Saying Goodbye to Law School Grading Curves?

Sometimes studies tell us what some people already know. A good example is the collection of results from a study conducted by Kathryne M. Young, an Assistant Professor in the Department of Sociology at the University of Massachusetts, Amherst, and an Access to Justice Faculty Scholar at the American Bar Foundation. She published the results, along with her methodology and examples of the interviews underlying the study, in Understanding the Social and Cognitive Processes in Law School That Create Unhealthy Lawyers, 89 Fordham L. Rev. 2575 (2021). The study was undertaken to understand the effect that law school education practices contribute to the higher-than-average rates of depression, anxiety, substance abuse, and other mental health problems that afflict lawyers. The study concluded that several aspects of how law is taught contribute to the problem. Two of those aspects pose challenges that I addressed early in my law teaching career.

One contributing factor to law student anxiety and discontent is the use of a curve for grading. I have never used a curve, even though a variety of complex academic rules mandating curves but allowing for exceptions were in place. Whenever challenged, I managed to explain why what I was doing did not technically violate the curve rules. How do I grade? I grade against a standard. I learned that from several sources, including several of the law school faculty who taught me, and from teachers both in the family and among friends. Grades are designed to send a message to whomever needs to know about the student, that is, the extent to which a student understands and perhaps even masters the material. There are benchmarks and I share those with students. For example, if a student can earn at least 20 percent of the points that I would earn on the graded exercises and examination in a course, then the student has at least learned something and deserves to pass, albeit with a very low grade. In contrast, a student who can earn roughly 80 percent of the points I would earn has earned an A. I use the word “roughly” because I also try not to put a letter grade cut where there is no gap in the raw scores.

Proponents of the curve argue that students need to be ranked in some way that limits the number of students earning the high letter grades. Why? It is difficult to find plausible arguments in favor of grading curves, and many arguments against using them. At least with respect to law school, the notion that it is necessary to identify the “top ten percent” supports the use of a curve, because a curve that limits the “A” grade to the top ten percent will generate a “top ten percent” for all students taking into account all grades. One historical reason for this approach was the invitation to Law Review membership, a prestigious position, that was limited to the “top ten percent.” But during the last several decades, the admission of students to Law Review membership based on “open writing” competitions has demonstrated that being in the “top ten percent” does not necessarily mean that someone has what is needed to write and edit well, and that not making the “top ten percent” does not necessarily mean that the student lacks those skills. Another reason for this “top ten percent” approach is to assist big law firms, who traditionally would limit interviews to those in the “top ten percent,” though in recent years that tradition also has eroded. Of course, without a grading curve, it is theoretically possible that all students would end up with grade point averages that are, for all intents and purposes, the same. So what? Well, the “so what” is that the grading needs to be based on an articulated standard. And that doesn’t always happen. The “throw the exams down the stairs and see where they land” joke is pretty much just that, a joke, but as an undergraduate student I encountered faculty who were unable to explain how they arrived at the grade that they assigned.

Interestingly, most grading curve mandates allow exceptions that reflect to some extent the arguments that can be made against grading curves generally. For example, very few grading curve rules apply to small classes, the definition of which varies from enrollments of 10 to enrollments of 30 or 40. So how can a faculty justify to students that if one or two students add a course during drop-add that the grading system will change from application of a standard or benchmark to a curve?

Though students consider grading curves to be unfair because they think curves lower their grades, and that often happens to some students, there are other problems. The fact that the curve “pushes down ” some students’ letter grades caused many schools to add grades so that a student who missed the A grade would get an A-minus or B-plus rather than a B. This, in turn, has contributed to “grade inflation” because what would have been a B grade becomes a B-plus or A-minus. The almost complete disappearance of the C-minus, D, and F grades is a related, but different, issue. Another problem with the curve is that it can send a false message by assigning the A grade to the top ten percent of the raw scores even if those raw scores are far from excellent. Though most grade curve rules allow for adjustments, it doesn’t always work that way.

Some years ago, a colleague long gone said to me, “It’s easy. The best paper gets an A, the rest don’t.” I asked, “Even if there is another paper just about as good?” The answer was, “Yes.” I asked, “And what if the best paper is mediocre?” The answer was to the effect that someone always wins the gold medal. But education isn’t a competition. Well, it often is but it ought not be. Lawyers are perceived as combative competitors, and surely there are some who exhibit that trait, but lawyers also engage in cooperative endeavors, and the notion that students are competing in a course for “the A” or for “one of the eight A grades in a class of 80” is counterproductive. Professor Young’s article explains why.

Nothing that I am writing is something that I am expressing for the first time. I have written about grading curves in posts such as Once Again, Grades are "Coming Out", Yet More Reasons to Dislike Grading Curves, The Artificiality of Mandatory Grading Curves, and Some Thoughts on Teaching Law: Part XX: The Art or Science of Grading. And even before I blogged about the issue, I shared these thoughts with colleagues and administrators, both in faculty meetings and outside of faculty meetings. There probably are memos written by me somewhere in my school office, but I will refrain from digging them out, for a variety of reasons, not only to avoid needing to redact names but also because the points I made are repeated in the commentaries cited in this pararaph. Of course, faculty who arrived since I retired five years ago were spared, for better or for worse, from listening to or reading my memos about grading, though perhaps one or more of those famous memos might still be circulating. And perhaps some of them read this blog and have seen those earlier commentaries.

It is refreshing to see others call for the elimination of grading curves. Perhaps they will disappear, as law school education evolves. Why do I think this might happen? In the 1980s when I started administering during-semester graded exercises, I encountered much resistance and barely obtained permission to do so. Now, formative assessment in law schools is all the rage. So change is possible, and it happens. Whether curves disappear formally, and not just informally, during what’s left of my time teaching law school – which could end tomorrow or next year or three years from now but it will end, someday – is a question with only a guess as an answer. We’ll see.

Another contributing factor to law student anxiety and discontent is “cold calling.” I’ll write about that in my next post.

When Anti-Regulators Like Regulation

Many people in the anti-tax crowd also belong to the anti-regulation crowd. To most, tax is simply another form of regulation. Regulations and taxes are seen as constraints on the infinite freedom that the anti-regulation crowd uses as rhetoric to defend a self-focused, no-empathy-for-others approach that they carry into adulthood from their adolescent years.

In the economic facet of society and culture, the anti-tax and anti-regulation crowds worship the so-called “free market.” Of course, as I’ve pointed out many times, in posts such as Do Tax Credits Deserve Credit? (“People now understand that the free market isn't free, except to the extent some people thought it meant they were free to abuse, manipulate, distort, and undermine the market.”), and Can Tax Law Save Capitalism from Itself? (“Advocates of minimizing or reducing taxation and government regulation claim that the economy prospers when the marketplace is left alone to fend for itself. Of course, centuries of experience teach that the free market is not free, and that an unregulated market leads to fraud, deception, defective goods, shoddy services, and economic difficulties.”), that there is no such thing as a free market.

Yet when something close to a free market generates an outcome that is disliked by advocates of free markets, they are quick to seek regulation of the market. The latest example of this hypocrisy is the lawsuit filed by the de facto head of the political party that rests its approach on “freedom” and “free markets” while not hesitating to advocate regulation of what it dislikes. Last Wednesday, Donald J. Trump filed lawsuits against Facebook, Google, Twitter, and their chief executive officers, because he is unhappy that those companies suspended his accounts on their platforms. Leaving others to describe why they think the lawsuits were filed in the wrong forum, fail to describe the class he claims to represent, might be frivolous, and do not fit within the legal theories on which they appear to rest, as shared in reports such as this Vox analysis and this Law and Crime explanation, I focus on the absurdity of asking a government instrumentality, specifically, a court, to regulate a private company operating in a free market.

Defenders of this latest publicity stunt argue that Facebook, Google, and Twitter are monopolies and that government intervention is necessary. First, these companies are not monopolies. They are, at best, near monopolies but even that characterization is too broad. Facebook has more than a few competitors, and has been losing members who are shifting their social media lives to other platforms. The same can be said of Twitter, and the existence of Bing, Yahoo, and other search engines belies the claim that the only access to social media is through these three companies. Second, when anyone attempts to curtail the market power of other near monopolies, the beneficiaries of their campaign contributions and political lobbying are quick to jump into the fray by tossing out the “free market” buzz phrase and denouncing any government interference in the actions of companies such as Amazon, Walmart, or Microsoft, to name just three of the many monopolies and near monopolies dominating the economy. The hypocrisy is astounding, and this is far from the only example. The situation is not unlike what happens when lawmakers who rail against loopholes suddenly make a u-turn when it’s one of their supporters’ favorite loopholes that is being led to the chopping block.

