More Tax Ignorance

Circulating on facebook, and probably on other social media, is a photograph with this legend:

Up until 1913 Americans kept all of their earnings. Despite this, we still had: schools, colleges, roads, vast railroads, streets, subways, the Army, Navy and the Marine Corps, (who managed to win 8 wars. Tell me again why We The People need to be extorted ???

Though I could write for hours about the deficiencies of praising the roads and educational institutions of the nineteenth century, I prefer to focus on the first sentence.

Taken at face value, the first sentence makes no sense. Americans did not keep their earnings. They transferred their earnings to shopkeepers, physicians, and other providers of goods and services in order to have a place in which to live, to feed and clothe themselves and their families, and to tend to medical concerns. What the author of this sentence probably meant to say was “Americans did not pay taxes.” But that, too, is ignorance manifested. Americans have been paying taxes since the beginning. Before 1913, and since 1913, they have been paying federal excise taxes, state property taxes, local property taxes, state sales taxes, occupation taxes, head taxes, and a variety of other taxes.

My guess, based on the reference to 1913, is that the author meant to say that “until 1913 Americans did not pay a federal income tax.” That statement is mostly true. The first federal income tax was enacted to fund the costs of the Civil War, but it didn’t last long. But when the federal income tax appeared is not the author’s point. The author seems to be questioning the need for an income tax. The answer is simple. The so-called modern income tax, the one enacted in 1913, was designed to provide revenue to offset the revenue losses from reducing import duties. Import duties are an indirect tax, ultimately paid by the consumer as part of the price of the item being purchased. The income tax, as originally enacted, applied only to individuals with income exceeding $3,000 and married couples with income exceeding $4,000. Very few people had that sort of income. In other words, the income tax would put the brakes on the growing income inequality that had time and again rocked the American economy with recessions, panics, and volatile economic performance. It was not, and still is not, used to fund roads. Roads are funded by state and local revenues and by fuel taxes paid into the Highway Trust Fund. It did fund, and continues to fund, the military, which now demands far more investment than it did in 1913, a consequence of changes in world politics, and interestingly not the prime target, and in some cases not even a target, of the “cut spending eliminate taxes” crowd.

The problem with slogans, sound bites, and quips is that they omit the important details and mislead people. Someone with a genuine interest in the history, impact, administration, and rationale of the federal income tax, or any other tax for that matter, ought to dig into something more analytical, such as the articles provided by The Tax History Project. In particular, this article provides the information thoroughly lacking in the “Up until 1913” bunk.

How Difficult Is It to Understand Use Taxes?

A recent commentary in the Philadelphia Inquirer advocates extension of the moratorium on collection of sales taxes by out-of-state retailers. It rejects the claim that online merchants have an advantage over brick-and-mortar retailers, a claim made by those who want out-of-state retailers to collect sales taxes even if they have no nexus with the state.

The commentary makes good points and not so good points. It is true, as it points out, that some online sellers bear the cost of shipping. They cannot use promotions such as free, hot coffee to their shoppers. Their customers cannot easily try on clothing and shoes.

On the other hand, the author refers to the taxes in question as “internet sales taxes” when in fact, as I have explained in posts such as Collecting an Existing Tax is Not a Tax Increase, the tax in question is a use tax. That tax has been on the books for decades. Thus, when the author claims that “state lawmakers do not need another $23 billion in sales-tax revenue,” the author fails to explain that this revenue is revenue currently owed under existing law and that states are simply engaging in an attempt to collect unpaid but owed revenue.

Yet, I agree with the author of the commentary that requiring out-of-state online retailers to do the use tax collection for the state is wrong. As I explained in Collecting the Use Tax: An Ever-Present Issue, states ought not be trying to compel proprietors and entities over which they have no jurisdiction to their collection work. I did suggest that states consider entering into voluntary arrangements with out-of-state retailers willing to act as collection agents in return for compensation paid by the state.

The flaw in the argument that out-of-state online retailers ought to be collecting the use tax on behalf of states with which they lack nexus can be illustrated by examining what happens to an out-of-state bricks-and-mortar retailer. If a person living in Pennsylvania, which has a sales tax and a compensating backup use tax, travels to Delaware, which has no sales tax, to purchase an item, the retailer is not obligated to collect Pennsylvania use tax. Nor could Pennsylvania compel the retailer to do so. So why should Pennsylvania, or any other state with a use tax, be permitted to compel a Delaware online retailer to collect the use tax. Would that not put the Delaware online merchant at a disadvantage compared to the Delaware bricks-and-mortar merchant? Isn’t it questionable that those who claim to be seeking a level playing field between online and bricks-and-mortar merchants would end up un-leveling that playing field if their proposed legislation was enacted?

One wonders why the alleged collective wisdom of state legislators cannot fix this problem, especially when the solution has been provide to them, free of charge, by yours truly. And one wonders why the arguments being made on both sides of the debate are so consistently imprecise, confusing, and incomplete.

Satire, Tax or Otherwise, Lost on Americans

Few people understand satire. It’s such a dangerous practice that one wonders whether in the long run it does more harm than good. Recently, a website specializing in satire, but carrying a name that doesn’t hint at its character as nicely as, for example, the Onion, published a fake report claiming that the IRS would delay until October 2015 payment of income tax refunds normally received in the early months of the year. The best guess, taking up on a story such as this one, is that the authors were trying to spoof the delay in the filing season announced in early 2014 because Congress could not get its act together with respect to 2013 tax laws until very late in 2013.

