MauledAgain

One of the many areas of tax law in which facts matter as much as, if not more than, the statute and regulations is the determination of whether a transfer of money or property is a gift excluded from gross income or compensation included in gross income. The black letter law is simple. Section 102 provides that gifts are excluded from gross income. But what is a gift?

A recent case, Jackson v. Comr., T.C. Summ. Op. 2016-69, provides a helpful illustration of why facts matter. In 2012, the taxpayer was the pastor, a director, and the registered agent for a church. His wife also was a church director. The church had approximately 25 to 30 active members and as many as seven ministers, and offered services three days each week. The taxpayer had informed the church’s board of directors that he did not want to be paid a salary for his pastoral services but that he would not be opposed to receiving “love offerings,” gifts, or loans from the church. The taxpayer and his wife managed the church’s checking account, and apparently they jointly signed all of the church’s checks. During 2012, they signed numerous checks payable to the taxpayer, with handwritten notations such as “Love Offering” or “Love Gift” on the memo line.

From 1993 until 2015, one person served as the church’s bookkeeper. In 2012, the bookkeeper prepared and sent to the taxpayer a Form 1099-MISC, Miscellaneous Income, reporting nonemployee compensation of $4,815 from the church. When this bookkeeper left the church in late 2015, the taxpayer’s daughter became the church’s bookkeeper. When the taxpayer and his wife filed a joint federal income tax return for 2012, they did not include the $4,815 in gross income. The IRS issued a notice of deficiency based on the Form 1099, and the taxpayer and his wife filed a petition with the Tax Court.

The taxpayer did not deny receiving the $4,815. Instead, he claimed that it was improperly reported as nonemployee compensation. The taxpayer testified that he contacted the bookkeeper and asked her to retract the Form 1099 or issue a corrected one, but that did not happen. The bookkeeper was not called as a witness. The taxpayer claimed that the $4,815 represented nontaxable “love offerings,” gifts, or loans. Though the taxpayer’s daughter testified that some of that amount constituted a loan that the taxpayer could repay at his discretion, the taxpayer did not provide any documentation or records to support the assertion that the church made loans to the taxpayer.

The Tax Court explained that under existing case law, the key to identifying a gift is the intention of the transferor. This requires an examination of objective facts and circumstances rather than the recipient’s subjective characterization of the transfers. According to the court, the transfers were made to compensate the taxpayer for his services as pastor. The taxpayer had told the board of directors that he would accept “love offerings” and gifts a substitutes for a salary. The bookkeeper at the time considered the payments to be compensation, and reported them on the Form 1099. The frequency of the transfers and the fact they were made on behalf of the congregation strengthen the conclusion that they constituted compensation. The taxpayer failed to provide testimony by the board of directors or other evidence that would support a conclusion that the intent of the board of directors was to make gifts to the taxpayer.

So what is the answer to the question, “Do ‘Love Offerings’ and ‘Love Gifts’ Constitute Gross Income?” The answer is, “It depends.” It depends on the facts and circumstances. There certainly can be instances where a pastor, especially if receiving a full and adequate salary, is the recipient of transfers that are gifts from or on behalf of the congregation. Thus, it is inappropriate to conclude, from this case, that “love offerings do not constitute gifts excluded from gross income.” The desire for short sentences, 140-character tweets, and sound bites misleads people into thinking that simple rules provide all the answers all of the time. Occasionally they do, but often they do not.

What can be learned from this case is the need to document transactions before or as they occur. Documentation matters. Even when memories are keen, testimony too often is self-serving and twisted. Writing “love offering” on a check does not, in and of itself, make the transfer a gift. Nor does omission of that phrase, or any other words or phrases, prevent a conclusion that the transfer is a gift. Yes, it depends. It depends on facts and circumstances, and the best way to make certain the full set of facts and circumstances is considered is to maintain appropriate records.

From the outset, I have made it a point to work Halloween into MauledAgain, usually looking for the silly or goofy but occasionally taking a more serious approach. The posts began with Taxing "Snack" or "Junk" Food (2004), and have continued through Halloween and Tax: Scared Yet? (2005), Happy Halloween: Chocolate Math and Tax Arithmetic (2006), Tricky Treating: Teaching Tax Trumps Tasty Tidbit Transfers (2007), Halloween Brings Out the Lunacy (2007), A Truly Frightening Halloween Candy Bar (2008), Unmasking the Deductibility of Halloween Costumes (2009), Happy Halloween: Revenue Department Scares Kids Into Abandoning Pumpkin Sales (2010), The Scary Part of Halloween Costume Sales Taxation (2011), Halloween Takes on a New Meaning and It Isn’t Happy (2012), Some Scary Halloween Thoughts (2013), The Inequality of Halloween? (2014), and When Candy Isn’t Candy (2015).

This year, I’ve noticed people that among the costume suggestions being floated about are several that are tax related. At first I was amused, but then I figured that in light of present-day tax issues, someone answering the door and seeing one of these costumes might be frightened into total bewilderment.

Someone came up with a costume that consists of a t-shirt, sweatshirt, or hoodie, on which is emblazoned, “THIS IS MY SCARY TAX ACCOUNTANT COSTUME.” Here is a photo of the t-shirt version.

Someone at Hallowwen Costumes suggests dressing up as an IRS agent. Instructions are provided for “a drab outfit of the Internal Revenue Service reminded to put on a staff. Hit the resale shop for a pair of polyester pants and a short-sleeved shirt; add some horn-rimmed glasses, an oversized calculator and a great support purse with play money overcrowded.” It’s been quite a while, I fear, since that sort of outfit set someone apart as an IRS employee.

Someone at Quartz has a different idea. The suggestion is to put on a “tax inversion” costume. The instructions? “Dress in over-the-top American garb (maybe even a full Uncle Sam outfit) but insist that you are actually Irish and speak in a thick Dublin brogue.” I fear very few people, if any, would figure that one out.

You won’t find me wearing any of these costumes. If I had to create a tax-related costume, I’d get a sweatshirt and put the language of Internal Revenue Code section 509(a)(4) on it. While people were reading it and reeling in horror, I could shovel candy into my sack. No, seriously, I’d never do that. Take the candy, that is. I make no promises about the section 509(a)(4) costume. For those who don’t know what it says, dig in: “For purposes of paragraph (3), an organization described in paragraph (2) shall be deemed to include an organization described in section 501(c)(4), (5), or (6) which would be described in paragraph (2) if it were an organization described in section 501(c)(3).”

Most people know that being convicted of a crime brings all sorts of bad news. Convictions generate consequences ranging from prison terms and steep fines to probation and supervised release. In most instances, the conviction remains on a person’s record. Depending on the crime, the person can end up losing voting rights, having his or her name put on one of several “beware of this person” registries, and facing dismal employment prospects.

To the list of bad outcomes can be added a disadvantageous tax consequence. A case in point is demonstrated by the United States Tax Courtorder in Swartz v. Comr., Docket No. 3583-10. Swartz, a CPA who left his accounting firm to become an assistant comptroller for Tyco International Ltd., eventually was promoted to Chief Financial Officer. Swartz participated in a loan program, and in 1999 a journal entry reduced his outstanding loan balance by $12.5 million even though Swartz had not made any payments on this loan during 1999. Swartz did not include the $12.5 million on the tax return he filed with his wife, nor was it included on the Form W-2 that Tyco provided to Swartz.

