Monday, January 31, 2011
According to the plaintiff, a woman whom he knows – possibly the mother of a former girl friend – approached him and said that she understood he could not afford to pay for tax return preparation as he had done the year before. Subsequent testimony revealed that he had been a client of H&R Block. So this woman offered him a deal. Her sister, she explained, was a tax return preparer and charged less than H&R Block. The plaintiff takes her up on the offer. At some point, the woman or her sister suggested to the plaintiff that he claim as a dependent on his tax return the child of a woman – and because I missed the first two minutes, I’m not certain of this – who was the former girl friend. The plaintiff had never previously claimed an exemption for this child, even though his confusing testimony suggested that at some point he thought the child was his but at other times knew that the child was not his. It seems that the child’s mother wasn’t going to claim the child because, having little or no income, she did not need the deduction. So the plaintiff agreed. He also was told that he would be getting a sizeable refund. A few days later, the woman who had initially approached him called him and explained that he would get his refund more quickly if he agreed to have the refund deposited into the woman’s bank account. She promised she would immediately remit the money to the plaintiff. He agreed, but not surprisingly, she didn’t transfer the money to him. So he sued her.
Judge Judy looked at the return in question and noticed that not only was a dependency deduction claimed that should not have been claimed, but that a child tax credit also was claimed. It wasn’t clear how much of the refund was attributable to these two items. The camera zoomed in on a small portion of the return, from which it was impossible to dissect the underlying entries. Judge Judy quickly figured out that the intermediary defendant and her sister were running a scam, and that the plaintiff, knowing he was not entitled to the dependency exemption, was no less complicit. In her questioning of the plaintiff, she used the word “fraud” on at least three occasions. She also, through questioning the defendant, determined that the defendant was not the mother of the woman whose child was being claimed, but was, at best, a foster mother.
Accordingly, Judge Judy dismissed the plaintiff’s case. She pointed out that there are all sorts of doctrines on which she could rely, but that the doctrine of “clean hands” would suffice. The plaintiff had not come to court, she explained, as an innocent victim but as a participant in some sort of scheme. Judge Judy told the plaintiff, “You need to file an amended return. You need to file an honest return.” She added that he knew that he was not entitled to claim the child. She then told both parties that the IRS would be told that the defendant has the refund, that the defendant has money that “belongs to” the IRS, and that the IRS would want to get it back. She also told the parties that the IRS doesn’t like fraud. No kidding.
I wonder what sort of impact on the viewers this episode has made. Has it taught people that it doesn’t pay to commit tax fraud, that the improper filing might be identified even if it is not the IRS that discovers it, that con artists specializing in tax fraud are popping up all over the place, and that one should check out the credentials and experience of a prospective tax return preparer? Or is it putting ideas into the heads of people who figure that with a little more care they can avoid being detected?
There wasn’t any means for me to determine what happened thereafter. Did the plaintiff file an amended return? Did the IRS go after the defendant and recover the refund attributable to the improperly claimed deduction and credit? Did anyone go to jail? Did the tax return prepare sister have other clients? Did she work similar scams with them? Perhaps when “Judge Judy: The Aftermath” debuts, we’ll find out. In the meantime, yes, tax is everywhere.
Edit: Paul Caron of TaxProf blog found video of this particular Judge Judy episode, which he shares on his post Jim Maule and Judge Judy. Thanks, Paul.
Friday, January 28, 2011
Though the IRS initially took the position that the taxpayer was not in the trade or business of gambling, it later conceded the point. Considering that the taxpayer wagered almost $131,760 and won $120,463, it would have been difficult to persuade the court, in light of Comr. v. Groetzinger, 480 U.S. 23 (1987), that the taxpayer was not in a trade or business. The taxpayer also incurred $10,968 of business expenses, including travel, meals, telephone, internet, entry fees, subscriptions, and my favorite, ATM fees.
The IRS, however, also took the position that the taxpayer was permitted to deduct only $120, 463 of combined wagers and other expenses. The taxpayer argued that section 165(d) does not apply to professional gamblers. The taxpayer rested the argument on the premise that because section 165(d) does not apply to trades or businesses generally, it ought not apply to the gambling losses of gamblers who are in a trade or business and should be limited to the gambling losses of people who gamble without being in a trade or business. The taxpayer, in effect, was viewing section 165(d) as analogous in this respect to section 183.
The Tax Court noted that it had on several prior occasions rejected the proposition that the Groetzinger decision absolved professional gamblers from the restrictions of section 165(d). The court repeated what it had explained in a prior case, Valenti v. Comr., T.C. Memo 1994-483, namely, that section 165(d), the more specific provision, trumps section 162(a), which is more general. Thus, the taxpayer’s attempt to deduct more than $120,463 of his wagers of $131,760 was stymied.
However, when the Tax Court turned to the question of the other expenses, the taxpayer fared much better. The court decided that the term “losses from wagering transactions,” which is what section 165(d) limits, does not include the other expenses. The court noted that it had to work through the analysis without a benefit of the phrase in the statute, the regulations, or the legislative history. In fact, its own precedent on the point, the Offutt case, “offered no reasoning to support the conclusion that ‘Losses from wagering transactions’ should be interpreted to cover both the cost of losing wagers as well as the more general expenses incurred in the conduct of a gambling business.”
In reconsidering its position, the Tax Court relied on several strands of analysis. Each relied on analyses in prior case law.
First, it determined that because “gains from such [wagering] transactions” was limited to “proceeds from a wager by the taxpayer where the taxpayer stands to gain or lose on the basis of chance” and does not include a taxpayer’s other income, even income based on shares of a casino’s house fees, the term “losses from wagering transactions” should be limited to amounts lost on a wager. In other words, because income that is in connection with, but not a consequence of, placing a wager is excluded from the section 165(d) limitation, expenses that are in connection with, but not a consequence of, placing a wager should not be subject to the limitation.
Second, the court noted that in Comr. v. Sullivan, 356 U.S. 27 (1958), the Supreme Court cast doubt on the appropriateness of treating a professional gambler’s expenses other than wager costs as a loss subject to section 165(d). The Supreme Court treated a gambler’s wage and rent expenses were ordinary and necessary business deductions allowable under section 162(a). Because the taxpayer in Sullivan had gains from wagering transactions that exceeded the total of his wagering losses combined with the other expenses, the Supreme Court did not reach the section 165(d) issue, but its dictum suggests that it would have held that the limitation did not apply.
Third, the court noted that the Court of Appeals for the Ninth Circuit, in Boyd v. U.S., 762 F.2d 1369 (9th Cir. 1985), had distinguished, in dictum, between wagering losses and “expenses incidental to gambling,” characterizing the latter as not subject to section 165(d). The Ninth Circuit’s observations did not constitute a holding because the issue was precluded by the taxpayer’s failure to raise the matter in the refund claim the denial of which had led to the litigation.
Fourth, the court identified a series of cases in which the IRS itself had conceded that section 165(d) did not apply to expenses that were not wagering losses, or had failed to raise the section 165(d) limitation in the notice of deficiency. In fact, in Chief Counsel Memo AM 2008-013 (Dec. 19, 2008), the IRS announced that it would no longer follow the Offutt decision.
