MauledAgain

It was with a reaction of “huh?” that I read the news of Mitt Romney criticizing Donald Trump, Marco Rubio, and Ted Cruz for not releasing their tax returns. According to this report, Romney explained that, “I think we have a good reason to believe that there’s a bombshell in Donald Trump’s taxes. I think there’s something there. Either he’s not anywhere near as wealthy as he says he is or he hasn’t been paying the kind of taxes we would expect him to pay, or perhaps he hasn’t been giving money to the vets or to the disabled like he’s been telling us he’s doing.”

It seems ridiculous that a former Presidential candidate whose tax returns highlighted the inequity of the federal income tax system and its enablement of wealth and income inequality would be criticizing another candidate for not “paying the kind of taxes we would expect him to pay.” Did Romney pay the kind of taxes we would expect him to pay?

There are others who are making the same call for tax return release, and many of them pay taxes at effective rates higher than those paid by the wealthy. Thus, the fact Romney’s focus on the issue gets the headline ought not detract from the basic question. Should candidates – for any office, not just for the Presidency – be required to release their tax returns? Those in favor of such a requirement argue that voters should have an opportunity to “see whether there are any issues, noting they will give voters a sense of whether the candidates have been telling the truth about themselves.” If determining whether candidates have been telling the truth, about themselves or anyone or anything else, it’s not just tax returns that provide the necessary information. Would it not be helpful to see the candidates’ emails? Transcripts of their meetings with campaign funding donors and with lobbyists? Recordings of their telephone calls with officials and donors? If, as Romney and others claim, voters need the truth before selecting a nominee or deciding which candidate gets elected, then we need the whole truth and nothing but the truth. Tax returns would be a good start.

So long as tax return release is not required, but happens only on account of political pressure, the question of whether a particular candidate should release his or her returns distracts voters from the real issues. So long as candidates, former candidates, and others speculate about what might or might be on another candidate’s returns – and it is nothing more than speculation – time and attention will be wasted on phantom disputes rather than being devoted to figuring out why the nation is in such an economic, social, and political mess and what needs to be done to clean it up.

Those who argue that mandating tax return release by political candidates will discourage qualified individuals from running for office apparently do not agree that the current practice of not mandating tax return release has not exactly brought us a top-of-the-line outstanding array of candidates. Perhaps the nation would be better off with candidates whose tax returns are boring. And perhaps the nation would be even better off with candidates who not only offer boring tax returns but emails and telephone calls free of influence from moneyed interests and puppet-master donors.

So should candidates be required to release tax returns? Yes, along with everything else that permits voters to see the truth rather than the hype and twisted nonsense that is so freely available.

One of my readers read and article and sent it to me, along with a question. After reading the article, I understand why it caught his attention. It describes a rather uncommon living arrangement. Though the article is from almost ten years ago, it’s one of those many things that we were far less likely to see until the internet made distant events almost as close as our next-door neighbors. According to the article, a forty-five-year-old highway superintendent lives, or at least was living at the time, in a tree house on his parents’ property. The house, more than forty feet above ground, has a shower, a heater, and a ground-level outhouse. The article doesn’t mention a kitchen, but if there is water for a shower there surely is water for a kitchen.

My reader, who, like some of us, often has “tax on the brain,” quickly saw tax issues, and sent some to me. The questions are simple. It arises from thinking, “Suppose the person living in the tree house had a home office? Or rented it out?” The reader asked, “Can a tree house qualify under the Section 280A rules? Can a tree house be depreciated?” Though there’s no direct authority, careful reading of the applicable statute provides an answer.

The section 280A rules apply to dwelling units. Section 280A(f)(1)(A) provides that “The term ‘dwelling unit’ includes a house, apartment, condominium, mobile home, boat, or similar property, and all structures or other property appurtenant to such dwelling unit.” If a house boat is a house, a tree house is a house. It does not matter whether the house is on the water, on the ground, on wheels, or in a tree. To the extent the requirements for depreciation are satisfied, the cost of the tree house is depreciable, no less than the cost of a house boat or mobile home used for a trade or business or in a for-profit activity.

Proposed Treasury Regulation section 1.280A-1 (c)(1) provides that a dwelling unit includes a "house, apartment, condominium, mobile home, boat, or similar property, which provides basic living accommodations such as sleeping space, toilet and cooking facilities." From the facts discerned from the article, if the taxpayer used a portion of that particular tree house as a home office, for example, it would be subject to section 280A. That’s not to say all tree houses would be so treated, because most tree houses do not have running water, cooking facilities, and the other features of a dwelling unit.

A little more than three months ago, in The Fallacy of “Job Creating” Tax Breaks, Yet Again, I shared the news that recent studies demonstrated the inefficiencies of state tax breaks for companies promising to create new jobs in the state. It turns out that the out-of-state companies moving operations into the state and thus getting the tax breaks create one percent of the jobs, while in-state companies managing to get the breaks create 19 percent of the jobs and start-up businesses account for 80 percent of the new employment. I had previously explored the reasons these so-called job-generating tax breaks are unwise, starting with When the Poor Need Help, Give Tax Dollars to the Rich, and continuing through Fighting Over Pie or Baking Pie?, Why Do Those Who Dislike Government Spending Continue to Support Government Spenders?, When Those Who Hate Takers Take Tax Revenue, and Where Do the Poor and Middle Class Line Up for This Tax Break Parade?.

In Fighting Over Pie or Baking Pie?, I described the practice of states persuading companies to relocate from other states through the use of tax breaks was, “from a national perspective, nothing more than a zero sum game.” I added, “States fight over pieces of the private sector by using tax dollars to increase the size of the economic pie that they can grab, while the small business entrepreneurs who actually bake pie struggle because they cannot afford to put huge campaign contributions in the pockets of the politicians using tax dollars to enhance their power.” I predicted, “If state governors and legislators continue down this path, eventually there won’t be any pie for them to fight over.”