Of course, as reported in this story, the lawsuits quickly became a tool for fund raising, and it is a good guess that the monies collected on the pretext that the lawsuits are designed to protect the “rights” of the anti-tax, anti-government, and anti-regulation crowds will help the plaintiff accumulate resources with which to pay his many debts. It’s the same pattern seen in the fund raising ostensibly marketed as necessary to fight phantom election fraud. Already, many in those crowds are rejoicing that these lawsuits have been filed. Unfortunately, millions will fork over funds, even and especially those who are not in the best of economic condition. There is a reason con artists have thrived throughout the entirety of human history. When mixed with hypocrisy, the work of con artists becomes deadly to genuine freedom.

The Self-Proclaimed Tax Know-It-All Gets Stumped

He claimed, in August of 2015, by asking, “Who knows taxes better than me?,” that he was more knowledgeable about taxes than anyone else. In “Who Knows Taxes Better Than Me?”, I replied that his other statements proved he knows very little about taxation that matters.

He also claimed, not long thereafter, by asking, “Who knows the tax code better than me?,” that he understood an unspecified tax code more than anyone else did. In “Who Knows the Tax Code Better Than Me?”, I replied that there are people who understand the tax code, whichever one it might be, more than he does.

At the same time he claimed that he had great people helping him pay as little tax as possible, using “every single thing in the book.” In that same commentary I noted that these “great people” surely understood tax more than he did, and cautioned that paying as little tax as possible isn’t an issue “as long as what he is doing is within the law.”

He also claimed, some time thereafter, that paying no taxes made him smart. In Does Not Paying Federal Income Tax Make a Person Smart?, I pointed out that even if paying zero taxes is a smart thing, it doesn’t necessarily mean that the taxpayer is smart, and using the word “smart” is misplaced if the reason for not paying federal income taxes is tax fraud.

He also claimed, seven months ago, that the claim he paid $750 in 2016 was true because it was a “statutory number”, that is, “a filing fee.” In How Not to Prove You Know Taxes and the Tax Code Better Than Anyone Else, I pointed out that his statement, like some other statements he made, demonstrated that he was nowhere near being a tax expert.

Now, as reported by many sources, including this hillreporter.com story, he offered this tidbit:

They go after good, hard-working people for not paying taxes on a company car. You didn’t pay tax on the car or a company apartment. You used an apartment because you need an apartment because you have to travel too far where your house is. You didn’t pay tax. Or education for your grandchildren. I don’t even know. Do you have to? Does anybody know the answer to that stuff?

Wait! I thought he knew everything about taxes. And he doesn't don’t know the answer to a question that diligent students in a basic income tax course can answer? Perhaps those who adore him might now realize that his boasts of omniscience, whether about taxes, infections, medical cures, what the generals know, and pretty much anything else, as the bunk and hokum that they are. Perhaps they will understand that behind all the ranting claims of greatness is nothing more than a con artist, that his claims about election fraud are as absurd as his claims about his tax knowledge, and that the politicians and operatives who are loyal to him are a menace.

Will the Re-Introduced Legislation Permitting Tax Return Preparer Regulation Be Enacted, and If So, Would It Make a Difference?

When tax return preparers engage in fraud, they cause damage not only to their clients who end up needing to find funds with which to pay the resulting tax deficiencies and to invest time in dealing with the consequences but also to taxpayers generally. The damage, in terms of lost revenue and time waste, is extensive. I have written about tax return preparers who have been charged with, been convicted of, or have pled guilty to various tax fraud crimes, in posts such as Tax Fraud Is Not Sacred, More Tax Return Preparation Gone Bad, Another Tax Return Preparation Enterprise Gone Bad, Are They Turning Up the Heat on Tax Return Preparers?, Surely There Is More to This Tax Fraud Indictment, Need a Tax Return Preparer? Don’t Use a Current IRS Employee, Is This How Tax Return Preparation Fraud Can Proliferate?, When Tax Return Preparers Go Bad, Their Customers Can Pay the Price, Tax Return Preparer Fails to Evade the IRS, Fraudulent Tax Return Preparation for Clients and the Preparer, Prison for Tax Return Preparer Who Does Almost Everything Wrong, Tax Return Preparation Indictment: From 44 To Three, When Fraudulent Tax Return Filing Is Part of A Bigger Fraudulent Scheme, Preparers Preparing Fraudulent Returns Need Prepare Not Only for Fines and Prison But Also Injunctions, Sins of the Tax Return Preparer Father Passed on to the Tax Return Preparer Son, Tax Return Preparer Fraud Extends Beyond Tax Returns, When A Tax Return Preparer’s Bad Behavior Extends Beyond Fraud, More Thoughts About Avoiding Tax Return Preparers Gone Bad, Another Tax Return Preparer Fraudulent Loan Application Indictment, Yet Another Way Tax Return Preparers Can Harm Their Clients (and Employees), When Unscrupulous Tax Return Preparers Make It Easy for the IRS and DOJ to Find Them, Tax Return Preparers Putting Red Flags on Clients’ Returns, When Language Describing the Impact of Tax Fraud Matters, and Injunctions Against Fraudulent Tax Return Preparers Help, But Taxpayers Still Need to Be Vigilant.

Several weeks ago, two members of Congress, one from each side of the aisle, with bipartisan support, reintroduced the Taxpayer Protection and Preparer Proficiency Act. Originally introduced in 2015 and again in 2019, the bill gives the IRS authority to regulate tax return preparers. The IRS had tried to regulate tax return preparers under the regulatory authority of 31 U.S.C. section 330, but in Loving v. I.R.S., the Court of Appeals for the District of Columbia Circuit affirmed the decision of the United States District Court for the District of Columbia that the authority granted by 31 U.S.C. section 330 did not extend to regulation of tax return preparers. The court concluded that tax return preparers are not agents of the taxpayer and do not practice before the IRS by virtue of preparing a return. The legislation has been proposed and reproposed in order to expand section 330 to remove the limitations currently in the statute that were identified by the court.

Though the court’s analysis and conclusion are correct, one wonders why any tax return preparer would object to regulation of an industry undermined by unscrupulous participants. According to this report, strong support for regulation of tax return preparers, and thus for the proposed legislation, has come from organizations such as the American Institute of Certified Public Accountants, the National Association of Enrolled Agents, and the National Association of Tax Professionals. Some people objected to the IRS attempt to regulate tax return preparers because they prefer that “things be done by the book,” and thus support the legislation though objecting to what the IRS attempted. Others, sadly, simply object to what the IRS attempted to do because they object to regulation generally, or object to particular regulation that impedes what they are trying to do.

The proposed legislation requires tax return preparers to demonstrate minimum competency standards. They can do so by obtaining an identifying number, satisfying any examination and annual continuing education requirements required by the IRS, and completing a background check administered by the IRS or Treasury. These requirements are waived for preparers who have been subject to comparable requirements administered by the IRS or comparable state licensing program, as well as individuals supervised by preparers who fit within the waiver. The legislation requires preparers to include their identification number on any return or claim for refund prepared by the preparer. The legislation provides that the IRS can rescind a preparer’s identification number after appropriate notice and opportunity for a hearing, if recission would promote compliance with the tax law and effective tax administration.

The proposed legislation might add a bit of “paperwork” and a small fee for legitimate preparers, but it will not put them out of business. What will the proposed legislation do to the tax return preparers who engage in fraud? In theory it would put them out of business. In theory, taxpayers seeking tax return preparation assistance would ask for proof that the preparer has an identifying number, and would refrain from patronizing those who do not have such a number. In practice, though, the law-breaking preparers will forge ahead, falsely claiming to have, and showing a false, preparer identification number. Some clients will continue to use the services of unscrupulous tax return preparers because the temptation of bigger refunds and the elimination of additional tax due is too strong to resist. But with at least yet another fraud charge arising from the false use or presentation of a preparer identification number raising the adverse consequences of being caught, perhaps some unscrupulous preparers will terminate their businesses, or get the required clearances and give up on the fraud. I doubt it, though, because the fraud is so deeply connected with the marketing promises used to bring in clients. A shift to competition in a market dominated by competence rather than false promises is not a market in which the unscrupulous wish to participate.

