ataxingmatter

Murphy and Emotional Distress Damages--Rehearing

In an earlier posting, I commented on the government's petition for rehearing in the D.C. Circuit's decision in Murphy that held section 104(a)(2)'s treatment of damages for nonphysical personal injuries as unconstitutional.  I hoped then that the court would hear the case en banc and "put the Murphy opinion out of its misery."

Well, the court didn't have to take the case en banc, because (as Paul Caron announced on Tax Prof) the D.C. Circuit panel that heard the appeal has vacated its opinion and agreed to rehear the case.  See these posts on Tax Prof: Order Vacating Judgment and Agreeing to Rehearing ,  Rehearing announced and Bashman WSJ Law Blog discussion excerpted.  The Tax Prof posts provide numerous additional sources and links to other materials.   

Without doubt, this is one of the "Ten Most" tax cases to be noted for 2006, however it comes out in the April 2007 rehearing.   For just a few of the discussions available, see Joseph Dodge's comprehensive article on "The Constitutionality of Federal Taxes and Federal Tax Provisions, available on SSRN here; Sheryl Stratton's article on expert reaction to the August decision, here; and even a wikipedia entry, here.  Murphy's response to the government's petition for rehearing is here, and you can access most of the other legal filings connected with the case at the defense attorneys' site, here.

Was the tax blogosphere at all influential in the court's decision to vacate and rehear the case?  It may be that the ability of bloggers (and op-ed writers) to sketch out objections quickly can have influence when there are opinions like Murphy that so clearly appear to misunderstand the issues and the stakes involved.  If so, that is an appropriate impact of expert commentary.

Yet when one reads some of the comments in the blogosphere, such as these comments to the Volokh Conspiracy posting announcing the petition for rehearing or these on NewsWithViews by Phil Hart,  it seems clear that the mix of tort and federal statutory preemption arguments, along with a good bit of bias towards tax practitioners, could create more confusion than clarity about the tax and constitutional arguments.  Particularly lacking from those comments is an understanding of the way basis works in the tax system or the nuances of the constitutional arguments explained by Joe Dodge (see above).  Here's one example, from Hart, who essentially equates human capital with tax basis.

The entire case turned on whether or not Murphy's award represented a return of diminished capital, or an economic gain? The entire Murphy Case was about setting the boundary line between direct taxes and indirect taxes. Direct taxes are taxes on capital, indirect taxes are taxes on gains. This lack of experience of Murphy’s lawyers and the three-judge panel allowed them to do their legal research and analysis with an open mind. And these open minds, aided by their legal training, caused them to arrive at the correct interpretation of the intent of the Sixteenth Amendment as it relates to this narrow issue.  NewsWithViews by Phil Hart.

Perhaps even more worrisome is the view (as evidenced in the quoted comment from Hart's blog) that judges and lawyers do better at this kind of analysis when they don't understand tax law.  I have argued throughout my career about the fundamental importance of interpreting the tax law from a position that seeks to find structural coherence.  The approach supported by the Murphy case is one of looking at one item almost in isolation and certainly without understanding how that provision fits into the other obviously related ones (section 61, for example) or how the concept of basis carries throughout the code to track after-tax investments in property.

What will be the outcome of the rehearing?  One suspects the judges took the case  because they've already had a chance to reconsider the wisdom of finding unconstitutional a provision that treats monetary damages as income.  Although they could reconfirm their original views, it is likely that they expect to reach a different decision.  The parties have another chance to file complete briefs.  Maybe they, too, will take advantage of the abundance of commentary in print and elsewhere to refine the arguments made in the orginal trial.

More on Big Oil

Yesterday, I reported on Citizen for Tax Justice's summary of the various ways that Big Oil has been given excessive tax breaks that could be cut back to help the budget situation. See this post.   It's worth noting the report in the New York Times today by Edmund L. Andrews, Incentives on Oil Barely Help U.S., Study Suggests (Dec. 22, 2006).  In addition to all those tax subsidies we've been throwing at the wealthy oil companies (immediate deductions for a "percentage depletion", super-accelerated depreciation, treating them as manufacturers entitled to the new lower rate based on the section 199 manufacturing deduction, etc.), we've also been offering them "some of the most lucrative incentives in the world" for drilling in our public waters.  Id.   The US has "sweetened incentives" in recent years, while other countries have been demanding a larger share of oil company revenue.  The US gets about 40% of the revenue from oil and gas produced on federal lands (that's counting royalties and corporate taxes, which are supposed to be paid at a statutory rate of 35% by the big oil companies).   But "the worldwide average 'government take' is about 60 to 65 percent."  Id.  Britain gets 50% from the North Sea companies; Norway gets "from 70 to 78% (based on oil prices).

An Interior Department study (held back for more than a year--were they afraid it would cause even more damage in the mid-term elections?) estimates that these incentives let companies drill in the Gulf and "escape tens of billions of dollars in royalties that they would otherwise pay the government for oil and gas produced in areas that belong to American taxpayers."  Id.  The Times story notes that in 2004 the Bush "administration offered lucrative new royalty incentives for companies that drill extremely deep natural gas wells in shallow water", in addition to the new tax breaks Congress added. 

