MauledAgain

A reader shared some links in response to my recent post, Is Basic Math Enough?. I had quoted a previous post, from 2005, in which I had shared statistics on the extent to which American school systems require high school students to take one or more courses in financial literacy. At that time, “only seven states require personal financial education as a high school graduation requirement, one requires high schools to offer a course in the subject though it is not a required course, and one state requires that it be taught in middle school.” According to this 2013 report, Financial education: Does your state make the grade?, progress has been made. Twenty-three states require either a financial literacy or personal finance course as a condition of graduation, or require that financial literacy be incorporated into a required course. But twenty-three is less than half of the states. So there’s still much to be accomplished.

That much more needs to be accomplished is evidenced by yet another report, from the Educational Testing Service. Testing literacy, numeracy, and problem-solving, the outcome was dismal. “In numeracy, U.S. millennials ranked last.”

Those who are curious can test themselves, though I suspect most people reading this blog will do quite well with this test. Administered globally, the test revealed that Americans scored worse than other major English-speaking economies.

My reaction? Wow. Just wow. So much for claims of American exceptionalism. Assuming that America no longer is “great” – whatever that means – and needs to be made “great again,” the foundational work needs to be done in the education space. Uneducated people cannot accomplish what educated people can do. By education, I don’t mean only formal classroom sessions, but also training and hands-on learning in all sorts of skills, trades, professions, and occupations. It’s not just the white-collar financial analysts, brokers, and tax professionals who need numeracy skills. Carpenters, roofers, mechanics, and cooks, to name just a few, also work with numbers. And everyone needs to understand cash, finances, investments, interest rates, present value, inflation, compounding, and the time value of money. I’ve yet to hear any of the candidates for President talk about these basic underpinnings of a successful economy. I wonder why.

A question was posed by a tax practitioner that caught my eye, in part because it seemed to be an unusual situation, and in part because it could be used as an excellent examination question in a basic income tax course to measure students’ grasp of statutory interpretation and judicial opinions, and to argue by analogy. The facts are rather sad.

A man with Alzheimer’s disease lives at home. He receives help from an Alzheimer’s care specialist, is under a doctor’s care, and takes medications to alleviate and prevent other health problems. One day, he fainted. He fell back into the glass door of the oven. The glass shattered. The man’s head was injured but fortunately he only need medication for the headache and the lump on his head.

The oven was rendered useless. It cannot be fixed because the manufacturer no longer makes parts for the oven. Unfortunately, that part of the story is not unusual, because the “make no replacement parts, force purchase of a new item” approach to boosting profits is sweeping through the world. So the man needs to purchase a new oven.

The tax question is easily stated. Can the man claim a medical expense deduction or a casualty loss deduction for the cost of the new oven? Actually, those are two questions.

The first question is easy to answer. The cost of the oven does not qualify as medical care. Under Internal Revenue Code section 213(d)(1), medical care consists of “the diagnosis, cure, mitigation, or prevention of disease, or for the purpose of affecting any structure or function of the body, . . . transportation primarily for and essential to medical care, . . . qualified long-term care services, or . . . insurance . . . covering medical care. . . “ There’s simply no way the cost of the oven fits within that definition.

The second question is a bit more challenging. Under Internal Revenue Code section 165(c)(3), a casualty loss is a loss that arises “from fire, storm, shipwreck, or other casualty.” Because the incident did not involve fire, storm, or shipwreck, the question becomes one of determining if it fits within “other casualty.” The courts have defined a casualty as “an event due to a sudden, unexpected, or unusual cause.” The list of events that have been treated as casualties does not include destruction of an appliance on account of a fainting episode. However, arguing by analogy, the outcome should be the same as that reached when analyzing damage to property caused by an automobile accident triggered by a medical condition that causes loss of consciousness or control of the vehicle. If a person faints while driving and the vehicle consequently crashes, the event is a casualty. Now, whether the amount spent for the new oven would survive the $100 limitation and the ten-percent-of-adjusted-gross-income floor, and in turn be sufficient to permit disregard of the standard deduction, is a question that cannot be answered without having more information. What was the value of the old oven before the casualty? Is the value of the old oven after the casualty zero because it cannot be repaired? What is the taxpayer's adjusted basis in the old oven? That question must be answered because the amount of the casualty cannot exceed basis in the case of personal use property. Is the cost of the new oven an acceptable surrogate for cost of repairs in attempting to measure the decline in value? What is the cost of the new oven? What is the adjusted gross income? How much, if any, insurance reimbursement was available under the homeowner’s policy?

