MauledAgain

Though the decision to cut taxes while initiating military action turned out to have had serious adverse consequences for the American economy, the temptation of using the “everyone gets a tax cut” as a political campaign ploy continues. And politicians continue to fall for it. Cutting taxes when the need for the revenue expires, such as the conclusion of a war during which taxes had been increased, makes sense. Cutting taxes when a government and its constituent agencies and localities are struggling to provide basic services is long-term foolishness for the sake of short-term political expediency.

According to this Philadelphia Inquirer article, New Jersey’s Governor Christie has proposed, in his annual State of the State speech, that “Every New Jerseyan will get a cut in taxes.” Because the proposed cut would be proportional across the board, a married couple with $100,000 of income would see a $275 tax reduction, whereas a person with a $1,000,000 income would receive a $7,265.75 cut. The effect of the reduction in state revenue likely means a $1 billion reduction in school funding. At a time when education is the pathway to success in the workplace and favorable competition with other nations’ economies, does it make sense to let education funding take yet another significant hit?

About a year ago, in The Price of Insufficient Tax Revenue, I described how the City of Camden, New Jersey, was compelled to make substantial reductions in its police, fire fighting, and other departments because New Jersey was compelled to reduce its funding assistance to its most economically devastated locality. A few months ago, in When Tax Revenues Are Insufficient: Affordability, Resistance, and Diversion, I described the impact of the New Jersey cuts on Pennsauken Township, which gave notice it would release 12 police officers, joining the almost 1,400 police officers and fire fighters who were laid off in New Jersey in 2010. As I pointed out in that post, when the carrot of tax cuts is waved before voters as the means to force cuts in government spending, “Though it sounds good at a theoretical level, the practical problem with cutting taxes in order to force a cut in government spending is that the health and safety of citizens is what gets cut.”

When the citizens who had been the beneficiaries of government services such as police protection, fire prevention, education, health, animal control, and the like, realize that the consequence of tax cuts disproportionately favoring the wealthy are being financed with reductions in the condition of ordinary people, they might consider again the question, “When taxes are cut, what’s really being cut, and for whom?”

The other day, in a conversation with someone, the focus turned to lotteries, sweepstakes, and whether it made any sense to enter allegedly “free” contests. One of the “opportunities” available to the other person was for a $1,000,000 annual prize. At one point, the other person commented, “Plus, why bother? If I win anything, the government will take fifty percent of it.” I asked why they thought half the winnings would be taken by the government. “Taxes” was the reply. I explained that the highest federal income tax rate was 35 percent, a rate that would apply to only part of the winnings, and that the likely impact, without doing actual computations, was closer to 28 percent. In Pennsylvania, the state income tax is slightly more than 3 percent. I commented, “Ignoring for a moment that whatever you would net is better than nothing, where did you get the idea that taxes would reach fifty percent?” The answer was not surprising. “That’s what they say.” I knew, of course, who the “they” are. So I explained, “They say this because they want to rile people up, to put taxation in a bad light, to make the impact of taxes look worse than they are, in an effort to ramp up opposition to taxation.” The other person became very quiet. I could tell some thinking was underway. Finally, “So they are twisting the truth.” My reply was simple. “As ever.”

Is it any wonder that the nation is so misinformed about taxation? Aside from the lack of tax education, a problem on which I’ve posted many times ( e.g., 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, Tax Ignorance of the Historical Kind), there is the crisis of propaganda, deliberate lies, and half-truths advanced by the anti-tax crowd. Yet is it any wonder that the anti-tax crowd engages in this sort of scare-mongering? Surely they have concluded that stating the truth would not get the reaction that they need for their ultimate purposes, so they lie. I do wonder how many people believe the nonsense that is being spewed by those who appear unable to tackle the issues based on the actual facts. It is essential that these lies, half-truths, and misrepresentations be combated at every turn. I may have enlightened only one person the other day, but if everyone who understands the truth of taxation enlightens one person every day, and each enlightened person in turn does so, within months tax truth can go viral, and the darkness of the tax lies will be extinguished.

Jared Eutsler, a faculty member at Rasmussen College who writes for the colleges’s Business School blog, has released his 20 Blogs Accounting Students Will Love. Included among his selections is none other than MauledAgain, joined by Paul Caron’s TaxProf blog, Kay Bell’s Don’t Mess With Taxes, Byrne Hobart’s Tax Rascal, Russ Fox’s Taxable Talk, and more than a dozen accounting blogs.

It would be wonderful if accounting students, to say nothing of law students, loved this blog. My less ambitious hope is that law and other students, tax practitioners, and taxpayers generally find MauledAgain interesting, provocative, and challenging. True, I prefer that people not hate the blog, either, though the worst reaction, as far as I am concerned, is apathy.

Eutsler describes me as having “taught federal income tax for 20 years.” Oh, I wish I were as young as I was when I attained my twentieth tax-teaching anniversary in January of 2000. I’ve been teaching federal income tax as a member of a law faculty for 31 years. Because I make every effort to be honest, I simply cannot claim to have started teaching law school when I was 15. However, I can say that when I started teaching, the combination of my age and law school student demographics at the time left me younger than at least one-fourth, and perhaps even one-third, of my students. That’s no longer the case. Oh, well. But I’m still younger than the federal income tax, and always will be.

It is not difficult to guess what part of the second paragraph of the opinion in United States v. Allen, Nos. 10-2160, 10-2161 (1st Cir. 01/06/2012), caused me to stop reading, go back, and re-read the paragraph:

Frederick and Kimberlee Allen—husband and wife—appeal from their convictions for tax-related offenses. For some years the Allens filed annual federal income tax returns reporting their income. However, for tax years 1997 through 1999, despite reportable income, the Allens filed returns reporting zero income. On the advice of their dentist, and their own research, they concluded that no provision of the Internal Revenue Code imposed “liability” on them for taxes, and attached this explanation to their returns.

On the advice of their DENTIST? My dentist is a great dentist, a conversational fellow, a very good golfer, a savvy observer of life, and interested in tax and politics, but I’m not going to take tax advice from him, and I would not take tax advice from him even if I were not a tax professional.

Almost seven years ago, in The First Ten Tax Urban Legends, I noted the risks of obtaining tax advice from people who are not tax professionals:

One story tells of a high school teacher and coach who concluded that money earned during the summer as an umpire was not taxable because umpiring was a hobby. When challenged by a very bright and experienced tax lawyer turned tax professor, the teacher-coach dismissed the explanation because, get this, the commissioner of the baseball league had explicitly told the umpires that their income was not taxable. Amazing. Get your tax advice from a baseball commissioner, and have your surgery done by a lumberyard sales clerk.

