Gasoline Prices: Not the Only Thing on the Increase

My recent post about gasoline price increases brough not only a response from one of my students, Nakul Krishnakumar, posted here, but also a response to that exchange by another student, Anand Dash, with whom I had this dialogue:

Regarding your Blog article from March 23 on Gasoline Prices and solutions and my friend Nakul's response:

I will begin by saying that because of my lack of thorough knowledge and information on gasoline taxes and how they would affect consumption, I do not propose a tax related solution to the current high gas prices. But regarding your comment that we are "oversensitive and insufficiently illogical when it comes to the environment", I respectfully disagree.

First, specifically, as to drilling in the ANWR, I understand after speaking to Prof. Dellapenna that many of the major oil digging companies have refused to accept drilling contracts because the amount of oil that could be extracted is simply not worth their time and investment.

But more importantly even if there was a large amount of oil to be found there, I still cannot see how we could justify digging in the ANWR. My reason is that say that we do dig and in the process we get enough oil for the time being to lessen our dependence on foreign sources and thereby ultimately reduce the gas prices. But in the meantime we have destroyed the natural habitats of animals native to the area and moreover left the place as an eyesore. But the oil that we take from the ANWR is only so limited that it will eventually run out, i.e. oil is a finite natural resource. And when it runs out, we will have left parts of the ANWR as a waste land and the problem of oil supply and high prices will resume.

As to being oversensitive about the environment and against anti-roads bans, I can only pray that you really don't mean that:
Last summer I took a solo road trip to Baxter State Park in the remote mountains of Maine, and I remember distinctly asking myself after being just overwhelmed by the smell of pine trees, the immense beauty of the mountains, and the single lonely dirt road running through the remote wilderness area, how can anyone who has ever truly experienced the wonders of nature think to take a metal chain saw and massacre one of the greatest gifts that God has given us: Natural beauty and a wilderness that is a sanctuary from our technology-driven and hectic lives. Personally, if ultimately I couldn't afford to pay the gas prices I would walk or ride a bike to school or the store or where ever I needed to go, rather than see the natural wonders of the Earth destroyed.

I admit that in posting these lines, I have not fully thought through many of the logical consequences of my plea and of course of the well crafted and well-argued counter responses that may follow by you...

And I admit that this posting may come across as being sentimental, but if you have ever experienced the indescribable feelings that I did in Maine in your own travels, whether in Europe or in the States, I hope that you will see that my feelings are genuine and that we can never be too oversensitive when we only have one Earth. I think we would be insulting the intelligence of human beings if we are to say that in light of our material needs we have no solution but to demolish and destruct the true and natural beauty of our Home.

Anand raised some important concerns, and prompted me to think about how I had articulated my views. To that end I replied:

Anand,

I do think too many environmentalists get carried away. I have been a conservationist since I was a child. I enjoy the outdoors and I object to unmanaged sprawl or the building of resorts in remote wilderness areas. What's being done to the Amazon rain forest is horrible.

Yet it is embarrassing to watch opposition to dam construction because of a fish (snail darter) that turns out not to exist in the river in question. Or to watch a highway reduced to 2 lanes each way to appease anti-highway forces (some of whom proudly announce their use of the highway), only to see traffic sit and spew pollution and gobble gasoline because the highway capacity is outdated before it is built.

As for ANWR, I like the idea of leaving it alone until everyone else runs out of oil. But I don't think that doing work on a hundred acres of a million acre area is going to be a problem. The same fears were expressed with respect to the pipeline, and yet it turned out to be an environmental plus. The notion that drilling would create a wasteland isn't supported by experience or the facts.

The real problem is something people don't want to discuss. It's overpopulation. At 6.5 billion, and growing, overpopulation threatens every single resouce. Long before the forests are gone, we will run out of fresh water. Long before the oil is gone, we will run out of food. A report issued last week by a panel of experts maps out the resource problem. Almost every environmental problem (and some others, such as urban decay, violence, and war) can be traced to overpopulation. Yet attempts to have intellectual analysis override emotional reaction fail time and again. There are people who claim the planet can support 10 or 15 billion people (the estimated population by mid century), yet even at 6.5 billion there are shortages of steel, lumber, oil, concrete, fresh water, medical services, and all other sorts of things. No home, even a mansion, can remain beautiful if 750 people are living in a 12,000 square foot palace.

* * * * *

Thanks for writing.

Anand in turn followed up on my comments:

Perhaps unlike a good lawyer, I have no rejoinder but to honestly say that I fully agree with you that many environmentalists do get carried away and that population certainly is a major and most critical issue.

The population issue especially strikes a chord with me because somewhat unrelatedly, I believe population also to be the single greatest impediment to the societal and environmental progress of my parents's homeland, India. In India, the country has most of the modern comforts and amenities in their big cities as we have in ours, their computer and software technology as you may know is equal if not superior in many respects to the States, and they are a strong and stable democracy. Sadly, however, it is primarily their population that is severely holding them back in almost every aspect of conservation, development and progress. India's population I believe will soon surpass China's because of the fact that as a democracy India is not currently able to limit the births per family.

One further note on the population issue is that I had a professor at William and Mary who posed a question as to whether human beings should be viewed strictly like any other species of animals who are susceptible to the natural law of survival. And following this premise, if eventually the human population vastly exceeds food supply and natural resources, should the strong and fittest of the population in order to stablize the population "squeeze" out the weak, as would occur in the animal kingdom? Clearly, I recognize that there are basic moral and ethical issues involved, but from a purely biological and scientific viewpoint, perhaps the theory makes sense and may turn out to be the only solution to a overcrowded world with finite resources. But in light of the Schiavo case, and with all due respect and sympathy, I imagine that there would be critics who would jump all over this natural law theory as applied to human beings.

Thank you for taking the time to respond. * * * * *

The population issue is not going to go away. It will move to the forefront. It will get more attention not only on account of end-of-life issues such as those currently making headlines but also on account of beginning-of-life issues that will get increasing attention as medical and scientific developments present even more challenges to each and every person on the planet. Whether the population issue takes center stage because of conferences, articles, discussions, and legislative debate, or whether it takes center stage because it triggers the sorts of problems that are percolating under the surface (wars, violence, crime, and economic disorder) is a question that will be determined by the decisions each person makes. From the perspective of tax policy, which cannot avoid entanglement with environmental issues, population is an ingredient in the analysis that often gets taken for granted. Will the connection between tax law and population also move into the spotlight? We will see.

Another Setback for the Telecommuting Nonresident Taxpayer

Back in January I shared my analysis of a case involving New York's insistence on taxing a Tennessee resident, who is not a New York resident, on the income he earns in Tennessee doing computer work for a New York organization. He lost at the trial court level. He appealed.

Now comes news that by a 4-3 vote the New York Court of Appeals has rejected the taxpayer's appeal. The taxpayer's attorney is considering taking the case to the Supreme Court.

I hope they decide to do that, and I hope the Supreme Court gets it right.

