Buying and Selling Dependency Exemptions for Tax Purposes

A reader alerted me to this story. It fits into the “we don’t need to make things up” category that I often mention when posing questions to my students.

A man in Missouri placed an ad on Craigslist. There’s no good way to paraphrase it. Yes, it deserves to be quoted:

WANTED: KIDS TO CLAIM ON INCOME TAXES - $750 (SPRINGFIELD, MO)
IF YOU HAVE SOME KIDS YOU ARENT CLAIMING, I WILL PAY YOU A $750 EACH TO CLAIM THEM ON MY INCOME TAX. IF INTERESTED, REPLY TO THIS AD.

Perhaps surprisingly to some, but not others, the man received replies. On his 2014 federal income tax return, the man listed three dependents by name, social security number, and alleged relationship. One problem was that all three had the same names. Another problem? They had the same social security numbers. Though listed as two sons and one daughter on the 2014 return, on the man’s 2012 and 2013 return they are listed as two daughters and one son.

Not surprisingly to anyone who understands tax law, or even law generally, or perhaps just common sense, the man has been indicted for filing false income tax returns. No word on whether the people who presumably were paid $750 for sharing social security numbers with the man have been, or will be, indicted.

This man would not be in the position he is today had the Congress enacted at least part of the reform proposal I offered more than twenty years ago. In Tax and Marriage: Unhitching the Horse and Carriage, 67 Tax Notes 539 (1995), I suggested “a system based on transferable exemptions,” among other things. Part of my explanation of why I made this proposal anticipated the precise sort of arrangement for which the Missouri man has been indicted:

C. Sales of Unused Exemption Amounts

Individuals with no income, such as the homeless, could benefit by selling their unused exemption amounts to taxpayers, thus putting income redistribution into a private-sector marketplace and removing it from federal bureaucratic inefficiencies. The proceeds would be excludable from income, and the amount paid would not be deductible, for the same reasons the federal income tax is not deductible in computing federal income tax liability. Once sold, the exemption is unavailable even if subsequent audits determine that the individual's income was greater than originally estimated.

This unused exemption amount sale aspect of the proposal is not as mercenary as it initially appears. If unused exemption amounts could not be sold, then tax revenues, or budget deficits, would need to be increased to provide funds for public welfare programs benefitting the impoverished. Permitting impoverished individuals to sell unused exemption amounts transfers to those persons directly the dollars that would otherwise be collected by the federal government and transported through a bureaucratic maze that would reduce the amount reaching those in need by some substantial percentage. In a sense, it would create a 'private market negative income tax.'

To the extent a negative income tax is unattractive because it involves cash grants from the government, the shifting of its incidence to the private sector eliminates direct governmental involvement and casts the exemption sale transactions in a private enterprise light. Though the negative income tax, even in the form of unused exemption amount sales, is considered by some to be a work disincentive, the amount for which the unused exemption amount could be sold would be less than the amount needed for anything more than bare subsistence and would not deter the ambitious or the proud from seeking employment.

Precedent for the sale of governmental benefits can be found in the transfer system permitting businesses to sell or transfer sulfur dioxide pollution allowances. In terms of the policy of permitting transfers, the unused exemption amount is essentially the same as the pollution allowance, because a person without the need for it can sell it to someone who does have such a need. [footnotes omitted]

Of course, the fact that what the Missouri man did would make a good deal of sense had it been permitted under law is no defense to doing something that is impermissible under the law. The man in Missouri surely will end up convicted and punished. It’s too bad Congress cannot be indicted, convicted, and punished for making a mess of the tax system, continuing to make it worse, and refusing to clean it up.

What Gets Taxed If the Goal Is Health Improvement?

Several days ago, in Philadelphia’s Latest Soda Tax Proposal: Health or Revenue?, I questioned whether the latest soda tax proposal in Philadelphia was more a matter of raising revenue than improving health. My question was triggered by my long-held position that if the goal of a soda tax is to reduce the ingestion of sugar, the tax ought to be a sugar tax imposed on far more than just soda. That’s not to say that a sugar tax is ideal, because sugar is far from the only substance that can cause health problems. It’s simply a matter of logic and consistency, and the unfairness of singling out one sugar-containing item while claiming that a tax on that item reflects the health hazards of sugar.

In reaction to the sugar tax proposal, Will Bunch offers the suggestion that the tax ought to apply not only to regular soda but also to diet soda. His suggestion takes two perspectives. One is that diet soda also is unhealthy. The other is that expanding the base of the tax would permit either increased revenue or a lower tax rate.

