MauledAgain

In a letter to the editor in Sunday’s Philadelphia Inquirer, which I could not find on the newspaper’s web site, asserts that Pennsylvania should not impose a severance tax on the shale-gas industry. The writer asserts that if such a tax were to be enacted, the industry would leave Pennsylvania. The writer also claims that the same Marcellus Shale exists in West Virginia and Ohio.

This claim, which has been made by the industry for several years, is nothing more than a test-the-waters threat. If it works, excellent. If it doesn’t, so be it. The risk is that those to whom the threat is delivered, take it seriously.

Why do I not take it seriously? Pennsylvania does not have a shale severance tax. Ohio and West Virginia do. Why would the shale gas industry, opposed to a shale severance tax, implement its opposition by fleeing to a state with such a tax? The reasoning presented by the writer suggests that the industry should be abandoning Ohio and West Virginia, and every other state, considering Pennsylvania is the outlier in terms of the severance tax, as it flees from taxation to a paradise of no or little taxation. But that is not what has been happening.

Consider the child who threatens to run away from home because she dislikes her parents’ imposition of a 9 p.m. curfew. If the child threatens to move in with a friend whose parents impose no curfew and let their children have free run of things, the threat might have some teeth, aside from the question of whether the other parents would open their home with welcoming arms. But if the child threatens to move in with a friend whose parents impose a 9 p.m. curfew, or, worse, an 8:30 p.m. curfew, the threat needs to be treated as the bluster that it is.

There is little or no downside to making threats in order to obtain something. The worst is a loss of credibility, but when credibility does not exist or is not valued, there’s not much to lose. It’s understandable that the industry would take the “there’s no harm in asking” or “no harm in threatening” approach. What’s not understandable is that people are cowed by the threat. The current downturn in oil and gas prices won’t last forever, and so long as there is a profit after taxes, the yet-to-be-extracted oil and gas will be an economic opportunity for someone. If the industry is willing to do business in states with severance taxes, as it currently is doing, it will be willing to do business in Pennsylvania even if it has a severance tax, and especially if that tax is lower than what is imposed by other states.

A recent case, Co v. Comr., T.C. Memo 2016-19, demonstrates the challenges for taxpayers who rely on advice from, and decisions by, IRS employees. From no later than 2007 through at least 2011, the taxpayer was paid by the Department of State to do engineering work on various projects overseas. The contractual arrangements and characteristics of those arrangements did not change during those years.

The primary issue was whether the taxpayer qualified for the section 911 exclusion from gross income for compensation earned abroad, but because the exclusion does not apply to employees of the United States or its agencies it was necessary to decide if the taxpayer, who was paid by a United States agency, was an employee of that agency.

On his 2007 and 2008 federal income tax returns, the taxpayer claimed the section 911 exclusion. The taxpayer’s position was that he was not an employee of the United States or any of its agencies. The IRS audited the taxpayer’s returns for those years. The IRS auditor informed the taxpayer that he was entitled to the section 911 exclusion for those years.

The taxpayer also claimed the section 911 exclusion on his federal income tax returns for 2009 through 2011. The IRS audited those returns, concluded that the taxpayer was an employee of a United States agency, and issued a notice of deficiency. The IRS claimed not only the tax liability arising from the denial of the exclusion, but also accuracy-related penalties.

The Tax Court held that the taxpayer was an employee as the IRS claimed, and rejected the taxpayer’s claim that he was an independent contractor. The fact that an IRS auditor told the taxpayer otherwise did not bar the IRS from taking its position. This aspect of the case is not news, as there are dozens if not hundreds of cases in which taxpayers following incorrect advice from IRS employees nonetheless were required to comply with the correct analysis of the tax law.

But when it came to the penalties, the Tax Court concluded that the taxpayer had acted with reasonable cause and in good faith. The penalties do not apply to a taxpayer who so acts. The Tax Court noted that the taxpayer did not have a background in accounting, finance, or tax. Under those circumstances, it was reasonable for the taxpayer to conclude that he was not an employee. The issue facing the taxpayer, namely, whether he was an employee or independent contractor, is an issue that confounds tax practitioners and judges, because its resolution is fact intensive and often rests on very close factual distinctions.

The question of how to deal with incorrect advice from IRS employees has befuddled the tax practice community for decades. On the one hand, it seems unfair to disregard the effects of that advice on the taxpayer’s preparation of a return. On the other hand, it seems unfair to all other taxpayers to permit someone to escape tax liability because an IRS employee is confused about, or ignorant of, the tax law. One solution, stopping IRS employees from giving advice, not only is counter-productive, but would not be a solution in situations such as this one, where the advice came during an audit. Another solution, having a supervisor review the advice would increase costs at a time when the IRS is under Congressional siege. Yet another solution, simplifying the tax law, though possibly reducing the number of times incorrect advice is given, would not solve the problem because sometimes the incorrect advice is given with respect to rather basic tax law questions.

In all fairness, dealing with incorrect advice about the tax law is not a unique problem. Similar issues arise with respect to every other area of the law, such a zoning, traffic regulation, environmental impacts, business licensing, and wills. The bad advice comes from every direction, not just government employees dealing with the issues, but from neighbors, relatives, friends, journalists, commentators, and even professionals in the relevant field. Perhaps better education, not only about the rules but about ways in which people can educate themselves about ever-changing rules, offers the best long-term solution. Perhaps teaching people to think like lawyers ought to begin in elementary school and not 20-some years into one’s education.

Readers of MauledAgain are well aware that I dislike tax break giveaways to wealthy corporations as rewards for moving jobs from one state to another. Job relocation is not job creation. One of the states that engages in this game of giving to the rich is New Jersey. As I’ve described in When the Poor Need Help, Give Tax Dollars to the Rich, Fighting Over Pie or Baking Pie?, Why Do Those Who Dislike Government Spending Continue to Support Government Spenders?, When Those Who Hate Takers Take Tax Revenue, and Where Do the Poor and Middle Class Line Up for This Tax Break Parade?, New Jersey has handed out tax dollars to companies that are doing well for themselves, claiming that by doing so New Jersey residents would get jobs. Instead, the employees of those companies keep their jobs.

In The Fallacy of “Job Creating” Tax Breaks, Yet Again, I pointed out that a report by KPMG and the Tax Foundation matched my previous conclusions: “But when it comes down to it, the tax breaks usually just move firms around a region and, on net, rarely yield much.” I noted that what they did yield was “quite a bit for the corporate owners who are already drowning in cash and profits.”