So if the legislation is enacted, will it have a beneficial effect? Probably, though surely not one that wipes out all or most of the fraudulent tax preparation industry. Will the legislation be enacted? One might think so, considering it has bipartisan support, but it had bipartisan support in 2015 and in 2019, and failed to advance. Why? Perhaps not enough members of Congress want to stop tax fraud. Perhaps not enough members of Congress understand the seriousness of the problem. Perhaps too many members of Congress are under the sway of lobbyists and contributors who engage in tax fraud and fear any movement to suppress it. Perhaps not enough Americans are putting sufficient pressure on their Congressional representatives to get this legislation enacted.

Injunctions Against Fraudulent Tax Return Preparers Help, But Taxpayers Still Need to Be Vigilant

Tax fraud by tax return preparers happens much too often, and the IRS lists ”unscrupulous tax return preparers” as one of its “Dirty Dozen” tax scams that taxpayers should be careful to avoid. I have written about tax return preparers who have been charged with, been convicted of, or have pled guilty to various tax fraud crimes, in posts such as Tax Fraud Is Not Sacred, More Tax Return Preparation Gone Bad, Another Tax Return Preparation Enterprise Gone Bad, Are They Turning Up the Heat on Tax Return Preparers?, Surely There Is More to This Tax Fraud Indictment, Need a Tax Return Preparer? Don’t Use a Current IRS Employee, Is This How Tax Return Preparation Fraud Can Proliferate?, When Tax Return Preparers Go Bad, Their Customers Can Pay the Price, Tax Return Preparer Fails to Evade the IRS, Fraudulent Tax Return Preparation for Clients and the Preparer, Prison for Tax Return Preparer Who Does Almost Everything Wrong, Tax Return Preparation Indictment: From 44 To Three, When Fraudulent Tax Return Filing Is Part of A Bigger Fraudulent Scheme, Preparers Preparing Fraudulent Returns Need Prepare Not Only for Fines and Prison But Also Injunctions, Sins of the Tax Return Preparer Father Passed on to the Tax Return Preparer Son, Tax Return Preparer Fraud Extends Beyond Tax Returns, When A Tax Return Preparer’s Bad Behavior Extends Beyond Fraud, More Thoughts About Avoiding Tax Return Preparers Gone Bad, Another Tax Return Preparer Fraudulent Loan Application Indictment, Yet Another Way Tax Return Preparers Can Harm Their Clients (and Employees), When Unscrupulous Tax Return Preparers Make It Easy for the IRS and DOJ to Find Them, Tax Return Preparers Putting Red Flags on Clients’ Returns, and When Language Describing the Impact of Tax Fraud Matters.

But is it enough simply to warn taxpayers to be on the alert for suspicious behavior and questionable marketing techniques by tax return preparers? No, it is not. More needs to be done, and has been done. For example, as described in a recent Department of Justice news release, a federal court ordered that a tax return preparer in Illinois, who prepared returns with false information, false deductions, and false credits, who is known by at least two names, and who does business under another name, be permanently enjoined “from preparing returns for others and from owning, operating or franchising any tax return preparation business in the future.” The order permits the federal authorities “to conduct post-judgment discovery to monitor compliance.” It also requires the preparer, both individually and through the business, to notify various individuals, presumably including clients, that the injunction has been entered. The order additionally requires the preparer to advertise the injunction in places where the preparer does business.

The press release noted that during the past ten years, the Department of Justice has “obtained injunctions against hundreds of unscrupulous tax preparers.” The Department tries to help taxpayers avoid having returns prepared by enjoined tax return preparers and tax return preparation businesses by providing an alphabetical listing of these persons and businesses.. Unfortunately, the Department of Justice’s attempts resemble a game of whack-a-mole, as unscrupulous preparers pop up to replace those who are shut down almost as soon as injunctions go into effect. Worse, some enjoined preparers simply open up shop using new names for themselves or their businesses.

It’s nice that the Department of Justice is trying to help taxpayer avoid dangerous tax return preparers, but that is not enough. Taxpayers need to exercise due diligence. In past commentaries I have offered some advice to taxpayers who want to steer clear of fraudulent tax return preparers. In Are They Turning Up the Heat on Tax Return Preparers?, I wrote, “I will simply repeat what I have written several times in the past: ‘The lesson at the moment? Choose a tax return preparer as carefully as choosing a surgeon or child care provider. In other words, do research, talk to friends and neighbors, look at online reviews, and interview the preparer.’” I had shared that advice earlier in More Tax Return Preparation Gone Bad and Another Tax Return Preparation Enterprise Gone Bad. In Need a Tax Return Preparer? Don’t Use a Current IRS Employee, I noted, “[I]t is best to do some background checks and research just as one would do when looking for a physician or roofer.” In When Tax Return Preparers Go Bad, Their Customers Can Pay the Price, I elaborated:

What’s a taxpayer to do? Talk with relatives, friends, and business associates. Ask them to describe their experiences with the tax return preparer that they use. Seek out a tax return preparer who has been preparing the other person’s returns for many years free of problems. Beware of the advice to use a tax return preparer who has been used only once, or even not at all. Look at reviews on various web sites. Google the name of the tax return preparer. If the preparer is a company, ask for the names of its owners and managers, and google those names. If the return that is prepared is “too good to be true,” don’t agree to its being filed, but ask for a copy and take it to another preparer for a second opinion. If it’s good to go, return to the original preparer and approve the filing. If it’s not good to go, file a complaint about the preparer with the IRS, and seek a fee refund from the original preparer.

Because it is unlikely that tax return preparers under indictment and waiting for trial put “under indictment” signs in their windows or “under indictment” tags on their web sites, and because enjoined preparers might not comply with orders to contact clients and put notices at their places of business, it is essential that clients exercise due diligence not only when seeking a new preparer but even when returning to a preparer used in an earlier year.

The Mileage-Based Road Fee Is Superior to This Proposed “Commercial Activity Surcharge”

On at least four dozen times I have written about the need to shift to a mileage-based road fee to fund the repair and maintenance of the nation’s highways, bridges, and tunnels. I have done so in posts such as Tax Meets Technology on the Road, Mileage-Based Road Fees, Again, Mileage-Based Road Fees, Yet Again, Change, Tax, Mileage-Based Road Fees, and Secrecy, Pennsylvania State Gasoline Tax Increase: The Last Hurrah?, Making Progress with Mileage-Based Road Fees, Mileage-Based Road Fees Gain More Traction, Looking More Closely at Mileage-Based Road Fees, The Mileage-Based Road Fee Lives On, Is the Mileage-Based Road Fee So Terrible?, Defending the Mileage-Based Road Fee, Liquid Fuels Tax Increases on the Table, Searching For What Already Has Been Found, Tax Style, Highways Are Not Free, Mileage-Based Road Fees: Privatization and Privacy, Is the Mileage-Based Road Fee a Threat to Privacy?, So Who Should Pay for Roads?, Between Theory and Reality is the (Tax) Test, Mileage-Based Road Fee Inching Ahead, Rebutting Arguments Against Mileage-Based Road Fees, On the Mileage-Based Road Fee Highway: Young at (Tax) Heart?, To Test The Mileage-Based Road Fee, There Needs to Be a Test, What Sort of Tax or Fee Will Hawaii Use to Fix Its Highways?, And Now It’s California Facing the Road Funding Tax Issues, If Users Don’t Pay, Who Should?, Taking Responsibility for Funding Highways, Should Tax Increases Reflect Populist Sentiment?, When It Comes to the Mileage-Based Road Fee, Try It, You’ll Like It, Mileage-Based Road Fees: A Positive Trend?, Understanding the Mileage-Based Road Fee, Tax Opposition: A Costly Road to Follow, Progress on the Mileage-Based Road Fee Front?, Mileage-Based Road Fee Enters Illinois Gubernatorial Campaign, Is a User-Fee-Based System Incompatible With Progressive Income Taxation?. Will Private Ownership of Public Necessities Work?, Revenue Problems With A User Fee Solution Crying for Attention, Plans for Mileage-Based Road Fees Continue to Grow, Getting Technical With the Mileage-Based Road Fee, Once Again, Rebutting Arguments Against Mileage-Based Road Fees, Getting to the Mileage-Based Road Fee in Tiny Steps, Proposal for a Tyre Tax to Replace Fuel Taxes Needs to be Deflated, A Much Bigger Forward-Moving Step for the Mileage-Based Road Fee, Another Example of a Problem That the Mileage-Based Road Fee Can Solve, Some Observations on Recent Articles Addressing the Mileage-Based Road Fee, Mileage-Based Road Fee Meets Interstate Travel, If Not a Gasoline Tax, and Not a Mileage-Based Road Fee, Then What?>, and Try It, You Might Like It (The Mileage-Based Road Fee, That Is).

