Monday, August 07, 2006
In one of your recent posts you refer to the compliance burden and the need for tax simplification. In my opinion, THE most complicated aspect of the tax code is that it regularly changes. If the law were to remain relatively constant, then taxpayers and practitioners could learn the law and each year's tax filings would be much easier. Of course, taxes could be increased or decreased by changing only the rates of tax.When I replied, I mentioned the proposed five-year moratorium on tax changes that passed the Senate on June 24, 1986. It was rejected, however, in conference the following month. The text, which can be found in the June 23, 1986 edition of the Congressional Record at page S8175 is as follows:
The problem that I see with "simplification" is that it requires additional changes to the tax laws. As a result, simplification creates complexity. In addition, I am skeptical that the legislative process can achieve and/or maintain true simplification.
SEC. . MORATORIUM ON TAX LEGISLATION.Does anyone want to guess why this proposal was rejected? Perhaps some lobbyists saw their incomes jeopardized? And it only was a "sense of the Congress" and still the Congress couldn't bring itself to agree to the obvious.
(a) Findings.--The Congress finds that--
(1) constant and conflicting policy changes in the Internal Revenue Code of 1954 (hereinafter referred to as the "Tax Code") make it difficult for individuals to properly plan for the future,
(2) constant and conflicting policy changes by the Congress retard capital formation by increasing the risk of a project,
(3) constant and conflicting policy changes by the Congress place undue burdens on individuals and businesses by requiring utilization of financial resources to anticipate such changes and modifications in the Tax Code,
(4) the Internal Revenue Service is drained of limited resources in trying to adapt to changes in the Tax Code,
(5) one of the greatest burdens placed upon small businesses is the completion of paperwork to comply with the Tax Code, and constant changes by Congress unnecessarily compound this paperwork burden,
(6) any tax reform legislation passed by the Congress should stimulate economic growth, encourage investment, promote capital formation, expand job opportunities, and encourage savings, and
(7) the American taxpayer deserves certainty in the tax treatment of economic decisions.
(b) Sense of Congress.--It is the sense of the Congress that the provisions of the Internal Revenue Code of 1954 which are added or amended by this Act remain unchanged for at least 5 years in order to provide stability for the American taxpayer and the private sector.
The difficulty is that during the two decades since this noble attempt failed, the very thing that was most feared came to pass. The tax law has been riddled with special interest legislation that has turned the Internal Revenue Code into an almost-unadministrable thicket hanging onto the edge of the implosion cliff with its fingernails. A moratorium at this point would be the equivalent of putting garbage in the freezer.
Andrew is correct, though, that simplification will require transition and adjustment. If not with respect to every change, then surely with respect to many changes. And if not with respect to compliance, then surely with respect to planning. After all, elimination of special low tax rates on capital gains would make tax return preparation easier, reduce the "fit it on one page" pressure faced by forms drafters, and shrink the size of tax preparation software. That would make compliance easier from the moment of change. Tax planning, however, would be a whirlwind of panic and frenzy, as those in a position to benefit most from these special low tax rates would be frantic in their search for a replacement tax escape package.
I'm willing to pay the short-term price for long-term tax simplification. It's like cleaning out the garage. Yes, it requires an investment of time to sort everything into a trash pile and a retention pile, and to separate the latter into organized segments. But in the long-run, it makes finding things much easier, and the time saved over the long haul far exceeds the time invested. If the garage is not cleaned, it will get worse, and eventually someone, someday, perhaps when the house is sold or the owner dies, will face an almost Herculean task of digging through mounds of stuff. Of course, had things been kept organized from the get-go there would be no need to engage in a garage cleaning effort, but the tax law is long past the point of sensible development.
Ultimately we have no choice. Either we fix the tax law today, or we wait and fix it tomorrow. Oh, we could ignore repair altogether and watch the lifeblood system of the nation implode. It's not unlike the choice facing us with respect to the federal budget deficit. Fix it today or deal with it tomorrow. In both instances, the task waiting for us in the future will be exponentially more difficult than it would be today. Like the messy garage, sooner or later something will give. Why not deal with it while there are choices?
Friday, August 04, 2006
What does disappoint, but not surprise, me is the even lower levels to which politicians sink in an attempt to manufacture artificial support for something. Rather than sell their estate tax plan on its merits, the opponents of the so-called "death tax" resorted to other tactics. In all fairness, they did try to sell their plans on their respective merits, but no matter which variation on the theme they advanced, America wasn't buying. Rather than admit defeat, these stubborn advocates of tax cuts for the wealthy resorted to what must be called political bribery and trickery.