Note: On 10 May 2016, I added to the list of questions to be asked, in response to a reader's inquiry and suggestion that the original list of questions implied that the cost of the new oven would automatically be used to measure the deduction.

Though I’ve never tried to calculate which topic has been the subject of the most MauledAgain commentaries, certainly my strong support for mileage-based road fees is a candidate for topping the list. If it doesn’t, it’s not far behind. Readers of this blog surely are aware of the arguments I have made in favor of this particular fee, and the rebuttals I have offered against criticism. The analysis began with Tax Meets Technology on the Road, and has continued through Mileage-Based Road Fees, Again, Mileage-Based Road Fees, Yet Again, Change, Tax, Mileage-Based Road Fees, and Secrecy, Pennsylvania State Gasoline Tax Increase: The Last Hurrah?, Making Progress with Mileage-Based Road Fees, Mileage-Based Road Fees Gain More Traction, Looking More Closely at Mileage-Based Road Fees, The Mileage-Based Road Fee Lives On, Is the Mileage-Based Road Fee So Terrible?, Defending the Mileage-Based Road Fee, Liquid Fuels Tax Increases on the Table, Searching For What Already Has Been Found, Tax Style, Highways Are Not Free, Mileage-Based Road Fees: Privatization and Privacy, Is the Mileage-Based Road Fee a Threat to Privacy?, So Who Should Pay for Roads?, Mileage-Based Road Fee Inching Ahead, and Rebutting Arguments Against Mileage-Based Road Fees

Now comes a report that, according to a survey by HNTB, an infrastructure solutions firm, “The majority of Americans would support road-usage fees to help fund transportation costs.” The survey revealed that 65 percent of Americans favor mileage-based fees and similar options to finance repairs to a crumbling infrastructure. An even higher number, 69 percent, favor “priced managed lanes.” There are a variety of priced managed lane formulations, but all involve some sort of fee for access to presumably less congested highway lanes.

What caught my attention was the difference in responses among Millennials, Gen-Xers, Baby Boomers, and “seniors” to the question of funding infrastructure. A higher proportion of Millennials and Gen-Xers preferred using higher property taxes to close the funding gap than was found among Baby Boomers and “seniors.” That makes sense, because property taxes are not well received by those on fixed incomes who cannot control what they are paying by altering their infrastructure-use choices.

Younger respondents were more in favor of mileage-based road fees than were older people. It is possible this reflects some combination of understanding technology, being less apprehensive about technology, and being accustomed to using technology of this sort. It also is possible that this reflects the proportionately lower use of highway infrastructure by younger people. Sometimes the future can be predicted, at least to some extent, by looking at what younger people are doing, and saying. If that is the case with this issue, the future, sooner or later, will see the implementation of mileage-based road fees. That I have something more in common with the younger generations than with my own is encouraging. Perhaps it ought not be, but it is. Am I young at (tax) heart?

One of my second cousins once removed shared on Facebook a meme apparently originating in a tweet by Sage Boggs and then posted by George Takei. The meme states “I’m glad I learned about parallelograms instead of how to do taxes. It’s really come in handy this parallelogram season.” One of the many people commenting on the original post stated, “If you cared about learning these things you would have taken a business studies unit in your final high school years. Don’t complain about a terrible education when you made the choice that some things were more important than learning things that might be useful.” In turn, this comment brought several reactions. Among them was the observation that it was “Easy to say unless your school doesn’t HAVE such courses.” Another asked and answered, “Did you school have basic math? That’s all that’s really necessary.” Another explained, “Actually, I did take all of the business classes in high school, including accounting. And taxes weren’t covered.”

Understanding basic arithmetic, which is the most elementary subset of mathematics, is helpful but not absolutely essential when it comes to doing tax returns. Why? Because tax preparation software handles the computations, and for portions not handled by the software, such as adding up receipts, there is other software, such as the Microsoft Windows Calculator, and physical calculators. I wonder if anyone still owns an adding machine with paper “tape”?