Throughout this fourteen-year period, opposition to the proposal has been vocal. Some comes from people who agree that using liquid fuel taxes to fund these repairs and maintenance is no longer viable, but they seek to raise the necessary revenue through means that have nothing to do with highways, bridges, and tunnels. Some come from people who fear that the proposed road fee would invade their privacy or pose assorted claimed logistical challenges. Some simply want a “let me use it and make someone else pay” approach.

Recently, in a Politico commentary, former Maryland Secretary of Transportation Pete Rahn proposed generating the funding from a commercial activity surcharge. He is among those who favor abolishing liquid fuel taxes, and though he mentions only the federal gasoline tax, it does not appear he wants to preserve state gasoline and diesel taxes.

But Rahn opposes what he calls the “vehicle miles traveled” tax, or VMT. I prefer the word “fee” because the mileage-based road fee is a fee. It relates directly to usage, which is the hallmark of a fee. Rahn’s opposition rests on two concerns. One is the familiar concern about “personal privacy.” The other is what he calls the “cost of collection.”

Rahn’s concern about personal privacy is his claim that as secretary of transportation in Maryland, he observed “the public’s fear of just using anonymous, aggregated cell phone data for planning purposes.” He thinks that “having the government actually be able to identify a person’s type of vehicle and see where and when it is driven will generate opposition that will not be overcome.” He insists that there are “many people who will not get a transponder to pay tolls for this very reason.” Yet people already are giving that information to authorities. In fact, they are giving far more information than a road fee transponder would generate. Cell phones identify where a person is, even when not in a vehicle. Cameras, which are increasing in number hourly, record vehicles and pedestrians. Though Rahn notes the concerns about opening the door to “Big Brother,” the reality is that “Big Brother” already is here and has been for some time. I debunked the privacy concerns of the sort Rahn raised in Is the Mileage-Based Road Fee a Threat to Privacy?, which I concluded with these words: “Existing technology, such as roadside cameras, credit card receipts for fuel purchases, electronic toll systems such as EZPass, and observations by law enforcement authorities, already provide substantial information concerning the location of a vehicle. Similarly, the location of an individual when in public areas is not a secret. The mileage-based road fee does not generate a significant increase in the revelation of vehicle location information, and does nothing to increase the disclosure of individual location information.”

When it comes to the cost of collection, Rahn argues that shifting from a liquid fuel tax that is collected from 600 fuel distributors to collecting from 263 million vehicles presents a significant increase in the cost of collecting the revenue. He claims that projections setting the cost at 15 percent of revenue is too high, and that the estimated percentage is too low. The track record of existing transponder-based tolling systems, such as EZ-PASS, demonstrates that concerns about collection costs are exaggerated. As I wrote in Once Again, Rebutting Arguments Against Mileage-Based Road Fees, in critiquing a report from another opponent of the mileage-based road fee, “The Glostone analysis claims that the mileage-based road fee “would require every vehicle owner to periodically report distance tax and create a costly new bureaucracy that would have to audit these reports,” and that the “added bureaucracy alone could eat up any gains in tax revenue.” The tracking device reports without any need for owner intervention. Digital technology eliminates the need for the roomfuls of eyeshade-wearing human auditors.”

Instead, Rahn wants to implement what he calls a “beneficiary pays” system. He rests this idea on the existence of people benefit from highways, bridges, and tunnels even though they do not drive or ride on those roads. Of course, he is referring to the “national highway system,” but when analyzing the issue in terms of all highways, the number of people who never drive, ride, walk, or bike on a road is a tiny percentage of the population, essentially those who are spending the rest of their lives homebound, imprisoned, or in care facilities. Yet Rahn’s point that even those folks benefit from the nation’s roads because they receive deliveries of products shipped on those roads makes sense. The question is whether it makes enough sense to absolve actual users of any funding responsibility.

Rahn proposes a surcharge on commercial activity “on U.S. streets and highways of approximately 8 percent.” To what would he apply the 8 percent surcharge? It would apply to “what that company charges their customers for transportation services.” Right there is a big problem. Many companies already offer “free shipping” to all or certain customers, but guaranteed these companies are making this up in other ways, such as the prices charged for their products. So perhaps Rahn is thinking about imposing the surcharge on what companies pay to ship goods, but that would require far more collection activity than an EZ-PASS type transponder system would. For someone concerned about the cost of collection for a mileage-based road fee, Rahn doesn’t hesitate to treat the cost of computing and collecting the proposed surcharge as worthy only of a comment about companies that do their own shipping. Not only would trying to do the complex cost accounting of allocating driver salaries, manager salaries, benefits, and other outlays create a new expense, companies would play all sorts of games to minimize what gets included in “cost of shipping.”

Note that Rahn shifts from focusing on the “national highway system” in part of his commentary to “U.S. streets and highways” when describing the proposed surcharge. Though he proposes factoring the cost of rail, vessel, and air shipping out of the amount to which the surcharge would apply, yet another complex cost accounting task that would add to the cost of collection of the surcharge, he doesn’t propose dividing the shipping costs subjected to the surcharge between those applicable to use of federal highways, bridges, and tunnels, and those applicable to use of state and local highways, bridges, and tunnels. Does he propose to allocate some of the surcharge revenue to states and localities? Does he envision abolition of state liquid fuel taxes? Does he contemplate putting all highway, bridge, and tunnel repair and maintenance within the scope of the proposed surcharge?

Rahn claims that the proposed surcharge “more directly aligns the cost of maintenance and improvement with the benefit.” However, that approach ignores the fact that the wear and tear on a highway varies according to the weight of the vehicle, yet the proposed surcharge does not adequately take that difference into account. The mileage-based road fee does, because it is tied directly to the vehicle and adjusted for weight.

The worst part of the proposal is the free ride that it gives to people who would use highways, bridges, and tunnels for personal purposes. Though Rahn might argue that these folks would be paying through the passing on to them of the surcharge imposed on millions of businesses, not everyone makes the same use of product shipping, and that use is disproportionate to the total use people make of highways even taking into account what I call indirect use, that is, the use made by others in order to deliver goods to people.

Rahn’s proposal technically is a “user fee” because it relates to use of roads, highways, and bridges. However, it measures use in a convoluted way, focusing on shipping costs, which are not directly proportional to actual use. And it leaves out use that is unrelated to product shipments. In other words, Rahn has offered, as many do, a theory that cannot hold up to practical reality.

Public Official Doesn’t Answer Question, “Why Are You Delinquent on Your Tax Payments?”

Reader Morris pointed me to this story and asked, “Does this Councilman and financial advisor make any sense with his reasons for being behind on his tax payments? To understand the question posed by reader Morris, it is necessary to get some background.

According to the story, Memphis, Tennessee, City Councilman Martavius Jones supports a property tax increase, but is delinquent in paying at least $5,500 in property taxes to Memphis and Shelby County. The tax increase was voted down by the city council. Before the meeting at which the vote was taken, a reporter from WREG asked Jones if he was “up to date” on his tax payments, and Jones replied, “No, I’m not.” The reporter then asked, “Ok, so how can you ask people to pay more money if you’re not up to date?” Jones replied, “Because I’m paying interest on that so at the end of the day, they will receive more money from me than what was originally allocated to me.” When asked why he is behind on his tax payments, Jones would not answer. Instead he admitted he was delinquent, promised to write a check the upcoming Friday, and repeated, “But it will be more money that I’m paying to the city based on what’s expected of me.” According to the story, This was the third time WREG questioned Jones about being delinquent, the other two occurring in 2016 and 2018. Jones is a financial advisor who said “he would advise his clients to be behind on their taxes so they’re paying interest, [b]ecause it can be a tax write off for individuals.”

So why has Jones been late paying property taxes? My guess is that he thinks it is financially advantageous to delay paying the tax, and then pay even more money in the form of interest. Why would he think that? The interest rate, according to the City of Memphis web site is 1.5 percent per month, or 18 per cent annually. So someone thinking that it makes sense to delay paying the taxes seems to be concluding that it makes less sense to pay $100 today and more sense to pay $106 four months in the future. That conclusion is logical if the person can earn more than $6 on the $100 during the four-month period. That is almost impossible to do without gambling, either in a casino or in the stock market.