Two years later, Swartz became a member of Tyco’s board of directors. Shortly thereafter, the board learned the vice president to whom Swartz reported was the target of a criminal investigation for state sales tax violations. That vice president was indicted and resigned, and his successor initiated an audit by an outside law firm to examine Tyco’s business, including compensation paid to, and transactions with, its officers and directors. This process opened up a discussion about the $12.5 million loan reduction entry made in 1999, and that led to Swartz repaying the $12.5 million with interest. Two months later, Swartz, along with the former vice president, was indicted for multiple counts of grand larceny, falsifying business records, conspiracy, and other violations. Though the first trial ended up with a hung jury, the second jury convicted Swartz on all but one count. One of the counts on which he was convicted alleged that “in or about August 1999 and thereafter, [Swartz] stole property, to wit, money, having a value in excess of $1 million, to wit, $12,500,000 from Tyco International Ltd.” Another count on which he was convicted alleged that Swartz, during 1999, “with intent that conduct constituting the felonies of Grand Larceny in the First Degree, Grand Larceny in the Second Degree, Criminal Possession of Stolen Property in the First Degree and Criminal Possession of Stolen Property in the Second Degree be performed, agreed with each other and with others known and unknown to the Grand Jury to engage in and cause the performance of such conduct . . . .” Swartz argued that he thought the $12.5 million loan reduction was part of his bonus, but the jury found that it was not authorized by Tyco and that Swartz knew that. Swartz was sentenced to serve between 8 1/3 years and 25 years in prison and ordered to pay a fine of $35 million plus restitution. His appeals were rejected and the conviction is final.

The IRS issued a notice of deficiency, concluding that the $12.5 million loan reduction in 1999 constituted gross income to Swartz. After Swartz filed a petition with the Tax Court, the IRS moved for partial summary judgment, arguing that the criminal conviction estops Swartz from denying that the $12.5 million constituted gross income.

The Tax Court grants summary judgment if there is no genuine dispute of any material fact and the party moving for summary judgment is entitled to judgment as a matter of law. The other party must present specific facts showing that there is a genuine issue for trial. The party moving for summary judgment continues to bear the burden of proving there is no genuine dispute of material fact. In analyzing the arguments, the Tax Court reads factual inferences in a manner most favorable to the nonmoving party.

Swartz claimed that the issues in the Tax Court were different from those arising during the criminal trial because in 2002 Tyco adjusted its records to show a $12.5 million repayment obligation on Swartz, and because Swartz repaid the $12.5 million. He also claimed that the adjustment shows that the 1999 journal entry reduction the loan amount was null and void from the outset, and that he did not raise this issue during the criminal trial. He argued that erasing and then restoring the record of a debt in corporate books has no tax consequences because, in effect, the two actions offset each other.

The collateral estoppel sought by the IRS applies when an issue of law or fact in the second case is the same as one in the first case, there has been a final judgment in the first case, the party to be precluded is the same or in privity with a party in the first case, the issue that is precluded was actually litigated in the first case, and the controlling facts and legal principles are unchanged. If the parties in the second case are not identical, federal law requires the court to examine state law to determine if nonmutual collateral estoppel exists. The Tax Court determined that under New York law, nonmutual collateral estoppel does exist, and concluded, “that's good enough for us.”

Though conceding that the IRS showed several of the requirements for collateral estoppel existed, he argued that issue identity and actual litigation had not been shown because he never presented his "null and void" theory in the criminal case. The Tax Court explained that one problem with this argument is that a party's failure to make an argument about an issue in the first case doesn't mean that he is entitled to try again in the second, quoting the Restatement (Second) of Judgments, sec. 27 comment c, which elaborates, “if the party against whom preclusion is sought did in fact litigate an issue of ultimate fact and suffered an adverse determination, new evidentiary facts may not be brought forward to obtain a different determination of that ultimate fact. . . . And similarly if the issue was one of law, new arguments may not be presented to obtain a different determination of that issue.”

The Tax Court suggested that perhaps Swartz was arguing a subtler point, that, although his distinction between a void theft and a voidable one might not have mattered as a matter of New York criminal law, it should matter under federal income tax law. This distinction, though, according to the court, fails as a matter of law because gross income arises regardless of whether the thief does not obtain title or obtains voidable title. In other words, gross income includes ill-gotten income, whether obtained through embezzlement, larceny, false pretenses, extortion, or any other type of theft. Though the court has “entertained” an exception to this principle if the thief makes repayment in the same year in which the theft occurs, that did not happen in this instance.

Thus, the conviction estopped Swartz from denying that he embezzled $12.5 million in 1999. Nor, therefore, could he argue that the $12.5 million did not constitute gross income. Though the order does not disclose the impact of the inclusion on Swartz’s tax liability, presumably the inclusion causes it to increase by somewhere on the order of $4 million. The court specifically noted that the tax consequences of the 2002 repayment was not before it. Even if it causes a reduction in Swartz’s 2002 federal income tax liability, the time value of money and possible rate differences makes it very likely that a 2002 tax liability reduction does not fully make up for the 1999 increase, and it is also quite possible that the statute of limitations for 2002 has expired.

During the many years I taught basic federal income tax, some students would explain why they did not take the course or were reluctant to do so. Their arguments followed a general pattern. “I’m not going to be a tax lawyer, and although I understand that lawyers who focus on areas like corporate law, domestic relations law, and wills and trusts, I’m going to be a criminal defense lawyer (or prosecutor), and I’ll pay someone to do my tax returns. So studying basic tax law doesn’t matter to me.” My reply usually began, “Oh, yes, it does.” Indeed it does. Crime simply doesn’t pay.

When I taught the basic federal income tax course, I tried to help students understand that the practice of tax law is not simply a matter of rules and numbers. The toughest part often is figuring out the facts. Sometimes figuring out the facts requires classifying information by finding the appropriate place to draw a line. For example, is an insect infestation that destroys trees a casualty? In this instance, the tax practitioner must become more than casually acquainted with insects, infestations, biology, and botany.

In Germany, the VAT is imposed at different rates depending on the transaction. The basic rate of 19 percent is reduced to 7 percent if the transaction is the purchase of a ticket to an event of high culture. That is why people attending a classical concert pay the reduced VAT on the ticket price. But what about tickets to attend events at a nightclub? Does the ticket to the nightclub qualify for the reduced rate?

According to this story, a German court concluded that tickets to the Berghain nightclub qualified for the reduced rate. The court focused on the events most often hosted at the club, specifically, “marathon techno sets.” It didn’t matter much that the club also made space available for book readings, photograph exhibitions, and fashion shows. The club’s attorney made his case by comparing techno sets with classical music concerts. Both the club and concert halls have stages. The music in both venues has a recognizable beginning and end. In both instances, people in attendance have the opportunity to applaud between pieces. The attorney also noted that both club goers and concert attendees could achieve a “trance-like ‘intoxication’ ” by listening to “a Mahler symphony or a Planetary Assault Systems DJ set.”

I’m confident that, given the choice between doing research on insects and trees, and research on music, I’d choose the latter. The challenge, though, for tax practitioners, is that they rarely get a choice. They must deal with what the client brings to them.

