When There Are No Surplus Proceeds From a Tax Sale Yet Equity Shifts to the Purchaser

Sometimes when a problem appears to have been solved, it turns out that the problem hasn’t been solved because a way is found to circumvent the solution. Why would this happen? It happens when the solution gets in the way of those who benefit from the problem. In other words, sometimes what is a problem for some is a windfall for others and thus the solution to the problem becomes an obstacle to obtaining the windfall. In turn, attempts are made to bypass the solution in order to continue obtaining the windfall.

One situation in which this problem-solution conundrum often pops up is when a property owner fails to pay real property taxes, the taxing jurisdiction causes the property to be sold, and the property owner loses whatever equity the property owner had in the property.

Five years ago, in Who Gets Surplus Proceeds From a Tax Sale?, I explained that the Michigan Supreme Court issued a decision in a case involving the sale of a property on which the real property taxes had been unpaid. A Michigan statute permitted the taxing jurisdiction to retain any excess of the selling price of the property over the amount of unpaid taxes, interest, fees, and costs. The Michigan Supreme Court held that permitting the taxing jurisdiction to retain more than the unpaid taxes, interest, fees, and costs violated the Michigan Constitution. Michigan was one of about twelve states with that sort of statute and I noted that it remained to be seen whether other states would eliminate this practice.

Three years later, in Supreme Court Puts An End to a Bad Tax Practice, I explained that a dispute involving a similar practice in Minnesota has reached the United States Supreme Court, which held that this practice violated the Takings Clause of the United States Constitution. The Court explained that a government cannot take more from a taxpayer than what is owed. Presumably, if a taxing jurisdiction in any other state with a statute similar to those in Michigan or Minnesota retains or tries to retain the excess proceeds, it will face a challenge and it will lose that challenge. Presumably the problem was solved.

But then a year later, in It Turns Out the Supreme Court Didn’t Put An End to a Bad Tax Practice, I had to backtrack on my previous headline, “Supreme Court Puts An End to a Bad Tax Practice,” with a commentary whose headline, “It Turns Out the Supreme Court Didn’t Put An End to a Bad Tax Practice,” because states had found a way to get around the Supreme Court’s holding. In this commentary, I explained that officials in Oakland County, Michigan, seized the home of a delinquent property owner, gave that home to a private company, which sold the house, remitted the unpaid taxes to the county, and kept the excess. The property owner received nothing. When the property owner sued, the judge dismissed the case because “the government itself didn’t make a profit.” What made this situation outrageous was the explanation from the property owner’s lawyer that the private company in question was operated by the mayor and the city administrator. Apparently the company collected $10 million in selling houses in this manner. In July of this year, the Michigan Supreme Court held that what had happened violated the Michigan Constitution, in Jackson v. Southfield Neighborhood Revitalization Initiative.

Today Reader Morris alerted me to a Pennsylvania Commonwealth Court decision, , Gaynor v. Delaware County Tax Claim Bureau and CJD Group, LLC, filed earlier this year. A property owner neglected to pay real estate taxes in 2020 because the pandemic paused visits to the courthouse and paused enforcement of overdue real estate taxes. When she later tried to pay those taxes her payment, unbeknownst to her, was applied to her 2021 tax bill. Later, when notices with respect to the 2020 taxes were sent she apparently did not respond because, according to this story, her mental faculties were declining. The county then sold the property to a private company for the amount of the unpaid taxes, interest, fees, and costs. The home, worth about $247,000, was sold to the private company for $14,000, and the company acquired the $233,000 equity. The homeowner received nothing. The homeowner sued, alleging that the notice of the tax sale was insufficient or defective, that she was not offered an installment payment plan, and that the property was worth more than 15 times what was paid by the private company at the tax sale. The Common Pleas Court rejected the homeowner’s petition, and the homeowner appealed to the Commonwealth Court. On appeal, the homeowner argued “that the trial court erred by failing to find that the price for which the Property was sold was grossly inadequate in comparison to the actual sale price.” The Commonwealth Court explained that the homeowner “did not allege any sale irregularities in her Petition, nor did she present any evidence thereof at the trial court hearing,” and held that, “ Thus, assuming, arguendo, that the Property was sold for a grossly inadequate price, because there is no evidence to even suggest that there were irregularities in the tax sale that contributed to the grossly inadequate sales price, the trial court properly denied the Petition.”

The Commonwealth Court noted, in a footnote, that the Statement of Questions Involved portion of her brief, the homeowner had presented two additional issues for the court to review, specifically “(1) whether the trial court erred by failing to exercise its equitable powers to set the tax sale aside where [homeowner’s] son testified that he would be able to pay all tax arrearages; and (2) whether the trial court erred by failing to set the tax sale aside where the County Tax Claim Bureau (Bureau) had failed to give proper notice or service of the sale in accordance with the requirements of Section 602 of the Real Estate Tax Sale Law.” The Court pointed out that the only issue addressed in the Summary of Argument and Argument portions of her brief was the question of “whether the trial court erred by failing to find that the price for which the Property was sold was grossly inadequate in comparison to the actual sale price.” The court treated the failure to address in the Argument portion of the brief the two issues described in the Statement of Questions Involved portion as having been waived.

There are two ways to analyze this case, which perhaps is being appealed to the Pennsylvania Supreme Court. One is that a procedural glitch prevented the court from getting to the root of the problem and that had the issues been presented in accordance with the procedural rules it would have reached a different conclusion. The other is that even if the court considered those other two issues it would still have concluded, based on its reasoning, that so long as there were no irregularities in the sale, the sale was valid and the property owner’s equity shifted to the buyer.

The story about the homeowner’s loss of her home and her equity in it revealed that according the Channel 6 in Philadelphia, the company that purchased the homeowner’s property has purchased 62 properties since 2011. It is not the only company engaged in this practice.

Several Pennsylvania legislators have introduced a bill designed to stop these situations from happening through a change in the notice procedure. It would permit homeowners to designate an agent who would also receive the notices. This would protect homeowners who for some reason don’t receive the notices, or receive them but fail to act perhaps because their faculties are declining, are in the hospital, or dealing with some other setback. However, this does not solve the problem. The problem is that the taxing authority is permitted to sell the property for less than its fair market value. In a time when housing is scare and prices high, it is puzzling that no one showed up to acquire a $247,000 property for more than $14,000. Surely someone wanting to purchase a home similar in size, features, and location to the one in question but who could, and was willing to, pay, say, $150,000 or some similar amount would have jumped at the opportunity to make such a purchase. Why that did not happen is a question that can and should be asked of real estate agents who are representing buyers. Why not take the potential buyer, who is struggling to find a sufficiently sized yet affordable home, to these tax sale auctions?

A Foolish Tax Proposal That Surely Isn't Fair

Representative Earl Carter of Georgia has continued the practice of at least one representative from Georgia introducing the Fair Tax Act when each new Congress convenes. First introduced in 1999, the most recent version of the proposal is not what its sponsors claim it to be. In his press release, Carter claims that the “The Fair Tax would repeal the current tax code and replace it with a single national consumption tax.” Though it would enact a consumption tax, it would not repeal the current tax code. It would repeal parts of the current tax code. Carter claims that the “Fair Tax would also eliminate the need for the Internal Revenue Service.” Yet the bill leaves to “the Secretary” [of the Treasury] a long list of responsibilities and tasks that if not assigned to the Internal Revenue Service that would be assigned to existing or new departments or bureaus that would differ chiefly in name only. The proposal leaves in place some taxes, such as excise taxes, and there would still need to be some sort of federal agency to administer them.

Replacing an progressive income tax with a consumption tax, which is a fancy name for a sales tax, would eliminate the corporate income tax. It would reduce the amount of federal taxes paid by the wealthy. It is a regressive tax, which means that the percentage of income paid in taxes would decrease as income increased. Even with the absurdly complicated rebate system proposed for people living under the poverty level, the consumption tax would hit the middle class, or what’s left of it, while letting the wealthy pay a token amount of tax. The tax would not apply to investments. That, of course, is quite a relief to those who have investments but is an exception of no use to those struggling to get by on poverty wages. On a Myth v. Fact release, Carter rejects the claim that the “FairTax will hurt the poor and give the rich a huge tax cut” by pointing out the rebate system for the poor, and then argues that “the FairTax is not riddled with shelters and loopholes, meaning wealthy taxpayers cannot minimize what they pay in taxes,” but without mentioning that the wealthy spend very little of their income and wealth on consumption compared to everyone else in the country. The exception in section 102(a)(2) of the proposal is pretty much a shelter if not a loophole. It’s actually a flaw in the consumption tax, and it makes ridiculous the claim that the “FairTax is the only progressive tax reform bill currently pending before Congress” because it’s not a progressive tax.

If you are interested in how the mechanisms for people to qualify for a rebate that would be mailed to individuals qualifying for consumption tax relief, read the details in the bill. The definitions, the reporting, the hoops through which people must jump are no less complicated and in some instances more complicated than existing federal tax law.