Bunch makes a good point. It is not dissimilar to my concern that limiting an allegedly pro-health tax to only one of many substances that contribute to poor health is a bit too disingenuous. Bunch has provided a good service to everyone involved in the soda tax debate, by putting the spotlight on a substance that does not contain sugar but that is similarly unhealthy. For decades, so-called sin taxes have been applied to items perceived as dangerous, yet popular, such as tobacco and alcohol. True, those items pose serious health risks. Tobacco is a health risk, period. Alcohol is a health risk when used to excess, and in some instances is beneficial to health. Sugar, too, poses its risks when consumed in high quantity. Removing all sugar from one’s diet also endangers health. But does the list stop with sugar-containing soda, or diet soda? There’s a long list of items that, if consumed excessively, or even at all, pose health risks. In my last post on the issue, I mentioned French fries, red meat, deep fried cheese sticks, churros, popcorn shrimp, and junk food. Bunch widened my perspective. The question becomes, what other items belong in the list? GMO modified foods? Non-organic food? Water from Flint, Michigan? Governments that truly care about health ought to act consistently with that claim, and not use health as an excuse for taxing certain selected items.

Estate Tax or Inheritance Tax, Which Is It?

According to several reports, including this one, New Jersey is considering repealing its estate tax as part of a larger proposal to increase and decrease assorted taxes. New Jersey also has an inheritance tax. Maryland is the only other state to have both an estate tax and an inheritance tax. There is a federal estate tax but no federal inheritance tax.

An estate tax is imposed on the passing of property by a decedent’s estate to the heirs. An inheritance tax is imposed on the receipt of property by an heir from a decedent. In other words, the same transaction is being taxed twice. Yes, there are exemptions and exceptions that limit the scope of the double application but, nonetheless, the dual taxation invites examination of how property passing at death should be taxed.

Generally, the inheritance tax, which is far more prevalent, has a larger reach than the estate tax which, where it exists, usually is limited to larger estates. In terms of curtailing income and wealth inequality, the estate tax does a better job than does the inheritance tax. Inheritance tax exemptions tend to favor transfers to blood relatives. For example, in New Jersey, transfers to children and grandchildren are exempt from the inheritance tax, but transfers to the spouses and domestic partners of children and grandchildren are not. What other purpose could there be for this sort of tax differentiation than the preservation of dynastic wealth?

Those who oppose the estate tax claim that even in the absence of an inheritance tax, it constitutes double taxation. That is true to the extent that funds generated by transactions subject to the income tax are subject to the estate tax. Yet a substantial portion of funds subject to estate taxes are not generated by transactions subject to the income tax because for both federal and state income tax purposes, the unrealized appreciation in property is never subject to the estate tax. I’ve long advocated dismantling the estate tax provided unrealized appreciation is subjected to the income tax. Appropriate provisions for spreading payment of the tax over time can be designed to resemble those that already exist for property such as qualified farms.

So, in other words, the answer to the question, in an ideal tax system, would be “neither.” Instead, the huge unrealized appreciation tax loophole, which has contributed quite a bit to income and wealth inequality, would be eliminated.

Philadelphia’s Latest Soda Tax Proposal: Health or Revenue?

It was more than seven years ago when I first wrote about the soda tax, in What Sort of Tax?. Since then I have revisited the issue at least eleven times, in The Return of the Soda Tax Proposal, Tax As a Hate Crime?, Yes for The Proposed User Fee, No for the Proposed Tax, Philadelphia Soda Tax Proposal Shelved, But Will It Return?, Taxing Symptoms Rather Than Problems, It’s Back! The Philadelphia Soda Tax Proposal Returns, The Broccoli and Brussel Sprouts of Taxation, The Realities of the Soda Tax Policy Debate, Soda Sales Shifting?, Taxes, Consumption, Soda, and Obesity, and Is the Soda Tax a Revenue Grab or a Worthwhile Health Benefit?. The soda tax is on my “top ten most visited topics” list because it has more lives than the proverbial cat.

Philadelphia’s previous mayor proposed a soda tax several times. It failed each time. Among those in City Council voting against the soda tax was the city’s current mayor. Now, according to this story, the city’s current mayor is proposing a soda tax. What would account for the turn-around? The answer appears to be quite simple. The new mayor has discovered that his spending proposals, such as universal pre-kindergarten, community schools, park and recreation center upgrades, and similar projects, require revenue. Rather than raising any existing taxes, he has turned to a tax on certain sugary drinks.