Aside from the obvious lesson to be learned from the case, namely, that the Tax Court takes the position that section 165(d) does not apply to expenses otherwise deductible under section 162(a) that are not wagering losses, there are other lessons to be learned. For example, though many people who are not tax practitioners might think otherwise, the Tax Court is no different from other courts in overruling its earlier decisions if and when careful analysis determines that it is appropriate to do so. Another lesson is the need to look carefully not only at what appears to be a rule extracted from a case, but at administrative issuances and the procedural history of other cases. Knowing that the IRS had conceded the issue and failed to raise the issue in some cases, while litigating the point in other cases, suggests that its original position was not as airtight as might otherwise appear.
Wednesday, January 26, 2011
The article told me that, according to a Texas Traffic Institute study, motorists in my home metropolitan area wasted 39 hours each year sitting in traffic. For motorists in the fifteen largest cities, the average is 50 hours. The list of cities where drivers encounter the most delays included Washington, D.C., Chicago, and Los Angeles, three of the cities I would have nominated for the “honor.” But the other two cities in the top five were Houston and San Francisco. My visits to San Francisco were on the BART system, and my one drive through Houston came during a torrential thunderstorm, so I’m not surprised that I did not include them among the worst. The prize goes to Chicago and Washington, D.C., where drivers waste 70 hours a year sitting in traffic queues.
The good news is that congestion eased a bit in the Philadelphia area during the past three years because the economy slowed. Of course, compared to 1982, when only 12 hours were lost each year to the consequences of more demand for highways than the supply, that’s not the best of good news. The bad news is that any improvement in the economy will bring even more traffic snarls. What then?
Assuming the economy improves, ought not the nation compel the improving economy to pay for its own costs? Put another way, the choice between doing nothing to improve the roads and bridges and finding revenue to pay for required improvements probably appears to most people as a choice between the fire and the frying pan. In the long run, doing nothing will dampen the economy, as delivery delays and increased transportation costs caused by congestion digs into business profits and personal disposable income. Increasing taxes to pay for necessary improvements also reduces business profits and disposable income, but it provides something in return, namely, a better transportation system that in the long run makes the arteries of commerce more free flowing.
Mass transit seems to be a nice alternative but for two problems. Surface mass transit, such as a bus, is no less bottled up by inadequate highway capacity. Rail has its benefits but it’s very expensive, particularly with so many rights-of-way having been abandoned to the private sector. The mass transit option poses the question of where resources should be funneled, but it doesn’t deal with the underlying question of where the resources will be found.
Even aside from the predicted increase in traffic congestion, consider the impact of current transportation deficiencies on the economy. Surely, having workers lose the equivalent of one or two full-time work weeks to the consequences of highway capacity not keeping up with population increases rips into business profits and disposable income at least as much, and almost surely, much more than would increasing taxes to pay for what is needed.
Most of the solutions required by the report require additional resources. It costs money to redesign intersections, to synchronize traffic signals, to remove damaged and broken-down vehicles from travel lanes, to build and label high-occupancy and bus lanes, to enforce limited-use lane rules, to add more roads, to widen roads, to build mass transit lines, to purchase mass transit vehicles, and to relocate housing developments. The one proposal that on its face appears to impose little or no cost, though it might when applied to particular business enterprises and employees, is to stagger employee commuting by permitting workers to begin and end work at times other than “peak hours.” The problem with this proposal is that “peak hours” now run from five or six in the morning until six or seven in the evening.
Ultimately, if paying for increased capacity doesn’t sell, the alternative is to cut demand. However, mechanisms designed to cut demand also bring the same howls of opposition as do proposals to pay for increased capacity. Though the mileage-based road fee, particularly as a replacement for gasoline and other liquid fuels taxes, would solve the financing problem and bring equity to the funding of highway use, as described in previous posts such as Making Progress with Mileage-Based Road Fees, Tax Meets Technology on the Road, Mileage-Based Road Fees, Again, Mileage-Based Road Fees, Yet Again, and Change, Tax, Mileage-Based Road Fees, and Secrecy, it, too, encounters severe resistance from those who benefit from current road funding practices. Perhaps while they’re sitting in stalled traffic, they might want to read the various reports and studies cited in those posts and reconsider whether principled opposition to replacing one source of funding with another is worth yet another few hours a week going nowhere.
Monday, January 24, 2011
The consequences of a default by the federal government on its debt would begin to appear before it actually “ran out of money.” Even if the default was short-lived, the catastrophic economic consequences would, according to the Secretary of the Treasury, “last for decades.” A protracted stalemate would make the Great Depression look like a walk in the park.Nine days later, in a Wall Street Journal op-ed, Republican Senator Pat Toomey, after declaring that all should agree that “Under no circumstances is it acceptable for the U.S. to default on its debt,” claimed that “even if Congress doesn't raise the debt ceiling, a default on our debt need not follow when our borrowings reach their limit in the next few months.” He also claimed, “In fact, if Congress refuses to raise the debt ceiling, the federal government will still have far more than enough money to fully service our debt. Next year, for instance, about 6.5% of all projected federal government expenditures will go to interest on our debt, and tax revenue is projected to cover about 67% of all government expenditures. With roughly 10 times more income than needed to honor our debt obligations, why would we ever default?” Toomey explained that he plans to introduce legislation that would require the Treasury to make interest payments on our debt its first priority in the event that the debt ceiling is not raised.” He argues that, “This would not only ensure the continued confidence of investors at home and abroad, but would enable us to have an honest debate about the consequences of our eventual decision about the debt ceiling.” Toomey adds, “If we do not raise it [the debt ceiling], the government's tax revenue will enable us to fund roughly two-thirds of projected expenditures, including interest payments.”
And yet the Republicans, and far too many Americans, carry on as though there is no catastrophic tidal wave building up out at sea. Those who raise the alarm are viewed as the Reincarnation of Chicken Little, as alarmists who don’t understand that it is possible – according to the wizards of tax reduction and elimination – to cut taxes, cut spending, and eliminate the budget deficit without actually identifying and cutting the spending for any specific federal program. Wow.
Toomey’s goal of curbing the federal budget deficit is laudable. Though he complains about increased spending as a cause of the deficit, he makes no reference to the tremendous increase in military spending during the past decade that not only was funded through money borrowed chiefly from overseas investors and foreign nations, but that was incurred in the face of continuing and increased tax cuts. But that’s not the worst flaw of his reasoning.
Toomey leaves out of his analysis the psychological element. If the Congress refuses to increase the debt ceiling, investors will react by dumping their holdings in U.S. debt, long before the government misses an interest payment. This dumping won’t be a matter of investors selling off the debt. It will take place as investors decline to re-invest in Treasury obligations when they receive the proceeds of the obligations coming due within the next few years. Fear of being the “last investor in the game” will deter the reinvestment. Consider that during the next year almost $2.5 trillion of Treasury obligations will come due, as summarized in this chart, for reasons explained in this prescient warning with respect to the shortening of maturities on Treasury obligations. In other words, not only must the government pay interest on the outstanding debt, it must also come up with cash to pay off the maturing obligations. Usually, it does so by issuing new obligations, but will it be able to raise $2.5 trillion if the Congress has frozen the debt ceiling? Even if some investors decide to “roll over” their investments, the reverberations through world stock, commodity, and other markets if even one-quarter or one-third of the required cash cannot be raised will be tremendous. And it’s likely that what does get raised will demand higher interest rates, thus wedging even more spending into future federal budgets.
