Friday, August 02, 2013
As an example, consider a partnership formed by three individuals, A, B, and C. A and B each contribute $100, which is used to purchase several assets that are not depreciable and that are not ordinary income assets. C contributes services and is promised one-third of the partnership’s value after subtracting the $200 contributed by A and B. C is not entitled to any income generated by partnership operations, and is not responsible for partnership losses. The partnership earns $500 of income each year, which is allocated to A and B and which is distributed to them. At the end of five years, the partnership terminates by selling its assets to X for $2,600. The partnership section 1231 gain is $2,400. It is allocated equally among the partners. Of the $2,600, $900 is distributed to A, $900 to B, and $800 to C. Under current law, C reports $800 of section 1231 gain, and in the absence of any other 1231 transactions, treats the $800 as capital gain, thus avoiding ordinary income taxation for amounts that reflect services provided by C.
Alternatively, assume that instead of selling its assets to X, the partnership distributes $100 to each of A and B, so that the partnership has a value of $2,400 and each partnership interest is worth $800. X acquires the partnership by paying each partner $800 for each one-third partnership interest. Under section 741, C reports long-term capital gain of $800. Again, under current law, C is obtaining capital gain treatment for amounts received for performing services.
It is possible that the services performed by C are worth only, say, $500, and that the other $300 is a result of appreciation in the assets of the partnership in which C has an interest. That is why the proposal is not to treat all of C’s gain as ordinary income, but only a portion reflecting the value of the services that C has performed. Though determining that the services are worth $500 requires factual analysis particular to each case, that sort of analysis already is done with respect to the same sort of issue in other areas of the tax law, for example, reasonable compensation determinations.
Wednesday, July 31, 2013
Why did I wait until I finished teaching Partnership Taxation? I did not want students to conclude that what I happened to think should be done with a particular subchapter K glitch is the law, as students often decide, or that my proposal should be the focus of their attention. In contrast, I gladly pointed out the glitches and repeatedly pointed out the need for the Congress to something about the problem. In many instances, I suggested to students that if they needed a topic for their required tax paper course, they could dig into one or another of these problems. In many instances, I shared the arguments that could be made for one particular solution or another, but left students with the precautionary note that what I thought should be done wasn’t worth anything more than what any of them thought should be done.
The proposals do not extend to changes that extend beyond subchapter K even though they would simplify subchapter K. For example, the special treatment of capital gains and losses accounts for a substantial amount of complexity in subchapter K, and elsewhere, but that discussion is one that transcends subchapter K and thus is beyond the scope of the revisions I plan to discuss.
I have identified nineteen changes that I would make to subchapter K or to the regulations under subchapter K. Surely there are more things that need attention, but I am not trying to be exhaustive. My goal simply is to put these on the table, until someone either removes one or more for further study and development or sweeps them off the table to make room for something else. I address these changes in the sequence in which they were discussed in the Partnership Taxation course.
Monday, July 29, 2013
Now comes a report that Senators have been promised by the Finance Committee that their tax reform proposals will be kept secret from America for 50 years. Presumably, if tax reform moves forward and proposals make it into publicly disclosed legislation, no one will know which Senator or Senators suggested, pushed for, or sponsored a particular provision in the legislation.
What’s the point of keeping tax reform proposals secret? Are there comparisons to keeping military plans hidden from the enemy? It seems that the reason for the confidentiality promise is to protect Senators from retaliation by their campaign contributors. In other words, the secrecy is to protect the system that now afflicts American politics, namely, the purchase of legislators and the funding of special interest legislative provisions by those wealthy enough, selfish enough, and arrogant enough to do so.
Tax law legislation should reflect what is best for the country. It ought not be the outcome of secret back-room deals between legislators and well-funded lobbyists. It’s “of the people, by the people, for the people,” not “of the people with money, by the people with money, for the people with money.” Instead of hiding things, there ought to be a disclosure of the names of people, corporations, and other entities that obtained existing tax law provisions through moneyed influence. To begin reform of tax law, there first needs to be reform of the tax legislative process.