After all, the taxpayer spends 25% of his time in New York, so it's tough to argue with New York taxing 25% of his income. But, no, New York wants to tax all of it. The Court of Appeals noted that perhaps if the taxpayer spent 1% of his time in New York, a tax on 100% of his income would be disproportionate but a 100% tax on someone spending 25% of their work time in New York isn't. Excuse me, did anyone study arithmetic? OK, maybe I can be sold the idea of 100% taxation when the time spent in New York is 99% or even 95% (though there's no reason not to multiply the total income by 99% or 95%). But 25% is NOT proportionate to 100%. Not on this planet.

The fact that most states do the right thing and apportion should be even more proof that New York is out of line. It's tough to give up that $100 million annual revenue stream, especially for a state that is so addicted to collecting and spending money. Money from people who do not vote in New York, who impose far less burden on New York services than do New York residents, and who might begin pressuring businesses to move their operations to other states. Finding a state with open arms of welcome will not be difficult for businesses who want out of the tax revenue siphon.

When New York argued that it had a right to tax 100% of the employee's income because the employer received benefits from New York all the time, the red flags began to fly. That theory would permit New York to tax all the employees, no matter where located and no matter where working, of employers with offices in New York. The flaw in the reasoning is serious. That four judges bought the argument is discomforting.

The good news is that even the four judges who voted in favor of New York's Department of Revenue suggested that there is a limit, and taxing nonresidents with "remote" connections to the state would not fly. I predict that when New York goes after the person with a 5% or 10% connection its reach for everything will be a reach too far. If New York officials cast their eyes 90 miles to the south, they can see their future, a place that shows the consequences of insisting on tax policies that drive businesses out. It's called Philadelphia. And it's in a state that doesn't set much of a good tax policy example for that city.

Ultimately, if a person or state does not play fair, that person or state will discover that no one will play with them. Even if they are the biggest on the block.

The First Ten Tax Urban Legends

It may be time to begin collecting Tax Urban Legends. It's not so much the quantity, but the quality of the misinformation. Thanks to the alert eyes of Paul Caron over at the TaxProf blog, I found myself reading an AP story about the taxation of income earned through selling items on eBay.

A woman who sells household items wanted to know if she was required to report her income for federal income tax purposes. Somehow she ended up unable to get a clear answer. Perhaps it's because she posted her question to an online discussion forum operated by eBay for its sellers.

eBay is big business. Had I guessed, I would have been far off the mark, because $34 billion would not have been on my radar screen. That's $34 billion of sales, to at least some of the 135 million people registered on the site. And to think someone once told me the Internet really wouldn't make much of a difference in the lives of most people. Almost half a million people derive all or substantially all of their income from selling things on eBay. Wow.

Well, here's the answer: Gross income includes income from whatever source derived, unless there is an exclusion. A person who sells property on eBay has gross income equal to the sales proceeds reduced by the adjusted basis of the property, which in most instances will be what the person paid for the property. These principles appear in sections 61, 1001, and 1011 of the Internal Revenue Code. There are no exclusions available, unless the person sells their principal residence and meets the requirements of section 121. I doubt that has happened, but I'm not ready to write off the possibility.

What happens if the item is sold for less than its adjusted basis? I have no doubt that this happens frequently, when people sell for a few dollars some old no-longer-needed household item that they purchased for more than the selling price. The answer is that there is a loss. Is it deductible against other income? It depends. If the person is in the business of acquiring and selling these sorts of items, yes, according to section 165(c), but how long can one stay in business if one keeps incurring losses? The deductible loss will occur for the business entrepreneur who unloads a few items for less than cost to clear out the warehouse. But if the sale is not a business transaction, or is not a sale of property held for investment, the loss is not deductible. By definition, hobbies are not businesses nor are they for-profit activities. There are dozens of tax cases so holding.

Time for the urban legends?

Not quite. The AP story is filled with quotes that taken out of context appear to qualify. I'll let those go. After all, it's unclear whether the person was responding to a question about deductions (allowable for businesses but not for hobbies), losses (same), or gross income (no distinction).

The one quote that withstands criticism is the comment by one veteran eBay vendor that many sellers overlook taxes. Indeed. The comment by an eBay spokesperson that eBay is simply a venue like the mall or flea market is unsettling, because it's very likely that the flea market vendors are swimming in the same tax urban legend infested waters. Another is the comment that if you are selling on eBay and making a profit, it's taxable.

Here's eBay tax urban legend #1: One person commented that people think they're not a business if they're selling on eBay. Not only is that not so, it doesn't make a difference when it comes to the matter of reporting income. Of course some of the vendors on eBay are operating businesses, and operating on eBay doesn't preclude being a business. But, business or not, the income is gross income and must be reported. At that point, what matters are deductions, and for deductions, it's better to be a business. It's easy to see that people are very confused.

Here's eBay tax urban legend #2: The woman who asked the question that triggered the discussion went to lunch with a friend, and the friend told her that because eBay is not regulated there's no need to file. Guess what, friend? You are flat out wrong. Read sections 61, 1001, and 1011 of the Internal Revenue Code. When you're finished, I'll point you to the penalty provisions.

Reports from other tax professors disclose that the AP story ended up in a variety of newspapers, where re-writing and editing ended up adding more urban legends:

eBay tax urban legend #3: Gains on personal use property are not taxed. Wrong. Just because losses on personal use property are not deductible under section 165(c) does not mean that gains are not taxed under section 61.

eBay tax urban legend #4: Capital gain rates apply to the income. True, if the item is an investment item or a personal use item, but if it's inventory, that is, merchandise purchased with an intent to resell, the income is not capital gain and is subject to ordinary income tax rates. Take a peek at section 1221.

eBay tax urban legend #5: The limitations on the deduction of hobby losses creates an exclusion for hobby income. Wrong. Hobby gross income can be offset by hobby expenses, but if hobby gross income exceeds hobby expenses, the excess is taxed. Section 183 is the place to go to read about this rule.

It gets better. Inevitably, when tax professors discuss these sorts of practice world questions, good stories emerge.

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.

silly tax urban legend #6: Income from pursuing a hobby is not taxable. WRONG. Do I need to repeat the Code cites?

Along comes another story. Referees at a Special Olympics don't want their paperwork for having officiated events so that they can report their income, they want them so that they can take a charitable contribution deduction. Maybe they plan to donate their fees. Or perhaps they're thinking of....

tax urban legend #7: It is permissible to claim a deduction for doing work for a charity. Absolutely not. The charitable contribution deduction requires a donation of money or property. See section 170.

It continues. A tax professor who is a basketball referee tries to educate his colleagues who are discussing the possiblity of incorporating. Despite the tax professional's attempt to refute them, not one, but TWO, urban legends emerge:

tax urban legend #8: Incorporation would make officiating fees that are not taxable subject to tax. Duh, the fees are taxable whether or not there is an incorporation. It's that pesky section 61 again.

tax urban legend #9: Unless you receive a Form 1099, the fees aren't taxable. NO! A Form 1099 is required only under certain circumstances, and its absence does not change the character of compensation as includible in gross income.

All of this led another tax professor to suggest what may become the next mantra of the tax protestor crowd:

tax urban legend #10: My income is not taxable because I enjoy my work.

At that point, I had to comment that as I get my students to understand that income analysis begins with the search for an increase in economic wealth, they realize that non-economic riches, such as a kind stranger's warm smile, isn't subject to federal income taxation, generating the truism that "happiness is not taxed."

