If At First It Doesn’t Work, Try, Try, Try Again

Not much is worse than a failed attempt at a resolving a problem being offered as a solution to the very problem it failed to resolve. True, one ought not give up after one unsuccessful try, but is there not some limit to the pursuit of futility? Professional baseball tends not to give up on a prospect who goes zero for four in his first minor league game, but how likely is a franchise to keep in its system a player who is zero for eighty?

Such is the life of one of the business world’s favorite tax breaks. Entrepreneurs salivate at the idea of getting a deduction for making an investment. The idea of getting a tax break for swapping cash for equipment of equal value is the sort of thing that makes lower-income taxpayers roil, because they don’t have the opportunity to get, in effect, cash flow from the government in the form of lower taxes by swapping cash for equipment of equal value.

In a speech on Wednesday, the President proposed that “all American businesses should be allowed to write off all the investment they do in 2011,” and explained that “This will help small businesses upgrade their plants and equipment, and will encourage large corporations to get off the sidelines and start putting their profits to work. . .” More specifically, the Administration is proposing that taxpayers be permitted to take a deduction for 100 percent of the cost of “qualified investments” acquired in between September 8, 2010 and December 31, 2011. Technically, section 168(k), which provided for a deduction equal to 50 percent of the cost of “qualified investments” made during 2008 and 2009, and which expired of its own terms at the end of 2009, would be revived, though with 100 substituted for 50 and the effective dates altered as described.

The Administration fact sheet asserts that this proposal “would provide tax incentives for business to invest in the United States when our economy needs it most, which should both help create jobs now and expand the capital stock to support future growth.” Is this in fact the case?

The previous incarnation of section 168(k) “bonus depreciation” as well as continual expansion of section 179 expensing have been consistently hailed as solutions to the nation’s economic woes of the moment. Yet no evidence exists that these tax giveaways have had the claimed effect. Why is it, for example, that during 2008 and 2009, while businesses basked in the benefit of 50-percent bonus depreciation, the economy got worse, not better? Where are all the jobs whose creation was promised when the proposal for the 2008 and 2009 tax break was being trumpeted as the answer? Where is the economic recovery that supposedly was an inescapable consequence of enacting those tax breaks? Similar questions can be asked about the long parade of tax breaks for business investments during the past 50 years. Though the economy doesn’t benefit, though economic fundamentals do not improve, though joblessness doesn’t abate, something fuels the repetitive re-enactment of this bundle of tax breaks. Could it be that it’s good for business? Could it be that what’s good for business isn’t necessarily good for those in need, especially if the funds generated by the tax break go the same way as the excess cash that businesses have been accumulating during the past year and a half, namely, somewhere other than the economy?

In early 2009, when the House Ways and Means Committee included expansion and extension of, among other things, bonus depreciation and first-year expensing, I wrote, in Just Because It Didn’t Work the First 50 Times Doesn’t Mean It Will Work Next Time:

Does it make sense to increase deductions for acquisitions of equipment? How does that restore confidence in the economy, which is essential to putting the nation back on track? How does a tax provision that encourages businesses to use their limited funds to buy machinery put people in this country back to work? Nothing in the provision requires that the property be built in the United States, and it's almost certain that such a requirement would violate at least a few trade agreements and treaties. What's the point of enacting tax breaks that create jobs in other nations? Dollar-for-dollar, a tax break for creating jobs directly is worth much more than a tax break for purchasing equipment.

With the nation's economy in rampant turmoil, does it make sense to turn to the same shop-worn provisions that came with promises of outstanding national economic performance that failed to materialize behind the façade of debt-driven unaffordable consumption? Advocates of these provisions argue that they give businesses an incentive to create jobs, but if that were the case, why hasn't unemployment dropped while previous increases and expansions of bonus depreciation and first-year expensing were being increased?

What Congress is proposing to do is more of the same. It didn't work last time around. Why would it work now? Sometimes persistence is a virtue. Other times it is foolishness.

The answer is simple. The things that need to be done are neither palatable nor easy to explain. Dishing out more tax breaks that are easy to explain and promise relief with no sacrifice sell better when election day rolls around. The depreciation provisions, including bonus depreciation and first-year expensing, have contributed to the current economic mess by allowing taxpayers to compute taxable income as though their economic position declined when in fact it remained the same or improved. Packaged into tax shelters, LILO deals, tax-exempt leasing arrangements, and other devices that contribute to the tax gap, these provisions ought not be considered remedies for the very economic diseases that they have caused and aggravated.

If Congress were running professional baseball, we’d probably see a fair number of zero-for-eighty ball players being brought up to the major leagues. One cannot fault the Congress for having tried bonus depreciation and expanded first-year expensing. One can fault the Congress for continuing to trot out the same failures after it has become clear that these ploys aren’t making the economy better and aren’t providing benefits to the general public.

Back in 2009, I concluded Just Because It Didn’t Work the First 50 Times Doesn’t Mean It Will Work Next Time with this prediction:

If, indeed, it is time for change, Congress should be given that message and understand it. Change does not mean doing something over and over when it hasn't worked and shows no signs of working. Just as consumers need to abandon the bad habit of spending beyond one's means and borrowing beyond one's ability to repay, Congress needs to break its bad habit of using the tax code as a vote generator. The likelihood of Congress embracing genuine change and doing more than giving lip service to the concept remains, unfortunately, very low. Its recalcitrance may prove to be one of the most difficult obstacles to the incoming Administration's success in solving the mess in which we find ourselves.

That the Administration has joined up with the pro-fake-writeoff crowd in Congress is not only disappointing but alarming. Except, perhaps, to the companies and people in other nations that make money selling equipment to American businesses.

When User Fee Diversion Smacks of Private Inurement

More than two years ago, in Soccer Franchise Socks It to Bridge Users, I criticized the decision of the Delaware River Port Authority (DRPA) to contribute $10 million of bridge toll revenues to the developers of the professional soccer stadium in Chester, Pennsylvania. I rejected the DRPA claim that the contribution was for development of the area surrounding the stadium, and thus in some mysterious way an investment that would increase use of the bridges that the DRPA is charged with maintaining. It would take a huge increase in traffic to generate tolls sufficient to make up for the $10 million give-away.

A week later, in a follow-up post, Bridge Motorists Easy Mark for Inflated User Fees, I questioned the wisdom of the DRPA having racked up debt in order to finance monetary gifts to places such as “Lincoln Financial Field, the Kimmel Center, the New Jersey Aquarium, and dozens of other projects that surely are not bridges.” I expressed disappointment that the then-governor of New Jersey, who had announced a readiness to veto further giveaways, backed down, with every indication being that he did so in expectation of his state continuing to get a piece of the DRPA pie. And it did. For example, the New Jersey town of Pennsauken, according to this Philadelphia Inquirer article, picked up $700,000 in bridge toll revenue to fund a football complex for the town.

The DRPA saga is a long story. Recently, in DRPA Reform Bandwagon: Finally Gathering Momentum, I reviewed my commentaries on the subject and provided a list of links to stories that had emerged in the several months since I had last visited the topic. It’s not a pretty picture.

Over the weekend, news reports, such as this Philadelphia Inquirer story, appeared that highlighted the egregiousness of the DRPA’s actions. Recall that the DRPA’s excuse for diverting bridge toll revenues from bridge repair and maintenance to unrelated projects was that by helping fund those projects it would be fostering a better economic climate, one that would increase bridge traffic and thus bring more revenue. It was not surprising, of course, when the DRPA announced it needed to raise bridge tolls, as apparently tossing toll revenue at stadiums and concert halls did not have the traffic increase consequence that the DRPA had hyped. The most recent news discloses that the projects and groups getting their hands on bridge toll revenues were not necessarily those whose future success would jack up bridge traffic, and thus toll revenue, but organizations and enterprises with close ties to DRPA board members and executives. It seems that the car allowances, free E-ZPass transponders, nepotism, and pension deals discussed in the articles to which I referred in DRPA Reform Bandwagon: Finally Gathering Momentum weren’t enough. What fun it must be to use someone else’s money to bolster one’s favorite enterprises.

The list of toll revenue recipients is long, and a selected subset of the list has been published at the end of the Philadelphia Inquirer story. Can someone explain why the Philadelphia Eagles and the University of Pennsylvania need “contributions” from the DRPA? Who’s getting what for what? On the other hand, it’s easy to figure out why almost $60,000 was shoveled into the Philadelphia Tribune, a paper whose publisher happens to sit on the DRPA board. Isn’t there something very wrong about a person holding a public trust shifting public money into his personal business enterprise? Aren’t there laws in place prohibiting that sort of behavior? If not, why not? If so, why no prosecutions? Though the DRPA and some of the board members whose affiliated interests received money claim that the board members were isolated from the selection process, anyone who has any inkling of how boards work knows that isolation simply isn’t possible.

