Sunday, February 29, 2004

Comments Roll In 

One of the intended consequences of this blog is to plant ideas and energize discussion. To that extent, this blog is beginning to succeed. Word is getting out. One person wrote "A friend sent me your web site address." Now there's the start of five minutes of fame!! [Eventually I'll figure out how to put a pictorial emoticon in here, showing a laugh]. I've had comments from several folks, which I will share.

Note: I play it safe and identify people if they so request. Please do let me know whether you want the publicity or prefer the anonymity. Far better to go back and add a name than to try the impossible task of removing one!!

Ron Feinman shared this:

"I liked your analysis of the "spin" on the respending of the taxes by the taxpayer for dividends.

"I wonder what would happen if you included in your analysis a comparison with what happens to those tax dollars if the tax cut isn't implemented -- i.e they stay with the government and 100% are spent immediately.

"No matter what the velocity of money, the government spending produces more stimulus and (according to your spiral) more tax dollars.

"Of course you might note the savings rate (I suggest it's higher for the wealthy) provides a drain on the money to be spent from the tax savings. That is the government spends 100% of its tax dollars and the rich save a portion creating less flow."

Good questions. Ultimately it comes down to this: is it better for a given amount of money to be paid in taxes and spent by the government or to be left with citizens and spent by them? The answer is one of those "it depends" musings. The existence and size of the deficit is a factor. The nature of the spending matters; for example, in time of war the government can and must spend for the sort of goods and services that citizens generally cannot purchase. (Well, in recent years a lot of military hardware is out there for purchase, but it's illegal, and anyhow, last I looked, there weren't any aircraft carriers on e-bay. Yet. Groan.) Lastly, there is an issue of efficiency, that is, does the private sector get more for its dollar when it spends a dollar than does the federal government? New reports and anecdotes suggest, yes, that the dollar spent in the private sector is more efficient and has a greater impact on gross domestic product. But that doesn't answer the question.

The original question arose when I pondered how tax cuts could increase federal revenue. Clearly tax increases increase federal revenue. If tax cuts also increase federal revenue, then increases in federal revenue are unavoidable. Hmmm. Of course, the federal government, as the writer points out, doesn't appear to save or invest so it pumps more back into the economy than would the citizen retaining and spending what otherwise would be a tax payment. I'm unsure about this proposition. For one thing, the government does invest. It purchases and builds assets, such as buildings, military bases, equipment, and other long-term assets. For another, when a citizen invests (saves), it generates interest income, which is taxed (whereas interest payments aren't always deductible), which has a net increase effect on federal revenue. The investment, in turn, provides resources for others, for example, a business that borrows (uses the citizen's investment with the bank) in turn pays a salary that is taxed, or pays for supplies that enter into the taxable income computation of the vendor.

With all these variables, is it any wonder that different "parts" of the government reached such contrasting conclusions about the impact of cutting taxes?

Another writer pointed out that the deficit itself is a "hidden tax" that causes the value of the dollar to drop against foreign currency. This writer wondered if he was the only one considering this aspect of the economy. He's right, I surely didn't factor it into the equation. Living abroad, this writer is very aware of how the drop in dollar value diminishes the value of his income but yet causes an increase in the value (in dollars) of his assets. There's a long-term consequence sitting here, as he points out, and I join him in wondering if anyone in the Congress or Administration is studying the matter.

A third writer wrote "An interesting topic might be to review the subject of existing generation skipping trusts. I believe in the late 60's new trusts were banned but existing trusts were allowed to remain. Some will be in existence for perhaps another 100 or more years. In the debate about estate taxes it seems only fair to propose to eliminate immediately this shelter and perhaps tax the assets at the tax rate now in existence. Senators such as Ted Kennedy seem quite willing to tax others as long as they can retain their own exemption for taxes they believe are fair for others. "

Indeed, it is an interesting topic. Onto the "to write about" list it goes. Funny, I had some concern I'd not have enough ideas to keep this blog going, but I need not have worried. My brain, the growing number of tax stories in the newspapers (an AMT article today), and now ideas from visitors will keep the selection large and rich. Well, not THAT kind of rich, ha ha. Seriously, there is something unsettling about the "grandfathered" trusts, especially because a few years ago Congress did not hesitate to make some tax increases retroactive even though taxpayers who had died were denied any chance to restructure their tax planning to take the tax increases into account. Let me ponder this for a while. As they say, I'll get back to you.

Finally, yet another writer simply said, "Excellent blog -- taxation with a little humor." Thanks. I try. I teach this stuff. If it weren't for the humor, the course would be intolerable. OK, sometimes the humor gets a bit crazy, but it works for most students. Here's an example: Students have "spring" break this week, and I reminded them it's a good time to review, assimilate, and get a handle on things so that they can dig in during the second half of the semester. Knowing that many are heading out for a week of vacation, I urged them to take their tax books. "You just don't know who will sit next to you on the plane, or on the beach, look over at what you are reading, and decide to strike up a conversation. Surely you won't be at a loss for words and it will be easy to chat. After all, tax is tough to resist." Coming next: "How to Meet People By Reading and Doing Taxes" soon at amazon.books.com. Here I REALLY do need an emoticon with a look of "you're kidding, right?" Yes. Rest easy. No pick up books from me.

Thanks to all who wrote.

Friday, February 27, 2004

A Response to the Social Security Suggestions 

From James Howard, a tax professional who is a ABA-TAX list colleague:

"I scanned today's blog and believe there's another alternative for social security. It's not an obvious one, and it's probably not even reasonable, but one I thought of in a discussion of tax lawyers yesterday. Everyone hates the estate tax, right? [So let's] repeal the estate tax when social security is fully funded. In the interim, remove estate tax revenue from the general revenue and apply all receipts to funding social security benefits. Isn't the whole concept of the estate tax a redistribution of wealth? If the estate tax goes into general revenue to pay government expenses, such as contract obligations, is there really a redistribution? Put that money in social security and you have an immediate and direct redistribution."

"Probably will never get any traction, because the Rep's won't defer on the tax repeal for that long and the Dem's won't tolerate the loss of receipts. But as a policy matter, it accomplishes 2 goals, elimination
of the estate tax and shoring up social security. With 3-4% of the gross revenue being added to social security, I think you could get to a level of full funding pretty quick."

This is an interesting idea. It can be categorized as a "challenge": Look, Congress, if you're serious about not letting Social Security wither and shrink, it has to be funded. It's primarily an income/wealth redistribution arrangement, so where's a good place to get the funds? The estate tax. If you're willing to make the repeal of the estate tax permanent, then make that repeal conditioned on funding social security the way you require private employers to fund pensions. No more pay as you go. Can you do that, Congress? Can you show the citizens that you're serious about this?"

Sadly, I agree that the chances of this happening aren't high. That's too bad. Goodness, at the moment I'd go for a high chance of it being discussed and made visible. That's what blogs are for (at least if anyone from Capital Hill is reading this). Thanks, James Howard, for an idea that wasn't in my head but that has found a nice place there not too far from the fire.

Now if I can figure out how to set up a poll like they have on the cable news websites.... :-)

Triple Tax / Tax Times Three 

Six stories on the front page of the Philadelphia business section and THREE are about taxes.

One of the stories is a followup on the Pennsylvania tax breaks for profitable companies and their owners who apparently cannot build or rent office space in Philadelphia without taxpayer assistance. I've already written about this, but some new news: (1) we can see a few more names of persons who would benefit or who already are getting the tax break, (2) proposals are being made to limit the tax breaks to persons who actually generate new jobs, and (3) the chairman of one company getting benefits said it was "offensive" to call the tax breaks a result of cronyism. OK, well, you didn't see that charge here. Cronies or not, a bad thing is a bad thing.