Now, I can think of a lot of things this government should be doing instead of passing new tax and other breaks for Big Oil (or for any other comfortably wealthy Americans, for that matter).  If we're going to talk taxes, how about my 2004 proposal to treat capital gains preferential rate as an AMT preference?  That'd raise a good bit of money from those who can afford to pay it,and make up somewhat for the skewing of the tax system in favor of the wealthy over the last 6 years.)   

Mr. Bush says he's willing to keep thinking about taxes--but it's the wrong kind of thinking.  He's talking about trading support for a minimum wage hike for "small business tax relief."  They've already (regrettably, I might add) extended the Section 179 expensing provision to 2009, a favorite of the business lobby to get a huge paper loss deduction up front.   Santorum wanted to let more businesses use cash method accounting.  Another provision that might be on the table is to change the deduction for meals and entertainment: they don't want to eliminate it (that would be a change I could support) but to increase it.    They also want to let small business owners sponsor fringe benefit plans for themselves.  The Democrats need to really learn how to say "no".   Pass the wage hike, and pass by the business tax cuts.

I can think of many ways to spend those funds that are better than providing a tax break to Big Oil or to business generally.  How about cutting the deficit?  Or helping the poor in New Orleans hit by Katrina?  Or providing a larger earned income tax credit for struggling families?   How about more funding for all those government functions tht are being overlooked and neglected right now--from environmental issues to the Forest Service, from the National Parks to the Centers for Disease Control.

Paul Krugman doesn't like the first suggestion.  He says that the Democrats should not spend much time right now trying to bring the deficit down.  See Democrats and the Deficit, New York Times (Dec 22, 2006).  His reason--any resulting move towards a surplus, in this wacky political milieu, just enables right-wing class warfare like George W Bush's "push for greater after-tax inequality"  with tax cuts favoring the rich.  Id.   Better, he says, to just try not to make the deficit worse. 

(Right.  Again, let's hope the Dems learn to "just say no" to these multiple "extender" packages that just keep coming, like the energizer bunny, digging the deficit (and debt) hole deeper and deeper mostly for the benefit of those already well off.) 

Instead, says Krugman, if the Dems succeed in freeing up some money by fixing the Medicare drug program, ending the Iraq war or even rolling back the worst of the Bush tax cuts, they should spend the money well.  That way, they can remind Americans of the importance of good government as a benefit to all our lives. 

I'm for that. Remember that the wealthiest people in the US could, on their own (with almost no  real sacrifice, unless you consider retaining $2 or $3 million a year too little to live on) end the worst of world poverty in a decade.   Let's roll back the Bush tax cuts so we tax the most bloated incomes enough to have them pay their fair share for the many benefits of living in a stable market economy.  Let's do fix Medicare, and do pull our troops out of Iraq now--not two years, another 2000 American deaths, tens of thousands of Iraqi deaths and another 2 or 3 hundred billion dollars later.  Let's use that new tax money and freed up resources to fund universal health insurance and give enough of a demi-grant (through the earned income tax credit and through new programs) to those at the very bottom that they have a chance to participate in the opportunities that abound in this country.   Let's use this holiday season, when we are supposed to reflect on the more meaningful aspects of our lives, to start thinking about the lives of others, instead of the crass "greed is good" philosophy that seems to have caught on in the upper income brackets where a good number of CEOs have showered themselves with lucrative backdated options.

Big Oil, Big Subsidies: Citizens For Tax Justice Says End Them Now

CTJ has just released a report on Big Oil, The 110th Congress Should End Tax Subsidies for Big Oil (Dec 21, 2006).  It notes that the American public and the incoming Congress seem to have finally wakened to the fact that Big Oil is making runaway profits and is in no need of a supportive subsidy from the tax system.  There's even talk of instituting a windfall profits tax or carbon tax, for both revenue and environmental reasons.  But CTJ thinks Congress should first focus on just getting rid of the many loopholes that let Big Oil pay much less than its fair share of taxes to the federal government, many of them added or increased in the ridiculous Energy Act of 2005.   Put simply:

If the public debate revolves around whether or not Big Oil needs to be subsidized through the tax code at a time when oil prices are at an all-time high, it will be much more difficult for the energy companies to win the debate. As a practical policy matter, it makes sense for Congress to get energy companies to simply pay the taxes they would owe without special loopholes, before considering adding a new tax on their excess profits.

For the Joint Committee on Taxation's spreadsheet on the revenue costs of the various loopholes for Big Oil in the 2005 Act, see this link.  For various other JCT documents on the energy bill, see here.

Here's the list of the biggest tax expenditures benefitting Big Oil.