In Another Sales Tax Exemption Taking Off as the Economy Continues to Sink, I criticized the developing pattern of states enacting sales tax exemption exemptions intended to lure businesses away from the state, which in turn encouraged enactment of similar exemptions as a revenue defense, which then triggered escalation of exemptions by the other states, in an accelerating trend of sales tax erosion. I concluded my commentary by pointing out the dangers of this pattern of legislative behavior: “Rather than generating new business, states are intent on stealing from each other. Fought with tax policy rather than guns, this modern civil war among the states shows the fundamental flaws of federalism. Constant poaching does nothing beneficial for the national economy.”

There were those who considered my description of this pattern as a "civil war," offering the usual disapproving evaluation of my characterizations, as excessively exaggerated. But now comes more evidence that, in fact, the states indeed are engaging in economic warfare. According to this report, the New Jersey Chamber of Commerce, advocating retention of the various tax breaks enacted by the state, has told a legislative committee, "There's an economic war going on out there." Yes, those were the words: economic war. Not dispute. Not argument. Not disagreement. Not conflict. War. On the other side, opponents of the tax breaks claim that the ultimate cost of those economic weapons is paid with public workers’ pension benefits. Some opponents claim that the cost also is being borne by those who use deteriorating infrastructure and those who have lost mental health care services.

In so many ways, this fight over the national economic pie resembles a shooting war, and is just as deadly in the long run. War often is fought over limited resources, and that is in part what is happening as states grab jobs from each other. War often is funded, not by those who benefit from the war, but from those who are dragged involuntarily into its turmoil, often losing financially as well as psychically. What difference is there, in terms of practical effect, between people suffering from the ravages of war and suffering from the loss of promised retirement benefits? What difference is there, in terms of practical effect, between people suffering from the consequences of bombed-out roads and bridges and the consequences of roads and bridges falling apart because of underfunded and unfunded maintenance?

And when the war ends, albeit usually for just some relatively short period of time, what’s the outcome? A few wealthier people and companies, hordes of dead and impoverished individuals, and no permanent solution to whatever it is that triggered the conflict. Until and unless the underlying causes of economic inequilibrium that has hurled the states into this fight for economic survival, having been identified, are corrected, the pattern will continue, will accelerate, and will intensify. In the long run, no one wins a war, whether it is fought with guns or tax and economic policies. In the long run, all that might remain is rubble.

One of the basic principles that students in the basic tax course must learn and understand is that damages for personal physical injuries and sickness are excluded from gross income but damages for emotional distress are not. That’s what section 104 specifically provides.

A recent case, Barbato v. Comr., T.C. Memo 2016-23, drives this point home. The taxpayer worked for the United States Postal Service (USPS) as a letter carrier. In 1987, she was injured in a vehicle accident while on the job. Because of the ensuing physical limitations from the injuries, the USPS reassigned the taxpayer, with her consent, from carrying mail to working in the post office staffing the counter and doing various administrative tasks. When a new manager was appointed, the taxpayer was reassigned to carrying mail, which caused her to suffer more pain. The manager, and other employees, scrutinized her work more closely than that of other employees, retaliating because of her request for medical accommodations, and creating a hostile work environment. This caused the taxpayer to experience severe stress and emotional difficulties.

The taxpayer filed a complaint against the USPS with the Equal Employment Opportunity Commission (EEOC). The EEOC issued a decision, specifying that the taxpayer was “entitled to non-pecuniary damages in the amount of $70,000, for the emotional distress which . . . [she] established was proximately caused by the discrimination” of USPS employees. The EEOC also specifically determined that the taxpayer’s physical pain was not caused by the discriminatory actions of the USPS, explaining that “It is also clear that . . . [the taxpayer] experienced significant physical distress and pain as the result of actions which have not been found here to be discriminatory, and that . . . [her] conditions were exacerbated by non-discriminatory actions which occurred during the same time period that the discriminatory actions were also taking place.” The EEOC noted that “[h]ad all of the physical and emotional distress experienced by . . . [the taxpayer] been caused by . . . discriminatory actions, . . . [she] would have been entitled to $100,000 in non-pecuniary compensatory damages.”

The taxpayer and her husband filed a joint return and excluded the $70,000 from gross income. The taxpayer explained that she considered the award not taxable because her emotional distress was related to her previous physical injury. The IRS examined the return, and issued a notice of deficiency increasing the gross income by $70,000, and adding a substantial understatement penalty. The Tax Court upheld the deficiency, holding that damages received for emotional distress are not excluded from gross income under section 104. However, without explanation, the Tax Court did not sustain the substantial understatement penalty.

These sorts of cases, even though appearing to be crystal clear, do pose challenges for taxpayers. In many instances, the determination of the adjudicator awarding damages does not clearly delineate the split between damages for physical injuries and damages for emotional distress. The distinction came into the tax law at a time when science did not understand as deeply as it does now that emotional distress is caused by biological and chemical changes in the brain. If chemical damage to a person’s skin is a physical injury, why is chemical damage to a person’s brain not a physical injury? It is time for the distinction to be eliminated, but until and unless that happens, taxpayers are caught by it and must file their returns in compliance with what section 104 provides.

Louisiana faces a huge budget deficit. Though I could explore how it ended up with a deficit that threatens cutbacks in essential services, that is something to explore another day. In many ways, it’s not unlike what happened in other states that enacted tax cuts for those who promised that tax cuts would generate robust economies.

The new governor of Louisiana has proposed a variety of tax increases. Among the proposals are increases in the state sales tax, increases in the tobacco tax, and increases in the alcohol tax. Members of the legislature have reacted as one might expect, some supporting the idea of raising taxes, and others determined to oppose tax increases and wield the spending-cut axe. Some legislators and some citizens have provided different responses depending on the tax. As the president of the Louisiana Senate put it, “The sales tax seems to be the one causing the most grief. The sin taxes have more support.”