The bill shifts to the revenue departments of states that have sales taxes the task of administering the federal consumption tax, which surely cannot delight existing overworked state revenue department employees. The federal government, through the use of some sort of IRS replacement agency, would remain the administrator of the tax in states that do not have sales taxes. Considering the difficulties states face in collecting the backup use tax, relying on a system that provides just as many compliance and enforcement challenges as does the existing federal income tax is unwise, even foolish.

Though the press release claims that the Fair Tax would eliminate the need for taxpayers to have “a team of lawyers or accountants to fill out their taxes,” the bill contains language that contemplates the need for professional advice to deal with the inevitable mistakes, overcharges, erroneous poverty rebates, and other glitches sure to arise. Worse, some taxpayers may not realize that they have been overcharged or under rebated, and so they wouldn’t know they need professional assistance, which is not a good reason to not retain professional assistance.

One of the co-sponsors claims that a national consumption tax would “make the American Dream affordable again.” He doesn’t understand, or perhaps does but does not want to admit, that the unaffordability of the American dream for almost everyone who isn’t attaining it rests on the income and wealth inequality caused by the reduction of income tax progressivity. Eliminating that progressivity with a regressive consumption tax guarantees that the American Dream will be out of reach except for the several hundred families that would eventually own 99 percent of wealth in this country. Progressivity means progress, which encompasses the American Dream. Regressivity means regression, which encompasses the flaws that this nation has been trying to remediate for the past 90 years.

Sponsors of the proposed legislation, as quoted in the press release, keep tossing around words and phrases such as prosperity, pro-growth, and fair share. These buzz words are the hallmark of the Oligarchic Dream, which is the antithesis of the American Dream. It is legislation welcomed by the ruling oligarchy and that will make the economic position of most Americans even worse than what it currently is.

Representative Carter went so far as to claim that the legislation is “the only tax proposal out there that is pro-growth, simple, and allows Americans to keep every cent of their hard-earned money.” If Americans keep every cent of their hard-earned money, then no one would be paying taxes, except perhaps for those who have easy-earned money. So who has easy-earned money? Certainly not the hard-working electricians, police officers, farmers, engineers, bookkeepers, caregivers, nurses, and other workers. The easy-earned money accrues to those who sit around living off trust funds and inherited wealth. Yet I am confident that the Fair Tax is not designed to remove tax obligations from those who work hard or have worked hard.

Carter goes even further, telling us that he is “proud to lead this Georgia-grown legislation that puts the American people, not bureaucrats, in charge of their tax rate.” If that is what he intends, put the tax rate to a popular vote. If I were to bet, I would bet that zero percent would win. Not only would it reflect the ubiquitous distaste for taxation shared by most people, it would also reflect the efforts of the oligarchy that wants to eliminate government or reduce it to a structure under the control of the oligarchy, and replace it with a nation whose economy is totally, or close to totally, a private sector under the control of oligarchs who are not subject to votes, recall, or impeachment. In that world, the services currently provided by government would either be eliminated or would be available for purchase from oligarchs who own highways, hospitals, banks, police and fire departments, grocery stores, clothing stores, and everything else, and who can refuse service to whomever they want to push aside, who can charge whatever they want to charge, who can damage the environment however they wish, who can sell defective and dangerous products if doing so enhances their net worth, who can use false advertising to procure customers, who can be the marketplace capitalist bullies that is their oligarchic dream.

Some Tips About Tips and Taxes

Both major party candidates for the presidency have expressed support for the notion of eliminating federal income (and perhaps employment) taxes on tips. There is no question that this is a ploy designed to gather votes, especially since the proposal wouldn’t amount to much of a benefit, if at all, for most workers who rely on tips to make ends meet.

Why would this proposal do little or nothing for workers who rely on tips? According to several reports, such as this one from Axios, and this one from Alternet, Alex Morash of the advocacy group One Fair Wage, in a report compiled in collaboration of the University of California at Berkeley Food Labor Research Center, concluded that nearly one-half of tipped workers in restaurants earn less than the $13,850 cutoff for paying federal income taxes. About two-thirds of them live in households with income too low to create federal income tax liability. In other words, excluding tip income from the gross incomes of these workers does absolutely nothing for them. I think the number of workers who would not benefit is even higher, because these computations apparently do not take into account any credits to which the workers may be entitled to claim. This conclusion is supported by analyses offered by the Tax Policy Center. And if tips are exempted from employment taxes, it jeopardizes the eligibility of tipped workers for Social Security and Medicare coverage or reduces what they are eligible to collect.

So who would benefit from excluding tip income from gross income? Most likely, the small percentage of tipped workers who collect large amounts of tips. Those workers, estimated to constitute about 5 to 10 percent of tipped workers, gather their tips at luxury hotels and restaurants. Though they would welcome a reduction in their federal income tax liabilities, assuming they have any, in the long run it would work to their detriment. Let’s see why.

Cutting federal income taxes on tips gives the employers of tipped workers another argument against raising the minimum wage or at least reducing any increase. Though excluding tips from gross income would benefit only a small percentage of tipped workers, the concept would help employers spare themselves the expense of raising wages for all workers, including those who are barely getting by even with tip income.

Who else might benefit? Tips are nothing more than another form of compensation for the performance of services. It should make no difference whether money flows directly from a customer to a worker or from the customer to the worker through the employer. In both instances the worker is receiving compensation. If the handful of tipped workers who pay taxes on their tips should be excused from doing so because they are perceived to be earning insufficient income, then the same benefit should be given to all other workers who are earning the similar amounts of insufficient income. In other words, raise the standard deduction or make adjustments in the tax rate schedules rather than singling out one class of worker for special treatment.

Then there are those who would manipulate the system to convert non-tip forms of compensation into tips. Already there are planners thinking about ways to make this happen. It’s not my intention to provide blueprints for this sort of behavior other than to note that it is possible. Imagine the impact on the economy, to say nothing of the operation of government, if suddenly all wage earners were being paid minimum wage and the rest of their pay in “tips.” It could be worse, as clever planners find ways to convert partnership and S corporation distributions, C corporation dividends, and other forms of income into “tips.” At least the presumptive nominee for one major political party includes in the proposal plans to find ways to prevent this from happening.

Of course, as is the case with many special interest tax provisions, the proposal is nothing more than a band-aid designed to soften rather than address the impact of the underlying problem. Even if the proposal to exclude tips from gross income was a sincere effort to help underpaid workers and not a vote-grabbing ploy in the state where it was announced, a state where a high proportion of workers rely on tips, it is a feeble excuse of a solution for the problem of underpaid workers. There needs to be an increase in the federal minimum wage, which has not been changed since 2009. Even though some states have stepped up to deal with this Congressional neglect, there are workers in states that have not done anything to deal with the problem. Worse, the federal minimum wage is sharply reduced for workers in industries where tipping is the norm, so long as the tips bring the worker’s hourly pay up to the federal minimum wage. This exception encourages tipping.

Tipping is a major ingredient of American culture. It’s different in other countries, where workers are paid a living wage and do not need to rely on the decisions of customers. Though many customers tip based on the quality of service, too many cut tips if they are unhappy with other aspects of their experience beyond the control of the tipped worker, too many don’t leave tips (or leave very tiny tips) because they “don’t believe in tipping,” too many “forget” to tip, and too many, including the many tourists from other countries, simply don’t understand the tipping culture. Making a shift from the “American way” of compensating workers in certain service industries to the pattern in place in other countries would be difficult but not impossible, and in the long run far more efficient.

Those who oppose changing the culture of tipping want to retain “a way to show the business that its services is terrible.” The way to show a business that its service is terrible is to stop patronizing the business. Then the business in theory fixes the problems or goes out of business. If the problem is the worker, the worker needs to be retrained or released. If the problem is something else, as it often is though “taken out” on the worker through a reduced or eliminated tip, then the business either fixes the problem or goes out of business.

Once again, it is apparent that blurting out something that “sounds good” in a sound bite or tweet isn’t so good when the idea is subjected to examination, analysis, and critical thinking. Very few Americans understand the full ramifications of a simple “stop taxing tips” ploy. It’s not that simple.

Another Wealthy Stadium Owner Grabs Taxpayer Money

Here we go again. Those who read MauledAgain are familiar with my opposition to public funding of, and tax breaks for, businesses owned by multimillionaires and billionaires. I have written about this problem, particularly with respect to public financing for the sporting dreams of billionaires, in posts such as Tax Revenues and D.C. Baseball, four years ago in Putting Tax Money Where the Tax Mouth Is, Taking Tax Money Without Giving Back: Another Reality, and Public Financing of Private Sports Enterprises: Good for the Private, Bad for the Public, Taking and Giving Back, If You Want a Professional Sports Team, Pay For It Yourselves; Don’t Grab Tax Dollars, Is Tax and Spend Acceptable When It’s “Tax the Poor and Spend on the Wealthy”?, Tax Breaks for Broken Promises: Not A Good Exchange, Tax Breaks for Wealthy People Who Pretend to Be Poor, When One Tax Break Giveaway Isn’t Enough, It’s Not Just Sports Franchise Owners Grasping at Tax Breaks, Grabbing Tax Breaks, Sports Franchises, Casinos, and Now, a Water Park, and Tax Breaks For Starving Team Owners.