Though many of the recipients are in and of themselves good causes, such as the Red Cross, United Way, Seamen’s Church Institute, and the Boy Scouts, and though it’s possible that these organizations weren’t actively soliciting funds from the DRPA, it’s still wrong for the DRPA to take money paid for the repair and maintenance of bridges and ship it off to some other undertaking. So it would be bad enough if the recipients consisted entirely of charitable enterprises. Though I and many others are fans of the Philadelphia Eagles, not everyone paying a toll holds that characterization. And what does one do with this information, as the the Philadelphia Inquirer story puts it: “And when DRPA board member E. Frank DiAntonio retired as president of Laborers Local 172, the DRPA contributed $2,000 to the E. Frank DiAntonio Retirement Gala Committee.” Wow.

The DRPA claims that the give-aways have ended, and that it is “engaged in an effort to regain the public’s trust.” Good luck with that. As much as I am an advocate of charging user fees and collecting taxes to the extent required to give governments the opportunity to do what they need to do, I’m no fan of diverting user fees from the stated purpose to some other activity over which the payor of the fee has no control and as to which the payor has not consented. Though I do not think that there is sufficient fraud and misuse of funds in government budgets to permit the near-elimination of taxes that the anti-tax crowd advocates, I’m surely dead-set against the sort of corruption and mismanagement that has plagued not only the DRPA but surely other government agencies and boards throughout the nation.

Do the DRPA board members and their counterparts throughout governments understand how their actions undermine public support for government? Do they understand that when government loses public support, it withers? Does the public understand that a withered government is in no position to protect the freedoms, rights, and liberties that cannot be sustained without strong government? The way to restore public trust in government is to bring the hammer down on public servants who forget the meaning of the phrase “serve the public” and who betray their government and the people whom government serves. There’s a word for the sort of betrayal that contributes to a growing threat to the survival of the government and the nation. I’ll let the politicians look it up.

Legislative Tax Procedure: Confusion Runs Rampant

Somehow, they just don’t get it. Considering how law students struggle with procedure and process – one of the most critical aspects of lawyering and law-making – it’s not surprising that journalists also don’t get it. On Friday, in More Democrats Balk at Raising Taxes for Rich, David Lightman of McClatchey Newspapers writes, “Tax cuts enacted in 2001 and 2003 expire at the end of this year. . . However, a small but growing number of moderate Democrats are balking at boosting taxes on the rich. . . Without their support, the push to raise rates on the rich will probably fail.”

He, and many others, have it backwards. If Congress does nothing, tax rates on the all taxpayers, including the wealthy, will go back to what they were in 2000. In other words, tax rates on the rich will increase unless Congress acts affirmatively to prevent that from happening. So the folks who need to gather votes are the folks who want to extend the tax cut bestowed on the wealthy nine years ago. Let’s look at the numbers shared in the article.

According to the article, it’s in the Senate where things matter, because in the House, the Republicans who presumably would vote to extend tax breaks for the wealthy are so outnumbered that even if a few moderate Democrats join them, it won’t happen. But the Senate, with its quirky rules that make simple majorities into minorities and give controlling power to 40 Senators, poses a strange phenomenon. If 41 Senators can block legislation, even with the defection of some moderate Democrats, a sufficient number of Senators who oppose extending tax breaks for the wealthy can block legislation that would do so.

Where it gets confusing is when alternative legislation is tossed into the mix. The Administration proposes extending tax breaks for those with adjusted gross incomes under $200,000 ($250,000 for joint returns) but not extending tax breaks for the wealthy. To get this legislation through the Congress, the Administration needs to find 61 Senators to support it. It probably would pass the House. But 41 Senators could block it.

In other words, Congress will come to loggerheads. This sort of stalemate is familiar, so it’s not surprising. It’s simply frustrating, because taxpayers and their advisors need to know what the 2011 federal income tax landscape will resemble. Note that similar planning concerns afflict estate planners and their clients. Thank you, Congress.

The confusion also manifests itself in this sentence: “The bigger problem for Democrats is in the Senate, where Reid’s immediate problem is getting the 60 votes needed to cut off debate on the [Administration] measure. Democrats control 59 seats, and at least three – Bayh, Ben Nelson of Nebraska, and Kent Conrad of North Dakota – have signaled they won’t back a permanent repeal of the tax cuts for the wealthy.” The catch is that there is no permanent repeal to back. It is going to happen, unless supporters of extending the tax rate reductions can pull together 60 votes to get an extension through the Senate. So if these moderate Democrats sit back and refuse to support a measure, the outcome will be precisely what they say they oppose. But if they step up and affirmative vote for tax breaks for the wealthy, they put themselves at risk when elections roll around.

Is it any wonder that getting sensible, rationale debate on these issues is so difficult? If the rules of the Congressional game aren’t understood, what are the chances that the outcome will be what people want it to be, even setting aside the wisdom of any of the particular positions being put forth? Congress has painted itself into a corner. It would be tempting to leave it there, except that when Congress paints itself into a corner, it puts the public in a bind. The first step in getting this mess straightened out is inspiring journalists to educate the public with the correct information. I seriously doubt that will happen. I’ve tried, but MauledAgain doesn’t have the circulation of McClatchey Newspapers or any of the other huge media outlets that can’t seem to figure out how to explain something that, all tax things considered, isn’t all that complicated.

Taxes and Parties

No, this is not about taxes and the Tea Party, or taxes and the Democratic Party, or taxes and the Republican Party. It’s about taxes and a cocktail party.

No, this is not about the deductibility of cocktail parties, or the possible exclusion, as a fringe benefit, of an employer’s cocktail party for employees. It’s about a cocktail party for taxpayers.

Indeed, according to this Philadelphia Inquirer story, Philadelphia’s Office of Arts, Culture and the Creative Economy and Philadelphia’s Department of Revenue are staging a cocktail party for “bloggers, entrepreneurs, freelancers, artists, and creatives.” This is the city’s response to the outcry over its determination to impose a $300 business privilege license tax on bloggers, even if their gross receipts are minimal, as I discussed last Friday in A Tax on Blog Writing or on Blog Business?.

The city’s goal is to “answer any questions about the business-privilege license and tax that have riled Philadelphia bloggers.” So the solution from the bureaucrats is to ply the taxpayers with liquor?

Wait, perhaps Philadelphia city officials are onto something. Consider the increase in IRS audit efficiency if taxpayers and their representatives were hosted at a cocktail party before being conducted to a revenue agent’s office. Consider the increase in tax revenue if tax return preparation was restricted to taverns, pubs, and night clubs. Imagine the IRS throwing a cocktail party for taxpayers, and holding it across the street from, say, a Tea Party meeting.

In all seriousness, all of this could backfire. Inebriated tax return preparers are no more likely to make errors in the IRS favor than they are to make them in favor of the taxpayer. Perhaps the release of inhibited subconscious desires would increase the chances of errors favoring taxpayers. Audits involving plastered taxpayers and their representatives could get ugly, fast. And imagine what happens if the bloggers and others who show up at Philadelphia’s “soften them up with alcohol” event get feisty, as drunk people often do. What might strike someone as a good idea when planning an event sometimes can backfire. Just ask the folks who came up with Disco Demolition Night and Ten Cent Beer Night.

If the bloggers and others attending Philadelphia’s “free booze makes taxes more palatable” bash get so feisty that they drive the planners to tears, will we hear strains of "It’s My Party and I’ll cry if I want to"? Speaking of parties and taxes, if the Bush tax cuts are not renewed, will they be singing, "party like it’s 1999"?

And if all else fails, you can always throw your own tax party, following this advice from the folks at C-NET. Be sure to click on all five numbered tabs.

An Exercise in Futility?

The other day, a distant cousin – distant both geographically and in terms of degree of relationship, something on the order of fifth cousin – sent me The Best of All Possible Americas, a posting on The Smirking Chimp, a blog with which I was not familiar. The posting, by Marty Kaplan, explored the dysfunctions in our system of government, and pointed out that the answer rests with voters, who aren’t quite as smart as one would wish that they would be or that they need to be in order to bring the present political polarization to an end. This caught my eye, because on more than a few occasions, I’ve suggested that the solution to one or another problem is for voters to step up and make their dissatisfaction evident.

Kaplan focuses on how the polarized debates pushing centrists out of the public arena is fueled by all sorts of misinformation. He presents a variety of examples of lies, distortions, and unverified rumors being dished out to tens of millions of Americans. The speed with which information goes viral makes it difficult to rectify these sorts of errors and intentional dishonesty. Kaplan notes that having “smarter voters, who in principle would elect better legislators” is a “strategy [that] puts a premium on better information, delivered to rational people through quality education or a free press.” Kaplan then explains why this hasn’t happened and perhaps won’t.

Pointing to studies done by University of Michigan political scientist Brendan Nyhan, published in When Corrections Fail: The Persistence of Political Misperceptions, and moved into the mainstream media by Joe Keohane’s Boston Globe’s article, How Facts Backfire: Researchers Discover a Surprising Threat to Democracy: Our Brains, Kaplan,borrowing from Keohane, sums up the problem as follows:

Our brains are designed to create shortcuts like inference and intuition in order to avoid the cognitive discomfort required to process and assimilate dissonant information. It hurts our heads to change our minds.

Kaplan summarizes some of the Nyhan research. For example,

People who believed WMDs were found in Iraq believed that fiction even more strongly when they were shown a news story correcting that mistake. The same was true of people who believed that the Bush tax cuts increased government revenue; a correction -- revenues actually fell -- also backfired, further entrenching people in their error. This finding transcends ideology: People who believed that Bush banned all stem cell research continued to believe that even when they were shown that only certain federal funding of stem cell work was stopped.