The second story describes IRS intentions of getting tough on "high risk tax evaders." Who's the target? This group:

  • wealthy people hiding income. (They wouldn't do that now, would they? haha)

  • tax professionals inventing questionable tax shelters (a profession in and of itself these days)

  • people mis-using charitable tax-exempt status (is nothing sacred?)

  • people hiding income off-shore (wouldn't it be annoying if they asked for military assistance to retrieve their hidden funds?)

    Let's have some fun. Here's a list of the sort of stuff the tax evaders get into (and note that no one would do any of this but for the saving of taxes with schemes that aren't economically feasible other than the tax evasion and avoidance effect): In the area of reducing taxable gain, they use arrangements with names like Tempest, InsureCo, Basis Importation, 79-21, BLAST, B-FLIP, Asset Monetization/Asset Protection (Triple By-Pass), 501(c)(15) Co., LADD, Leveraged Disposition, Othello, Prepaid Lease, Mixing Bowl, Enhanced Mixing Bowl, CPLS II, Basis Leap, Busted 351, Venture Capital Planning, Leveraged 704(c), PIF, SC2 Gain Mitigator, and PERX. To avoid or evade taxes in the international arena, they resort to things with names like U.S. Withholding Tax Eliminator, A&M Base Shifting, Alhambra, Pathfinder, and Short Option. To jack up losses and deductions, there's CCB, 172(f), Mitigation, 382, FEIGHT, CLC, Dot-Bomb-Monetization, and PALS (partnership allocating loss strategy) -- Income Absorption. Or how about Insureco, 501(c)(15) Captive, PINSCO (Personal Insurance Company), Captive Tune-Up, 21% Solution, WITS, E Replacement (WITS for Homebuilders), and Employee Benefits Captive? They take S corporations and use them for what they weren't intended to do, with things like SC2, SC2 Variation #1, SC2 Gain Mitigation, SC2 CLAS, S-corp Basis Enhancer, and SC2 Redemption Strategy. And then there's the finance and leasing stuff: AF-EXO (Alternative Financing for Exempt Organizations), Dot-Bomb-Monetization, Enhanced Venture Leasing, Inbound Cross Border Leasing, LIFT, PERX, PIF (Partnership Investment and Financing Structure), SLOTS (Sale Leaseback of Tenant Improvements), TAT. Or they go the accounting strategy route, with Bad Debt Reserve Acceleration Strategies, Inventory Methods Review, Contested Liability Acceleration Strategy, California Franchise Tax Acceleration, MEALS, Acceleration of Prepaid Expenses, Service Company Strategy, and IBNR: Incurred But Not Reported. These things sound like Pentagon weaponry, cleaning products, and video games. But it's no game. The last one says it all: "incurred but not reported." The last time I jumped on tax avoiders (namely, the tax protest crowd), I got all sorts of email from people who had fancy ways of telling me I was wrong to criticize them for wanting a free ride from the rest of us.

    Who creates this stuff? To paraphrase Cal Johnson, who teaches tax law at Texas, it's a bunch of very bright people paid big bucks to outsmart IRS employees. The IRS, not permitted nor funded to pay big bucks, can't compete. The IRS is being out-brained. And it's being out-numbered.

    So, the IRS wants more money to do this enforcement. They're asking a Congress that annually REDUCES the IRS budget. What fools. There has been a cadre of politicians who earn votes by running for election and re-election on an anti-IRS platform. It plays well to the crowds who don't realize that they're being persuaded to vote for someone whose chopping of the IRS ultimately will shift the tax burden from the tax cheats to these voters. Except that polls show a majority of Americans are willing to cheat on their taxes. Big surprise. Honesty isn't exactly king (or queen) in this nation anymore (and no political party is free of responsibility).

    During the past 8 years, the number of IRS revenue officers is down 27%, the number of special agents (who investigate criminal tax fraud), down 13%, and the "tax gap" is officially $311 billion. Unofficially it's surely twice that or more. Budget deficits? Why blame enacted tax cuts when most of the deficit arises from "self-appointed tax cuts." How do you react to the idea of paying a higher bridge toll to offset bridge toll losses from people driving through the EZPass lane without paying, while the bridge revenue authority fires all its toll takers and police officers? Well, that's where things have been headed. What's really outrageous is that the IRS bashing that led to the funding cuts were orchestrated by hearings at which witnesses presented what is now admitted to be fraudulent testimony about alleged IRS abusive treatment of taxpayers. Not only did most of the stuff not happen, but there are clowns in Congress who think it is abusive for the IRS to send a letter to someone who owes taxes and to ask for payment. How DARE they ask someone to pay a bridge toll? Amazing.

    And that brings us to the third story. Alan Greenspan once again is predicting (correctly) that the Social Security and Medicare/Medicaid system funds are going to go broke. Well, they can't go broke they way you and I can, because the government can print more dollars or borrow money to meet the obligations, but the problem is that the amounts going OUT of these funds is going to exceed the amounts coming IN by a lot. A WHOLE LOT. Right now the value of the amount due to recipients under current law is FOURTEEN TRILLION DOLLARS. And the value of what is available now plus what is scheduled to come in is a mere THREE AND A HALF TRILLION DOLLARS. The shortfall? TEN AND ONE HALF TRILLION DOLLARS. Put that in perspective. People are (rightly) worried about a quarter to half trillion dollar federal deficit.

    So what happens?

    1. If the government prints money, it will generate inflation. Retirees and other recipients of these programs will demand cost of living adjustments. Inflation also stagnates the economy (were you there in the late 70s? Do you remember 18% home mortgage interest rates? I do.) Long-term, very bad move.

    2. If the government borrows money, it increases the federal deficit. It put pressure on the capital markets. Interest rates increase. It becomes more expensive, if not impossible, to start businesses and buy homes. Long-term, bad move.

    Most economists believe that absent a better solution, the standard of living in America WILL DECLINE if either or both of the preceding paths are taken. Hey, Congress, are you listening? Hey, voters (with or without great grandchildren), are you listening?

    Are there other options?

    Indeed there are.

    1. Raise the payroll taxes. This won't sell, will it? Well, one bit will. At present there is a cap on the amount of wages that can be taxed for Social Security. Eliminate it. Why should someone making $1,000,000 a year pay the same social security tax as someone making $100,000? The answer traditionally has been that they both would get the same benefit. That argument, though, didn't stop the Congress from eliminating the cap for the OASDI portion (the 1.45% part of the tax). Eliminating the cap will affect relatively few (though politically powerful) wage earners, so it would sell at the grass roots level. But of course it won't raise all that much money. It's not enough.

    2. Cut back benefits. OUCH OUCH OUCH. I debate this with other tax law professors and I'm in the minority. See, I look at the official name of Social Security and one word pops out. You see "FICA" on your paystub and on your W-2. What does it mean? Federal INSURANCE Contributions Act. Yes, insurance. Insurance is something we purchase with no guarantee of return (other than whole life insurance, and for that the price is very high). The rest is a gamble that we want to LOSE! If I can get through life never collecting on my fire insurance policy, or my disability insurance policy, hey, I'd be much happier than if I had to file a claim. Ditto for auto theft insurance, auto collision insurance, and the rest of them. Gee, if you can tell me how to avoid my beneficiaries collecting on life insurance, you're onto something. Somehow people have come to view social security as an ENTITLEMENT. Why? Do we get paid fire insurance if there is no fire? Car theft insurance if there is no theft? NO. Some folks, of course, TRY to collect when there is no car theft, and well, not a good idea. So let's stop paying social security to people who aren't poor or who are covered by pension plans, IRAs, Roth IRAs, and all the other tax-favored retirement savings plans.

