Wednesday, September 26, 2012

Biting the Tax Hand That Feeds the Tax Critic 

The Republican candidate for the presidency holds in disdain people he describes as dependent on government. He considers this dependency to be a bad thing, bad for the economy, bad for the country, and surely bad for his wealthy friends and supporters.

Thanks to a reader, I’ve identified someone who is dependent on government. This person attended the Naval Academy. Who paid? The government. This person attended the U.S. Naval War College. Who paid? The government. This person started a business, borrowed half a million dollars, on a loan guaranteed by the federal government. Who pays when the business defaults? The government. Another of his businesses collected money on government contracts. This person also received other government benefits. Who pays? The government. The business that received the government-guaranteed loan hasn’t paid taxes. Governments have had to spend money auditing this person and his businesses, paying for filing liens, and in one instance incurring costs in shutting down a business for not paying state registration fees. Who pays for all of this? The government, but we know that this means other taxpayers are paying. So one must suppose that some taxpayers who resent paying taxes, those who hail the Republican candidate as the font of all wisdom, must resent forking over money to finance someone getting government benefits and not paying taxes.

Incidentally, what does the Republican candidate think of taxpayers who should be paying taxes but aren’t? Does he include them among his famous 47 percent as freeloaders?

One might think that this person whose business hasn’t paid taxes considers government spending is a good thing. One might think that this person would be disturbed that the Republican candidate for the presidency has a dismal view of government programs and government assistance. One might think that this person considers himself to be held in disdain by the Republican presidential candidate.


This person has said that government is the problem. He claims that government stimulus programs are a bad thing. He insists that government spending must be cut. In fact, he blames government stimulus programs for the failure of his business. How?

According to this person, the current president is responsible for his business failure. He explains, “Our business was closely linked to commercial real estate, so when that market faltered, so did ours.” Here’s some news for this person. The real estate market collapsed before the current president was sworn into office. It collapsed as a result of shenanigans by the wizards of Wall Street coupled with decreased government regulation advocated by the Republican party. This person continued to explain that his business “crater[ed] again as uncertainty grabbed hold of the economy.” The uncertainty is the product of obstructionism in the Congress. And everyone knows who is responsible for obstructing progress, not only announcing their plans to do so but proudly proclaiming that they have succeeded. That success, according to the owner of the business in question, is a reason that the business failed.

So who is this person? According to this report, it is Ernie Liediger, a Republican member of the Minnesota House of Representatives. Yes, that’s right. A Republican. A Republican who got his from the government and now wants to close the door on those who follow him. There’s a word to use that describes someone who benefits from government programs and government spending while criticizing it. Look it up. This sort of attitude reminds me of teenagers who, while eating meals at their parents’ dinner tables, complain that their parents don’t love them and don’t do anything for them. There’s a word for that, too. Look that one up, too.

Monday, September 24, 2012

Raising the Tax Shame Noise Level 

Attempts to shame people into paying their taxes are multiplying and taking on new forms. Back in March, I considered the effectiveness of the shaming approach, in Taxes, Citizenship, and Shame. I noted that, “We live in an age when shame does not have the effect it once did.” A month later, in Cheating, Taxes, and Shame, I examined a survey that revealed most people do not consider being caught cheating on one’s taxes as shameful as three other behaviors. Earlier this month, in Taxes, Citizenship, and Something More Than Shame, I discussed the California reaction to the limited effect of shaming, one in which the state revokes or denies professional and business licenses to tax delinquents.

During the past week, a reader sent me several references to news items discussing the use of shame in dealing with nonpayment of taxes. One dealt with the globalization of the shame technique, one dealt with finding new ways to shame taxpayers, and the third dealt with both issues.

Tax shaming is not limited to the United States. According to this article, Croatia disclosed the names of tax delinquents, which in turn has brought calls for similar action in Bosnia. According to another article, tax authorities in India are taking steps to shame delinquent taxpayers.

According to this article, officials in Great Falls, Montana, tried a new tactic when sending tax bills to delinquent taxpayers. They stamped the word DELINQUENT on the envelope. Although collection agencies are prohibited from stamping an envelope in that manner or even identifying their status as a collection agency, governments are not similarly restricted. Yet the fallout from the stamping practice was enough to convince the local government to ditch the stamp next year. According to the article, “And if Americans hate anything, they hate being shamed,” but yet that survey indicated many Americans are not particularly shamed by failure to pay taxes. My concern about stamping DELINQUENT on the envelope is that there are times when the local tax collector is in error, the records are jumbled, the person no longer owns the property in question, or some other circumstances preclude the person from being delinquent. Shaming someone ought not occur if the person has not yet been given an opportunity to exonerate herself from having done anything deserving of shame. The strange thing about envelopes – in contrast, for example, to a sign on the front lawn of the property – is that the only people who see the envelope are the postal workers handling it, and the people who live at the same address and might see the front of the envelope when they bring in or open the mail. Odds are that the people in those circumstances either already know of the problem or ought to know of the risk in which they are being placed.

In India, according the previously mentioned article, the South Delhi Municipal Corporation has decided to send drummers to pound out rhythms at dawn outside the homes of property owners who are delinquent in paying their property taxes. It is unclear whether the drummers will visit the homes where the property owners live or the property itself even if the taxpayers live elsewhere. The authorities also intend to inform the neighbors about the tax delinquents. Otherwise, I suppose, the neighbors would wonder why all of the racket early in the morning. I doubt, though, that the explanation is going to soothe the anger and annoyance felt by law-abiding citizens when noise keeps them from sleeping, from focusing on their take-home work, or from trying to get a sleepy infant to nap. At least the authorities also plan to publish a list of the top delinquents and to seize their properties for auction.