First, the trick. The estate tax reduction and elimination crowd tacked their proposal onto a bill that would increase the minimum wage. They figured that by doing so, opponents of the unpopular estate tax reduction and elimination plan would be forced to vote for it because they would otherwise be tagged as having voted against a bill increasing the minimum wage. Fortunately, this Machiavellian, manipulative nonsense didn't work. For whatever reason, these medieval tactics were seen for what they are, and were rejected. Perhaps the advent of 24-hour-a-day news channels, email, blogs, and other avenues of watching Congress operate in real time has moved the nation past the days when deals were made in smoky back rooms, and the populace learned about the shenanigans after the fact. "Well, that's politics," my critics have said and will say. My response is simple. That sort of politics ought to be rejected and outlawed. It taints the principles and ideals for which this nation claims to stand.
Second, the bribes. Advocates of the estate tax reduction and elimination plan added so-called "sweeteners" to the legislative package. Each one was designed to target the vote of one or two particular Senators. There was a deduction for timber capital gains, as if special low tax rates weren't enough. There was a tax credit for state and local taxes. There was a program to encourage reclamation of abandoned mines and a tax benefit for investing in mine safety. There was a deduction for research and development. There was a deduction for the travel expense of spouses. There was a deduction for college tuition. Ironically, most of the Senators whose votes were the target of these bribes did not fall for the gambit. They voted against cutting off debate. Considering the impact of these so-called "sweeteners," namely, more complications in the tax law, bad policy, increases in the federal budget deficit, and ineffectiveness of the provisions, it's a good thing that they failed to buy the votes.
Of course, all that has happened is that debate continues. In fact, Senator Frist changed his vote from supporting the motion to cut off debate to voting against his own proposal so that he could preserve his right to resume debate when the Senate reconvenes. He just doesn't get it. He's a physician. He's accustomed to keep trying when resuscitation efforts don't revive his patient. He's in the habit of applying the electric paddles time and again. Stubbornness may be a fine quality in a physician, but in a representative political system, there's a point at which defeat must be accepted and efforts turned to other projects. Even the best medical professionals are compelled by reality to stop and pull the sheet over the patient's face. Your estate tax plans are flat-lined, Senator Frist. Pull the plug.
Wednesday, August 02, 2006
Never one to rest on his laurels, or charts, Andrew also revised several charts that he had previously put up on his web site. This recent activity brings the total number of charts to 279. According to Andrew,
The recent charts include:and charts have been revised for
1. Davis (Transfer for Release of Marital Claims)
2. Eisner v. Macomber (Stock Dividends are Not Taxable)
3. General Utilities (No Gain on In-Kind Corporate Distributions)
4. Glenshaw Glass (Accessions to Wealth)
5. Hendler (Liability Assumption was Boot in a Reorganization)
6. INDOPCO (Deductibility of Takeover Expenses)
7. Kirby Lumber (Gain on Bond Retirement)
8. Knetsch (Sham Interest Expense)
9. Lucas v. Earl (Income is Taxed to the Person who Earned It)
10. Schlude (Prepaid Dance Lessons)
11. Tufts (Debt Relief from Nonrecourse Mortgage: FMV of Property Less Than Debt)
12. Welch v. Helvering (Deductibility of Reputation Payments)
:1. Crane (Debt Relief from Nonrecourse Mortgage)For those needing cross-references to my previous commentary on Andrew's chart work, look here, here, here, here, here, here, here, here), here, here, here, and here.
2. Gregory v. Helvering (Spin-off with Transitory Controlled)
3. Seagram (Pre-Acquisition Continuity of Interest in Multi-Step Forward
Andrew continues to welcome comments on his charts. You can contact him through his web site. For direct access to the charts, you can enter by Topic, by Alpha-numeric order, or by Date uploaded . I suppose if you don't see a chart for something you'd like to see in visual representation, you can send Andrew a nomination for another chart. I have a feeling he'd be glad to add one to the growing collection.
Monday, July 31, 2006
The report to which Matt steered me questions the revised estimate. It points out that when borrowing from the social security trust funds is taken into account, the deficit is on the order of $470 billion. By ignoring this borrowing, the Administration's deficit estimators shift the true excess of spending over revenue to the future years when that trust funds will need to be repaid. During the past five years, according to the report, more than $800 billion has been borrowed from the social security trust funds to finance the shortfall in revenue.
Members of the Administration are touting the revised deficit estimate, and its cause, as a sign that tax cuts are working as intended. Excuse me, but that makes no sense. Without the tax cuts there would be little or no budget deficit. So we're supposed to cheer because the mess isn't quite as bad as it appeared to be? I'd be impressed if the revision showed a budget surplus, because THAT would demonstrate the validity of the "cut taxes, double revenue" nonsense spouted by the "I refuse to pay taxes because I'm special" crowd and the "I cannot pay taxes because I'm selfish" group.
