Taxing the Internet: Reprise

Three years ago, in Taxing the Internet, I reacted to a series of proposals to "tax the Internet." Explaining that taxing the Internet is like taxing a highway, I explained that the proposals actually consisted of two ideas: "One is taxation of transactions and activities conducted on or through the internet. The other is taxation of access to the internet. Continuing with the "information superhighway" metaphor, the first is similar to taxing gasoline used by vehicles to drive on a toll road, and the second is similar to the toll charged for access to the toll road."

It's time to revisit the question. Why? Senator Enzi has introduced a bill allowing states to impose sales tax collection responsibilities on internet sellers that have no other connection with the state. Lobbying for the proposal, deceptively named the Streamlined Sales Tax Agreement, has been intensifying, orchestrated and led by state governments that somehow seem incapable of enforcing their own use taxes on their citizens. Of course, it's understandable that state politicians would prefer to put tax collection duties on merchants, considering that the alternative -- collecting the use tax -- would be too obvious to state citizens. It's also cheaper to have merchants in other states -- who have no voting rights in the state imposing the sales tax -- bear the collection burden. But is it right?

On top of this renewed effort galvanized by a perception that the new Congress is more tax friendly, state and local governments are seeking power to impose taxes on Internet access. According to this story yesterday by Declan McCullagh, one senator even predicts taxes on email. Now there's an idea that should earn someone a nomination to the high intelligence hall of fame.

The justification is amazing. Enzi claims that states are losing sales tax revenue, and thus will be compelled to raise income and property taxes. The problem with this claim is that states have no right to collect sales tax on transactions taking place outside the state. What's hurting the states is their unwillingness to do what must be done to collect use taxes. These ancient bureaucracies, some of which have only recently become familiar with the Internet and still have miles to go before their web sites are as good as they can and should be, struggle to make adjustments as the world around them changes. How easy to pass the work off to distant merchants.

The director of federal relations at the National Governors Association claimed, "The independent and sovereign authority of states to develop their own revenue systems is a basic tenet of self government and our federal system." Really? There does happen to be something called the federal Constitution, and the last time I looked at the case law state 1 has no "independent and sovereign authority" to impose a sales tax on a transaction that takes place in state 2. Whether the state 1 resident travels to state 2, phones a merchant in state 2, or contacts the merchant in state 2 through the internet, state 1 is powerless to impose any tax until the state 1 resident returns to state 1 with the item. If state 1's legislature and tax bureaucracy cannot figure out how to do that, perhaps they can resign and make room for those who do. If the fear is that state 1's residents don't want a use tax, or don't want to pay one, then state 1 needs to repeal its use tax, and even its sales tax, and enact whatever tax its residents wish to have.

The so-called Streamlined Sales Tax Agreement supposedly deals with the existence of more than 7,500 taxing jurisdictions, each with its own definitions and rules with respect to sales taxes. That prediction is nothing more than a promise. It's another of those "trust us and we will spare you the details" arrangements of which politicians are so fond.

Three years ago I set forth the principle that should apply when dealing with this issue:

when it comes to taxing transactions and activities conducted on or through the internet, or taxing access to the internet, those transactions, activities and access should be taxed no differently from the way in which transactions and activities conducted through means other than the internet are taxed.

I pointed out that "This principle, though, is ignored by those who take either extreme position with respect to taxation and the internet." Goodness, no one has proven me wrong. Those entrusted with the care of the nation continue to behave as though they never sat through a tax class. Oh, wait, most of them haven't and most of the ones who did were there reluctantly. Tax? Boring. Too difficult. Of course. It's extremely important and it requires serious diligence. Not willing to pay the price? Don't meddle with something about which not enough is known by the meddler.

As I re-read my three-year old Taxing the Internet, I see descriptions of the same arguments being advanced today by the "tax the Internet" crowd and by the "no taxes at all" group. The flaws in the rationales for taxing email continue to exist. I urge all those involved with, or interested in, this latest round of "tax the Internet" to read Taxing the Internet. Then it will be fairly easy to understand my proposal: "(1) tax access as is taxed telephone and cable access, (2) tax retail transactions as catalog sales are taxed, imposing use tax collection responsibilities on those with sufficient nexus to the taxing state, (3) eliminate and prohibit "Internet only" taxes, and (4) find another way to deal with spammers, casinos, and other social behavior that is considered unacceptable or inappropriate."

Now what are the odds that politicians will follow this sensible approach?

Turnpike Cash Grab Heats Up

About three months ago, in Selling Off Government Revenue Streams: Good Idea or Bad?, I explored the wisdom of proposals to have Pennsylvania and New Jersey sell their toll roads to private enterprises in exchange for lump sums that presumably would be used to reduce taxes. Though I approached the issue with a list of questions, there's no hiding my disfavor for the idea. There are too many risks, and insufficient benefits, to embark on this quick money grab.

Yesterday brought news, more fully reported in this story, that the governor of Pennsylvania has submitted his "turnpike lease plan" to the legislature. The carrot that he dangles is a suggestion that the proceeds of the deal would pay for repairs to the state's damaged roads and bridges and might even generate funds for public transit. There are no guarantees, are there? Yes, there is one. Analysts and the governor's deputy chief of staff point out that under the plan, tolls will increase. No kidding.

The Philadelphia Inquirer story explains that the current $19.75 toll for the main eastbound section could climb to $287.20 in 50 years. Wow. The governor's response? No problem, people's salaries will increase. Sure. If the past few years are any indication, most people will far less of an increase than the projected toll increase, which might explain who would see the increase in income. The folks with enough spare cash to buy, oh, sorry, lease, the turnpike.

Why charge turnpike users to fix other highways? Why not impose tolls on I-76 east of Valley Forge, I-95, I-80, I-468 south of Plymouth meeting, and on other, highly traveled routes? Those whose driving contributes to the deterioration of roads and bridges should be the ones who pay. It's called a user fee, and in this instance they make sense, particularly with the sorts of technology now available that eliminates the need to build toll booths.

The plan can be classified under the "trust us" category. The governor seeks legislative authority to solicit bids and to select a lessee, without any additional involvement by the legislature. It is difficult to imagine any legislature, let alone Pennsylvania's, abdicating its authority and handing the golden goose to the governor. Of course, everyone knows that the proposal transmitted yesterday is nothing more than a first offer.

Not surprisingly, more than a few legislators oppose the idea. Letters to editors and other expressions of public opinion confirm that there is no groundswell of support among Pennsylvania residents. Considering Harrisburg's track record, it's a wonder anyone in the state is comfortable with anything that happens in the capital.

The administration, taking cues from the private sector, is using the term "monetize" to describe its goal. Sadly, some people can be persuaded that an idea is worthwhile because a fancy, glittering, snazzy word is invented to describe it. It's one of those qualities of post-modern culture that doesn't endear itself to me. Neither does the term "post-modern," but I'm not ready to campaign for a more descriptive and sensible term to describe our current culture. Finding one that will get past the censors is part of the challenge.

The icing on the cake is that the administration continues to hold back information on all but one of the 48 proposals that have been received. The one that has been made public? The information received from the Turnpike Commission. In other words, the governor wants the ok to make a deal without telling any of us anything other than his final decision. How would anyone know if that deal was the best possible, and in the best interests of the Commonwealth and its citizens? Remember that third great lie? "Hi, I'm from the government and I'm here to help you."

Somehow, it has been learned that proposals have been submitted by New York investment banks, the governor's former employers, previous employers of New Jersey's governor, law firms, construction companies, a think tank, and international developers. A think tank? Theory this and theory that? Perhaps we will pay theoretical tolls to ride on theoretical roads? Law firms? Running a toll road? What's next, attorneys doing heart surgery?

Ought not this entire scheme be put in front of voters through a referendum? I wonder if the outcome in last week's referendum has generated some distaste for a repeat with respect to the turnpike shuffle?

No Deductions for Medical Marijuana Distribution Expenses

A recent case highlights the inconsistent boundaries that the tax laws draw between different types of illegal activity. It's no wonder that students and practitioners alike struggle to reconcile the differences.

First, some general background. The IRS, in regulations, has concluded that an otherwise deductible trade or business expense is not disallowed merely because allowing the deduction would frustrate a sharply defined public policy. Despite that position, some courts had held, under some circumstances, that otherwise deductible expenses should not be allowed if the allowance would frustrate a sharply defined public policy. In 1958, in Commissioner v. Sullivan, 356 U.S. 27 (1958), the Supreme Court held that business expenses paid by a taxpayer operating an illegal bookmaking business were deductible because they were ordinary and necessary expenses of the business, noting in dictum that if the expenses were paid to avoid the consequences of violating the law or otherwise contravened federal policy. Seemingly, this overruled an earlier Tax Court decision in which a taxpayer illegally selling whiskey was prohibited from treating the cost of confiscated liquor either as part of cost of goods sold or as a loss, based on public policy grounds.

Yet even though the Supreme Court seemed to have limited the denial of deductions on public policy grounds, lower courts proceeded to render decision that were inconsistent. In some instances, deductions were not disallowed solely due to the illegality of the business. For example, taxpayers running illegal numbers games, illegal lotteries, and illegal gambling operations were allowed to deduct the expenses of their businesses. Nonetheless, the Tax Court held that no deduction was permitted for illegal gambling proceeds forfeited to the government, and other courts held that no deductions were permitted for the value of illegal gambling devices seized by authorities.