Unfortunately, many people who read these sorts of satirical compositions take them at face value, and do not bother to cross-check the information. Then, instead of simply saying something to a handful of colleagues at the office or friends at the corner bar, as was the practice several decades ago, they take to social media, and within minutes the entire planet has been informed of a news development that isn’t news but that is circulated as though it were. Is it any wonder people are making more and more bad choices? The information pool is becoming increasingly polluted.

If spoofs re necessary, a better one would have been to satirize the Congress, the source of the delay in the start of the last filing season. But, unfortunately, that would be rather difficult, because the Congress has become a self-perpetuating spoof, a satire on the political condition of this nation. If satire is intended to get people to laugh, there’s no point in doing Congressional spoofs. That legislative body is no laughing matter. It’s something over which the Founders would cry.

Soda Sales Shifting?

In last Wednesday’s post, Escaping Tax and User Fee Revenue Diversion, my analysis of a Philadelphia cigarette tax included an exploration of city residents making purchases outside the city in order to escape the tax. That point was just one piece of my criticism of a tax that puts an education expenditure burden on a narrow group of taxpayers and not on all of those who benefit from the expenditures.

Another tax that doesn’t impress me is the so-called “soda tax,” designed to change people’s beverage drinking habits. In a series of posts, beginning with What Sort of Tax?, and continuing in The Return of the Soda Tax Proposal, Tax As a Hate Crime?, Yes for The Proposed User Fee, No for the Proposed Tax, Philadelphia Soda Tax Proposal Shelved, But Will It Return?, Taxing Symptoms Rather Than Problems, It’s Back! The Philadelphia Soda Tax Proposal Returns, The Broccoli and Brussel Sprouts of Taxation, and The Realities of the Soda Tax Policy Debate, I have criticized singling out soda when there are all other sorts of beverages and food items that contribute to excessive sugar intake. I have also criticized the disconnect between the tax and public health improvement.

Now comes news that soda tax proposals in two neighboring California cities have met different fates. According to this report, the soda tax proposal in Berkeley passed. On the other hand, according to this report, a soda tax proposal in San Francisco failed. So now what happens? Will people in Berkeley drive to San Francisco or some other nearby locality to make soda purchases, including bulk purchases? For a serious soda drinker, the tax is high enough to make the costs of the drive bearable if sufficient quantities are purchased during one shopping venture. On the other hand, for the casual drinker, the option of going out of town to make the purchase is not practical.

Does anyone seriously think that the soda tax will reduce the number of obese people in Berkeley, or raise enough revenue to make the cost of administering and complying with the tax worthwhile? Is it nothing more than symbolism? I will be watching for follow-up reports.

Foolish Tax Filing Decisions Disclosed to Judge Judy

From time to time, tax issues pop up on television court shows. I have described these episodes on five previous occasions, starting with Judge Judy and Tax Law, and continuing through Judge Judy and Tax Law Part II, TV Judge Gets Tax Observation Correct, The (Tax) Fraud Epidemic, and Tax Re-Visits Judge Judy. That there have been only five, until now, reflects not only the infrequency of tax issues showing up on these shows but also the reality of my inability to view all of the shows. Surely I have missed some.

This time, once again a Judge Judy episode, the tax issue that came to light had no direct bearing on the outcome of the case, and drew no comment from the judge that I recall. The plaintiff had met a man, who when asked by her about his marital status, claimed to be single. So the plaintiff and the man started into a relationship. Eventually the man’s wife found out. She made the plaintiff aware of the fact that he was married. The plaintiff confronted the man, and he maintained his claim that he was single. He even showed the plaintiff a copy of his W-4 form, on which he claimed single status. The judge asked the defendant, the man’s wife, if that was true, and the defendant replied that yes, it was, that they both filed as single individuals. How can that be? They are married and lived together, so the only appropriate choices for filing are married filing jointly, and married filing separately. Filing as single individuals is not permitted.

But Judge Judy wasn’t interested in this issue. It wasn’t a tax case. The case involved the plaintiff’s claim against the man’s wife. The wife had assaulted the plaintiff, essentially because the plaintiff was in a relationship with the defendant’s husband. It’s not difficult to guess how this turned out. Why the defendant could not understand that the bad guy in this story was her husband and not the plaintiff remained unanswered.

I wonder if someone from the IRS caught this episode, and tracked down the tax returns filed by these two individuals. If that happens, the damages sought by the plaintiff will pale in comparison to what the IRS seeks.

Tax law often is complicated. But sometimes it’s simple. Married people cannot use the unmarried filing status.

Perhaps there should be a television court show dealing with tax issues. I’d have so much fun with that. As the judge, I mean.

Escaping Tax and User Fee Revenue Diversion

Several months ago, in Delaying a Questionable Tax, I explained one of my objections to the then pending, and subsequently approved, new Philadelphia cigarette tax designed to raise money to fund the city’s public schools. Expecting cigarette smokers to carry an additional burden for a public good that benefits everyone, including the students, the employers who will hire them, and society that benefits from the contributions made by educated students, creates an imbalance in funding. I compared the tax with the diversion of toll revenue by the Delaware River Port Authority to fund projects having nothing to do with the repair and maintenance of the bridges on which the tolls are collected.