Friday, July 26, 2013
The taxpayer was an ordained minister who entered into an employment agreement with a church in September 2005. Under the agreement, he became the church’s pastor, and received a salary of $80,000. The agreement also provided that the church would pay the taxpayer a $500 housing allowance for six months. The six month period was subject to an extension if the church’s Deacon Ministry approved. The taxpayer excluded from gross income payments received after the six-month period expired. The IRS issued a notice of deficiency that treated the payments received in 2007 as gross income.
Section 107(2) excludes from gross income “the rental allowance paid to him as part of his compensation, to the extent used by him to rent or provide a home and to the extent such allowance does not exceed the fair rental value of the home, including furnishings and appurtenances such as a garage, plus the cost of utilities.” Under regulations section 1.107-1(b), the rental allowance must be designated before it is paid. The designation can be in the employment agreement, in minutes, in a budget, or in any other instrument that evidences the action.
The taxpayer did not argue that the six-month period had been extended. Instead, the taxpayer provided a second employment agreement dated 2005, but signed by the church and the taxpayer in 2012. The taxpayer argued that the second agreement was intended to clarify the September 2005 agreement because that agreement was a “generic type layout contract” between the parties in which “some of the stuff * * * had not been defined”. The second employment agreement provided for a parsonage allowance that included all costs associated with facilitating proper living facilities. Accordingly, the Tax Court held that the second agreement did not designate rental allowances paid in 2007 because it was not executed until 2012.
It appears that the parties, after realizing that the September 2005 contract lacked the necessary language to trigger the section 107 exclusion for the taxpayer, decided to fix the problem. Unfortunately, the revised contract executed in 2012 was too late to provide the outcome that would have been obtained had the language in the September 2005 contract covered more than six months, had the six-month period been extended before it expired, or if the second agreement had been executed by March 2006 rather than in 2012. Whether the delay was a consequence of procrastination, of a late realization that the September 2005 agreement was inadequate, or both, is unclear, but what is clear that taking tax issues into account needs to be done when drafting contracts rather than after the fact.
Wednesday, July 24, 2013
On Sunday, it became clear that the “reduce tax rates” is just the tip of a bigger flawed policy iceberg. During an interview on CBS News, House Speaker John Boehner let a bit more of the agenda cat out of the bag when responding to an accusatory question. Boehner was asked to describe how he felt about presiding over one of the “least productive” and “least popular Congresses in history.” Boehner’s response was that the Congress “should not be judged by how many new laws we create,” but “ought to be judged on how many laws we repeal.” He claimed that there are “more laws than the administration could ever enforce.”
So it’s clear that the ultimate agenda of those who control the House of Representatives is to eliminate as many laws as possible. The argument that reduction in the number of laws increases law and order runs into the same absurd outcome as does the foolish “tax rate reductions increase revenue” nonsense. If Boehner concedes that zero laws is not ideal, where is the magic number? It’s the same challenge as finding the best tax rate. There is an additional factor, though, because Boehner and his comrades can make it impossible for the administration to enforce any laws, through cutting appropriations for the enforcement of laws and through enacting moratoria on the enforcement of laws. Both are tactics used by Congresses in the past.
There’s a simple reason laws are needed. People are unable to regulate themselves. If every employer took steps to put the health, safety, and welfare of employees above his or her or its profit-seeking efforts, would an OSHA be required? If no one chose to rob a bank, would laws criminalizing bank robbery be needed? If every corporation made certain to refrain from polluting air and water, would the EPA need to exist or be of its existing size?
When opponents of laws and taxes argue that the number of laws has increased during the past however many years, they fail to take into account the fact that the nation’s population has grown during those years. As the population grows, the number of potential events requiring regulation increases. The increase is not proportional to population, but proportional to the number of connections. Adding a person to a population of 300 million adds at least 300 nillion possible opportunities for behavior that require regulation that is not self-generated. Toss in the millions of corporations, LLCs, trusts, estates, partnerships and other non-people entities treated as people, and the amount of economic and personal activity that cries out for regulation grows at exponential rates that challenge the largest computers.
History will judge Boehner and his Congress. It will not award prizes for encouraging pollution, poverty, hunger, gerrymandered electoral districts, voting repression, and concentration of wealth in the elite.