On the other hand, taxpayers have been permitted to include in cost of goods sold the amounts paid for extra bottles of liquor purchased illegally at posted prices. Yet life insurance agents were not permitted to deduct rebates illegally paid to persons buying policies, even though in once instance the deduction was allowed because the insurance commission knew that rebates were being paid. A taxpayer convicted of price fixing was permitted to deduct rebates granted by the taxpayer in order to meet the competitors' prices.

Despite the position taken in the regulations, the IRS has concluded the compensation paid to someone to burn down a building is not deductible. The Tax Court has treated blackmail payments as nondeductible, but on the ground that blackmail payments are not ordinary expenses.

Second, some specific background. In a series of cases in the late 1970s and early 1980s, the Tax Court held that persons engaged in selling or transporting illegal drugs were permitted to deduct the expenses paid or incurred in connection with their business activities. In response, Congress enacted section 280E, denying deductions for "any amount paid or incurred during the taxable year in carrying on any illegal drug sale trade or business." Congress explained that it so acted because there is a "sharply defined public policy against drug dealing."

Third, the case. In Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner, 128 T.C. No. 14 (2007), the Tax Court was presented with the deductibility of expenses incurred by an organization that provided its members with medical marijuana pursuant to the California Compassionate Use Act of 1996 and instructed those individuals on how to use medical marijuana to benefit their health. CHAMP (what an acronym!) required each member to have a doctor’s letter recommending marijuana as part of his or her therapy and an unexpired photo identification card from the California Department of Public Health verifying the authenticity of the doctor’s letter. CHAMP prohibited its members from reselling or redistributing the medical marijuana they received.

The Tax Court determined that section 280E applied to CHAMP's drug distribution expenses. The court held that CHAMP's activities constituted trafficking in illegal drugs. It also held that section 280E does not disallow all of CHAMP's deductions, but only those connected with the drug distribution activities. Finally, the court decided that CHAMP had two businesses, providing care to its members and providing medical marijuana.

Fourth, my two cents. The court's decision was inevitable. Section 280E says what it says. It's tough to see how the court could have reasoned to any other conclusion.

The case, though, presents several questions:

1. Why should the deductibility of an expense turn on the nature of the business? Persons engaged in illegal activities don't pay higher bridge tolls, sales taxes, or real property taxes, so increasing their income tax liabilities seems inconsistent.

2. Why should the tax law be used to enforce other laws? Is the IRS really that much more efficient than the agencies primarily responsible for enforcing non-revenue law?

3. Does anyone think that the denial of the deduction actually deters people from engaging in illegal activities?

4. Why dedicate a Code provision to the denial of deductions for the expenses incurred by dealers in illegal drugs, without dedicating Code provisions to the denial of deductions for the expenses incurred by dealers in illegal guns, illegal fireworks, illegal counterfeit products, and stolen goods?

I guess each of my rhetorical questions is worth half a cent. Surely tax practitioners asked for advice about the deductibility of expenses incurred by clients who are operating near the boundary between legal and illegal activities will cost more.

Taxes and School Funding

Last Friday, in A Perplexing Tax Vote Decision, I looked at the local school district income tax proposal and noted, "It will be interesting to see what happens on Tuesday." I concluded that "I don't have any clue as to the fate of the proposals."

Now, I do, after reading this story. The proposal was overwhelmingly rejected. Not only did it fail in all but 4 school districts in the entire state reject it, including 63 of the 64 school districts in the Philadelphia area, the margins of disapproval were significant. The voters have spoken.

What's next?

Three ideas are getting attention. The first is an increase in the state sales tax, dedicated to school funding. The second is an increase in the state income tax. The third is an increased emphasis on cutting school spending.

The sales tax is pretty much as regressive a tax as is the local property tax. It's difficult to imagine the folks on fixed incomes trying to deal with real property tax increases being any more thrilled with a sales tax increase than they have been with property tax increases. The difference is that the legislature can vote to increase the sales tax without holding a referendum. Considering the voter backlash last November against Pennsylvania legislators whose antics did not earn much admiration, one must wonder if the state legislature would be agreeable to a sales tax increase.

Increases in the state income tax are certain to face all sorts of challenges. Some legislators already are setting up their position by noting that "people don't want taxes increased, period." If voters nixed local income taxes, why would they support increases in state income taxes?

Cutting school spending is a soundbite phrase almost as old as the hills. The challenge in cutting school spending is finding the expenditures to cut. If we value our children and their education, it makes no sense to cut teacher salaries, already too low for all the things they are called to do and the roles they must fulfill. One local school cut its foreign language programs. How short-sighted. The school board did so under the pressure of "cut school funding" from taxpayers, who I suppose must think that the residents of the planet will speak English to accommodate their children. Anyone who proposes a cut in athletic programs must be ready for a barrage of bitter invective.

Let's face it. Good things don't come cheap. We get what we pay for. There may be some waste and bad decision making in school spending, but surely it doesn't count for so much that elimination would generate any sort of noticeable tax decrease. There are inefficiencies, but it is unlikely that proposals to eliminate them would fall on happy ears. Some state legislators are knocking on this door, suggesting that the state reduce the number of mandates it imposes on local schools. The twist to this issue is that the federal government has been adding to the list of mandates for many decades, with little regard for the funding challenges presented to local taxpayers.

The tax question is not the problem but a symptom. The discussion needs to focus on the tension between what people want schools to do and what people are willing to pay for whatever it is that schools do. The more people demand that schools provide everything for everybody, the more expensive it will be to operate the schools. For the discussion to make sense, the schools need to disclose their expenditures in ways that educate the taxpayers. The true cost of each program, each mandate, and each activity needs to be publicized. Some school districts do this, some come close, and others don't. Many taxpayers don't look at the details, even though we live in a world where details matter and in a world where many people don't like details. Fix that and the door might open to a meaningful examination of the underlying problem.

Getting to Know You, from Taxgirl

A 17-question virtual interview of yours truly has been posted by Lawmummy on theTaxgirl Blog. It was nice to have an opportunity to share some thoughts that I almost certainly would not have shared on MauledAgain on my own initiative. There's more on Taxgirl Blog than just the "Getting to Know You Tuesday" feature. For example, there's "Fix the Tax Code Friday," quite an ambitious undertaking. There's commentary and news. It's well worth a visit.

P.S. My next post will look at the outcome of the local tax reform proposals that on yesterday's Pennsylvania primary election slate. They don't get the headlines and television coverage of other questions, such as the Philadelphia mayoralty race.

A Downside to Electronic Tax Filing

Today brings another increase in postage rates. This development can be seen as yet another reason to endorse and use electronic tax filing. For me, though, that consideration is offset by a new disadvantage of electronic filing, namely, the opportunity to use a particular postage stamp on envelopes transmitting tax returns and tax forms.

Among the new 41 cent postage stamps is one carrying the image of Darth Maul. Go to this story, scroll down to the Star War series, and then click several times.

It would have helped had his name appeared on the stamp. Think of all those unfortunate folks who don't know about Darth Maul.

Don't ask where the "e" went. It's an easily misspelled name. If you are so inclined, you can slog through a long, technical explanation, called A DISCOURSE ON THE SURNAME "MAULE" AND ITS VARIANTS. Pop quiz next week.

Note to self: Add to one of my "to do" lists the task of getting my picture on a widely circulated postage stamp.

A Perplexing Tax Vote Decision

Along with the usual nominee selection decisions, next Tuesday's primary election also contains a tax question for voters living in some school districts. The question is whether the district should adopt a plan that will provide property tax abatements, financed by an income tax and some projected but not guaranteed state funds from gambling revenue. The plan is complicated, debate has been underway for quite a while, many people are frustrated by extent of guesswork involved, and many people are convinced that when all is said and done they will be paying more in taxes if the plan is adopted.

Among the many issues that have been raised, one in particular strikes me as a good example of why these sorts of major tax policy and tax reform questions are so difficult. One of the objections to the plan is that renters will become subject to a school district income tax but will not receive property tax relief because they are not property owners. The plan, as proposed by the legislature, does not take into account the portion of rent payments that reflect the landlord's need to collect enough so that property taxes can be paid. Accordingly, renters are expected to vote against the proposal because for most of them - there is an exception for renters who work in, and pay wage tax to, Philadelphia - would incur a tax increase if the proposal passes.

But what of property owners? Should the plight of the renter be taken into account in determining whether the proposal deserves an affirmative vote? I suppose many people will simply decide whether the plan reduces, or is likely to reduce, their overall tax burden, and if it does, cast a vote in favor of it. Even some people who think their tax burden would be reduced at the outset might be so untrusting of future decisions that they choose not to give their school districts access to an income tax. Other people might base their vote on their perception of the plan's fairness and practicality. For these people, the renter situation should be a factor that is taken into account.

The plight of the renter is reflected in what I call the windfall of the landlords. If the income tax is limited to wages, which is the case in some of the school districts, then the landlords will receive real estate property tax abatement checks without incurring an income tax liability. Even if the income tax reaches all income, most landlords show a net tax loss with respect to their rental activities - chiefly because of depreciation deductions - while experiencing positive cash flow. There is nothing in the plan that requires landlords to pass on to their tenants the real estate tax relief that they will obtain if the plan passes. Nor is there anything in the plan to pay real estate tax abatements to tenants, even though tenants indirectly pay real estate taxes.