Now these matters don't involve the complicated part of the tax law. What's complicated about "gross income includes income unless there is an exclusion"? Nothing. The exclusions may be complicated, but simply reading a list (gift, scholarship, fringe benefit....) is enough to learn that there is no exclusion for hobby gross income.

No, this has nothing to do with complexity. It has to do with an "ignore the tax law" culture that runs rampant not only among eBay vendors and amateur sports officials, but even among some personal injury and domestic relations attorneys. "Simply ignore the tax consequences" is a scary (and stupid) motto. The damage done to the clients can be overwhelming, as illustrated by a no longer common practice of tax-savvy domestic relations attorneys foisting burned out tax shelters onto their clients' ex-spouses in property settlement agreements when they realized the other attorney was clueless. The tax bar rode to the rescue on that one, educating domestic relations lawyers one-on-one and at seminars almost a decade ago. And they wonder why as a practical matter the pervasive role of taxation in legal matters commands that every law student take the basic tax course while in law school. And yet many law schools do not require the course. How unwise.

Of course, if tax principles were taught in the K-12 world, both at school and at home, along with checkbook balancing, identity theft prevention, flat tire changing, the value of doing good deeds, the long-term disadvantage of greed, and a variety of other life skills and values that ought not be restricted to the college-educated, the tax urban legends could be starved of the nutrients on which they feed, namely, ignorance and greed.

Oh, did I mention sales taxes on eBay transactions? Or state and local income taxes? Or business registration taxes? Whew. I've had enough for the evening and other things to do.

More on Gasoline and Free Markets

Larry Staton, referring to the gasoline and free markets post asked:

Are these two statements contradictory?

"Any method we can employ to increase production of oil in the United States and decrease dependence on foreign oil should be a top priority for our government."

"I don't think the government needs to interfere with the price of gasoline to achieve what it deems as a socially desirable goal"

BTW, I agree with the first statement and agree with you that we should increase user fees on gasoline. The user fee income should then be used to subsidize alternative energy sources, such as biodiesel and solar.

* * * * * gasoline companies are and have been heavily subsidized. Perhaps the gasoline companies can return/forgo those subsidies and then the market will reflect the true price of gasoline!

In my reply, I noted several things and identified a follow-up posting:

Yes, there is some inconsistency, unless one considers the second statement to reflect a view that interference with price via taxes would not cause increased oil production in the U.S. In other words, it's an argument that the government should use any method but not one that won't work and thus is not needed. That's how I read it.

There are a lot of strange subsidies in the tax law for oil and gasoline. Depletion deductions can aggregate to more than the amount paid (causing a weird "negative basis" concept that is not called that). Offshore drilling platforms qualify as "intangible drilling costs" but since I've never touched an offshore drilling platform I can't vouch that they're not intangible, ha ha. There also are subsidies for certain alternative energy sources, but in a hodgepodge mishmash conglomeration of piecemeal bits and pieces. In other words, incoherent.

I sense a follow up posting that goes over the income tax impact on energy. Could be a book. I had best be careful.

Well, this morning, I did a quick run through the Internal Revenue Code (class coming up in a few minutes, so no time to do extensive research), and identified these energy incentives in the tax law:

Section 29 provides a credit for producing fuel from a nonconventional source.

Section 30 provides a credit for qualified electric vehicles.

Section 40 provides a credit for alcohol used as a fuel, but section 87 provides that the credit must also be included in gross income.

Section 40A provides a credit for biodiesel used as a fuel, but section 87 provides that the credit must also be included in gross income.

Section 43 provides a credit for enhanced oil recovery.

Section 45 provides a credit for electricity produced from certain renewable resources.

Section 45H provides a credit for production of low sulfur diesel fuels.

Section 45I provides a credit for production of oil and gas from marginal wells.

Section 48 provides that the energy credit portion of the investment credit is available for certain equipment using solar energy to generate electricity, to heat, cool, or provide hot water for a structure, or to provide solar process heat, and for certain equipment used to produce, distribute, or use energy derived from a geothermal deposit.

Section 136 provides that gross income does not include direct and indirect subsidies from public utilities to customers for the purchase or installation of equipment designed to reduce consumption of electricity or natural gas.

Section 142 provides that exempt facility bonds, which qualify as tax-exempt bonds, the interest on which is not taxed, even though they finance private activity, include bonds issued to provide facilities for the local furnishing of electric energy or gas, to provide local district heating or cooling facilities, or to provide environmental enhancements to hydroelectric generating facilities, and then provides extensive and detailed definitions of these types of facilities.

Section 179A provides a deduction for clean-fuel vehicles and certain refueling property.

Section 193 provides a deduction for qualified tertiary injectant expenses.

Sections 611 through 613A provide a deduction for depletion, computed in a manner that in some instances allows the taxpayer to deduct more than what was paid for the natural resouce subject to depletion.

Section 616 provides a deduction for certain costs of developing a mine or other natural deposit, other than oil or gas wells.

Section 617 provides a deduction for certain costs of ascertaining the existence, location, extent, or quality of any ore or other mineral deposit.

Eventually I'll find time to identify some of the provisions that give special tax breaks on the disposition of energy property.

Being a tax practitioner without understanding energy is somewhat limiting. Of course, being a tax practitioner requires a lot of energy, but that's another tale for another day.

Tax License Plates Resurface

Saw a license plate the other morning, just a mile from home. RAD TAX was on a car parked in front of the offices of Radnor Tax Services. Easy guess is that the vehicle, and the plate, belong to the owner. Radnor is the township in which I live, and in which Villanova University is located.

I wonder if someone in adjacent Haverford Township has HAVE TAX or HAVER TAX on a license tag. Or if someone in another adjacent township, Newtown, where I grew up, has NEW TAX. Want more? Yet another adjacent township is Lower Merion. Would a plate with LOWER TAX on it fly? Not in that township.

If you didn't get a chance to follow the tax license plate posts some months ago, you can take a look here.

Gasoline and Free Markets

My recent comments about the increase in gasoline prices brought a reply from one of our students, Nakul Krishnakumar, who is no stranger to my taxation outlook, as he has been in my courses. He says:

I just read your very interesting blog on the rise in oil prices. I have to say that I respectfully disagree with your analysis on a few points.

First, I think you are right in stating that oil prices, like everything else in the economy, are subject to supply and demand. Nonetheless, I don't think the meteoric rise in oil prices in the last year is solely due to a serious change in supply and demand (although I would certainly concede that this is part of it). I think one main reason (which you mention) is the relative weakness of the dollar as of late (due to mild increases in inflation) and also the war in Iraq (which is having a temporary affect on oil supply). Once these problems are rectified, if indeed they do become rectified, I imagine that oil prices will stabiize.

More importantly, I disagree with your assessment that we should INCREASE the taxes on gasoline. I believe that is unnecessary. I don't believe that tax incentives, or quite frankly, tax disincentives will solve the problem. The fact is that oil and gas, as compared to other forms of energy are relatively cheap. If this were not the case, the market simply would have shifted to another form of energy that is less expensive.