According to Kaplan, “This . . . puts a ceiling on what we can expect from education.”

Kaplan presents the approach that has long characterized my outlook on education, one that has motivated my decision to teach:

It’s not that they don’t have the facts, goes this view; it’s that they lack a good education, which cultivates critical thinking. Reason, the scientific method, media literacy: it’s widely believed that these tools can overcome not only propaganda and superstition, but also the inherent limitations of how we’re wired. We may possess lizard brains, but we also possess several centuries’ worth of methods for transcending our species’ propensity for paranoia, intransigence and irrationality. Education trumps ignorance.

Perhaps part of the explanation for my struggle to understand how someone can sit in one of my courses for 14 weeks and yet end up “not getting it” can be attributed to the difficulty, or even impossibility, of emptying their brains of nonsense to make room for careful analytical processes.

An example might help. Early in my teaching career, when I reached the subject of moving expense deductions, I turned to a problem in the book that presented a solo practitioner in City A deciding to combine his practice with a law firm in City B, some miles away. The solo practitioner decided to move to City B. The question was determining how far away City B needed to be in order for the mileage requirement of the moving expense deduction to be satisfied. A student raised his hand. He claimed that the hypothetical could not exist. After three or four exchanges, I finally figured out what he was trying to say. The solo practitioner, he claimed, could not become a partner in the City B firm until he had worked there for seven years. No one, claimed the student, becomes a partner in a firm without working at the firm as an associate for seven years. When I explained that a solo practitioner with a book of business, namely, a stable of paying clients, combined efforts with an existing firm, it was not uncommon for the firm’s partners to welcome, with open arms, the rain-making solo practitioner. Sensing that the rest of the class, who pretty much understood this point, was getting restless, I let it go. Whether the student in question ever got it is something I don’t know, but now I understand that some sort of misinformation or consequence of faulty reasoning got wired into his head, namely, the notion that no one can become a partner in a law firm without working at least seven years as an associate at that firm, and it just wasn’t going to be unhooked.

For me, the question is whether some people are genetically or otherwise constituted so that their brains are more easily hard wired or more resistant to re-wiring through education. If the answer is yes, then I wonder whether it is a futile exercise to try to help such people get it right. Someone sufficiently convinced that one plus one equals seven might not ever understand that one plus one equals two no matter what a teacher does, no matter how many classes the person takes, no matter how much reading the person undertakes. Scary. Very scary. Especially when the outcome of a collective effort by an aggregation of such individuals bestows on the nation or the world a gift of truly ignorant leadership.

Kaplan believes that “Even the brightest among us are run by the same limbic system that ran us when we roamed the savannahs. Even the best-educated citizens sometimes can’t help being bedazzled by illusion, seduced by spectacle and misled by morons. Our public education system may be failing us, but even in the most splendid of educational circumstances, schooling can’t prevent smart people from occasionally being totally wrong about the facts.” It would be wonderful if I, or anyone, could prove Kaplan wrong. Or rebut Keohane’s report. Or refute Nyhan’s studies. Perhaps that will happen. But until it does, we must give serious credence to the possibility that the limbic system gets in the way of the sapiens part of sapiens sapiens, and that it might make sense to invest more time and money figuring out better ways to re-wire badly hard-wired brains. Why? Because if that doesn’t happen, we’re in for a long stretch of political polarization and the even worse consequences that it can and will bring. It will make most tax policy debate a luxury that will slide to a very deep back burner. But in the meantime, I intend to continue teaching, and will continue trying to shake students who have a hard-wired adherence to passive learning out of that mindset, to persuade students beholden to a disdain for class preparation that their approach has been disproven, and to encourage the sort of intellectual curiosity that has constrained unbridled limbic system behavior. But in the back of my mind will be that wee bit of doubt, something about exercise and futility.

BP, Oil Spills, and Giving Up Tax Breaks

The news of a few weeks ago (see, e.g., this report) that BP intended to claim deductions and credits arising from expenditures has caused quite a commotion. For example, according to this report, Senator Bill Nelson of Florida requested hearings on the issue and called BP’s intention to claim these deductions and credits “unacceptable.” Others stories, such as this one, suggest that public pressure will force BP to forego these tax breaks. A Tax Notes article, “BP, the Gulf, and Tax Deductions, 128 Tax Notes 569 (2010), reports that President Obama asked BP to give up its deduction for oil spill cleanup costs, whereas another article, “Cash on the Barrelhead: BP and Taxes, 128 Tax Notes 571 (2010), explained that it was the president’s press secretary, Robert Gibbs, who “called on BP to forgo the deductions, but conceded that the tax law permits them.”

There are three separate, though related, issues raised by these stories. They are too easily entangled in a manner that muddies up the analysis.

The first issue is whether BP is entitled to the deductions and credits in question. Assuming that the facts are as they have been reported, for example, that BP has in fact incurred the expenditures in question in the amounts in question, there is no question that BP is permitted to claim them. As explained in this opinion, “In short, it would likely take an act of Congress to keep BP from deducting its payments.” The word “likely” allows for the possibility that some other reason might persuade BP to give up on the tax breaks in question.

The second issue is whether BP should voluntarily give up the deductions and credits in question. On this question, reasonable minds can differ. On the one side is the notion that deductions are deductions, and barring application of public policy restrictions, which case law establishes don’t apply in this instance, taxpayers have claimed deductions for all sorts of things that might offend some other person’s sensibilities. On the other side is the notion that from a moral, philosophical, theological, political, or public relations perspective, BP has far more to lose by claiming the deductions and credits than it has to gain from doing what it is legally entitled to do. As noted in this report, Goldman-Sachs, as part of a settlement with the Securities and Exchange Commission, agreed that it would not deduct the penalties to be paid under the settlement. This is not the first time a taxpayer has made such a decision. The process that led to, and the consequences of, the decision at Boeing to do what Goldman-Sachs would do is discussed many paragraphs deep into this USA Today story.

The third issue is whether BP is permitted to give up the deductions and credits in question. The debate over the question of whether deductions and credits are mandatory became so intense that it inspired me to address the question in an article I wrote several years ago, “No Thanks, Uncle Sam, You Can Keep Your Tax Break,” 31 Seton Hall L. J. No. 1 (2007). Though the abstract will suffice for the casual reader, the serious researcher will want to read the entire article. So what’s the answer? As the abstract notes:

The article concludes that deductions are not mandatory other than in the computation of self-employment tax, as to which the IRS and courts have concluded deductions cannot be ignored, and other than the earned income tax credit which incorporates the self-employment tax computation concept. This conclusion is based on ample statutory evidence that allowable deductions will go unclaimed, on the failure of courts, aside from the self-employment tax situation, to compel taxpayers to claim all allowable deductions, and on the explicit and implicit approval by the IRS of disregarded deductions. The article suggests that aside from the two situations in which specific authority requires taxpayers to claim deductions, there is no reason for taxpayers who wish to forego deductions to hesitate in doing so.

But the more important question is “Why is that the answer?” I’m going to guess that some tax lawyer at BP or at a firm representing it is going to end up reading the article. If you do, let me know. It’s nice to see that an article is of value to practitioners.

A Tax on Blog Writing or on Blog Business?

The blogosphere is in a tizzy over the news from Philadelphia that the city is imposing its $300 business privilege license fee on bloggers who earn revenue from hosting ads on their blogs. In the referenced story, Robert Moran asks if there is a Tax on Phila. Bloggers? The answer is yes and no.

What has generated the uproar is the city’s insistence that the fee is due even if the blog generates less than $300 in revenue. According to this report, a blogger who raked in all of $11 over two years has been told to pay the fee, as was another blogger who collected $50 over a period of several years. The city’s response to the latter’s plea that she “makes pennies on her hobby” was to tell her to hire an accountant.

This issue came to my attention thanks to Andrew Oh-Willeke and Paul Caron. Andrew emailed me to ask if I had paid the tax. I pointed out to him that I don’t live or work in Philadelphia, but that I would not step away from the debate just because I’m not personally affected. At least for the moment, I’m not. Perhaps if I were raking in the cash, so to speak, I would have even more of a vested interest than I do, but that’s not a concern considering that aside from roughly a hundred people the 6-billion-plus people on the planet don’t think MauledAgain is worth visiting, even when it is free and unencumbered by ads.

Philadelphia contends that bloggers who collect revenue are conducting a business and must acquire a business privilege license. The catch in this analysis is not whether a business must acquire a business privilege license. That much is clear, and the city’s revenue officials are stuck with the statutory language. Those who think the imposition of a fixed fee makes little sense can look to Philadelphia City Council, the local equivalent of Congress, for an explanation of its decision to impose a flat fee rather than one based on a percentage computation. As pointed out Hot-Air, all sorts of taxes and fees apply to businesses that are making little, if any, money, whether due to start-up status, a down year thanks to a weak economy, or failure of customers and client to pay bills. In BPT Rears Its Ugly Head . . . Toward Bloggers, Doron Taussig notes that the tax applies not only to bloggers collecting revenue but to children who earn money babysitting or operating a lemonade stand. Compliance among the younger entrepreneurs probably is low because they fly under the radar, leaving little, if any, evidence of their activity or revenue collection on the internet as do bloggers.

