It's Raining Charts

TaxChartMan, the nickname I've assigned to Andrew Mitchel, has inaugurated the new year with another 30 charts. Like the rain that has sprinkled down in the Philadelphia area the past few days, Andrew's charts arrive in small bursts, in a steady pattern of useful resources. The plants and wildlife, and humans, too, put the rain to good use (though apparently some people would be happier with slippery ice and transportation-clogging snow), and the tax world can put Andrew's collection to similar good use. This time around, quoting Andrew:

Cases and Rulings
1. Avery (Dividend Not Taxable Until Unqualifiedly made Subject to Shareholder's Demands)
2. Cox (Installment Sale Treatment Not Available For 304 Transaction)
3. Helvering v. Horst (Fruit Not Attributed to a Different Tree)
4. Indianapolis Power & Light (Customer Deposits Were Not Advance Payments)
5. Burnet v. Logan (Open Transaction Doctrine (Contingent Payments))
6. MedChem (P.R.), Inc. (Section 936 - Active Conduct of Trade or Business Within a Possession)
7. P.G. Lake, Inc. (No Capital Gain on Sale of Right to Receive Ordinary Income)
8. Taisei Fire (U.S. Agent of Japanese Insurance Companies was an Independent Agent)
9. Rev. Rul. 61-156 (Liquidation - Reincorporation with 45% Common Ownership
10. Rev. Rul. 63-234 (Two Step Exchange Did Not Qualify As B Reorganization (Remote Continuity))
11. Rev. Rul. 64-155 (Outbound Contribution to Capital)
12. Rev. Rul. 67-448 (Reverse Triangular Merger Was, in Substance, a B Reorganization)
13. Rev. Rul 69-630 (Bargain Sale Between Brother-Sister Corporations)
14. Rev. Rul. 2003-96 (Nonapplication of Section 482 to Lease Stripping Transaction)
15. Rev. Rul. 2003-125, Sit. 2 (Check the Box Election As Identifiable Event For Worthless Stock Deduction)
16. Rev. Rul. 2004-3 (Foreign Partner Deemed to Have A Fixed Base in the U.S.)
17. Rev. Rul. 2004-79 (Subsidiary Purchase of Parent Debt)
Other
18. Installment Obligation Received in Forward Triangular Merger [Prop. Reg. 1.453-1(f)(2)(iv), Ex. 1]
19. Check-the-Box Planning to Get 901 Credits and to Avoid 10/50 Basket [Reg. 1.701-2(d), Ex. 3]
20. Dividends Received Deduction for Dividend from Foreign Corporation [Reg. 1.861-3(a)(3)(iii), Ex. 1]
21. Subpart F Income: CFC for Full Year [Reg. 1.951-1(b)(2), Ex. 1]
22. Subpart F Income: CFC for First Part of Year [Reg. 1.951-1(b)(2), Ex. 2]
23. Subpart F Income: CFC for Last Part of Year [Reg. 1.951-1(b)(2), Ex. 3]
24. Hopscotch Rule & PTI Dividend [Reg. 1.951-1(b)(2), Ex. 4]
25. Subpart F Income: CFC for Last Part of Year [Reg. 1.951-1(b)(2), Ex. 5]
26. 12 Month Ownership Test Under US-UK Tax Treaty with Disregarded Entity [PLR 200626009]
27. Section 304 Can Be a One-Way Street
28. Signature Authority Regarding Check-the-Box Elections [Reg. 301.7701-3(c)(2)]
29. Non-Corporate Purchaser: De Facto 338 Election
30. U.S. Corporate Seller of CFC: Buyer Makes Immediate Check-the-Box Election

Andrew also added a section 351(g) flowchart to the collection a few days after the batch of 30 were uploaded. It's a fine chart, and if I covered that provision in detail in my J.D. business entity taxation overview course I'd ask that you not tell them it exists, because I think they learn more by making their own chart than by looking at someone else's production. If for no other reason, take a look because it's a marvelous illustration of how much complexity Congress can shove into one Code subsection. Multiply it by the number of Code subsections, and it's easy to see that the "chart of the tax cosmos" would be immense beyond comprehension.

For those needing cross-references to my previous commentary on Andrew's chart work, look here, here, here, here, here, here, here, here, here, here, here, here, here, here, and here.

Andrew continues to welcome comments on his charts. You can contact him through his web site. For direct access to the charts, you can enter by Topic, by Alpha-numeric order, or by Date uploaded .

How Political Blackmail Enhances Tax Law Complexity

On Wednesday, the House voted to raise the minimum wage. The legislation passed by the House does just that. I found the text of the bill at this Library of Congress site, but it may be necessary to go to the main page, search for "minimum wage" and then select the enrolled version of the House bill.

The bill now goes to the Senate. Senate Republicans, though, want to attach tax breaks to the legislation. Senate Democrats might accede to the demand simply to get the minimum wage legislation enacted.

Here's are my questions: why can't the Senate simply vote on the minimum wage increase proposal based on its merits? Why do the Republicans in the Senate hold the legislation hostage for more small business tax breaks?

The Senate Republicans claim that the tax breaks are required in order to assist business owners in finding funds with which to pay the minimum tax increases. I'm not convinced. Many minimum-wage employees work for corporate giants, which have been recording record profits while paying exorbitant salaries to their top-level executives. Surely they can come up with the money to provide a living wage to their employees without needing even more tax breaks. Many small businesses that employ low-wage employees either are not subject to the minimum wage, or are in states that have higher minimum wage amounts in place. Some small business owners pay themselves salaries so high that a small pay cut will go far in raising low-wage employee compensation. Blanketing these considerations is the fact that compensation paid to low-wage employees is deductible, which means that the employer's taxes will be reduced even in the absence of additional tax breaks.