1. an immediate deduction for "intangible" drilling costs (wages, materials for wells, etc.) that are normally expensed over the life of property in other industries

2. an immediate deduction for "percentage depletion" for oil and gas properties that amounts to a flat percentage of gross revenues off the top, whereas other industries have to expense such costs over the properties useful life (and the Big Oil Giveaway (energy) Bill of 2005 actually increased the benefit to Big Oil of this provision!)

3. an almost immediate two-year amortization of costs for searching for oil--even when it is discovered

4. an immediate deduction of 50% of the costs of certain equipment for refining--created as an "incentive" to Big Oil in the Big Oil Giveaway (energy) Bill  of 2005 when costs per barrel were already over $50!

5. an immediate deduction for "domestic manufacturing" --a loophole extended to Big Oil by a 2004 "legislative slight-of-hand", when Congress was required to repeal a provision that aided manufacturers in violation of international trade law and enacted an even bigger giveaway that was extended to industries like Big Oil that weren't even eligible for the repealed provision

6.  even faster accelerated depreciation for natural gas distribution lines--also added by the Big Oil Giveaway (energy)  Bill of 2005, when the existing accelerated depreciation system already provided front-loaded depreciation much faster than economic depreciation

7. credits (dollar for dollar reduction of taxes) for foreign taxes that Big Oil probably doesn't actually pay

As the CTJ article notes, "the next Congress has many options to close unnecessary and wasteful energy-related tax loopholes. "  Let's hope that it starts out with at least this list of wasteful items so Big Oil can pay its fair share of taxes. 

And for my Christmas wish:  Perhaps Congress can finally figure out a way to get those tax funds to places that they are really needed, like the victims of Hurricane Katrina in New Orleans.

IRS Enforcement--Boast or Reality? TRAC report on large corporations

Commissioner Everson has been boasting of an enhanced enforcement effort at the IRS (see my discussion, and doubts, at this November 21 posting), but the TRAC team at Syracuse has now posted information that suggests that audits of the 250 largest corporations, in terms of time committed, remain at just about the bottom of the trough reached in 2002, after some slight gains in 2004 and 2005.  Yet those 250 largest corporations control the lion's share of resources and owe the lion's share of taxes. 

The TRAC report, Easier Times for Biggest Corporations, is at this link.  It is based on previously undisclosed data released to TRAC by the IRS as a result of the judge's order last April in TRAC's freedom of information suit in Seattle. TRAC focused on only the largest public corporations, to see whether the IRS is paying sufficient attention to audits in this area.

Although the number of the largest corporations is small, these giants are a very significant force in the American economy. In a recent year, for example, while filing only 0.2% of all corporate returns, these powerful organizations controlled 90% of all corporate assets and received 87% of all the corporate income.  Id.

The report shows that  "audit attention given those with $250 million or more in assets has substantially declined in the last five years."  That is true whether you look at coverage time (the amount of time devoted to a audit) or coverage rates (the number of corporations subject to audit) have declined substantially.  Coverage time has dropped from an average 1210 hours in 2002to an average 958 hours in 2006 (estimated based on six-months reported numbers)!  Coverage rates today are about where they were in 2002--34.4% of the largest corporations subject to audit--which is considerably lower than the 50% coverage rate of 10 years ago.                           

The graph (side), from the TRAC website, shows the steep decline, with 2004 and 2005's slightly higher audit rates a mere blip on the horizon.

In addition, TRAC reports that coordinated industry case (CIC) audits--the source of 90% of the IRS's audit findings of underreportings for the largest corporations--have similarly declined, from 58% in 2002 to 51% in 2006.  Even those CIC audits that are conducted are conducted less intensely--down from an average of 1741 hours to an average of 1558 hours. 

The TRAC report asks why results of enforcement show more tax collected, even with this weak enforcement effort.  It could be that the enforcement is actually more efficient than it appears.  Or, it may just mean that it has become relatively easier to find some of the misreported tax dollars, since so many more big corporate taxpayers are cheating.

Tax Executive Institute's Letter on FASB's FIN 48

BNA's banking report notes today the Tax Executives Institute's letter to FASB to urge a one-year delay (from Dec. 15, 2006 to Dec. 15, 2007) in implementation of the new FIN 48 accounting standard for reporting uncertain tax positions.  Subscribers to BNA should be able to access the story at this link.  The TEI letter itself is available on the TEI website at this link.

The TEI letter describes the impetus for FIN 48 as follows.

What is now FIN 48 can be traced to a December 2003 speech at the AICPA Conference on SEC Developments, where an SEC staff member expressed concern about the application of FAS 109 to “tax advantaged transactions,” and questioned whether tax assets should be recognized when the benefit may not be realized. In a March 2004 roundtable discussion involving representatives of the Big Four accounting firms, SEC, and FASB staff, the participants discerned significant “diversity in practice” in the recognition of tax benefits associated with aggressive transactions. On this basis, the FASB concluded during its July 27, 2004, meeting that an interpretation of FAS 109 should be developed to address the treatment of uncertain tax positions.1 An exposure draft of the proposed interpretation was released for comment on July 14, 2005, and a roundtable discussion was held on October 10, 2005. Subsequently, the exposure draft was modified incrementally via re-deliberations at Board meetings from December 2005 through May 2006. FIN 48 was released July 13, 2006, and is effective for fiscal years beginning after December 15, 2006.

