Friday, May 22, 2009

Pay Taxes, Be Happy 

While I was away, Paul Caron's TaxProf Blog posting alerted me to an OECD report, which I think is this one, in which it reported that the nations whose people ranked the happiest in a new survey are those with tax rates among the highest. Thomas Kostigen suggests that the reason may be that these particular nations provide so much for their citizens that their taxpayers feel that they get something in return and know what it is, whereas in the United States people "are never really quite sure of what we get in return for paying them, other than the world's biggest military." People who worry about being able to get health care and other services tend not to be happy, according to Kostigen.

There may be another factor at work. In What Makes Us Happy, in this month's Atlantic Magazine, Joshua Wolf Shenk, describing a 72-year-long longitudinal study at Harvard, notes "that money does little to make us happier once our basic needs are met." One might expect, therefore, that taxation would generate unhappiness among lower-income taxpayers whose chances of reaching the "basic needs" level of after-tax income are diminished by taxation. Yet the loudest cries in this nation against taxation come from those whose basic needs have been met, and who feel threatened by taxation that reduces their after-tax income to levels that are still significantly above the "basic needs" level. The answer, it appears, is closely related to the same impetus that fuels the greed that has put the national economy into such a dire condition. For some people, no amount of money is enough. I suspect that they not only resent paying taxes, they also balk at paying for goods or services if they can find a way to get them for free. Somehow they've become accustomed to the notion that they are owed whatever it is that they want. Some people work this out through burglary, robbery, and vehicle theft, while others do so by cooking books, selling low-quality goods and services, monopolizing markets through bullying, and, yes, evading taxes while complaining about the taxes that they are paying.

Why is this? Why are some people content to make enough, or perhaps not quite enough, to meet their basic needs while devoting their lives to a career, occupation, or profession that fulfills them in other ways while others are so intent on "making a killing" that they never find happiness even as their after-tax incomes skyrocket. Is it possible to be so addicted to money for its own sake that resistance to taxation, even when that taxation procures benefits, is unavoidably wired into the person's psyche? Some years ago, on a first date that for reasons to be disclosed momentarily never became a second date, I was asked how I would spend the money if I won a lottery that paid me $10,000,000 a year. I replied that after paying taxes, paying off the mortgage, seeing to the financial security of my children, and setting aside a small reserve fund, that I would give away a good chunk of the winnings. That pretty much ended conversation. When recounting this story to a friend several days later, she told me that I had flunked the test because I did not explain that I would make the money available to my wife or girlfriend. I laughed, because if that was indeed the explanation for the faded conversation, I was thrilled to have flunked. I don't mind having enough money to be comfortable, but I don't want to get to the point where I have so much money that I invest significant time worrying about it. Yet I am not alone, and I may be in the minority.

Kostigen's observation that this nation's taxpayers aren't sure what they get in return for their taxes suggests that if people did know that they'd be less resistant to paying. That may be true for some people. For those folks, it might make sense to install signs that indicate what the taxes procure. Throughout Pennsylvania there are signs telling us that one or another group has adopted a stretch of highway for purposes of keeping it litter-free. Why not signs indicating how many tax dollars were invested in a bridge, traffic signals, or police patrols? I've seen signs during construction indicating that a particular number of toll dollars are being used for the project, but when the construction ends, the sign goes away. Keep it. Perhaps move it to a safer location, but let people be reminded that they're getting something for the toll that they have paid. Perhaps police vehicles should carry a logo that reads, "$x of your local property taxes funds this vehicle and the salary of the officer in it." Despite the ease with which the internet makes it possible to read federal, state, and local government budgets and expenditure reports, people don't bother to do so. They need the information shoved into their faces.

Yet the implied suggestion in Kostigen's observation won't matter to those who are so addicted to money that they would no more adjust their attitudes toward paying taxes than they would relent in their distaste for paying for anything. They want it, they want it all, and they want it now. For them, Queen wrote their anthem. Nothing in a tax code, nothing on a "your taxes at work" sign, nothing in a blog is going to cure the deep insecurity that drives this distaste for paying taxes. Sadly, nothing, not even all the wealth in the universe, can satisfy these people and bring them happiness. Somewhere, somehow, someplace, something didn't get through to them. Even if they cannot change, perhaps the focus should be on preventing them from warping the minds of those whose resistance to paying taxes would diminish if they understood what they were getting for the taxes that they paid. It ought not cost much to do this, and there's no good reason to pass up on the opportunity. The public officials who undertake this effort will be happy that they did so.

Wednesday, May 20, 2009

Horsing Around with Tax 

On my return from my daughter's graduation, I dug through the newspapers that had arrived during my absence. I didn't expect to see a headline like this in the sports section of the Philadelphia Inquirer: Tax Ruling Wins National Hunt Cup. A quick glance at the first paragraph explained it all. Someone named a horse Tax Ruling. Specifically, Tax Ruling is a 6-year old brown gelding. According to the article, Tax Ruling "doesn't like the heat," "loves being on the front end," "can be a little fussy," and is a "little quirky if he doesn't get his own way." Does that describe a horse or a tax auditor? Tax Ruling won a race by beating, among others, The Price of Love.

My mind immediately began to think of the great contribution that tax law could make to horse racing. No, I'm not talking about tax breaks. Those already exist. I've refer to them while teaching the basic tax course, and have complained about them in posts such as Not to Its Credit. Even the Commonwealth of Pennsylvania found a way to involvehorses in revenue raising.

What crossed my mind were all the fun horse names that the tax law can provide. It's very possible that somewhere, sometime, someone gave one of these names to his or her horse. But perhaps not. Consider this a public service, a gift to the horse industry for use when name selection is a challenge.

Accrual Method
Accumulated Earnings
Active Management
Adjusted Basis
Alimony Recapture
Arbitrage Bond
Capital Expenditure
Capital Gains
Cash Method
Claim of Right
Competent Authority
Consolidated Returns
Constructive Dividend
Deduction Limitation
Deferred Compensation
Distributive Share
Double Taxation
Earned Income
Flow-Through Entity
Hobby Loss
Holding Period
Horizontal Equity
Imputed Income
Inflation Adjustment
Information Return
Installment Sale
Involuntary Conversion
Jeopardy Assessment
Joint Return
Kiddie Tax
Like-kind Exchange
Liquidating Distribution
Loss Carryforward
Marginal Rate
Passive Activity
Parsonage Exclusion
Patronage Dividend
Percentage Depletion
Permanent Establishment
Phaseout Threshhold
Portfolio Income
Principal Residence
Private Inurement
Revenue Neutraility
Standard Deduction
Substantial Underpayment
Substituted Basis
Tax Avoidance
Tax Evasion
Tax Expenditure
Tax Loophole
Tax Shelter
Transfer Pricing
Transferred Basis
Treasury Regulation
Two-Percent Floor
Unadjusted Basis
Unearned Income
Vertical Equity

This list could be much longer. What I've presented is a sample. Others surely could enhance the litany.

It could have been worse. Imagine the track announcer informing the crowd, "It's Tax Shelter following Passive Activty, but here comes Treasury Regulation with Deduction Limitation. It looks like Substantial Underpayment is back in the race. Capital Expenditure has fallen behind, and Revenue Neutrality has broken down. It's Treasury Regulation, gaining on Tax Shelter, and on the inside it's Jeopardy Assessment." Yes, imagine how the tax law could saddle the horse racing industry.

Monday, May 18, 2009

Another Degree for Another Maule 

Yesterday it was Sarah's turn. My daughter graduated from Smith College. Last week's trip to Ann Arbor, Michigan, was just the first graduation journey of the season. This one, a bit shorter and in a different direction, took me back to New England.

Congratulations, Sarah. You have done well. I am delighted, and I know you are thrilled. You've studied, you've learned, and you have polished many skills. You now have letters after your name. We know you worked and worked, piling on all sorts of academic challenges. That neurobiology stuff is way beyond tax law. Perhaps you'll make a career of analyzing the brain circuits of tax practitioners.

As scientific as were many of her courses, Sarah also possesses outstanding artistic skills. She has won awards for her drawings, and has been using pen, crayon, chalk, charcoal, paint, and just about every other substance imaginable to produce portraits, landscapes, and still life. Going to an art museum with her is an experience. She has provided artwork that has decorated my office door for years. It seems serendipitous that in the month she graduated I had to take all of it down because the law school is moving into a new building. Yes, I'm taking the art with me.

Here is a tidbit from the "trivia in which perhaps few others are interested" category. Sarah is not the first descendant of Thomas Maule of Salem, Massachusetts, to earn a degree from Smith College, but she is one of a very few. Nancy Jane Maule, to whom Sarah is a fifth cousin three times removed, graduated almost 60 years ago. Caroline Haigh West, my fifth cousin, the 3-great-granddaughter of Sarah Ann Maule (the sister of Sarah's 5-great-grandfather), graduated from Smith College 30 years ago. A few years later she graduated from what is now the Penn State University Dickinson School of Law 1985, and was a first-year student during my last year on its faculty, though at the time neither of us knew of the connection. So Sarah is the third. Honorable mention goes to Gretchen Leutheuser, who married Charles Somers Davis, great-great-grandson of Sarah Ann Maule (the sister of Sarah's 5-great-grandfather) and who graduated from Smith almost 40 years ago. If there are others, I've not yet discovered them.