It gets worse. Because of the pay-go rules adopted last week, any tax cuts enacted in favor of "small businesses" will require tax increases to offset the cost of the cuts. So who's going to be targeted for those increases? When the smoke clears, if these folks are successful, the tax law will be even more complicated.

While I was hunting, unsuccessfully, for information on the specific tax breaks and tax hikes that the Senate Republicans, with help from certain Democrats, seek to enact, and reached this paragraph in my essay, I discovered that I'm not the only one critical of the "more tax breaks required for small businesses" ploy. Steven Pearlstein's Minimum Wage, Maximum Myth deserves a close read. He makes some points I overlooked, such as the tendency of businesses to pass minimum wage increases on to their customers and the exaggeration that most new jobs are created by small businesses. His comment that small business owners deserve more IRS audits than more tax breaks because of their position as the largest contributors to the revenue gap surpasses any commentary I could have provided.

What is most troubling is the unwillingness of certain politicians to permit separate up or down votes on each proposal based on the merits. What's so wrong with a vote on the minimum wage followed by a vote on the proposed tax breaks? If the proposed tax breaks are so wonderful, would they not be enacted on their own? I suspect the reality is that the tax break advocates understand that their grab for even more tax reductions won't fly, and that the only way to impose it on the nation is to attach it to legislation that has significant support. Coming from legislators who are quick to condemn and outlaw blackmail, extortion, and con games, it seems rather hypocritical. To those who would reply, "That's how politics works in this country," I reply, "Then it's time for this country to reform politics."

A Sarcastic Tax Thanks for the Outgoing Congress

In my commentary on the adverse effects of last-minute end-of-December tax legislation enactment that is effective as of the beginning of the year, On the Way Out, They Grabbed Tax Breaks by the Hundreds, I pointed out that when Congress waits until December to tell us what the tax law is for the previous eleven months, it causes all sorts of planning, logistical, and tax administration problems. One concern was the chaotic state of tax forms and instructions, which the IRS had already prepared and circulated, as it had to do if it was to be on time, but which were rendered obsolete, so to speak, by the typical last-minute antics of a Congress more concerned with elections and power retention than with public service. I explained:

This year, unfortunately, the IRS forms and instructions process is so far along that the IRS has told taxpayers that they will be using forms and instructions that do not reflect the changes. Taxpayers, and tax practitioners, will need to figure out independently how to modify the instructions in order to incorporate the changes. How seamless will this be? The IRS may issue supplemental instructions, but if the manner in which my tax students, among the nation's best and brightest, have assimilated mid-stream changes over the past two decades is any dedication, confusion will run rampant. One interesting example of what the IRS must do involves the sales tax tables for the revived sales tax deduction. The IRS plans to do another mailing to taxpayers to distribute the tables. Will the Congress step up to the plate and provide the IRS with funds to pay for this mailing, or will the IRS be expected to make cuts in some other program area? Does Congress want less taxpayer service? Of course not, because Congress harps on that issue every week. Does Congress want fewer audits? Wouldn't that make a great headline? Has Congress thought about the impact of the inefficient manner in which it does business?

Now comes a useful news release from the National Association of Tax Preparers addressing some of the problems. The title of the news release, Income Tax Form 1040’s Missing Lines for Key Deductions - Here’s How to Claim Them, is enough to demonstrate the aggravation Congress causes for citizens when it cannot do things in a timely manner.

The forms mailed by the IRS do not have any lines for the sales tax deduction, the higher education deduction, and the deduction for teachers' expenses. Fortunately, there is time for people to learn about this glitch and make adjustments, because the IRS cannot begin processing tax returns until February at the earliest. Why? It must reprogram its computer system. Will it have time to test the changes? I doubt it. So it would not be surprising to discover in March or April that hundreds of thousands of tax returns have been processed incorrectly. If Microsoft can't get it right the first, second, or umpteenth time around, can the IRS?

The NATP has a nice, plain English explanation of the instructions provided by the IRS on how taxpayers who file their returns on paper can "jiggle" the forms to make "room" for the missing deductions. Taxpayers using software must get updates from the vendors before preparing their returns. Vendors are working on revisions, and they, too, face the disadvantages of making changes and trying to test them under severe time pressure.

So, hey, thanks, Congress! Do you think perhaps people don't feel so bad they invited a lot of you to go home? And for those remaining and those newly arrived, there's a lesson to be learned. In the long run, it is better to do the job correctly than it is to amass power for power's sake or for the sake of a select few to whom one ends up becoming indebted because of the grab for power.

Tax Carnival #9 Has Appeared

Kay Bell, of Don't Mess With Taxes, has posted Tax Carnival #9: Welcome to Tax Season 2007. With links to stories and commentary about the start of the tax filing season, tax preparers, tax deadlines, paying taxes electronically, changes in the tax laws, tax software updates, and more, it's a posting worth a visit from tax practitioners no matter their location or specialty.

Talking Like a Philadelphian

OK, it's not tax, or chocolate chip cookies, or model trains. It might be related, tangentially, to genealogy and perhaps even law school teaching. What is it? It is how I talk.