    3. Let's tax social security receipts that exceed what the employee paid in. That sounds bad, but it isn't. The tax law already taxes some social security receipts, but it uses a convoluted formula that drives everyone nuts when they see it and try to apply it. Ask the students in the Basic Federal Income tax class. Ask your grandparents. Or anyone you know who gets social security. The complexity arises from a desire not to tax people who are scraping by on social security. Well, if the standard deduction and personal exemption are set at the right level (that is, don't tax poor people) then there's no harm in treating social security as gross income because it won't be taxed if the person has no other income or very little other income. Another reason for the complexity is the notion that a person should not be taxed on a recovery of their own savings. True. The Social Security Administration has a record of a person's contributions, so if the person contributed $10,000, the first $10,000 of social security ought not be taxed. Then the rest of it is included in gross income and taxed if the person's other income is enough to trigger tax liability (that is, not poor).

    4. Increase the retirement age. This has been happening and I predict it will continue. After all, 70 years ago, when social security was first put into the law, not that many people lived to retirement age and most died within a few years of retirement. Now, many people in their sixties are active and healthy, and most will live for another 20 or more years. Oh, say the critics, increasing retirement age will compel people in poor health to keep working. No, it won't. They'd be eligible to retire if the statute is properly drafted. Oh, say the critics, you're forcing people to work. Or at least discouraging retirement at 65. Good, I reply. It's good to do things. It's good to work. Why not permit a scaling back of hours rather then the "all or nothing" retirement arrangement? After all, some companies already permit this. Oh, say the critics, you're taking jobs from the younger people? What younger people? When social security was enacted there were 20 workers for every retiree. In 1950, 16 workers for every retiree. Now, there's about 5, and by 2025, only 2 and a quarter workers for every retiree. It's not a matter of too many workers and not enough jobs. It's a matter of job - worker matching. And we'll get into overseas outsourcing later.

    5. Let's cut out the fraud. What fraud? Well, those folks that are trying to avoid income taxes with all those tax shelters? They not only are trying (and often succeed) in avoiding the INCOME tax, they also avoid the social security and other payroll taxes. It's not that the amount in question is enough to offset a ten and a half TRILLION dollar deficit, but it is wrong to put the burden of that shortfall on honest, hard-working Americans when there are a growing few who are trying to stick their good life on everyone else's tax back. A crackdown here sends a message: this sort of behavior is no less a threat to the well being of America than is any other assault.

  • Wednesday, February 25, 2004

    Philadelphia Admits its Tax System is a Mess 

    Full story from the Philadelphia Inquirer

    Favorite quotes and reports:

    1. By Paul Levy, head of the Center City District: "The city's array of local taxes, designed for the industrial age, are hampering growth of knowledge industries that are the key to the region's future."

    Why I like it: It's easy to explain by that bridge-toll comparison I use so much. Suppose that when bridges replaced ferries and automobiles replaced wagons, the toll continued to be computed on the basis of the number of mules that you were taking across the river. Because it is easy to see the silliness, it's easy to understand how the public would bring pressure on whoever set the bridge tolls to get out of the past and into the present. Other types of revenue (such as taxes) aren't so easy to understand, so the public doesn't understand why or how the system is so bad, and even after it realizes how inefficient the system is it doesn't know what to advocate. This opens the door to the politicians whose desire to be and remain elected surpasses their sense of service-leadership. The few politicians who aren't that way (yes, there are some) just don't have the clout.

    2. Levy "proposed business tax breaks, akin to those in the commonwealth's Keystone Opportunity Zones, for all companies that create jobs, not just those moving to new buildings."

    Why I like it: It puts the spotlight on the disservice that governments do to their citizens when they fashion tax provisions designed to benefit a few, when there are far more who do just as much, if not more, for the common good of the society. I've already shared my views on the silliness of extending the tax break to companies that don't need it, in Tax Breaks, Politician Takes. It's nice to see that there are others who understand the double whammy of a tax break that favors some but not all, and a tax break that favors those who are least in need.

    Feel free to send the URL for these comments to your favorite legislator or executive branch administrator. Or your least favorite.

    Sunday, February 22, 2004

    Tax Spin: Rotating the Numbers in Circles 

    Well, it's fun enough, isn't it, to work through a tax return line by line, pausing every now and then to jump to another form or a worksheet, travel through that morass, and then bring a number back to the place where one left off. It's even more fun to explore the numbers that ultimately generate the forms, the lines on the forms, the instructions, and the joys of tax return preparation.

    Most people don't go near this topic. It rarely makes the front pages or the soundbite news shows, but it's a topic at the very heart of the tax policy debate. And there will be a LOT of that during the summer and early fall. Election campaigns, especially presidential ones, tend to bring taxation discussions to the surface, but much of the chatter is just that, peppered with spin.

    Last year Congress decided to lower the rate of tax on some corporate dividends. Of course, the major policy issue is why? If it is to reduce the tax burden on retirees depending on investment income, then the rate on interest income should have been reduced. It wasn't. If it is to encourage investment, doesn't the reduction of tax on pay-outs from the corporation encourage withdrawal of monies from the corporation supposedly being encouraged to invest and produce? And what tax reduction awaits those who invest or operate business through partnerships and LLCs? Oh, say the supporters of the lower dividend rate, it's to eliminate the double taxation of corporate profits. Corporate profits are taxed to the corporation, and when the after-tax profit is paid out as dividends, it is taxed again. But advocates of "corporate shareholder tax integration" (the notion that corporate income should be taxed once) don't offer reduced dividend taxation as the most efficient or most sensible approach. No matter, the folks who advocate the reduced dividend tax rate are the folks who brought us the reduced capital gains tax rate. And that is a topic that deserves its own post, which it will get, later. The short of it is that when two people go into the coffee shop for a latte, the person behind the counter doesn't ask if the dollar bills being offered in payment are "wages dollars," "capital gain dollars," or "dividend dollars." Note that the folks with the capital gain and dividend dollars will have more of them, proportionately, than does the person with the wages dollars.

    All of that is bad enough. Now comes the spin. The Congress, through its Joint Committee on Taxation, estimates that the reduction of tax rates on dividends from 25%, 28%, 33% and 35% to 15% will cost 66.1 BILLION dollars for 2004 alone. Well, that makes sense. If the goal is to reduce taxes, one would expect that a tax cut would reduce tax revenue.

    It isn't difficult to imagine that someone might challenge the computation and decide that the cost is 60 billion or 68 billion or some other amount. That's fairly common with just about every change made to the Internal Revenue Code other than the ones affecting procedure and paperwork. But the White House budget describes the dividend tax cut as a "negative tax expenditure", that is, something that INCREASES tax revenue by 26.7 billion dollars. How's that? Well, the argument is that the taxes not paid by the recipients of dividends are in turn used by them to purchase goods and services, and the providers of the goods and services then pay taxes on the income from selling those goods and services.

    So, let's see. Dividend recipients save $66 billion, and spend the $66 billion. The people receiving the $66 billion pay taxes of, say, $22 billion on the $66 billion of income from the sale of goods and services (and that's not quite right, because someone selling goods isn't taxed on the sale price, but on the sale price minus the cost of the goods sold). That means the net cost of the dividend tax cut is $44 billion. But it's still a revenue loss.

    Ah, wait. The people who received $66 billion in revenue from the purchase of goods and services by the dividend recipients will in turn spend the $44 billion they have left over after paying the $22 billion in taxes. So that the people selling goods and services to THEM will have $44 billion of income, generating taxes of, say, $14 billion. So the net cost of the dividend tax cut would be $30 billion.

    One can play this loop over and over. Economists call it the economic multiplier. Where does it get us? Theoretically, the cost of the dividend tax cut can be reduced to zero. Maybe. But how does it then go in the other direction and generate additional tax revenue?