Apparently this is not an unusual situation. Another experienced, able tax lawyer turned tax professor reported that a basketball referee he knows claimed that HIS fees were not taxable. Apparently steroids aren't the only problem in the sports world.

The taxpayers in the Allen case are tax protesters, who simply do not want to pay taxes. After their dentist steered them in the direction of a tax protester organization and a tax protester organizer who later was convicted of criminal tax fraud, the taxpayers tried to demonstrate a lack of criminal intent by claiming that they acted in good faith. One does not act in good faith in the tax world by getting one’s tax advice from a dentist and from a convicted tax protester organizer. One acts in good faith by getting a tax education or by relying on advice from a tax professional who has a tax education.

It is amazing that people who almost certainly would not ask a lumberyard sales clerk to do their surgery so readily start filling their heads with tax, estate planning, and similar advice from people who are not expertised in tax or estate planning. Not getting one’s tax advice from a tax professional is certain to gum up the tax return. The ensuing audit, and in some instances, criminal trial, can be far more painful than a root canal.

The IRS has just released its latest tax gap estimates. Because the collection and analysis of data lags behind the filing of returns and the conducting of audits, the latest information if for the taxable year 2006. It is unlikely that compliance has improved in later years.

According to the IRS, taxpayers underpaid their tax liabilities by $450 billion in 2006, an increase from the $345 billion shortfall in 2001. The compliance rate fell from 83.7 percent to 83.1 percent. Although the IRS chased down $65 billion of the unpaid taxes for 2006, an increase from the $55 billion it recovered for 2001, the increase in IRS collections did not keep pace with the increase in the tax gap. Some commentators think that the actual tax gap is higher than what the IRS reports, and I favor that perspective.

Why is there a tax gap? There are two major categories of causation. One is mistake, triggered either by carelessness or by the complexity of the tax law that makes “getting it right” a rather daunting task. The other is fraud, triggered either by the greed of those who think they are special, entitled to go straight out of the left-turn lane and to reap the benefits of living in civilized society while paying less than the law requires, or by the frustration of those who think that cheating is the only way they can level the playing field made uneven by the greed of the first group.

As the IRS explains in its news release, compliance is best when information reporting is required. For example, the noncompliance rate with respect to wages is in the vicinity of one percent. On the other hand, the noncompliance rate with respect to income for which reporting is not required is a whopping 56 percent. Efforts to reduce this shortfall by requiring information reporting and withholding have failed. In 2005, Congress enacted a law requiring businesses making payments to independent contractors to withhold 3 percent, but the effective date was postponed time and again until the Congress repealed the requirement in November 2011. In 2010, Congress enacted a law requiring businesses and landlords to file Form 1099 for payments to corporations exceeding $600 a year, but this requirement was repealed in April 2011. Justification for the repeal of the 3 percent withholding was that “it would have hurt cash flow for many small businesses.” That is nonsense. Business A contracts to pay $20,000 to Business B for services. Whether Business A pays $20,000 to Business B, or, under the repealed law, pays $19,400 to Business B and $600 to the Treasury has no adverse consequences on Business A’s cash flow. Business B’s cash flow is unaffected because it would reduce by $600 the estimated taxes it should be paying on the $20,000 received from Business A. In other words, absent the withholding, Business B is operating on the taxpayers’ dime. Justification for the repeal of the information reporting requirement was simply a matter of Congress and the Administration giving in to pressure from the private sector that it would be burdensome. Filing forms W-2 is burdensome, but Congress hasn’t bowed to any pressure to repeal that requirement, for the simple reason that wage earners are the backbone of the nation’s revenue system, and the privileged business class refuses to subject itself to measures that will up its compliance rate from 44 percent to 99 percent. In and of itself, that contrast is quite telling.

Imagine what the financial situation of the federal government would be had it collected, using a conservative estimate, $4.5 trillion of unpaid taxes over the past 10 years. Though it would not have wiped out the deficit, that sort of collection success, easily obtained through reporting and withholding requirements, would alleviate the threat to national security posed by pending cuts and would alleviate the poverty, hunger, and medical crises afflicting the nation because 20 percent of taxpayers not only can’t live with lower tax rates but insist on self-enacted zero percent tax rates. I am confident that most of the compliant 80 percent would welcome the enactment and enforcement of reporting and withholding requirements that would bring tax receipts to what they should be under existing law and would be delighted by a consequent reduction in tax rates for the compliant wage-earners of the nation. Does anyone think the other 20 percent will let that happen?

ADDENDUM: This post has generated all sorts of reactions, via email and on listserves. Some have disagreed with my analysis or terminology, while others have expressed disappointment in how Congress backed down.

The word "nonsense" is a bit strong for some situations. Here is an example where there is a problem. Suppose an S corporation with 10 equal shareholders enters into a contract with a government agency to perform services for $1,000,000, and its expenses are $950,000, leaving $50,000 of nonseparately stated income. Without withholding, the 10 shareholders collectively estimate that each will have $5,000 of income and thus add, let's say, $1,400 to their estimated tax payments. So the corporation makes distributions to each shareholder totaling $1,400 to cover that increase. Assume withholding is enacted. The payor government withholds $30,000 from the payments. According to the FAQs issued by the IRS before the repeal of section 3402(t), provision would be made to treat the S corporation shareholders as having paid the amounts withheld from the payments received by the S corporation. Presumably the IRS would treat each shareholder as having paid $3,000 of tax. The shareholders would reduce estimated payments and even wage withholding by as much as $3,000. In the worst case situation, only the $1,400 payment would be eliminated, and the shareholder is overwithheld by $1,600.

Reading between the lines of the FAQs that the IRS issued suggested that there would be adjustments permitted for instances where the payee could demonstrate this sort of problem. The same sort of problem exists in the world of wage withholding, and there are mechanisms to alleviate, though not necessarily eliminate, the impact. Consider the employee who loses a job part way through the year, and ends up with zero tax liability but has had taxes withheld on the assumption that the paychecks would continue through the year. The withholding surely exacerbate the cash flow problem. If withholding returns, perhaps there will be an exception for businesses that can demonstrate that they do not make money or that they (or their pass-through owners) are in tax compliance.