According to a Philadelphia Inquirer story several days ago, it appears that smokers are escaping the new cigarette tax by taking their business to stores outside the city. City merchants report not only that cigarette sales have dropped by as much as 80 percent, but also that the impact on total revenue has been so strong that they have had to let employees go. A wholesaler who supplies corner stores throughout the city described a 50-percent downturn in the amount of tobacco products, candy, and other goods being purchased by those stores for resale.

To combat the practice by city residents of purchasing cigarettes outside the city, the state Department of Revenue plans to hire enforcement agents. Exactly how they will combat city residents purchasing cigarettes while out of town has not been explained. Unlike agents watching license plates on vehicles as they try to enforce a sales tax avoidable by shopping out of state, these agents will need to find some other way of determining the residences of shoppers inside a Wawa or 7-11 outside the city limits.

When I compared using a cigarette tax to fund public education to the use of bridge tolls to fund unrelated projects, I did not mention an important difference. The cigarette tax is easily avoided, as the recent story describes. The bridge toll is not easily avoided if it is essential, for business or other reasons, to cross the Delaware River. There are no practical alternatives, unlike those available to circumvent the cigarette tax. In some respects, this makes the bridge toll revenue diversion more pernicious. Nonetheless, with projections indicating that the cigarette tax will raise much less revenue than predicted, it becomes a “lose-lose” situation, as the schools don’t get the expected funding and neighborhood stores go out of business. The city official who called the tax “win-win” because it will raise money for schools and reduce smoking is banking on theory and not practical reality. The smokers are still smoking, buying their nicotine at stores outside the city, and the school funding will fall short. In the end, all that will change is that some small business owners will close up shop. That’s a rather deplorable long-term result.

Letter from the Tax Advisor? Read It

A recent Tax Court case, Singhal v. Comr., T.C. Summ. Op. 2014-102, presents an important lesson for taxpayers. The taxpayers were married, and were the only members of a limited liability company which went by the name of Man Machine Interface Technologies (MMIT), and which was treated as a partnership for federal income tax purposes. A third party accountant prepared the partnership tax return for MMIT, and sent Schedules K-1 to the two taxpayers, along with a letter. The letter explained that the Schedule K-1 “reflects the amounts you need to complete your income tax return. The amounts shown are your distributive share of partnership tax items to be reported on your tax return, and may not correspond to actual distributions you have received during the year.” The husband taxpayer prepared the taxpayers’ joint federal income tax return. Instead of including all the distributive share amounts on the Schedules K-1, he reported the distributions received from the partnership. The IRS sent a notice of deficiency indicating that the amount reported was incorrect because the amount reported to the IRS was different from what was on the return.

Although the taxpayers did not contest the change to their return that added what had not been reported, they contested the accuracy-related penalty imposed by the IRS. In rejecting the taxpayers’ argument that the underreporting was because they “made a mistake of law in good faith” that was “reasonable,” the Court noted that the third-party accountant had sent a letter advising them to use the amounts from the Schedule K-1 and warning them that those amounts “may not correspond to actual distributions.” The Court explained that at trial, the petitioner was asked, “what does it mean to you when a letter to you and your wife says, this information reflects the amounts you need to complete your income tax return?” and answered “To be truthful, I never read it.” The Court asked again, “You never read it?” and the taxpayer replied, “Yes.” The Court then reasoned that if the taxpayer had read the letter, it would not have been reasonable to ignore the information provided by the accountant, and if he had not read the letter, it was not reasonable to have done so.

When tax professionals put advice and information in writing, it is because they have determined that advice and information to be important. They usually don’t waste time and resources writing letters or memoranda about unimportant matters. The taxpayer to whom the letter has been sent almost always has paid for the advice and information contained in it. That, too, should be an incentive to read the letter.

True, we are so bombarded with so many types of information that it is difficult to separate the music from the noise. Yet when the letter is from someone to whom payment has been made, is expected, and refers to something as important as tax matters, it should be much easier to pull it out of the pile and examine it. In the case of these taxpayers, the price paid for not reading the letter exceeded $12,000. Ouch.

If You Don’t Own the House, You Don’t Get the Interest Deduction

A recent case, Puentes v. Comr., T.C. Memo 2014-224, illustrates the principle that a taxpayer who is neither legal nor equitable owner of a residence is not permitted to deduct interest paid on the mortgage loan secured by the property. Instead, for tax purposes, the taxpayer who makes those payments is making a gift to the owner, who is deemed to pay the interest. Of course, if the owner does not need the deduction, or stands to acquire less of a tax benefit than would the non-owner, the non-owner has every incentive to try to claim the deduction. Unfortunately, the outcome of the principle is harsh.

The facts of the case are fairly simple. The taxpayer’s brother purchased a residence, made the downpayment, financed the balance of the purchase price with a mortgage loan on his name, and took title to the property in his name. The taxpayer did not contribute to the downpayment, was not obligated on the mortgage loan, and was not on the deed. In 2003, the taxpayer moved into her brother’s house. Their father moved into the house in 2005. The taxpayer’s brother made all mortgage loan payments until 2009, when he became unemployed. During the taxable year in issue, 2010, all three lived in the house, the father paid for repairs and supplies, and the taxpayer paid property taxes, homeowner insurance, and mortgage loan payments. The mortgage company issued a Form 1098 in the name of the taxpayer’s brother. When the taxpayer claimed the interest deduction, the IRS disallowed it. The taxpayer petitioned the Tax Court for a redetermination.