Now comes news that the Wisconsin legislature has passed, and the state’s governor intends to sign, legislation that shifts almost half a billion dollars from taxpayers to the owners of the Milwaukee Brewers so that the stadium in which they play can be repaired. I’ll leave to the engineers the question of whether one building that needs that much money for repairs should be fixed or demolished. The legislation succeeded even though the Brewers have sufficient funds to pay for the repairs.

When the legislation passed, a Brewers official stated, ““It’s a great day for the franchise but I think an even greater day for the state.” But is it a great day for taxpayers in the state who aren’t fans of the Brewers?

The governor justified his support by noting that the money will create jobs. On that theory, perhaps all jobs should be financed by taxpayers. Of course, that would make no sense. Just as many jobs would be created if the Brewers paid for their own repairs, just as other property owners pay for their own repairs. Isn’t it interesting that the same politicians who object to government programs to help poor people fix their homes are ferociously eager to use taxpayer funds to help wealthy individuals and corporations fix their properties? There’s some hypocrisy lurking behind this charade.

Of course, the team used the well-worn threat of leaving town if they didn’t get taxpayer money. Then let them leave. If Milwaukee is a great place to have a baseball team and stadium, then free market capitalism will entice another set of owners to move to Milwaukee. And if that doesn’t happen, it demonstrates that Milwaukee cannot support a baseball team in a free market capitalism world. So be it. Interestingly, after making that threat, Brewers officials backed off. Apparently that sort of threat doesn’t make for good public relations.

Supposedly the public funding is palatable because the team is kicking in about 20 percent of the cost. Using that approach, ought not taxpayer funds be used to finance 80 percent of whatever it is that someone wants to purchase? Or is that deal reserved for the wealthy?

Some Republicans in the Senate balked at the original funding plan, and scaled back the state’s contribution from $411 million to $386 million, while the city and county of Milwaukee would kick in $135 million. So where do they get the funds? Unlike the deal in Buffalo that I criticized in Tax Breaks For Starving Team Owners, they apparently aren’t chopping $800 million off the funding of the state’s equivalent of New York’s Office of Children and Family Services. No, instead, they have added a $4 “surcharge” on tickets to non-baseball events and an $10 “surcharge” on luxury suite tickets to non-baseball events. I wonder how baseball fans would react to a “surcharge” on baseball game tickets to fund opera, ballet, and symphonies.

The supporters who claim that it makes sense to fund the wealthy because doing so benefits the public and creates jobs ignore the logic that taking this approach in a fair manner requires public funding for almost everyone, because almost everyone engages in employment, activities, and enterprises that benefit the public and creates jobs. Why doesn’t the person who hires contractors to repair their home get this treatment? Because that homeowner lacks the resources to fund politicians’ campaigns, to hire lobbyists to pressure public officials, and to pay marketers to make the public think that government funding for the stadiums owned by wealthy individuals and corporations is a wonderful thing to do. Worse, they manage to impose “surcharges” on people who are not necessarily fans of baseball or the Brewers. These supporters of public funding for stadiums proclaim their worship of free market capitalism, but when free market capitalism fails to help the wealthy achieve a goal, they are quick to jump in with what gets condemned as socialism if that sort of assistance is proposed for the poor and middle class who encounter free market capitalism failures. The hypocrisy is disappointing and dangerous.

Will “Tax and Spending” Get Support in a Place Traditionally Hostile to Taxes and Government Spending?

Eleven years ago, in How Not to Spend Tax Revenues, I criticized the school district in Allen, Texas, for spending $60 million on a high school football stadium. School district officials explained that it was not their intention to recoup the costs through revenues from the stadium, pointing out that it was not practical to do so. The bonds undertaken to fund the construction are being paid back by the taxpayers. The stadium, for high school students, has a 38-foot wide high-definition video screen, spacious weight rooms, separate practice areas for the wrestling and golf teams, and concrete rather than aluminum stands. The absurdity of the cost was highlighted by the fact that in 2012 dollars, the Cotton Bowl cost $4.5 million, and the stadium being built at the time by the University of North Carolina-Charlotte cost about $45 million. I pointed out that someone’s making money on this deal, and it isn’t the taxpayers and it isn’t the students.

What surprised me at the time was the inconsistency exhibited by those who object to “excessive government spending” but who vote for what one person called “monumentally stupid” and another called “pathetically ridiculous.” Dare I say that opposition to spending peaks when the dollars would benefit “the others” but disappears when it helps “one’s own.” As I pointed out in the 2012 commentary:

The father of one football player provided a comment that could be considered a response: “There will be kids that come through here that will be able to play on a field that only a few people will ever get the chance to play in.” So it’s good to fork over tens of millions of taxpayer dollars to benefit a few kids? In return, what do the taxpayers get? A more educated nation? A nation whose citizens are competitive in a global marketplace? A healthier citizenry? Or just another version of taxpayer-funded entertainment for the benefit of a select group? What about facilities for the debate team? The language clubs? The science fair? The math contestants? Do they not matter?

Apparently my 2012 commentary didn’t find its way to a sufficient number of people, or perhaps they ignored it, or perhaps they didn’t understand it. Why do I say that? Keep reading.

The other day reader Morris directed my attention to this report about a proposed high school stadium in Prosper, Texas. The school district in that town has put several bond propositions on the ballot, one of which, if approved, would authorize the borrowing of $94 million to build a second high school football stadium. In an attempt to justify what would be the most expensive high school stadium in Texas (and, I think, perhaps anywhere), a spokesperson for the school district claimed that the stadium should not be considered a stadium but “the district’s largest classroom.” The spokesperson explained that students would run concessions, organizations such as the band, cheerleaders, and spirit squad would “contribut[e] to the game day atmosphere,” the stadium would be used for community events, several spring sports, and graduation. Note that the existing stadium would not be closed but instead football teams would “rotate” between the two facilities.

In all fairness, the district is also presenting three other bond propositions. One would finance six new elementary schools, a second early childhood school, two ne middle schools, a new high school, an outdoor learning center, an administration and professional learning center, and modernization and expansion of existing schools. Another would provide updated technology for students, teachers, and staff. The third would finance a new performing arts center. And in all fairness, it appears that voters could approve one or more of the propositions without approving all of them.

So what will the voters do? Approve all, which would require significant increases in tax revenues, something abhorrent to most Texans? Approve the financing for a professional-level football stadium for a high school and reject the others? Vote for the stadium and the new schools but turn down the technology upgrades and performing arts center? Approve all but the football stadium?

What the voters do will tell us quite a bit about what the voters think is important. It will also reveal some truths about the extent to which objections to “tax and spending” is an objection only to certain taxes and spending. It will be interesting to learn, years from now, how much complaining blossoms as taxpayers in the district begin looking closely at their tax bills.

Stop the "Stop EV Freeloading Act" Because The Mileage-Based Road Fee Is a Much Better Way to Go

Senator Deb Fischer has introduced the “Stop EV Freeloading Act,” a description of which is provided here. The justification for the proposal makes sense, as do all the other attempts to deal with the fact that fuel taxes are not collected with respect to electric vehicles. But the proposed solution is unfair and burdensome in terms of compliance and paperwork.

Fischer proposed a two-tier tax. A tax of $1,000 would be imposed “at the manufacturer level, at the point of sale.” The $1,000 is computed by multiply 10 (because the average lifespan of an electric battery is 10-15 years) by $100 (the high end of the average $87 to $100 in federal liquid fuel taxes paid with respect to light-duty vehicles to the Highway Trust Fund). Another tax of $550 would be imposed on each battery module weighing more than 1,000 pounds, imposed at the manufacturing level. The $550 is the cap on the excise tax paid with respect to heavy trucks.

The rationale for the proposal rests on the claim that these taxes would “offset the damage to roads and bridges” caused by electric vehicles. The problem with the proposal is that it assumes each electric vehicle causes the same amount of damage. Yet the amount of damage caused by a vehicle varies depending on the number of miles driven, the weight of the vehicle, the distribution of the weight based on the number of axles and wheels, and the type of road surface on which the vehicle is driven. The proposal subsidizes high-mileage drivers at the expense of low-mileage drivers. That’s not fair. The proposal would require manufacturers to keep all sorts of records and fill out a variety of forms in order to comply with the manner in which the taxes are imposed and collected.