Now comes yet another report demonstrating that these tax breaks are built on the false promises of job creation. The Center on Budget and Policy Priorities issued a report about a week ago, the title of which offers a clue as to its conclusions: State Job Creation Strategies Often Off Base. The report concluded that “[t]he vast majority of jobs are created by businesses that start up or are already present in a state – not by the relocation or branching into a state by out-of-state firms,” and that “[d]uring periods of healthy economic growth, startups and young, fast-growing companies are responsible for most new jobs, that “businesses older than one year in aggregate lost jobs relative to their prior-year employment levels.”

The report also shared the conclusion of another study, that “only 5% of entrepreneurs cited low tax rates as a factor in deciding where to launch their company.” The report concluded that income tax cuts for businesses do little to generate job growth. The report noted that attempts to bring out-of-state companies into a state end up as “zero-sum attempts.” In other words, tossing out tax breaks based on the promise of more and new jobs when in fact the companies receiving the tax breaks do nothing more than move existing jobs amounts to yet another false promise from the devotees of supply-side economics.

The report makes sense, and its conclusions are not surprising. At a time when the focus should be on national economic growth, the constant luring of a company from one state to another is nothing more than economic civil war. The economic waste generated by lobbying activities focused on reshuffling production within the nation hampers the effort to maintain national economic strength on the global stage. As the report recommends, states should encourage the launching of new businesses and help existing businesses fulfill their potential.

A reader sent me a story that I probably would have otherwise missed. According to several reports, including this one, a woman and her son walked into a Liberty Tax Services office in Toledo, Ohio, pointed what appeared to be a gun over which a towel was draped, demanded money, and made off with $280. Someone in the office hit the son with a chair, but that did not stop him and his mother from escaping. Nor did a Liberty Tax Services employee outside the office door who was dressed as the Statute of Liberty. The two thieves managed to avoid being caught, but their good luck lasted only for a short time. It turned out that the “gun” was a curling iron. And it also turned out that the staff recognized the two as customers who had used Liberty’s services a few days earlier. It apparently didn’t occur to the mother-son team that they had provided Liberty Tax Services with all sorts of identifying information used in preparing their returns. Information like name, address, and social security number. Information that authorities are using to track down the thieves.

It was the sort of news that spreads so quickly that notices came to me from multiple directions. There was a posting on a tax listserv, an item in a daily tax update email, on-line articles, and newspaper reports. According to an IRS news release, its tax processing systems became unavailable because of a “hardware failure.” According to this report, the failure was caused by “a power or electrical issue.”

All sorts of thoughts passed through my brain. Was the failure caused by a power spike? If so, were surge protection devices in place? If not, why not? If yes, why did they fail? Were they outdated? Worn out? Improperly maintained?

Was the failure caused by a loss of power? If so, did backup generators kick in? If not, why not? Are there backup generators? Are they maintained properly? Are they outdated?

And once the hardware went down, why did the system not shift to backup facilities? Are there backup facilities? Are they maintained properly? Are they up-to-date?

The IRS explained that taxpayers should continue to file returns electronically and that the e-file providers will hold the returns until the IRS is ready to accept them. The IRS also explained that some of its web site services, such as “Where’s My Refund” are not operating even though other parts of its web site are up and running. The IRS expects no “major refund disruptions.” Of course, that depends on getting the hardware failure fixed, identifying the cause, and putting in place safeguards to prevent it from happening again.

Fixing the problem and preventing its recurrence requires money. Perhaps the antiquated status of IRS technology has something to do with this glitch. Imagine the outcry from Congress if a similar failure occurred with Defense Department computers. What Congress appears not to understand is that without a properly functioning IRS, including its technology system, there cannot be a properly functioning Defense Department or any other federal government agency or department, and many state and local government units.

Though some Americans might rejoice at the thought of the IRS being unable to function, the joy will turn to anger when they discover it means refunds aren’t being processed.

And again I ask, backups, anyone?

The headline to this article caught my eye. It caught my eye primarily because I could see it catching the eye of many people. It appeals to the need or desire for money that affects almost everyone. The headline?

“How to Get the Biggest Tax Refund This Year”

Wouldn’t it be fun to be the taxpayer with the biggest refund this year? Could that happen? What if there is someone out there who paid estimated taxes of, say, $500,000, and ended up overpaying by $300,000, and asked for a refund? How could I possible tweak my tax return to get a $300,000 refund? It isn’t going to happen. And it isn’t going to happen for at least 99 percent of taxpayers.

But perhaps the reference isn’t to the biggest refund this year of all taxpayers, but to the taxpayer receiving a refund this year that is the biggest the taxpayer has ever received. But can that happen? Yes. Is it likely to happen? No.

So I read the article. It contains a list of suggestions about one’s tax return, all of which are common knowledge to tax return preparers, and most of which are familiar to many taxpayers. A taxpayer who might overlook one or another of the tips that are provided but who is made aware of the deduction or other suggestion might end up with a bigger refund than would otherwise be received. Or perhaps with a smaller tax-due payment to be remitted to the U.S. Treasury. The article deserves a headline that reads, “How to Get a Bigger Tax Refund This Year” but that won’t get quite the attention that a headline with “Biggest” in it will bring.

Yes, that’s the question a reader posed to me. The reader also commented, “You think your taxes are complicated, try having a dependent who’s a clone.”

First things first.

Only an individual can be a dependent, either as a qualifying child or as a qualifying relative. Is a clone an individual? There is no legal authority on the question, because there has been no need to answer the question. If a clone is an individual, then under section 7701(a)(1), the clone would be a “person” for purposes of the federal tax law. But that doesn’t answer the question. Nor does it answer other questions that arise. For example, section 152(b)(3)(A) generally requires that a dependent be a citizen or national of the United States. Is a clone a citizen? Are clones “born”? As another example, consider the requirement that a qualifying child must meet the section 152(c)(2) relationship test. Is a clone a child, descendant of a child, a brother, sister, stepbrother, stepsister, or descendant of such a relative? The relationship test in section 152(d)(2) that must be met by a qualifying relative poses similar questions, adding to the list of possible relationships. Perhaps the easiest one to work out is the section 152(d)(2)(H) test of having the same principal place of abode, for that determination can be made in the affirmative if the clone is an individual. Yet even that provision raises another, surely bizarre, question. A spouse, by definition, cannot fall within section 152(d)(2)(H). If a person’s clone is not defined as bearing one of the specified relationships, then what is to stop a person from marrying his or her clone? Granted, that question takes us beyond tax law but tax analysis is not confined to the tax law.