Somewhere, some people are shaking their heads in disbelief, wondering how anyone could consider a nightclub to be a bastion of “high culture.” All jokes aside – yes, I know what you’re thinking, and so am I – no one has a monopoly on defining culture, high or otherwise.

As I also told my students, the practice of tax law is fun. It’s far from boring, no matter what one thinks of rules and numbers.

Last week I started a project that has been on the to-do list for longer than it should have been. The tile floor in the laundry room, at least 45 years old, was breaking up. The plan was to replace the floor. After moving everything but the washer and dryer out of the room, I realized that it would make sense to paint the room. That hasn’t been done for a long time. Then I realized that before painting the walls, they needed to be cleaned, and in a few places, patched. On Wednesday I discovered that the laundry tub trap was leaking, perhaps as a consequence of my banging into the tub legs while taking up the floor.

The point of this anecdote is that too often, when we set out to accomplish a project, the task grows to include far more than we had planned to do. There is a parallel phenomenon when it comes to tax, or any other, legislation. Proposed bills grow, making the successful enactment of the original proposal much more difficult.

Earlier this month, in Getting a Tax Statute Right the First Time is Much Easier Than the Alternative, I discussed a decision by the Supreme Court of Pennsylvania to strike down the state’s slots tax because it, in effect, subjected casinos to varying rates of taxation in violation of the uniformity clause of the state’s constitution. The court gave the legislature 120 days to fix the statute, by staying its order for that length of time. One reaction, from almost every direction, was a prediction that fixing the statute would be difficult, because, among other things, the legislature would be tempted to do more than simply redraft the slots tax provisions. For example, the emergence of video-gaming terminals and online gambling during the years since the statute was originally enacted most likely will entice legislators to offer provisions dealing with those activities.

Now comes news that competing interests will cause the legislature to “be pulled in multiple directions as it tries to fix” the slots tax. Aside from video-gaming terminals and online gambling, the distribution of the revenue raised by the tax is now getting attention. Many legislators on the House Gaming Oversight Committee want to change the formula used to distribute the tax proceeds. Under existing law, the revenue is shared by the state and the localities in which the casinos are located. They point to instances in which casinos in one county or municipality is very close to, but not in, another county or municipality, and thus receive services from police, fire fighters, and others who are funded by the locality in which the casino is not located. These legislators hint that getting votes for fixing the rate issue will require agreement on changing the distribution rules.

Although the Supreme Court stayed its decision for 120 days, the localities in which the casinos are located have less time to put together their budgets for next year. Without assurances of what will happen with the tax, people subject to taxation by these localities, especially those who pay real property taxes, face the prospect of significant tax increases to offset the anticipated loss or delay of slots revenues. In one locality, the tax provides 40 percent of its budget.

Even if the legislature could accomplish its task within 120 days, localities face serious financial planning problems. Yet the odds are high that the legislature, encumbered by additional items placed on the to-do list, will not produce a revised statute within 120 days. My bet is that I will finish the laundry room project before the Pennsylvania legislature fixes the slots revenue statute.

The state of Kansas continues to provide excellent insights into the failings of trickle-down economic theory. The theory, long discredited but revived by Donald Trump in an even more severe form, insists that tax cuts create jobs. The experience in Kansas says otherwise. And the Kansas story now has another chapter.

In A Tax Policy Turn-Around?, I explained 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. In A New Play in the Make-the-Rich-Richer Game Plan, I described how Kansas politicians have been struggling to find a way to undo the damage caused by those ill-advised tax cuts for the wealthy. In When a Tax Theory Fails: Own Up or Make Excuses?, I pointed out that the Kansas experienced removed all doubt that the theory is shameful. In Do Tax Cuts for the Wealthy Create Jobs?, I described recent data showing that the rate of job creation in Kansas was one-fifth the rate in Missouri, a state that did not subscribe to the outlandish tax cuts for the wealthy that Kansas legislators had embraced. In Kansas Trickle-Down Failures Continue to Flood the State, I highlighted some of the additional disadvantages faced by ordinary Kansas citizens as a consequence of the trickle-down tax cuts for the economic elites of Kansas. Several days later, in The Kansas Trickle-Down Tax Theory Failure Has Consequences, I shared the political fallout from the failed trickle-down policies, as Kansas voters woke up and voted out many of the legislators who had supported the tax cuts.

Now comes news that Kansas governor Sam Brownback, architect of the Kansas trickle-down tax cuts, facing another budget crisis compounded by those tax cuts, refused to take a definite stand against tax increases. He prefers not to raise taxes, arguing that taxpayers in the agricultural and energy sectors are struggling with what he calls a “rural recession.” Brownback is term limited, so there’s not much that Grover Norquist and the anti-tax crowd can do to retaliate if Brownback ends up supporting a tax increase.

Yet Brownback has a way out, one that does not inflict tax increases on Kansas taxpayers whose incomes have dropped because of the difficulties faced by the agricultural and energy industries. Brownback can simply explain that the tax cuts were predicated on the promise of a robust economy with high job creation, that the promise was not fulfilled, and that the only suitable, and fair, remedy is to undo those tax cuts. In other words, the tax increase should be placed on the shoulders of the folks who walked away with the tax cut windfall in 2012 and 2013. Perhaps next time a governor or president proposes, and a legislature decides, to cut taxes on the wealthy because doing so will generate advantageous economic outcomes, the legislation should be in the form of a contract, with tax increase penalties for breach by those making the promises.

It comes from every direction. Tax ignorance, that is. Readers of this blog know that dislike ignorance of any kind, and tax ignorance is particularly bothersome to me. I’ve written about it time and again, in posts such as Tax Ignorance, Is Tax Ignorance Contagious?, Fighting Tax Ignorance, Why the Nation Needs Tax Education, Tax Ignorance: Legislators and Lobbyists, Tax Education is Not Just For Tax Professionals, The Consequences of Tax Education Deficiency, The Value of Tax Education, More Tax Ignorance, With a Gift, Tax Ignorance of the Historical Kind, A Peek at the Production of Tax Ignorance, When Tax Ignorance Meets Political Ignorance, Tax Ignorance and Its Siblings, Looking Again at Tax and Political Ignorance, Tax Ignorance As Persistent as Death and Taxes, and Is All Tax Ignorance Avoidable?

I find tax ignorance in articles, in comments, in arguments, on television shows, and even public service announcements. And now, thanks to a reader, it shows up in a comic strip. Granted, this is more than a year old, and somehow I missed it when it first appeared. In this particular comic, the dialogue goes as follows:

Woman in a restaurant booth: “Hey, we’re getting a tax refund.”
Man sitting with her: “Woo-hoo! Free money!”
Man sitting in the adjacent booth: “Sigh. Sounds like a job for . . . OBVIOUSMAN”
He continues: “You didn’t win a prize there . . . Your refund only means you gave the government an interest-free loan! Now it’s taxable income for this year!”
Man: “Wait. . . . What?”
Woman: “You mean we would’ve been better off NOT getting a refund?”
Obviousman: “Right. . . . My work is done here!”
Woman: “Thanks for keeping our moment of joy so brief, Obviousman.”
Obviousman: “You’re welco. . . oh . . . sarcasm, right?”
Woman: “Ah, nothing gets past you, sir. . . .”