In his post on the issue, Andrew Oh-Willeke notes that Philadelphia’s interpretation of its tax laws are “contrary to all common sense.” What lacks common sense is the law that is being interpreted. As often is the case with federal tax issues, the culprit isn’t the administrative agency but the legislature, in this case Philadelphia City Council. This is the same city council that also imposes a gross receipts tax, which can burden a business that loses money, and which I discussed in Don’t Like This Tax? How About That Tax?.

Is the fee is unconstitutional? This question was asked, for example, by The Conglomerate. Philadelphia explains that the fee is imposed on the conducting of a business and not on the content. It actually claims that the fee applies because the bloggers “made money,” though technically that is true only if “made money” means “collected revenue” in contrast to “generated a profit.” Newspapers and other publishers operating in Philadelphia pay the fee, and some of them have had years in which they did not make profits. Yet I doubt that the constitutional argument will get very far.

Instead, the issue is whether bloggers who collect revenue are necessarily conducting a business. For federal income tax purposes, a business does not exist simply because revenue is collected. If the taxpayer wants to deduct the expenses of a business, the taxpayer must demonstrate that a business exists, and the resolution depends on the facts and circumstances. The IRS and the courts apply a long list of factors to distinguish businesses from hobbies. Is a blogger who collects $11 or $50 over a two or three year period operating a business? Playing with a hobby? The answer is, “It depends.” Did the blogger set up operations in a manner consistent with an objective of making a profit? Does the blogger conduct operations in a manner consistent with good business practices? Does the blogger engage in efforts to increase revenue by marketing the blog? Does the blogger keep books and records? Does the blogger devote all, most, much, some, or a little bit of his or her time to the blogging activity? According to a spokesman for the mayor, a blog “is not a business unless it starts selling ads or otherwise generating revenue.” That conclusion sums up the problem. Collecting revenue does not create a business. Ask the taxpayers who try to take business deductions for vacation homes that they rent out on an occasional basis. They collect revenue, but that doesn’t elevate their situation to one of being in business. Is a person who wins a lottery, who surely is collecting revenue, conducting a business?

There’s a simple solution. City Council needs to define “business” so that the business taxes and fees apply only to those taxpayers who file a Schedule C or Schedule C-EZ with their federal income tax return. Would this be burdensome? No. In fact, according to Tax on Phila. Bloggers?, the city has been obtaining tax information from the IRS and has been going after bloggers “who reported blog income to the IRS, no matter how little.” Apparently the city has not limited itself to income reported on Schedule C, nor has it bothered to look at the bottom line. If City Council does not move on this issue quickly and appropriately, even more young, creative, tech-savvy entrepreneurs will leave the city for other places. Short-term thinking often blocks good long-term planning, which is how the city ended up in the mess in which it finds itself in 2010. Isn’t it time for City Council to put the brakes on the downward spiral? Otherwise, by 2020, there may not be anyone doing business in the city.

Pennsylvania State Gasoline Tax Increase: The Last Hurrah?

Several years ago, in Are State Gasoline Taxes the Best Source of Highway Revenue?, I pointed out that Pennsylvania faces a a $1.7 billion annual shortfall in road and bridge maintenance requirements. Last year, in Another Reason Why There Are, and Need to Be, Taxes and User Fees, I noted that New Jersey is in a similar predicament. The same is true of most, if not all, of the states. The nation’s transportation infrastructure is crumbling. How quickly people forget the bridge collapse in Minnesota. In Pennsylvania, an attempt to impose tolls on I-80 to fund highway and bridge projects elsewhere in the state was shot down by the Federal Highway Administration, as I explained in User Fee Philosophy Vindicated. Various proposals to grab short-term egg dollars by selling the long-term goose by turning the Pennsylvania Turnpike over to private sector investors whose primary goal would be to suck profits out of the public asset have failed, fortunately, to gather sufficient support. Calls to increase the gasoline tax frighten politicians who fear losing votes because they tell the voters the truth. The state’s governor and legislature have exchanged ideas, criticisms, and objections but have been unable to agree on a workable solution.

Now, according to this Philadelphia Inquirer report, the governor intends to make one last attempt to convince the legislature to deal with the crisis. To fix 5,000 failing bridges and 7,000 miles of deteriorating roads, the governor wants to impose a tax on oil-company profits, with a prohibition against passing the tax increase on to motorists. There are three problems with this idea. The pass-through prohibition might be unconstitutional. If enacted, the tax would be challenged and litigated, a process that would take years. Expecting oil companies to pay for the damage caused by motorists to roads and bridges is as wrong as expected motorists who pay tolls to cross the bridges between New Jersey and southeastern Pennsylvania to pay for soccer stadiums and football fields, on which I commented in Soccer Franchise Socks It to Bridge Users, Bridge Motorists Easy Mark for Inflated User Fees, and other posts dealing with the misadventures of the Delaware River Port Authority.

The chances of the legislature dealing with the problem in a sensible manner are slim to none. Several have admitted that with elections just two months away, they are not about to increase taxes, tolls, or any other fees that might jeopardize their ability to gather votes. They say this even though they confess that there is an “urgent need” to resolve the crisis. Proposals to increase the state gasoline tax to reflect inflation since its last increase 13 years ago again are circulating in Harrisburg. The governor claims that a recent poll financed by his campaign account shows that a majority of the state’s citizens “would be willing to pay a little extra for safer roads and bridges and better transit systems.”

Here’s the conundrum. So long as legislators continue to hold fast to the old ways, fearful of losing votes as a price of demonstrating and exercising leadership in a time of change, the crisis will not be resolved, bridges and roads will continue to fall apart, and eventually someone, or many, will die as an overpass, bridge, or road collapses. The resulting chorus of “I told you so” will do nothing to bring back the victims of political cowardice.

Those who read MauledAgain know that I oppose selling public assets so that private investors can milk them for short-term profits at the expense of the citizenry, as I have explained in posts such as Are Private Toll Roads More Efficient Than Public Tolls? and More on Private Toll Roads. Likewise, I oppose funneling tolls or user fees to projects unrelated to the toll or fee, as I explained in posts such as User Fee Philosophy Vindicated, Soccer Franchise Socks It to Bridge Users, and Bridge Motorists Easy Mark for Inflated User Fees.

What I support is the mileage-based road fee, a 21st century concept that seems to elude legislatures and politicians still living in the 19th and 20th centuries. It is time for them to sit down and read Tax Meets Technology on the Road, Mileage-Based Road Fees, Again, Mileage-Based Road Fees, Yet Again, and Change, Tax, Mileage-Based Road Fees, and Secrecy, and the articles and studies cited therein. During the transition period, while the technology is being adopted and installed, it is essential to raise the state – to say nothing of the federal – gasoline tax, for the reasons set forth in posts such as Is Gasoline Tax Increase in the Pipeline?, The Return of the Federal Gasoline Tax Increase Proposal, Raise, Don’t Lower, Fuel Taxes, Gasoline and Free Markets, Up, Up, and Away, Gasoline and War, and A Tax Trifecta: Gas, Enforcement, and Special Interests.

Though it is easy to paint tax increases as harsh, even if they are in the nature of user fees, the reality is, as explained in Funding the Infrastructure: When Free Isn’t Free, a mature population understands that it must pay for what it wants. In The Return of the Federal Gasoline Tax Increase Proposal, I noted that one hero of the anti-tax-increase crowd, Ron Paul, went so far, to use his words, to claim, while blasting a suggested increase in the federal gasoline tax, that the cost of gasoline should be adjusted to fit what people are able to pay rather than the economic burdens gasoline use imposes on society and the economy. Applied to all goods and services, this mentality would bring about more societal destruction than would the return of Attila the Hun and his hordes. As I also wrote in The Return of the Federal Gasoline Tax Increase Proposal:

It is human nature to want things for free, to seek preferential treatment, to get someone else to do one's work, to live on the backs of others. It takes intelligence, wisdom, and a sense of justice to understand that there is no such thing as a freeway, even if a select few find a way to make it free for themselves. Someone needs to pay. The mentality that brings the "I get to go straight out of the left turn lane because I am special" approach to driving surely dovetails with the "I get to use the highways without paying for them" mindset. The gasoline tax hasn't been increased for 15 years. The costs of repairing highways has increased during the same time period. That alone should close the door to the notion that the federal gasoline tax should be locked in forever at its current level.

Realists point out that increasing the federal gasoline tax is a politically difficult thing to do. For example, the Washington Post quotes Leon Panetta as explaining, "I don't think there's any question that as a matter of policy it makes a lot of sense to move in that direction, but politically it's a very high hurdle to get over." Of course it is. But if the nation doesn't clear that hurdle, the gasoline tax debate might become trivial in comparison to what awaits us if this situation isn't fixed, and fixed quickly.

Though it has been “only” 13 years in Pennsylvania, the same reasoning applies. If the Pennsylvania legislature doesn’t get it right this time, there may not be a next time. Or, if there is, it will be a crisis so dwarfing the current one that the sort of taxes and user fees required to repair the mess will make the proposals I offer today seem trivial in terms of ultimate taxpayer cost.