    Now we get to another piece of tax policy argumentation. Theoretically, people who are invested in things that generate interest income will pull their investments out of those things and put it into dividend-paying stock. Well, won't that REDUCE tax revenue? Well, it would unless the dividends are paid at a higher rate than the interest rate. For example, if $100 generates $2 of interest income taxed at 25% (50 cents of tax), then the $100 needs to generate a dividend of $3.33 so that the 15% rate generates the same 50 cents in income. Does the market do that? Perhaps. If everyone is moving money INTO stocks, then stock prices will react to the demand for stocks and increase. Presumably, the increased trading in stocks will generate capital gains which, though taxed only at 15%, will generate tax revenue.

    There's a lot of "ifs" going on this analysis. There's a lot of guessing. There's a lot of financial pyschological prediction. Maybe. Maybe not. Perhaps. Could be.

    The point is, no one really knows until after the fact what will happen. Some tax cuts do in fact stimulate the economy and in turn generate even more revenue. Other tax cuts don't. Can one distinguish between the two types based on the nature of the tax cut? No. The outcome isn't so much whether the tax rate is cut on dividends instead of interest, or dividends instead of wages, or capital gains instead of wages. It appears that it is more a matter of the national mood, international trade and politics, and a variety of other measurable economic data and immeasurable psychological data.

    What's sad is that these numbers get trotted out by their respective adherents as though they were handed down from on High. No one, at least not on the soundbite news, bothers to explain that they are nothing more than conjecture. People make voting decisions based on information of this sort, and yet it isn't information. People also reserved rooms in Houston, Texas, thinking the Philadelphia Eagles were a shoo-in. But in economics, taxation, and elections, nothing is certain except that we will continue to be spun, as the numbers are tossed in circles and circles.

    It's dizzying, isn't it?

    Thursday, February 19, 2004

    Pennsylvania Taxes: Making the Feds Look Good 

    The next time you get annoyed, frustrated, bewildered, shocked, or overwhelmed by a federal income tax form or by trying to fill one out, say to yourself, "It could be worse."

    It could.

    It is.

    Come live in Pennsylvania and see what happens when you set up an LLC.

    An LLC is a limited liability company. It's not a corporation, it's not a partnership, it's not a trust. It is an entity invented in Wyoming several decades ago, and now permitted in all states.

    For federal income tax purposes, LLCs with one member are treated as sole proprietorships and those with two or more members are treated as partnerships. The LLC can elect to be treated as a corporation but that rarely, if ever, happens. Most states follow the federal approach.

    But what does Pennsylvania do? At first, Pennsylvania treated LLCs as corporations for state corporate income tax purposes and for state capital stock tax purposes (the latter is the tax that has driven businesses OUT of the state, causing the legislature to schedule its phaseout, but that has been put on hold because the state needs money. Of course the state needs money.... businesses and their jobs have been leaving).

    Then Pennsylvania decided to treat LLCs as partnerships for state income tax purposes. But they treat the LLC as a corporation for capital stock tax purposes.

    Understand that LLCs don't have capital stock because they're not corporations. So that makes the idea of imposing a capital stock tax on them as sensible as imposing a gasoline fuels excise tax on the sale of shoes, or better yet, imposing a bridge toll on people who don't cross the bridge.

    OK, so there are some conceptual problems here. Sometimes I wonder if the folks making these decisions took a tax course. I surely hope they weren't students in my courses. What an embarrassment.

    But the real problem is the practical one. LLCs are required to fill out a capital stock tax form that is designed for corporations. The form asks for the names of corporate officers. Duh, there aren't any. It asks for the name of the corporation. OK, cross out the word corporation and ink in "LLC" and maybe (after a few more years of doing this) someone will get the message. The form asks for shareholders' equity at the beginning and end of the year. LLCs don't have shareholders so they don't have shareholders' equity. But, well, we can figure out what the Department of Revenue wants to know, so plug in a number for something approximating members' equity. They ask for percentage of stock owned by each shareholder. Huh? In fact, if the LLC is set up to make special allocations, there is no one fixed percentage. So one has to write in "varies" across the tiny spaces provided for percentage numbers.

    Then there is the manufacturing exemption, and the reconciliation schedules, and, new for this year, a multiple-column multiple-row classification matrix. By the time one is finished:

    The federal income tax return for the LLC is 2 sheets (4 pages) plus a K-1 for each member partner.

    The Pennsylvania income and capital stock tax return for the LLC is 8 sheets (16 pages) with 2 of the sheets being a fold out exemption schedule. Plus, of course, a K-1 for each member partner and a second K-1 for each nonresident member partner.

    The irony is that almost all LLCs are small business operations. So they qualify for the $125,000 "valuation exemption" for the capital stock tax. But they still must fill out the forms, which could be as many as 10 pages including schedules.

    And the form has such entries as this: If line a is more than twice as much or less than half as much as line b, enter ..... WAIT! Is this algebra class? Sometimes I think that computer game players who need a job line themselves up to create tax forms with sections that aren't unlike the "aha secret place to click to get more ammo" features one finds in computer games.

    The "paperwork burden" that Pennsylvania imposes is absurd. The LLC either pays someone to do the returns, or a member of the LLC does the return. The cost of paying someone, or the value of the time, can be significant when compared to the income each member draws from the LLC. This is especially so if the LLC is a start-up company.

    The Department of Revenue offers electronic filing. No way. This is the same Department of Revenue that won't permit taxpayers to download the capital stock tax forms from its web site.

    Maybe Vincent Fumo can muscle the water companies or some other utility to make contributions so he can set up a "fix the Pennsylvania tax system and its tax administration and tax filing systems" Foundation. If it does half the job he claims his South Philly "We can use PECO dollars better than PECO customers can use reduced rates" Foundation does, he'd make the news for a good reason.

    I'd volunteer to go fix it myself if they gave me the authority, but I doubt the folks in Harrisburg would appreciate the outcome. Taxpayers would, but hey, what do taxpayers know? (he says with more than a tinge of sarcasm).

    Let me duck so I don't get run over by the stampede of LLCs joining in the exodus of businesses from Pennsylvania. I'll hang around just in case the Governor decides that I deserve to be a Keystone Opportunity Zone, with tax credits that let me not worry about filing forms or paying taxes. Oh, wait, the KOZ form is probably another 45 pages with questions asking me to report the number of shareholders in my LLC.

    Stay tuned. There are more tax returns yet to do.

    Tuesday, February 17, 2004

    Tax Breaks, Politician Takes 

    Here in the Philadelphia area (and the rest of Pennsylvania for that matter) much is being written about the proposal to give Comcast a tax break for keeping its corporate offices in Philadelphia.

    It all goes to show that whatever the feds can do, the states and localities can do just as well.

    Find an industry or company that is doing quite well, and find a way to throw more money their way. Not that the outcome will be a reduction in the cost of the company's product or services. Or even a reduction in the rate of increase of the company's pricing.

    The Governor of the Commonwealth defends his proposal by claiming that Comcast will bring 1,000 more jobs to the region if it gets the tax break, and very easily could add another 2,000 jobs in the future.

    And without the tax break? I suppose the Governor's reasoning suggests that without the tax break Comcast will not add the jobs. That means Comcast either will require its existing workers to do more work, or Comcast won't do the work that the 1,000 hypothetical new employees would have done, or Comcast won't go out and offer to purchase Disney.

    If Comcast has enough money to purchase Disney, how does it not have enough money to hire 1,000 new workers? Sure, perhaps Comcast doesn't have enough money to do both, but if it genuinely needs 1,000 new employees to make quality cable service available at reasonable prices to customers in its monopoly-controlled service area, then spend the money on the jobs and retreat from or postpone participation in the "Bill Gates purchase the world" competition.