According to the What American Accent Do You Have Quiz, I speak like a, surprise, Philadelphian:

What American accent do you have? Your Result: Philadelphia   Your accent is as Philadelphian as a cheesesteak! If you're not from Philadelphia, then you're from someplace near there like south Jersey, Baltimore, or Wilmington. if you've ever journeyed to some far off place where people don't know that Philly has an accent, someone may have thought you talked a little weird even though they didn't have a clue what accent it was they heard.
The Northeast
The Midland
The Inland North
The South
Boston
The West
North Central
What American accent do you have? Quiz Created on GoToQuiz

Yet, for me, a Philadelphian is someone who says Iggles rather than Eagles, or whadduya? rather than what do you? Decades ago, Philadelphia magazine ran a story, and then a followup, "How to Speak Like a Philadelphian." The authors pointed out that there are many Philadelphia dialects, and provided quizzes from which one could identify not only the neighborhood in which a person grew up but the decade during which they were a child. It would be nice to see those quizzes go online.

So how good is this What American Accent Do You Have Quiz? Let me know.

Some Tax Resolutions the Congress Should Not Make

At the end of December I shared A Proposed Congressional New Year's Tax Resolution. I proposed that Congress "[j]ettison the dozens of exclusions, deductions, and credits directed toward special interests, put an end to special low tax rates, remove the working poor from the tax rolls, and restore progressivity so that someone with $30,000,000 of taxable income is taxed at meaningfully higher rates than someone with $1,000,000 or $400,000 of taxable income." I noted that if Congress properly fixed the income tax, "a genuine reform would permit reduction of tax rates so that there would not be as much incentive for special interest groups to seek special tax breaks and would permit repeal of the AMT."

In yesterday's Philadelphia Inquirer, Jeff Brown shared his Readers' wish list to Congress. The ones focusing on the income tax -- several dealt with the social security system and the estate tax -- provide an interesting insight into how people "think" about the tax law.

Suggestion #1: Eliminate the tax on social security benefits because that constitutes "sticking it to the middle class!" How's that? Every social security recipient escapes taxation on 15% of the receipts, and most escape taxation on much more than that, in some instances escaping taxation on all of their social security receipts. The suggestion is an emotional one. Carefully analyzed, the taxation of social security benefits should reflect two concepts. First, receipts in excess of contributions, constituting economic gain, should be included in gross income. Second, a genuinely well-designed income tax rate structure would ensure that the very rich who receive social security are taxed at higher rates, whereas those whose gross income is on the low side even with social security profits included in it would be taxed a low rates or not even taxed. It is understandable that folks receiving social security on which they are taxed are upset when there are much wealthier people finding ways to receive income free of tax. The solution isn't to expand the nonsense but to curtail it.

Suggestion #2: Capital gains distributions from mutual funds that are reinvested in more shares of the fund should not be taxed until the money is withdrawn from the fund. In other words, a deferral of tax similar to that permitted for like-kind exchanges should apply to mutual funds. The sense of this proposal is simple, namely, whatever justifies deferral of tax when there is a like-kind exchange applies no less to mutual fund reinvestments. But why stop there? Why not permit deferral of all gain (rather than excluding $250,000 or $500,000) when a home is sold and replaced, or when stock is sold and replaced, or when appreciated personal artwork is sold and replaced? There are two answers. First, it would pretty much leave the income tax as a tax on wages (which some people want to see happen), and to prevent revenue loss the tax rate on wages would soar. Second, deferral is an idea has been increasingly restricted, from the repeal of the home sale and replacement deferral in favor of an exclusion to the growing list of transactions not eligible for like-kind exchange treatment. Been there, done that, don't work.

Suggestion #3: Index the AMT for inflation. If all else fails, this is a quick and acceptable, though far from ideal, fix.

Suggestion #4: Repeal the AMT. I'd vote for that if the regular income tax were cleaned up so that the reasons for an AMT were eliminated. Simply put, the regular tax would look much like the current AMT, in terms of fewer exclusions, far fewer deductions, and even fewer credits.

Suggestion #5: Raise the age at which money in retirement plans must be withdrawn. Under current law, distributions must start by the time someone is 70 and a half. The suggestions rests on the idea that leaving money in these accounts permits it to grow tax-free for a longer period of time. So long as the whatever taxable amounts remaining in the account are taxed when the account owner dies, the proposal could be seen as another request for deferral. It makes sense if someone has not retired by age 70 and a half, and perhaps folks who are still working should be permitted to delay withdrawals. Otherwise, the proposal makes little sense.

Suggestion #6: Index capital gains for inflation before applying the special low tax rate. Whoa! A significant justification for the special low tax rate on capital gains is that some of the gain reflects inflation and not real dollars. For years, I've advocated indexing basis for inflation. Once that is done, there is no reason for special low tax rates. The idea of indexing basis while retaining a special low tax rate is another proposal fueled by emotion, the one called greed.

Jeff Brown concludes his article with a wish: "To this reader and all the others who wrote, thanks. Let's hope the new Congress is as wise and fair-minded as you are." Let's hope not. Surely the first and last suggestion are unwise, and two of the others are dubious at best. The third and fourth suggestions, which are two of several alternative solutions to the AMT mess, are the only ones deserving of further consideration. Ironically, what's missing from the readers' suggestions that were shared are some changes that are sorely needed: eliminating the joint return, raising the standard deduction and personal exemption so that they match the poverty level threshold, ditching most credits and deductions, cleaning up the at-risk and passive loss rules, and ending off-shore income evasion mechanisms. Browse MauledAgain and I'm sure there are other suggestions that were overlooked.

Don't Buy Tax Snake Oil

I'm beginning to think that the tax law is complicated principally because people think they are special and others aren't. So we see the addition of tax law provisions written in convoluted terms that are designed to direct the tax breaks to a select few. In other instances, we see complicated statutes and even more complex regulations crafted to preclude the various games that are played to avoid taxes.