So why would lawmakers and taxpayers be less opposed to sin tax increases than sales tax increases? The answer, I think, is easy. People tend to examine tax proposals by asking, “How does this affect me?” Almost everyone would look at a sales tax increase proposal as having a negative effect on their finances, at least in the short-term. Many people look at tobacco and alcohol taxes and conclude that because they do not purchase, or purchase relatively little, tobacco or alcohol products, increases in those taxes are no big deal.

There are risks in basing tax policy decisions on how one perceives the effect of changes on one’s particular position at a particular time. What happens when an activity not currently considered a “sin” worthy of taxation becomes the target of tax increase proposals? Societal and cultural norms change. There was a time when tobacco use and alcohol use were pervasive, and those who did not drink or smoke were somewhat out of the mainstream. What mainstream activities of the past several decades will be the basis of “sin taxes” a decade or two from now?

In a letter to the editor in Sunday’s Philadelphia Inquirer, which I could not find on the newspaper’s web site, asserts that Pennsylvania should not impose a severance tax on the shale-gas industry. The writer asserts that if such a tax were to be enacted, the industry would leave Pennsylvania. The writer also claims that the same Marcellus Shale exists in West Virginia and Ohio.

This claim, which has been made by the industry for several years, is nothing more than a test-the-waters threat. If it works, excellent. If it doesn’t, so be it. The risk is that those to whom the threat is delivered, take it seriously.

Why do I not take it seriously? Pennsylvania does not have a shale severance tax. Ohio and West Virginia do. Why would the shale gas industry, opposed to a shale severance tax, implement its opposition by fleeing to a state with such a tax? The reasoning presented by the writer suggests that the industry should be abandoning Ohio and West Virginia, and every other state, considering Pennsylvania is the outlier in terms of the severance tax, as it flees from taxation to a paradise of no or little taxation. But that is not what has been happening.

Consider the child who threatens to run away from home because she dislikes her parents’ imposition of a 9 p.m. curfew. If the child threatens to move in with a friend whose parents impose no curfew and let their children have free run of things, the threat might have some teeth, aside from the question of whether the other parents would open their home with welcoming arms. But if the child threatens to move in with a friend whose parents impose a 9 p.m. curfew, or, worse, an 8:30 p.m. curfew, the threat needs to be treated as the bluster that it is.

There is little or no downside to making threats in order to obtain something. The worst is a loss of credibility, but when credibility does not exist or is not valued, there’s not much to lose. It’s understandable that the industry would take the “there’s no harm in asking” or “no harm in threatening” approach. What’s not understandable is that people are cowed by the threat. The current downturn in oil and gas prices won’t last forever, and so long as there is a profit after taxes, the yet-to-be-extracted oil and gas will be an economic opportunity for someone. If the industry is willing to do business in states with severance taxes, as it currently is doing, it will be willing to do business in Pennsylvania even if it has a severance tax, and especially if that tax is lower than what is imposed by other states.

A recent case, Co v. Comr., T.C. Memo 2016-19, demonstrates the challenges for taxpayers who rely on advice from, and decisions by, IRS employees. From no later than 2007 through at least 2011, the taxpayer was paid by the Department of State to do engineering work on various projects overseas. The contractual arrangements and characteristics of those arrangements did not change during those years.

The primary issue was whether the taxpayer qualified for the section 911 exclusion from gross income for compensation earned abroad, but because the exclusion does not apply to employees of the United States or its agencies it was necessary to decide if the taxpayer, who was paid by a United States agency, was an employee of that agency.

On his 2007 and 2008 federal income tax returns, the taxpayer claimed the section 911 exclusion. The taxpayer’s position was that he was not an employee of the United States or any of its agencies. The IRS audited the taxpayer’s returns for those years. The IRS auditor informed the taxpayer that he was entitled to the section 911 exclusion for those years.

The taxpayer also claimed the section 911 exclusion on his federal income tax returns for 2009 through 2011. The IRS audited those returns, concluded that the taxpayer was an employee of a United States agency, and issued a notice of deficiency. The IRS claimed not only the tax liability arising from the denial of the exclusion, but also accuracy-related penalties.

The Tax Court held that the taxpayer was an employee as the IRS claimed, and rejected the taxpayer’s claim that he was an independent contractor. The fact that an IRS auditor told the taxpayer otherwise did not bar the IRS from taking its position. This aspect of the case is not news, as there are dozens if not hundreds of cases in which taxpayers following incorrect advice from IRS employees nonetheless were required to comply with the correct analysis of the tax law.

But when it came to the penalties, the Tax Court concluded that the taxpayer had acted with reasonable cause and in good faith. The penalties do not apply to a taxpayer who so acts. The Tax Court noted that the taxpayer did not have a background in accounting, finance, or tax. Under those circumstances, it was reasonable for the taxpayer to conclude that he was not an employee. The issue facing the taxpayer, namely, whether he was an employee or independent contractor, is an issue that confounds tax practitioners and judges, because its resolution is fact intensive and often rests on very close factual distinctions.

The question of how to deal with incorrect advice from IRS employees has befuddled the tax practice community for decades. On the one hand, it seems unfair to disregard the effects of that advice on the taxpayer’s preparation of a return. On the other hand, it seems unfair to all other taxpayers to permit someone to escape tax liability because an IRS employee is confused about, or ignorant of, the tax law. One solution, stopping IRS employees from giving advice, not only is counter-productive, but would not be a solution in situations such as this one, where the advice came during an audit. Another solution, having a supervisor review the advice would increase costs at a time when the IRS is under Congressional siege. Yet another solution, simplifying the tax law, though possibly reducing the number of times incorrect advice is given, would not solve the problem because sometimes the incorrect advice is given with respect to rather basic tax law questions.