For many businesses, even if withholding was extended beyond the reach of the repealed section 3402(t) -- which had its own long list of exceptions -- many business receipts would not be subject to withholding. For example, one person commented that retail businesses have low profit margins, and thus a 3 percent withholding on gross receipts would generate significant tax overpayments. But retail businesses receive their gross income from payors -- customers and clients -- who have not been required and almost certainly would not be required to withhold.

In sum, withholding can generate a cash flow problem for a limited number of businesses, just as wage withholding can generate a cash flow problem for a limited number of wage earners. To elaborate on why I used the word "nonsense": If the consequence of a few businesses having a cash flow problem is to repeal withholding for all, then why not let the consequence of a few wage earners having a cash flow problem be the repeal of all wage withholding? I am confident that repealing all wage withholding is an idea that would earn the label "nonsense" from almost all tax practitioners and almost all members of Congress. In other words, I should have more clearly stated that it's not nonsense to claim that there is a cash flow problem, but it is nonsense to repeal all of section 3402(t) as a solution, and it's debatable whether "many" businesses would have had negative cash flow from the withholding.

Tax practitioners are very cognizant of how tax can be used as a retaliatory tactic. Consider the disgruntled employee who reports, or threatens to report, the employer to the IRS or a state revenue department for skimming revenue from the books. Surely people who are not tax practitioners have heard similar stories.

Late last week, the Philadelphia Inquirer reported an AP story concerning the use of tax as a retaliatory tactic by an employer against retired employees. The employer in question is a government agency, the Port Authority of New York and New Jersey. Until the end of 2010, employees, retirees, and officials of the Port Authority were permitted to use Port Authority bridges, tunnels, and other facilities toll-free. After criticism by New Jersey’s Governor Christie, the Port Authority revoked the toll-free privilege for all but a few employees. The perk remains in effect for marked emergency vehicles, employees compelled to commute to locations other than the former World Trade Center headquarters, and spouses of employees killed in the 1993 and 2001 attacks.

Two retired employees filed suit against the Port Authority, claiming they are contractually entitled to the toll-free perk, and at least one plaintiff intends to obtain class action status for his lawsuit. Whether the Port Authority is contractually prohibited from cutting off the retirees’ toll-free privileges is a question that cannot be answered until the facts are discovered and subjected to legal analysis.

In the meantime, the executive director of the Port Authority disclosed that he has asked the New York and New Jersey revenue departments to “investigate whether the retirees owed taxes, interest, and penalties on the free benefits they received until the program was discontinued.” Clearly annoyed with the litigation, which he called, “offensive to me,” the Port Authority’s executive director has taken what surely must be considered a retaliatory tactic in the nature of a complaint to a tax agency.

The irony of the situation is apparent from the possible outcomes. One possible outcome is that the perk is excludible from gross income as a no-additional cost service, for which retirees count as employees, considering that no one is barred from a bridge or tunnel to make way for the retiree. In this instance, the request will waste the time of some state revenue department employees, and annoy the retirees, but otherwise have no bearing on the litigation. Another outcome is that the fringe benefit should be included in gross income, the employees received a Form 1099-R or other documentation from the Port Authority reporting the value of the perk – which the Port Authority can compute from the retiree’s EZ-Pass account – and failed to report it. In this instance, though the request for audit of the retirees’ returns will generate some tax revenue for the state, it will have no impact on the factual and legal issues in the litigation. Yet another outcome is that the fringe benefit should be included in gross income, and the Port Authority did not provide any information to the retirees. In this instance, ought not the Port Authority be estopped? Unfortunately, estoppel does not apply in this situation, but one must wonder about an equivalent situation, an employer complaining to the IRS or state revenue department that employees failed to report wages and yet not pointing out that the employer did not file Forms W-2 for the employees.

Using tax as a retaliatory tactic can backfire. For a private sector employer, it can bring all sorts of negative consequences. For a government employer, it isn’t clear that the adverse consequences can be as severe as they can be for a private sector employer, but it isn’t beyond the realm of possibilities that individual employees of the agency can suffer consequences such as dismissal or public reprimand.

About a month ago, the Tax Court, in Rodriguez v. Comr.,, 137 T.C. No. 14 (2011), considered whether corporate earnings included in a married couple’s gross income under sections 951(a)(1)(B) and 956 were dividends eligible to be taxed at the special low rates applicable to qualified dividends. The taxpayers, citizens of Mexico and permanent residents of the United States, owned all of the stock of a Mexican corporation that conducted activities in the United States. The corporation owned real and personal property in the United States. Under sections 951(a)(1)(B) and 956, the taxpayers, as shareholders, were required to include in gross income, and did include in gross income, the portion of the corporation’s earnings invested in United States.

Under section 1(h)(11)(B)(i)(II), qualified dividends eligible for the special low rates include dividends received from qualified foreign corporations. The corporation in question is a qualified foreign corporation. The issue for the Court was whether the gross income inclusions constituted qualified dividends.
Under section 316(a), a dividend is “any distribution of property made by a corporation to its shareholders” out of earnings and profits. The Supreme Court, in Comr. v. Gordon, 391 U.S. 83 (1968) defined a distribution as a “change in the form of . . . ownership [of corporate property,] separating what a shareholder owns qua shareholder from what he owns as an individual.” The Tax Court concluded that the section 951 gross income inclusion was not a distribution, and thus not a dividend, because it did not change ownership of corporate property. The Court noted that there are no provisions in the tax law treating a section 951 gross income inclusion as a dividend for section 1 rate purposes, unlike the regulated investment company provision in section 851(b) that treats section 951(a) gross income inclusions as dividends to the extent there is a distribution under section 959(a)(1) out of the RIC’s earnings and profits, the section 904(d)(3)(G) provision that treats section 951(a) gross income inclusions as dividends for foreign tax credit limitation purposes, or the section 960(a)(1) provision that treats section 951(a) gross income inclusions as dividends for purposes of the indirect foreign tax credit rules. Similarly, although Congress has enacted provisions treating distributive shares and similar amounts as distributions, there is no provision treating a section 951(a) gross income inclusion as a distribution. The Court explained that when Congress enacted section 951, it also enacted section 1248, which treats certain gain from the disposition of stock in corporations such as the one in question as includible in gross income as a dividend, and that the deliberate decision of the Congress to treat section 1248(a) gross income as a dividend but to not so treat section 951(a) gross income solidifies the conclusion that the latter is not a dividend. Reflecting this analysis, Treasury regulations also distinguish between “deemed dividends” and “deemed inclusions.”