What matters most is the ability to read, to understand words, and to follow logic. What also matters is the ability, and willingness, to retain and sort a variety of documents representing financial information. Even so, it helps not only to be able to read, but also to acquire an appreciation for the language of tax rules and the way in which those rules are written. That is why it is most useful to enroll in a tax course of some sort.

Though some high schools provide students with an opportunity to become familiar with their tax obligations and how to comply with tax law requirements, too many schools fall short. Nine years ago, in Congress Invites My Ideas for Improving Tax Compliance and Of Course I Respond, I shared the letter I sent to Congress, and repeat here a portion of it:

Thank you for the invitation to suggest approaches for improving tax compliance. The tax gap is a concern that demands attention from the Congress.

There is no one “magic bullet” to solve the problem. Instead, I advocate a six-pronged strategy for improving compliance. Those six prongs are tax education in high schools, tax simplification, increased reporting, expansion of withholding, funding an improved tax audit process, and strengthening the ability of the Department of Justice to prosecute tax crime.

Making tax education a part of high school curricula throughout the nation would go a long way in reducing noncompliance. A significant portion of noncompliance is inadvertent, the result of taxpayers’ inability to understand the nature of the federal tax system and to recognize the flaws in the many inappropriate “tax savings” schemes offered to them by unscrupulous promoters of noncompliant tax reduction plans. The tax education I suggest is not a technical tax return preparation course, but one that blends an understanding of the rationale for taxation and the basic features of the tax system with advice on how to maximize compliance and minimize the aggravations that arise from noncompliance. Educating citizens before or as they enter the taxpaying world is much more efficient and effective than trying to remove their misperceptions after the fact during tax audits and tax litigation.

About a year later, in Does It Matter Who or What is to Blame?, I reiterated and expanded on a point I had made back in 2005:

And more than three years ago, in Economically Depressing?, I referred to "my expressed desire that K-12 education be revamped so that high school graduates enter society with the survival tools needed for life in the 21st century." According to the 2005 report of the National Council on Economic Education, the latest I could find, only seven states require personal financial education as a high school graduation requirement, one requires high schools to offer a course in the subject though it is not a required course, and one state requires that it be taught in middle school. There are 50 states in the union, plus the District of Columbia and some overseas possessions. Surely personal finance is no less important than other subjects being taught in middle school and high school.

Though comments on a facebook thread do not necessarily reflect national mood, I think it is a safe guess that most Americans would welcome high school courses that provide students with an awareness of the practical realities of financial responsibility, particularly tax obligations. I also think it is a safe guess that many Americans would react to these opportunities with comments along the lines of, “I wish they had something like that when I was in high school.” Politicians of the nation, federal, state, and local, it is time to step up and improve high school curricula by adding courses that prepare young people for life when tax reality hits home. Basic math courses aren’t enough, and provide very little of what is necessary.

A little more than a month ago, in Soda Tax Debate Bubbles Up, I noted that I had heard a radio spot on a local radio station seeking support in opposition to the soda tax proposed by Philadelphia’s mayor. I explained:

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.

Though I oppose the soda tax as it is presently constructed, particularly because the concern is sugar, not beverages, I suggested that gross mischaracterization could work to the detriment of those overstating their case against the tax:

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.

So it was no surprise to me when, a few days ago, I read a letter to the editor of the Philadelphia Inquirer by Dr. Barbara W. Gold, vice chair of Food Trust’s board. She pointed out that calling the soda tax a grocery tax is a scare tactic, is dishonest, and misleading. On those points she is correct. The soda tax will not cause a “large spike in grocery prices.” She describes other food items as “real groceries,” though that designation also is confusing, because soda is an ingestible item sold in, among other places, grocery stores.

Where I disagree with Dr. Gold is her support of a tax on “the beverage industry’s multibillion-dollar annual profits” to pay for desirable city programs. As I have continually pointed out, as unhealthy as soda can be, so too are other items, including some of the baked goods and frozen foods Dr. Gold includes within the category of “real groceries.” Medical research has demonstrated that one of the serious culprits in health issues is sugar. Limiting a sugar tax to sugary drinks is akin to limiting a tobacco tax to tiny cigars.