A closer look at the source of the increased tax revenue is most revealing. A significant chunk of it reflects increased corporate taxes, a natural consequence of the huge increase in corporate profits during the past half-year. Most of the rest reflects taxes on high-income taxpayers who have received bonuses. The Washington Post article goes into greater detail on these points. It also explains that taxes on wages are barely increasing, because wages are increasing only slightly. In other words, the tax revenue increases are consistent with the shift of income gains away from the middle class and toward the very top of the income and economic ladders. The rich get richer ....
Making the situation worse are the allegations that the Administration initially overestimated the deficit so that it could return and claim that it deserved kudos for reducing it. That's a ploy not unlike the child who says to a parent, "Would you be upset if I told you I broke the heirloom vase?" only to follow-up with the following comment to the rattled parent, "Well, I didn't. It's just that the picture window is broken." There's one word to describe this approach: manipulative.
Worse, the Administration used the phrase "mission accomplished" to describe the news. What mission? Was the goal to have a deficit? That's a stupid goal. If the goal is to eliminate the deficit, the mission was not accomplished. Of course, the Administration excels at premature declarations of accomplished missions. The only mission that is being accomplished is the continued shifting of income and wealth from the vast majority of Americans to the few power elites who make eighteenth century French nobility appear gracious and generous.
Unless spending is reduced, and one can debate how much existing spending can or should be eliminated, revenues must be increased to cover the cost of government spending. If the level of revenues required to sustain current spending is unacceptable, then the advocates of the spending must re-think the matter. It is interesting that some of the strongest champions in Congress of government spending, identified by voting record and not campaign rhetoric, are also strong supports of special low tax rates for capital gains and repeal of the estate tax. One wonders if they truly believe in what they are doing or simply are trolling for votes (to use the euphemistic version of the phrase I'd like to use), for if they truly believe that reducing taxes raises revenues, why not reduce all tax rate to zero on the claim it would produce infinite revenue?
The price that is going to be paid for this fiscal irresponsibility will be steep. Those who warn us that our children and grandchildren will be paying this price are far too optimistic. The price will be paid, very soon. So very soon, in fact, that we will be paying the price. In more ways than one.
The solution is easy: remove the special low tax rates for capital gains. Adjust asset basis for inflation. Restructure the income tax rates to reflect the windfall nature of incomes exceeding $5,000,000 per year and $25,000,000 per year. Abolish tax credits and deductions designed to influence social policy. Fund the IRS with adequate means to chase down unpaid taxes owed under existing law. Either reform Medicare spending or increase the Medicare payroll tax so that Americans can see the true cost of the Medicare program. And ditch the pork barrel spending projects.
This solution will not be enacted. Politicians drunk with power have no more ability to restrain their binging than does a addict crawling down the street looking for the dealer. We have only ourselves to blame for sending these folks to Washington year in and year out. It is said one gets what one pays for. It also should be said that one gets what one votes for. And in this case, it is federal budgetary disaster.
Friday, July 28, 2006
In the early 1990s, the IRS proposed a requirement that persons seeking to be revenue agents complete at least thirty semester hours of accounting courses, and demonstrate knowledge in five specific areas of accounting. Thirty semester hours, incidentally, is equivalent to ten three-credit courses. The thirty-hour requirement would replace an existing 24-hour requirement. The IRS proposal was approved by the Office of Personnel Management and included in its Qualifications Handbook.
The IRS implemented the change in 1995. It "grandfathered" existing agents, letting them continue in their positions even if they did not meet the new requirements. However, because of budget constraints, the IRS did not apply the new requirements to job applicants until 2002. When the IRS denied an application by an employee to become a revenue agent because she did not meet the thirty-hour requirement, she filed a grievance. The union also filed a grievance, taking the position that requiring agents to have knowledge in five areas of accounting was unacceptable.
The grievances went before an arbitrator, who concluded that both new requirements were educational requirements, and that because existing agents could perform their duties successfully without satisfying either of the new requirements, imposing the requirements on new job applicants violated section 3308 of United States Code title 5. That provision states, "The Office of Personnel Management or other examining agency may not prescribe a minimum educational requirement for an examination for the competitive service except when Office of Personnel Management decides that the duties of a scientific, technical, or professional position cannot be performed by an individual who does not have a prescribed minimum education..."
The arbitrator also concluded that imposition of the new requirements violated Section 3(B) of Article 13 in the collective bargaining agreement between the IRS and the union. That provision states that "selective placement factors will only be used in determining eligibility when they are essential to successful performance in the position to be filled." Again, because the arbitrator concluded that existing agents were able to perform their duties satisfactorily without having met the new requirements, the IRS violated the agreement when it imposed those requirements on new job applicants.