The taxpayers sought support in the fact that the legislative history described section 951(a) inclusions as “the equivalent of a dividend” and on statements in judicial opinions that a “dividend equivalency” rationale underlies section 951(a). The Tax Court explained that characterizing something as equivalent to a dividend or as “much like” a dividend is not the same as concluding that it is a dividend. The taxpayers also pointed out that an introductory paragraph in one of the opinions stated the issue as whether uncollected payables balances “constitute investment in U.S. property within the meaning of section 956, resulting in dividend income” and that the headnote puts the issue in the same terms. The Tax Court explained that the body of the opinion did not address whether the section 951(a) inclusion was a dividend, nor was that question essential to resolving the issue in the case, which was the character of the uncollected payables balances as U.S. investments.

The Tax Court also noted that dividend distributions reduce the distributing corporation’s earnings and profits, whereas section 951(a) inclusions do not. Similarly, a dividend distribution does not increase the shareholder’s adjusted basis in the stock, but the section 951(a) inclusion does.

Turning to the question of why Congress enacted the special low rates for dividends, the Court looked at the legislative history and focused on the stated goal of removing a disincentive for corporations to pay out earnings as dividends rather than retaining them. In contrast, section 951(a) inclusions represent earnings that are retained and invested in U.S. property rather than being paid out as dividends. Logically, the section 951(a) inclusion is not a dividend.

As a technical matter, the language of the special low rates for dividends determines whether the taxpayer has the requisite holding period in the stock on which the dividends are paid by referring to the ex-dividend date. Section 951(a) inclusions do not involve dividends and thus there is no ex-dividend date and no way to apply the special low rate provisions to section 951(a) inclusions.

For unknown reasons, the instructions to the 2004 Form 5471 provide that section 951(a) inclusions should be reported as ordinary dividend income. The IRS, describing the instructions as “ambiguous,” explained that the same instructions require corporate taxpayers to report the inclusions as “other income” and not as dividends. The Tax Court simply pointed out that IRS instructions inconsistent with the statute are not determinative.

The time, resources, effort, and energy invested by the IRS, by the taxpayers, and by the IRS in resolving this issue is but one of many examples of how the existence of special low rates for capital gains and dividends is wasteful. Taxpayers generally, and their advisors, not only try to find ways to bring income within the special low rates but also to structure their business activities in ways that they otherwise would avoid, simply to take advantage of special low rates. Repeal of these rates would not only allow removal of at least one-third of the Internal Revenue Code and a similar substantial part of the regulations, it would free taxpayers, the IRS, and the courts from a huge chunk of planning and litigation that consume far more of the economy than the special low rates contribute to it.

On Saturday, 71 federal income and excise tax provisions “expired.” In other words, as of January 1, 2012, these provisions are no longer effective. The simplicity of that information is deceptive. It would not be surprising if at some point, the Congress reinstates some, most, or even all of these provisions, making the reinstatements effective as of January 1. Unfortunately, for taxpayers who are trying to make plans for 2012, they are in tax limbo, uncertain of what the rules will be. Many tax-paying individuals and businesses will play it safe, waiting until the Congress clarifies what the rules will be. This waiting process will inject some degree of stagnation into the economy.

In Punting on Taxes and in Tax Politics and Economic Uncertainty, I explained why playing politics with tax and economic policy is a dangerous game.

The list of recently “expired” provisions demonstrates not only the wide scope of the taxpayer activities that are pushed into the shadow of uncertainty but also the absurd extent to which the tax law and the IRS are used to implement policy decisions that ought to be enacted in other law and administered by other agencies. Skim the list. Is it not interesting that Congress, so critical of the IRS and so anxious for its reduction and even removal, turns time and time again to the IRS to implement its agenda?

Here is a list of the 71 provisions, taken from the Staff of the Joint Committee on Taxation’s List of Expiring Federal Tax Provisions, 2010-2020, omitting provisions that expired earlier in 2011:

1. Credit for certain nonbusiness energy property (sec. 25C(g))
2. Personal tax credits allowed against regular tax and AMT (sec. 26(a)(2))
3. Credit for electric drive motorcycles, threewheeled vehicles, and low-speed vehicles (sec. 30(f))
4. Conversion credit for plug-in electric vehicles (sec. 30B(i)(4))
5. Alternative fuel vehicle refueling property (non-hydrogen refueling property) (sec. 30C(g)(2))
6. Expansion of adoption credit and adoption assistance programs (secs. 36C, 137, sec. 10909(c) of P.L. 111-148)
7. Alcohol fuels income tax credit (secs. 40(e)(1)(A), (h)(1),(2))
8. Alcohol fuel mixture excise tax credit and outlay payments (secs. 6426(b)(6), 6427(e)(6)(A))
9. Income tax credits for biodiesel fuel, biodiesel used to produce a qualified mixture, and small agri-biodiesel producers (sec. 40A)
10. Income tax credits for renewable diesel fuel and renewable diesel used to produce a qualified mixture (sec. 40A)
11. Excise tax credits and outlay payments for biodiesel fuel mixtures (secs. 6426(c)(6), 6427(e)(6)(B))
12. Excise tax credits and outlay payments for renewable diesel fuel mixtures (secs. 6426(c)(6), 6427(e)(6)(B))
13. Tax credit for research and experimentation expenses (sec. 41(h)(1)(B))
14. Placed-in-service date for facilities eligible to claim the refined coal production credit (sec. 45(d)(8))
15. Indian employment tax credit (sec. 45A(f))
16. New markets tax credit (sec. 45D(f)(1))
17. Credit for certain expenditures for maintaining railroad tracks (sec. 45G(f))
18. Credit for construction of new energy efficient homes (sec. 45L(g))
19. Credit for energy efficient appliances (sec. 45M(b))
20. Mine rescue team training credit (sec. 45N)
21. Employer wage credit for activated military reservists (sec. 45P)
22. Grants for specified energy property in lieu of tax credits (sec. 48(d), sec. 1603 of P.L. 111-5)
23. Work opportunity tax credit (sec. 51(c)(4))
24. Qualified zone academy bonds – allocation of bond limitation (sec. 54E(c)(1))
25. Increased AMT exemption amount (sec. 55(d)(1))
26. Deduction for certain expenses of elementary and secondary school teachers (sec. 62(a)(2)(D))
27. Parity for exclusion from income for employer-provided mass transit and parking benefits (sec. 132(f))
28. Treatment of military basic housing allowances under low-income housing credit (sec. 142(d))
29. Premiums for mortgage insurance deductible as interest that is qualified residence interest (sec. 163(h)(3))
30. Deduction for State and local general sales taxes (sec. 164(b)(5))
31. 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements (secs. 168(e)(3)(E)(iv), (v), (ix), 168(e)(7)(A)(i), (8))
32. Seven-year recovery period for motorsports entertainment complexes (sec. 168(i)(15))
33. Accelerated depreciation for business property on an Indian reservation (sec. 168(j)(8))
34. Additional first-year depreciation for 100% of basis of qualified property (sec. 168(k)(5))
35. Special rules for contributions of capital gain real property made for conservation purposes (secs. 170(b)(1)(E), (2)(B))
36. Enhanced charitable deduction for contributions of food inventory (sec. 170(e)(3)(C))
37. Enhanced charitable deduction for contributions of book inventories to public schools (sec. 170(e)(3)(D))
38. Enhanced charitable deduction for corporate contributions of computer equipment for educational purposes (sec. 170(e)(6)(G))
39. Increase in expensing to $500,000/$2,000,000 and expansion of definition of section 179 property (secs. 179(b)(1), (2), (f))
40. Election to expense advanced mine safety equipment (sec. 179E(a))
41. Special expensing rules for certain film and television productions (sec. 181(f))
42. Expensing of “brownfields” environmental remediation costs (sec. 198(h))
43. Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico (sec. 199(d)(8))
44. Above-the-line deduction for qualified tuition and related expenses (sec. 222(e))
45. Tax-free distributions from individual retirement plans for charitable purposes (sec. 408(d)(8))
46. Special rule for sales or dispositions to implement Federal Energy Regulatory Commission or State electric restructuring policy (sec. 451(i))
47. Modification of tax treatment of certain payments to controlling exempt organizations (sec. 512(b)(13)(E)(iv))
48. Suspension of 100-percent-of-net-income limitation on percentage depletion for oil and gas from marginal wells (sec. 613A(c)(6)(H)(ii))
49. Treatment of certain dividends of regulated investment companies (secs. 871(k)(1)(C), (2)(C), 881(e)(1)(A), (2))
50. RIC qualified investment entity treatment under FIRPTA (sec. 897(h)(4))
51. Exceptions under subpart F for active financing income (secs. 953(e)(10), 954(h)(9))
52. Look-through treatment of payments between related controlled foreign corporations under the foreign personal holding company rules (sec. 954(c)(6))
53. Special rules for qualified small business stock (sec. 1202(a)(4))
54. Basis adjustment to stock of S corporations making charitable contributions of property (sec. 1367(a))
55. Reduction in S corporation recognition period for built-in gains tax (sec. 1374(d)(7))
56. Designation of an empowerment zone and of additional empowerment zones (secs. 1391(d)(1)(A)(i), (h)(2))
57. Increased exclusion of gain on the sale of qualified business stock of an empowerment zone business (secs. 1202(a)(2), 1391(d)(1)(A)(i))
58. Empowerment zone tax-exempt bonds (secs. 1394, 1391(d)(1)(A)(i))
59. Empowerment zone employment credit (secs. 1396, 1391(d)(1)(A)(i))
60. Increased expensing under sec. 179 for empowerment zones (secs. 1397A, 1391(d)(1)(A)(i))
61 Nonrecognition of gain on rollover of empowerment zone investments (secs. 1397B, 1391(d)(1)(A)(i))
62. Designation of DC Zone, employment tax credit, and additional expensing (sec. 1400(f)(1))
63. DC Zone tax-exempt bonds (sec. 1400A(b))
64. Acquisition date for eligibility for zero percent capital gains rate for investment in DC (secs. 1400B(b)(2)(A)(i), (3)(A), (4)(A)(i), (B)(i)(I), (e)(2), (g)(2))
65. Tax credit for first-time DC homebuyers (sec. 1400C(i))
66. Definition of gross estate for RIC stock owned by a nonresident not a citizen of the United States (sec. 2105(d))
67. Disclosure of prisoner return information to certain prison officials (sec. 6103(k)(10))
68. Excise tax credits and outlay payments for alternative fuel (secs. 6426(d)(5), 6427(e)(6)(C))
69. Excise tax credits and outlay payments for alternative fuel mixtures (secs. 6426(e)(3), 6427(e)(6)(C))
70. Temporary increase in limit on cover over of rum excise tax revenues to Puerto Rico and the Virgin Islands (sec. 7652(f))
71. American Samoa economic development credit (sec. 119 of P.L. 109-432)

How many of these tax breaks benefit you? Would it not be nice if tax punting, tax uncertainty, and tax complexity expired?

Ian Ayres and Aaron Edlin have come up with an interesting tax idea. In Don’t Tax the Rich. Tax Inequality Itself, they propose that whenever the ratio of the average income of the nation’s richest one percent to the median household income exceeds 36, a tax bracket is added to the existing rate schedule to generate enough tax on the richest one percent to bring the ratio back to 36. The idea is interesting if for no reason other than it forces the advocates of tax cuts for the wealthy to step up and show confidence in their rationales.

Those who want to shift the tax burden away from the wealthy claim that tax cuts for the rich create jobs. Though the facts show otherwise, they stick with this argument because, among other things, it makes for a good sound bite. A misleading one, but short and simple. Apparently the predecessor rationale, the so-called “trickle down” theory, has been pushed off center stage because it doesn’t quite have the same resonance, to say nothing of the fact that it was tried and failed. So, too, was the “rising tide lifts all boats” claim, one that fails because boats with holes in the hull don’t rise with the tide.

If the advocates of tax cuts for the wealthy are sufficiently confident that their approach works, they should endorse the Ayres-Edlin proposal because the tax bracket it contemplates would never be triggered. The guardians of the Bush tax cuts should rest easy, that as the tax burden on the wealthy is reduced, the ratio is maintained or reduced, and the wealthy don’t risk a tax increase. But I doubt the advocates of tax cuts for the wealthy will jump on board, because they can look at history and realize that if the Ayres-Edlin proposal had been put in place ten years ago, tax rates for the wealthy would have increased.