Monday, July 22, 2013
An attorney for two of the establishments against which the city is attempting to collect the amusement tax claims that the city’s action is “financial desperation” and constitutes an attempt to “tax the same thing twice.” The attorney explained that the establishments have been paying the amusement tax as required, on “the admission fee or privilege to attend or engage in any amusement.” An unidentified “source close to the matter” explained that the lap dance is “a separate experience” and thus subject to an amusement tax.
If a fee is paid for the lap dance is in addition to the admission fee, then the amusement tax should be computed not only by taking into account admission fees but also by including amounts paid for lap dances, if in fact the lap dance is an amusement. As I told students in the basic income tax class, tax attorneys need to resolve all sorts of issues, many not involving numerical computations, and some of which give tax law practice a level of interest very different from the “tax is boring” mindset of those whose perception of tax practice is limited. Thus, the first issue* that must be decided is whether a lap dance constitutes amusement. Having never had a lap dance, and having never seen one in person, I do not know. I doubt that perceptions gleaned from news reports, documentaries, and movies are dispositive of the question. So I will let readers chime in on their conclusions. I wonder if there are folks who can be called as expert witnesses on the question. If the taxpayers’ challenge to the assessments makes it to trial, it may be worth attending for that aspect alone.
*Another issue is whether the fee paid for the lap dance goes directly to the dancers, who would be liable for the tax if it applied, or whether the fees are turned over to the establishments, which in turn would be responsible. Again, not knowing how the fees are handled precludes resolving the issue until the experts step in.
Friday, July 19, 2013
The facts are not uncommon. In 1990, John David Nye and Alice C. Nye divorced. The Florida state court’s final judgment dissolved the marriage, and incorporated and attached a separation and property settlement agreement into which the two had entered. That agreement provided that John would pay Alice alimony of $3,600 each month until she remarried or either of them died. It also provided that he would pay rehabilitative alimony of $200 each month for 30 months, also to terminate if Alice remarried or either of them died. The agreement provided that at the earlier of John’s death or the death of both of his parents, he would transfer to Alice title to certain real property in which his parents were then living. The agreement also provided that if Alice decided to purchase a residence within three years of the date of the agreement, John would provide her down payment assistance not to exceed $10,000. The agreement further provided that John would attempt to obtain and would maintain major medical health insurance for Alice, but if she was uninsurable or he could not obtain insurance, he would pay her $150 each month for as long as he was obligated to pay the $3,600 monthly payment.
In 2006, Alice filed for additional alimony and additional medical insurance funds. In 2007, John and Alice entered into a second agreement, in which John agreed to pay Alice $350,000 before March 6, 2008, and in which Alice agreed to quitclaim certain real property to John. The agreement provided that once those transfers had been made, all obligations from John to Alice would terminate. John made the payment, and the state court issued a final judgment incorporating and approving the second agreement.
On their 2008 federal income tax return, John and his then wife claimed an alimony deduction of $350,000. The IRS allowed $3,750 to reflect one month’s payment of $3,600 and $150, and disallowed the other $346,250.
The Tax Court agreed with the IRS. It pointed out that a deduction under section 215 for alimony paid requires that the amount in question qualify as alimony or separate maintenance payments under section 71(a), which also would require the payee to include the payment in gross income. Under section 71(b), a payment does not constitute alimony or separate maintenance payments unless, among other things, the obligation to make the payment does not survive the death of the payee and there is no obligation to make a substitute payment after the payee’s death. The Court first examined the agreement to determine if there was any provision specifying whether the obligation to pay the $350,000 survived the payee’s death, and determined that no such provision existed. The Court accordingly examined Florida law and concluded that under Florida law, as set forth in several cases, including one very similar to the Nye situation, the obligation did survive the payee’s death. Accordingly, the payment did not qualify as alimony or separate maintenance payments, and no deduction was allowable.
The lesson is simple. If the alimony deduction is desired, the payor must persuade the payee not only to agree to the concomitant gross income inclusion for the payee but also to accept the risk of having the payor’s obligation terminated if the payee dies before the payment is made. An offer to increase the payment to compensate the payee for the payee’s income tax liability on the gross income inclusion and to cover the actuarial cost of the death risk might bring about success in the attempt to obtain the payee’s agreement. The agreement signed by both parties ought to reflect what they have agreed to do, and the question of whether the obligation survives the payee’s death should be set forth in the agreement, particularly if state law provides, in the absence of an agreement, for an outcome contrary to what the parties intend.