I once had an economics professor in college who asserted that we will NEVER run out of oil! While that seems chimerical at first, it makes sense when one thinks about it. All else being equal, as the availability of oil starts to decrease, it will become more expensive to drill, refine, and convert oil into energy. As such, the price of oil, relative other forms of energy such as solar, nuclear and wind will increase. Once this happens, it will be cheaper to provide the world's energy needs through other forms of energy, and the use of oil will become relatively obscure. In essence, we will stop USING oil long before we actually RUN out of it.

Whether this happens in my lifetime or not is immaterial. The point is that at the current point in time, oil is still the predominant energy source because it is inexpensive when compared to other forms of energy (taking into account transition costs). Moreover, I don't think adding another tax to gas prices, as an incentive to FORCE people to use other forms of energy, is a proper solution. The invisible hand of the market will eventually lead to a shift in the energy sources we use, we don't need politicians meddling even more in the workings of the market.

In the meantime, we should relax environmental laws that prohibit drilling oil off of Lake Michigan, Texas and other oil rich areas in the United States. Drilling in Anwar would also be helpful. Any method we can employ to increase production of oil in the United States and decrease dependence on foreign oil should be a top priority for our government.

I look forward to your comments.

And, of course, I was more than willing to share comments:

You're right that there are other factors, as speculation is contributing to the price increases. Yet speculation is part of the market, and if the market "sees" future shortages the speculators drive up the prices. If the market does not agree, the speculators don't have much, if any, effect.

Experts who analyze oil production and demand have projected shortages. Currently production barely exceeds demand, and OPEC has no more capacity. True, Iraq's production is down, but it will be quite a while before things stabilize enough to bring back pre-1991 levels of production. Future production estimates count on oil flowing through the still unfinished Caspian pipeline, which is in yet another unstable area of the world. China and India will double their demands during the next 5 years, and by 2020 will be "demanding" more than the U.S. uses.

Because taxes on gasoline are generally fixed in amount rather than set as a percentage, they have been falling over the past few decades. I blogged that point in an earlier post and failed to (forgot to) link to it. [It's here.] Taxes such as a gasoline tax are really a user fee, and ought to compensate society for the cost of using gasoline (pollution, cancer, leaks, etc.) Americans pay too little gasoline tax, compared to, for example, Europe. Americans are wasteful of oil, and now sit on the edge of disaster. One refinery fire and there will be long lines at the pumps.

I don't see tax as a way to compel using other energy sources. People could choose to reduce energy consumption. There is a price to be paid for the sprawling developments built out in the middle of nowhere because the land is cheap, and that price is a price shifted by the developers to the home buyers who are many miles from work, and in one instance with which I am familiar, 5 miles from the nearest store or anything other than a farm. In other words, artificially low user fees insert irrationality into the market, or at least subsidize it.

I agree that we are oversensitive and insufficiently logical when it comes to the environment (hence my criticism of the anti-road lobby). There are all sorts of areas where oil can be extracted with far less harm to the environment than would have taken place using the technologies in place when the environmental restrictions were imposed. Yet I wonder if there is truth to the accusation that the U.S. is deliberately "using up" OPEC oil rather than its own so that someday OPEC will have very little oil and then we will open up our taps and become the OPEC for China and India. If that's true, it's conspiratorial. And devious. But very clever. It could work. By the way, the really HUGE oil resources are in areas you didn't mention: off the coast of California. Dwarfs even the Arctic according to some experts.

And, of course, as all good lawyers-in-training do, Nakul rejoined:

* * * * * In general, I'm uncomfortable with "user fees" for gasoline or any other product. The price of gasoline, set by the market, is a user fee. As oil becomes less abundant, that user fee will increase in accordance with the dictates of the laws of supply and demand. When that user fee becomes too much, or if India and China begin demanding more oil, that will only accelerate the demise of oil and the emergence of a new form of energy. I don't think the government needs to interfere with the price of gasoline to achieve what it deems as a socially desirable goal (which usually means a couple of politicians thinking they know more than everyone else).

One more point. I don't believe that the market for gasoline is irrational. In order to believe that prices for gasoline are irrational, one has to buy into the idea that there is some inherent value to gasoline separate and apart from the actual price that the market sets. The price of gasoline that exists today (minus taxes and other transaction costs) is the socially objective value, determined by supply and demand. I would be opposed to any action by the government to cure the " irrationality" of gasoline prices in the same sense that I would be opposed to the Federal Reserve or any other monetary authority curing the "irrationality" of the stock market.

As you can probably tell, I'm a free market capitalist, so I am looking at this problem from that vantage point. Nonetheless, I'm a dying breed, so I suspect, most people will disagree with my assessment of this problem.

Speaking of user fees, there's an interesting article in today's Philadelphia Inquirer about TerraPass, which could be characterized as a voluntary user fee. Creative idea, more on it later. In brief, a fascinating way to encourage grass roots self-regulation instead of waiting for the government to step in.

Tax Return Filing Advice: Request Return Receipt

It really is sad to learn that a problem that should have been solved wasn't solved. Some years ago, IRS employees were discovered to have trashed incoming tax returns in order to keep up with daily quotas. It was a huge mess, and the lesson learned by tax practitioners and even by others who were paying attention was to send tax returns as certified mail, return receipt requested. Then if the IRS notifies the taxpayer that the return was not filed, there is proof that it was filed, and the IRS has to deal with the problem internally.

Apparently the IRS decided to "outsource" the receipt of tax returns. Whether that is permissible or even a good idea is one thing, considering the privacy issues that are implicated. Worse, it turns out, according to this story, that an employee at Mellon Financial, which the IRS paid to receive tax returns and process tax payments, told five co-workers to "hide and destroy" about 80,000 tax returns and $1 billion in payments. EIGHTY THOUSAND? ONE BILLION DOLLARS?

Yep. This happened back in the spring of 2001. Now a grand jury has indicted the six Mellon Financial employees. Check out the charges: conspiracy to commit major fraud against the United States, theft of government property, and theft of mail matter.

The excuse is that the employees "felt swamped by the amount of work." Too bad. Join the world. Choose another option. Report the problem to the supervisor. Let the stuff pile up. Then the executives hauling in salaries in the upper six and seven digit range can hire a few more people. Good for the economy, too.

So I guess a lot of tax practitioners are going to be getting phone calls from at least some of the 80,000 taxpayers whose returnes disappeared. I really do hope they knew to send the returns by certified mail, return receipt requested, that they kept the return card from the postal service, and that they have a copy of their return.

Speaking of Gasoline

On the heels of yesterday's post about gasoline prices and the environment comes news that the Senate has approved H.R. 1270, which extends the financing rate for the Leaking Underground Storage Tank Trust Fund from April 1, 2005 until October 1, 2005. The House had passed the measure by a 431 to 1 vote, and so now the bill goes to the White House for an expected signature.

This fund assists states and the EPA pay the expenses of cleaning up environmental damage caused by underground oil and gasoline tanks that leak. A leak from an underground tank pollutes the groundwater, and sometimes the leaking product can travel miles underground. Messy stuff.

The fund is financed with a tax under section 4041(d). It's the Leaking Underground Storage Tank tax. And, as tax practitioners aren't ones to shy from acronyms, this one does take the prize. It's the LUST tax.

