Monday, January 24, 2005

The Social Security Chicken and Egg 

Andy Cassel's column in Friday's Philadelphia Inquirer raised several very important points about the social security debate that is beginning to heat up a bit. Two of his observations strike me as fundamental to the debate.

Andy's first fundamental point is that there is no point in addressing any of the issues (existence or scope of crisis, financing devices, investment possibilities, retirement age, benefits, etc.) until and unless we have "some basic notion of what we want Social Security to accomplish." He is dead-on right. Part of the problem, perhaps the principal cause of the problem, is that Social Security has a split personality. Is it insurance against being in poverty after retirement? Is it a savings plan? Is it a wealth transfer plan? Is it a disability plan? Is it a survivor benefit plan? If it is some combination, how should each element be weighed?

Though many debate this point, I (and others) continue to assert that Social Security was designed as insurance against being in poverty after retirement. The "I" in FICA is for "INSURANCE." Over the decades, it was expanded to include survivors of retirees, and then survivors of potential retirees. It came to include disabled workers who had not yet retired. Medical benefits were added, though eventually the Medicare portion was separated to some extent. During the heydey of Rep. Pepper's "all elderly are poor, let me get them benefits and their votes" campaigns, any notion of a means test was tossed out the window. Of course, today there are more children living in poverty than there are elderly, and this vote-getting expansion of Social Security surely is partially, if not entirely, to blame.

But before this question can be answered, other information is required to shape the context in which the question is asked. This brings me to Andy's second important point.

Andy's second fundamental point is that we need to reach agreement on whether government-run social insurance does more harm than good or more good than harm. He refers to assertions by Martin Feldstein, a Harvard economist who advised Ronald Reagan and who may succeed Alan Greenspan as chair of the Federal Reserve System. Feldstein argues that social programs are disincentives, claiming that unemployment insurance increases unemployment, retirement pensions induce earlier retirement, and health insurance programs increase medical costs, just as air bags subtly encourage people to speed. There's some merit to these arguments. The existence of unemployment insurance might cause an employer to lay off an employee that the employer might otherwise try to retain because the employee has a family. Some people do retire earlier than they would retire because they have retirement benefits waiting for them. Health insurance might encourage people to get check-ups that they might avoid because of financial restrictions, though I'm not convinced that the cost of wellness is more than the cost of sickness.

Here's the problem. Most insurance is unlike the lottery. One pays, and then prays to lose. Do you REALLY want to collect fire insurance, auto collision insurance, auto theft insurance, or flood insurance? Sure, but only if the fire, accident, theft, or flood occurs. Almost everyone prefers that the casualty not occur. Not only does the insurance not cover the entire loss, these events pose dangers to life and health and are a general inconvenience of the highest order. Life insurance is a strange exception. If it's term insurance, again, most folks don't want to collect during the term. If it's whole life, sure, it will pay someday, but the hope is that it is a day far in the future. All of these insurances cost money, but payment of the premium is good "insurance" against the risk of an undesired but unpredictable and possible event.

Let's turn to retirement. Ideally, individuals would save for retirement. Few people do so. Some are unable to do so. Others are unable to see a long-term need as having the same or higher priority as a short-term want. Many depend on the retirement portion of an employment package, but then end up on the streets when an employer goes under, leaving behind unfunded retirement obligations. That's what FICA was designed to address, namely, retirees who through no fault of their own were left penniless because an employer went bankrupt. FICA was enacted decades before the pension reforms of ERISA that brought us the Pension Benefit Guaranty Corporation, which essentially insures pensions from the employer's perspective. The combination of FICA and PBGC coverage, though far from being duplicative, creates a situation in which many Americans conclude, erroneously as any half-sensible financial planner will explain, that they don't need to save for retirement. And if that is indeed the effect of the current structure, changes are needed.

First, let's separate the different goals of "Social Security" and deal with each one separately, just as a person would treat each goal separately when dealing with each in his or her own way. Just as Medicare has been somewhat cordoned off of Social Security generally, so, too, should be pre-retirement disability and, as a separate matter, financial protection of survivors of people who die before retirement. Let's stop here and consider how this should be done. If it is means-tested, then there is, as Feldstein argues, an incentive to refrain from purchasing disability or life insurance because "the government" will step in to help. On the other hand, using benefits restriction as a means to encourage private investment in disability or life insurance penalizes those who cannot afford to do so. The age-old question arises again: if society elects to assist those in need through government programs, what is to prevent people from pretending to be in need or in "arranging" to be in need. We see this in the game of Medicare qualification when wealthy families shift familial burdens onto society. We see it when tax provisions are used by those for whom they were not intended. Any sort of means testing, aside from being intrusive and judgmental, invites complications of the same order of magnitude as administration of the tax law, or worse.

Second, let's consider putting responsibility for retirement, disability, casualty loss, and premature death planning on the individual. Yes, there are those who cannot afford the premiums, but they also cannot afford food and medicine. Let's issue insurance stamps just as the government issues food stamps, though I wonder if I'm not doing a frying-pan-into-the-fire metaphor with that one. Better yet, instead of separate programs for food stamps, cheese give-a-ways, house insulation projects, etc., all of which create redundant bureaucracies and compel impoverished individuals to fill out reams of forms, let's create one "help those in need" program which will provide funding, lasting only so long as needed, for the basics of life. We can define the basics of life to include not only food and insulation, but also premiums for disability, life, and casualty insurance and contributions to retirement savings. Toss in health insurance.

In the long run, administering such a program would be easier than the combined burden of the disparate offices sprinkled throughout state and federal government agencies. In the short run, the transition could be challenging. But since when have we, as a people, shrunk back from challenges?

And this would put to rest all the subsidiary questions. Retirement, disability, and survivor benefits would return to the private sector, where food and most casualty insurance have been and have remained. Perhaps the government would need to insure the insurers (as it already does to some extent for certain things), but ultimately the individual could choose retirement plans as many employees now do. The tax law dealing with deferred compensation could be overhauled and simplified. Means-testing social security benefit payments would be unnecessary, as the means testing would take place with respect to insurance premiums and plan contributions.

It would not surprise me to hear from a reader explaining that all of this was proposed years ago by someone no less, and perhaps more, creative than am I. And, the reader might point out, the suggestion was rejected. For me, that simply means that those who did the rejection, and their political heirs, now have an opportunity to admit mistake and fix the mess they have created before it swallows all of us.

But, as Andy Cassel points out, these are the debates in which we should now be engaged. Only after these issue are resolved, and only if resolved in certain ways, would it be appropriate to turn to the issues that have grabbed the current headlines. Sometimes spotlight hogs need to be pushed aside and taught patience.

Friday, January 21, 2005

State Taxation of Nonresidents 

Yet another nonresident income taxation case has moved into the spotlight in New York, though its impact can and will be felt throughout the nation. Thanks to loyal reader, former student, and Graduate Tax Program adjunct teaching colleague Ryan Bornstein for the heads up, which he sent several days ago, and which Paul Caron just picked up on TaxProf. The ABA has provided a good writeup of the case.

The case involves a Tennessee resident who is employed by a New York organization to do computer work. Thomas Huckaby does about 75% of the work at home in Tennessee and is in New York for 25% of the time. He's not a New York resident. So unless one is familiar with the twists and turns of interstate taxation, one would conclude that New York can tax 25% of Huckaby's income. Of course, most folks would guess that New York tries to tax all of it. On this sort of guess, picking that conclusion is almost always a winner.

New York's approach rests on the assumption that the employee could do the work in New York, and that unless the employer requires the employee to do the work in another state, the employee should be treated as doing the work in New York even if the worker is not in New York. This approach uses what is called the "convenience of the employer" test. New York claims that Huckaby's employer did not require Huckaby to do the work in Tennessee.

Of course, Huckaby's not about to commute to New York from Tennessee. And Huckaby lives in Tennessee, not to escape the New York income tax, but for personal reasons. Tennessee, incidentally, does not have an income tax on salaries.

Huckaby balked at what New York tried to do, and litigated. He lost in the New York Supreme Court (which, here's another law quirk that non-lawyers will find counter-intuitive, is the state's lowest court!), and he lost again on appeal to the appellate division of the state Supreme Court. So now he's up to the New York Court of Appeals, and oral argumentw were heard recently. Here's the cite for those who want to read the appellate division opinion: 776 N.Y.S.2d 125 (2004).

What are his chances? Tough to say. He's not the first to challenge the rule. A law professor who teaches in New York City but who does some of his teaching-related work at home in Connecticut challenged the convenience of the employer rule and lost. Eventually the United States Supreme Court declined to hear the case. The Supreme Court rarely takes up a case the first few times the issue appears, as the Justices appear to prefer waiting until the matter sorts itself out to some extent in the lower courts. Being a pioneer is tough. Take a look: Zelinsky v. Tax Appeals Tribunal, 769 N.Y.S.2d 464 (2003).

New York and only a few other states use the convenience of the employer rule. It is politically easy to adopt, because nonresidents don't have a vote. Taxation without representation, eh? Most states tax income that is earned while a person is physically present in the state. A physically present nonresident imposes a burden on the state by being the beneficiary of police protection, street cleaning, emergency services, and similar municipal services. The issue is not unlike that raised by Pennsylvania localities implementing the emergency and municipal services tax, which I discussed in this recent post. The court in Zelinsky, though, asserted that the employee's decision to reduce the time he spent in New York "did not diminish" what New York provided. That is flat-out wrong. If Zelinsky reduced his physical presence in New York to zero, would New York have a right to tax him in perpetuity because he worked there at some previous time? Lee Sheppard's suggestion that judges be required to attend business school, discussed here, jumps into my brain. If the judges' in-laws visit only twice a year and not once a week, there's no reduction in what the judges provide to their guests? There are times I understand why non-lawyers think lawyers have lost all traces of common sense.