Ayres and Edlin quote Louis D. Brandeis. It’s a bit longer than a sound bite but it conveys the seriousness of what has been done to this nation by unwise tax cutting during wartime. Said Brandeis, “We may have democracy, or we may have wealth concentrated in the hands of a few, but we cannot have both.” During the past 30 years, the top one percent of Americans, in economic terms, have doubled their share of the nation’s pre-tax income. It now is higher than what it was when Brandeis reacted to the social turmoil generated by inequality when he made his astute observation. Ayres and Edlin note that in terms of after-tax dollars, the top one percent has more than doubled its take. In other words, tax policy has made inequality worse rather than reducing it.

The ratio of 36 measures the pre-tax income of the average person in the top one percent compared to the median income in 2006. By picking this number, Ayres and Edlin are being generous. In 1980, before the so-called Reagan Revolution, the ratio was 12.5. If anything, a good argument can be made that the Ayres-Edlin tax bracket should be triggered when the ratio exceeds 12.5 or 15 or 20 or 25 or 30 or some other factor that is less than 36. In some respects, using 36 suggests an acceptance of the status quo.

Ayres and Edlin suggest that if nothing is done and the ratio reaches 40 or 50, democracy will erode even more than it already has. They predict that if nothing is done, the ratio will reach 80 within 20 years. It would be interesting to hear a defense of a nation in which the inequality reached to double what it now is and quadruple what it was thirty years ago. At what point does the nation awaken and comprehend the seriousness of the problem? At what point does it demand that the Congress do something? Ayres and Edlin have put something on the table that not only is interesting but deserves careful study, close attention, and widespread publicity.

Earlier this week, in Punting on Taxes, I noted that the two-month extension of the payroll tax reduction “leaves businesses, hiring managers, payroll planners, and payroll departments in an economy-threatening limbo.” It also leaves employees and payroll managers in a place other than paradise.

Because the extension of the payroll tax reduction is, at the moment, limited to two months, it is not as simple as merely continuing reduced withholding for two months. Here’s why. The tax that is reduced applies only to the first $110,100 of wages. Consider two taxpayers. The first taxpayer earns $48,000 a year. If the payroll tax reduction were in effect for all of 2012, that taxpayer would experience a tax reduction of $960 (2% x $48,000). However, because the reduction applies, at the moment, only to the first two months, this taxpayer will experience a tax reduction of $160 (2% x $8,000 of wages for January and February). The second taxpayer earns $4,800,000 a year. If the payroll tax reduction were in effect for all of 2012, that taxpayer would experience a tax reduction of $2,202 (2% x $110,100). However, because this taxpayer receives a monthly salary of $400,000, and because the tax, and its withholding, applies to the first $110,100 of wages, this taxpayer would experience a tax reduction of $2,202 in January, compared to what would have been withheld and paid in the absence of the tax reduction extension.

Congress was concerned about two situations. The first is that the second taxpayer ends up with 100 percent of the tax reduction that would apply had the extension been enacted for all of 2012, whereas the second taxpayer ends up with only 16.7 percent of the tax reduction that would apply had the extension been enacted for all of 2012. To its credit, the Congress decided not to permit high income taxpayers to end up with this sort of advantage. The second issue is the possibility that savvy taxpayers would find a way to front-load salary into the first two months of the year in order to increase the tax reduction. For example, if the first taxpayer somehow could persuade the employer, which could be, for example, the taxpayer’s solely-owned corporation or a family-owned business, to pay the entire salary in January, the first taxpayer would benefit from the full $960 tax reduction.

To prevent the skewing that these situations would cause, Congress also enacted a new tax. Yes, a new tax. Section 101(c) of the Temporary Payroll Tax Cut Continuation Act of 2011 adds a new section 601(g) to the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. It provides:

(1) IN GENERAL.—There is hereby imposed on the income of every individual a tax equal to 2 percent of the sum of wages (within the meaning of section 3121(a)(1) of the Internal Revenue Code of 1986) and compensation (to which section 3201(a) of such Code applies) received during the period beginning January 1, 2012, and ending February 29, 2012, to the extent the amount of such sum exceeds $18,350.
(2) REGULATIONS.—The Secretary of the Treasury or the Secretary’s delegate shall prescribe such regulations or other guidance as may be necessary or appropriate to carry out this subsection, including guidance for payment by the employee of the tax imposed by paragraph (1).

Under this provision, the second taxpayer would be subject to a tax computed as follows. Wages within the meaning of section 3121(a)(1) equal $110,100. That amount exceeds $18,350 by $91,750, which when multiplied by 2 percent yields $1,835. The taxpayer’s payroll tax reduction of $2,202 is offset by the new tax of $1,835, generating a net reduction of $367. This amount of $367 is one-sixth of the maximum $2,202 payroll tax reduction available to the second taxpayer had the reduction been enacted for all of 2012. In addition, if the first taxpayer tried to increase the payroll tax reduction by moving the full year’s salary into January, the 2 percent tax would generate an offset that would negate the advantage otherwise obtained.

Four points need to be made about this complexity. First, it provides another example of a lesson I try to get across to the students in my basic tax class, namely, there is much statutory tax law that is NOT in the Internal Revenue Code. Second, if the Congress sees fit to extend the payroll tax reduction through all of 2012, the additional tax should “disappear,” but whether that happens depends on what the Congress does with the new tax. Third, employees surely are going to make noise when they see a new tax on their paystubs, payroll departments will need to re-program their payroll software and might not be able to do so in a timely manner, and employers will need to invest time and resources explaining this to their employees, though they are invited to provide their employees a link to this post. Fourth, this complexity is yet another example of why, in Punting on Taxes, I reiterated the point I made in Tax Politics and Economic Uncertainty that playing politics with tax and economic policy is a dangerous game. Diverting the nation’s resources to the demands of coping with complexity necessitated by political ineptitude threatens the nation in multiple ways, from its national security through its economic prosperity.

This time, the tax ignorance takes on an historical flavor. In a Philadelphia Inquirer article comparing the Great Depression with the current Recession, Two Eras of Hurt, the author quotes a person named Paul Rees. According to Rees, his family managed to get through the Great Depression because of “his father’s entrepreneurship,” something he thinks “is out of reach for many today.” Rees explains, “So many people don't work for themselves and can't, because of the governmental regulation and the inability to cope with the taxation problems and sale taxes. None of that affected people during the Depression.”

The tendency to blame government, whether it is government regulations protecting people and the environment, or government taxation, or both, for the failure of Americans to show some initiative and self-reliance is a popular political sound bite. The lack of self-reliance, and I agree with Rees that it is a problem, is surely not isolated by the growing ranks of helicopter parents and children who grew up without learning how to fend for themselves.

