ataxingmatter

Xmas tax goodies: more Birkenfeld UBS info? will SCt grant cert to Textron?

The holidays seem to bring unexpected 'gifts' of interesting tax tidbits, as always.  We'll look at a few that are worth noting.

(1) UBS and hidden offshore assets:

As we head toward the new year, many a wealthy taxpayer who has held a "hidden" account at UBS over the last few years and has not joined the more than 14,000 voluntary disclosures may be experiencing a sensation similar to sitting under Poe's pendulum as it swings lower and lower.  Bradley Birkenfeld, the former UBS banker who helped hide assets from US tax authorities and is now headed to prison, filed for postponement and reconsideration of the sentence over the Christmas holiday weekend.  See  Reuters, Informant says he will assist further in tax case against Swiss bank, NY Times, Dec. 27, 2009.  Birkenfeld says he will "cooperate further."  Does that mean there is more information about UBS's shady tax evasion assistance practices?  or about particular Americans aided by Birkenfeld that have hitherto remained unrevealed?  If anyone used Birkenfeld to do their UBS work, their assets may be suddenly more vulnerable to taxation than they thought.

(2) Textron files for certiorari:

The First Circuit reviewed Textron's tax accrual workpaper case en banc, concluding that those work papers could not be withheld under the work product doctrine and clarifying that the "because of litigation" test that the Circuit applies to test for work product protection could not extend to documents routinely required for a non-litigational business purpose and not prepared because of litigation. 

I commented extensively on the First Circuit decision here (Textron: is this a turning point in courts' approach to corporate attempts to reduce taxes with aggressive planning? Aug. 14, 2009) and here (Textron's SILOs and its tax accrual workpapers: First Circuit Sides with the Service, Aug. 13, 2009) and on the District Court case here (Textron, Inc.: Tax Accrual Workpapers, Attorney-Client Privilege, and Work Product Protection, Aug. 30, 2007). 

In the analysis of the district court decision, 507 F. Supp. 2d 138, I noted that the "because of" test as applied is "so easy to satisfy that any document that provides a rationale for its being created connected with the word 'litigation' would probably qualify.  It is a wrong-headed test that turns the purpose of work-product protection on its head, especially in the tax context.  Work product protection is supposed to give an attorney a 'zone of privacy' when he is preparing a case for trial, so that he can work through strategies and approaches withouy revealing his every hand to his adversary.  Preparation of tax accrual papers to make the determination of how much funds should be considered reserved in the eventuality that the tax positions taken over time by a company on its returns are not held up after an audit is not an activity at that stage of an adversarial process--in fact, it should not be viewed as adversarial at all at that state...The assessments of success on the merits provide the basis for the positions taken in the return, which is a document that is disclosed to the IRS."  

In my analysis of the First Circuit decision (553 F.3d 87), I argued that the overly broad workproduct test as applied in several circuits had moved far away from the seminal Hickman v. Taylor case involving attorney investigative efforts to prepare for expected litigation.  In the tax context, where tax standards require an assessment of the likelihood of success on the merits, success on work-product protection for tax accrual workpapers "would likely result in most any materials prepared in connection with accounting issues about tax accruals being protected."  

In my analysis of the en banc decision (577 F.3d 21), I saw four important contributions. 

• First and foremost, the en banc decision recognized that work product protection is not meant for documents that are prepared in the ordinary course of business but only for case preparation materials.  And it relied heavily on the Hickman v. Taylor case to underpin its interpretation of the work product protection standard, including the federal rules advisory committee's notes, in doing so.  As I commented, "It would completely defeat the IRS summons power if the mere possibility of the subject matter of the papers being litigated were sufficient to provide work product protection, since that possibility exists for every position about which there is any uncertainty." 
• Second, the discussion of tax accrual workpapers sheds light on their purpose and use that further supports the conclusion that they do not merit workproduct protection. 
• Third, the court made clear that revelation of tax accrual workpapers does not present the concern that workproduct protection addresses--the fear that making materials available would discourage sound preparation for the law suit--since there are independent obligations to prepare the papers.
• Fourth, the facts show that the government's concerns about corporate abuse of the tax laws is well founded.