As more and more employees telecommute, the issue of state income taxation will get more attention and generate more litigation. After all, if a person can work from home, why not let that happen, or perhaps require it? It saves energy by cutting down or eliminating commuting, the employer reduces rent or other building costs because less space is required, the need for parking spaces is reduced, and other economic advantages accrue to the employer. The convenience of the employer test will have an ever-increasing "drag" effect on the nation's transition to a digital economy.

But if New York continues to prevail, other states will see the convenience of the employer test as an invitation to revenue enhancement. If the nonresidents live in states that don't impose an income tax on wages, then there is a net revenue flow to the state adopting the test. On the other hand, if the state in which the nonresident lives adopts the same rule, it could cause net tax revenue to flow to that state and away from the state originally adopting the rule. So, in the long run New York might win by losing and lose by winning.

Percolating on Capitol Hill is the Telecommuter Tax Fairness Act, which almost certainly will be introduced again after the new Congress gets its business underway. The Act would bar states from using the convenience of the employer test. My guess is that it will get saddled with other provisions attempting to deal with other interstate taxation problems exacerbated by the emergence of the digital economy. The lobbying will be intense. The ABA reports that at least $100 million in annual tax revenues is at stake in New York alone.

I close with a question that I cannot answer because I don't know all the facts about Huckaby's employment. I have a pretty good idea of the situation in Zelinsky. Any chance Huckaby could set up as an independent contractor? Would it be worth finding a few other clients and thus establishing self-employment status? People doing business or working with New York entities and persons might want to consider the possibilities. I don't think there's much chance that full-time law faculty would set up as independent contractors with respect to the services provided to the University (unless they were full-time in the sense that they provide services to several Universities, a trend that is growing among undergraduate faculty as colleges and universities seek to cut expenses, and even in those situations the question isn't that easy to answer).

Putting the Tax Law to Good Use 

OK, suppose I cave in and support the idea that the tax law should be used for non-revenue purposes. What would be on my list of tax-encouraged and tax-discouraged activities?

Well, the list of tax-discouraged activities would be long. At the moment, I'll select one. I choose it thanks to an item on Politech (and thanks to Declan McCullagh).

Take a look at Ben Edelman's Investors Supporting Spyware list. I wonder how many of these enterprises are marketed as tax-savings investment vehicles (to use a euphemism).

So.... here we go, a proposal for a Congress that thinks it can simply declare spyware illegal and all the bad guys will comply. Take away all tax benefits associated with investments in enterprises that engage in Spyware.

Well, I guess I just made some new friends with this post!!!

Wednesday, January 19, 2005

So What Am I Trying to Teach? 

My response to a moderately complicated partnership taxation question posted on the ABA-TAX listserv brought a comment from one of the participants. He expressed a concern that for my students' sake issue spotting was the more important part of the exam and that reaching the correct result is of less importance.

Here's my reaction:
Spotting the issues gets a student to a passing grade. Spotting the issues is often rather easy in tax. Getting the right analysis is what matters most. Correct result is important if there is one.

My exams are a mixture. Some easy questions, with easy issue spotting and/or easy correct results. Some in the middle. And a few tough ones to identify the A students.

I tend not to emphasize arithmetic. There's some, but it's not pervasive. I try to distinguish use of or reference to the wrong number from can't add or divide. The former is serious, the latter trivial (for the exam but not in practice so they lose a point or two at most out of 150).

Generally, I am as demanding of my students as clients are of their advisors and partners are of their associates. No use lulling the students into a false sense of law practice. They have TV shows to do that for them!
It has always been an obstacle to my teaching to encounter students whose educational experience has led them to conclude that memorization and regurgitation, or identifying issues, is sufficient to succeed in practice. It has always been a frustration that there are a few law school faculty who choose not to break first-year students of this misperceptions because they fear the dislike of students and the resulting low evaluation scores, because it means I get an even more difficult task of disabusing students of their years of misimpression, which has been even more deeply imbedded into their mental processes because one or two of their law faculty have enabled the flaw.

One of the reasons I invest a lot of time creating 10 new questions each semester for use in during-semester exercises is that I want the opportunity to identify for each student the sort of question-answering pattern that costs them examination points. I prefer that a student do poorly on one 8 point question during the semester and learn not to respond in the same manner the next time around than to have a student do poorly on 50 points worth of questions when there is no next time around (at least not in that course). Too many episodes of remorse and tears accompanied by "I wish I knew this before the exam" and "Now I know why I didn't do so well on my first-year exams" propelled me into the during-semester evaluation process that is unusual for law school courses other than simulation, clinic and other hands-on small enrollment courses (which generally are small enrollment partly because of the need for during-semester evaluation). I've turned my courses into small-enrollment type courses with enrollments of 50, 75, 100, and sometimes more. I've been told by the Dean that it must be an insane amount of work, and it is. But that is, I am convinced, what I am being paid to do.

The tough questions that my students encounter aren't the ones that ask for issue spotting, or even the ones that ask for result. The tough questions are the ones that give the answer and ask why, that ask which argument doesn't fit with the others, that ask what information needs to be obtained from the client before analysis can begin, or that ask which facts need to be changed to alter the outcome.

A few years ago, one very bright, top-of-the-class student who was struggling with the during-semester exercises and baffled by the inconsistency between those scores and the previously-earned grades, said to me, after a series of conversationd over a several-week span, "I get it. Everyone else says 'Here are the facts, what is the answer?' and you're saying 'If we want the answer to be x, what must the facts be?' You've turned around the process into an analytical reasoning. I get it." Sure did. Exercises scores rocketed back up into familiar territory and the student aced the course. The following semester the student returned to tell me that the change in the thinking process had been carried into writing, and that the law firm for which the student had clerked made an on-the-spot offer because of the excellence of the analysis in the writing. THAT means far more to me than the popularity contest played out in student evaluations, some filled out by students who admit to investing an hour or less each week to the course or who otherwise have failed to get on board and are angry because they have not been spoon-fed and coddled.

The problem exists in other professions. There is such a reluctance to offend a student or hurt a student's feelings by telling it like it is that the pressure to inflate grades continues to intensify. I've seen several stories during the past month about faculty at other institutions claiming they had been terminated for having refused to inflate grades. Society is already beginning to pay the price, the price of having people given responsibilities for which they are not prepared, trained, educated, or ready. In the long run, it is a good thing to identify areas needing improvement and to highlight the message with scores and grades that rattle the student. It also makes sense to explain to students what it is they need to be doing and to give them opportunities to try that aren't an all-or-nothing end-of-semester examination. Teaching requires and demands feedback. When I try to persuade students to work throughout the semester and to ditch the end-of-semester cram silliness encouraged by the all-or-nothing end-of-semester exams (even those who evaluate in that manner do not intend to discourage during-semester work), I emphasize that a failed effort is better than no effort because it teaches.

For the students who do what needs to be done, happily or not, their clients someday will benefit. And I don't care that their clients may never know what went into the shaping of the student's mind that contributed to the successful professional. I know, the student knows, and I suppose Higher Authority knows. Oh, I guess now you know.

Tuesday, January 18, 2005

ALL of Gross Income?  

I'm now starting to roll along my latest major writing project, the revision of TM 501-2, Gross Income: Overview and Conceptual Aspects. That's a BNA Tax Mgmt Inc income tax series portfolio for those of you who don't recognize the "TM 501-2" tag. The 501 is the number (first in the revised series beginning at 501) and 2 means it is the second edition. What I produce will be 501-3.

It's hard to believe that this is the third time through with this one. Back in the late 80s, Tax Mgmt approached me with a plan for an "overview" series of income taxation. There were three goals. First, provide the forest that often cannot be seen for the trees. Second, address conceptual issues that don't get attention in the topic-specific portfolio, which puts its focus on practical implementation. Third, pick up detailed discussion of the "orphan" provisions that aren't addressed in other portfolios because they are too "small" to warrant their own book, and lumping them together without an overarching theme would create a jumble.

So I wrote an "overview" of the income tax, other than procedural rules. Don't be misled by "overview" because it is a thorough discussion of every provision, anchored on the Code and dipping into the regulations. For topics needing that detailed discussion, the overview gets into the cases, rulings, and other authorities.

The scope and extent of the product was overwhelming. The original 501 was too big for the binding process that is used, so it was split into two portfolios. TM 502 deals with assignment of income, claim of right, and the tax benefit rule. The original deduction portfolio was split into three (TM 503, 504, 505), with trade or business deductions and deduction limitations each getting their own portfolio. TM 506 covers tax computations and TM 507 covers tax credits. Then TM 560, an overview of tax basis, was added, followed by TM 590, an overview of the taxation of real estate transactions. Recently TM 597 was put together, though it has not yet emerged. It's close, and it will cover Tax Incentives for Low-Income Areas. Most of these portfolios end up as 400 to 700 double spaced pages of text, with anywhere from 3,000 to 5,000 footnotes. I really do wish I could find a way to compel every member of Congress to read these and then in good conscience continue to do to the tax law what they've been doing to it for the past several decades.

Lest this cause you to think I only do overviews, I have also written and updated TM 525, Deduction for Taxes, and TM 531, MACRS. And then there are a bunch of chapters in the digital Tax Practice Series.

Because tax law is so dynamic (a fancy way of saying it constantly changes), these portfolios need to be updated. The 501-507 series went through a series of updates in the late 90s into 2001. Then I turned to updating 560, 590, 525, and 531. Now it's time to update the 501-507 series again. It's been 8 years since 501 evolved into 501-2. And when I'm done generating 501-3 it will be time to turn to, yes, 502, 503, .......