As I also pointed out in in Soda Tax Debate Bubbles Up:

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.

Dr. Gold’s letter is a step in the right direction, but it doesn’t go far enough, and it adds, perhaps inadvertently, another layer of confusion by introducing the confusing term “real groceries” into the discussion.

Ultimately, claiming that the proposed soda tax is a grocery tax will backfire. It distracts people from the central issues. Some people will look at that claim, consider it an overstatement, and decide that it reduces their confidence in the position being taken by those opposing a tax on, or limited to, certain beverages. To the extent these people end up supporting the tax proposal because of the overstatement by an opponent of the tax, the hyperbole will turn out to be counter-productive.

It isn’t unusual for a taxpayer to report less income on a federal income tax return than is shown on an information return such as a Form W-2 or Form 1099 if the taxpayer thinks that the amount on the information return is too high. And, sometimes, a taxpayer might report nothing, or even fail to file a return, as a reaction to an information return that reports more than what the taxpayer thinks should be reported.

A recent case, Chambers v. Comr., T.C. Memo 2016-72, presents an approach that was backwards to what one might expect to see. The taxpayer did not file a federal income tax return for 2011, so the IRS completed a substitute return, on which the IRS reported $35,257 of annuity income. According to records of the Office of Personnel Management, the taxpayer was entitled to a gross annuity of $46,392, of which $35,257 was paid to the taxpayer and $11,134 was paid to his former spouse.

The taxpayer did not dispute that he received annuity payments of $35,257. He argued that the Office of Personnel Management had miscalculated his annuity and that he should have received a higher amount. Thus, according to the taxpayer, the amount shown by the IRS on the notice of deficiency was incorrect.

The Tax Court concluded that it did not have jurisdiction to determine the proper amount of the taxpayer’s annuity for 2011. The Tax Court’s jurisdiction is limited to those matters over which Congress has authorize it to act. Determining the proper amount of the annuity is not one of those matters. Not surprisingly, the Tax Court held that the taxpayer had gross income in 2011 of $35,257, which was reduced by $3,152 on account of an IRS concession reflecting $3,152 that the taxpayer had contributed to the retirement plan under which the annuity was paid.

Even if the taxpayer was correct that he should have received additional annuity payments, logic prohibits concluding that the taxpayer’s gross income for 2011 was anything less than $35,257 reduced by the $3,152. Unlike an instance in which the taxpayer understandably does not want to be taxed on amounts erroneously reported on an information return but allegedly not received by the taxpayer, there is no sensible reason for concluding that tax is not due with respect to income that happens to be less than what the taxpayer thinks the income should have been.

The opinion in the case does not explain what the taxpayer thought was done incorrectly in computing the annuity. That makes sense, because those facts would be relevant to a decision over which the Tax Court has no jurisdiction. Thus, we do not have the benefit of what the taxpayer was attempting to do by not filing a return. My guess is that it was something along the lines of “the government paid me less than it should have paid me so I’ll get back at the government by not filing a tax return and not paying income tax on what I did get,” as though somehow the resulting tax reduction would offset the alleged annuity underpayment. As I pointed out in If This Happens, It Would Be a Tax Miracle:

It amuses me when people refer to “the government,” as though there is a monolithic, internally coordinated, and smoothly-functioning machine called “the government” that acts in a unilateral fashion to make decisions. Lumping all government offices, officials, employees, and agencies into one group makes it too easy to avoid placing responsibility where it belongs.

The practical reality of the situation is that the people who computed the taxpayer’s annuity payment would remain blissfully unaware of his failure to file a return and pay taxes until they read the opinion in the taxpayer’s case, which is something they are very unlikely to do.

The taxpayer paid a high cost for his decision to pay no tax on the annuity he received because he wanted a larger annuity payment. Not only does he end up paying the tax, plus interest, he was also held liable for the section 6651(a)(1) penalty for failure to file a tax return and the section 6651(a)(2) penalty for failure to timely pay the tax due. It can be expensive to go backwards.

In a recent private letter ruling, PLR 201616002, the IRS concluded that a corporation’s matching contributions on account of employee political contributions are not deductible. This is one instance where the complications are not a product of tax law.