If the drumming doesn’t work, what’s next? Trumpet blasts? Amplified heavy metal music? If they need other ideas, there are some at this sound experiment site. If all else fails, perhaps they will roll in a blackboard on wheels under the care of someone with long fingernails.

Friday, September 21, 2012

Subsidies and Tax Breaks 

In an effort to defend tax breaks available only to the oil, gas, and extractive mineral industry, a variety of commentators are claiming that reference to “subsidies” received by the industry ought not include tax breaks. For example, in this American Spectator article, Bernard L. Weinstein asserts that:
But the industry doesn't actually receive "subsidies." What it does receive is access to the same "deductions" that are available to most corporations. Simply put, deductions from gross revenue allow businesses to write off legitimate expenses incurred in the production of that revenue to ensure that taxes are levied on net income.

By contrast, a "subsidy" is a direct payment from the government -- i.e. taxpayers -- to a business enterprise.
It’s not only commentators who make this claim. Senator Scott Brown has stated that “Oil companies don’t get subsidies. . . . I’m positive. They’re able to take deduction like every other business.”

There are two different issues to consider when analyzing these statements. One involves the meaning of subsidy. The other involves the tax breaks available only to the oil, gas, and extractive mineral industry.

About a year and a half ago, in Whether There is Money Depends on Who’s Asking, I explained, “Tax breaks, of course, are nothing more than government spending equivalent to a direct grant to the taxpayer getting the tax break.” Weinstein wants people to think there is a difference between getting a check from the government and getting a reduction in tax liability from the government. If A wants to give $10 to B, does it matter whether A writes B a check or A tells B to reduce the amount that B owes A on a previous loan? A list of experts who agree that tax expenditures are the equivalent of subsidies, and it surely is not a complete list, is nicely set forth by EcoWatch and include the Joint Committee on Taxation, the Tax Policy Center, the Pew Charitable Trusts SubsidyScope, and the Center for American Progress. The attempts by Weinstein, Brown, and the others who are trying to mask subsidies as something other than subsidies are simply wrong, and though some of them may be ignorant and misled by the industries in question, others are deliberately incorrect.

At about the same time, addressing the issue of tax breaks for the oil and gas industry, in One of the Great Mysteries of Tax Law?, I explained why it is disingenuous to claim that a subsidy is not a subsidy if it is clothed as a tax break:
Distinguishing tax incentives from subsidies for special interests is very difficult, if not impossible, because in many instances they are the same thing. It can be argued that all subsidies for special interests embedded in the Internal Revenue Code are tax incentives, because these subsidies are in the form of incentives that reduce tax liability. However, there are tax incentives that are not subsidies for special interests because they are available generally and are not limited to a select group of taxpayers. For example, . . . the deduction for income or sales taxes, because that deduction is available to all taxpayers. Yet there are tax incentives in the form of subsidies for special interests. For example, section 181 permits taxpayers who produce films and television programs to deduct costs in a more favorable manner than taxpayers in other industries whose deduction is computed under less generous depreciation deductions.
There is no question that every tax break available to an oil, gas, or extractive minerals business that is not generally available to all businesses is a subsidy.

The resolution of the first issue turns attention to the second issue. Are there tax breaks available to the oil, gas, or extractive minerals industry that are not available to other taxpayers? Absolutely. In in One of the Great Mysteries of Tax Law?, I explained two of the tax breaks available only to oil and gas companies, specifically, the deduction for depletion and the deduction for intangible drilling costs. There are at least seven others, as outlined in this list.

Consider the percentage depletion deduction. It permits a taxpayer to deduct the cost of its oil by subtracting from gross income a percentage of the income generated by the sale of that oil. For example, if a taxpayer pays $100 for the right to extract the oil in a specific place, and sells that oil for $1,000, the taxpayer’s depletion deduction easily can exceed $100. Taxpayers in other industries do not have this tax advantage, though surely they would like to benefit from such a tax break. Imagine paying $10,000,000 for a building and deducting $50,000,000 over the period of time that the building is owned. To claim, as Weinberg and others do, that “What [the industry] does receive is access to the same "deductions" that are available to most corporations” is to misstate completely the reality of the tax law and the tax break in question.

When a special interest or specific industry gets a tax break, it causes one or the other, or a combination, of two things to happen. First, if nothing else is adjusted, the reduction in tax revenues causes an increase in the federal deficit, which in turn adversely affects everyone. Second, if revenue is maintained, it means other taxpayers must pay more in taxes to make up for the reduction in taxes for the special interest or specific industry, and that clearly affects everyone. I wonder if, when the hero of the business world speaks with disdain about those who allegedly think they are entitled to government hand-outs, subsidies, and similar breaks, the special interests and specific industries that benefit from tax breaks are crossing his mind. Or does he, too, erroneously conclude that a tax break for a specific industry or special interest is not a subsidy?

Wednesday, September 19, 2012

Taxes and Teachers 

I’ve known for many years that K-12 teachers dip into their own funds to provide supplies and materials for their students because school districts, constrained by insufficient tax revenues, are unable to provide what is necessary for children to learn. I’m aware of this problem not only because there are K-12 teachers in my near and extended family, but also because for taxable years beginning during 2002 through 2011 the federal income tax law provides a tax break for these expenses. Under section 62(a)(2)(D), an exception to the requirement that employee business expenses be treated as itemized deductions, and thus often wasted on account of the standard deduction, exists for employee business expense deductions “not in excess of $250, paid or incurred by an eligible educator in connection with books, supplies (other than nonathletic supplies for courses of instruction in health or physical education), computer equipment (including related software and services) and other equipment, and supplementary materials used by the eligible educator in the classroom.” This exception permits the taxpayer to deduct the expenses in computing adjusted gross income, the effect of which, generally speaking, is to reduce taxable income by the amount of the deduction, thus reducing tax liability. The $250 limitation means that somewhere between $10 and $75 of federal income taxes is saved by the K-12 teacher who is bearing a disproportionate burden of financing the education of the nation’s future.