In all fairness, dealing with incorrect advice about the tax law is not a unique problem. Similar issues arise with respect to every other area of the law, such a zoning, traffic regulation, environmental impacts, business licensing, and wills. The bad advice comes from every direction, not just government employees dealing with the issues, but from neighbors, relatives, friends, journalists, commentators, and even professionals in the relevant field. Perhaps better education, not only about the rules but about ways in which people can educate themselves about ever-changing rules, offers the best long-term solution. Perhaps teaching people to think like lawyers ought to begin in elementary school and not 20-some years into one’s education.

Readers of MauledAgain are well aware that I dislike tax break giveaways to wealthy corporations as rewards for moving jobs from one state to another. Job relocation is not job creation. One of the states that engages in this game of giving to the rich is New Jersey. As I’ve described in When the Poor Need Help, Give Tax Dollars to the Rich, Fighting Over Pie or Baking Pie?, Why Do Those Who Dislike Government Spending Continue to Support Government Spenders?, When Those Who Hate Takers Take Tax Revenue, and Where Do the Poor and Middle Class Line Up for This Tax Break Parade?, New Jersey has handed out tax dollars to companies that are doing well for themselves, claiming that by doing so New Jersey residents would get jobs. Instead, the employees of those companies keep their jobs.

In The Fallacy of “Job Creating” Tax Breaks, Yet Again, I pointed out that a report by KPMG and the Tax Foundation matched my previous conclusions: “But when it comes down to it, the tax breaks usually just move firms around a region and, on net, rarely yield much.” I noted that what they did yield was “quite a bit for the corporate owners who are already drowning in cash and profits.”

Now comes yet another report demonstrating that these tax breaks are built on the false promises of job creation. The Center on Budget and Policy Priorities issued a report about a week ago, the title of which offers a clue as to its conclusions: State Job Creation Strategies Often Off Base. The report concluded that “[t]he vast majority of jobs are created by businesses that start up or are already present in a state – not by the relocation or branching into a state by out-of-state firms,” and that “[d]uring periods of healthy economic growth, startups and young, fast-growing companies are responsible for most new jobs, that “businesses older than one year in aggregate lost jobs relative to their prior-year employment levels.”

The report also shared the conclusion of another study, that “only 5% of entrepreneurs cited low tax rates as a factor in deciding where to launch their company.” The report concluded that income tax cuts for businesses do little to generate job growth. The report noted that attempts to bring out-of-state companies into a state end up as “zero-sum attempts.” In other words, tossing out tax breaks based on the promise of more and new jobs when in fact the companies receiving the tax breaks do nothing more than move existing jobs amounts to yet another false promise from the devotees of supply-side economics.

The report makes sense, and its conclusions are not surprising. At a time when the focus should be on national economic growth, the constant luring of a company from one state to another is nothing more than economic civil war. The economic waste generated by lobbying activities focused on reshuffling production within the nation hampers the effort to maintain national economic strength on the global stage. As the report recommends, states should encourage the launching of new businesses and help existing businesses fulfill their potential.

A reader sent me a story that I probably would have otherwise missed. According to several reports, including this one, a woman and her son walked into a Liberty Tax Services office in Toledo, Ohio, pointed what appeared to be a gun over which a towel was draped, demanded money, and made off with $280. Someone in the office hit the son with a chair, but that did not stop him and his mother from escaping. Nor did a Liberty Tax Services employee outside the office door who was dressed as the Statute of Liberty. The two thieves managed to avoid being caught, but their good luck lasted only for a short time. It turned out that the “gun” was a curling iron. And it also turned out that the staff recognized the two as customers who had used Liberty’s services a few days earlier. It apparently didn’t occur to the mother-son team that they had provided Liberty Tax Services with all sorts of identifying information used in preparing their returns. Information like name, address, and social security number. Information that authorities are using to track down the thieves.

It was the sort of news that spreads so quickly that notices came to me from multiple directions. There was a posting on a tax listserv, an item in a daily tax update email, on-line articles, and newspaper reports. According to an IRS news release, its tax processing systems became unavailable because of a “hardware failure.” According to this report, the failure was caused by “a power or electrical issue.”

All sorts of thoughts passed through my brain. Was the failure caused by a power spike? If so, were surge protection devices in place? If not, why not? If yes, why did they fail? Were they outdated? Worn out? Improperly maintained?

Was the failure caused by a loss of power? If so, did backup generators kick in? If not, why not? Are there backup generators? Are they maintained properly? Are they outdated?

And once the hardware went down, why did the system not shift to backup facilities? Are there backup facilities? Are they maintained properly? Are they up-to-date?

The IRS explained that taxpayers should continue to file returns electronically and that the e-file providers will hold the returns until the IRS is ready to accept them. The IRS also explained that some of its web site services, such as “Where’s My Refund” are not operating even though other parts of its web site are up and running. The IRS expects no “major refund disruptions.” Of course, that depends on getting the hardware failure fixed, identifying the cause, and putting in place safeguards to prevent it from happening again.

Fixing the problem and preventing its recurrence requires money. Perhaps the antiquated status of IRS technology has something to do with this glitch. Imagine the outcry from Congress if a similar failure occurred with Defense Department computers. What Congress appears not to understand is that without a properly functioning IRS, including its technology system, there cannot be a properly functioning Defense Department or any other federal government agency or department, and many state and local government units.

Though some Americans might rejoice at the thought of the IRS being unable to function, the joy will turn to anger when they discover it means refunds aren’t being processed.

And again I ask, backups, anyone?

The headline to this article caught my eye. It caught my eye primarily because I could see it catching the eye of many people. It appeals to the need or desire for money that affects almost everyone. The headline?

“How to Get the Biggest Tax Refund This Year”

Wouldn’t it be fun to be the taxpayer with the biggest refund this year? Could that happen? What if there is someone out there who paid estimated taxes of, say, $500,000, and ended up overpaying by $300,000, and asked for a refund? How could I possible tweak my tax return to get a $300,000 refund? It isn’t going to happen. And it isn’t going to happen for at least 99 percent of taxpayers.

