time. They are “annoyed, disappointed, and frustrated,” but the Pennsylvania legislature, in abandoning the capitol, seems to be taking the lead from the Congress, also champions of being absent more than present.

In all fairness, there are serious questions about the wisdom of the proposed tax, but facing the issue and voting on it is what legislators are paid to do. If the Philadelphia School District is given authority to collect this tax, will other school districts ask for the same and should their requests be granted? Another question, raised by Stu Bykofsky in this commentary, is why schools should be funded with a tax on cigarettes. Bykofsky points out that most smokers are “on the bottom of the socioeconomic ladder” and are among those least able to deal with the extra tax burden. He points out, as is the case with all “sin” taxes, that if the tax causes people to reduce, or even stop, smoking, the revenues it generates will fall or even disappear. Taking the same position that I do with respect to user fees, as I noted in When User Fee Diversion Smacks of Private Inurement and its predecessor posts, it doesn’t make sense to “tax smokers to use the Walt Whitman bridge.” Bykofsky suggests taxing “the actual users of the schools” or their parents. On this point, I disagree. Public education benefits more than just the children enrolled in the schools. It benefits the employers who hire the schools’ graduates, it benefits society through the contributions the graduates make by using their education, it benefits civilization by adding intelligence to the voter gene pool.

I’m not sure how serious Bykofsky is, because he seems to suggest that his proposal isn’t “real,” and that instead the tax should be imposed on laywers, lobbyists, bankers, and politicians. He claims that lawyers use the taxpayer-funded court system “for free,” but that’s factually inaccurate because lawyers pay to be members of the bar, and they and their clients pay all sorts of filing fees and court costs. Taxing lobbyists would run into First Amendment problems, and taxing politicians isn’t going to happen. Why tax bankers and not hedge fund managers?

The tax that makes the most sense to fund public education is the income tax. Most public education is funded through the real property tax, which lets off the hook more than a few people who benefit from public education. Of course, the anti-tax, anti-government crowd objects to any taxation and objects to public education. An educated electorate is the enemy of an oligarchy.

Though tax law is not the only area of law, or life, that is complicated by the twists and turns of retroactive repeals and pretending something that existed didn’t ever exist, it certainly is a contender for being at the top of the list of law practice areas afflicted by yet another sort of complexity that bedevils not only tax practitioners but also taxpayers trying to comply with the law. Worse, there are times that the “pretend it never existed” becomes “pretend it never existed except for the times we pretend that it does exist.”

The provision in question is section 121(d)(11). Last week the Office of Chief Counsel to the IRS issued CCA 201429022, in which it explained the status of that particular paragraph of the Internal Revenue Code. The question presented to the Chief Counsel was a simple one. Is section 121(d)(11) still in effect?

Section 121(d)(11) was originally enacted as section 121(d)(9) by section 542(c) of P.L. 107-16, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). It became section 121(d)(10) when re-numbered by section 101(a) of P.L. 108-121, the Military Family Tax Relief Act of 2003, and then became section 121(d)(11) when again re-numbered, this time by section 403(ee)(1)-(2) of P.L. 109-135, The Gulf Opportunity Zone Act of 2005.

Section 121(d)(11) provides that when deciding if a taxpayer qualifies for the section 121 exclusion on gain from the sale of property acquired from a decedent, the taxpayer may take into account ownership and use by the decedent in determining whether the ownership and use periods required by section 121 have been met. Section 121(d)(11) was effective for estates of decedents dying after December 31, 2009, but under section 901 of EGTRRA, it would not apply in taxable years beginning after December 31, 2010.

However, section 301(a) of P.L. 111-312, The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (TRUIRJCA) repealed section 121(d)(11), as though it “had never been enacted.” Nonetheless, section 301(c) of TRUIRJCA provided that the executor of a decedent dying in 2010 could elect to apply section 121(d)(11) as though the repeal in section 301(a) did not apply to property acquired or passing from the decedent. Subsequently, section 101(a)(1) of P.L. 112-240, The American Taxpayer Relief Act of 2012 (ATRA) repealed the title of EGTRRA that contained section 901. Section 101(a)(1) of ATRA does not repeal section 301 of TRUIRJCA nor does it reenact section 542(c) of EGTRRA.

Thus, when the dust and smoke of this jumble of legislative juking and dodging cleared away, the bottom line is a bit less complicated. If the decedent died in 2010, and the executor makes the election under section 301(c) of TRUIRJCA, section 121(d)(11) does apply, despite being repealed as though it never existed, and the decedent’s periods of ownership and use can be taken into account in determining if section 121(a) applies to the property acquired from the decedent. Otherwise, the decedent’s periods of ownership and use are ignored. Thus, for property acquired from decedents dying before or after 2010, or in 2010 if the executor does not make the election, the decedent’s periods of ownership and use are irrelevant.

So section 121(d)(11), originally enacted as section 121(d)(9) but repealed before it could spring into life under its original terms, survives for a very limited number of taxpayers. So the answer to the question of whether it is still in effect is the classic, “It depends.” It is, for a very few taxpayers, and it is not, and never was in effect, for most taxpayers.