If the concern is health, as soda tax advocates claim, and if a significant cause of health problems is sugar, as soda tax advocates claim, and as research tends to demonstrate, then why not a sugar tax? Why not a tax not only on sweetened drinks, but also on cakes, cookies, pies, donuts, sugared coffee, ice cream, and candy? When soda tax advocates single out certain beverages and label them as “empty calories,” they make two mistakes. One is that something like sweetened ice tea contains more than just emptiness, as tea has been shown to provide health benefits. The other is that some of the sugary items they exempt from the tax are just as lacking in nutrients. Donuts, for example, which are fried and loaded with fat, are no more healthy, and in some ways even less healthy, than soda. For those who are curious, I have not consumed soda for more than two decades and over the past thirty years I may have eaten two donuts and I’m not even sure of that. Nor do I drink iced tea. So a soda tax, as proposed, has no impact on my personal nutrition or wallet.

Research has demonstrated that about 10 percent of deaths related to obesity and diabetes under age 45 can be attributed to consumption of sugary beverages. Surely consumption of cake, pies, donuts, cookies, candy, and carbohydrates generally have something to do with diabetes and obesity at any age. So when the soda tax advocates point to the “10 percent of deaths” study, they overlook the other 90 percent, particularly the portion caused by other items. Why the reluctance to tax sugar generally?

Research into the effects of Mexico’s soda tax indicates that soda consumption dropped when the tax was enacted. That’s not a surprise. But two questions remain. First, did people simply substitute other sugary items, including fruit drinks, which have been exempted from almost all, if not all, soda tax proposals. Second, did the reduction in soda consumption generate any health benefits? As pointed out in Is the Soda Tax a Revenue Grab or a Worthwhile Health Benefit?, it will take years to determine the answer to that question. If people are substituting another sugary item for soda, the best guess is that there would be little, if any, health improvement.

From a tactical perspective, if Philadelphia enacts a soda tax, it will not have the revenue or health effects that are predicted. Philadelphians will simply make their purchases outside of the city, just as thousands of Pennsylvanians avoid the sales tax by driving to Delaware. That journey, by the way, is for most Pennsylvanians a longer trip than the ones Philadelphians would need to make to purchase sweetened beverages outside of the city. Several individuals interviewed by the writer of the news story promised that they would be making these out-of-the-city shopping expeditions. Because the tax would not apply to drinks to which consumers add sugar, such as hot tea and coffee, perhaps the manufacturers of sugary drinks will being selling them without the sugar so that consumers can add sugar as they do to hot coffee and tea. What we have here is a proposal that has not been thought through to its logical conclusion.

Would it not be easier to discuss the advantages and disadvantages of a soda tax if the mayor simply stated, “Look, I opposed the soda tax when the previous mayor, a member of the same political party to which I belong, tried to persuade City Council to enact one. Now that I am mayor, and have plans to spend more money, I need revenue, so that’s why I’ve changed my position on the soda tax.” The fact that the tax would be spent for a variety of programs, and would not be limited to health improvement efforts, makes the “we’re doing this to improve health” argument much easier to dismiss as pretext.

If health was the driving force, why not a tax on French fries, red meat, deep fried cheese sticks, churros, popcorn shrimp, and junk food? But health apparently is not the driving force this time around.

Should Candidates Be Required to Release Tax Returns?

It was with a reaction of “huh?” that I read the news of Mitt Romney criticizing Donald Trump, Marco Rubio, and Ted Cruz for not releasing their tax returns. According to this report, Romney explained that, “I think we have a good reason to believe that there’s a bombshell in Donald Trump’s taxes. I think there’s something there. Either he’s not anywhere near as wealthy as he says he is or he hasn’t been paying the kind of taxes we would expect him to pay, or perhaps he hasn’t been giving money to the vets or to the disabled like he’s been telling us he’s doing.”

It seems ridiculous that a former Presidential candidate whose tax returns highlighted the inequity of the federal income tax system and its enablement of wealth and income inequality would be criticizing another candidate for not “paying the kind of taxes we would expect him to pay.” Did Romney pay the kind of taxes we would expect him to pay?

There are others who are making the same call for tax return release, and many of them pay taxes at effective rates higher than those paid by the wealthy. Thus, the fact Romney’s focus on the issue gets the headline ought not detract from the basic question. Should candidates – for any office, not just for the Presidency – be required to release their tax returns? Those in favor of such a requirement argue that voters should have an opportunity to “see whether there are any issues, noting they will give voters a sense of whether the candidates have been telling the truth about themselves.” If determining whether candidates have been telling the truth, about themselves or anyone or anything else, it’s not just tax returns that provide the necessary information. Would it not be helpful to see the candidates’ emails? Transcripts of their meetings with campaign funding donors and with lobbyists? Recordings of their telephone calls with officials and donors? If, as Romney and others claim, voters need the truth before selecting a nominee or deciding which candidate gets elected, then we need the whole truth and nothing but the truth. Tax returns would be a good start.