There’s a better way. Readers of MauledAgain already know, and probably knew when they started reading this commentary, what I am about to write. Yes, it’s the mileage-based road fee. I’ve written about this easy-to-apply-and-enforce concept many times, including posts such as Tax Meets Technology on the Road, Mileage-Based Road Fees, Again, Mileage-Based Road Fees, Yet Again, Change, Tax, Mileage-Based Road Fees, and Secrecy, Pennsylvania State Gasoline Tax Increase: The Last Hurrah?, Making Progress with Mileage-Based Road Fees, Mileage-Based Road Fees Gain More Traction, Looking More Closely at Mileage-Based Road Fees, The Mileage-Based Road Fee Lives On, Is the Mileage-Based Road Fee So Terrible?, Defending the Mileage-Based Road Fee, Liquid Fuels Tax Increases on the Table, Searching For What Already Has Been Found, Tax Style, Highways Are Not Free, Mileage-Based Road Fees: Privatization and Privacy, Is the Mileage-Based Road Fee a Threat to Privacy?, So Who Should Pay for Roads?, Between Theory and Reality is the (Tax) Test, Mileage-Based Road Fee Inching Ahead, Rebutting Arguments Against Mileage-Based Road Fees, On the Mileage-Based Road Fee Highway: Young at (Tax) Heart?, To Test The Mileage-Based Road Fee, There Needs to Be a Test, What Sort of Tax or Fee Will Hawaii Use to Fix Its Highways?, And Now It’s California Facing the Road Funding Tax Issues, If Users Don’t Pay, Who Should?, Taking Responsibility for Funding Highways, Should Tax Increases Reflect Populist Sentiment?, When It Comes to the Mileage-Based Road Fee, Try It, You’ll Like It, Mileage-Based Road Fees: A Positive Trend?, Understanding the Mileage-Based Road Fee, Tax Opposition: A Costly Road to Follow, Progress on the Mileage-Based Road Fee Front?, Mileage-Based Road Fee Enters Illinois Gubernatorial Campaign, Is a User-Fee-Based System Incompatible With Progressive Income Taxation?. Will Private Ownership of Public Necessities Work?, Revenue Problems With A User Fee Solution Crying for Attention, Plans for Mileage-Based Road Fees Continue to Grow, Getting Technical With the Mileage-Based Road Fee, Once Again, Rebutting Arguments Against Mileage-Based Road Fees, Getting to the Mileage-Based Road Fee in Tiny Steps, Proposal for a Tyre Tax to Replace Fuel Taxes Needs to be Deflated, A Much Bigger Forward-Moving Step for the Mileage-Based Road Fee, Another Example of a Problem That the Mileage-Based Road Fee Can Solve, Some Observations on Recent Articles Addressing the Mileage-Based Road Fee, Mileage-Based Road Fee Meets Interstate Travel, If Not a Gasoline Tax, and Not a Mileage-Based Road Fee, Then What?>, Try It, You Might Like It (The Mileage-Based Road Fee, That Is) , The Mileage-Based Road Fee Is Superior to This Proposed “Commercial Activity Surcharge”, The Mileage-Based Road Fee Is Also Superior to This Proposed “Package Tax” or “Package Fee”, Why Delay A Mileage-Based Road Fee Until Existing Fuel Tax Amounts Are Posted at Fuel Pumps?, Using General Funds to Finance Transportation Infrastructure Not a Viable Solution, In Praise of the Mileage-Base Road Fee, What Appears to Be Criticism of the Mileage-Based Road Fee Isn’t, Though It Is a Criticism of How Congress Functions, Ignorance and Propaganda, A New Twist to the Mileage-Based Road Fee, The Mileage-Based Road Fee: Simpler, Fairer, and More Efficient Than the Alternatives, Some Updates on the Mileage-Based Road Fee, and How to Pay for Street Reconstruction. So how about it, Senator Fischer, why not go for the simpler rather than the more complicated? Why not go for what’s fair rather than what’s imprecise? Why not follow the lead of the states that are already working with, experimentally or more conclusively, the mileage-based road fee? And by calling it what it is, a fee and not a tax, it will be easier to obtain support because there is a direct connection between what is being paid and what is being obtained for that payment.

A New Tax Game?

Reader Morris alerted me to proposed legislation in North Carolina that would eliminate state income tax on bonuses up to $2,500 and overtime pay. The benefit would be provided in the form of a deduction, according to the language of the bill.

The reasoning behind the legislation is that it would encourage employees to work extra shifts, and help employers fill vacant positions. Of course, if the reason someone isn’t working extra shifts is because of other responsibilities, such as caring for family members, pursuing an education, or engaging in community service, a tax break might not move the needle enough to change the person’s schedule.

Putting aside the question of whether this legislation would further the goals stated by the sponsors, it creates a new tax game. It would be rather easy for employees and employers to reduce compensation by $2,500 and replace it with a $2,500 bonus. That thought popped into my head several sentences into reading the article, and so I wasn’t surprised to read, deeper into the article, that Timothy Vermeer, a senior policy analyst with the Center for State Tax Policy at the Tax Foundation observed that “You might not see more productivity from certain professions, you may just see a shift of how they are compensated.” Indeed.

There may be less of a game to play with overtime pay, because the proposed legislation limits the tax break to “overtime compensation pursuant to sections 206 and 207 of the Fair Labor Standards Act.” Section 206 provides for a minimum wage, so it appears to me that no portion of the minimum wage compensation could be converted into overtime or bonus pay. Section 207 provides that overtime pay is required at not less than one and one-half times the regular pay rate if the employee is employed for more than a specified number of hours per week (which varies by industry). It is unclear to me if an employer can specify a lower number of hours as the threshold for overtime pay and thus shift some compensation into overtime pay classification. To avoid paying extra amounts the employer would need to do some computations to determine how many hours to shift.

This proposed legislation is yet another theory that, if enacted, will not work well when it encounters practical reality. There will be employees in a position to shift the classification of their compensation without adding shifts. As Vermeer noted, “There’s really not a good economic reason for treating those different classes of income differently.” And he noted that there are employees who not receive bonuses or overtime pay, and I wonder if in some instances the particular employment situation makes those types of pay either impossible or impractical.

I have no doubt that this legislation, if enacted, will simply create another tax game. It will be a game that is not needed and that would be harmful.

How to Tax Billionaires?

Reader Morris pointed me in the direction of Yahoo reprint of a Business Insider article that suggests treating loans taken out by the wealthy as realized income. The article points out that by borrowing on assets rather than selling them, the wealthy can extract cash without adverse income tax consequences. That conclusion is correct. The article contends that when assets “are used as collateral to draw a line of credit and avoid a taxable event, it creates immediate value for the owner.” This conclusion is incorrect. There is no increase in value when a taxpayer adds cash to the asset side of the balance sheet and an equivalent amount of debt to the liabilities side of the balance sheet. Income arises when a person is wealthier, and borrowing money does not make a person wealthier.

The key, though, is determining when to tax an increase in wealth. Existing tax law does not tax increases in asset value until that increase is “realized.” Under existing law, borrowing money while using the asset as collateral is not a realization event, whereas a sale of the asset is a realization event. Proposals to tax unrealized income, that is, the increase in asset value that isn’t taxed under current law, encounter objections because determining value can be difficult in some instances. On the other hand, because most lenders limit the amount of a collateralized loan to something less than the asset’s value, the act of borrowing money while using an asset as collateral can establish some amount of a minimum value.

Reader Morris asked me, “Does this article describe an easy way to tax billionaires that would actually work?” I doubt it. First, defining borrowing as a realization event could have unintended consequences. What if the borrowing is designed to raise cash to invest in the business rather than to support consumption? The article describes reducing consumption by the wealthy as one objective of reducing or eliminating the use of collateralized loans to generate untaxed cash flow. Second, finding an appropriate, justifiable, and fair way to spare the non-wealthy from being taxed when collateralizing assets to borrow money would be challenging. It not only requires deciding if wealth or income should be the measuring stick, but also determining where the cut-off should be. On top of that, how to treat taxpayers whose wealth or income fluctuates above and below the cut-off poses challenges. If this proposal were to be enacted and curtail borrowing by the wealthy, what would that do to credit markets and interest rates? Perhaps someone already is doing studies to determine the answer. But without assurance that the outcome would not have undesirable unintended consequences, taking this approach requires great caution.

Reader Morris also asked me, “Do you have an easy way or anyway to tax billionaires that would actually work?” I jokingly replied that perhaps it was a proposal I had seen, perhaps not intended as a joke, that the tax law should have a section that states, “You are now worth a billion dollars. You won! You have all you need. Any income over $20,000,000 a year will be taxed at 100 percent so others can enter the game.” Seriously, the easy way is to repeal the provisions that were enacted under the pretext of trickle-down, and to do so retroactively. One specific provision that has been in the tax law since the beginning that needs to be jettisoned is the allowance for depreciation deductions on property that is not depreciating in value, one of the major types of assets used to collateralize the sort of loans the Business Insider article wants to tax.

In Praise of the Mileage-Base Road Fee

John Tsitrian, whose commentary about road funding was the subject of my recent post, Using General Funds to Finance Transportation Infrastructure Not a Viable Solution, has written a reply. It appears that our disagreement rests on how the financial burden of maintaining and repairing highways, bridges, and tunnels should be apportioned.