One of my first thoughts on reading the reader’s email was, “Hmm. This is like the “what is the value of a law review article on the tax consequences of time travel?” example I use in class to warn students about drifting from the practical into the theoretical when doing so is inappropriate. Then I realized, having the ability to generate a clone is not the remote science-fiction notion that time travel prevents, and of course, some things that were dreams and imaginations in the science fiction books my brother let me read when I was eight and nine years old, to the chagrin of my parents, are today’s technology. And, of course, some aren’t. Yet.

The challenge is the tendency of legislatures to dilly-dally when it comes to being prepared for technological and societal advances. Some legislatures struggle just to do their current to-do list. History tells us that people and courts struggled with the legal and tax consequences of surrogate motherhood, email, radio, and a long list of other developments. I am confident that human clones will appear before legislatures take any steps to specify the legal and tax consequences.

So, my answer to my reader simply is, “I don’t know. I can guess, and you can guess, and it’s fun to share our guesses. But in the end, it’s that classic response, ‘It depends.’ Until then, think about it from time to time.”

Bill Dingfelder, a Philadelphia Inquirer reader, is fed up with the failure of the Pennsylvania legislature to approve a budget. He’s not alone. I’m certain far from impressed watching legislators serve special interests and campaign contributors with far more zeal than they devote to serving the people.

Dingfelder, in a letter to the paper’s editor suggests that the people of Pennsylvania “have the means to effectively pressure our elected officials to get this task done.” He encourages residents of Pennsylvania to stop sending tax payments to Harrisburg and instead to deposit them into an escrow account at their bank. He also suggests notifying the governor, state senator, and state representative that this is being done, and why it is being done.

Dingfelder notes that there are risks in doing this. He is correct. The biggest risk is that it will not work. Most taxes are paid into Harrisburg automatically. Most tax payments are controlled by software. Sales taxes are collected at the point of sale and transmitted through digital networks. Employer payroll departments use automated systems to issue paychecks or direct deposits, and those systems transfer funds automatically to the state treasury. The amount of taxes that can be held back by residents is rather small, and would be noticed only by Department of Revenue computers that would automatically issue notices and perhaps levies and liens.

On top of this, I am not confident that all, or even most, state residents are unhappy with the state legislature’s failure to pass a budget. It is no surprise that a budget cannot be approved, because different tax and spending policies are represented by the executive and by the majority of the legislature. So long as people keep electing legislators who hold positions opposite to those taken by the executives elected by the voters, stalemate is guaranteed. We have years of experience in Washington to illustrate this point, and it’s no surprise that state legislatures, including Pennsylvania, are similarly afflicted.

Holding back tax payments might be a marvelous, though risky, symbolic gestures. But gestures aren’t the answer. Politics and politicians are replete with gestures. What’s required is education, common sense, and attachment to principles that rise above what currently is stinking up American politics and its electoral system.

According to several reports, including this story, drivers contracting with ride-sharing outfit Uber were surprised when they logged into the company’s web site to obtain their Forms 1099. They discovered that what popped up was someone else’s Form 1099. These forms include home addresses and, worse, social security numbers. Understandably, drivers who received another driver’s information are concerned that their information has been disclosed to some other driver.

Uber attributed the mix-up to a “bug” in its system. It explained that the bug has been fixed. It is unclear whether it was just one driver’s information that popped up on multiple drivers’ computer screens. Apparently, and I had missed this, several months ago, the licenses and tax information of almost a thousand Uber drivers were disclosed to persons who should not have had access.

If my three decades of using digital technology, including programming, has taught me anything, it has reinforced what I have learned from my tax and law experience, namely, it only takes one little flawed detail to cause a cascading effect of problems. Actually, I learned that long before I wandered into tax, and long before I started in accounting by double and triple checking financial statements and tax returns. I learned it as a child, not only from my parents but from other adults, including employers for whom I worked while in middle and high school. Attention to detail matters. And because it’s so easy to make a mistake – I make more than enough of them – it helps to have a second, third, or even fourth pair of eyes review what one has done. Yet sometimes those extra pairs of eyes are nowhere to be found. For most people, editing is not as fun as writing, and testing is not as much fun as developing. Fortunately there are exceptions, such as those folks who enjoy being test pilots and copy editors.

The frustrating aspect of this story is the futility of trying to prevent it from happening. Often, there are lessons to be learned from a tax story that help individuals take steps to protect themselves, to guard their information, and to prevent troubling outcomes. In this instance, I’ve yet to figure out what sort of advice to give to a Uber driver to ensure that his or her tax information doesn’t show up on someone else’s screen. And it’s probably not just Uber drivers who faced or will face this risk. It’s all of us. It’s that aspect of tax that deserves the word “scary.”

No, it’s not ME asking that question. Who asked it? According to this story, Donald Trump did. Trump added that rhetorical quip to the end of a paragraph in which he opined, “What’s going on on Wall Street is ridiculous. Who knows it better than me?” I daresay there are people who know Wall Street better than does Donald Trump. I am very confident that there are people who know the tax code better than does Donald Trump.

Trump shared his thoughts during a speech a few days ago in which he explained that he pays as little tax as possible, using “every single thing in the book.” As long as what he is doing is within the law, so be it. Of course, the tax law is skewed in favor not only of the Wall Street “hedge fund guys” Trump criticized, but also wealthy investors like Trump himself. Trump admitted that he manages to “pay as little as possible” because “I have great people.” It is far from impossible that his “great people” know the tax code very well. Perhaps they know it better than anyone else, though that is unlikely. But surely they know it better than Donald Trump. That’s why he’s willing to pay them to do the tax work.

So, the answer to Donald Trump’s question is, “Your great people, for starters. And a lot of other people, too.”

In a recent announcement, the IRS has explained how it is attempting to reduce tax return identity theft. It revealed that some states, dealing with state income tax identity theft, will be asking taxpayers to provide a driver’s license number. The theory is that identity thieves generally do not know the taxpayer’s driver’s license number even if they have managed to acquire the taxpayer’s social security number, and that by asking for the driver’s license number, the state can match its driver license database with the tax return.

