The Grand Delusion: Balancing the Federal Budget Without Tax Increases

The debate between the choices of raising taxes or cutting spending continues, and is certain to become more intense, louder, and more confusing. One problem is that the two choices are not mutually exclusive. It is possible to raise taxes and reduce spending. In fact, that might be the remedy, considering that a significant reason the federal budget deficit is so large is the decision to cut taxes while raising spending. I’ve written about the foolishness of that decision several times, most recently in Some Insights into the Tax Policy Mess, in which I wrote:

The deficit cannot be eliminated merely by cutting spending, unless Congress wants to strip the military down to pretty much nothing, eliminate Social Security and Medicare, and put an end to a variety of other programs. The nation faces huge deficits not only because tax rates on the wealthy are lower than they need to be, but also because the deficit reflects eight years of taxes that should have been collected but that were forgiven by a Congress anxious to reward the economic elite and ballooning interest payments on the debt undertaken to finance the deficits generated by trying to finance a war while cutting taxes.

In FICA, Medicare, and Payroll Taxes, I noted that “Advocates of tax cutting need to identify the cuts they would make to balance the budget, and if they don’t touch defense, Medicare, Social Security – and they’re stuck with the interest payment on the debt – there’s not enough to cut.”

So today I invite the advocates of using spending cuts as the sole solution to the budget deficit crisis to identify sufficient cuts to bring the budget into balance. Off the table is the “trickle down” nonsense that claims tax cuts increase revenue, because when that was tried it didn’t happen. Though there was a momentary upward blip in tax revenues, the long-term experience demonstrates that short-term success is simply that, transitory illusion.

A month and a half ago, the Kaiser Family Foundation released poll results revealing that 40 percent of Americans “think that foreign aid is one of the two biggest areas of spending in the federal budget.” This, of course, is totally incorrect. Once again, the question pops up, “Why are Americans so wrong about something so easy to learn?” The Wall Street Journal, in this article, reported on the poll results and asked the Washington think tank Third Way to prepare “A Taxpayer’s Itemized Receipt” that shows where federal tax revenues go. The “Receipt,” which accompanies theWall Street Journal article, shows what happens to the $42,978 of total income and payroll taxes paid by a working couple with income of $200,000, and what happens to the $7,555 of total income and payroll taxes paid by a retired couple with income of $100,000. What I have done is to convert the figures to show how much of every $1,000 of total income and payroll taxes is expended on some of the categories.

Of the $1,000, $192.64 is paid out in Social Security benefits. Military operations account for $179.29, of which $41.42 is attributable to operations in Iraq and Afghanistan. Another $120.76 is used for Medicare, and $71.32 goes for Medicaid. Interest on the national debt takes $53.16, and veterans’ benefits and health care consume $25.24. Food stamps cost $15.38, the CIA gets $14.15, and federal highways, $11.83. The amounts spent on NIH, Department of Energy, housing subsidies, and each of the other categories is even less. Foreign aid takes $8.53, an amount which puts it far down the list, certainly not one of the top two categories.

Seen another way, the proposed 2011 federal budget, according to this summary, would consist of receipts totaling $2.567 trillion, expenditures amounting to $3.834 trillion, and a deficit of $1.267 trillion. To balance the budget without raising taxes, $1.267 trillion of the $3.834 expenditures would need to be cut. That’s 33 percent of the expenditures. Social security, Medicare, Medicaid, military operations, and interest on the national debt alone constitute 62 percent of the expenditures. Unless those are cut, then 89 percent of all other expenditures, including veterans’ benefits and health care, the CIA and other intelligence activities, NIH, military retirement, border security, immigration, the FBI, the courts, FEMA, the Coast Guard, federal prisons, and a long list of services that the country surely needs, would need to be axed.

Some might propose cutting Social Security, Medicare, and Medicaid, but that proposal would bring howls of opposition from across the spectrum, with people of all ages and political stripes objecting. There are those who would cut military operations, but again, objections would pour in from those concerned about the consequences. Who would rejoice at cutting almost 90 percent of national intelligence activities, border security, federal highways, and the Coast Guard? How about NASA? Having already had its budget cut, it has cancelled the program to replace the shuttle, which means China, or perhaps Japan or Russia, will put people on the moon, plant their flag, and leave the United States gasping in the wake of these other nations’ successes. Cutting interest on the national debt would destroy the country’s credit, and accelerate the deep spiral into which it already is heading. Note that to reduce interest on the federal debt, the debt must be cut, which means chopping even more expenditures in order to generate a budget surplus that can be used to pay down the debt.

Those who claim that there is waste that can be eliminated want us to believe that one-third of federal expenditures constitute waste. That simply isn’t so, and no study of the question has ever projected a ratio anywhere near that level. There are those who would cut all the social programs other than Social Security, Medicare, Medicaid, and veterans’ benefits, but that won’t generate a 33 percent reduction in spending. With state and local governments unable to take up the burden, that sort of cutting would create a desperate conglomeration of destitute individuals driven to do more than demonstrate. Do the people who advocate this sort of cutting ever stop to picture or imagine what society would become under those circumstances?

Those who want to tinker with various spending cuts -- as well as revenue adjustments -- will find this interactive federal budget puzzle to be interesting, and in some strange way, almost fun.

I find it interesting to consider what would have happened had taxes not been cut, let alone raised, when the nation went to war nine years ago. Imagine the trillions of dollars that would have been collected during that period. Imagine the impact on credit markets. Imagine an economy not bloated with tax cut money and thus not sucked into bubbles that eventually burst. It’s too late to go back and do the right thing that should have been done. It’s politically impossible to collect “back taxes” with interest to compensate for the error in judgment. And until Americans understand the reality, it’s politically impossible to put an end to one of the principal causes of the economic mess in which the country is mired. With 40 percent of the nation’s citizens thinking foreign aid is one of the top two federal expenditures, we have a very long way to go before Americans are cleansed of the lies and misleading sound bites of the extremists and ready to tackle the problem. By then, it will be too late. Unless taxes are raised – and that’s not saying there should be no cutting of expenditures – but, I repeat, unless taxes are raised, America will be a second-order, or perhaps even third-order, nation by the end of this century.

Stamping Out Tax Misinformation

It’s a long story with a simple lesson. Not only is the story long, it’s about taxes. Nonetheless, it’s worth reading. I’ve tried to shorten it without losing the message.

It begins with a TaxProf blog post about a Canadian couple who won a lottery and gave almost all of their winnings to charities. In his post, Paul Caron pointed out that if the couple lived in the United States, they would have a tax problem, because only 50 percent of their charitable contributions would be deductible, leaving them taxable on roughly half of their winnings. Roughly, because they did not give away all of their winnings and they probably would have other deductions; perhaps they have other taxable income. But, give or take a little bit, they would be paying federal income taxes.

A student in a course taught by another tax law professor saw the TaxProf blog post and directed that professor to this Wall Street Journal article. In the article, the author tries to explain that deciding whether to make charitable contributions in late 2010 or early 2011 isn’t as easy as it might appear. Though some advisors suggest waiting until 2011, when higher rates might generate larger tax savings that offset the reduction in the present value of the tax savings arising from the delay, there are other considerations that favor donating in 2010. The author then writes:

Another consideration is the absence of limits this year on itemized deductions for charitable giving. Limits tied to income will come back next year unless Congress acts to stop that.

When I saw that, my immediate thought was, “Whoa! Was there a tax law change that I missed? When the basic tax course reaches the charitable contributions deduction topic in a few days, will I be teaching the wrong law?” I stopped what I was doing and did some research, even though the tax law professor to whom the student had pointed out the Wall Street Journal article had noted that this was something of which she had been unaware. But perhaps she and I were wrong. When in doubt, research it.

What I discovered is that there is nothing in section 170 suspending the 50 percent limitation on charitable contributions to public charities. I found nothing in any amendment to section 170 suggesting such an outcome. I found nothing in uncodified legislation. I discovered that the people at Grant Thornton think the limits are still in place; Go to their Year-End Tax Guide For 2010, go to chapter 7, and from there go to the charitable contributions chart. I shared with my tax law professor colleagues across the nation not only the results of my research but this thought: “I wonder if it was a change in a limit on something else related to charitable contributions?”

In response, another tax law professor noted that he did not see anything in section 1400S, where, to quote him, “most of the [section] 170 percentage limitation suspension rules reside.” He also informed us that he and his co-authors had not discovered anything suspending the 50 percent limitation while they were preparing their current developments outline, which, as he explained, “requires reading every new tax provision.” This response was comforting. I, too, read every new tax provision and had not seen anything. The fact that, by this point, four of my colleagues across the country were reaching the same conclusion reduced the odds of my having missed something.

Another tax law professor suggested, “Perhaps it had to do with charitable contributions of IRA accounts.” Yet another colleague chimed in that it was “probably a reference to the temporary elimination of the income-based deduction phaseout in section 68.” That phaseout affects many more itemized deductions than charitable contributions, and has no effect on the 50 percent charitable contributions deduction limitation. This same law professor had taken the research effort in a different direction, sharing a link to the IRS web site, where the August 25, 2010, version of Publication 78 Help, Part II, describes the 50 percent charitable contributions limitation as still in effect.

Still another tax law professor opined that the author of the Wall Street Journal article must have been referring to the return of the section 68 phaseout. He explained that there have been some articles, such as this one from SmartMoney magazine that recommends increasing 2010 charitable giving, especially if the taxpayer’s only itemized deduction, or perhaps only significant itemized deduction, is charitable contributions. This professor then warned, “these sorts of articles can confuse people into thinking that the [section 68 phaseout] is only for charitable gifts, when in fact it applies to all itemized deductions.” Exactly. The lack of precision opens the door to misunderstandings.