So perhaps fairness dictates that the renters plight be solved, in a way that pretty much eliminates the windfall of the landlords. Theoretical determinations of fairness so suggest. But what about the practical reality? Both possible approaches pose challenges. Should landlords be required to reduce rents? How would that be accomplished? Who would determine the amount of the decrease for each tenant? Who would police and enforce the reductions? Would there not be the risk that some sort of rent control arrangement, horrible as it sounds and is, would emerge? Perhaps the alternative is better? Instead of sending property tax relief checks to landlords, the school district could send them to tenants. How would the school district determine how much each tenant should receive? How would the school district identify and locate the tenants, considering that they are not on the rolls of real property tax taxpayers? Because tenants often are highly mobile, how would school districts catch up with tenants who move from the district?

Both methods of dealing with the fairness issue would be cumbersome. Both present all sorts of administrative and logistical problems. Both present costs that would eat into the tax relief. Perhaps the solution is to exempt renters from the income tax. Supporters of the plan would balk at that solution, in part because it would reduce the available property tax relief, thus increasing the number of plan opponents, and in part because it would shrink the pool of taxpayers for future income tax increases.

If we were starting on a clean slate, the plight of the renter and the windfall of the landlords would not be a serious issue. Changing from one tax system to another, whether in whole or in part, presents transitional issues that are thornier than then underlying question of choosing a taxation type. Transitional issues are the almost insurmountable hurdle to federal income tax reform. How does one say, and not lose support by saying, "You've had a good deal that you ought not to have had, and although we're not taking away what you reaped in the past, going forward you no longer have your good deal." Transitional issues pit landlord against renter, employee against employer, cities against rural areas, and young against old. The person who finds a way to close these divides indeed will deserve the praise he or she earns. No such person has yet appeared.

It will be interesting to see what happens on Tuesday. I haven't seen anything that projects the outcome, probably, I suppose, because the nomination races - such as that for Democratic nominee for mayor of Philadelphia - are getting most or all of the attention. So I don't have any clue as to the fate of the proposals. Do you?

When Your Client is a Dog

A former student, helping me prove what I tell my classes, namely, "we don't need to make up hypotheticals," sent along this story about the appointment of an attorney to represent a dog. A man who committed suicide, though worth several million dollars, did not have a will. Are the survivors fighting over the money? Yes, but they're putting their best efforts into attempts to get ownership of his golden retriever.

Four people claim the dog. The decedent's parents, who are divorced, each claim a right to Alex, now 13 years old. The decedent's fiancee also was interested in having Alex. To round out the quartet, the decedent's former girlfriend put in a claim, noting that the dog stayed with her because the decedent's father, who has had custody since his son's death, has cats in his house. The former girlfriend has known Alex since he was a puppy.

It doesn't take a degree in psychology to understand what's really going on. The dog's attorney put it best when he explained that the case "is similar to a bitter custody battle involving children" to which they bring their attempts "to punish each other for past transgressions." In the Decedents' Estates and Trusts course that I teach, I try to persuade my students that there is more to lawyering than knowing law, and that learning how to deal with people and reach beyond black-letter rules is essential to developing a successful practice, no matter the area of law under consideration. Stories such as this one demonstrate why it is so important for law faculty to acclimate students to the realities of their clients' lives.

One of the issues I pose to my students early in that course is why people should have wills. Like most people, many law students think that wills and estate planning are luxuries for the wealthy. I ask my students whether they care who gets their clothes, i-pods, and books, pointing out that even if saddled with student loans, the banks are unlikely to seek ownership of these items. I then ask them if they have pets. From year to year, the response rate remains about the same, somewhere in the neighborhood of one-half. "Who gets your dog?" I ask them. They look at me as though I am out of touch with reality. Perhaps they will be lucky, and no one will fight over their pets. Perhaps they will be busy fighting over their emails. But that is a different story for another day, although I have mentioned it in the past, in this series of commentary: Sorry I Wrote....? , The Impact of Death on Web-Based Content, Now It's Time for Taxes Meet Emails at Death, and News in the "Emails at Death" Case.

Oh, the judge in the case awarded cyclical custody to the decedent's parents. Each will have the dog for two weeks at a time. I'm not so sure that this is good for the dog. The mother has expressed an intent to permit the fiancee to spend time with Alex.

Cutting Off One's Tax Nose to Spite One's Ex-Spouse's Face

It is a fascinating scenario. It begins as do millions of similar tales. A couple is getting divorced. The wife seeks a settlement that includes her share of the value of the husband's business. The husband seeks to put as low a value as possible on the business. There's a tangent percolating there, which will blossom in full flower when husband, a year or two later, tries to convince a lender that the business is worth many times what it was worth at the time of the divorce.

One way of valuing a business is to examine its gross receipts. Generally, higher gross receipts correlate with higher value. So wife asserts that the actual gross receipts of the business are higher than what has been reported on the couple's tax returns over the years.

Could it be that wife has made a startling discovery? One that shocks her not only in terms of the property settlement discussions and litigation but also in terms of the tax return? Could it be that the wife finds herself as having signed tax returns that understated gross receipts and thus taxable income?

Absolutely not. Wife, it turns out, was the bookkeeper for the business. This is how she knows the gross receipts were understated. And according to wife's lawyer, she is ready to testify to this effect.

Wow.

So wife, trying to make life difficult for the husband, now is prepared to testify under oath that she, as bookkeeper, was involved in the underreporting of gross receipts, gross income, and taxable income. After all, she signed a joint return as to which she had knowledge of unreported cash receipts she handled as bookkeeper.

If wife is telling the truth at this point, either she is a strangely incompetent bookkeeper, a highly unlikely outcome, or she participated in tax fraud. If the wife is lying at this point, then she is attempting to commit fraud with respect to the valuation issue that has arisen in connection with the divorce proceeding, a fraud on both husband and the court.

Wife has an attorney. He has issued a subpoena to the accountant. Seemingly determined to prevail on the valuation issue, he appears to have overlooked the tax compliance implications. It's a common phenomenon among law students to analyze a problem or hypothetical question by zooming in on one issue to the detriment of related matters. Students often struggle with, and complain about, professorial attempts to get them to pull back and look at the larger picture. The word "tangents" pops up in evaluations critical of the course and the teaching. Oh, were life and law so simple.

More than once have we seen situations in which a wife asserts that the husband's mistress was the bookkeeper and they were in cahoots to make the income (and thus the value) of the business lower so that wife gets less than the amount to which she thinks she is entitled. If wife is correct, on this point she earns sympathy (which she may or may not forfeit once the rest of the story is told). Yet it's a totally different thing for the wife herself to assert that she herself either (a) assisted in making the amounts on the tax return lower than what she knew them to be from doing the bookkeeping work or (b) signed a joint return showing gross receipts less than what she knew they should be. Why in the world would she admit to such behavior, when, if she succeeds, she is damning herself with her own testimony?

Someone suggested that the answer is greed. Perhaps. Yet ultimately the effect of wife's testimony will be a visit or call or letter from the IRS, and what's left for husband and wife to share will probably be reduced to the point that wife ends up with less than she would have received had she not said anything. Supposedly, in the situation being described, despite the business having some value, the couple is pretty much close to broke.

Someone else pointed out that "rational decision making goes out the window in many divorce cases, as many spouses adopt a 'Give me what I want or I will take us both down' attitude." Or as someone else put it, in a "divorce case[, t]he hatred is so intense . . . . each party does not care what the consequences to themselves will be, only that it will bring shame or harm to their soon to be ex-spouse." It turns out that the situation isn't as unusual as I would have expected. Unhappy spouses often threaten to expose financial wrongdoing in which both have participated, such as hidden offshore bank accounts, unreported income, or jointly embezzled funds. It's one thing, though, for these threats to pass between the spouses, and another for them to be elevated into the public arena through subpoena and litigation.

Someone asked, rhetorically, "Is it wise to admit under oath assistance in tax fraud?" and then answered his own question, "Obviously not."

It seems wisdom, like rational thought, too often takes a back seat to emotion. Such is perhaps both the blessing and curse of the human condition.

An Epidemic of Cheating: Tax and Otherwise

It is so disheartening. For me, what some might see as two seemingly unrelated recent stories easily connect, and in turn mesh with an ongoing story. Paul Caron of TaxProf Blog relayed a Wall Street Journal story telling us that "55% of Lawyers Pad Bills; 35% Double Bill" and highlighted with this news: "Study Suggests Significant Billing Abuse." Five thousand attorneys were surveyed by a Samford University Cumberland School of Law professor, and 251 replied. More than half, up from 40% a decade ago, admitted "they had sometimes performed unnecessary tasks just to bump up their billable output." Some clients are billed for work that isn't done, and others are billed for time exceeding the time actually invested for the client. More than a third of the attorneys admit to "double billing," the practice of billing one client for travel time while using that time to do work for another client who is billed for that time. Only 52% of attorneys consider the practice unethical, down from almost-two thirds a decade ago.

Perhaps the typical non-attorney's reaction simply is that everyone knows that attorneys, or most attorneys, or many attorneys, cheat. For those who view lawyers as having the classic stereotypical lawyer personality, the news is probably not a surprise. Unfortunately, it simply fuels the stereotype.

Many of those who single out attorneys as dishonest might consider them a breed apart from the rest of the population. But the second story refutes such a view of society. According to a CNN story, the largest cheating scandal in the history of Duke's business school triggered the proposed expulsion of nine students, the proposed suspensions of another 15, and grade reductions for yet another 10. The university expects the students to appeal. Those who think lawyers have some sort of monopoly or near monopoly on cheating ought to consider the finding of a Rutgers University professor whose surveys revealed that 56 percent of MBA students admitted cheating in 2005, compared to 47 percent of students in other graduate programs.