So long as tax return release is not required, but happens only on account of political pressure, the question of whether a particular candidate should release his or her returns distracts voters from the real issues. So long as candidates, former candidates, and others speculate about what might or might be on another candidate’s returns – and it is nothing more than speculation – time and attention will be wasted on phantom disputes rather than being devoted to figuring out why the nation is in such an economic, social, and political mess and what needs to be done to clean it up.

Those who argue that mandating tax return release by political candidates will discourage qualified individuals from running for office apparently do not agree that the current practice of not mandating tax return release has not exactly brought us a top-of-the-line outstanding array of candidates. Perhaps the nation would be better off with candidates whose tax returns are boring. And perhaps the nation would be even better off with candidates who not only offer boring tax returns but emails and telephone calls free of influence from moneyed interests and puppet-master donors.

So should candidates be required to release tax returns? Yes, along with everything else that permits voters to see the truth rather than the hype and twisted nonsense that is so freely available.

Section 280A and the Tree House

One of my readers read and article and sent it to me, along with a question. After reading the article, I understand why it caught his attention. It describes a rather uncommon living arrangement. Though the article is from almost ten years ago, it’s one of those many things that we were far less likely to see until the internet made distant events almost as close as our next-door neighbors. According to the article, a forty-five-year-old highway superintendent lives, or at least was living at the time, in a tree house on his parents’ property. The house, more than forty feet above ground, has a shower, a heater, and a ground-level outhouse. The article doesn’t mention a kitchen, but if there is water for a shower there surely is water for a kitchen.

My reader, who, like some of us, often has “tax on the brain,” quickly saw tax issues, and sent some to me. The questions are simple. It arises from thinking, “Suppose the person living in the tree house had a home office? Or rented it out?” The reader asked, “Can a tree house qualify under the Section 280A rules? Can a tree house be depreciated?” Though there’s no direct authority, careful reading of the applicable statute provides an answer.

The section 280A rules apply to dwelling units. Section 280A(f)(1)(A) provides that “The term ‘dwelling unit’ includes a house, apartment, condominium, mobile home, boat, or similar property, and all structures or other property appurtenant to such dwelling unit.” If a house boat is a house, a tree house is a house. It does not matter whether the house is on the water, on the ground, on wheels, or in a tree. To the extent the requirements for depreciation are satisfied, the cost of the tree house is depreciable, no less than the cost of a house boat or mobile home used for a trade or business or in a for-profit activity.

Proposed Treasury Regulation section 1.280A-1 (c)(1) provides that a dwelling unit includes a "house, apartment, condominium, mobile home, boat, or similar property, which provides basic living accommodations such as sleeping space, toilet and cooking facilities." From the facts discerned from the article, if the taxpayer used a portion of that particular tree house as a home office, for example, it would be subject to section 280A. That’s not to say all tree houses would be so treated, because most tree houses do not have running water, cooking facilities, and the other features of a dwelling unit.

Economic Civil War Poses No Less of a Threat Than A Shooting Civil War

A little more than three months ago, in The Fallacy of “Job Creating” Tax Breaks, Yet Again, I shared the news that recent studies demonstrated the inefficiencies of state tax breaks for companies promising to create new jobs in the state. It turns out that the out-of-state companies moving operations into the state and thus getting the tax breaks create one percent of the jobs, while in-state companies managing to get the breaks create 19 percent of the jobs and start-up businesses account for 80 percent of the new employment. I had previously explored the reasons these so-called job-generating tax breaks are unwise, starting with When the Poor Need Help, Give Tax Dollars to the Rich, and continuing through Fighting Over Pie or Baking Pie?, Why Do Those Who Dislike Government Spending Continue to Support Government Spenders?, When Those Who Hate Takers Take Tax Revenue, and Where Do the Poor and Middle Class Line Up for This Tax Break Parade?.

In Fighting Over Pie or Baking Pie?, I described the practice of states persuading companies to relocate from other states through the use of tax breaks was, “from a national perspective, nothing more than a zero sum game.” I added, “States fight over pieces of the private sector by using tax dollars to increase the size of the economic pie that they can grab, while the small business entrepreneurs who actually bake pie struggle because they cannot afford to put huge campaign contributions in the pockets of the politicians using tax dollars to enhance their power.” I predicted, “If state governors and legislators continue down this path, eventually there won’t be any pie for them to fight over.”