Last week, I received an email directing me to the web site for Takepart’s Great Back-to-School Challenge. What got my attention is the scope of the problem. According to the web site, American teachers dish out THREE BILLION DOLLARS each year to buy supplies for their students. I don’t think the three billion dollars includes the amounts paid by teachers to provide their own teaching supplies. According to census figures, there are about 7 million K-12 teachers in the United States, some of which surely teach at private academies whose staff is not required to dig into their own pockets to fund the education system. If roughly 5 million teachers are privately funding their students’ education, the three billion figure means each teacher is spending about $600 each year to help their students with expenses that the citizenry fails to fund. A federal income tax savings of $10 to $75 doesn’t make much of a dent in what amounts to a $600 pay cut.

The sad thing about section 62(a)(2)(D) is not that it is more symbolic than anything else, but that it even was needed in the first place. How many wait staff in restaurants end up paying, out of their own pockets, for tablecloths and utensils for the customers to use? How many bank loan officers are required to pay, out of their own pockets, the cost of the forms that they hand to customers to fill out? How many electric utility repair personnel pay, out of their own pocket, the cost of the trucks they use to travel to, and repair, downed wires? How many hedge fund managers are required to pay, out of their own pockets, the cost of the computer software used by their firms?

In many respects, the three billion dollars shelled out by teachers is a hidden tax. It’s a tax on teachers. It’s not a tax paid by wait staff, bank loan officers, utility workers, or hedge fund managers. Section 62(a)(2)(D) does not solve the problem, nor could it, nor should it. At best it was a very leaky band-aid. So when proponents of reducing taxes on the wealthy complain about how little in taxes allegedly are paid by the non-wealthy, they ought to take this hidden tax, and others like it, into account.

Monday, September 17, 2012

When Tax Ignorance Meets Political Ignorance 

If asked which I dislike the most, tax ignorance or political ignorance, my reaction is to duck the question, not by saying “both, equally,” but by pointing out they are difference facets of the same thing, namely, civic ignorance. The sad and sorry state of knowledge and understanding among the citizens of this nation is appalling. I’ve shared my views on tax ignorance in posts such as Tax Ignorance, Is Tax Ignorance Contagious?, Fighting Tax Ignorance, Why the Nation Needs Tax Education, Tax Ignorance: Legislators and Lobbyists, Tax Education is Not Just For Tax Professionals, The Consequences of Tax Education Deficiency, The Value of Tax Education, More Tax Ignorance, With a Gift, Tax Ignorance of the Historical Kind, and A Peek at the Production of Tax Ignorance. Now there is an opportunity to appreciate the extent to which the two aspects of civic ignorance reinforce each other.

According to recent Reuters article, describing a Reuters/Ipsos poll, when asked if the wealthiest Americans should pay higher taxes than they now do, more than 80 percent of those interviewed agreed. But when asked who had the “better approach” to taxes, 35 percent favored Mitt Romney and only 25 percent favored Barack Obama. That means at least 55 percent of those polled, though agreeing with a major element of Obama’s tax policy approach, preferred the approach of someone who wants to reduce taxes on the wealthy. The same sort of incongruent poll responses were generated by questions dealing with health care and public assistance. If the poll results are extrapolated across the population, there are a huge number of very confused or very irrational people in this nation. Or perhaps it’s a matter of people letting their emotions, subconscious or otherwise, color their analysis. Read the article, to the very end.

Friday, September 14, 2012

Building It With Publicly-Funded Tax Breaks 

Here’s a question for NFL fans. Can you identify the only NFL stadium built without any public funding? The answer is provided in this article. The point of the article is that all sorts of private enterprise sports businesses grab funding from the government revenue streams that many of their owners attack as unwarranted. The article, for instance, notes the Bloomberg News analysis showing that $4 billion of taxpayer subsidies have been pumped into sports stadium and arena construction since 1986, through tax exemptions and subsidized bonds. One example provided by the article is the property tax exemption granted to the owner of the Dallas Cowboys franchise for its stadium.

The point made by the article isn’t new. Eight years ago, in Tax Revenues and D.C. Baseball, I explained why, given the finite limits of government revenue and spending, private sports franchise owners ought not be grabbing for public financing when so many other more basic needs, such as food and shelter, are unmet. Earlier this year, in Putting Tax Money Where the Tax Mouth Is, I again explained the problem: “Private enterprise, which for the most part rejects taxation and government regulation, is quick to find ways to tap into public funding that is financed by the very tax systems that private entrepreneurs detest.” These are but two of the several posts that I’ve shared focusing on the misdirection of tax revenues from the hands of the average taxpayer into the wealthy owners of private enterprise.

It amuses me to listen to the private sector claim that “we built it.” Surely the private sector has built things, but the public funding of sports arenas and other private enterprise facilities, such as warehouses, factories, and office buildings, makes it impossible to consider the private sector claim as anything other than, at best, a gross exaggeration, and at worst, a calculated lie. Perhaps what is lost on the folks making this argument is the irony of the location selected by the Republican Party for its convention. The Tampa Bay Times Forum was built by, and is maintained with, public funds, as described on its website. Perhaps the solution is to cut taxes and simultaneously cut all tax breaks for the “we can build it ourselves without any government help” private sector. What better way to bring the anti-tax crowd out to show its true vision of tax policy.

Wednesday, September 12, 2012

Taxes, Citizenship, and Something More Than Shame 

Six months ago, in Taxes, Citizenship, and Shame, I reflected on the effectiveness of publishing the names of tax scofflaws, noting “We live in an age when shame does not have the effect it once did.” A month later, in Cheating, Taxes, and Shame, I reacted to a survey showing that being caught cheating on one’s taxes did not generate as much shame as three other behaviors. With almost half of Americans, according to the survey, unashamed about cheating on their taxes, some other incentive is necessary.