However, the arbitrator concluded that the IRS had not violated section 300.103 of Code of Federal Regulations title 5, because it "rationally could have found" the requirements related to a person's performance as a revenue agent. The arbitrator determined that the IRS had conducted three analyses of the revenue agent job, which according to the IRS' expert witness, provided "cumulative and converging evidence of the content validity" of the requirement that revenue agents have knowledge in five areas of accounting.
The arbitrator also rejected claims that imposition of the requirements violated the Uniform Guidelines for Employment Selection Procedures, concluding that there was no evidence the new requirements had an adverse impact on minority job applicants. The expert witnesses for the IRS and for the union used different approaches to determine if there was an adverse impact, but the arbitrator found that "any adverse impact of individual components of the process is not dispositive.
Rather than imposing a remedy, the arbitrator ordered the parties to negotiate a remedy. He gave them ninety days.
The IRS filed interlocutory exceptions with the FLRA, challenging the arbitrator's jurisdiction over the thirty-hour requirement dispute. The FLRA agreed, determining that the arbitrator lacked jurisdiction because the 30-hour requirement was set forth in an Office of Personnel Management regulation. However, the arbitrator's jurisdiction over the requirement of knowledge in five areas of accounting was not challenged by the IRS and the FLRA did not address it.
The parties, unable to negotiate a remedy, turned to a different arbitrator to resolve that issue. That arbitrator specified various remedies. The IRS then challenged both the conclusion that the requirement of knowledge in five areas of accounting violated section 3308 and the remedies that were specified. The Union then challenged the first arbitrator's conclusions that the IRS had not violated section 300.103 or the Uniform Guidelines for Employment Selection Procedures.
After pointing out that section 3308 only applies to requirements that may be satisfied solely through education, the FLRA noted that the first arbitrator had concluded that the requirement of knowledge in five areas of accounting could "be satisfied through education or experience." Thus, when he concluded it violated section 3308, he erred in subjecting it to a statutory provision that did not apply. The vacancy announcement provided that the requirement could be satisfied through education or experience, which, according to the FLRA, undercut the union's argument.
Turning to the arbitrator's conclusion that the IRS violated the agreement between itself and the union, the FLRA concluded that the arbitrator finding of a contract violation was contrary to management's right to make employment selections. Because the union did not argue that the arbitrator was enforcing a provision negotiated under section 7106(b) of the labor statute or any applicable law, the union failed to provide a basis for concluding that the first prong of the applicable labor law test had been satisfied.
Next, the FLRA concluded that the union failed to show that the arbitrator erred when concluding that section 300.103 had been violated. That provision requires federal agencies to hire using a job analysis that identifies "(1) The basic duties and responsibilities; (2) The knowledges, skills, and abilities required to perform the duties and responsibilities; and (3) The factors that are important in evaluating candidates," that "[t]here shall be a rational relationship between performance in the position to be filled . . . and the employment practice used[,]" and that "[t]he demonstration of rational relationship shall include a showing that the employment practice was professionally developed." The FLRA accepted the arbitrator's conclusion that three job analyses were conducted in developing the requirement of knowledge in five areas of accounting, and the weight he gave to the testimony of the IRS expert witness testimony on the professional standards used in the analysis. The FLRA rejected the union's attempt to have it give weight to its own expert's testimony that the IRS job analyses were flawed, because that was a matter of fact for the arbitrator. Nor did labor law require the FLRA to impose a different employment practice merely because it would have been preferable. The FLRA rejected the union's claim that the requirement reflected bias in favor of external applicants over internal applicants, both because the arbitrator had not made any such finding, and because such a bias does not demonstrate that the requirement is not rationally related to a revenue agent's job duties. For similar reasons, the FLRA rejected union claims that the IRS relied on college degree requirements that had "little relation" to the revenue agent position.
Finally, the FLRA concluded that the union failed to show that the arbitrator erred when concluding that the IRS had not violated the Uniform Guidelines on Employee Selection Procedures. Because the IRS had no evidence reflecting that the overall selection process had no adverse impact, it should have evaluated the individual components of the employment selection process. Yet, even though the FLRA concluded that the arbitrator erred in this respect, it put aside the error as irrelevant because his legal conclusions were "consistent with law, based on the underlying factual findings." It relied on the fac that the IRS evaluated the requirement of knowledge in five areas of accounting, concluding that this component did not cause an adverse impact on minority applicants, thus excusing the IRS from satisfying documentation requirements the union claimed it ought to have met. Because the union's expert evaluated the thirty-hour requirement and requirement of knowledge in five areas of accounting in combined form, rather than separately, the expert's conclusions could not be broken out and applied solely to the latter requirement. The FLRA concluded that the union was not arguing the requirements had an adverse impact on minority applicants, only that the IRS failed to follow some documentation requirements.