The refund is not taxable income. It might be gross income, if it is a state or local income tax refund, and it was deducted in the year it was paid, and that deduction generated a tax benefit. And even if it is gross income, it might not generate taxable income, depending on what other deductions are available. If it is a federal income tax refund, it’s not gross income, period.

If the point that the comic author was trying to make was the disadvantages of overpaying income taxes and getting a refund in a subsequent year, because of the lack of interest on the amount in question, then that point could have been made without getting into the question of whether a refund causes an increase in gross or taxable income. If the author was also trying to make the point that all income tax refunds generate taxable income, it’s way off the mark.

So I wonder how many people will think that because they saw this comic, in the newspapers or on the internet, that the claims made by its Obviousman character are correct. Surely those who understand some basic tax law principles would know it’s not so. But only a small proportion of the population has experienced education on that issue. Sad, isn’t it?

Several months ago, in A Not So Hidden Tax Increase?, I commented on the decision by New Jersey’s Governor Chris Christie to explore the termination of the income tax reciprocity agreement between New Jersey and Pennsylvania. I explained how the repeal of the agreement would increase income tax burdens on higher-salaried Pennsylvanians working in New Jersey and lower-salaried New Jersey residents working in Pennsylvania. Shortly thereafter, New Jersey’s governor terminated the agreement. Why? New Jersey needs revenue

In the meantime, New Jersey has been dishing out tax breaks to companies that it has enticed to move to New Jersey. Though the claim that handing out tax reductions ultimately raises tax revenue is offered as justification for these deals, the reality is that these sorts of tax breaks are as effective as trickle-down tax cuts, that is, they’re not. I have written about these giveaways many times, most recently in The Tax Break Parade Continues and We’re Not Invited, and previously in When the Poor Need Help, Give Tax Dollars to the Rich, Fighting Over Pie or Baking Pie?, Why Do Those Who Dislike Government Spending Continue to Support Government Spenders?, When Those Who Hate Takers Take Tax Revenue, and Where Do the Poor and Middle Class Line Up for This Tax Break Parade?.

So perhaps it was a surprise to read, in this news story, that executives from at least three of the companies who were the beneficiaries of those relocation tax breaks are “furious” with the governor’s decision. One described his reactions as feeling “blindsided” and “very disappointed.” In fact, he explains that the company is “reevaluating” its move, and that, “Had we known about this, before our construction of headquarters and our national training center, we may have reached a different conclusion. It would have factored into whether we moved.” Of course it would. It’s this sort of political decision making that leaves businesses grappling with uncertainty, because today’s promise becomes tomorrow’s breach.

Having no access to the negotiations that preceded the individual tax break handouts, I do not know if these companies even tried to negotiate promises that the overall tax and economic landscape would not be altered. I doubt that they tried, and I am confident that even if they did, no such promises were forthcoming. Otherwise they would be preparing to sue the state for breach of contract.

The entire situation demonstrates the dangers of trying to work out private deals to obtain tax and economic benefits superior to those available to the average citizen. When Americans who are angry about the tax and economic condition of the nation take the time to examine who is responsible, and to look beyond the headline-grabbing federal tax system to the state and local tax scene, they might discover who really is responsible for the mess, and vote accordingly. This story, and the larger drama in which it plays out, is far from over.

Jokes abound about those who cannot make up their minds. “I used to be indecisive. Now, I’m not sure.” So, too, do complaints. More than a few people have heard, “Make up your mind or else . . .”

Now it appears that those who cannot decide whether they favor or disfavor a proposed tax increase can vote for both. According to this report, the choices on a Broward County ballot question includes a yes/no choice. The question is whether the sales tax should be increased by one-half of one percent to fund transportation improvements. The intent was to provide two choices, yes and no. The intent also was to provide the choices in three languages, English, Spanish, and Creole. The intent was to have the first choice read “YES/SI/WI” and “NO/NO/NON.” What appears on the ballot question? “YES/SI/NO” and “NO/NO/NON.”

It seems funny, but it’s not. What happens when someone wanting to vote “no” sees the “NO” in the first choice and selects that choice because it appears to be what should be selected for a NO vote? What happens is that the vote is counted as a YES.

Because ballots have already been mailed and people have already voted, officials claim there is no way to fix the problem. The practical solution would be to reprint the ballots on a different colored form, and start over. My guess is that there is some sort of deadline set by law that makes this impossible absent a legislative change. Ballots that have not yet been mailed will include an insert explaining the error.

One official expressed hope that voters would not be confused. Because one line begins with yes and the other with no, voters presumably would figure out what each line means. But that presumes voters would be looking at, and understanding, the first word in each line. Most probably do, but there’s no guarantee.

How did the error occur? No one knows. Multiple proofreaders review the ballot. The proofreaders include individuals who speak one or more of the three languages. It’s easy for this sort of mistake to happen when only one person looks at the document. The chances of an error should go down as more people examine the language. Yet, sometimes, ever once in a while, a mistake gets through even though multiple pairs of eyes have looked at the language.

The ballot was not intended to include “unsure” as a third choice. But now, for those who are undecided, apparently it does.

According to this story, officials in several dozen California cities are thinking of imposing a tax on video streaming platforms such as Netflix and Hulu. And it would be a good guess that officials in other places are also thinking about the same thing. In California, the proposal is to subject video streaming to a tax already in place that applies to cable television. Pennsylvania and the city of Chicago have enacted taxes on video streaming. What encourages these actions is the loss of tax revenue from individuals who are unsubscribing to cable television and getting their movies and television shows through the internet.

As described in this report, the Chicago tax has been challenged. Though one of the grounds is procedural, focusing on which Chicago officials have the power to impose the tax, the challengers also claim that the video streaming tax violates the Internet Tax Freedom Act, which prohibits states and cities from enacting taxes that apply only to the internet. The Chicago tax rate on video streaming is higher than the rate imposed on DVD sales and on live entertainment.

Opponents of the California proposals claim that taxing video streaming would be double taxation. Their reasoning is that the user pays local taxes for internet access provided by internet service providers and for smart phone connections.

Is there double taxation? Travel back in time to the days when movies were rented from brick-and-mortar retail stores. In most states, the sales and use tax applied to the rental charge. Was that the only tax? Any person using a vehicle to obtain access to the retail store also paid tax on the fuel used to power the vehicle. If the person used a bicycle, the person had paid a sales and use tax on the bicycle. In other words, is taxing access the same as taxing the item being procured through the access? If the tax on the amount paid on the service provided to access the internet is comparable to the tax paid on the fuel used to access the retail store, and the tax on the rental of the movie is comparable to the tax paid on the downloaded video stream, then knocking down the video streaming tax on the double taxation claim will be difficult.

But that does not end the analysis. To the extent that the tax is imposed on video downloaded through the internet and not on video obtained through other channels, then the attempt to overturn the tax has a higher chance of success. The same is true if the rate of tax on streamed video is higher than the rate imposed on other types of video and, in the case of amusement taxes, on other types of amusement.

A recent Tax Court decision, Costello v. Comr., T.C. Memo 2016-184, provides helpful instructions about what to do and not to do when combining an LLC with a corporation. Though it’s too late for the taxpayer in that case, there are lessons that should prove helpful to others facing the issue in the future.