Of course, there are questions about how this will work, and whether it will work to reduce tax return identity theft. As expected, and as pointed out in this Bamboozled commentary, confusion abounds. New Jersey, for example, has announced that adding the driver’s license number when filing electronically will be an option. According to the Federation of Tax Administrators, an organization representing state tax department, almost every state and the IRS is requesting the number. The IRS, in its announcement, emphasized that providing a driver’s license number is not required to file a federal return.

In the meantime, tax return preparation software has been programmed to request the driver’s license number for all states except those, as of yet unidentified, that have opted out. It is unclear whether taxpayers can refuse to provide the number, whether the software will process the return without a number even if providing it is optional, and what happens to the taxpayer who has no driver’s license. In Alabama, for example, taxpayers can enter a string of zeroes instead of a driver’s license number. Will that slow down the processing of that return? That also is unclear.

Some tax return preparation software allegedly is requiring a driver’s license number even if the state makes it an option rather than a requirement. If a person has no driver’s license and the software refuses to accept a string of zeroes, what happens?

In the Bamboozled commentary, taxpayers are encouraged to provide their driver’s license numbers, if they have one. The commentary argues that providing the driver’s license makes it more difficult for identity thieves to engage in their fraudulent behaviors. The commentary then points out that people should “keep their driver’s license number protected.” Good luck with that. Social security numbers have been used, even in violation of law, by all sorts of businesses as a means of identifying customers. And for years, businesses have been using driver’s licenses to confirm identities, and have been entering the number, as well as photographs and photocopies of driver’s licenses into their databases, in many instances together with social security numbers. Those databases are not immune from hackers. Nor are the state and federal tax databases safe from intrusion. What happens once the hacking community gets into these databases and compiles lists of people’s names, addresses, social security numbers, and driver’s license numbers? And the Bamboozled commentary recognizes this risk, asking “Imagine if an identity thief has your Social Security number and your driver's license number?” and answering, “Not pretty.” No, not at all.

The problem is two-fold. On one side, better systems of identification are necessary, and need to be based on information that is not as easily stolen. Databases need to be secured more carefully than at present. On the other side, identity thieves and those thinking of engaging in that behavior need to be presented with changes in their risk analysis. Not only are better methods required to track them down, they also need to face more severe consequences for their behavior. True, privacy advocates who take extreme positions that permit criminals to hide will not appreciate steps that reveal the identity thieves, but in balancing interests, the experience of identity theft victims who end up alive but without a life demands that practical reality be given sufficient consideration.

Regardless of my comments, federal and state tax agencies will begin collecting driver’s license numbers. Not from everyone, but from enough people to permit, in a year or two or three, evaluation of whether doing so eased the tax return identity theft problem or made it worse.

A recent case, Garada and Elghosein v. Comr., T.C. Summ. Op. 2016-1, demonstrates the importance of understanding how constructive payments of deductible expenses should be treated. The taxpayers were shareholders in an S corporation. The taxpayers owned a property on which real estate taxes were due. The S corporation paid the real estate tax bill. The taxpayers deducted the real property taxes on their federal income tax return. The IRS denied the deduction, arguing that the deduction was not allowable to the taxpayers because the taxes had been paid by the corporation. Later, the IRS informed the court that it treated the payment as a nontaxable distribution to one of the taxpayers.

The Tax Court explained that payment by an S corporation of a shareholder’s personal expense is a constructive distribution. It pointed out that this principle had previously been articulated by the court. Thus, explained the court, “ It also follows that for purposes of claiming the deduction, the shareholder is treated as constructively paying the obligation.”

If the corporation had been a C corporation with earnings and profits, the constructive distribution would have been a taxable dividend. In the absence of earnings and profits, the constructive distribution would reduce the shareholder’s adjusted basis in the stock, and if the adjusted basis were insufficient to absorb the distribution, the balance would be treated as capital gain. In the case of an S corporation that has no C corporation earnings and profits, the distribution is a reduction of adjusted basis in the stock. But if the adjusted basis is insufficient, the balance is treated as capital gain. Thus, the fact that the constructive distribution was nontaxable to the shareholders in this case does not mean all constructive distributions from S corporations are nontaxable. It was nontaxable in this case because the taxpayers had sufficient adjusted basis to offset the constructive distribution. Had that not been the case, the shareholders would have recognized gain.

Would the tax analysis have been easier if the S corporation had written a check to the shareholders, and the shareholders then written a check to the jurisdiction imposing the real estate taxes? Of course. But as I’ve told students in the basic tax class, one of the techniques that tax professionals must learn to use well is the ability to take what appears to be one transaction, in this case a check from an S corporation to a local jurisdiction, and to split it into two, or more, transactions. Actually, that is a skill useful in other areas of law as well as in other disciplines, but it is a skill that many people find difficult to understand.

The “lower taxes means more jobs” argument continues to find support. Specifically, there are two variations of the argument. One is that lowering taxes on wealthy individuals generates jobs. The other is that lowering or eliminating taxes on corporations generates jobs. The first variation was used to justify huge tax cuts for the wealthy in the early years of this decade, and it was followed by one of the worst economic experiences of this nation’s history. When tax rates were permitted to increase somewhat, though not totally offsetting the cuts, the economy recovered. Now attention has turned to the second variation. An example is this commentary, in which Tom Giovanetti of The Institute for Policy Innovation argues that eliminating the corporate income tax would create an “explosion of economic growth and job creation.” Would it?

There are good reasons to eliminate the double taxation of C corporation income. But doing so requires something different than simply eliminating the corporate income tax. The income needs to be taxed to those who earn it, namely, the shareholders. This concept of integrating corporate taxation has been around for decades, and has been implemented to the extent corporations elect to be S corporations, though not all corporations have that option. It is true, as Giovanetti points out, that the corporate income tax ends up being paid by the corporation’s employees, shareholders, and customers, though economists differ widely on how much of the burden is carried by each of the three groups.

What happens if the corporate income tax is eliminated without corporate income being taxed when it is earned? Corporations, or more specifically, corporate shareholders, will continue to have incentive to limit dividends, because the income would be taxed only when dividends are paid. As for the accumulated earnings tax, designed to impose a tax on corporations that do not distribute earnings, it is useless because there are all sorts of exceptions that permit corporations to come up with excuses that include phrases such as “future expansion.”