Tsitrian and I agree on several basic underlying facts. First, the nation’s highway infrastructure is in bad shape and needs quite a bit of attention, ranging from inspection through repairs. Second, roads are important for society and the economy. Third, the increasing fuel efficiency of gasoline and diesel powered vehicles and the increasing shift to electric vehicles has been causing fuel tax revenues to decline. Fourth, fuel taxes are, as a practical matter, user fees even though called taxes. Fifth, the mileage-based road fee is a user fee. Sixth, the status quo, which I define as fuel taxes, is untenable.

Tsitrian thinks that using general funding rather than user fees would be “fairer and probably more economically beneficial way to spread the cost of our road system, which benefits everybody, regardless of how much they drive or even if they don’t drive at all.” Though it is true that the road system benefits everyone, or at least almost everyone save, maybe, for the hermits living off-grid, what also is true is the fact that people do not use the road system equally. Some people drive 3,000 miles a year and rarely order items online. Other people drive 15,000 miles a year and have online deliveries multiple times a week. Using general funds would apportion the cost, not in proportion to use, but in proportion to income, value of real property owned, or some other basis unrelated to road use. That is not fair. It would shift cost from heavy users to light users. Tsitrian admits as much when he contends that shifting to the use of general funds, which he agrees would simply replace fuel taxes with other taxes, would even out the tax burden among all taxpayers. But the fact that all, or almost all, taxpayers use the roads does not mean that they all should be charged the same amount, unless they all used the roads equally, which certainly is not the case.

The cost of paying for roads, whether through fuel taxes or a mileage-based road fee, ultimately falls on the user. A person who uses the road to go to the grocery store pays a fuel tax and would pay a mileage-based road fee, designed to cover the cost of the wear-and-tear that the person’s vehicle puts on the road. A delivery company that pays a fuel tax and that would pay a mileage-based road fee, which also would cover the cost of the wear-and-tear that the truck puts on the road, passes that cost either to the recipient (who might not own a vehicle or have a driver’s license) or to the shipper, who in turn would pass the cost along to the recipient customer. So, under the current system and under the mileage-based road fee, the ultimate cost indeed already falls upon the people and entities who are beneficiaries of road use. The key point is that the cost would be apportioned in a manner reflective of that use, which would not be the case if general funds were used.

Tsitrian opposes the mileage-based road fee because he thinks it “retains the untenable tax burden on drivers.” But as I point out in the preceding paragraph, that burden, as is the case with the fuel tax, would be based on to the ultimate beneficiaries of the road system, whether it is the driver enjoying a scenic ride or going to the store or the customer sitting at home getting package delivered by trucking companies and delivery vehicles. He notes the pilot program in the pending federal infrastructure legislation, which is far from the first pilot program for mileage-based road fees. Even though those state pilot programs have demonstrated the superiority of mileage-based road fees compared to fuel taxes, a federal pilot is necessary to answer logistical matters germane to the federal fuel taxes whereas the state pilot programs provided that information for particular state fuel taxes.

The mileage-based road fee** is much more fair that fuel taxes because it solves the existing problem of electric vehicle owners not paying fuel taxes, and paying little or nothing in terms of vehicle fees, thus shifting the cost onto users of non-electric vehicles. The mileage-based road fee is a user fee, but it ought not be condemned simply because the fuel tax, which is in effect a user fee, has become untenable.

Tsitrian continues to insist that, “Meantime, consumers would enjoy a bonanza of spendable income once they’re spared the onerous taxes they have to pay at the gas pump.” That simply isn’t the case. The fuel taxes would be replaced by increases in income, real property, sales, or other taxes. What would occur are two shifts. People who are relatively light users of roads would save what little they pay in fuel taxes and then face higher, perhaps much higher, other taxes, thus realizing a decrease in spendable income. On the other hand, people who are relatively heavy users of roads would save what they pay in fuel taxes and then face lower, perhaps much lower, other taxes, and they would realize an increase in spendable income. The increase and decrease would net to a wash. Total spendable income would not increase. It simply would cause disruptive shifts that would increase, rather than decrease, unfairness in road funding.

Tsitrian sets aside my concern that using general funds would “put road building in the crosshairs of political warfare.” He concedes it is possible but thinks that politicians would face backlash from individual and corporate interests. That might happen in a healthy political system but we don’t have a healthy political system. Corporate and individual backlash has not prevented government shutdowns. It has not prompted legislatures to act responsibly to fix potholes and deteriorating bridges afflicting individuals and businesses on a grand scale. The legions of vehicle owners paying for flat tires, wrecked suspensions, injuries, and deaths haven’t moved legislatures, so I doubt very much that a legislature proposing to cut road funding because the general fund is too low and the amounts in it are needed for other purposes will act responsibly and maintain road funding. The only corporate and individual backlashes to which legislators pay attention are those coming from their big donors.

The bottom line is that I don’t understand why drivers who use the road, including those who can pass the cost of using the road to customers, should be relieved of paying for the use of roads, with the burden being imposed disproportionately on all people no matter their relative use of the road. Liquor taxes are paid by those who purchase alcohol, and tobacco taxes are paid by those who purchase tobacco products. This reflects the matching of burden with the cost imposed on society. As an advocate of user fees generally, I stand in favor of repeal of fuel taxes and revenue replacement with mileage-based road fees. Will that happen? Time will tell us.

** For my other analyses of the mileage-based road fee, see Tax Meets Technology on the Road, Mileage-Based Road Fees, Again, Mileage-Based Road Fees, Yet Again, Change, Tax, Mileage-Based Road Fees, and Secrecy, Pennsylvania State Gasoline Tax Increase: The Last Hurrah?, Making Progress with Mileage-Based Road Fees, Mileage-Based Road Fees Gain More Traction, Looking More Closely at Mileage-Based Road Fees, The Mileage-Based Road Fee Lives On, Is the Mileage-Based Road Fee So Terrible?, Defending the Mileage-Based Road Fee, Liquid Fuels Tax Increases on the Table, Searching For What Already Has Been Found, Tax Style, Highways Are Not Free, Mileage-Based Road Fees: Privatization and Privacy, Is the Mileage-Based Road Fee a Threat to Privacy?, So Who Should Pay for Roads?, Between Theory and Reality is the (Tax) Test, Mileage-Based Road Fee Inching Ahead, Rebutting Arguments Against Mileage-Based Road Fees, On the Mileage-Based Road Fee Highway: Young at (Tax) Heart?, To Test The Mileage-Based Road Fee, There Needs to Be a Test, What Sort of Tax or Fee Will Hawaii Use to Fix Its Highways?, And Now It’s California Facing the Road Funding Tax Issues, If Users Don’t Pay, Who Should?, Taking Responsibility for Funding Highways, Should Tax Increases Reflect Populist Sentiment?, When It Comes to the Mileage-Based Road Fee, Try It, You’ll Like It, Mileage-Based Road Fees: A Positive Trend?, Understanding the Mileage-Based Road Fee, Tax Opposition: A Costly Road to Follow, Progress on the Mileage-Based Road Fee Front?, Mileage-Based Road Fee Enters Illinois Gubernatorial Campaign, Is a User-Fee-Based System Incompatible With Progressive Income Taxation?. Will Private Ownership of Public Necessities Work?, Revenue Problems With A User Fee Solution Crying for Attention, Plans for Mileage-Based Road Fees Continue to Grow, Getting Technical With the Mileage-Based Road Fee, Once Again, Rebutting Arguments Against Mileage-Based Road Fees, Getting to the Mileage-Based Road Fee in Tiny Steps, Proposal for a Tyre Tax to Replace Fuel Taxes Needs to be Deflated, A Much Bigger Forward-Moving Step for the Mileage-Based Road Fee, Another Example of a Problem That the Mileage-Based Road Fee Can Solve, Some Observations on Recent Articles Addressing the Mileage-Based Road Fee, Mileage-Based Road Fee Meets Interstate Travel, If Not a Gasoline Tax, and Not a Mileage-Based Road Fee, Then What?>, Try It, You Might Like It (The Mileage-Based Road Fee, That Is) , The Mileage-Based Road Fee Is Superior to This Proposed “Commercial Activity Surcharge”, The Mileage-Based Road Fee Is Also Superior to This Proposed “Package Tax” or “Package Fee”, and Why Delay A Mileage-Based Road Fee Until Existing Fuel Tax Amounts Are Posted at Fuel Pumps?.

Words Matter: The Tax Treatment of Legal Malpractice Awards

A recent Tax Court case, Holliday v. Comr., T.C. Memo 2021-69 [to see the full opinion, go to the case docket, scroll down to item 36, and click on that link], addressed the tax treatment of a legal malpractice award. In March 2010, the taxpayer’s then husband filed for divorce. The taxpayer retained J. Beverly as her attorney, and after she and the attorney engaged in mediation, she executed a settlement agreement. She objected to the agreement, though it is not clear why she objected to an agreement to which she had agreed and which she had signed. In April 2012, the divorce court entered the decree of divorce. The next month, Beverly filed a motion for a new trial, alleging that the taxpayer received $74,864 less than her equal share of the community estate. That motion was denied. Beverly told the taxpayer he would appeal, but he did not do so.