Christmas eve brought the filing of the petition for certiorari by Textron [hat tip Tax Prof].  The petition notes the conflict among the circuit courts with respect to the standard for applying work-product protection, which protects most work prepatory to litigation unless there is a demonstration of hardship and provides very strong protection for opinion work product.    The petition emphasizes the breadth of the "because of" test as applied by various circuits (though I would note that the language in the Wright treatise that gave rise to the "because of" standard seems much less broad than the expanded interpretation given that language in some of the circuit courts' opinions). Adleman, heavily relied on by petitioner, is the Second Circuit case that has been particularly influential, yet Adleman's text on dual -purpose documents does not really support the breadth of the test petitioners' claim.  Adlemant provides work-product protection to dual-purpose documents that "would not have been prepared in substantially similar form but for the prospect of [anticipated] litigation."  That is a far cry from tax accrual workpapers, which are required to be prepared in a form that analyzes prospects of success on the merits of tax positions, whether or not a company anticipates having to litigate those tax positions.  There will likely be no company that has no uncertain tax positions--i.e., positions for which it cannot express clear certainty of the appropriate treatment.  That is because companies typically take quite aggressive tax positions and because complex transactions entail innate uncertainties of interpretations regarding the proper application of the law.  The low probability of certainty is one of the reasons that taxpayers are permitted to report tax positions for which they have only substantial authority (generally thought to provide only 40-45% likelihood of being correct).   They may report such positions even when they believe that an alternative analysis is more likely than not correct. 

Does the fact that many commentators are critical of the narrower standard hold much weight on this matter?  I don't think so.  Regretably, practitioner commentary can be expected to favor taxpayer-biased remedies in spite of our attempt, as members of the bar, to weigh in evenhandedly on policy issues.  Academicians, perhaps, tend to be more open-minded on these issues, but even here there are a number whose consulting contracts and other interests push them to identify with the practicing bar and with taxpayers. 

The petitioner's assertion that the "because of" standard would clearly cover tax accrual workpapers seems dubious as well.  One lower court has concluded as much (N.D. Alabama, in Regions Fin. Corp. v. United States, 2008 WL 2139008) but no court of appeals has yet so held.

The petitioner's assertion that the First Circuit's interpretation of the "because of" test (prepared for use in litigation) directly conflicts with Fed. R. Civ. Proc. 26(b)(3)'s "in anticipation of litigation" language is clearly wrong.  The entire phrase "prepared for use in litigation" encompasses both actual use in trial and the preparatory phases of litigation preparation when an attorney foresees litigation.  The petitioner's brief erases any line between routine documents that a company creates in the ordinary course of business that are required to look forward, in however weakly a predictive mode, to the possibility that someday the subject matter of the document might be the subject of litigation and litigation-related documents in which a particular issue that is expected to be subject to litigation is analyzed to determine particular steps that should be taken.  The civil procedure rule requiring that documents be prepared "for trial" or "in anticipation of litigation" presupposes that documents covered by work-product protection be directly related to impending litigation  and not to ordinary business routines that must be undertaken under independent obligations.

Further, the petitioner's assertion that the standard is irreconciliable with policies animating the work-product privilege is misguided for several reasons.  Financial accounting serves the public interest by providing appropriate information to investors and creditors who must rely on information in a company's financial statements to make determinations about the success or failure of the firm.  Tax accrual workpapers, in particular, satisfy this public interest role of accounting work, since they relate to positions taken by a company on its tax return.  The filing of a tax return with the government is an assertion that information is appropriately accounted for and tax liability appropriately reported under the rules.  Accordingly, I have argued that evidentiary privileges--including attorney-client privilege and work-product protection--should be reviewed in light of the nature of the tax return filing, and any advice or workpapers prepared in respect of tax return positions prior to the filing of the return should be considered incorporated by reference in the return and available to the IRS under appropriate circumstances. 

TAx, here, as in so many cases, presents special dilemmas that are different from other areas of the law.  Taxpayers are required to report their income through a filing process that relies on taxpayer self-assessment and payment.  A major problem with taxpayers' retaining absolute control over any papers revealing basic information about their taxable transactions is that information here is almost exclusively within their control.  The government battles a monster tax revenue shortfall, partly made possible by hidden accounts, transactional gimmicks, and gross misreporting.  Without access to documents that underly the transactions reported on returns, it has little hope of reconstructing much of this information.  One can't be surprised that taxpayers want to "have their pie and eat it, too" by filing their returns based on their own aggressive interpretations of the Code, while retaining all information that reveals the actual grounds on which those interpretations reside and the likely flimsiness of many of them.  But the courts should not further this along by treating tax accrual workpapers as attorney opinion workproduct that merits protection from the IRS.  That information is routine business information that should be readily available to the IRS when triggered under its own policies.