It is unclear what the parties in this case intended. It is obvious that the payor desired a deduction, but it is unclear whether that desire was communicated to the payee’s attorney by the payor’s attorney. It is unclear whether the issue was discussed. It is unclear whether the issue was considered when the agreement was drafted, and whether the lack of a provision was the consequence of a deliberate decision not to address the issue or the consequence of the issue not being considered at all. The court is not in a position to guess what the parties intended or what they discussed. It is the responsibility of the parties, and their lawyers, to deal with the issue, resolve the issue, and to draft the agreement in accordance with that resolution.
Wednesday, July 17, 2013
Now comes a report that the privatization of the tax refund process in Virginia is yet another kick in the face of ordinary taxpayers, this time in Virginia. Republicans who control Virginia’s legislature, working with the state’s Republican governor, passed and signed a law that required the Department of Taxation to stop issuing refund checks, except in unusual situations, and to replace the checks with debit cards issued by a private sector entity. Accordingly, the Department of Taxation contracted with Xerox Corporation to provide debit cards issued by Comerica Bank, at no cost to the state. However, Xerox was given the right to charge fees in connection with the use of the debit cards.
So how has this privatization move worked out? The simple answer is bad for the taxpayers, good for the folks at Xerox and Comerica.
As explained in this report, taxpayers attempting to transfer their refunds into their bank accounts are being charged $2. When they call to find out why, they are charged $1 per call. Getting through to a live human is almost impossible. Taxpayers who try to dispute fees are charged yet again for calling customer service. One taxpayer, told that the fees would be reversed, called after nothing happened for almost two weeks, and was then charged another fee for making that call. Another taxpayer who tried to use an automated phone system to make the transfer but who cancelled the process when a pre-recorded voice explained that the transfer would take two days, discovered that he nonetheless had been charged for using the automated phone system. When he called again in an attempt to get the fee cancelled, he was “put on hold for 1 hour and 51 minutes before being hung up on.” Some banks refuse to permit cash withdrawals from the debit cards. Banks also are refusing to provide cash withdrawals to taxpayers holding debit cards if the taxpayers do not have accounts with the bank. Apparently, other problems have arisen because the Department of Taxation has referred to efforts to deal with unidentified other issues.
Of course, the Department of Taxation attributes the problems to the challenges of starting up the privatization process. Xerox claimed that there was a problem but that it was unable to fix it quickly. Perhaps Xerox ought to stick to photocopiers and leave the tax refund business to Department of Taxation professionals who aren’t trying to masquerade as photocopier manufacturers. Surely the Department of Taxation is investing more time and resources dealing with the mess than it would have expended had the privatization stunt not been enacted. Comerica refused to comment. I wonder why.
As one frustrated Virginia taxpayer put it, “There certainly isn’t any incentive for the card provider to operate in a just, moral fashion.” But perhaps there are a bunch of $1 and $2 incentives for Virginians to vote out of office the Republicans who have sold out to the segment of the private sector that continues in its attempt to take over the nation.
Monday, July 15, 2013
Mike Razar, at American Thinker suggests, surely tongue-in-cheek, that the federal tax system should be reformed by abolishing the IRS and basing tax collection on the honor system. Doing this would be a most interesting experiment. Granted, it would be dangerous, but educational.
One key question is the definition of “honor system.” To me, an honor system means that a requirement exists to do or to refrain from doing something, and though no one is enforcing the requirement, compliance is mandatory. To others, an honor system means “comply if it suits you.” Though some honor systems use random enforcement as an incentive to encourage compliance, that is not what Razar is suggesting, because the current federal tax system uses that approach. Razar is describing a system where no enforcement exists.
Another key question is which existing system provides the best comparison. For example, what sort of compliance rate exists under existing honor systems for stores in small towns when the proprietor needs to step away from the counter? Compliance with certain laws is quite high, even in the absence of visible enforcement. On the other hand, compliance with speed limits is almost non-existent except when heavy traffic eliminates all other options.