So in October 2013, the petitioner filed a malpractice lawsuit against Beverly, claiming that his representation constituted negligence and gross negligence and that he breached the duty of fair dealing and his fiduciary duties “by influencing * * * [her] to mediate and enter into a transaction that was not fair to * * * [her] under the circumstances” and by not pursuing an appeal. Later, she amended the malpractice petition to add claims for deceptive trade practices, treble damages, and attorney’s fees. She sought damages for “pecuniary and compensatory losses”, including “damages for past and future mental anguish, suffering, stress, anxiety, humiliation, and loss of ability to enjoy life”, as well as punitive damages and disgorgement of the attorney’s fees she paid in the divorce proceeding, resulting from the malpractice defendants’ conduct. In October 2014 Beverly and the taxpayer entered into a settlement agreement that stated, “while there remain significant disagreements as to the merit of the claims and allegations asserted by the Parties to this lawsuit, the Parties have agreed to compromise and settle such claims and allegations, without any admission of fault or liability on the part of any party.” Beverly and his firm agreed to pay $175,000 to the taxpayer “[i]n consideration for the mutual promises and obligations set forth in this Release”. The parties released each other from all claims related to the malpractice lawsuit “in exchange for the * * * [settlement proceeds]”. All claims included those “of whatever kind or character, known or unknown * * * which * * * [petitioner] may have against * * * [malpractice defendants] arising out of or related to the * * * [malpractice lawsuit].” Beverly and his firm did not admit liability or fault in the settlement agreement, and the parties did not allocate any of the settlement proceeds toward any particular claim or type of damages. The taxpayer received the settlement proceeds of $175,000, from which she paid her malpractice attorney’s $73,500 fee through direct payment to the attorney by the defendants so that she received a check for $101,500.

On her 2014 Form 1040, the taxpayer reported other income of zero, and she acknowledged the receipt of $101,500 through an attached Form 1099-MISC Summary and a “Line 21 Statement” on which she reported “Other Income from Box 3 of 1099-Misc” of $101,500. The Line 21 Statement also subtracted $101,500 with the description “Misclassification of Lawsuit recovery of marital assets”, resulting in total other income of zero. The IRS issued a notice of deficiency, determining that the $101,500 should be included in gross income. After the taxpayer filed her petition in the Tax Court, the IRS reviewed the settlement agreement and amended its answer to also include in the taxpayer’s gross income the $73,500 of her settlement proceeds that were paid to her malpractice attorney.

The taxpayer argued that the settlement proceeds were a nontaxable return of capital because they compensated her for the portion of her marital estate that she “was rightfully and legally entitled to, but did not receive, due to the legal malpractice of * * * [her divorce attorney].” The IRS argued that the settlement proceeds are taxable income because they compensated the taxpayer for the alleged failings of her divorce attorney and are not excluded from gross income. The taxpayer did not make any arguments based on section 104(a), dealing with compensation for personal injury, or section 1041, dealing with transfers of property between spouses incident to divorce.

The court first noted that settled case law provides that “when a litigant’s recovery constitutes income, the litigant’s income includes the portion of the recovery paid to the attorney as a contingent fee.” It also noted that under settled case law “recovery of capital is not income.” It then explained that whether a payment received in settlement of a claim represents a recovery of capital depends on the nature of the claims that were the basis for the settlement. The question to be decided is, “[I]n lieu of what was the . . . settlement awarded?” The answer is a question of fact, and finding the answer requires looking at the language of he agreement for indicia of purpose, focusing on the origin and characteristics of the claims settled in the agreement. Turning to the agreement in question, the court determined that it made clear that the settlement proceeds were in lieu of damages for legal malpractice. The text of the agreement stated that its purpose was “to compromise and settle * * * [taxpayer’s] claims and allegations” against malpractice defendants and that payment “in exchange for” release of claims related to the taxpayer’s lawsuit against the malpractice defendants.

The court rejected the taxpayer’s argument that the settlement proceeds were only for those claims that involved the marital estate and that they represented compensation for lost value or capital because they “are based on her recovery of the property interest that * * * [she] rightfully should have received from her divorce as her share of the marital estate.” The court rejected this argument because the settlement agreement stated that the settlement proceeds were for the release of “all claims * * * of whatever kind or character, known or unknown * * * which * * * [the taxpayer] may have against * * * [malpractice defendants] arising out of or related to the * * * [malpractice lawsuit].” The court treated the taxpayer asking the court “to look through the settlement agreement and consider only her claims related to recovery of marital property,” but the court refused to look past “the plain terms of the settlement agreement,” instead concluding that the settlement proceeds were to compensate the taxpayer for her attorney’s malpractice. Accordingly, the settlement proceeds must be included in gross income.

The court pointed out that it had “recently rejected a similar attempt to recharacterize the settlement of a legal malpractice claim arising from a personal injury lawsuit,” citing Blum v. Comr., T.C. Memo. 2021-18. In that case, the taxpayer filed a malpractice claim against her personal injury attorney, resulting in a settlement payment from the personal injury attorney. She asserted that the settlement payment represented a return of capital “in that it compensated her for a loss that she suffered because of the erroneous advice of her lawyers, viz, the nontaxable amount she would have received had she prevailed in her personal injury lawsuit.” The court in Blum focused on the language of the settlement agreement, which specified that it was entered into “for the purpose of compromising and settling the disputes”, and concluded that the settlement payment was not a return of capital to the taxpayer but rather to compensate her “for distinct failings by her former lawyers.”

The court also noted that even if the taxpayer had convinced it that some of the settlement proceeds were meant to replace her purported loss of marital property and that the loss was a nontaxable recovery of capital, she failed to provide a basis on which the settlement proceeds could be allocated between that hypothetically nontaxable recovery and other taxable amounts. The settlement agreement did not allocate any of the settlement proceeds toward any of the various claims or types of damages. According to the court, to the extent the proceeds included amounts representing interest, that portion could not be excluded from gross income in any event.

Though as Robert Wood pointed out earlier this year in Does IRS Tax Legal Malpractice Settlements? that there is “surprisingly little authority” to help drafters of settlement agreements “predict the tax treatment of legal malpractice recoveries,” the Holliday case and the Blum case that it cites teach and reinforce the lesson that the language of the settlement agreement is critical to the tax treatment of the settlement proceeds. I have written about the necessity for careful drafting, and the adverse impact of imprecise drafting, in posts such as Taxing Damages, In Tax, As in Much Else, Precision Matters, Contracting a Tax Outcome, and Looking for an Exclusion That’s Not in the Documentation.

It is understandable why the defendants in the litigation want the settlement agreement to cover all claims including those “of whatever kind or character, known or unknown * * * which * * * [petitioner] may have against * * * [malpractice defendants] arising out of or related to the * * * [malpractice lawsuit].” But that language in and of itself is not the problem. It’s the lack of additional language that allocates a specific portion of the settlement proceeds in this case to the taxpayer’s recovery of the amount that she would have received for her share of marital property had the divorce settlement agreement been drafted differently. It is the lack of that language that forced the Tax Court to conclude that no part of the settlement proceeds had been proven to be for return of capital and that, even if that had been proven, no part of the agreement provided sufficient specificity for allocating a specific dollar amount to what would have been excluded from gross income. As so often is the case, words, or the lack of them, matter.

The Tax Gap, Like Greed, Is on Steroids

Perhaps people were surprised or even shocked when various reports, including this Reuters article, shared the testimony of the IRS Commissioner given to the Senate Finance Committee that the tax gap approaches and possible exceeds $1 trillion annually, a substantial increase since the last official estimates in 2011 through 2013 of a $441 billion annual shortfall.

The tax gap is the difference between what taxpayers should be paying if they were in full compliance with the tax law and successful in avoiding mistakes and what taxpayers actually pay in taxes. Note that the tax gap in question is the federal income tax gap, and surely states, especially those whose tax liability computations start with federal gross, adjusted gross, or taxable income, have their own income tax gaps.

I was not surprised by the Commissioner’s testimony. In , Tax Gap Becoming a Tax Chasm, I noted that “The tax gap for calendar year 2003, the latest year for which sufficient statistical information is currently available, is $1.0417 trillion.” My guess is that the tax gap in 2018, 2019, and 2020 probably exceeds not only $1 trillion but $1.5 trillion. What does surprise me is the willingness with which authorities accept the low figures reported by the IRS. For example, in Closing the Federal Tax Gap , I noted that in 2006, three years after the Bureau of Economic Analysis had computed the $1 trillion figure, the National Taxpayer Advocate issued a report pegging the annual tax gap as “somewhere between $250 to $300 billion.” I suppose the IRS is caught between a rock and a hard place. It could report the higher number in an effort to encourage Congress to stop cutting its budget and restore its ability to ramp up audits and foster compliance. But reporting that higher number poses the risk that Congress and others would judge the IRS as unworthy of any funding by treating it as the cause of the tax gap.