At some point 501 may need to split yet again. The amount of tax law changes and additions affecting gross income is staggering. It's not just "what is gross income" and "what are the requirements for this specific exclusion" but also a question of describing what gross income affects aside from taxable income (e.g., limitation on other amounts), and how gross income intersects with other provisions. Almost every change adds text to the Code, and the additions pour out of Congress incessantly as the special interests line up for their "absolutely necessary" exception to the exception to the exception.

I do learn a lot. I get to write about Code provisions that are far beyond the boundaries of the courses I teach, and that includes the courses in the LL.M. (Taxation) program. I get to see the "entire fabric" of the income tax law, and must make judgments about the depth to which any specific provision is described. It's not like visiting the sausage factory, it's like setting up an easel and painting a portrait while standing a few feet from the production line. I get to read the complicated stuff that most critics discuss in general terms. I'm only into the third of twelve chapters (the first two being relatively short because they are introductory) and already I've met two definitions of hedging, and definitions of six different types of financial products dealers.

Maybe when (if) the newly-appointed Commission on tax reform (haha) decides to look closely at why the tax law is such a mess, they can call me and I'll gladly take them on a tour. After visiting TM 501 I'll let them know that despite its voluminousness and complexity, they will find even more quantities of even more tangled material in TM 506, TM 507 and to some extent, the rest of the series. And then for dessert we'll dig through TM 597, awash in enterprise zones, renewal communities, empowerment zones, and a whole array of different designations for what essentially could be called by one name.

Anyhow, if you notice my usual M-W-F posting pattern change (as it already has), it's because when I get immersed in a segment of a portfolio I stay there and don't emerge for much else. I'll still be sharing my thoughts, but probably on a more erratic pattern, such as T-Th-Sa, M-T-Th, M-T-Th-F, and the like. So check in each day.

Addendum: This posting is about as close to the sort of items one reads in an "online diary" type of blog as I've published. I thought a behind the scenes look at the writing of TM portfolios would be interesting, especially for those who use them. And, of course, I couldn't resist getting in my jabs at the Congress, at the complexity of the tax law, and at the futility of approaching tax reform with a commission many of whose members aren't tax experts.

Monday, January 17, 2005

Spotlights Now Turn to That Penna. Stealth Tax 

In yesterday's post I described the surprise and unhappiness with which employees had greeted the news, from their employers, that the new muncipal emergency services tax of $52 would be withheld from their wages. I noted that not much had been said about the tax by the media and proposed some sort of continuing civics education for citizens and taxpayers

This morning's Inquirer has an article about the tax, on the front page of its second section. Knowing what I do about deadlines, I am guessing that the article was written about the same time as I was posting to MauledAgain, or sooner, because the two writers did some research which makes the article deserving of a read by those interested in what this tax is about.

Popping from out of nowhere onto the radars of many people, hitting paychecks before the recipients can murmur a protest, this tax truly arrived as a stealth tax of the second type. And similar enactments will continue to appear until citizens set up effective long-distance early-warning systems. Or someone does it for them. I prefer the former. Society has enough, no, too many, "get someone else to do it for me" situations. As I asked yesterday, $52 today, $104 next year?

Sunday, January 16, 2005

Stealth Tax, Type Two 

Stealth tax increases always fascinate me. There are at least two types of stealth tax increases. One is the increase that is hidden so deeply in the fine print, masked by assertions of tax neutrality, that it takes a while before taxpayers realized they've been had. The "raise taxes without raising rates" deduction phaseouts enacted by the Congress back in the 80s and 90s are examples.

The other type is of particular interest at the moment. It occurs when a legislature raises a tax, and makes it obvious in the legislation that it is doing so. But for some reason the increase doesn't get much publicity. Sometimes it's because other events grab the news headlines, and sometimes it's because all the attention is given to the "news worthy" portions of the revenue bill.

A few months ago the Pennsylvania legislature enacted an array of tax provisions, highlighted by the legalization of certain gambling and by permitting local school districts to reduce local real property taxes by opting to share in state gambling revenues and enacting a local earned income tax. Buried in the legislation was a provision that permits local municipalities to increase the per capita occupational privilege tax from $10 to $52, renaming it the emergency and municipal services tax.

The legalization of gambling and the prospects for reduction of the local property tax grabbed the news spotlight. The per capita tax provision got about as much attention as a wallflower.

In November of 2004 the township in which I live and work (Radnor) proposed raising the per capita tax and renaming it as an emergency and municipal services tax, and published that proposal in a local newspaper. Some neighboring townships took similar steps. It has been reported that more than half the municipalities in the state in a position to raise the tax have done so.

The Radnor change was adopted this month, retroactive to the beginning of the year. Because the tax is imposed on the privilege of working in the township, or, under the new nomenclature,is imposed on persons potentially using township services, it is collected by employers. And thus the employers had the task of informing their employees that instead of $10 being withheld from the first paycheck of the year, $52 would be withheld.

Employees were not happy. For most, this indeed was news. One employer reports that the staff official responsible for spreading the news was bombarded with phone calls and emails. Unfortunately, that person was merely a messenger, not responsible for the change, and unable to do anything about it. Employees asked if "$52" was a typographical error. No, it was not. Employees asked if the employer was imposing the tax. No, it is imposed by the township, and the employer has no jurisdiction to impose a tax.

It is no secret I prefer user fees. Traditionally, municipalities tax residents for services. Decades ago, there was a strong correlation between those using the services and those being taxed in some way for the services. Present-day living, working, and commuting trends create a situation in which the municipality's services are used not only by residents but by thousands of non-residents working in the township. The renaming of the tax reflects the intention of the legislature that the proceeds of the tax be used to offset the cost of police, fire, EMT, and road repairs, which are conferred on resident employees and non-resident employees alike. Unemployed individuals are not taxed, even though they, too, use these services, and the assumption must be that they are retirees living in poverty or near-poverty. Bad assumption, especially in this township.

There are two concerns with the tax. First, it is a fixed fee, and thus is the same for an employee earning $25,000 and one earning $400,000. User fees are like that. So, too, are the prices of milk, gasoline, and movie tickets. My township has a provision that exempts persons earning less than $2,500 a year. That's not much progressivity, but it's a start. The $2,500 amount ought to be set at poverty level. Second, there have been reports (not involving my township) that municipalities have failed to set up mechanisms to ensure that the proceeds of the tax are funneled into the appropriate fund accounts. If those reports are true, there may be some interesting litigation to report at some future time.

And there remains the major concern about the enactment of the tax increase. It wasn't well publicized. Few people read the local newspaper. The township's web site contained an after the fact report. Rarely do I visit the township's web site, because I consider it as i do a telephone book, namely, I look when I need information. I've not seen anything about this tax that caught my eye in the occasional newsletter that arrives from my representative or state senator in the state legislature. The regional newspapers and television news services don't seem to have given the provision anything more than a mention in passing at the end of an article. Gambling and property tax relief involve many more dollars and just plain make for better headlines and screen-bottom tickers. Film at 11.

The gap between government administration, including revenue and spending decisions, and the citizenry is widening. For many people, education about public sector activity ends with graduation, assuming that it even began. Do they still teach civics?

Many professions require their members to continue education past graduation. There's CLE for lawyers (yep, Continuing Legal Education), CPE for accountants (Continuing Professional Education), and I'm almost certain that physicians, nurses, fire fighters, and others must meet continuing education requirements. Why not CCE? Continuing Citizenship Education. Of course, with taxes, we'd be running to stay in place, considering how frequently the law changes, but think of all the facets of life that have changed since most people were in school: even aside from tax, there have been significant changes in laws, at every governmental level, affecting the environment (dumping, recycling, leaf burning), laws affecting government intrusion into privacy, crimes, vehicle operation (today I saw someone turn right on red despite four large "NO TURN ON RED" signs, so I prefer to think the person needs some education rather than that the person is a callous self-centered transgressor), home businesses, employment of nannies, and on and on and on.

After all, I have the benefit of getting print and digital updates about law, chiefly tax, estate, technology, and First Amendment law, and I missed this change. So how likely is it that folks not plugged into a tax news update service would have been aware of the change? No wonder that a substantial of employees expressed bewilderment, agitation, and frustration. But perhaps this is a lesson. This year, $52. Next year, $104. Ten years from now?

Only an educated citizenry is a free citizenry. Proof of that conclusion can be found all over the world and throughout history.

Thursday, January 13, 2005

The Impact of Death on Web-Based Content 

My post last week on the treatment of email after death has resonated with many people. A friend who graduated from the law school two years after I did sent me an email to inform me that the post had been brought to the attention of 25,000 subscribers to Dave Farber's Interesting People list, though this entry pretty much reaches anyone who surfs the Internet and finds it.

Several people pointed out that a solution to the privacy concern was encryption. For the most part, I agree. I say "for the most part" because there are some danger zones. First, if a person has material that they want to keep encrypted but also make available to the executor (such as financial information and tax returns) and also has those "dark secret" emails, then the password(s) used for one type of document needs to differ from those used for the other type. And the person had best remember which one is which when encrypting and re-encrypting. Anyone who juggles, as I do, more than 100 username and password combinations, understands the danger. Second, if the recipient of email de-encrypts the email, the "published by recipient" problem is not ameliorated. I just read an article in Atlantic that mentioned the purchase at auction by the estate of Eppie Lederer ("Ann Landers") of letters to her from Winston Churchill and other celebrities. Third, don't keel over while the "dark secret" email is being composed or is in unencrypted mode. OK, so I'm being a bit paranoid here. Or so some would say.

Another person raised questions that take the issue beyond emails. She asked about web-based property (such as web sites, photos on web sites, and I presume, though she didn't mention it, information in FTP directories and other Internet accessible data that is not web-based (for, as we often forget, the Internet is more than the world-wide-web)). She wondered what rights the heirs have and how one ensures that the heirs can access the material. She plans to write an article, and so I'll limit my comments to something short of a treatise!