Explain that to your friends visiting from abroad.

Up, Up, and Away

So gasoline prices are getting higher, and news media have something to write about during the four-day lull between the second and third rounds of the NCAA Basketball Tournaments. Yes, it's news, but what should we make of it?

First, gasoline prices are not as high as they appear to be if they are adjusted for inflation. It's interesting to hear someone who earned $30,000 a year when gasoline was $1.30 a gallon complain about gasoline that costs $2.10 a gallon when they're making $90,000 a year. But at least many of the media stories are pointing out the difference between nominal price and inflation-adjusted price comparisons. Near the end of the stories, of course, which is fine except that most readers don't make it to the end of the story.

Second, gasoline prices are getting higher for reasons that suggest that they will continue to increase. At some point they will begin increasing at rates exceeding inflation or economic growth rates, emulating health care costs. At least with health care, consumers are getting new and improved technology and actuaries can demonstrate that we are living longer (contributing, of course, to the financial pressures on the Federal Insurance Contributions Act ("Social Security") system). But with gasoline, we're still getting the same gallon of gasoline. Perhaps a wee bit improved, environmentally, perhaps not. What happens when gasoline reaches $4 or $5 a gallon? Keep reading.

Third, that gasoline prices are rising is a warning. Gasoline is a finite resource. Whether there is a 50-year supply or a 100-year supply is an argument about deck chair arrangements. Drilling in the Arctic is, at best, a short-term solution, and distracts attention from the impending crisis. Of course, that doesn't mean drilling in the Arctic should be dismissed out of hand, but it gives advocates of long-term planning some leverage to get the world for the post-gasoline era. Planning needs to be underway NOW because even with a 100-year supply, the oil wells begin to sputter long before 2105.

Fourth, that gasoline prices are rising is a second warning. The cause, though attributed by some to environmental regulation, is a simple one: demand outpaces supply, and expected increases in demand exceed expected increases in supply. OPEC claims it cannot solve the problem, because it's at full pumping capacity, and I don't doubt its claims. When two countries, each with populations exceeding ONE BILLION PEOPLE move into modernity, their collective appetites are enormous and will increase to gargantuan. Today it is oil. And concrete. And steel. Tomorrow it will be food. The day after tomorrow it will be medicine. And they will have the money with which to outbid the rest of the world on the marketplace. The money obtained by exporting more than they import and by providing the outsourcing that corporate managers think is the solution to all economic problems. Map out the trend lines. Figure out who will be living in a "third world country" in 2105.

Fifth, slowing down increases in domestic demand don't solve the problem but simply buys some time. For all the autophobes who cry for bicycle use, there are sensible people crying for traffic sensors so that vehicles don't sit for 90 seconds waiting for the invisible cars on the cross street to pass by. Aside from the fact that if bicycle transportation were so great the demand for oil in a once-bicycle-intense nation like China would not be going through the roof, and aside from the fact that invisible cars do exist as any long-time automobile insurance claims agent can attest ("an invisible car came out of nowhere, hit my car, and drove off"), improving vehicle fuel efficiency is pointless if we don't do something about the ZERO MILES PER GALLON that EVERY VEHICLE attains at the many "dumb" intersections population the nation. Toss in the insufficiencies of highways, which reflect the foolish argument that building roads brings traffic (when we know that what brings traffic is the juxtaposition of increased population and the movement of residences to places further and further away from work locations), and the avoidable energy waste becomes a near crime. Why are our public servants not dealing with these matters? They're too busy grandstanding on baseball player steroid use. Now, if we could just drop some steroids into the gasoline tanks....joking aside, that causes me to think:

Sixth, how about developing practical applications of infinite energy resources? Whether it's vehicles, heaters, air conditioners, or power plants, a nation with almost 300 million people and a world with more than 6 BILLION people, 10% of whom are in the top 10% intellectually, ought to be able to figure out how the sun, the wind, and where I live, the snow, can be used to power the economy. Think about the headline when someone invents the automobile that runs on ocean water. The socio-political consequences would be shattering. Literally. But how likely is this to happen when children are encouraged away from the sciences ("it's too hard") and into the softer disciplines (sorry, folks, but some of those "life fulfilling" and "dream enhancing" college majors don't cut it, either in terms of finding meaningful jobs after graduation or making a needed, useful contribution to humanity). The launch of Sputnik caused a sea-change in American education in the 1950s and yet, half a century later, we're sitting around figuring the person next door will solve our problem (which is so typical of the "it's always someone else's job and someone else's fault and someone else's problem" mentality of the postmodern spoiled brat culture in which we live).

Seventh, as for taxes on finite energy, raise them. Call them users fees and crank them up. In taking this approach, I part ways with those who advocate doing nothing, though that opinion was written almost half a year ago. The scarcer the resource the higher the tax. In contrast, there's no point in taxing the infinite resource. A tax of $10 per gallon on gasoline and a $0 tax on solar or sea-water energy should add a nice economic incentive to get the folks who invent all those miracle drugs to invent some not-really-a-miracle technological improvements. As for calls to reduce gasoline taxes, why pretend that gasoline is inexpensive? Why reduce the message-sending sting of the service station pump? Though the poor and impoverished would suffer, to some extent, from higher gasoline taxes, the impact isn't as serious as imagined, because so many of the poor and impoverished do not own or use cars and thus don't purchase gasoline. Until gasoline prices hit $4 or $5 a gallon, all that will happen (aside from the usual griping) is that consumers will shift some of their discretionary income from purchasing $150 brand-name athletic shoes (that enrich some already wealthy athlete) or ten more made-overseas video games to the purchase of gasoline and slightly less flamboyant footwear and fewer recreational items. Businesses using gasoline need to pass their increased costs onto their customers. That's how the market works. In turn, the incentive to fix those "dumb" traffic lights, improve public transportation so that it is useful, eliminate choke points in the highway grid, and move residences back to the vicinities of workplaces will be, sorry, energized.

And eventually no one will care about gasoline prices. When's the last time you chatted with somebody about buggy whip prices?

C'mon, Surprise Me!

Did you see the headline in the Wall Street Journal?

Federal Tax Code Draws Criticism From Citizens, Experts, Economists [headline now archived]

Now I WOULD be surprised with this one:

Federal Tax Code Draws Praise From Citizens, Experts, Economists

THAT would be worth blogging.

After they picked me up off the floor.

Law Schools: Preparing Students for Practice?

An interesting article at the Law.comsite, All You Really Need to Know You Learned in Law School, by Prof. Kristen David Adams of Stetson University College of Law makes an interesting defense of law school education against the oft-heard charges that law schools are not living up to their duties to prepare students for law practice. As I read it, the temptation to respond overwhelmed me.

Prof. Adams makes some points that rest on what I believe to be shaky premises. These are the things law school teaches:

"Law school teaches discipline" because law professors are deliberately "rigid" and have rules that reflect those in practice (due dates mean due dates, being late is costly, etc.)

"Law school also taught you time-keeping" because many law school examinations are timed, and students in clinics and perhaps on law review must keep time sheets.

