When Analyzing (Tax) Law, First the Facts, Then the Law

One of the points I try to get across to my students is that analysis of the law cannot be undertaken properly until and unless the facts are determined. Yes, it is possible to do legal analysis in the absence of all the facts, but that sort of analysis requires bifurcated reasoning along the lines of “if the facts are X then the analysis is 1 and the conclusion would be sigma but if the facts are Y then the analysis is 2 and the conclusion would be gamma.” That sort of analysis helps in planning transactions, in guiding litigation strategy, in helping someone learn the significance of facts and their impact on analysis, but it doesn’t, of course, resolve disputes or provide definitive answers.

So with one of the goals of a legal education being the importance of paying attention to facts before making legal arguments or engaging in legal analysis, it was disappointing to read what happened in a case brought to my attention by reader Morris. In Benton v. Comr. T.C. Summ. Op. 2020-12, the IRS challenged various deductions claimed by the taxpayer in connection with his picture framing business.

The taxpayer operated his picture framing business out of a house in a residential neighborhood. The taxpayer rented the house, and paid rent of 38,576 to the owner. For unknown reasons, the taxpayer claimed a rent deduction of $42,000 on the tax return. The house included a living room, a dining room, a kitchen, three bedrooms, and two bathrooms. Neither the taxpayer nor his wife resided in the house. The taxpayer testified that he used the house exclusively for business purposes and offered photos to show that he displayed framed pictures and various types of artwork in some of the rooms. One of his customers testified at trial that she visited the house two or three times during the year in issue to pick up photos that the taxpayer had framed for her and it was her impression that he used the house to conduct the framing business. And the parties stipulated that neither the taxpayer nor his wife resided in the house.

The IRS argued that the entire deduction for rent expense should be disallowed because section 280A(a) provides the general rule that a taxpayer may not claim a deduction “with respect to the use of a dwelling unit which is used by the taxpayer during the taxable year as a residence.” The court rejected this argument. It stated:

Respondent’s reliance on section 280A(a) in this case is misplaced. The parties stipulated that petitioners did not reside in the house where [the taxpayer] conducted his business. [The taxpayer] testified that he used the house exclusively for business purposes and offered photos to show that he displayed framed pictures and various types of artwork in some of the rooms. In addition one of [his] customers appeared at trial and testified that she visited the house two or three times during the year in issue to pick up photos that [the taxpayer] had framed for her and it was her impression that he used the house to conduct the framing business. We conclude that petitioners did not use the house in question as a residence, see sec. 280A(d), and that section 280A is not applicable.

Although conducting a picture framing business in a house in a residential community might be considered unusual, we conclude that the rent [the taxpayer] paid was an ordinary and necessary expense within the meaning of section 162(a). The expense was ordinary in that obtaining adequate space to display framed photos and other artwork is one that commonly or frequently occurs in connection with a picture framing business. The expense likewise was necessary in that [the taxpayer] had a convenient place to meet with potential customers and otherwise conduct business with them. It follows that [the taxpayer is] entitled to a deduction for rental expenses of $38,576.

If there had been a dispute over whether the taxpayer used the house for residential purposes, then arguing that section 280A applied would make sense because it would be the logical consequence if the IRS prevailed in showing that the use of the house was not exclusively for business purposes. But there was no dispute on this issue. The parties stipulated that the house was not used for anything other than business purposes. The taxpayer drove that point home with his testimony and that of his customer, but even without that testimony, the IRS had, in effect, conceded the point. Once the fact exists, whether stipulated or proven in a dispute, that the house was not used as a residence, section 280A should not have been given any attention.

Put plainly, lawyers should not make arguments that are inconsistent with the facts. Actually, that advice applies to anyone making an argument about anything. In today’s world, too many people want to jump into a discussion with an argument that appeals to them emotionally without taking the time to determine if the facts are consistent with that argument. Perhaps the title of this post could have been “When Debating Anything, First the Facts, Then the Argument.”

Tax Noncompliance: Greed on Steroids

Readers of MauledAgain know that I have no sympathy for starving oligarchs who use some of their wealth to lobby for tax cuts that increase their wealth by more than the costs of lobbying, who fail to create most of the jobs they claim the tax cuts will permit them to create, and who in some instances respond by cutting existing jobs. Readers also know that I have warned that the failure of Congress to provide adequate resources to the Internal Revenue Service contributes to lax tax enforcement and promises to add to the erosion of revenue already underway because of multiple instances of unnecessary tax handouts to the wealthy and large corporations.

About a week ago, the Treasury Inspector General for Tax Administration issued a report, the title of which serves as a warning: High-Income Nonfilers Owing Billions of Dollars Are Not Being Worked by the Internal Revenue Service. The news is bad.

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

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

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

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

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

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

Another Tax Trap for the Unwary

Not all taxpayers realize that unemployment compensation payments are gross income for federal income tax purposes, and for purposes of state income taxes in some, but not all, states. Not all taxpayers realize that penalties are imposed if withheld taxes plus estimated tax payments are insufficient. In New Jersey, as explained in this article, not all recipients of unemployment compensation are aware that the state is not withholding federal income tax on the $600 portion of unemployment compensation provided by the federal government in response to the virus-caused economic crisis. Even if a recipient wants the New Jersey Department of Labor to withhold on the $600, there is no way to make that happen.

The Department of Labor, when asked, explained that it preferred to get the payments out to unemployed workers as quickly as possible, rather than delaying payments for several weeks while it updated its operating procedures and software. Even though New Jersey withholds federal income taxes on the basic state-provided payments, bringing the supplemental payments within the system is not something that can be done overnight or over a weekend. In the meantime the state is attempting to update the system to permit withholding on the supplemental payments but there is no clue as to when, or if, that will happen. According to the U.S. Department of Labor, New Jersey is not the only state with this issue. It notes that “a number of states” are having “technology challenges” setting up withholding, but I have not attempted to dig into the unemployment payment withholding systems in other states to identify those states, nor do I assume it would be possible to get that information.

States that do not withhold on the supplemental payments must notify recipients that the payments are subject to federal income tax, and must issue a Form 1099-G early in 2021 to the recipients. Recipients thus have two choices. They can make estimated tax payments. Or they can sit back and hope that they qualify for an exemption from underpayment penalties. How are underpayment penalties avoided? First, if the taxpayer owes less than $1,000, the penalties do not apply. Second, there are no underpayment penalties if combined withheld taxes and estimated tax payments equal 90 percent of federal income tax liability or 100 percent of the previous year’s income tax liability (with the 100 percent increased to 110 percent for taxpayer with adjusted gross income over $75,000 (or $150,000 for married taxpayers filing joint returns)).