One of my readers brought to my attention something that California is doing with respect to tax cheaters. He pointed me to this article, which describes how California Assembly Bill 1424, enacted a year ago, will allow the Medical Board of California to deny an application for licensure or to suspend the license of any licensee owing more than $100,000 in California taxes. The article referred to a press release from the Board.

The reader asked, quite understandably, “Do certain occupations or professions have a higher duty to pay their taxes in full and on time?” In other words, why pick on doctors?

Curious, I dug up Assembly Bill 1424. Among the many things it does, it requires the State Board of Equalization and the Franchise Tax Board to publish a list of the 500 largest tax delinquencies. It requires the Franchise Tax Board to include additional information on the list with respect to each delinquency, including the type, status, and license number of any occupational or professional license held by the person or persons liable for payment of the tax and the names and titles of the principal officers of the person liable for payment of the tax if the person is a limited liability company or corporation. Assembly Bill 1424 also requires a state governmental licensing agency that issues professional or occupational licenses, certificates, registrations, or permits, to suspend, revoke, and refuse to issue a license if the person’s name is on the list of delinquents.

So it turns out that California is not picking on doctors, though it appears to be picking on tax delinquents engaged in a business or activity that requires any sort of state licensing. But, not surprisingly, there are exceptions. The provision does not apply to the Department of Motor Vehicles, the State Bar of California, the Alcoholic Beverage Control Board, or the Contractors’ State License Board. So, it turns out after all that California is singling out some professions and occupations, but not all, for this income-jeopardizing consequence. For most licensed professions and occupations, loss of license is tantamount to loss of income.

The first set of questions addresses the scope of the provision. Why not permit the revocation of law licenses held by lawyers who are delinquent in their taxes? Why not revoke the licenses of bars and restaurants that are delinquent? What about contractors who aren’t current in meeting their tax liabilities? And why limit this approach to licensed professions and occupations? Why not pull the driver’s license held by a delinquent taxpayer?

The second question addresses the effectiveness of the provision. If losing one’s license to practice a profession or occupation reduces or eliminates the person’s income, would that not also reduce state revenue by reducing the tax base? I suppose that the answer is an expectation that the business would be taken to another professional or entrepreneur, who thus would earn more income and pay more taxes to offset the revenue loss incurred by the income reductions afflicting those whose licenses have been revoked.

Assembly Bill 1424 also prohibits California state agencies from buying goods or services from a contractor whose name is on the delinquent taxpayer lists. Though this cuts back to some extent the exception made in favor of contractors, it doesn’t have any impact on contracts not involving California.

The new law appears designed more as an incentive to compliance than as a punishment for noncompliance. Yet something more than mere shame is involved when a person not only sees his or her name appear on a tax delinquent list but also sees his or her license to practice or engage in an occupation revoked and watches that revocation receive state-wide publicity. The question is whether this “something more” is enough.

Monday, September 10, 2012

Do-It Yourself Lawyering Brings Tax Unhappiness 

It is understandable why do-it-yourself lawyering has become popular. Although there always have been a few people who, for reasons of thrift or to prove to themselves that they were no less capable of handling their own legal matters than an educated lawyer, decided to be their own lawyer, in recent years do-it-yourself lawyering has become ever more commonplace. Part of the reason is that the cost of retaining an attorney has become increasingly less affordable for growing numbers of people in a shaky economy, and part of the reason is the proliferation of web-based do-it-yourself lawyering kits.

A recent Tax Court case, Larievy v. Comr., T.C. Memo 2012-247, demonstrates the adverse tax consequences of venturing into do-it-yourself lawyering. Acting as one’s own lawyer without the appropriate training can pose all sorts of other adverse outcomes aside from tax, but I leave those issues aside. In Larievy, a husband and wife decided to divorce. In 2004, they agreed to separate. Without consulting an attorney or any other professional, they reached an oral agreement that the husband would pay $2,605 each month for the living expenses of his soon-to-be former wife and for their children. Four years later, in May 2008, they filed for divorce, again without consulting an attorney or other professional. On December 1, 2008, the court entered a divorce decree, which included a provision that the former husband would pay $1,400 each month in alimony to his former wife, to continue until either one died, but that beginning on June 1, 2009, the amount would be reduced to $1,100 through June 1, 2013. The husband made the $2,605 payment each month, except for one month in which he wrote a check for $2,600. In the papers filed with the court in 2008, the former spouses included a document that recited the history of the payments made since 2004 but did not indicate how much of the $2,605 was for spousal support and how much was for child support. Apparently the husband and wife had an understanding of how the $2,605 was split but they did not reduce that understanding to writing until it was set forth in the December 1, 2008, divorce decree.

The former husband deducted the payments as alimony. However, no deduction is allowed for alimony unless the amount that has been determined is in writing. The statute, the regulations, and previous case law establishes that principle. Even if the agreement to pay $2,605 per month had been put in writing, the failure to designate the portion that was child support also would have precluded the deduction. In this instance, as the court explained, “no qualifying written divorce or separate agreement existed until December 1, 2008.”

It is unfortunate that because, for whatever reason, the former spouses did not have the benefit of professional advice, the former husband lost significant deductions and thus paid more federal income tax than would have been payable had the simple task of putting in writing the agreement and the specific alimony and child support amounts. The taxpayers were not trying to game the system. They were not trying to hide income in overseas bank accounts. They were not trying to make use of offshore tax shelters. They simply did not understand the technical requirements of the tax law.