Worse, Toomey not only fails to take into account the need to repay principal, he tosses out facts that don’t survive scrutiny when examined closely. Toomey claims that there is “roughly 10 times more income than needed to honor our debt obligations.” The arithmetic belies this claim. The total debt is roughly $14 trillion, whereas estimated total federal receipts for 2010 is about $2.5 trillion. A good chunk of those receipts “belong” to the social security and related trust funds. Even if those receipts were available to “honor our debt obligations,” how can the government pay the $360 billion it owes in interest, plus pay the $2.5 trillion that is due in principal repayment, when it has $2.5 trillion of receipts? Basic arithmetic tells me that “roughly 10 times more income” means Toomey thinks federal receipts top $28 trillion per year. No wonder he and his comrades think taxes are too high. Even I would cringe at the sort of taxation level that would generate $28 trillion in receipts. It takes just a moment to identify the flaw in Toomey’s facts. He views the nation as honoring its debt obligations if it pays the interest that is due. Well, sort of. For the income to be “roughly 10 times” more than the interest that is due, government receipts would need to be roughly $3.6 trillion a year. Oops.
By equating interest payment obligations with “debt obligations,” Toomey ignores principal repayments, and appears to think that when these obligations become due the nation’s creditors necessarily will pony up cash to pay for replacement obligations even though the debt ceiling has not been raised and debt principal hasn’t been paid down. Investors will NOT be racing to the Treasury seeking to put their cash into more debt. Why not? Consider a corporation that borrows money, continues to spend beyond its income, refuses to increase its income, and eventually gets to the point where it can borrow no more money (either because of the market or because of some state or federal law regulating the amount of debt the corporation can incur). It’s true that the corporation can make payment of interest on the debt a priority, but it’s going to start defaulting on other payments, and long before it gets to a point of failing to pay principal, the credit markets are going to write off or sell off the corporation’s debt, and it will plummet into insolvency and bankruptcy.
So what happens if the debt that is due within the next year is not repaid because investors fear the consequences of a frozen debt ceiling? The entirety of all federal receipts would be required to pay off the investors holding the obligations that have come due. I’m not sure where the government would find $360 billion to pay interest. Not only would nothing be put into the social security and Medicare trust funds, those funds would not be able to make any payments, because their “assets” are tied up in Treasury debt which would not be convertible into cash because the Treasury would not have the resources to redeem that debt. There would be no money to finance the military, to staff and operate Homeland Security, the FBI, the CIA, the Center for Disease Control, the Food and Drug Administration. Taxes would be paid, but all federal government services would stop. Perhaps the Federal Reserve could churn out dollar bills, but the resulting inflation would dwarf that of the late 1970s and inject hyperinflation into the economy.
The nation is approaching, more and more quickly, the point of no economic return. I wonder when someone will make it clear to the entire nation, and not just to the few readers of this and a few other blogs who understand the maxim, a nation is doomed when it spends trillions on war while simultaneously continuing and increasing tax cuts that especially benefit the wealthy. I wonder when someone will succeed in persuading the nation that the only hope is a reversal of the mistake, even though it cannot be fully reversed. Even a partial reversal poses the possibility of redemption. Toomey wants “concrete steps toward fiscal sanity.” Would not undoing the fiscal insanity of the past decade be the place to start?
Friday, January 21, 2011
At first, I thought I could use this as an exam question. But then I decided it was too good to let it wait. On an exam, I would prefer to provide a transcript of this particular episode, but I’ve been unable to find transcripts of the Judge Judy Show.
Any student who has taken the basic tax course and has paid attention knows that there is no deduction for the transferor in a marital property settlement, and that the property received by the transferee spouse is not included in gross income. Section 1041 tells us that. The deduction/gross income treatment applies to alimony, not property settlements. That’s what we learn from section 71. Even if the one-time $3 million payment had been treated by the parties as alimony, the alimony recapture rules would have offset almost all of whatever tax break the plaintiff would have had, as well as giving the transferee spouse a deduction almost equal to the $3 million.
Tax is everywhere. It shows up even in television courtrooms where tax cases surely are rejected by the producers. It didn’t occur, and I would not have expected it to occur, to the plaintiff to bring his tax returns for the taxable year in which he made the $3 million payment to which he referred. Perhaps he didn’t realize he was going to mention it until he started explaining his case. Perhaps he didn’t realize he was going to be asked a tax question about it. Had someone told him to bring a tax attorney with him, he would have been bewildered by the idea. Surely had someone told Judge Judy to have a tax lawyer on call, she or the show’s producers would have been incredulous. And yet, once again, the pervasiveness of tax and the continuing need to have tax practitioners within close reach take center stage.
EDIT: Of course it's section 1041, not 1014. Typo. Thanks to the readers who pointed it out.
Wednesday, January 19, 2011
New Jersey, like California and many other states, and like the federal government, is reeling under the impact of tax reductions enacted at the insistence of voters who object to every possible spending cut aside from the magical “reduce fraud” solution that they foolishly think accounts for the totality of budget deficits. In the case of the federal government, I have repeatedly asked the tax-cut advocates to identify the spending cuts they wish to make. I did this most recently in The Grand Delusion: Balancing the Federal Budget Without Tax Increases. Though I did not ask this question specifically with respect to New Jersey’s fiscal crisis, I should have done so, though holding up California’s experience as an indicator made, and continues to make, sense.
Now comes news, news that very likely would have had an impact on voter decisions had it been released before, rather than after, the election. New Jersey’s governor insisted that one way of balancing the state budget was to reduce or eliminate state payments to local governments. And so the cuts were imposed. Faced with reduced state assistance, Camden City Council, as explained in numerous reports, such as this one, has voted to cut up to one-fourth of the city work force, including almost half of the city’s police officers and one-third of its firefighters. Some residents claim that they will be “buying weapons” because they will “have to defend ourselves [and] our families.” The head of the City Council put the blame on the state’s decision to reduce city funding. In response, according to this report, the governor essentially replied, “Don’t blame me.” He claims that the council is at fault, because “they’re the ones who have been managing the city for all these years.” Christie supported the notion of having the city of Camden “spend less.” And so it will. Christie justified his decision in part on corrupt city politicians that he had helped, in his former position as U.S. Attorney for New Jersey, put in jail. However, barring evidence that these politicians absconded with tax receipts equal to the budget shortfalls in Camden’s past and present fiscal years, the existence and eventual removal of corrupt politicians does nothing to solve the problem. Camden, like New Jersey, California, almost every other state, most other cities, and the entire country, has insufficient resources to protect its citizens, to maintain the infrastructure that the citizens wish to have, and to defend the rights of its residents.
How long until severe reductions in police and fire fighting departments sweeps across the nation? How long until bridge and tunnel collapses, sinkholes, water main breaks, and other infrastructure failures begin to occur at a rate too rapid for even 24-hour cable news to keep pace in reporting? How long until public health systems collapse? How long until voters realize what’s in offshore tax haven accounts, who put it there, and what a difference would have been made had the evaded taxes been paid when they should have been paid? Some people in the anti-tax crowd continue to hide income and assets, even while their precious rate reductions are enacted and extended, because deep down inside, they want a totally free ride. An early installment of the price for that ride is being paid in the form of the looming crisis for people Camden, and later installments eventually will reach far beyond the city that sits across the Delaware River from Philadelphia.