Does eliminating the corporate income tax generate jobs? No. First, there are many corporations that do not pay income tax because they use a variety of tax breaks, special credits, and purchased losses to shield themselves from taxation. Elimination of the corporate income tax would not do anything for the cash flow of these corporations. Second, although corporations that do pay income taxes under current law would experience increased cash flows from repeal of the corporate income tax, there is no evidence that they would run out and hire people. There currently are corporations drowning in cash, and they aren’t hiring. Why? A business does not hire unless it needs employees. Acquisition of cash is not a reason to hire. A business hires if it needs employees. It needs employees if it has more work to do than its current employees can handle. Those situations arise when the gross receipts of the business increase. That happens when customers spend more. Customers do not spend more unless they have both resources and either a need or desire for the goods or services being sold by the business. That happens when money is infused into the hands of consumers. In other words, what works is demand-side economics. Eliminating the corporate income tax does not increase demand.

That’s not to say that the corporate income tax should continue to exist. It makes more sense to replace it by making subchapter S applicable to all corporations. Tax-exempt shareholders would be taxed under the unrelated business income tax provisions. Nonresident aliens would be taxed to the extent the income reflects activities conducted within the United States. But don’t expect this change to cause the economy to grow explosively. For that to happen, the tax burden needs to be re-allocated, and that requires at more than nominal rates. As long as secretaries pay tax at rates higher than corporate officers, the economy will be insufficient for long-term growth.

A question popped up recently that drew my attention to birthdays and the tax law. Actually, the tax law uses the phrases “attain the age of” and "attain age" far more often that its occasional use of the word “birthday” but few of us talk about “attaining an age” when we are conversing about the anniversaries of our arrival on the planet.

Why does the tax law care about birthdays or age attainment? There are a variety of tax provisions whose application depends on the age of the taxpayer. For example, taking money out of a qualified retirement plan, IRA, or similar investment before the age of 59 ½ generates penalties unless an exception applies. Withdrawals from those accounts must begin, generally, by the time the taxpayer attains age 70 ½.

The question that popped up referred to section 63(f) of the Internal Revenue Code. This provision increases the standard deduction if the taxpayer or the taxpayer’s spouse “has attained age 65 before the close of his taxable year.” Line 39a of the 2015 Form 1040 asks if the taxpayer or the spouse was born before January 2, 1951. Rephrased, the question was whether a person born on January 1, 1951, attains the age of 65 in 2015. The Form suggests that the answer is yes, because that person was born before January 2, 1951. If asked, many people, perhaps most people, would conclude that this person attained the age of 65 on January 1, 2016, when the person celebrates his or her sixty-fifth birthday. Is the Form wrong? Let’s back up to higher tax authority.

The provision in section 63(f) giving an additional standard deduction to persons who have attained the age of 65 replaced a provision in section 151 that gave an additional personal exemption deduction to persons who had attained the age of 65. The reasoning behind the change was to limit the benefit to those persons who used the standard deduction, thus taking it away from higher income taxpayers who are much more likely to itemize. Thus, long before section 63(f) was enacted, the phrase “attained age 65” was in the Code and in need of interpretation. The interpretation is found in Regulations 1.151-1(c)(2). The regulations state, “For the purposes of the old-age exemption, an individual attains the age of 65 on the first moment of the day preceding his sixty-fifth birthday. Accordingly, an individual whose sixty-fifth birthday falls on January 1 in a given year attains the age of 65 on the last day of the calendar year immediately preceding.” Does this make sense?

The idea that a person attains an age on the day before the person’s birthday makes sense. Consider a person born on January 1, 1951. That person attained age one, that is, finished one year of life, on December 31, 1951. The person started their second year of life on January 1, 1952. This is why Treasury took the position in the Regulations that it did.

But this approach created a problem. A person with a January 1 birthday benefits, for tax purposes, from attaining age 65 on December 31 rather than January 1. The person can claim an additional standard deduction if the person is not itemizing deductions. But what happens if the attaining of an age takes away a benefit? Consider section 152(c)(3)(A). To be claimed as a dependent, a person must be a qualifying child or qualifying relative. Under section 152(c)(1), a person is a qualifying child if, among other things, the person meets the age requirement of section 152(c)(3). Section 152(c)(3)(A) provides that a person meets the age requirement if the person “has not attained the age of 19 as of the close of the calendar year in which the taxable year of the taxpayer begins” or “is a student who has not attained the age of 24 as of the close of such calendar year.” A child who is a student and who was born on January 1, 1992, would attain the age of 24 on December 31, 2015 and thus would have attained the age of 24 as of the close of 2015. This would make the child ineligible as a qualifying child (though perhaps the child could qualify as a qualifying relative).

So the IRS decided to change the definition of age attainment, but only for certain purposes. In Revenue Ruling 2003-33, the IRS provided “A child attains an age on his or her birthday for purposes of Code sections 21 (child and dependent care credit), 23 (adoption credit), 24 (child tax credit), 32 (earned income credit), 129 (excludable dependent care benefits), 131 (excludable foster care benefits), 137 (excludable adoption assistance benefits), and 151 (dependency exemptions). “ So, in the example provided, the child born on January 1, 1992, would not attain age 24 until January 1, 2016, and thus would be a qualifying child, assuming the other requirements were satisfied, for taxable year 2015.

The IRS position does not apply to the issue of attaining age 65, or 59 ½, or 70 ½, or any other tax law provision other than the ones specified in the Revenue Ruling. So that means the phrases “attains the age” ends up with two different interpretations. Does it make sense to give a phrase two different meanings when the statute using the phrases does not do so? Of course, this is once again a matter of Congress not thinking through the implications of what it enacts. That’s probably because few members of Congress actually read, let alone think deeply about and think through the consequences of, the legislation on which they vote.

But no matter what the tax law does, each day we are a day older. And as Pink Floyd tells us, “The sun is the same in a relative way, but you're older, shorter of breath and one day closer to death.” Now I must go and instruct my executor what to insert into my obituary as my age if I die on my birthday.

One of the benefits of being on Facebook – aside from genealogy, class reunion arrangements, and keeping current with what friends and relatives are doing – is getting a perspective of the world, and particularly the nation, that is not necessarily otherwise available. I have the opportunity to “converse” with, or in most instances, to “listen” to, people with whom I’d have little or no interaction in my other day-to-day activities. I learn things.