To claim that taxation problems and sales taxes did not affect people during the Depression is to ignore history. The individual income tax has been in place since 1913, though it also existed briefly during the Civil War. The corporate income tax is a wee bit older. By 1920, income tax revenues exceed $5 billion annually. The Tax Foundation has provided a full list of income tax brackets and rates over the years. To say that “none of [the income tax] affected people during the Depression” is, at best, a gross hyperbole.

According to this Wikipedia article, sales taxes in the United States can be traced to an 1821 Pennsylvania tax, though sales taxes as they exist today were enacted during the Depression. Apparently there is some dispute over the identity of the state with the dubious honor of being the first to adopt a modern-era sales tax. During the height of the Depression, specifically, during the 1930s, more than half of the states that ended up with sales taxes enacted sales taxes. To say that “none of [the sales taxes] affected people during the Depression is simply erroneous.

It would not surprise me that Rees “learned” his tax history from his father, and I can imagine his father claiming that “back in my day there was none of this government taxation and regulations.” It probably snowed in the winter and he walked to school and home barefoot, uphill both ways. How can America engage in tax policy debates and address its economic woes if so many people do not know the history of taxation in this country? How can a nation that at one time boasted the world’s best education system, though it no longer can make that claim with a straight face, let its children of today and of yesterday, and worse, of tomorrow, be so horribly misled by propagandists? I have stressed this point throughout my time as a blogger, for example, in 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, and The Value of Tax Education. Yet every time I hear or read tax misinformation, and realize how many people are making decisions based on erroneous premises, I shudder at the outcome. From pockets of tax ignorance, the educational deficiency now grips the nation from village schoolhouse to the halls of Congress. I wonder if some future historian – if there are any – will caption the chapter dealing with the early twenty-first century as “The Triumph of Ignorance.”

On Friday, the Congress decided to resolve the conflict over the payroll tax cut extension by punting the issue two months into the future. According to this CNN report, Congress voted to extend the payroll tax cut by two months in order “to give negotiators more time to hammer out a deal over how to pay for the continuation.”

Here’s a safe prediction. During the last week of February we will see and hear the same sort of squabbling that took place over the past several weeks. Why am I so confident that it will play out this way? On January 1, 2011, the Congress knew that it had 365 days to decide, one way or the other, what to do with the expiring payroll tax cut. Yet despite knowing that there was a deadline, members of Congress used the issue as a political football, trying to influence 2012 electoral politics. So entrenched in diametrically opposed positions, Congress managed to fumble on this issue. The Congress now knows it has 66 days to work out a solution. That’s the position in which the Congress found itself on November 2, 2011. Other than ramping up the rhetoric, what did the Congress accomplish? Would it be a surprise if on February 29, 2012, the Congress votes for another two-month extension? Though the lingering uncertainty of a final score may put people in the seats at a sports event, it leaves businesses, hiring managers, payroll planners, and payroll departments in an economy-threatening limbo. Playing politics with tax and economic policy is a dangerous game, as I explained in Tax Politics and Economic Uncertainty.

Friday’s outcome did nothing to answer either of the questions I asked earlier that day in Two Tax Questions. So long as the Congress continues to value electoral politics and re-election as more important concerns than fulfilling its fiduciary duties to the nation, the downward spiral will continue.

Will the members of Congress so adamantly opposed to preventing the expiration of the payroll tax cut hold fast to that approach when the Bush tax cuts reach their postponed expiration date? Why did the members of Congress so adamantly opposed to preventing the expiration of the payroll tax cut refuse to join those who were adamantly opposed to the preventing the expiration of the Bush tax cuts?

The answers to these questions should be evident to anyone who examines closely the workings of Congress. For many, even most, Americans, the answers, if they bother to seek them, are alarming.

For the past several years, I have reacted negatively to the policies and practices of the Delaware River Port Authority (DRPA) that funnel bridge tolls to a variety of projects that have nothing to do with maintaining or repairing the bridges or adjacent highways. I addressed this abuse of public trust in a series of posts, beginning with Soccer Franchise Socks It to Bridge Users, continuing through Bridge Motorists Easy Mark for Inflated User Fees, Restricting Bridge Tolls to Bridge Care, Don't They Ever Learn? They're At It Again, A Failed Case for Bridge Toll Diversions, DRPA Reform Bandwagon: Finally Gathering Momentum, and ending with When User Fee Diversion Smacks of Private Inurement.

What should be funded by tolls? In User Fees and Costs, I explained:

The toll should be based on the cost of building, expanding, improving, repairing, maintaining, policing, and monitoring the road. . . .

. . . The analysis I support is one that looks at the impact of the toll road and its use on surrounding residents, neighborhoods, and infrastructure. Traffic volume surrounding a toll road interchange is higher than it otherwise would be, and that generates additional costs for the local government. It makes sense to include in the toll an amount that offsets the cost of widening adjacent highways, installing traffic signals, increasing the size of the local police force, adding resources to local emergency service units, and similar expenses of having a toll road in one's backyard. I understand the argument that because the locality benefits economically from the existence of the toll road and its interchange that it ought not be subsidized by the toll road. It is unclear, though, whether the toll road is a net benefit or disadvantage. If it were such a wonderful thing, why are new roads so vehemently opposed by so many towns and civic organizations?

I reiterated this analysis, more succinctly, in Timing, Quantifying, and Allocating User Fees, by explaining, “Tolls should be used to pay for the costs of building, repairing, maintaining, and operating the toll road, and to defray the economic burden that the road imposes on the surrounding neighborhoods. Tolls should not be used for programs unrelated to the road.”

There now is an opportunity to put this approach to the test. The opportunity consists of two components.

The first component was highlighted a little more than a week ago, in a Philadelphia Inquirer story that explained what the DRPA planned to do with the balance of the toll money it had set aside for projects unrelated to its mission. Of the roughly $30 million remaining in the account, the DRPA decided to set aside $10 million for “future capital projects” and voted to spend the other $20 million on “local food banks, a new cancer center in Camden, student housing for Rutgers-Camden, and Cooper River rowing facilities,” along with unallocated monies for the New Jersey Economic Development Authority and a pier. Two unappointed members of the Authority’s board, including Pennsylvania’s Auditor General, voted against the $20 million expenditure, failing to persuade the others that it should also be dedicated to transportation projects or reducing the DRPA’s $1.4 billion debt.