What this means is that some unemployment compensation recipients may discover that because no federal income taxes have been withheld from the supplemental portion of the unemployment compensation payments, not only will they need to pay taxes in early 2021 with respect to their 2020 federal income tax return, they may also be subject to underpayment penalties. It also is possible that the additional payments push the taxpayer into a higher bracket, so that the withholding on the basic unemployment compensation payments generates an additional tax payment shortfall, because the withholding rate on those payments is only 10 percent.

My advice to any taxpayer is to use an online calculator, or the tax estimation feature of tax preparation software, to get a rough idea of what the 2020 tax situation will be for the taxpayer, and to make estimate tax payments if the calculations suggest the need to do so. The challenge is that many taxpayers are, and will remain, unaware of the problem, and even some of those who realize there is an issue will not concern themselves about it until it is too late. Though it is unfortunate that some states, like New Jersey, are not withholding on the supplemental payments, even if they did, or even if they do, it will not necessarily solve the problem. Failure to make estimate tax payments has been a trap for the unwary for many years, and now will grab even more taxpayers.

No Charitable Contribution Deduction for Donating Services

This time, reader Morris directed my attention to a web page directed at barbers who participate in the St. Baldrick Foundation’s head-shaving events held to raise money for childhood cancer research. Specifically, reader Morris pointed out this question and answer on the web page:

Does the St. Baldrick's Foundation provide a tax write-off for barbers who volunteer their services?

Yes, we do! Please fill out the In-Kind Donation Form and a letter stating your average hourly pay, and turn it in to your event treasurer. St. Baldrick's will issue you a tax receipt for your services!

Reader Morris then commented, “I believe the Foundation issuing a tax receipt for barber services based on average hourly pay is incorrect or illegal. The barber can't deduct the charitable contribution for the value of his{her} time or services.” He is correct. There is no charitable contribution deduction for donating services. Treasury Regulations section 1.170A-1(g) states, “Contributions of services. No deduction is allowable under section 170 for a contribution of services.”

Reader Morris then asked, “Is this tax fraud?” I explained that his question cannot be answered until and unless additional information is ascertained. If those who are issuing receipts stating that a barber has contributed a dollar amount to the Foundation, which appears to be a qualified charity, compute that amount based on the barber’s hourly rate knowing that charitable contribution deductions are not allowed for the donation of services, then it is very likely that tax fraud is being committed. Whether the IRS notices what is happening is a different question, as is the question of whether the IRS would choose to pursue the matter. That decision would reflect the amounts involved, resources available to the IRS, whether its tax fraud investigators are focused on other situations, and its evaluation of how likely it would be that it could obtain a conviction or plea.

It is also possible that those issuing these receipts are unaware of the tax law or have been given bad advice. In this instance, the requisite intent to violate the tax law would be missing and tax fraud would not be an issue. However, there are a variety of negligence and other penalties that the IRS could choose to impose. It also could choose to impose these penalties if it decided that it was not worth pursuing the tax fraud possibility.

The Foundation is located in California. California follows the federal income tax rule prohibiting deductions for donated services. It appears that the Foundation sponsors head-shaving events in other states, but as best as I can determine, every state with an income tax follows the federal income tax prohibition on deducting the value of services donated to a charity. So certainly with respect to events held in California, the possibility of IRS audits, fraud charges, and penalties is compounded by the possibility of California Franchise Tax Board audits, fraud charges, and penalties.

The rationale for the denial of the deduction is worth mentioning. The barber participating in the event could charge the person whose head is being shaved, collect the cash, report the gross income, transmit the cash to the Foundation, and claim the deduction. The net effect on taxable income would be zero. If the barber simply provides the shaving services without charging, the net effect on taxable income should still be zero, and allowing a deduction for the value of the services would be inconsistent with that outcome. Because the person donating services does not include the value of those services in gross income there is no tax basis to support a deduction.

Does the Donor of Brain Tissue Get a Tax Deduction?

That’s the question reader Morris posed to me a few days ago. He directed my attention to a February 2020 article with the interesting title, “How to donate a piece of your brain to science—while you’re still alive.” The article describes how this can be done. When a person undergoes brain surgery, they can agree that “a piece of their brain that would otherwise be tossed away” can be used by researchers to increase understanding of how human brains function, particularly the function of each neuron. Otherwise brain-healthy individuals are not candidates for this sort of donation.

Reader Morris noted that out-of-pocket expenses for brain surgery, whether to treat epilepsy or remove tumors, are medical expenses that qualify for the medical expense deduction. He suggests that the donation of the brain tissue would also qualify for the deduction.

First, I would want to see the contract between the patient and the hospital, the surgeons, and the laboratory. If there is a separate payment to the patient, which I do not think is the case, then there would be no deduction, and the tax consequences would parallel those that I describe in Tax Consequences of Kidney Sales. If, instead, the amount charged to the patient is reduced because of the permission granted by the patient to do research on the brain tissue, the amount qualifying for the medical expense deduction would be similarly reduced.

If the patient is not paid for the brain tissue and is not given a reduced invoice, then the question is different. Because there is no authority, the patient or the patient’s tax advisor must consider the question of whether there should be a deduction. One hurdle that needs to be addressed is putting a value on brain tissue. I don’t know how to do that. I don’t think there is a legal market for brain tissue. But even getting past the valuation question, how would the IRS react if a deduction were to be claimed and the taxpayer’s return audited? My guess is that the IRS would take the position that there is no deduction. I rest my guess on the position that the IRS takes with respect to the donation of blood. The IRS treats the donation of blood as a service and thus places it within the prohibition of charitable contribution deductions for contributing services. Is the IRS position correct? I think it is wrong, but that’s me, though I think there are others who would agree with me.

Interestingly, some states have enacted deductions for donations of organs for transplants. These statutes avoid the valuation issue by specifying a dollar amount. For example, Maryland provides for a $7,500 deduction against Maryland state income tax for an organ donation for transplant, with legislation pending to increase it to $10,000. However, letting a lab do research on a piece of brain tissue is not a donation for organ transplant and would not generate a deduction for state income tax purposes.

More than a few commentators, academics, researchers, politicians, and others have written articles, op-ed pieces, and blog posts advocating for a federal income tax deduction for organ donations for transplants. Unless such a statute were drafted to reach more than organ donations, the patient who permits the lab to do research on otherwise discarded brain tissue would not be entitled to a deduction.

So How Long Does It Take to Read the Internal Revenue Code?

Reader Morris found a doozy. The folks at TaxAct offer a free Tax Code sleep track which they have named Tax Code Coma. Someone had the unenviable task of reading aloud the Internal Revenue Code.

So reader Morris asked me how long it takes to read the Internal Revenue Code. The answer, of course, rests on two factors. One is the number of words in the Internal Revenue Code. The other is the speed with which a person reads.