Someone suggested that the student who brought the Wall Street Journal article to the attention of his professor be encouraged to contact the Wall Street Journal and identify the error. We’ve been told that the student has been so advised.

One way of checking out something that is alleged about taxes is to put the question to others who have expertise in the matter. That is what happened in this instance when the professor to whom the Wall Street Journal article was shown had doubts and asked her tax law professor colleagues throughout the country for their reactions. Unfortunately, most people, when hearing or reading something about taxes, simply treat the information as true. And therein lies the lesson.

Whether the misinformation is accidental, as I’m very certain is the case with the Wall Street Journal article, or deliberate, its impact can be damaging. It’s not just the taxpayers who accelerate or delay charitable giving when in fact they should have done the opposite. Sometimes a substantial portion of the electorate can go to the polls and make decisions based on deliberate misinformation with respect to taxes, as discussed in this analysis. The ultimate lesson for everyone, not just tax law professors, tax students, or tax practitioners, is to figure it out for one’s self, with the help of the source material and those with expertise in the matter. Otherwise, tax misinformation that needs to be stamped out will proliferate. There is no good to be found in that outcome.

And So Now Philadelphia Listens?

Several months ago, in A Tax on Blog Writing or on Blog Business?, I reacted to the news that Philadelphia was subjecting bloggers to its $300 business privilege license fee no matter the amount of income received by the bloggers, even in instances where the blogger’s advertising receipts fell far below $300. I noted:

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.

Now comes news, as reported in thisPhiladelphia Inquirer story, that Councilman Bill Green, joined by five other members of Council, has introduced legislation that would prevent the city from imposing the business privilege license fee on individuals whose blogging is a hobby. The determination of whether the individual’s blogging was a hobby would be determined using federal income tax law. In other words, if the blogging income showed up on a federal Schedule C or Schedule C-EZ, the blogging would be treated as a business, but if the de minimis blogging income showed up as miscellaneous income, and was not treated as a business for federal income tax purposes, the blogging would be treated as a hobby. For federal income tax purposes, the effect of treating an activity as a hobby is that any deductions that would otherwise be deductible in full are limited to the total income, except for deductions allowable in any event, such as interest and taxes. For those interested, here is the text of the proposed Philadelphia legislation.

Coming on the heels of the news, on which I commented two days ago in Life for My Proposed Marcellus Shale User Fee?, that Pennsylvania legislators are now considering Marcellus shale natural gas extraction user fees as I suggested in Tax? User Fee? Does the Name Make a Difference?, this most recent development has me thinking that perhaps, just perhaps, legislators, or at least members of their staffs, are paying attention. It remains to be seen whether this change in Philadelphia tax law gets enacted.

Life for My Proposed Marcellus Shale User Fee?

More than a month ago, in Tax? User Fee? Does the Name Make a Difference?, I suggested that a key to breaking the stalemate in the Pennsylvania legislature, and between the legislature and the governor, with respect to the taxation of Marcellus shale natural gas could be reliance on user fees rather than on a tax. I reiterated this point almost a month later, in Giving Up on Taxes = Surrendering Taxpayer Rights?

Now comes news, in a Philadelphia Inquirer story, that is best summed up by the headline: “New Pa. GOP Leaders Eye a Fee on Natural Gas Instead of a Tax.” Have these people been reading my MauledAgain posts? It’s possible. One of the legislators, an incumbent re-elected without opposition, and who is moving up to a leadership position, is someone I’ve known since I was in high school. The House Republicans, who at first had been opposed to a tax, but later offered a low-rate version, have explained that they think there should be “a way for industry to contribute to local municipalities to help out with the impact” of road and environmental damage, to name two of the several burdens that otherwise would fall on local taxpayers. Though I commend the announced plans, I am troubled with the phrase “help out” because it suggests something less than a fee sufficient in amount to cover the full cost of what economists call the externalities. And, as usual, it remains to be seen whether the legislature gets anything done with respect to this issue. Announcing plans isn’t quite the same as accomplishing the goal, particularly with so many distractions, interruptions, roadblocks, negotiations, lobbying, and other impediments to legislative progress. Considering that the Republican governor-elect is opposed to taxes across the board, and that many House Republicans are willing to consider a tax, the idea of a user fee – as I proposed more than a month ago – indeed provides a pathway to breaking the legislative logjam.

The Horror of Halloween Widens

Last Wednesday, in The Horror of Halloween?, I noted that I was shocked, and certainly not treated, when a small girl whom I did not recognize and who had arrived at my door seeking candy, saw what I was handing out and said, “No thank you, I don’t like Reese’s Peanut Butter Cups.” There’s someone who doesn’t like Reese’s?

On Thursday, it got worse. A faculty colleague emailed me to tell me that two other faculty colleagues do not like Reese’s Peanut Butter Cups, because they do not like peanut butter. Wow. It’s worse than I realized. But is it bad news because it explains why the Reese's four-packs are no longer available in the places I look due to a declining market? Or is it good news because it means there are more Reese’s Peanut Butter Cups available for those of us who think they are the elite candy, even if they come in those tiny two-packs?

Perhaps I should be asking more people about their views on Reese's Peanut Butter Cups? Then emails such as the one I received on Thursday would not be so shocking?

Taxes and Religion: A Totally Different Perspective

No, this isn’t a post about the tax-exempt status of religious institutions. It’s not a post about the relationship between theological principles and tax policy. It’s about, well, keep reading.

Several days ago, while continuing a long project of working methodically through the database holding information on the descendants of Thomas Maule of Salem, Massachusetts, I reached the entry for Louis Blaul, who had married Mary C. Clendenon, a descendant of Thomas Maule through the Clendenon branch of the family. Louis was a well-known photographer in Philadelphia, operating a business that was taken over by his son, also named Louis, when he died. My google search for “Louis Blaul” brought me to an entry on google books. It was Volume 10, No. 1 (Jan–Feb. 1910) of the Single Tax Review, subtitled “A bi-monthly record of the progress of single tax and tax reform throughout the world.”

What was the single tax? A tax on unmarried individuals? No, it is a tax on the value of land, proposed by Henry George in the latter part of the nineteenth century. The theory was, and remains, that the revenue collected from taxing land would be sufficient to permit elimination of all other taxes. The underlying justification for the tax is that, although a person should be treated as the owner of all that he or she creates, that which is found in nature, such as land, belongs to society as a whole. The point of this post is not to get into a discussion of the single tax. It’s something else.

What caused google to send me to the Jan-Feb 1910 edition of the Single Tax Review was an obituary for Louis Blaul. Unfortunately, it contained no genealogical information, though it did illuminate some aspects of his personality. In a short, two-paragraph write-up under the simple headline, “DEATH OF LOUIS BLAUL,” an unidentified writer shared this information:

The death of Louis Blaul, of West Philadelphia, robs that city of an earnest and devoted Single Taxer. Though for years he has been a helpless invalid he has made his influence felt through an ever increasing circle of friends.

Though informative and interesting, the first paragraph is not what triggered the thought of “taxes and religion.” It was the second paragraph, which described something that I had not previously encountered:

The funeral was conducted as he had desired, not according to the rites of any church, but by officiating Single Taxers. Mr. Ross read from Progress and Poverty, portions of the “Central Truth,” and “The Individual Life.” Among other Single Taxers present were Henry C. Lippincott, Chas. F. Shandrew, Haines D. Albright, Miss Musson, Dr. and Mrs. Wright, and Dr. Sullivan, of Albany, N.Y.

The idea of having one’s funeral conducted by members of a tax reform movement opens up all sorts of stupefying possibilities. Would a staunch advocate of the, or should I say, one or another, flat tax want someone to read a portion, or perhaps all, of proposed flat tax legislation? Would an defender of the progressive income tax want someone to read from the legislative history of the Internal Revenue Code? Would a supporter of the unitary method of apportioning income for state income tax purposes prefer that someone read from the latest judicial opinion on the matter? Would anyone want a reading from a United States Supreme Court opinion dealing with a tax issue? People often cry at funerals and memorial services. I can’t imagine giving them even more reason to do so.

Could it be that devotion to a tax reform concept can rise to the level of being itself a religion, under which, for example, funerals are held? Would that open the door to weddings performed under the auspices of adherents to a VAT? Would meetings of consumption tax proponents morph into some sort of worship service?

At what point does it become, not “Taxes and Religion,” but “Taxes as Religion”?

The Horror of Halloween?

For me, Halloween started when, during an afternoon conversation with my neighbor, he asked me if I was planning to hand out candy this year. I assured him I was ready. He told me that I had a reputation in the neighborhood for handing out good candy. No kidding! I’ve been distributing Reese’s Peanut Butter Cups for years. True, my inability to find the four-packs has compelled me to hand out the smaller two-pack, but Reese’s Peanut Butter Cups it will be. This is the fifth year that I’ve come up short in the four-pack department, with the first episode of the bad news described in Happy Halloween: Chocolate Math and Tax Arithmetic, the continuation noted in Tricky Treating: Teaching Tax Trumps Tasty Tidbit Transfers and in A Truly Frightening Halloween Candy Bar. By last year, I had become so accustomed to the disappearance of the four-pack from my shopping venues that I considered it no longer noteworthy. This time around, I want to reassure the neighborhood children that I continue to look, and if I see four-packs return, I will acquire them. I have a candy-distribution reputation to maintain!