    But that's not what this is REALLY about, and the people involved must think that the rest of us will fall for the "more jobs" mantra because jobs are difficult for some people to find at the moment. Note, some people. Nurses, accountants, natural gas riggers, hey, some folks have the skills that are in short supply. And what about a guarantee that if Comcast gets the tax break and fails to create 1,000 new jobs it pays the escaped taxes, with interest and penalties? There's no need for a "no way Comcast loses" flavor to the deal, is there?

    No, what this is about is extortion. Companies do this. Sports franchises do this. Athletes do this. Anyone who thinks he, she, or it can get away with the "I'm running away from home unless you increase my allowance and reduce my chores list" gambit tries to pull it off. (Hey, do kids have chores anymore?)

    The response ought to be, "then leave." Where will you go? California? New York? Some state with higher income tax rates? Or some state with seemingly a lower tax burden? (Note, "seemingly") And after you and all your employees show up, putting additional demands on that state's government and its localities for services, you'll discover that taxes will go up. Including yours. And especially your employees'.

    Take a lesson, corporate managers, from the sports teams that leave a city because the locals can't or won't give in by spending tens of millions of tax dollars for a playhouse for athletes who earn poverty wages (oh, excuse the sarcasm). Then these teams, wooed by the greener grass on the other side of the fence in some other town, pick up and leave. Supposedly the locals suffer for their insolence in not publicly funding a private enterprise. Gee, Los Angeles has really suffered since Al Davis went back to Oakland and the Rams went to St. Louis. (more sarcasm, but this topic really invites it.)

    And how long did the honeymoon last? Count the number of such teams that moved back, or moved yet again. Give Al Davis of the Oakland Raiders a call. He's quite experienced in the game, and I'm sure at this point he'll has a totally different perspective than he did years ago. Better yet, call the towns that did the wooing and ask them if they're all that happy about their success. Call the folks in Phoenix and ask them about their joy in having enticed the Cardinals to leave St. Louis and traipse west into the desert. Sometimes departures are good for everyone involved, except those who depart.

    The advocates of these individualized tax breaks argue that they are necessary, because without them all of the state's citizens will suffer in some way. Well, even WITH the tax breaks the citizens will suffer because someone has to make up the revenue loss. Oh, no, say the advocates, the additional revenue will come from the 1,000 new employees who arrive and pay income taxes. True. Except that the 1,000 employees and their families will impose additional demands on state and local government services, such as the need for 1,800 additional seats in schools, teachers to go along with them, highways (which will become more clogged), etc. etc. And so local real estate taxes will go up. Bridge tolls will go up. The cost of lost time sitting in traffic jams will go up.

    What the "Comcast needs a tax break" advocates don't want to hear are the pleas of the "all businesses need a tax break" advocates. Why not a tax break for the mom and pop grocery store in Chinatown? Why not a tax break for the self-employed home hospice care giver? Why not a tax break for the landscaper? The three-person tree removal companies? The woodworking outfit? After all, together these businesses could create not 1,000 but 2,000 or 5,000 or 10,000 jobs if their taxes were reduced. Instead, they see an increase in the state income tax, a deferral of the repeal of the antiquated capital stock tax, a revenue department that still doesn't quite grasp how an LLC should be taxed.

    Well, the reason these small businesses don't get tax cuts is two-fold. First, they don't have clout. Second, without the tax cuts they become more vulnerable to the mega-companies buying out the world. Don't you want your landscaping done by the ComcastDisney Lawn Mowing Subsidiary? How about nursing care from the ComcastDisney Nursing Practice?

    Why don't they have clout? They don't get to rub shoulders with the "movers and shakers." They aren't invited to the meetings and parties where the decisions get made. They can't afford big-time political campaign contributions. Standing alone they don't have enough to offer. Until now, they haven't had enough incentive to stand together, these owners of small businesses that offer goods and services in a wide expanse of industries and service fields.

    Here's why this sort of "tax break for the big and wealthy" doesn't work. To make up the revenue loss, costs are increased for the "small and not wealthy" businesses. Costs include not only taxes, but decreased public services, increased time waste, and lost revenue on account of the continuing exodus of residents from Philadelphia to other places. As small businesses then join the flood of people crossing City Line Avenue, the city's tax position worsens, it raises taxes yet again, and the cycle accelerates. Eventually the Comcasts will leave, long-term leases or not. (They'll find lawyers who can get them out of those leases, and that's assuming they don't have escape clauses written in at the outset, which surely they must.)

    There's the story of the guy who killed the goose that laid the golden eggs. There's also the story of the exiles who ate the seed corn. Somewhere in here Comcast might figure out that it would be better off NOT getting a tax break. Not only in terms of public relations, but in terms of long-term present value analysis that looks not only at the corporation's projected financial statements but also at the projected financial statements of the city and state from whom it is trying to extract these tax breaks.

    Unless of course, Mr. Roberts, after you acquire Disney with the money you've saved in tax breaks, you decide to distribute the acquired Disney shares to each of your cable subscribers. Now THAT would be rather innovative, wouldn't it? And a public relations coup that would dwarf the effect of announcing that flush with the financial werewithal to acquire Disney you really don't need the tax breaks.

    Think about it. (And if you do it, I won't even charge you for my advice.)

    Saturday, February 14, 2004

    Marriage and Taxes 

    I should know better than to think that commentary on marriage and taxes can fit into a brief posting to this weblog, but the question is out there, at least for those not familiar with the intricacies of tax law:

    "Will the same-gender couple marriages in San Francisco be recognized for tax purposes?"

    The answer is no. The IRS has interpreted the federal tax laws dealing with marriage (e.g., joint returns by married couples, the estate and gift tax marital deductions for transfers to one's spouse, the gain deferral provision applicable to transfers between spouses and transfers incident to divorce) as limited to persons who are validly married under state law. The courts have agreed. The San Francisco same-gender couple marriages aren't valid under existing California law.

    "What about same-gender couple marriages in Massachusetts if it turns out that the legislature in Massachusetts doesn't resolve the issue and the decision of the Supreme Judicial Court takes effect as scheduled?"

    The answer here is that a federal statute not in the Internal Revenue Code limits recognition of marriage for purposes of federal law to marriages between a man and a woman. So despite the IRS definition of marriage as a marriage valid under state law, the same-gender couple marriages that would presumably take place in Massachusetts won't be recognized for federal income tax purposes. I'm no expert on Massachusetts state income tax, but I suppose that for state income tax purposes Massachusetts would be required to treat same-gender marriages as it treats different-gender marriages in terms of joint filing and whatever other tax benefits and tax detriments affect married couples in Massachusetts.

    Civil unions? Not marriages for federal income tax purposes.

    So that answers the questions, but there's more to consider.

    A couple that is treated as married for federal income tax purposes usually is worse off, in terms of the federal income tax, than if they were not married. That's the so-called "marriage penalty." (The couple is better off for purposes of the federal estate, gift, and generation-skipping transfer taxes.) But sometimes they are better off; that's the so-called "marriage bonus." Generally, if the each of the two persons has roughly the same income, they're worse off, and if they have substantially different incomes, they are better off. The best "marriage bonus" is attained when one spouse has no income. (Interesting insight, isn't it, into what the tax law encourages?)

    I've written several journal articles discussing the marriage penalty and bonus, and related issues. E.g., Tax and Marriage, Unhitching the Horse and Carriage, 67 Tax Notes 539 (1995). It's on-line only through subscription web sites such as Lexis, Westlaw, and Tax Notes, so there's no point in trying to link to what would be a dynamic link.