The second component was described several days ago in another Philadelphia Inquirer article. The City of Philadelphia plans to extend Delaware Avenue as part of the “master plan for the development of the Delaware River waterfront” in order to provide better access to the area. To extend Delaware Avenue, the city needs an easement from the DRPA because the Avenue would go under the Betsy Ross Bridge, one of the DRPA’s bridges. The DRPA has refused to issue the easement because it wants the city, in return, to take title to Hedley Street. The DRPA acquired Hedley Street when it bought the land on which the bridge supports rest. The city doesn’t want Hedley Street, in part because it is not paved and does not meet city street codes, and in part because it has no use for it. The city is willing to take ownership of the street if the DRPA returns it to its former compliant condition, a project that would cost $2 million. As one might expect, the city says that the DRPA is responsible for the cost, and the DRPA claims that the city should pay. If the DRPA continues to block the city’s plans, the city will lose $15 million of federal funds that had been granted some years ago to help defray the cost of the Delaware Avenue extension project.

The DRPA took the street, let it fall apart due to bridge construction and decades of neglect, now wants to pass it off to the city, along with the $2 million repair bill, and is using the threat of easement withholding in an attempt to bludgeon the city. The DRPA is the land owner and the DRPA is responsible for the condition of the street. It does not violate my view of responsible use of user fees for the DRPA to use some of the $20 million to fix the road that it owns, a road adjacent to one of its bridges. Instead, the DRPA is trying to get the city’s taxpayers to foot the bill while it diverts toll revenue to totally unrelated projects. The irony is how the DRPA defends itself. A spokesman said, "Our position is firm. We're not going to budge. . . . It would cost our toll payers $2 million, and they'd get nothing in return.” Why wasn’t that argument noted when the DRPA was forking over money, and as it continues to fork over money, for things that provide nothing in return to its toll payers?

Late last week, a TaxProf blog story explained that the Sentencing Law & Policy Blog had reported on a $2.3 million award to a wrongfully imprisoned man. The latter post contained a “follow-up question” which was in turn posed to Paul Caron at the TaxProf blog, specifically, “Does [the plaintiff] now get to enjoy this $2.3 million award free from all federal and local taxes?” Here’s an aside to the students in basic federal income tax law school courses: this is yet another example of why lawyers who have no intention of practicing tax law need to understand the basics of tax law, need to take the basic tax course, and thus learn, as was the case here, when to, as I put it, “ask for help.”

In his a TaxProf blog story, Paul explained, correctly, that the answer depends on whether the award was received on account of “personal physical injuries,” citing a half-dozen previous TaxProf posts on the issue. I had not taken a close look at the stories Paul had cited when he posted earlier this year and in 2010, principally because the black letter law was clear. That was a mistake. Had I done so, I would have noticed before now some interesting assertions about the taxation of false imprisonment damages.

As to the policy issue, namely should false imprisonment damages be subject to income taxation, there are good arguments on both sides. In some ways, those arguments reflect the ones advanced on both sides of the debate about the exclusion generally of damages for personal physical injuries and sickness. My focus today is not on those arguments but on the issue of who makes the decision.

Section 104(a)(2) of the Internal Revenue Code makes it clear that the exclusion of damages from gross income applies only to damages received on account of personal physical injuries and sickness. Section 104(a)(2) has been amended several times during the past several decades, which may explain why the IRS, in 2007, obsolete rulings from the 1950s in which it had concluded that gross income did not include damages received by survivors of Nazi concentration camps, Japanese-American internees, and American POWs.

Surely it is the language of section 104(a)(2) that constrained the Tax Court, in a case affirmed by the Sixth Circuit, from extending the exclusion to damages received for false arrest. The court opined that “[p]hysical restraint and physical detention are not ‘physical injuries’ . . . Nor is the deprivation of personal freedom a physical injury.” Robert Wood has provided a very good analysis of this case in Why the Stadnyk Case on False Imprisonment Is a Lemon, an article worth reading by anyone with a serious interest in the issue. In 2010, the IRS issued CCA 201045023, in which the IRS advised that a falsely imprisoned person who suffered physical injuries and sickness while incarcerated can exclude from gross income the damages for those injuries and sickness. Though many people tried to interpret the CCA as justifying exclusion of all damages for false imprisonment, the CCA does not go that far, as carefully explained, again by Robert Wood, in Wrongful Imprisonment Tax Ruling Stirs Controversy.

In Tax-Free Wrongful Imprisonment Recoveries, Robert Wood argues that the IRS takes too narrow a view of what “physical injuries and sickness” means and suggests that the IRS could issue administrative guidance excluding all false imprisonment damages from gross income, and in Why the Stadnyk Case on False Imprisonment Is a Lemon, he provides observations on why the IRS may be reluctant to do so but urges that the IRS or Treasury issue guidance specifying which false imprisonment damages are excludable. Similarly, in Tax On Wrongful Imprisonment Needs Reform, Wood argues that “It’s time for the IRS or Congress to fix this.” Wood is not alone in thinking that the IRS can resolve the problem by adopting definitions of “physical” that reach beyond what the word means. See Expanding Section 104(a)(2)'s Tax Exclusion. On the other hand, in Did the Sixth Circuit Get It Right in Stadnyk?: What to Do About the § 104(a)(2) Personal Injury Damages Exclusion, the author calls on the Congress to fix section 104(a)(2) to settle the question and provide certainty to plaintiffs. In fact, bills have been introduced in Congress to make false imprisonment damages excluded from gross income. On December 6, 2007, the Wrongful Convictions Tax Relief Act of 2007 was introduced, and on March 3, 2010, the Wrongful Convictions Tax Relief Act of 2010 was introduced. Neither bill was passed by the Congress.

There is no question that section 104(a)(2) has flaws and needs to be revised. There is no question that the Congress needs to determine the scope of section 104(a)(2) and whether or not it applies to damages for false imprisonment and similar situations where physical injury or sickness is absent. Congress could, if it chose, to provide a definition of the word “physical” that extends beyond physical, but the better approach would be to provide more explicit parameters for the scope of the exclusion, assuming that the exclusion is maintained. To expect the IRS or the courts to step in and apply section 104(a)(2) as though it had been drafted in some other manner, even if it should be or have been drafted in a more helpful way, is to extend to the executive or judicial branch the responsibility for doing the work of the legislative branch. Congress needs to put aside the politics and get to work, on this and a long list of other matters that need its attention.