So what does this maze of procedural and evidentiary jousting mean? To me, it means that, for the moment, the IRS can proceed in its attempt to upgrade the job performance quality of its revenue agents. It also makes me wonder why a labor union would oppose requirements that would make its members more educated. The flaw, perhaps, was that in "grandfathering" existing agents, the IRS gave the union some ammunition to use in its argument that revenue agents don't need any additional education to perform their jobs.
The agents now being hired by the IRS may end up working for the agency until 2030 or 2040. The tax law is unlikely to become less complicated or easier to analyze. During the past several decades, the tax law has become so difficult to learn and apply that law students, who surely are among the brightest, characterize it as the "nuclear physics" of law school. Surely it makes sense to have revenue agents, who need not be lawyers or law-educated, to immerse themselves in at least ten accounting courses and to gain knowledge in at least five areas of accounting. Of course, I would recharacterize the requirement as one of knowledge and understanding, for the latter is far more important, but this is not the place where I want to quibble about the specifics of the new requirements.
I don't understand the resistance to taking a few more courses, even if it means going back to school. I understand that there is a cost to the employee if he or she must return to school, and hopefully the IRS would reimburse existing employees for doing so. People currently in college who decide to apply for a revenue agent position ought select courses based on utility and value, signing up for accounting courses numbers nine and ten rather than for some course scheduled at a convenient time, taught by a non-demanding professor, or ideal for grade point padding. I also understand that the real dispute was the impact of the new requirements on a decades-long practice of IRS employees sliding into revenue agent positions after having worked for some period of time in some other capacity. That practice, perhaps becoming some sort of entitlement in the minds of a few employees, isn't necessarily the best practice for an agency charged with enforcing the tax laws in a manner that does right by both taxpayers and the government and that reaches correct results.
Of course, I would prefer that all revenue agents, and all tax practitioners, earn a law degree, because the thinking process that is acquired or polished while studying law has become a sina qua non for tax analysis. Tax is more than running numbers. I've previously posted on why having an accounting degree or background is not a prerequisite for being a good tax practitioner and how it is not even a guarantee that one would be a good tax practitioner. Yes, it helps, but it is far from essential.
The point isn't whether accounting or law is the better pathway to tax practice. The issue is whether someone who has no law background and a limited accounting background should be a revenue agent, or if, instead, it makes sense to jack up the accounting requirement for job applicants who have no law background. That was the issue. I sincerely hope the union surrenders and invests its energies into getting its members access to more tax education, and if it's going to battle the IRS it ought to do so over things such as reimbursement for additional course work and not in opposition to enhancing revenue agent education.
Wednesday, July 26, 2006
The study of determinants of a college student's academic performance is an important issue in higher education. Among all factors, whether or not attending lectures affects a student's exam performance has received considerable attention. In this paper, we conduct a randomized experiment to study the average attendance effect for students who have chosen to attend lectures, which is the so-called the average treatment effect on the treated in program evaluation literature. This effect has long been neglected by researchers when estimating the impact of lecture attendance on students' academic performance. Under the randomized experiment approach, least squares, fixed effects, and random effects models all yield similar estimates for the average treatment effect on the treated. We find that, class attendance has produced a positive and significant impact on students' exam performance. On average, attending lecture corresponds to a 7.66% improvement in exam performance.Thanks to Paul Caron's TaxProf Blog for the tip.
Another factor that does not seem to have been the subject of any serious empirical research is classroom seating position. I've done some informal studies of my students and have discovered that there is a chicken and egg question. After grades are released by the Registrar and I receive a list of names with grades, I've mapped out the grades on the seating chart. Then, using transparent markers, I have coded the grades by color, using green for the higher grades, yellow for the so-so grades, and red for the abysmal grades. The greens generally are clustered in the front and middle, whereas the so-so grades and abysmal grades are on the periphery. It does not matter whether the classroom is full or too large for the class. In other words, some students will sit in the back row even if there are empty seats in the intermediate rows and even if those rows are empty, and those students rarely earn the very high grades.
The question is whether the seating position affects grades, or grades affect the seating position. In other words, because studies show that people on the periphery are not as involved in the proceedings (whether it's a class, a meeting, or some other event), and probably have difficulty hearing and seeing as well as they would were they closer, it is easy to assume that academic performance is compromised by the distance. On the other hand, there is anecdotal evidence that disengaged students seek out the remote seats, even if there are empty seats available closer to the front and center of the room. One could conclude that the selection of seats by students is a self-sorting event.