How can similar outcomes in the future be prevented? Although simplifying the tax law is one quick response, it isn’t applicable in this situation because the whole point of requiring a writing is to provide the requisite proof of the agreement. In this instance, the taxpayers were derailed by failing to put an agreement in writing, a wise move in most transactions in life, and not just for tax purposes. Somewhere along the line, the taxpayers either did not hear or did not get the message, put it in writing. Lawyers often are accused of slowing down transactions or complicating deals when they insist on a writing, and even face charges of being unromantic when advising couples to sign ante-nuptial agreements, but there are too many situations in which the lack of a writing worked to the detriment of someone. Under the circumstances at issue in Larievy, the risk of being unromantic surely was not a concern. It’s just that there was no one, lawyer or otherwise, reminding the taxpayers that a written document is a wise choice even when not required by law.

Friday, September 07, 2012

Using Taxes (or Money) to Measure Generosity (or Values) 

Last week, in Using Taxes to Measure Generosity, I made the point that using tax information to determine the relative generosity levels of states whose electoral votes went one way or the other in the last presidential election is unwise for three reasons. First, using the charitable contribution deduction as a determinant of charitable giving ignores the donations made by taxpayers who do not itemize. Second, the charitable contribution deductions in a state of any given “color” are not necessarily proportionately attributable to taxpayers who vote a particular “color.” Third, failure to remove contributions to religious organizations for activities and facilities that benefit the donors skews the results.

An alert reader pointed out a fourth flaw in the study that was the subject of Using Taxes to Measure Generosity. The charitable contribution deduction does not reflect contributions of time. The IRS does not collect any information that shows how many hours a person volunteers for charitable purposes. The reader correctly pointed out that most charities would not survive solely on the monetary contributions they receive if they were not the beneficiaries of unpaid volunteer labor. Even if the IRS could get past the legal and practical barriers to collecting and disclosing information on a taxpayer’s voting record and the identity of the taxpayer’s charitable contribution recipients, it would not necessarily have any information about volunteers’ time contributions.

I pointed out to the reader that collecting information about volunteer hours through a survey runs the same risk of using surveys to identify contributions of money. The risk of over-reporting is very real. I also pointed out that in measuring generosity, limiting the analysis to contributions of time and money to charitable organizations still falls short. Is there not generosity when a 5-year old shares a cookie with a friend? Or when an adult opens the door for an older person? Or when a teenager helps someone pick up the groceries she has spilled?

Perhaps the true flaw in the study examined in in Using Taxes to Measure Generosity is the attempt to quantify a moral value with dollars. As questionable as it might be to try to quantify a moral value with any sort of number, the use of dollars reflects the extent to which money addiction has permeated present-day culture. For too many people, all that matters is money and money equivalent. Turning to money as the measure when trying to evaluate generosity might be the poster child for what ails this nation. As I try to entice my basic federal income tax students to comprehend and express, the value of a stranger’s smile is not included in gross income.

Wednesday, September 05, 2012

A Peek at the Production of Tax Ignorance 

Readers of this blog know that I do not like tax ignorance. That dislike is one of the many reasons I teach and write about taxes. In posts such as Tax Ignorance, Is Tax Ignorance Contagious?, Fighting Tax Ignorance, Why the Nation Needs Tax Education, Tax Ignorance: Legislators and Lobbyists, Tax Education is Not Just For Tax Professionals, The Consequences of Tax Education Deficiency, The Value of Tax Education, More Tax Ignorance, With a Gift, and Tax Ignorance of the Historical Kind, I have lamented the sorry state into which the collective understanding of the body politic has fallen when it comes to taxation.

Though I think I have a pretty good idea of how and why tax ignorance has spread throughout the nation in a frightening exhibition of an intellectual pandemic, I read an article several weeks ago that highlighted the danger of sound bites and misleading headlines. The story described the decision by a retail chain to open a store in Delaware. The headline proclaimed, “Tax-free Cabela’s planned for I-95 site.” What’s a reader to think if the reader does not know or understand taxation? It is not unlikely for the reader to think, “Oh, I can shop there without being taxed.” But that’s not true. About a year ago, in Collecting the Use Tax: An Ever-Present Issue, I explained that residents of states surrounding Delaware who make purchases in Delaware without paying a sales tax are obligated to pay a use tax to their state of residence. As states become more immersed in the challenge of balancing budgets, increasing attention will be given to use tax payment shortfalls. That effort is already well underway in many states. So is it helpful when a taxpayer’s ignorance of use tax responsibilities is bolstered by a headline suggesting that the taxpayer’s outlook is correct?

As I wrote in Tax Ignorance of the Historical Kind:
Yet every time I hear or read tax misinformation, and realize how many people are making decisions based on erroneous premises, I shudder at the outcome. From pockets of tax ignorance, the educational deficiency now grips the nation from village schoolhouse to the halls of Congress. I wonder if some future historian – if there are any – will caption the chapter dealing with the early twenty-first century as “The Triumph of Ignorance.”
If watching tax legislation is like watching sausages get made, what does watching tax ignorance being fertilized resemble?

Monday, September 03, 2012

Tax Labor 

If asked to define “tax labor,” many taxpayers would think of a tax on labor, such as the inclusion of wages in gross income. Others would probably think of the effort required to fill out income tax returns and to file them with the IRS or appropriate revenue department. Business entrepreneurs would add to the list the many other returns that are required.

But tax labor involves more than filling out returns. It includes the effort required to gather up the records from which information is extracted that permits the entry of numbers and text on a tax return. But it also includes the creation of the records at the time that the event occurs which has an impact on the taxpayer’s tax situation.