Monday, January 17, 2011
According to the Time Magazine article cited by Paul, this “tax arrangement” exists in Switzerland. Switzerland! The municipal council of the town of Reconvilier, frustrated by increasing numbers of dog owners failing to pay the $48.50 dog ownership annual fee, announced that it would take steps to collect the unpaid taxes, including enforcement of a 1904 law permitting seizure and killing of dogs with respect to whom the tax has not been paid. What made matters worse is that the head of the council, in describing actions taken 30 years ago, stated, “A lethal injection is sentimentality. We took them to a knacker’s yard, shot them in the head, and it was done . . . Euthanasia is for humans, and in our era, we’re not going to dilute the truth.” In reaction to the not unexpected expressions of outrage and dumbfoundedness, the council head explained that the unpaid taxes could be paid in installments and that killing dogs would be an extreme and unlikely outcome. He added, “This isn’t about eliminating all the little doggies! We don’t even have an extermination worker – our police forces aren’t even armed!”
A reader of TaxProf Blog pointed out that there are jurisdictions within the United States that have similar laws on the books. A reader named “US Law” quoted section 19-20-2 of the West Virginia Code:
It shall be the duty of the county assessor and his or her deputies of each county within this state, at the time they are making assessment of the personal property within such county, to assess and collect a head tax of three dollars on each dog, male or female; and in addition to the above, the assessor and his or her deputies shall have the further duty of collecting any such head tax on dogs as may be levied by the ordinances of each and every municipality within the county. However, no head tax may be levied against any guide or support dog especially trained for the purpose of serving as a guide, leader, listener or support for a blind person, deaf person or a person who is physically or mentally disabled because of any neurological, muscular, skeletal or psychological disorder that causes weakness or inability to perform any function. Guide or support dogs must be registered as provided by this section. In the event that the owner, keeper or person having in his or her possession or allowing to remain on any premises under his or her control any dog above the age of six months, shall refuse or fail to pay such tax, when the same is assessed or within fifteen days thereafter, to the assessor or deputy assessor, then such assessor or deputy assessor shall certify such tax to the county dog warden; if there be no county dog warden he or she shall certify such tax to the county sheriff, who shall take charge of the dog for which the tax is delinquent and impound the same for a period of fifteen days, for which service he or she shall be allowed a fee of one dollar and fifty cents to be charged against such delinquent taxpayer in addition to the taxes herein provided for. In case the tax and impounding charge herein provided for shall not have been paid within the period of fifteen days, then the sheriff may sell the impounded dog and deduct the impounding charge and the delinquent tax from the amount received therefor, and return the balance, if any, to the delinquent taxpayer. Should the sheriff fail to sell the dog so impounded within the time specified herein, he or she shall kill such dog and dispose of its body.West Virginia is not alone with this tax enforcement approach. Under section 17-526 of the Nebraska Revised Statutes, the approach is similar:
Second-class cities and villages may, by ordinance entered at large on the proper journal or record of proceedings of such municipality, impose a license tax in an amount which shall be determined by the governing body of such second-class city or village for each dog or other animal, on the owners and harborers of dogs and other animals, and enforce the same by appropriate penalties, and cause the destruction of any dog or other animal, for which the owner or harborer shall refuse or neglect to pay such license tax.In Utah, section 10-8-65 of the Municipal Code states, “They may license, tax, regulate or prohibit the keeping of dogs, and authorize the destruction, sale or other disposal of the same when at large contrary to ordinance.” There probably are similar provisions in the statutes of other states. So before fingers are pointed at Switzerland, it would be prudent to engage in some self-examination of laws in the United States. There is something absurd about inflicting punishment on the dog, who hasn’t done anything wrong, rather than on the owner. Fortunately, there are some states that do not take out the tax nonpayment on the dog, but instead look to the imposition of fines on the deadbeat owner, at times classifying the failure to pay as a misdemeanor.
Though statutes providing for the killing of dogs with respect to whom their owners have not paid applicable taxes have been on the books for quite some time, there is something not only immoral but also illogical in the killing aspect of the remedy. If a person does not pay a vehicle registration fee, do states confiscate the vehicle and then send it to the car smashing machine at the junkyard? No, the state auctions the vehicle in an attempt to raise revenue. If a person does not pay real property taxes, the state or local government files a tax lien and eventually can end up owning the property. Does it burn down the house or other structures on the property? No, again, it sells the property at a tax sale. If a person fails to pay an occupation tax, the state might shut down the person’s business, but it doesn’t put the person on death row. If a person does not pay a per capita tax, does the local government cut off the person’s head? Hardly.
The only good thing to come out of the Switzerland story is that it makes people aware of something formerly unnoticed and might trigger movements to take these laws off the books. Sometimes, the best way to teach a lesson to others is to set a good example. Are you listening, state legislators?
Friday, January 14, 2011
The folksy style pops up early, when in the preliminary chapter, Julian replies to the question, “It pays for me to file jointly. But I don’t want to reveal my income to my wife. Suppose I have her sign a blank return and then fill in the figures?” with a quick, “Don’t bother.” He follows up with an explanation that the taxpayer’s wife would be able to get a copy of the return from the IRS. We’re not told why the taxpayer wants to hide his income, but perhaps Julian doesn’t know. He also deals with more mundane question, such as shifting from married filing separately status to joint returns, and vice versa, the prohibition against one spouse itemizing and the other claiming the standard deduction, the tax treatment of a surprise “additional alimony payment . . . not required by our divorce decree,” and deductions for contraception and gender change surgery. He also gets into the deductibility of payments to girlfriends hired to manage rental properties or to do office work for the taxpayer.
Part 1 focuses on filing status, and includes discussion of when status is determined, amending returns, the scope of joint liability on joint returns, and the advantages and disadvantages of filing separately. Julian alerts those immersed in wedding preparations that they ought not ignore the tax issues. He explains the marriage penalty and the marriage bonus, and how the scheduling of weddings planned for near the turn of the year provides tax planning opportunities. He also explains the tax treatment of surviving spouses, and tax traps for same-sex couples. Julian’s summary of how the Defense of Marriage Act affects unmarried couples, how it came to be enacted, and what would happen if it was repealed or declared unconstitutional is itself worth the price of the book.
Part 2 deals with the tax consequences of divorce, which can bewilder couples who are going through personal upheavals and encountering an array of financial and property decisions. Among other topics, the tax treatment of the legal fees, the effect of invalid divorces, and the difference between the tax consequences of an annulment and a divorce, and the determination of which parent claims the dependency deduction for children get close attention. Part 2 concludes with a section as interesting as its title suggests, “Unearthing Hubby’s Hidden Assets.” It is a good introduction to forensic accounting, as it explains what sorts of information can be derived from the information appearing on a joint return.
Part 3 explores the tax consequences of home sales by married couples, divorcing couples, divorced couples, and unmarried couples. It concludes with a look at the tx consequences of leaving property in both names while one of the two live in the house.
Part 4 untangles the taxation of social security benefits. Julian explains the computation of modified adjusted gross income, and provides examples to help readers understand what is one of the more complicated elements of individual federal income taxation. Part 4 includes some planning advice with respect to the impact on the computation of taxable social security benefits of filing jointly or separately, and concludes with some reminders about the use of social security numbers in connection with tax returns.
Part 5 is titled “Oddball Situtations,” a title that makes sense when one examines the subtitles within Part 5. What’s discussed in “Having an Affair Can Be Taxing” is obvious and well worth reading. Several of the cases, and most of the issues, have inhabited my basic federal tax course for many years, because they are, as I tell my students, simply too good to pass by. More than a few taxpayers will be interested in “Dependency Exemptions for Live-in Lovers,” for reasons that should be readily apparent.
The book concludes with two short segments. Part 6 examines changes in withholding that might be necessary when taxpayers marry or divorce. Part 7 discusses amending returns.