The new standard applies a more-likely-than-not test to determine whether tax benefits are recognized in a financial statement.  The following excerpt from the FASB summary at the beginning of the FIN 48 document explains how the new standard works to recognize and derecognize tax positions.

This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accountingfor Income Taxes. This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.

The evaluation of a tax position in accordance with this Interpretation is a two-step

process. The first step is recognition: The enterprise determines whether it is more likely

than not that a tax position will be sustained upon examination, including resolution of any

related appeals or litigation processes, based on the technical merits of the position. In

evaluating whether a tax position has met the more-likely-than-not recognition threshold,

the enterprise should presume that the position will be examined by the appropriate taxing

authority that has full knowledge of all relevant information. The second step is

measurement: A tax position that meets the more-likely-than-not recognition threshold is

measured to determine the amount of benefit to recognize in the financial statements. The

tax position is measured at the largest amount of benefit that is greater than 50 percent likely

of being realized upon ultimate settlement.

Differences between tax positions taken in a tax return and amounts recognized in the

financial statements will generally result in one of the following:

a. An increase in a liability for income taxes payable or a reduction of an income tax

refund receivable

b. A reduction in a deferred tax asset or an increase in a deferred tax liability

c. Both (a) and (b).

An enterprise that presents a classified statement of financial position should classify a

liability for unrecognized tax benefits as current to the extent that the enterprise anticipates

making a payment within one year or the operating cycle, if longer. An income tax liability

should not be classified as a deferred tax liability unless it results from a taxable temporary

difference (that is, a difference between the tax basis of an asset or a liability as calculated

using this Interpretation and its reported amount in the statement of financial position). This

Interpretation does not change the classification requirements for deferred taxes.

Tax positions that previously failed to meet the more-likely-than-not recognition

threshold should be recognized in the first subsequent financial reporting period in which

that threshold is met.  Previously recognized tax positions that no longer meet the

more-likely-than-not recognition threshold should be derecognized in the first subsequent

financial reporting period in which that threshold is no longer met.

Obviously, this new standard has a potential to highlight to the IRS a company's aggressive tax positions that do not meet the more-likely-than-not standard.  Derecognition because of failure to meet the threshold would suggest that either a more conservative analysis or some new court or regulatory authority has shed light on the aggressive nature of the transaction and revealed that it is not more likely than not to succeed.  The first statement that is filed under the new standard may well also reveal a good deal about the aggressiveness of company's tax positions.  This is a good development, in line with recommendations I have long made for shedding more light on corporate tax behavior (Putting SEC Heat on Tax Risk and Corporate Tax Shelters). 

What are the arguments for delaying implementation?  The TEI letter focuses on the hassle of getting the information in line for large companies with multijurisdictional operations who, in switching from the contingency approach to the more-likely-than-not (MLTN) approach, "must analyze their entire inventory of tax positions."  It argues that companies need sufficient time to analyze the new rules and obtain relevant advice about correct reporting, and that FASB has overlooked the work that is "tantamount to, and as challenging as, re-filing an income tax return in every jurisdiction for every open tax year." 

While I don't doubt that companies will have to work to satisfy the implementation deadlines, I think the TEI is overstating the burden.   First, most companies' tax departments are well aware of positions that do not have a more than 50% likelihood of being sustained on the merits.  Those are the cases where internal memoranda are written or external "penalty-protection" tax advice is sought and where considerable discussion takes place about the advisability of the transaction.   Second, the more likely than not standard already applies to corporate tax shelters under the Internal Revenue Code and relates to disclosure requirements, so companies should already have evaluated their tax positions in light of those rules.  Finally, even more telling in light of TEI's claim that companies need time to seek advice, the IRS offered a program of FIN 48 expedited review to assist companies in making their FIN 48 filings.  See this legal firm's tax advisory about the pros and cons of using the IRS program.  The program has had apparently had few takers.  see this.

The Rich: the UN on World Distribution of Wealth, the IRS on Statistics of Income facts about The Wealthy, and Peter Singer about the Moral Obligations of the Wealthy

Three items have caught my attention over the last few days, all having to do with the increasing concentration of wealth.  They are worth considering as a new Congress prepares to take over and hopefully bring a rededication to our fundamental beliefs in the dignity of each human being.

1.  Let's start with James B. Davies , Susanna Sandstom, Anthony Shorrocks, and Edward N. Wolff, The World Distribution of Household Wealth, (Dec. 5, 2006). 

Various studies have shown an increasingly unequal global distribution of income.   The authors note the importance of capital to household wellbeing (and, more broadly, economic development and growth), and ask whether the distribution of capital--physical and financial assets less liabilities--is similarly unevenly distributed. They find that there are a number of reliable statistics on wealth available today, and that those statistics cover more than 80 percent of the world's household wealth, so that it is possible to impute most needed data for countries for which wealth statistics are missing.