Will the Supreme Court grant certiorari to hear the Textron case?  It seems likely that they will.  There is a substantial circuit split on the issue, and there is a strong lobby--the corporate lobby, the tax bar and the accounting profession--interested in securing work-product protection for tax accrual workpapers, and there is enough uncertainty around the issue to suggest that it is time for the Court to resolve it. 

Will the outcome favor the groups that lobby most strenuously for work product protection?  That is harder to call, given the precedents that give strong voice to the public interest role played by the accounting profession and financial statements generally.  The Court should find the "because of" test too broad--it hardly sets any standard at all, and the inclusion of dual-purpose documents that are primarily created because of ordinary business obligations points to a test that fails to draw the proper line.  I hope that the Court recognizes that, if it does take cert here, and that it is attuned to the peculiar nature of the tax system that requires taxpayers to assess their confidence level in the merits of their position when filing a return.

Economic Theory--how much is it worth

[hat tip--Yves Smith at Naked Capitalism] 

Michael Hudson, an economist at the University of Missouri-Kansas City, asks how the economic discipline became so "trivialized from its classical flowering""taking for granted the social structures and dynamics that should be the substance and focal point of the analysis."  See Michael Hudson Responds to Paul Krugman, Dec. 19, 2009.  He answers the question by discussing "the 'intellectual engineering' that has turned the economics discipline into a pulibc relations exercise for the rentier classes criticized by the classical economists: landlords, bankers and monopolists. It was largely to counter criticisms of their unearned income and wealth, after all, that the post-classical reaction aimed to limit the conceptual 'toolbox' of economists.... It has ended up as an intellectual ploy to distract attention away from the financial and property dynamics that are polarizing our world between debtors and creditors, property owners and renters, while steering politicas from democracy to oligarchy."  Economists, Hudson complains, developed consistent theories that won them Nobel prizes, even while pointout that there was no need to be "committeed unduly as to the relation between reality and these [abstract economic] assumptions" (quoting Nobelist Paul Samuelson)--in fact, "the results are implicit in the assumptions made" (quoting Nobelist William Vickery).  Yet these theories were nonetheless used to arrive at policy conclusions that impact individuals in the real world.

Something very similar--and perhaps even more perverse--happened to tax analysis.  It got coopted by this consistent economic theory and the importance of equitable considerations got shunted aside.  At the Congressional level, economic models showing economic growth from tax cuts were relied on in the face of evidence to the contrary to justify one tax cut after another.  The predominance of shoddy economic analysis on behalf of the vested interests and their property and "rent" rights made it possible.  In academe, economic theories of efficiency were given precedence over discussion of equity--it is still somewhat hazardous to an academic tax professor's career to write about tax without at least giving nominal homage to efficiency theories.  The Volcker panel, appointed by the Obama White House to think about tax policies, is dominated by economists and, in fact, doesn't include a single tax professor.  See this March 25, 2009 Bloomberg.com story on Volcker's appointment and the long list of former government officials with economics backgrounds that were appointed to the panel.  It is bad enough that the panel was hobbled with instructions not to consider raising taxes on anyone making less than $250,000 but the makeup of the panel suggests that issues that should be on the table will be shunted aside.

In a way, the spread and misuse of theoretical economics to answer questions across a range of policy issues relates to the spread of "law and economics" in law schools.  Funded by millions from the Olin Foundation and driven by people like the George Mason Dean who sought to inculcate economic approaches in the entire law school faculty (economics and tenure went together like love and marriage), law school faculties hired more and more law and economics professors (law degrees not always necessary) and those professors brought in even more faculty who wrote in some aspect of law and econ.  As a result, schools across the country host a wide variety of scholars who do some aspect of "economics" research, including tax professors, corporate finance, and policy theorists. 

So an interesting question to ask is how the utter failure of the economic model to foresee and deal with the financial crisis should impact the credibility of economics as the theoretical starting point for so many different analyses.  In my view, it should cause us to step back and examine the premises on which so much of modern economic research is based--the use of math to hide the shallowness of conclusions that arrive exactly where they must given the starting points, even when the starting points have little to do with the real world.  But there are many careers invested in arguing from the Milt Friedman perspective of free markets.  It won't be so easy to dethrone that approach.