The case involved collection actions for employment tax liabilities. The resolution required identifying the tax status of the employer. Though the amount of the tax liabilities was undisputed, the issue required identification of the responsible taxpayer.

In 1989, the taxpayer’s father incorporated Heber E. Costello, Inc. (HECI). The taxpayer’s father was the sole shareholder of HECI. HECI filed Form 1120 for each of its taxable years. At some point before 2004, the taxpayer’s father died and the taxpayer became the sole owner of HECI.

On December 31, 2003, the taxpayer formed an LLC. He was the sole member. The LLC never filed Form 8832, Entity Classification Election. On December 31, 2003, HECI and LLC merged – though the better word would be “combined” – and HECI ceased to exist. After the combination, the LLC filed Forms 1120 using HECI’s employer identification number. The taxpayer filed Forms 940 and 941 on behalf of the LLC but did not make sufficient tax deposits or pay the tax due for its employment tax liabilities for the first three quarters of tax years 2007 and 2008 or pay the tax due for its employment tax liabilities for the periods ending December 31, 2006 and 2008. The IRS issued a notice of intent to levy (NOIL) on June 1, 2011, for all of those periods and a notice of Federal tax lien (NFTL) filing on December 13, 2011, for all those periods other than 2006. The taxpayer timely submitted Forms 12153, Request for a Collection Due Process or Equivalent Hearing (CDP hearing), on June 26, 2011, and January 6, 2012, in response to the NOIL and the NFTL filing, respectively. The taxpayer indicated he could not pay the liabilities and wanted either an installment agreement or an offer-in-compromise (OIC). Though it was unclear if an OIC was submitted, it appears that any OIC would have been based on his argument that he was not individually liable for the LLC’s employment tax liabilities, which is the same argument he made before the Court. The taxpayer’s CDP hearing requests indicated he wanted Appeals to consider the abatement of taxes. Though asked to do so, the taxpayer did not submit a Form 433-A or any collection alternatives before the hearing. When an Appeals official met with the taxpayer’s representative, the taxpayer did not submit an OIC or any other collection alternatives to Appeals, nor did he present any argument with respect to the abatement of taxes. Instead, the taxpayer argued that the LLC, and not the taxpayer personally, is liable for the LLC’s employment taxes. The IRS issued the notices of determination upholding the proposed lien and levy actions on November 28 and December 3, 2012, respectively. Petitioner timely filed a petition for review of the determination.

After dealing with procedural issues, the Tax Court turned to the substantive question of whether the LLC or the taxpayer was liable for the employment taxes. The court explained that a single-member LLC is disregarded as a separate entity for federal tax purposes unless it elects to be treated as a corporation. The LLC did not file the election. Therefore, it was a disregarded entity.

The taxpayer, however, advanced three arguments in support of his position that the LLC should be treated as a corporation. The Tax Court rejected all three.

First, the taxpayer argued that the combination of HECI and the LLC was a valid F reorganization, and that the resulting entity was a corporation. The court concluded that regardless of whether the combination qualified as a F reorganization, the failure of the LLC to file Form 8832 electing to be a corporation kept it from being a corporation. Though the court did not directly answer the question, is it possible for a disregarded entity to enter into an F reorganization? Logically, the conclusion would appear to be no, because an F reorganization requires a mere change in identity, form, or place of incorporation, and in this case HECI disappeared, and the LLC did not change its identity or form, nor did it have a place of incorporation to change.

Second, the taxpayer argued that by filing Form 1120 for the first taxable year after the combining of HECI and the LLC was a valid election by the LLC to be treated as a corporation. The Tax Court concluded that the election to be treated as a corporation must be made on Form 8832 and is not made simply by filing a Form 1120.

Third, the taxpayer argued that the doctrine of equitable estoppel prevented the IRS from arguing that the LLC is not a corporation because of its “tacit acquiescence” to the filings of Forms 1120 for the year of the combination and subsequent years. The Tax Court concluded that equitable estoppel did not apply, because it requires proof that the IRS made a false representation or wrongful misleading silence, proof that the error was in a statement of fact and not in an opinion or a statement of law, proof that the taxpayer was ignorant of the true facts, and proof that the taxpayer was adversely affected by the
acts or statements of the person against whom estoppel is claimed. The court explained that the IRS made no false statements to the taxpayer, and its failure to reject the LLC’s Forms 1120 was not a wrongful misleading silence. The court also explained that the taxpayer knew that the LLC had never filed a Form 8832 to be treated as a corporation.

For wages paid in the years in question, the activities of a disregarded entity are treated in the same manner as those of a sole proprietorship, branch, or division of the owner. Thus, the sole member of an LLC and the LLC itself are a single taxpayer or person personally liable for purposes of employment tax reporting and wages paid before January 1, 2009. That left the taxpayer liable for the LLC’s unpaid employment tax liabilities.

The lesson is clear. If the member or members of an LLC want the LLC to be treated as a corporation, file Form 8832. There is no alternative. As complicated as tax law is, the filing of Form 8832 is one of the easier tasks to undertake. Though deciding whether to treat the LLC as a corporation requires somewhat more sophisticated judgments, projections, and planning, once the decision is made, the filing of the form is not difficult.

On Monday morning, a commentator -- who may have been a guest -- on a cable news network claimed that a family living in Connecticut, with income of $250,000, putting four children through college, paid 55 percent of its income in taxes. The comment was made as a comparison to the tax rates faced by the ultra-rich and the economically deprived, with the observation that many of them paid no federal income tax. I have not succeeded in finding the commentary online.

If the 55 percent claim was intended to describe the percentage of the Connecticut family’s income paid in federal income taxes, it’s erroneous on its face. If it was intended to describe the percentage of the Connecticut family’s income paid in all income taxes, it’s no less erroneous on its face. If it’s intended to include all taxes paid by that family, it is erroneous. A computation using this calculator, with the unrealistic assumption that the family has no deductions other than personal exemptions, shows that the family pays $49,131 in federal income taxes. That’s an effective rate of 19.65 percent. The family pays FICA taxes of $10,972. That’s an effective rate of 4.39 percent. The family pays state income taxes of $13,100. That’s an effective rate of 5.24 percent. Overall, that’s $73,203 in income and FICA taxes. That’s an effective rate of 29.2 percent. That’s not even close to 55 percent.

Even if the comment was intended to include other taxes, tossing in sales, fuel, and property taxes, based on the average Connecticut taxpayer, adds another $9,414 to the family’s tax bill. That’s a total effective tax rate of 33 percent. That’s still not close to 55 percent.

If the family’s probable income tax deductions, such as the property taxes, the state income tax, and mortgage interest are taken into account, the federal income tax decreases to $40,957. That’s an effective tax rate of 16.4 percent. The state income tax drops to $12,380. That’s an effective tax rate of 4.95 percent. That brings the effective overall income tax rate down, from 29.2 percent to 25.7 percent. That’s less than half of 55 percent.

It’s difficult to figure out where the commentator, whose name I did not notice as I was watching the television at the gym on closed captioning, obtained 55 percent. It’s probably some meme circulating on social media. Even the often-made error of using the top applicable marginal rate – in this case, 28 percent for the federal income tax and 6 percent for the state income tax doesn’t generate 55 percent.