For the moment, Sarah is not another Dr. Maule. Give her time.

Friday, May 15, 2009

Graduation Day: A Time to Think 

Today is graduation day at the Law School. While students look back at what they have accomplished, they also are looking forward. The financial and employment stresses pulsing through the third-year class are impossible to miss. The looking forward part of the equation reflects, in no small part, what happened during the time to which they are looking back. Have they accomplished enough to persuade an employer to give them an opportunity to apply what they have learned and to sharpen their skills? Some have. Others, though developing sufficient skills, have run into a buzzsaw of a turbulent economy. Still others never quite got it. It's a difficult time to be graduating from law school, and these students are caught in the gap between the business-as-usual of years past, and the hopefully reformed legal education paradigm of the near-term or longer-term future.

Almost two months ago, in How A Transformative Recession Affects Law Practice and Legal Education, I analyzed the intersection of legal education, law practice, and the economy, and concluded, among other things, that the long-term impact on legal education might take one or more of several forms, including this one:
One other possibility remains. Bar associations and bar admissions committees, and perhaps state supreme courts, will question the wisdom of limiting bar applicants to graduates of accredited law schools. Enterprising practitioners, perhaps law firms joining together in collaborative and creative efforts, will form schools focused on preparing people to practice law. Properly operated, they need not charge the tuition rates currently being charged. Wise organizers will hire people with law teaching experience and ability, who have more attachment to teaching and less concern about scholarship, to administer and teach in these new institutions. They should be able to provide more experience in the nature of clinics, practical writing, transactional courses, and marketable post-graduation skills. With sufficient clout, they and their practitioner organizers should be able to persuade bar admission authorities to accept their graduates as bar exam candidates. By hiring bright, accomplished law graduates to team teach with experienced practitioners, they will foreclose the expected arguments from the law school monopoly that only faculty at law schools of the present kind know how to teach law. Ultimately, universities will see this development as a threat to their law school revenue sources, and seek to imitate or take over these institutions, at a far greater cost than would have been the cost of reforming their own law schools. Despite that disadvantage, it would provide the benefit of returning law schools to their principal mission, and like other industries, cause legal education to emerge from this transformative recession in a new and more robust form as will happen in other professions and areas of business.

Even if it does not come to pass in precisely this way, the possibility should compel legal educators, including law faculty, to think seriously about where they've been, where they are, and where they might be going, voluntarily or involuntarily. The threat of change ought be considered not as a risk but as a welcomed encouragement.
I know there are people who think my warnings and predictions are total nonsense. Several days ago, news broke that something not unlike the "law firms … form[ing] schools focused on preparing people to practice law" had arisen. In Diamonds May Be a Law Firm's Best Friend in Economic Downturn, Gina Passarella of the Philadelphia Legal Intelligencer gave this report, referring to the "current economy and a clear shift to a buyer's market""
The latest example of that shift comes from Drinker Biddle & Reath, which told its incoming associates last week that it would lower starting salaries for the first six months of the year to $105,000. The associates will then be in a training program for those six months without the pressures of a minimum billable requirement. The salary will then go back up to "market rate" at the end of the six months. During the training period, associates will have formal training but will also be expected to shadow partners in more of an apprenticeship model.
In other words, the new associates are going to continue their schooling. Though they will not be charged tuition, they will see their salaries cut by tens of thousands of dollars. Economically, that's equivalent to being hired at the previously prevailing rate and then paying tuition.

Why is the Drinker firm doing this? The answer was provided in that same How A Transformative Recession Affects Law Practice and Legal Education post: "When they [law school students] learn that fewer and fewer law firms are hiring law school graduates because clients are not willing to pay for what little law school graduates bring to the table, some will turn away from the idea and others will join in the increasing chorus to reform legal education." Or as Drinker chairman Alfred Putnam Jr. explained, "[H]e thought about deferring the 34 associates who would be affected, but at the end of the day they would still be first-years, just a year later. Putnam said clients are particularly averse to paying for first-year associates, and this was a way to make them 'saleable.'" He noted that, "[E]ven for very robust firms that continue to have profitable work flowing in the door, there is a marked shortage of work for newly made lawyers. In addition, the days of large law firms assigning (and clients paying for) 'armies' of very junior lawyers to large-scale litigation or transactions are over -- likely never to return." This was in a letter that Putnam sent to the associates. Putnam expects this new model to continue.

Can you imagine entering law school, thinking that if you did well you would graduate into a position paying $150,000 a year, sufficient to pay off the $100,000 or more of loans undertaken to finance the law school education, only to discover that even though you did do very well your salary would be roughly $45,000 less because you needed more training to reach the point at which clients would pay for your services? How long will it be before a sharp, creative, and determined young associate sues his or her alma mater for a $45,000 refund? Whose fault is it that the associate isn't ready to practice? The associate, who did what was asked by the faculty and was told that he or she had done very well, with a high cumulative average, honors, and perhaps even Order of the Coif? The law firm, which didn't warn law schools, and hammer home to them the fact that their graduates were increasingly less prepared and acceptable to clients? Or the law schools, to a greater or lesser extent depending on the degree to which they have made available to all of their students educational experiences that match what law practice demands? Will the eventual consequence be pressure to eliminate the third-year of law school so that students can invest a year, perhaps at little or no salary but without tuition outlays, in training at law firms? This suggestion, which has been around for decades, was highlighted by Joan Arnold, a partner at Philadelphia's Pepper Hamilton firm, who remarked that "there needs to be a seismic shift in the way attorneys are trained before they even join a firm." Joan, by the way, is a Villanova graduate and a member of the school's Graduate Tax Program adjunct faculty.

Perhaps a useful, but frightening, analogy can be drawn from reports beginning to emerge from investigations into the crash of the Continental Connections flight in Buffalo a few months ago. According to this CNN report, the pilot had learned the theory of operating the stick-pusher emergency system but "had never trained in a flight simulator" with that system. Another pilot, making an analogy not unlike the "watching me ride the bicycle doesn't cause you to get in shape" message I give to my students, explained "It's similar to picking up and throwing a groundball in baseball. You can study it academically all you want but you really need to develop the proficiency, the skill, the muscle memory required to do that."

If there is any doubt that even the so-called best law schools aren't getting the job done that needs to be done, one needs only to read a response given by Justice Antonin Scalia during a talk at American University Washington College of Law. According to this New York Times report, a student asked what she needed "to do to become 'outrageously successful' without 'connections and elite degrees.'" After telling her "Just work hard and be very good," Scalia told her that her chances of being selected as a clerk to a Supreme Court justice weren't good. His explanation was a backhanded slap at legal education: "By and large, I'm going to be picking from the law schools that basically are the hardest to get into. They admit the best and the brightest, and they may not teach very well, but you can't make a sow's ear out of a silk purse. If they come in the best and the brightest, they're probably going to leave the best and the brightest, O.K.?" [emphasis added] In other words, law schools are unable to wreck the intellectual skills of the best law students who, as some faculty recognize, pretty much teach themselves and often accomplish what they do despite what some members of law faculties do or fail to do. But what of the bottom 90 percent of the class? Though I disagree with Scalia that none of the best and the brightest end up at other than the elite fifteen, he probably thinks it is too time consuming to try to ferret out the outstanding students who are "hiding" in the 185 or so law schools that aren't in the top cluster.

The economic tailspin did not cause the sea changes that are and that will be swamping law practice and legal education. When the wind blows over a fence whose posts have been rotting for years, is the wind to blame? The recession may have been the catalyst, but had legal education been producing law graduates capable of doing work worth hundreds of dollars an hour during the year after graduation, the impact of the economic downturn would have played out very differently. That's water over the dam, but surely work must begin now to prevent even worse consequences the next time things go haywire, and though that may be some years in the future, the legal education crisis is not going to be resolved in a matter of days, weeks, or months. There's enormous amounts of work to be done, and highly challenging arguments to be made to persuade law faculties that the work should be done, before anyone can get started on that work.

But today, at least for a few hours, the graduates hopefully can put these thoughts aside, and enjoy their moment. Tomorrow will arrive soon enough.

Wednesday, May 13, 2009

Paging Dr. Maule 

The journey to Ann Arbor, Michigan, is complete. I went to that town to attend two graduations. My son earned his J.D. degree from the University of Michigan Law School, the day after my daughter-in-law earned her M.D. degree from the University of Michigan Medical School. Technically, the Law School has not yet distributed diplomas, but assurances that it is a mere technicality have been given. It seems that the faculty has not finished its grading responsibilities.

Two and one-half years ago, in Dr. Maule, I Presume?, I explained why I don't use "Dr." before my name even though the University does so. Law students and law school graduates don't like the news that the J.D. degree is a "fake doctorate" because its recipients lack the underlying LL.B. degree and very few obtain, after the fact, the LL.M. degree. Nonetheless, most lawyers, including those who don't realize the history of the J.D. degree, consider themselves to hold a doctoral degree and, presumably, would call themselves "Dr." but for the cautionary advice issued by some state bar ethics committees that doing so would be inappropriate if it were to mislead the public. That concern, as I pointed out in Dr. Maule, I Presume?, is not universal.