The Internet, Virtual Meetings, and Taxation

A recent decision, Foundation of Human Understanding v. U.S., No. 2009-5129 (Fed. Cir. Aug. 16, 2010), demonstrates the continuing difficulties encountered by tax administrators and judges schooled in pre-digital days and caught in a pre-digital mindset as the technological developments in the communications arena raise tax law issues. The case involves a Foundation incorporated in 1963, recognized as a tax-exempt entity by the IRS in 1965, and classified by the IRS as not a private foundation because it qualified as a publicly supported organization. The Foundation’s claim that it was not a private foundation because it was a church was rejected by the IRS, an conclusion that had no bearing on the outcome.

Two decades later, in 1983, the Foundation again requested that it be treated as a church, the IRS denied the request, the Foundation sought a declaratory judgment by the Tax Court, and the Tax Court held it was a church. The Tax Court relied on five facts: the Foundation owned a building where it conducted services several times a week, it operated a school for children where it taught its doctrines, it owned another property where it held seminars, meetings, and other activities, it purchased a second building for church services, and it provided “regular religious services for established congregations.” The Tax Court concluded that the Foundation’s radio broadcasting and pamphlet printing activities did not support its claim of being a church, but considered these factors to be insignificant compared to the Foundation’s other activities.

As the years progressed, the Foundation changed its operations. It moved its school into a separate corporation and operated it as a private non-denominational Christian school. It sold its church buildings. It continued to “disseminate its messages through broadcast and print media” and when the Internet became popular, began to use it for the same purposes. In 2001, the IRS determined that the Foundation no longer qualified for church status. The Foundation sought a declaratory judgment in its favor, this time in the Court of Federal Claims, where it lost.

The Court of Federal Claims noted that there are two approaches to determining church status. One is a bundle of 14 criteria invented by the IRS, about which the court expressed concern because it “appears to favor some forms of religious expression over others,” but the court examined the criteria and determined that the Foundation, though meeting some, had not proven that it “had a regular congregation or that it held regular services during the years at issue.” The other approach, a so-called associational test developed by the courts, was the basis for the decision by the Court of Federal Claims. That test defines a church as an organization that includes a body of believers who assemble regularly for communal worship. Accordingly, the court concluded that because the Foundation did not provide regular religious services to an established congregation, and because the extent to which the Foundation brought people together to worship was incidental to its main function of spreading its message, it was not a church. The court rejected the Foundation’s argument that a church exists if “there is a body of followers beyond the scope of a ‘family church’ . . . [who] seek the teachings of the organization and express or acknowledge an affiliation with its religious tenets” because, according to the court, “every religious organization has members who express an affiliation with the organization’s tenets.” Ultimately, the court held that the Foundation failed to establish that “it held regular services with a regular congregation during the years at issue and because its ‘electronic ministry’ did not satisfy the associational test.”

On appeal, the Federal Circuit affirmed. After noting that neither Congress nor the IRS has done much to explain the meaning of the term church in section 170, explaining that the definition of church is more limited than the definition for a religious organization, and agreeing that the 14 IRS criteria raise issues, the court decided to apply the associational test. It quoted other decisions that require “an associational role,” “a body of believers or communicants that assembles regularly in order to worship,” “a cohesive group of individuals who join together to accomplish the religious purpose of mutually held beliefs,” and “an organization [that] bring[s] people together as the principal means of accomplishing its purpose.” The court agreed with the trial court that holding occasional seminars in various locations did not constitute regular meetings, a regular congregation, or a regular assembly for worship, and that there was no proof that the seminars enabled participants to establish a community of worship. The court explained that while the associational test does not set a minimum frequency of gathering, it does require “gatherings that, by virtue of their nature and frequency, provide the opportunity for members to form a religious fellowship through communal worship.”

The Federal Circuit also rejected the Foundation’s argument that by listening to sermons broadcast over radio and the internet at set times, its members had established worship as a “virtual congregation.” The court noted, “The fact that all the listeners simultaneously received the Foundation’s message over the radio or the internet does not mean that those members associated with each other and worshiped communally.” The court decided that even though the Foundation permitted members to call in and to have their comments shared with those who were listening, it did not permit members to interact and associate with each other in worship. The Foundation’s reliance on a case holding that there can be a “church without walls” was rejected because in the cited case the church not only had a “street church” congregation, it also had a conventional bricks-and-mortar church building where worship services were held.

It is the rejection of the “virtual congregation” argument that poses problems. Even if, on a technical basis, the court’s decision is correct because it rests on the Foundation’s failure to meet its burden of proof, it merely postpones to another day a similar case where the organization brings in expert witnesses to explain how it is possible for people to interact without being physically proximate. Consider the various definitions provided for the associational test. One speaks of “an associational role,” but does not require physical proximity. Experiences by millions of individuals with social networking sites demonstrates that people can associate, sometimes quite intimately, without being physically proximate. Or consider the definition of “a body of believers or communicants that assembles regularly in order to worship.” Many denominations theologically propound the notion of “body of believers” as a bonding that transcends the physical limitations of a church building. Nothing in the definition requires that assembly cannot occur other than by physical proximity. Nor is there anything to suggest that worship requires interaction, particularly when one considers the many instances in which individuals arrive at a church, listen, and leave without speaking to anyone or at least without speaking to anyone concerning theological issues. For a court to decide that religious fellowship cannot be formed other than with physical proximity is for the court to intrude on the theological beliefs of the organization. In fact, religious fellowship can be established without physical proximity, and thus the court’s application of the associational test, if not the test itself, poses the same concerns as does the 14-criteria test of the IRS. Something called the First Amendment overshadows both tests.

Yet there is something of even wider import brewing in this decision. The terms “regular services” and “regular congregation” have their counterpart in the definition of an educational institution. Section 170(b)(1)(A)(ii) defines educational organizations eligible for tax-deductible charitable contributions as those “which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on.” Aside from jokes about irregular faculty, irregular curriculum, and irregular students, I ask those in the basic federal income tax course who are trying to learn the parameters of the scholarship exclusion, which incorporates the section 170(b)(1)(A)(ii) definition, what happens to the on-line university? Are its students in attendance at the place where its educational activities are regularly carried on? Where is that place? Is it cyberspace? Is it the collective space formed by the aggregation of the various rooms scattered throughout the world where the students are sitting as they listen to, and in many instances respond to, the instructor and other students? Is physical proximity a prerequisite for “attendance at the place”?

The world has changed. People can interact without being in physical proximity in all sorts of ways that they could not accomplish before the advent of internet communications. Consider a class or a religious gathering taking place through video-conferencing. If the school or church relies solely on this technology, ought it be considered in some way “deficient” or “unqualified” as contrasted with their bricks-and-mortars predecessors? In many ways, reaching out, whether to students or congregants, in this manner opens the doors to people otherwise precluded, for mobility or other reasons, saves energy, eases pressure on the environment, and achieves a variety of other worthy goals.

True, the IRS and the courts can sit back and wait for Congress to amend the tax code to insert “whether or not in physical proximity” to bring the tax law into the 21st century. I am quite confident that this adjustment is thousands of pages deep in the pile of tax law changes that are on the Congressional desk. The words “regular,” “place,” “attendance,” “assembly,” and “association” are ambiguous in this context, and it is the obligation of the IRS and the courts to focus on these terms with 21st century eyes and minds. The next case will not be any less challenging. But it is “out there,” waiting.

Tax Politics and Economic Uncertainty

According to Martin Regalia, chief economist of the U.S. Chamber of Commerce, “Uncertainty is the probably the biggest factor retarding economic growth.” He made this comment at an economic summit, at which, according to this report, other participants called for cuts in government spending, reduction of the federal budget deficit, a reduction in government regulation of business, and reform of the tax system, though Regalia, according to another report, also supports extension of the Bush tax cuts. As is the case with others who support reduction of the federal budget deficit and tax cut extensions, specifics on how to cut trillions of dollars in federal spending in order to reconcile those two inconsistent goals was not offered.

Yet aside from the inconsistencies with respect to budget deficits and tax cuts, Regalia is dead-on when he ascribes much of the nation’s ability to get its economy back on track to uncertainty. It is difficult to plan, whether for a business or individual decision making, when tomorrow’s tax climate is unknown. Though uncertainty cannot be eliminated in the business world, considering, for example, that no one can predict when and where the next earthquake will strike, it seems rather absurd for a nation to let its citizens dangle as they try to figure out what to do in their personal and business financial lives.

Decisions by businesses to purchase or to refrain from purchasing new equipment have been turned into a gambling game. It’s one thing to know what the tax consequences will be of making a purchase in August 2010, in December 2010, in 2011, or in 2012. That permits the decision-maker the opportunity to compare the various outcomes under each alternative. It’s another thing to wallow in uncertainty. So long as members of Congress continue to propose bigger and new tax breaks for equipment investment by businesses, it becomes difficult to make the purchase now when there is a chance that by doing so the opportunity to make the purchase next year, with a better tax break, will disappear. Indecision sets in, and business stagnates. A new tax break might be retroactive. It might not be. When this conundrum is extended to all of the tax components of business decision-making, such as rates, deduction limitations, foreign tax credit rules, and hundreds of other issues, the resulting matrix of confusion paralyzes America’s entrepreneurs.