But perhaps the reference isn’t to the biggest refund this year of all taxpayers, but to the taxpayer receiving a refund this year that is the biggest the taxpayer has ever received. But can that happen? Yes. Is it likely to happen? No.

So I read the article. It contains a list of suggestions about one’s tax return, all of which are common knowledge to tax return preparers, and most of which are familiar to many taxpayers. A taxpayer who might overlook one or another of the tips that are provided but who is made aware of the deduction or other suggestion might end up with a bigger refund than would otherwise be received. Or perhaps with a smaller tax-due payment to be remitted to the U.S. Treasury. The article deserves a headline that reads, “How to Get a Bigger Tax Refund This Year” but that won’t get quite the attention that a headline with “Biggest” in it will bring.

Yes, that’s the question a reader posed to me. The reader also commented, “You think your taxes are complicated, try having a dependent who’s a clone.”

First things first.

Only an individual can be a dependent, either as a qualifying child or as a qualifying relative. Is a clone an individual? There is no legal authority on the question, because there has been no need to answer the question. If a clone is an individual, then under section 7701(a)(1), the clone would be a “person” for purposes of the federal tax law. But that doesn’t answer the question. Nor does it answer other questions that arise. For example, section 152(b)(3)(A) generally requires that a dependent be a citizen or national of the United States. Is a clone a citizen? Are clones “born”? As another example, consider the requirement that a qualifying child must meet the section 152(c)(2) relationship test. Is a clone a child, descendant of a child, a brother, sister, stepbrother, stepsister, or descendant of such a relative? The relationship test in section 152(d)(2) that must be met by a qualifying relative poses similar questions, adding to the list of possible relationships. Perhaps the easiest one to work out is the section 152(d)(2)(H) test of having the same principal place of abode, for that determination can be made in the affirmative if the clone is an individual. Yet even that provision raises another, surely bizarre, question. A spouse, by definition, cannot fall within section 152(d)(2)(H). If a person’s clone is not defined as bearing one of the specified relationships, then what is to stop a person from marrying his or her clone? Granted, that question takes us beyond tax law but tax analysis is not confined to the tax law.

One of my first thoughts on reading the reader’s email was, “Hmm. This is like the “what is the value of a law review article on the tax consequences of time travel?” example I use in class to warn students about drifting from the practical into the theoretical when doing so is inappropriate. Then I realized, having the ability to generate a clone is not the remote science-fiction notion that time travel prevents, and of course, some things that were dreams and imaginations in the science fiction books my brother let me read when I was eight and nine years old, to the chagrin of my parents, are today’s technology. And, of course, some aren’t. Yet.

The challenge is the tendency of legislatures to dilly-dally when it comes to being prepared for technological and societal advances. Some legislatures struggle just to do their current to-do list. History tells us that people and courts struggled with the legal and tax consequences of surrogate motherhood, email, radio, and a long list of other developments. I am confident that human clones will appear before legislatures take any steps to specify the legal and tax consequences.

So, my answer to my reader simply is, “I don’t know. I can guess, and you can guess, and it’s fun to share our guesses. But in the end, it’s that classic response, ‘It depends.’ Until then, think about it from time to time.”

Bill Dingfelder, a Philadelphia Inquirer reader, is fed up with the failure of the Pennsylvania legislature to approve a budget. He’s not alone. I’m certain far from impressed watching legislators serve special interests and campaign contributors with far more zeal than they devote to serving the people.

Dingfelder, in a letter to the paper’s editor suggests that the people of Pennsylvania “have the means to effectively pressure our elected officials to get this task done.” He encourages residents of Pennsylvania to stop sending tax payments to Harrisburg and instead to deposit them into an escrow account at their bank. He also suggests notifying the governor, state senator, and state representative that this is being done, and why it is being done.

Dingfelder notes that there are risks in doing this. He is correct. The biggest risk is that it will not work. Most taxes are paid into Harrisburg automatically. Most tax payments are controlled by software. Sales taxes are collected at the point of sale and transmitted through digital networks. Employer payroll departments use automated systems to issue paychecks or direct deposits, and those systems transfer funds automatically to the state treasury. The amount of taxes that can be held back by residents is rather small, and would be noticed only by Department of Revenue computers that would automatically issue notices and perhaps levies and liens.

On top of this, I am not confident that all, or even most, state residents are unhappy with the state legislature’s failure to pass a budget. It is no surprise that a budget cannot be approved, because different tax and spending policies are represented by the executive and by the majority of the legislature. So long as people keep electing legislators who hold positions opposite to those taken by the executives elected by the voters, stalemate is guaranteed. We have years of experience in Washington to illustrate this point, and it’s no surprise that state legislatures, including Pennsylvania, are similarly afflicted.

Holding back tax payments might be a marvelous, though risky, symbolic gestures. But gestures aren’t the answer. Politics and politicians are replete with gestures. What’s required is education, common sense, and attachment to principles that rise above what currently is stinking up American politics and its electoral system.

According to several reports, including this story, drivers contracting with ride-sharing outfit Uber were surprised when they logged into the company’s web site to obtain their Forms 1099. They discovered that what popped up was someone else’s Form 1099. These forms include home addresses and, worse, social security numbers. Understandably, drivers who received another driver’s information are concerned that their information has been disclosed to some other driver.

Uber attributed the mix-up to a “bug” in its system. It explained that the bug has been fixed. It is unclear whether it was just one driver’s information that popped up on multiple drivers’ computer screens. Apparently, and I had missed this, several months ago, the licenses and tax information of almost a thousand Uber drivers were disclosed to persons who should not have had access.