It's a total disgrace. This sort of cheating is designed to do one thing, and only one thing. It is designed to persuade others that the cheater has attained a level of accomplishment that the cheater does not have. In the long run, not only does the cheater suffer but many others can end up dead, injured, impoverished, or otherwise damaged.

Think about it. Someone cheats on a statistics exam. A few years later, the student, now being paid by an employer to do work, is asked to prepare a report requiring knowledge and understanding statistics. Does the person cheat again? How? Trick someone else into doing the work? Or does the person turn in a flawed report? Do we want engineers who cheated through school certifying airframes? Do we want physicians who cheated through school performing surgery? What's the point of trying to persuade others that a particular accomplishment exists when the lack of skill is going to be discovered sooner rather than later?

The excuses that cheating is necessary because the material is too difficult, or because there wasn't enough time to study because of other commitments, are terrible excuses. If the material is too difficult, withdraw from the program and find something that is manageable. If there isn't enough time, reorganize the schedule or postpone studies until there is enough time.

According to the Duke business school cheating story, if the proposed punishments hold, the determinations will remain on the students' records for three months to three years. Why? Is there some magic that turns a cheater into a non-cheater after three months or three years elapse? More than 1,140 individuals applied for the 411 openings in the program, so what's the disadvantage to the school of kicking out the cheaters and taking in some of the 729 who didn't get in when they applied?

Is it any wonder that tax cheating is so rampant? So long as most students who cheat don't get caught, they will conclude that they have at least as much a chance of success when it comes to cheating with respect to taxes. Yes, the type of cheating that takes place with respect to taxes isn't so much a matter of trying to persuade someone that an absent or weak skill exists in high quality as it is a matter of trying to avoid an obligation. The similarities aren't difficult to spot, though, because both types of cheating involve trying to get something that isn't deserved (a high grade, a degree, extra money) while making a presentation (exam, paper, tax return) that isn't a true reflection of what it should be indicating.

To be fair to the schools and to the legal system, integrity is a value that needs to be learned early in life. Parents need to instill qualities in their children long before the children head off for their education. Why is cheating so rampant? Do parents not value integrity? Do they not know how to teach it to their children? Is peer pressure to cheat too strong when compared with beneficial influences? Has the pretense of post-modern "reconstructionism" affirmed the notion of pretending to have skills one does not have? Is cheating rewarded far too often and punished far too infrequently? Are the punishments for cheating too lenient? Society had best answer these questions, and answer them quickly. The alternative is more than worrisome.

Tax Records: Don't Let Go

Recently an interesting question was posed to tax practitioners and taxpayers: How long should tax records be retained?

Answering the question requires a definition of tax records. Tax returns are tax records. So, too, are supporting schedules not filed as part of tax returns. Also included are the receipts, contracts, and other documentation that justify the inclusions, exclusions, deduction, and credits reported and claimed on the return.

Many commentators look at statutes of limitations and conclude that once a statute closes, it's acceptable to trash (or shred) the files. I disagree.

My answer to the question is simply "forever." In an age when information can be digitized and preserved, the principal objection that traditionally has been raised, the need for storage space, can be dismissed as insignificant. Yes, there are some issues. Relying on a program like Turbotax to be the archive is dangerous; when I installed my first Windows XP system I discovered that earlier versions of Turbotax could not be loaded and thus there was no way to access the datafiles created by Turbotax. But the print-outs of the returns can be scanned and retained in a format no so proprietary as that used by Turbotax. It would not be surprising to discover that an enterprising entrepreneur will write a utility that permits read-only access to tax returns stored in proprietary format.

Why do I say "forever"?

First, to assume that a statute of limitations has closed is to put too much faith in the IRS taking the same view of the taxpayer's return as does the taxpayer. If the IRS asserts fraud, despite the fact it has the burden of proof, a savvy and prepared taxpayer should have in hand the documentation to refute any IRS allegations.

Second, to trust the IRS to provide a copy of an old return is to put too much faith in the IRS computer systems. The sorry state of IRS technology is well documented.

Third, tax data may be useful in litigation that deals with years for which the tax statute of limitations has closed. Tax data has value for more than simply determination of tax liability.

Fourth, many tax computations use adjusted basis, which in turn reflects transactions entered into during all the years that the taxpayer has owned the property or predecessor property and perhaps years during which the taxpayer's predecessor owned the property. Tossing a stock purchase record or a home improvement invoice once the tax statute of limitations closes for the year in question is foolish. Even if the IRS were totally reliable in producing old tax returns, even if the IRS accepted the taxpayer's denial of fraud, and even if tax data were useless in other litigation, this fourth reason alone compels the retention of tax records.

Strangely, the IRS itself advises taxpayers to dispose of records after specific periods of time, usually three to seven years. I'm not about to rely on IRS advice with respect to this issue. In all fairness, the IRS describes the period for which records MUST be retained, whereas I'm addressing the question of whether it is prudent to dispose of tax records for longer periods. And in all fairness, the IRS advises retaining records with respect to property until three to seven years after the taxpayer disposes of the property.

Considering how much time it would take to sort through each year's tax file, it's faster, safer, and cheaper simply to retain the file. If space is an issue, digitize it. In the long run, it makes the most sense.

Should the Tax Law Provide a Fix for This Looming Catastrophe?

Usually I'm dissecting or criticizing the tax law, or questioning the actions of legislators and other decision makers that affect taxation. Sometimes I turn my attention to legal education, or education generally, sharing insights and experience. Today I turn to another of my selected topics, but one that infrequently takes first billing.

When I turned to the business section of Saturday's Philadelphia, it wasn't the headline, Hershey's 'mockolate' move that alarmed me. I had never seen the word mockolate and wasn't certain what it meant. Did it mean jeering those who are tardy? No, it doesn't.

It was the next sentence that startled me: "Would chocolate containing trans fats and sugar substitutes taste as sweet as the real thing?" No sooner was I taken aback by the question than my brain began circulating wake-up signals when my eyes scanned the next sentence: "Hershey Co. and other candy-makers say yes." In an instant I had figured out what mockolate was, and identified a looming disaster for those who appreciate the medicinal and recreational characteristics of chocolate.

Here's the story in a paragraph: The Chocolate Manufacturers Association, membership in which belongs, of course, to large chocolate manufacturing enterprises, has asked the Food and Drug Administration to redefine chocolate. The CMA wants cocoa butter and cocoa solids removed from the definition so that substances made with artificial sweeteners, milk substitutes, hydrogenated vegetable fats and trans fats could be marketed as "chocolate." The motivation for the request is an increase in cocoa prices caused by speculation with respect to future weather patterns.

Let's take this apart. Let's enumerate the glitches in the reasoning.

First, the CMA wants to redefine chocolate so that people can pretend something that is not chocolate is chocolate. Shades of post-modern deconstructionism. "Here, have some broccoli, but pretend it is chocolate." Why is the world so enamored of the pretend game? When will it stop? Perhaps I can petition the NBA to redefine "power forward" and you can see where I will take that one. So what that the net needs to be brought down to six feet so that I can slam dunk?

Second, cocoa is what makes chocolate chocolate. Automobiles remained automobiles even when manufacturers began installing halogen headlights and radial tires. But when we run out of gasoline and return to riding horses, will we redefine automobile so that we can call our horses automobiles? If there's no cocoa, it isn't chocolate.

Third, why in the name of all that is intelligent and good would anyone with a dedication to justice and an appreciation of common sense advocate the insertion into chocolate of trans fats? Has someone been trying to out-do the poisoned pet food fiasco? Trans fats are so bad that some cities have banned their use and sale.

Fourth, why has the world's economy been hijacked by gamblers who, bored with slot machines, poker, roulette, and other games of chance, have invaded the stock and commodities markets to gamble on future prices? Last year, they ran up the cost of oil without increasing its value. Now they're running up the cost of cocoa. Don't they have something better to do, something that would actually add to the world's wealth rather than manipulate it? Perhaps filling potholes, inventing solar automobile energizer packs, or developing cures for cancer? Wait, that sounds like work.

Fifth, even if the price of cocoa is increasing - allegedly for a pound of chocolate made with cocoa that costs $2.30 someone can conjure up the trans fat "mixture" for 70 cents per pound - why not simply raise the price? After all, we get what we pay for, and if we want chocolate it ought to be available. If we prefer "trans fat junk" we can opt to purchase that stuff. But don't call it chocolate. Oh, it also might help to reconsider some of the other costs of manufacturing chocolate, such as the multi-million dollar salaries of the CEOs who labor away, sweating the tough task of figuring out how to dupe people into thinking that some sort of trans fat brew is chocolate.

Fortunately, the ploy has been revealed. Cyble May, of CandyBlog is encouraging people to file protests with the FDA. Gary Guittard, owner of Guittard Chocolate Company opposes the trans fat substitution plans of the megagiant chocolate companies and is organizing opposition to the proposed deception. He has set up Don't Mess With Our Chocolate, and has succeeded in persuading the FDA to extend the period during which it will accept comments.

Apparently this trans fat concoction, which surely is no confection, is available. A Julie Anderson, for whom I cannot find a blog but who reportedly writes on the topic of chocolate, claims that there is a "distinct taste difference" between chocolate and the trans fat stuff. She describes it as "waxy or greasy." Kudos to Julie for subjecting herself to this experience in the interest of keeping us informed about the true nature of the trans fat product. Karalee LaRochelle, who owns Cocoalocoa, reminds us that genuine chocolate has flavenols and antioxidants that don't exist in trans fats. Flavenols and antioxidants are what reduces the risk of strokes and heart problems. Here's what I'm thinking: so not only is the peddling of trans fats bad because they're unhealthy, they also remove the healthy components of chocolate. If chocolate has a health value of +50, the trans fact concoction has a health value of -50. Perhaps the CMA would like to make a big donation to our health care plans to cover the costs of the increased health problems caused by the replacement of flavenols and antioxidants with trans fats? Uh, there's a reason that trans fats are cheap. They're garbage.