Analyzing the question requires that we divide web-based material into two groups, that which is publicly accessible and that which is not. If it is not publicly accessible (such as business records stored on an off-site commercial storage site), the contract with the storage site owner ought to provide that the customer's executor or attorney have the right of access. The username and password need to be made available by the individual to his or her attorney or executor. Of course, if the person is doing business in corporate or LLC form, then that entity survives the death of the owner and the estate (or trust) succeeding to ownership of the entity would continue to have access under the entity's contract with the site. The risk, of course, is that no one knows the username or password.

For publicly accessible material, the question isn't one of privacy (after all, it's out there for the world to see), but a matter of ensuring that the value of the material, if any, is protected. Material that has little financial value, such as the information on my Maule Familygenealogy web site, might pose a different issue: how to ensure that the site continues. That's fairly easy. Designate a beneficiary in the will or trust, and find a means of transmitting the username and password to the person (together with the files, in case the web site server loses them). I happen to have appointed a "genealogical materials trustee" because there are other items in addition to the web site that need attention that requires a different sort of expertise than does a general or financial fiduciary.

But perhaps there is no need for continuation. For example, the MauledAgain blog will terminate when I check out, and all that is necessary (but not really) is that someone, having my username and password, go on and post news of my demise. Just call it "You'll Be MauledNoMore." Surely blogger.com isn't going to close down my blog minutes after I pass. It probably will sit there for some time. If it were a paid account, then blogger.com's awareness of my demise might come sooner, when someone else (the estate) pays the bill, but that might not necessarily trigger a reaction or even an acknowledgment by blogger.com. Anyhow, I doubt my blog has much value, and considering how quickly tax and technology change, they can put my blog in a digital library (which I think happens anyhow, because there is an outfit somewhere that is trying to preserve every web page that has ever existed in every variation it has manifested).

And what of the "online diary" type of blog, where the owner is anonymous to the world? Is there a danger that the "deep dark secrets" would be publicized? No, unlike the love letters and email discussed in the original post, this stuff already is public. The risk is that somehow the identity of the owner becomes publicly associated with the material. Surely caution on the part of the executor is necessary. I may be missing something here, and I'll let others educate me about the risks of such a connection being made. It may not be as low a risk as I think.

If the publicly accessible material has value (for example, the on-line computer assisted tax law instruction exercises at TaxJEM Inc., if it were held in sole proprietorship form and not in corporate form as that is), then the owner needs to wrap this within the overall planning for the continuation or dissolution (and sale) of the business. The executor or trustee needs to be given the username and password. And the contract with the ISP or other provider needs to permit the executor or trustee to access the site. As a practical matter, the ISP or provider won't know that it is the executor and not the now-deceased owner, who has accessed the site. The first clue would come when any payment for the site is paid with a check from the estate or a transfer from the estate's account rather than with the owner's credit card. And the executor must be vigilant to make certain that the web material isn't being used without authorization elsewhere, because thieves who may be less reluctant to pilfer when the owner is alive (because the owner may periodically check) can be encouraged by death to take advantage of what they think would be a less attentive executor. This may sound as though I have little faith in some people, but consider how many robberies are accomplished by thieves who read obituaries and hit the house during the funeral (which is yet another task for the executor, having someone watch the house, but now I'm getting a wee bit off on a tangent).

These are the thoughts that popped into my head when I received the question and pondered it for a little bit, somewhat organized and hopefully coherent. Comments welcome, and when I get news of the article, I'll share a link or other reference.

Putting Corporate Tax Shelters into the Public Spotlight 

In response to my recent posting about the setbacks experienced by the government in dealing with corporate tax shelters, Joe Kristan of Roth and Co., who delivers the Tax Updates blog, made a suggestion, which he fully describes in his most recent post. Essentially, he recommends that publicly held corporations, which already are subject to a variety of disclosure requirements, be compelled to publish their tax returns.

Joe makes a, oh I ought not do this, compelling argument. He questions whether there are downsides to his proposal. When he put the question to me through email, I replied thusly:
A very interesting idea. These are public companies, so their SEC related disclosure requirements, including "book-tax" differences doesn't make return disclosure an intrusive event.

Would competitors search and disclose? Maybe not. Maybe they'd search and imitate! I think the scrutiny would come from public interest groups, reporters, academics, etc. That's assuming, of course, that from the disclosure one could get to the facts, that is, the underlying documents, etc. But, like you, I ask, what's the harm in trying?
Joe subsequently suggested that some stock brokers might pick up on inconsistencies and questionable items, triggering deeper investigation.

If this idea ever comes to fruition, I hope the world remembers that it originated with Joe. Unlike many, he has thought about the problem and has tried to craft a solution. Even if it never sees the desk of a legislator, it deserves kudos for the effort.

Wednesday, January 12, 2005

Battle Plans for the Tax Shelter Wars: Dealing with Government Losses 

It's late, but I just realized I had tucked this away several days ago. Wednesdays I have four hours of class, and when there is a faculty meeting and some other course-related activities, the blog takes a back seat.

In last week's Tax Notes, Lee Sheppard writes an interesting piece about a tactic used by tax shelter developers to avoid IRS detection and judicial rejection. It's one that is working, as the government has been dealt set-backs in several tax shelter cases, raising serious concerns about the strength of the tax system itself. In "Bury Your Tax Shelter in a Business" (106 Tax Notes 20 (3 Jan 2005)), Lee writes about the bizarre impact of the tax shelter game on businesses, which end up overpaying for things just to get a tax break. (Id. at 21) Take a look. I'm not going to focus on that aspect of the article.

I want to look at Lee's question, "What are the cures?" because among the recommendations are sending federal judges to business school, privatizing tax litigation, and eliminating the "attractive nuisances" in the code. Each of these is a fascinating suggestion.

I like the first idea, but in some respects it reflects deficiencies in our higher education system. After 16 or 19 years of education, a person should have some understanding of how business works. Twenty-year olds may not be interested in the "boring," "complicated," or "oppressive" panorama of the business world, but twenty years later when hindsight becomes 20/20 the reluctance of higher education faculty to require a truly inclusive course of instruction shows its long-term disadvantages. The folks at Wharton required me to take two English Literature courses, and to take several courses from a group that ended up being Anthropology, Roman History, and American Civilization. I groused a bit, but I am so glad I was compelled to do so, even though it meant I needed 40 courses to earn a degree while my friends in the College of Arts and Sciences got by on 32. That's a 25% increase. I surely got my tuition's worth.

The second idea strikes me as attention to a symptom rather than the underlying problem. Lee's idea arises from an understandable concern that private sector attorneys are thumping government lawyers in too many recent tax shelter cases. In the article Lee demonstrates how the cases could have been argued and presented in ways more conducive to a government victory. The problem Lee highlights isn't new, however. For years I've held the position that the famous Sol Diamond case in partnership tax law gave us a bad opinion, in part because it was not argued well, probably because the attorneys didn't really understand partnership taxation (which isn't that much of a surprise). Several decades later, the Campbell case, involving similar issues, ended up a mess because an argument raised by Justice Department attorneys on appeal (which happened to be the right argument) could not be considered because it was not raised by IRS attorneys at the trial level.

As a general proposition, government tax lawyers are younger and less experienced than their private sector counterparts. I observed a Tax Court hearing where a just-out-of-law-school IRS attorney was demolished by a seasoned and nationally renowned corporate tax expert. The taxpayer could afford to pay the latter. The government cannot afford to hire the best and highly experienced. Government pay scales attract law school graduates and other less experienced attorneys, most of whom leave for the more fertile fields of private practice after a few yeras of getting their feet wet. Many of those who remain are assigned administrative responsibilities that distance them from day-to-day litigation.

Privitizing the litigation raises two problems. First, there would be too many conflict of interest situations. It isn't easy finding an experienced tax attorney who isn't handling, and doesn't have partners handling, tax shelter cases. And that's assuming they'd want to take on the task. Second, it would cost a lot of money. Would it not make sense to spend the money hiring, rather than using on a contract basis, experienced tax attorneys? Yes, but where does one find experienced tax attorneys? Every day I get email from law staffing and recruiting companies looking for experienced tax practitioners. In the meantime, graduates who are intelligent, hard working and professionally promising cannot find jobs because attorneys no longer have enough time to mentor a budding tax lawyer. That's one of the disadvantages of the legal profession having become a business. Perhaps a fourth year of law school and an increase in LL.M. program credits from 24 to 48, coupled with more tax clinic experience, would help law schools "deliver" more experienced graduates, but I don't think even such a drastic change would help enough. The tax law is just flat out too complex and twisted.

And that brings us to Lee's third idea. By suggesting the removal of attractive nuisances from the tax code, Lee reminds us that much tax law abuse is generated by the complexities of the tax code that arise from the enactment of special interest provisions whose benefits are sought and exploited by taxpayers not on the radar when the provision was proposed. "This should work for us, too," though not justifying some of the outrageous behavior inherent in many tax shelters, has a bit of an appeal to the taxpayer who is sick and tired of "the other person" getting the break because of a well-placed campaign contribution or a connection to a well-connected lobbyist. Removal of the junk from the tax law would cut back opportunities to scam the system, and it also would make it easier for law school and LL.M. graduates to become seasoned tax litigators.

So back we come to tax reform. I hold out little hope. Bruce Bartlett has written an excellent analysis of why it is unlikely we're going to see genuine reform. It's well worth the read. Sometimes I'd rather keep my expectations low and enjoy the unexpected success than to get my hopes up so that outcomes have me crashing down. This is one of those times when I will believe it when I see it. That won't, however, keep me from griping about the tax system when the opportunity arises. And I'm sure I'll see plenty of those.

Tuesday, January 11, 2005


In her just-released Annual Report, the National Taxpayer Advocate of the IRS has concluded that "The most serious problem facing taxpayers and the IRS alike is the complexity of the Internal Revenue Code."

