Friday, August 03, 2018
The taxpayer started using her self-designed tax shelter in 2010. She reported non-cash charitable contributions of $18,288. In 2011, she claimed $32,672, and in 2012, the year in issue, she claimed $34,401. In the two following years, which were not in issue, her claimed deductions rose to $40,351 and $46,978. That’s a lot of shopping.
The items that she donated in 2012, for which she claimed a non-cash charitable contribution deduction of $34,401, cost her $6,047, consisting of $2,520 in cash, and $3,527 in store “loyalty points.” The items were described by her on Forms 8283 as dresses, jackets, and other clothing.
The IRS denied all but $2,520 of the claimed deduction, concluding that the taxpayer’s method of determining fair market value was not a qualified method. On appeal, the IRS increased the deduction to $6,117, mostly by including the loyalty points. It’s unclear why the $6,117 exceeded the $6,047 outlay. Thereafter, the IRS issued a notice of deficiency and the taxpayer filed a petition with the Tax Court. The IRS moved to reduce the allowed deduction by $3,527, arguing that it had erred when it included the loyalty points in the allowed deduction, but the court denied the motion because it was untimely and would prejudice the taxpayer.
The Tax Court denied the taxpayer’s claimed deductions in excess of what the IRS had allowed. It did so because the taxpayer had failed to obtain a qualified appraisal, required because the clothing items, when grouped together as required, exceeded $5,000 in claimed value. The Forms 8283 that the taxpayer had attached to her return were not executed by an official of the donee organizations. In addition, the court held that the taxpayer had not obtained the contemporaneous written acknowledgments. The court then explained that even if the taxpayer had provided the required substantiation, her claimed deduction would be disallowed because she did not use a qualified method for determining fair market value. The court pointed out that fair market value of an item is not the price at which a retailer initially offers the item for sale. The fair market value is the price for which the item was transferred from the retailer to the purchaser, which was the amount the taxpayer had paid. And, the court added, even if the taxpayer could establish that the fair market value of the items exceeded what she paid for them, because she donated them shortly after purchasing them, she would be required to reduce the deduction by the amount of gain that would not be long-term capital gain had the taxpayer sold the items for the claimed fair market value.
One of the many symptoms of the current tax law’s sickness is the ease with which the wealthy can enter into tax shelter arrangements that are unavailable to taxpayers of much lesser means. Tax shelter promoters, whether hawking legitimate or not-so-legitimate deals, turn their attention to the wealthy, in part because it doesn’t pay to offer $10 tax shelters, in part because investment regulations block people of modest means from most private offerings, and in part because the wealthy are in a better position to cause the enactment of legitimate tax shelters in the tax law that are feasible only for those with sufficient funds. It is not surprising that a retired grandmother, whose income from the facts appears to have been quite modest, would engage in a creative but misguided scheme to reduce her tax liability.
Wednesday, August 01, 2018
What are they up to this time around? It’s the Capital Gains Inflation Relief Act of 2018. Not unexpectedly, its advocates claim that passage would fire up the economy and bring all sorts of economic benefits to those most in need of economic assistance. Nonsense. That sort of trickle-down policy does not work, has never worked, and yet continues to bamboozle enough Americans that they line up to vote for the very people who are making their lives miserable.
The legislation would index the adjusted basis of some capital assets for inflation. What’s wrong with that? In and of itself, nothing. The problem is that the special low rates paid by investors on their investment income, rates lower than what wage earners pay on their salaries, have been justified by the lack of inflation adjustments to offset the portion of capital gains that reflect inflation rather than real income. Indexing adjusted basis for inflation makes sense, but only if the special low rates are repealed.
Many years ago, in Capital Gains, Dividends, and Taxes, I explained how this would work:
The advocates of low (or no) capital gains taxation claim that they are being taxed on "phantom" income because some of the gain represents adjustments in price that reflect inflation. They point out that adjustments for inflation exist in the tax law for a wide variety of items (for example, the personal and dependency exemption amount, the standard deduction, the cut-offs for the phase-out of various deductions and exclusions, etc.) But they overlook the fact that the tax rate schedules themselves are adjusted for inflation. Not good enough, they reply.But as I pointed out several years ago, in Special Low Tax Rates Hurt the Economy and Thus the Nation, the goal of the oligarchs is not fairness, but tax oppression:
The answer, therefore, is simple. Make an inflation adjustment to the basis in the asset being sold. Capital gain reflects the difference between the net selling price and the amount invested ("basis") in the asset. So if T buys stock for $100 and ten years later sells it for $400, T has capital gain of $300. If T is in the 30% marginal bracket, T pays tax of $90 on the gain. But T argues some of the gain reflects inflation. How that justifies taxing T at a rate of 5% or even (as the advocates admit is their goal, zero percent) is impossible to understand, let alone accept. Why should T's tax on the gain be $15 or $0? Let's assume that during the 10-year period in question inflation was 35% (that's roughly 3% a year compounded). What makes sense is to let T adjust the basis from $100 to $135. Then T's gain would be $265 ($400 minus $135). Taxed at 30%, T would have a tax liability on the capital gain of $79.50. That's lower than $90 but not near the unfathomable $15 or $0 that T thinks is "fair."
Advocates of special low tax rates for capital gains have one sensible argument, an argument that is inapplicable to dividends. To the extent that the gain reflects increases in value of property that mirror inflation, taxing the gain would be taxing non-real income. The solution, of course, is to index adjusted basis for inflation. There are dozens of places in the tax law where amounts are indexed for inflation. It’s not a new concept, it’s something easily done, and it solves the problem cited by the advocates of special low tax rates for capital gains. So why do they push that solution aside? The answer is that it would not permit real gains to escape taxation at the same rate that wages are taxed, and the advocates of special low tax rates for capital gains and dividends are intent on taxing labor at higher rates. Why? It’s not difficult to figure out that taxing labor at high rates and investment income at low rates speeds up the growth of income inequality and shuts down the upward mobility that tax-cut and tax-elimination advocates claim is their goal.So now the advocates of wealth and income inequality have decided, considering the current political atmosphere and the accelerating pace of middle-class destruction, that it’s time to stop pushing aside the indexed-adjusted-basis approach, and to adopt it, not in substitution for unwarranted low and zero tax rates on the oligarchy, but in addition to those tax breaks. Apparently, the grab-all-the-plates-you-can-and-stuff-yourself-at-the-tax-break-giveaway-buffet-while-shouldering-the-small-fry-out-of-the-way bonanza has reached fever pitch. It’s too bad there are so many Americans who do not understand how the tax system works, who do not give themselves the opportunity to look at tax forms and tax returns to observe the discrepancies in how people are treated, and who do not understand the extent to which they are being snookered by a group of self-centered greedy money addicts, who in the process of feeding their addiction are destroying the nation.