This past week I’ve acquired interesting insights into people’s attitudes and expectations concerning huge lottery prizes. Aside from the expressions of intentions to buy or not buy tickets, there are expectations. Specifically, there are expectations about how much would be available if a person won, and expectations about what would happen if the prizes were structured differently.

The first set of expectations involves how much money a person would have available. Surprisingly, many people think that if they win – assuming they are the only winner of the big prize – they would be walking around with at least $1.4 billion in their pockets, figuratively. What they fail to consider are two realities. One is the time value of money, that is, the nature of the prize and its valuation. The other is taxation.

The announced total of $1.4 billion – an amount which probably will have increased – is not a “cash in hand when you win” amount, but an arithmetic total of what a person receives if the prize is taken in the form of an annuity paid over 30 years. There is an option to take a lump sum, but as explained in a variety of commentaries, including this story, what one would receive today in a lump sum is a “mere” $868 million.

And then there are the taxes. There is a federal income tax. In most states, there is a state income tax. If the winnings are shared with friends and relatives, and they are not co-owners of the winning ticket, the transfers – depending on amount – are subject to a federal gift tax. The total tax bill will be somewhere on the order of 40 percent.

Granted, taking home a lump some of roughly $500 million ought not generate complaints. But I’m confident it will. Wouldn’t it be nice if the birthday gift check had been for $500 instead of $50? A windfall is a windfall.

The second set of expecations involves alternative prize arrangments. For example, though I have reservations about lotteries generally because they tend to impoverish the poor who see them as the only realistic ticket out of poverty, it seems to me that the big prizes deepen the wealth and income inequality that is undermining the market system. Would it not make more sense, for example, to replace the big $1.4 billion prize with 1,000 $1.4 million prizes? Lottery specialists explain that this approach might reduce the number of people purchasing tickets. If that is so, and it very well could be, is it not interesting that people don’t see a 1,000-fold increase in the chances of winning a “lot of money” as worth the price? That, of course, reflects the financial illiteracy that afflicts American and fertilizes all sorts of scams and political con games.

The expectation that widened my eyes is a meme circulating on facebook, and elsewhere, I suppose, that claims splitting the $1.4 billion evenly among all Americans would give each person $4.33 million. Good grief! This is just so wrong. The responses pointing out the error are themselves amusing, with the best one pointing out that it would generate $4.33 per person, enough to buy a calculator. And, of course, there are those who claim that because of taxes and the time value of money, what would be available to split is $500 million, or roughly $1.60 per person. That’s not quite correct, because if the amount were divided by the lottery and not by a winner, the tax impact would be negligible, though the resulting $2.80 or so per person is pretty much just as disappointing. Perhaps $1.4 billion isn’t all that much money nowadays. It takes much more than that to buy a Congress, does it not?

A recent Tax Court decision, Blagaich v. Comr., T. C. Memo 2016-2 should provide some interesting classroom questions for those teaching the basic federal income tax course. It also is providing some interesting insights for myself, and hopefully for readers of MauledAgain.

The taxpayer was involved in a romantic relationship with Lewis E. Burns from late 2009 until early 2011. During 2010, when the taxpayer was 54 and Burns was 72, he transferred to her property worth at least $743, 819, including cash and a Corvette. At the end of November in that year, the taxpayer and Burns entered into a written agreement intended to confirm their commitment to each other and to provide financial accommodation for her. They had no intention to marry and the agreement was, at least in some respects, intended to formalize their "respect, appreciation and affection for each other" in the way a marriage otherwise would do. The agreement provided that the parties "shall respect each other and shall continue to spend time with each other consistent with their past practice", and that both "shall be faithful to each other and shall refrain from engaging in intimate or other romantic relations with any other individual". The agreement also required Burns to make an immediate payment of $400,000 to the taxpayer, which he did. Soon thereafter, the relationship soured, an on March 10, 2011, the taxpayer moved out of Burns’ house, and on the next day he sent her a notice of termination of the agreement. Shortly thereafter, he concluded that she had been involved in a romantic relationship with another man throughout the relationship between himself and the taxpayer.

In late March of 2011, Burns sued the taxpayer in the Circuit Court for the Eighteenth Judicial District, DuPage County, Illinois, seeking nullification of the agreement, return of the Corvette and a diamond ring, and an order directing the taxpayer to return cash “and other accommodations” that Burns had provided to her, totaling more than $700,000. On April 8, 2011, Burns caused there to be filed with the IRS a Form 1099-MISC, reporting a transfer to the taxpayer of $743,819 in 2010. Based on the Form 1099, the IRS asserted a deficiency against the taxpayer, who filed a petition in the Tax Court on March 8, 2013. The IRS learned of the state court action and in May of 2103 requested the taxpayer’s attorney to provide copies of depositions taken in the case, any filings and motions relating to the Form 1099-MISC, and the fraudulent inducement claim asserted by Burns. In October 2013, the taxpayer moved for a continuance, reporting that the IRS did not object, and the Tax Court granted the motion. At some point during this time, Burns died.

In November 2013, after trial, the state court found that the taxpayer had fraudulently induced Burns to enter into the agreement, and entered a judgment ordering her to pay $400,000 to Burns’ Estate. The court held that the Corvette, the ring, and $273,819 in checks were “clearly gifts” to the taxpayer that she was entitled to keep. Subsequently, the executors of the estate caused an amended Form 1099-MISC to be issued, reporting $400,000 of income, and noting that the taxpayer had paid the $400,000 pursuant to the state court order.

The taxpayer then moved in the Tax Court for summary adjudication. The taxpayer relied on two arguments.

First, the taxpayer argued that $343,819 of the amount transferred to her by Burns was excluded from gross income as “clearly gifts.” She also argued that the IRS was estopped by the state court decision from denying that this amount represented gifts. The IRS argued that it was not so estopped because it was not a party nor in privity with any party in the state court action. The Tax Court agreed with the IRS and rejected the taxpayer’s collateral estoppel claim. The court rejected the idea that the IRS was estopped because it took steps to keep itself informed about the state court action. It also rejected the argument that the IRS bound itself to the outcome of the state court case by agreeing to a continuance in the Tax Court proceedings.