I wonder if faculty at other schools, and in other disciplines, have done similar evaluations of their students' grades and seating positions. Perhaps someone with education and expertise in classroom dynamics could collect the data and write up something called Classroom Seating Position and Exam Performance. What little I have is insufficient for such a paper. What I have is interesting and thought-provoking. I'd be glad to share the data if I could find the marked up seating charts. That is an entirely different issue, to be addressed someday in Tax and Clutter: How the Internal Revenue Code is a Bad Influence on Office Filing.
Sunday, July 23, 2006
Is it me or does it seem obvious that taxpayer burden will not be alleviated until the tax law is simplified and fixed? Does Congress need a hearing to make this determination? What’s next, hearings on whether the earth is flat? Yes, I know about the Flat Earth Society and I know there are people who think the tax law is child’s play. Those folks don’t enter into the equation. Not in my world, and hopefully not in yours.
The report also contained information from OMB showing that more than three-fourths of the compliance burden imposed by the federal government is on account of taxation. Wow. Considering all the other reporting requirements, from SEC filings to passport applications, from federal loan guarantee applications to background check, I would not have guessed it was that high. This is simply another reason that the tax law must be changed, and to do that the tax legislative process and the culture of tax break entitlement
must be altered.
As an example of the challenges faced by the IRS in its attempt to reduce taxpayer burden in the face of legislative piling on, Tucker pointed out that the recently enacted Energy Policy Act forced the IRS to make more than 600 changes to 107 tax forms, publications, and other products, and compelled the IRS to invent seven new tax forms. Am I surprised? No. I predicted this, a little more than a year ago.
And so the Congress that made the mess is now holding hearings to find out that there is a mess and why there is a mess. I’ll make it easy for Congress. Call me. I can answer the question in 15 seconds and give you a solution in 30. You won’t like it.
Friday, July 21, 2006
Prof. Maule -Elaine also recalls another person who did not understad that small entries ought not be ignored on audit because they could hide much larger offsetting items, any of which could be very significant.
ROFL at your latest blog. I would add the following –
Anyone who doesn’t understand the zero = positive – negative or the matter/anti-matter concept probably hasn’t ever reconciled a bank account, let alone participated a financial audit. The net difference in the ending balance per the bank statement and that per your checkbook may only be a few dollars, but it’s most likely comprised of a variety of DRs and CRs. The best example seared in my memory happened on a financial audit. A staff accountant was supposed to review the client’s bank reconciliation. He neglected to focus in on the fact that say a $10 mil outstanding DR should have hit an expense while a $9 mil outstanding CR item should have hit A/R. He considered the net difference in the reconciliation to be "immaterial", yet the various correcting entries had material effect on specific accounts.
In a follow-up email, Elaine wondered if the difficulty for people trying to grasp the concept is that the components of zero or some other amount in the partnership context are hypothetical. I don't think so. Consider, for example, gain on the sale of contributed property. Splitting partnership gain of $60 into gain of $80 and loss of $20 reflects the actual pre-contribution gain of $80 and post-contribution loss of $20, both of which are very real. The numbers, it seems to me, are merely representations of the underlying concepts, and perhaps those are what baffle the folks who struggle with the splitting of an aggregate number into the two components that formed it.
Jim,And he sent a link to this story.
It seems that the government of India has removed the blocks from blogs that were established as you described a couple of days ago. Maybe China will follow suit.
I must say that was a quick resolution of an inadvertent and ill-advised move. Welcome back to my readers in India.
You'd think the leaders of the People's Republic of China would want their citizens to read my more than occasional criticism of American tax policy. Maybe they just don't believe that America permits its citizens to speak out. Or perhaps they are fond of American tax policy. After all, think of all the economic good it has done for China's economy.
Wednesday, July 19, 2006
According to this report, the government of India wanted to block access to one particular blog in the wake of the Mumbai train bombings, as further explained here. The internet service providers took the quick route, and blocked all of blogspot rather than the particular blog in question. Of course, I don't understand the point of blocking a blog. I prefer to see what others are thinking and writing rather than forcing them underground and into encrypted messaging.
I suppose the folks running the internet service providers in India will figure out how to fix this problem. If not, explains how to get around the block. The problem is that my readers in India cannot get to MauledAgain to access this link.
So spread the word. Pass the link along via email so people in India can resume reading blogs on blogspot. This nation might have a trade deficit in exporting goods but it surely can export First Amendment concepts. For all that India is and wants to be, its government needs to advise the internet service providers that overkill in response to a request is no less ill-advised than the initial request.