A good example of how failure to generate records works to the taxpayer’s disadvantage is presented by Watley v. Comr., T.C. Memo 2012-240. The Watley case presented four issues, specifically, whether the taxpayer was entitled to a dependency exemption deduction for her sister’s two children, whether the taxpayer was entitled to file as head of household, whether the taxpayer was entitled to additional child tax credits related to the two children, and whether the taxpayer was entitled to an earned income credit. Because the taxpayer failed to prevail on the first issue, the unfavorable outcome with respect to the other three issues was unavoidable.

There were two alternative avenues for the taxpayer to take to qualify for the dependency exemption deduction for the two children. One was to show that each child was a qualifying child. The other was to show that each child was a qualifying relative.

One of the requirements that must be satisfied to show that someone is a qualifying child is that the person and the taxpayer have the same principal place of abode for more than one-half of the taxable year. In Watley, the taxpayer and the IRS stipulated that the children lived in the home of the taxpayer’s sister from January 1, 2009 through September 9, 2009. At trial, however, the taxpayer claimed that the children started living with her in July 2009. According to the court, her testimony was unclear, because at another point in the trial she testified that the children had been in her care since August 2009. The court noted that the taxpayer “did not introduce documents that showed the children lived with her before September of 2009.” But even if the taxpayer could produce documentary evidence supporting her claim that the children moved in with her in July of 2009, it would have been insufficient to meet the one-half year abode requirement. The taxpayer offered into evidence a letter from a real estate company stating that the taxpayer had taken possession of her mother’s apartment and would reside there with two minors, but the taxpayer testified that she moved into the apartment after her mother died in April of 2010. The taxpayer conceded that the date on the letter was wrong, and the court excluded the letter as hearsay.

One of the requirements that must be satisfied to show that someone is a qualifying relative is that the taxpayer provide more than one-half of the person’s support for the taxable year. The court noted that the taxpayer failed to “introduce documents showing that she paid expenses related to” the children. She “also did not show the total amount of child support furnished to [the children] by all sources for 2009.”

The Court held that the taxpayer was not entitled to a dependency exemption deduction for either child. With that outcome, the taxpayer lost on the other issues.

For most issues, the tax law is quite demanding that the taxpayer offer evidence to support the taxpayer’s claims. What may seem obvious to the taxpayer isn’t necessarily obvious to the IRS or a court. The taxpayer’s testimony almost always must be taken with a grain of salt because it is self-serving. Valuable evidence includes documentation. Yet how many people, when engaging in a transaction, think of creating or retaining a document? In the Watley case, the taxpayer’s nieces and nephews were found alone after the taxpayer’s sister headed off to another location. In the turmoil of dealing with what appears to have been an emergency, in the uproar of relocating children, it is highly unlikely that anyone would be aware of the labor that needed to be expended to preserve any sort of tax benefit. True, in Watley, if the children did not, in fact, move into the taxpayer’s abode until July, there would have been no point in gathering evidence, but the lesson is there to be learned by taxpayers in other situations. If the taxpayer waits until the tax return is being filed, it might still be possible to find and safeguard the evidence, but even more labor and effort must be undertaken.

Tax is work. Work is taxed. Tax is laborious. It is laborious to learn, and it is laborious to apply, whether planning or complying with return filing requirements. In the tax world, as in some other worlds such as raising children, every day is a labor day.

Friday, August 31, 2012

When Taxing Social Security, What is Social Security? 

Most retired people, and many not-yet retired people, know that social security benefits are subject to federal income taxation. Describing the principle in simple terms is challenging, because the computation of how much of a taxpayer’s social security benefits is included in gross income is complex. One can say that a portion of social security benefits, ranging from zero to 85 percent, is included in gross income, but even that statement fails to convey the reality and it also presumes that identifying social security benefits is easy. I have previously described the complexities in The Joys of IRC Section 86 and More Joys of IRC Section 86. Suffice it to say that law professors who teach the basic federal income tax course do not agree on the depth to which law students should be required to go when studying section 86. It ought to be no surprise that I take my students on the grand tour, not with the purpose of turning them into computational automatons but so that they can understand the concept of the bubble and how marginal tax rates are highest in the lower and middle, and not top, income ranges.

When I teach section 86, one issue on which I do not dwell is the determination of social security benefits. That amount is one of many elements in the computation of the gross income amount. Because of time constraints, the complexity of section 86, and the fact that I can make the points I want to make without getting into the determination of social security benefits, the situations we examine simply reflect some dollar amount of social security benefits.

Yet the determination of social security benefits for purposes of engaging in the section 86 computations is more than an abstract conceptual theory in the lives of taxpayers. A recent case, Moore v. Comr., T.C Memo 2012-249, illustrates the significance of the issue. The taxpayer received social security disability benefits of $11,947.20. Of that amount, $5,844 was paid by check to the taxpayers, $1,388.40 was deducted and transmitted for the payment of Medicare Part B premiums, and $4,714.80 was offset because the taxpayer received state workers’ compensation benefits in that amount. The taxpayer’s computation of social security gross income began with $5,844, not with $11,947.20. The taxpayer contended that because workers’ compensation benefits are not included in gross income, it would be unfair to require them to include them in gross income by starting the social security gross income inclusion computation with an amount that included the workers’ compensation offset. The taxpayer did not explain why the portion used to pay Medicare Part B premiums had been omitted from the computation, and at trial did not contest the IRS adjustment with respect to that amount.

Section 86(d)(3) provides that “if, by reason of section 224 of the Social Security Act (or by reason of section 3(a)(1) of the Railroad Retirement Act of 1974), any social security benefit is reduced by reason of the receipt of a benefit under a workmen’s compensation act, the term ‘social security benefit’ includes that portion of such benefit received under the workmen’s compensation act which equals such reduction.” In other words, social security benefits for purposes of the section 86 computation include the amount of workers’ compensation benefits to the extent they reduce or offset the total social security benefits to which the recipient is entitled.