Monday, July 30, 2018
Several days ago, K. Davis Senseman, a member of the Main Street Alliance, a national network of small business owners, and a member of the Executive Committee of Main Street Alliance of Minnesota, a statewide network of small business owners, testified in front of the House of Representatives Committee on Small Business and provided a more detailed statement on the subject of the committee’s hearing. What was the committee investigating? The title of the hearing says it all: “The Tax Law’s Impact on Main Street.”
Senseman made four points. “First, the majority of small businesses in Minnesota and across the country are not seeing consequential gains from the [2017 tax legislation]. * * * Second, * * * the Act’s small business provisions were quite confusing for all but the most sophisticated small business owner, [and m]any business owners * * * will see nearly all of the savings the [legislation] may have provided eaten up by attorney and accounting fees, as they paid experts * * * to parse through the [legislation] and advise them on their best next move. Third, to build an equitable economy that works for small business owners * * *, large corporations and wealthy individuals must pay their fair share of taxes. * * * [F]ourth[,] * * * no matter what you believe in the theories of trickle-down or up economics, the system of American corporate law * * * simply forbids corporations from doing anything that doesn’t provide the greatest economic benefit to their shareholders, and that this is why a corporate tax cut, no matter what size business it is aimed at, can never bring about the greatest economic stimulus for Americans."
It is most encouraging to see and hear small business owners and their representatives explain why the 2017 tax legislation does little or nothing for small business owners, and in some respects, hurts them, just as I, and others, have explained why that legislation does little or nothing for most Americans, and in some respects, hurts them. It is not a coincidence that the legislation, particularly when coupled with the impact of unwise tariffs and other decisions, causes even more wealth and income to shift from the many to the few. The oligarchs who are seeking a transnational system of global indentured servitude are counting on laziness and ignorance to implement their agenda under cover of false promises, fake news, and convoluted explanations that bewilder all but those sufficiently determined to cut through the propaganda.
If, indeed, the goal of the Congress and the Administration is to assist all Americans, including small business owners, then it would have proceeded, and would proceed, in a manner consistent with the platitudes too many of its members tweet, bark, and spew. Instead of handing out tax breaks to large corporations and wealthy individuals while driving up the deficit that will wreck the economy, Congress and the Administration should have, and could have, made tax breaks available only after the tax break recipient performs what has been promised. This is what I suggested in How To Use Tax Breaks to Properly Stimulate an Economy, How To Use the Tax Law to Create Jobs and Raise Wages, Yet Another Reason For “First the Jobs, Then the Tax Break”, and When Will “First the Jobs, Then the Tax Break” Supersede the Empty Promises? Of course, my suggestions fall on deaf ears in the nation’s capital, because it is no secret that adopting this approach would expose what is really happening behind the curtain of deflections, misstatements, and fabricated claims. What is happening is not good for the vast majority of Americans, nor is it good for small business.
Friday, July 27, 2018
Because states cannot compel a business to do use tax collection for it unless the business has nexus with the state, some states are attempting to expand the definition of nexus so that it makes nexus exist under pretty much all circumstances. For a variety of reasons, it is wrong, both as a matter of policy and as a matter of efficiency and administration, to require businesses lacking a real connection with a state to do use tax collections for the state. * * * What is being imposed on the retailers is the aggravation and financial cost of being required to collect taxes for a state with which the only connection is the ability of a resident of that state to view a retailer’s web site on servers not located in that state.This commentary was the culmination of a long string of posts on the issue, starting with Taxing the Internet, and continuing through Taxing the Internet: Reprise, Back to the Internet Taxation Future, A Lesson in Use Tax Collection, Collecting the Use Tax: An Ever-Present Issue, A Peek at the Production of Tax Ignorance, Tax Collection Obligation is Not a Taxing Power Issue, Collecting An Existing Tax is Not a Tax Increase, How Difficult Is It to Understand Use Taxes?, Apparently, It’s Rather Difficult to Understand Use Taxes, and Counting Tax Chickens Before They Hatch, A Tax Fray Between the Bricks and Mortar Stores and the Online Merchant Community, and Using the Free Market to Collect The Use Tax.
Compelling a business to collect use tax for a state * * * force[s] out-of-state retailers to function as tax collectors for the state. It constitutes a radical expansion of government police power. In that context, objections can be raised that might not find strong ground if the proposal to expand nexus is viewed as an expansion of the taxing power. * * *
* * * Compelling a business to collect use tax for a state is “forcing a business to do work without representation.” That is, in some ways, a more serious matter. The use tax itself, like a sales tax, can be passed along to customers, because they are the ones with an existing legal obligation to pay that tax, though few do. The cost and aggravation of functioning as a tax collector for a state in which the retailer does not do business can be passed along to customers only if the retailer wants to risk losing customers because of the price increase.
A few weeks after I wrote the June commentary, the Supreme Court, in its Wayfair decision, overruled its earlier decisions requiring physical presence by a retailer in a state for there to be sufficient nexus justifying the state’s imposition of use tax collection burdens on the retailer, stated that clearly sufficient nexus exists if the out-of-state retailer engages in a significant quantity of business in the state, and remanded the case for further proceedings.
The Wayfair decision, a 5-4 outcome, has been praised and criticized. Even without reading the news, it’s not difficult to guess who likes and who dislikes the decision. State revenue departments are delighted, in-state retailers are happy, out-of-state retailers aren’t thrilled, and consumers will be annoyed when their online shopping price tags are increased by the taxes they thought they were avoiding.