Perhaps Jones thinks his delay advice works because of his claim that the interest paid by his clients is a “tax write off.” So let’s take a look at section 163 of the Internal Revenue Code. Subsection (a) tells us “General rule -- There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness.” But wait! Subsection (h), paragraph (1) tells us, “(h) Disallowance of deduction for personal interest -- (1) In general -- In the case of a taxpayer other than a corporation, no deduction shall be allowed under this chapter for personal interest paid or accrued during the taxable year.” What (a) gives, (h)(1) takes away. But paragraph (2) of subsection (h) gives back the deduction for six types of interest: trade or business interest, investment interest, interest taken into account in computing section 469 passive income or loss, qualified residence interest, interest payable on delayed federal estate tax payments, and education loan interest. Does the interest that Jones and his clients are paying on delinquent real property taxes fit within any of these six exceptions? Clearly the interest is not trade or business interest, it’s not taken into account in computing section 469 passive income or loss, it’s not interest on delayed federal estate tax payments, and it’s not education loan interest. That leaves two possibilities. Is it qualified residence interest? A careful reading of paragraph (3) of subsection (h) makes it clear that the tax debt is not qualified residence interest. Is it investment interest? A careful reading of paragraph (3) of subsection (d) makes it clear that the interest on the tax debt might be investment interest if the property is investment property, which a personal residence is not. But even if the interest on the tax debt qualified as investment interest, under section (d) it is deductible only to the extent of investment income. So it’s a wash.

So, sure, if someone thinks they can earn more than 18 percent on the money that they would otherwise use to pay their property taxes on time, they can take that risk. But in most instances, that gamble will fail. Wait long enough, and the taxpayer then needs to bear the cost of the ensuing administrative procedures and even litigation triggered by the delinquency, including foreclosure sale of the property.

In the end, we don’t know why Jones delays paying his property taxes. Perhaps he has a cash flow problem. Perhaps he forgot. Perhaps he thinks there is a financial advantage. Perhaps he advises clients to delay payment. Perhaps not. We just don’t know.

Revenue Department Employee Fraud: A Conundrum?

It is unsettling when tax collectors and heads of state revenue departments go rogue. I have written about charges brought against some tax collectors in posts such as A Reason Not to Run for Tax Collector (or Any Other Office)?, Perhaps Yet Another Reason Not to Run for Tax Collector, Running for Tax Collector (or Any Other Office)? Don’t Do These Things, When Behaving Badly as a Tax Collector Gets Even Worse, Tax Collector Behaving Badly: From Even Worse to Even More Than Even Worse, Bribing the Tax Collector: Bad Outcomes on Both Sides of the Deals, When Tax Collectors Do Too Many Things, So Who’s the Worse Tax Collector? , So Is There Now a “Worst Tax Collector” Contest?, and Can Long-Term Tax Collector Embezzlement Be Prevented?. Recently, in Fighting Fraud Even More Difficult When Tax Leadership Succumbs, I wrote about the embezzlement conviction of the former New Mexico Secretary of Taxation and Revenue.

Though tax collectors and revenue secretaries who succumb to the temptation to commit tax fraud, embezzlement, and similar crimes get big headline attention, the problem is a much deeper one. For example, last week, according to this report, a retired compliance supervisor for the Virginia Department of Taxation has been arrested and charged with embezzling almost $1.3 million and with computer trespass. Officials of the state’s Inspector General’s office spent a year looking into information provided by the Department of Taxation after it had done an internal investigation. Allegedly, two employees of the department gave the supervisor “access to the department’s computer systems and ‘confidential taxpayer accounts.’” The Inspector General did not reveal how that embezzlement was implemented, probably to avoid giving a blueprint to others thinking about engaging in the same sort of behavior. According to the report, the retired supervisor repaid about $250,000 of the embezzled funds. Attempts to determine how long the supervisor had worked for the department were thwarted by restrictions on the disclosure of personnel information other than name, position, job classification, and salary.

This case is troubling. Though diligent investigation, both by the department and then by the Inspector General, uncovered the theft, one wonders how many other incidents, in Virginia and elsewhere, go undetected. The key is prevention, and yet it seems that steps can be taken to prevent one person from single-handedly doing something wrong, when two or more employees are in cahoots, the protection schemes break down. For example, designing a safe so that two individuals with two different keys rather than one individual can open it prevents unauthorized entry by one individual, the protection arrangement breaks down if the two individuals decide to collaborate. Though a two-person requirement reduces the chances of mistake, it relies on the assumption that at least one of the duo is a safeguard against malicious behavior by the other. Yet history teaches that conspiracies often extend far beyond two individuals. The problem extends far beyond taxation and revenue department embezzlement, and poses a challenge that has yet to be successfully and pervasively answered.

When Language Describing the Impact of Tax Fraud Matters

One would think that tax return preparers would read the news, and after seeing the parade of tax return preparers charged with, convicted of, and pleading guilty to various tax fraud crimes, decide to refrain from engaging in the preparation of fraudulent returns. A small sample of these situations has been addressed by me in posts such as Tax Fraud Is Not Sacred, More Tax Return Preparation Gone Bad, Another Tax Return Preparation Enterprise Gone Bad, Are They Turning Up the Heat on Tax Return Preparers?, Surely There Is More to This Tax Fraud Indictment, Need a Tax Return Preparer? Don’t Use a Current IRS Employee, Is This How Tax Return Preparation Fraud Can Proliferate?, When Tax Return Preparers Go Bad, Their Customers Can Pay the Price, Tax Return Preparer Fails to Evade the IRS, Fraudulent Tax Return Preparation for Clients and the Preparer, Prison for Tax Return Preparer Who Does Almost Everything Wrong, Tax Return Preparation Indictment: From 44 To Three, When Fraudulent Tax Return Filing Is Part of A Bigger Fraudulent Scheme, Preparers Preparing Fraudulent Returns Need Prepare Not Only for Fines and Prison But Also Injunctions, Sins of the Tax Return Preparer Father Passed on to the Tax Return Preparer Son, Tax Return Preparer Fraud Extends Beyond Tax Returns, When A Tax Return Preparer’s Bad Behavior Extends Beyond Fraud, More Thoughts About Avoiding Tax Return Preparers Gone Bad, Another Tax Return Preparer Fraudulent Loan Application Indictment, Yet Another Way Tax Return Preparers Can Harm Their Clients (and Employees), When Unscrupulous Tax Return Preparers Make It Easy for the IRS and DOJ to Find Them, and Tax Return Preparers Putting Red Flags on Clients’ Returns.

What caught my eye in the latest tax return preparer sentencing story to come my way wasn’t the fact that the preparer was caught, charged, convicted, and sentenced, nor the details of what the preparer did, because those were pretty much similar to what most other convicted preparers had done, but a sentence in the story. The sentence stated, “In total, Santa Ana caused a tax loss of at least $2.9 million to the IRS.” Curious, I tried to find the Department of Justice press release for the sentencing, but failed. What I did find was the Department of Justice press release describing the preparer’s guilty plea. That press release turned out to be the source of the words in the sentencing story. The press release stated, “In total, Santa Ana caused a tax loss of at least $2.9 million to the IRS.” I’m not sure why I hadn’t noticed this language in earlier Department of Justice press releases. But this time I did.

So why did this catch my eye? For me, describing the loss as a loss to the IRS fails to make clear to all taxpayers that the loss is a loss to all taxpayers, and to the nation. The IRS is simply a funnel that collects tax revenue and transmits it to the Treasury for disbursement. The Department of Justice news release hinted at this when it quoted Acting U.S. Attorney Christopher Chiou, who stated, ““Our office is committed to working closely with the IRS Criminal Investigation team to investigate and prosecute unscrupulous tax preparers who take advantage of law-abiding taxpayers and cause tax losses to the IRS.” Indeed, tax return preparers who commit fraud, along with taxpayers who commit fraud and tax advisors who help plan fraud, are doing more than taking advantage of compliant taxpayers. They are harming compliant taxpayers, and themselves, by reducing planned expenditures for defense, road repair, disease control, air safety, and a long list of additional services funded with taxes.