Progressivity and the Income Tax

Martin Sullivan's analysis of the progressivity of the income tax appears in the Dec. 14 edition of Tax Notes (at 1135).  Looking at 1007 data, he finds that the effective rate levels off between one and two million AGI at 24.1%.  Above that amount of AGI, the rate declines, down to 19.7% for incomes in excess of $10 million.  Effective rates increase graduatally for incomes below $100,000, but AGIs between $100,000 and $500,000 rise steeply to about 19.5%--just under the effective rate for the wealthiest multimillionaires.

What's the cause of the decline in the rate for the wealthiest taxpayers.  Sullivan concludes that it is the preferential rate that applies to capital gains and dividends.  Households with average AGI incomes between $50,000 and $75,000 receive only 2.3% of their income in a form that gets the preferential rate, whereas about 70% of the income is in that form for those with AGIs over $10 million.

Here's Sullivan's conclusion:

My casual impression is that some people favor progressive rates and about an equal number favor flat rates.  Very few openly endorse regressive rates.  Nevertheless, that is what we have in the United States.  The data in this article clearly show that high-end regressivity is largely the result of a preferential rate on capital gains.  The most straightforward way to restore progressivity to the U.S. income tax is to increase the capital gains tax rate.

Is Goldman really a bank? Would some tax increases make sense right away?

As economists claim that we are coming out of our Great Recession, and Bernanke opines that getting (nonexistent) inflation under control is more important than doing something to prevent 10% unemployment from plaguing the country for at least a half-a-decade to come (see these various postings on Bernanke's reappointment at head of the Fed: DeLong (12/07/09), What is Ben Bernanke Thinking? Delong (12/16/09) (excerpting Matthew Yglesias on Bernanke) (read through the comments here), Reconfirm Ben Bernanke; ) and as Congress moves to enact puny banking reforms that paper over real problems (in the House version, by allowing a "systemic risk council" to rewrite accounting rules if the economic substance revealed by accounting rules might expose a systemic risk and by permitting too-big-to-fail (TBTF) institutions to continue their same old tricks, so long as they contribute a puny amount to a fund to help liquidate a few of them if the same thing happens all over again sometime soon--which it well might with these febrile efforts at reform), maybe it's worthwhile to consider just what the big "investment banks" turned bank holding companies like Goldman make their profits from in the first place.  How much of their 'banking' activity adds value to the economy, and how much is just a kind of financial sector casino gambling that moves dollars around but adds nothing productive?  These days, it seems like the answer to the last question is "too much".

A recent study suggests that big banks in the TBTF category now enjoy a significant cost-of-funds spread compared to other banks.  That is, they can borrow money more cheaply, leading to greater ability to make profits, than can other banks, because of the implicit guarantee that the federal government will step in and save them because they are TBTF and pose a systemic risk.  That advantage may amount to as much as 48% of the TBTF banks' profits this year (or as 'little' as 9%, on very conservative assumptions).   The government, by the way, gets nothing for this implicit guarantee--unlike a commercial guarantor, it is not being paid a regular premium for the service.

Where else does Goldman's profits come from?  Why, their high-speed trading desks--financed by all that Fed stimulus to banks and that guaranteed lower cost of borrowing.  Remember that these are the parts of the 'bank' that make money by betting on trades, using customer and other information input into a 'proprietary' computer program.  These are   often "flash" trades that customers can't do because they can't afford the software development and because they don't have the confidential customer information that Goldman has.  Is this a significant source of profits?  You betcha.  See, e.g., SIFMA's article on the need for heightened security to protect this information, noting the "millions" of profits from this activity.  Code Green: Goldman Sachs & UBS Cases Heighten Need to Keep Valuable Digital Assets from Walking Out the Door, Millions in Trading PRofits May Depend on It (July 20, 2009).

Maybe these TBTF banks are really just "glorified hedge funds" as one commenter on the Yglesias posting linked above suggested. And perhaps there really are few options at the Fed for affecting employment with monetary policy and the asset side of the Fed's balance sheet.  We know that tax cuts--the recommended elixir from the right--won't work and were essentially wasted as a large part of the economic stimulus legislation. 

