MauledAgain

Sometimes basic tax principles are easy to state but difficult to understand. Recently, in Lamas-Richie v. Comr., T.C. Memo. 2016-63, the Tax Court had the opportunity to address a tax principle that defies common sense but that can be expressed in simple language. The taxpayer formed an LLC, taxed as a partnership, with an investor to continue and enlarge a web site that posted gossip. The taxpayer held 41 percent of the tax partnership and the investor and the investor’s affiliate owned 59 percent. The name of the web site was changed to thedirty.com, and the LLC was called Dirty World LLC. The taxpayer entered into an employment agreement with another of the investor’s affiliates, to compensate him for his services in managing the web site and editing its content.

The LLC filed a Form 1065 for 2011, which included a Schedule K-1 issued to the taxpayer. The Schedule K-1 reported a distributive share of the LLC’s income for the taxpayer, equal to 41 percent of its ordinary business income. However, the taxpayer did not receive the Schedule K-1, did not report the income, and learned of the Schedule K-1 when the IRS began to examine the taxpayer’s 2011 return. The taxpayer testified that there had been no Schedules K-1 in previous years because the LLC had not reported any profit in previous years, an assertion the Tax Court found credible. No distributions were made to the taxpayer.

The Tax Court held, not to the surprise of anyone who understands the taxation of partnerships and S corporations, that although no distributions had been made to the taxpayer, the taxpayer was subject to federal income tax on his share of the LLC’s income. This principle is well-settled. For many taxpayers, the idea of being taxed on something that they have not received makes no sense. One way of understanding the principle is to consider the taxpayer has having received his share of the profits and then having put them back into the LLC.

The Tax Court also held that the taxpayer was not absolved from reporting his share of the LLC’s income even though he had not received the Schedule K-1. That, too, is well-settled. Nor did the existence of losses in previous years help the taxpayer, because the taxpayer provided no evidence of the amount of those losses and thus did not demonstrate the existence of a loss carryforward.

When taxpayers form or join pass-through entities with the assistance of tax professionals, it is wise for the professional to explain to the taxpayer, both in spoken and written form, the tax consequences of doing so. Taxpayers should be cautioned to watch for Schedules K-1, and to forward them to their return preparer or, if they are doing their own taxes, to fill out Schedule E. Taxpayers also should be advised to contact the pass-through entity if and when an expected Schedule K-1 does not appear.

One of the basic principles I try to help students understand is that in the tax world, as elsewhere, timing matters. That is a concept overlooked in many tax reform proposals, but having discussed that issue in the past, and surely with opportunities to discuss it again in the future, I’ll set it aside. Instead, it’s a good time to explore the impact of timing in a much more narrow situation.

Section 25A of the Internal Revenue Code permits taxpayers to claim the American Opportunity Tax Credit (AOTC) equal to the sum of two amounts. The first amount is 100 percent of the qualified tuition and related expenses paid by the taxpayer during the taxable year for education furnished during any academic period beginning in that taxable year, or $2,000, whichever is less. The second amount is 25 percent of those expenses that exceed $2,000 but that do not exceed $4,000. Thus, the maximum amount of the credit is $2,500. For a cash method taxpayer, the expenses are treated as paid in the taxable year in which they are actually paid. An exception in section 25A(g)(4) provides that if the expenses are paid during a taxable year for an academic period that begins during the first three months of the following taxable year, the academic period is treated as beginning during the taxable year in which the expenses are paid. The regulations explain this exception by pointing out that if the expenses are paid during one taxable year for an academic period that begins during the first three months of the following taxable year, the AOTC is allowed with respect to those expenses only in the taxable year in which they are paid.

The impact of this timing rule was the focus of the Tax Court’s decision in McCarville v. Comr., T.C. Summ. Op. 2016-14. The taxpayer, who used the cash method, attended college starting in 2008 and graduating in 2012. He worked to support himself and pay his tuition and other education expenses. He paid his tuition for the fall 2011 semester on August 6, 2011. He paid his tuition for the spring 2012 semester, which began in January 2012, on December 18, 2011, even though the due date was January 25, 2012. He paid early because, as he explained, he wanted it to be “in the bank.”

When the taxpayer filed his 2012 federal income tax return, he claimed an AOTC of $2,500. His college did not issue a Form 1098-T, Tuition Statement, for 2012, which generated an IRS examination of the 2012 return. The IRS denied the credit and issued a notice of deficiency. The taxpayer then filed a petition with the Tax Court.

The IRS conceded that the taxpayer was entitled to an AOTC for 2012 in the amount of $247.47, which is what the taxpayer paid for textbook rental in 2012. The IRS did not dispute that the taxpayer paid qualified tuition of $4,895 on December 18, 2011 for the semester beginning in January 2012. But the IRS argued that any credit for that amount, if allowed at all, would be in 2011, not 2012. Because of the $2,500 limit, the taxpayer could not use any additional AOTC in 2011. The taxpayer argued that “[i]t just seems kind of wrong” to be denied the AOTC credit in 2012 “essentially for paying [the tuition] early.” The Tax Court acknowledged that the statutory timing requirements “may very well seem to work a harsh result in a case such as this when a mere two-week delay in making the December 18, 2011 payment would have occasioned a different outcome.” But, the Court concluded, it was bound by the statute.

This case provides an example of why and how the income tax can frustrate taxpayers. It illustrates why planning is necessary. It illustrates the problems that arise when a statute is not drafted to take into account the very common practice of paying tuition in December for semesters that begin in January, especially when they begin early in January. It demonstrates why providing financial assistance for education ought not be in the income tax law and administered by the IRS but should be handled by the Department of Education. But accepting for a moment that a provision designed to assist and encourage people with education goals is in the tax law, it is unfortunate that the provision does not accomplish what it was designed to do, and applies in a haphazard manner.

As the taxpayer discovered, timing matters. Hopefully everyone discovers this principle before it is too late and time runs out on planning and other opportunities.

Actually, today isn’t tax day even though it is April 15. Because of a holiday, tax day is either April 18 or April 19. All these April holidays surely generate confusion! Because Emancipation Day is Saturday, April 16, it gets pushed back to the nearest weekday, thus making April 15 a holiday and thus ineligible this year to be the due date for filing individual income tax returns. So the due date is pushed to Monday, April 18, except in Maine and Massachusetts because in those states it’s Patriots Day, pushing the deadline to Tuesday, April 19. So, I’m going to post tax day numbers today, just as a distraction and a warm-up for what could be a very busy weekend for some people.

The folks at WalletHub have released their annual tax day numbers for 2016. Here are some highlights.

The average wait time encountered by people calling the IRS in 2015 was 30.5 minutes. That’s worse than most hold times, but I’ve experienced and heard of people on hold for much longer. Still, that’s abysmal. What’s worse is that 62 percent of those calling the IRS ended up not getting through to anyone. C’mon Congress, either put up the funds so that more people can be hired and trained to answer taxpayer phone calls, or simplify the tax law so that there aren’t as many questions.

The average American invested 16 hours working on his or her federal income tax return. As bad as that sounds, and it is bad, it’s a reduction from the 30 hours averaged in 2006. The problem with averages is that it doesn’t let us know if 90 percent of taxpayers are averaging far less on account of 10 percent averaging much more.