"Law school also taught . . . how to manage time" because law students have to juggle multiple tasks (classes, trial or moot court practices, interviews, journal deadlines, etc.)

"Law school also taught you how to conduct an initial client interview" because the process of working through an examination is "an excellent simulation of an initial client conversation" by giving the opportunity to sort through information, and organize facts.

"Law school taught you to think on your feet" because students are called on in class, with questions that were not known in advance.

"Law school taught you how to be both a mentee and a mentor" because upper-year students help first-year students.

Here's how I would amend the statements: "Law school COULD teach you [fill in the skill] IF the law faculty took the time to do so rather than dumping students into situations where they had to figure it out for themselves." I will elaborate.

Yes, law school teaches discipline, if in fact discipline exists and is enforced. Disciplinary rules at law schools (and at other educational institutions) began to erode in the 70s. Many faculty and administrators are quick to excuse late responses. Why? They'd rather avoid the lawsuit, and, yes, law students are not reluctant to sue the moment rules aren't bent to their preferences. Law faculty are extremely reluctant to dismiss students who have failed to comply, creating instead waivers and allowances permitting students to make up credits in the summer after graduation or excusing requirements if a sympathetic case is put before the school. Faculty who attempt to be rigid are criticized (by students and even other faculty, and sometimes by administrators), marginalized, and depopularized.

I've yet to see a law school teach time-keeping, other than on a haphazard basis. Clinic faculty, still in many law schools a "second class" of faculty citizen, if not in form, at least in attitude, sometimes require time records (even though clients are not being billed). Faculty using research assistants may, on an individual ad hoc basis, require some sort of time sheet for pay purposes. The number of law students with these experiences is small.

Law schools do not teach time management, other than through the sink-or-swim-teach-yourself method, or through the occasional one-on-one or small group explanation of time budgets. I have sat down with students who sought advice about time constraints, and have shared my time budget approach. "There are 168 hours in the week. What will you do with them?" As I show them how spending a weekend back home golfing crushes the budget, their eyes widen. Of course, in defense of law schools, there's no reason law schools should need to teach this other than the total failure of the K-12 and undergraduate education systems to do so. It is no surprise to those who read my postings on education that I consider time management a life skill, rather than a skill over which lawyers have a monopoly. Considering that many faculty at every level of education have time budgeting issues, I can understand why the students are learning how to manage their time.

Yes, law schools offering courses in client interviewing and counselling teach students how to conduct an initial client interview. But examinations do not do so. At best, examinations require students to do SOME of the things attorneys need to do when interviewing clients, and hopefully they are things that have been taught to the students before the examination takes place. Examinations do not teach students how to deal with emotional, crying, weeping, angry, yelling, and fuming clients. They do not teach students how to react to the client who lies. They do not teach students how to make a client feel comfortable, to set lighting properly for clients whose eyesight is failing, or to arrange things in a manner that minimizes challenges for disabled clients. They teach nothing about interviewing multiple clients, such as marital couples. They teach nothing about deciding what needs to be put into writing and signed by the client. If law schools were teaching ALL students how to interview clients, they would require ALL students to take realistic client interviewing courses. Sorry, the fact that some existing law school examinations requires SOME of the same skills used in an interview isn't enough for me to agree that law schools teach students "how to conduct an initial client interview."

Do law schools teach students how to think on their feet? Yes, in classes where students are questioned without warning, and in appellate and trial practice arguments. The practice of calling on students without warning has almost disappeared, a victim of the backlash against the "cruel Kingsfields" of the law school world. Instead, students are told in advance that they will be "up" or "principally responsible rows" are assigned. Some faculty sit with the selected group ahead of time. The desire to decrease student discomfort and to increase popularity (for those ever-present student course evaluations used in tenure and compensation decisions) pervades the halls of academia. I gave up calling on students years ago, when I discovered that too much valuable class time was lost because students were unprepared and wasted time trying to appear prepared (though, admittedly, some simply passed without consuming too much time doing so). Instead, I now use the classroom clicker system, and student responses on some of the question count toward their grade. For students who want to be challenged, it works. They like the clickers. Every student is now on notice that he or she will be called on, and there is no hope that "someone else" will be tagged. Students who want to be in an active learning environment jump in. Other students avoid my classes because they want nothing other than an examination at the end of the semester and have no tolerance of being required to provide answers to clicker questions and other semester exercises that will be counted toward a grade.

I've yet to see any law faculty teach law students anything about being mentors or mentees other than, again, through happenstance, or a student's subsequent realization, years after graduation, that they had been mentored. Sometimes it's support staff who come through in specific instances in this regard. But what happens surely isn't something for which the faculty can or should be taking lots of credit.

My classes, to the chagrin of many, are in fact designed to prepare students for practice. Not practice in the sense of finding the courthouse, learning who's who therein, filling out forms, or doing time sheets. I focus on practice as a place where lawyers have two major objectives: prevent problems and solve problems. The skill set for doing so is one that is emphasized. Even in doctrinal classes, I ask students what to say or ask of the client. I ask students to weigh the law, the facts, and the risks and determine what advice to give to the client. Against the backdrop of black letter law I turn their attention to the acquisition of facts, the setting aside of irrelevant information, the connections with other doctrinal area, and the seamless web of transactional reality.

Perhaps at Stetson there is more emphasis on practice reality than there is at most of the schools in, or clamoring to be in, the U.S. News and World Report upper echelon rankings. Surely the emphasis on writing the "think piece" and trying to get it published in an "elite" academic law journal (read: edited by students and so far behind in publication schedule that for some areas of the law it's history by the time it appears) has spilled into teaching at many institutions. Emphasis on "what should the law be" and "let's get interdisciplinary" has overshadowed "let's get ready to practice." I've been told that "we're not in the business of prepping lawyers, we're here to train the legal philosophers." Wow, let's put that in the "view book" (the former "admissions brochure") and on the web sites and see what happens to law school applications at schools other that those sitting at the U.S. News head table, fighting with each other over seating position, and pushing aside all interlopers.

I don't disagree that students can leave law school having learned, in some way, something about discipline, time keeping, time management, client interviewing, thinking on their feet, and mentoring. They must learn some of these things, at least at a rudimentary level, if they're going to pass their courses and graduate. My disagreement is (a) law schools do very little teaching of this sort intentionally, (b) law schools do not have these considerations at the forefront in designing curriculum, (c) law schools do not do as much of this sort of teaching as they can and should, and (d) law schools come up short because their faculties are distracted by the philosopher take-over that is sweeping through law and other areas of education.

Someday the nation will pay a steep price for sitting by as those fearful or distasteful of the practice world and its engineers, nurses, accountants, computer programmers, technicians, and effective lawyers marginalized those disciplines. It is no wonder that it is in those areas there are shortages of college graduates. It is no wonder that it is in those areas that outsourcing of jobs to other countries has made inroads. It is no wonder that fewer and fewer law firms want to hire new law school graduates (other than those coming out of the U.S. News elite, the top 10% at other schools, and those coming out of their alma maters) and looking more and more to find laterals who need far less post-law-school training (that some other firm has undertaken).