Although the taxpayer conceded she was not a legal owner of the residence, she argued that she was an equitable owner and thus entitled to the deduction despite having made that argument and lost in an earlier Tax Court case involving 2009. She tried to distinguish the facts of the earlier case by pointing out that she also paid the property taxes and the homeowner insurance, and shared in the maintenance expenses. Under California law, the legal owner is the equitable owner unless clear and convincing proof is presented that someone else is an equitable owner. The taxpayer failed to show that any agreement or understanding existed by which her brother held title on her behalf or to present any other evidence supporting her claim of being an equitable owner. The Court noted that the taxpayer had not contributed to the downpayment, was not obligated on the mortgage loan, and did not have her name on the deed.

If the taxpayer wanted the interest deduction, she needed to do something to shift ownership. One possibility would be entering into an agreement by which she became part legal owner of the property, and assumed an obligation to make mortgage loan payments. There probably would be countervailing considerations that could lead to a decision not to shift ownership. The availability of the interest deduction ends up as one of several factors that need to be considered. However, no matter what ultimately is decided, it makes sense in these sorts of situations to obtain advice about the best approach to take.

Mortgage Loan Modification Can Imperil Interest Deduction

With mortgage loan modifications rather commonplace, particularly during times of economic downturns, taxpayers need to be careful when re-arranging their loan terms, particularly with home mortgages. There are lessons to be learned from what happened to the taxpayers in a recent Tax Court case, Copeland v. Comr., T.C. Memo 2014-226.

The taxpayers, who use the cash method, applied for and were granted a loan modification by their mortgage lender. Under the modification, the interest rate was reduced, payment terms were changed, and the loan balance was increased. The increase in the loan balance included past due interest that the taxpayers had been unable to pay. The taxpayers claimed a deduction for the unpaid interest that was added to the loan balance. The IRS disallowed that deduction, and the Tax Court sustained the IRS determination.

Interest is deductible by a cash method taxpayer when the interest is paid. The taxpayers in Copeland did not pay the interest, because adding the interest to the loan balance is not payment but simply a promise to make the payment in the future. This principle is well settled in the tax law. To get around this principle, the taxpayers asked the Tax Court to treat the loan modification as if they had borrowed money from another lender and then paid the outstanding principal and past due interest on the existing loan. The court declined to do so, pointing out that what the taxpayers actually did was not the same in economic substance as what they were trying to persuade the court to pretend that they did. The court explained that the taxpayers did not establish that they could have obtained a loan from a third party, and that even if they had been able to do so, the fact that they did not do so confined them to the tax consequences of what they actually did.

If these taxpayers did have the opportunity to borrow from a third party and use the loan proceeds to pay off the existing principal and interest obligations, doing so would have provided them with a tax benefit. Whether non-tax factors would have outweighed the tax advantage is something that cannot be determined from the facts presented by the court’s opinion. But for taxpayers and their tax advisors, it is something worth examining when a taxpayer sets out to restructure a debt obligation.

The Tax and Traffic Squeeze

Last week, on my 10-hour round-trip drive to meet my first grandchild, a thought crossed my mind. It was triggered by the experience of needing to move back and forth between the right lane and the left lane on those inadequate four-lane limited access highways. The need to leave the right lane was triggered by the drivers who dilly-dally, driving at 10 to 20 miles per hour below the speed limit. But getting into the left lane, and staying in it while passing a slowpoke, was a dangerous adventure, because of the drivers who think they are NASCAR heroes and roar down the road at 20, 30, 40 and even more miles per hour than the speed limit. So, it struck me, those who are driving within 5 or 10 miles per hour of the speed limit are squeezed between the two extremes.

And then a second thought hit me. Being squeezed between the laggards and the speedsters is not unlike being squeezed between extremists on the right and extremists on the left. When it comes to tax policy, there are those advocate returning to 90 percent marginal rates, an idea that is absurd, and there are those who advocate eliminating taxes, another idea that is no less absurd. Neither side has the ability to fit their idea into the reality of the overwhelming majority who do not sit on the extreme edge.

What causes this behavior? The answer is simple. Addiction. When passing someone who is lumbering along in the right lane, I will increase my speed in order to minimize the time spent passing, remembering the lesson that the longer two vehicles are running parallel, the greater the chances of a collision. Along comes the speedster who, even though I am now driving 10 miles per hour above the speed limit, hangs on my rear bumper. I’ve experimented. Speeding up does nothing. Though I’ve not tried hitting 80 or 90 miles per hour, it’s never enough for these speed-addicted fools. And the same is true of wealth generation. Most individuals would be happy with salaries in the high six-digit range, and with wealth in the low seven-digit range. But the nation’s multi-millionaires, billionaires, and multi-billionaires aren’t happy. They can double their income and wealth time and time again, and even if they could reach an infinity of dollars, would still be unsatisfied. Something’s missing in their psyche, and like the speedster who does not understand and cannot accept the reality of limits, they, too, cannot stop, for there is no limit on their insatiability.