According to the survey, 35 percent “of taxpayers would rather discuss sex with their kids than do their taxes.” That bad, eh? I would have expected the percentage to be much higher. When it comes to educating people about three-letter words, tax is the bigger challenge.

As of April 7, 2016, there were 276,000,000 visits to the IRS web site this year. Good grief, I wouldn’t mind seeing one percent of those folks stop by MauledAgain.

And, then, at the end, WalletHub offers the claim that there are 4,000,000 words in the “tax code.” Please, not this again. Really, folks. End the ignorance. I analyzed this question, in detail, in Anyone Want to Count the Words in the Internal Revenue Code?, and I shared a summary of the fallacies in the entire “70,000-page Internal Revenue Code” falsehood in Tax Myths: Part XII: The Internal Revenue Code Fills 70,000 Pages.

But despite that last glitch, the WalletHub Tax Day Numbers posting is well worth checking out in its entirety. There’s much more than what I highlighted.

A reader referred me to an article asking, “Can 'Fat Tax' Curb Americans' Appetite for Unhealthy Foods? My answer is no. A “fat tax” – a shorthand expression for an excise or sales tax imposed on foods containing specified levels of fat – might reduce some Americans’ consumption of foods containing fat, but it certainly won’t reduce appetites for unhealthy foods.

The proposition that a tax on foods containing fat would reduce purchases of those foods reflects a study done by a marketing professor and two colleagues who determined that pricing milk according to fat content shifted purchasing somewhat from whole milk to reduced fat milk. The catch, according to the researchers, is that consumers must see the actual price difference on the shelf.

The researchers suggest that milk is not the only product for which this effect could be generated. They suggested pricing differentials between fried and baked foods, and sugar-free and regular gum. They also suggest that a “fat tax” could include a subsidy for foods that are healthier, in an effort to avoid adverse impacts on the revenue collected by food retailers.

The challenge with designing a “fat tax” that works is determining which foods to tax, and by how much. Not all fat is unhealthy. Certain amounts of particular fats are essential, and I speak from experience after having tried, some years ago, a totally fat-free diet, which brought a rebuke from one of my physicians. Nor is it possible to ascertain how much fat is harmful, because the degree to which fat, or for that matter, sugar or salt, is detrimental depends on a person’s biochemical make-up, and in turn, on their size, the level of their physical activity, and the other foods that they eat. If the imposition of a tax on fat, or sugar, or salt, causes a person to reduce their intake of fat, sugar, or salt, to harmful levels, then the tax is counterproductive.

Obesity, which is the concern that sparked this particular study, as well as thousands of others, is the consequence of a variety of factors. Ingesting fat, or sugar, is but one. The lack of physical exercise is another. Medications cause some people to gain weight. A small percentage of the population suffers from genetic-based metabolic disorders that prevent weight loss even when food intake is reduced to a bare minimum.

Another challenge is the danger of labeling certain foods as healthy and other foods as unhealthy. As my mother explained when I was a child, it’s all about moderation, and it’s all about having multiple colors on the plate. Spinach is a healthy food, yet for some people it is not, and for most people, eating too much spinach is unhealthy. Candy bars, which contain fat and sugar, are supposedly unhealthy, but an occasional candy bar isn’t going to kill most people.

Yet it is undeniable that most Americans have an appetite for sweet foods, salty foods, and fatty foods. Why? In part, because they taste better than the alternatives, though I do know people who find brussel sprouts delicious and chocolate-chip cookies “disgusting.” But another contributor to Americans developing an appetite for supposedly unhealthy foods is advertising. I’ve seen many commercials for beer, fast food, fried chicken, pizza, and donuts, any of which, consumed in great quantities, are unhealthy. I don’t remember having seen advertisements for carrots, kale, or okra. Has anyone done a study to determine the impact of marketing on food consumption? And if there is a connection, what should be the reaction? Proposals to ban or tax advertising for certain foods would face huge hurdles, challenges based on the First Amendment, and efforts to distinguish candy bars from tobacco.

But no matter what is done, tax or no tax, advertising or word-of-mouth invitations, Americans’ appetites for particular food items will not be changed by a tax. Appetites are more than economic attributes.

Readers of this blog know that I do not subscribe to the claim that tax cuts for the wealthy create jobs. As I’ve explained many times, for example, in Job Creation and Tax Reductions, people don’t create jobs unless they need workers. They don’t need workers unless they have customers who want to purchase the goods and services that they would provide. If the American middle class and those living in poverty or near-poverty don’t have money, they don’t make purchases. In fact, they cut back on purchases. And that, understandably, causes the owners of capital and the entrepreneurs of the business world to cut, not create, jobs.

One of many states in which this theory was implemented is Kansas. As I pointed out in When a Tax Theory Fails: Own Up or Make Excuses?, it didn’t work. In A New Play in the Make-the-Rich-Richer Game Plan, Kansas politicians are struggling to find a way to undo the damage caused by the Kansas tax cuts for the wealthy. A few weeks earlier, in A Tax Policy Turn-Around?, I had described how the Kansas income tax cuts for the wealthy backfired, causing the rich to get richer, the economy to stagnate, public services to falter, and the majority of Kansans to end up worse than they had been. I suggested that perhaps Republicans were beginning to realize that there are limits to tax cuts, and that tax cuts for consumers are more valuable than tax cuts for money stashers. But perhaps there’s another play in the Kansas Republican tax game plan.

Now comes news that after having three years to generated jobs, those 2012 Kansas tax cuts failed. According to this summary of job reports from the Bureau of Labor Statistics, Missouri job growth was almost quintuple the job growth in Kansas. Job growth in Missouri? A 2.4 percent increase. Job growth in Kansas? A 0.5 percent increase. All of the job gains in professional and business services took place in Missouri.

Was the 0.5 percent increase in jobs in Kansas courtesy of the tax cuts? Perhaps. But if the alternative is a much higher rate of job growth in the absence of those sorts of tax cuts, then why would any rational person support supply-side theory and its tax cuts? Perhaps because they don’t understand reality or simply are beneficiaries of those cuts.

When those who are not tax practitioners, and even some tax practitioners, complain that the tax law is complicated and often makes little or no sense, they are far from wrong. The tax law is complicated. Too much of it makes no sense. And now we have a Tax Court decision, in Senyszyn v. Comr., 146 T.C. No. 9 (2016), that provides an outcome that appears to make no sense. A taxpayer convicted of tax evasion ends up owing no tax.

The taxpayer was an internal revenue agent who became increasingly involved in the business affairs of David Hook, a real estate developer. Slowly, the taxpayer acquired more and more control over Hook’s business, so that by the middle of 2002, he had nearly full control. In September of 2002, the taxpayer, as part of his tax planning for Hook, executed a trust indenture identifying the taxpayer as grantor and trustee, but whether any assets were transferred to the trust is unclear from the evidence. Later, Hook transferred real property to the trust, because he understood that his children were the trust’s sole beneficiaries, but he also was a beneficiary. Not long thereafter, when Hook sold some other property, $202,626 of the proceeds were placed in the trust. The taxpayer and Hook also purchased real property as joint tenants with right of survivorship, because when Hook expressed an intention to purchase the property alone, the taxpayer informed Hook that Hook had insufficient funds to do so, and offered to be a one-half purchaser, an offer accepted by Hook.