So perhaps it is time to consider a real stimulus package along with some judicious tax increases to help pay for it.  The real stimulus would be direct spending on public infrastructure (railroads and mass transit--Buffet is wise, after all; water; parks projects), education, and unemployment assistance.  The judicious tax increases could include an estate tax bill in early January with about $2 million exemption and graduated rate structure rising to 65% or so on estates worth more than $20 million--giving the Republicans the "certainty" that they say people expecting to die soon deserve (and their heirs who may otherwise be subject to moral hazard requiring protection orders next year) while raising about $30 billion a year to help offset needed spending, in a totally painless after-death tax exaction as far as the ones who accumulated the wealth subject to tax.  Other tax increases would be elimination of the R&D credit, the active financing exception to subpart F, the cross-crediting permitted under the Bush-regime changes to the foreign tax credit, and undoing Treasury's announcement that allowed banks like Citi to have full use of its losses after the government ownership changes.   Something that Congress could consider is tightening the rules for tax-free mergers and acquisitions of any financial sector organization--rather than facilitating the growth of systemically risking financial institutions, the tax rules should act as an anchor weighing down on such expansions and making them more costly to undertake.

Bank Lobbying Continues Full Force--the American Bankers Association "Call to Action"

The Huffington Post spread the word today about the bank lobbying group's "call to Action" to squash Congress's efforts to enact financial reforms.  See Bank Lobbyists Launch 'Call to Action' to Crush Financial Reform, Huffington Post (Dec. 16, 2009).  The memo announces the American Bankers Association's "shock" that the organization of community banks had supported the House bill and the desire to present a united front and defeat financial reform in the Senate.

The banks have successfully lobbied, once again, to keep a mortgage cramdown provision out of financial reform.   The effort this time was spearheaded by the small banks, but the big banks are quite happy with that result, hoping that this additional defeat means the provision won't have a chance. Why Congress goes along with this is a mystery, other than the obvious fact that money from banks smooths the wheels of almost every Congressperson's reelection efforts.  There is simply no good argument for not allowing mortgages to be modified in bankruptcy. Yes, banks will have to recognize more losses.  But like the bank's arguments against fair value accounting, calling a loss a gain doesn't change the fact.  Banks that are insolvent should be recognized as such and allowed to fade from the scene, with their shareholders bearing the burden.  We should undo the governmental guarantee, and we should take steps to break the big banks up, rather than the Treasury acting unilaterally to uhdo enacted legislation by allowing banks to retain full use of their losses after ownership changes, which encourages more of the kinds of bank mergers that we ought to be discouraging.

The Post story notes a comment from a representative of the community banks about the lobbying organizations that represent one or more of the Big Banks (the "too big to fail" constitutencies):

"All the other folks out there who do financial services representation" -- that means bank lobbying -- "they all have some of the larger banks in their membership and the larger banks don't truly want a real bill because it will require higher capital, tougher regulations, make them pay into an insurance fund and maybe even downsize. They may pay lip service to having a strong or effective bill, but I just don't think their heart is in it."

There are lots of problems with the financial reform bill--it is at best a first step on the road to a revamped financial system that should address the "shadow" banks, derivatives, "too big to fail" banks, and other problems.  Ideally, we will end up breaking up the banks and instituting strong capital, leverage and other rules to make much less significant the risky betting with other people's money (which is the main way that banks like Goldman Sachs make money these days, plus the fact that their cost-of-funds is so much less with the implicit government guarantee).

Two provisions in the bill (in addition to its failure to include a mortgage cramdown provision) are especially worrisome--they are ones that the banking association celebrates as victories for its lobbying efforts.  First, the provision in the House bill allowing the new "systemic risk council" to oversee FASB's accounting rules is sheer idiocy.  Banking regulators can set --and should set--capital standards that make sense for banks.  But they should not pass rules that hide the truth of the banks' financial situation in order to pretend that a problem doesn't exist.  Having a "doctor supervisor" that tells your regular doctor to rewrite the diagnosis so that you don't appear to have a terminal illness would be considered quackery by every patient.  Yet that is essentially what the banks have got in an agency override to FASB accounting rules that require "fair value accounting". 

The other provisions that are worrisome deal with jurisdictional issues--ability of national banks to establish state branches in competition with local banks and to have federal law preempt state banking regulation.  We need more regulation, not less, and more restrictions on expansion and growth of big banks, not the opposite.

We should start a letter writing campaign on these and other issues so that Congress hears again and again that we do not want Wall STreet to make the rules to its own advantage.

Looking for any excuse to justify a tax cut.....

As anyone who has read much of my blog knows, I find it frustrating that many on the right wing of the Democratic party (and almost all of the Republican Party) recommend tax cuts like the elixirs hawked in small towns during the Gold Rush--the remedy for all fiscal ills.  If there is a boom and a surplus, the right recommends tax cuts (for the rich, usually).  If there is a bust and a deficit, what does the right recommend?  Why, tax cuts for the rich, of course, sprinkled liberally with reduction in any programs intended to help the vulnerable and poor, and seasoned by words about "responsibility" and "accountability". 