Much paper, ink, and digital bytes have been dedicated to discussion of the tax gap and proposals for dealing with it. I have no intention of trying to write a treatise about the tax gap. I simply will review some of the things I have written about it over the years. In Tax Gap Becoming a Tax Chasm, I noted:

One must wonder what motivates noncompliance. Perhaps some psychologists will conduct surveys to determine if it simply greed, or a growing rebellion in which people are "voting with their feet" by appropriating unto themselves their own special tax break that they cannot get through the Congress because they lack the clout of the lobbyists who have managed to reduce the tax on capital gains to extremely low levels. How much of the noncompliance is simple ignorance, stupidity, carelessness, or confusion? How much of the gap arises from people trying to hide information about the activities generating the income?

Some people may not realize they are contributing to the tax gap, because they are making good faith efforts to comply with an absurdly and unjustifiably complex income tax system. Others know full well what they are doing when they engage in "pay cash, pay less" schemes, launder money, or simply fail to file. I suppose this reflects our culture, for surely it resembles what one finds on our highways: drivers who try to comply and succeed, drivers who are ignorant, stupid, careless and confused, and drivers who think they are so much more important than or better than everyone else that they flaunt whatever rules get in the way of their own self-centered approach to life.

A fun calculation is to determine how much tax has not been paid on the tax gaps for 2002, 2001, 2000, and earlier years, add interest and penalties, and imagine what happens if Treasury had the ability to collect the total amount due. The shock to the world economy might be staggering. We'll never know, because Treasury lacks the ability to collect even a minute fraction of this amount. Why? Because Congress has not implemented a system that ensures all taxpayers pay their fair shares.

Until Congress does two things, the tax gap will continue to grow, and the ultimate outcome might be far worse than the impact of quadrupled prices for oil and gas, shortages of concrete, or devastating hurricanes. Congress must reform the income tax system so that it is easy to understand, inviting of compliance, and difficult to evade. Congress must also put in place safeguards that prevent noncompliance and punish tax evaders. Ideally, a well-designed system that prevents tax evasion will reduce the number of tax evaders and thus reduce the need for prosecution of tax evaders. Law enforcement could then redirect more resources to the prevention of, and prosecution of, other crimes.

In Closing the Federal Tax Gap, I shared these thoughts:

The tax gap fascinates me and frustrates me. * * * I'm both fascinated and frustrated by the willingness of people to avoid their legal responsibilities. Of course, that fascination and frustration is not limited to tax avoidance devotees but also the behavior of those who violate a variety of rules and regulations.

* * * * *

[The National Taxpayer Advocate’s] report points out that when taxable transactions are properly reported to the IRS, the rate of tax collection exceeds 90 percent, but when payments are not reported compliance drops to a range of 20 to 68 percent, depending on the type of transaction. Sometimes reporting does not occur because people are noncompliant. Sometimes reporting does not occur because it is not required. * * *

[The National Taxpayer Advocate] recommends expanding the list of transactions that must be reported. This is the sort of suggestion that makes one wonder why it wasn't done decades ago. The answer is easy. As [the National Taxpayer Advocate] points out, tax revenues would climb if every taxable transaction was subject to reporting requirements. That, however, would be an onerous burden. * * *

I add that compliance is enhanced when withholding takes place, because withholding shifts the tax payment and not just information to the Treasury.

A year later, in Closing the Tax Gap Requires Congressional Introspection, I described a GAO report, "TAX COMPLIANCE Multiple Approaches Are Needed to Reduce the Tax Gap." I described the report thusly:

The report concludes that the tax gap "has multiple causes and spans different types of taxes and taxpayers." Accordingly, "Multiple approaches are needed to reduce the tax gap. No single approach is likely to fully and cost-effectively address noncompliance since, for example, it has multiple causes and spans different types of taxes and taxpayers."

Three major approaches are considered:

1. Simplifying or reforming the tax code.

2. Providing the IRS with more enforcement tools.

3. Devoting additional resources to enforcement. Minor approaches include "periodically measuring noncompliance and its causes, setting tax gap reduction goals, evaluating the results of any initiatives to reduce the tax gap, optimizing the allocation of IRS’s resources, and leveraging technology to enhance IRS’s efficiency."

The report points out that billions of dollars of the tax gap could be avoided if the tax law were simplified or fundamentally reformed. It explains, for example, that the IRS "has estimated that errors in claiming tax credits and deductions for tax year 2001 contributed $32 billion to the tax gap."

Unfortunately, the report then concludes that "these provisions serve purposes Congress has judged to be important and eliminating or consolidating them could be complicated." Even fundamental reform, in which tax preferences are limited and "taxable transactions are transparent to tax administrators," is "difficult to achieve." The report provides an almost irrefutable axiom, that "any tax system could be subject to noncompliance." Finally, it provides another difficult-to-rebut observation: "Withholding and information reporting are particularly powerful tools."

I criticized the report because it presupposed Congress as a whole does not even know what is in the tax law though some individual members are aware of whatever provision they championed. I also questioned why members of Congress caved in to the lobbyists whose clients oppose the expansion of reporting and withholding and who misrepresented attempts to increase withholding by falsely describing the effort as a “new tax.” I then explained:

Left to instinct, most people would prefer to pay no taxes, and exist as beneficiaries of others. History teaches that most of those who can grab have done so, and that many who could not exerted themselves to find ways to do so. The tax gap is a reflection of some unintentional errors and lots of intentional evasion. Careful intellectual reasoning, though, teaches us that civilization requires taxation, economic principles tell us that taxation should be efficient, common sense tells us it should be simple, and ethical principles tell us that it should be fair. It takes leadership to persuade the civilized world why it makes no sense, in the long-run, to behave in ways that generate tax gaps. Fraudulent behavior by taxpayers contributes to the tax gap. So, too, does the way in which Congress does business. Ought not the Congress take the first step in leading by example? Until the Congress understands that the way it does business encourages the non-filers, the protesters, the illegal tax shelter promoters, and the rest of the noncompliant population to act in ways that undermine the tax law and fuel the rapid growth in the tax gap, talking about closing the tax gap is not much more than rhetoric. Yes, I talk and write about it, but I've not undertaken the responsibility that members of Congress have sought and accepted. If they don't think they can or want to fix the problem, no one will stop them from returning home.

Shortly after I wrote those words, I received a letter from Senator Max Baucus, chairman of the Senate Finance Committee, and Senator Charles E. Grassley, ranking member of that committee, in which they asked for "suggestions on ways to improve compliance with our tax laws, including specific recommendations to reduce the tax gap." I described my response in Congress Invites My Ideas for Improving Tax Compliance and Of Course I Respond, and I included in that posting a copy of the letter I sent to the Congress. I do not republish it today because a quick click on the preceding link should suffice. In summary, I pointed out that a six-prong approach is required, namely, making tax education a part of high school curricula, simplifying the tax law, increasing reporting, expanding withholding, funding increased and improved audits, and strengthening the ability of the Department of Justice to prosecute tax crimes. I closed that day’s post by telling readers “I will let you know if I receive a response.” I did not. I did not receive a direct response. Nor have I seen the Congress respond by taking steps to deal with a rapidly ballooning tax gap.

Almost a decade later, in Tax Compliance and Non-Compliance: Identifying the Factors, I reacted to yet another report from the Taxpayer Advocate. The report focused on characteristics of so-called high-compliance and low-compliance taxpayers. I noted:

Some of the findings are not surprising. According to the survey underlying the report, high-compliance taxpayers are more trustful of government, appear to be more intent on minimizing mistakes on their tax returns, viewed government positively, are more likely to rely on tax return preparers, and were motivated by moral concerns and deterrence. Low-compliance taxpayers are less trustful of preparers, are less likely to follow a preparer’s advice when using a preparer, tend to think that other taxpayers have negative views of law and the IRS, are suspicious of the tax system, and are more likely to consider the tax system unfair. All taxpayers viewed the tax law as complicated.

Other findings struck me as unexpected. Low-compliance taxpayers are “more likely to participate in local organizations.” They also asserted that they had a moral duty to report income accurately. Non-compliance is higher among sole proprietors of construction companies and real estate rental firms than sole proprietors of other types of businesses.

Though the IRS explains that geographic location is not a factor in selecting returns for audit, the survey results revealed that low-compliance taxpayers were clustered in specific areas. Towns and neighborhoods near San Francisco, Houston, Atlanta, and the District of Columbia, including Beverly Hills, California, Newport Beach, California, New Carrollton, Maryland, and College Park, Georgia, were among 350 communities in which low compliance taxpayers were clustered. In contrast, very few of the 350 communities were in the Midwest or Northeast. What about high-compliance taxpayers? The top of the list consisted of the Aleutian Islands, West Somerville, Massachusetts, Portersville, Indiana, and Mott Haven, a neighborhood in the Bronx.

It did not take long for stories about the Taxpayer Advocate’s report to focus on the nature of the identified communities. For example, an MSN report noted that the low-compliance clusters were in very wealthy neighborhoods. A Yahoo news story put the conclusion in its headline, “IRS Report Shows Many of Biggest Tax Cheaters Live in Wealthy Areas.”