One of those individuals not pleased with the decision is John Tamny, who explains his disagreement in Let's Be Blunt, Internet Sales Taxes Are Economy-Sapping Domestic Tariffs. As was the case with my analysis, in in Getting Past Nexus and Into Voluntary Use Tax Collection Compensation Plans, of George Pieler’s Washington Examiner commentary, I agree with Tamny’s ultimate goal, relieving out-of-state retailers from doing a state’s use tax collection work, but I disagree with some of his reasoning.
Tamny begins with an example of a Washington, D.C. resident purchasing cigarettes in Arlington, Virginia. He asks if this person should pay a sales tax to the District of Columbia. Because the District of Columbia does not impose a use tax on items that its residents purchase that are subject to sales tax where purchased, the answer is no. But consider the Pennsylvania resident, living in a state with a sales tax and a use tax, who travels to Delaware, which does not have a sales tax or a use tax, to buy items to bring back into Pennsylvania. In this instance, the answer to Tamny’s question is, “No, the Pennsylvania resident does not pay a sales tax to Pennsylvania but is required to pay a use tax. Of course, compliance is terrible, just as it is with Pennsylvania’s alcohol tax which, because it is so much higher, brings tales of Pennsylvania revenue agents sitting in vehicles outside liquor stores in the District of Columbia, and looking for heavily loaded vehicles crossing into Pennsylvania on one of the New Jersey bridges or on one of the interstate highways. So, although Tamny appears to be arguing against the imposition of a use tax, the use tax already exists. Technically, it’s the use tax that was at issue in Wayfair.
Tamny argues that tax competition arising from differences in tax rates, including a tax rate of zero where there is no sales or use tax, “serves a very real purpose.” He explains that “local taxing authorities” should consider the existence of lower or zero rates elsewhere when “helping themselves to more of what we earn.” He considers the ability of state residents to make out-of-state purchases in places with lower or zero sales or use taxes to provide an incentive for state and local legislators to keep their taxes low. Yet legislators in every state with a sales tax have responded to that argument, decades ago, by enacting use taxes to back up their sales taxes.
Thus, when Tamny claims, “it’s a good bet that most – regardless of ideology – would blanch at the notion of reporting all purchases completed outside the city and state they live in so that they could be taxed on those purchases,” he seems to suggest that use taxes are a “notion” that has not yet been implemented. Of course most people find the idea of reporting out-of-state purchases to be annoying, but that’s a different question from whether they are presently legally required to do so. Recent attempts by states to increase compliance, for example, by including a reporting line on state individual income tax returns, illustrates the extent to which people confuse what the law actually is with what they think the law is or should be.
Tamny argues that if a D.C. resident isn’t subject to D.C. sales taxes when buying cigarettes in Virginia by going there in person, that resident ought not be taxed when making the purchase by staying in D.C. and making the purchase online from the Virginia. As I understand state sales and use taxes, the obligation to pay use taxes does not depend on whether the resident goes to another state to purchase something brought back into the state or stays home and orders online. The instructions to the District of Columbia Consumer Use Tax form make no distinction between purchases made out-of-state and those made online, referring simply to items on which no sales tax was paid to any state. Under current law, a D.C. resident who goes to Delaware, purchases an item and brings it back to D.C. must pay use tax, and also must pay use tax if making the purchase from the Delaware retailer through the retailer’s web site (ignoring the de minimis exception in the law).
Tamny supports his argument by claiming that sales taxes are designed to provide local government services, and that because out-of-state businesses do not benefit from those services they ought not pay sales taxes. This argument suggests to me that Tamny, like many Americans, does not understand the difference between sales taxes and use taxes or the difference between tax incidence and tax collection. The flaw in Tamny’s reasoning is illustrated by his claim that “when judges and politicians talk about the importance of levying sales taxes on outside vendors, what they’re really saying is that they want government to dip its hands into our pockets twice.” The flaw is that sales taxes are NOT levied on out-of-state businesses. Nor are they levied on in-state businesses. Sales taxes are not imposed on or paid by retailers. They are imposed on and paid by the consumer but collected and remitted by the business. Businesses, of course, pay business taxes, and those are not imposed on out-of-state retailers with no physical presence or business activity in the state. Use taxes also are imposed on consumers, but because many consumers are not paying the use tax, states are trying to put the collection burden on out-of-state businesses. When and if those out-of-state businesses are required to collect a use tax, they add the tax to what the consumer pays, and thus are not paying the tax. What’s at issue is the administrative burden and cost of collecting and remitting the tax, which requires the business to modify its software, bookkeeping, and similar processes.
When Tamny refers to the “internet sales tax” in his claim that “the internet sales tax isn’t about leveling the tax playing field as much as it’s yet another grab of the economy by politicians,” he reinforces my conclusion that he doesn’t understand sales and use taxes. The tax in question is the use tax, a tax that already exists and that should be paid by consumers making certain out-of-state purchases but that isn’t being paid by many of those consumers.
At one point, to his credit, Tamny gets to the point I made in June. He argues, “No reasonable person would support a byzantine system whereby a retailer in Virginia would collect taxes for Washington D.C.’s Office of Tax and Revenue.” Indeed. If, using my example, Pennsylvania wants Delaware retailers to collect use taxes on its behalf, it needs to offer Delaware retailers an incentive, namely, giving them some or all of the administrative costs avoided by Pennsylvania when it refrains from hiring thousands of additional revenue agents to patrol borders and monitor online sales transactions by Pennsylvania residents. Unfortunately, that is not how the situation has played out.