The taxpayer and his wife filed a joint 2003 federal income tax return, reporting wages of $78,116, Schedule C gross receipts of $25,850, and Schedule F gross receipts of $1,200. At about the same time, Hook sued the taxpayer, alleging that the taxpayer and his wife embezzled at least $400,000 from Hook. At trial, Hook alleged that the embezzled amount was $1,000,000. In partial settlement of Hook’s claim, the taxpayer and Hook transferred the jointly held property into Hook’s sole name.

Hook’s lawsuit caused the IRS to investigate the taxpayer. Agent DeGrazio examined various records belonging to the taxpayer, to Hook, and to related entities. He concluded that the taxpayer had received “net benefits” of $252,726 from Hook that were not reported on the 2003 return. He reached this amount by subtracting from gross benefits of $481,947 an amount of $229,221 representing funds returned to Hook by the taxpayer. DeGrazio treated the assets of the trust as Hook’s for purpose of the analysis, and thus treated the taxpayer as receiving benefits on account of the taxpayer’s use of trust assets to pay personal and family expenses of the taxpayer. Included in the $229,221 of payments returned to Hook by the taxpayer was $104,237 that the taxpayer allegedly transferred to the trust.

On September 20, 2007, the U.S. Attorney for the District of New Jersey filed a four-count information against the taxpayer, including a charge of tax evasion. The information alleged that the taxpayer embezzled $252,726 from Hook during 2003 and failed to report it. The information also alleged that the taxpayer prepared and filed a fraudulent return on behalf of a corporation owned by Hook. At the time the information was filed, the taxpayer signed an agreement to plead guilty to all four counts, stipulating that he knowingly and willfully did not include about $252,726 in additional taxable income for 2003. In exchange for the taxpayer’s agreement, the U.S. attorney dropped charges against the taxpayer’s wife. The taxpayer entered the guilty plea in accordance with the agreement. Subsequently, he moved to withdraw the plea to the tax evasion count but the U.S. District Court denied the motion, and thereafter entered judgment pursuant to the plea. The taxpayer’s appeal to the Third Circuit of the order denying his motion to withdraw the plea was rejected. He did not appeal his criminal sentence, and his conviction became final.

On June 30, 2008, the taxpayer and his wife filed an amended 2003 return, but the IRS did not process it. The amended return, which the taxpayer explained he filed at the instruction of the U.S. District Court judge, reported an additional $262,726 of gross income, showing gross receipts of $481,947, and an offset of $229,221 based on DeGrazio’s determination of amounts transferred by the taxpayer to Hook. The amended return also reported deductions of $476,005, wiping out the additional gross income, and generated a loss on the Schedule C. The taxpayer described the deductions as additional payments to Hook that DeGrazio had left out of his analysis. Those payments were made by the taxpayer into escrow as part of the purchase price of the property purchased jointly by Hook and the taxpayer.

The IRS issued a notice of deficiency, and the taxpayer petitioned the Tax Court. At trial, the taxpayer offered evidence of $595,000 transferred from the taxpayer’s brokerage account to the trust, an amount different from the $91,437 used by DeGrazio in computing the amount transferred by the taxpayer to Hook. The brokerage statement also showed $250,000 transferred from the trust to the taxpayer.

The IRS argued that the deficiency and penalties could be sustained solely on the basis of the taxpayer’s stipulation in the criminal case. The Tax Court, in a previous decision, had held that the stipulation did not collaterally estop the taxpayer from challenging the amount of the deficiency, but that it was strong evidence of the amount.

The IRS argued that by filing an amended return based on DeGrazio’s analysis, the taxpayer admitted the deficiency. The Tax Court disagreed. It noted that although the taxpayer included amounts from DeGrazio’s report, it also included the additional deductions reflecting the taxpayer’s claim that DeGrazio omitted some of the repayments to Hook. Even though the Tax Court rejected the amount claimed as a deduction, the fact that it was claimed proved that the taxpayers were not admitting to the totality of DeGrazio’s report.

The Tax Court approved the method used by DeGrazio to compute the taxpayer’s omitted income, but that he had incorrectly computed the relevant amounts. The Tax Court found that the taxpayer returned to Hook more than the $481,947 of benefits that he received from Hook in 2003. The court reasoned, based in part on DeGrazio’s agreement that all transfers from the taxpayer’s brokerage account to the trust should be treated as repayments to Hook, that DeGrazio had understated the amount of the repayments. The IRS objected to this conclusion, claiming that the taxpayer presented the total of transfers from his brokerage account but omitted transfers to the account from the trust. The court noted that the only such transfer was the $250,000 amount that had also been presented. The IRS also argued that the taxpayer had not identified the source of the funds in the brokerage account that were transferred t the trust, and that if they came from Hook they ought not be treated as repayments to Hook. The Court rejected this argument by explaining that a taxpayer who embezzles $20 from a victim and returns $15 to the victim in the same year has $5, and not $20, of gross income, even if the $15 came out of the $20. Accordingly, there was no deficiency, but the taxpayer was precluded from a refund because the amended return was filed after the statute of limitations for claiming a refund had passed.

The Tax Court explained that although the evidence did not support any deficiency in the taxpayer’s tax liability, it could apply collateral estoppel to uphold a deficiency in whatever minimum amount would justify the taxpayer’s conviction for tax fraud. The court, after examining cases addressing the question of how much of a deficiency was required to uphold a tax evasion conviction, concluded that there was no authority for the proposition that something more than a minimum amount was necessary. The court determined that collateral estoppel need not be applied when the purposes of the doctrine do not support its application. The court pointed out that it had not previously faced the question of whether a taxpayer’s prior conviction for tax evasion requires the determination of a deficiency when the evidence shows none exists. The Court concluded that the purposes of the collateral estoppel doctrine would not be served by upholding a deficiency where none existed. Upholding a deficiency would not promoted judicial economy, because even after the conviction, the Tax Court was required to hear the deficiency case. Any inconsistency between the taxpayer’s prior conviction and a later decision that no deficiency existed would not undermine “reliance on judicial action” because the inconsistency resulted not from conflicting judicial findings by different courts but from the taxpayer’s entry of a guilty plea to charges that the evidence, as presented to the Tax Court, would not support.

The outcome seems troubling, and not only to those not versed in tax law and the doctrine of collateral estoppel. The Court noted that it did not understand why the taxpayer agreed to the guilty plea if the evidence did not support it. My guess is that he wanted to get his wife off the hook (sorry, could not resist). What remains unclear is the outcome if the taxpayer had not entered a guilty plea but had been convicted after a trial. To what extent could the conviction be vacated because the evidence that was presented was incomplete, or tainted by a mistake? What if the guilty plea was extracted on account of prosecution threats against the taxpayer’s wife, whose role in the entire scheme is unclear? She had made a protective innocent spouse claim that the court did not need to address because of its conclusion that no deficiency existed.

In this particular case, the absence of the deficiency ought not justify vacating the conviction. The taxpayer also entered a guilty plea to preparing a fraudulent return for Hook’s corporation. Yet, would the sentence imposed in the criminal proceedings have been reduced if there had been no conviction on the tax evasion charge?