Shortly after 6 in the evening, children – many accompanied by parents, some coming to the door because they were carrying, or holding the hands of, little ones, and some standing off at a short distance – began ringing the bell, knocking on the door, or simply making noise loud enough for me to notice. They were delighted with the Reese’s Peanut Butter Cups. Having the chance to see what was in their bags, pumpkins, or other containers – hats off to the young teen who was using a 30-gallon drawstring plastic trash bag – it appeared to me that the per-ounce take from my premises was on the high side.

But then came the shocking non-treat of the night. A small girl whom I did not recognize said to me, “No thank you, I don’t like Reese’s Peanut Butter Cups.” I found some other candy to give her, though it may have been sitting around long enough to have become stale. That didn’t dawn on me until after she walked away. I was still in shock. There was someone who didn’t like Reese’s Peanut Butter Cups. Horrors! Later that evening, I wondered if perhaps she had turned it down because she was allergic to peanuts and didn’t want to disclose that fact. There’s a young man in the neighborhood who is allergic to peanuts, and who would tell me that every year. But a year or two ago, he stopped telling me that and took the Reese’s Peanut Butter Cups. Did he outgrow, or get cured of, the allergy? Perhaps, and hopefully so, but I think it is more likely that he uses the Reese’s Peanut Butter Cups as trade bait. We could have a future professional sports general manager in the making in our neighborhood.

The following morning, I heard on the radio that someone had ranked candy from worst to not-so-worst in terms of health aspects. After digging around, I discovered that the source must have been this candy ranking. The radio announcers disclosed the ten worst, and Reese’s Peanut Butter Cups was not among them. Of course not. Peanuts are protein and chocolate is, yes, medicinal. It took many, many clicks – as each candy has its own slide in the slide show – to determine that Reese’s Peanut Butter Cups came in 32nd out of 40. That means there are 31 candy bars worse for one’s health than the Cadillac of candy. But does this mean that, considering there must be hundreds of different kinds of candy bars, let alone candy – though I was unable to find any sort of accurate count or estimate – this could be even more bad news. Imagine this conclusion: “There are 643 types of candy healthier than Reese’s Peanut Butter Cups.” Impossible. How could, for example, hard candy – which is pure sugar – be healthier than Reese’s Peanut Butter Cups?

But the real horror was the percentage of children toting UNICEF trick or treat boxes. Zero. In a conversation at the gym the following morning, several other people noted the same phenomenon. What has happened to the UNICEF tradition? My children abandoned Halloween candy acquisition expeditions years ago, so I’m out of the loop. Perhaps we need a tax credit for families whose children take UNICEF boxes and collect money for a good cause while they make their candy rounds? That would be even more horrible. It reminds me of a parent I once overheard saying to a child, “If you’re nice to your brother, I’ll pay you a dollar.” Ouch.

Could Tax Law Professors Be More “Tax Return Hands-On” Than Tax Practitioners?

Thanks to an item on Paul Caron’s TaxProf blog, I found myself reading a Time Magazine article, “Why $1,700 Means Joel Stein is Rich.” There are all sorts of blogworthy tidbits in the article – ranging from the definition of income subject to the proposed $250,000 cut-off for extending tax cuts to some amusingly sarcastic commentary about how a tax cut should be used by the taxpayer – but the one that gets attention today is the comment made to Stein by a tax lawyer he contacted about the tax cut debate. Mike Foster, who practices with Venable LLP, said, “I don’t even do my tax returns anymore. I don’t know any tax lawyer who does their own tax returns. The forms are Greek even to us.”

Hopefully someone does a survey to determine how many tax lawyers do their own returns. Anecdotally, there is evidence that among tax law professors, a more than insignificant number do their own returns. I use that phrase generously, as I include not only those who prepare their returns manually but also those who use software such as Turbotax. Even if the latter doesn’t count as “doing one’s own return” – though I wholeheartedly think that it does – there are tax lawyers who do their own returns. It is interesting to me that one can find these tax lawyers in academia, whereas one might expect there to be a higher percentage among full-time practitioners. If Foster is correct, there exists what I would consider to be the reverse of the stereotypes, namely, academics doing tax returns and practitioners handing the task off to someone else. Hence the desire for a survey to corroborate or rebut this apparent counterintuitive outcome.

So here’s a project for someone in need of a research topic, particularly if it is one for which empirical research would be valuable. Are there any LL.M. (Taxation) students about ready to enroll in a Tax Research and Writing course? The only price I charge for coming up with the idea is a request that you share the results of the survey and provide a link to the paper that you write.

Happy Halloween: Revenue Department Scares Kids Into Abandoning Pumpkin Sales

It’s Halloween! It’s a frightening time of the year. Actually, considering how frightening the world has become for the rest of the year, let’s say that it is an even more frightening time of the year. And what could be more frightening than employees of a state revenue department descending on two children, both under the age of 7, and shutting down their pumpkin-selling fund-raising efforts?

Is it more frightening than Taxing "Snack" or "Junk" Food (2004)? More unnerving than Halloween and Tax: Scared Yet? (2005)? More intimidating than Happy Halloween: Chocolate Math and Tax Arithmetic (2006)? More alarming than Tricky Treating: Teaching Tax Trumps Tasty Tidbit Transfers (2007) and Halloween Brings Out the Lunacy (2007)? More unnerving than A Truly Frightening Halloween Candy Bar (2008)? More terrifying than Unmasking the Deductibility of Halloween Costumes (2009)?

Indeed, in many ways it is. According to this story, two children, ages 4 and 6, decided to raise money for school sports. They set out to sell pumpkins at a roadside stand outside their family home. Along came a state tax collector who told the children, and their parents, that because they did not have a state sales tax license they had to shut down. Shades of the Philadelphia business privilege license fee being imposed on baby sitters, as I discussed in A Tax on Blog Writing or on Blog Business?.

If I had any worthwhile artistic skills, I’d crank out a cartoon, showing two terrified youngsters looking up aghast at a big, stern, glowering tax department employee. The caption would simply be, “What’s a sales tax license, mister?”

The sad, ironic, and perhaps galling aspect of the story is the part that hasn’t been told. Why would two children who haven’t even reached the age of reason decide they needed to raise money for school activities? Is there some background information missing? Could, perhaps, their efforts be a reaction to the consequences of insufficient funding, a by-product of opposition to tax increases? I don’t know. Perhaps someone in Lewiston, Idaho, where this took place, can let us know. That’s assuming someone in Lewiston reads MauledAgain. I’m afraid that’s a mighty monstrous assumption. But I could be wrong, and wouldn’t that be such a nice treat?

P.S. Please do read the five-sentence story. See if you can find the five plays on words.

Juggling Tax Return Due Dates

The American Institute of CPAs (AICPA) has forwarded to the Congress a proposal to alleviate the procedural challenges posed by the current set of due dates for filing corporate and partnership returns. The problem that the proposal addresses is a serious one. For example, under current law, an individual who is a partner in a partnership must file his or her tax return by April 15, but the partnership is not required to file its return until April 15. As a practical matter, the partner does not have, by April 15, the information that is required to file the return by April 15. Even though extensions of time to file the returns can solve the problem in many, though not all cases, the taxpayer nonetheless must pay his or her taxes by April 15. This requires cautious taxpayers to overestimate their tax liabilities to avoid possible interest and penalty charges.

The AICPA proposal suggests the following:

Moves the original due date of partnership returns one month earlier and reinstates a 6-month extension (3/15 and 9/15);

Separates the due dates of S and C corporation returns;

Maintains the longstanding due dates of Form 1040 (4/15 and 10/15);

Moves the original due date of S corporation returns to two weeks after partnership returns and two weeks before the original due date of individual, trust and C corporation returns (3/31);

Moves the extended due date of both S corporation and trust returns so that they are two weeks after partnership returns and two weeks before the extended due date of individual and C corporation returns (9/30);

Moves the original and extended due date of C corporation returns one month later (4/15 and 10/15); and

Maintains the original due date of employee benefit plan returns on July 31 but allows for automatic three and one-half month extension by moving the extended due date one month later (11/15).

The proposal explains the reasoning for these changes, and the reasoning makes sense.

However, I would go further. Because there are so many partnerships that, in turn, are partners in other partnerships, I would set up an even more gradated schedule. Partnerships that have other partnerships as a partner would be required to file by the last day of February. Partnerships that do not have other partnerships as a partner would be required to file, as the AICPA proposes, by March 15. By providing an earlier due date for partnerships with other partnerships as partners, partnerships that do not have other partnerships as partners will not be delayed by having a due date that is the same as the due date for the partnership from which they are waiting for information. It would be nice if this pattern could be extended so that partnerships with partners that are partnerships with other partnerships as partners would have an even earlier due date, but two limitations make this unwieldy. First, it would move a due date to the middle of February, which is too early to have all the information ready. Second, a partnership with other partnerships as partners knows that it has other partnerships as partners, but does not necessarily know if that other partnership itself has other partnerships as a partner.

Further, in an effort to spread the demands on the IRS return processing functions over a longer period. I would move the due date for certain individuals to March 15. Individuals who have no gross income from partnerships, S corporations, trusts, estates, or other pass-through entities, and who thus are not waiting for information returns from pass-through entities, should have all the necessary information for filing their returns by the end of January and thus should be able to meet a March 15 due date.