What is wrong with the Wayfair decision is that it focuses on the out-of-state business and its position vis-à-vis the in-state business rather than focusing on the consumer, the consumer’s use tax obligation, the state’s refusal to deal with its noncompliant residents directly, and the state’s shifting of that burden onto out-of-state businesses. Of course, it’s not so much the Court’s fault as it is the arguments made, and not made, by those arguing the case. Similarly, had the issue of whether retailers in low or zero sales tax states are encouraging tax evasion when, in advertisements, they invite out-of-state residents to come into the state to escape the tax, as I discussed in What Is a Retailer’s Obligation Not to Provide Misleading Tax Information?, been presented to the Court, the analysis would have been more richly informed and perhaps would have led to a different outcome or at least a different set of principles to be applied on remand.
Better understanding of sales and use taxes, by commentators, advocates, judges, and justices, would contribute to workable solutions, such as the one I offered in Tax Collection Obligation is Not a Taxing Power Issue:
Perhaps a better approach is for states to seek voluntary contracts with out-of-state retailers, compensating them for serving as tax collectors. There may be state Constitutional provisions or legislation that prohibits contracting tax collection to out-of-state individuals or entities, though I doubt that is the case. For some businesses, being compensated to engage in use tax collection might help the bottom line.It was not without good reason that I argued in Getting Past Nexus and Into Voluntary Use Tax Collection Compensation Plans, “If state governments and out-of-state merchants found a way to communicate productively, the problem could be resolved rather easily.” What happens during the next few months will be interesting to watch.
Wednesday, July 25, 2018
The Tax Court concluded that because the children did not have the same principal place of abode as the taxpayers for more than one-half of the taxable year, there was no need to determine whether they were qualifying children or qualifying relatives. The failure to share a principal place of abode was enough to disallow the taxpayers’ claimed deductions based on claiming the children as dependents.
I have seen summaries of this case describing the outcome as reflecting the impact of adoption, as though a person who has been adopted cannot be the qualifying child or qualifying relative of the biological parents. Yet, at least in some cases, such as this one, the adoption caused the children to become the nephew and niece of the biological parents. If, for example, the children and their aunt had lived in the same abode as did the taxpayers, then the Court would have needed to explore the other elements of the definition of qualifying child. Because the children met the age requirement and did not provide more than one-half of their own support, the question would have been whether they met the relationship test. After the adoption, both children were descendants of a sister of the biological mother and thus satisfied that test. But because they also were children of the adopting parent, the aunt, the rules applicable when two or more taxpayers can claim the same qualifying child would have needed to be examined.
Two things matter. First, if there are multiple paths to an answer to a tax question, take the simpler path. Second, don’t extrapolate a general rule from a case that is limited to a specific situation and rests on specific grounds. As pointed out in the preceding paragraph, the fact of an adoption, or, to mention another characterization I’ve observed, an award of custody, does not in and of itself foreclose or mandate a conclusion with respect to the child’s status as a qualifying child or qualifying relative. Extrapolating general rules from one anecdotal instance is a template for trouble.
Monday, July 23, 2018
In upholding the soda tax, four of the six Pennsylvania Supreme Court justices concluded that the soda tax was not a second sales tax because it is imposed on the distributors of the taxed items and not on the consumers, even though the distributors pass the tax onto the consumer. This is the sort of distinction drawn by lawyers that aggravates many non-lawyers. Technically, the court is correct. The court noted the tax is imposed even if the item on which the distributor paid the tax is not sold to a consumer.
The door is now open for Philadelphia to enact a “store exit” tax on stores for the privilege of allowing customers who entered the store to leave the store, based on the amount of money spent in the store by the customer. The tax would not violate Pennsylvania law because it would not be a double tax. Why? Because it would be imposed on the store and not on the consumer. To those who suggest that no one would ever propose or enact such a tax, I say, don’t be so confident. There even has been a to tax the air that people breathe. And I suppose at some point a tax on inhaling air will be treated as different from a tax on exhaling air, perhaps justified as not a double tax because the chemical content of inhaled air differs from the chemical content of exhaled air.
It’s outcomes and suggestions like these that inspire the anti-tax crowd. That’s sad, because opposition to all taxes because of one or two bad taxes is like disliking all people of a particular background because a few people of that background have behaved badly. If more people informed themselves about taxes and participated eagerly in the tax enactment and amendment process, the nation could end up with a much more rational tax system than now exists. But that requires giving reasoning skills priority over emotional reactions. Will that happen?
Friday, July 20, 2018
The program that provides the tax-exempt status sought by the developer is designed to encourage investment in “underutilized or underdeveloped areas.” The area in which the developer is planning the project is what has been called “the hottest neighborhood in the country.” It is neither underutilized nor underdeveloped. Putting aside the question of whether the tax-exempt program in question is wise, it surely ought not be available in this instance. Seeking tax-exempt status in this situation is not unlike millionaires finding ways to get food stamps.
The developer claims that the tax-exempt status is necessary in order to attract financing for office development. If financing for office development in the area in question is a good thing, the banks and other lenders will step up. If they don’t, then either the developer is not one with whom they want to work, or the area is not one properly positioned at this time for office development. Either way, the private sector is speaking.
When people understandably complain about the city of Philadelphia “taxing everything,” a hyperbolic but reasonable concern, do they take into account the impact on revenue of tax breaks benefitting people with ability to pay? Do they realize that every tax break requires shifting tax burdens from those getting the breaks to those who are not necessarily in a position to finance the pet projects of those with ability to pay taxes? Perhaps if they did, they would let that analysis affect what they do at the polls.
One more point needs to be made. If the tax breaks are required, as the developer insists, to open up financing that otherwise would not be available, then isn’t the tax break simply a piece of investment in the property? If the banks and other lenders get interest on their loans, ought not the taxpayers get interest on the tax break advanced to the developer? Better yet, ought not the taxpayers, who are in effect financing part of the project, be treated as shareholders entitled to vote on decisions with respect to the project? Surely the developer would oppose paying interest to taxpayers or letting them vote, though grabbing tax revenue through tax breaks seems perfectly acceptable. There’s something wrong with that sort of approach to doing business. Either the project is worthwhile and can stand on its own in the private sector, or it ought to be shelved.