There are several lessons. One, don’t embezzle money. Two, don’t fail to report embezzlement income. Three, be very careful when dealing with tax evasion criminal charges, and be certain to get legal advice, and to investigate thoroughly the facts, before entering a guilty plea.

Last week, a reader shared with me a story which, though about three and a half years old, is something I wish I had not missed. But, it’s never too late.

According to a MedicalXPress writeup of a study by two psychologists, people with math anxiety experience brain responses similar to those experienced by a person who suffers physical pain. For these people with math anxiety, “the anticipation of doing math prompts a similar brain reaction as when they experience pain.” It is the anticipation of being required to do math, and not the actual doing of math, that “looked like pain the brain.” The psychologists used tests to identify people with math anxiety, and then tested them in an MRI machine while they did math. They also were given short word puzzles. The researchers discovered that “[t]the higher a person’s anxiety about math, the more anticipating math activated the posterior insula – a fold of tissue located deep inside the brain just above the ear that is associated with registering direct threats to the body as well as the experience of pain.” So when a student about to enter a basic federal income tax class, mistakenly viewing the course as the equivalent of a math course, shares his or her “math phobia,” it does make sense to allay the student’s fears at the outset, by explaining that the class is mostly words and logic, and that the numbers used in the class usually are used in ways not unlike what the student encounters in day-to-day life.

The writeup of the study caused me to wonder what would happen if taxpayers, without regard to their levels of math anxiety, were tested in an MRI machine while being told that they would be doing their own tax return, and while doing the return. I wonder if the anticipation of doing a tax return generates fear and anxiety whereas the actual doing of a return does not. There are a variety of experiences in life in which the anticipation is frightening but the actual even turns out to be acceptable, if not pleasant, or even enjoyable.

My guess is that a study of tax pain would disclose that anticipating doing a tax return indeed causes some people pain in the brain. For me, watching the Congress debate and enact tax legislation creates a different sort of pain. That might be the case for others, as well.

A reader sent me a link to a Hallmark e-card that you might want to share with your family, friends, colleagues, and clients. Or not.

I confess. I laughed and laughed. And replayed it several times.

The reader began his email, “Since tax day is rapidly approaching . . .” Indeed, it is. Some of us are finished with our tax returns. Some of us managed to finish without screaming. But there are others, who scream.

Perhaps the next tax scream card will be a card for taxpayers who are being audited.

Many people dislike paying taxes. Some people dislike, or even fear, the prospect of sitting through and taking an exam in a tax course. Very many people dislike preparing and filing tax returns.

How badly do people dislike tax return preparation? According to a WalletHub Survey, the list of things Americans would rather do than prepare tax returns demonstrates the extent to which tax return preparation is disliked, and in many instances postponed until the last minute. Of those surveyed, 77 percent would rather do laundry, 60 percent would rather mow the lawn, 48 percent would rather teach their children budgeting, 47 percent would rather cook Thanksgiving dinner for their in-laws, 43 percent would rather change a baby’s diapers, 23 percent would rather miss a connecting flight, 13 percent would rather spend a night in jail, and 8 percent would rather have their arm broken. My connection with tax is undeniable, because I’d rather do tax return preparation than doing laundry, mowing the lawn, breaking an arm, or spending a night in jail.

Asked what they would do for a “tax-free future,” 27 percent would accept an “IRS” tattoo on their body in exchange for future freedom from tax return preparation and filing. Another 11 percent would clean toilets at Chipotle. Ten percent would be willing to stop talking for a month. Four percent would be willing to kill someone. That’s far more frightening that taxation.

When asked what the fear most about tax returns, 36 percent feared making math errors, 26 percent feared identity theft, 19 percent feared getting audited, and 19 percent feared not having enough money to pay tax due. The fear of math errors should be alleviated by tax return preparation and other software. The risk of being audited is so low that very few need worry. The big risk is identity theft, and that is an issue that should concern, if not disturb, everyone. It’s widespread, and yet to be sufficiently suppressed.

The survey did reveal a bright side to the agonies of taxation. Even though almost 90 percent are dissatisfied with the IRS, and even though almost 60 percent think their taxes are too high, only 19 percent would hide money offshore even if they were guaranteed that they would not be caught. I would have guessed an outcome higher than that. I’m pleasantly surprised.

And, no, this is not an April Fool's Day joke. It's very real. I'll let others offer their April Fool's tax stunts.

When I was teaching the basic tax course, at the beginning of almost every semester during which the course was offered, at least one student would come to my office, seeking advice and help because they dreaded the thought of taking the tax course. No, they weren’t afraid of being bored to death. They feared “math,” and explained that they “were no good with numbers.” Some were near tears, and a few shed some. I explained to them, as I explained to the entire class on the first day, that every student had dealt with numbers since they were very young. I pointed out their use of telephone numbers, addresses, birthdays, zip codes, test scores, asking for allowances, telling time, and noticing speed limits. By the end of the semester, they realized that “math” did not dominate the course, nor does it overshadow the language, logic, and policy issues that permeate taxation.

There is another fear of tax that extends far beyond enrollment in a tax course. And that is the fear of the IRS, or, more specifically, the fear of being audited by the IRS. It is a very real fear for those whom it afflicts. I have known people, some very educated, who almost trembled at the thought of having to interact with the IRS, particularly during an audit.

Now comes a report on a NerdWallet survey that asked people about their tax fears. Roughly 70 percent of taxpayers are concerned about making a mistake, paying too much, or not getting the biggest possible refund. But concern is not fear. Concern does not paralyze the brain and the body. Concern simply encourages greater care, deeper thought, and one more review.

So how many taxpayers fear the audit? According to the survey, only 11 percent. Another survey generated a similar outcome, slightly higher at 14 percent. To put this in perspective, the report reveals that Americans have other fears that are more widespread. One-third fear reptiles. Twenty-eight percent dread public speaking. Twenty-two percent are afraid of death. And almost as many people, 8.5 percent, fear zombies as fear IRS audits. The extent to which these fears overlap wasn’t evident.

So why is the number of people fearing IRS audits so much smaller than one would guess after interacting with people? The report suggests it is because many taxpayers do not have the opportunity to do the things that are more likely to trigger audits. Slightly more than two-thirds of taxpayers claim the standard deduction, and thus have no itemized deductions to be audited. Most taxpayers generate income that is reported on Form W-2 or Form 1099. Increasing numbers of taxpayers have their returns prepared by tax professionals, and accordingly perceive reduced chances of their returns containing errors that would catch the attention of the IRS. Many tax return preparers offer audit protection, usually for an additional charge, and some offer other audit assistance promises.

But the biggest reason for the low percentage of taxpayers fearing IRS audits is the fact that the IRS is performing fewer and fewer audits as the years go by, thanks to reduced funding by the Congress. The overall audit rate is 0.84 percent, which is less than one in a hundred. Even taxpayers with income of $10,000,000 or more are audited only at a rate of 16.22 percent, and most taxpayers aren’t in that economic ballpark. For most taxpayers, whose income is in the $25,000 to $1000,000 range, the audit rate is 0.5 percent, or one in two hundred.