The bottom line, no pun intended, is that it is easier for businesses to make decisions if they know what lies ahead, regardless of what lies ahead, than if they don’t know what lies ahead. Businesses can react to higher tax rates and to lower tax rates, if they know what the tax rates will be, but their decision modeling suffers when virtually everything in the tax law remains open to change, perhaps retroactively, sometimes at a moment’s notice.

Why is the Congress unwilling to provide America with a sufficiently certain tax law for the future? Notice that I did not ask why it is unable. Congress is capable of doing so, but chooses not to do so. The answer is that uncertainty provides members of Congress with the opportunity to use the promise or threat future tax law changes as bargaining chips in their continued pursuit of political power for the sake of power. Greed, it should be noted, isn’t restricted to the desire for money per se, although one significant consequence of holding political power is, as has too often been demonstrated, access to money. Perhaps, once business leaders realize that the very conditions of which they complain that are making business decisions so impossible to make are generated by a Congress grown addicted to campaign contributions and lobbying efforts with respect to specific tax provisions, they will turn their attention to fighting for more certainty, even at the expense of those who profit by pushing for continual changes in the tax rules.

As I pointed out in A Zero Tax, A Zero Congress, Congressed has betrayed America. I wrote:

What I can offer is my condemnation of the Congress for putting America into yet another economic mess. Several commentators have noted, cynically perhaps, that members of Congress benefit from having the estate tax issue held open because it encourages lobbyists for the various positions to rustle up more cash for the campaign coffers of members of Congress. Far be it for me to criticize a cynical observation. Truth be told, I think these commentators are making a valid point. It's not unlike members of Congress to put personal objectives, including raising re-election funds and grabbing power, ahead of what needs to be done for the national economic good. One look at the bribery involved in crafting a health care bill tells us quite a bit about the value system in play on Capitol Hill.

. . . .

There are a variety of words to describe the manner in which the Congress has handled the estate tax question. Irresponsible is my favorite. Short-sighted is another good one. Unwise, incompetent, and outrageous also come to mind. There also are some phrases that can be used. Derelict in its duty. A breach of its fiduciary obligation.

. . . .

There may not be any constitutional requirement that Congress do its job properly and in a timely manner, nor a provision that prohibits the Congress from creating the mess in the first place. Nor is there any statute that can be invoked to compel the Congress to live up to its responsibilities, particularly when the responsibility is one of its own making. But there is more to law than just a constitution and statutes, regulations and cases, rulings and decrees. There is a moral imperative, an overarching array of dedication to the national interest, respect for the citizens, decent treatment of the taxpayers, adherence to diligence, integrity, common sense, and fiduciary duty, and a deep understanding of the difference between the good and the expedient. Whether the Congress ever had or exercised this set of values is debatable, but what's not in dispute is the conclusion that the current Congress fails miserably in this regard. It is morally bankrupt. It earns a zero.

It ought to be crystal clear to the business leaders of America where the problem lies, and it ought to be crystal clear to them what needs to be done. Will they rise to meet the challenge? Or will they remain mired in the woeful world of tax politics, caught up in a spiral of economic degeneration?

DRPA Reform Bandwagon: Finally Gathering Momentum

Some time ago, I criticized the decision of the Delaware River Port Authority to use toll revenues for contributions to the construction of a major league soccer stadium. In Soccer Franchise Socks it to Bridge Users, I pointed out that tolls paid for the use of a bridge should be used for the maintenance and repair of the bridge and not for other purposes, as the DRPA had become accustomed to doing. In a follow-up, Bridge Motorists Easy Mark for Inflated User Fees, I noted the absurdity of the DRPA’s call for increased bridge tolls because it needed money to repair its bridges. Perhaps had money not been diverted to soccer stadium construction and other projects, there would have been funds for the DRPA to perform its stated functions. The criticisms that I, and a few others, offered fell on deaf ears, as a year later, I explained in Don’t They Ever Learn? They’re At It Again that the DRPA had announced plans to funnel more toll revenues into projects having nothing to do with the bridges and waterways it is charged with tending. Shortly thereafter, in A Failed Case for Bridge Toll Diversions, I lambasted the governor of Pennsylvania for his unwise attempt to justify using bridge tolls for other purposes.

A few days ago, I returned from some travels to discover that the DRPA had come under fire, again, for all sorts of mismanagement and misappropriation of its resources. Just take a look at some of the headlines in recent Philadelphia Inquirer articles and at some of the highlights:

Dougherty Furious at, Underwhelmed by, DRPA (local union leader serving as commissioner for DRPA unimpressed by response to his questions to the DRPA concerning continued salary payments to a dismissed DRPA employee, use by a DRPA official’s family member of a DRPA E-ZPass unit, and shifting car allowance payments into the DRPA general counsel’s salary in order to increase pension payments)

DRPA Safety Head Suspended for Improper E-ZPass Use, But More Questions Loom for Agency

Pa. Treasurer Demands Much Financial Data from DRPA (“The heat increased on the Delaware River Port Authority on Friday, as the Pennsylvania state treasurer demanded a broad accounting of car allowances, free E-ZPass transponders, hiring of family members, awards of contracts, conflicts of interest, and pension deals.”)

Facing Criticism, DRPA to End Free Bridge Passes, Car Allowances (top officials of DRPA to lose “free bridge passes and lavish car allowances” in response to “rising public and political criticism”)

Rendell Backs Changes at DRPA After Controversy (Pennsylvania governor demands state audits of DRPA, open meetings, public record access, public votes on DRPA contracts, limiting family hiring to one relative, prohibition on moonlighting by officials, elimination of private board meetings, and elimination of free E-ZPass units and car allowances)

DRPA Board Chairman Calls Criticisms Lots of Smoke, Little Fire (chairman of DRPA agrees to make changes requested by Pennsylvania and New Jersey governors)

DRPA Safety Chief Quits Amid Free E-ZPass Complaints

Investigation Sought Over DRPA Emails (allegations that agency email system used to solicit campaign contributions)

Pa. State Sen. to conduct hearings on DRPA (hearings to focus on DRPA “broad mandate to spend money freely” and "widespread allegations of mismanagement, fraud and political patronage")

Gov. Rendell Accepts “Lion’s Share of Blame” for DRPA Failures

Official Accused of E-ZPass Abuse Improperly Received Pension Credits

Despite Its Largesse, DRPA Should Stop Backing Non-transportation Projects, Pennsauken Board Member Says (but accepts $700,000 DRPA grant for building a football complex in the town of which he is a mayor)

Criticism of DRPA Management Decisions Continues

Pa. Treasurer Urges Major Changes to DRPA Rules

Ringside: DRPA’s Family Feud Exposes Waste, Abuse

Politically Connected Firms Reap Big DRPA Contracts

It is this sort of mismanagement, political cronyism, misuse of funds, and general failure to appreciate the “servant” portion of “public servant” that causes me to have sympathy for those who rail against government, and who call for cutting or eliminating taxes as a means of ending the corruption. The problem is that the service that the government or a government agency is supposed to be providing needs to be provided. The answer isn’t cutting taxes, or in this case, tolls, as the first step. The answer rests in some serious housekeeping, reform of the political system, implementation of oversight that is accountable to motorists who pay tolls and taxpayers who fund the agency, so that an accurate assessment can be made of what it costs to do what the agency should be doing. At that point, tolls can be adjusted downward if the numbers warrant. Merely cutting taxes or tolls doesn’t guarantee that the outcome won’t be continued funding of soccer stadiums and football complexes while necessary bridge maintenance and repairs are reduced or omitted.

The bottom line is that when government officials and employees engage in the sort of behavior manifested by the DRPA, they give a bad name to the many public servants who are doing their job, acting honestly, and avoiding political machinations. Granted, the DRPA is an egregious case and makes it easy for opponents of government to turn it into the poster child for underfunding government. The cause of the problem isn’t the existence of taxation or the imposition of tolls. It’s the existence of incompetent, corrupt, and unaccountable officials who rejoice when citizen anger is directed at the concept of taxation rather than at specific individuals misbehaving and making bad decisions while holding positions of trust. Imagine if the anger and energy of the anti-tax and tax reduction crowds could be channeled into genuine reform of government service.

It does amaze me when I read, in Gov. Rendell Accepts “Lion’s Share of Blame” for DRPA Failures, that Pennsylvania’s governor credited John Dougherty, a DRPA Commissioner and a long-time labor leader in Philadelphia “for bringing attention to possible abuses at the bistate agency.” It also bothers me to read, in The Bandwagon Gets Crowded in Calls for DRPA Reform, Monica Yant Kinney crediting Dougherty as having “filled a full-size bandwagon” on which former DRPA enablers are “piling on.” Dougherty certainly deserves credit for speaking up, but he didn’t build the wagon or form the band. It was lonely in the garage constructing that wagon as I complained about the use of bridge tolls for unrelated purposes. Granted, I didn’t see all of the abuses that Dougherty disclosed from his position as an insider, but what those were red flags flying from the wagon. Oh well, at least the governor of Pennsylvania has retreated from his almost-blind defense of the DRPA, even if it was a case of trying not to be run over as the DRPA reform bandwagon gathered momentum.