It does not matter that the taxpayer does not receive the entire amount of the social security benefits. This is not an outcome limited to social security payments. For example, ignoring tax-deferred and tax-excluded contributions to retirement and other plans, an employee whose salary is $1,000 each week but whose weekly paycheck is less than $1,000 because of federal income tax withholding, state income tax withholding, FICA withholding, medical premium withholding, and similar payroll deductions, nonetheless must report $52,000 of compensation gross income for the year. The principle is that a taxpayer’s gross income computations include amounts that are not received by a taxpayer but that in some way inure to the taxpayer’s benefit.

In a previous case, the taxpayer had raised the same issue. However, that case was settled by a stipulated decision in which no opinion was issued by the court. Although the taxpayer contended that in the earlier case the court suggested that the taxpayer was correct. However, in the case under discussion, the court rejected any reliance on the previous case because it had been settled, no opinion had been issued, and no precedent had been established. At best, it would help the taxpayer escape a section 6662(a) penalty, but the IRS had withdrawn its initial suggestion that the penalty apply.

Law students, who rank among the nation’s brightest, struggle with section 86 even when not asked to do computations. It is no wonder that taxpayers generally stumble when dealing with section 86. Yet in this instance what tripped up the taxpayer wasn’t the calculations, but the selection of the starting number. That amount is clearly stated on the Form SSA-1099 that the taxpayer receives. Even if section 86 had been simplified, this taxpayer almost surely still would have reduced the benefits amount improperly. There’s only so much that simplification can do, but that’s no reason to abandon efforts to attain a simpler federal income tax law.

Wednesday, August 29, 2012

More on Income Averaging 

After my post in which I asked Where Are You, Income Averaging?, an alert reader pointed out that a type of income averaging was revived for farmers, and a few years later for commercial fishermen. What was revived isn’t quite what was repealed. The original income averaging taxed income by computing a tax equal to 3 times the tax that would be due if the taxpayer’s taxable income were 1/3 of what it actually was. It applied to all income. The special rule for farmers and commercial fishermen in effect permits the taxpayer to carry back 1/3 of farming and fishing income to the second preceding taxable year and compute tax as though it was earned in that year, and to carry back another 1/3 of farming and fishing income to the preceding taxable year and compute tax as though it was earned in that year. This income averaging is beneficial only if the rates applicable to the preceding two years are lower than those applicable in the current year. The repealed version of income averaging reduced taxes regardless of the status of rates in other years.

I did not mention the special farming and fishing income rule because it has no relevance to the plight of the taxpayer described in Where Are You, Income Averaging?. When the carryback method of income averaging was enacted for farming income, the committee report described the rational as appropriate because “income from a farming business can fluctuate significantly from year to year due to circumstances beyond the farmer’s control. Allowing farmers an election to average their income over a period of years mitigates the adverse tax consequences that could result from fluctuating income levels.” It didn’t take long before the fishing business lobbyists weighed in. But what about other businesses in which income fluctuates over the decade or half decade, as I described in Where Are You, Income Averaging?? Are their lobbyists less effective? Do they have lobbyists?

The special income averaging for farm and fishing income is available regardless of the economic status of the taxpayer. In the meantime, the taxpayer in Francis v. Comr., T.C. Summ. Op. 2012-7, a member of the Armed Forces not counted among the ranks of the wealthy, is stuck with a disappointing tax outcome caused by circumstances beyond his control. Why the better tax treatment for farming and fishing income and not for military back pay? Something about this nation’s tax priorities isn’t right, but those who pay attention have known that for a long time.

Monday, August 27, 2012

Using Taxes to Measure Generosity 

A recent report about the level of charitable giving is certain to generate all sorts of debates about the meaning of its conclusions, but there are so many flaws in the study that its value is far less than has been and will be attributed to it. The report examined IRS statistics showing the total charitable contribution deductions claimed by taxpayers in each state, and then compared that number with income. The report divides states by color, reflecting the state’s presidential vote in the 2008 election, and concludes that the eight “most generous” states were states won by John McCain and the seven “least generous” states were ones won by Barack Obama. The report concludes that there are two primary reasons for the perceived discrepancies. One is the difference “in each area’s political philosophy about the role of government versus charity.” The other is that “regions of the country that are deeply religious are more generous than those that are not.”

The first problem with the study is that it uses the charitable contribution deduction as a determinant of charitable giving. This means that charitable contributions by taxpayers who do not itemize deductions are omitted from the analysis. Although there is no hard evidence, it is not unreasonable to conclude that taxpayers who do not itemize are principally lower-income taxpayers, and there is evidence suggesting that lower-income taxpayers are more likely to attend church. Though they almost certainly make small donations in absolute terms that, although not showing up in IRS statistics, add up, their giving as a percentage of income appears to be higher than average. So, in effect, the study ignores a significant chunk of data, data likely to alter the study’s outcome.

The second problem with the study is that it assumes that the charitable deduction information for taxpayers in a particular state reflect the philosophy of that state’s political majority in 2008, even if that majority is only 51 percent or 52 percent or some other marginal proportion of the population. It is possible, and perhaps even more than likely, that higher levels of giving among the state’s political minority makes it appear that the state’s political majority is more generous. The only two states that most likely do not fall within this flawed analysis are Utah and Idaho, where members of the Church of Jesus Christ of Latter-Day Saints, bound to tithe, make up a significant percentage of the population, cause the two states to dwarf other states in terms of charitable deduction percentage, and have a political majority that is far above the usual percentages in the low fifties. Making this problem worse is the fact that there are increasing numbers of voters and taxpayers who do not identify with either political party. There also is the interesting twist that states voting in favor of John McCain claim fewer members of the one-percent than do states voting in favor of Barack Obama.