No. What a shock. What a surprise.

Congress itself, in section 7803(c)(2)(B)(ii)(IX) of the Internal Revenue Code, requires the National Taxpayer Advocate, in its required annual report to the Congress, to "identify areas of the tax law that impose significant compliance burdens on taxpayers or the Internal Revenue Service, including specific recommendations for remedying these problems."

Nina Olson, the National Taxpayer Advocate, explains that:
Focusing on the tax system as a whole, this is an easy mandate to fulfill: Without a doubt, the largest source of compliance burdens for taxpayers and the IRS alike is the overwhelming complexity of the tax code, and without a doubt, the only meaningful way to reduce these compliance burdens is to simplify the tax code enormously. In the balance of this part of the report, we identify and discuss 20 additional serious problems encountered by taxpayers, as required by IRC ยง7803(c)(2)(B)(ii)(III). Most serve as case studies that illustrate the consequences of tax law
To do this, she has issued a 630-page report.

Today's questions:

1. Considering that Congress directs the submission to itself this report, how many members of Congress will read it?

2. How many citizens will read the report?

3. How many citizens will be surprised by its conclusion and analyses?

4. What will Congress do in response to the report, other than issuing a nicely-worded message of thanks to the National Taxpayer Advocate?

5. Will the newly-appointed Tax Reform Commission issue recommendations whose chances of implementation will be enhanced by the content of this report?

The Congress in this regard reminds me of the person who visits a physician to get well, and when the physician points out the person's need to change their lifestyle by no longer smoking, by getting exercise, by eating properly, etc., the person thanks the doctor and ignores the advice. It's as though going to the doctor is sufficient. And in today's climate, when the person dies the doctor gets sued.

Congress doesn't need any more reports. The Tax Reform Commission need not do much but line up the many existing reform proposals, create side-by-side comparisons, and evaluate the arguments made in favor and against each one. The public needs an opportunity to speak (referendum, perhaps?) and then Congress needs to act. Actions speak more loudly than do words, even if there are millions of words already making up the corpus of tax law.

When I arrived in Washington in the late summer of 1976, much discussion centered on the "unnecessary" and "unacceptable" increase in the complexity of the tax law. Almost three decades later, all that has changed is the degree of the complexity. It is far worse, and any reasonable trend line projection suggests that by 2015 the tax law will be incomprehensible to all but omniscient supernatural beings.

Now that this headline news has been flashed around the world (and thanks to Paul Caron's TaxProfBlog for sending in the initial report), we can go back to our lives. In my case I will return to today's project: culling through the last 47 Public Laws that have amended the Internal Revenue Code since I last revised BNA Tax Management Portfolio No. 501 (Gross Income: Overview and Conceptual Aspects) seven years ago. That's roughly a change every two months.

Monday, January 10, 2005

More on Flattery 

In response to my posting earlier today about the risks of letting flattery or skepticism get in the way of what lawyers call due diligence, a reader alerted me that Prof. Fernandez-Barros is an member of the adjunct faculty at the University of Miami School of Law and not a member of the full-time faculty. I did some research, and determined that this is the case.

Though it makes my concerns about the level of legal practice by a full-time law professor irrelevant to the story, it does make it more distressing that a practitioner would not make inquiries of Penske before proceeding. All that has happened is unfortunate. Perhaps this is the story that will trigger a flurry of warnings to all persons, whether educated in law, business, or some other field, to BEWARE of the spammer scammers.

Don't Let Flattery Get Them Everywhere 

It is said that flattery will get you everywhere. Unless, of course, you are on the receiving end and fall for it. Here's a disturbing story.

Back in October, in a post commenting on the surge in spam inundating my email inboxes, I wrote:
And the Nigerian scam has been so outed that only people who have been living under a rock for the past five years would be susceptible.
So when the news broke late last week about the University of Miami law professor caught in a Nigerian spam scam, I figured it behooved me, a lawyer, to look closely at the facts.

According to this story in the Miami Herald, a person claiming to be an official of the Nigerian government emailed professor Enrique Fernandez-Barros, asking him to review some contracts. Fernandez-Barros, a foreign law expert who holds three academic degrees, explained that it was his international reputation that brought the solicitation. The official offered to pay Fernandez-Barros $200,000 and to send him additional legal work if he would help Nigeria and a Nigerian entrepreneur recover $1.68 million from Penske Truck Leasing.

Fernandez-Barros received a check from Penske for $1.68 million, deposited it in his credit union account, and then wired the money to Nigeria. All in a day's work for a lawyer, but Fernandez-Barros ended up involved in a Secret Service investigation that triggered a lawsuit. To make matters worse, Fernandez-Barros explains that he was not paid the promised $200,000.

Apparently Penske owed $1.68 million to Freightliner for trucks that the latter manufactured and sold to Penske. Penske mailed the check but it never reached Freightliner. No one seems to know why. Instead, a check in the same amount was mailed to Fernandez-Barros. According to the complaint in the lawsuit, the check received by Fernandez-Barros had the same check number, date, and signature as the original check but was altered in several noticeable ways. So perhaps my guess is wrong. Perhaps the Freightliner check was mailed to another address, altered, and sent on to Fernandez-Barros, or perhaps it was altered by a Penske employee before it was mailed to Fernandez-Barros. All signs do point, though, to someone at Penske being involved. Perhaps that person, too, was suckered in by the same Nigerian spammer-scammer. Fernandez-Barros explained that the Nigerian business man claimed Penske owed him money for a stock sale, and that the check was sent by an associate of the business man in Atlanta. Fernandez-Barros says that he did not alter the check nor did he know it had been altered.

Penske, instead of suing Fernandez-Barros, is suing its own bank, Fleet, and the credit union into which Fernandez-Barros deposited the check and from which he wired the funds to Nigeria. Allegedly Fleet refused to seek reimbursement from the credit union. The credit union claims it suspected the check had been altered, and held the check for seven days while it contacted Fleet, which allegedly told the credit union that the check was authentic. The credit union claims it held the check for four more days, contacted Fleet again, and received the same reply. The credit union cleared the check after Fleet provided funds from Penske's account to cover the check. No one contacted Penske.

Fernandez-Barros said he "felt flattered" when he was approached by the Nigerian government. He also claims that the Nigerian government got him into the "mess" and that "they used [him] like a ches piece to steal the Penske money."

It seems clear that Fernandez-Barros is innocent. But he was duped. A law professor, an internationl law expert, a highly educated man, was duped. How? He neglected to follow some basic principles.

1. Do not engage in business with a person who solicits you via e-mail and who is a stranger, until you check out the person through other sources. Ask for references who you know. Make inquiries.

2. If the person is from a country known for spammer scammers, contact the embassy or consulate of that nation. In this instance, it would probably have come out that the spammer scammer was not an official of the Nigerian government.

3. Don't let yourself be flattered. Expert or not, be suspicious. In a post-modern world based on selfishness, self-centeredness, rationalization, and greed, it is prudent to be suspicious.

4. Law professors should be teaching and writing. If they are practicing law, they should do so with the permission of their deans, and under circumstances that do not adversely affect their teaching and that safeguards the school's reputation. That's why law professors should not be litigators, because it leaves the class schedule subject to the vagaries of the court schedule. It's one thing to be of counsel to a reputable law firm, and to provide consulting services. It's another thing to embark on a huge project involving millions of dollars with six-digit fees. Had Fernandez-Barros talked to his dean or to a practice-connected trustee of the school, he may have been the beneficiary of their reluctance, suspicion, or need to ask more questions.

5. Think like a lawyer. If Penske owes money to someone it will pay that person directly. If Penske claims it does not owe the money, it has a reason. Contact Penske. A lawyer should, and if competent would, suspect something wrong when asked to receive money from one party and transmit it to another party without having had an explanation and agreement from both parties.

6. Think like a lawyer. The arrangement of taking money from one party and remitting it to another party overseas waves the red flag of money laundering. That's not to say every such transaction is illegal, but a person, lawyer or not, should not participate in it without a full and thorough investigation. Relying on the second party's representations about the first without checking them out is bad lawyering.

What troubles me is the energy that this story gives to the "those who can't, teach" part of the misguided slogan, "those who can, do, those who can't, teach." It insults good teachers. It presumes that lawyers in practice would not have made the same mistake, but in fact lawyers in practice have also been caught up in these scams. Hopefully some good will come out of this story, as it causes more people to be aware of the risks. The spammer scammers will stop only when they receive no replies for months on end. At the moment, I fear, word is spreading in Nigeria, "Americans are easy to dupe. They're gullible. Even their hot-shot law professors can be had." Let's prove them wrong.

Friday, January 07, 2005

The Bad Idea Gets Enacted, So Now What? 

Well, Congress enacted the bad idea I described in a posting the other day. Congress decided that letting people deduct on their 2004 tax returns contributions made in January 2005 for tsunami relief would be a good idea. I suppose the incentive is as follows. A $100 deduction made in January reduces taxes by, say, $20, but that wouldn't be "seen" until early 2006 in the form of a larger refund, or a lower additional tax due. Theoretically, it could be "seen" during 2005 through a reduction of quarterly estimated taxes or a payroll adjustment, but a $20 amount doesn't really work out for those purposes. By letting the deduction be claimed on the 2004 return, the $20 tax savings is "seen" in early 2005. So, at best, the $20 is "seen" a year earlier. What is the value of $20 a year from now? Probably, at current interest rates, about $19.50. So, in theory, someone will decide to make a contribution because the tax law provides an incentive of FIFTY CENTS for every $100. ANYONE who lets THAT be the factor that tips the decision to contribute is, never mind.

And, as I pointed out, for folks who don't itemize, this "incentive" does nothing. A better incentive, that might have had some effect, would have been to make the deduction allowable in computing adjusted gross income so that folks who don't itemize would get a tax benefit.