This is a book worth reading. Someone needing or wanting to make a small gift to a friend or relative who has announced an engagement or shared the unsettling news of a divorce should consider giving the person a copy of Julian’s book. It might not be a glamorous present, but it’s a useful one, and one for which the recipient will be appreciative. The book is published by PassKey Publications.
Wednesday, January 12, 2011
The author makes several assertions which are not quite accurate, but these misunderstandings don’t detract from the basic points, which is that students need to take into account employment prospects, the risk of defaulting on loans, and other economic factors in addition to whatever other information they consider, and that they need help from law schools in doing so by having full disclosure of the relevant, and accurate, employment, salary, and other information. For example, the author claims, “Those huge lecture-hall classes — remember ‘The Paper Chase’? — keep teaching costs down. There are no labs or expensive equipment to maintain.” This may be true at some law schools, but law schools that maintain clinics providing services to the needy while giving law students an opportunity to experience law practice in an environment other than a classroom not only are burdened with what amounts to the cost of operating a public-interest law firm but also are constrained in terms of the number of students who can be permitted to enroll. Clinics are important but they aren’t money makers. The huge lecture-hall classes are disappearing, as more and more law schools limit class size to improve students’ educational opportunities. This change is being reflected in law school construction, as, for example, Villanova’s new law school building has only one classroom that can accommodate more than 100 students, whereas the old building had four. The author also confuses the issue when he highlights a student with $250,000 of student loans in a manner that suggests undergraduate education had nothing to do with the size of the debt.
So though there are a few things in the article with which I disagree, the author is calling attention to concerns not unlike those I have made in the past. For example, in Law Schools, Teaching, Legal Scholarship, and the Economy, where I stated, “What law schools, and their parent universities, need to do is to become honest.” In How A Transformative Recession Affects Law Practice and Legal Education, I predicted that “When prospective law school students begin to realize that the chances of getting a job upon graduation have fallen to the levels faced by college graduates with degrees in those majors that have persistently not been rewarded by the economy, even some of the more idealistic of them will view a J.D. degree as an over-priced ticket for admission to what at best is an employment lottery. When they 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.” I also suggested that there will be “some combination of a reduction in the number of law schools and a transformation of what transpires at those that survive” and that “[e}nterprising practitioners, perhaps law firms joining together in collaborative and creative efforts, will form schools focused on preparing people to practice law,” and that [p]roperly operated, they need not charge the tuition rates currently being charged.
The focus of the criticism has been an emphasis on the need of law schools to disclose the realities of job opportunities. It has been proposed that law school applicants should be told that very few law school graduates earn those highly publicized $150,000 salaries when they graduate. It has also been proposed that applicants should be told, and in too many instances are not being told, that significant numbers of law school graduates are not finding law-related jobs when they graduate. Eventually someone will propose that law schools disclose why, after three years of law study, law school graduates are not in a position to practice law, are not near the stage of progress that their peers coming out of medical school have attained, and that some law firms refuse to hire new J.D. graduates for this reason.
Even though I agree that law schools should disclose information such as their graduates’ employment record, and that the information should be specific and free of manipulations such as law schools hiring recent graduates for make-work positions so that the employment numbers can be inflated, I also think there are other disclosures that need to be made by other segments of the legal profession. Why not require legal practitioners to offer full disclosure about the practice of law? Why not require law school applicants to read explanations of how the exciting scenes they see on television dramas and in the movies – cited by more than a few law students over the years as the inspiration for their decision to attend law school – are, like $150,000 entry-level salaries, a fairly rare situation? Why not require lawyers to disclose to law school applicants that there is a good chance they will be confined to small offices, for as many as 16 hours a day, reading through box after box or DVD after DVD of documents and other evidence? Why not require law firms and legal departments to disclose that a specific percentage of their associates or legal employees have concluded their jobs are tedious, stressful, and unfulfilling? Ought not law firms disclose how many newly-hired associates don’t “make partner” and how many choose to leave or are asked to leave after one or two years with the firm? Might not this sort of information cause potential law students to think again about their career decisions? Perhaps law firms ought to be required to explain why some law graduates are offered salaries that are four or five times those offered to other graduates even though all those graduates share a common characteristic, namely, little or no experience. Perhaps someone should explain why there are so many people in need of legal assistance and yet so many lawyers unable to find jobs? Perhaps someone should explain why the connection between those needing legal assistance and the lawyers who could provide it hasn’t been made. Considering that the ratio of lawyers to population is 1:300, and the ratio of lawyers not employed by government, corporations, or tax-exempt organizations, etc. to the population is more like 1:400 or 1:500, ought not each lawyer have 400 or 500 individual clients? Has the legal marketplace failed in this respect? Who is responsible for making these disclosures? It makes sense to require law schools to disclose information about their activities, but the legal profession in its entirety has no less an obligation to be transparent about itself.
The discussion will continue. It will be interesting. It will be contentious. From time to time, it will get sidetracked into other legal education and law practice issues. Whether it will trigger meaningful changes remains to be seen.
Monday, January 10, 2011
The Republican members of the House want to cut federal spending. If they fail to cut federal spending, their refusal to raise taxes means that the federal budget deficit will cause the total national debt to increase. The problem with letting the total national debt increase is that under current law, the total debt is not permitted to exceed $14.3 trillion. At the moment, the debt is at roughly $13.96 trillion. This means that the limit will be reached at some point during April or early May, depending on how effectively Treasury can “juggle the books” to postpone the day of reckoning. Once the limit is reached, the nation faces the prospect of government default on the debt, triggered in part by its inability to borrow additional money to make interest payments on existing debt.
The Republicans have announced, as explained in several stories, including this one, that they will not agree to an increase in the debt limit until federal spending is cut. According to the Speaker of the House, John Boehner, “While America cannot default on its debt, we also cannot continue to borrow recklessly, dig ourselves deeper into this hole and mortgage the future of our children and grandchildren.” Goodness, isn’t that pretty much what I said, initially in A Memorial Day Essay on War and Taxation and then in many follow-up posts, when Congress decided to increase federal spending by hundreds of billions of dollars to finance wars while also dishing out tax cuts that chiefly benefitted the wealthy? If it’s so wrong for the government to spend more than it takes in, are the Republicans going to go back and correct their previous errors?
So perhaps it would be helpful to learn what spending items the Republicans wish to eliminate. After all, they want to use their opposition to an increase in the debt limit as leverage to compel spending cuts. According to this report, when asked which programs could be cut, Boehner replied, “I don’t think I have one off the top of my head. But there is no part of this government that should be sacred.” Aside from the continued refusal to identify spending cuts, surely out of fear that lobbyists for those adversely affected by such cuts would descend on their Capitol Hill offices in a stampede, the Republicans are being boxed into a corner by their leader. When Secretary of Defense Robert Gates announced plans for a very small increase in the military budget for next fiscal year, plans that include shrinking the size of the Army and Marine Corps and cutting two major weapons systems, as explained in this story, Republicans objected, suggesting that the proposal puts the nation at risk. Is it possible to imagine how Republicans would respond to a proposal to decrease total defense spending when they go ballistic over smaller than expected increases? Do they truly think nothing in government is sacred? In The Grand Delusion: Balancing the Federal Budget Without Tax Increases, I invited “the advocates of using spending cuts as the sole solution to the budget deficit crisis to identify sufficient cuts to bring the budget into balance.” I’ve had no replies from those advocates that identify specific cuts or even general spending reduction ideas. I’m not surprised.