There are times when a project cannot stand on its own because the nature of the project makes it necessary yet financially unfeasible for the private sector. In these instances, it is appropriate for taxpayers to fund the enterprise but the enterprise must be owned and controlled by the taxpayers, that is, by a federal, state, or local government or an agency thereof. These are projects that have a direct, rather than indirect, effect on taxpayers and must be under the control of taxpayers. That is why I oppose privatization of public enterprise and why I oppose public grants to, and tax breaks for, private sector enterprises.
Wednesday, July 18, 2018
The taxpayer owned a business in called AA+ Smog Check. AA+ operated a smog inspection station in Burlingame, California. The taxpayer had established AA+ in 2007 as a sole proprietorship. During the taxable years at issue, AA+ was a test-only smog check station. The taxpayer was legally restricted to performing smog inspections and other minor maintenance work, such as oil changes. The minor maintenance work generated roughly 5 percent of AA+’s business.
The taxpayer lived in a one-bedroom apartment four doors down the street from AA+. He paid rent of $1,450 per month, which entitled him to the use of the apartment, shared laundry facilities, and one-half of a shared two-car garage attached to the apartment building. The taxpayer did not park his car in the garage but instead used the space as business storage. As a smog check business owner, the taxpayer was required by California to keep certain invoices and records regarding smog checks for at least three years. Invoices must be kept on location for purposes of immediate inspection. AA+ had no formal office or storage space, and real estate in the area was expensive. Because the garage was so close to the AA+’s location, the taxpayer decided to use it as storage for his business records, including the smog inspection invoices that California required him to retain. In addition to these business records, the taxpayer also stored business-related items such as backup air compressors, printers, monitors for the smog machine, and various parts such as oil filters and wipers. He stored no personal items of note or value in the garage, other than some pencils and stationery.
On his federal income tax returns for 2009 through 2011, the taxpayer claimed home office expense deductions for the use of his garage. He argued that he was entitled to those deductions because the garage was used to store business records, he was required to maintain the records by the State of California, and the garage was the most convenient and inexpensive place to do so. The Tax Court explained that neither of the two possible exceptions to the denial, under section 280A(a), of deductions for expenses with respect to the use of a taxpayer’s residence applied. One exception, for expenses attributable to space allocable within a “dwelling unit which is used on a regular basis as a storage unit for the inventory or product samples of the taxpayer held for use in the taxpayer’s trade or business of selling products at retail or wholesale, but only if the dwelling unit is the sole fixed location of such trade or business,” did not apply because the taxpayer was not in the trade or business of selling products at retail or wholesale, and his business records and invoices do not constitute inventory. Nor did the exception for expenses allocable to a portion of the taxpayer’s dwelling that is used exclusively on a regular basis as the taxpayer’s principal place of business apply, because the garage was not exclusively used as his principal place of business.
The result seems harsh. The taxpayer operated a business, and stored business records and business-related items in a space for which he paid rent. The problem is that the space where he stored these items was available to the taxpayer because it was bundled with the apartment in which he lived. Would the deduction have been available had the taxpayer entered into a lease for the apartment unit and use of the laundry facilities, while causing AA+ to enter into a lease for use of the garage? The answer depends, in part, on information not available. Would it violate local law to treat the apartment unit and the garage as two properties subject to two different leases? My guess is, perhaps not, because there certainly are instances, at least in places with which I am familiar, in which the owner of a property on which there is a house and a barn, or a house and a garage, rents the house to one person, and the barn or garage to another. However, many jurisdictions have restrictions on this sort of splitting if it causes, or could cause, the number of household units on a property to exceed what is permissible under local zoning ordinances. Another concern would be the existence of prohibitions on renting to a business a property zoned for residential use; it is possible that the taxpayer’s use of the garage for business storage violated some local law though that was not raised in the Tax Court. Yet another obstacle might be the impact on insurance coverage of entering into two separate leases. If these, and other hurdles not coming to mind, are overcome, the IRS might still consider the identity of lessor and lessee to warrant application of a substance-over-form argument, one that it would probably raise even if the taxpayer put the business into a corporation or LLC treated as a corporation.
I doubt any of this occurred to the taxpayer when he set up his business and looked for a place to store the records he was required to keep. It is yet another example of how the complexity of the tax law gets in the way. Fiddling with tax rates to the advantage of the oligarchy does nothing to simplify a law riddled with complexity. To the extent that the tax law causes, or should cause, people to think about alternative ways of structuring a business that they otherwise would not need to consider, it creates impediments far worse than the mere existence of a tax. Section 280A was enacted because some taxpayers were being far from truthful when claiming business use of their home, yet in this case there is no question at all that the taxpayer was using the garage for business purposes and only for business purposes. Section 280A needs to be fixed.
Monday, July 16, 2018
As described in multiple reports, including this one, Pennsylvania legislators quietly and quickly inserted into tax legislation a provision that permitted the sale to unlicensed individuals a variety of aerial fireworks previously restricted to use by trained professionals. Prohibitions on the use of these aerial fireworks, such as forbidding use by minors and intoxicated individuals or within 150 feet of buildings, reflect the dangers of people shooting off explosives the way some people foolishly fire guns into the air in crowded neighborhoods on New Year’s Eve. People get hurt. Yes, the new legislation contains those restrictions, but what happened two weeks ago, with fireworks being set off close to neighbors’ homes at all hours of day and night, demonstrates the futility of expecting any sort of compliance. The new law permits the sale of “Roman candles, bottle rockets, firecrackers and some types of reloadable aerial shell launchers.”
The legislative change was inserted into the Pennsylvania tax law, rather than, say, provisions dealing with the use of explosives, because the new law came with a tax twist. Sales of fireworks are subject not only to the usual state and local sales taxes but also to a special, additional 12 percent sales tax on “amusement products.” Clearly the goal of the legislature was to raise revenue by widening the use of fireworks, dangerous as they are, and then imposing a tax on the sales.
In the meantime, fireworks vendors, according to this report, have sued the state not only because of the tax, which the industry claims violates the Pennsylvania constitution, but also because established vendors are subject to a variety of safety regulations either being ignored or not applicable to roadside fly-by-night vendors. The legislation permits temporary tent setups for fireworks sales but those are not required to have containment walls, sprinkler systems, or smoke alarms. Nor are there in place systems to ensure that the new tax, or even any sales tax, is being collected or remitted to the state.