Although my son now has the dilemma of deciding if he wants to refer to himself as "Dr. Maule," and I doubt that he will, my daughter-in-law unquestionably is "Dr. Maule." This is going to confuse Joe Kristan. Just nine days ago, in Saving the Right of States to Pick the Athlete's Pocket, he referred to me as "Dr. Maule," though he also refers to me as Jim Maule, in that post and elsewhere on his blog. He's not the only one to do so, as I have several colleagues who alternate between the two forms of address. But now that there is another Dr. Maule, or two or three (my youngest sister also has a J.D. degree) in the family, it will take a wee bit of contextual interpretation to determine which of us is getting Joe Kristan's attention. It should be an easy task, because both my son and my sister are careful, quite affirmatively, to resist any attempt to characterize them as tax attorneys though both can handle the subject well. Role modeling has its limits, I presume. Contextual interpretation also requires clarification of the word "family," for if the entire family were to be considered, Joe and anyone else referring to "Dr. Maule" could be referring to a long list of people, including Dr. Lawrence Maule, Dr. Jake Giles Maule, Dr. William Maule, Dr. Cynthia Maule, Dr. Marion Maule, Dr. Rosanna Maule, Dr. Linda Maule, Dr. Charles Maule, the long-gone Dr. Patrick Maule, Dr. Colette Maule, Dr. John Maule, or any one of dozens and perhaps more than a hundred Dr. Maules.

When, in a few months, my son is admitted to practice, he will become yet one more "Attorney Maule." Because almost no one refers to me in that manner, I haven't paid it quite the attention that I've given to Dr. Maule. And if either or both of them decided to teach, we can discuss the more than several Professors Maule throughout the world, present and past. For now, I'll leave the fun of tallying those known as Dr. Maule, Prof. Maule, Attorney Maule, Rev. Dr. Maule, etc., for the genealogy project in which I am tracking the occupations in which the descendants of Thomas Maule of Salem, Massachusetts, have been engaged.

Returning to the beginning of this post, permit me to indulge in a public congratulatory message to Charles and Karen. As I told them shortly after each ceremony, well done and they have every reason to be joyful and proud. I'm delighted. So, too, will be their patients and clients. Perhaps when I retire from blogging, I can persuade them, in cooperation with my daughter Sarah, to present MauledAgain: The Next Generation. Or perhaps, after reading this, they'll get that going long before I stop typing.

Monday, May 11, 2009

Fashionably Powerful Taxation 

For several months, I have been reading Michael Quinion's Gallimaufry, subtitled "A Hodgepodge of Our Vanishing Vocabulary." This is a book that I try to digest several pages at a time. Each chapter brings dozens of new words for me, words that are so old that they have passed out of common usage. It's not that I need ammunition for crossword puzzle solving attempts, but that I simply enjoy learning about language. If even a dozen of these words enter into my everyday vocabulary or writing, it will have been it. But in addition to teaching me about words and their origins, the book is filled with various trivia, yet another feature to which I am drawn.

In the chapter on wigs --- yes, there is an entire, though not very long, chapter on wigs --- Quinion comes up with an interesting bit of trivia. Wigs had been in fashion since the 1660s, and yet by the beginning of the nineteenth century had gone out of fashion. Why? Among the many reasons for the abandonment of wigs was William Pitt's powder tax. People who wore wigs powdered them. Pitt's tax, a substantial guinea per year on wig powder, caused people to set aside their wigs. Eventually, the revenue raised by the powder tax declined to almost nothing. Though I had not known this story, it isn't some obscure trivia. There is a more detailed explanation on page 403 of the Encyclopedia of Hair. No, it's not a deep study of the Broadway play of some decades ago that recently was revived.

It appears --- see, for example, the discussion in the chapter, "Hair Powder," in The Spirit of Despotism -- that Pitt's goal was two-fold. One was to raise revenue to defray military expenses. The other was to reduce the amount of flour used for dusting wigs, apparently a significant portion of domestic wheat production was so used, because there was a shortage of bread and other foodstuffs that required flour as an ingredient. Opponents, few in number, did point out the risks of relying on a tax based on fashion. One opponent went so far as to note that the tax might cause people to stop powdering wigs. Another member of Parliament thought the tax too low, and proposed that the solution was a prohibition on the use of flour for the powdering of wigs. Outright prohibition rather than strangulation through taxation was his preference, but it did not prevail. The tax, though, had the same effect as prohibition.

Using a tax to discourage, or perhaps a tax credit to encourage, a fashion trend probably poses a huge temptation to many politicians and voters. It is easy to think of present-day fashions that some not insignificant group of people would prefer disappear. One obstacle, of no concern to Pitt, is the First Amendment. A tax that has the practical effect of prohibiting tattoos would not fare well. But what of fashions that cause health problems and contribute to the rising cost of medical care? Ought they be subject to a medical expense user fee? Surely there are some tax policy papers hiding in these questions, so students, take note if you are in search of a topic.

Friday, May 08, 2009

One Tax Bandaid But Multiple Tax Wounds 

Senators Lincoln and Hatch have introduced S. 978, which would increase the $3,000 limit on the capital loss deduction to $10,000, and which would index the $10,000 amount for inflation beginning in 2010. Consistent with existing law, the $10,000 amount, including the inflation-adjusted amount, would be halved for married taxpayers filing joint returns.

Many commentators have criticized the fact that the $3,000 limitation has been unchanged for decades. What was a substantial amount thirty years ago is now relatively minimal. Increasing the amount and indexing it for inflation makes sense from a narrow perspective, that is, looking solely at section 1211(b), but falls short when viewed from a vantage point that encompasses the entire Code.

The limitation on capital loss deductions exists as some sort of trade-off for the special low tax rates that apply to capital gains. This trade-off, however, is unbalanced, because the different treatment of short-term and long-term capital gains doesn't match up well with the treatment of short-term and long-term capital losses. This flaw is but a symptom of the entire capital gains mess, and thus slapping a band-aid on this wound in tax policy doesn't do much to improve the system's chances of survival. It would make much more sense to treat gains no differently from how income of any other kind is treated, and to permit deduction of losses that arise from trade, business, and for-profit activities. The casualty loss deduction has its own flaws and would best be replaced with some sort of credit or, better yet, some direct subsidy program administered by people who are experts in casualties rather than by tax auditors.

The limitation on capital loss deductions has not been indexed for inflation, but no one has ever explained why that has been the case. Yet it is not the only fixed dollar amount in the tax law that is not indexed for inflation. The $100,000 threshhold for phase-out of the active management exception to the passive loss limitation has been $100,000 for more than twenty years. In contrast, the threshhold for phase-out of the personal and dependency exemption deduction and for phase-out of itemized deductions have been indexed for inflation since their first unfortunate appearance in the Internal Revenue Code. Why the difference? The base amount and adjusted base amount used in the determination of whether, and how much, social security income should be included in gross income have remained the same since their introduction into the law, whereas the earned income amount and earned income investment limitation threshhold for purposes of the earned income tax credit are indexed for inflation. Why the difference?

Wherever an amount is not indexed for inflation, taxpayers subject to the limitation or other restriction that the amount represents bear an increasingly higher proportion of the revenue burden as do taxpayers who are subject to limitations that are indexed for inflation. Many taxpayers are subject to multiple limitations, and so their position in terms of being subjected to increasingly higher or lower proportions of the tax burden depend on how those limitations interact in their overall tax computation analysis. By providing an inflation adjustment for the capital loss limitation, but leaving the active management exception limitation and the social security base amount and adjusted base amount unfixed, the sponsors of S. 978 are taking steps that benefit high-rolling investors but that ignore middle-and-low-income taxpayers on social security and middle-income taxpayers who invest in a modest vacation home that they can afford only by renting it out for most of the vacation season.

When a group of people with the same problem see a select few get help while the others continue in their tax pain, it isn't surprising that those left behind would support changes in those charged with fixing the problem. The nation continues to lack an explanation for why some fixed dollar amounts in the Code are adjusted for inflation and others are not. The nation similarly lacks any explanation for why the lack of an inflation adjustment for the capital loss limitation should be more worthy of attention than the lack of that adjustment for other limitations that affect more taxpayers and affect more taxpayers of moderate means. Which of the sponsoring Senators is going to stand up and begin a speech with, "We're sorry, social security recipients, but your problem just isn't as pressing a need as is the capital loss limitation issue for the big-time investors who need more tax relief….."

Maybe they think that most social security recipients aren't sufficiently savvy to know that they're getting the short end of the stick on this one. If they read this, now they'll know. And, yes, the proportion of social security recipients who vote is among the highest in the nation, if not the highest. I'm sure Congress knows that. Perhaps they take some things for granted that ought not be taken for granted any longer. It's time to make all the fixed dollar amounts in the tax law subject to inflation adjustments.