Even without my suggested modifications, the AICPA proposal makes sense. It’s a substantial improvement over the current system. And it’s a far better idea than the one floated some years ago by a member of Congress who wanted to make tax returns due on the taxpayer’s birthday. Imagine how that would work.

Yet More Reasons to Prefer User Fees

Earlier this month, in Better to Tax Gross Receipts, Net Income, or a Combination?, I revisited the question of whether, and if so, how, the Philadelphia business tax structure should be changed, following up on comments I made on the issue in Don’t Like This Tax? How About That Tax?. The core question in the discussion, as framed by the City Council members advocating a change and those supporting the idea, is whether businesses should be taxed on gross receipts, on net income, or on some combination of the two. From my perspective, there exist other alternatives, such as the imposition of user fees to charge businesses for the costs that they impose on the city.

On Sunday, Mark Zandi, chief economist of Moody’s Analytics Inc., published an opinion piece, Philadelphia Business-Tax Code Needs Change, in the Philadelphia Inquirer. The point made in the headline is one with which few people disagree. The city’s business tax structure is antiquated, and does not serve well the city, its citizens, or the businesses operating in it. The challenge is identifying what sort of tax structure would be a worthwhile improvement.

Zandi argues in favor of shifting away from a hybrid structure that taxes both profits and sales to a tax based on sales. The existing structure, if left alone, will shift, by terms of already-enacted legislation, from its hybrid form to a tax on profits. Zandi advances several arguments in favor of a tax based on gross receipts.

First, he claims that taxing gross receipts “broadens the tax base,” by spreading the tax burden from profitable businesses to businesses that are profitable and businesses that are unprofitable. Here’s the catch. One of Zandi’s arguments demonstrating the need for business tax reform is the claim that combined with all other taxes, it puts businesses in a position where they “could pay more than half” their profits in taxes. If that’s a terrible thing, then how does one react to a tax that would be imposed on a business with little or no profits? Even if a business with $100 in profits pays $51 in total taxes – with the Philadelphia business tax being a small portion of that – is it better to ask a business with a loss of $20 to pay $5 in sales-based taxes, or to ask a business with $4 in profits to pay $5 in sales-based taxes? The broadened base would quickly disappear as these borderline businesses closed their doors or moved out of the city. Zandi’s goal of “lightening the load . . . for successful firms” would end up increasing the load for those firms as they ended up being the only businesses remaining in the city to be taxed, until, of course, they, too, departed.

Second, in a related argument, Zandi claims that by taxing profits and not taxing sales, the city will encourage successful businesses to leave the city. There’s logic in that argument, but shifting the tax burden in order to kill the chances of barely profitable firms becoming successful merely changes the sequence and timing of continued erosion of the city’s business tax base, as explained in the preceding paragraph. Though Zandi seems to argue that the many businesses that already have left the city did so because of taxes, other factors also entered into those decisions, including the decision to move operations to areas where employees live and customers and clients live and do business. Many suburbanites are reluctant to go into Philadelphia, for reasons other than tax policy, and thus to retain customers from among those individuals, it made sense for businesses to relocate.

Third, Zandi argues that a profits-based business tax is more easily avoided than is a sales-based business tax. He claims that profits are “harder to accurately measure and easier to manipulate than are sales.” It would be helpful to see proof of this proposition, particularly when far more tax dollars are evaded in the federal income tax arena through under-reporting of gross income -- think of the cash skimmed from the register – than are avoided through overstatement of deductions. A sales-based business tax would encourage more of the “pay cash, pay less” schemes. The advantage of a profits-based tax is that the city could let the IRS and state revenue departments do a good chunk of the auditing work. Granted, Zandi’s argument that “[a]nything that simplifies the tax code is likely, therefore, to produce greater compliance and more tax revenue” is valid in a general sense, but the argument carries within its message a suggestion that the answer might lie in something other than sales-based and profits-based business taxes.

Fourth, Zandi argues that profits are “extraordinarily volatile, swinging wildly with changes in the economy,” and thus making revenue based on profits unreliable and difficult to predict. That’s also the case with sales, as Zandi concedes, and though he claims that sales are less volatile, it isn’t difficult to appreciate that profits drop when the economy tanks because revenue declines faster than expenses can be cut. If anything, Zandi is again making a strong case to minimize reliance on both sales-based and profits-based business taxes.

Fifth, Zandi dismisses the impact of a profits-based business tax on small firms by pointing out the $100,000 sales exemption that is included in the most prominent of the proposals to reform the business tax. He also dismisses the impact of a profits-based business tax on less profitable companies by suggesting the concern about the impact “probably is overdone, as such firms also likely have weak sales.” Brushing aside the concern in that manner neglects the principal danger of a profits-based business tax on less-profitable enterprises, namely, these are often the fledgling companies whose rise to success would contribute to the well-being of the city’s economy, but are most at risk of going under if their $4 profit must be used to pay a $5 sales-based business tax.

Sixth, Zandi concedes that shifting to a sales-based tax “would benefit professional-services firms such as accountants, lawyers, and management consultants, along with some manufacturers, information-service companies, and the publishing and broadcasting industries.” No kidding, though I think very few manufacturers and very few publishers would be better off. Zandi also notes that “[h]otels, retailers, and construction firms would be hurt” by a sales-based business tax. His response to this issue is to claim that the companies that would benefit “generally employ educated workers, who bring lots of income and wealth to the city,” and that the businesses that would suffer “are less likely to leave the city even if they face higher taxes.” Is there any evidence suggesting that the “educated workers” employed by the firms that would be shifting their tax burden to the companies that are easy tax targets actually bring income and wealth into the city? Don’t most of these workers live in the suburbs? Don’t most of them spend most of their discretionary dollars outside of the city? Isn’t there something a bit alarming about a tax proposal that shifts the tax burden from highly profitable companies with their highly-paid educated employees to businesses employing lower-compensated individuals and having little or no opportunity to escape?

Zandi argues for a “more rational tax code.” Is it not more rational to determine the costs that a business imposes on the city and to charge it accordingly? Do not general taxes, such as a sales-based or profits-based exaction, skew the relationship between the benefits accorded a business and the amount it pays for those benefits? Don’t businesses have an obligation to bear the costs of their operations? Would it not make sense for the city to identify the services it provides to businesses and to utilize some cost accounting techniques to calculate the cost? Perhaps there is justification to calculate cost for a few services based on sales. For example, jewelry stores have relatively higher sales receipts per transaction, are more in need of police protection – perhaps because of the high-end value of their merchandise – whereas other enterprises are far less likely to be criminals’ targets, and thus dividing some portion of the cost of the police department by total sales in the city and allocating the cost in that manner would make more sense and move the tax system closer to a more rational, fair outcome. Fire protection should reflect the asset value of a business, an amount that may or may not be proportional to sales or profits. Businesses and their employees use city streets, and what an interesting opportunity to impose mileage-based road (or street) user fees. The city provides services that makes it a source of customers and clients, and ought not businesses be charged a user fee for this benefit, best measured by profits, not sales, because profits reflect not only the sales revenue brought by those customers and clients, but also the costs that a business must incur by reason of doing business in the city.

Reforming taxation in the 21st century, whether federal, state, or local, demands more creativity and courage than to kick around the same tired, worn-out, disproven, ineffective, and irrational tax structures that have been in place for more than a century. It is time for tax policy, and the politicians, economists, commentators, and others who are involved in tax policy decision making, to think beyond what they learned in school however many years ago they underwent that experience, to open their eyes and ears to ideas coming from sources other than the traditional power brokering segments of society, and to move past the present. Why? Because the citizens and taxpayers deserve nothing less.

Giving Up on Taxes = Surrendering Taxpayer Rights?

A week ago Friday, in Polls, Education, Taxes, and User Fees, I lamented the fact that the Pennsylvania legislature and the state’s governor were making no headway in keeping Pennsylvania from continuing its absurd status as the only state with no tax on natural gas extraction. I pointed out that the dispute pretty much came down to a disagreement on the rate of tax, and referred back to my suggestion, made in Tax? User Fee? Does the Name Make a Difference?, that a key to breaking the stalemate could be reliance on user fees rather than on a tax.

Now comes news that the governor has declared efforts to enact a natural gas extraction tax are dead. He blamed the Republicans in the legislature, claiming that they declined to accept his invitation to put a counterproposal on the table. The Republicans disagreed, arguing that they are interested in working not only for a “fair tax rate” but also on “a whole host of regulatory and safety issues.” Senate Republicans claim that they would support a 1.5 percent tax but only on wells producing more than 150,000 cubic feet of natural gas. The governor finds that idea unacceptable. If, next month, the Republican nominee for the governor’s mansion wins, it is unlikely any tax would be enacted, because, as he has stated more than once, he is “against a natural-gas tax.” If the Democrat nominee wins, nothing will happen unless the Democrats also take control of the legislature. That is not likely to happen. In other words, the easiest thing to predict is a continuation of the stalemate.

In the meantime, taxpayers continue to fund the costs imposed on the state and its citizens by the tax-free-riding gas drilling companies. As the politicians fiddle, the state’s economic well-being burns. Until a user fee, or even a tax, is imposed on these companies, the cost of repairing damage caused to roads by drilling and other equipment, the costs of cleaning up polluted groundwater and streams, the cost of removing waste dumped on land adjacent the wells, the costs of wildlife habitat disruption, the costs of dirtier air, and all other social, environmental, and economic costs triggered by gas extraction will be borne by the state’s taxpayers and not by the companies making a profit on the extraction activities. The companies, of course, are following a principle taught in business schools and permeating modern American capitalism: the secret to making money is getting someone else to pay one’s bills. The taxpayers have a right not to be cornered into paying what ought to be the expenses of the natural gas extraction industry, but those rights are being surrendered by the Pennsylvania politicians who lack the courage to do what needs to be done.