The phrase “tax rate” is ambiguous. Without an adjective modifying it, there is no way of knowing with certainty what is being described. There are nominal tax rates, marginal tax rates, average tax rates, effective tax rates, and others. Using the phrase “tax rate” indiscriminately generates confusion and bad decisions based on misunderstanding, misinformation, and mistakes.

When Pennsylvania enacted legislation in 2004 permitting casinos to operate in the state, it also imposed taxes on casinos. One of the taxes is collected by the state and remitted to the municipality in which the casino operates. Casinos outside of Philadelphia must pay the greater of 2 percent of its net slot machine revenues or $10,000,000. Accordingly, if the casino’s net slot machine revenues are $500 million or less, it will always pay a $10,000,000 tax, whereas if its net slot machine revenues exceed $500 million, it will pay more than $10,000,000. These casinos outside Philadelphia also pay another tax, also collected by the state but remitted to the county in which the casino operates. The tax equals 2 percent of net slot machine revenues. Casinos in Philadelphia – at present there is only one – pay a tax equal to 4 percent of net slot machine revenue, because the municipality of Philadelphia is coterminous with Philadelphia County. Two resort casinos outside Philadelphia are exempt from the $10 million minimum payment.

Mount Airy Casino, located outside Philadelphia, challenged the tax that is remitted to the municipality. Mount Airy argued that the tax violated the uniformity clause of the Pennsylvania Constitution because a Philadelphia casino was not subject to a $10 million minimum. It also argued that in constructing the tax, the legislature divided casinos outside Philadelphia into two categories, each taxed differently. It further argued that the imposition of the minimum tax on casinos outside Philadelphia violated the uniformity clause because it created separate tax rates on casinos with net slot machine revenues of $500 million or more and those with net slot machine revenues of less than $500 million. The case reached the Supreme Court of Pennsylvania, which agreed with Mount Airy’s second argument, and thus did not consider the other two.

The court stayed its decision for 120 days, to give the legislature time to fix the statute. The problem, according to those familiar with how the legislature works, and as described in this report, is that fixing the statute will be difficult. Aside from the complexity of the tax provisions, the emergence since the law was initially enacted of video-gaming terminals and online gambling will tempt legislatures to take on more than just redrafting the revenue provisions. Once the legislature begins to engage in bargaining over other provisions, the process could drag on for more than 120 days, and probably will. An indication of how long it will take is evident from a comment made by a spokesperson for the Senate Majority leader, who explained that legislators and staff would “consider . . . next steps, if any, in the coming weeks.”

It is readily apparent to anyone who understand the uniformity clause that the tax on slot machine revenue, as enacted, violated that clause. There are two possibilities as to what happened. First, no one involved in the drafting of the statute was aware of the uniformity clause or understood it. Second, one or more persons did point out the problem and their warnings were dismissed. Whatever happened, it is disappointing. Legislators, and their staffs, need to be familiar with existing law when drafting new laws. Now there is yet another crisis in Harrisburg. What happens in 120 days? Check back later.

As readers of this blog know, I’m not a fan of ReadyReturn. In October 2005, I addressed the ReadyReturn concept, in Hi, I'm from the Government and I'm Here to Help You ..... Do Your Tax Return. I revisited the issue in March of 2006, in ReadyReturn Not a Ready Answer. A year later, in Ready It Was Not: The Demise of California’s Government-Prepared Tax Return Experiment, I shared the news that California’s experience with the program persuaded it to end the program. Yet I had to return to the topic in As Halloween Looms, Making Sure Dead Tax Ideas Stay Dead, where I noted the refusal of the ReadyReturn advocates to admit the failure of the program. And in December 2006, I reacted to the attempt to resurrect the failed program, in Oh, No! This Tax Idea Isn’t Ready for Its Coffin. Yet the advocates of the proposal, despite all of the many problems and its failure in California persisted. In October 2009, in Getting Ready for More Tax Errors of the Ominous Kind, I again pointed out why people should not fall for something described as simple, bringing relief, and carrying a catchy title. I looked at it again in January 2010, in Federal Ready Return: Theoretically Attractive, Pragmatically Unworkable. Later that year, in April 2010, I was interviewed by National Public Radio on the advantages and disadvantages of ReadyReturn; a summary of the discussion and the reaction to it, along with links to previous discussions is in First Ready Return, Next Ready Vote?. In 2012, as pressure from its advocates resurfaced, I extensively analyzed the ReadyReturn proposal, in a 14-part series. That, however, was not enough to diminish the insistence of ReadyReturn advocates that the only thing blocking success for the program was Intuit’s lobbying, a concern I addressed in Simplifying theTax Return Process. Two years later, in Surely This Does Not Boost Confidence In The ReadyReturn Proposal, I shared my concern that an error made by the IRS that caused serious problems for one taxpayer could easily become an error that affected all taxpayers. Yet another, and bigger, flaw in IRS data security triggered my reaction in Imagine ReadyReturn Afflicted with This Sort of IRS Error.

Discussion of the ReadyReturn proposal among tax law faculty generated an invitation to two of us. Prof. Joseph Bankman, Ralph Parsons Professor of Law and Business at Stanford Law School, one of the nation’s leading advocates for the ReadyReturn concept, and I engaged in a written exchange of the reasons we take the positions we do. Though it took a while for the debate to find its way into print and into the digital world, it has arrived. Published in Volume 35, Number 4, of the ABA Tax Times, Perspectives on Two Proposals for Tax Filing Simplification is now available for those interested in the issue to consider renewed, restructured, and refined expressions of our arguments. Both Joe and I agree, I think, that every taxpayer should be interested in the issue, because it is one that ultimately will affect every taxpayer in some way. Hopefully, this latest publication will help people understand the issue and give them things to ponder.

As reported by many sources, including the Wall Street Journal, “When Mrs. Clinton said there were years when Mr. Trump paid no taxes, he replied, ‘That makes me smart.’” The reference to taxes was in the context of federal income taxes. So, does paying no federal income taxes means, as Trump claims, that the taxpayer is “smart”? The answer is “No.”

Why is the answer “no”? Because even if paying no federal income taxes is a smart thing, in and of itself it doesn’t make the taxpayer smart.

First, if the smart thing or things that are done in order to reduce federal income taxes to zero are the product of the taxpayer’s advisers and return preparers, then the taxpayer ought not take credit for anything other than retaining those advisers. And even that act isn’t necessarily a measure of a person’s “smartness.”

Second, whether what is done to reduce the taxpayer’s federal income tax is a “smart” thing depends on what was done. Using the word “smart” is misplaced if the reason for not paying federal income taxes is tax fraud, business failure causing losses, mistakes in filling out the return, or engaging in activities that prevent the taxpayer from generating income.

So is Donald Trump “smart” because there were taxable years in which he paid no taxes? Suppose the reason Donald Trump did not pay federal income taxes is because he lost so much money in businesses that ended up bankrupt that his income was more than offset by business loss deductions. Suppose the reason constitutes tax fraud. If either of those is the reason, perhaps something other than “smart” was underway.

Until and unless Donald Trump’s federal income tax returns are available, it is impossible to determine whether “smart” things were done or whether “smart” decision were made. Whether Donald Trump is “smart” or “not smart,” or in between, it’s because of all sorts of things, only one of which is his federal income tax return situation. Even if not paying federal income taxes is a smart thing, it does not necessarily mean that the person doing the smart thing – or finding advisers who do a smart thing – is a smart person. Sometimes smart people do stupid things, and sometimes not-so-smart people do smart things.