Pennsylvania is not the only state to expand the list of permissible fireworks in an attempt to raise revenue. Though Indiana raised about the amount of revenue that was predicted, revenues in Georgia and West Virginia reached only one-fourth and one-third, respectively, of what legislators were told would be raised. The revenue estimators working on these legislative initiatives must be taking the same courses that have produced the supply-side economic theory advocates who also look upon their own proposals with far too much optimism.
This is what happens when legislation is rushed, squeeze into other bills, and enacted without public hearings and discussion. This is what happens when revenue policy is a patchwork of concepts rather than a reflection of an overall analysis of taxes, the economy, behavior, and social benefits. If the goal of the change in the fireworks law is to raise revenue, which defenders of the legislative package claim that it is, as reflected by its inclusion in the tax statutes, then the legislature must be counting on a huge surge in the purchase and use of these fireworks. An increase in fireworks sales and use surely will be accompanied by an increase in explosions, fires, personal injuries, and even death. Yes, it’s only a matter of time before someone loses a hand or gets blown up, but whatever it takes to raise revenue, well, perhaps cigarettes and alcohol should be sold to minors, especially because teenagers have quite a bit of purchasing power. As many commentators have noted, the legislature simply did not think through the impact of this change. That’s typical, and no less unsatisfactory.
Friday, July 13, 2018
The plaintiff had been incarcerated for 20 years and had not filed tax returns during that time because he had no income. After being released and getting a job, he met the defendant, a tax return preparer, through the defendant’s husband at an event where defendant was handing out business cards. The plaintiff needed to have his federal and state tax returns prepared.
The defendant tax return preparer was not a CPA, had earned a bachelor’s degree in accounting, had worked for a CPA firm for 5 years, and then went out on her own for 3 years. She testified she takes continuing education courses. She held a full-time job aside from the tax preparation business, and prepares about 75 returns each year.
The plaintiff testified that the defendant quoted a price of $100 for doing the returns. When he asked about the 21-day fast refund process provided by the defendant, he said he was told it would be an additional $200. The defendant denied this, and claimed she billed by the hour. After preparing the returns, the defendant sent a $5,000 invoice to the plaintiff, of which $4,300 was for telephone calls. There was no retainer agreement.
The defendant testified that filing a return after 20 years of not filing returns would trigger an identity verification audit, and that this was the reason the plaintiff did not get his refund within 21 days. She claimed that she had previously told him there would be a delay if there were any problems, such as an identity verification audit. The defendant testified that a month after filing the federal return for the plaintiff, the IRS sent a letter to the plaintiff. The plaintiff denied receiving the letter.
The defendant claimed she had obtained a power of attorney from the plaintiff, but did not produce a copy of it because she was moving and the copy was allegedly in a box somewhere. The defendant testified that she communicated with the IRS and explained the plaintiff’s situation to the agency. The plaintiff testified that he was the only one who communicated with the IRS. He stated that he called the IRS, and then visited an IRS office, where he spoke with an agent. The agent gave the plaintiff a copy of the plaintiff’s tax transcript, on which there were no contacts recorded between the IRS and the defendant as the defendant had claimed.
The defendant received the federal income tax refund on the plaintiff’s behalf by having it deposited in her bank, held back $5,000 out of it for payment of the invoice, and remitted the balance, roughly $1,000, to the plaintiff. The plaintiff testified, and a copy of the return showed, that his income for the year was roughly $14,000. One of the judges suggested that the refund was held up by the IRS because of the size of the refund when compared to the amount of reported income.
The plaintiff also testified that when he did not get his state income tax refund, he contacted the state revenue department. Someone at that agency told him that the state tax refund was direct deposited into the defendant’s bank account. The defendant claimed she in turn paid the refund to the plaintiff, but there was a discrepancy between what was deposited into her account and what she said was remitted to the plaintiff. The defendant testified that because she processed four state income tax refunds on that day she could not explain the discrepancy and would need more time to determine to whom she sent each of the four checks she claimed to have sent to four clients, including the plaintiff.
One of the judges, looking at the invoice, asked the defendant for her time sheets. The defendant testified that they were in baggage lost by an airline. The invoice included charges for time that the defendant claimed to have been on the phone, on hold, with the IRS. She also billed the plaintiff for calls to the plaintiff, but the plaintiff produced his telephone records which showed that there were nowhere near as many calls between the plaintiff and defendant as the defendant charged. On one call that showed 5 minutes according to the plaintiff’s telephone bills, the defendant charged him for a one-hour call. On another call, lasting 2 minutes according to the plaintiff’s telephone bills, the defendant charged for one-half hour because her policy is to round up to the nearest half-hour. In response to sharp questioning by the judges, the defendant claimed that some of her phone calls with the plaintiff were on another telephone number of the plaintiff.
In conference, the judges found the defendant’s testimony to lack credibility. They considered the defendant’s behavior to be unreasonable, and her practice of charging for time spent on hold, when the defendant was or could have been doing other things, to be obnoxious. They held in favor of the plaintiff. The defendant protested, the court sent her from the courtroom, and announced that they would refer the case to the local prosecutor because they considered the defendants’ behavior to be a violation of at least several criminal statutes.
There are several lessons to be learned from this case. First, do not let tax return preparers receive your anticipated refund. Have the refund sent to you, directly or through deposit into your bank account. Second, preserve and backup evidence, so that even if an airline loses luggage or boxes are moved, there is an alternative source for the evidence. Third, do not lie, Fourth, do not try to take advantage of people. Fifth, do not sass judges when they are handing down their rulings.
Wednesday, July 11, 2018
First, I thought, “how nice.” Who doesn’t like a refund of taxes, especially when it is caused by a larger-than-anticipated budget surplus?