It was predicted that playing the U.S. News and World Report rankings game would cause serious problems over the long-term. I'd rather go for another sort of ranking: a measurement of the success of law school graduates, based on something other than "reputation" surveys. How about a survey of law school graduates 3, 7, and 15 years out of law school, asking them the extent to which they learned in law school the things they needed for practice, with a very long list not just of the six skills Prof. Adams addresses, but the others, such as time budgeting, client management, and those I mentioned in connection with client interviews? Every time I propose that, I get the same reaction I receive when I propose bringing professional educators in to run seminars for law faculty on pedagogical topics. I'll let you know when it happens.

A New Scam: Beware

OK, it's not quite taxes, or chocolate chip cookies. One of these days I'm going to share my thoughts about the entire scam industry, but for the moment, read, learn, copy, paste, share....

Got this from a friend - seems like good advice.

Friends, the following story is a good reminder of how vigilant we need to be in protecting ourselves from scams. These scam artists sound pretty smooth and convincing.

This information is worth reading. By understanding how the VISA &Mastercard Telephone Credit Card Scam works, you'll be better prepared to protect yourself. Thanks to Dr. Pat Cloney for passing this on. Those con artists get more creative every day.

My husband was called on Wednesday from "VISA", and I was called on Thursday from "MasterCard". The scam works like this:

Person calling says, "this is , and I'm calling from the Security and Fraud Department at VISA. My Badge number is 12460. Your card has been flagged for an unusual purchase pattern, and I'm calling to verify. This would be on your VISA card which was issued by bank. Did you purchase an Anti-Telemarketing Device for $497.99 from a marketing company based in Arizona?"

When you say "No", the caller continues with, "Then we will be issuing a credit to your account. This is a company we have been watching and the charges range from $297 to $497, just under the $500 purchase pattern that flags most cards. Before your next statement, the credit will be sent to (gives you your address), is that correct?"

You say "yes". The caller continues... "I will be starting a Fraud investigation. If you have any questions, you should call the 1-800 number listed on the back of your card (1-800-VISA) and ask for Security. You will need to refer to this Control #" The caller then gives you a 6 digit number. "Do you need me to read it again?"

Here's the IMPORTANT part on how the scam works. The caller then says, "he needs to verify you are in possession of your card". He'll ask you to "turn your card over and look for some numbers. There are 7 numbers; the first 4 are your card number, the next 3 are the 'Security Numbers' that verify you are in possession of the card. These are the numbers you use to make Internet purchases to prove you have the card. Read me the 3 numbers". After you tell the caller the 3 numbers, he'll say, "That is correct. I just needed to verify that the card has not been lost or stolen, and that you still have your card. Do you have any other questions?" After you say No, the caller then thanks you and states, "Don't hesitate to call back if you do", and hangs up.

You actually say very little, and they never ask for or tell you the card number. But after we were called on Wednesday, we called back within 20 minutes to ask a question. Are we glad we did! The REAL VISA Security Department told us it was a scam and in the last 15 minutes a new purchase of $497.99 was charge on on our card.

Long story made short, we made a real fraud report and closed the VISA card, and they are reissuing us a new number. What the scammers wants is the 3-digit PIN number on the back of the card. Don't give it to them. Instead, tell them you'll call VISA or Master card direct. The real VISA told us that they will never ask for anything on the card as they already know the information since they issued the card! If you give the scammers your 3 Digit PIN Number, you think you're receiving a credit. However, by the time you get your statement, you'll see charges for purchases you didn't make, and by then it's almost to late and/or harder to actually file a fraud report.

What makes this more remarkable is that on Thursday, I got a call from a "Jason Richardson of MasterCard" with a word-for-word repeat of the VISA scam. This time I didn't let him finish. I hung up! We filed a police report, as instructed by VISA. The police said they are taking several of these reports daily! They also urged us to tell everybody we know that this scam is happening.

Please pass this on to all your friends. By informing each other, we protect each other.

[Urban legend? I doubt it. See this analysis. To which I add: After all, they REALLY do want what they're trying to get. Interestingly, web sites that take credit cards but that don't verify billing address and the other information make it easier for these thieves to do their dirty deeds. So tell your business clients to tighten up the input forms. A little paranoia goes a long way.]

More Makeover, More Questions

The Extreme Makeover? Extreme Tax post did not pass unnoticed. A nearby CPA asked several questions.

His first question was whether section 109 would apply. Section 109 provides that a landlord does not have gross income to the extent of the increase in value of the rented property caused by improvements made by the lessee, provided those improvements are not paid as substitutes for rent (in which case their value would constitute rental gross income).

For section 109 to apply, several conditions must be satisfied. First, the transaction between ABC/producers and the homeowners must be a rental. ABC appears to be buying the homeowners' story, and the stories of the other members of the household, and they appear to be purchasing their time (in this instance, the time spent painting a hospital). It does not appear that ABC or the producers are renting the house for use as a house. Second, the improvements must not be a substitute for rent. In the paradigm, the lessee pays rent and also adds an improvement. If this transaction is a rental, where is the rent payment? We're back to the section 280A issue. Third, lessee improvements are improvements made and used by the lessee. ABC and the producers did not live in the house that was demolished or in the house that was built. The house is no more a lessee improvement than is a house constructed on my raw land by a contractor. Yes, the contractor's employees are "in" the house as it is being built but they are not "using" the house.

Apparently (and I would have known this if I watched the show but I haven't), ABC and/or the producers also bless the family with big-screen TV sets, new furniture, and all other sorts of personalty. Unquestionably, section 109 does not apply. Nor would section 280A. And if the family is characterized as employees, compensated to perform painting and public relations services, section 102(c) precludes treating these items as gifts. So there's even more gross income. Does ABC "gross up" its payments so that the families have money with which to pay the tax? We don't know.

The CPA's second question is whether I think the IRS would go after these families, some of whom were in dire straits. His question referred to orphans, so I'm guessing (I should stop writing tax stuff and watch TV) that in one episode some orphans got a new or remodeled home. I do wonder what the IRS will do (assuming that ABC/producers are not providing money to be used to pay the taxes). Would it make for bad PR for the IRS to issue notices of deficiencies against these families? Maybe. Surely other families, in similar circumstances but not getting new or remodeled homes, might not be so sympathetic. Or perhaps they would be. Of course, politicians, especially the "eliminate the IRS" crowd, would jump all over this, oblivious to the fact that the LAW that applies is law that they wrote, but we know that they, paradigms of postmodern culture, are expert at shifting blame from themselves to anyone within range and anyone they don't like.

But if ABC issues 1099s to these taxpayers, the IRS computer system will automatically flag the tax returns of these families. It isn't a question of whether the IRS is "too busy" to do something, but whether someone at the IRS manually overrides the mis-match flagged by the computer. The first, benevolent negligence, is not all that uncommon, as the IRS has for decades "overlooked" some things for reasons of administrative logistics or policy, even though the law required something else. But the second, stopping a computer-generated "there is a mismatch" letter from going out to the taxpayers, is an affirmative interference with a system set up in compliance with, and designed to increase compliance with, the tax law. It might even be a violation of IRS internal working procedures for tha sort of interference to take place.