If my three decades of using digital technology, including programming, has taught me anything, it has reinforced what I have learned from my tax and law experience, namely, it only takes one little flawed detail to cause a cascading effect of problems. Actually, I learned that long before I wandered into tax, and long before I started in accounting by double and triple checking financial statements and tax returns. I learned it as a child, not only from my parents but from other adults, including employers for whom I worked while in middle and high school. Attention to detail matters. And because it’s so easy to make a mistake – I make more than enough of them – it helps to have a second, third, or even fourth pair of eyes review what one has done. Yet sometimes those extra pairs of eyes are nowhere to be found. For most people, editing is not as fun as writing, and testing is not as much fun as developing. Fortunately there are exceptions, such as those folks who enjoy being test pilots and copy editors.

The frustrating aspect of this story is the futility of trying to prevent it from happening. Often, there are lessons to be learned from a tax story that help individuals take steps to protect themselves, to guard their information, and to prevent troubling outcomes. In this instance, I’ve yet to figure out what sort of advice to give to a Uber driver to ensure that his or her tax information doesn’t show up on someone else’s screen. And it’s probably not just Uber drivers who faced or will face this risk. It’s all of us. It’s that aspect of tax that deserves the word “scary.”

No, it’s not ME asking that question. Who asked it? According to this story, Donald Trump did. Trump added that rhetorical quip to the end of a paragraph in which he opined, “What’s going on on Wall Street is ridiculous. Who knows it better than me?” I daresay there are people who know Wall Street better than does Donald Trump. I am very confident that there are people who know the tax code better than does Donald Trump.

Trump shared his thoughts during a speech a few days ago in which he explained that he pays as little tax as possible, using “every single thing in the book.” As long as what he is doing is within the law, so be it. Of course, the tax law is skewed in favor not only of the Wall Street “hedge fund guys” Trump criticized, but also wealthy investors like Trump himself. Trump admitted that he manages to “pay as little as possible” because “I have great people.” It is far from impossible that his “great people” know the tax code very well. Perhaps they know it better than anyone else, though that is unlikely. But surely they know it better than Donald Trump. That’s why he’s willing to pay them to do the tax work.

So, the answer to Donald Trump’s question is, “Your great people, for starters. And a lot of other people, too.”

In a recent announcement, the IRS has explained how it is attempting to reduce tax return identity theft. It revealed that some states, dealing with state income tax identity theft, will be asking taxpayers to provide a driver’s license number. The theory is that identity thieves generally do not know the taxpayer’s driver’s license number even if they have managed to acquire the taxpayer’s social security number, and that by asking for the driver’s license number, the state can match its driver license database with the tax return.

Of course, there are questions about how this will work, and whether it will work to reduce tax return identity theft. As expected, and as pointed out in this Bamboozled commentary, confusion abounds. New Jersey, for example, has announced that adding the driver’s license number when filing electronically will be an option. According to the Federation of Tax Administrators, an organization representing state tax department, almost every state and the IRS is requesting the number. The IRS, in its announcement, emphasized that providing a driver’s license number is not required to file a federal return.

In the meantime, tax return preparation software has been programmed to request the driver’s license number for all states except those, as of yet unidentified, that have opted out. It is unclear whether taxpayers can refuse to provide the number, whether the software will process the return without a number even if providing it is optional, and what happens to the taxpayer who has no driver’s license. In Alabama, for example, taxpayers can enter a string of zeroes instead of a driver’s license number. Will that slow down the processing of that return? That also is unclear.

Some tax return preparation software allegedly is requiring a driver’s license number even if the state makes it an option rather than a requirement. If a person has no driver’s license and the software refuses to accept a string of zeroes, what happens?

In the Bamboozled commentary, taxpayers are encouraged to provide their driver’s license numbers, if they have one. The commentary argues that providing the driver’s license makes it more difficult for identity thieves to engage in their fraudulent behaviors. The commentary then points out that people should “keep their driver’s license number protected.” Good luck with that. Social security numbers have been used, even in violation of law, by all sorts of businesses as a means of identifying customers. And for years, businesses have been using driver’s licenses to confirm identities, and have been entering the number, as well as photographs and photocopies of driver’s licenses into their databases, in many instances together with social security numbers. Those databases are not immune from hackers. Nor are the state and federal tax databases safe from intrusion. What happens once the hacking community gets into these databases and compiles lists of people’s names, addresses, social security numbers, and driver’s license numbers? And the Bamboozled commentary recognizes this risk, asking “Imagine if an identity thief has your Social Security number and your driver's license number?” and answering, “Not pretty.” No, not at all.

The problem is two-fold. On one side, better systems of identification are necessary, and need to be based on information that is not as easily stolen. Databases need to be secured more carefully than at present. On the other side, identity thieves and those thinking of engaging in that behavior need to be presented with changes in their risk analysis. Not only are better methods required to track them down, they also need to face more severe consequences for their behavior. True, privacy advocates who take extreme positions that permit criminals to hide will not appreciate steps that reveal the identity thieves, but in balancing interests, the experience of identity theft victims who end up alive but without a life demands that practical reality be given sufficient consideration.

Regardless of my comments, federal and state tax agencies will begin collecting driver’s license numbers. Not from everyone, but from enough people to permit, in a year or two or three, evaluation of whether doing so eased the tax return identity theft problem or made it worse.

A recent case, Garada and Elghosein v. Comr., T.C. Summ. Op. 2016-1, demonstrates the importance of understanding how constructive payments of deductible expenses should be treated. The taxpayers were shareholders in an S corporation. The taxpayers owned a property on which real estate taxes were due. The S corporation paid the real estate tax bill. The taxpayers deducted the real property taxes on their federal income tax return. The IRS denied the deduction, arguing that the deduction was not allowable to the taxpayers because the taxes had been paid by the corporation. Later, the IRS informed the court that it treated the payment as a nontaxable distribution to one of the taxpayers.

The Tax Court explained that payment by an S corporation of a shareholder’s personal expense is a constructive distribution. It pointed out that this principle had previously been articulated by the court. Thus, explained the court, “ It also follows that for purposes of claiming the deduction, the shareholder is treated as constructively paying the obligation.”