In an earlier Department of Justice press release reminding taxpayers of their reporting obligations, explaining why tax return preparers should be chosen carefully, and listing some cases in which taxpayers and preparers had been successfully prosecuted, the same Christopher Chiou explained, “Tax offenses are neither victimless nor without consequence, as taxes are how governments provide essential services.” To some extent, that relieved my concern that there is an institutional sense that it is the IRS that loses when there is tax fraud. But I think that if the boilerplate language in press releases was changed from “[defendant] caused a tax loss of at least [dollar amount] to the IRS” to “[defendant] caused a reduction of at least [dollar amount] in essential services provided by the federal government,” the news outlets publishing reports about the charge, conviction, guilty plea, or sentencing would likely pick up this proposed revised language just as they pick up the existing language. This, in turn, would reach the public, who might not be very concerned, and might even be happy, to read that the IRS lost money, but who might be more motivated to engage in compliance and refrain from engaging in, or helping others engage in, activities that harm the common good. Changing that language is an easy fix, costs little to nothing, but would have a significant impact on taxpayer attitudes and reactions.

Update: Reader Morris found an IRS news release describing the sentencing. Interestingly, the news release quoted Special Agent in Charge Albert Childress of IRS Criminal Investigation as stating, "Santa Ana defrauded the U.S. of at least $2.9 million dollars when she knowingly prepared fraudulent tax returns on behalf of her clients. She harmed both her clients — who remain responsible for paying the correct amount due and owing for each of these tax years — and the people of the United States as a whole." That language best describes the impact of tax fraud, specifically, that it is not a matter of an IRS loss but a harm to the nation and the people of the nation as a whole. Incorporating that language into the press releases dealing with individuals pleading guilty to, or convicted of, tax fraud would be very helpful in letting Americans know why tax fraud is dangerous.

Fighting Fraud Even More Difficult When Tax Leadership Succumbs

Tax fraud has always existed. Like many of society’s ills, its incidence is climbing. Though now and then I have written about a taxpayer convicted of tax fraud, it has become so common that I have ignored all but the most notorious. Instead, I have focused on fraud and other illegal behavior among those obligated to provide a level of defense.

That is why I have written at least 20 posts about tax return preparers involved in fraudulent tax return preparation, false tax return filings, and other tax noncompliance activities. These posts include Tax Fraud Is Not Sacred, More Tax Return Preparation Gone Bad, Another Tax Return Preparation Enterprise Gone Bad, Are They Turning Up the Heat on Tax Return Preparers?, Surely There Is More to This Tax Fraud Indictment, Need a Tax Return Preparer? Don’t Use a Current IRS Employee, Is This How Tax Return Preparation Fraud Can Proliferate?, When Tax Return Preparers Go Bad, Their Customers Can Pay the Price, Tax Return Preparer Fails to Evade the IRS, Fraudulent Tax Return Preparation for Clients and the Preparer, Prison for Tax Return Preparer Who Does Almost Everything Wrong, Tax Return Preparation Indictment: From 44 To Three, When Fraudulent Tax Return Filing Is Part of A Bigger Fraudulent Scheme, Preparers Preparing Fraudulent Returns Need Prepare Not Only for Fines and Prison But Also Injunctions, Sins of the Tax Return Preparer Father Passed on to the Tax Return Preparer Son, Tax Return Preparer Fraud Extends Beyond Tax Returns, When A Tax Return Preparer’s Bad Behavior Extends Beyond Fraud, More Thoughts About Avoiding Tax Return Preparers Gone Bad, Another Tax Return Preparer Fraudulent Loan Application Indictment, Yet Another Way Tax Return Preparers Can Harm Their Clients (and Employees), When Unscrupulous Tax Return Preparers Make It Easy for the IRS and DOJ to Find Them, and Tax Return Preparers Putting Red Flags on Clients’ Returns.

That also is why I have given attention to charges brought against some of those serving in yet another line of defense against tax fraud, specifically tax collectors. I have described the woes of several in posts such as A Reason Not to Run for Tax Collector (or Any Other Office)?, Perhaps Yet Another Reason Not to Run for Tax Collector, Running for Tax Collector (or Any Other Office)? Don’t Do These Things, When Behaving Badly as a Tax Collector Gets Even Worse, Tax Collector Behaving Badly: From Even Worse to Even More Than Even Worse, Bribing the Tax Collector: Bad Outcomes on Both Sides of the Deals, When Tax Collectors Do Too Many Things, So Who’s the Worse Tax Collector? , So Is There Now a “Worst Tax Collector” Contest?, and Can Long-Term Tax Collector Embezzlement Be Prevented?.

Now comes a report that the former New Mexico Secretary of Taxation and Revenue, Demesia Padilla, has been convicted of embezzling more than $25,000 from a client of a separate business she was operating while she served in the governor’s cabinet. She also was convicted of computer access with intent to defraud or embezzle. She managed to shift the money from her client’s bank account by linking her credit card to that account. She claimed that the company ceased to be her client when she was appointed to the cabinet, but her husband signed off on the client’s tax returns for several years thereafter. It is unclear if the company became the client of the husband or if he was a tax return preparer.

According to another story, in 2016 state prosecutors initiated an investigation into allegations that Padilla ordered department employees to terminate an audit of one of her former clients. Though what happened to that investigation is unclear, it appears that charges related to the allegation were either dropped or dismissed.

When taxpayers see officials treating the law with disdain, they face even greater temptation to follow the “if they can do it, so can I” philosophy of dealing with obligations. It’s bad enough that tax return preparers assure taxpayers that what is happening on a fraudulent return is not a problem, but when public officials responsible for the appropriate administration of the tax laws, whether they be tax collectors or a cabinet secretary overseeing the entire state revenue department, public confidence in government is further eroded. It makes it even more difficult to teach noncompliance and to shape a culture that treats tax fraud as unacceptable. As a nation, we can do better, and if we don’t, we might end up with a nation in even more dire straits.

Philadelphia Parking Tax Decrease Proposal Fails: Pick a Reason

Two and a half weeks ago, in Who Benefits from a Philadelphia Parking Tax Reduction?, I criticized the claim that a proposed decrease in the Philadelphia parking tax would be “a handout to wealthy parking garage magnates.” I explained that the way the tax is computed and collected would cause the reduction to be reflected in the amount paid by patrons of parking facilities and would not increase the net income of the proprietors. I also explained that the decrease would not cause an increase in the use of the parking facilities sufficient to generate any significant in parking revenue. I noted that “My point isn’t that the parking tax should be reduced, or should not be reduced, or should be increased,” but that my “point is that when arguments for and against changes in the parking tax are lined up, ‘handouts to the wealthy’ should not be on the list.” I also stated that, “Coming from someone who opposes tax breaks for the wealthy, that might seem surprising, but my point is that reducing the parking tax paid by vehicle owners, very few of whom are wealthy, is not a tax break for the wealthy. It’s a tax break for drivers of all economic groups.”

Now comes news that the proposal to reduce the parking tax has been withdrawn by the City Council member who had submitted it. The goal of the proposed legislation was to encourage parking facility owners to increase their employees’ wages, though it is unclear how reducing the amount of tax funneled from drivers to the city would encourage wage increases. Nor can City Council legally mandate increased wages for those employees. Reportedly two parking facility companies had agreed to some sort of promise to increase wages but writing that into tax decrease legislation was not possible. The abandonment of the Council bill was in response to opposition from “progressives, who said the companies shouldn’t need a tax break to pay living wages, and from urbanists who favor dense neighborhoods and oppose car-centric infrastructure.” Other reports allege that the proposal was abandoned when other parking facility owners would not agree to the wage increases.

Does it matter why the proposal failed? Perhaps. The reaction of various constituencies to the proposal can inform anyone who crafts a future proposal designed to reduce taxes, or increase wages, or otherwise regulate parking in the city. For the moment, though, the issue now sits on a back burner, a very far back burner.

Is a Tax the Best Way to Fund Rural Broadband Access?

A recent Bloomberg article has drawn attention to the question of how rural broadband access should be funded. Although almost everyone living in urban and suburban areas has access to broadband at home, the percentage of individuals who have home broadband service in rural and tribal areas is low.

To deal with this issue, about twenty years ago, Congress imposed a percentage fee on the revenues derived by telecommunications companies from their users for interstate and international calls. This fee is passed on by the companies to their customers. Verizon tags this portion of its bills as the “Federal Universal Service Fund charge.” Some states also have enacted similar fees. As a practical matter, the fee is being passed on mostly to low-income customers who cannot afford to drop landline service and shift to more expensive alternatives.