But what the extremists tend to forget is that if you squeeze too hard, something is going to pop. And the longer it takes for the pressure to build, the stronger the eruption. Some speedsters never learn until that last micro-second before they and their vehicle become on lump of fused human and metal material. I wonder what will be the limit-teaching event for the tax policy extremists.

The Inequality of Halloween?

From the outset, I have made it a point to work Halloween into MauledAgain, usually looking for the silly or goofy but occasionally taking a more serious approach. The posts began with Taxing "Snack" or "Junk" Food (2004), and have continued through Halloween and Tax: Scared Yet? (2005), Happy Halloween: Chocolate Math and Tax Arithmetic (2006), Tricky Treating: Teaching Tax Trumps Tasty Tidbit Transfers (2007), Halloween Brings Out the Lunacy (2007), and A Truly Frightening Halloween Candy Bar (2008), Unmasking the Deductibility of Halloween Costumes (2009), Happy Halloween: Revenue Department Scares Kids Into Abandoning Pumpkin Sales (2010), The Scary Part of Halloween Costume Sales Taxation (2011), Halloween Takes on a New Meaning and It Isn’t Happy, and Some Scary Halloween Thoughts.

This time, I explore how the national dissension over wealth and income inequality has intruded on children’s Halloween activities. An unidentified reader recentlywrote to a Slate.com columnist, asking whether Halloween should be restricted to neighborhoods. The reader lives in what the reader describes as a very wealthy neighborhood, though a few blocks away from the billionaires and celebrities. According to the reader, most of the children knocking on the doors “arrive in overflowing cars from less fortunate areas,” something the reader thinks is “inappropriate.” The reader claims that “Halloween isn’t a social service or a charity . . . for less fortunate children,” and notes that “”we already pay more than enough taxes toward actual social services.”

The columnist’s response deserves a salute. She pointed out that she lived in an urban neighborhood that welcomed families not from the immediate area, and that it was a delight to see the children dressed up in costumes. She explained that her family shelled out an additional $20 to have enough candy to give out. She then described the reader’s letter as a “whine” that caused her to wish that “people from the actual poor side of town come this year not with scary costumes but with real pitchforks.” She advised the reader, “Stop being callous and miserly,” and advised the reader to get some candy to give to children who get one day a year to “marvel at how the 1 percent live.”

Personally, although distributing sugar might be feeding or creating a sugar addiction, I enjoy handing out candy to children on Halloween. When one of them runs down the driveway yelling to friends, “He’s giving out Reese’s Peanut Butter cups,” I get to smile and sometimes laugh. As a child, I canvassed not just my neighborhood but also the adjacent ones, though all of the neighborhoods were of the same socio-economic condition. I paid attention to my older brother and quickly argued for permission to head out with a pillowcase and not a small paper bag. The few people in other neighborhoods who did not know who I was simply asked. The idea that we should stay within our own neighborhood just didn’t exist, at least not by the time we were eleven or twelve. Nowadays, the children who arrive at my door not only come from my neighborhood, but from adjacent ones where the housing prices are meaningfully higher and from the university’s dorms at the northern edge of an adjacent neighborhood. I don’t ask for ID. I suppose that is what the Slate.com reader would be suggesting. I wonder if it would need to be a photo ID.

How Not to File a Tax Court Petition

A recent case, Sanchez v. Comr., T.C. Memo 2014-223, demonstrates how a taxpayer should not file a Tax Court petition. The taxpayer received a notice of deficiency that was mailed on December 2, 2013, making the petition due by March 3, 2014. The taxpayer used an unidentified third party to prepare the petition. That person was “given documents to mail,” printed postage from Stamps.com, added extra postage for making the mailing certified, took the petition to the post office, noticed there were long lines, and dropped the envelope in the outgoing mail slot without getting a postal service employee to stamp certified on, and postmark, the envelope. The petition arrived at the Tax Court on March 10, 2014, bearing a postmark of March 4, 2014.

Not surprisingly, the Tax Court granted the IRS motion to dismiss for failure to file the petition in a timely manner. The court pointed out that the postal service postmark trumped the March 3, 2014, date on the postage generated by Stamps.com, that the postal service postmark could not be trumped by other marks unless it was missing or illegible, and that testimony of delivery to the post office of the petition on a day earlier than the postmark must be disregarded.

There are two major lessons to be learned from this case. First, stand in line and get that hand-stamped postmark. Second, avoid the need to learn the first lesson by treating the petition as due EIGHTY days after it is mailed. That provides a cushion of time, an allowance for unforeseen circumstances, and contingency insurance. The inability of most people to deceive themselves in this manner has its roots in childhood, when too many missed deadlines are tolerated, and lessons in timeliness aren’t taught and when taught, aren’t absorbed. More than a few law students have encountered serious academic difficulties because a variety of circumstances, some unpredicted and some to be expected, caused them to miss deadlines. People complain that law schools should be teaching time management, but, seriously, why are people arriving at law school lacking time management skills? The answer is, for the same reason people not going to law school have the same issues. Better to learn the consequences when what’s at stake is something minor and not a taxpayer’s Tax Court petition.

The True Cost of Stopping a Tax Increase

From this story, I learned that there is a ballot question in Massachusetts asking voters to decide whether the inflation-adjustment indexing of the state gasoline tax, enacted in 2013 and scheduled to go into effect in 2015, should be repealed. The writer of the story introduces it by asking, “Repealing a yet-to-be-implemented gas tax provision passed in 2013 is the top question on the ballot Nov. 4, but what does that really mean for your wallet?” It’s a good question.