As to the first factor, it’s been a while since I last computed the answer. I have written about the size of the Internal Revenue Code, mostly in response to absurd claims about the number of pages it fills, in many posts, beginning with Bush Pages Through the Tax Code?, and continuing with Anyone Want to Count the Words in the Internal Revenue Code?, Tax Commercial’s False Facts Perpetuates Falsehood, How Tax Falsehoods Get Fertilized, How Difficult Is It to Count Tax Words, A Slight Improvement in the Code Length Articulation Problem, and Tax Ignorance Gone Viral, Weighing the Size of the Internal Revenue Code, Reader Weighs In on Weighing the Code, Code-Size Ignorance Knows No Boundaries, Tax Myths: Part XII: The Internal Revenue Code Fills 70,000 Pages, Not a Surprise: Tax Ignorance Afflicts Presidential Candidates and CNN, The Infection of Ignorance Becomes a Pandemic, Getting Tax Facts Correct: Is It Really That Difficult?, Reaching New Lows With Tax Ignorance, Incorrectly Breaking Down the Internal Revenue Code, and Is Tax Ignorance Eternal?. When I last did a rough count, I determined that there are about 400,000 words in the Internal Revenue Code. That’s not counting annotations, notations of repealed or amended portions, and references to the specific legislation adding, amending, or repealing provisions. By now, with various additions and amendments, the word count probably is 425,000, but for the sake of determining how long it takes to read the code, I’ll use 500,000.

As to the second factor, the answer depends on how fast a person reads. The average person reads roughly 200 to 250 words per minute. Note that it’s one thing to read, and a totally different thing to understand. Someone trying to understand written text might need to read more slowly, or to go back and reread some or all of the text. The focus of the question posed by reader Morris is read, not understand. If his question had been how long it takes to understand the Internal Revenue Code, the answer would be years at the very least.

The next step is arithmetic. Reading 500,000 words at 250 words per minute means it takes 2,000 minutes to read the Internal Revenue Code. At 200 words per minute, it would take 2,500 minutes. So anywhere from 33 hours to 42 hours. Of course, because no one in his or her right mind would want to, or could even, read for that many hours without taking a break, it would not be surprising for someone who has read the Internal Revenue Code to state that it took a week or two, reading perhaps 3 to 6 hours each day.

The folks at TaxAct, on the page offering the free Tax Code Coma, claim that “It would take 19 days straight to read the entire U.S. Tax Code.” It is unclear how they computed that number. Perhaps they meant to say that it takes 19 days straight to read the Internal Revenue Code out loud. But I doubt that is the case, because the average person reads about 150 words out loud per minute. That would translate to roughly 55 hours. Nineteen days contain 27,360 minutes. Someone reading aloud 150 words per minute could read roughly 4,000,000 words. That suggests they are running with the impossible-to-exterminate erroneous claim that the Internal Revenue Code contains tens of thousands of pages. Over at The Motley Fool, Maurice Backman, disclosing reliance on the 74,000-page Internal Revenue Code nonsense, concludes that it would take 1,200 hours to read the Internal Revenue Code. How many days is that? Fifty. That’s two and a half times what the Tax Act folks computed.

I have read the Internal Revenue Code. No, not in one sitting. No, not cover-to-cover like a novel. But because I wrote a series of Tax Management, Inc., portfolios that covered gross income, deductions, and credits, I had no choice but to read all of those provisions, accompanying procedural provisions, and some other portions of the Code. Many years earlier, before I started writing tax books and articles, I did read the Internal Revenue Code, in an effort to teach myself what I had not yet learned in tax courses. Granted, though I continued to read provisions as they were added and amended, I did not keep up with the excise tax portion of the Internal Revenue Code, so it’s safe to say that at this point there are some Internal Revenue Code sections I have not read in their present form. And, no, my experience is not unique. There are people in this world who have read all of the Internal Revenue Code, though almost certainly not cover-to-cover. Yet we are far and few between. The vast majority of Americans who are subject to one or another federal tax, and that means all Americans, have never read any portion of the Internal Revenue Code. That is, in many ways, unfortunate.

Re-examining Damages When Tax Software Goes Awry

For me, there are advantages to watching television court shows. Whenever I see one that involves a tax issue, or in which tax is a factor, I take the opportunity to write about it. For example, I have written about television court shows involving tax dozens of times, including these posts: Judge Judy and Tax Law, Judge Judy and Tax Law Part II, TV Judge Gets Tax Observation Correct, The (Tax) Fraud Epidemic, Tax Re-Visits Judge Judy, Foolish Tax Filing Decisions Disclosed to Judge Judy, So Does Anyone Pay Taxes?, Learning About Tax from the Judge. Judy, That Is, Tax Fraud in the People’s Court, More Tax Fraud, This Time in Judge Judy’s Court, You Mean That Tax Refund Isn’t for Me? Really?, Law and Genealogy Meeting In An Interesting Way, How Is This Not Tax Fraud?, A Court Case in Which All of Them Miss The Tax Point, Judge Judy Almost Eliminates the National Debt, Judge Judy Tells Litigant to Contact the IRS, People’s Court: So Who Did the Tax Cheating?, “I’ll Pay You (Back) When I Get My Tax Refund”, Be Careful When Paying Another Person’s Tax Preparation Fee, Gross Income from Dating?, Preparing Someone’s Tax Return Without Permission, When Someone Else Claims You as a Dependent on Their Tax Return and You Disagree, Does Refusal to Provide a Receipt Suggest Tax Fraud Underway?, When Tax Scammers Sue Each Other, One of the Reasons Tax Law Is Complicated, An Easy Tax Issue for Judge Judy, Another Easy Tax Issue for Judge Judy, Yet Another Easy Tax Issue for Judge Judy, Be Careful When Selecting and Dealing with a Tax Return Preparer, Fighting Over a Tax Refund, Another Tax Return Preparer Meets Judge Judy, Judge Judy Identifies Breach of a Tax Return Contract, When Tax Return Preparation Just Isn’t Enough, Fighting Over Tax Dependents When There Is No Evidence, If It’s Not Your Tax Refund, You Cannot Keep the Money, Contracts With Respect to Tax Refunds Should Be In Writing, Admitting to Tax Fraud When Litigating Something Else, When the Tax Software Goes Awry. How Not to Handle a Tax Refund, Car Purchase Case Delivers Surprise Tax Stunt, Wider Consequences of a Cash Only Tax Technique, Was Tax Avoidance the Reason for This Bizarre Transaction?, Was It Tax Fraud?, Need Money to Pay Taxes? How Not To Get It, and When Needing Tax Advice, Don’t Just “Google It”.

But, for me, there are disadvantages to watching television court shows. There are so many of them that sometimes I get fooled. How? The other day I noticed the word “tax” in the cable guide, so I paid close attention. It was episode 63 of season 6 of Hot Bench. It began well, with one judge opening the proceedings by describing the case as involving “the thing Americans fear most, being audited by the government.” As I watched and started taking notes, I realized, “Wait! I’ve seen this episode. I think I blogged it.” I checked. Indeed, I had, in, When the Tax Software Goes Awry.