Because the fee is imposed on telecommunications companies but not on internet-based communications, as landline usage dropped and internet-based messaging increased, the telecommunications revenues subject to the fee have dropped from roughly $72 billion in 2010 to about $47 billion in 2019. To maintain revenue from the fee, the fee increased from 6.8 percent of revenue to 31.8 percent. It isn’t difficult to predict that the revenues subject to the fee will continue to drop and the percentage will need to increase. This, however, is an untenable situation. Though Congress enacted an emergency broadband program that provides $50 monthly subsidies to several million households, that program will run out of funds in a few months.

There are many reasons that it is in the national interest, including national security, that broadband access needs to be available to everyone. The cost per person to bring broadband access into rural and tribal areas is far higher than it is in urban and suburban areas. If the private sector relied solely on the market, broadband access would not reach rural and tribal areas because the cost would be prohibitive for most residents of those areas. Thus the implementation of the universal service fund and its fees.

Why did Congress choose to impose a fee on telecommunications companies to provide broadband access? After all, as one member of the FCC, which administers the fund, stated, “That’s like taxing horseshoes to pay for highways.” True, it’s technically not a tax, but even if he had said, “That’s like imposing a fee on horseshoes to pay for highways,” the point would be well taken.

Some have proposed that a tax should be enacted that would be paid by “companies such as Amazon, Google and Netflix.” The justification is that these businesses benefit from the internet and pay almost nothing. But are they the only businesses that benefit from the internet? More specifically, are they the only companies that benefit, or would benefit, from an expansion of internet access in rural and tribal areas? Of course, the trade group that includes the big online companies consider this proposal to be a punishment of “innovative, high-quality streaming services.” Proponents argue that bringing these companies within the scope of the fee would reduce the percentage to less than 5 percent.

Others have suggested that Congress should simply appropriate funds from general revenues. Opponents point out that this would probably subject the subsidy to the vagaries of budget approvals and funding disputes.

The solution isn’t easy to find. As Doug Brake, director of broadband and spectrum policy at the Information Technology and Innovation Foundation, noted, “Really almost any proposed source of funding is going to be controversial.”

A possible workable solution is for Congress to appropriate funds to bring broadband service to rural and tribal areas, and then to require companies that derive revenue from rural and tribal customers to pay a percentage of that revenue to replenish the funding. That percentage would be very low, probably even lower than the 5 percent projected by proponents of taxing internet companies. That’s because it also would include companies that would be able to reach, and sell to, customers in rural and tribal areas. Of course, all of these companies would then pass the fee along to their customers. If they were required to pass the fee along to all customers, and not merely to the rural and tribal area customers because that would shift the cost to those unable to fund the full cost of broadband expansion, the arrangement would be very similar to a tax. In other words, broadband users everywhere who do business with companies collecting revenue from rural and tribal areas would be paying a fee for something they might think they are not using. This was one of the principal objections raised when the universal service fund was implemented. The answer to this objection is that everyone benefits if everyone has broadband access and, similarly, everyone loses if there are people without broadband access. In an era when information dominates the marketplace, and rapid distribution of information is essential, letting everyone know of impending severe weather, other emergencies, and national security related alerts is essential.

So, no, a tax is not the answer to the broadband access funding question. The answer is a fee, a fee imposed not only on the rural and tribal individuals and businesses who use rural and tribal broadband infrastructure, but also on all other broadband users, who benefit from the fact that rural and tribal individuals are brought into the broadband network.

Of Course, Tax is Not “Just Numbers”

Last week, reader Morris directed my attention to an article analyzing H&R Block stock from an investment perspective. The article quoted Jagjit Chawla, general manager of Credit Karma’s tax business, who had stated, in a 2018 Barron’s article, that tax “is just a math problem. It’s numbers in and numbers out. And rules for that are calculated and defined by the IRS.”

Reader Morris then commented to me that, “I believe you have mentioned in your blog and in your emails that Taxes Aren’t ‘Just Numbers’.” He is correct. I have written about the “non-numerical” aspects of taxation multiple times. I have done so to dispel the absurd notion that “tax is just numbers” and to share how I tried to allay the fears of law students who, at the beginning of the basic federal income tax course, expressed fear because they claimed that they were “mathphobic,” “math deficient,” or “not good with numbers.” I share here some of the examples I have provided as proof that tax is much more than numbers:

In Don’t Tax My Chocolate!!!, I examined whether large marshmallows are food exempt from the Pennsylvania sales tax or candy to which the sales tax applies. In Halloween and Tax: Scared Yet?), I focused on the dilemma of whether candy bars made with flour are candy subject to the sales tax or baked goods exempt from that tax. In Halloween Brings Out the Lunacy, I addressed whether pumpkins are food exempt from the sales tax. In Why Tax Practitioners Must Be Good With Words, and Not Just Numbers, I discussed a case in which the issue was whether aircraft hangars were exempt from property taxation under a provision that exempted any “building used primarily for . . . aircraft equipment storage.” In Pets and the Section 119 Meals Exclusion I shared the challenges of deciding whether the section 119 exclusion for meals applied to food purchases by the taxpayer for a pet. In Who Is a Farmer? A Taxing Question?, I discussed the issue of who qualifies for a New Jersey real estate property tax limitation applicable to land actively devoted to agricultural or horticultural use.” In Tax Meets the Chicken and the Egg, I explained how a property tax exemption for “all poultry” and a property tax exemption for “raw materials of a manufacturer” required a court to determine whether chicken eggs constitute poultry and whether hatching and raising chickens constitutes manufacturing. In When Tax Isn’t About Numbers: What is a Bank?, I explained the challenges of determining whether a particular entity qualifies as a bank. In Taxes, Strip Clubs, and Creativity, I commented on the attempt by a New York strip club to avoid sales taxes by arguing that its dancers were providing therapy to its customers, and thus the amounts it charged customer fit within the sales tax exception applicable to amounts paid for massage therapy or sex therapy. In Tax Question: What Is a Salad?, I described how the Australian Taxation Office gave up trying to define “salad” for purposes of the goods and services tax exemption for fresh salads, sharing the comments of a representative of that office who noted, “It depends on what you define a salad as. Some may define it as a bowl of lettuce, some may define it as a BBQ chicken shredded up with three grains of rice on it. I'm not trying to be facetious... there [are] a range of products that are very, very different that are marketed as salads." In Another One of Those Non-Arithmetic Tax Questions: What Is a Sport?, I shared the challenges faced by the English Bridge Union when it took the position that for purposes of applying the value-added tax on competition entry fees, which exempted fees paid to enter sports competitions, bridge is a sport. In Getting Exercised About A Sales Tax Exercise Exception, I pondered whether yoga constituted exercise for purposes of the New York City sales tax that applies to sales of services by weight control salons, health salons, gymnasiums, Turkish and sauna bath and similar establishment. In Not That More Proof Is Needed, But Here’s Another Example That Taxes Aren’t “Just Numbers”, I described how the resolution of a tax dispute turned on whether a youth hostel was a hotel for purposes of the Philadelphia hotel tax.

Anyone who knows anything about taxation knows that tax involves much more than numbers. Thus, when reader Morris then asked, “Is the general manager's description of the tax business accurate?” the answer is a resounding “No.”

What reader Morris did not ask was whether Chawla’s claim that the “rules for that [tax computation] are calculated and defined by the IRS.” That’s another error. The rules for defining what is subject to taxation and for computing the amount of tax are provided by the Congress. Again, anyone who knows anything about taxation knows this. I have written about this misperception, which originates in deliberate lies, in posts such as Is Public Truly Getting IRS-Congress Distinction?, If Congress Says So, Don’t Blame the IRS, Taxes and Anger, and It’s Not the IRS, It’s the Congress.

So how does a manager of a large company’s tax division manage to goof on two major core principles of taxation? Curious, I did a bit of research, and found his education and work experience on several sites. The one that I found with the most information was this profile on SignalHire. According to this profile, Chawla recently left Credit Karma to join Facebook. His education is listed as a Bachelor of Engineering at Punjab Engineering College, a Master of Business Administration at HEC Paris, and a Master of Business Administration at Indian School of Business. Surely tax is not in the curriculum of an engineering college. At HEC-Paris, tax is not listed as one of the core courses, nor does it appear in this list of its electives. Nor could I find any tax courses in this list of courses at the Indian School of Business. As for experience, his list of positions consists of software engineer at Infosys Technologies in Bangalore, India, software engineer at Adobe Systems in San Jose, California, product manager at Google in Mountain View, California, director of product management, then senior director of product and general manager of tax, and then vice president and general manager of tax and savings at Credit Karma in San Francisco, California, and now director of product management at Facebook in Menlo Park, California.