The irony is that most Pennsylvania taxpayers, if they understood the arithmetic, would support natural gas extraction taxes. Why? Because they face two alternatives. One is for THEM to pay higher state and local taxes to cover the costs of extracting natural gas. The other is for THEM to suffer life with torn-up roads, polluted wells and streams, disrupted wildlife, dirtier air, and a general decline in the quality of life. The few who are raking in royalties soon will discover that those royalties are insufficient to make up the short-term and long-term direct and indirect costs of extracting natural gas.

Dealing with this issues is a social and moral responsibility the governor and the legislature. A viable solution is at hand. Yet it appears that dedication to party ideology has trumped devotion to the common weal of Pennsylvania and its citizens. This travesty is but a microcosm of what has been happening at the national level, so it comes as no surprise. That, however, does not make the failings of the politicians any less unacceptable or any less justified. The price for this irresponsibility will be high, will last a long time, and will damage the state many times over what alleged “damage” would have been done by enacting a natural gas extraction tax or set of user fees. To paraphrase what I stated in Polls, Education, Taxes, and User Fees, most Pennsylvanians are “more interested in getting things done, whereas the legislators are more interested in finding political advantage.” If it were possible, the governor and the legislators ought to be compelled to remain in Harrisburg until they get this done, and until they get this done, they don't go home, even if that means they lose the opportunity to campaign. Getting the job done means much more to voters than tossing more electoral rhetoric around the neighborhoods.

Tax Law as Subterfuge: Best Use Valuation v. Current Market Valuation

An article in Sunday’s Philadelphia Inquirer asked an important question with its headline: More taxes on worn buildings, vacant land? The article was inspired by a 16-year-long dispute involving Philadelphia properties owned by the estate of Sam Rappaport, once a prominent Philadelphia landlord. The estate’s executor is a New Yorker, Richard Basciano. One of the problems is that the properties have not been put to their best use, thus causing them to be valued for real estate tax purposes at amounts lower than presumably would be assessed if they were developed beyond their current state. Philadelphia builders claim that they have tried to purchase the properties from Rappaport’s estate, but that Basciano wants them to “charge New York prices for Philadelphia lots.” Basciano’s attorneys explained that many of the properties were tagged with violations of the building code, and that the properties were severely encumbered with debt. They also explained that the estate indeed has sold some of the properties to Philadelphia developers. Apparently, though, those sales took place more than ten years ago.

The article asked another question. “If Basciano can afford to hold the properties in search of higher profits, what’s to stop him?” and answered it by proposing “Maybe Philadelphia’s tax assessment system.” It is undisputed that under the current system, an empty lot is assessed at a lower value than would be the same lot with a commercial or residential building on it. A lot used as a parking lot carries a lower assessment than the same lot with an office building on it. The chief of Philadelphia’s Center City District suggests that the real property tax system be changed so that properties are assessed at their highest and best use. The theory is that by being taxed at the best-use value, property owners would be encouraged either to develop the property or to sell it to someone who will. The practical impact, however, could be destructive.

The suggestion that the tax assessment system be changed to value properties at best-use value poses a serious threat to owners of properties that are more than empty lots or parking areas but that are not the best use of the property. Consider the number of properties in the city with buildings that, if resources were available, could be torn down and replaced with more efficient, more functional, and more attractive, in other words, buildings that would have a higher value. This sort of valuation process would adversely affect owners of properties with older, functional yet aging, adequate yet not modern-looking buildings.

The article notes that the idea that the property tax should be imposed on land, not buildings, is a very old idea, and is one that ensures “property owners feel pressure to erect buildings as valuable as their neighbors’ instead of leaving them speculatively vacant.” There are several serious flaws in this approach. First, this approach would encourage the disappearance of green space within the city and would discourage property owners from devoting some portion of land to something other than concrete and steel development. Second, any attempt to mitigate the effect by restricting best-use valuation either geographically, such as the center city district, or by limiting it to empty lots, would violate a variety of state, if not federal, constitutional and statutory provisions. Third, this approach opens up the need to determine, and thus to dispute and litigate, the question of what is the best use and the question of what value should be assigned to a hypothetical best use.

A proponent of the best-use approach explains, “But I have a fundamental issue with someone saying, 'For tax purposes, it's worth $1 million, but when I want to sell, it'll be $20 million." So do I. The problem isn’t one that can be solved only by shifting to a best-use system. The problem is that a property that sells for $20 million, barring an absurd surge in market values the day before the sale, ought not be “worth $1 million” for tax purposes. The problem is the same one that has afflicted the Philadelphia real property tax for decades, namely, erroneous assessments. I have previously commented on the Philadelphia real property tax system, and its flaws, in a long series of MauledAgain posts, starting in An Unconstitutional Tax Assessment System, and continuing in Property Tax Assessments: Really That Difficult?, Real Property Tax Assessment System: Broken and Begging for Repair, Philadelphia Real Property Taxes: Pay Up or Lose It, How to Fix a Broken Tax System: Speed It Up? , Revising the Board of Revision of Taxes, How Can Asking Questions Improve Tax and Spending Policies?, This Just Taxes My Brain, Tax Bureaucrats Lose Work, Keep Pay, Testing Tax Bureaucrats Just Part of the Solution, A Citizen Vote on Taxes, Freezing Real Property Tax Reassessments: A Nice Idea, The Tax Price of a Flawed Tax System, Can Bad Tax Administration Doom the Tax?, Taxes and Priorities, R.I.P., BRT, and A Tax Agency Rises from the Dead. Getting assessments done properly poses the same challenges whether the assessors are trying to determine current market value or a theoretical best-use value, although one could safely assume that assessors are more likely to miss the mark when trying to determine best-use value than when trying to determine current market value.

The same proponent also advocates a “flipper’s tax” on passive property investors. His argument is that people who improve a property pay “a lot more tax” than do people who simply buy land and hold it, or buy land with run-down buildings and let it “rot” while waiting for the value to increase. Are there not laws already in place that impose penalties on property owners who let their properties “rot”? If there is a tax on people who hold property such as a parcel of land waiting for the best time to sell or develop, will there also be a tax on someone who owns a residence but who doesn’t install a deck that would increase its value? Yet does this sort of thinking not lead to a tax on employers who fail to hire more employees?

It’s not permissible for a government to tell the owner of a vacant lot to build a building on it, even though it is permissible for the government to tell the owner not to dump toxic waste on it or to tell the owner to clean the trash piling up on it. The tax law ought not be used as an end-around subterfuge to accomplish the impermissible.

Gross Income from Finding Things

One of my favorite classes in the basic federal income tax course is the one that deals with the tax treatment of items that a person finds. The point of the discussion is to give students a chance to understand the scope of gross income, and to appreciate the fact that not every specific instance of gross income is set forth in the statute. The course book that I use includes a case dealing with a taxpayer who finds cash in a piano that was purchased. In my supplemental materials, I provide them with newspaper articles about a person who found a copy of a first printing of the Declaration of Independence inside a painting purchased at a flea market for $4, another couple who found cash – in this case $140,000 – in a piano purchased at an estate sale for $70, and a person who found valuable autographs inside a table purchased for $3 at an auction. I share with them other stories, noting that most semesters I hear or read about a new one in the news about the time we discuss the topic. The stories are fun. After learning of someone who purchased a used violin only to discover it was a Stradivarius, I ask the class why these sorts of things don’t happen to me or to them.

One of the attributes of all the stories and hypotheticals is the ease with which the person discovers the valuable item. Someone purchases an item at some sort of sale and, presto, it’s a Ming Dynasty vase. Or someone is walking down the street and sees a diamond ring, or a Rolex. In some examples, I have the person identify the owner and return the property, in order to get across some aspects of realization and increase in economic wealth.

Now comes a Philadelphia Inquirer story about another way in which people find things. The title alone says almost everything: Hidden Treasure in Philadelphia-Area Sewers. That’s right. Sometimes to find a treasure one must do more than go to an auction or watch the ground carefully while walking. Sometimes one must get down into the muck and get dirty. All that advice about keeping out of the gutter and staying out of the sewer turns out to be misleading when it comes to finding valuable things.

The tax side of the story is what gets my immediate attention, but there’s so much more to the article. So if you’re interested in the details about “guns recovered after a burglary,” “[k]ids will throw anything down a hole,” “We’ve had ducks,” “Are there alligators?,” “catfish,” “Curly . . . the ball python,” and the hundreds of Nerf footballs from a “marketing attempt gone bad,” read the story. Even if you don’t get a chance to drop some fun trivia on a first date, it’s a fun read.

The tax questions arise from several revelations on the part of the sewer workers. One worker explained that the “crew’s payload is about $10 in change every month,” and that “once every two months a worker will find a piece of jewelry – though mostly costume.” We’re told that “Most sewer departments have a finders-keepers philosophy. If the guy is willing to reach in and grab it, it is his.” As for small amounts of money, “The found money gets spent treating coworkers to lunch,” but “sometimes, [found coins] are just spent in the vending machine.” Rings and other jewelry often are so damaged that they are “sold to jewelers as scrap.” Old coins are taken in for appraisal. On one occasion, a worker was able to identify the owner of a 40-year old class ring, and returned it. See where this is going? The tax questions are jumping out at us. Does the worker who finds something of value and keeps it have gross income? Do the coworkers have gross income when they receive lunch courtesy of money found in the sewer pipes? What is the tax treatment of the worker who found the class ring and returned it to its owner?