Last week a question was posed to the ABA-TAX list. A subscriber described situation involving an S corporation whose shareholders entered into an agreement stating "that the Board of Directors can arbitrarily decide who the profits of the corporation are distributed to." The agreement contained a "set formula" and "some 'bonus based on performance' provisions." Under the formula, the profits would be used to pay the "owner's taxes and to pay enough to
the younger owner to finance his buyout of the older owner."

The attorney who drafted the agreement explained "that the plan allows the ownership percentage to be adjusted to however we want it, thus moving income from the high tax bracket owner to the low tax bracket owner even though the profits were not distributed that way."

The question: "Can they do this?" Stated differently, " Is a corporation allowed to arbitrarily decide annually who is getting and reporting the profits?"

The answer is, "Yes, they can do this but they're going to have a pile of tax problems."

If the profits are distributed disproportionately to stock ownership, the S corporation will have a second class of stock and the S election will terminate. Without going into details, suffice it to say that termination of the S election is bad news.

In addition, if they start changing ownership percentages there's going to be an interesting array of gift tax, stock transfer tax, and income tax (disposition) issues. Unless the stock is worthless (which would make the profit allocation question moot), the outcomes will not be welcomed by the shareholders.

What they're trying to do can be explained in simple terms: A takes the income, B gets taxed. Any student who understands basic tax principles knows that this game was played decades ago and the taxpayers lost. Of course, taxpayers keep trying to find new ways of making B pay the tax on A's economic gain. One has to wonder if the attorney who drafted the shareholder agreement understands the basics of federal taxation, let alone S corporation tax rules.

The subscriber who posted the original question replied that the attorney claims that "the actual stock doesn't transfer ... but the 'phantom stock' plan allows the stockholders to manipulate who
reports what, even if the stock does not change hands." Wow.

The attorney reportedly also explained that, "[a]s for pushing tax to the lower bracketed owner, the agreement says all taxes of the shareholders will be paid by the corporation, so he says
that doesn't matter." Sorry, but it does matter. Because the shareholders are in different tax brackets, the tax paid on behalf of one shareholder's share of the profits will be disproportionate to the tax paid on behalf of the other shareholder's share. This creates a second class of stock. It is an issue specifically addressed in the regulations because some states permit, or require, S corporations to pay state income taxes on behalf of shareholders, in some instances, the non-resident shareholders. Corporations must be careful to make payments in a way that maintains the proportionality characteristic of one class of stock.

It was also reported that the attorney in question is "a pretty renowned tax INSTRUCTOR part time at a university." Oh, my.

The discussion was taking such a strange turn, I had to clarify things. So I asked:

So let me see if I have this.

A owns, say, 30%. B owns, say, 45%. C owns 25%.

The S corporation has profits of $100,000. They want A to get, say, $72,000, but to pay the tax on $30,000?

So if A takes a distribution of $72,000, it's disproportionate and the S election does down the tube.

Oh, wait, so they'll claim that $42,000 of what goes to A is really B's and C's. And what is that? Seems to me there's a gift from B and C to A. Or some sort of taxable event. Either way, big problems.

Oh, no, it is claimed. A owns 72 of the 100 pretend shares. So A can take $72,000 and it won't be disproportionate.

Yes, but what about the attempt to have $42,000 of the $72,000 taxed to someone else? Isn't that assignment of income?

No, comes the reply. We're special. We don't worry about that. That's because we'll pretend that A is paying pretend taxes on the $72,000.

Better yet, we'll have the corporation pay the taxes. There's no deemed distribution there, is there? Oh, no, not more disproportionate distributions? Goodness, we're in an algebraic computational time loop.

What nonsense.

As [another subscriber] pointed out, the only way to split the corporation's earnings in a way that comports with tax law is to pay compensation. It's not a problem measuring it with phantom this or that. There are people who earn compensation based on phantom work. But that compensation must be taxed to the person to whom it is paid, and if the corporation pays the income tax, there's even more compensation. Old Colony Trust ... a case reached very early in the basic tax course, even before the assignment of income cases.

But I doubt such an approach will be satisfactory to shareholders who are trying to do the "I get the money, you pay the tax" routine. It's a routine almost as old as the tax law itself.

So I wonder how long it takes before umpteen dozen students are offering this "phantom plan" to *their* clients, tagging it as renowned. Gee, if enough S corporations do this, maybe it becomes tax law de facto?

Yes, there's more than a wee bit of sarcasm in my inquiry, but why do people insist that somehow they can find a way around a very simple, basic rule? If A owns x% of the S corporation stock, A must pay tax on x% of the S corporation's profits. Any attempt to distribute something to A other than x% of the profits, or to have some other shareholder taxed on some or all of A's share of the profits simply isn't permissible. What's so difficult to understand about that principle? Why are some folks so intent on disregarding it? Do they really believe that they are so special that a different set of rules should apply to their situation?

It gets worse. When another subscriber pointed out that this issue, and similar if not identical plan, had been discussed a few months ago, the subscriber who posed the recent question explained that the previous topic had also been generated by his question, dealing with a different client, same attorney. Apparently the earlier client chose to ignore the attorney's plan. Good move.

So in addition to asking why some people are so intent on trying to create a special set of tax rules that work to their advantage, I also ask why there are tax practitioners who so willingly offer to those people "plans" that supposedly do what those folks want to do? Is the desire for money so strong that people will set aside logic, reasoning, common sense, statutory language, others' bad experiences, and honesty in order to drum up business?

The response to these ploys will be yet more pages of tax law. Tax laws that say "we really mean it." Tax laws that use 30-word phrases instead of a word so that the masters of deception find it even more difficult to peddle the tax snake oil to unsuspecting, though perhaps greedily gullible, taxpayers.