Republicans had put forth a goal of cutting federal spending by $100 billion, which is a very, very small piece of the budget and quite a tiny amount of spending when viewed from the wider perspective. Yet, according to this report Republicans are now backing down, claiming that cutting more than $50 billion will be almost impossible. Not surprisingly, the Republicans are blaming the Democrats for the inability of the Republicans to identify $100 billion in spending cuts. As Representative Chris Van Hollen explains, “I think they woke up to the reality that this will have a direct negative impact on people’s lives. You know, it’s easy to talk about these things in the abstract. It’s another thing when you start taking away people’s college loans and Pell Grants or cutting early education programs.” It gets better. The Republican plan to repeal health care reform would add $230 billion to the federal budget deficit, as explained by the CBO and reported in this story.
The consequences of a default by the federal government on its debt would begin to appear before it actually “ran out of money.” Even if the default was short-lived, the catastrophic economic consequences would, according to the Secretary of the Treasury, “last for decades.” A protracted stalemate would make the Great Depression look like a walk in the park.
And yet the Republicans, and far too many Americans, carry on as though there is no catastrophic tidal wave building up out at sea. Those who raise the alarm are viewed as the Reincarnation of Chicken Little, as alarmists who don’t understand that it is possible – according to the wizards of tax reduction and elimination – to cut taxes, cut spending, and eliminate the budget deficit without actually identifying and cutting the spending for any specific federal program. Wow.
Friday, January 07, 2011
Several days ago, CNN reported on a story with a headline that grabbed my attention: Convicted Killer Could Inherit Victim’s Assets. That’s a very unusual outcome, so I just had to read the full report. I’m glad I did. If I were still teaching the course, the tale would become the basis of an examination or semester exercise question. The fact pattern is simple, though there is one fact in dispute and two that are unclear. Brandon Palladino pleaded guilty to killing his mother-in-law in 2008. The report doesn’t explain why he killed her, and the reason doesn’t matter. For those who are curious, a 2009 report explains that he choked her to death after she arrived home earlier than expected and discovered that he was robbing her house. Brandon, who pleaded guilty to first-degree manslaughter, is awaiting sentencing, and he will be sentenced to as many as 25 years in prison. When Dianne Edwards, the mother-in-law, was killed, her property passed to her daughter Deanna Palladino. Some reports, such as the one from CNN use the word “inherit” or a variant to describe how the property passed to Deanna, but others, such as this one, state that Dianne Edwards had executed a will in favor of her daughter. Whether Deanna took through inheritance or under a will does not matter. Deanna, meanwhile, remained married to Brandon. Two years after her mother’s death, Deanna died. The CNN story states that Brandon will inherit Deanna’s property, which includes the property she inherited from her mother. But another report explains that Deanna “left everything to her imprisoned husband,” which suggests she executed a valid will. In this instance, the difference does matter. What’s in dispute is Deanna’s involvement in the robbery. According to this story, Dianne Edwards’ sister Donna claims that Deanna gave Brandon the key to her mother’s house, assisted in covering up the crime, pawned some of her mother’s jewelry, and used some of the money received from her mother to pay for Brandon’s legal defense.
Wow. As I tell my students, we law professors don’t need to make up our hypothetical questions. We get plenty of material from life itself.
As a matter of law, under what is known as the Slayer’s Act, people who kill another person are precluded from inheriting or otherwise taking property from the decedent. The scope of this rule’s application varies from state to state, many applying it to all homicides, some only to murder, and so on. Those details aren’t pertinent in this case. The problem is that Brandon Palladino is not inheriting from his victim. He is either inheriting from his wife or taking property under his wife’s will. He is not an heir of his victim nor was he a beneficiary in her will. Thus, the reports, about the situation, such as this one, claiming that “a convicted killer is set to inherit a quarter-million dollars from his victim” are wrong. It’s true that the victim’s property, or much of it, will end up in her killer’s hands, but that’s not because he is inheriting from her. It’s because of what her daughter did with respect to her own estate planning.
The victim’s daughter chose to let her husband take her property. If she did this by writing a will that named him her beneficiary, then she made a decision that she was capable of making because her mother’s earlier decision to let her property go to her daughter gave her daughter the opportunity to transfer the property however she chose. If the daughter did this by failing to write a will, then it’s less clear whether she chose to let the inheritance statutes apply or whether she didn’t even give a moment’s thought to the question and unwittingly let the property go to her mother’s killer.
When I taught the Decedents’ Estates and Trusts course, I tried to instill in my students a sense of thinking through all possibilities when mapping out an estate plan. One needs to help a client understand what happens with the client’s property after the client dies. And this is more than simply identifying the intestate heirs or working through the contingencies that trigger alternate beneficiaries under a will if a primary beneficiary fails to survive. It involves getting the client to understand that once the heir or beneficiary takes the property, he or she may use the property for some purpose that the client dislikes, or transfer the property by gift or will to a person that the client dislikes, or neglect to write a will and let the property go to someone who is a stranger to the client, such as a spouse whom the beneficiary meets and marries years after the client dies. There are ways, of course, to reduce the chances of these things happening, such as setting up trusts and imposing conditions on the bequests and devises, but the attorney needs to help the client get past the temptation to think that the unexpected will not happen.
Estate planning is a risky business. People die out of expected sequence. Someone lives much longer than expected. Beneficiaries marry. They divorce. Beneficiaries adopt children. Beneficiaries’ spouses commit crimes. A beneficiary’s spouse or friend might even kill the decedent.
The statute in question blocks the killer from inheriting property from the victim and from taking under the victim’s will. The statute does not apply to Brandon Palladino. The reaction of the victim’s family, and many others, reflects common sense. Common sense seems to tell us that there’s something not quite right about Dianne Edwards’ property ending up, albeit through a two-step process, in the hands of her killer. But statutes don’t always reflect common sense, nor is all common sense codified in statutes. Perhaps if Dianne knew what would end up happening, she would have written a will that kept Brandon from getting the property, by use of a trust. We don’t know what Deanna intended, and there are indications that she wanted her husband to have the money. If she did not, then the experience is yet another example of why people need wills and need to think carefully about what they put in those wills.
It would not surprise me to learn that one or more members of the victim’s family initiate litigation to prevent Brandon Palladino from taking possession of the property in question when he is released from prison. It’s unclear whether the family tried to stop Deanna from taking her mother’s property after her mother was killed. If they did, they obviously failed to prove by a preponderance of the evidence that Deanna also was a killer of her mother and thus blocked from taking her mother’s property. If they did not, it’s too late. So they’re left with trying to find some theory on which to block Brandon from taking the property. It would not surprise me to learn that they tried and failed.
It also would not surprise me to learn that a legislator introduces a bill to amend the statute to extend the Slayer’s Act to these sorts of situations. And it would not surprise me to learn that the bill received little or no attention in the legislature. It would not surprise me that some lawyers started adapting their will drafting to take these sorts of situations into account. And it would not surprise me that other lawyers did not.