Tuesday, July 18, 2006
The issue comes up in Partnership Taxation, the course sometimes described as the "quantum physics" of the Graduate Tax Program. Be aware that in the general J.D. program, tax is described as the quantum physics of law school. It's not just the intellectual similarities. Just as quantum physics is ever present in the cosmos and creation, so, too, tax is ever present in the law. There’s no escaping either one.
When a partnership interest is transferred through sale or by reason of death, the transferee partner’s adjusted basis in the partnership interest reflects purchase price or fair market value, respectively, whereas the partnership’s adjusted basis in its assets, and the transferee partner’s share of that adjusted basis, reflects the partnership’s historical experience with the assets, including purchase, contribution, and depreciation. To make things easier to describe, the partner’s adjusted basis in the partnership interest often is called "outside basis" and the partnership’s adjusted basis in its assets often is called "inside basis." Usually, but not always, outside basis does not equal the partner’s share of inside basis.
That discrepancy can cause all sorts of problems, such as the transferee partner being taxed on income already taxed to the transferor partner. To alleviate this imbalance, the tax law permits the partnership to elect, and in some special situations requires the partnership to make, a basis adjustment. The adjustment is the difference between outside basis and the partner’s share of inside basis. If outside basis equals the partner’s share of inside basis, the amount of the adjustment is zero. If the election is not made and the mandatory adjustment situation does not apply, there is no adjustment.
What’s the use of a zero adjustment? It’s zero, it’s nothing? No. A zero adjustment can be split into positive and negative components to apportion to each partnership asset, whereas if there is no adjustment, there is nothing, and thus nothing to apportion to partnership assets. In other words, there is a difference between zero and nothing. That is a rule of physics. It shows up in computer programming, where zero and nul are different concepts.
Some students are boggled by this idea. They consider zero and nothing to be the same thing. "There’s no difference," one of them once argued, "between having zero in my wallet and having nothing in my wallet. Either way, I’m broke." Yes and no. Even with money and financial assets it is possible to be worth zero and yet own assets, because there would be an offsetting liability.
So, when an adjustment of zero is apportioned into positive and negative components, it appears to be a matter of creating something from nothing. It’s not. It’s the creation of things from zero. Zero is not nothing.
By the time the students reach the part of the course where they meet this basis adjustment (there are two others), they already have experienced the "something from zero" concept. Twice. When I get to the second and third instance of the concept I ask them to identify the previous instance or instances where we encountered the concept. Some can answer. Others, thinking that a person can cram the night or half week before the exam, stare as if they were sitting in the classroom for the first time. It’s a wonderful example that I use to pound home the necessity of assimilating and learning as the semester progresses.
For those curious about the two previous instances, here’s a very brief explanation. When a partnership sells property contributed by a partner, and uses the remedial method to allocate the gain or loss, it is possible for the partnership to recognize zero gain and yet allocate $x of gain to the contributing partner and $x of loss among all the partners. Of course, the partnership might recognize, say, $50 of gain and end up allocating $87 of gain to the contributing partner and $37 of loss among all partners. Similarly, a partner who sells a partnership interest for an amount equal to his or her adjusted basis in the partnership interest, the partner appears to recognize zero gain or loss, but because an aggregate approach is applied, that zero will be split between ordinary income or loss and offsetting capital loss or gain. Again, a selling partner might recognize, say, $50 of gain and end up recognizing $87 of ordinary income and $37 of capital loss.
When tax students, or even J.D. law students, struggle with these concepts, even after being guided, tutored, and repetitively drilled, I begin to wonder if their minds have been honed sufficiently to do the sort of reasoning that is pervasive in tax, and even law. I try to get the point across by using an example of, say, 50 cookies being turned into 87 cookies and 37 anti-matter cookies. I dare not use loaves and fishes, for I might upset the theology department. There are students unaware of the concept of anti-matter. Seventeen or more years of education and they haven’t encountered the concept of antimatter? What have they been doing? I use railroad marshaling yard analogies to describe what section 736 prescribes for liquidating distributions, and I get even more stares. I’ve been fearful of asking if any students thing food is grown in grocery stores.
So there you have it. Tax folks can generate something from zero. But not from nothing.
Sunday, July 16, 2006
Why the reluctance to retain the records forever? Storage requires space and space costs money. It's called rent. There also is the concern that clients become dependent on the practitioner rather than taking ownership of their fiscal affairs.
There are things clients need to understand about record retention, and tax practitioners should, and usually do, tell their clients about these concerns.