The rule is simple: If A owns x% of the S corporation stock, A must pay tax on x% of the S corporation's profits. It's too bad some people just cannot take it for what it is.

Can Tax Cuts for Shareholders Increase Employee Wages?

Last week, Paul Caron's TaxProf Blog directed me to a Wall Street Journal editorial advocating a cut in corporate tax rates. Why? Because, according to the editorial, if corporate tax rates are cut, the wages of corporate employees will increase. The editorial claims that jobs migrate to nations with the lowest corporate tax rates.

The arguments advanced by the editorial aren't new, and they're plausible. But, for all intents and purposes, they are theoretical. They are based on data that is isolated from context, and disconnected from the many variables that enter into wage determination. Farm jobs exist where crops can be grown. Mining jobs exist where the ores are in the ground. Jobs disappear in war-torn areas. It's not so simple as accepting the plea of starving shareholders, "Give us more money by cutting corporate taxes and we promise we'll hire more people. Honest." More people being hired? At minimum wage? "No, wait," say the shareholders, "we'll increase wages of current employees." The WSJ editorial notes that "the real average wage for non-supervisory employees has risen 2.8%" during 2006. Big whoop. That's $1,200. Does the editorial mention what has happened to the wages of CEOs, CFOs, and other high-level supervisory employees? The editorial claims that employee non-wage benefits have increased, but it's unclear if the editorial is referring to the many stock option and similar deals available to top hat employees.

The editorial also advocates making the "Bush tax cuts" permanent, suggesting that those tax cuts created capital that was translated into those marvelous 2.8% wage hikes. The editorial overlooks the fact that the same fiscal policy caused state and local governments to find tax hikes inescapable, so that some of the wage hikes were diverted to increases in state sales taxes, local property taxes, state income taxes, and similar exactions. Would it not be better to eliminate the special low tax rates for the capital gain and dividend income of the wealthy, increase the progressivity of the tax rates for taxable incomes above $500,000, fix the regular tax so that the AMT could be jettisoned, and then reduce taxes overall so that folks at the low end get a meaningful tax break? Perhaps that would drive down the upward pressure on wages, and bring more workers into the job force so that the cost of labor to corporate and other employees would be mitigated. If all taxes imposed on a person earning $60,000 a year were cut in half, the pressure for a 3% wage increase in 2007 might soften into a demand for a 2% increase, even though purchasing power would continue to increase. Unfortunately, what's really at work here is an arrangement by which the very wealthy control the nation's tax revenue and most of its other income, and dictate who gets what. A very few determine which jobs exist, where they will be, who will fill them, and how much salary they will generate. Their ability to set terms would be constrained if they weren't living with effective 10% tax rates. To suggest that the corporate executives of the Fortune 500 should have even more after-tax money with which to control the economy is the very antithesis of a "free" market. I wonder if the Wall Street Journal realizes that its editorial is in some ways very inconsistent with its alleged core philosophy.

A tax colleague at another school suggested that the solution should be an income tax credit "based on the increase in wage rates for the lowest paid 10% of the workforce in excess of inflation, or the rate of increase in rate of compensation of the five highest paid employees." Though I detest the addition of another credit to the tax code, I much prefer this idea to the one floated by the WSJ editorial. It forecloses the risk that the savings from corporate tax cuts would be plowed into high-end salaries. Perhaps the answer to my "no new credits, please" request is to jettison the other wage credits in the Code and wrap their concepts into this one.

Ideally, corporate profits should be taxed to the true earners of corporate income, namely, shareholders. I have no conceptual disagreement with abolishing the corporate income tax, though I fully appreciate the logistical challenges. In turn, those profits must be taxed at realistic tax rates that treat dollars as dollars regardless of source and that reflect a genuine progressivity that does not treat a person with $400,000 of taxable income as deserving of the same tax rate as someone with taxable income of $4,000,000 or $40,000,000.

One last point deserves attention. So many corporations have structured their dealings in such a way that they do not pay corporate income tax. For those corporations, a cut in the corporate tax rates would be useless. So, too, would be the credit proposed by my colleague, unless it were a refundable credit, and I do not think he had a refundable credit in mind. Thus, the corporate tax rate cut proposed by the editorial would simply eliminate, or come close to eliminating, the corporate income tax without shareholders paying the price for that arrangement. It's not unlike the goals of those who want to eliminate the estate tax without paying the price of taxing unrealized appreciation at death.

It never ceases to amaze me how many people think they have the right to go straight out of the left-turn lane because they're special. It never ceases to amaze me how often some folks come back to the public feeding trough. Corporate shareholders in this nation surely are starving if their trips to the tax food bin are any indication. Hopefully, the new Congress understands that voters aren't willing to take 2.8% wage hikes that are consumed by state and local tax increases in exchange for letting the privileged few enjoy special low tax rates on capital gains and dividends, and regular tax rates short on progressivity. Lest the wealthy think I'm picking on them, perhaps they'd like to think where their incomes will be when the foreign creditors to whom America owes trillions of dollars borrowed to finance the Bush tax cuts arrive to collect their due and take over American businesses. Then who will be taking the high-end salaries? Hopefully these folks' economic roads to Damascus won't come too late.

My Holiday Tax Gift

The family holiday gathering was delayed until yesterday, New Year's Day. Among the gifts I received was one that focused on taxes. There were worries that I already owned it. I didn't. Now I do.

What is it?