But fear, of course, is not logical. If a one in two hundred chance of being audited explains an audit fear rate of 11 percent, then why do 8.5 percent of Americans fear zombies? The answer, of course, is that fear is emotional. What triggers someone’s emotions, whether positive like elation or negative like fear, varies from person to person. And, because fear is irrational, in the end, there’s no explaining it.

A recent Tax Court decision, El v. Comr., 144 T.C. No. 9 (2016), presented an issue of first impression, specifically, whether section 7491(c) shifts the burden of production to the IRS when it asserts that the taxpayer owes the section 72(t) 10-percent additional tax. The Tax Court held that the answer is no. The Court’s analysis is an excellent lesson in statutory interpretation similar to what I have tried to help students in the introductory tax course learn.

The facts of the case, as they relate to this issue, are simple. The qualified plan in which the taxpayer was a participant made loans to the taxpayer, of which $2,802 was taxable. The plan issued a Form 1099-R to the taxpayer reporting a taxable distribution of $2,802. The taxpayer did not file a federal income tax return for the year in question. The Tax Court concluded, based in part on the taxpayer not disputing these facts, that the $2,802 was includible in the taxpayer’s gross income.

The IRS determined that the section 72(t) 10-percent additional tax applied. The IRS argued that section 7491(c) did not impose on it the initial burden of production with respect to the section 72(t) additional tax. It presented two reasons. First, the section 72(t) tax is an “additional tax” and not a “penalty, addition to tax, or additional amount.” Second, because the issue was whether the taxpayer qualified for any of the exceptions to the section 72(t) tax listed in section 72(t)(2), even if the section 72(t) tax is an “additional amount” for purposes of section 7491(c), the burden of production with respect to statutory exceptions should be on the petitioner. Because the Tax Court disposed of the issue by focusing on the first reason, it did not address the second.

Section 7491(c) provides, “Penalties.--Notwithstanding any other provision of this title, the Secretary shall have the burden of production in any court proceeding with respect to the liability of any individual for any penalty, addition to tax, or additional amount imposed by this title.” The Tax Court noted that the terms “penalty, addition to tax, or additional amount” mirror, in part, the title of chapter 68 of the Code, which is “Additions to the Tax, Additional Amounts, and Assessable Penalties.” According to the Tax Court, what these terms have in common is that they refer to amounts that are assessed and collected as taxes but are not themselves taxes or surtaxes. The Court had previously held, in Pen Coal Corp. v. Comr., 107 T.C. 249, 258 (1996), that Congress used the phrase “any additional amount, or any addition to the tax” in section 6214(a) to ensure an understanding that the Court’s jurisdiction encompasses items that are to be assessed, collected, and paid in the same manner as taxes, including the additions to tax and other additional amounts not labeled as “additions to tax” described in chapter 68.

The Tax Court concluded that the section 72(t) additional tax is a “tax” and not a tax is a “tax” and not a “penalty, addition to tax, or additional amount” within the meaning of section 7491(c). It provided three reasons. First, section 72(t) calls the exaction that it imposes a “tax” and not a “penalty”, “addition to tax”, or “additional amount”. Second, several Code provisions, such as section 26(b)(2), 401(k)(8)(D), (m)(7)(A), 414(w)(1)(B), and 877A(g)(6), expressly refer to the section 72(t) additional tax by using the unmodified term “tax”. Third, section 72(t) is in subtitle A, chapter 1 of the Code, with subtitle A bearing the descriptive title “Income Taxes”, chapter 1 bearing the descriptive title “Normal Taxes and Surtaxes,” chapter 1 providing for several income taxes, and additional income taxes being provided for elsewhere in subtitle A, whereas, in contrast, most penalties and additions to tax are in subtitle F, chapter 68 of the Code. The Tax Court noted that in Ross v. Commissioner, T.C. Memo. 1995-599, it had relied on some of the same reasons in holding that the section 72(t) additional tax is a tax and not a penalty for purposes of section 6013(d)(3). The court also pointed out that its construction of section 72(t) is consistent with its legislative history, which indicates that section 72(t) was enacted to “impose an additional income tax on early withdrawals” to discourage early withdrawals from retirement accounts for nonretirement purposes and, in the event of such early withdrawals, to recapture a measure of the tax benefits provided. The court acknowledged that although section. 7806(b) provides that “[n]o inference, implication, or presumption of legislative construction shall be drawn or made by reason of the location or grouping of any particular section or provision or portion of” the Code and that “descriptive matter relating to the contents of * * * [the Code cannot] be given any legal effect”, it had previously held, in Corbalis v. Commissioner, 142 T.C. 46 (2014), that it is permitted to consider the similarity of terms and provisions within the Code, as well as any descriptive matter, as an aid to interpretation.

Thus, because the section 72(t) additional tax is a “tax” and not a “penalty, addition to tax, or additional amount” within the meaning of section 7491(c), the burden of production with respect to the additional tax remained on the taxpayer. Because the taxpayer failed to introduce any credible evidence showing that he was not liable for the section 72(t) additional tax on the distribution from the qualified plan, the Tax Court sustained the IRS determination on this issue.

It’s easy to put all wealthy individuals into one tax policy basket, accusing them of wanting nothing but lower taxes. But as I have pointed out from time to time, not all wealthy individuals support the never-ending cry for reduced taxes on the wealthy. There are rational, sensible tax policy voices among those in the highest income and wealth brackets, but those voices are drowned out by the cacophony of those who remain wedded to the discredited supply-side tax philosophy.

Now comes news that almost four dozen millionaires in New York have advised New York governor Andrew Cuomo that the people of New York would be best served by an increase in the state income tax rate applicable to incomes over $2 million. The plan getting most attention would raise the top rate for incomes between $2 million and $10 million from 8.82 percent to 9.35 percent, for incomes between $10 million and $100 million to 9.65 percent, and in excess of $100 million to 9.99 percent. For a person with annual income of $5 million, the increase in the state income tax bill would be roughly $25,000.

What motivates these millionaires is the realization that, in the long run, insufficient tax revenue erodes the infrastructure on which the economy rests, an economy that generate the income and wealth held by the millionaire and billionaires. Similarly, as the number of “New Yorkers who are struggling economically” increases, there is a decrease in the amount of purchased goods and services, in turn harming the overall economy. Put simply, though these millionaires did not articulate it in this manner, a healthy state economy, just like the national and global economies, depends on demand-side activity. The death of supply-side, trickle-down economic theory is a slow one, but its final breath draws nearer.

In the letter, the millionaires explained that state's millionaires "have both the ability and the responsibility to pay our fair share. We can well afford to pay our current taxes, and we can afford to pay even more." Opponents of the tax increases, clinging to their blind allegiance to the anti-tax movement, re-asserted their opposition to all revenue increases, stating, “Whether it’s income taxes, property taxes, business taxes, user fees, or tolls, we don’t support raising taxes or asking hard-working New Yorkers to dig deeper into their pockets to pay more.” These same folks, though, have no qualms about people reaching deeper into their pockets to pay the costs of failing infrastructure and stagnant economies.

The concern is not that the writing is on the wall for outdated trickle-down economic theory. The concern is that some people are unable to read that writing or to understand what it means or why it is there.