These questions have fairly easy answers. I’m not going to provide them, because I or my tax professor colleagues across the country might turn this into an exam question or something to raise in the classroom. But perhaps the answer to my question about why these sorts of things don’t happen to me or to my students comes from one of the sewer workers interviewed for the story. “You have to be at the right place at the right time.” How true. When’s the last time you’ve been in the sewer? And digging through the tax law doesn’t count.

IRS Decides Not to Follow Tax Court Decisions That It Won

An unusual event has occurred in the tax world. The IRS issued Revenue Ruling 2010-25. The issuance of a Revenue Ruling, though something that happens much less frequently than it did twenty years ago, is not the unusual event. Nor is the conclusion reached by the IRS. What is unusual is that in the revenue ruling, the IRS concluded that the outcome in two cases in which it had prevailed was wrong. In other words, the IRS has decided not to continue taking the position that it had taken and that the Tax Court had upheld. Though from time to time the IRS announces that it does not plan to follow a Tax Court decision in which it lost, it is a rare occasion when the IRS wins, wins again, and then decides it should have lost.

The issue, on the surface, is fairly easy to set forth. How much of the interest paid by a taxpayer on a mortgage loan undertaken by the taxpayer to purchase a principal residence is deductible? The analysis is a bit more challenging.

Section 163(a) permits a deduction for all interest, but for individuals section 163(h)(1) disallows deductions for personal interest. Personal interest is all interest, other than trade or business interest, investment interest, passive activity interest, qualified residence interest, certain interest in deferred estate tax liabilities, and education loan interest. The relevant exception is the provision that allows a deduction for qualified residence interest.

Qualified residence interest consists of two components. One is interest in acquisition indebtedness with respect to a qualified residence. The other is home equity indebtedness with respect to a qualified residence. A qualified residence is the taxpayer’s principal residence and one other residence owned by the taxpayer that is selected by the taxpayer as a qualified residence. Acquisition indebtedness is any indebtedness “incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer” and that is secured by the residence. No more than $1 million of indebtedness can be treated as acquisition indebtedness. Home equity indebtedness is any indebtedness “other than acquisition indebtedness” secured by a qualified residence to the extent that it does not exceed, in effect, the lower of $100,000 or the excess of the residence’s fair market value over the acquisition indebtedness with respect to the residence.

So assume a taxpayer purchases a principal residence for $1,500,000, by using $300,000 of cash and borrowing $1,200,000 secured by a mortgage on the residence. The taxpayer owns no other residences. The taxpayer pays interest on the $1,200,000 loan. How much of that interest is deductible.

In Pau v. Comr., decided in 1997, the Tax Court agreed with the IRS that only the interest on $1,000,000 could be deducted, reasoning that there is $1,000,000 of acquisition indebtedness but no home equity indebtedness because the taxpayers did not prove that any of the debt was not incurred in acquiring, constructing, or substantially improving the residence. Three years later, the Pau decision was followed by the Tax Court in Catalano v. Comr.

The difficulty with the Tax Court’s reasoning is its conclusion that indebtedness cannot be home equity indebtedness if it was used to acquire, construct, or substantially improve the residence. But that is not what the statute says. The statute defines home equity indebtedness as indebtedness “other than acquisition indebtedness” secured by a qualified residence to the extent that it does not exceed, in effect, the lower of $100,000 or the excess of the residence’s fair market value over the acquisition indebtedness with respect to the residence. Thus, one must first identify acquisition indebtedness. The taxpayer used $1,200,000 of indebtedness to purchase the principal residence, but the statute treats only $1 million of this amount as acquisition indebtedness. In other words, the other $200,000 of indebtedness is NOT acquisition indebtedness. If the $200,000 is not acquisition indebtedness, then $100,000 of it can be home equity indebtedness provided the fair market value of the residence is at least $1,100,000. The Tax Court treated the statute as though it defined home equity indebtedness as indebtedness “not used to acquire, construct, or substantially improve a residence” that is secured by a qualified residence to the extent that it does not exceed, in effect, the lower of $100,000 or the excess of the residence’s fair market value over the acquisition indebtedness with respect to the residence.

Though it took ten years, the IRS finally decided that the conclusions reached on this point in the Pau and Catalano decisions are wrong. It issued Revenue Ruling 2010-25 to set forth the explanation that had been provided years ago by those who disagreed with the approach advocated by the IRS and adopted by the Tax Court in Pau and Catalano.

The IRS should be commended for giving up on an erroneous position. One wonders whether the IRS is prepared to give up on its erroneous position with respect to section 280A apportionment of interest and taxes that was first rejected by the Tax Court in Bolton v. Comr., rejected in every subsequent case, and rejected by every Court of Appeals that has considered the issue. There are similar issues ready for a similar admission of error by the IRS. The answer to why the IRS has not moved on those cases might lie in the answer to why the IRS challenged the taxpayer’s deductions in the Pau and Catalano cases. Could it be that not every IRS employee or Chief Counsel attorney fully understands the tax law? I wonder whose fault it is that the tax law is so difficult to understand because it is so confoundedly and needlessly complicated.

Polls, Education, Taxes, and User Fees

Efforts by the Pennsylvania legislature to deal with proposals to tax Marcellus Shale natural gas have, to borrow from the headline of this Philadelphia Inquirer story, reached a stalemate. The suggestions I made two weeks ago to prevent or break a stalemate, discussed in Tax? User Fee? Does the Name Make a Difference?, apparently have not been invited to Harrisburg. Nor have I. It only takes one read of the the Philadelphia Inquirer story to understand why. I’m more interested in getting things done, whereas the legislators are more interested in finding political advantage.

One of the reasons that a stalemate exists is the contradictory evidence generated by the pollsters. According to another Philadelphia Inquirer story, in one poll, only 35 percent of Pennsylvanians supported a tax on natural gas extraction, while 49 percent were opposed. Five months later, in a different poll, 78 percent of Pennsylvanians approved the idea of a gas severance tax, and 14 percent were opposed. Was there a sudden shift in voter attitudes? No.

The difference in the poll results are caused by the manner in which the poll question is framed. Consider the poll generating 49 percent opposition. After asking questions with respect to proposals to increase the tax on cigars and smokeless tobacco, and to impose tolls on I-80, the poll asked whether those questioned supported “increasing taxes on companies that extract and sell natural gas.” On the other hand, the poll generating 78 percent support asked a 123-word question – and, no, I did not write it – that explained what Marcellus shale natural gas is, that “large multinational gas-drilling companies from other states and other countries are coming here to lease land and extract this gas,” that “This discovery holds the promise of significant economic development and the creation of new jobs, but it has also placed new an difficult stresses on local services, harmed water supplies, and destroyed local roads,” and that “In other states, these companies pay a special tax to fund programs that will protect our environment and help local governments handle the increased demand on their services” before asking “Would you favor or oppose a special tax on these multinational gas companies for that specific purpose?”

The Philadelphia Inquirer story suggests that the difference is “all in how the question is asked.” That’s true, but it glosses over the meaning of “how.” To me, the differences in the poll results illustrate the differences in outcome when someone who is educated about an issue is answering a question and when someone who is not educated about an issue and is answering a generic sound bite question is answering a question. The director of the poll generating the 49 percent opposed outcome, which asked a short question without providing background information, agreed, saying, “I think it is not exactly the residents of the state know much about or are very much concerned about, despite the fact it’s a huge policy and political issue in the state.” I wonder how his poll would have turned out had he provided educational information before asking the question. Perhaps the answer can be found in a third poll, administered after the first poll and before the second one, that simply asked, “Do you support or oppose increased taxes on America’s oil and natural-gas industry?” and obtained a 31 percent favor, 61 percent opposed result. Notice that the question mirrors the current “don’t tax us” advertising campaign being waged by the fossil fuels industry.

The inconsistent poll outcomes demonstrate not only the need to educate the public, but the need to put the issue in terms that make sense to people. That’s why I suggested that what should be under consideration are user fees. Imagine a poll question that asked, “Should natural gas extraction companies be charged a fee for polluting underground water or should that cost be paid by taxpayers and homeowners?” and “Should natural gas extraction companies be charged a fee to pay for fixing the damage their large vehicles do to local roads, or should local taxpayers pay?” It would be shocking if people replied that they were willing to pay taxes and other costs to bear the burdens that generate benefits for the extraction companies and their owners.

The irony of the stalemate is that the governor and legislators are battling over rates. The Senate Republicans favor a 1.5 percent tax on natural gas extraction, House Democrats favor 9.8 percent, and the governor suggested 6.2 percent. If principle is going to stand in the way of compromise on a rate, perhaps principles can be unified to go the user fee route. There’s much less arbitrariness in selecting a fee based on actual costs than in selecting a rate that focuses on revenue generally rather than on costs and expenses.

Tax Return Preparer Regulation: What About Attorneys and CPAs?