Isn't it interesting that as the megagiants keep gobbling up smaller businesses, the quality of service and the quality of product heads downhill? Bigger isn't better, and the business schools of this country need to start teaching this to their students and to their graduates. The insane dash for money, at the expense of all values, is poisoning society no less than the rush to increase profits by selling tainted pet (and, supposedly, human) food puts the species at risk of extinction. My cynical side, the one that sees something more than coincidence in much of the bad side of life, wonders if the plan to infect chocolate with trans fats is wholly unrelated to the decision to fill food with contaminants. Remember the sawdust that was used to put "fiber" in bread?

It isn't too difficult to imagine the CMA or chocolate manufacturers not members of the CMA asking the Congress for a tax credit to subsidize the increased costs of cocoa. There are tax credits for all sorts of activities and expenditures, ranging from energy-related products to the rehabilitation of buildings and the adoption of children. Is the tax law going to be the answer to yet another problem? I hope not.

What adds to the disappointment is this: somewhere there are lawyers investing their talent and education in counseling their clients on how to get permission to use the word chocolate to describe trans-fat mixtures that might superficially look like chocolate the way I might superficially look like a late-in-career middle relief pitcher for a major league baseball team. Did it not occur to anyone that the better, more moral approach would be to market a less expensive product called "Fake Chocolate" and let people decide whether they valued their health and their tastebuds more than they valued money?

If Government Employees Don't Pay Taxes, Who Will?

The story broke back in January. A Washington radio station, WTOP, using information obtained under a Freedom of Information Act request, gathered information that demonstrated Federal Workers Owe Billions in Unpaid Taxes. According to anitem on Paul Caron's TaxProf blog, on Wednesday Senate Finance Committee Chairman Max Baucus and the ranking Republican, Charles Grassley, write to the President to complain about this news. My concern isn't why it took them three months to get a letter out. After all, they may not have become aware of the news until recently, and drafting a tactful letter takes time. My concern is why nearly half a million federal employees and retirees owe $3 billion in taxes.

Which agency takes the prize for noncompliant employees? Rolling in at 9.4% is the U.S. Commission on Civil Rights. Perhaps it ought to be renamed the U.S. Commission on Civil Obligations and its employees sent to tax compliance classes. Not far behind is the Government Printing Office. Perhaps they ought to be reading the IRS instruction booklets that they print. The Treasury Department comes in near the bottom, at 1.3%. Yes, that's 1.3% too many, but at least the department responsible for tax law administration is near the top in terms of compliance. Even the Tax Court's noncompliance rate is disturbing because 4.9% is simply too high. In terms of total delinquent taxpayers, the Postal Service leads the way with more than 50,000. According to the WTOP report, 71 employees in the Executive Office of the President are delinquent with respect to more than half a million dollars in taxes for 2005 alone.

The WTOP story asserts that the IRS is unable to continue comparing the compliance rates of federal employees with those of the general public because "this year, the IRS is not able to track the compliance rate for the general public." Huh? Why not?

Let's think this through. A substantial portion of the gross income of federal employees comes from salaries. For the retirees, it's their pensions. Most of the remainder would come from investments. Wages and pensions are subject to withholding, and dividends and interest can be made subject to backup withholding if the payees aren't complying with the tax laws. The federal government is the payor of the wages and pensions, and surely can make certain that sufficient taxes are being withheld. Perhaps the underreporting arises from overstated deductions, but the amount in question makes that less likely.

If the IRS knows that these taxes have not been paid, why isn't it collecting those taxes? The IRS claims that it's no easier to collect taxes from federal employees than from other taxpayers. It ought to be easier, though, to slap liens on these delinquent taxpayers and jack up their withholding. Of course, some federal employees, such as those at the IRS, can lose their jobs for not paying taxes. That outcome doesn't bring the cash into the Treasury.

What sort of example are federal employees setting? Is it surprising that taxpayers will try to find ways to avoid taxes so that they're not "left out" of these do-it-yourself tax reduction arrangements? It ought not be difficult for those responsible for running the government to put in place and administer procedures that prevent tax avoidance on income flowing from the federal government. The question is whether they are willing to do so.

Bar Exams, Law Practice, and Law School Curricula

Not too long ago, Paul Caron alerted us with this question: Why Isn't Tax on Every State's Bar Exam? Paul was bringing our attention to Seth Chandler's Another Call For Bar Reform on the Conglomerate Blog. I'd like to rephrase the question. Why isn't basic tax a required course in every law school?

Seth points out that bar examiners continue to test on the long-time, traditional first-year subjects and, in some states, on a short list of additional subjects. He explains that in most states, bar applicants are not examined on "(1) administrative law; (2) antitrust; (3) civil rights law (1983, ADA, etc.), (4) environmental law (Clean Air, Clear Water, Endangered Species, CERCLA, OSHA, etc.); (5) Health Law (ERISA, HIPAA, COBRA, Medicare, Medicaid); (6) immigration law; (7) intellectual property law (copyright, patents, trademarks); (8) labor law (NLRA); (9) maritime law" and that "Some states require virtually no knowledge of tax or bankruptcy." I'm happy to report that tax is on the Pennsylvania bar exam, which inspires some students who otherwise would not take the course to take it. Somehow these students, who would not take the course if it were not on the bar exam, and the students who avoid the course for a variety of reasons, principally anxiety, dislike of allegedly boring subject matter, and an unwillingness to take on challenging material, think that they can get through forty or more years of professional law practice ignorant of tax. They somehow think that they can find a practice area in which tax is irrelevant.

Seth predicts the expected bar examiner replies:

(A) These are things lawyers will pick up in practice. (B) We can’t require students emerging from law school to know everything. (C) Once we open the Pandora’s Box there’s no non-arbitrary way to select from amongst the massive set of federal statutes. (D) Statutory law changes too frequently to make it a sensible subject of bar examinations designed for lifetime entry into the profession. (E) Imposing more barriers to entry of the legal profession would raise the cost of legal services or somehow reduce already-low diversity in the profession.

He then expertly takes those excuses apart. His list of client matters that would be overwhelmingly difficult for a law graduate to tackle is well worth reading. Not only is it a long list, but it's a list of common problems likely to cross the desk of many attorneys.

Though I'm in agreement with Seth, I want to push the analysis a bit further. At the end of his essay, Seth relates the comments of a former president of the American Association of Law School, who called Seth's suggestion for reform "the worst idea he'd ever heard." That, to me, is a clue. As the academy drifts unrelentingly into the world of legal philosophy and political jurisprudence, law students are signing up for fewer "bread and butter" courses. The number of students taking courses that deal with the subjects Seth proposes be added to bar exams, with a few exceptions, is dropping. Once upon a time, almost every student enrolled in wills and trusts, business organizations, basic tax, and sales, and many students enrolled in family law, bankruptcy, environmental law, and civil rights courses. International law, which is becoming almost as pervasive as tax, is not on the radar of many students. Now, unless a course is a required course, it isn't uncommon to find that 20, 30, 40 or even 50 percent of the graduates have not enrolled in one or more of the core courses. Aside from evidence, which still pulls in almost as many students as traditionally enrolled, and constitutional law, which is required in most law schools, students are investing their credits elsewhere.

Why?

Many students are very focused on grade point average and class rank, because those matter so much, unfortunately, in their employment search. Students seek positions that will provide the means to pay off huge debt loads. As more than several students have told me, "I can't risk my GPA for a course that presents a high risk of a bad grade." Understand that nowadays a bad grade is anything lower than a B+. At the same time, law school curricula have grown by leaps and bounds, giving students so many choices that "fitting in" the core courses is more difficult. Some of the curriculum growth reflects changes in the legal system, and thus we see courses in international law, immigration law, health law, and technology law. But much of the growth reflects courses that are intellectually interesting and fascinating, though how they connect to what graduates will be doing in practice isn't all that easy to detect.

Very bright students can enroll in just about anything, and adapt well to practice because they are very bright. In some ways, law schools cannot do wrong by their best and brightest. But 90 percent of the students aren't in the top 10 percent, and they need the experience of doing the sort of analysis, interpretation, thinking, and writing that law practice will demand of them. They get some of it, but they don't get enough.

Here's what I think will happen. Over time, employers will become increasingly frustrated by what law graduates are unable to do. Pressed by the business exigencies of law practice, with the bottom line taking center stage, employers will have even less time to train and mentor new associates. Their complaints will find their way to the bar examination committees. Pressure from practitioners to reform the bar examination and adapt it so that it more accurately measures readiness to practice will increase. As the nature and scope of bar examinations begin to resonate with the 21st century, law students will find their way back into the courses that cover the topics of 21st century law practice. One course selection factor that holds its own against grade point average and class rank goals is the status of a course as "on the bar exam."

The change, though, might not be a simple matter of adding more subjects to the bar examination. It may include adaptation of the bar examination questions that are doctrinal in nature to problems that are transactional in nature. If the sorts of situations Seth describes in his essay were transformed into bar examination assignments, bar applicants would need to bring an array of courses dealing with those transactions. Law students looking at sample bar examination questions will be galvanized into restructuring their course selections. Bar review enterprises will have a lot of retooling to do, because these sorts of questions test something more than rule memorization and the application of the dreaded IRAC (issue, rule, application, conclusion) that has so little relevance to law practice.