The third problem with the study is that it does not isolate charitable contributions to religious organizations. A significant amount of charitable deductions reflects donations to religious organizations. Though some of that money is used for missions and other projects that assist third parties, much of it remains at home, so to speak, paying for buildings in which members meet and worship, paying for clergy and staff to minister to the donors, and paying for programs that benefit the donors. Treating these amounts as measures of “generosity” is misleading and taints the study. Looking solely at donations that benefit third parties without yielding the donors something more than the good feeling that comes with generosity would generate a much better measure of generosity.

It is easy to criticize the report’s authors for skimming some information from IRS reports and compiling a flawed and arguably misleading analysis. But in their defense, getting the information that is needed to make a more meaningful measure of generosity is pretty much impossible. One approach would require analyzing not only the identities of charities listed on specific tax returns, which would require a violation of federal tax privacy laws, but also some sort of means to tag each taxpayer as a member of a particular political party. This approach, therefore, not only would require law-breaking, but would require the virtually impossible tasks of tagging taxpayers and getting information from the huge numbers of taxpayers who do not report charitable contributions on their tax returns. Another approach would be to survey individuals. The problem with these sorts of surveys is that the self-reported information is misleading. People tend to overstate their charitable giving because, after all, few people want to appear selfish and miserly when answering these sorts of questions.

So when the campaign heats up with allegations about which party’s members are more generous, the allegations, from both sides, will be resting on flimsy foundations. But they make for good sound bites, from the perspective of campaign managers, and so we are certain to be assaulted with flawed conclusions about generosity. They will be dumped in with all the other flawed allegations that will assault our eyes and ears in the months to come.

Friday, August 24, 2012

Where Are You, Income Averaging? 

Decades ago, when the federal income tax rate structure included as many as 24 different rates, with the highest reaching 91 percent, the tax law included a computational process known as income averaging. In effect, income averaging permitted a taxpayer whose income spiked in a particular year to avoid being pushed into the very high tax brackets by taxing the income as though it had been earned during the preceding three years, thus subjecting it to the lower rates to which it would have been subject had it in fact been earned somewhat proportionately over those years. Income averaging was complex. The first portfolio that I wrote for what is now Bloomberg BNA was devoted entirely to Income Averaging. It is the only one of the portfolios that I have written that I do not periodically revised, because it was withdrawn when Congress repealed income averaging.

In 1986, when Congress reduced the number of income tax brackets and reduced the top rate to 28 percent, in exchange for removing many exclusions, deductions, and credits, it eliminated income averaging because there ni longer was a possibility that a surge in income would push the taxpayer into very high tax brackets. Though there was still a possibility that someone usually in the 15 percent bracket would be pushed into the 28 percent bracket by a sudden spike in income, the impact was considered too small to warrant retention of a provision that contributed to tax law complexity.

A recent case, Francis v. Comr., T.C. Summ. Op. 2012-79, involved taxpayers who sought to obtain the benefits of income averaging in a different manner but who failed to persuade the Tax Court that they were entitled to do so. In 2008, the taxpayer received a payment of almost $25,000 representing backpay representing amounts that would have been received by the taxpayer in 1998 through 2002 had the taxpayer not been wrongfully passed over for promotion in 1998. The taxpayer failed to report the backpay on the 2008 return. In Tax Court, the taxpayer argued that the backpay should be allocated to, and reported on, their 1998 through 2002 returns, because the marginal tax rate applicable to their income for those years was lower than the rate applicable to their income in 2008. The taxpayer did not prove, and nothing in the record indicated, that the taxpayer constructively received the backpay in a year before 2008. Accordingly, under section 451(a), regulations section 1.451-1(a), and prior case law, the backpay was includible in the taxpayer’s 2008 gross income. In fact, a taxpayer in a previous case had unsuccessfully attempted a similar allocation of one year’s income to prior years.

The Tax Court noted that, “Although not clear from the record, it may very well be that petitioners would have paid less tax with respect to the promotion backpay if the promotion denial had never occurred. Under the circumstances we can appreciate petitioners’ dismay.” However, even if the taxpayers were permitted to compute tax as though the backpay had been received during the 1998 – 2002 period, the interest for period beginning with the year of inclusion and ending in 2008 would more than offset the tax savings obtained by computing tax using the presumably lower marginal rates applicable in those earlier years. But if the income spike had not been $25,000 but $2,500,000, the interest component most likely would not wipe out the tax savings.

There are two types of income spikes, but only one is deserving of income averaging. It is sufficiently uncommon that Congress decided to leave income averaging out of the Internal Revenue Code even when the top rate was increased from 28 percent to 39.6 percent and subsequently 36 percent. When a taxpayer has a business that generates little income in some years and significant income in other years, income averaging is warranted because the annual nature of income tax liability computations is detrimental to taxpayers whose business activities are pegged to a cycle that extends over more than one year. Just as some businesses are seasonal within a year, such as ski resorts or Christmas tree retailers, some businesses are seasonal within a decade or half-decade. On the other hand, if a taxpayer’s income spikes because the taxpayer wins a $100,000 lottery prize, the justification for treating that income as though it was earned over a period of years does not exist. In the Francis case, the income was attributable to a period of years. In that sense it was much more similar to the half-decade seasonal business rather than the one-time lottery win.

Though most half-decade and decade seasonal businesses have ways of spreading the income, such as using the completed contract method of accounting, the taxpayer in Francis did not have that opportunity. Even though the backpay was designed to put the taxpayer in the same position he would have been in had the promotion been made when it should have been made, it did not have that effect because the tax consequences were not taken into account. Certainly it is possible to work into the computation of the award the tax impact, with adjustments for the interest factor. The Francis case involved military compensation, and perhaps it was not permissible for the parties to take those factors into account. In that event, Congress needs to change the statutes regulating the computation of military backpay, but that is a topic beyond the scope of this blog.

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