First, the client needs to keep duplicate copies because in the event of fire, computer storage media failure, or other disaster, a client who relies on the practitioner to take sole responsibility for retention will be in serious trouble when calamity befalls the practitioner's office and the IRS happens to come calling on the client.
Second, when the practitioner does choose to remove old records from his or her files, the client should accept the opportunity to collect them from the practitioner. Otherwise, the client's backup, in the event calamity strikes the client's home, will disappear. The client then needs to store the duplicate set of records in a place different from the place where the primary set is maintained.
Third, clients need to understand the danger in believing that after three (or four, or five, or six) years records can be tossed. That is true of records with no tax significance, such as grocery receipts for food the purchase of which did not justify a deduction. What is important to remember is that many records seemingly not connected with tax are tax records. The cost of the new roof will reduce gain on the sale of a home, and if the gain exceeds the section 121 exclusion amount, failure to have the record of the roof work, and the likely impossibility of proving the cost, guarantees payment of tax that could have been avoided.
A little more than a year ago, I touched on this topic when commenting on Jack Bogdanski's Statute of Limitations expiration shredding party:
But, folks, go easy with the shredder. DON'T SHRED anything that has to do with what you've paid for assets, or to improve those assets, because those amounts become part of adjusted basis, which is used to compute gain or loss when the asset is sold. Likewise, don't shred any information about the value of inherited property when the decedent died, or the donor's adjusted basis in property received by gift. Hang onto those contractor's invoices for the addition built onto the home. Keep all those investment records showing dividends plowed back into the stock through a dividend reinvestment program.My advice has not changed.
Back in 2004, in writing about the digitization of tax data, I explained
There also exists the question of archiving. In the digital world, what guarantee is there that the return will be accessible in the future? Fortunately, my previous year editions of Turbo Tax run on my almost-expired Windows 98 computer, including those that originally ran under Windows 95, and, goodness, MS-DOS!! Will these programs run on the XP computer that sits alongside the Windows 98 box (or the XP computer that will replace it)? I'll find out during the next month or two. In the meantime, because digital backup may mean nothing, I have consistently printed out the return and the supporting schedules. But at least it's one copy and not two.I was wrong. Turbotax for pre-XP versions of Windows cannot be installed on XP systems. What hasn't been printed is inaccessible other than through a Windows98 desktop, of which few remain. So my prediction, from the same post, of what lies ahead seems even more likely:
Why the concern? Though some people don't hold onto their tax returns for more than say, 3 or 7 years, relying on the statute of limitations, I recommend holding onto all returns, if for no reason other than to maintain records of basis and to guard against the strange day when the IRS claims a return from some years ago was not filed, which would open the statute of limitations, and which can be rebutted quite easily by providing a copy of the return. And what if a lender asks for copies of tax returns for the past three years? If not already in print format, they need to be printed. Will the XP computer run TurboTax for 2000? I think so.
What may end up happening is that the returns will be "printed to disk" in something like a PDF format. PDF, I am assured by those in the computer industry closer to the action, will endure for decades. So perhaps I will be spending some time (when? ha ha) printing all my returns to PDF and making a CD that holds the entire batch.For a world living in the information age, there surely is a serious information preservation problem. Is it like the marooned sailor in Samuel Taylor Coleridge's Rime of the Ancient Mariner, "Water, water, everywhere but not a drop to drink"?
Friday, July 14, 2006
Unlike, say, in the tax code, however, in physics new laws are more elegant and economical than the ones they replace.Ellen asked if "new tax laws less elegant and econmical than the ones they replace."
My reply was one of my shortest utterances: "Unquestionably. Imagine Congress legislating the laws of gravity." I then appended "Don't fall all over that one!"
Bad? Well, yes, the pun is. But tax legislation drafting leaves much to be desired, as do many of the policies generating the "new" rules of tax. It's not bad to point that out.
Wednesday, July 12, 2006
It would not be surprising to discover tax students grabbing hold of this chart and using it to answer exam or semester exercise questions. Too many students much prefer being given answers than being required to create decision charts. Guaranteed, Andrew learned more by designing this chart than those using it will learn by reading it. That's why I give my students a few charts early in the semester, to show them the goal that they should have, namely, learning how to think through a problem rather than look up (or receive) an answer. Many students are unhappy with this challenge, preferring to listen and repeat rather than solve problems.
I think I will ask Andrew for permission to hand out to my students an amended version of his chart, with one or two errors deliberately introduced. I will then ask the students not for the correct version, because that simply would reward those who can find things on the Internet, but for an explanation of WHY the identified errors are errors. THAT is how lawyers and tax practitioners learn to think.
One of the charts I recommend students create in Partnership Taxation is a matrix of the allocations regulations. Now there, if done properly, is a formidable chart.