    Anyhow, many others in the tax profession, mostly law faculty but also several practitioners, have also written on this topic. So if you're interested, there's a lot out there to read. Not only is the problem analyzed and dissected, a variety of solutions are offered.

    My solution? I don't think marital status ought to have anything to do with taxation. Now that gets some people upset, because they think that it would mean the end of civilization if the tax law did not in some way encourage or reward marriage (even though the income tax "marriage penalty" does far more economic damage than is offset by the benefits of estate and gift tax marital deductions). Pennsylvania's income tax, for example, though permitting joint filing, doesn't treat married couples different from single persons (principally because there is a flat tax rate). Despite what some may think, civilization in Pennsylvania has not ended.

    My solution reflects not so much my unwillingness to accept the notion that married persons SHOULD be treated differently from single persons for tax purposes, as it is a rejection of the discrimination between husbands and wives and other combinations. Consider, for example, two sisters who remain in the family home, care for their elderly parents, and in turn maintain the household after their parents die. Their economic position is no different than that of a married couple. They have similar non-tax concerns; for example, the spousal hospital visitation preference that is one of the concerns raised by same-gender couples seeking marital status is no less a concern for the two sisters. Of course, anyone can execute powers of attorney and other legal documents, but not only do many hospitals, banks, and other institutions deal inadequately with these documents, it's sadly just not something that many people think about or get around to doing. The same is true of wills, burial directions, health care powers of attorney, medical directives, etc. etc. (As an aside, many institutions accept declarations of marital status without getting into paperwork proof whereas they won't accept declarations of other legal relationships (such as a power of attorney) without a process that is not unlike the annoyance of filing a tax return!)

    The broader solution, beyond treating people as individuals when it comes to tax returns, is to treat people as individuals when it comes to everything else (setting aside the question of minors and the limitations on their capacity to function as individuals with respect to legal matters). Think for a moment, again, of the toll booth. "Welcome to the Ben Franklin Bridge." "How much is the toll?" "Well, there's $1 for you, and if the woman in the passenger seat is your wife, it's another 50 cents, but if not, it's another $1." "She's my wife." "Prove it." How long would Americans (or people in any country, for that matter) put up with this silliness?

    So what to do about the hospital visitations, domestic benefits, health care coverage, and all the other incidents of marriage? Permit people to name a "designee" for purposes of hospital visitation, medical decisions, default beneficiary under insurance policies and retirement plans, and so on. Would a person be permitted to name a different designee for different purposes? Yes, but it usually would be unwise for a variety of reasons. Would a person be required to name a spouse? No. Sometimes a spouse is NOT the best person to have a power of attorney, or to be a beneficiary, to make medical decisions, or to be a "designee."

    Would a person and the designee file a joint tax return and get tax benefits? No. Because there wouldn't be any joint returns or tax benefits on account of having a relationship of any sort with any person. No deductions for boyfriends, no exemptions for fiancess, no bridge toll discounts for mistresses, and so on. Excuse the sarcasm there, but the attempted use of tax law to influence people's behavior in areas in which even the psychological experts don't quite understand why people behave as they do is a grand example of Congressional and lobbyist hubris.

    So what happens to marriage?


    And everything.

    Marriage should be to the state as is birth and as is death. And as would be the naming of a designee. Or the revocation of such a naming. Or the ending of a marriage. That's the libertarian in me talking. Hear me out.

    Consider birth. The state records births (and people are under obligations to register births with the state when they occur). Note that it is the state and not the federal government that does the registration (though the issuance of social security numbers to children for purposes of claiming tax dependency exemptions brings the federal government very close to operating a central birth registry). And even as a libertarian, I recognize the need for society (through government) to know when a person arrives (either as a visitor, an immigrant, or as a new-born).

    No state (nor the federal government) requires the filing of an application for permission to bring about a birth. (If the government tried to do that, the ranks of the libertarians would swell to enormous proportions.) Though some may advocate requiring licenses to cause birth, that is flat-out inconsistent with the concept of personal liberty as enshrined in the Constitution. Governments are known to have encouraged births, discouraged births (e.g., the People's Republic of China), and to have been indifferent. Governments and others can advocate and fund programs to teach people (read: youngsters) about the consequences of causing birth, but licenses for doing so aren't issued.

    The same is true of death. Again, even though there are some who might favor such an idea (I don't), governments do not require licenses to die. That's pretty much for practical reasons, but most plans advanced by advocates of euthanasia include some sort of pre-death regulation. That is yet another factor that makes euthanasia a controversial topic (and one in which the government ought not be involved).

    So why, of the three chief genealogical events (birth, death, marriage), is marriage singled out (sorry, couldn't resist) for special treatment? Is it any more significant than causing birth? Hardly. Is it because traditionally, births were caused only as a follow-up to marriage? Many so think, but history demonstrates that most "traditional" practices end up being 19th and 20th century customs that were unlike their 16th century predecessors. For example, the current out-of-wedlock birth rate isn't very different from the out-of-wedlock birth rate in medieval England.

    The reason, I think, is the incompletion of the church-state separation that began during the Protestant Reformation, that sharpened during the Enlightenment, and that was incorporated into the First Amendment. True, full separation of church and state has not happened. The marriage situation is a good example.

    States record births. States do not record the christening, the baptism, the bris, the sealing, or the dedication (to name but a few of the religious ceremonies that accompany the arrival of a new child). Clergy do not record births on behalf of the parents who bring their child for a religious celebration of the birth.

    States record marriages. States provide for ceremonies for the "performing" of marriages. Technically, the state is providing for the "witnessing" of a marriage. Must one marry in a government building? In front of a government official? No. One can marry in front of clergy and the state accepts it. That means, at one level, the state is accepting or rejecting clergy in terms of the validity of the marriages they "perform" or witness. That alone is a First Amendment problem. Most European countries have this figured out. One marries in front of a government official, and if one chooses to have a religiously witnessed or blessed marriage, one does so. They are two independent ceremonies. As is the recording of a birth and the baptism of a child. And, interestingly, as is divorce (where the disparity between treatment by church and treatment by state is very sharp).

    In most civilizations, marriage has its roots in religious ceremony (as do just about every other ritual or practice in society). Unlike the cutting of hair, the attainment of legal age, the acceptance in the warrior group, or the recording of birth, civil union has not separated itself from religious marriage. Because no one advocates interfering with religious definition of marriage (other than the difficult-to-defend arrangement that ended polygamy in Utah), the question is one of how the CIVIL government ought to deal with relationships between people.

    And that's how I came to think that the naming of a "designee" is the solution. It doesn't try to match religious marriage with a civil imitation thereof. For those inclined to think along the following terms, it leaves to God the things that are God's and to Caesar the things that are Caesar's. It lets a person have multiple spouses for religious purposes (if the religion so professes) but limits the person to one designee for civil purposes.

    I know of no religion that would permit the two sisters (from that example a few paragraphs back) to marry. I know of a few religions (or denominations) that bless same-gender unions, and there may be a few that technically permit same-gender marriage. Most religions and denominations (there have been a few exceptions) permit marriage. Some accept divorce, others do not. Most have some sort of ceremony on the arrival of a new-born. Most (if not all) have some sort of ritual upon death. At present, all of these events (other than marriage) are independent of the civil transaction. It should be so with all.

    Will civilization as we know it end if same-gender couples are permitted to marry? I doubt it. The problem is that the state ought NOT be defining marriage because in doing so it intrudes into religious matters. The state ought to be defining the rights of named "designees". Does the state have an interest in encouraging marriage? It has an interest in encouraging stable relationships of all sorts. It has an interest in the welfare of children. It has an interest in domestic (family) tranquility. To date, the state has not demonstrated that it (or its bureaucrats or officials) are any more skilled at bringing these things about than are the clergy, members of communities of believers, agnostics, atheists, or secularists. It's time for the state to stop trying to do the same or a better job than the churches, temples, mosques, worship halls, and synagogues are doing and time to develop methods to improve the efficiency and effectiveness of civil transactions.