This process of change, though, will take time. It will generate all sorts of debate. It should trigger scrutiny of bar examination topics and law school curricula by law practitioners. The extent to which the chasm between the academy and law practice deepens and widens, or closes, is tough to predict. I'll try. I think, at first, it will indeed deepen and widen, but once the dangers are appreciated, a new wave of cooperation will bring law schools and practice into a closer alignment. There probably will be positive correlation with the continuing decline in the utility of traditional legal scholarship, as fewer judges turn to law reviews, and with what I predict to be a new measurement of law school rankings that reflects the success of graduates in law practice. That, after all, the essence of law school education. We are in for an interesting and lively journey.

Where Do Bad Lawyers Come From?

Somewhere, I suppose, it is written that lawyers should be bold. But where is it written that they should do foolish things, be dishonest and ignorant, and break the law? There is a fine but distinct line between bold and imprudent.

Of course, some lawyers do foolish things. Some are dishonest. Some are ignorant. Some break the law. They're the ones that make it so easy for people to criticize lawyers. When those to whom the law has been entrusted disregard it, the glue that holds society together comes undone. When bar applicants behave in dishonest, foolish, ignorant, and illegal ways, it's quite likely that, if admitted to practice, they will become one of those attorneys who gives the profession a bad reputation.

What triggers my present exclamation of offense and astonishment is a story well described by its headline:
EarthLink Subpoenaed for Customer Records When Anonymous Web Posting Reveals Bar Questions. It seems that someone who took the multistate bar examination posted 41 questions on the Internet. The examination contains specific instructions prohibiting examinees from disclosing the questions. The National Conference of Bar Examiners (NCBE), which prepares the multistate bar examination, owns a copyright in the questions. Posting the questions on the internet is foolish and dishonest. Doing so is an act of ignorance, not only about the restrictions but also about the consequences. Simple common sense tells a would-be lawyer that exam questions ought not be disclosed. The copyright law protects the owner of the copywritten material. Violating the copyright illegal; even if it does not violate the criminal law, it breaks the civil law.

The hunt is on to identify the person who posted the questions. Whether the internet service provider has the records is unclear. If it does, it's likely that it will disgorge that information, if not voluntarily, then under court order. The NCBE coyly refuses to disclose if it will seek civil damages if it identifies the poster. The contract into which bar applicants enter provides that unauthorized disclosure can trigger not only civil damages, but criminal charges, revocation of the test scores, rejection from bar admission, and disciplinary action if the matter arises after the person has been admitted to the bar.

The blog on which the questions were posted was taken down shortly after the NCBE contacted the Texas Board of Law Examiners. The blog in question was created by a Texas attorney. How the NCBE tracked the questions to the blog is an illustration of careful investigative techniques, is described in the story, and is well worth reading. The story also explains why the NCBE does not want questions disclosed, and why re-use is essential to maintaining the year-to-year steadiness of the exam.

I do hope that the person is identified. And I fervently wish that the person is excluded from practicing law. Yet I wonder what profession or trade would welcome someone who has demonstrated an inability to follow directions, adhere to contractually binding promises, maintain confidentiality, and comply with law. With any luck, not one with which any of us needs to do business.

How Good is Ninety Percent for Tax?

A parent is teaching a child to drive. Suppose the parent tells the child to try stopping 90 percent of the times the child encounters a red light or stop sign. Is that acceptable?

A restaurant is serving meals. Suppose it sets as a goal making certain that 90 percent of the meals do not contain food poisoning. Is that acceptable?

An airline is scheduling flights. Suppose it sets as a goal making certain 90 percent of its airplanes do not crash. Is that acceptable?

A telephone company is setting up cellular service. Suppose it tells its engineers to set as a goal having service available 90 percent of the time. Is that acceptable?

A Congressional committee is considering the problems of the tax gap. Suppose the Committee's chair sets as a goal 90 percent compliance. Is that acceptable?

Senator Max Baucus, Chair of the Senate Finance Committee, in his Hearing Statement Regarding the Administration’s Plan for Reducing the Tax Gap, announced:

I am setting a goal of 90 percent voluntary compliance by the year 2017. That is six percentage points higher than today’s rate. This is a realistic goal. It is achievable, within 10 years. When it is reached, collections of taxes legally owed will increase by at least $150 billion each year. It is up to the Treasury Department to develop and present to this Committee a plan that will achieve this 90 percent compliance goal. I invite the Secretary to appear before this Committee in 90 days - on July 18, 2007 - to deliver his plan, complete with benchmarks and timetables.

Why 90 percent? Why not 99.99 percent?

Goals are aspirations. There's no reason that a goal should not be set as high as it ought to be set, with an understanding that falling short of the goal can happen. I understand that it is common to set goals short of where they should be so that performance can be tagged as having "exceeded the goal," but setting a goal too low brings expectations down from a level of excellence to a level of mediocrity that ought not be accepted.

Sometimes a new driver will fail to spot a stop sign. Hopefully, there is no accident. Food poisoning happens. Airplanes crash. Cellular phone service goes down. Yet failure, even almost certain failure, ought not deter drivers from having a goal of stopping at every stop sign, restaurants of keeping food poisoning out of all their meals, airlines from keeping all the planes flying, and cellular phone companies from providing 24/7 service.

Almost of the tax gap is caused by mistakes and deliberate noncompliance. Even with the tax education, tax law simplification, and enforcement enhancements I suggested in my Letter to Senators Baucus and Grassley on the question, taxpayers will make mistakes, and fall short of full compliance, but they won't be making mistakes 10 percent of the time. The goal should be 100 percent compliance, and if the outcome is 98 percent compliance, it can be tolerated. Aim for 90 percent, and it is likely the outcome will barely reach into the 80-percent range.

Professional and amateur sports teams set out to win every game. Few succeed, yet aiming to win some or most of the games is more likely to generate an even worse performance. Students in my courses aim to score 100 percent, yet they know they can earn an A with less than a perfect performance. If they aimed simply to reach 80 or 90 percent, they'd end up with even lower scores and lower grades.

Setting a goal of 90 percent is equivalent to admitting defeat with respect to 10 percent of the taxes that should be collected. Go for it, Senator Baucus. Set the goal at 100 percent, sending a message to all taxpayers that each and every one of us is expected to comply fully with the tax law. Then make that goal attainable by putting in place the education, simplification, and enforcement initiatives I outlined in my letter. The nation deserves and needs no less.

Mapping the Tax Code

Everyone knows I'm fond of tax charts, and if there's any doubt, check my most recent review of Andrew Mitchel's contributions. Other forms of graphical representation of tax also appeal to me, if they're well done.

Paul Caron, of the TaxProf blog, has brought to my attention the Tax Map, created by Chaim Kirby, a law student who has a programming and computer expertise background. What he has created is proof that tax law is, in its own strange way, a thing of art. To quite him:

The Tax Map is a graph of the United States Tax Code, represented as a network. In the network each node represents a section of the tax code, while each edge represents a reference from one section to another. * * * As anyone who has ever attempted to do their taxes will tell you, the tax code is a mass of rules and exceptions that seem to require an advanced degree in n-space topology to digest. I wondered how that complexity would bear out if one were to look at the mere structure of the tax code, stripped naked of its rules and semantics. Thus was born The Tax Map.

Mr. Kirby proceeds to describe the attributes of fractal geometry, chaos, and white noise. He concludes that there is no "discernable pattern" and that the map reminds him of "spider webs woven by spiders on drugs." Yes, they do experiments like that in chemistry departments, which may be why law studies often find themselves tagged as boring. Drugs and tax law make for a bad combination. Go take a look. If you find it sufficiently mesmerizing, you can get a poster. Now THAT would be a conversation piece.

Several years ago Shari H. Motro and Deborah Schenk put together another sort of tax map, called, yes, The Income Tax Map. It's more in the nature of a flowchart. It is very useful in putting tax analysis into the appropriate sequence and seeing how the pieces fit in an applied rather than conceptual framework. It, too, is something I recommend, though my advice to law students is that they should design their own because they will learn much more by designing their own than by looking at the result of someone else's efforts. The latter undertaking makes sense when it's time to evaluate one's own tax mapping efforts.

The "Check the Box" Regulations: Chapter Three

Almost two years ago, in Check-the-Box Regulations: Simplification Isn't Simple, I reported on the Littriello case, in which the District Court held that the "check the box" regulations were valid. In that analysis, I explained how two lines of thought had developed, one taking the position that the IRS lacked authority to issue regulations that arguably overruled the Supreme Court, and another taking the opposite position. Three months later, I updated my commentary, in A Return to the "Check the Box" Regulations, explaining that the court agreed to reconsider the case after the taxpayer brought to its attention a recent law review article supporting the position that the regulations were invalid. The court concluded that the regulations did not overrule the Supreme Court, and that they were valid.

I predicted, "as I pointed out in my initial posting on Littriello, the possibility of appeal cannot be discounted, and this most recent development does not appear to remove or even significantly reduce the possibility, whatever it may be, of an appeal." For once, I was correct. The case was appealed.

Near the end of my second commentary, I advised, "Stay tuned, though I doubt there will be any surprising developments even if an appeal is taken." I'm on a roll, because the Sixth Circuit has affirmed the district court. Thanks to Paul Caron of TaxProf blog for bringing the appellate decision to my attention.