Second, I thought, “Wait a minute. The way they did this might be a problem.” The refund were the same for each property owner whose land held a structure. Would it not have been better to have provided a refund proportional to the amount of township tax paid by the owner? I don’t know enough of the facts to conclude that there is any legal violation, but it certainly raises issues of fairness that are tolerable only because the amount of money involved isn’t very much. Consider two homeowners. One owns a $300,000 property and paid a township property tax of $300. The other owns a $600,000 property and paid a township property tax of $600. Each one has paid a tax equal to one-tenth of percent of the property’s value, consistent with the proposition that property taxes should be uniform – though in fact, because of warped assessments, special rebates, and other flaws, they aren’t. Each homeowner receives the $68 refund, so that the first homeowner has paid $232 and the second, $532. The first homeowner has paid a tax equal to .000773 percent of the property’s value, whereas the second homeowner has paid a tax equal to .000886 percent of the property’s value. Perhaps in this instance of a small refund, “rounding” might provide the escape route.
Third, I thought, “Why not save money and simply provide each property owner with a credit rather than mailing a check?” Present-day technology makes that an easy thing to do, and also makes it easy to calculate a proportional credit rather than an everyone-gets-the-same-amount check. Perhaps the supervisors, being politicians, wanted to put something in front of property owners who also are voters.
Fourth, I thought, “Here we go again, with misleading analysis.” That thought was a reaction to a comment by the director of policy analysis at the Commonwealth Foundation. She said, “It’s really impressive to see a local government that’s practicing spending restraint.” Yet the refunds originated with a budget surplus roughly $1,000,000 larger than expected. How did that happen? Was it spending cuts? Most of the surplus, more than eighty percent, came from the collection of delinquent taxes. What’s amazing is how the tax burdens on compliant taxpayers can be eased when those who don’t comply are forced to do so. What also wasn’t mentioned was the township’s decision to increase spending for the police force by hiring another officer.
Perhaps the most important message isn’t the mantra of “cut expenditures, shrink government, rip it out by the roots,” but “step up, contribute, do your share, don’t be a deadbeat, stop looking for tax breaks for yourself or your narrow special interest group.” Doing taxes right means taxes go down without services being impeded.
Monday, July 09, 2018
But it is possible to enact a tax designed to encourage a particular behavior or transactions. According to this report, Hong Kong is planning to impose a tax on unsold newly built apartments. The goal of the tax is to boost supply in what is considered to be the most expensive property market in the world. In theory, increasing supply should reduce prices. What I don’t understand is how a tax on unsold newly built apartments will lower prices or increase supply.
When the builder or developer of a property is subject to a new tax, it is not unlikely that some or all of the tax would be passed on to the buyer. That would increase, not decrease, prices. If the idea behind the proposal is that the developers and builders would reduce prices in order to accelerate the sale of the units, and if that succeeded in getting the units sold, the impact would be a reduction in supply. In turn, that would increase prices. The proposed tax would also have the effect, it seems, of discouraging developers and builders from constructing additional units because those would increase the inventory of unsold newly built apartments. That, too, would reduce supply and increase prices.
Proponents of the tax claim that it will deal with a situation in which “demand has surged ahead of a chronic under-supply of homes. Yet if there is a shortage, why are there unsold newly built apartments?
Analysts from several investment companies predict that the tax, if enacted, “won’t dent soaring prices.” They consider the proposed tax to be one that “developers can easily absorb” and characterize the “absolute level of tax as “relatively manageable.”
Perhaps the problem is a mismatch of demand with ability to pay. If housing unit prices were within reach of a sufficient number of potential purchasers, inventory of newly built units would not stagnate. Hong Kong, however, suffers from the same economic disease as does the United States and too many other nations, namely, income and wealth inequality that is out of control. According to this report, as of a year ago Hong Kong’s wealth gap had reached an historic high, with the top ten percent earning roughly 44 times what the poorest ten percent pull in.
The solution is not a tax on unsold newly constructed units. That does nothing to restore equilibrium to a market warped by inequality. A tax on excess building profits would generate revenue that could be used to reduce taxes on those with low incomes. Though opponents of taxation claim that such a tax would put developers out of business, the fact that the land cannot expatriate itself and the fact that there still are after-tax profits to be made ensure that someone would step in to fill in the vacuum even if a developer did withdraw from the market. According to this commentary, Hong Kong developers are hoarding land. So perhaps a tax on undeveloped land would be effective, though it would be contrary to the goal of preserving open spaces. Hong Kong’s population increases, which are a factor in the housing shortage problem, demonstrates the tension between unbridled population growth and a finite earth. That problem is one I have addressed in several posts, including Can Tax Rebates Help Prove Malthus Wrong?, and it ought not be a surprise to anyone that nothing in the ten years since I wrote that commentary has changed my outlook other than to strengthen it and make me even more pessimistic.
Hong Kong has a problem. Hong Kong is the canary in the coal mine. Today, Hong Kong, tomorrow, our nation. Until those whose money addictions have caused the problem are deprived of the ability to continue their depredations and worsen world economies, the preclusion of all but the economic elite from life’s basic necessities will become increasingly widespread and potentially very dangerous. Taxes on unsold newly constructed housing units are not the answer and will not solve the problem.
Friday, July 06, 2018
Almost immediately, the anti-tax lobbies roared into action. One group put together a plan to gather signatures for a referendum putting repeal of these tax increases on the November ballot. According to this report, the Oklahoma Supreme Court rejected the referendum initiative because of insufficient signatures, and the group behind the initiative decided to abandon its effort. It claimed it was not given enough time to obtain the signatures, but perhaps the problem was an insufficient number of voters willing to sign. Perhaps they failed to notice, as the report explains, that “Many of the anti-tax Republicans in the House who voted against the package faced primary opposition this year.” Two were defeated in primaries, and others failed to obtain majorities, thus facing runoff elections. At least some people seem to be waking up to the damage caused by supply-side economic theory nonsense.