So let's look at the language of the window dressing that doesn't do anything, really, to spark donations but that will add complexity and compliance issues. It's in H.R. 241:

(a) IN GENERAL- For purposes of section 170 of the Internal Revenue Code of 1986, a taxpayer may treat any contribution described in subsection (b) made in January 2005 as if such contribution was made on December 31, 2004, and not in January 2005.

(b) CONTRIBUTION DESCRIBED- A contribution is described in this subsection if such contribution is a cash contribution made for the relief of victims in areas affected by the December 26, 2004, Indian Ocean tsunami for which a charitable contribution deduction is allowable under section 170 of the Internal Revenue Code of 1986.
Subsection (a) isn't too difficult to understand. But what of subsection (b)? What is the meaning of "a cash contribution made for the relief of victims in areas affected by the ... tsunami"? Is it a contribution made to a fund set up for that purpose? Is it a contribution to a charity that is designated for such relief under a protocol set up by the charity? Does it include a contribution designated for such relief made to a charity that doesn't accept such designations? Is it a proportionate share of a contribution made to a charity that expends a portion of its contribution receipts on such relief?

Will the IRS need to issue guidance? Will it be able to do so by January 31, a day only 24 days away? Surely it can't issue regulations that quickly. It can issue an Announcement, but I doubt it would be out next week.

Tax return preparers, including taxpayers who do their own returns, need to remember to add their January contribution to the contributions total spewed out by their Quicken or other checkbook program. Worse, they need to mark the entry so that in early 2006, when the checkbook program spits out the total for 2005 contributions, they back out the amount deducted on the 2004 return. I am guessing that the IRS will want some indication on the 2004 return that this is being done so that it can set itself up to catch the erroneous second deduction on the 2005 return. I am sure there will be a LOT of those, for unlike the accelerated casualty loss deduction that I described in the previous post, the charitable contribution deduction amount is generated out of checkbook summaries and thus poses a duplication risk that the accelerated casualty loss deduction does not present.

So here we are. It looks good. It doesn't do anything, really, to help anyone, except members of Congress who can crow about their "sensitivity" to the plight of the victims. I have far more admiration for the two former Presidents (interestingly, one from each party) who are making the rounds encouraging contributions than I have for a bunch of politicians who have rarely, if ever, done tax returns and who don't understand tax administration, enacting a concocted theory that doesn't make a difference or have an impact. Once again, underneath the hype, the Congress does more harm than good.

Privatizing Mass Transit: Solving the Opinion Poll Puzzle 

The Pennsylvania Economy League has released results of a poll taken by IssuesPA/Pew, that indicates a majority or Pennsylvanians support new dedicated funding to finance local mass transit systems, but don't show nearly the same level of support on identifying the financing. Although more than two-thirds think there should be "new funding" for local mass transit, only 25% favor a new state tax, only 32% prefer an increase in auto registration and license fees, 41% want to use portions of current sales tax revenue, 45% would use existing gasoline tax revenues, and 46% would give county governments power to create new local taxes.

Pennsylvania is in the midst of a furor over the financing of the Southeastern Pennsylvania Transportation Authority (SEPTA) financial mess. The problem is simple to describe: its expenditures exceed its revenues by many tens of millions of dollars each year, and the trend lines are bad, portending serious cutbacks or even total shut-down if nothing is done. The state legislature, which is involved because it created SEPTA when it commandeered private companies and brought them under government control, has been unable to work out an acceptable solution. The governor crafted a temporary plan that puts a band-aid on a gash, and his request for a special session of the legislature has not been well received by some legislators.

The economics are simple. Either revenues going into SEPTA must increase, or expenditures must decrease. The SEPTA board, even after raising fares yet again (they are among the highest in the nation), also proposed service cutbacks. But even that combination doesn't make the numbers balance.

Expenditures can be cut in one of three ways. The first is to cut back on service, and the howls of protest, from the mayor of Philadelphia, through public advocacy groups, down to the daily rider, have been loud and intense. The second is to cut jobs and ask the remaining workers to do more. Guaranteed, that won't get smiles out of the union. The third is to cut wages or benefits or both. If the second method doesn't get smiles from the union, the third will bring work stoppages and legal action.

So, perhaps the practical solution requires increasing revenues. There are three sources of revenue: users, taxpayers, and private enterprise. The user source is pretty much tapped out, because fare increases push people out of public transit and into cars, and there isn't any way fares could be increased beyond the proposed increases that already are being criticized as excessive. The taxpayer source is the one getting attention in the polls, and it poses the conundrum that the poll reveals. Taxpayers want to provide public (taxpayer) money to mass transit but they cannot agree on where to find that money. New or increased taxes or fees are the poll's biggest losers. Using existing revenue gets a little more support, but who will stand up and identify the programs that get cut? Already there have been proposals to cut highway projects, an idea that is a long-term stupidity. The third source of revenue, private enterprise, deserves some attention.

Understand that although the poll deals with mass transit generally, and there are mass transit systems throughout the state, it is SEPTA that has the biggest problem, in terms of dollars, in terms of number of riders, and in terms of geographic impact. How did it get into this mess? The answer is, government got involved where government didn't have expertise, enterprise became politicized, bad decisions were made, and a hole was dug so deep that it may be impossible to solve the problem.

Years ago, there were several private enterprises operating mass transit in the Philadelphia area. The Philadelphia Transportation Company (PTC) operated subway-elevated lines, busses, and trolleys in the city. Red Arrow Lines operated busses and trolleys in the suburbs. Frontier (whose exact name I don't remember) also operated busses in the suburbs. There were a few others. Commuter rail lines were operated by the Pennsylvania and Reading Railroads, and these lines ran from the suburbs into the city.

As Philadelphia's economy deteriorated and people fled the city for the prosperity and security of the suburbs, during the 50s and early 60s, PTC's ridership went down. A few years later, the Pennsylvania Railroad made some bad decisions that led to its bankruptcy. The suburban companies were financially successful though not wildly so.

Had the free market been permitted to play itself out, PTC would have cut back service on routes no longer needed, and would have re-arranged routes to reflect the changing commuter patterns. As the 60s evolved into the 70s, more and more jobs also left the city, for the suburbs. Instead, PTC started eliminating trolleys. So did Red Arrow. When the trolleys along Route 3, from Philadelphia's western terminal to West Chester were replaced by busses, mass transit forfeited one of its advantages, that is, the ability of a trolley rider to zip along tracks in the median of the highway while ever-increasing traffic snarled at traffic lights. In the meantime, surface routes duplicating the few remaining rail routes were protected from elimination because of protests from riders afraid to go on the subway.

So in step the politicians. They bundle all these systems into one huge bureaucratic mess called SEPTA. City and suburban representatives on the board, speaking for constituents with totally different goals, sniped and quarreled. Year after year, the state would step in with funding, and SEPTA would cry for more. Occasionally something good would happen, such as the construction of the center city rail tunnel that connected the old Pennsylvania and Reading terminals so that regional rail trains could travel from one suburban terminus to another. A line to the airport from center city opened.

In the meantime, automobile traffic grew tremendously. People votes with their tires, or their steering wheels, however one wants to put it. Highway projects were scuttled or scaled back, most long-delayed. If anyone was looking at Los Angeles for an example of what happens when mass transit does not adapt to the needs of the citizens, their voices did not get much attention. So compounding the stupidity of shutting down trolley service was SEPTA's inability or unwillingness to open routes that reflected commuter preferences. When an occasional route was added, it was in the form of a bus that sat in the same backed-up traffic. So what do we have today? Huge busses, with few riders. Take a look, if you live in this area, next time you pass a SEPTA bus.

In recent years, talk of a rail line along the Route 422 corridor has been just that, talk. The cost goes up and up and up as the talk goes on and on and on. That happened with I-476 (the Blue Route) and it now is an unavoidable element in every mass transit improvement project. SEPTA, or more likely, taxpayers, are paying the price for all the bad decisions made during the past several decades. It has become a black hole that will suck more and more money out of the public arena until it goes kaput.

Then what to do? Auction off route rights to private enterprise. Let investors put their money into projects just as they have been putting them into private toll road projects. Let them operate efficiently, without the cumbersome labor protection and politician enhancement syndromes that have burdened SEPTA. Identify commuting patterns and generate route plans that compete with the car. Arrange schedules to meet commuters' needs. Abandon the 9-to-5 live-in-the-suburbs-work-in-the-city foundation that still characterizes SEPTA's operation. Put a trolley back onto the median of Route 3 between the western terminal at 69th Street in Philadelphia and West Chester. Put one on the median of I-476. Put one on the median of Route 422. Put one on the median of Route 202. Make it convenient to use mass transit, and make it economically viable.

And that brings me to the next point. As painful as it may be, it is necessary to impose on cars, trucks and other highway vehicles the true cost of their operation. The gasoline tax needs to be raised. Not to fund mass transit, but to make mass transit comparatively cheaper. So long as the gasoline tax is artificially low, mass transit faces a competitive disadvantage. Use the gasoline tax revenues to fund highway safety, repairs, security patrols, etc. and to fund health care on account of the impact of highway vehicle pollution on individual's health.

And if people vote with their feet and cars, and mass transit doesn't work when it is privatized, then let it die. If democracy means that the voters decide, it means that the voters can decide to do things that aren't all that sensible. It isn't for a few, grabbing power, to dictate to the rest that what the few think is best is what ought to be done. If Philadelphia citizens decide that they want to sit in cars for an average total of 4 work weeks a year rather than use mass transit, so be it.

It is far more likely that private enterprise will create an efficient mass transit system than it is that government would. Government helped create the current mess, particularly by supporting labor demands that would not fly in a free market, and then by amalgamating corroding systems with good systems so that in the end, as a rotten apple does to the good ones in the barrel, the entire system became a mess.