Wednesday, January 05, 2011
4. Cutting the employee FICA rate. This may be the most dangerous provision in the compromise. Ultimately, it worsens the financial health of the social security system. It dumps even more financial burdens on younger generations. Advertised as beneficial for people at the lower end of the income ladder, the roughly $2,000 tax reduction will be available to all wage earners, including those whose salaries are in the millions and tens of millions. Do those people need even more tax reduction? Why? Certainly not to create jobs.Had I looked more closely, I would have noticed that the provision worsens the financial health, not of the social security system, but of the nation. The legislation contains the following provision:
There are hereby appropriated to the Federal Old-Age and Survivors Trust Fund and the Federal Disability Insurance Trust Fund established under section 201 of the Social Security Act (42 U.S.C. 401) amounts equal to the reduction in revenues to the Treasury by reason of the application of subsection (a). Amounts appropriated by the preceding sentence shall be transferred from the general fund at such times and in such manner as to replicate to the extent possible the transfers which would have occurred to such Trust Fund had such amendments not been enacted.A similar provision makes up the shortfall in amounts otherwise collected and credited to the Railroad Retirement Fund.
What will happen is that the nation’s general fund will transfer to the Social Security and Railroad Retirement funds what are, in effect, IOU notes. The general fund will borrow from those other funds, issue special bonds to cover that debt, and in turn use the money borrowed from those funds to pay into those funds the cash that would have been paid into those funds had the full employee portion of FICA taxes been collected. At some point, when the Social Security and Railroad Retirement funds need cash to pay benefits, they will call on the general fund to pay up the borrowed amounts plus interest. Where will the general fund get the money?
The general fund will get the money to repay its debt to the other two funds in one of two ways. The amount in the general fund can be increased by raising taxes. The general fund can obtain funds by borrowing from other nations. Keep in mind that the amount of taxes that will need to be raised, if that route is chosen, is more than the tax cut generated by the reduction in the employee FICA rate.
Consider another possibility, namely, the general fund defaults on its obligation to the Social Security and Railroad Retirement funds. That leaves three choices with respect to the latter two funds. First, Social Security and Railroad Retirement tax rates can be increased to make up the difference. Second, benefits can be cut. Third, the funds can borrow from other nations, assuming that by this time there are other nations willing to lend money to these funds.
Imagine being in a vehicle moving forward at a high rate of speed. Imagine a passenger sees a cliff ahead. Imagine the drive assuring everyone, “We’ll deal with that when we get there, and, anyhow, by the time we get there the edge of the cliff will have advanced into the distance.” How much confidence do you have in the driver’s braking reaction skills and in the vehicle’s braking system?
Consider again, carefully, what is happening: “What will happen is that the nation’s general fund will transfer to the Social Security and Railroad Retirement funds what are, in effect, IOU notes. The general fund will borrow from those other funds, issue special bonds to cover that debt, and in turn use the money borrowed from those funds to pay into those funds the cash that would have been paid into those funds had the full employee portion of FICA taxes been collected. At some point, when the Social Security and Railroad Retirement funds need cash to pay benefits, they will call on the general fund to pay up the borrowed amounts plus interest.” In other words, the funds are being funded with money that does not exist. It’s not unlike the non-existing road surface beyond the face of the cliff.
Monday, January 03, 2011
The facts are fairly simple. Taxpayer was married in approximately 1986, and in April 2002, he and his wife were divorced. In the divorce decree, the taxpayer was ordered to pay $400 twice a month to his former wife “without a specific ending date.” The decree also provided that after five years, the court would review the taxpayer’s obligation to make the payments. At some point, the taxpayer and his former wife agreed to reduce the amount that he was paying because of changes in the taxpayer’s financial circumstances. They did not ask the court for a revision of the divorce decree because it would have cost money to do so.
During 2007, the taxpayer paid $6,240 to his former wife through a direct deposit into a checking account set up for her. At the end of 2007, a grandson of the former wife told the taxpayer that his grandmother had remarried in 2006. On learning this, the taxpayer stopped the direct deposits. The taxpayer claimed an alimony deduction of $6,240 on his 2007 federal income tax return.
The IRS disallowed the deduction, arguing that the payments were not made under a divorce or separation instrument. It agreed that the other definitional requirements for payments to be alimony had been satisfied.
The IRS argued that because the taxpayer’s obligation to make alimony payments terminated under state law when his former wife remarried in 2006, the payments in 2007 were not received under a divorce instrument. The Tax Court, however, pointed out that there is no requirement in section 71(b) that payments be made under a legally enforceable duty. It noted that “Although it was once the case that entitlement to an alimony deduction under section 71 required payments to be made under a legally enforceable obligation, it has not been so for more than 25 years.” The Deficit Reduction Act of 1984 repealed the requirement that the payment be made under a legally enforceable obligation. The Court then wrote the sort of sentence that no attorney wants to read about his or her efforts: “Respondent’s legal argument has as its foundation old law and does not reflect amendments to the statute.” The Court noted that cases so holding dealt with situations where no decree had been issued, payments made before the decree was effective, or situations to which the old version of section 71 applied. The Court also noted that Treasury Regulation section 1.71-1(b) had been, in effect, obsolete by the temporary regulations issued under section 71 after the enactment of the Deficit Reduction Act of 1984. In fact, section 1.71-1T(a), Q&A-3 of those regulations states that the requirement that alimony payments be “made in discharge of a legal obligation . . . has been eliminated.”
So what happened? It seems, from the Court’s description of the IRS arguments, that the idea of voluntary alimony payments being deductible did not sit well with the IRS. Yet, there is a good argument that the payments were not voluntary. They were obtained through lack of disclosure. Was the former wife under an obligation to inform the taxpayer when and if she remarried? I don’t know what state law in Washington requires, but what’s the harm in putting such an obligation in the divorce decree? The case does not reveal if the taxpayer sued his former wife to recover the payments she should not have received. If he does recover those payments, he’s looking at a tax benefit rule issue. The case also does not reveal if the former wife included the 2007 payments in gross income. If she did not, and the IRS let her go on that decision because it considered the payments not to be alimony, it whipsawed itself.
Or it simply could have been an oversight by one or more IRS employees. Were the IRS personnel involved in the case doing what some of my students continue to do despite my many warnings, namely, working from “old outlines”? Did no one look at the Temporary Regulations issued years ago? I doubt we ever will know.
With the tax law changing almost daily, thanks to frequent legislative tinkering and hundreds of cases and administrative issuances being delivered almost daily, anyone dealing with the tax law must stay on top of the changes. Speaking from experience, that is a staggering undertaking. But it’s an inescapable one.
Friday, December 31, 2010
The facts are simple. A religious organization employed the taxpayer, who owned more than one home. One was a principal residence in Cleveland, Tennessee, and the other was a second home at the Parksville Lake Summer Home area of the Cherokee National Forest in Lake Ocoee. After selling the second home in 1998, the taxpayer acquired another second home, but this fact doesn’t affect the analysis. The taxpayer did not use either home for commercial purposes, nor was either home rented to third parties. The religious organization paid to the taxpayer a parsonage allowance to cover the costs of owning and maintaining both the principal residence and the vacation home. The taxpayer excluded the allowance, which increased from roughly $25,000 in 1996 to almost $200,000 in 1999, from gross income under section 107.
The IRS took the position that the section 107 exclusion applies with respect to only one home. The IRS argued that the term “a home” in section 107 refers to one home. The taxpayer argued that the only limitation in section 107 is that the amounts excluded under section 107 be used to provide a dwelling place for a minister, and that both homes were used as dwelling places, a fact to which the IRS and taxpayer stipulated.
An examination of earlier versions of the exclusion, which first appeared in 1921, was not helpful. Originally the statute referred to “a dwelling house and appurtenances thereof” and the transformation in 1954 of this phrase into “a home” was described by Congress as intending no change in the law.