But it wasn’t a total loss of a blogging opportunity. As I watched the episode, a thought occurred to me that had not crossed my mind when I wrote about the case in November of last year. Before describing that thought, I will share the facts of the case as I summarized them last November:

The plaintiffs, a married couple, sued the accountant who prepared their federal and state tax returns. The Commonwealth of Virginia Department of Revenue, after noticing larger than usual deductions and credits, contacted taxpayers, asking for an explanation. In turn, the plaintiffs contacted the defendant, who examined the returns and concluded there had been a software error.

The defendant explained to the court that when he examined the returns, he figured out that the software pulled amounts from the federal return onto the state return, generating erroneous deductions and credits. He also explained that when he spoke to someone at the Department of Revenue, that person informed him that thousands of Virginia taxpayers had been affected by this software glitch. Accordingly, the Department of Revenue waived all penalties but did not have the authority to waive interest.

The plaintiffs argued that the defendant should have noticed the error before filing the returns, and wanted him to pay the entire amount demanded by the Department of Revenue. The defendant replied that it was an error by the software and not his fault. He also pointed out that he was willing to pay the interest owed by the plaintiffs, but that during negotiations the plaintiffs refused that offer because they wanted him to pay the entire amount due, including the tax.

The court concluded that the defendant had not acted intentionally or maliciously and that the tax that was due was an obligation of the taxpayers that they would have paid on time had the software error not occurred. Accordingly, the court held that the defendant was liable for the interest.

As I listened, I began to think more carefully about the decision to issue a decision in favor of the plaintiffs for the amount of the interest they had been required to pay.

In one sense, the defendant’s statement that he was willing to pay the interest tilted the judges’ decision. What would have happened had the defendant not agreed to pay the interest but had refused any obligation to do so?

Yes, it is possible to argue that the defendant’s software error, or more accurately, failure to notice and do something about the error, was the reason that the plaintiffs incurred interest charges, and that the defendant should reimburse the plaintiffs. Had there been no error, the plaintiffs would not have received a larger refund than that to which they would have otherwise been entitled.

On the other hand, the plaintiffs received the use of an excess refund for the time between when their account was credited with the excess refund and when they repaid the excess refund. So though they had to pay interest, they had the use of the money. In effect, they borrowed money. Suppose they had invested the money and earned interest or other income. In that event, how could they claim that they suffered damages, unless the interest rate charged by Virginia exceeded the rate of return they earned on their investment? Imagine borrowing money, investing it, making a return, and having someone else pay the interest on the loan. Even if they consumed the excess refund, for example, by taking a vacation, they were able to do something they otherwise would have been unable to do, because they had the use of money that wasn’t theirs and that they were obligated to repay. Using someone else’s money has value, measured by the interest charged by the lender.

Had I been representing the defendant, from the outset, I would have cautioned him about the dangers of offering to pay the interest, especially when the defendant’s clients wanted him to pay the excess refund. Once the case went to trial, I would have advised the defendant not to disclose the negotiations that failed to lead to a settlement. I also would have argued that the plaintiffs, by having the use of the money, did not suffer damages when they were required to pay interest on the borrowed money. I would have asked the plaintiffs to disclose what they did with the excess refund when it was received.

I don’t know if my approach would have spared the defendant from paying the interest. But I certainly would have taken that position, made the argument, and advised the defendant not to disclose he had offered to pay the interest.

How NOT To Collect Unpaid Taxes

The caption for this morning’s commentary comes from reader Morris. It’s the subject line from his email, though I put “not” in upper case letters for emphasis. When I went to the story he referenced, the headline made me gasp. It reads, “Swiss dog tax: Pay it or your pet dies.” Are you kidding me? Is this from the Onion? Sadly, no, it’s not. Though it is a nine-year old story, and I usually focus on recent developments, this is so shocking I had to express my reaction.

The town of Reconvilier, Switzerland has a yearly dog tax. In American dollars, it’s $48.50. Not surprisingly, some people fail to pay. Town officials decided to make use of a law from 1904, a law “that allows officials leeway to kill dogs as a last resort for collecting unpaid taxes.” Threatening to exercise the power authorized by this law was triggered by the fact some dog owners had failed to pay the tax for years. According to the story, one town official noted that “as recently as the 1960s, [the town] dealt with troublesome dogs in a brutally straightforward fashion.” It’s one thing to put down a rabid dog. But the failure of a dog owner to pay a tax does not make the dog “troublesome.”

The law should never have been enacted. It should be repealed. Until it is repealed, it should be ignored. Not only is it wrong on so many counts, morally, politically, theologically, philosophically, it also would be absurdly ineffective. Killing a dog doesn’t put money into the town treasury. Surely there are some individuals who have failed to pay the tax but who no longer own a dog. Does the law then authorize killing some other family pet that isn’t a dog and with respect to which there is no tax?

Logically, the approach taken when this law was enacted would generate similarly unacceptable statutes. If a person fails to pay a per capita, or head, the person is decapitated. If a person fails to pay a real property tax, the person’s home is burned down. If a person fails to pay an automobile registration fee, the person’s car is taken to the car-crushing facility. I can’t imagine what was going through the minds of those who enacted the 1904 town statute in question.

Fortunately, as the article explains, “the town is facing criticism from all corners.” One town official explained that he has “been overwhelmed by insults and threats" since the town disclosed that it was going to implement the 1904 law. Petitions to stop the town’s plans, such as this one and this one, circulated, and according to this web site, the town council “heard the public outcry and is now proposing to amend or abolish the archaic law so the threat of killing dogs is no longer on the books.”

I have not been able to determine if the law was repealed or amended. My guess is that something was done, and my guess and hope is that town officials found a different, and more sensible, way to collect the unpaid taxes.

When Needing Tax Advice, Don’t Just “Google It”