The call for tax cuts for the wealthy continues. More than several candidates for the Presidency, including some who have since dropped out of the race, claim that tax cuts will solve just about every problem that the nation faces. Though they advertise the tax cut cry as beneficial for working Americans, it fact almost all of the proposed cuts, like the ones enacted at the beginning of the century, go to the wealthy.

It’s not just a federal tax issue. The same folks who advocate tax cuts for the wealthy at the federal level also take their campaign to the states, and in many instances, to localities. In every instance, the advertising is the same. Tax cuts provide more money for the wealthy, so that the wealthy can hire more employees and create jobs. Of course, that hasn’t happened and will not happen. As I’ve explained many times, for example, in Job Creation and Tax Reductions, people don’t create jobs unless they need workers. They don’t need workers unless they have customers who want to purchase the goods and services that they would provide. If the American middle class and those living in poverty or near-poverty don’t have money, they don’t make purchases. In fact, they cut back on purchases. And that, understandably, causes the owners of capital and the entrepreneurs of the business world to cut, not create, jobs.

One state where the “tax cuts for the wealthy are good for the economy” argument was adopted, and turned out to be a disaster, has been Kansas. As widely reported and as recalled in this article, the godfather of so-called “trickle down,” supply-side, cut-taxes-on-the-wealthy theory, Arthur Laffer, told people in Kansas, back in 2012, that Kansas would experience “enormous prosperity” if it cut its income tax rates. Kansas took his bad advice. As I explained in A Tax Policy Turn-Around? and Success for the Anti-Tax Crowd: Closing Down Education, Kansas is paying the price. And Kansas paid not only the price of a staggering economy, but also the $75,000 fee that was put in Laffer’s pocket for his consultation with the governor who pushed through the tax cuts.

Now Laffer claims that he is not surprised that the tax cuts created huge budget deficits. Kansas also has seen very little in the way of new jobs, and its economy has stagnated. Laffer claims that though he is not surprised by the deficits, he doesn’t know why they have occurred. Is he serious? He expected deficits but doesn’t know why? That sort of reasoning would not earn good grades in Economics 101. He tried to back out of this inconsistency by claiming that revenue would increase, though perhaps in the distant future. He argued that it could take ten years for revenue to begin to increase. If it begins to increase in ten years, how many years will it take before it generates enough to offset the deficits? Twenty years? Thirty years? And then how many more years before there is a positive return on the so-called “tax cut investment.” In the meantime, the wealthy are partying, and the middle class and the poor are struggling.

Another of Laffer’s justifications for cutting income taxes would also do poorly in Economics 101. Laffer claims that economic growth is higher in states that do not have income taxes than in states with income taxes. Even if that is true, the reason is simple. States without income taxes rely on other sources of revenue. Alaska, for example, sitting on a pool of oil, not only eliminated its income tax but paid dividends to its citizens. Though the other states without income taxes aren’t sitting on oil, so to speak, they pull in money from gambling, tourism, or higher taxes on sales or property.

Critics of the tax cuts have suggested they be rescinded. Laffer claims that doing so would be a “bad thing.” Somehow he does not see the consequences of the unwise tax cuts as being a bad thing. He insists that the governor of Kansas, for whom he feels sorry, did the right thing. No, he did not. The proof is in the outcome.

There’s nothing wrong with trying something when the economy is sick. But if the attempted solution does not work, it is best to acknowledge the failure and look for another cure. Laffer’s devotees claim he is brilliant. He probably is. But so was Einstein, who told us that insanity is doing the same thing over and over again and expecting different results. The supply-side, “trickle down,” tax-cuts-for-the-wealthy theory was tested, and has been found wanting. A brilliant person realizes when an experiment has failed, admits the flaw, backs off, and looks for another path. It’s time for demand-side economics to be given a chance.

There is a group of voters, and politicians representing them, who decry state and federal budget deficits. Yet most of these deficit-haters have supported cuts in IRS and state revenue department budgets, which in turn reduces revenue. Reduced revenue increases deficits, unless there are spending cuts. Using decreased revenue as an excuse to cut spending rarely works, because it is a technique that distracts attention from close examination of how much is being spent, and on what programs.

Some claim that through increased efficiency, imposing longer work hours on IRS and revenue department employees, and automating decision making previously provided by humans, revenues can increase despite cuts in department budgets. Though here and there some marginal success can be attained, for the most part, the nation gets what it pays for. Additional proof of this outcome has been shared in the Transactional Records Access Clearinghouse’s report, IRS Auditing of Big Corporations Plummets.

Information from the IRS reveals that “total revenue agent audit hours aimed at larger corporations – those with $250 million or more in assets – dropped by more than one third (34%) from FY 2010 to FY 2015.” It is not a coincidence that during “the same period, the resulting additional taxes the agents uncovered that has been lost to the government dropped by almost two-third (64%) – from $23.7 billion down to $8.5 billion.”

A closer look at IRS audits of huge corporations – those with $20 billion or more in assets – reveals that audit time dropped by almost one-half, and recommended additional taxes dropped by almost three-quarters. The translation is simple. It is becoming much easier for large corporations to escape audits, and thus succeed with questionable or even erroneous tax reporting. Accordingly, income tax revenues from corporations continue to fall.

Worse, though the IRS planned to increase audits of businesses in FY 2016, the number of audits is 22 percent lower than in FY 2015. Another IRS plan, to increase audits of foreign corporations and S corporations with assets of $10 million or more, groups for which noncompliance is significant, has derailed. Audits of foreign corporations in FY 2016 are down 58 percent compared to FY 2015, and audits of large S corporations are down 20 percent.

These reductions match the funding reductions enacted by Congress. Between FY 2010 and FY 2015, Congress has caused the number of IRS employees to fall by 19 percent. In turn, this reduces taxpayer assistance, which contributes to increased noncompliance, and tax law enforcement, which encourages deliberate noncompliance. Yet while cutting the IRS budget, Congress has piled on more responsibilities, such as administration of the Affordable Care Act, a task that should be assigned to the federal agencies responsible for health.

What happens if this trend continues? If those responsible for this trend permit it to continue, and in fact require it to continue, are they responsible for what happens? Is the trend consistent with, and supportive of, their goal? What is their goal? Apparently it’s not deficit reduction.

The re-introduction of a soda tax proposal in Philadelphia has triggered a outpouring of objections, support, questions, criticisms, and re-evaluations. For example, as reported in many stories, including this one, a close look at the proposed legislation revealed that the per-ounce rate on soda sold from fountains would be higher than the rate applied to soda sold in bottles. Proponents of the tax promised to review and revise the language of the bill. The debate over soda tax proposals has been underway for almost a decade, and this blog has not been without reactions, starting with What Sort of Tax?, and continuing through The Return of the Soda Tax Proposal, Tax As a Hate Crime?, Yes for The Proposed User Fee, No for the Proposed Tax, Philadelphia Soda Tax Proposal Shelved, But Will It Return?, Taxing Symptoms Rather Than Problems, It’s Back! The Philadelphia Soda Tax Proposal Returns, The Broccoli and Brussel Sprouts of Taxation, The Realities of the Soda Tax Policy Debate, Soda Sales Shifting?, Taxes, Consumption, Soda, and Obesity, Is the Soda Tax a Revenue Grab or a Worthwhile Health Benefit?, Philadelphia’s Latest Soda Tax Proposal: Health or Revenue?,
What Gets Taxed If the Goal Is Health Improvement?, and The Russian Sugar and Fat Tax Proposal: Smarter, More Sensible, or Just A Need for More Revenue?