In Another Sales Tax Exemption Taking Off as the Economy Continues to Sink, I criticized the developing pattern of states enacting sales tax exemption exemptions intended to lure businesses away from the state, which in turn encouraged enactment of similar exemptions as a revenue defense, which then triggered escalation of exemptions by the other states, in an accelerating trend of sales tax erosion. I concluded my commentary by pointing out the dangers of this pattern of legislative behavior: “Rather than generating new business, states are intent on stealing from each other. Fought with tax policy rather than guns, this modern civil war among the states shows the fundamental flaws of federalism. Constant poaching does nothing beneficial for the national economy.”

There were those who considered my description of this pattern as a "civil war," offering the usual disapproving evaluation of my characterizations, as excessively exaggerated. But now comes more evidence that, in fact, the states indeed are engaging in economic warfare. According to this report, the New Jersey Chamber of Commerce, advocating retention of the various tax breaks enacted by the state, has told a legislative committee, "There's an economic war going on out there." Yes, those were the words: economic war. Not dispute. Not argument. Not disagreement. Not conflict. War. On the other side, opponents of the tax breaks claim that the ultimate cost of those economic weapons is paid with public workers’ pension benefits. Some opponents claim that the cost also is being borne by those who use deteriorating infrastructure and those who have lost mental health care services.

In so many ways, this fight over the national economic pie resembles a shooting war, and is just as deadly in the long run. War often is fought over limited resources, and that is in part what is happening as states grab jobs from each other. War often is funded, not by those who benefit from the war, but from those who are dragged involuntarily into its turmoil, often losing financially as well as psychically. What difference is there, in terms of practical effect, between people suffering from the ravages of war and suffering from the loss of promised retirement benefits? What difference is there, in terms of practical effect, between people suffering from the consequences of bombed-out roads and bridges and the consequences of roads and bridges falling apart because of underfunded and unfunded maintenance?

And when the war ends, albeit usually for just some relatively short period of time, what’s the outcome? A few wealthier people and companies, hordes of dead and impoverished individuals, and no permanent solution to whatever it is that triggered the conflict. Until and unless the underlying causes of economic inequilibrium that has hurled the states into this fight for economic survival, having been identified, are corrected, the pattern will continue, will accelerate, and will intensify. In the long run, no one wins a war, whether it is fought with guns or tax and economic policies. In the long run, all that might remain is rubble.

Yes, Damages for Emotional Distress Are Gross Income

One of the basic principles that students in the basic tax course must learn and understand is that damages for personal physical injuries and sickness are excluded from gross income but damages for emotional distress are not. That’s what section 104 specifically provides.

A recent case, Barbato v. Comr., T.C. Memo 2016-23, drives this point home. The taxpayer worked for the United States Postal Service (USPS) as a letter carrier. In 1987, she was injured in a vehicle accident while on the job. Because of the ensuing physical limitations from the injuries, the USPS reassigned the taxpayer, with her consent, from carrying mail to working in the post office staffing the counter and doing various administrative tasks. When a new manager was appointed, the taxpayer was reassigned to carrying mail, which caused her to suffer more pain. The manager, and other employees, scrutinized her work more closely than that of other employees, retaliating because of her request for medical accommodations, and creating a hostile work environment. This caused the taxpayer to experience severe stress and emotional difficulties.

The taxpayer filed a complaint against the USPS with the Equal Employment Opportunity Commission (EEOC). The EEOC issued a decision, specifying that the taxpayer was “entitled to non-pecuniary damages in the amount of $70,000, for the emotional distress which . . . [she] established was proximately caused by the discrimination” of USPS employees. The EEOC also specifically determined that the taxpayer’s physical pain was not caused by the discriminatory actions of the USPS, explaining that “It is also clear that . . . [the taxpayer] experienced significant physical distress and pain as the result of actions which have not been found here to be discriminatory, and that . . . [her] conditions were exacerbated by non-discriminatory actions which occurred during the same time period that the discriminatory actions were also taking place.” The EEOC noted that “[h]ad all of the physical and emotional distress experienced by . . . [the taxpayer] been caused by . . . discriminatory actions, . . . [she] would have been entitled to $100,000 in non-pecuniary compensatory damages.”

The taxpayer and her husband filed a joint return and excluded the $70,000 from gross income. The taxpayer explained that she considered the award not taxable because her emotional distress was related to her previous physical injury. The IRS examined the return, and issued a notice of deficiency increasing the gross income by $70,000, and adding a substantial understatement penalty. The Tax Court upheld the deficiency, holding that damages received for emotional distress are not excluded from gross income under section 104. However, without explanation, the Tax Court did not sustain the substantial understatement penalty.