Those television court shows with a tax angle do come in bunches. There’s another one to add to the list of these shows on which I have commented. They include Judge Judy and Tax Law, Judge Judy and Tax Law Part II, TV Judge Gets Tax Observation Correct, The (Tax) Fraud Epidemic, Tax Re-Visits Judge Judy, Foolish Tax Filing Decisions Disclosed to Judge Judy, So Does Anyone Pay Taxes?, Learning About Tax from the Judge. Judy, That Is, Tax Fraud in the People’s Court, More Tax Fraud, This Time in Judge Judy’s Court, You Mean That Tax Refund Isn’t for Me? Really?, Law and Genealogy Meeting In An Interesting Way, How Is This Not Tax Fraud?, A Court Case in Which All of Them Miss The Tax Point, Judge Judy Almost Eliminates the National Debt, Judge Judy Tells Litigant to Contact the IRS, People’s Court: So Who Did the Tax Cheating?, “I’ll Pay You (Back) When I Get My Tax Refund”, Be Careful When Paying Another Person’s Tax Preparation Fee, Gross Income from Dating?, Preparing Someone’s Tax Return Without Permission, When Someone Else Claims You as a Dependent on Their Tax Return and You Disagree, Does Refusal to Provide a Receipt Suggest Tax Fraud Underway?, When Tax Scammers Sue Each Other, One of the Reasons Tax Law Is Complicated, An Easy Tax Issue for Judge Judy, Another Easy Tax Issue for Judge Judy, Yet Another Easy Tax Issue for Judge Judy, Be Careful When Selecting and Dealing with a Tax Return Preparer, Fighting Over a Tax Refund, Another Tax Return Preparer Meets Judge Judy, Judge Judy Identifies Breach of a Tax Return Contract, When Tax Return Preparation Just Isn’t Enough, Fighting Over Tax Dependents When There Is No Evidence, If It’s Not Your Tax Refund, You Cannot Keep the Money, Contracts With Respect to Tax Refunds Should Be In Writing, Admitting to Tax Fraud When Litigating Something Else, When the Tax Software Goes Awry. How Not to Handle a Tax Refund, Car Purchase Case Delivers Surprise Tax Stunt, Wider Consequences of a Cash Only Tax Technique, Was Tax Avoidance the Reason for This Bizarre Transaction?, Was It Tax Fraud?, and Need Money to Pay Taxes? How Not To Get It.

This time it is episode 155 of Hot Bench season 6. The plaintiffs entered into a contract to purchase a home from the defendant. There was a contingency in the contract that required the plaintiffs to prove that they had sufficient liquidity to make the purchase in the event that the defendant received a better offer. The defendant did get a better offer, notified the plaintiffs, and asked for proof of liquidity. The plaintiffs provided the defendant with a bank account statement and a stock account statement.

The defendant, who admitted she was not a lawyer, treated the stock account statement as a 401(k) plan statement even though nothing on it indicated that it was a 401(k) plan statement. The defendant explained that she then “googled it” to find out how much of the stock account statement could be withdrawn to purchase a home She determined that only $50,000 could be taken out of the account to purchase a home.

The plaintiffs testified that they had informed the defendant’s real estate agent that the account in question was a stock account. They also testified that they gave the agent guidance on learning more about how long it would take to get cash out of the account and the process through which they could do so.

The defendant, relying on her conclusions with respect to 401(k) plans, cancelled the contract. The defendant did not give any explanation for why she treated the stock account statement as a statement with respect to a 401(k) plan.

The defendant admitted she did not seek professional advice with respect to the liquidity available to the plaintiffs from the two accounts. In fact, the plaintiffs had much more liquidity in the two accounts combined than they need to purchase the home outright for cash.

The plaintiffs had sued not only for return of the deposit, but also for the expenses they incurred because of the cancellation. For example, because they had already entered into a binding contract to sell their existing home, they had to pay rent for temporary living quarters.

The court entered judgment for the plaintiffs in the entire amount they sought. One of the judges pointed out to the defendant that using google to interpret a sophisticated legal contract is unwise. Indeed.

The Meaning of an Interesting Phrase in a Tax Law

Like most states. Michigan has a sales tax. Like most states with sales taxes, Michigan provides for exemptions from its sales tax. Here is the relevant language from the statute:

GENERAL SALES TAX ACT (EXCERPT)

Act 167 of 1933

205.54a Sales tax; exemptions; limitation.
Sec. 4a.
(1) Subject to subsection (2), the following are exempt from the tax under this act:
* * * * *
(e) Except as otherwise provided under subsection (3), a sale of tangible personal property to a person engaged in a business enterprise that uses or consumes the tangible personal property, directly or indirectly, for either the tilling, planting, draining, caring for, maintaining, or harvesting of things of the soil or the breeding, raising, or caring for livestock, poultry, or horticultural products, including the transfers of livestock, poultry, or horticultural products for further growth.(emphasis added)

So what are things of the soil? The Court of Appeals of Michigan recently had an opportunity to answer that question.

TruGreen, a lawn care company, requested a refund of use taxes it had paid on “fertilizer, grass seed, and other products” that it uses to care for lawns. It took the position that these purchases fell within the exemption for “things of the soil.” Not surprisingly, the Michigan Department of Treasury rejected the refund claim, causing TruGreen to expand its refund claim for use taxes paid during the past four and a half years. TruGreen requested a conference with an independent referee, who agreed with TruGreen, but the Department decided not to pay the refund. So TruGreen sued in the Michigan Court of Claims, which held in favor of the Department. TruGreen appealed to the Michigan Court of Appeals.

In its decision, two of the court’s three judges held for the Department. One of those two judges wrote a concurring opinion. The third judge dissented.

The majority rejected TruGreen’s argument that because it plants and cares for grass it is engaged in “caring for things of the soil.” The majority considered TruGreen’s interpretation of the text to be erroneous because it was made “in isolation from the rest of the text.” Relying on the principle that tax exemption statutes should be strictly construed, the court noted that although “grass and trees” are “things of the soil,” the latter phrases is “surrounded by words describing activities that take place on farms.” The majority concluded that “things of the soil” means “the products of farms and horticultural businesses, not blades of well-tended grass.” The majority also concluded that “the Legislature intended the exemption to apply to agricultural activities,” and that “read as a cohesive whole, [the statute] was and is intended to benefit businesses that contribute to our state’s agricultural sector.” The court noted that in previous decision Michigan courts had referred to
the statute in question as the “agricultural-production exemption.”

The judge who concurred did so to “address some aspects of the dissenting opinion.” The dissent rested on the ideal that “things of the soil” is not a term of art. The concurring judge disagreed. The concurring judge also disagreed with the dissent’s argument that the definition of “things of the soil” can be found in a dictionary. The concurring judge also argued that for the 70 years the exemption has been in existence, “no case has ever suggested” that residential lawns are within the scope of “things of the soil.”

The dissent pointed out that the legislature did not use, though it could have used, the phrases “agricultural products” or “products of the soil,” but instead used the phrase “things of the soil.” It also pointed out that a proposed amendment to add the words “for agricultural purposes” after the words “things of the soil,” a change supported by the Department, failed to survive in the legislation that was enacted. The dissent noted that the original exemption was enacted for “agricultural producing” but was changed to “things of the soil,” and that this change must have meaning, namely, that “things of the soil” encompasses more than “agricultural producing.”

What none of the judges mentioned, and my guess is that neither of the parties mentioned, is the language used by the Michigan legislature in another exemption. One of the exemptions provided by Michigan to its property tax is found in this statute:

THE GENERAL PROPERTY TAX ACT (EXCERPT)

Act 206 of 1893

211.9 Personal property exempt from taxation; real property; definitions.

Sec. 9.