Here's one more piece of evidence:  Chris Farrell's BusinessWeek Viewpoint, "Fight the deficit Monster with Tax Reform," Dec. 13, 2009.  (Hat tip tax prof and Mike McIntyre)

Farrell starts with "daunting" numbers--the potential $12 trillion national debt level and the potential 10-year deficit of $9 trillion.  Then he admits that much of that is a reflection of temporary measures, and that though interest has gone up, so has GDP, so that the average percent of the GDP paid out as interest will actually be lower than it was in the decade from 1985 to 1994 (when we were dealing with the huge Reagan tax cut).

But then he goes nutty, claiming that "simpler" tax rules can solve the problem.  Now, "simpler" in the mouth of a right-winger tends to mean cutting programs that help the poor, increasing tax welfare for the big multinationals (especially Big Finance), and providing tax cuts for the rich (like zero capital gains taxation, etc.).  What does Farrell mean?   Hmmm. Let's analyse.

1. eliminate all or most tax credits, tax deductions, income phase-ins and phase-outs, exclusions and exemptions.

That might sound nice as a start.  A little like Steve Forbes' plan to have everybody file a flat tax on a post card.  But let's face it.  The reason for a huge number of those exemptions, exclusions, phase-ins, credits, and deductions is to prevent the income tax from taking too big a bite out of the funds available to middle and low income taxpayers.  The Earned Income Tax Credit is a tremendously important item for low income taxpayers at this time of recession.  The personal exemption and standard deduction are calculated to try to ensure that every American can earn enough to cover bare necessities.  The phase-outs help (though don't go far enougn) in preventing the wealthy from getting all the benefit. 

Sure, there are deductions and credits that we should remove.  We should eliminate the R&D credit, so that corporations aren't able to immediately get a full dollar of tax relief for each dollar of R&D expenditure--especially when it is Big Pharm just varying the formula on a patented medicine so that it can continue reaping ridiculously high charges for its patented medicines.  But simplification is the wrong policy for reforming the tax code.  Complex provisions aren't really such a problem for wealthy taxpayers and corporations, so simplification can primarily benefit lower and middle income taxpayers.  Just arguing simplification, rather than the rationale for the particular item being "simplified" out of existence, is a foolish way to go about tax reform.

2. keep "important tax cuts from earlier in the decade" including "low rates on dividend and capital gains taxes"

Well, now Farrell is being more upfront with his agenda.  He wants to retain the horribly expensive Bush tax cuts that primarily benefited the wealthy as a way of dealing with the deficit?????  Surely he jests.  Almost any tax professor will tell you that one of the best features of the base broadening 1986 tax reforms was elimination of the capital gains preference.  The Bush tax cuts went in the wrong direction--they increased the preference (lowering the capital gains rate to zero percent on the first brackets and then 15%) and added dividends to the preference, making it even less likely that an adequate corporate and shareholder tax would be collected.

Farrell includes the Alternative Minimum Tax (AMT) in his group of simplifying suggestions, arguing again that it was "aimed at high-income taxpayers" but now "threatens increasing numbers of middle-income families."  The AMT should be reformed, but not to repeal it.  See many earlier articles here explaining how the AMT works and what kinds of reforms make sense.  In fact, the main taxpayer groups that will be increasingly hit by the AMT are those with incomes well beyond the middle class--the $250,000 to $500,000 set.  Probably Congress should just quit "patching" the AMT, so that it does its work, since Congress doesn't seem to have the courage to patch the regular tax to remove the too  expensive tax cuts enacted during the Bush years.

3. Broaden the tax base and simplify the Code

Farrell's article is really poorly organized.  He mentions again here all the phase-ins and outs, deductions and credits.  But he names a few--like the child-care credit and employer-provided health insurance.  Now I will agree wholeheartedly that there are a number of deductions and credits we could remove with impunity because they primarily constitute redistribution upwards to the wealthy through "reverse welfare" in the Code.  But the child care credit isn't one of them, and energy conservation credits are not either.  Nor is employer-provided health insurance--at least not until Congress enacts real reform (rather than the current giveaway to Big Insurance that it appears dead set on enacting). 