If the corporation had been a C corporation with earnings and profits, the constructive distribution would have been a taxable dividend. In the absence of earnings and profits, the constructive distribution would reduce the shareholder’s adjusted basis in the stock, and if the adjusted basis were insufficient to absorb the distribution, the balance would be treated as capital gain. In the case of an S corporation that has no C corporation earnings and profits, the distribution is a reduction of adjusted basis in the stock. But if the adjusted basis is insufficient, the balance is treated as capital gain. Thus, the fact that the constructive distribution was nontaxable to the shareholders in this case does not mean all constructive distributions from S corporations are nontaxable. It was nontaxable in this case because the taxpayers had sufficient adjusted basis to offset the constructive distribution. Had that not been the case, the shareholders would have recognized gain.

Would the tax analysis have been easier if the S corporation had written a check to the shareholders, and the shareholders then written a check to the jurisdiction imposing the real estate taxes? Of course. But as I’ve told students in the basic tax class, one of the techniques that tax professionals must learn to use well is the ability to take what appears to be one transaction, in this case a check from an S corporation to a local jurisdiction, and to split it into two, or more, transactions. Actually, that is a skill useful in other areas of law as well as in other disciplines, but it is a skill that many people find difficult to understand.

The “lower taxes means more jobs” argument continues to find support. Specifically, there are two variations of the argument. One is that lowering taxes on wealthy individuals generates jobs. The other is that lowering or eliminating taxes on corporations generates jobs. The first variation was used to justify huge tax cuts for the wealthy in the early years of this decade, and it was followed by one of the worst economic experiences of this nation’s history. When tax rates were permitted to increase somewhat, though not totally offsetting the cuts, the economy recovered. Now attention has turned to the second variation. An example is this commentary, in which Tom Giovanetti of The Institute for Policy Innovation argues that eliminating the corporate income tax would create an “explosion of economic growth and job creation.” Would it?

There are good reasons to eliminate the double taxation of C corporation income. But doing so requires something different than simply eliminating the corporate income tax. The income needs to be taxed to those who earn it, namely, the shareholders. This concept of integrating corporate taxation has been around for decades, and has been implemented to the extent corporations elect to be S corporations, though not all corporations have that option. It is true, as Giovanetti points out, that the corporate income tax ends up being paid by the corporation’s employees, shareholders, and customers, though economists differ widely on how much of the burden is carried by each of the three groups.

What happens if the corporate income tax is eliminated without corporate income being taxed when it is earned? Corporations, or more specifically, corporate shareholders, will continue to have incentive to limit dividends, because the income would be taxed only when dividends are paid. As for the accumulated earnings tax, designed to impose a tax on corporations that do not distribute earnings, it is useless because there are all sorts of exceptions that permit corporations to come up with excuses that include phrases such as “future expansion.”

Does eliminating the corporate income tax generate jobs? No. First, there are many corporations that do not pay income tax because they use a variety of tax breaks, special credits, and purchased losses to shield themselves from taxation. Elimination of the corporate income tax would not do anything for the cash flow of these corporations. Second, although corporations that do pay income taxes under current law would experience increased cash flows from repeal of the corporate income tax, there is no evidence that they would run out and hire people. There currently are corporations drowning in cash, and they aren’t hiring. Why? A business does not hire unless it needs employees. Acquisition of cash is not a reason to hire. A business hires if it needs employees. It needs employees if it has more work to do than its current employees can handle. Those situations arise when the gross receipts of the business increase. That happens when customers spend more. Customers do not spend more unless they have both resources and either a need or desire for the goods or services being sold by the business. That happens when money is infused into the hands of consumers. In other words, what works is demand-side economics. Eliminating the corporate income tax does not increase demand.

That’s not to say that the corporate income tax should continue to exist. It makes more sense to replace it by making subchapter S applicable to all corporations. Tax-exempt shareholders would be taxed under the unrelated business income tax provisions. Nonresident aliens would be taxed to the extent the income reflects activities conducted within the United States. But don’t expect this change to cause the economy to grow explosively. For that to happen, the tax burden needs to be re-allocated, and that requires at more than nominal rates. As long as secretaries pay tax at rates higher than corporate officers, the economy will be insufficient for long-term growth.

A question popped up recently that drew my attention to birthdays and the tax law. Actually, the tax law uses the phrases “attain the age of” and "attain age" far more often that its occasional use of the word “birthday” but few of us talk about “attaining an age” when we are conversing about the anniversaries of our arrival on the planet.

Why does the tax law care about birthdays or age attainment? There are a variety of tax provisions whose application depends on the age of the taxpayer. For example, taking money out of a qualified retirement plan, IRA, or similar investment before the age of 59 ½ generates penalties unless an exception applies. Withdrawals from those accounts must begin, generally, by the time the taxpayer attains age 70 ½.

The question that popped up referred to section 63(f) of the Internal Revenue Code. This provision increases the standard deduction if the taxpayer or the taxpayer’s spouse “has attained age 65 before the close of his taxable year.” Line 39a of the 2015 Form 1040 asks if the taxpayer or the spouse was born before January 2, 1951. Rephrased, the question was whether a person born on January 1, 1951, attains the age of 65 in 2015. The Form suggests that the answer is yes, because that person was born before January 2, 1951. If asked, many people, perhaps most people, would conclude that this person attained the age of 65 on January 1, 2016, when the person celebrates his or her sixty-fifth birthday. Is the Form wrong? Let’s back up to higher tax authority.

The provision in section 63(f) giving an additional standard deduction to persons who have attained the age of 65 replaced a provision in section 151 that gave an additional personal exemption deduction to persons who had attained the age of 65. The reasoning behind the change was to limit the benefit to those persons who used the standard deduction, thus taking it away from higher income taxpayers who are much more likely to itemize. Thus, long before section 63(f) was enacted, the phrase “attained age 65” was in the Code and in need of interpretation. The interpretation is found in Regulations 1.151-1(c)(2). The regulations state, “For the purposes of the old-age exemption, an individual attains the age of 65 on the first moment of the day preceding his sixty-fifth birthday. Accordingly, an individual whose sixty-fifth birthday falls on January 1 in a given year attains the age of 65 on the last day of the calendar year immediately preceding.” Does this make sense?