It's the "Death and Taxes poster," available from The Budget Graph, and visible in this very large jpg file of the poster. Mine came framed, ready to hang, and so now I must find search my house for an appropriate place in which to hang it. There's no room next to the framed replica of the very first federal individual income tax form. Plus there's a limit to how much tax wall art should be in one room. It could be too overwhelming for guests and visitors. On the other hand, perhaps putting all of these things in one place could provide a litmus test: if you can survive the tax room, you can survive Maule.

As best as I can tell, this particular item wasn't on Paul Caron's list of Christmas Gifts for that Special Tax Person. No link because there are so many of them on TaxProf Blog, so just visit TaxProf Blog and search for "Christmas Gifts for that Special Tax Person."

But where, oh where, are my IRS chocolates?

Tax Year 2006 Closing With A Guarantee of At Least One Good Tax Year 2007 Story

Readers of MauledAgain have emailed me. Reporters have called me. Paul Caron's TaxProf blog alerted me. The news is now a week old. For it was last Friday that the United States Court of Appeals for the District of Columbia Circuit issued an order vacating the judgment in Murphy v. United States, and setting a date and time for briefs and oral arguments in front of the same three-judge panel that rendered the decision in August.

It's not time to repeat my position on the decision. In terms of the analysis, nothing has changed since I shared my thoughts in Why Hold Section 104(a)(2) Unconstitutional When There's No Need to Do So?, It Didn't Take Long: Negative Reaction to My Criticism of the Murphy Decision, The Murphy Opinion and Tax Protesters, and En Banc Hearing in Murphy? Will It Happen? What Will Happen?. The short version is that it is a bad decision. My prediction that the entire D.C. Circuit Court would not permit it to stand seems even more likely to pan out. Of course, I'm far from alone in my opinion or my prediction.

What's interesting is that the case has been set for hearing in front of the same three-judge panel that issued the decision, and not in front of the court en banc. The government had requested an en banc rehearing, and not a panel rehearing. It's unclear how the case ends up as a panel rehearing, though one might guess that the court deemed the request for en banc rehearing to include a request for a panel rehearing. Why not simply grant the motion for an en banc rehearing? My guess is that the full court does not want to embarrass the three-judge panel, and that it is being given an opportunity to change its decision and rewrite its opinion. If the entire court agreed with the three-judge panel, the logical choices would have been to deny the government's motion for an en banc rehearing, or to have granted it and emphasized the full court's agreement with the three-judge panel. The only reason, it seems to me, to put the case in front of the three judges once again is what my children called "do over." I suppose I was wrong when I told them that in real life "do over" isn't an option. It is, this time, for three judges who have a great opportunity to set things to right. I'm also going to guess that most, perhaps all, of the judges on the D.C. Circuit have been reading the commentaries by tax practitioners, tax law faculty, constitutional law experts, and others.

Do I dare predict the outcome? I'm tempted. I think the three-judge panel will revise its opinion. It might, for example, try to remove any suggestion that it supports the position advocated by tax protesters that wages do not constitute gross income. It might, for example, clean up the language that treated section 104 as an inclusion provision. I'm not certain, though, that it will reach a different conclusion.

With oral argument scheduled for near the end of April, it is unlikely there will be anything from the court before June at the earliest. Surely there will be many other tax issues to contemplate while the briefing process and oral argument in Murphy is underway. And we know there will be some more Murphy stories to blog as 2007 moves along.

Speaking of 2007, Happy New Year. Yes, it's a bit early, but I doubt I'll be back with a MauledAgain posting in 2006.

A Proposed Congressional New Year's Tax Resolution

With each passing year, the number of taxpayers subject to the alternative minimum tax (AMT) grows, as does the attention given the issue in mainstream media. It is a popular tax topic for journalists, as evidenced by reports such as this one, particularly because its growing reach does not sit well with those who are brought within it on account of the way the AMT is structured.

Though Congress has tinkered with the AMT to offset some of its growth, the fixes are temporary. When those fixes expire, assuming that they are not extended, as many as 30 million taxpayers may find themselves subject to a tax that was designed to prevent wealthy taxpayers from using tax breaks to reduce their income tax liability.

Some reformers call for repeal of the AMT. Others think that further polishing will solve the problem. For example, one proposal is to make capital gains and dividends that otherwise are taxed at special low rates subject to the AMT. Take a look at Linda Beale's "Congress Fiddles While Middle America Burns: Amending the AMT (and Regular Tax)". Others suggest permanent increases in the threshold amounts below which the AMT does not apply. A few have advocated repealing the regular income tax and letting the AMT be the structure used to compute income tax liability.

I take a very different approach, though I doubt I am the only one to consider it or even to adopt it. To me, the AMT is nothing more than a patch on a very flawed regular income tax. In other words, if the regular income tax were properly designed, there would be no need for a "fix" to deal with the consequences of taxpayers whose regular income tax liabilities are reduced because they take advantage of the deductions available in the tax law. If the regular income tax causes some taxpayers' tax liabilities to be less than what people think they ought to be, and yet those tax liabilities are computed properly, then the problem is in the design of the regular income tax. In other words, the existence of the AMT is proof positive of the flaws of the "regular" tax. Fix the regular tax and there's no need to fix the fix.

The most frequently heard or read disagreement with my approach is a political one. Succinctly, it is easier for a politician to tinker with the AMT than it is to fix the regular income tax mess. It takes far more courage, far more vision, and far more technical savvy to heal the wound than it does to change the color of the band-aid.

Sadly, it probably is true that the Congress, whether controlled by Democrats or Republicans, will not do what needs to be done. Whether it will adjust the AMT remains to be seen, but surely the eternal quest for votes will trigger some sort of relief lest the next electoral results exceed a simple turning out of the incumbents.