Some specifics about the data may be of interest.  The authors note that the lack of data on land or investment real estate in some countries does not permit imputation, but suggest that the gaps for those items will not have "exaggerated" impact on the results. In contrast, they have been able to impute numbers for consumer durables. They have used wealth surveys from various countries, but note that sampling erros exist and non-sampling errors--such as the fact that wealthy households are less likely than others to respond to a survey and that there will tend to be underreporting of wealth.  As a result their estimation procedures are likely to underestimate wealth holdings at the top of the distribution (in the top 10% and top 1%) and hence wealth inequality.  Cf Id. at 30-31

Their conclusions are disheartening.  They find significant difference between countries--from the US (the wealthiest) with about $144,000 per person in 2000 to India (one of the poorest for which there is wealth data) with about $6,500 per capita.  This difference is true for wealth (based on household balance sheet information) per capita (US first at about $144,000 and South Africa last at about $16,000) and for other items, but the range in per capita wealth is much larger than for the other items such as GDP per capita (the US ranks first at almost $36,000 and South Africa last, at about $8,000), personal disposable income per capita (US first with about $25,500 and South Africa last with about $4,500), and real consumption per capita (US first with about 4.7 times South Africa).  The differences in wealth are even more pronounced based on survey data that include China, India and Indonesia, where the US is still first but India is now last at about $6,500 per capita.   Consider this set of statistics:

countries                          world wealth                world population

24 highincome OECD            63.7%                       14.8

43 highincome nonOECD        3.23%                      0.93%

39 uppermiddleincome          9.2%                        11.4%

64 lower income                   8.3%                        39.9%

Wealth is also highly concentrated within countries--"wealth is unambiguously more unequally distributed than income."  Id. at 23.  Gini coefficients in wealth data range from about 0.65 to 0.75 with highes above 0.8, while the mid range for income is only 0.35 to 0.45. Id. at 3-4. 

In looking at global wealth distribution, the authors determine that wealth per adult is the more meaningful statistic.  Children generally have little formal or actual wealth, and membership in households can be fluid.  Individuals may take their separately owned assets with them when they leave the family.  With those caveats, the reports finds for 2000 that "only $2161 was needed in order to belong to the top half of the world in wealth distribution, but to be a member of the top 10 percent required at least $61,000 and membership of the top 1 percent required more than $500,000 per adult."  The "top 10 percent of adults own 85 percent of global household wealth," and the bottom 50 percent owns "barely 1 percent of global wealth." Id at 26.

Dividing wealth groups into thirds, India comprises just less than a third of the bottom third in wealth distribution.  China is more than a third of the middle third.  And North America, Europe and high-income Asia dominate the top third (with about a third each).  Latin America's population is fairly evenly spread, but Africa's is concentrated in the bottom.  The US has 25% of the world 10% wealthiest adults and 37% of the world's top 1% in wealth.

For some wonderful graphs of selected data from the report and Gary Beck/Richard Posner debate links, see this link on TaxProf.

2.  Let's add the distribution of tax-exempt interest income to the very rich, and a good dose of realistic understanding of just how rich the super-rich really are compared to the rest of us.

How do the rich keep getting richer?  Try this:  they buy municipal bonds the interest of which is not subject to tax, under one of the many tax expediture provisions of special benefit for the rich in the Code.  See this article: Joe Mysak, Say This About the Rich--They Love Tax-Free Bonds (Dec. 15, 2006) Bloomberg (also mentioned on TaxProf) (discussing the fall edition of the IRS Statistics of Income Bulletin).  Mysak notes that the statistics prove that "the higher up you go in terms of adjusted gross income, the more people there are who appreciate tax -exempt income and preservation of capital"--of the 9600 American taxpayers with adjusted gross incomes of $10 million or more, about 80% of them reported tax-exempt interest. If you expand the income category to include those with only $5 million or more, 72% report tax-exempt interest totaling about $2 billion.

"What a tiny market this is.  You could hold a meeting of all those taxpayers with adjusted gross incomes of $1.5 million and up who also own tax-exempt bonds, and you still wouldn't be able to fill the new $1 billion, 100,000 seat football stadium the Dallas Cowboys siad they were building for themselves in Arlington, Texas this week (with the h elp of several hundred million in tax-exempt bonds, by the way)."

As Mysak reminds us, it is important to keep perspective.  "91 million taxpayers reported adjusted gross incomes of less than $50,000 in 2004" out of the 132.2 million returns filed. 

3.  Finally, let's consider Peter Singer's views about the worth of a human life and the ethical obligations of those same super-rich, as described in peter singer, What Should a Billionairer Give--and What Should You? New York Times Magazine (Dec. 17, 2006).

Singer's article is a long and rich assessment of the ethical and moral responsibilities of the wealthy--particularly, America's weathy--towards the world's poor. He notes that we often profess a belief in the inherent dignity and worth of all humans, no matter their gender, race, nationality or place of residence.  Yet our actions don't square with those beliefs. 