A recent opinion piece with respect to IRS regulation of tax return preparers, which came to my attention thanks to Paul Caron’s TaxProf Blog, has caused quite a stir. In the opinion piece, Dan Alban attacks the IRS proposal to regulate tax return preparers on a number of grounds. First, he claims that by exempting attorneys and CPAs from the requirements, the proposed rules will “create an anti-competitive barrier to entry in the market for tax return preparation that benefits large tax preparation firms as well as attorneys and CPAs. Second, the proposed rules, by giving the IRS more control over preparers, will make preparers “dependent on the IRS for their livelihood” and thus “give the IRS increased leverage in disputes . . with preparers.” Third, the proposed rules are not necessary because there already are in place criminal and civil penalties applicable to preparers who violate the law, and because preparers face possible civil litigation filed by misrepresented clients. Fourth, the proposed rules will increase the cost to taxpayers of tax return preparation. Alban points out that as a Harvard Law School graduate who has passed the bar, he would not be subject to the proposed rules even though he “has never so much as taken a law school class or continuing legal education in tax law” and who doesn’t even do his own tax returns. Alban is a staff attorney for the Institute for Justice, where apparently he deals with legal issues other than taxation.

To the extent Adler considers regulation of tax return preparers by the IRS to be a bad idea, I disagree. Tax return preparation is no different from any other industry whose participants have the power to help or hurt its clients or customers. Existing penalties are not preventing the unethical behavior of a few “bad” preparers whose actions end up tainting the entire industry’s reputation. Some taxpayers have been ill served by their tax return preparers, and “some” is too much. When one considers the various industries that are properly regulated, in every instance clients and customers are better off than they were before regulation, and when one considers the various industries that are not regulated or that are inadequately regulated, clients and customers end up on the short end of the deal. Aside from the ethical issues raised by preparers who file fraudulent returns, steal refund checks, or otherwise cheat their customers, the bigger issue is one of competence. When Money Magazine ran its individual federal income tax return preparation test promotion, the outcome always produced as many different versions of a tax return from the same set of facts as there were preparers trying to win the prize. The prize, incidentally, was creating the following year’s set of facts for the next contest. The participants, as best as one can tell, were ethical. All but one, and in most instances, all of them simply lacked what it takes to complete an individual federal income tax return properly. That, of course, is a consequence of Congressional mismanagement of the tax law.

To the extent that Adler objects to the proposed exemption from regulation for attorneys and CPAs, I wholeheartedly agree. The notion that attorneys and CPAs are somehow per se lacking the need for regulation is nonsense. Even if unethical behavior occurs among a smaller proportion of attorneys and CPAs than among tax return preparers, that difference does not justify a blanket exemption. True, attorneys and CPAs are regulated as such by state licensing boards or their equivalent, but those entities do not focus on tax return preparation ethical issues in contrast to ethical issues generally. When it comes to competence, there are tax return preparers not blessed with a J.D. degree or a C.P.A. certificate who can run circles around most lawyers and CPAs, including some of those who specialize in taxation. It is dangerous to assume that attorneys and CPAs do not need regulation when it comes to preparing tax returns.

Though much of the attention has been focused on preparers who handle individual returns, thus bolstering arguments that the CPAs and the few attorneys who do engage in tax return preparation are likely to be adequately skilled, the competency issue reaches far beyond individual returns. The error rate for tax returns of corporations, partnerships, trusts, estates, REITs, tax-exempt organizations, and other taxpayers is frighteningly high. Almost every semester, one or two students in my Graduate Tax Program courses tell me that after the courses open their eyes to the fact that what they and their firms have been doing is inconsistent with the law. Every week, I hear stories from friends and former students in practice who describe the sloppy condition of returns prepared by their clients’ former tax advisors and preparers. Every week, I read stories about ill-prepared returns generated by lawyers and CPAs. Every day I read posts on listservs that suggest a surprising lack of understanding of one or another tax law issue by lawyers and CPAs, including some who specialize in taxation. The need for education, examination, and licensing of attorneys and CPAs is no less urgent than it is for other preparers.

Defenders of the attorney-CPA exemption point to CLE and CPE requirements as a distinction that sets them apart from other preparers. That suggestion is more nonsense. Attorneys are not required to enroll in CLE courses that address tax as a precondition to practicing tax law or preparing returns. Worse, attorneys are not required to demonstrate that they learned anything from sitting through a CLE session because there are no examinations. When CLE was initiated in Pennsylvania, I urged the adoption of a testing mechanism, but the idea was rejected, ostensibly for logistical reasons but primarily because attorneys would balk at the idea. So even if attorneys were required to take tax courses and tax CLE classes before preparing tax returns, and they’re not, there’s no way of knowing if they’ve learned what they need to learn until they slip and fall on an actual tax return. Attendance at CLE and CPE classes does not guarantee the acquisition of knowledge and understanding, let alone expertise.

Defenders of the attorney-CPA exemption also point out that attorneys carry malpractice insurance whereas preparers do not, though I wonder if that’s true of the large tax return preparation enterprises. They also point out that attorneys have as much as seven additional years of education than do tax return preparers with high school diplomas. The existence of malpractice insurance ought not be a ticket to unregulated tax return preparation activities. If the IRS were to require malpractice insurance by all tax return preparers, it would simply mean that attorneys would already be in compliance. As for those additional seven years of education, there’s no guarantee that it does much of anything to make a person more competent as a tax return preparer.

Defenders of the attorney-CPA exemption also argue that with limited resources the IRS needs to focus on preparers who are much more likely to present problems in terms of ethics and competence. One difficulty with this argument is that it presumes attorneys and CPAs to be per se less likely to present problems. That may or may not be the case. Another, more important, difficulty is that the exemption is a flat-out exemption, whereas the better response to limited resources would be to implement the preparer requirements in stages, without absolving any one group in perpetuity. Letting attorneys and CPAs wait until other preparers have been examined is acceptable as a practical matter even if it means competent preparers who are not attorneys or CPAs are brought into a preparer regulation system before attorneys and CPAs who lack competence. But that’s much different from letting attorneys and CPAs off the hook.

Defenders of the attorney-CPA exemption suggest that states are in a better position to regulate attorneys, CPAs, and even other preparers. The problem with state regulation is that preparers of a nation-wide federal tax should be subject to one standard, not fifty-plus differing systems. This is particularly a practical problem because many preparers do not limit their clientele to the residents of just one state. Does the SEC rely on state regulatory boards to determine who has sufficient expertise to practice before the SEC or represent clients in SEC matters? The same question can be asked of the NLRB, the EPA, and a long list of federal agencies dealing with federal law.

It also has been pointed out that several federal statutes might preclude the IRS from requiring attorneys and CPAs to satisfy testing and continuing education requirements. For example, 5 U.S.C. §500(b) provides:

An individual who is a member in good standing of the bar of the highest court of a State may represent a person before an agency on filing with the agency a written declaration that he is currently qualified as provided by this subsection and is authorized to represent the particular person in whose behalf he acts.

Similarly, 5 USC §500(c) provides:

An individual who is duly qualified to practice as a certified public accountant in a State may represent a person before the Internal Revenue Service of the Treasury Department on filing with that agency a written declaration that he is currently qualified as provided by this subsection and is authorized to represent the particular person in whose behalf he acts.

Finally, 5 USC §500(d)(2) provides:

This section does not . . . authorize or limit the discipline, including disbarment, of individuals who appear in a representative capacity before an agency

Do these statutes indeed protect attorneys and CPAs? It depends on the meaning of “represent a person before an agency” and “represent a person before the Internal Revenue Service.” If those phrases includes tax return preparation, then the IRS enrolled agent requirements, that limit representation by non-attorney/non-CPA individuals before the IRS but that do not limit the preparation of returns to attorneys and CPAs, suggest that “represent a person before the Internal Revenue Service” means “act as an advocate in an adversarial proceeding” and not tax return preparation. But even if the cited statutes prohibit testing, licensing, and imposing CE requirements on all preparers, including attorneys and CPAs, 5 USC §500(d)(2) permits the IRS to impose the “discipline” of examination and CE on every preparer who violate the disciplinary standards of correct returns coupled with ethical behavior. It would take but a few years before every preparer was subject to discipline. Are there any preparers with a perfect track record over a three or four year period? I doubt it. Consider those Money Magazine “tax return preparation contests.”

If the goal of preparer regulation simply is to stop preparers from stealing refund checks, then limiting examination and certification to preparers who are not attorneys and CPAs might be defensible. But if the goal is to produce more accurate returns, and thus improve revenue and compliance across the board, as it ought to be, I maintain that most lawyers and many CPAs aren’t as expertised as they need to be. In all fairness, Congress has created a tax law that rivals quantum physics in terms of difficulty, which surely makes attaining competence just that much more elusive, but that does not diminish the need for tax competence by all preparers. Demonstrating that competence ought to be accomplished by actual testing and not by erroneous presumption.

Looking More Closely at Mileage-Based Road Fees

My Friday post, Mileage-Based Road Fees Gain More Traction brought a comment and question from a reader:

I've skimmed all the posts about the per-mile fee idea. It's logical to believe that fewer people would drive if they knew they were being charged for every mile they drove regardless of their vehicle's fuel efficiency. Wouldn't this have a discriminatory effect on the disabled, and yes, overweight people, who essentially have no choice but to drive to work every day. The rest of us may have the choice of walking, carpooling, or public transportation, but some may not. I know they would driving the same amount they do now, and they are also paying taxes on the fuel/gas they use now, but at least they can choose to lessen the burden by buying more fuel-efficient vehicles.