The idea that a person attains an age on the day before the person’s birthday makes sense. Consider a person born on January 1, 1951. That person attained age one, that is, finished one year of life, on December 31, 1951. The person started their second year of life on January 1, 1952. This is why Treasury took the position in the Regulations that it did.

But this approach created a problem. A person with a January 1 birthday benefits, for tax purposes, from attaining age 65 on December 31 rather than January 1. The person can claim an additional standard deduction if the person is not itemizing deductions. But what happens if the attaining of an age takes away a benefit? Consider section 152(c)(3)(A). To be claimed as a dependent, a person must be a qualifying child or qualifying relative. Under section 152(c)(1), a person is a qualifying child if, among other things, the person meets the age requirement of section 152(c)(3). Section 152(c)(3)(A) provides that a person meets the age requirement if the person “has not attained the age of 19 as of the close of the calendar year in which the taxable year of the taxpayer begins” or “is a student who has not attained the age of 24 as of the close of such calendar year.” A child who is a student and who was born on January 1, 1992, would attain the age of 24 on December 31, 2015 and thus would have attained the age of 24 as of the close of 2015. This would make the child ineligible as a qualifying child (though perhaps the child could qualify as a qualifying relative).

So the IRS decided to change the definition of age attainment, but only for certain purposes. In Revenue Ruling 2003-33, the IRS provided “A child attains an age on his or her birthday for purposes of Code sections 21 (child and dependent care credit), 23 (adoption credit), 24 (child tax credit), 32 (earned income credit), 129 (excludable dependent care benefits), 131 (excludable foster care benefits), 137 (excludable adoption assistance benefits), and 151 (dependency exemptions). “ So, in the example provided, the child born on January 1, 1992, would not attain age 24 until January 1, 2016, and thus would be a qualifying child, assuming the other requirements were satisfied, for taxable year 2015.

The IRS position does not apply to the issue of attaining age 65, or 59 ½, or 70 ½, or any other tax law provision other than the ones specified in the Revenue Ruling. So that means the phrases “attains the age” ends up with two different interpretations. Does it make sense to give a phrase two different meanings when the statute using the phrases does not do so? Of course, this is once again a matter of Congress not thinking through the implications of what it enacts. That’s probably because few members of Congress actually read, let alone think deeply about and think through the consequences of, the legislation on which they vote.

But no matter what the tax law does, each day we are a day older. And as Pink Floyd tells us, “The sun is the same in a relative way, but you're older, shorter of breath and one day closer to death.” Now I must go and instruct my executor what to insert into my obituary as my age if I die on my birthday.

One of the benefits of being on Facebook – aside from genealogy, class reunion arrangements, and keeping current with what friends and relatives are doing – is getting a perspective of the world, and particularly the nation, that is not necessarily otherwise available. I have the opportunity to “converse” with, or in most instances, to “listen” to, people with whom I’d have little or no interaction in my other day-to-day activities. I learn things.

This past week I’ve acquired interesting insights into people’s attitudes and expectations concerning huge lottery prizes. Aside from the expressions of intentions to buy or not buy tickets, there are expectations. Specifically, there are expectations about how much would be available if a person won, and expectations about what would happen if the prizes were structured differently.

The first set of expectations involves how much money a person would have available. Surprisingly, many people think that if they win – assuming they are the only winner of the big prize – they would be walking around with at least $1.4 billion in their pockets, figuratively. What they fail to consider are two realities. One is the time value of money, that is, the nature of the prize and its valuation. The other is taxation.

The announced total of $1.4 billion – an amount which probably will have increased – is not a “cash in hand when you win” amount, but an arithmetic total of what a person receives if the prize is taken in the form of an annuity paid over 30 years. There is an option to take a lump sum, but as explained in a variety of commentaries, including this story, what one would receive today in a lump sum is a “mere” $868 million.

And then there are the taxes. There is a federal income tax. In most states, there is a state income tax. If the winnings are shared with friends and relatives, and they are not co-owners of the winning ticket, the transfers – depending on amount – are subject to a federal gift tax. The total tax bill will be somewhere on the order of 40 percent.

Granted, taking home a lump some of roughly $500 million ought not generate complaints. But I’m confident it will. Wouldn’t it be nice if the birthday gift check had been for $500 instead of $50? A windfall is a windfall.

The second set of expecations involves alternative prize arrangments. For example, though I have reservations about lotteries generally because they tend to impoverish the poor who see them as the only realistic ticket out of poverty, it seems to me that the big prizes deepen the wealth and income inequality that is undermining the market system. Would it not make more sense, for example, to replace the big $1.4 billion prize with 1,000 $1.4 million prizes? Lottery specialists explain that this approach might reduce the number of people purchasing tickets. If that is so, and it very well could be, is it not interesting that people don’t see a 1,000-fold increase in the chances of winning a “lot of money” as worth the price? That, of course, reflects the financial illiteracy that afflicts American and fertilizes all sorts of scams and political con games.

The expectation that widened my eyes is a meme circulating on facebook, and elsewhere, I suppose, that claims splitting the $1.4 billion evenly among all Americans would give each person $4.33 million. Good grief! This is just so wrong. The responses pointing out the error are themselves amusing, with the best one pointing out that it would generate $4.33 per person, enough to buy a calculator. And, of course, there are those who claim that because of taxes and the time value of money, what would be available to split is $500 million, or roughly $1.60 per person. That’s not quite correct, because if the amount were divided by the lottery and not by a winner, the tax impact would be negligible, though the resulting $2.80 or so per person is pretty much just as disappointing. Perhaps $1.4 billion isn’t all that much money nowadays. It takes much more than that to buy a Congress, does it not?