So I wonder how the question of whether a transfer of money from one person to another is a loan, a gift, or compensation would be reduced to numbers by a software engineer and product manager. I wonder how the question of whether chicken eggs constitute poultry would be reduced to numbers by a software engineer and product manager. I wonder how many people read the quote in Barron’s or its republication in SeekingAlpha and came away thinking that tax is just numbers and the IRS makes the tax rules.

Words Matter: The Tax Treatment of Legal Malpractice Awards

A recent Tax Court case, Holliday v. Comr., T.C. Memo 2021-69 [to see the full opinion, go to the case docket, scroll down to item 36, and click on that link], addressed the tax treatment of a legal malpractice award. In March 2010, the taxpayer’s then husband filed for divorce. The taxpayer retained J. Beverly as her attorney, and after she and the attorney engaged in mediation, she executed a settlement agreement. She objected to the agreement, though it is not clear why she objected to an agreement to which she had agreed and which she had signed. In April 2012, the divorce court entered the decree of divorce. The next month, Beverly filed a motion for a new trial, alleging that the taxpayer received $74,864 less than her equal share of the community estate. That motion was denied. Beverly told the taxpayer he would appeal, but he did not do so.

So in October 2013, the petitioner filed a malpractice lawsuit against Beverly, claiming that his representation constituted negligence and gross negligence and that he breached the duty of fair dealing and his fiduciary duties “by influencing * * * [her] to mediate and enter into a transaction that was not fair to * * * [her] under the circumstances” and by not pursuing an appeal. Later, she amended the malpractice petition to add claims for deceptive trade practices, treble damages, and attorney’s fees. She sought damages for “pecuniary and compensatory losses”, including “damages for past and future mental anguish, suffering, stress, anxiety, humiliation, and loss of ability to enjoy life”, as well as punitive damages and disgorgement of the attorney’s fees she paid in the divorce proceeding, resulting from the malpractice defendants’ conduct. In October 2014 Beverly and the taxpayer entered into a settlement agreement that stated, “while there remain significant disagreements as to the merit of the claims and allegations asserted by the Parties to this lawsuit, the Parties have agreed to compromise and settle such claims and allegations, without any admission of fault or liability on the part of any party.” Beverly and his firm agreed to pay $175,000 to the taxpayer “[i]n consideration for the mutual promises and obligations set forth in this Release”. The parties released each other from all claims related to the malpractice lawsuit “in exchange for the * * * [settlement proceeds]”. All claims included those “of whatever kind or character, known or unknown * * * which * * * [petitioner] may have against * * * [malpractice defendants] arising out of or related to the * * * [malpractice lawsuit].” Beverly and his firm did not admit liability or fault in the settlement agreement, and the parties did not allocate any of the settlement proceeds toward any particular claim or type of damages. The taxpayer received the settlement proceeds of $175,000, from which she paid her malpractice attorney’s $73,500 fee through direct payment to the attorney by the defendants so that she received a check for $101,500.

On her 2014 Form 1040, the taxpayer reported other income of zero, and she acknowledged the receipt of $101,500 through an attached Form 1099-MISC Summary and a “Line 21 Statement” on which she reported “Other Income from Box 3 of 1099-Misc” of $101,500. The Line 21 Statement also subtracted $101,500 with the description “Misclassification of Lawsuit recovery of marital assets”, resulting in total other income of zero. The IRS issued a notice of deficiency, determining that the $101,500 should be included in gross income. After the taxpayer filed her petition in the Tax Court, the IRS reviewed the settlement agreement and amended its answer to also include in the taxpayer’s gross income the $73,500 of her settlement proceeds that were paid to her malpractice attorney.

The taxpayer argued that the settlement proceeds were a nontaxable return of capital because they compensated her for the portion of her marital estate that she “was rightfully and legally entitled to, but did not receive, due to the legal malpractice of * * * [her divorce attorney].” The IRS argued that the settlement proceeds are taxable income because they compensated the taxpayer for the alleged failings of her divorce attorney and are not excluded from gross income. The taxpayer did not make any arguments based on section 104(a), dealing with compensation for personal injury, or section 1041, dealing with transfers of property between spouses incident to divorce.

The court first noted that settled case law provides that “when a litigant’s recovery constitutes income, the litigant’s income includes the portion of the recovery paid to the attorney as a contingent fee.” It also noted that under settled case law “recovery of capital is not income.” It then explained that whether a payment received in settlement of a claim represents a recovery of capital depends on the nature of the claims that were the basis for the settlement. The question to be decided is, “[I]n lieu of what was the . . . settlement awarded?” The answer is a question of fact, and finding the answer requires looking at the language of he agreement for indicia of purpose, focusing on the origin and characteristics of the claims settled in the agreement. Turning to the agreement in question, the court determined that it made clear that the settlement proceeds were in lieu of damages for legal malpractice. The text of the agreement stated that its purpose was “to compromise and settle * * * [taxpayer’s] claims and allegations” against malpractice defendants and that payment “in exchange for” release of claims related to the taxpayer’s lawsuit against the malpractice defendants.

The court rejected the taxpayer’s argument that the settlement proceeds were only for those claims that involved the marital estate and that they represented compensation for lost value or capital because they “are based on her recovery of the property interest that * * * [she] rightfully should have received from her divorce as her share of the marital estate.” The court rejected this argument because the settlement agreement stated that the settlement proceeds were for the release of “all claims * * * of whatever kind or character, known or unknown * * * which * * * [the taxpayer] may have against * * * [malpractice defendants] arising out of or related to the * * * [malpractice lawsuit].” The court treated the taxpayer asking the court “to look through the settlement agreement and consider only her claims related to recovery of marital property,” but the court refused to look past “the plain terms of the settlement agreement,” instead concluding that the settlement proceeds were to compensate the taxpayer for her attorney’s malpractice. Accordingly, the settlement proceeds must be included in gross income.

The court pointed out that it had “recently rejected a similar attempt to recharacterize the settlement of a legal malpractice claim arising from a personal injury lawsuit,” citing Blum v. Comr., T.C. Memo. 2021-18. In that case, the taxpayer filed a malpractice claim against her personal injury attorney, resulting in a settlement payment from the personal injury attorney. She asserted that the settlement payment represented a return of capital “in that it compensated her for a loss that she suffered because of the erroneous advice of her lawyers, viz, the nontaxable amount she would have received had she prevailed in her personal injury lawsuit.” The court in Blum focused on the language of the settlement agreement, which specified that it was entered into “for the purpose of compromising and settling the disputes”, and concluded that the settlement payment was not a return of capital to the taxpayer but rather to compensate her “for distinct failings by her former lawyers.”

The court also noted that even if the taxpayer had convinced it that some of the settlement proceeds were meant to replace her purported loss of marital property and that the loss was a nontaxable recovery of capital, she failed to provide a basis on which the settlement proceeds could be allocated between that hypothetically nontaxable recovery and other taxable amounts. The settlement agreement did not allocate any of the settlement proceeds toward any of the various claims or types of damages. According to the court, to the extent the proceeds included amounts representing interest, that portion could not be excluded from gross income in any event.

Though as Robert Wood pointed out earlier this year in Does IRS Tax Legal Malpractice Settlements? that there is “surprisingly little authority” to help drafters of settlement agreements “predict the tax treatment of legal malpractice recoveries,” the Holliday case and the Blum case that it cites teach and reinforce the lesson that the language of the settlement agreement is critical to the tax treatment of the settlement proceeds. I have written about the necessity for careful drafting, and the adverse impact of imprecise drafting, in posts such as Taxing Damages, In Tax, As in Much Else, Precision Matters, Contracting a Tax Outcome, and Looking for an Exclusion That’s Not in the Documentation.

It is understandable why the defendants in the litigation want the settlement agreement to cover all claims including those “of whatever kind or character, known or unknown * * * which * * * [petitioner] may have against * * * [malpractice defendants] arising out of or related to the * * * [malpractice lawsuit].” But that language in and of itself is not the problem. It’s the lack of additional language that allocates a specific portion of the settlement proceeds in this case to the taxpayer’s recovery of the amount that she would have received for her share of marital property had the divorce settlement agreement been drafted differently. It is the lack of that language that forced the Tax Court to conclude that no part of the settlement proceeds had been proven to be for return of capital and that, even if that had been proven, no part of the agreement provided sufficient specificity for allocating a specific dollar amount to what would have been excluded from gross income. As so often is the case, words, or the lack of them, matter.