Second, the taxpayer also argued that the $400,000 portion of the transfers was not gross income under the doctrine of rescission. In other words, because she returned the money she ought to be treated as having not received it in the first place. The IRS argued that the doctrine of rescission was not applicable because the taxpayer did not return the $400,000 to Burns in 2010. The Tax Court agreed with the IRS, explaining that the doctrine of rescission is a narrow exception to the claim of right doctrine, which requires cash method taxpayers to include gross income in the year received if acquired without consensual recognition, express or implied, of an obligation to repay and without restriction as to disposition. The doctrine of rescission applies if the amount that is received is returned within the same taxable year. The Tax Court rejected the taxpayer’s reliance on cases in which the obligation to return the amounts that had been received had been acknowledged in the year of receipt even though actual repayment was made following that year, because in this instance the taxpayer did not acknowledge, in 2010, any obligation to return the $400,000.

Accordingly, the Tax Court issued an order denying the taxpayer’s motion for summary adjudication. Whether any portion of the $743,819 constitutes gross income to the taxpayer, or can be excluded as a gift, remains to be decided. Though it has been reported that the $400,000 payment for being monogamous was gross income, the taxpayer still has the opportunity to argue that the amounts received were gifts, particularly the amounts received before she and Burns entered into the agreement. Whether she succeeds remains to be seen.

For students in the basic federal income tax class, the question is simple. “Suppose your romantic partner pays you to remain monogamous. Do you have gross income?” When a student objects that “no one does that,” there now is proof that people do. Perhaps not very many people, but sometimes the most interesting tax cases arise from activities in which very few people participate.

Recently, the IRS Taxpayer Advocate issued a ”Most Serious Problems” analysis, reacting to proposals that the IRS increase existing user fees and add new ones. The Taxpayer Advocate recommended that the IRS avoid fees that have significant adverse impacts on its mission, on voluntary compliance, on taxpayer rights, or on taxpayer burdens. The Taxpayer Advocate also recommended careful analysis of fee changes before implementing or increasing a user fee, publication of that analysis, and opportunity for comment from the public.

The reason fee increases were recommended is the refusal of the Congress to fund the IRS adequately so that it can fulfill its mission, provide taxpayer services, and protect the revenue. A reader of this blog, after examining the Taxpayer Advocate’s report, wrote to me: “How to solve the IRS funding problem. Instead of user fees could the IRS charge fees for advertising on their websites, forms, publications , etc. to individuals, corporations, etc. For example, I could see lawyers, accountants , and corporations buying advertising to promote products and services.”

Is monetizing IRS forms, website pages, and publications a sensible way of funding the IRS? Selling advertising space raises money if people are willing to purchase it. My guess is that there would be at least some individuals and entities willing to put their names in front of taxpayers. Logistics could be challenging, because a local or regional tax return preparer, for example, would want the ad directed to potential customers or clients in the preparer’s area. I think that can be accomplished with today’s technology, but it costs money, which would make the ad more expensive. The key would be the cost, because no one is going to pay for ads that are more expensive than alternatives. But what would be the effect of these ads on taxpayers? Website ads clutter the page, making it difficult to get to what the user wants to see; in recent months the websites for most media outlets have taken far too long to load and crash repeatedly because dozens upon dozens of ads and other clutter make it difficult to get to the principal purpose of the page. As for putting ads on tax forms, the result would be longer forms, or smaller fonts, or both, which would adversely affect taxpayers. The idea of longer forms, or forms with additional pages, for the purpose of advertising is nothing more than monetization on super steroids, an idea that would not sit well with most taxpayers. The same would be the case with digital tax forms. Add to this the inevitable disputes that will arise when advertising is purchased by controversial businesses or entities. And how long until politicians and their PACs demanded the right to clutter tax forms and publications with their tax nonsense?

Ads on IRS forms and web pages are not the only changes that taxpayers might see in the future. According to this report, the IRS is planning to automate the tax filing process so that it resembles how people interact with their bank. Online filing will become the norm, and a secure email will be sent as a receipt. Communication through postal mail will be replaced by electronic messages, not only for questions and payments, but also for audits. The IRS Taxpayer Advocate, however, sees this plan as eliminating the ability of taxpayers to interact with a human being, by phone or in person. The Taxpayer Advocate warned that the planned system “threatens to create a ‘pay to play’ system where the only taxpayers who will get personal service are those who can afford to pay for it.” There is a risk that using online accounts to handle taxpayer issues, as the IRS is preparing to do, ultimately will increase taxpayer dissatisfaction and frustration and increase noncompliance. The IRS is pursuing these plans because it is trying to find ways to compensate for significant budget cuts by the Congress. The IRS Commissioner claims that taxpayers want to interact through impersonal digital communications and do not want to “see us at all.” Reconciling that claim with the millions of taxpayers and tax return preparers sitting on hold for near-eternity waiting for an IRS employee to answer the phone is not easy. The Commissioner claims that the online plan will not put an end to phone conversations or in-person meetings.

Unmentioned is the risk of doing business online with an agency that struggles to maintain its computer systems, that uses decades-old technologies, that has suffered cyber-intrusions, and that is plagued by employee turnover, inadequate funding, and revolving door management. Most of those problems, of course, are caused by a Congress dominated by individuals intent on bringing down the IRS and ultimately government in order to make way for private corporations to own and operate the country and its citizens. Until the Congress adequately funds IRS use of technology, and until the IRS demonstrates that its use of technology is secure, effective, and efficient, taxpayers ought not be put at risk.

There is no doubt that the face of the IRS will change. The question is, though, what sort of face will the IRS be presenting to taxpayers? Even though the current system is afflicted with all sorts of problems, changing to a system that presents the same, or even greater, risks is unwise. Rather than trying to imitate the private sector, the IRS should be learning from the mistakes of the private sector’s struggles with technology and developing a plan that is superior in all respects. Doing so requires more money than the IRS has available, which brings the problem back to the cause, namely, the Congress.

As the header on this blog indicates, there are times when I find it interesting and even useful to try connecting law, or legal principles, to genealogy. My expectation has been that these connections would involve issues of privacy, of post-mortem ownership of DNA residing at genealogy DNA testing businesses, post-mortem ownership of genealogical databases, disputes over application of genealogical software, copyright concerns, and similar problems. But the other day I found a law-genealogy connection that I was not expecting.

While watching an episode of Hot Bench, another one of the television court shows I use as a source for classroom hypotheticals, blog posts, and general intellectual growth, I heard a litigant use the term “great cousin.” The plaintiff’s name was Alicia Kafka. As she told her story, one of the judges described her account as “Kafka-esque,” and then proceeded to explain her comment to the courtroom audience. The plaintiff interjected, referring to Franz Kafka, “he’s my great cousin.” When asked to elaborate, she explained that her father was a Kafka and was the subject of some of the famous author’s writings.