These sorts of cases, even though appearing to be crystal clear, do pose challenges for taxpayers. In many instances, the determination of the adjudicator awarding damages does not clearly delineate the split between damages for physical injuries and damages for emotional distress. The distinction came into the tax law at a time when science did not understand as deeply as it does now that emotional distress is caused by biological and chemical changes in the brain. If chemical damage to a person’s skin is a physical injury, why is chemical damage to a person’s brain not a physical injury? It is time for the distinction to be eliminated, but until and unless that happens, taxpayers are caught by it and must file their returns in compliance with what section 104 provides.

One Person’s Sin Is Another Person’s Tax Revenue

Louisiana faces a huge budget deficit. Though I could explore how it ended up with a deficit that threatens cutbacks in essential services, that is something to explore another day. In many ways, it’s not unlike what happened in other states that enacted tax cuts for those who promised that tax cuts would generate robust economies.

The new governor of Louisiana has proposed a variety of tax increases. Among the proposals are increases in the state sales tax, increases in the tobacco tax, and increases in the alcohol tax. Members of the legislature have reacted as one might expect, some supporting the idea of raising taxes, and others determined to oppose tax increases and wield the spending-cut axe. Some legislators and some citizens have provided different responses depending on the tax. As the president of the Louisiana Senate put it, “The sales tax seems to be the one causing the most grief. The sin taxes have more support.”

So why would lawmakers and taxpayers be less opposed to sin tax increases than sales tax increases? The answer, I think, is easy. People tend to examine tax proposals by asking, “How does this affect me?” Almost everyone would look at a sales tax increase proposal as having a negative effect on their finances, at least in the short-term. Many people look at tobacco and alcohol taxes and conclude that because they do not purchase, or purchase relatively little, tobacco or alcohol products, increases in those taxes are no big deal.

There are risks in basing tax policy decisions on how one perceives the effect of changes on one’s particular position at a particular time. What happens when an activity not currently considered a “sin” worthy of taxation becomes the target of tax increase proposals? Societal and cultural norms change. There was a time when tobacco use and alcohol use were pervasive, and those who did not drink or smoke were somewhat out of the mainstream. What mainstream activities of the past several decades will be the basis of “sin taxes” a decade or two from now?

The Tax Runaway

In a letter to the editor in Sunday’s Philadelphia Inquirer, which I could not find on the newspaper’s web site, asserts that Pennsylvania should not impose a severance tax on the shale-gas industry. The writer asserts that if such a tax were to be enacted, the industry would leave Pennsylvania. The writer also claims that the same Marcellus Shale exists in West Virginia and Ohio.

This claim, which has been made by the industry for several years, is nothing more than a test-the-waters threat. If it works, excellent. If it doesn’t, so be it. The risk is that those to whom the threat is delivered, take it seriously.

Why do I not take it seriously? Pennsylvania does not have a shale severance tax. Ohio and West Virginia do. Why would the shale gas industry, opposed to a shale severance tax, implement its opposition by fleeing to a state with such a tax? The reasoning presented by the writer suggests that the industry should be abandoning Ohio and West Virginia, and every other state, considering Pennsylvania is the outlier in terms of the severance tax, as it flees from taxation to a paradise of no or little taxation. But that is not what has been happening.

Consider the child who threatens to run away from home because she dislikes her parents’ imposition of a 9 p.m. curfew. If the child threatens to move in with a friend whose parents impose no curfew and let their children have free run of things, the threat might have some teeth, aside from the question of whether the other parents would open their home with welcoming arms. But if the child threatens to move in with a friend whose parents impose a 9 p.m. curfew, or, worse, an 8:30 p.m. curfew, the threat needs to be treated as the bluster that it is.

There is little or no downside to making threats in order to obtain something. The worst is a loss of credibility, but when credibility does not exist or is not valued, there’s not much to lose. It’s understandable that the industry would take the “there’s no harm in asking” or “no harm in threatening” approach. What’s not understandable is that people are cowed by the threat. The current downturn in oil and gas prices won’t last forever, and so long as there is a profit after taxes, the yet-to-be-extracted oil and gas will be an economic opportunity for someone. If the industry is willing to do business in states with severance taxes, as it currently is doing, it will be willing to do business in Pennsylvania even if it has a severance tax, and especially if that tax is lower than what is imposed by other states.

Relying on Incorrect IRS Advice Spares Taxpayer Penalty

A recent case, Co v. Comr., T.C. Memo 2016-19, demonstrates the challenges for taxpayers who rely on advice from, and decisions by, IRS employees. From no later than 2007 through at least 2011, the taxpayer was paid by the Department of State to do engineering work on various projects overseas. The contractual arrangements and characteristics of those arrangements did not change during those years.

The primary issue was whether the taxpayer qualified for the section 911 exclusion from gross income for compensation earned abroad, but because the exclusion does not apply to employees of the United States or its agencies it was necessary to decide if the taxpayer, who was paid by a United States agency, was an employee of that agency.