(1) The following personal property, and real property described in subdivision (j)(i), is exempt from taxation:

* * * * *

(j) Property actually used in agricultural operations and farm implements held for sale or resale by retail servicing dealers for use in agricultural production. As used in this subdivision, "agricultural operations" means farming in all its branches, including cultivation of the soil, growing and harvesting of an agricultural, horticultural, or floricultural commodity, dairying, raising of livestock, bees, fur-bearing animals, or poultry, turf and tree farming, raising and harvesting of fish, collecting, evaporating, and preparing maple syrup if the owner of the property has $25,000.00 or less in annual gross wholesale sales, and any practices performed by a farmer or on a farm as an incident to, or in conjunction with, farming operations, but excluding retail sales and food processing operations.

It is clear from the language that the exemption applies to agricultural operations and agricultural production. The legislature did not use the term “things of the soil.” This adds a substantial amount of strength to the argument that “things of the soil” is different from, and broader than, “agricultural products.” Yet the majority opinion concludes that “things of the soil” means “agricultural production.” That conclusion flies in the face of the fact that the legislature used two different phrases, something inconsistent with the claim that both exemptions are intended to have the same scope. I wonder why neither party directed the court’s attention to the language in the property tax exemption.

Need Money to Pay Taxes? How Not To Get It

Another television court show with a tax angle popped up on the screen recently. The list of these shows on which I have commented continues to grow, including Judge Judy and Tax Law, Judge Judy and Tax Law Part II, TV Judge Gets Tax Observation Correct, The (Tax) Fraud Epidemic, Tax Re-Visits Judge Judy, Foolish Tax Filing Decisions Disclosed to Judge Judy, So Does Anyone Pay Taxes?, Learning About Tax from the Judge. Judy, That Is, Tax Fraud in the People’s Court, More Tax Fraud, This Time in Judge Judy’s Court, You Mean That Tax Refund Isn’t for Me? Really?, Law and Genealogy Meeting In An Interesting Way, How Is This Not Tax Fraud?, A Court Case in Which All of Them Miss The Tax Point, Judge Judy Almost Eliminates the National Debt, Judge Judy Tells Litigant to Contact the IRS, People’s Court: So Who Did the Tax Cheating?, “I’ll Pay You (Back) When I Get My Tax Refund”, Be Careful When Paying Another Person’s Tax Preparation Fee, Gross Income from Dating?, Preparing Someone’s Tax Return Without Permission, When Someone Else Claims You as a Dependent on Their Tax Return and You Disagree, Does Refusal to Provide a Receipt Suggest Tax Fraud Underway?, When Tax Scammers Sue Each Other, One of the Reasons Tax Law Is Complicated, An Easy Tax Issue for Judge Judy, Another Easy Tax Issue for Judge Judy, Yet Another Easy Tax Issue for Judge Judy, Be Careful When Selecting and Dealing with a Tax Return Preparer, Fighting Over a Tax Refund, Another Tax Return Preparer Meets Judge Judy, Judge Judy Identifies Breach of a Tax Return Contract, When Tax Return Preparation Just Isn’t Enough, Fighting Over Tax Dependents When There Is No Evidence, If It’s Not Your Tax Refund, You Cannot Keep the Money, Contracts With Respect to Tax Refunds Should Be In Writing, Admitting to Tax Fraud When Litigating Something Else, When the Tax Software Goes Awry. How Not to Handle a Tax Refund, Car Purchase Case Delivers Surprise Tax Stunt, Wider Consequences of a Cash Only Tax Technique, Was Tax Avoidance the Reason for This Bizarre Transaction?, and Was It Tax Fraud?.

Today’s post is based on episode 83 of Judge Judy’s season 24. The plaintiff’s husband died in an automobile accident, and she received a $20,000 settlement. The defendants were a husband an wife. The plaintiff’s husband had worked with the defendant husband, and through them, the plaintiff and the defendant wife became friends.

The defendants fell behind trying to pay their property taxes. The defendants claim that the plaintiff offered them some money to help them out. The plaintiff disagreed, claiming that she transferred money to them after they asked. Judge Judy pointed out that people don’t ask others out of the blue if they are behind in their taxes or if they need money. Surely, she concluded, the defendants had brought their financial troubles to the attention of the plaintiff. Defendant wife then admitted that she mentioned to the plaintiff that they were behind in paying their property taxes. She also claimed that she was going to go to the bank to get a loan. She also claimed that the plaintiff said that she would pay the defendants’ taxes, would not seek repayment, and would treat it as a gift.

Asked why the plaintiff would make a gift to the defendants, the defendant husband claimed that he and his wife previously did things for the plaintiff when the plaintiff’s husband died and at times thereafter, such as taking her on errands. He also claimed they offered to pay back the money to the plaintiff.

Judge Judy pointed out that the defendants had no problem paying their property taxes until the plaintiff received her settlement. Then suddenly they had trouble paying property taxes. The defendant husband claimed that they were short on money to pay property taxes because in the previous month they had used the money for unexpected repairs required for their truck.

The plaintiff claimed that there were other monies and a television transferred from the plaintiff to the defendants. The defendants denied the additional money transfers. They admitted the plaintiff had transferred a television to them, but that it also was a gift for what they had done for the plaintiff. Judge Judy pointed out that they had already used that as justification for the transfer of money to pay the property taxes. The defendants had previously testified that the plaintiff asked them to help her put the television in her apartment but they declined to go there because their cousins lived in the same complex and the defendants had a restraining order against the cousins. Judge Judy told the defendants that they were offering conflicting stories about the television.

The defendants counterclaimed, alleging that the plaintiff had made false allegations accusing them of elder abuse. The plaintiff had filed a complaint, and a social worker concluded that the allegation of financial exploitation was false. Judge Judy dismissed the social worker’s conclusion by noting that the social worker should “go back to school.”

Judge Judy described the defendants as two people taking advantage of an elderly lady. The defendants countered that the judge’s statement was inconsistent with the fac that the defendant husband was putting money into the plaintiff’s bank account. The defendants wife claimed that the plaintiff put the defendant wife’s name on the plaintiff’s bank account. Judge Judy gave no weight to these claims. She dismissed the counterclaim and entered judgment for the plaintiff, in the full amount of the money transferred along with return of the television.

The lesson from this case isn’t about substantive tax law or tax procedure. It’s something much simpler. When a person is having difficulties coming up with money to pay taxes, there are a variety of steps the person can take. The person can borrow money from a bank. The person can contact the appropriate tax authority and work out a payment plan. What the person ought not to do is to take money from someone, and then offer conflicting explanations about that transfer. To argue that it was a gift, but to also claim that repayment was offered is a red flag warning that something is amiss. One wonders whether they actually were having problems finding money to pay taxes or if, as Judge Judy noted, they simply figured they found a way to share in what they thought was the plaintiff’s windfall.