Wednesday, May 06, 2009

Tax Law Ought to Make Sense 

The President has unveiled a cluster of proposed changes to the income tax rules applicable to international transactions. The changes would require companies that defer taxation of foreign income to also defer deductions, would preclude the foreign tax credit to for foreign taxes paid on income not taxed by the U.S., would prohibit companies from treating certain foreign subsidiaries as disregarded entities for tax purposes, would make permanent the research and experimentation credit, and, as reported here would require U.S taxpayers who transmit money to banks that do not cooperate with the U.S. Treasury to rebut the presumption that they were engaging in tax fraud. The same report explains that Obama will ask Congress to fund the hiring of 800 new IRS tax agents.

Not surprisingly, business leaders have raised objections to the proposals. According to this report, several hundred corporations and trade associations claim that the proposals would "make U.S. companies less competitive." If U.S. companies cannot be competitive without paying tax at an effective rate of 2.3 percent, something is wrong with how those companies do business.

According to another report, " although the rule changes are narrower than some anticipated, business leaders still oppose them as a tax hike." Somehow, requiring enterprises and wealthy individuals to pay the taxes that they have been avoiding by manipulating the rules and stashing money in secret overseas locations is a tax hike. Perhaps employers who short-change their employees should refer to the court judgments handed down in the employees' favor as "pay raises." Perhaps motorists who finally are caught running red lights should refer to what they've been ignoring as "newly installed traffic signals."

What is the sense of permitting taxpayers to defer taxation on foreign income while claiming current deductions for foreign expenses? Taxpayers who want to claim deductions in the current year should also report and pay tax on the income. Taxpayers who want to defer the income should defer the deductions. Not only does this make sense, it is fair.

What is the sense of permitting a foreign tax credit with respect to income on which U.S. income tax has not been paid? Is not the purpose of the foreign tax credit to reduce or eliminate double taxation of the same income by both the U.S. and a foreign nation? Where is the double taxation if there is no U.S. taxation of the income?

What is wrong with shifting the burden of proving the lack of tax fraud to individuals and companies that stash money in banks that advertise their willingness to thwart tax collectors? Should people who do business with enablers of tax fraud be blessed with a presumption of good intentions such that the IRS should have the burden of showing the fraudulent purpose? There are plenty of places to invest money that aren't trying to hide from the IRS. People who choose to do business with the tax evasion specialists ought not be complaining.

The tax law is sufficiently complicated that it ought not be made even more incomprehensible by rules that favor special interests or that permit manipulation by those who want to go straight from the left turn lane. Tax compliance by law-abiding citizens ought not be devalued by rules and systems that give the edge to law-breakers and people who game the system. Effective tax administration requires that taxpayers feel that they are being treated fairly, and when abuses are identified, the protests against reform ought to be seen as what they are, namely, nonsense.

Monday, May 04, 2009

Taxes, Sausage, and Politics 

Following up on this morning's post, it's worth noting that the Philadelphia Inquirer is running a three-part series on the Board of Revision of Taxes and how it operates. The first part, Assessment: Broken appeared in yesterday's Inquirer. The second part, BRT Serves as Political Jobs Bank was published today. Presumably, the third part will show up tomorrow.

It's worth the read. These are long articles, with several side stories. They are well worth reading. Take a deep breath every few minutes, especially if you live in Philadelphia. The stories are a lesson in how taxes ought not be administered, how public "servants" ought not behave, how children's education is shortchanged on behalf of politicians and their friends, and why reform is so desperately needed in Philadelphia politics. There is such a chasm between political and legal theory and what transpires in the city's everyday life that studying local taxation without studying this series is simply insufficient.

Inching Closer to a Sensible Philadelphia Real Property Tax Assessment Process 

The long journey undertaken to bring Philadelphia's real property tax assessment system into conformity with state law and common sense is a wee bit closer to its destination. Recent news requires yet another chapter in a story that, to date, has been the attention of at least six MauledAgain posts: An Unconstitutional Tax Assessment System, Property Tax Assessments: Really That Difficult?, Real Property Tax Assessment System: Broken and Begging for Repair, Philadelphia Real Property Taxes: Pay Up or Lose It, How to Fix a Broken Tax System: Speed It Up?, and Not the Sort of Tax Loss Taxpayers Prefer.

Several days ago, the BRT announced that it had submitted to the mayor and city council of Philadelphia a list of what it considers to be the market value of almost 600,000 properties subject to the city's real property tax. If adopted, this would be the first assessment for which actual fair market value is used. Considering that state law has required the use of actual fair market for years, it's a wonder that it has taken this long, and there still remain several steps before the city is in compliance. For example, these values will not be used for fiscal year 2010 taxes.

The BRT expects the mayor and city council to implement the use of actual values by phasing in the changes. Otherwise, some property owners will face tax increases that would leave them with property tax bills that are double, triple, or even worse. Already, one city council member has moved in this direction.

According to this report, Councilman Frank DiCicco has prepared legislation that would cushion taxpayers against what might be, for some, "a significant increase" in their property taxes. One approach that DiCicco is considering would tax residents on a five-year average of their tax bills. Though this doesn't make sense, to compute a tax bill based on average tax bills, I think the intention is to impose the tax based on a five year average of assessed values. For example, if a property had been assessed at $80,000, but under fair market value assessment is re-assessed at $200,000, then for the first year under the new system, the tax would be computed by applying the tax rate to $104,000 (($80,000 + $80,000 + $80,000 + $80,000 + $200,000)/5). For the second year, it would be applied to $128,000 ((($80,000 + $80,000 + $80,000 + $200,000 + $200,000)/5), for the third year, $152,000 (($80,000 + $80,000 + $200,000 + $200,000 + $200,000)/5), and so on. That might work. Another approach being considered by DiCicco is a so-called "floating tax rate." Under a floating tax rate, the city would determine how much revenue it needs and set the rate to generate those revenues. Isn't that what gets done under present law?

The changes in assessment do not require, nor do they necessarily mean that there will be, an increase or decrease in overall revenue raised by the city from the property tax. It means two things. First, because the total assessed value of the almost 600,000 properties surely will be higher under fair market value assessment than under the current system, the rate can be reduced to keep the revenue flat. It would not be surprising, though, to see the city lower the rate but at the same time generate more revenue. Second, some taxpayers will find themselves paying lower real property taxes under a reduced rate because their assessments under fair market value assessment are the same or not much more than they are under the current system. Many other taxpayers will face increases, though of varying degrees, depending on how far below fair market values their current assessments are. Though complaints should be expected, this is precisely the outcome that should occur and surely a goal of fair value assessment. Under the present system, two taxpayers, each owning properties of equal value, are charged different amounts under the real property tax. Under fair market value assessment, that should not happen. That's why state law was amended years ago to compel fair market value assessment.

The next step appears to be city council approval of the revised assessments. Whether common sense and compliance with state law can trump the special interest group and political fund-raising protocols remains to be seen. It is likely there will be an eighth post on this topic.

Friday, May 01, 2009

Curtailing Multistate Tax Filing Burdens 

Several members of the House of Representatives, led by have introduced the Mobile Workforce State Income Tax Fairness and Simplification Act, H.R. 2110, intended to "limit the authority of States to tax certain income of employees for employment duties performed in other States." Essentially, the legislation would prohibit a state from taxing the wages of nonresident employees who perform services in the state for fewer than 31 days, and would relieve their employers from any obligation to withhold income taxes on behalf of a state in which an employee performed services for fewer than 31 days unless the employee was a resident of the state.

The text of the bill is worth reading:
Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

This Act may be cited as the ‘Mobile Workforce State Income Tax Fairness and Simplification Act’.

(a) In General- No part of the wages or other remuneration earned by an employee who performs employment duties in more than one State shall be subject to income tax in any State other than-- 1) the State of the employee’s residence; and

(2) the State within which the employee is present and performing employment duties for more than 30 days during the calendar year in which the income is earned. >
(b) Wages or Other Remuneration- Wages or other remuneration earned in any calendar year are not subject to State income tax withholding and reporting unless the employee is subject to income tax under subsection (a). Income tax withholding and reporting under subsection (a)(2) shall apply to wages or other remuneration earned as of the commencement date of duties in the State during the calendar year.

(c) Operating Rules- For purposes of determining an employer’s State income tax withholding and information return obligations--
(1) an employer may rely on an employee’s determination of the time expected to be spent by such employee in the States in which the employee will perform duties absent--
(A) actual knowledge of fraud by the employee in making the estimate; or

(B) collusion between the employer and the employee to evade tax;
(2) if records are maintained by an employer recording the location of an employee for other business purposes, such records shall not preclude an employer’s ability to rely on an employee’s determination as set forth in paragraph (1); and

(3) notwithstanding paragraph (2), if an employer, at its sole discretion, maintains a time and attendance system which tracks where the employee performs duties on a daily basis, data from the time and attendance system shall be used instead of the employee’s determination as set forth in paragraph (1).
(d) Definitions and Special Rules- For purposes of this Act:
(1) DAY-
(A) An employee will be considered present and performing employment duties within a State for a day if the employee performs the preponderance of the employee’s employment duties within such State for such day.