The intrusion of politics is unfortunate. Service to country and fellow citizens has taken a back seat to loyalty to party and party bosses. Crafty publicists hawk tax breaks in a superficial manner, leading taxpayers to think they are getting a tax break even though the AMT blocks that tax break from having any real effect. How is this possible? The tax law is so complicated that most taxpayers don't understand that they are being conned. Perhaps it is not a mere oversight that tax law is not taught in the nation's high schools.

What's worse, some people prefer a flawed regular income tax system. They have more to gain by it than from a transparent, honest, efficient, sensible and fair income tax system. The advantage of a flawed tax system is that it permits the folks who think they're entitled to go straight from the left turn lane and to cut in front of everyone who have been waiting patiently to sneak in a special break without anyone noticing, while also tossing in symbolic tax reductions that end up vaporizing under when the AMT is applied.

Nonetheless, I offer this challenge to the newly elected Congress whose members have assumed a mandate of "leading this country in a new direction" to back up their promises with action. Rather than wasting time and intellectual capital arguing over the trivial stuff, take the opportunity to clean up the income tax mess. Jettison the dozens of exclusions, deductions, and credits directed toward special interests, put an end to special low tax rates, remove the working poor from the tax rolls, and restore progressivity so that someone with $30,000,000 of taxable income is taxed at meaningfully higher rates than someone with $1,000,000 or $400,000 of taxable income. Done properly, a genuine reform would permit reduction of tax rates so that there would not be as much incentive for special interest groups to seek special tax breaks and would permit repeal of the AMT. The Pennsylvania individual income tax, with few exclusions, almost no deductions, a handful of credits, a prohibition against using a loss in one category of income to offset income in another category, and a rate of just over 3 percent, simply doesn't attract the sorts of power brokering, back room dealing, hideaway dinner meetings, and disguised lobbyist favors that have infected the federal income tax.

The incoming Congress has a golden opportunity to make a genuine difference. Let's see what it can, and cannot do.

Proof Chocolate is Medicinal: More Reason to Buy Me IRS Chocolates

The other day I commented on IRS chocolate and pointed to it as a gift suggestion. Now comes a much longer-lasting gift. It's in the form of news, described in an article with a fun headline: Chocolate Can Do Good Things for your Heart, Skin and Brain.

Indeed. According to the report, chocolate also increases blood flow, reduces clotting, reduces platelet stickiness, decreases bad cholesterol, prevents cell damage, reduces inflammation, reduces blood pressure, assists muscle recovery after exercise, promotes smoother and moister skin, helps memory, lengthens attention span, reduces reaction time, and sharpens problem-solving ability. But there's no proof it functions as an aphrodisiac.

It has to be dark chocolate. White chocolate doesn't provide the benefits because the flavonoids, the source of the good health, have been removed.

Yes, folks, as I've been saying for years, chocolate is medicinal. Just don't overdose. The good news is that we can drive and operate heavy machinery after taking our daily allotment.

Should Tax Advisors Say "Speed Up the Birth"?

Yesterday, on his TaxProf blog Paul Caron directed our attention to a New York Times story that suggests the recent increase in December births is a consequence of tax law changes. Paul was alerted to the story by none other than Villanova's dean, Mark Sargent. It's always good for law school deans to know how pervasive tax law can be, for it lets them understand the value of tax law professors. Ha ha.

In the story, To-Do List: Wrap Gifts. Have Baby, David Leonhardt provides an interesting array of observations:

1. Modern medical technology has made it easier for women to select a day for their child's birth.
2. For four of the seven years from 1997 through 2003, December has pushed September aside as the month with the highest number of births; data for years since 2003 has not been released.
3. Since the early 1990s, the tax code has provided an increasing number of tax benefits based on the existence of, and number, of a taxpayer's children.
4. The tax value of a child being born before the end of the year, in contrast to after the beginning of the next year, is in the thousands of dollars.
5. Among the tax breaks are the dependency exemption deduction, the child tax credit, the earned income tax credit, and the medical expense deduction.

From these observations, Leonhardt concludes that the tax law is encouraging people to have children in December. He acknowledges that this conclusion isn't easy to accept. He quotes one economist who describes the spike in December births as "astounding." Because there are other reasons people might prefer having their children in December, several economists ran some tests and determined that there was a correlation between tax breaks and birth timing. Leonhardt concludes that of the 70,000 children who would otherwise be born during the first week of January, 5,000 have their births "accelerated" into December "partly for tax reasons." One of the economists thinks Leonhardt's estimate is "conservative."

Two salient concerns jump out at me. The first is whether people ought to plan their child's birth dates with deference to the tax laws. The second is whether people ought to take steps to "accelerate" a child's birth in order to obtain tax benefits.

Perhaps I am naive, or perhaps I am a cynic. I don't think people ought to do things that they otherwise would not do because there is a tax advantage for doing so. The tax law ought to be a factor only when it influences the taxpayer to select one of two or more choices any of which would be acceptable to the taxpayer. Thus, the tax law encourages taxpayers to select a particular form of business entity but it ought not cause a person to operate a business in the first place that the taxpayer would not otherwise choose to own. I've always wondered, and half-jokingly ask my tax students, if people sit around and decide to adopt a child because the Congress enacted or increased the adoption credit. Now I'm beginning to worry that perhaps people do think in those terms. Can you imagine a child being told that he or she was adopted because the tax laws induced the parents to do so? Perhaps I am wrong in thinking that the days of having as many children as possible because there were many acres of farmland to till are behind us. Leonhardt thinks that "[u]nless you’re a cynic, or an economist," it might be too much to think that the tax law has intruded on something so personal as the decision to have a child. I share his astonishment.