The rich, especially, have an obligation to give.  He bases the obligation in part on the "social capital that is responsible for most of their wealth (quoting Herbert Simon, who estimated that a 90% flat tax on the wealthy would be a fair return to the government of the portion of their wealth due to efforts other than their own).  In part he relies on the moral obligation we all recognize to help those we can without too much sacrifice--if a small child is drowining in a shallow pond, it would be wrong not to save the child even if we may ruin a new pair of shoes doing so.  In fact, he asserts, our obligation is stronger than the analogy, because we are not mere innocent passers-by on the world stage of distribution of wealth.  Thomas Pogge has noted that part of our affluence comes at the expense of the world's poor. International corporations purchase natural resources around the world, from whatever government will sell without regard to the ability of corrupt dictators to seize a nation's resources for their own benefit, yet the world legal order doesn't treat the corporations as criminals in possession of stolen goods.  The "theft" benefits affluent industrial nations while wreaking havoc on resource-rich, poor countries and their peoples.

Singer makes short shrift of the extremist free-market argument that the actions of the wealthy nations, in their own interests, really benefit the poor by providing employment and trickling down better standards of living.  He notes that "the rich in industrialized nations buy virtually nothing that is made by the very poor".  Expanding trade has helped some but has failed to benefit the poorest 10 percent.  Since the US government spends most of its aid money on what it considers to be to its strategic advantage (Iraq currently is at the front, then Egypt, Jordan, Pakistan, Afghanistan and not Subsaharan Africa or the poorest populations in India), the philanthropy of the wealthy is needed to balance.  Even so, he notes, Scandinavian countries give 3 or 4 times as much in proportion to the size of their economies to the  poorest countries as the US does in private and public monies. 

Concluding that the rich should give, Singer then asks, how much.  His answer may have made even Bill Gates and Warren Buffet uncomfortable.  He notes that Gates, after his $30 billion gift to create his foundation, is still is the richest American with $53 billion, still hase a 66,000 square foot home worth $100 million (property taxes of $1 million annually), still possess rare books (a da Vinci worth more than $30 million) and really hasn't done nearly enough to give away his own personal fortune.  Here's the line:  "If he really believes that all lives have equal value, what is he doing living in such an expensive house and owning a Leonardo Codex?  Are there no more lives that could be saved by living more modestly and adding the money thus saved to the amount he has already given?"  He suggests that Gates--and the rest of us--should take our rhetoric about the inherent equality of human life as "a guide to life."

To do that, Singer suggests that the richest Americans' incomes should be used to fund the UN's Millenium Goals--reducing the extreme poverty rate by half, the ones who suffer hunger by half, the mortality rate among children under 5 by 2/3, halting the spread of HIV and malaria, reducing by 3/4 maternal mortality, reducing by half those without safe drinking water. Jeffrey Sachs computed the annual cost of doing this at just $121 billion in 2006 (about one third of the funds alreaady appropriated for the US to wage war on Iraq)  and $189 billion in 2015, and could be funded with just $48 billion more than committed by official development aid in 2006 and $74 billion in 2015.   If the top 0.01% of US taxpaying units (14,400 in 2004 earning an average of 12.775 million a year) gave away a third of their annual income, they could provide $61 billion to fund world poverty relief and still have at least $3.3 million in annual income.  The top 0.1% (129,600 with average incomes of $2 million and minimum incomes of $1 million) could give a quarter of their income, raising $65 million and leaving each unit $846,000 annually.    Singer suggests that for each significant percentile down the income distribution, a slightly lower percent of annual income should be donated, and in that way the top 10 percent of American families could easily raise $404 billion to more than meet the Millenium Goals.  That's just doing "our fair share" to alleviate world poverty.

The fair share may not be enough--if there are children to be saved, other rescuers not willing to step in, and we are capable of doing even more. "[I]t should be seen as a serious moral failure when those with ample income do not do their fair share toward relieving global poverty." It would be easy !for the world's wealthy to end global poverty.  "Measured against our capacity, the Millennium Development Goals are indecently, shockingly modest.  If we fail to achieve them--as on present indications we well might--we have no excuses."

So with those thoughts in mind, isn't it equally immoral to continue to find ways to give tax breaks to those very international corporations --especially Big Oil and the other extractive industries--who have become extraordinarily wealthy by acquiring natural resources around the world and making them available to ease the lives of the world's wealthiest people?  Or to continue to lessen the tax burden on the top percentiles of the income distribution at the cost of less funds for the many government functions that deal with domestic and world poverty and the social and economic negatives that result therefrom?  These statistics from the UN, and these thoughts about our obligations as people who have founded our society on an oft-expressed belief in the equal worth of all human life, are directly pertinent to the decisions we make about the federal income and payroll tax provisions.