Actually, there is another lesson to learn from the case. If making a transfer to someone that is intended to be a loan, put the arrangement in writing if the amount is an amount that needs to be returned. Relying on friendship and trust might be noble, but the law requires more.

Using a Tax Agency to Collect Tithes: A Very Bad Idea

A little more than a week ago, in Using a Revenue Agency to Collect a Fine Does Not Convert the Fine Into a Tax, I answered a question from reader Morris, who asked whether using a tax agency to collect a fine converted the fine into a tax. My response was no. Using a tax agency’s collection mechanism to compel payment of a non-tax obligation is a practice in which a number of jurisdictions have used for many years. I pointed out that the IRS used to collect past-due federal taxes, unpaid state income taxes, certain state unemployment compensation repayments, child support obligations, spousal support obligations, and nontax federal debts such as student loans. I shared my observation that legislators eager to cut funding for revenue agencies because they don’t like taxes are rather quick to assign non-tax debt collection tasks to those same agencies.

Reader Morris followed up with a similar question, referring me to this story that describes a request from the Catholic archbishop of Kampala, Uganda, asking the government to collect on behalf of the church the 10 percent tithes that its members are encouraged to pay to the church. Reader Morris asked if the government agrees to do the collecting, does it convert the tithe into a tax. Again, the answer is no. I explained that the collected money goes to a non-government recipient, a church, just as child support collected by the IRS goes to the custodial parent and not a government. Using the government’s money collection apparatus to collect money does not make the collected money a tax.

Not surprisingly, thousands of Catholics have objected to any cooperation by the government in this collection effort. One person pointed out that giving to the church is voluntary and should not occur under threats from church authorities. They argue that using a government to collect tithes violates Catholic teachings. Leaders of other faiths also criticized the request. Some argued that Scripture does not support governments collecting tithes on behalf of churches.

The Ugandan archbishop offered as a model a provision in Germany under which the government collects a “church tax” for the Catholic Church. Critics claim that millions of people have left the church because of the German law. The archbishop wants the government to deduct the tithe from the wages of Catholics because the church is low on funds and many members do not voluntarily tithe. According to the archbishop, "The Bible says a tenth of whatever you earn belongs to the church, and you should give me support as I front this proposal because it is good for us."

Could it happen in this country? It should not. One of the motivations for the First Amendment separate of church and state was opposition to taxes imposed on colonists to support the payment of salaries for clergy in whatever denomination held power in a colony taking this approach. Of course, this tax was just one of many steps taken by dominant denominations to control a colony’s religious practices. Of course, there are those who argue that tax exemptions for churches are the equivalent of spending taxpayer money for those churches. With respect to property taxes, many churches pay user fees, and the question can be resolved by shifting as much of the general property tax to user fees. With respect to income taxes, most churches incur expenses that match income, but those for-profit religious enterprises that somehow bring millions into their fold of course should be paying income taxes.

Having a government collect revenues on behalf of a church is wrong. It invites religious denominations to fight for political dominance and opens the door to the winner of that struggle battle trying to impose its beliefs on the population. The Puritans in Massachusetts did that, until, among others, Thomas Maule challenged their authority and was acquitted of the charges they brought against him for opposing their religious dictatorship. Today, their theological descendants continue trying to compel others to adhere to their beliefs.

My response to churches trying to get governments to collect taxes on their behalf or trying to force their belief system on a country is simple. If a religion or denomination cannot attract and retain adherents, or persuade them to contribute, without the use of physical or legal force, it is demonstrating, by its very plea for government collection assistance or the desire to compel membership, that it lacks justification. It is not the business of government to prop up churches or function as their debt collectors.

Reading Tax Instructions Is Important But Why Not Make Things Easier for Taxpayers?

Reader Morris sent me an email titled “Read tax instructions carefully." I knew he wasn’t trying to get ME to read tax instructions carefully, so what was this about? He included a link to this story about an Oregon taxpayer, Michael Miller, who ran into problems when trying to donate a portion of the state’s “kicker credit” to the Oregon Department of Education. What happened?

Oregon has a “kicker credit” that permits taxpayers to claim a credit on their state income tax returns if state revenues for any two-year budget period exceed projected revenues by a specified percentage. Oregon permits taxpayers to choose between using the credit to reduce their state income tax liability or donating the credit to the Oregon Department of Education. Miller, using Turbo Tax, explained that he checked a box next to a Turbo Tax instruction that stated, “If you elect to donate your kicker to the State School Fund, check this box.” After checking the box, Turbo Tax inserted $75 in the following column. Miller decided that although “$75 is a lot of money,” he would make the donation because it was going to help schools needing help.

A few weeks later, Miller received a letter from the Oregon Department of Revenue, telling him that his state income tax return was being adjusted so that all $1,185 of his kicker credit would be donated to the Department of Education. Miller, understandably, was upset, and his distress was exacerbated when he learned that his decision to check the donation box was irrevocable. He complained, “It didn’t warn me” that “You are donating your entire kicker.”

A Department of Revenue spokesperson replied that “it’s important to read the tax instructions closely” and that taxpayers cannot donate just a portion of the kicker credit. Taxpayers who want to donate a portion need to avoid checking the donation box, and then to write a check t the Department of Education.

That seems to be a clunky way to administer the credit and the donation. It certainly is possible to program the software used by the Department of Revenue to separate the kicker credit into two portions, one to be transmitted to the Department of Education and the other to be applied to the taxpayer’s tax liability. The IRS and state revenue departments permit taxpayers to split overpayments into two portions, one to be refunded and the other to be applied to the following year’s estimated tax payments. So we know it can be done. In a day and age when electronic communication has become so widespread and even necessary, asking taxpayers to write checks to be sent through the mail seems so antiquated. Worse, taxpayers are less likely to share a portion of their kicker credits if they must engage in a separate transaction by writing a check than if they can simply indicate on the tax return how to split the credit.

I was unable to determine whether the “donate all or nothing” rule is based on statute or is something dictated by the Department of Revenue. For me, the answer to that question simply specifies who needs to fix the problem. True, if it’s a departmental regulation, it’s much easier to fix and can happen more quickly than if the legislature needs to make changes.

Fortunately for Miller, filing deadlines for 2019 returns have been extended because of the pandemic. Miller plans to file an amended return to remove the attempted donation. Even though the election is irrevocable, apparently it can be reversed through an amended return, because the Department of Revenue recommended that Miller file the amended return. It isn’t clear whether he plans to write a $75 check to the Department of Revenue. If he doesn’t, it’s unfortunate that someone’s decision to make the donation an “all or nothing” deal means $75 less for Oregon’s school children.

A Tax That Won’t Accomplish Its Purpose

Governments around the world are facing the challenge of persuading and compelling people to maintain physical distancing. Understandably, most people do not prefer to self-isolate or be in quarantine. Most people get tired of staying at home very quickly. Different governments take different approaches to achieving their physical distancing goals. Almost all use various sorts of announcements and publication of rules. Enforcement officials in some cases issue warnings. In other instances, tickets are issued and fines are imposed. In still other situations, arrests are made.