The effectiveness of the honor system depends on the culture, norms, and self-discipline of a society. I’m told, for example, that in Japan, because stores are so small, people leave their packages at the door, and they are there when the patrons exit. On the other hand, consider that, according to this article, airport baggage retrievals are no longer on an honor system in many South American and Asian countries, suggesting that the incidence of theft had become too high. Hotel mini-bars, once based on a absolute honor system, are now rigged with computer sensors that automatically charge the guest’s invoice. I am confident that the compliance rate was so low that hotels computed a revenue recovery in excess of the cost of the refrigerators equipped with computer sensors. Quite recently, according to this story, the honor system has been ditched by the Los Angeles Metro system. In the tax world, to use this article as one example, compliance with the use tax is woeful. So it’s fair to predict that an “honor system” approach to federal taxation would reduce revenues tremendously.
Why are honor systems generally so ineffective? The answer is that the primary incentive for compliance, shame, has lost its power in present-day culture. I discussed this phenomenon in the context of taxation in Taxes, Citizenship, and Shame. Cheating, Taxes, and Shame, Taxes, Citizenship, and Something More Than Shame, and Raising the Tax Shame Noise Level. Surveys show that most people do not consider cheating on taxes to be shameful. I concluded, “We live in an age when shame does not have the effect it once did.” A person needs only to look around for a few hours, for example, by sitting and watching people in a shopping mall, to understand why I, and others, have reached this conclusion.
The bottom line is that no tax system works unless there is some sort of enforcement authority. Whether it is called the Internal Revenue Service, the Department of Revenue, the Bureau of Internal Revenue, the Division of Taxation, or the Franchise Tax Board does not matter.
Friday, July 12, 2013
My fascination with numbers and structures reaches back to very early childhood. So it’s no surprise that over the years I have enjoyed reading and taking courses in arithmetic, science, computer programming, and languages. But I have also immersed myself in books and courses dealing with history, theology, and geography.
The path to taxation is easy to describe. When, in high school, I decided to apply to the University of Pennsylvania, the undergraduate business program at Wharton grabbed my attention. When I arrived at Wharton and started selecting my courses, I was drawn to accounting, which to me was a combination of math, science, and language. One of the advantages of the Wharton undergraduate program at the time was its business law department. I took every available course, benefitting from sitting in courses taught by outstanding practitioners and law faculty. At about the same time I started working part-time for an accounting firm. The partners quickly detected my facilities with tax, and had me preparing and reviewing returns within months of my arrival. They began to talk of bringing me in full-time after I graduated, to be groomed to replace the tax partner who was nearing retirement. But I had noticed that among the firm’s clients were a dozen or so law firms, some of whose partners were doing tax work and bringing home significantly more than the accounting firm partners were earning. It was one of the few times in my life that dollar signs influence me more than I would have expected. I decided to attend law school, explaining to the partners that it would make me better at dealing with tax issues. And that was the route I was ready to take until I arrived at law school, the teaching urge resurfaced, and I changed directions. It was all for the better, because the accounting firm merged with another firm and eventually was absorbed into oblivion. I doubt that I would have ended up as the firm’s partners had projected. It was, as it often is said, all for the better. And the rest, as they also say, is history.
Wednesday, July 10, 2013
Though I had administered quizzes when I was teaching Latin to eighth-graders many years earlier, examination administration and grading were not parts of the other teaching activities in which I had engaged. So it was with some degree of delight that I responded in the affirmative when the Chief Judge of the Tax Court asked me, and another attorney-advisor, to design and prepare the examination administered to non-lawyer tax practitioners who want to be admitted to practice before the court.
We did not construct the exam in a vacuum. Our work product was reviewed by several judges. We were quizzed on why we included the questions we had selected. We were asked why and how we developed the choices that were offered on the multiple-choice questions. When it came time for me to prepare my first law school examination as a law professor, I could look back and make use of what I had learned from developing the Tax Court’s admissions exam. That exam was superseded time and again during the more than 30 years that have since zoomed by.