The strikingly amazing aspect of this situation is the claim by the anti-tax group pushing the referendum that it is “not opposed to raising teacher pay” but that “state leaders should have found other ways to fund the raises without raising taxes.” How? What are the practical suggestions? They aren’t forthcoming because these anti-tax groups realize that the moment they share the alternatives, even more people will recognize the failures of the anti-tax philosophy. There are two alternatives. One alternative is to reduce the number of teachers, using what would have been paid to the fired teachers to increase the pay of those who remain. Of course, this approach would put more stress and work requirements on the remaining teachers, and further weaken education in a state that needs better, not weaker, education. The other alternative is to take funding from other programs and shift it to teacher pay. Identifying the programs to be defunded for this purpose would cause all sorts of harms. Do the people of Oklahoma want reduced road repair funds? Reduced police, fire, and EMT services? Reduced tornado warning system and shelter funding? Worthwhile programs, goods, and services are not free, nor cheap. The mentality of the anti-tax groups who claim they support one or more programs, goods, and services reflects an inability to understand this reality. So long as they persist in their approach, income and wealth inequality will continue to increase, real wages will continue to decline, the middle class will continue to shrink, and the strength of the nation will continue to weaken. Enough already, supply-siders. You’ve had your chance. In fact, you’ve had multiple chances at the federal level and in far too many states. You tried. You failed. It’s time to step aside and let the rest of us have our turn.
Wednesday, July 04, 2018
We probably will never know, at least before the Last Judgment, who started this misstatement. But we do know that way too many people heard it and repeated it, without thinking about it and without checking it out. This isn’t the sort of issue on which deep rocket-science research is required. It’s a matter of common sense to think about the practical realities of life. So, for example, one could think, “Hmm. If someone not in the country legally makes a purchase, do they escape paying sales tax?” The answer, which should pop into just about everyone’s brain, is “Of course not.” Or, what if that person purchases gasoline? Do they pay the gasoline tax? Certainly. What if the person buys a tobacco product, or an alcoholic beverage, or telephone service? Do they pay the taxes imposed on those transactions? Most certainly. Moving to the big ones, do these folks pay federal and state income taxes? Do they pay social security taxes? Folklore might cause people to think, no, because they’re all being paid in cash. But a wee bit of research, a skill that should have been learned somewhere along the way in a person’s K-12 journey, reveals that most individuals who are not in the country legally but who are working are not paid in cash, have taxes withheld from their pay, receive Forms W-2, and file income tax returns. Some end up overpaying and do not receive their refunds. None of them qualify for social security benefits even though they are paying into the system.
When Anonymous added the nonsense that illegal immigrants don’t pay taxes because they don’t have social security taxes, that person took the ignorance up a few notches. Social security cards have nothing to do with the paying of sales taxes, gasoline taxes, tobacco taxes, alcohol taxes, or phone taxes. They have nothing to do with the paying of income taxes and have nothing to do with the paying of social security taxes. It is amusing that someone whose statements reveal a complete ignorance of reality has the courage to use the word “dumb” in describing those who know what they are writing about.
It’s difficult to erase ignorance through education when the purveyors of falsehoods are flooding the world with their harmful lies and taking steps to take over the education systems that are designed to make propaganda more difficult to spread, easier to detect, and easier to rebut. If we haven’t yet reached the tipping point, we almost certainly will, very soon, unless people wake up, exercise their thinking skills, engage their brains, and push back against those who don’t have the best interests of Americans at heart. Otherwise, celebrating “independence” will be celebrating a theory with little practical meaning.
Monday, July 02, 2018
Paul Benedict argues that private repair of potholes “tells us that it appears the federal and state gasoline taxes that most of us pay are not going toward much-needed road repairs.” After pointing out that “Pennsylvania has the highest gasoline tax in the country” and “receives all the revenue” from the Turnpike, he asks “Where are all these funds going?” He also asks, “Why does it take so long for municipalities to fix potholes?”
The answer is simple. There is insufficient gasoline tax and other revenue to fix all the roads, bridges, and tunnels that are in disrepair. Even if there was sufficient revenue, there is no logistical way to repair all potholes the day after each one appears. Potholes tend to appear in clusters, usually after a freeze-thaw-freeze-thaw cycle. So it is not unreasonable, though it is frustrating, that it takes days and weeks for potholes to be repaired.
Paul Benedict’s questions can be answered by examining the revenues and expenditures of the Pennsylvania Department of Transportation and the local counties and municipalities. The Department of Transportation 2017-2018 actual, available, and budget can be found at the Commonwealth Budget, beginning on page E41-1. The department is responsible not only for pothole repairs, but also for bridge repairs, bridge reconstruction, road repairs, road reconstruction, construction of new roads and bridges, hiring and training employees, promoting road safety, maintaining signs, clearing drains, the list is long.
The recent increase in the Pennsylvania gasoline tax was earmarked for rebuilding crumbling bridges and highways. A chunk of Pennsylvania Turnpike revenue is used to fund maintenance and repair of the state’s portion of the toll-free Interstate 80. It helps to analyze the facts.
To repair potholes more quickly, the authorities responsible for fixing potholes have three choices. They can persuade the legislature and local governments to provide more revenue. They can divert funds from other projects. They can find ways to reduce the costs. The first approach requires either higher taxes, which won’t find support, or diversion of funds from other departments, which won’t sit well with those who benefit from what those other departments, such state police protection, public health regulation, and environmental care. Imagine having potholes repaired overnight at the expense of eliminating the state police. The second approach requires diversion of funds from road and bridge repairs, drain cleaning, etc. Imagine having potholes repaired overnight at the expense of being on a bridge when it falls into a river. The third approach, a favorite among anti-tax groups, requires finding the huge amounts of waste that the privatization advocated claim exist but rarely can find in more than de minimis amounts, or worse, reducing worker pay. Though some relish the idea of paying workers minimum wage or less, that idea is inconsistent with vibrant economic growth.
The bottom line is that we get what we pay for. Asking for pothole repair, or any other service, to be increased because there are more potholes, more robberies, or more chemical spills, while expecting to pay the same price is unreasonable. Perhaps paying the true cost of the transportation infrastructure people claim to want would be less burdensome if people’s wages, adjusted for inflation, had not remained stagnant over the past 35 years while the oligarchy has stuffed its pockets and overseas accounts with tax breaks. It’s not easy to see and understand the big picture, but it’s necessary.