A Miscellany: Backdating Stock Option Exercises; Relaxing Sarbanes-Oxley; Leashing Corporate Prosecutors

  Tuesday's Wall Street Journal carried extensive stories about the tax consequences of baddated options.  Theo Francis noted that many companies, and their executives, being investigated for backdating stock options could face stiff tax bills and potential penalties, including unpaid payroll taxes and the new surcharge enacted in 2004 for improperly priced options.  See  Another Consequence of Backdated Options, Dec. 12,  2006 Wall St. J.  at B1. CEOs, however, are taking advantage of various "fixes" for her improperly priced option recipients' unwanted taxes.  McGuire, the former UnitedHealth CEO, has apparently removed a tax risk of about $13.7 million for options vesting in 2006 by having the company replace improperly priced options with new, properly priced ones.  Others are setting a fixed schedule for exercise of unexercised options to escape the deferred compensation penalties.  But there isn't a fix for already exercised, improperly priced options, which may land a number of executives in tax penalty and interest territory.  Company problems include liability for their executives' unpaid taxes, penalties for failure to withhold, failure to collect payroll taxes on the value of the options when they were exercised, and associated penalties.

In another story, How Backdating Helped Executives Cut Their Taxes, Wall St. J., Dec. 12, 2006, at A13, Mark Maremont and Charles Forelle explore the tax advantages of executives' backdating option exercise dates.  By claiming to exercise options at an earlier date when stock prices were lower (i.e., "rigging" the dates), an executive could reduce the amount of the profits taxed as ordinary income (at a higher rate) and increase the amount taxed at the lower capital gains rate.  And a statistically unlikely number of option exercise dates appear to fall on particularly advantageous pricing levels.

Although there is continuing news about corporate and executive misbehavior on backdating of option grants and option exercise, the push to relax the increased regulatory oversight provided by Sarbanes-Oxley seems to be gaining force. See, e.g., this Technet discussion of the need to reform Sarbanes-Oxley's regulatory reach; this release by Sen. DeMint (Nov 30, 2006) regarding legislation to require the SEC to relax some of Sarbanes-Oxley's requirements for small businesses and to clarify terms.  One of the reasons proffered for the push by the Commitee on Global Markets Regulation, led by former White House adviser Glenn Hubbard, is the rapid decline in the number of IPOs on US exchanges over the last five years, see this article on CNN,  but that decline may be more realistically related (as the same CNN article notes) to the decline of the importance of the US markets as China, India and other markets outside the US expand at a much more rapid pace, the US deficit grows while military costs escalate, and the US dollar declines against other currencies. 

In addition, the Justice Department has now yielded to the clamor from attorneys, corporations and several politicians to change its consideration of requests for waiver of attorney-client privilege and non-provision of legal services for indicted corporate employees in the context of potential prosecutions of corporations.  See Lynnley Brownley, U.S. Moves to Restrain Prosecutors, New York Times, Dec. 13, 2006.  The new policy does not completely abandon the ability of prosecutors to request privilege waivers, but centralizes decisions to request a waiver and indicates that use of the request will be rare.  The Legal Profession Blog and White Collar Crime Blog ask whether the more restrained approach of the McNulty Memo will be sufficient to blunt Senator Arlen Specter's proposed legislation to completely reverse the Thompson Memo approach. 

Like the easy response to regulation (there's too much of it), there's a good deal of easy talk about the "sacrosanct" privilege--any erosion of privilege is cast as a major problem.  Perhaps we should also consider more fully whether there is ample justification for maintaining the privilege, particularly in the corporate context.  We ignore the frequent misuse of privilege to cover corporate misdoing, and the many times that the conditions for its application are simply not available in the corporate transactional context.  Lonnie Brown suggests that a more appropriate response would be to refocus and narrow the corporate attorney-client privilege.  See Reconsidering the Corporate Attorney-Client Privilege.  In the context of considerations to reduce tax shelters (and the pervasive tax minimization norm), I've suggested that we should deny evidentiary privileges to pre-return advice because the traditional justifications for privilege simiply do not appear to apply.  See Linda Beale, Tax Advice Before the Return.

The Service's New Indopco Ruling--letting a public company deduct securities class action litigation expenses

The Service has released a private letter ruling 200649011 on a question of deductibility of litigation expenses and a settlement amount.  The case involves a merger in which it is later claimed that the target corporation engaged in significant accounting fraud that inflated the value of its stock and that the acquiring corporation actively prevented disclosure of that fraud in the proxy statement in connection with the merger.  The Service applied the origin of the claim analysis to conclude that the litigation expenses, and the settlement amount, are deductible.

The Service analyzed in detail Missouri Pacific Corp v. United States, 5 Cl. Ct. 296 (1984) (holding that claims that led to settlement amounts were in respect of false representations in a prospectus for an acquisition of target shares that overstated the vvalue of taxpayer's shares and understated the value of target's shares and thus originated in the taxpayer's acquisition of target and were not deductible) and Berry Petroleum Corp. v. Comm'r, 104 T.C. 584 (1995), aff'd 142 F.3d 442 (9th Cir. 1998) (unpublished) (holding that the claims of selling classes of shareholders and merging classes of shareholders originated in fraud in the representations made to accomplish the merger at a good price and not merely fraud in the operation of the companies).  Both of those cases found the origin of the claim related to the acquisition and thus denied deduction.  The Service distinguished the current case, concluding that the claims at issue here were rooted in ongoing accounting fraud that occurred in the ordinary operations of the company and hence payment need not be capitalized.