But even if one accepts the idea that people who might otherwise not have children decide to do so because of the tax law, or choose to have more children than they otherwise would have because of tax advantages, it is even more difficult to accept the notion that medical technology ought to be used to bring a child into the world before nature says it is time to do so. Aside from medical necessity that demands earlier birthing, doing Caesareans or pumping up the pitocin in order to make certain the child arrives before the ball falls on Times Square is dangerous. Leonhardt points out studies that show infant mortality increases when Caesareans are performed. I'm going to guess there is more risk to the mother as well. Compounding this approach is the increased cost of accelerating a birth. Leonhardt asks if the "health care system should be subsidizing parents' desire for a smaller tax bill." Good question. Easy answer. No. According to Leonhardt, some health care systems are now discouraging voluntary birth acceleration.

Leonhardt suggests a solution, and his suggestion makes sense. The tax advantages pegged to a child should be prorated, so that having a child in December would qualify a taxpayer for a small fraction of what's at stake. The significance of "out before the ball drops" would disappear. Of course, the proration also should apply to other instances where the tax law currently puts a premium on making a personal decision by midnight of December 31. Thus, for example, two individuals who marry on December 31 would be entitled to use joint return rates for 1/365 of their income rather than for all of it.

I doubt Congress will take the suggestion seriously. It's too easy to win votes by proclaiming one's self as pro-family and by proving one's status as pro-family by voting for enactment and retention of tax breaks that reward the acceleration of marriage and births. Never mind that the tax breaks are doing damage to children and mothers.

I don't understand why people who are planning to have children don't simply just have them. So what if the child arrives in September or October? What's the point in delaying the child's arrival until December and then resorting to Caesareans or pitocin to avoid a January birth? The cost of raising the child isn't reduced, and probably increases because inflation will make the cost of raising a child born in December of 2006 slightly higher than the cost of raising a child born in September of 2006. Could people be factoring time value of money into the computation and determining that the highest internal rate of return on having a child occurs when the child is born on December 31? Yikes, I cannot imagine how people whose decisions are based on that sort of reasoning determine how much to spend on an engagement ring or when to present it. "Excuse me, dear, but please stop complaining that you didn't get a ring on Valentine's Day. My financial adviser tells me it's best to pop the question next Thursday." OK.

Yesterday, I closed a commentary posted to a tax professor listserve with this observation: "The sad aspect of the story is that people should have children for every reason other than tax savings. What's next? Investing in a partnership that purchases children instead of oil and gas or real estate investments?" A tax colleague on the West Coast replied, "In many cases, leasing provides greater flexibility and superior discounted cash flow." He got me.

What to Buy, Oh, What to Buy?

Paul Caron, over at the TaxProf Blog has started a series on "Christmas Gifts for that Special Tax Person." His first suggestion, he presents the framed exact reproduction of the original 1913 Form 1040. Oh, well, I already have one of those, a gift from family some years ago. It hangs in my dining room, catercorner to a framed blowup of the BNA Tax Management advertising copy with my portrait on it. Now that is something one won't find in stores. As far as I know, only one other print of that size exists, and the last time the other copy was in front of my eyes was when I walked through the lobby to Tax Management's offices. Considering that a few years have passed, perhaps it has been supplanted and consigned to storage or worse. I hope not. When they decide to toss it, I'd love to have it. Then each of my children can have one when I move on!

It's Paul's second suggestion that has me mesmerized. Did you know there are IRS chocolates? What an unexpected combination. Chocolate and the IRS. Perhaps what makes them good partners is that both operate with bean counters. OUCH, that was really bad. Sorry. Go take a look at Paul's blog, because the photos alone are worth the visit. They come in cases of 50 (though one version comes in cases of 20). Let that not stop anyone who wants to buy me a gift and doesn't know what to get. Don't worry, I'll share. Apparently Linda Galler brought these to Paul's attention. I don't know if Linda sought these out or came upon them by happenstance. Perhaps she, too, has a nose for chocolate. No matter, thanks to Linda for alerting the tax world, and I'm doing my best to spread the news. I know members of my family read this blog. OK, don't complain this year that I never give anyone suggestions. It's true, usually I say, truthfully, that I don't want anything. But this year, aha, these are too good (ouch again) to pass up. The fun question is whether they melt in your hand or in your mouth.

The serious question is whether there is a tax credit for purchasing IRS chocolate. There's a credit for almost everything else. What this country needs is a good chocolate purchase credit. Happy Holidays!

If They Enact It, Will Taxpayers Use It?

Monday's post, Tax Planning Challenges When Congress Dilly-Dallies brought a most interesting response from Andrew Mitchel, the tax chart guru. He points out that delays in dealing with expiring provisions are not the only snags to productive tax planning. Sometimes a provision that is enacted with an expiration date does not get used because of the uncertainties about its continuation. To quote Andrew, with his permission:

I liked your recent blog about people not acting because certain tax provisions expired and they weren't sure if they would be renewed. In a similar vein, I know that I personally have not made any contributions to 529 plans in the past because the law exempting distributions used for educational purposes was to sunset prior to my children reaching college age. This year the exemption was made permanent. I have now made a contribution to a 529 plan and I know of others that have done the same (for the first time).

Not only do expired tax benefits have distortions on intended behavior, but sunsetting provisions have similar effects.

I wonder if the experts who predict how taxpayer behavior will change in response to legislative enactments take this practical information into account. Perhaps their analyses are limited to the theoretical, a trend that is becoming far too prevalent. The famous question, "If they build it, will they come?" can be rephrased, "If they enact it, will taxpayers use it?"