The writer points out that it is impossible to predict future gasoline tax increases because the index for inflation adjustment is unpredictable. The writer looks at what would have happened in previous years had the indexing been in effect, but then warns that it is unwise to project the amount of the gasoline tax 20 years from now based on what indexing for the past 20 years would have been. Good point.

The writer explains that the current Massachusetts gasoline tax, raised in 2013 from an even lower level, still remains below the national average and below the regional average. The writer then shares some hypothetical gasoline tax costs using mileage numbers for so-called average drivers.

The flaw in this analysis is that the writer omits other components of the analysis. A repeal of the scheduled indexing will “save” drivers some undetermined amount of additional state gasoline taxes. But it also will cost them in ways that most Americans, including political leaders, writers, and analysts fail to consider. With the failure of gasoline taxes to keep pace with road repair and maintenance costs, a phenomenon mentioned by the writer, the condition of roads, bridges, and tunnels deteriorates. That leads to emergency closings, more accidents, and slower traffic trying to avoid potholes and other deformities. These consequences cause drivers to need more time to make the trips they are trying to make. Time is money. So there’s a cost. And pity the driver who hits a pothole, or whose vehicle is damaged when hit by loose stones kicked up by another vehicle because the road is falling apart. The cost of a front-end alignment alone exceeds what the driver would have paid in increased gasoline taxes. And the damage doesn’t stop at front-end alignment. It can include tire and wheel damage, bent frames, and far more costly damage to vehicle and occupants from accidents caused by drivers swerving around potholes.

In some ways, taxes are like insurance. For example, not everyone will hit a pothole. Not everyone will suffer a house fire. But the purchase of insurance, aside from providing financial peace of mind, spreads the risk so that it can be borne by the individuals who constitute a society. But the anti-tax crowd also is an anti-insurance crowd, for those who subscribe to the “get rid of government” mentality cannot admit, and perhaps don’t even understand, that deep down inside they are adhering to a “get rid of society, let’s just have every person go for himself or herself” philosophy. The failure to understand the individual’s need for society, itself an insurance against the chaos of pure libertarianism, is what lies at the heart of a maladjustment exploited by the manipulative few who see this as an opportunity to be more libertarian than the rest of us.

So, go ahead, vote for a repeal of scheduled increases in the gasoline tax. But please let us know who you are so that when you suffer vehicle damage and start complaining that “the government should have been doing something about” the pothole or whatever caused the accident, we can remind you that you brought it on yourself. It’s a tough way to learn that the long-term needs just as much consideration as the short-term. That is true for many things, including taxes.

At The Mercy of the Tax Office

It could be anyone’s nightmare. For one woman, it is her reality.

According to this story, the city of Norcross, Georgia, has sold a woman’s condominium unit because she did not pay a $94.85 city tax bill. She did not receive the bill because the address on the bill was wrong and it was returned to the sender. For the same reason, the follow-up notices that the property would be sold did not reach her.

It is troubling that in the so-called information age, a city office cannot get a tax bill and notices to a taxpayer, especially after the items are returned because the address on them is incomplete. How difficult would it be to find the taxpayer’s address? Though the information age brings an abundance of data, it also has generated a culture of relying on machines that are no more capable than the programmers who design them and the software they run. The city’s mayor claims that the city is examining why this error happened. The answer should be easy to find. What happens when a tax bill or notice is returned by the postal service? Does a human see it? What is that person required to do? If they do something, is a record maintained of what was done? If only one mailing had been returned, it would be a bit easier to comprehend the oversight, but multiple items were returned. The answer sits somewhere between badly designed procedures and carelessness or laziness.

The purchaser of the condominium unit has already sold it to another person. There is no way the woman can recover possession of her property. Perhaps the city could offer to purchase it back from the new owner at a premium that entices a sale, but even if that happens, all of the city’s taxpayers would bear the burden of what could turn out to be one person’s mistake.

How does one protect one’s self from this sort of outcome? First, learn what taxes apply to ownership of real property. Examine taxes imposed by the local community, by the county, by the state, and by those multi-jurisdictional agencies and authorities. Second, learn when the tax bill is mailed and when the tax is due. Third, set up some sort of reminder system to keep track of bills as they arrive, and if one doesn’t arrive within three weeks of the due date, contact the appropriate tax office. Yes, it’s more work for someone who doesn’t bear primary responsibility for a task, but that is a marker of current culture, in which too many people bring a lackadaisical attitude to their responsibilities because they figure someone else will bail them out.

Tax Complications Often Mask Tax Breaks

On Monday, a reader of the Albuquerque Journal sent an inquiry to a columnist who carefully answered the question. The reader wanted to know why it would be better to make a charitable donation of stock rather than a donation of cash in the same amount as the value of the stock. The reader pointed out that, whichever choice was made, the charitable contribution deduction would be the same. The columnist explained that there was a big difference. By donating the stock, the reader avoids paying the capital gains tax that would be due if the reader sold the stock and donated cash proceeds.

The donation of stock to a charity in lieu of cash clearly is a tax break. It is a complicated tax break because not all stock donations qualify, and in some instances the capital gains tax does apply. It is not unusual for tax breaks to be complicated, because most are designed to benefit a very narrow group of taxpayers, sometimes even one person or company or a handful of family members, but complicated definitions serve to disguise the identity of the tax break beneficiaries.