The taxpayer, a corporation, is barred by the Federal Election Campaign Act (FECA) from contributing to federal election campaigns. So the corporation set up a political action committee (PAC), funded by the taxpayer’s employees and by employees of the taxpayer’s subsidiary corporations. The PAC was established as a political organization exempt from federal income tax under section 527. It’s purpose is to “disburse funds to candidates” for public office, and the recipient candidates are selected by the PAC. The taxpayer encouraged its employees to contribute to the PAC. As an incentive, it promised that if an employee contributed at least an undisclosed amount, not in excess of another undisclosed amount, to the PAC, it would in turn make a contribution in the employee’s name to one or more charities selected by the employee.

The taxpayer sought a ruling from the IRS that the contributions to the charities were deductible as ordinary and necessary business expenses under section 162. The IRS concluded that they are not deductible.

The IRS explained that section 162(e)(1)(B) prohibits deduction of amounts paid or incurred in connection with a political campaign. The contributions to the charities, according to the IRS, ‘are inextricably linked” to the contributions to the PAC. The contributions to the PAC are a prerequisite for the contributions to the charities. The contributions to the charities are matched to the amounts contributed to the PAC. The reason for the contributions to the charities is to encourage contributions to the PAC.

So, in addition to creating a complicated arrangement designed as an end-run around FECA, the taxpayer tried to create a tax benefit from the arrangement. The attempt to create the tax benefit was also an end-run, around the restrictions of section 162(e). The tax attempt failed. Nothing in the PLR explains whether the FECA end-run works.

Once upon a time, Donald Rumsfeld, who finished his career in government as Secretary of Defense, served in Congress. He served as administrative assistant to a member of Congress from Ohio, then as staff assistant to a member of Congress from Michigan. In 1962 he was elected to Congress, and served until 1969 when he became Director of the Office of Economic Opportunity.

Now, though retired, he is back in the news. According to this report, Rumsfeld filed for an extension of time for filing his 2015 federal income tax return. He included a letter in which he explained that he remains “mystified as to whether our tax returns and tax payments estimates are accurate,” pointing out that although he has a college degree and retains an accounting firm, he is not confident that the returns he files with his wife are “properly completed.”

In the letter, he expresses the hope that “the U.S. government will radically simplify the tax code.” It amuses me when people refer to “the government,” as though there is a monolithic, internally coordinated, and smoothly-functioning machine called “the government” that acts in a unilateral fashion to make decisions. Lumping all government offices, officials, employees, and agencies into one group makes it too easy to avoid placing responsibility where it belongs. The Internal Revenue Code is a product of Congress. It is enacted by Congress. It is amended by Congress. Portions of it have been repealed by Congress. Why did Rumsfeld not express hope that “the Congress of the United States simplify the Code”? My guess is that facing the truth about the failures of Congress would hit too close to home. Rumsfeld served in Congress. He knows what it does. He knows better.

Worse, he told CNNMoney that although “his pleas are somewhat misdirected,” he thinks that the “IRS could do a whale of a lot to simplify the tax code.” No, it cannot. If the IRS tried to change the Internal Revenue Code, its actions would be null and void. It would be a miracle if someone in the IRS caused the language of the Internal Revenue Code to change.

Rumsfeld did admit that “the real burden in on Congress to take action.” Of course. But expecting the Congress of the United States to reform the tax law would be asking for yet another miracle. Beholden to special interest groups that in recent years have drafted many of the amendments to the Internal Revenue Code, the Congress lacks the courage, the incentive, and the determination to fix the mess that afflicts most people. Rumsfeld called the Internal Revenue Code “disgraceful.” He is correct. But who is to blame?

Rumsfeld has sent a similar letter to the IRS every April for as long as he can remember. Though he has never received a reply, he plans to continue sending the letter every April. It ought not surprise him that he will never receive a reply. That’s because the IRS is not to blame for the Internal Revenue Code, and cannot do anything to change it.

My question for Donald Rumsfeld is simple. Why not send the letter to every member of the Congress? Why not share the replies, if there are any? Why not share the names of those who do not reply? Why not shine the spotlight on those who are responsible? It’s too easy to focus on the IRS, which Congress has chosen to be the scapegoat for the sins of the legislature. Donald Rumsfeld, unlike most of the rest of us, is in a position to shift the focus of the spotlight. Will he?

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.