What does Farrell suggest should be the guide for this effort to broaden the tax base?  Why, Bush's 2005 Advisory Panel on Tax Reform.  But that was REQUIRED to place off the table any consideration of undoing the ridiculous tax cuts that had been passed under the Bush regime.  So that is not a very good starting off place--neither for simplification nor for real tax reform.

All in all, Farrell's piece seems yet another in the long line of cut taxes for the wealthy and cut out every bit of the New Deal that provide a decent baseline in terms of how the country cares for its sick, its downtrodden, its elderly citizens.  "Expanding the revenue base" while retaining Bush's favoritism for the capital gains primarily enjoyed by the wealthy perpetuates the lopsided "haves and have-mores" thinking that marked the years of the Bush regime.

Banks exiting TARP

Citibank has confirmed its plans to pay back the bailout funds directly provided to it.  See NY Times.  Of course, the fact that banks are paying back direct bailout funds does not mean that there is no further bank bailout going on.  The government now stands as guarantor, an assurance that has provided a significant cost-of-funds advantage to big banks.  One has to wonder whehter there will ever be a complete reckoning regarding the total amount of the assistance that big banks and insurers have received.  It is something that is terribly important, if we want to make wise decisions on financial system reforms.   One suspects that whatever bill passes the Congress will have a number of poor provisions, given the influence of bank lobbyists and the vulnerability of Congress to that influence.  Without public pressure expressing the rightious rage at bank's profiting from the bailout without corresponding assistant to Main Street and bankers' profiting personally while middle America hemorhages jobs, we'll continue without the significant changes that are needed.

Not surprisingly, the banks that exit the US bailout program are going to continue to benefit from the "special" rules written to override the regular rules preventing loss trafficking.  Last week, Treasury made clear that government sales of stakes in banks won't be taken into account  in determining whether there has been a sufficient ownership change to invoke the rules under section 382 et seq that limit loss use to a formula intended to keep losses used at pre-ownership change use rate.

Veritas Software (Symantec Sub) and Transfer Pricing

Transfer pricing adjustments under section 482 are supposed to assure that the Secretary can "distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among [organizations owned or controlled directly or indirectly by the same interests] if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect thye income of any of such organizations, trades or businesses."  That statutory provisions gives considerable discretion to the government to determine whether a company's allocation is a "clear reflection of income."  It is not supposed to permit companies to short-change the government by working out "transfer pricing" deals with subsidiaries that low-ball the figure in order to shortchange the tax revenues.

It looks like Symantec may get away with just that--"selling" a supported intangible property developed in the US for a lowball figure of a not even 200 million when the income stream (to the now-foreign owner) will be worth billions, based on the taxpayer's claim that its method of determining the worth of the product is better than the Service's income method.  See Veritas Software, 133 TC No. 14 (2009), Download Veritas Software transfer pricing case.121009 (BNA).

Folks, the primary (and often only) reason US software companies established two-tier Bermuda and Irish subsidiaries like Veritas did--i.e., Bermuda-resident subsidiaries incorporated in Ireland's low-tax jurisdiction that have  Irish-resident and incorporated subsidiaries-- was to offload income from their products to that area from the US and avoid US taxes.  If they could "sell" their software cheap, and then have a hefty royalty income stream going directly to the foreign subsidiary, they could substantially reduce US taxes.  Veritas established the subsidiaries and then assigned "exclusive and permanent rights" its existing sales agreements with European subsidiares and to various "covered intangibles" (inventions, patents, copyrights, computer programs, updates, translations, adaptations, specifications, etc.)  to the Irish subsidiary of the Bermuda-resident Irish corporation, while still agreeing by contract to provide R&D and technology support for the product to its subsidiaries and the right to use "trademarks, trade names, service marks".  This deal was done for an initial $166 million lump sum buy-in (later adjusted to $118 million) and royalties.  

The IRS thought the buy-in payment should be somewhere between $1.9 billion and $4 billion, settling on $2.5 billion in the notice of deficiency, based on the forgone profits and market capitalization methods applied by Brian Becker.  But in the court, the IRS indicated that it would no longer use Becker as a witness or rely on the market capitalization method, but rather, based on actual income figures, assert a new forgone income amount of $1.67 billion, developed by cost-sharing expert John Hatch using a discounted cashflow analysis.

The company assserted that its "comparable uncontrolled transaction method" was appropriate and that the IRS's new determination was arbitrary and capricious.  The tax court agreed, arguing that the IRS's mechanism was inappropriate because it did not refer only to preexisting intangibles in disregard of Reg. section 1.482-7(g)(2) and because it valued short-lived intangibles as though they had a perpetual useful life and because the court found Hatch's determinations "unsupported, unreliable, and thoroughly unconvincing."