But wouldn’t it be nice if that $700,000 football complex grant was returned as an act of public servant leadership? It’s tough doing the right thing, but that’s what public service is all about.

Structuring Introduction to Taxation of Business Entities: Part XX

The syllabus for Introduction to Taxation of Business Entities includes one last topic, namely, Introduction to Reorganizations. Only twice in the 18 times that I have taught the course has there been time to cover this topic, and even on those two occasions there were merely 10 or 20 minutes to present an extremely superficial overview of the most basic of basics. Needless to say, the students were told that there would not be any reorganization questions on the exam.

Experience taught me that it would make no sense to include death of a shareholder or death of a partner in the course. There simply isn’t the time, though both topics provide more opportunities to review previously covered material. For these interesting topics, students must wait until they are in another tax course.

When students leave the course, assuming they have been diligent and have learned what I intend for them to learn, they are capable not only of doing simple corporate and partnership tax returns but also of understanding basic planning questions, figuring out how to find answers to more advanced questions, and taking with them a solid foundation for more tax courses. It’s a difficult area of taxation, thanks to the Congress, it’s essential that students get a firm grip on the material, and it has always been my principal goal to put them in a position to succeed in practice even though that requires demanding assignments, intense concentration, and voluminous coverage. Does it work?

About two months ago, a former student shared these thoughts about the course on a professional networking site: “Professor Maule is one of the most captivating and brilliant professors I have ever encountered. His J.D. level, Taxation of Business Entities course is one of the most rigorous and intellectually stimulating courses I have ever taken. He is approachable, helpful, and makes a rather troublesome topic quite manageable.” It worked for this student, it has worked for others who have made similar comments, and hopefully by now it has worked for those who haven’t (yet) had anything to say about their experience in the course.

Structuring Introduction to Taxation of Business Entities: Part XIX

Three partnership liquidation patterns are considered. Only one gets extensive attention.

The first pattern is a so-called true liquidation, in which the partnership sells its assets and distributes the cash. The consequences follow principles with which the students are familiar, namely, the property disposition checklist, the passing through of gain or loss, the increase or decrease in partners’ adjusted bases in their partnership interests, and the 15-step distribution checklist. The latter has a simplified application, because the nature of the transaction obviates any need to consider sections 704(c)(1)(B), 737, 736, or 751(b). A brief example illustrates a burned-out tax shelter in which the sole asset disposition is a quitclaim of encumbered property to the creditor.

The second pattern is a proportionate distribution of all assets to the partners. Again, the consequences follow principles previously studied, namely, the by-now-shopworn 15-step distribution checklist. In this instance, although sections 736 and 751(b) remain irrelevant, sections 704(c)(1)(B) and 737 can come into play. There is no time to consider a problem based on this pattern.

The third pattern is a disproportionate distribtion of assets to the partners, a pattern that is far more likely to occur than the other two. Yet again, the consequences follow principles previously studied, namely, the by-now-shopworn 15-step distribution checklist. In this instance, although sections 736 remains irrelevant, sections 704(c)(1)(B) and 737 can come into play, and section 751(b) works its magic unless the transaction involves a proportionate distribution of the ordinary income assets. A problem involving two partners and four assets is used to demonstrate how to report this sort of partnership liquidation. At the end of the problem, discrepancies between potential ordinary income and capital gain and reported ordinary income and capital gain, caused by disappearing and created basis and the inability to make a basis adjustment, permits a preview of the basis adjustment issues waiting for discovery in a Partnership Taxation course.

Tucked in at the end of this topic is an examination of what happens when a partnership terminates by reason of sales of partnership interests. This discussion is deferred until this point because the consequences involve a deemed liquidating distribution, though the 1997 regulations created a conceptually bizarre momentary one-partner partnership in order to bail out the legislative mess created by having a limited time period in sections 704(c)(1)(B) and 737.

Next: Bringing It to an End

Structuring Introduction to Taxation of Business Entities: Part XVIII

As the course winds down, the transactions that mark the end of an entity’s existence take center stage. The word liquidation presents almost as much ambiguity in the corporate liquidation context as it does with respect to partnership liquidating distributions.

There are several ways a corporation can structure its demise. If it sells all of its assets, it must recognize gain or loss, but this aspect of the situation requires students merely to review what they learned in the basic tax course.

For the shareholder’s tax consequences, the class takes a look at sections 331 and 334, giving a quick glance at section 332, because transactions involving subsidiaries aren’t within the scope of the course. From the corporation’s perspective, the operative provision is section 336. It would be a simple provision but for the overlapping provisions in paragraphs (1) and (2) of subsection (d) and the mostly redundant language of section 362(e), which the students encountered when learning about the tax consequences of corporate formations. Several examples, and some comparisons that students are expected to refine, help navigate this maze of bad drafting.

This topic closes with several problem sets. One focuses on the consequences to the shareholders. The other addresses the consequences to the corporation, principally the three loss limitations provisions of sections 336(d)(1), (2), and 362(e).

The S corporation liquidation topic is a 2-minute explanation that the same provisions apply, that any corporate gain or loss passes through to the shareholders, in turn affecting their adjusted basis and thus the gain or loss on the liquidating distribution. Fifteen seconds are expended mentioning the possibility of the built-in gains tax applying under certain circumstances.

Next: Partnership Liquidations

Structuring Introduction to Taxation of Business Entities: Part XVII

The partnership redemptions topic consists of two major subtopics. One deals with partial reductions in a partnership interest. The other deals with complete reductions of a partnership interest, in other words, partnership liquidating distributions.

The class returns to the 15-step distributions checklist that it first met when learning about partnership operating distributions. This time, notations in italics compares the application of the checklist to a partial reduction to its application in the case of operating distributions. With a few technical exceptions, all are the same, a consequence of the same statutory provisions applying to partial redemptions as apply to operating distributions. By this point in the semester, the students are beginning to understand why I predicted that the final few weeks would become increasingly a matter of review.

Because section 751(b) was avoided when doing operating distributions by keeping those distributions proportionate, this is the first time the class comes to grips with what was once the most difficult topic in the course until the section 704(b) regulations came along. The good news is that the definition of unrealized receivables is the same as it is for section 751(a) purposes, so they already know, or should know, this material. The bad news is that section 751(b) is not triggered by inventory items but only by substantially appreciated inventory items, so there’s another layer of complexity with which they must deal. I warn the students that there’s no sensible reason for the distinction but that it does provide good exam possibilities, aside from being a trap for the unwary tax practitioner. We then work through a problem involving a partial reduction in a partnership interest, including section 751(b) analysis. In fact, the section 751(b) portion of the problem solving is the only “new” black letter law being explored.

Having now arrived at liquidating distributions, it is necessary to deal with terminology issues arising from multiple definitions of the word “liquidation.” That having been accomplished, the students yet again see the 15-step distribution checklist show up on the projection screen, though not all at one time! This time, of the 15 steps, five require application of different principles than applied to operating distributions and partial redemptions. One of the differences requires extensive study, and that is the maze that constitutes section 736. Though it’s a simple sorting function, section 736 befuddles most students. So I use all sorts of methods to get the point across, including treating the paragraphs in that section as people engaged in a conversation, comparisons to marshalling yard (which fewer and fewer students recognize), and a more conventional flowchart. At this point the class is ready to take on two problem sets, one involving a simple application of section 736 that permits attention to be paid to section 731(a)(2), and the other letting the class dig into the finer points of section 736. The first problem set lets students discover that a taxpayer can realize gain yet recognize a loss. The second problem set is limited to cash distributions, because property distributions in a section 736 setting are far too complicated for this course.

This topic then concludes with what I call a review problem. It involves a lawyer retiring from a law firm, with the partners having several options as to how the deal will be structured. It’s a problem that could also be presented in a Business Planning course. By working through four alternatives, one a sale to the other partners, one a distribution with a provision for goodwill, one a distribution without a provision for goodwill, and one a sale to the other partners using partnership cash, the students are in a position to review a substantial portion of the partnership segment of the course. They also get a glimpse into drafting by focusing on the negotiations that would take place among the parties, particularly with respect to the danger of inconsistent tax reporting of the transaction, aand by identifying the language that would be needed to protect whichever of the parties is their client.

Next: Corporate Liquidations

Structuring Introduction to Taxation of Business Entities: Part XVI

Having explored sales of interests, the class turns to the tax consequences of corporate redemptions. Even though corporate redemptions resemble sales of stock, though to the corporation rather than a third party, the applicable rules are quite different.

The first set of issues involves the impact on the shareholder. This requires not only reading and understanding section 302, but also remembering what happens when section 301 applies. This happens because any redemption that fails to qualify as a distribution in exchange for stock is treated as a run-of-the-mill distribution. Again, student who have been assimilating previous topics are in much better position to learn the current material than are those who fall victim to the “the existence of reading periods suggests institutionalization of pre-exam cram time” mindset, one that makes learning not only more challenging but perhaps impossible in this course. The second set of issues involves the impact on the corporation. This is a much easier topic, for it requires another visit to section 311, a quick glimpse of section 162(k), and a few minutes of reading and interpreting section 312(n)(7).