(B) Notwithstanding subsection (d)(1)(A), if an employee performs material employment duties in a resident state and one nonresident state during one day, such employee will be considered to have performed the preponderance of the employee’s employment duties in the nonresident state for such day.

(C) For purposes of subsection (d)(1), the portion of the day the employee is in transit shall not apply in determining the location of an employee’s performance of employment duties.
(2) EMPLOYEE- The term ‘employee’ shall be defined by the State in which the duties are performed, except that the term ‘employee’ shall not include a professional athlete, professional entertainer, or certain public figures.

(3) PROFESSIONAL ATHLETE- The term ‘professional athlete’ means a person who performs services in a professional athletic event, provided that the wages or other remuneration are paid to such person for performing services in his or her capacity as a professional athlete.

(4) PROFESSIONAL ENTERTAINER- The term ‘professional entertainer’ means a person who performs services in the professional performing arts for wages or other remuneration on a per-event basis, provided that the wages or other remuneration are paid to such person for performing services in his or her capacity as a professional entertainer.

(5) CERTAIN PUBLIC FIGURES- The term ‘certain public figures’ means persons of prominence who perform services for wages or other remuneration on a per-event basis, provided that the wages or other remuneration are paid to such person for services provided at a discrete event in the form of a speech, similar presentation or personal appearance.

(6) EMPLOYER- The term ‘employer’ has the meaning given such term in section 3401(d) of the Internal Revenue Code of 1986 (26 U.S.C. 3401(d)) or shall be defined by the State in which the duties are performed.

(7) STATE- The term ‘State’ means each of the several States of the United States.

(8) TIME AND ATTENDANCE SYSTEM- The term ‘time and attendance system’ means a system where the employee is required on a contemporaneous basis to record his work location for every day worked outside of the state in which the employee’s duties are primarily preformed and the employer uses this data to allocate the employee’s wages between all taxing jurisdictions in which the employee performs duties.

(9) WAGES OR OTHER REMUNERATION- The term ‘wages or other remuneration’ shall be defined by the State in which the employment duties are performed.
This Act shall be effective on January 1, 2011.
The bill focuses on a problem that afflicts many business entreprises. An employee who lives and works in the state in which the employer operates performs services in another state for part of a day, a day, or several days. Many states require the employer to withhold income taxes on the portion of the employee's compensation apportioned to the state, and even if withholding is not required, many states require the employee to file a nonresident income tax return with the state. If an employee performs services for a few days in, say, a dozen states, the employee ends up being required to file a dozen state income tax returns. This can be burdensome, not only in terms of quantity, but in terms of working out things such as the credit for taxes paid to other states. It can create a complexity to rival that posed by the federal income tax law.

The bill appears to resolve another thorny area of state income taxation. Some states take the position that a person who is not physically present in the state, and who therefore can be taxed as though they are present only if they have sufficient nexus with the state, has that nexus if he or she is virtually present in the state by virtue of telecommuting. I explained this issue when I described the travails of Thomas Huckaby, a Tennessee resident, who, though spending only 25% of his time at the New York offices of his employer, discovered that New York required him to pay New York income tax on all of his compensation. The story of his case, and of a Connecticut resident who did not have any physical presence in New York, are recounted in a series of MauledAgain postings: State Taxation of Nonresidents, Another Setback for the Telecommuting Nonresident Taxpayer, New York Takes a Strike in the Tele-commuter Tax Game, Supreme Court Refuses to Resolve Interstate Tax Dispute, If the Supremes Won't Sing for the Taxed Telecommuters, Will the Congress Dance? It seems that the Congress will dance for Huckaby only if he limits his presence in New York to fewer than 31 days.

The language of the bill does suggest several questions. In no particular order, here they are:

1. Why, in section 2(c)(2), permit an employee's determination to trump records maintained by an employer that record the employee's location for other business purposes? If the employee is in State X, the employee is in State X. Considering that section 2(c)(3) requires an employer's time and attendance system to trump the employee's determination, it makes no sense to treat any other set of records keeping track of the employee's location any differently.

2. Why use a preponderance standard in section (d)(1)(A)? Would it not make more sense to provide more specific rules that deal with instances in which, for example, an employee resident of State T, performs, on a particular day, 3 hours of work in State X, 2 hours in State Y, and 2 hours in State Z? Would the employee be treated as having performed work in none of the three states?

3. Has consideration been given to the imprecise meaning of the term "material employment duties"? Would it not make more sense to use a test identical to, or similar to, the preponderance test? It's one thing to measure hours, and it's a totally different, and much more challenging, task to measure the materiality of employment duties.

4. Why is there no relief for independent contractors? Do they not face similar issues in terms of both tax return filing and the equivalent of withholding obligations, namely, estimate tax payment requirements?

5. Though it is obvious why professional athletes and professional entertainers are excluded from the definition of employee, does it make sense to define the exception in this manner? If the proposed legislation applied to professional athletes and entertainers, the wages paid to most of them would not be subject to taxation by the states in which they perform services because they usually are in those states for fewer than 31 days. Even so, under current law, states collect substantial amounts of revenue by taxing nonresident professional athletes and entertainers who work even for one day in the state. In the absence of the exclusion, state opposition to the proposed legislation would be even more intense and vociferous. But does it make sense to permit states to continue taxing nonresident professional athletes and entertainers whose income is relatively small, considering the transaction cost to those individuals of complying with the income tax laws of dozens of states and filing tax returns with dozens of states? Does this make sense considering the application of the proposed legislation to high-income individuals who are not professional athletes or entertainers but who work for a few days each year in many different states? Would it not make more sense to tie the exclusion from the bill's protection to total income, so that professional minor league ballplayers earning survival wages are relieved of dealing with multistate income tax return filing, while high-income attorneys, architects, and other professionals who work for five or six days in each of fifteen states are treated in the same manner as high-income athletes or entertainers who perform for five or six days in each of fifteen states? In other words, why single out individuals on the basis of the name of their occupation rather than their income?

6. How many times will the phrase "persons of prominence" be litigated? Does it matter that everyone is famous for at least 20 minutes? Is the CEO of a corporation, whose name is known only to family, friends, and some business associates a person of prominence? Should this person be relieved of multistate income tax return filing if he or she works for a few days in each of the twenty-two states in which the company has offices? Again, ought not the exclusion, if there is to be one, rest on income and not difficult-to-define occupational labels?

Despite these criticisms, there is some sense in what the bill attempts to do. Individuals with low or even moderate income, whether employed or self-employed, who work for a few days in a particular state, ought not be burdened with the high transaction costs of filing an income tax return that generates relatively few dollars of revenue for the state. Lest the state see this as a revenue loss, consider that the state's own residents will be similarly relieved of paying taxes to other states, in turn cutting down on the credit for income taxes paid to other states that they would otherwise claim. In other words, though there may be some shifting of state income tax revenue from states with proportionately higher numbers of nonresident workers to states with proportionately lower numbers of nonresident workers, for most states the change will be negligible.

Whether Congress actually does something with the proposed legislation remains to be seen. What is unlikely is passage of the bill in its current form. That's not a problem. The introduction of the legislation ought to trigger conversations and analyses, which in turn should lead to refinements and improvements.

Wednesday, April 29, 2009

The (Non) Value of Old Exams 

The exam period begins today at the law school. Anxiety and stress, particularly among first-year students but also among the more seasoned upper-year students, is rampant. One of the "exam preparation" techniques most favored by students is to get their hands on a previous semester's exam in the same course with the same professor. Somehow, students think, by looking at the old exam they will have a better chance of doing well on their upcoming exam. Unless the exam comes with a model answer, an description of erroneous answers and why they don't earn credit, and an explanation of how to think through the facts of the question to get to the correct answer or answers, the old exam is of little value. Surely a student looking at an old exam and thinking to himself or herself, "Oh, yeah, I know the answer to this one" gathers as much positive reinforcement as I do when I look at a basketball hoop and think, "Oh, yeah, I can dunk the ball." Of course, some students will then bring the old exam to the professor and ask for the answers. At this stage students ought to be trying to answer the question to see if they can do so, and at best should be bringing to the professor the answer that the student has already worked out.

It's clear why students want to dig out old exams. For whatever reason, many law students continue to approach legal problems with the notion that there is a finite set of possible questions, and if they can find all of them in a setting that provides the answers to all of them, when they get to the exam that counts, they can dial up whichever one matches the question on the exam. The flaw in this reasoning, of course, is the idea that there are a finite set of possible questions. I know that students do this, because they tell me that they do this. Not long ago, a student approached me about a semester exercise -- think of a short-answer question extracted from what otherwise would be an exam and presented to the students as a stand-alone graded assignment -- with the concern that he had looked everywhere and could not find an example (facts and solution) that matched the assignment. Of course he wouldn't find it, and he was wasting his time looking for it. I explained that he needed to identify the issues for each of the four very short question within the exercise, and then apply the process for resolving that issue. The process could be in the form of a checklist, a chart, a Harvard outline, a Venn diagram, whatever. Eventually he returned, and was delighted that he had figured it out. On many occasions, when I get the point across to a student that the key is the process and not the information, the reaction is along the lines of "I wish I had figured this out during my first year." So do I. But that's another topic, a highly sensitive one, and I will leave to another day the question of why students come into upper-year courses, or even get through law school and into an LL.M. Program, without having grasped the "secret" to thinking -- no, not thinking like a lawyer, but simply thinking -- that is the key to doing well not only in law but in numerous other professions, trades, and activities.