Finally, being smart, in and of itself, ultimately means nothing. How does a person who is “smart” use his or her “smartness”? When I was a child I was told, by my mother, that being intelligent meant nothing. Why? I remember her words to this day: “There are plenty of intelligent people in prison.”

According to this story, the owner of several Atlantic City businesses admitted in federal court that he and his associates in one of the businesses deliberately hid profits in order to avoid paying more than $100,000 in federal taxes. He also admitted that he knew the business kept two sets of books, one that recorded the actual profits and one that reduced income for tax purposes. Accordingly, he pled guilty to tax evasion.

His attorney explained that the is client “got involved in a business” and owners, including the taxpayer, “were not very careful in recording tax receipts and including them in company and personal tax returns.” Prosecutors had described the arrangement as a structured scam in which two of the taxpayer’s partners, one of them the bookkeeper, deliberately failed to report revenue.

The taxpayer’s attorney hopes that his client’s philanthropic work will bring a sentence of probation rather than prison. The judge probably will take into account the fact that seven years ago the taxpayer was placed in pretrial intervention after being charged with blackmail.

What I don’t understand is how a deliberate plan to keep separate books in order to hide income and evade taxes is a matter of being “not very careful.” Carelessness in keeping tax-related information and carelessness in filling out tax returns is not uncommon. When identified, it can cause a taxpayer to incur civil penalties and additions to tax for negligence. It does not result in criminal prosecution. Tax evasion is not a matter of carelessness. Words matter.

Most people have heard at least one anecdote about a student who attempts to take a final exam in a course, only to discover that failure to have enrolled in the course shuts the door to the opportunity to earn a grade in the course. Most people have heard at least one anecdote about a student whose failure to enroll in a course causes the student to have insufficient credit hours to earn the desired academic degree. How many people realize that failure to enroll for a course can create adverse tax consequences?

In a recent case, Pilmer v. Comr., T.C. Summ. Op. 2016-59, the United States Tax Court held that IRS denial of a taxpayer’s claimed American Opportunity Tax Credit (AOTC) was correct, because the taxpayer failed to enroll in a course. The taxpayer was a student at Saddleback College, a community college offering two-year associate’s degrees and courses for credit transferable to four-year institution. During the spring 2012 semester, the taxpayer enrolled in a five-credit physiology course, and attended a three-credit health course on an “informal” basis. The taxpayer did not enroll in the latter course, and stopped attending after approximately eight weeks.

The taxpayer and her husband filed a joint federal income tax return. On that return they claimed an AOTC credit based on the taxpayer’s education expenses. The IRS disallowed the credit, and the dispute eventually ended up in the Tax Court.

The AOTC is available to eligible students. An eligible student is a student who satisfies two conditions. First, the student must be enrolled or accepted for enrollment in a degree, certificate, or other program leading to a recognized educational credential at an institution of higher education that is an eligible institution. Second, the student must carry at least half the normal full-time workload for the course of study the student is pursuing. The IRS did not dispute that the taxpayer satisfied the first condition. Whether the taxpayer satisfied the second condition was in dispute.

The taxpayer argued that her enrollment in the five-credit course combined with her informal attendance of the three-credit course constituted carrying at least a half-time workload. The Tax Court disagreed. It explained that under the regulations, a student carries a half-time workload if “[f]or at least one academic period that begins during the taxable year, the student enrolls for at least one-half of the normal full-time work load for the course of study the student is pursuing. The standard for what is half of the normal full-time work load is determined by each eligible education institution.” The IRS and the taxpayer agreed that in 2012 Saddleback defined a full-time workload as 12 academic credits and a half-time workload as 6 academic credits. The Tax Court pointed out that during the spring semester the taxpayer was formally enrolled in only the five-credit physiology course, and had never formally enrolled in or
received academic credit for the three-credit health course. Because the taxpayer was enrolled in only a four-credit course in the fall 2012 semester, qualification for the AOTC depended on the spring 2012 semester. Thus, because the taxpayer was enrolled only in a five-credit course during the spring 2012 semester, the taxpayer did not carry at least a half-time workload during either semester and was not entitled to the AOTC for 2012.

It is not clear why the taxpayer did not enroll for the three-credit health course. The taxpayer explained that the professor permitted her to attend and add the course later if there was room. Why did the taxpayer not add the course? Was there insufficient room? If so, why did it take eight weeks to make that determination? Was it a lack of money? Was it failure to add within the drop-add period? Was there sufficient room? If so, did the taxpayer lose interest in the course? Without knowing why the taxpayer did not enroll in the course, or in any other course in order to meet the six-credit-hour requirement for the AOTC, it is difficult to identify what the taxpayer could or should have done.

The lesson, though, for taxpayers generally who want to claim the AOTC is easy to discern. Determine how many credits are required for full-time status, multiply by 50 percent, round up, and be certain to enroll in, and remain enrolled in, enough courses to meet that requirement. Of course, considering how many students fail to enroll for courses and thus end up precluded from taking final exams or from earning a degree, it would not be surprising to learn that failures to qualify for the AOTC continue to afflict students in the future.

Supply-siders like to argue that by reducing tax rates, people and businesses will engage in economic activity squelched by higher tax rates, and that taxes on that increased activity will increase tax revenues. Not only have supply-siders argued this theory, they have managed to persuade voters to elect politicians who subscribe to the theory that reducing tax rates increase tax revenue. Of course, when this theory meets practical reality, its shortcomings are evident. The beneficiaries of the tax cuts benefit, at least in the short-term, and everyone else deals with the fallout.

Philadelphia officials subscribed to this supply-side strategy. It cut taxes and has plans to cut more taxes. Supposedly, businesses and people would flock to the city, generate economic transactions, and thus increase tax revenues. Though activity in the city has increased, it is unclear how much was driven by tax rate reductions, how much was driven by the national economic recovery during the past eight years, and how much was driven by the cultural behavior pattern of younger people wanting to live in urban settings. No matter what caused the increase in economic activity, the increase wasn’t enough to generate tax revenues to offset the price of the tax rate reductions. According to this story, the combination of the rate reductions and increased spending based on the anticipated tax revenue increases, the city’s general fund balance is at risk of disappearing. It could happen within a year, and when it does, the consequences will be the usual awful outcome. First, the city’s credit rating will be reduced, increasing its cost of borrowing, which in turn worsens the fund balance and increases deficits. Second, essential services will be cut, and the city might even be compelled to raise taxes, though the people hit by the tax increases are unlikely to be the people and businesses benefitting from the previous rate reductions. For example, the soda tax enacted by the city will generate less revenue than the revenue loss over the next five years from the rate reductions, and those paying the soda tax aren’t necessarily those benefitting from the tax rate reductions.

So now financial experts are advising the city to freeze the planned future tax rate decreases, or increase property taxes. Others suggest cutting spending, though none have identified specific programs to be jettisoned. They know that if they do, it will trigger an outcry. In the meantime, the city’s finance director argued that the best way to solve the problem is to “grow the economy” and that to do so, the city needs to “keep reducing tax rates.”