Once the groundwork has been set out, it is time to pause so that the constructive ownership rules of section 318 can be digested. After this has been done, the focus can shift back to the application of section 302. Constructive ownership is one of those tax topics that most closely resembles a puzzle. Some students delight in its intricacies, while others begin to doubt their intellectual capacity. Attribution to entities meets attribution from entities, and the anti-sidewise-attribution limit shows up, demanding that the two not be conflated. After taking the students through some examples, I invite them to solve several problems, though none get as complicated as they could be. They are boggled by the lack of symmetry in rules that tell them they must attribute from granddaughter to grandfather but not from grandfather to granddaughter. If I have any misgivings about constructive ownership, it’s that we don’t have the several hours that I would like to dedicate to the topic.

Next on the list is complete termination, waiver of family attribution and the family hostility dilemma, disproportionate redemptions, the bizarre not-essentially-equivalent-to-a-dividend rule, and partial liquidations. Students learn why it sometimes makes more sense to try to avoid exchange treatment, because section 301 permits full use of basis whereas section 302 limits basis to a proportionate share of total basis. The existence and purpose of section 303 is mentioned but otherwise ignored. Constructive dividends get some attention, particularly the problems that arise in divorce situations as arose in cases such as Arnes and Read. We look at the regulations designed to alleviate the whipsaw, evaluate whether they truly solve the problem, and consider the dangers of not dealing with the issue in premarital agreements. The students learn why those among them who plan to be tax practitioners might be getting phone calls from their classmates who decided to practice domestic relations law and who, even if taking the basic tax class, usually are surprised when business tax gremlins appear. The class then deals with several problem sets focusing on one or another of these issues.

All of this having been done in the C corporation context, the shift to the S corporation world is rather simple. The rules are the same, and the application is much easier. If there are accumulated C corporation e&p, remembering what the accumulated adjustments account is will serve students well. Two short and simple problems conclude this topic.

Next: Partnership Redemptions

Structuring Introduction to Taxation of Business Entities: Part XV

There are three topics dealing with sales of interests in the entity. Only one receives any significant amount of class time.

In the case of C corporations, the tax treatment of stock sales gets three minutes of class time, as I take the students through a quick review of the property disposition checklist they hopefully have saved from the basic course, and point out refinements they must make to that list on account of redemptions, section 306 stock, and two other transactions that the course does not cover. No problems are tackled.

In the case of S corporations, the tax treatment of interests in the entity consists of a reference to the just-completed C corporation stock sale topic, a reminder that sales to the wrong person can trigger termination of S status, a reminder that sales during the year require taking into account varying interests, and a quick comparison with the apportionment that occurs if S status is terminated. As is the case with C corporation stock sales, no problems are undertaken.

However, in the case of sales of partnership interests, the analysis becomes more demanding. It’s time for yet another professor-provided checklist. This one, however, consists of only nine steps, of which only three are complicated in any manner. The first step requires some discussion, because sales for federal income tax purposes are different from sales in the state law context, where they exist only under special circumstances. This step also requires a visit to section 707(b) and the disguised sale rules. Students need to learn that sales of partnership assets and sales of distributed assets, though in the family of sales, nonetheless are different transactions and ought not be confused with sales of partnership interests.

Though the second step essentially is a return to section 706(d) in the event the sale occurs other than at the end of the taxable year, the third step examines section 706(c), the phenomenon of bunching income, and the logistical difficulties of applying section 706(d) when the partner’s tax return is due many months before the partnership taxable year closes. This particular issue is an example of demonstrating why something that makes sense theoretically often breaks down when taken into the practice world.

The fourth through seventh steps are reflect typical disposition issues, though section 752(d) comes into play when dealing with amount realized. It’s the eighth step that consumes much of the class time devoted to the checklist. Students meet section 751, specifically, section 751(a), and the definition of section 751 assets. They discover that if they haven’t fully assimilated the allocations material, they will struggle when trying to apply the rule that ordinary income or loss equals the ordinary income or loss that would have been allocated to the selling partner had the partnership sold the section 715 assets for fair market value immediately before the sale of the partnership interest. The final step, whether the partnership terminates, poses much less of a challenge and is deferred until entity liquidations and terminations are discussed. The section 743(b) basis adjustment’s existence is mentioned but it is not studied, as it, too, was a subtopic removed when the course was packaged as a combined 3-credit course.

After dealing with a problem that takes the students through alternative facts, the topic closes with an example of why partnership taxation is so strange. Students are shown that a partner who sells a partnership interest for an amount realized equal to the partner’s adjusted basis in the partnership interest nonetheless may end up recognizing ordinary income and, of course, offsetting capital loss. This exercise has the effect of hammering home to the students the inadequacies of a basic tax course, which leads people to believe, as might clients with a smattering of tax knowledge, that there are no tax consequences when amount realized equals adjusted basis.

Next: Corporate Redemptions

Structuring Introduction to Taxation of Business Entities: Part XIV

After dealing with operating distributions of cash and property, the course advances to the topic of corporations distributing stock. There is no partnership analog in this area.

This topic begins with a brief review of the tax consequences of stock splits and stock dividends as learned in the basic tax course, and then embellishes those principles with the more refined principles found in sections 305 and 307. Distributions of stock by C corporations and by S corporations are covered, even though three of the exceptions in section 305(b) cannot apply in S corporation situations. Section 305(c) and section 304 are beyond the scope of the course. However, the impact on the corporation of the transaction, including the nonrecognition of gain or loss and the effect on e&p, is covered. Application of these principles to specific fact situations is worked out in a problem set involving variations in the type of stock held by the different shareholders.

At this point, it is time to consider section 306. This provision serves as a vivid example of how the tax law becomes complicated because of the need to shut down tax avoidance devices, in this case, the preferred stock bailout. The computation of ordinary income and capital gain or loss under section 306 is explored, as are the various exceptions to application of section 306. Yet another problem set gives students a glimpse into how section 306 works and why careful practitioners take steps to avoid it.

Next: Selling Interests in the Entity

Structuring Introduction to Taxation of Business Entities: Part XIII

The discussion of partnership operating distributions begins with clarification of terminology. Students learn that one set of rules applies to liquidating distributions and another set applies to distributions that are not liquidating distributions. They learn that distributions that are not liquidating distributions often are called operating distributions but that technically, they can be divided into distributions that reduce but do not eliminate a partner’s interest in the partnership and those that do not affect a partner’s interest. It is this last group that comprises the topic.

At this point, I take the students through a 15-step checklist that identifies the essential questions that must be addressed when analyzing a partnership distribution. I give this checklist to the students because if I leave them on their own to create it, the odds are that most of them will end up with something that hurts, rather than helps, their learning process. Even though two of the steps are not applicable, I leave them in place so that the same checklist can be used when we reach distributions that reduce a partner’s interest and when we reach liquidating distributions. Several of the steps are simple, but others contain sub-steps. Unless one works through the analysis in logical sequence, one will end up jumping around in ways that cause some steps to be omitted and some to be considered multiple times. I emphasize the need to work with the checklist because I’ve seen too many exam answers that demonstrate the mess that is generated when methodical analysis is forsaken, and I make that point as forcefully as I can. This is followed by working through a problem set involving distributions of cash and property, simultaneously and then in sequence, that touches upon partnership draws, but that leaves the partners with unvarying interests, no contributed property, and no 751(b) issues.

Omitted from this topic, other than taking their place in the checklist are the section 704(c)(1)(B) and section 737 contributed property rules, the 751(b) ordinary income asset rules, the section 731(c) marketable security rules, the section 732(c) basis allocation rules, and the section 734 basis adjustment rules. Of these, the first two will get attention in subsequent topics, whereas the others are simply omitted from the entire course.

The topic concludes with an analysis of section 735, including a comparison to its counterpart section 724, which is not quite identical. This is followed by a problem set that illustrates the tax treatment of a partner’s disposition of distributed property. Although the class does explore the puzzling case of gifted distributed property, it does not go into the ramifications of a partner’s disposition of distributed property that carries a depreciation recapture taint. That’s just too much for a course of this sort.

Next: Corporate Stock Distributions

Structuring Introduction to Taxation of Business Entities: Part XII

In comparison to the tax treatment of C corporation operating distributions, the principles applicable to S corporation operating distributions are far less likely to leave students overlooking analytical steps. The world of S corporation distributions is divided into two parts, one involving S corporations that have no accumulated C corporation e&p and the other involving S corporations that do.

The rules for the former group that are covered in the course are about as simple as things can get in the tax law, and one short problem is sufficient to illustrate how they work. For the latter group, the concept of the accumulated adjustment account is introduced, and students are taken through a series of examples that illustrate many of the possibilities in terms of the size of the distribution and the size of AAA.

The class does not learn about the impact of tax-exempt income on AAA, the election to distribute earnings first, or restricted bank director stock. These are the sorts of issues that are among the first to go when shoehorning business entity taxation into a 3-credit course.

Next: Partnership Operating Distributions