It’s getting to the point where it is difficult to decide what is worse, a Congress that like the present one, does nothing other than gripe and complain, or a Congress that does things but produces the sort of muddled legislative history summarized in the preceding paragraphs. But, as too often now happens, they make it harder than it needs to be.

A recent commentary from The Institute for Policy Innovation bemoans the possible derailment of the Permanent Internet Tax Freedom Act by the addition of unrelated provisions to the legislation. Since its inception, the movement of legislation through the Congress has been hampered by extraneous amendments, a snag in the process that ought to be eliminated. On that point, I agree with the commentary.

The commentary points out that if the legislation does not pass, the existing moratorium on certain internet taxation will expire. The current moratorium prevents internet access taxation, and also prevents states from requiring use tax collection by out-of-state retailers with no connection with the state. The commentary carries the headline, “The Senate’s Plan to Increase Your Taxes,” and projects tax increase amounts that include both internet access taxes and use tax collections.

When it comes to internet access taxation, expiration of the moratorium, which in all fairness cannot be considered a plan of the Senate or even a plan of those who are using the legislation for other purposes with no avowed intention of derailing it despite their inability to see that outcome as a consequence, the commentary is correct. Letting the moratorium expire would permit states and localities to impose access taxes, and those taxes would qualify as tax increases.

But when it comes to the use tax, it is wrong to classify the tax as an increase. The use tax is an existing tax. People who are not paying the tax and thus violating the law are not facing a tax increase when they are obliged to comply with the law. The tax obligation exists and is not being increased when it is being collected. The use tax issue presents a different concern. States struggle to collect the use tax, as I have explained in posts such as Collecting the Use Tax: An Ever-Present Issue, a person who purchases taxable items in another state is required to pay the use tax, but does so only if avoidance is pretty much impossible because the purchase is a big-ticket item that needs to be registered, such as a vehicle or boat. Thus, for example, a resident of Pennsylvania who goes to Delaware, a state without a sales tax, to make a purchase owes a use tax to Pennsylvania. Pennsylvania cannot compel the Delaware merchant to collect the Pennsylvania tax. Nor should Pennsylvania be permitted to require the Delaware merchant to collect the tax if the purchase is made when the resident goes to the Delaware merchant’s web site, unless the Delaware merchant otherwise has enough activity in, or connection with, Pennsylvania to be subject to Pennsylvania jurisdiction. Letting the moratorium expire would open the door to states trying to compel out-of-state merchants to do tax collections, but it would not increase the use tax that already is owed. What would increase is the administrative burden and expense faced by out-of-state merchants.

One solution that ought to be considered is a simple one. If state 1 wants to collect an existing – not increased – tax from its residents’ purchases from out-of-state merchants, it ought to offer those out-of-state merchants a financial incentive to do the collection. Surely whatever cost there is in re-programming web sites and in-store point-of-sale terminals to collect the sales tax – something already done by the national retail businesses – can be more than offset with a payment equal to a percentage of the use tax being collected. Though the state would not necessarily receive as much as it would if the residents paid the existing tax, the state would be getting something, which is more than the nothing that that states usually receive.

The commentary’s main point, though not articulated as precisely as it could or should be, is important. Legislation addressing an issue ought not be sidetracked with unrelated matters. But that is not enough. Legislators ought to be focusing on ways of collecting an existing tax using sensible processes, and commentators ought to be encouraging productive efforts by legislatures.

I must admit I was surprised to discover someone asserting that “Obviously retired people do not pay INCOME TAX.” I had not previously encountered this myth. In another post, a commentator provides some of the flawed reasoning behind this sort of assertion, explaining “there are some small percentage who retire before age 65 and these retired people do not pay taxes (due to no income, except that they are well-off to live on past earnings.” Someone who is retired and living off of accumulated savings surely has investment income, which is taxed. Retired individuals, no matter the age at which they retire, are taxed on their pensions, their retirement income, and in some instances, on a portion of social security benefits. To claim that retired people do not pay income tax is just one more unfortunate tax myth.

It isn’t difficult to find web sites that contain statements claiming that children do not pay tax. For example, an answer to the question How many taxpayers are there in the U.S.? was tagged as “wrong” because “Children do not pay tax.” The statement was followed by another erroneous assertion. A similar reaction appeared in response to the question Is it really true half the country doesn’t pay income tax?, from someone who not only claimed that “children do not pay income tax,” but also delivered several other questionable assertions.

Though there are some exceptions to certain state taxes based on a person’s status as, for example, unemployed or elderly, the federal income tax does not contain any blanket exemptions based on age, physical condition, or occupation. A tax liability exists if taxable income exceeds zero, or if a taxpayer has positive taxable income but qualifies for a credits that reduce tax liability. Those credits, however, are not sufficient to exempt all children from having federal income tax liability. A child of any age, with gross income exceeding whatever standard deduction is available, has federal income tax liability.