The analogy I use is the solving of crossword puzzles. What many students try to do when learning law is to acquire a set of all possible crossword puzzles and their solutions, so that when they encounter a puzzle, the solution is at hand. The flaw in this approach is the fact that there are an infinite number of crossword puzzles. There is no way one can have an inventory of all possible crossword puzzle solutions. Instead, the secret to solving a crossword puzzle is to have a methodical process of working through the puzzle, analyzing each factor that is relevant, such as the number of letters, letters already in place from having worked out another clue, possible letters already in place from having identified tentative resolutions of other clues, understanding the theme of the puzzle if there is one, etc. I wrote about this issue five years ago in Doing Puzzles While Learning & Practicing Law, which appeared in the law school's weekly newsletter. I wrote this essay not only to explain to law students why the thinking involved in solving puzzles is almost identical to the thinking required to solve legal problems, but also to encourage students to question whether their alleged dislike for doing puzzles meshed well with their expressed interest in pursuing a career of solving problems. The flip side, preventing problems, is more similar to creating crossword puzzles, which is, as anyone who has tried to do so understands, far more challenging than solving one. I have come to understand the comments made to me by more than a few of my law school faculty who later became my colleagues to the effect that preparing and designing an exam is far more challenging than taking one. I plan to write about that particular challenge at some later date.

In my tax courses, there is yet another reason to discourage students from digging into old examinations. Tax law changes so frequently that what was a good question on last year's examination may have become obsolete. Or perhaps the answer has changed. Or perhaps the choices are no longer valid, either as correct answers or as plausible erroneous answers. Or perhaps the issue has gone from one that is easily resolved using general principles to one that must be wrung through a maze of new statutory or regulatory provisions, such that without additional or different facts, the question is close to useless. Or perhaps the question addresses a topic no longer covered in the course because it became too complex, or needed to be removed in the on-going triage of finding space for the new "tax goodies" bestowed on tax students by the Congress. Going through an old exam, explaining why a question is obsolete, or explaining why the choices are misleading, ends up confusing the student by filling his or her head with more information, information which is extraneous to the scope of the course and of little or no interest to students not headed for tax careers.

For these reasons, I do not publish old examinations. I don't want to enable the sort of thinking that causes students to hunt for old examinations, or even to dig through the old examination database that the school maintains. I don't want to waste students' time or mine going through an exam that is obsolete in part, misleading in part in light of intervening changes, or that covers topics no longer covered in the course. I don't want to take students away from what they should be doing.

Instead of digging through old exams in search of the "magic key" to the kingdom of legal studies, students ought to be assimilating the material that they have covered during the semester. In fact, they should be doing this throughout the semester and not in one end-of-semester flurry of catch-up-and-cram insanity that includes the rush for the "quick and easy" solution, and that results in acquisition of knowledge that vanishes from their brains hours after the examination, unavailable for recall in the next course or while representing the next client. Throughout the semester and at the end, students ought to be reviewing the problems that were analyzed in class. They should be creating, or, better, refining their own checklists, flowcharts, matrices, outlines, Venn diagrams, whatever. They should be teaching each other in study groups. They should be taking the various problems and hypothetical questions from class and running through the many possible permutations on those problems and questions. They should be going to CALI and working through the hundreds of questions that do, in fact, give them a chance to test themselves, and, within moments, to find out if they understand what they need to understand to do well on an examination.

By requiring students to turn in responses to assignments during the semester, I get the opportunity to identify students who approach problems by trying to regurgitate law, or by answering something that hasn't been asked, or by misreading the facts, or by making one or another of the very common errors law students make on examinations and, if uncorrected, when representing clients. I'd rather that a student lose 2, 4, 8 points on an exercise than commit the same mistake repeatedly on an examination and lose 40, 60, or 80 points with no chance to engage in ameliorative endeavors. This process encourages students to do what they should be doing early enough that the product of their efforts sticks in their brains for a much longer time, provides them with the opportunity for positive reinforcement when they are on track, and gives them the chance to identify flaws in their approach to problems long before grades are released months after the course is finished.

If law required only the identification of all possible situations, each with a correlative answer, computers could replace lawyers. Some people, in jest or not, might find this to be an improvement in life and for society. Yet computers cannot replace lawyers, at least not for many decades, because the contribution of lawyers to society is not only in the application of settled rules to the ordinary transactions of some clients, but to the development of answers to the problems that arise for the first time. A lawyer does not work through the case of first impression by looking up an answer or by having memorized some rules. A lawyer works out the problem by using a process of thinking. Once a student understands this "secret," the possibilities, as a student once told me, are staggering. Indeed, they are.

Monday, April 27, 2009

The Collapsing Economy: A Clue and Some Advice 

Last Tuesday, the Hearing Board of the Illinois Attorney Registration and Disciplinary Commission (IARDC) issued a report and recommendation for the three-year suspension from the practice of law of an attorney who, over a period of years, answered law school application questions by omitting the fact he had attended medical school and the fact he had been dismissed for academic reasons, provided to prospective employers law school transcripts which he had altered to show markedly higher grades than the ones he had earned, and failed to disclose to the Illinois State Bar's Character and Fitness Committee his fraudulent alteration of transcripts. Though there is much that can be said about this unfortunate series of events, most of it has already been shared, notably by commentators at the ABA Journal, the American Law Daily, the American Lawyer, and the Legal Profession Blog. Thanks to Paul Caron's TaxProf Blog for bringing this update in the story to my attention.

Some of the reports included, without much comment, a reference to one of the tangential facts of the case. In its report, the Hearing Board of the IARDC explained that the attorney in question "is currently pursuing an MBA at the University of Illinois Business College." In his application to that school, he "did not mention the falsified transcripts, the problem with the law school paper, or the omission on the law school application, but he did not believe that information was responsive to any question on the application. He did disclose his dismissal from medical school." The problem with a law school paper refers to an investigation with respect to a suspicion of plagiarism that did not lead to formal charges by the school. The attorney reported that he contacted the assistant dean of student affairs at the University of Illinois Business College before he began the program, to explain the complaint pending before the IARDC, "disclosed the general nature of the allegations, and offered to provide a copy of the complaint, but his offer was declined because the school was only interested in matters of a criminal nature."

If indeed the University of Illinois Business College is interested only in "matters of a criminal nature" when screening applicants, and if that is the general practice among business schools, is it any wonder that a critical mass of business school applicants who have issues with respect to integrity and disclosure are getting into those schools, graduating from those schools, entering the business world, and ending up in positions where the lack of integrity and disclosure causes long-term and serious damage to people, enterprises, industry, and the economy? Ought not business schools, and, in fact, all schools, identify applicants who are in need of integrity counseling, and either refuse admission or make admission and graduation contingent on the student straightening out his or her life? Are not business schools responsible for preparing people to function in the business world, and is not one of the requirements for doing so not only an understanding of what integrity and disclosure require but also a demonstration that a person possesses a character marked by those traits? If schools are unable to "teach integrity," then they ought not admit someone into their programs who lacks that attribute.

Whether, and to what extent, schools need to investigate the background of their applicants are debatable questions. Surely, though, it costs little and perhaps nothing to add to the application questions that reach beyond "only … matters of a criminal nature." Does it hurt to ask applicants if they have ever altered transcripts, submitted fraudulent resumes, plagiarized papers, or violated the Academic Rules or Honor Code of any institution in which they previousl were enrolled? Considering the high rate at which people confess, anonymously in surveys, that they submit false resumes, is it any wonder that people willing to lie to get a job would be willing to commit fraud in order to make money marketing or selling whatever it is they're foisting on an unsuspecting public, be it tainted securitized mortgage loan packages, defective products, shoddy services, or some other junk? Is there not an obligation among business and other schools to require applicants and students to have and follow principles of integrity so that the nation's culture squeezes out practices like these, practices apparently so widespread that the litany of resume fraud committed by specific individuals shared by that particular site is a drop in the bucket of the dishonesty pervasive in "modern" American business culture? The "everybody does it" nonsense hyped by this site is nothing more than an excuse for people unwilling to take responsibility for doing what is right. The attorney who was the subject of the report and recommendation of the IARDC Hearing Board admitted that he did what he did in part because he "wanted to portray an image of being successful" and "felt that he needed to work at a premier law firm to confirm that he was successful." In other words, he went for the appearance rather than the substance of being successful. He admitted he "gave no thought to any harm his actions might cause the university." Does this not resemble the behavorial pattern of financial industry wizards who, giving no thought to the possible harmful consequences of their dealings, did whatever they decided needed to be done in order to achieve success, both in terms of finances and in terms of image?