The argument in the letter ruling appears to suggest that settlement of any claims relating to accounting fraud will not be treated as nondeductible capital expenditures unless the fraud was undertaken solely in order to increase the value of the stock for acquisition purposes.  The Service emphasizes that the accounting improprieties themselves did not stem from conduct in the course of a particular acquisition taxationor the merger of target with taxpayer.  The Service also treats the Section 14(a) securities claim (related to falsification of a proxy statement by instructing an accounting firm not to consider certain target accounting errors that had already been discovered) is treated as not arising in the context of the merger.  Instead, the Service states that "the actual origin of this claim was ...the ongoing fraud allegedly perpetrated by [the target corporation] during the years prior to the merger." 

The basis for this statement is that (i) there were statements about the financial condition of the companies that "did not originate in the merger transaction" [emphasis added] but rather reported financial statements previously published, (ii) the additional misrepresentation by causing the firm giving the merger opinion letter to fail to consider the accounting errors was only of "incidental value" to the claim; and (iii) the allegations of these misrepresentations and omissions were not "made solely in the context of, and for the purpose of, an acquisition"  [emphasis added].

Especially with this last statement, the Service appears to be narrowing the Indopco test even further than the regulations (considered by some as inconsistent with the Code in permitting deduction of otherwise capitalizable expenditures).  The language in the private letter ruling suggests that litigation costs related to accounting fraud will not be viewed as sufficiently related to an acquisition to require capitalization unless the underlying misrepresentations and omissions are "solely for the purposes of an acquisition."  Id. [emphasis added].  Costs of litigating claims related to accounting fraud, which so nicely serves an assortment of purposes all to the advantage of the managers committing the fraud (e.g., inflating executive pay, inflating value of stock for acquisitions, inflating value of stock for monetization, etc.), would under this test only in the rarest of cases be sufficiently connected to a particular acquisition to be required to be capitalized.

Looks like the wrong answer to me as a general approach, given the well-understood value of inflated stock as acquisition currency.  Looks like the wrong answer in particular in the case of the Section 14 claims here, where the taxpayer is accused of instructing the accounting firm preparing a letter to be used in the merger from considering certain accounting improprieties.

Lame-duck Tax Bill

Well, Congress has gone and done it again--passed another tax bill that can't be paid for except by borrowing that mostly benefits people or businesses that don't need the benefit.   See this write up in today's Washington Post and this AP story.  The tax bill will cost another $38 billion over 5 years.  Id.

Take the research and development tax credit for one.  The credit is claimed to be necessary in order to incentivize research and development by today's multinational businesses.  Tell me, would any business worth its salt hold back on research and development because it could only deduct it and not get a credit for it?  I doubt it seriously.  And, this "extension" of the R&D credit is retroactive.  Meaning that businesses that have already done or not done the research will get the credit--not much incentive that.  So it is not really about providing an incentive for research at all, but about providing yet another tax break to big Pharma, big Oil and the other big industries that have lobbied hard for this tax break every year (and pay the politicians for it with big contributions).  Enough!  The R&D credit is not good economic policy.  If Congress wants to support research, it should provide dollars directly to support basic research at educational institutions.

What's another revenue reduction so necessary that this lame-duck Republican Congress had to pass it now (in spite of not passing most of the budget bills needed, and in spite of not fixing the AMT problem)?  Try the state and local tax deduction.  That tax expenditure, like so many of them, primarily favors the wealthiest quintile with multiple expensive properties.  It doesn't make sense, as I explain in my AMT article, see Congress Fiddles While Middle America Burns.

High visibility arrest for tax fraud--Actor Wesley Snipes

One way enforcement actions--and the wrongfulness of the tax fraud that leads to them--is made very real and visible to ordinary Americans is through arrests of millionaire celebrities who apparently have scoffed at the tax laws.  Such a case is Wesley Snipes, who was indicted for filing false refund claims for about $12 million and for not even bothering to file tax returns from 1999 through 2004.  Snipes, of course, had considerable income throughout that period as an actor made famous in the "Blade" vampire films.  See this article in the Washington Post for the latest news of Snipes' surrender to authorities in Florida this morning.

I suppose this arrest could have one of two results.  Either the arrest of a high-profile actor for tax fraud will help convince people that appropriate compliance with the tax code is important and intentional failure to comply costly because it will be enforced and may even lead to jail time, or it will convince people that there is more and more noncompliance and so, even though every once in a while a high profile person with millions at stake gets caught, maybe they shouldn't work so hard to comply so that they can enjoy the extra tax boon of noncompliance just like the multimillionaires do.   Leandra Ledermann's empirical research suggests it can well be the former.  Let's hope that's right.