This opinion illustrates yet again the problem with offering multinational corporations various "elections" about how to determine a matter relevant to their taxable income and in the variability of numbers that financial "experts" can come up with.   The opinion appears to rely very heavily on the company's description of its industry and mode of operation, resulting in a very low figure for the value of the intangible transferred.   Of course, the lack of credibility of the IRS's expert is problematic as well--the IRS needs to better prepare its cases at the early stages and the DOJ and Treasury need to work together to make sure that litigation strategies are implemented appropriately.  The Tax Court also refused to consider new regulations as relevant, when the old regulations did not explicitly cover workforce, goodwill or going concern value.

In the long run, it would be reasonable for sales of intangibles to affiliates to apply a uniform hind-sight calculation based on present valuing expected future income streams, so that the full value of an asset is taxed when it is transferred to another country.  Congress, and the Treasury, need to reconsider the value of "flexibility" in  the Code and regulations.  The Tax Court ought generally to grant greater deference to the Secretary in these transfer pricing cases--the Code makes it clear that the Secretary has authority to reallocate.

Another day, another indictment for failure to pay taxes

Maybe, just maybe, the number of high profile indictments for failure to report income and pay taxes will begin to sink in to that minority who thinks they are above the (tax) law.  At any rate, here's another one to chalk up to the "gotcha" side today. 

Tsen Toma, a resident of Queens, was indicting for tax evasion for a business that he ran in the late 1990s, Tomo Painting Construction.  Download Toma Tsen Indictment.121009.  According to the indictment, he received checks in payment for painting contracts and cashed them at check cashing businesses for his personal use.  But he never recorded the receipts--amounting to more than a million dollars over three years' returns-- on the books of his business or reported the income on his income tax return.  For example, in 1998, Tsen reported only $29,901 of taxable income, when the IRS corrected amount was $452,244, resulting in additional tax due of $168,718.

The press release Download Tsen PleaPR.121009 notes that Tsen left the US during the investigation and was arrested at Kennedy Airport when he flew back from Taiwan on Nov. 24.  He faces a maximum sentence of 5 years in prison for the tax evasion count and a fine of $250,000 or twice the gross gain from the offense.

 

IRS tips for year-end deductions

Publication 526 offers information on charitable contributions, but at the end of the year when many donations are made, the IRS often offers reminders about key guidelines.  IR-2009-114 offers a number of tips for taxpayers who want to be able to deduct year-end gifts.  Here's the list:

1) Limited time offer (I hope) tax-free deduction for $100,000 contributions direct from IRAs for owners 70 1/2 and older

Clearly this is a benefit for the wealthy donors who already get most of the benefit of the charitable contribution deduction.  Another of those Bush-era options (created in 2006) that should be allowed to bite the dust when it expires at end of this year.

2) Donations of household items and clothing "must be in good used condition" to be deductible

Hmmm. How many people attempt to get a deduction for junk contributed to Salvation Army??? And will whether or not there is this requirement???  Hey folks.  Give that stuff away and don't try to claim a deduction.  You probably don't deserve to get to call it charity if it is junk to you--i.e., stuff that you don't want anyway.

3) Monetary donations require a "bank record or a written communication from the charity showing the name of the charity and the date and amount of the contribution."

The release notes that contributions for credit card charges are dated from the "transaction posting date", while bank records include "canceled checks" or "bank or credit union statements".  That seems to conflict with some authority that suggests that the mailing rule applies rather than the cancelation date for the check.  The material in ""reminders"  clarifies, helpfully, that charges to a card by year-end are ok, even if they aren't paid til 2010, and that checks mailed in 2009 are ok, so long as they are cleared shortly thereafter. 

My own advice--be wary of mailed charge-card contributions to charities.  They often take quite a while to process and may not be charged to your account by year-end even if you mailed a charge slip with your donation early in December.

4) Substantiation of gifts is stricter than it used to be

A taxpayer is also supposed to have an acknowledgment from the charity for donations of $250 or more.

If the amount of all noncash contributions is over $500, taxpayers have to complete Form 8283 with their tax return.

5) Donating a motor vehicle, boat, or airplane will permit a deduction limited to the gross proceeds from the charity's sale of the vehicle.  See Form 1098-C, required to be provided by the charity to the donor and attached to the tax return.