The law firm that was duped by the false resume altered its practices and now requires a certified resume from the law school rather than a resume transported by the student. By getting the resume directly from the school, printed on special paper and with other mechanisms for preventing alterations, the law firm took steps to remove an opportunity for a person to commit fraud. There is no reason that business and other schools cannot change their admissions process to identify not only applicants with criminal histories but also applicants with a record of engaging in fraudulent and dishonest behavior. There also is no reason for these institutions to be lenient when enrolled students engage in behavior predictive of dishonest practices in the workplace.

Ultimately, the steps that can be taken by employers, such as the law firm that was duped, and schools are nothing more than some form of quarantine process so that those afflicted with dishonesty disease can be kept away from people, places, industries, professions, and economies that can be harmed by manifestations of that disease. The excuse often given by those who object to undertaking a screening process of the sort described is that it doesn't address the underlying problem. That is true, but it doesn't negate the benefits of low-cost, high-yield examination of applicants' records, whether they are applicants to a school, to a profession, or for a job. The truth of the excuse, though, demands that society do more.

The time and place for dealing with dishonesty disease is early in a person's life and in the person's home. By the time a person is old enough to apply to law school, or for a job, that person's character has been formed. Their outlook on life, however acquired, will have been established. Though occasionally someone past adolescence will modify his or her character and acquire a new outlook on life, the fact that when this happens it usually makes the news indicates how rare these transformations are. It is always better to prevent problems than to seek solution, and the best prevention is the instillation of a code of integrity in the minds of the nation's young people. The message must be sent not only in words but by actions. Parents who lie to other people while their children are listening, or who object to disciplinary sanctions for their children's dishonest deeds, are not doing their children, or the rest of the world, any favors. They harm the children by enabling behavior that eventually gets the children in trouble. Persistent and serious dishonest behavior, as evidenced by the attorney in the case, is something that has its roots in the person's early life, years before law firms, bar admissions committees, or employers can intervene.

The recommendation of the Hearing Board of the IARDC is that attorney be suspended for three years. Counsel for the Administrator, who presented the case against the attorney, argued for either disbarment or suspension until further order of the court. The arguments made on behalf of that position, the arguments made on behalf of the attorney for discipline less severe that what the Board recommended, and the Board's reasoning for its conclusion are in the report and recommendation. They're worth reading.

When people ask how so much fraudulent activity, which fuels a significant portion of the current economic turmoil, could occur, a clue to the answer can be found in the apparent disinterest of business schools in the non-criminal fraudulent and other dishonest behavior of their applicants. The advice that must be given to schools and employers, which isn't new and which is beginning to find willing recipients, is to find ways to identify people with these behavorial traits early in the process and to refrain from letting people off the hook too easily. After all, the economic distress generated by the "money and image ahead of all else" culture hasn't let its victims off the hook so easily.

Friday, April 24, 2009

Why Tax Practitioners Must Be Good With Words, and Not Just Numbers 

Many people think tax is "all about numbers." So claim the students who arrive in my office before or at the beginning of the fall semester, expressing trepidation about taking a course in which "the math majors and the accountants have the edge" in the A-grade collection game. I explain that they don't have an edge. They might even have a disadvantage, because if they haven't built up for themselves an expertise with the use of words, they will stumble at least as many times over language as the self-professed "mathphobic" will stumble over numbers.

A recent case in the Third District of the Texas Court of Appeals illustrates this point. The case isn't about numbers, though ultimately it involved whether or not some dollars would be paid by the taxpayer. The case was "all about words." In ICAN Enterprise, Inc. et al v. Williamson Co. Appraisal Dist. & Williamson Co. Appraisal Rev. Bd., the court held that aircraft hangars were not exempt from property taxation under a provision that provided an exemption for any "building used primarily for . . . aircraft equipment storage" and that met certain other requirements.

The taxpayer leased aircraft hangars from the City of Georgetown in Texas that were located at the Georgetown Municipal Airport. The taxpayer stored airplanes in those hangars. Generally, under section 11.11 of the Texas Tax Code, property owned by Texas or one of its political subdivisions is exempt from taxation if the property is used for public purposes. However, under section 25.07(a) of the same law, leaseholds in exempt property may be taxed, but section 25.07(b)(3)(A) provies an exception for leaseholds in property that "is part of a public transportation facility owned by an incorporated city or town and . . . is . . . a building used primarily for . . . aircraft equipment storage.

Because there was no dispute that the hangars are part of a public transportation facility owned by an incorporated city or town and that the hangars are buildings, the case turned on the meaning of "used primarily for . . . aircraft equipment storage." The taxpayer an interesting argument in its attempt to prove that it used the hangars for the storage of aircraft equipment.

Relying on the Merriam Webster Online Dictionary definition of an aircraft as a "vehicle (as an airplane or balloon) for traveling through the air," relying on 14 C.F.R. section 1.1 of the Federal Aviation Regulations definition of an aircraft as "a device that is used or intended to be used for flight in the air," relying on the Merriam Webster Online Dictionary definition of device as "a piece of equipment . . . designed to serve a special purpose or perform a special function, and relying on the Merriam Webster Online Dictionary definition of vehicle as "a piece of mechanized equipment," the taxpayer argued that an aircraft is a device, and that because devices are equipment, an aircraft is equipment. The taxpayer also argued that an aircraft is a vehicle, and that because vehicles are equipment, an aircraft is equipment. The court rejected this argument for four reasons.

First, the court noted that because tax exemptions are strictly construed against the taxpayer, the taxpayer had the burden of proving that it was entitled to the exemption. It resolved all doubts against the taxpayer, implying that the validity of the taxpayer's reasoning was doubtful. But the court did not stop with this point.

Second, the court noted that the statutory language of the exemption was for "aircraft equipment storage" and not for "aircraft storage." Thus, although aircraft may be considered equipment under the common meaning of those terms, it does not follow that an aircraft is within the phrase "aircraft equipment." The pairing of "aircraft" with "equipment" limits the exemption to equipment used in manufacturing aircraft or to allow the aircraft to function. Turning the tables in the dictionary definition on the taxpayer, the court noted that Webster's New Collegiate Dictionary and the Merriam Webster Online Dictionary definition both define equipment as "the set of articles or physical resources serving to equip a person or thing: as . . . the implements used in an operation or activity." The court also noted that phrases such as "auto part" does not include an automobile.

Third, the court looked to other provisions in the Texas Tax Code to determine how the legislature used the terms aircraft and aircraft equipment. It discovered that the sales tax has exemptions for aircraft and separate exemptions for aircraft equipment, suggesting that the legislature considers aircraft to be in a separate category from aircraft equipment. It also went beyond the Texas Tax Code, and explored the Texas Transportation Code. The latter distinguishes between aircraft and "aircraft-related . . . property, including . . . equipment."

Fourth, the court rejected the taxpayer's reliance on Federal Aviation Regulations. The court examined the provision cited by the taxpayer and concluded that it defines "[j]ustifiable aircraft equipment" as "any equipment necessary for the operation of the aircraft." The provision thus distinguishes aircraft from aircraft equipment rather than treating the two phrases as equivalents.

This case illustrates the importance being precise when using words. Yes, it would have been helpful had the Texas legislature elaborated on the terms "aircraft" and "aircraft equipment" for purposes of the property tax exemption in question. Presumably, the legislature assumed that people would understand that an aircraft is one thing and aircraft equipment is another, but it should have been cognizant of the tendency of lawyers, and even lay taxpayers, to turn and twist words if their usage provided any looseness whatsoever. That's the drafting lesson. The case also illustrates the importance of being precise when reading words. Though the taxpayer's argument appears to rest on a very precise analysis, ultimately it was insufficiently precise, because it did not foreclose the similar approach to working out the meanings that the court employed to reject the taxpayer's analysis.

The case also demonstrates why it is useful, and sometimes necessary, to look at other provisions, not only in the tax law but in the jurisdiction's statutes generally, in the effort to parse a particular statutory provision. A common mistake of law students is to consider the departure for purposes of examining those other provisions to be an irrelevant tangent. It might be a tangent, but it surely is not irrelevant. Long ago, I stopped counting the number of students who expressed dissatisfaction with one or another of my tax courses because I "go off on tangents." The web created by these so-called tangents provides the fabric on which statutory construction takes place. How students get to the level of the courses that I teach while still under such misapprehensions is a question that law schools, undergraduate schools, and even the K-12 education system ought to answer. I know the answer, but much more would be learned if those institutions answered the question for themselves.

Though people generally think of numbers as things that must be used with precision whereas many people think they can play fast and loose with words. Yet, at the most foundational level, words and numbers aren't mutually exclusive. They share much in common. Both are symbols or tools for communication. In ancient languages, such as Egyptian hieroglyphics and Sumerian cuneiform, words and numbers were represented by what most people today would call pictures. Romans expressed numeric concepts by using letters, and also used letters to express words. I'm nowhere near as familiar with languages such as Chinese, but I recall being told the same sort of similarity exists. Ultimately, words and numbers, just like power tools, must be used with care and precision. Otherwise, it might be something more than taxes that get cut.

Wednesday, April 22, 2009

Tax Consequences, Tax Compliance, Tax Policy 

Tax law professors are well known for presenting students with hypotheticals and asking the students to analyze the tax and other legal consequences of the transaction. So let's look at a set of facts.