Two recent developments involving the Philadelphia soda tax proposal, one a letter of support and one a campaign in opposition, not only caught my eye but activated some of my brain cells. Both instances left me disappointed in how some approach the debate.

Earlier in the week, I spotted a letter to the editor of the Philadelphia Inquirer. According to the letter writer, “When I choose to eat out in Philadelphia, I pay the tax. When I decide to have a drink, I pay the tax. So, when you decide to have soda, pay the tax. It's your decision.” This approach misses the point. The issue isn’t what someone should do once the tax is enacted, if it is enacted. One issue is whether the tax should be enacted. The fact that someone pays a sales tax or an alcohol tax does not add weight to the argument for or against a soda tax. Another issue is whether a tax characterized as designed to improve health should be limited to just one of many allegedly unhealthy dietary items. The letter writer conceded this point by noting, “And evaluate your health status - and who will benefit from the tax.” The letter writer offered no proof that soda is more unhealthy than many of the other items, particularly those containing sugar, fats, and cancer-causing substances, that people ingest.

At about the same time, I heard a radio spot on a local radio station, and upon further research discovered that a group had been organized to campaign against enactment of the tax. What had caught my ear was the characterization of the tax as a “grocery tax.” According to the organization’s web site, No Philly Grocery Tax, the tax would be a “3¢ per ounce tax on everyday grocery items.” Sure, the site then adds “like sodas, sports drinks, juice drinks and some teas” but the initial characterization will cause people to think that a proposal is underway that will tax everything in their shopping cart. Once that seed is planted in most people’s brains, it’s difficult to root it out. Even if the tax was imposed on all unhealthy food and drink items, it still would not be a tax on groceries, because it would not reach a long list of healthy items.

Simplistic reactions and mischaracterizations, no matter from which side of an argument, do not serve the public well. Though they can help advance the cause of those who toss them about, they also can backfire. The ease with which people not only fling such accusations but also readily accept and repeat them contributes to the sad state of this nation’s public and private political debate in the twenty-first century. It’s time for those involved in the soda tax debate, as well as any other political discussion, to focus on the facts and to stick with logic.

One of the reasons I object to using the tax law to distribute economic benefits to particular individuals and businesses, aside from complexity and inequity, is the failure of most tax break recipients to deliver the benefits that they claim will trickle down to other individuals and businesses. Perhaps the most famous of these giveaways is the “tax cuts for the rich generate jobs for the poor and middle class,” a theory that has consistently fallen short when subjected to practical reality. Another example is the dishing out of tax breaks by one state to take jobs from another state, which does nothing for the economic condition of the country, as I discussed most recently in Economic Civil War Poses No Less of a Threat Than A Shooting Civil War

Now comes news that a company given by Nevada a package of state-funded infrastructure improvements and tax breaks will post a bond to cover the possibility that its planned car factory fails to deliver on its promises. Unfortunately, though the incentives could be as much as $336 million, the company is funding only a $75 million bond. Ideally, if a company claims that a state tax break of $100 will generate $300 in new tax revenues, $300 in economic benefits for the state’s residents, or some combination thereof, the company should post a $100 bond. In other words, the tax break should be a loan. Companies that object to providing what is, in effect, a reimbursement promise, and purchasing a bond to cover that promise, are revealing either a lack of confidence in their plans or a underlying desire to obtain free public money.

Another problem with the arrangement in Nevada is that the company will be released from its bond obligation once it builds the factory and begins selling cars. It ought not be released from the bond obligation until and unless an independent auditor certifies that the promised new tax revenues and economic benefits have been generated.

Last week, in What Gets Taxed If the Goal Is Health Improvement?, I commented on a suggestion that Philadelphia’s re-emerging soda tax proposal should be expanded to include diet soda. The disadvantages of limiting an alleged pro-health tax to only one allegedly unhealthy substance has been a recurring theme in my long parade of commentaries on the soda tax, starting with What Sort of Tax?, and continuing through The Return of the Soda Tax Proposal, Tax As a Hate Crime?, Yes for The Proposed User Fee, No for the Proposed Tax, Philadelphia Soda Tax Proposal Shelved, But Will It Return?, Taxing Symptoms Rather Than Problems, It’s Back! The Philadelphia Soda Tax Proposal Returns, The Broccoli and Brussel Sprouts of Taxation, The Realities of the Soda Tax Policy Debate, Soda Sales Shifting?, Taxes, Consumption, Soda, and Obesity, Is the Soda Tax a Revenue Grab or a Worthwhile Health Benefit?, and Philadelphia’s Latest Soda Tax Proposal: Health or Revenue?.

Now, alerted by a reader, I have become aware of a recent “sugar and fat tax” proposal ready for enactment in Russia. According to this report, the Russian government is about to impose a tax on sugary drinks, palm oil, and probably potato chips, electronic cigarettes, and foods with high levels of fat or sugar. Russian President Vladimir Putin is said to support the tax. Russian officials explain that the tax has a dual purpose, not only to reduce the consumption of sugar and fat, but also to generate revenue.

One of the arguments I offer in rejecting a tax limited to soda or soda and some sweet drinks is that such a limitation is inconsistent with the avowed goal of improving health. I have suggested that these taxes are not much more than an attempt to raise revenue, with lip service paid to issues of health. I have contended that if health improvement is a serious goal, and assuming that a tax would actually change eating habits, the tax needs to reach more than soda, and should extent to include items such as cookies, cakes, donuts, candy bars, and junk food. The Russians appear to be taking the approach I favor, even if they admit that revenue is a motivating factor in the proposal. I doubt, however, that the tax planners and legislators in Russia found inspiration for their proposal in the pages of this blog, though the traffic sources statistics tells me that there are people in Russia reading MauledAgain.

Why would someone want to sell losing lottery tickets? The answer is simple. Those losing tickets have value to someone who wins a lottery, because amounts paid for losing lottery tickets can be deducted from amounts won in a lottery.

So why should someone hesitate to sell losing lottery tickets? The answer is simple. The person buying those tickets and representing that they lost the face value of those tickets would be committing tax fraud. The person selling those tickets very easily could be caught up in conspiracy and other criminal charges.

A reader turned my attention to a story that has popped up in a number of sources. Though almost a year old, it had escaped my notice. According to the story, there are people selling losing lottery tickets on Craigslist, seeking buyers who intend to use them as evidence of gambling losses that can be deducted against their gambling winnings. One of the ads, in which a seller offers losing lottery tickets with a face value of $1,100 for $70, advertises, “Good for tax write-off for your . . . taxes to offset your winnings.” Would-be buyers also place ads, one in particular explaining, “I would like the ones your [sic] tossing in the trash.” According to this story, some people are renting losing lottery tickets to taxpayers who “need” losses to reduce their gambling winnings.