A personal anecdotal note. I have used mass transit, in Philadelphia and in other cities, including several cities abroad. Philadelphia's system is the worst. There is a regional rail station down the hill from the law school. In theory, if I need or want to go into the city it should take 25 minutes. Now, I go into the city only when I absolutely must do so. Why? Using the train became an absurd waste of time. Trains were late. They got stuck. They were cancelled. As much as I dislike driving in or to the city, I'd rather do that than miss yet another appointment. I would use mass transit for my other commutes, but it doesn't exist. I reached deep to buy a home near my workplace so that my commute would be short, and thus less polluting, less expensive financially, and less demanding in terms of time (to say nothing of less imbued with the stress of driving on a road system that also has its flaws).

So, in short, SEPTA is meeting the needs of very few people. That's why it doesn't surprise me that there isn't majority support for a public funding method. My guess is that the support for public financing generally is a recognition that there are some people who have no choice but to use SEPTA. I'd like to see another poll that puts private enterprise as an option. I think it might do well. And it would erode the preconceived notion held by so many that mass transit is and can only be a government endeavor.

Thursday, January 06, 2005

Maybe We Are Part of the Project, After All 

In yesterdays'post about the Comcast deal, I stated
Anyhow, I'm grateful to Andy Cassel for putting this issue in front of taxpayers as he has, bringing to them the facts and analyses so conveniently left out of the champagne-popping gala press conferences that the developers and Comcast hosted the other day. Oh, I wasn't invited. Were you? After all, we're not part of the project. Other than paying for part of it. Some might say we were mugged for it.
Well, perhaps I was a wee bit wrong. As this wonderful editorial cartoonfrom Signe Wilkinson of the Philadelphia Daily News shows, surely we are. And will be.

Wednesday, January 05, 2005

"Gimme All Your Money ... Oh, OK, Then Gimme Some of It" 

In his column in today's Philadelphia Inquirer, Andy Cassel notes that after considering the mayor's criticism of people who are "less than appropriately grateful" for Comcast's decision to build a new skyscraper in center city Philadelphia, he has concluded that he is "quite grateful" that the building will cost taxpayers $43 million rather than the much larger amounts that would have been required had Comcast succeeded in gtting the new building designated as a Keystone opportunity zone. Readers of MauledAgain know that I was among those who criticized Comcast's attempt to shift its costs onto the public, as this February discourse and this Thanksgiving praise for its rejection by the legislature will attest.

Consider a mugging in which the criminal says, "Gimme all your money." The victim, foolishly but courageously explains, "But I'm on my way to buy food for my babies." The mugger replies, "Oh, OK then gimme some of it." Is the mugger any less a criminal? Should the victim thank the mugger for the mugger's generosity?

Anyhow, considering the title of his column ("Let's be grateful for Comcast pork"), I do think Andy is having fun with this one. After all, he points out that far more tax dollars went into the two sports stadiums recently constructed in South Philadelphia. He explains that rents in the new building will need to be at rates far higher than those being charged for existing buildings, and that with current space only 80% occupied, it's a bit difficult to figure out where the tenants will be found. He notes that Comcast can afford the rent, a mere drop in its $20 billion annual revenue bucket. And he asks how would any of us react to the government dropping a $43 million subsidy on a competitor?

He concludes by highlighting the basic issue, namely, not whether the building would be built, but who would pay for it.

My response to that question remains as it has been. The owners and developers can pay for it. And they can recoup their costs by finding tenants willing to pay a 60% rental premium to locate their businesses in it. And if it falls through, the owners and developers can pay the price for their bad decision. Taxpayers haven't had a say in the making of the decision, so they ought not have to pay for the consequences of it. Alternatively, each taxpayer can be given $43 million to subsidize his or her pet project, and we'll be so kind as to cut the government in for a big chunk of our profits. If there are any. How's that for fairness? Or are most taxpayers, unlike Comcast and the developers, unworthy of such assistance? Why?

I wonder how much SEPTA and its riders would benefit from a $43 million subsidy. Considering the mayor's pleas for taxpayer bailout of the SEPTA mess, I wonder if he, the mayor, doesn't have his priorities in the right order. I wonder what happens to the value of the new building if SEPTA curtails or ends its operations?

Anyhow, I'm grateful to Andy Cassel for putting this issue in front of taxpayers as he has, bringing to them the facts and analyses so conveniently left out of the champagne-popping gala press conferences that the developers and Comcast hosted the other day. Oh, I wasn't invited. Were you? After all, we're not part of the project. Other than paying for part of it. Some might say we were mugged for it.

Complicated Acceleration: Good Intentions, Bad Idea 

According to an AP new report, two Senators are sponsoring a bill that would amend the Internal Revenue Code to permit taxpayers to claim as charitable contributions on their 2004 tax returns amounts that they contribute during January 2005 for tsunami relief. This would change the long-standing rule that charitable contributions are deducted in the year in which they are paid. That rule applies to most deductions; there is an exception that permits taxpayers to claim casualty loss deductions in an earlier year if the loss arises from a casualty occuring in the later year.

My question is "Why?" The Senators' response is that they hope the legislation would bolster support for private contributions for tsunami relief. Considering that private contributions are flooding (sorry) into charitable organizations, is there really any need for more incentive? Even if it is true that some people give only because there is a tax break, many people (most people) give for other reasons, and surely the advancing of a deduction from 2005 to 2004 is not the sort of thing that would generate a surge (sorry again) in giving.

Even if the proposal did spark an increase in giving, it isn't worth the cost. The proposal complicates the tax law. It presents at least two serious practical problems.

The first problem is that taxpayers would need to identify giving for tsunami relief. Must the contribution be to a tsunami relief organization? Can it be to any qualified charity, so long as it is designated for tsunami relief? What if it is made without such a designation, as some charities have been requesting, but the charity provides tsunami relief? Does the taxpayer treat x% of the donation as tsunami relief if the charity spends x% of its outlays on tsunami relief?

The second problem involves the reporting of the contribution on the tax return. When a taxpayer sits down in early 2006 and adds up charitable contributions, will the taxpayer remember that a few of the January checks were deducted in 2004? Maybe, maybe not. How will the IRS develop information for auditing the potential deliberate or mistaken double deduction, assuming Congress gives it funds to deal with the issue? Presumably, Schedule A would need a separate line showing "Jan. 2005 tsunami relief contributions." Yet Schedule A for 2004 has already been released. Changing it requires a several-week process, at the best (and usually takes months), because all sorts of agencies and reviewers get involved in a tax form development or revision. The downside of waiting for the revised form, thus delaying filing and delaying receipt of the refund, well may offset the benefit of accelerating the deduction into 2004.

There is one other observation that needs to be made. The proposal has no effect on taxpayers who do not claim charitable contribution deductions because they claim the standard deduction rather than itemized deductions.

Even though the Senators' aides predict quick passage, I have my doubts. There are other, less complicated, less chancy, and less questionable ways to assist those in need and to encourage others to do so.

Tuesday, January 04, 2005

Sorry I Wrote....? 

Time to wander from tax into another area of interest (and one in which I also teach), that of wills and trusts. Specifically, time to explore the application of superficially simple legal principles to practical application in a context often overlooked by people when they are looking at their estate planning and setting things in order.

Last month, the medial outlets lit up momentarily on a story that quickly faded into the background as other, more pressing and serious developments moved onto center stage. The story involves the family of an American soldier who was killed in Iraq and who want Yahoo to turn over his emails. The soldier had used Yahoo to send emails to members of his family.

Yahoo refused, citing language in the contract that the soldier had with Yahoo. It states: "No Right of Survivorship and Non-Transferability. You agree that your Yahoo! account is non-transferable and any rights to your Yahoo! I.D. or contents within your account terminate upon your death. Upon receipt of a copy of a death certificate, your account may be terminated and all contents therein permanently deleted." This language, and the entire contract, can be found at Yahoo's web site. Yahoo risks all sorts of legal problems, including actions by the FTC or a state's attorney general, if it violates these privacy provisions. The soldier's family could seek a court order directing Yahoo to turn over the emails, and that would absolve Yahoo from the risks it sensibly has tried to avoid.

There is, though, a lesson for all uf us in this unfortunate situation. Whether one's correspondence is digital (email) or pre-digital (paper letters), a person needs to consider what happens to that material when the person dies.

One view is that the correspondence is property, and as such becomes part of the decedent's estate. In the case of the Yahoo email, the contractual provision does not so much make the email Yahoo's property as it prohibits Yahoo from releasing the property to anyone (because there is some question as to the ownership of the property). Of course, emails and letters in the possession of recipients are not the decedent's property, and thus could not be the estate's property, but those items raise a totally different issue that transcends death. After all, a recipient of a letter or email who is not otherwise bound to confidentiality faces few legal obstacles to releasing the correspondence (and as a practical matter, the biggest obstacle is that the recipient usually has little to gain and much to lose by doing so, but if that's not the case, the tabloids and others can have a feeding frenzy).

If this view is correct, then the decedent's will dictates the disposition of the letters, subject to some restrictions. How many people deal with this issue in their wills? Few. If there is no will, the intestacy law applies. Does intestacy law deal with this issue? Not really, other than through some tortured analogies that are great efforts to deal with an overlooked problem. So what is the executor to do? Technically, absent a provision in the will, the correspondence goes to the residuary beneficiary. What if the residuary beneficiary is a charity? Or a distant relative? Or a casual friend? The information in the correspondence could easily be on the market within weeks.

Can the executor claim that the fiduciary obligation imposed on executors require or permit destruction of the emails and letters? No. In fact, even if the decedent directs the destruction of the correspondence it is questionable whether such a command will be followed. The law in this area is confusing and fascinating.