The appellate opinion is worth reading. Not only does it contain a concise history of the entity classification regulations, it takes apart the taxpayer's arguments. It rejects Littriello's attempt to bring his case within subsequently proposed regulations that would prevent a person in Littriello's position from having the liability Littriello has. I wonder if those regulations have not been made final because the IRS is waiting for the Littriello case to end, but that makes me wonder why the IRS even would issue the proposed regulations until Littriello exhausted his judicial remedies. And I wonder why the IRS doesn't cut Littriello a break, bringing him within the proposed relief. Perhaps the IRS has tendered some sort of settlement offer, short of concession; total concession isn't very uncommon because the IRS habitually tries to get "something" out of a case that has proceeded to this point. Why Littriello would refuse settlement and hold out for an extremely improbable appellate reversal, if in fact a settlement was offered, is something I don't understand. Perhaps eventually we'll learn more of the negotiating postures of the parties.

Will Littriello request review by the Supreme Court? I'll go out on a limb and respond, "Perhaps." Will the Supreme Court take the case if Littriello does seek its review? No.

Tax Compliant Attorneys Stand Up to Unjustified Indictment

In my last two posts, Some Aspects of Tax Law Aren't Complicated and Noncompliant Tax Attorneys Are Dangerous to the Tax System, I lamented the impact on the tax and legal systems, and on society generally, of tax noncompliance by attorneys, particularly tax attorneys. Now comes news of a case of two attorneys wrongfully charged with failure to report income, who have received payment from the Justice Department in settlement of their Federal Tort Claims Act litigation. The good news is that these two attorneys complied with the tax law. The bad news is that other attorneys erroneously took one of them to trial.

The long story is told in Texas Lawyers Fought the IRS and Won. It deserves a full reading, and my summary surely is inadequate to convey the full flavor of the fiasco. Alan Brown, a highly visible criminal defense attorney, and his wife Jean, a family lawyer practicing alone, were indicted for filing false income tax returns. The story begins when a person who had been employed by Alan Brown to do his firm's bookkeeping told an IRS agent that the firm was under-reporting taxable income because the amount in the cash receipts book exceeded what had been reported. Based on that information, the IRS agent obtained a search warrant for the Brown residence and Alan Brown's law office. The IRS picked through trash and talked with every business in the town. The IRS seized client files, which had a serious adverse impact on the attorneys' practices.

When Alan Brown went to trial, he was acquitted by the jury. The government then dropped charges against Jean Brown. What happened?

It turns out that the former employee turned informant had little credibility. Her boyfriend was in federal prison, and the employee laundered money through Alan Brown's law office. She approached the IRS thinking that she would get her boyfriend's 18-year sentence reduced.

When the IRS agent applied for the search warrant, he did not disclose any of this information. The IRS agent also knew or should have known, according to the trial judge in Alan Brown's case, that the cash that was not included in gross income was not gross income. Even though the agent knew or should have known this, he said nothing to the magistrate who issued the search warrant. Nonetheless, prosecutors took the case to the grand jury, obtained indictments, and proceeded with Alan Brown's trial.

After the acquittal and dismissal, the Browns sued for the estimated $1.5 million of profits lost on account of the indictment and trial. They settled for $1.34 million. After paying legal expenses of more than $1 million, the Browns will have nothing left, and haven't recouped their lost profits.

In their complaint, the Browns claimed that IRS agents had authorized a warrantless search of their property, that probable cause did not exist, that law enforcement officers used false or misleading evidence to obtain the search warrant and indictment, and that the prosecution was malicious. Except for one attorney, no one representing the prosecutors or the IRS will talk. That attorney described the settlement as a device to end the litigation and not a conclusion with respect to what IRS agents and federal prosecutors did or did not do. The attorneys representing the Browns suggest that he was targeted because he had defended news-making clients such as a former member of Congress, a professional boxer, and a country music star.

What must be understood is that the settlement paid to the Browns is funded with tax dollars paid by the taxpayers of this nation. The IRS agents and federal prosecutors responsible for the mess aren't paying a dime. Perhaps they have been dismissed from their jobs, perhaps not. We don't know.

What we do know is that there are some basic principles of tax law that every federal prosecutor pursuing a tax case ought to know. In this instance, even if the employee turned informant had been ignorant rather than devious, someone should have and could have done some forensic tax analysis and figured out that there was no unreported gross income. Perhaps they knew, and the allegation that they pursued Brown maliciously is true. Perhaps they weren't malicious but simply tax ignorant. Either way, it reflects poorly on the IRS agents and federal prosecutors involved in the case.

I cannot imagine the IRS agents involved in the case did not understand the basic tax law principle applicable to the situation. I can imagine that the federal prosecutors skipped tax when they were in law school, or perhaps enrolled in the course and forgot everything after they took the exam, because it is not uncommon for law students to use the "I don't need to know tax" excuse when they try to justify their detour around what many say is one of the most challenging courses in the curriculum, either by ignoring the course or looking for an easy version of it.

What I want to know is when will the taxpayers of this nation be reimbursed for the $1.34 million that they have paid on account of someone else's errors? Whether those errors arose from malicious intent or from ignorance doesn't matter. What matters is understanding the need for a renewed commitment that links competence and integrity with responsibility and power.

Noncompliant Tax Attorneys Are Dangerous to the Tax System

No sooner had I commented on the indictment of an attorney for failure to file federal income tax returns, in Some Aspects of Tax Law Aren't Complicated that Paul Caron alerted us to another lawyer’s conviction for failure to file, in A Tough Day in Tax Court: Lawyer Loses Two Failure to File Tax Return Cases -- His Client's and His Own.

In Harp v. Commissioner, T.C. Memo. 2007-83, the Tax Court considered a motion for summary judgement by the IRS. Harp, the taxpayer, is an attorney, admitted not only in Louisiana but also to practice before the Tax Court. He failed to file federal income tax returns for the years in issue,1995 through 2000. During the IRS examination, the taxpayer filed returns showing all zeroes, and attached to the returns documents entitled "Asseveration of Claimed Gross Income" and "Statement and Asseveration of Exclusion of Remuneration from Gross Income." The returns and attachments contained arguments typically raised by tax protesters. The IRS reconstructed the taxpayer’s returns using the bank depositsmethod, and issued a notice of deficiency asserting not only tax liabilities but also additions to tax and penalties. The taxpayer did not file a petition with the Tax Court. The IRS proceeded to assess the tax, the additions to tax, and the penalties, and issued a notice of balance and demand for payment, followed by a final notice of intent to levy. The taxpayer then filed two requests for a collection due process hearing, claiming violation of his right to confront and cross-examine witnesses. The IRS appeals officer assigned to the case wrote to the taxpayer and explained that his arguments have been rejected by the courts as frivolous or groundless. At the hearing, the taxpayer made the same protest arguments raised earlier, but did not provide any financial information or collection alternatives. The IRS then issued a notice of determination concerning collection action(s) sustaining the proposed collection. In response, the taxpayer filed a petition with the Tax Court, arguing that the appeals officer "cherry picked" documentation and that the assessments violated his due process rights.

The Tax Court followed precedent and concluded that when no petition is filed in response to a notice of deficiency the validity of the tax is not at issue and the Court will review the notice of determination for abuse of discretion. The Court refused to consider the taxpayer’s challenges to the notice of deficiency for this reason, and concluded that as typical protestor arguments they were frivolous and groundless. It dismissed the taxpayer’s objections to the appeals officer’s actions as "without merit." The Court imposed a $5,000 penalty on the taxpayer because he filed the petition in response to the collection determination primarily for delay and because his position was frivolous or groundless. The Court took into consideration the fact that the taxpayer is an attorney, and is admitted to practice before the Court.

The Court noted that the taxpayer had represented other taxpayers in Olmos v. Commissioner, T.C. Memo. 2007-82, and in Heers v. Commissioner, T.C. Memo. 2007-10. In Olmos, the taxpayer failed to file a tax return for 2001. In representing Olmos, Harp offered no evidence in support of the taxpayer but simply objected to all but one of the IRS exhibits. The Court overruled the objections, upheld the IRS determination of tax liability except for a $72 interest income item, and imposed the additions to tax proposed by the IRS. In Heers, the taxpayer failed to file a tax return for 2000. In representing Heers, Harp offered no evidence in support of the taxpayer but objected to three of the IRS exhibits. The Court overruled the objections, upheld the IRS determination of tax liability, and imposed the additions to tax proposed by the IRS.

The Court’s decision in Heers was delivered in January, and its decisions in Olmos and Harp were delivered on the same day, April 9. In baseball, three strikes and the batter is out. It would not be surprising to learn that the Tax Court has initiated proceedings to bar Mr. Harp from practicing before it, or to learn that Louisiana does the same.

In Some Aspects of Tax Law Aren't Complicated, I wrote, “So it is particularly embarrassing when someone not filing a required tax return is an attorney.” Today I must write, "Something is very seriously wrong when tax attorneys fail to file tax returns. It is more than embarrassing. It is dangerous."

Some Aspects of Tax Law Aren't Complicated

If the students in the basic tax course that I teach learn only one thing, it should be that they are under obligation to file federal income tax returns. Even if they don't learn how to prepare their own tax returns, an outcome quite understandable considering how complicated federal income tax law has become, they should learn to find a competent tax professional to prepare the returns for them.

The students in the course also learn that failure to file income tax returns is high on the list of reasons for which attorneys are disbarred or otherwise subjected to discipline. In many instances, the failure to file is also a symptom of other difficulties, and in other instances it stands alone.