    Marriage is a specific type of relationship between people that even now the law considers as something that is witnessed rather than created. The state can no more create marriage than it can create love.

    Well, long as this is, it isn't and wasn't intended to be a treatise or a full-blown proposal. It's a thought. Maybe it will have some useful effect. After all, the path that the nation is on at the present is divisive, emotional, and politically charged. Perhaps it makes more sense to sort out the issues and think them through so that a new landscape can be designed before trying to resolve matters by working within existing frameworks.

    Your comments are welcome.

    Wednesday, February 11, 2004

    The Impact of Culture on Tax Law 

    I heard a commercial this morning on my drive to the gym. It shed some fascinating light on what I consider one of the core problems in the administration of the tax law.

    The commercial begins with an assertion that no longer is a car shopper limited to a choice of new and used. Now there's a THIRD category, neither new nor used. What is it? The Lexus certified PRE-OWNED vehicle. Huh? PRE-OWNED? Isn't that just a fancy way to say used without saying used? It's bad enough to use the word, but the commercial surely is claiming that pre-owned is neither new nor used. Sure, some of us can see through the lie, but what about youngsters and those lacking the requisite perception skills? Let's face it. Either the car is new or used. If it has been owned and used, you can call it pre-owned, but that doesn't mean it is neither new nor used. Stop with the spin.

    The tax law often makes distinctions between recourse and non-recourse loans. If a loan is recourse, the lender can take the assets of the borrower if the borrower defaults. If a loan is non-recourse, the lender can take only the assets that have been pledged to the repayment of the loan, that is, the loan is secured by the asset but there is no personal liability. A loan can be partially recourse and partially non-recourse, but the tax law treats each part as a separate loan.

    Why the difference? Because there is personal liability on recourse loans, and not on non-recourse loans, the impact of the loan on a partner's basis in a partnership interest differs. Without getting into the technical stuff, basis is "good" because it allows losses to pass to the partner for use (perhaps) on the partner's individual return. A recourse loan creates basis for the partners who are personally liable for the loan. Limited partners aren't, by definition, liable. So they don't get basis from a recourse loan. They get basis, however, from a nonrecourse loan.

    So the incentive for a tax shelter promoter is to have the financing of the project be nonrecourse. Then basis can be obtained by (and losses passe through to) the limited partner investors. OK, then make the loan nonrecourse. That is more easily said than done (try it next time you take out a mortgage on your house: ask the lender for a nonrecourse loan and let me know if they stare you down or break out in hysterical laughter). So the lender wants recourse (especially if the project is something other than real estate) but the promoter wants nonrecourse.

    How do they try to make people happy? Let's quote an attorney who once asked me, "So how can we make the loan recourse for the lender and yet get the IRS to believe that it is nonrecourse?" My answer is that you can't. That's what the IRS and the courts say. But that hasn't stopped people from trying to "hide" the personal guarantees or other recourse devices by keeping them outside of the main loan documents and outside of the partnership agreement. Some get caught, some don't. It takes dozens of pages of IRS regulations just to deal with this issue. (Section 752 of the Code and its regulations if you're really dying to get into this).

    So what's the connection to the Lexus ad? Well, the tax shelter folks want to pretend that a recourse loan isn't recourse, when presenting the facts to the IRS. Lexus wants its customers to think that a used vehicle isn't used. Look, it's recourse or it's nonrecourse, it's used or it's new, a woman is pregnant or not pregnant. It boggles my mind that so much energy goes into the art of pretense.

    It's nothing new. Take a look (here comes the theological connection) at the Gospel of Matthew, chapter 23, verses 25 and 27. It doesn't work to clean the outside of a dirty cup, leave the inside unwashed, and then claim that the cup is clean. Sure, it's human nature. Well, maybe not. Maybe society can get past this culture of pretense. It afflicts tax law, it afflicts advertising, and it afflicts a long list of activities and situations that generally are troublesome in one way or another.

    I can understand the motives of the tax shelter promoters. If you can't get a nonrecourse loan from the lender, the deal is pretty much dead. Well, maybe it ought to be, considering how most of those deals turn out to be good for the promoters and bad for the investors. But what's Lexus' problem? It wants to sell a used car that it has certified, and rehabilitated? Then say so. It's a certified and restored used vehicle. But don't claim that it's neither new nor used. That's just plain stupid. And wrong.

    I wonder if this pretense stuff was really the problem that led to the decline of the Roman Empire? That's for another day.

    Monday, February 09, 2004

    Helping Poor People 

    I'm in the late stages of writing a BNA Tax Mgmt Income Tax Portfolio on "Tax Incentives for Low-Income Areas." At first glance, it's easy to explain what it's about. It's an analysis of tax law provisions that encourage taxpayers to conduct business or to make investments in ways that pump money into areas that are poverty stricken.

    Sounds good. Noble. Effective. Worthwhile. Efficient.

    But is it? If it requires a full Portfolio (pretty much a book, unless one insists that a book cannot be spiral bound), then there's surely a lot going on.

    Indeed, there is. First, there is the question of what is a low-income area. Pretty simple, right? Let's say, an area where n% of the population has income less than $y. Well, that's not far from the approach taken, except that there are different types of low-income areas. There are empowerment zones, enterprise zones, renewal communities, a special District of Columbia zone, and so on. Why? The short and simple answer is political expediency. So the n% and the $y varies, depending on what sorts of advantages are to be provided. The number of zones that the government can designate has been increased twice since the concept first found its way into the tax code more than a decade ago.

    Second, what sort of business or investment should be encouraged? Most of the provisions, for example, don't permit benefits to activities such as golf courses, spas, and similar entertainment facilities. I guess (being sarcastic) that poor people don't have time for, or need, spas? There are more than a dozen types of investments and business activities that qualify for benefits. Things like "qualified equity investment," "renewal community business," "enterprise zone facility," "enterprise zone business," "qualified business entity," and my favorite, the "qualified zone academy." Each of these (and many other) terms are in turn defined by reference to other terms which themselves need to be defined. Each is somewhat like and yet a little different from the other, so the room for taxpayers to trip over the minutiae of technicalities is very high.

    Third, what sort of benefit should be provided? An exclusion from gross income? A deduction? A credit? These are, of course, all good things because they reduce income tax liability. But they're not equal. A $100 credit is much better than a $100 deduction, because the credit reduces tax liability by $100 but the deduction reduces tax liability by $100 multiplied by the taxpayer's marginal tax rate (assuming, of course, that the deduction survives a gauntlet of floors, ceilings, limitations, phaseouts and other contraptions invented, for the most part, by those unwilling to put the real tax rates front and center (that'll be the subject of another posting, later). So? Well, at last count there are 16 different benefits, most in the form of credits and deductions. Some types of qualified activities or investments trigger one of the benefits, and others trigger more than one. Some benefits are available to only one type of qualified activity or investment but others are available to more than one. Charting this out pictorially would require a 4-D arrangement. Ah, the Matrix. Yep, that's where tax specialists go when they die. JUST JOKING.....

    As I learned all of this and then wrote a book explaining it, I began to wonder. WHY? Why such a hodge-podge? Why all the definitions, rules, benefits, different areas?

    WHY NOT JUST GIVE EACH POOR PERSON $T each year? That would be a LOT EASIER to administer. It wouldn't take 25 tax provisions. In fact, IT WOULDN'T EVEN BE IN THE TAX CODE. Of course, in recent years all sorts of non-tax public welfare stuff has been put into the tax code. Probably because the IRS is better at administering this stuff than the agencies that ought to be dealing with it.