Perhaps it would be helpful for those dealing with this issue to invest a few moments and check out When a Tax Theory Fails: Own Up or Make Excuses? Though I’ve written numerous posts explaining why supply-side economic theory is inadequate, I selected that post from March because it explores one of the worst supply-side experiences in the nation, specifically, the mess in Kansas. There are lessons to be learned about what not to do, and how not to try to dig out of the consequences of doing what ought not to have been done. Perhaps inviting some Kansas officials to visit the city will raise revenue, and not just from the taxes collected on their hotel and restaurant bills.

An attorney is retained to represent a plaintiff, and agrees to be compensated with a contingent fee. While the case is ongoing, the attorney and his wife end their marriage. They enter into a marital separation agreement. A section of the agreement titled “Spousal Support” provides that he is to pay her $7,000 per month and that the payment would end with either his or her death. Another section of the agreement titled “Division of Community and Co-owned Property” provides that she will receive some rental properties, along with ten percent of whatever contingent fee the husband receives from the ongoing litigation. No mention is made of whether that payment is made if he or she dies. The agreement also states that her ten percent interest in the fee “is a spousal support award from a contingent liability, the amount of which could not be definitely set at the time of the agreement, and that it “is taxable to [the wife] and
deductible to [the husband] as spousal support. This section of the agreement also provides that if the husband receives the contingent fee, he will pay a lump sum of $355,000 to the wife, and the agreement describes the sum as spousal support that would terminate on the wife’s death. Shortly after the couple’s divorce, the litigation settles, and the husband receives a $55 million fee spread out over several years.

Is this a law school hypothetical? No. It’s an actual case. It’s part of what happened in Leslie v. Comr., T.C. Memo 2016-171. There were other issues, and facts relevant to those issues, but those are left to other commentaries, including this excellent analysis from my colleague Les Book at Procedurally Taxing.

Essentially, the wife did not report the payments arising from the contingent fee as alimony. It is unclear, but one’s best guess is that the husband deducted the payments. The wife argued that test for determining whether the payments were alimony gross income is the seven-factor test of Beard v. Comr. The IRS argued that the enactment of section 71 made the Beard test obsolete. The IRS agreed.

The Tax Court looked at the language of section 71 and determined that the payments were alimony. There was no dispute that the payments were in cash, were made under a divorce or separation agreement, were made under an agreement that did not designate the payments as not includible in gross income nor deductible, were made by parties not members of the same household, and were not required if either party died. It was this last statutory requirement that generated additional disagreement. The wife argued that the obligation to make the payments did not end with her death. The court explained that although the agreement did not contain language that terminated the husband’s obligation to pay over part of the contingent fee on the wife’s death, and although the agreement did provide that payment of the $355,000 lump-sum was contingent on her not dying, applicable state law provided that amounts paid for support terminate on the death of either party.

The fact that the provision for payments based on the contingent fee were in a section of the agreement titled “Division of Community and Co-owned Property” does not matter. What matters is the language of the agreement, the language of the Internal Revenue Code, and the language of the applicable state law. Granted, the issue would have been even easier to decide, and perhaps would not have even made its way to the Tax Court, had the drafters of the agreement put the provision in the section of the agreement titled “Spousal Support” and included specific language providing that the payments would not be made if the wife died. It didn’t happen in this case, but hopefully those dealing with these issues in the future will fix the placement and include the language.

Yes, this is another MauledAgain post based on a television court show. The list is getting longer, and includes posts such as Judge Judy and Tax Law, Judge Judy and Tax Law Part II, TV Judge Gets Tax Observation Correct, The (Tax) Fraud Epidemic, Tax Re-Visits Judge Judy, Foolish Tax Filing Decisions Disclosed to Judge Judy, So Does Anyone Pay Taxes?, Learning About Tax from the Judge. Judy, That Is, Tax Fraud in the People’s Court, More Tax Fraud, This Time in Judge Judy’s Court, You Mean That Tax Refund Isn’t for Me? Really?, and How is This Not Tax Fraud?.

Almost thirty years ago, early in my teaching career, I read a case that reinforced my growing conviction that law faculty need not invent hypotheticals to get their students to think. It is not unusual for law faculty to make the hypotheticals outrageous in order to get students’ attention and to make what might otherwise be “boring” rather interesting. For example, though many consider tax classes to be “boring,” they often leave with the realization that tax practitioners often encounter fact situations no less eyebrow-raising than those encountered by those dealing with other areas of the law.

The case that caught my attention, Blackman v. Comr., 88 T.C. 677 (1987), involved a taxpayer who became angry with his wife. His employer had transferred him from Baltimore, Maryland, to South Carolina, and so he, his wife, and their children moved there. His wife did not like it there and returned with the children to Baltimore. During Labor Day weekend, in an attempt to persuade her to give life in South Carolina another chance, the taxpayer returned to the Baltimore home, which apparently had not yet been sold. He discovered that another man was living there with his wife and children, and the neighbors filled him in on the frequency of the man’s presence in the home, even before he and the family had moved to South Carolina. When he returned, his wife was having a party and her guests refused to leave when the taxpayer asked them to do so. He returned several times, he repeated his request, and he broke windows. The guests did not leave until 3 in the morning the next day. Later that day, he returned again, asked his wife if she wanted a divorce, they fought, and she left. After she left, the taxpayer took some of her clothes, put them on the stove, and set them on fire. He testified that he then dumped pots of water on the fire and put the fire out. However, the fire spread, the fire department arrived, but it was too late, and the house and its contents were destroyed.

When the taxpayer attempted to deduct the loss as a casualty loss, the IRS disagreed, and the Tax Court explained that even though negligence does not bar a casualty loss deduction, gross negligence does. In this instance, the fact that the fire fighters discovered the clothes still on the stove caused the court to disregard the taxpayer’s claim that he had extinguished the fire. In addition, the court concluded that allowing the deduction would violate Maryland’s public policy against arson, as it is a felony in Maryland to burn a residence while perpetrating a crime. Setting one’s spouses clothes on fire is a crime. In one of my many favorite sentences from the Tax Court, the opinion told us, “We refuse to encourage couples to settle their disputes with fire.”

For all the years I taught the basic federal income tax course, I included this case in the supplementary materials I provide to the students. I recall from time to time, though not every semester, I would point out, “Though this is an isolated instance, the lesson can be extended to other situations in which a person acts with gross negligence.” I might ask the class to think of situations not involving fire but that might far less unusual and that would involve gross negligence or intention. I wrote about this case more than ten years ago in Why Tax Law Can Fire Us Up.

It turns out that the clothes burning reaction to anger-provoking events is not as uncommon as I thought. On a recent Judge Mathis episode, the defendant admitted to coming home, finding her boyfriend cheating on her, and setting his clothes on fire. According to the defendant, “things got out of hand,” though it wasn’t revealed if the house burned down. The facts were incidental to the issues in the case, and there was no indication of what impact the events had on anyone’s tax returns. What is it with angry people burning clothes? Why clothes? Why fire?

And though I described the Judge Mathis episode as “recent,” I used that word as shorthand for “a Judge Mathis episode I recently viewed even though it is older.” I tend to catch these episodes haphazardly long after their original broadcast date. I’m sure I’ve missed hundreds of episodes that would supply this blog with years of material. I doubt I will ever see all of them, but it’s likely at least a few more will find their way to this blog.