The reader focuses attention on several matters that deserve more elaborate examination. My response, re-arranged somewhat, was as follows:

It’s possible that a mileage-based road fee would would cause a reduction in driving, even to the point of causing a few people to reduce their driving to zero miles. If the fee has the effect you think it will – and it might – then the reduction of miles driven is a nice side effect of the primary purpose of per-mile fees, which is to pay for the roads on which people are driving. It might cause people to “bundle errands” for example. The fee would be consistent with the overriding goal to reduce consumption of energy from finite resources. Until efficient means are found to make use of renewable and infinite sources (solar is infinite as a practical matter), it’s a matter of finding ways to reduce fossil fuel consumption. So a reduction in the number of miles being driven is not necessarily a bad thing. The issue is whether it is a bad thing if it compels certain people to abandon driving. That brings us to the discrimination question.

Will a per-mile fee cause discriminatory effects? Yes, it will hurt those who drive fuel-efficient vehicles, because instead of paying lower fuel taxes (because they use less fuel), they’ll be paying the same mileage rate as someone driving a fuel-inefficient vehicle. That’s ignoring the possibility of adjusting per-mile fees for the weight and other characteristics of specific vehicles (though that would happen, and has happened, with large trucks, which cause disproportionately more damage to roads). On the other hand, an adjustment for specific vehicles would make more sense if based on weight and other factors affecting impact on road condition than if based on fuel efficiency. I’ve not seen anything suggesting an adjustment for the weight of the driver or the passengers, nor do I think the variation is significant when compared to vehicle weight variations.

On an individual level, whether someone is better or worse off paying a per-mile fee rather than a gasoline tax depends on a variety of factors, including vehicle fuel efficiency, the gasoline tax rates in the state of residence, the relative amount of fuel purchased while driving in other states, etc.

As for choosing between driving and alternatives, again, the effect of the per-mile fee depends on what the person is driving, how many miles they drive, etc. For some people, the per-mile fee will be cheaper when compared to the baseline.

What makes the analysis a bit challenging is that the comparison should be made between current gasoline taxes and the one-cent-per-mile fee required to replace the gasoline tax revenue. If a higher per-mile fee is imposed to permit deteriorating roads to be repaired before more people die as happened in Minneapolis several years ago, then the comparison must be made to the alternative, which is an increased gasoline tax.

In any event, if the true cost of using the highways is x pennies per mile, why should we pretend that the nation as a whole can get highway use for less, or even for free? It may be that an “in your face” fee – not unlike a toll – would cause people to drive less, in contrast to the “hidden in the price per gallon” gasoline tax. On the other hand, toll roads in this country are far from deserted.

What would be helpful, and I don’t think I’ve seen this yet, is a web site where people can input the type of vehicle they drive, the number of miles they drive, the state (or area) in which they live, and the type of mileage-based fee with which they want to make comparisons. In other words, someone could input that she drives 12,000 miles a year, lives in eastern Iowa, and drives a Dodge minivan, and receive output that shows an estimate of the gasoline taxes she currently pays and the mileage-based road fee that she would pay if the fee were set at one cent per mile (gasoline tax replacement rate) or two cents per mile (road and bridge restoration rate). If I had the time and know-how I would create the page, but I’d rather see those who are more knowledgeable about specific vehicles, fuel efficiency, and the other required information generate something along these lines. Perhaps the folks at the Texas A&M University Texas Transportation Institute’s University Transportation Center for Mobility would find this a useful project for some students to undertake. Hint. Hint. It’s important for drivers and vehicle owners to have this sort of information so that they can contribute useful feedback during the inevitable upcoming debate.

Mileage-Based Road Fees Gain More Traction

Back in 2009, the University of Virginia’s Miller Center of Public Affairs held a transportation policy conference. One of the major topics on the agenda was “funding sources.” More than six dozen transportation experts from both the private sector and government agencies attended. As often is the case with conferences and symposia, the report was not issued for many months. According to the report, Well Within Reach: America’s New Transportation Agenda, the best option for dealing with the inefficiencies of the gasoline and other liquid fuel taxes is to adopt a per-mile fee. Is this surprising? No. Several weeks ago, in Making Progress with Mileage-Based Road Fees, I noted the work of the Texas Transportation Institute at Texas A&M University, particularly its University Transportation Center for Mobility, which presents a growing collection of information and research on the topic. Private sector experts and government agency officials are studying the assorted road mileage fee proposals, but as I lamented in Pennsylvania State Gasoline Tax Increase: The Last Hurrah?:

“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.

Though my suggestion and my analyses of the proposals did not see the light of day at the Miller Center conference, it’s encouraging to discover yet more support slowly but surely taking shape and gaining strength across the country. It is, I hope, just a matter of time.

The conferees also concluded, to no one’s surprise, that more spending is required to shore up the nation’s transportation infrastructure. It’s crumbling, in part because the gasoline and other fuels taxes being used to fund repairs and improvements have lost one-third of their purchasing power because they have not been increased for 17 years. Added to that is the decline in fuel use arising from the manufacture and sale of more efficient vehicles and shifts to motive power generated by means other than taxable liquid fuels. The shortfall in current spending is approaching $100 billion a year. When the time comes to pay the price for this shortfall and short-sightedness, the outcome will be no less catastrophic than the price to be paid for engaging in war while reducing taxes. The conferees calculated that a one-cent-per-mile fee would replace the revenue currently raised by the gasoline tax, and that a two-cent-per-mile fee would permit repair and maintenance of a crumbling infrastructure.

The conferees also recommended something that I’ve advocated for many years, not only with respect to transportation infrastructure but other government-funded projects as well. Investment in transportation infrastructure ought to be treated as just that, an investment, and not spending. If this approach were to be taken across the board, putting government accounting on an equivalence with enterprise accounting would provide a much more useful data set for policy makers, civic discourse, and voter decisions.

Reporting Transactions of Entities Disregarded for Tax Purposes

A question posed last week on the ABA-TAX listserv concerning the reporting of LLC transactions presents not only an opportunity to set forth a rule but also a chance to understand why the rule exists. The facts are fairly simple. A limited partnership is the sole member of a limited liability company. The partnership does not elect to treat the LLC as a separate entity, and thus the LLC is disregarded. The LLC engages in transactions. How should those transactions be reported? One choice, which has been followed in at least one instance, is for the partnership to report the LLC’s net income as one item on the “other income” line on the partnership’s tax return. Call this the “first method of reporting.” Another choice is for the partnership to treat each transaction of the LLC as its own transaction. Call this the “second method of reporting.”

The instructions require that all income, losses, gains, and other items must be reported as items attributable to the sole owner of the LLC. In the case of LLCs owned entirely by one individual, the common practice is to put the LLC’s transactions on a Schedule C (or in some instances a Schedule E) as though the individual had engaged in the transactions which the LLC undertook.

Partnership returns do not include a Schedule C because the return itself provides places to report the items that are reported on an individual’s Schedule C. What must happen is that each item arising from the LLC’s transactions needs to be combined with its counterparts from the partnership’s activities, and the aggregate for each type of transaction reported on the appropriate line or schedule of the partnership return. In other words, the second method of reporting is the correct method.

An example illustrates how the rule works and why it makes sense. The example is an elaboration of one that I posted in response to various replies that had been shared with respect to the original question.

Assume that the LLC has transactions generating gross income of $2,000,000. Assume it has advertising expenses of $100,000, salary expenses of $650,000, repair expenses of $150,000, and utility expenses of $200,000. Also assume that the LLC purchases section 179 property for a cost of $400,000, and purchases no other property. The property is 5-year property.

Assume that the partnership has transactions generating gross income of $3,000,000. Assume it has advertising expenses of $300,000, salary expenses of $1,150,000, repair expenses of $250,000, and utility expenses of $400,000. Also assume that the partnership purchases section 179 property for a cost of $300,000, and purchases no other property. The property is 5-year property.

Under the first method of reporting, the LLC would compute a section 179 deduction of $400,000, add it to the $1,100,000 of other deductions, subtract the total of $1,500,000 from the gross income of $2,000,000, and report the “net income” of $500,000 on the partnership’s return. The partnership would compute a section 179 deduction of $300,000, add it to the $2,100,000 of other deductions, and subtract the total of $2,400,000 from the combined gross income of $3,000,000 and LLC net income of $500,000 to show partnership taxable income of $1,100,000. That amount would be allocated among the partnership’s partners.

Under the second method of reporting, the LLC would do nothing but hand off its transactions to the partnership. The partnership reports gross income of $5,000,000. It has advertising expenses of $400,000, salary expenses of $1,800,000, repair expenses of $400,000, and utility expenses of $600,000. It is treated as having purchased section 179 property for a cost of $700,000, and as having purchased no other property. The property is 5-year property. The partnership’s section 179 deduction is $500,000. Its section 168(k) deduction is $100,000 (50% of the remaining $200,000). Its section 168(a) deduction is $20,000 (20% of the remaining $100,000). Its deductions on account of purchasing the property total $620,000. Its total deductions are $3,820,000. Its partnership taxable income is $1,180,000. That amount is allocated among the partnership’s partners.

The $80,000 additional partnership taxable income under the correct method of reporting is the $80,000 portion of the cost of the section 179 property that is not allowable as a deduction under section 179 and that is not allowable as a deduction under section 168 for the first year of use. This illustrates why the combination of gross income and deductions for the LLC is not permitted at the LLC level, because by doing so, the $500,000 section 179 limitation is avoided. In effect, the first method of reporting would permit the partnership to have the benefit of two $500,000 limitations, one with respect to the LLC and one with respect to itself. That is inconsistent with the concept of a disregarded entity because disregarded entities have nothing to report independently and thus do not have separate limitations.