    Is it because Congress doesn't want people to know that it has enacted all these provisions that help the poor? And that amount to a type of dole?


    Because a lot of this money doesn't reach the poor. The poor don't pay federal income tax and generally don't file tax returns other than, in some cases, to get the refundable earned income credit (another complex mess from Dr. Frankenstein's lab).

    So that might be part of it. Of course, if $T were distributed to each poor person, that person would have spendable dollars that would flow back into businesses in the normal course of the everyday marketplace. THAT is a better form of government assistance to the economy than these contrived plans that provide employment to bureaucrats and deal managers and, yes, indeed, people who write books about it.

    But I think there is something more involved. When each poor person would be given $T, he or she could use that money as he or she wished, within the bounds of existing law. In contrast, if the money is funneled through enterprise zones and qualified businesses and qualified property, the use of the money is HIGHLY REGULATED AND CONTROLLED. The present system not only is complex, it is a device for bureaucratic CONTROL of what should be laissez-faire (French for "LEAVE IT ALONE!!" (sort of) :-) ) market economics.

    There have yet to be any studies demonstrating that these "incentives" (in contrast to general tax reductions for the middle class, or increases in the earned income credit for the working poor) have had any real effect. General economic news tends to suggest, no, not really.

    Incidentally, this is not a partisan problem. These provisions have been planted and nurtured (and repeatedly amended, expanded, and upsized) by both Democratic and Republican administrations and Congresses. Ah, something the major political parties have in common (despite what they say): CONTROL PEOPLE'S BEHAVIOR THROUGH THE TAX CODE.

    And that would take us to things like the TAX CREDIT FOR ADOPTING A CHILD. ("Hey, Mabel, we get $500 off our taxes this year if we adopt a kid." RIGHT!!!). As if one can raise a child for $500. "Yes, John, we adopted you because it saved our taxes." God forbid someone gets adopted because the parents want to love and nurture a child. I really believe that NO ONE has let this $500 tip the balance one way or the other when it comes to such a serious decision as adoption (but isn't someone planning to pay people to get married or something like that? It's getting scary.) But this post is long enough, so perhaps I'll come back to that topic on another day.

    Friday, February 06, 2004

    Teachers and Lawyers: Is There a Difference? 

    Listserves are great. I belong to at least a dozen. Don't worry, Dean, other than the several for family history they're all law related.

    One of the benefits from the listserves is the steady parade of exam question possibilities that I can pose to my students. When they claim the question is unrealistic or irrelevant, I salute my listserve associates by explaining to the students that a practitioner's practice-world client indeed had the problem presented to the students. (The academy - practice dichotomy I'll leave for another day).

    Last night someone posted a question to a tax listserve concerning the deductibility by a would-be lawyer of bar review and bar exam expenses. My students ought to be able to answer that question because we cover it in the course. Why do I include it? I've learned that when students are dealing with topics that relate to their lives or their planned lives they pay closer attention.

    Anyhow, in the listserve discussion I pointed out that the expenses aren't deductible because they prepare the would-be lawyer for a new trade or business, that of being a lawyer. Not only has the IRS said that in regulations, there are cases in which the courts have so held.

    Then I pointed out that according to the IRS someone who already is a lawyer and who pays expenses to study for, and take, the bar exam in another state is not permitted to deduct those expenses because (according to the IRS) the practice of law in one state is a DIFFERENT trade or business than practicing law in another state. Standing alone, that seems to make sense. The law in one state differs from the law in another (even though in recent years the disparity is beginning to diminish). If someone licensed to practice law in Pennsylvania tried to practice in New York, at least in theory, he or she would be unable to do so because he or she lacks knowledge and understanding of New York law.

    But wouldn't the same hold for teachers? Suppose someone who is licensed to teach in Ohio moves to North Carolina. This may not be true today, but at the time in question, North Carolina requires the teacher to take courses in subjects such as North Carolina government, the history of North Carolina, North Carolina geography, and the like. Are the expenses incurred by the teacher deductible? The answer turns on whether being a teacher in Ohio is the same thing as being a teacher in North Carolina. Teachers in Ohio probably don't know much about North Carolina government, history, or geography. Just like Pennsylvania lawyers don't know much about New York legal procedure or parking regulations. Yes, Ohio teachers know the same algebra that North Carolina teachers know. But Pennsylvania lawyers know the same federal environmental law, Constitutional law, and criminal law that New York lawyers know.

    What did the IRS conclude? That being a teacher in one state is the same trade or business as being a teacher in another state, even if the subject matter differs.

    I make certain my students learn about this. It's such fun letting them discover how far from ideal the tax law really is.

    Does the IRS have something against lawyers? I doubt it, considering many of its employees are lawyers. Does the IRS especially like teachers? At the time of the IRS ruling on the matter, teachers were in short supply. Maybe that had something to do with it.

    There are many teachers in my extended family, including my sister and my niece-in-law. Let's see if they decide to share a "teachers are special and more important than lawyers" with us. Then I'll let my OTHER sister (who is a lawyer) respond. And I, the compromised lawyer-teacher, will sit back and watch!

    Wednesday, February 04, 2004

    Why So Complicated? 

    I finally succeeded in getting Turbotax loaded and running. It took a while because of some problem with kernel32.dll, and ended with a work around. The downside is that having loaded the program, it's now, yes, TAX TIME!! Yippee.... (sarcastically).

    There's a huge pile of paper to dig through, to find the stuff relevant for the return. It's getting difficult to remember the years I did the returns by hand. I've been using Turbotax for 11 years. It's a fine program, but it cannot dig through the paperwork and digital files for me. And it can't do the "pre-entry human decision" stuff.

    I can't imagine what it's like for folks who don't have tax education, and who have to sift through all their papers. Sure, take the big box to the tax return preparer, but having been on THAT side of the desk, I can guarantee that sometimes ONLY THE TAXPAYER KNOWS. I can't complain... God gave me a brain that understands (most of) income taxation. But it still is absurd that so much energy, talent, brain power, and money goes into tax compliance (that's the return filing part), and, worse, "creative" tax planning that recently has come to border on, and too often, is in fact, fraud.

    Imagine if "they" simplified the tax system and all these resources could be turned to something more productive (say, curing cancer, improving the education system, fixing the health care system....)

    Well, each day I do a little bit of data entry. When I need a break from writing the technical stuff ABOUT taxes. It's early still. The fun will be in April when friends start calling, their panic evident as they realize April 15 is around the corner and they haven't even thought about the tax thing.

    That's one reason I get started on mine early.

    Eventually I share my ideas of how the tax system can be repaired. Stay tuned.

    Tuesday, February 03, 2004

    What? A Bigger Tax Code 

    So the Administration wants to pile bunches more provisions onto the existing pile of law known as the Internal Revenue Code. Why not replace existing provisions? Why not combine things? Why add bunches more credits, exclusions, special rates, and exceptions?

    You'll soon discover I'm not a fan of the existing tax code, nor am I enthused about the proposals to make it even more complex. It is true that I understand a fair amount of the tax law, and once upon a time I read the code cover to cover. That was when it could be published in one volume. Now it's two, each volume thicker than the one I read, and each one wider and taller. And the print size? Smaller, of course.

    Maybe the grand plan is to make the tax code so huge that five million new jobs for tax lawyers, tax accountants, tax return preparers, tax appraisers, and tax actuaries will be created. Now THAT surely will get the economy going. It's much like hiring a bunch of folks to move bricks back and forth without building anything.

    Closing on a note of appreciating the good life. Imagine if the toll booths on bridges required toll computation the way Congress wants us to compute federal income tax liability. People would die of old age waiting in line.

    Stay tuned.

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