On his 2007 and 2008 federal income tax returns, the taxpayer claimed the section 911 exclusion. The taxpayer’s position was that he was not an employee of the United States or any of its agencies. The IRS audited the taxpayer’s returns for those years. The IRS auditor informed the taxpayer that he was entitled to the section 911 exclusion for those years.

The taxpayer also claimed the section 911 exclusion on his federal income tax returns for 2009 through 2011. The IRS audited those returns, concluded that the taxpayer was an employee of a United States agency, and issued a notice of deficiency. The IRS claimed not only the tax liability arising from the denial of the exclusion, but also accuracy-related penalties.

The Tax Court held that the taxpayer was an employee as the IRS claimed, and rejected the taxpayer’s claim that he was an independent contractor. The fact that an IRS auditor told the taxpayer otherwise did not bar the IRS from taking its position. This aspect of the case is not news, as there are dozens if not hundreds of cases in which taxpayers following incorrect advice from IRS employees nonetheless were required to comply with the correct analysis of the tax law.

But when it came to the penalties, the Tax Court concluded that the taxpayer had acted with reasonable cause and in good faith. The penalties do not apply to a taxpayer who so acts. The Tax Court noted that the taxpayer did not have a background in accounting, finance, or tax. Under those circumstances, it was reasonable for the taxpayer to conclude that he was not an employee. The issue facing the taxpayer, namely, whether he was an employee or independent contractor, is an issue that confounds tax practitioners and judges, because its resolution is fact intensive and often rests on very close factual distinctions.

The question of how to deal with incorrect advice from IRS employees has befuddled the tax practice community for decades. On the one hand, it seems unfair to disregard the effects of that advice on the taxpayer’s preparation of a return. On the other hand, it seems unfair to all other taxpayers to permit someone to escape tax liability because an IRS employee is confused about, or ignorant of, the tax law. One solution, stopping IRS employees from giving advice, not only is counter-productive, but would not be a solution in situations such as this one, where the advice came during an audit. Another solution, having a supervisor review the advice would increase costs at a time when the IRS is under Congressional siege. Yet another solution, simplifying the tax law, though possibly reducing the number of times incorrect advice is given, would not solve the problem because sometimes the incorrect advice is given with respect to rather basic tax law questions.

In all fairness, dealing with incorrect advice about the tax law is not a unique problem. Similar issues arise with respect to every other area of the law, such a zoning, traffic regulation, environmental impacts, business licensing, and wills. The bad advice comes from every direction, not just government employees dealing with the issues, but from neighbors, relatives, friends, journalists, commentators, and even professionals in the relevant field. Perhaps better education, not only about the rules but about ways in which people can educate themselves about ever-changing rules, offers the best long-term solution. Perhaps teaching people to think like lawyers ought to begin in elementary school and not 20-some years into one’s education.

More Evidence That False Promise Tax Breaks Fail

Readers of MauledAgain are well aware that I dislike tax break giveaways to wealthy corporations as rewards for moving jobs from one state to another. Job relocation is not job creation. One of the states that engages in this game of giving to the rich is New Jersey. As I’ve described in When the Poor Need Help, Give Tax Dollars to the Rich, Fighting Over Pie or Baking Pie?, Why Do Those Who Dislike Government Spending Continue to Support Government Spenders?, When Those Who Hate Takers Take Tax Revenue, and Where Do the Poor and Middle Class Line Up for This Tax Break Parade?, New Jersey has handed out tax dollars to companies that are doing well for themselves, claiming that by doing so New Jersey residents would get jobs. Instead, the employees of those companies keep their jobs.

In The Fallacy of “Job Creating” Tax Breaks, Yet Again, I pointed out that a report by KPMG and the Tax Foundation matched my previous conclusions: “But when it comes down to it, the tax breaks usually just move firms around a region and, on net, rarely yield much.” I noted that what they did yield was “quite a bit for the corporate owners who are already drowning in cash and profits.”

Now comes yet another report demonstrating that these tax breaks are built on the false promises of job creation. The Center on Budget and Policy Priorities issued a report about a week ago, the title of which offers a clue as to its conclusions: State Job Creation Strategies Often Off Base. The report concluded that “[t]he vast majority of jobs are created by businesses that start up or are already present in a state – not by the relocation or branching into a state by out-of-state firms,” and that “[d]uring periods of healthy economic growth, startups and young, fast-growing companies are responsible for most new jobs, that “businesses older than one year in aggregate lost jobs relative to their prior-year employment levels.”