The tax break for donating stock, though theoretically available to all taxpayers, is, as a practical matter, of value only to those persons who are sufficiently wealthy both to own stock and to be in a position to make a charitable donation of that stock. People who have lost jobs in the interest of boosting shareholder profits, disabled veterans trying to live on meager public benefits, retirees scraping by because a billionaire bought out their former employer and cancelled pension payments, the working poor, a good chunk of the declining middle class, and those afflicted with unplanned medical bills not covered by insurance either don’t own stock or, if they do, can’t afford to give it to charity. In other words, this tax break primarily benefits the rich. It’s a tax break that doesn’t show up in the list of government expenditures criticized by the puppets of the rich, nor is it among the outlays that the same critics label as giveaways to “takers.”

To find out who benefits from this tax break, propose its repeal. Then watch and listen for the response.

Putting the Brakes on Tax Breaks

Philadelphia City Council has approved legislation giving yet another tax break to employers. According to this story, city officials are using a tax break to do what state law prohibits them from doing directly. They want private sector employers to pay workers at least $12 an hour rather than the current $7.25 minimum hourly wage. The legislation would provide each employer an annual $5,000 tax credit for each new full-time worker hired at a rate of at least $12 an hour.

Some math is in order. An employer who would otherwise pay $7.25 per hour to an employee who works 2,000 hours but who raises the rate to $12 per hour faces an additional compensation outlay of $9,500, aside from other costs associated with the increase. How does a $5,000 tax credit persuade the employer to hire someone, and if hiring someone, to incur a $4,500 out-of-pocket cost? Even with the federal income tax savings from the deduction, the employer’s net cash flow would be negative.

A policy question is in order. Unless the employer otherwise would be hiring, of what use is the tax break? It isn’t triggered by raises handed out to existing employees working for a wage based on less than $12 per hour. Employers hire if they need help delivering goods and services, which requires the existence of a consumer class with money to spend, but we know how that’s been working out under policies set by the “we worship the wealthy and disdain the middle class” crowd.

Perhaps some insight comes from another aspect of the legislation. The tax break technically is the greater of $5,000 or 2 percent of the new employee’s salary. So if an employer brings in a new employee who would have been hired anyway, at a salary of $500,000, the tax credit is $10,000. Justifying the tax break on the theory that it is designed to increase wages paid to low-income workers is impossible when the tax break is of more value to employers when hiring high-end employees.

Advocates of this approach to dealing with the low-wage problem point to an existing tax break. They claim that 1,057 new jobs were created. Employers hiring those new employees claimed $1.8 million in tax breaks. What’s unproven is the connection between the tax break and the hiring. How do we know that the hiring would not have otherwise happened even without the tax break? Again, employers hire when they have a need that justifies the salary outlay, and a tax break that does not pay for the worker’s salary isn’t going to generate hiring in and of itself.

It is understandable why the city council took this path. Blocked by state law preventing it from raising the minimum wage paid in the city, and unlikely to get that law changed by a legislature dominated by friends of the wealthy, it wanted to try something, anything. But making a tax break available for the hiring of employees whose salaries are nowhere near minimum wage makes no sense. Nor does the tax break do anything for current employees. And unless the tax break picks up the entire cost of hiring someone, whether that cost is $9,500 or somewhat less on account of income tax deductions, it is insufficient incentive for employers to increase salaries. Worse, the tax break might tempt some employers who already pay $12 per hour or more to have their employees quit, only to be hired by an affiliated company and claimed as new employees, though hopefully the legislation would be written in a way to prevent that sort of game.

All of this brings me back to one of the core principles of how I would design a tax system. Never do indirectly through taxes what can and should be done directly. Put the brakes on tax breaks.

Fighting Over Pie or Baking Pie?

Four months ago, in When the Poor Need Help, Give Tax Dollars to the Rich, I criticized the decision by New Jersey’s Governor Christie to dish out tax credits to the Philadelphia 76ers in return for the team moving its practice facility to Camden. The state claimed that by giving away $82 million over 10 years it would get back $77 million over 35 years. That doesn’t add up, except for the private sector corporations and wealthy individuals who pocket the difference, which surely is much more than it appears to be. Why? Although these sorts of giveaways to the wealthy are defended by claims of job creation, the fact of the matter is that they simply move jobs from one state to another. In some cases, such as the 76ers, employees simply go to a new work location. In other cases, for every unemployed person who ends up with a job, someone, somewhere, finds himself or herself on the unemployment line.

Now comes news that New Jersey is getting ready to hand out more than $100 million in tax breaks to Lockheed Martin, in an effort to persuade it to move some jobs from wherever they are to Camden. This comes on top of a $260 tax break giveaway to Holtec International, which in turn added to the almost $4 billion in tax credits handed out by the state during the past ten years.

From a national standpoint, from the perspective of what is good for the nation, this is nothing more than a zero sum game. States fight over pieces of the private sector by using tax dollars to increase the size of the economic pie that they can grab, while the small business entrepreneurs who actually bake pie struggle because they cannot afford to put huge campaign contributions in the pockets of the politicians using tax dollars to enhance their power. If state governors and legislators continue down this path, eventually there won’t be any pie for them to fight over. Not that I advocate using tax breaks to encourage the private sector to do what it should be doing on its own, but if public money is going to be handed out, it ought to be limited to helping those who create jobs and not those who move jobs around in a tax break shell game.