Despite the not uncommon occurrence of lawyer being indicted for failure to file tax returns, each time such a situation comes to my attention the bewilderment reawakens. Why? By now every attorney should be aware of the filing requirement, should be aware of what happens to those who don't comply, and should take steps to ensure he or she doesn't go down the same unwise path. I confess that the first thing I do is to determine if the lawyer in question is a former student. Were that to happen, the bewilderment would be infused with frustration and disappointment.

News of the most recent information (equivalent to an indictment) reached my ears from a friend. Shortly thereafter I located the text of the information. The information is short. The defendants are accused of receiving gross income and not filing required tax returns.

Perhaps at trial the defendants will prove that they had no gross income, or that they filed returns which were misplaced by the IRS. I doubt it.

Attorneys, despite all the jokes, are entrusted with the care of the nation's law and legal system. Without those laws and without the legal system, anarchy and ruin would prevail. So it is particularly embarrassing when someone not filing a required tax return is an attorney.

Rightly or wrongly, law schools take pride in teaching law. Can law schools teach values? Should law schools be doing the work that should be underway long before their students arrive? Should law schools and bar examiners become more involved in screening bar applicants? Are those institutions capable of identifying those who will take a wrong turn? I don't know. I doubt it's that simple. It surely isn't as simple as understanding the basic precept that lawyers are obligated to file federal income tax returns.

What's the Harm in Giving Someone a Chance?

A few months ago, in Just A Chance, That's All, I commented on the attempt by Mel Thompson to sit for the Connecticut bar examination and the litigation he commenced when he was denied the opportunity. I noted that Mr. Thompson "took the route he took, not because he did not qualify for admission to an accredited law school, but because he faced financial obstacles" and asked, "Should his past financial struggles relegate him to a lifetime of being an over-educated paralegal?"

Recently I received an email from Mr. Thompson. He reports the his case was dismissed, on ripeness grounds. It was, and some of the claims were dismissed on account of standing and abstention. Mr. Thompson intends, as I understand it, to make a formal application for review of his unaccredited legal education, receive the expected rejection, and then renew his lawsuit. The irony, according to Mr. Thompson, is that the rejection will occur because the Connecticut Bar Examining Committee will not approve unaccredited education. He explained the financial obstacles that drove him to a less expensive, though unaccredited, law school. According to Mr. Thompson, some of his financial difficulties arose from an insurance company's refusal to pay to his mother the proceeds from an insurance policy on his mother's mother. His explanation includes an assertion that the first lawyer retained by his mother missed deadlines, thus preventing the next lawyer from pursuing Connecticut Unfair Trade Practices Act remedies against the insurance company. The case settled, but by the time the lawyers were paid and the expenses of the grandmother's estate were paid, not much remained. So Mr. Thompson undertook support of his mother in addition to his wife and child. And became even more motivated to enter the profession. He wouldn't be the first person to decide on a law career after having had a good or bad first-hand experience with lawyers.

I note, though, that when I go to the webpage of the Connecticut Bar Examining Committee cited by the court as stating "correspondence and internet law school work will NOT be approved," that language no longer is on the page. The court cites the page as having last been visited on March 29, so at some point during the last week the language in question has been removed. Nothing on the page or in the source code provides a revision date, but I'm guessing that the language was removed because it may have provided difficulties for the Bar Examining Committee on appeal. Of course, if the language was there when Mr. Thompson undertook to receive approval to sit for the bar examination, it ought not matter on appeal that the language was removed after the fact. A careful reading of the opinion provides a basis for speculating why the language was removed from the website.

Even though it is fun to engage in an intellectual slugfest, this situation is one in which it makes more sense to settle the matter in a practical way. Let Mr. Thompson sit for the bar examination. If he fails, then at least he knows he had the chance and didn't measure up. If he passes, then he knows his education, his study habits, and his experience made it possible for him to demonstrate an ability to practice law in Connecticut not demonstrated by the roughly 25 percent of Connecticut bar examinees who attended accredited or approved law schools and yet don't pass the examination. What's the harm in taking that approach? It's not as though Mr. Thompson is an applicant who has had no legal education, with respect to whom at least an argument can be made that the existing rules save the person from wasting their time and money in a futile effort. For Mr. Thompson, the attempt to pass the bar is not a futile effort. True, he's not a shoe-in but few are, but he's also not predestined to fail.

I expect we will hear more as this story develops. Stay tuned.

Tax and Music Reprise: And Sometimes the Combination Is Promising

It's time for a followup to yesterday's post on Tax and Music: Sometimes the Combination is Frightful. A reader sent along a link to the SIRIUS Beats the Tax-Time Blues Contest. Entrants write the lyrics, and those penned by the winner will be sung by blues artist Shemekia Copeland. I don't think she raps. I'm tempted to put my literary skills to the test. Or perhaps I'll wait until it's time to write the lyrics for the Teaching Taxation Tango contest.

Yes, it's getting scary. Be afraid. Be very afraid.

Tax and Music: Sometimes the Combination is Frightful

I am interested in tax. I am interested in music. So why am I bewildered by the appeal of the TurboTax Tax Rap Contest?

Perhaps it's because the entries I've seen are so bad? As of this moment there are 370 entries. It's possible to watch all of them by going to YouTube and using the arrow buttons to move from one page of entries to another. There doesn't appear to be a full list of entries. Instead, each time a person clicks on the link, an entry pops up at random.

I cannot imagine being a judge for this sort of contest. Vanilla Ice gets to pick the winner. He deserves to be the judge. He gets to listen to 370 entries. Hopefully they make him listen to all 370 in one sitting.

Am I going to enter the contest? No. I'll wait for the Gregorian Tax Chant contest. There are some melodies from the Requiem that would be fitting.

Watch Those Tax (and Other) Deadlines

Once again, someone's failure to apply scheduling skills has put a taxpayer at a disadvantage. Ronald S. Raczkowski has lost his opportunity to make his case in Tax Court because his petition was not timely filed. In Raczkowski v. Comr., the Tax Court has held that a petition sent by UPS Ground and recorded electronically to the UPS database on the day after petition filing deadline was not timely filed, compelling dismissal of the case. If the dispute is to be adjudicated, Raczkowski must pay the taxes proposed in the deficiency notice and sue for a refund in district court. The advantage of proceeding in the Tax Court, which permits the taxpayer to make a case without advancing the amount in dispute, has been lost.

The rule is simple. Petitions must be filed by the 90th day after the IRS issues the notice of deficiency. A petition that is timely mailed is considered timely filed. So the petition need not be at the Tax Court by the 90th day if it has been mailed by the 90th day. Petitions sent through a private delivery service are treated as timely filed if they are put in the hands of the private delivery service by the 90th day. The IRS has designated delivery company services that qualify as private delivery services, but UPS Ground is not on the list.

This is not the first such case. It isn't the tenth, or the hundredth, or even the thousandth. For year, the Tax Court has been awash in cases involving the timeliness of petition filing. There is no reason that timeliness ought to be an issue. Here's what baffles me. The 90-day deadline is not a surprise pulled on the taxpayer on day 88. When the notice of deficiency is received, it clearly explains that the petition must be filed by the 90th day (or the 150th if the taxpayer is outside the country). So why not simply calendar the petition for day 80? The petition is a fairly straight-forward document, using boilerplate language for the standard provisions that recite the procedural facts, and that sets forth the explanations for the taxpayer's position. Filing the petition does not require discovery, lining up witnesses, or drafting a pre-trial stipulation.

I suppose the last-minute crisis mentality afflicting so many petition filings is nothing more than a reflection of human nature or modern culture. Raczkowski was a pro se taxpayer, but attorneys have not been absent from the long list of case managers who failed to meet the deadline. The inability to plan ahead and to allow a cushion for the unanticipated snag begins at an early age. Leaving things go to the last minute is nothing but a recipe for trouble. Some law students seem to think that it is more important to learn how to argue for a deadline extension than it is to learn how to meet deadlines. Some law faculty think that rewarding a good excuse is more beneficial than teaching the lesson of consequences for tardiness.

Life teaches all of us that unplanned distractions occur when they are least expected. Some people take a lifetime to learn the lesson. Others figure out early in life that it's best to plan ahead and to allow for uncontrollable delays and interruptions. Why wait until the night before the exam to cram? The exam isn't a pop quiz. Why wait until the 90th day to begin the process of shipping a petition to the Tax Court? Every time someone misses a deadline and is let off the hook, that person learns to disrespect deadlines just a little bit more.

One of the most common reasons for attorney incompetence is letting a statute of limitations expire without taking the appropriate procedural action. Sometimes the consequences are tragic. The Tax Court has no choice but to dismiss the petition, because it has no discretion to change the rules. The same constraints limit the ability of courts to ignore noncompliance with a statute of limitations. It seems that in recent years law faculty and law school administrators are becoming less generous in brushing aside missed deadlines. Someday we may be fortunate, and discover that all incoming law students, and thus future lawyers, arrive with a deep dedication to being on time. That would tell us, of course, that their K-12 and undergraduate classmates also experienced the sort of education that instilled in them the need to be no less careful with deadlines as with walking one's child across the street. Considering the huge economic disadvantages that deadline noncompliance generates, life would be much better for everyone if last-minute craziness abated, taking with it the speeding commuter late for work, the surgeon who closes up in a rush, and the Congress that doesn't get fiscal year budgets approved in time. And I think my librarian friends would be thrilled if they no longer were confronted with overdue books and the need to impose fines.

Thanks to Paul Caron and his TaxProf blog for the link to the case.