The Taxpayer Advocate report does not disclose whether the low-compliance taxpayers in these clusters were high-income individuals, but it is safe to assume that at least a significant number of them were. Yet what sort of conclusions can be drawn? Is it possible that most low-income taxpayers are not low-compliance taxpayers because they don’t have much income to begin with, and thus no income to hide? Is it possible that because most low and middle income taxpayers realize most of their income from wages subject to tax withholding they have far fewer opportunities to cheat on their taxes? It would not surprise me to discover that someone will argue that the wealthy do cheat more, but would reduce their cheating if their tax rates were lowered. As logical as that proposition might sound, to the extent that greed and money addiction energize every sort of tax reduction attempt, whether lobbying for special breaks and low rates or taking the cheater’s route, it is unlikely that anything other than a zero percent tax rate will satisfy these folks, and even that probably is not enough.

And then, again almost a decade later, I drew attention to a major cause of the tax gap. In Tax Noncompliance: Greed on Steroids, I described the news revealed in a report by the Treasury Inspector General for Tax Administration issued a report, High-Income Nonfilers Owing Billions of Dollars Are Not Being Worked by the Internal Revenue Service:

The news is bad.

After pointing out that the tax gap – the shortfall between what the law requires taxpayers to pay and what taxpayers are in fact paying – is estimated to be $441 billion for 2011, 2012, and 2013, the report reveals that $39 billion is due from taxpayers who fail to file tax returns. Most of this shortfall is attributable to “high-income nonfilers.” The Inspector General determined that although the IRS is developing a new approach to dealing with nonfilers, it has not yet implemented that approach, and when implemented, it will be “spread across multiple functions with no one area being primarily responsible for oversight.”

Worse, the Inspector General determined that for taxable years 2014 through 2016, 879,415 high-income nonfilers failed to pay roughly $45.7 billion in taxes. Of those 879,415 high-income nonfilers, the IRS did not pursue 369,180 of them, accounting for an estimated $20.8 billion in unpaid taxes. Of the 369,180 were not put into the queue for pursuit of the unpaid taxes and the cases for 42,601 were closed without further action. The other 510,235 of the 879,415 high-income nonfilers “are sitting in one of the Collection function’s inventory streams and will likely not be pursued as resources decline.”

Even worse, because the IRS works on each tax year separately rather than combining cases when a taxpayer fails to file for more than one year, it “is missing out on opportunities to bring repeat high-income nonfilers back into compliance.” Of these high-income nonfilers for 2014 through 2016 that the IRS failed to address or resolved, the top 100 owed an estimated $10 billion in unpaid taxes. The Inspector General has proposed seven changes to deal with these problems, but the IRS agreed in full only to two of them, partially agreed with four, and disagreed with one. The IRS objected to putting the nonfiler program under its own management structure.

Here and there a failure to file arises from an understandable problem, such as a taxpayer falling ill without anyone realizing it in time, or developing dementia or similar mental impairments. Sometimes the failure to file arises from financial setbacks for taxpayers who don’t realize that in those situations it is best to file and indicate the inability to pay. Some instances of failure to file are expressions of principled protest against specific government policies. A significant portion reflect a deep greed rooted in a taxpayer’s perception that they have no obligation to contribute to society, with the failure to file and pay almost always defended as a justified expression of the taxpayer’s anti-tax philosopy.

Is it any wonder that so many people are enraged? Though there are many ingredients fueling social unrest, an important one is the growing sense among Americans that they are fools for complying with tax laws when “high income nonfilers” are “getting away with it.” Would it be a surprise if more taxpayers choose not to file, knowing that the IRS lacks the resources to chase them down? This sort of mob mentality is no less likely to spread among taxpayers as it can spread among crowds encouraged to break other laws.

Though it is easy to suggest that Congress needs to wake up and provide sufficient funding to the IRS, especially because every dollar invested returns roughly seven, but the Congress is incapable of doing this. Enough of It is controlled by the anti-tax, anti-government crowd that it lacks the ability to do what needs to be done. Until the makeup of the Congress changes, the tax gap will persist and even increase, adding to the growing deficit that threatens to cause havoc more catastrophic than what currently afflicts the nation. The greed that is fueling the income and wealth inequality contributing to so many of the nation’s problems is growing as though on steroids, and needs to be neutralized expeditiously.

We are at a tax system breaking point. We are here because the worst offenders have persuaded the non-offenders and the minor offenders that any effort to put an end to the shenanigans of the worst offenders will produce the most harm for the non-offenders and the minor offenders. Here is a helpful analogy. Underfunded highway troopers driving vehicles that are too slow to catch the “rocket ship” drivers instead focus on the speeders who are 5, 10, or 15 miles per hour over the limit. When a proposal is made to purchase high-end chase cars for the troopers so that they can catch, ticket, and even arrest the worst speeders, the lobbyists for those “entitled to speed without restriction because of freedom, freedom, freedom” characters persuade the majority of drivers, who are either not speeding or speeding just somewhat, that the proposal will cause the authorities to arrest the compliant drivers and confiscate their vehicles. What’s evil is the lobbying message. What’s sad is the fact that it works way too often. It is time to stop worrying about the specks and to start dealing with the logs.

The Shock and Reality of Real Property Tax Reassessments

Last September, in Just Because A Tax Involves Arithmetic Does Not Mean It Resembles Quantum Physics, I explained that when a jurisdiction, in that instance Delaware County, Pennsylvania, conducts a reassessment of real property subject to the real property tax, some property owners will see their real property taxes go up, some will see their real property taxes go down, and a few will see no change, or close to no change, in their real property tax bill.

The reassessment conducted in 2020 by Delaware County involved two steps. The first was redetermining the fair market value of each property, a process that included proposed valuations and the opportunity to appeal. The second was redetermining the tax rate so that the total revenue raised by the reassessment could not change. That was separate and apart from any annual increase in the rate, to be determined after the reassessment computation was complete.

The reassessment was ordered by the Delaware County Court of Common Pleas, following a Pennsylvania Supreme Court decision that addressed challenges to the county’s existing assessments and its appeals process. State law requires that taxation be uniform, but that requires reassessing all properties to make certain that the rate of tax applied to properties is the same. That doesn’t happen when one property is assessed at fair market value and another is assessed at the assessed value determined at some previous time. This situation arose because many properties were reassessed only when they were sold. This meant that properties that had been owned by the same person or entity for many years was assessed much more below market value.

Last Thursday, in a letter to the editor of the Philadelphia Inquirer, C. Tom Howes of Havertown complained about the county tax reassessment. There is no link to the letter because the Inquirer apparently no longer publishes on its web site the letters published in its print version, other than the replica edition on the web site that does not permit links to individual articles, letters, or other material.

Howes writes, “While our eyes have been nervously awaiting possible tax increases from Washington and Harrisburg, it turns out that our local Delaware County politicians have managed to pull the wool over our eyes and extracted the green from our purses. Their secret was a 2020 tax reassessment of county properties under the guise of more realistic values with equity and fairness.”

What Howes omits is that the reassessment was required by the Pennsylvania Supreme Court, as applied to Delaware County by the Delaware County Court of Common Please, in compliance with the Pennsylvania Constitution and Pennsylvania law. It was not ordered by, imposed by, or invented by “local Delaware County politicians.” In fact, reassessments have been undertake and are underway in other Pennsylvania counties.

Howes continues, “When they announced this action, they tried to soften the impact by claiming that any increases would be limited by law to 10%. However, as a taxpayer, I was shocked and disappointed when receiving the 2021 tax bills to find those increases failed to follow those assurances. For examples, township taxes have increased by 15.86% while the real estate taxes went up by a whopping 32.31%.”

Howes is conflating two issues. As I described, tax rates would be adjusted so that the reassessment did not change the total revenue raised by the tax. Once that step was taken, as I described, taxing jurisdictions had the option to increase the tax rate just as they had the option to raise rates in previous years. However, this rate increase was limited to no more than 10 percent. The 10 percent limitation has nothing to do with the changes in tax bills generated by the reassessment.

The percentage increases cited by Howes are a consequence of the reassessment. Haverford Township, in which Havertown is located, did not increase its tax rate for 2021, as described in this story. Nor did Delaware County increase its real property tax rate, as described in this report, which presumably is the tax described by Howes as “real estate taxes,” a term that includes the township tax that he mentions, as well as the school district tax though those tax bills are not sent until late spring or early summer. Thus, the increases facing Howes are a consequence of his property being under-assessed relative to other properties.

According to the $165,000 assessment on the property had not been increased since sometime before 2000. According to the Delaware County Treasurer, the reassessment has increased the assessment from $165,000 to $397,560. That’s quite a jump and certain accounts for the percentage increases Howes mentions. Though it is understandable that these sorts of increases are shocking, it’s also important to understand that for at least 21 years the property assessment did not increase to reflect fair market value, whereas the assessments on properties purchased during that time did reflect the purchase price, thus creating the lack of uniformity required by Pennsylvania law. So when Howes concludes by asking, “Is this the politicians interpretation of equity and fairness?” the answer is, “It is equity and fairness as required by Pennsylvania law and enforced by Pennsylvania courts."