Courts have long held under principles of public policy, that a decedent cannot direct the destruction of property after death. Thus, even though a person, while alive, can light a proverbial cigar with a proverbial rolled up $20 bill, one cannot order one's cash burned after death. Nor, according to several cases, can one order the razing of one's home (even if one could do so during lifetime), and this is an issue aside from permits and environmental concerns.

So in the classic hypothetical, when the decedent dies, love letters written to the decedent are found. Make the hypothetical interesting by identifying the writer as either a famous person or, better yet, someone whose position and status makes those letters scandalous (as if today there's much left that can fall within that term). So, however one wants to set up the facts, do so in a way that gives the love letters value. In our world of Warhol minutes, reality TV, and gossip run amok, it's unlikely that any love letters would lack value. The same is true of any other sort of letter (though love letters makes the hypothetical more interesting and gets the students' interest). The more secrets, the deeper the secrets, the more widespread those impacted or interested in the secrets, the higher the value of the email or other correspondence. I suppose that for celebrities' correspondence, the value reaches a peak and the issue is more likely to be litigated.

So if a decedent cannot order the burning of cash or the razing of a home, should a decedent be permitted to order the destruction of correspondence that has value? If the answer is yes, then those carving out an exception need to define the line, and I'm not convinced that the line can easily be drawn. Would it extend to home movies? Audiotapes? Photographs? Art work?

Surely one can think of reasons that the decedent would want the material destroyed, but then again, the decedent could have destroyed the material while alive. Except that destroying email on the email server of a commercial internet provider isn't easily accomplished, and might not be possible with emails less than 30 or 60 or 90 days old. But one also can think of reasons OTHER people would want the decedent's email and other materials destroyed: as one person pointed out (archived at Politech), "the emails might reveal the secret abortion of the sister or the secret first marriage of the father."

Digital technology puts yet another wrinkle on the issue. Paper correspondence sent to another person is in that other person's hands, and unless a photocopy was retained, it is beyond the reach of the decedent. The decedent cannot destroy it. Nor do the decedent's executor and beneficiaries have access (though, of course, the recipient's executor and beneficiaries might get their hands on it). With email, not only is the incoming correspondence on the server or computer, so too is the outgoing correspondence, or at least some of it is. Keep in mind that email is far more voluminous than is paper correspondence, perhaps by an order of magnitude.

Putting a direction in a will to destroy "love letters" could be counterproductive because wills aren't private. They become public when probated. "Destroy the love letters ....." or "Burn the letters received from ...." language would create all sorts of an uproar, and even if the contents never became public, the existence of the material would fuel the rumor mill for a long time, even if the decedent was not a national or international celebrity. After all, each one of us is a celebrity in our own little world. And, of course, "burn all correspondence" is overkill that by reaching legitimately retained financial and other information necessary for tax return and other compliance would give a court even more reason to hold to the principle that one cannot order the destruction of property after death.

It makes more sense to direct all property to a pre-existing trust and to give direction to the trustee (assuming, of course, that there is a right to order destruction of property). If the will inadvertently or deliberately incorporates the trust by reference, all bets are off because the trust is part of the probated will rather than a separate entity.

This is a huge issue for estate planners, but I don't think it gets enough attention. Perhaps, in days long gone, it wasn't an issue because there wasn't as much material, it was confined to letters, destruction could take place without anyone's knowledge except the executor or close family member, and the world wasn't as interested in the information. The digital world of email bring internet service providers into the picture, technology has opened the door to audio and video, the culture has become one very interested in the doings of other people, and the lure of money has become even stronger. All of those factors combine to make this issue one of growing, not lessening, importance.

Let me prove my point this way. When I teach this issue (and unfortunately it gets about 10 minutes), I ask my students to think about a possible premature death and the contents of their laptops and email accounts. A hush settles over the room, broken by sighs and groans. Clearly I have disturbed them, or at least their comfort zones. Then I point out that deletion of a file on a computer really isn't deletion (proving yet again why it is extremely difficult to practice or teach law effectively without having a good grasp of current and future technological developments).

I will close with a bit of theological insight that I don't share in my class (not only because of time constraints but also to spare taking the students on too wide of an analogy). In some of the theologies that include belief in an after-life, knowledge is universal. In the afterlife, everyone knows all things and all people, because everyone fully knows God, and by knowing God one knows all God knows. I don't profess an ability to explain this, though I can aver it was taught to me though not in those precise words. So if it does turn out that way, the only advantage to hitting the shred (not delete) function, and burning letters, is an information delay in the present temporal sphere. None of that, however, is going to reduce the tribulations of those whose secrets and private goings-on end up publicized among a small or wider audience because someone's email or letters were property with value that could not be destroyed.

Though I cannot give an "answer" to these questions, I can return to the tax world and share this conclusion: if the executor destroys the correspondence, there is no casualty loss deduction for the estate. Query whether the beneficiary who fails to recover damages from the executor for an unauthorized or illegal destruction has a casualty loss deduction.

So, estate planners and will drafters, what have your clients been asking you to do? And, for everyone, if you've thought about this question, what have you decided to do?

Sunday, January 02, 2005

Avoiding a Triple Whammy 

A question was raised about the tax treatment of transactions in which the SEC refunds to the shareholders of a corporation fines that the SEC imposed on the corporation for securities law and Sarbanes-Oxley violations committed by the corporation's officers, directors, and others. As is often the case, analyzing the tax consequences requires an understanding of the underlying transaction (which is why the tax lawyer is the last of the general practitioners: tax affects everything, so tax lawyers need to understand everything, and I'm here to help out, ha ha).

A policy question is simply why should the shareholders get a refund of fines imposed for illegal activities. The answer, I think, is that usually some of the shareholders are innocent of the wrong doing and in most instances have suffered economic harm. A good criticism of my analysis, though, is that the SEC doesn't make that distinction, so culpable shareholders end up sharing in the refund of the fines, a result that does not make much sense and is difficult to justify.

Yet I can understand treating all the shareholders as culpable if the fine is for activity that harms outsiders and not shareholders. One example offered to rebut one of my arguments is the fine imposed on a corporation because its trucks are overweight. In some respects none of the shareholders are responsible except for those who are officers, and yet in other respects all the shareholders are responsible because it is THEIR corporation that "misbehaved." In contrast, though, I distinguish the types of cases involving the SEC fines, because those are instances in which SOME shareholders deceive outsiders AND the OTHER shareholders. Analogies to partnership law support this distinction (which apparently isn't applied by the SEC when it makes the refunds, and note I use "apparently" because I don't know with certainty and wait to be enlightened).

Another question: why not refund the fines to the corporation? If that happens, the corporation's creditors get to the funds before the shareholders do. Why give the shareholders a financial advantage that they would not have under state law? I don't know. I need someone expert in securities law and in the nuances of Sarbanes-Oxley to explain this to us.

Now to the tax issues. Remember, the shareholders, innocent and culpable alike, almost surely have suffered a loss from the decline in the value of the stock. Then the stock value is further reduced when the corporation pays the fines, because that reduces the corporation's net asset value. When the shareholder receives the "refund," does the shareholder have gross income? Yes, unless an exclusion applies or unless the transaction is recharacterized in some manner. It is possible, to make things more confusing, that the shareholders receiving the refunds are not the shareholders who owned the stock at the time of the wrong doing or at the time the fines were paid.

If there is income, can shareholders increase their adjusted basis in the stock? There's no authority for doing so. What if the shareholder already sold the stock? Can the refund be treated as additional amount realized, thus reducing capital loss or increasing capital gain on the sale transaction?

If the SEC is refunding the fines to the shareholders because it doesn't think that the corporation would take the refund and distribute it to the shareholders (which, of course, the corporation very likely would be prohibited from doing because there are creditors lined up waiting to be paid), then why not treat the transaction as though that had happened? If that recharacterization applies (treating the one step transaction, refund from SEC to shareholders, as two steps, refund from SEC to corporation, and distribution from corporation to shareholders), then the refund to the corporation would be excluded from gross income under the tax benefit rule because the fines were not deductible. The deemed distribution to the shareholders would be treated under the usual rules, namely, dividend gross income to the extent of earnings and profits, and then reduction of basis in the stock, and then capital gain.

I like this question for three reasons:

1. It's a current issue with respect to which tens of thousands of shareholders, with assistance from their tax advisors, need to determine an answer so that they can report what ought to be reported on their income tax returns.

2. It's yet another example of transaction recharacterization, which law students, at least, find annoying. Years ago a student expressed annoyance at the "deemed this and deemed that which doesn't happen but which we pretend has happened." Though the deeming technique seems inconsistent with my dislike of the pretense approach, it actually works the other way around, namely, taking what appears to have happened and treating it as though what really has happened has actually transpired. The SEC, in other words, is refunding fines to the only person to whom it can refund the fines, namely, the payor corporation, and the only way the money ends up with the shareholders is a corporate distribution. I introduce students to the deeming technique with a problem in the coursebook that I use: an employer transfers an automobile to the spouse of an employee to induce the employee to remain with the employer and not take another job. What appears to be a transfer from the employer to the spouse is compensation from the employer to the employee and a tax-free marital gift from the employer to the spouse.

3. It's yet another wonderful example of the fallacy in the statement, "Oh, tax is just plugging numbers into a formula and it really isn't law like everything else we teach" and in similar assertions. Students who demand "Just give us the answers" are again exposed to more proof that the reasoning is more important, sometimes, than simply the answer. I say sometimes because when the answer is clear, the reasoning in support of the wrong answer isn't worth much. After all, the computer programmers can't do a thing until the tax lawyers explain what the transaction is and how it should be treated.

Now I'm going back to my other numbers-type project, which is rebuilding my ahnentafel. I may share some thoughts about some of the interesting challenges I've encountered and observations I've made. Later.

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