The majority of the Tax Court rejected the IRS analysis for several reasons. First, it viewed the IRS argument as one that substituted the phrase “a single home” or the phrase “one home” for the phrase “a home” in the statute. Second, it turned to section 7701(m)(1), which provides that “words importing the singular include and apply to several persons, parties or things.” Four judges joined this opinion, another concurred only in the result, and yet another did not participate in consideration of the case.
In a concurring opinion, Judge Wherry explained that he agreed with the majority opinion, but wrote “separately to emphasize the limited factual record on which this case was decided.” After noting that he disagreed with the dissenting judges’ position that the phrase “a home” is ambiguous, and that the parties’ stipulations essentially mandated the conclusion reached by the majority, Judge Wherry noted that “[n]ecessarily absent from our consideration of this case are important regulatory consideration which were not fully addressed in the stipulation or on brief.” For example, ministers whose duties require tending to persons living in sparsely populated rural areas may need two or more homes to reach everyone within their assigned area. As other examples, the question of whether the parsonage allowance was reasonable compensation, why it was provided in the amounts indicated, and whether private benefit and personal inurement existedwere issues not before the Court. Two of the judges who joined the majority opinion also joined this concurring opinion.
In a dissenting opinion, Judge Gustafson concluded that the IRS should prevail, for four reasons. First, under the principle that exclusions from gross income must be narrowly construed, section 107 should be limited to one home. Second, the fact that the word “a” and the word “home” are both singular, combined with the fact that in common usage a person has only one home and the facts that, according to the dissenting opinion, the term “home” refers to the place where the minister lives and that a person can live in only one place at one time, makes the IRS interpretation of section 107 “more likely.” The dissent dismissed the majority’s reliance on section 7701(m)(1) by noting that it applies only if the context does not suggest otherwise, and that in section 107, the context does suggest otherwise. To the notion that some people have multiple homes, as exemplified by a person referring to “my city home and my mountain home,” the dissenting opinion noted that the IRS had not conceded the use of terms such as “summer home” or “vacation home” “presumes the existence of a prior ‘home’ that is one’s habitual dwelling.” The dissent added, “The phrase ‘second home’ refers instead to a secondary residence that is not one’s actual ‘home’.” Third, in an argument connected with the second reason, the dissent, relying on the “to the extent used by him . . . to provide a home” language of the statute, concluded that a person can use only one home at a time, and that because the allowance cannot apply to a home that the minister does not use at all during the taxable year, it ought not apply for periods when the home is not in use. Fourth, the dissent argued that permitting a parsonage allowance exclusion for more than one home “would serve no evident legislative purpose.” Five judges joined in the dissenting opinion.
This sort of case demonstrates how frustrating it can be to interpret a statutory provision that does not deal with all of the basic possibilities. It is likely, at the time that Congress enacted the predecessor of section 107, that the thought of ministers owning or using multiple homes did not enter the collective Congressional mind. Of course, considering that, as the court pointed out, the origins and purposes of section 107 are “obscure,” it is speculation to conclude what, if anything, was in the collective Congressional mind.
It is easy to propose alternative language that would resolve the issue, but doing so simply emphasizes the inadequacy of the existing statute. If the language referred to “a home or homes,” the answer would be clear, as would be the case with the phrase “any home.” If the language referred to “the principal home” or “the home that is the principal residence,” the analysis would be fairly easy. The phrase “the home” would be more difficult to interpret than the preceding suggestions, but still less daunting than the existing language.
What’s left are several questions for the future. First, will the IRS appeal, and if so, will it prevail? Second, will the IRS continue to issue notices of deficiency in these sorts of cases, knowing that it would lose in the Tax Court but hoping that it would prevail on appeal to a different Court of Appeals? Third, might the Supreme Court end up dealing with this issue? Fourth, will the Congress amend section 107 to respond to the Tax Court’s decision, and, if so, what will it do? Fifth, might the Congress repeal section 107, the existence of which is difficult to justify under any sort of tax policy analysis? I’m willing to predict that at some point in the future, a subsequent development with respect to this issue will be the subject of a future MauledAgain blog post.
Wednesday, December 29, 2010
The website in question, Give It Back for Jobs, permits users to select from one of four charities: Habitat for Humanity, the Salvation Army, Children’s Aid Society, and Nurse Family Partnership. I’m sure these are worthy charities, in fact, I know that they are, but the three law faculty don’t disclose how they determined that these four charities, and no others, qualify. Surely there are other charities that meet the tests of promoting fairness, economic growth, and a vibrant middle class. I did not see any option to select a charity other than the four listed on the site.
Setting aside the question of charity selection, there remains another puzzler. Several commentators have suggested that those who wish to decline the tax cut they otherwise would receive should return it to the United States Treasury. Joe Kristan, over at Tax Update Blog, in You First, Buddy notes, “They are all worthy charities, but they do nothing for the entity most harmed by the tax cuts: the government.” Glenn Reynolds at InstaPundit shares an email from Hanah Volokh, who asks, “shouldn’t the only option be to send the money to the U.S. treasury?” and who wonders “do any of [the four charities] create jobs?” and ponders, “Wouldn’t the number of jobs in America grow more quickly if we all spent our tax cut money on consumer goods or home remodeling? Or by hiring someone to mow our lawns instead of doing it ourselves?” Peter Pappas, in Rich Liberals Say Give the Tax Cuts Back, notes that “After all, if they really believe they should be paying more taxes, the diversion of their tax savings to private charity doesn’t solve the problem. The feds are still out the money.” William Jacobson of Le-gal In-sur-rec-tion explains, “I am not sure the methodology is appropriate to the goal, since the money is not paid to the government and the donor gets a tax deduction for the donation.” He argues that “the net effect is that payment is not an act equal to paying higher taxes, in fact, it is just the opposite.” He also notes that “[i]t will be hard to know if the contributions actually represent a contribution of the tax savings from extension of current rates, or just a contribution which would have been made anyway.”
To these questions, I add more. I offer no answers.
Is it possible for charities, whether these four or a broader group, to use this additionally donated money to improve the economic situation of persons who otherwise would be the recipients of federal spending, thus reducing the amount of federal spending directed to these assisted persons? In other words, if these donations provide food for 1,000 families, does that not permit the federal government to reduce concomitantly its food assistance spending?
Is it the government that is harmed by the extension of tax cuts for the wealthy, or is it the middle class and the poverty class? Is the government of the people or something separate and apart from the people? Who are the people?
How can people spend their tax cut money on consumer goods, home remodeling, or anything else, when the impact of the tax cuts for non-wealthy people is that it permits them to continue spending what they’ve been spending but does not provide resources with which to increase spending? Does economic recovery arise from maintaining spending at current levels or from increasing spending from current levels? Does increasing investment in offshore trusts and foreign bank accounts create jobs in the United States?
Would people participating in the Give It Back for Jobs initiative be willing to provide proof that they increased their charitable giving as compared with previous years, rather than maintaining charitable giving while shifting it from other recipients to one or more of the four listed on the Give It Back for Jobs web site? Would people participating in the initiative be willing to give up their charitable contribution deduction for these donations so that they are not being financed in part by reductions in tax liability arising from the deduction?
What would happen if we eliminated government spending on all programs providing the sort of assistance also provided by charities, reduced taxes accordingly, eliminated the charitable contribution deduction, and relied instead on private philanthropy? Would there be an increase or decrease in the number of people living in poverty? Would there be an increase or decrease in the number of people dying prematurely? Would there be an increase or decrease in childhood disease? Would there be an increase or decrease in the number of students graduating from high school capable of competing for jobs in a global economy?