A non-profit social services organization offers its employees accounts in which it deposits something called Equal Dollars. Even the CEO of the organization receives $700 of his pay in Equal Dollars. These are not items of U.S. currency, but are scrip with the face of someone whose philosophy and examples are inspiration for the organization. The organization prints these Equal Dollars, in denominations of 1, 5, 10, and 20.

One day a week, vendors come to the organization to sell their wares. One sells earrings, another, Tupperware. Yet another offers baked goods, and still another markets pocketbooks. A person who wants to purchase something can pay in U.S. currency, Equal Dollars, or some combination thereof. The vendors use Equal Dollars to pay rent for the space in which they set up shop. In the same building in which the social services organization is located one finds a pharmacy, which accepts Equal Dollars in payment. The organization's CEO brings vegetables to sell to other employees for Equal Dollars. He also accepts Equal Dollars in exchange for teaching people line dancing and how to make pizza dough. A former employee of the organization continues to accept Equal Dollars in exchange for teaching people how to crochet. She uses some of those Equal Dollars to purchase earrings from the earring vendor.

But as I tell my students, law professors, including tax law professors, "don't need to make up this stuff." Paraphrasing from a decades-old leading Supreme Court case on taxation, one that addressed the concept of ordinary and necessary, I remind them that, "Life in all its fullness provides the examples." It also provides the clients whose business sustains tax practice.

So the preceding hypothetical isn't hypothetical. It's real. The facts come from Annette John-Hall's column in Monday's Philadelphia Inquirer, nicely titled The Currency of Bartering. She explains that the program started in 1996. It blossomed, reaching a point at which it had 864 participants, 298 businesses, and a newsletter with a circulation of 2,400. But for some reason the program fell dormant. Now, with the economy struggling, the program has had a resurgence. Its 200 members actively trade with each other. The program is making arrangements for a local credit union and a medical practice to accept Equal Dollars. The program has made an interest-free loan to another non-profit organization, which plans to use the money to hire someone, half of whose compensation will be in Equal Dollars.

John-Hall concludes her column by hailing the idea of privately-printed scrip: "More money to spend, more support for small businesses, and more cash to save or use for other means. In these economic times, I'd say it's a win-win-win." But is it? Will it be seen as all win when the IRS comes knocking on doors and stopping by vendors' booths?

There's nothing in John-Hall's column that indicates how the people using Equal Dollars treat them for tax purposes. Does the CEO's W-2 include the $700? Will the employee of the borrowing non-profit end up with a W-2 that includes only the amount of U.S. currency paid to her or will it also include the Equal Dollars? Do the vendors who accept Equal Dollars report those amounts as gross receipts? Does the pharmacy do so? What will the credit union and the medical practice report on account of Equal Dollars?

There are three major groups of issues implicated by this set of facts. One group of issues involves the tax consequences. The second touches on tax compliance. The third puts the spotlight on tax policy. Though the answers to the first two groups of issues inform analysis of the third, a student, just like a practitioner, needs to answer the questions that are posed. Too often, when faced with determining the tax consequences, students -- and too many law faculty -- jump into the wonderful world of what the law should be rather than providing to the client the assistance the client seeks. A client who is trying to comply might have some peripheral interest in how the world would be a better place if the answer were different, but the client isn't paying for that advice.

The consequences of the use of Equal Dollars should be easy to determine, but there is no explicit authority answering the question. Years ago, in Rev. Rul. 79-24, 1979-1 C.B. 60, the IRS concluded that gross income includes the value of property or services received in exchange for other property or services. About a year later, in Rev. Rul. 80-52, 1980-1 C.B. 100, the IRS concluded that the same result was reached even if the bartering was not direct but implemented by an organization crediting its members with trading units. Several years later, in Rev. Rul. 83-163, 1983-2 C.B. 26, the IRS concluded that members of a barter club must report gross income when they receive services through a barter exchange. The organizations operating these barter exchanges are required to comply with the barter exchange reporting requirements. The IRS has also concluded that organizations that provide a venue for individuals to exchange services on an informal, noncommercial basis and that do not give the participants any rights or impose any obligations with respect to the exchange are not barter exchanges subject to the reporting requirements. Thus, in private letter rulings, the IRS has concluded that nonprofit organizations issuing "Time Dollars" or similar credits for services provided by individuals to other individuals are not barter exchanges subject to the barter reporting requirements, chiefly because in the instances it reviewed, there was no guarantee that the recipient could get anything for the "Time Dollars" issued to the person. The IRS has specifically declined to answer the question of whether the participants in the program have gross income. Turning to the statute, unless an exclusion can apply, the recipients of the Equal Dollars have gross income because when they receive those dollars they receive something that has value, that can be used to acquire property or services of comparable value, and that are theirs to use unfettered by any restrictions or limitations. When one works through a list of possible exclusions, it's unreasonable to conclude that the Equal Dollars are received as a gift. A person who bargains to receive half of her salary in Equal Dollars isn't the recipient of a gift. Filling employee accounts with amounts that the employees can use to acquire goods or services isn't the making of a gift because transfers by employers to or on behalf of employees by statutory definition cannot be gifts. It's very difficult to conclude that the receipt of Equal Dollars represent imputed income, which the IRS as a matter of administrative practice declines to tax and which some theorists claim isn't income in the first place, because imputed income situations involve people doing work for themselves, such as mowing their own lawn or cooking their own meals. Consider, for example, the $700 of Equal Dollars received by the organization's CEO. How is that any different from receiving a gift certificate for $700 worth of services of products at a retail establishment? It isn't. Professor Deborah Geier has reached the same conclusion, in "When Helping Hands Have to Pay Taxes," an article published on page A24 of the January 22, 1993 edition of the New York Times.

As for the compliance questions, there aren't enough facts to determine what the organization and the participants are doing. Perhaps the recipients are reporting income, and perhaps they are not. Whether the details of the Equal Dollar program fall closer to the barter exchange or closer to the "Time Dollars" arrangement on the spectrum of "U.S. currency-free transactions" is unclear, and thus whether the organization described in John-Hall's column should be reporting cannot be answered at this point. The facts of the "Time Dollars" private letter rulings are sufficiently different from those of the "Equal Dollars" arrangements to make it risky for someone to reach a conclusion based on the general facts that fit into a newspaper column. Lurking in the compliance cluster is the situation that will arise when someone reports Equal Dollars as earned income in order to qualify for, or increase, the amount of his or her earned income tax credit.

The policy questions are important, and have as many answers as there are opinions to be set forth by tax experts, community organizers, non-profit organization executives and advocates, legislators, and citizens. If the transactions described in John-Hall's column were to be made the subject of an open-ended exclusion in the Tax Code, every transaction in the nation soon would be recast in Equal Dollars, and income tax revenues would vanish. Though the Tea Party crowd might rejoice at this outcome, their partying would end quickly when they dialed 911 and no one showed up or when they drove across a bridge and it collapsed. If the Congress created an exclusion limited in some way, it would create even more complexity and encourage people to squeeze into the exclusion transactions not intended to be within it. If the justification for exclusion is that poor people ought not pay income tax, is not the answer a personal exemption and standard deduction of sufficient size to permit people to avoid taxation if they receive small amounts of Equal Dollars but not if they receive a huge amount? Arguments for excluding these amounts from gross income are found in Vada Waters Lindsey, The Burden of Being Poor: Increased Tax Liability? The Taxation of Self-Help Programs, 9 Kan. J. L. & Pub. Policy 225 (1999). The programs discussed in the article, however, are significantly different from the Equal Dollars arrangements. For example, under the programs discussed in the article, the maximum that a person could receive in "Time Dollars" during a specific year was $2,000, whereas the description of the Equal Dollars program suggests that the amounts in question may turn out to be much higher.

In some ways, the use of Equal Dollars is tantamount to the creation of a separate currency system within the economy. So long as Equal Dollars can circulate only within the limited world that accepts their use, the tax issues aren't unlike those arising when a barter exchange or trading club sets up ways to measure members' economic positions through devices other than a national currency. If, however, the use of Equal Dollars or their equivalent become so widespread that they displace the use of national currency on a grand scale, the tax issues, especially the policy questions, will be cast in a totally different light. As for the issues that are not tax issues, others need to suggest the consequences and risks of issuing and dealing in these sorts of currencies. What, for example, will be the impact on the credit union's financial reporting and compliance with credit union regulations of accepting Equal Dollars?

Ultimately, the Congess needs to deal with these issues. Unfortunately, it, like most legislatures, usually waits until people sort things out for themselves, making it more difficult to prescribe sensible rules because a coalition of those wanting special exceptions, those wanting transition rules, and those unwilling to change their reporting practices prevent the legislatures from writing on clean slates. That has happened with digital technology, it happens with advances in biomedicine, and it is happening with the creation of substitute currencies. I wonder how many members of Congress understand that the issue exists, let alone understands the analyses applicable to dealing with the issues. And why has the IRS declined to give the nation guidance on these questions? What concerns cause it to hesitate?

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