We do know that the IRS went after Richard Hatch, another TV show winner, who failed to report his income. From what I understand, he wasn't a likeable guy, but should tax law outcomes reflect the presumed likeability of orphans (assuming orphans are per se likeable, which isn't necessarily the case) and the dislike of others? If the answer is that Hatch received cash and these families received property, the outcome would turn on a distinction always rejected in the tax law, namely, the fact something is received as property rather than as cash makes no difference in the gross income analysis (except for certain narrow exclusions not relevant to this discussion and arising from specific statutory exceptions). And if the argument "it's in property so don't tax it" carries the day, I guarantee that tomorrow all sorts of transactions will be shifted from cash exchange to property exchange arrangements. The IRS cannot write, and the Congress cannot approve, such a ticket.

The solution will make the income tax even more complicated. Would some other sort of tax be better? What of a sales tax? My guess is that ABC/the producers would simply pay it as part of the deal. What of a VAT? Same outcome, as it would be imposed on ABC/the producers who would choose not to shift it to the families. What of a consumption tax that had no exception for residential realty? Boom. The discussion would not involve the niceties of sections 102(c), 109, and 280A(g), but would be just as laden with cries of "this isn't right." Well, then, what is right?

Extreme Makeover, Extreme Tax

One of the ABA-TAX listserv participants explained earlier today that the producers of Extreme Makeover: Home Edition shifted gears last night and did more than a makeover. Following the family's request, the producers sent the family to paint a pediatric cancer center unit in another town's hospital. They were absent for a week.

ABC then tore down the family's house and built a 5400 square foot replacement. The family did not know this would happen. Gee, did anyone ever think someone could build a house in a week? Even ignoring time for the building permit and environmental clearance processes, actual construction in a week?

Anyhow, there's a tax issue here. (I really need to start watching television for other than sports, news, and weather. I'm told I don't get out enough. I also don't sit at home and watch network TV enough. I must be flunking something.)

Anyhow, does the family (or at least the parents) have gross income? And can ABC (or the producers or whoever actually paid for the new house) claim a deduction?

Let's start with gross income. Gross income is all income from whatever source derived, unless an exclusion applies. Go read section 61(a) of the Internal Revenue Code, which is where that not-for-everyday-conversational-use language can be found.

Income? Certainly. The owners are economically wealthier and they've taken the house into their ownership and possession.

Exclusion?

First possibility: the exclusion for gifts (section 102). For it to be a gift, it must come from the donor's "detached and disinterested generosity." That's a quote from a Supreme Court case called Duberstein, and even though the Court told us not to quote that language as a test, everyone, including the lower courts, has been doing that for decades, so why should I be different? ABC does this to get ratings, because ratings mean income. ABC is not the kindly uncle buying a house for his starting-out-in-life niece and her husband (disclosure: I have not done that. Warning to my son, daugher, nieces and nephews: don't get your hopes up). Someone suggested that it was a gift because if someone leaves money or property where an intended donee is expected or intended to find it, it's a gratuitous transfer. My response: Mr. Duberstein's employer left the car where he expected Mr. Duberstein to find it. And yet the Supreme Court held it was not a gift.

Second possibility: an exclusion for rental gross income if the rental period is less than 15 days of the year (section 280A(g)). Is this a rental? That question has been debated in instances where ABC remodeled a house. The obstacle in those cases is that the value of the benefit is disproportional to the rental value of the property. But this demolition scenario is even tougher. How can the owners claim ABC is paying rent for the house when ABC promptly demolishes the house? Rental for the land? If so, is $500,000 or whatever the house is worth equal to the rental value FOR A WEEK for a small plot of residential land? Hardly. The rumor mill has it that attorneys for ABC have advised it that section 280A(g) does apply, but even if that is true, there are serious reasons to doubt the conclusion. I'm very certain that if the attorneys advised anything, it's in a letter that hedges its way all over the map.

I'll come back to this after I consider ABC's deduction.

First possibility: ABC deducts the value of the house as a business gift. The problem with this approach is that there is a $25 (yes, twenty five dollar) limitation on the amount that can be deducted as a business gift to any one individual for a year. I cannot imagine ABC taking this approach.

Second possibility: ABC deducts the value of the house as a rental expense. The problem here is that the deduction is limited to ordinary and necessary rental expenses that are reasonable. There is no way that the value of a 5400 square foot house is reasonable for a one week "rental" of a plot of residential property. It won't fly.

Third possibility: ABC deducts the value of the shouse as an advertising expense. That's what it is. Advertising. Ordinary and necessary? Yes, within the context of the business (television production) in which it is incurred.

So why would ABC limit itself to a minuscule gift deduction or risk losing most of the deduction as a contrived rental deduction when it can get the best (and correct) tax result taking an advertising expense deduction? Of course, that leaves the owners in a tough place. What happens to the gift argument, already shot down under the gross income exclusion analysis? What happens to the rental exclusion that was struggling to stay alive?

Well, what happens, I contend, is that the family has gross income. That's a brutal result. So, too, were the results for the recipients of all those automobiles that Oprah gave away on one of her shows. At least in that case the producers forked over cash sufficient to pay the taxes. Does ABC do that with the Extreme Makeover: Home Edition episodes? We don't know. The families sign confidentiality agreements, evident from looking at the application.

One last item. In addition to the statutory provision making all income gross income unless there is an exclusion, yet another provision (section 74) provides that prizes are included in gross income. Is this house a prize? The families entered a contest, much like a lottery. Some selection process beyond their control is used to determine the winner. It's like a lottery, except it costs 37 cents for the postage rather than $1 for the ticket. Someone suggested that it might not be a prize because they don't enter to win it, but the application surely is an entry form.

Or perhaps, as one listserv participant suggested, the show is staged. I doubt it. I think they really do seek out "needy" families because it makes good television. After all, tax professionals are watching. Well, some of them, at least.

Oh, the producers or ABC or someone paid off the mortgage on the old house. Well, sure, after all, the bank wouldn't be too happy to see its collateral get razed!!! Think of all the loan officers who must be watching the show!

So, I'm sure once ABC's tax advisors realizes how important it is to ABC's deduction that it NOT be a gift, they'll decide to send that 1099 to the recipients. Then let the fun (and tax games) begin!

Learn by Teaching? Of Course

It's so nice to have the experts affirm what I assert. Several years ago I wrote an article for the Villanova University School of Law weekly newsletter, in which I asserted that the best way to learn is to teach someone else, and that law students should focus on learning how to teach, because they will spend their careers teaching clients, judges, other lawyers, bureaucrats, and others.

Now, in a new report about the comparative success of siblings, researchers claim that one reason, and probably the most important reason, first-born children tend to be more successful than their siblings is that they have more opportunity to, and in fact do, teach their younger brothers and sisters.

Of course. OK, so I'm the second-born of my parents' children. But I had two younger sisters who probably could claim to be my first students. Somehow, despite that, both have done quite well. One's a teacher, the other a lawyer. And I'm a lawyer who teaches.

Credit, though, goes to my mother, who through the years, even when I was in graduate school, would insist on my sitting down and explaining to her what I had learned. Until I was in my 20s I thought it was something for her benefit, which, of course, I was more than happy to do. Then I realized, it was really for my benefit. Too few parents do that for their children. Thanks, Mom.