Having not previously heard or seen the term “great cousin,” I did some research. Though not an “official” genealogical term, it is used by a handful of people to describe the cousin of a parent, though this usage is the subject of some disagreement. It’s a handy term, but will it catch on? What term would be used for the first cousin of one’s grandparent? What about the second cousin of a parent? I confess that I have tried to find a way to designate an ancestor’s cousin (of any degree). If a second cousin’s child is a second cousin once removed, then would not the second cousin’s parent, who is a first cousin of one’s parent, be a second cousin once back removed? That is, if coming “down” the tree is “removed,” then going back “up” the tree is “back removed.” Trust me, my terminology has not caught on. That could be a good thing.

As for tax, when the judge explained why she thought the case was “Kafka-esque,” she described Kafka’s writings with terms often applied to the tax law. I don’t remember the precise words, but think in terms of convoluted, confusing, and complicated.

A reader asked me three questions. First, “Are the definitions of qualified education expenses for the lifetime learning credit and tuition and fees deduction the same?” Second, “Is the definition of qualified education expenses for the American opportunity credit different than the definitions in question 1, if so how?” “Third, Is the definition of qualified education expenses for purposes of tax-free scholarships and fellowship grants, the same as defined in Question 1 or 2?”

Though one might argue that I was presented with four, or even five, questions, what matters is that these are good questions. They also are important questions. Why? Because the questions themselves present an opportunity to explore the Internal Revenue Code.

Let’s begin with the oldest definition, the one found in section 117(b)(2). It defines qualified tuition and related expenses for purposes of the exclusion: “For purposes of paragraph (1), the term “qualified tuition and related expenses” means — (A) tuition and fees required for the enrollment or attendance of a student at an educational organization described in section 170(b)(1)(A)(ii), and (B) fees, books, supplies, and equipment required for courses of instruction at such an educational organization.”

The lifetime learning credit, enacted in 1997, applies to qualified tuition and related expenses. Section 25(A)(f)(1)(A) defines these as follows: “The term ‘qualified tuition and related expenses’ means tuition and fees required for the enrollment or attendance of — (i) the taxpayer, (ii) the taxpayer’s spouse, or (iii) any dependent of the taxpayer with respect to whom the taxpayer is allowed a deduction under section 151, at an eligible educational institution for courses of instruction of such individual at such institution.” It also includes two exceptions. One provides that qualified tuition and related expenses “does not include expenses with respect to any course or other education involving sports, games, or hobbies, unless such course or other education is part of the individual’s degree program.” The other provides that qualified tuition and related expenses “does not include student activity fees, athletic fees, insurance expenses, or other expenses unrelated to an individual’s academic course of instruction.” For these purposes, an eligible educational institution is “an institution — (A) which is described in section 481 of the Higher Education Act of 1965 (20 U.S.C. 1088), as in effect on the date of the enactment of this section, and (B) which is eligible to participate in a program under title IV of such Act.”

The deduction for qualified tuition and related expenses, added in 2001, apples to qualified tuition and related expenses. Section 222(d)(1) defines these as follows: “The term ‘qualified tuition and related expenses’ has the meaning given such term by section 25A(f).”

Finally, the American Opportunity Credit, added in 2014, also applies to qualified tuition and related expenses. Section 25A(i)(3) defines these as follows: “For purposes of determining the Hope Scholarship Credit, subsection (f)(1)(A) shall be applied by substituting ‘tuition, fees, and course materials’ for ‘tuition and fees.’

So in addition to the differences, small and technical as they are, in the definitions of qualified tuition and related expenses, there also is a difference in what qualifies as an educational institution. Though most would fit within both the section 117 definition and the section 25A definition, there are some that would meet one and not the other.

Someone not an expert in taxation might ask another question, namely, why the differences? It, too, is a good question and an instructive one. When each provision is being considered, revenue loss estimates come into play. Lobbyists push their versions. Drafters offer their own language. Attempts to correlate with other provisions sometimes are made successfully, sometimes are not successful, and sometimes are not made.

I add one final question. Would it not make sense to have one definition and simplify the rules? The answer is easy. Of course it would. But it’s not the sort of thing we’ve come to expect from Congress.

Several days ago, in a New York Times editorial, Max Frankel proposed “a relatively simple new tax – officially called a user fee – “ based on “the grandeur of each lofty view” from the apartments being built in very tall luxury skyscrapers along the southern edge of Central Park. He suggested it could informally be called a “window tax” and he suggested various dollar amounts for windows and doors based on height, the existence or absence of obstructions, and the nature of what can be seen.

Frankel is concerned about the number and size of what he calls cloudscrapers, and by the impact they have on the city skyline. He points out that the wonderful views of Central Park exist because public money was invested in the park and its amenities. Though the new construction triggered his concerns, he proposes that the tax also apply to the buildings that have stood on the edge of the park since the nineteenth century.

Frankel proposes that those subject to the tax “would be paying a royalty for the privilege of consuming the city’s boundless beauty, eyeballing and mentally photographing costly municipal endowments.” He would spend the revenue on park upkeep and improvements as well as maintenance of roads and rivers. In turn, this would permit money currently being spent on those items to be redirected into housing, education and other services.

The proposed tax is not sensible. It poses a huge risk. Logically, what would follow is a tax on persons taking photographs of municipal buildings and attractions financed with tax revenue. One can envision toll booths at each intersection, charging higher tolls for walking or driving down scenic streets and city blocks, with lower fees for taking a route that passes shabby buildings.

The proposed tax is not necessary. Frankel notes that the value of these residences are enhanced by “pk vus, to a degree that has never been properly incorporated into conventional real estate taxes.” Real estate taxes are based on value. The better the view, the higher the value. If the real estate tax is not capturing this enhanced value, it is because the real estate tax is not being properly administered. Rather than directing time and energy into a new tax, or user fee, efforts should be focused on fixing the inefficiencies, incompetence, and administrative failures of the real property tax. Many years ago, recognizing the flaws of the income tax, the Congress, rather than fixing it, added an alternative minimum tax. Hindsight confirmed what some suggested, that it would make things more complicated, fail to solve the underlying problem, and present problems of its own. Much the same would be the case with Frankel’s window tax.