The report also shared the conclusion of another study, that “only 5% of entrepreneurs cited low tax rates as a factor in deciding where to launch their company.” The report concluded that income tax cuts for businesses do little to generate job growth. The report noted that attempts to bring out-of-state companies into a state end up as “zero-sum attempts.” In other words, tossing out tax breaks based on the promise of more and new jobs when in fact the companies receiving the tax breaks do nothing more than move existing jobs amounts to yet another false promise from the devotees of supply-side economics.

The report makes sense, and its conclusions are not surprising. At a time when the focus should be on national economic growth, the constant luring of a company from one state to another is nothing more than economic civil war. The economic waste generated by lobbying activities focused on reshuffling production within the nation hampers the effort to maintain national economic strength on the global stage. As the report recommends, states should encourage the launching of new businesses and help existing businesses fulfill their potential.

Stupid Criminals, Tax Version

A reader sent me a story that I probably would have otherwise missed. According to several reports, including this one, a woman and her son walked into a Liberty Tax Services office in Toledo, Ohio, pointed what appeared to be a gun over which a towel was draped, demanded money, and made off with $280. Someone in the office hit the son with a chair, but that did not stop him and his mother from escaping. Nor did a Liberty Tax Services employee outside the office door who was dressed as the Statute of Liberty. The two thieves managed to avoid being caught, but their good luck lasted only for a short time. It turned out that the “gun” was a curling iron. And it also turned out that the staff recognized the two as customers who had used Liberty’s services a few days earlier. It apparently didn’t occur to the mother-son team that they had provided Liberty Tax Services with all sorts of identifying information used in preparing their returns. Information like name, address, and social security number. Information that authorities are using to track down the thieves.

Backups, Anyone?

It was the sort of news that spreads so quickly that notices came to me from multiple directions. There was a posting on a tax listserv, an item in a daily tax update email, on-line articles, and newspaper reports. According to an IRS news release, its tax processing systems became unavailable because of a “hardware failure.” According to this report, the failure was caused by “a power or electrical issue.”

All sorts of thoughts passed through my brain. Was the failure caused by a power spike? If so, were surge protection devices in place? If not, why not? If yes, why did they fail? Were they outdated? Worn out? Improperly maintained?

Was the failure caused by a loss of power? If so, did backup generators kick in? If not, why not? Are there backup generators? Are they maintained properly? Are they outdated?

And once the hardware went down, why did the system not shift to backup facilities? Are there backup facilities? Are they maintained properly? Are they up-to-date?

The IRS explained that taxpayers should continue to file returns electronically and that the e-file providers will hold the returns until the IRS is ready to accept them. The IRS also explained that some of its web site services, such as “Where’s My Refund” are not operating even though other parts of its web site are up and running. The IRS expects no “major refund disruptions.” Of course, that depends on getting the hardware failure fixed, identifying the cause, and putting in place safeguards to prevent it from happening again.

Fixing the problem and preventing its recurrence requires money. Perhaps the antiquated status of IRS technology has something to do with this glitch. Imagine the outcry from Congress if a similar failure occurred with Defense Department computers. What Congress appears not to understand is that without a properly functioning IRS, including its technology system, there cannot be a properly functioning Defense Department or any other federal government agency or department, and many state and local government units.

Though some Americans might rejoice at the thought of the IRS being unable to function, the joy will turn to anger when they discover it means refunds aren’t being processed.

And again I ask, backups, anyone?

The Biggest Tax Refund?

The headline to this article caught my eye. It caught my eye primarily because I could see it catching the eye of many people. It appeals to the need or desire for money that affects almost everyone. The headline?

“How to Get the Biggest Tax Refund This Year”

Wouldn’t it be fun to be the taxpayer with the biggest refund this year? Could that happen? What if there is someone out there who paid estimated taxes of, say, $500,000, and ended up overpaying by $300,000, and asked for a refund? How could I possible tweak my tax return to get a $300,000 refund? It isn’t going to happen. And it isn’t going to happen for at least 99 percent of taxpayers.

But perhaps the reference isn’t to the biggest refund this year of all taxpayers, but to the taxpayer receiving a refund this year that is the biggest the taxpayer has ever received. But can that happen? Yes. Is it likely to happen? No.

So I read the article. It contains a list of suggestions about one’s tax return, all of which are common knowledge to tax return preparers, and most of which are familiar to many taxpayers. A taxpayer who might overlook one or another of the tips that are provided but who is made aware of the deduction or other suggestion might end up with a bigger refund than would otherwise be received. Or perhaps with a smaller tax-due payment to be remitted to the U.S. Treasury. The article deserves a headline that reads, “How to Get a Bigger Tax Refund This Year” but that won’t get quite the attention that a headline with “Biggest” in it will bring.