Years ago, someone shared with me one of those urban-legend-like IRS tales about a taxpayer who had done well at the racetrack. He reported net gambling winnings of zero. When audited, and asked by the IRS to substantiate his gambling losses, he produced a pile of losing tickets. His ploy failed when the IRS agent noticed footprints on the tickets. Though some reports of this story on the internet claim that the IRS issued rulings in which it takes the position that tickets with footprints on them are unacceptable as proof of losses, I have not found a ruling that mentions tickets with footprints on them.

Some of the stories about the Craigslist losing lottery ticket sales mention the tribulations of one Henry A. Deneault. For example, in this one, we are told that the former IRS revenue officer, working as a tax accountant, tried to help his client, Phillip Cappella. Cappella had won $2.7 million in the Massachusetts lottery, and wanted to reduce his taxes. Deneault decided to put a $65,000 gambling loss on the return, and needing substantiation for it, paid $500 to a man named William Jenner to rent $200,000 in losing lottery and racetrack tickets. Deneault sent several employees to pick up the tickets, which filled the bed of a pickup truck. The scam failed, the IRS caught on, and both Deneault and Cappella pleaded guilty to tax fraud and went to prison. It’s unclear what happened, if anything, to Jenner.

How much tax could be saved with $65,000 of losses when the taxpayer was looking at a minimum of $2.7 million in gross income? Was it worth it? Apparently not. Yet, we are told by various sources, the practice of selling or leasing losing lottery and racetrack tickets continues to this day.

Here’s the odd twist. Individuals with gambling losses that cannot be used, because of insufficient gambling winnings against which to set them, get in trouble if they sell them to other individuals in need of losses. Yet corporations saddled with losses that cannot be used have a variety of acceptable transactions by which, in effect, they sell those losses to other corporations that can use them.

A reader alerted me to this story. It fits into the “we don’t need to make things up” category that I often mention when posing questions to my students.

A man in Missouri placed an ad on Craigslist. There’s no good way to paraphrase it. Yes, it deserves to be quoted:

WANTED: KIDS TO CLAIM ON INCOME TAXES - $750 (SPRINGFIELD, MO)
IF YOU HAVE SOME KIDS YOU ARENT CLAIMING, I WILL PAY YOU A $750 EACH TO CLAIM THEM ON MY INCOME TAX. IF INTERESTED, REPLY TO THIS AD.

Perhaps surprisingly to some, but not others, the man received replies. On his 2014 federal income tax return, the man listed three dependents by name, social security number, and alleged relationship. One problem was that all three had the same names. Another problem? They had the same social security numbers. Though listed as two sons and one daughter on the 2014 return, on the man’s 2012 and 2013 return they are listed as two daughters and one son.

Not surprisingly to anyone who understands tax law, or even law generally, or perhaps just common sense, the man has been indicted for filing false income tax returns. No word on whether the people who presumably were paid $750 for sharing social security numbers with the man have been, or will be, indicted.

This man would not be in the position he is today had the Congress enacted at least part of the reform proposal I offered more than twenty years ago. In Tax and Marriage: Unhitching the Horse and Carriage, 67 Tax Notes 539 (1995), I suggested “a system based on transferable exemptions,” among other things. Part of my explanation of why I made this proposal anticipated the precise sort of arrangement for which the Missouri man has been indicted:

C. Sales of Unused Exemption Amounts

Individuals with no income, such as the homeless, could benefit by selling their unused exemption amounts to taxpayers, thus putting income redistribution into a private-sector marketplace and removing it from federal bureaucratic inefficiencies. The proceeds would be excludable from income, and the amount paid would not be deductible, for the same reasons the federal income tax is not deductible in computing federal income tax liability. Once sold, the exemption is unavailable even if subsequent audits determine that the individual's income was greater than originally estimated.

This unused exemption amount sale aspect of the proposal is not as mercenary as it initially appears. If unused exemption amounts could not be sold, then tax revenues, or budget deficits, would need to be increased to provide funds for public welfare programs benefitting the impoverished. Permitting impoverished individuals to sell unused exemption amounts transfers to those persons directly the dollars that would otherwise be collected by the federal government and transported through a bureaucratic maze that would reduce the amount reaching those in need by some substantial percentage. In a sense, it would create a 'private market negative income tax.'

To the extent a negative income tax is unattractive because it involves cash grants from the government, the shifting of its incidence to the private sector eliminates direct governmental involvement and casts the exemption sale transactions in a private enterprise light. Though the negative income tax, even in the form of unused exemption amount sales, is considered by some to be a work disincentive, the amount for which the unused exemption amount could be sold would be less than the amount needed for anything more than bare subsistence and would not deter the ambitious or the proud from seeking employment.

Precedent for the sale of governmental benefits can be found in the transfer system permitting businesses to sell or transfer sulfur dioxide pollution allowances. In terms of the policy of permitting transfers, the unused exemption amount is essentially the same as the pollution allowance, because a person without the need for it can sell it to someone who does have such a need. [footnotes omitted]

Of course, the fact that what the Missouri man did would make a good deal of sense had it been permitted under law is no defense to doing something that is impermissible under the law. The man in Missouri surely will end up convicted and punished. It’s too bad Congress cannot be indicted, convicted, and punished for making a mess of the tax system, continuing to make it worse, and refusing to clean it up.

Several days ago, in Philadelphia’s Latest Soda Tax Proposal: Health or Revenue?, I questioned whether the latest soda tax proposal in Philadelphia was more a matter of raising revenue than improving health. My question was triggered by my long-held position that if the goal of a soda tax is to reduce the ingestion of sugar, the tax ought to be a sugar tax imposed on far more than just soda. That’s not to say that a sugar tax is ideal, because sugar is far from the only substance that can cause health problems. It’s simply a matter of logic and consistency, and the unfairness of singling out one sugar-containing item while claiming that a tax on that item reflects the health hazards of sugar.

In reaction to the sugar tax proposal, Will Bunch offers the suggestion that the tax ought to apply not only to regular soda but also to diet soda. His suggestion takes two perspectives. One is that diet soda also is unhealthy. The other is that expanding the base of the tax would permit either increased revenue or a lower tax rate.

Bunch makes a good point. It is not dissimilar to my concern that limiting an allegedly pro-health tax to only one of many substances that contribute to poor health is a bit too disingenuous. Bunch has provided a good service to everyone involved in the soda tax debate, by putting the spotlight on a substance that does not contain sugar but that is similarly unhealthy. For decades, so-called sin taxes have been applied to items perceived as dangerous, yet popular, such as tobacco and alcohol. True, those items pose serious health risks. Tobacco is a health risk, period. Alcohol is a health risk when used to excess, and in some instances is beneficial to health. Sugar, too, poses its risks when consumed in high quantity. Removing all sugar from one’s diet also endangers health. But does the list stop with sugar-containing soda, or diet soda? There’s a long list of items that, if consumed excessively, or even at all, pose health risks. In my last post on the issue, I mentioned French fries, red meat, deep fried cheese sticks, churros, popcorn shrimp, and junk food. Bunch widened my perspective. The question becomes, what other items belong in the list? GMO modified foods? Non-organic food? Water from Flint, Michigan? Governments that truly care about health ought to act consistently with that claim, and not use health as an excuse for taxing certain selected items.