Monday, July 08, 2013
My conclusion that I am teaching students to teach has many roots. A very important one is the time I spent as an attorney-advisor to the Honorable Herbert L. Chabot of the United States Tax Court. He, too, was a teacher, and in fact that is how I met him. I was a student in the course he taught in my LL.M. (Taxation) program.
Judge Chabot brought his teaching style into his chambers. He would bring his one or both of his attorney-advisors into his office, and conduct a class on the issues in his upcoming cases that he wanted us to help him work through. The other judges on the court were bemused by the fact that he kept a blackboard, and chalk, in his office. Judge Chabot’s blackboard became a Tax Court legend. Who used it? He did. We did.
Judge Chabot also used a teaching approach to work through our drafts of the opinions in the cases assigned to him. He asked us why we wrote what we wrote. He asked us why we used the words we had chosen rather than others. He wanted us to explain how we were thinking. He wanted us to teach him. He knew, as he and I discussed in later years, that by being put in the role of teacher, we would be learning. I also learned from him the value of precision, of care in selecting language, of thoroughness in exploring issues, and I have tried to carry those lessons into my teaching, though often to the chagrin of my students.
Even after I left his chambers and entered into my teaching career, the judge and I continued to talk about teaching. He was yet another person who influenced my teaching persona. For that and many other of his lessons, I am grateful.
Friday, July 05, 2013
This professor suggested I talk with the dean to learn about the hiring process. What skills and experience did law schools want their faculty to have? In what sort of law practice should I engage until I started teaching? How many years should I invest in practice before applying for a faculty position? Should I write and publish while I was in practice? The answers then were, of course, different from what they are now. But that’s another story, one that is wrapped up in the transformation of law faculty from what law faculties once were to what they are now.
The same professor also invited me to sit in his first-year class, and to focus on how things transpired in the classroom. Having been through the course, I had a very different perspective. Without needing to take notes on the substantive discussions, I could observe developments of which I had been only been tangentially aware two years earlier. After class, the professor and I would sit down and talk about the class. I asked why he posed a particular question, or provided a particular response. I asked why he stayed with one student even though that student was struggling, and yet not persist with another student who similarly was struggling. I asked why he put certain topics in the sequence he had chosen. I asked why he focused on some portions of the assigned readings but not other portions.
Several members of the faculty spent time with me talking about their teaching philosophies, their exams, their grading systems, and their expectations of students. Another faculty member was content to let me teach portions of his class, about which I will say little but that it was a tax class and my classmates were delighted that I was doing so. To this day, I appreciate what all of these members of the faculty did to help me prepare for law teaching.
Near the end of my third year, some of the faculty made it known to me that they wanted me to return to Villanova to teach. They suggested that I go into practice, which I did, and check back with them in a few years. There already were quiet mentions of starting a Graduate Tax Program, and eventually that is what brought me back to my law school alma mater. But the development of my teaching would continue.
Wednesday, July 03, 2013
It turned out well. The student who was in serious academic difficulty turned it around, and ended up graduating with decent grades. He went on to a very successful career, and today his name sits on the donor plaque outside my office door, a request he made when he contributed to the fundraising campaign for the new building. And his friend? He made law review.
Monday, July 01, 2013
At some point, I thought to myself, “I can do what they’re doing,” and in a typical fit of self-confidence, “and I can do it more efficiently and effectively.” As the year progressed, I engaged in conversations with sevearal of my professors about how they came to be law professors, what they were doing in their teaching, and what they were trying to accomplish in their courses.
As my classmates became aware that I had a good handle on much of what we were doing, more than a few of them asked me to explain things to them. Because Criminal Law was my most challenging course, I invested extra time in trying to assimilate the course. At one point, I developed a huge flowchart to sort out the various types and degrees of homicide. When I showed it to several classmates, they were amused, so when I was convinced I had figured out this part of the course, I scrapped the flowchart. Some weeks later, as the exam loomed, these classmates asked if they could see the flowchart. They were not happy when I told them I had trashed it because I didn’t need it. The lessons I learned were that, first, had I hung onto the flowchart I would have had a teaching opportunity and, second, that by teaching I would be learning. This incident, and the time I spent helping my classmates with other subjects, reinforced the growing thought that teaching was in my future, and that it would be law teaching.