A Bad Tax Pun

I like puns, and word games. The other day I came across one that meshed with taxation. It’s bad, so it’s appropriate for hump day.

We know that taxes are used both to discourage activities on which society allegedly frowns, as well as to generate revenue to pay for the social cost of those activities. Thus there are taxes on tobacco, on gambling, on alcohol, and on inappropriate activities by private foundations, to name a few. So would it not make sense to develop a tax for another practice on which at least some part of society frowns.

And thus, it has been proposed that when people make grammatical errors, they should be subjected to a syn tax. Perhaps the suggestion is a joke. But in a country in which taxes are levied on just about every item and every behavior, it might end up as something not quite a joke.

So What Would You Have Advised?

A recent Tax Court case, Kalapodis v. Comr., T.C. Memo 2014-205, presents an opportunity to explore how the tax law affects the manner in which people decide to implement a plan. The taxpayers, a married couple, had a son who died. They received $75,000 of life insurance proceeds on his life. They decided they wanted to use the money to establish scholarships for deserving students. So they put the money into a trust, gave it a name, and directed the trust to pay $2,000 in scholarships to each of three high school students. The money came from investment income on accounts owned by the trust, and was paid with checks written on the trust’s account to the recipients. The trust did not apply for tax-exempt status.

The taxpayers claimed a charitable contribution deduction for the $6,000 paid to the three students. The IRS disallowed the deductions, and the Tax Court upheld that decision. The court gave several reasons. First, the $6,000 was paid by the trust, not the taxpayers, and there was no justification for treating the trust a grantor trust. Second, the payments were made to individual students, who do not qualify as charitable donees for purposes of the charitable contribution deduction. Third, the taxpayers did not provide evidence of a contemporaneous written acknowledgement of the payments.

Nothing in the opinion indicates whether the taxpayers sought professional advice on how to set up the scholarship program. Presumably, if they had done so, it would have been included in the facts provided by the court, but there’s no guarantee of that. If they did what they did based on professional advice, it would be troubling. Would it not have made more sense to set up a charitable entity, such as a trust or non-profit concern, that obtained tax-exempt status? Would that not make the contributions to the trust deductible, and leave the trust tax-exempt on its investment income? There’s no indication of whether the taxpayers deducted the $75,000 that they transferred into the trust. Granted, setting up a tax-exempt scholarship foundation isn’t something just anyone can do, as there are details that must be taken into account, record-keeping that is required, and safeguards that must be implemented. Would it have cost a few thousand dollars? Probably. But in the long run, the tax savings would have made the investment in professional advice worthwhile.

So is that what you would have advised? Or am I wrong and did the taxpayers set up the scholarships in a sensible way? Are there alternatives that would make more sense? I am confident that the taxpayers are not the last folks to decide to set up a fund for a charitable purpose, whether scholarships or some other good purpose. Hopefully, the next group of people to take this route follow the right path.

Who’s to Blame for Failure to Withhold?

Many Pennsylvania towns impose a local services tax, which is limited to $52. Most localities have opted to impose the maximum amount. The tax is imposed on all individuals who are employed or self-employed within a jurisdiction. Employers are required to withhold and remit the tax for their employers. See, for example, the regulations for Radnor Township.

What happens if the employer fails to withhold and pay the tax? According to this story, that’s what happened to employees of the United States Postal Service in Scranton, Pa. Actually, it happened to some of the employees but not all of them. For eight years, going back to 2006, the tax was not withheld and paid on behalf of at least 50 employees. Eventually Scranton’s tax office figured out that the tax has not been paid, and has sent bills to the employees. One employee received a bill for $669, including interest.

Now a dispute has arisen as to who is responsible. The employee in question stated that if he knew the tax had not been paid, he would have paid it, but no one told him. The Postal Service claims that it’s the employee’s responsibility to point out errors in withholding. The employees’ union disagrees, and has filed a grievance seeking to have the employees reimbursed.

Here is how I would resolve the dispute. The employees owed the tax, and to the extent it was not withheld and paid, they took more money home. They had the use of that money for the period during which the tax was not paid. Thus, as for the tax amounts, the employees should pay. As for the interest, the employees had use of the money, but the interest rate charged by Scranton probably is more than the interest rate that the employees could have earned on the money. The difference should be picked up by the employer, who has the obligation under the tax ordinance to withhold and remit the tax payments.

Of course, one of the underlying problems with this situation is that the tax is a nuisance tax. It’s a small amount. In Radnor, a sole proprietor who is not an employee is required to make four $13 payments and is not permitted to pay in one $52 lump sum, increasing the chances that a payment will be missed. It’s also a silly tax, because it is levied for services, and yet is not imposed on people receiving services who are not employed or resident in the locality. It also imposes an administrative cost on the locality, and the fact that it took Scranton eight years to discover that some of the employees of one the locality’s larger employers demonstrates the challenges facing tax collectors. It also is a regressive tax. I commented on this tax back in 2005, in Stealth Tax, Type Two, and Spotlights Now Turn to That Penna. Stealth Tax. Nothing in this recent story from Scranton suggests that my criticisms of the tax are misplaced.