Government officials in Delhi, India, have come up with an interesting approach to dealing with the failure of people to comply with physical distancing. According to this story, these officials have enacted a tax of 70 percent on retail alcohol purchases. The stated goal is to “deter large gatherings at stores” while lockdown restrictions are gradually eased.

When I read the story, several questions popped into my head. Even if a tax on alcohol reduces the size of crowds at alcohol stores, how does it encourage those who are present to maintain physical distancing? Even if a tax on alcohol somehow encourages physical distancing at alcohol stores, how does it bring about physical distancing at grocery stores, hardware stores, clothing stores, shoe stores, and other retail outlets?

The answer, I think, to each of those questions is, “It doesn’t.” So if the question is, “Why enact that tax?” the answer is found in the fact that alcohol taxes are significant portion of the revenue stream for most of India’s states and territories. And, of course, like other governments around the world, they are facing severe revenue shortages.

This sort of tax is regressive. Its computation does not take into account the economic status of the alcohol purchaser. If the tax does deter some people from purchasing alcohol, it will be the poor and lower middle-class that don’t show up. The wealthy can afford to pay the tax, and they can order online or pay a poor person to stand in line.

There are other ways to encourage or enforce physical distancing at stores. Decades ago, when gasoline shortages generated long lines at service stations that spilled into roads and disrupted traffic, officials in some states put into place an even-odd license plate final digit system. This halved the number of vehicles waiting for gasoline on a particular day. Depending on the item being sold, purchasers can be separated on the basis of a variety of benchmarks, such as first letter of surname, first digit in home address, or some other similar characteristic.

One official commented that if physical distancing is violated, the government “will have to seal the area and revoke the relaxations there.” Though that makes sense, it does not make the tax in question sensible. Using taxes to encourage social behavior is, at best, only very marginally effective and then only in certain limited circumstances. That is especially the case when it seems the tax is intended to raise revenue rather than affect behavior though marketed as a means of controlling behavior.

Why Tax Law Is More of a Mess Than It Needs to Be

Ever wonder why the federal income tax law is a mess? Ever wonder why it keeps getting changed? Ever wonder why it’s unclear. Here’s a good example.

One of the relief provisions enacted by Congress in the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) is the Paycheck Protection Program (“PPP”). As explained by the Small Business Administration (“SBA”), under the PPP loans are provided to small businesses to help them keep workers on the payroll. If a business keeps all of its employees on the payroll for at least eight weeks and uses the loan money for payroll, rent, mortgage interest, or utilities, the SBA will forgive the loan.

That brings us to the tax aspect of PPP. Under section 1106(i) of the CARES Act, if the loan is forgiven, the amount of the loan forgiveness is not included in gross income. This is an exception to the general rule that includes loan forgiveness in gross income.

In Notice 2020-32, the IRS explained that expenses paid with the proceeds of a forgiven PPP loan cannot be deducted. It based its conclusion on Internal Revenue Code section 265, and Regulations section 1.265-1, which provide that “no deduction shall be allowed for . . . any amount otherwise allowable as a deduction which is allocable to one or more classes of income other than interest . . . wholly exempt from the taxes imposed by this subtitle.” Citing several cases, the IRS explained that paying these expenses with the proceeds of a forgiven loan is equivalent to paying expenses and then being reimbursed. As any student of federal income tax law understands, a taxpayer who is reimbursed for paying an expense either includes the reimbursement in gross income offset by deducting the expense or excludes the reimbursement from gross income while not deducting the expense. Either way, the net effect on the taxpayer’s taxable income is zero. That makes sense because both in the case of reimbursement and in the case of the forgiven loan, the taxpayer is neither richer nor poorer, and thus taxable income is unaffected.

It didn’t take long for taxpayers and members of Congress to complain about the IRS Notice. Some tax advisors argue that because the CARES Act does not expressly deny the deductions, they ought to be allowed. Of course, if those tax advisors looked at the text of section 265 they would see that the answer to the question of whether the deductions should be allowed already is in the Internal Revenue Code. The answer is no.

One tax advisor, according to this report, claims that for taxpayers who are denied deductions means that “in effect they’re paying tax on this loan, which makes it worth less. Losing a deduction is the same as being taxed on something.” The lack of logic in this argument is appalling. Losing a deduction is not the same thing as being taxed on something if the something is, as is the case, excluded from gross income. Under this advisor’s argument, which apparently others share, the taxpayer should not only escape being taxed on the loan forgiveness but also should get a deduction that, in effect, has been paid by the Treasury (translation, other taxpayers) and not by the taxpayer. This advisor explains that “he believes PPP loan money wasn’t intended to be treated like normal tax-exempt income under the law.” We’ll get to that issue in a moment, but tax law should be based on reasoning and thinking, not believing and hoping.

Some members of Congress have chimed in. According to this article, Senate Finance Committee Chair Chuck Grassley argued, “The intent was to maximize small businesses’ ability to maintain liquidity, retain their employees and recover from this health crisis as quickly as possible. This notice is contrary to that intent.” My question to Grassley is simple. Where in the CARES Act is there an exception to section 265? If that is what you intended, why isn’t it in the legislation?

The writer of the article observes, “Still, there are good arguments for deductions too. There could be a dispute about what Congress really meant in the hastily passed CARES Act, and the push-back from some in Congress suggests that. Despite the IRS statement, some people have said they may try to deduct these expenses anyway and fight with the IRS about it if needed. And the tax law is sufficiently debatable that some of those taxpayers could win, too.” If such a case made it to court, would a judge ignore the language of section 265? Would a judge pretend that there is an exception in section 265 even though it isn’t there? Should the judge ignore the arguments of textualist Supreme Court justices, scholars, and others who argue that the applicable law is what is enacted and not what people think, or Congress says outside of legislation, what was meant? Will the opponents of “activist” judging stand up and cheer for a court’s rewriting of the statute?

As a practical matter, it would not be a surprise if Congress gets its act together and amends section 265. Whether that is a good idea in terms of tax policy is a different question. It’s not, but that’s not the answer that appeals to taxpayers who want to take deductions, and get tax savings, for expenses they are not paying. Imagine. Someone – in this case the Treasury (translation, other taxpayers) tell a business, “Hang in there, we will pay your expenses,” and the recipient of this assistance says, “Whoa! That’s not enough. Not only do I want you to pay my expenses, I also want you to give me an additional tax break computed as if I paid the expenses out of my own pocket.”

It's this sort of nonsense that make the tax law more complicated, and more unfair, than it needs to be. And the time and money expended in dealing with the dispute is another price that is paid for the Congress having failed to provide in legislation what it now claims it intended to provide.