ataxingmatter

DeficitWorries

There's been a lot of hoopla about the various groups focusing on the U.S. deficit and their recommendations to Congress and the President.  One of them is the Peterson-Pew group.  Peterson has been trying to get Congress to gut Social Security for decades, so it isn't surprising that Social Security comes up in their report. Getting Back in the Black: Summary; Full Report (Nov. 10, 2010).  The report argues for a limit on debt and a one-year freeze on discretionary spending, with adjustments thereafter based on growth rather than inflation (resulting in lower payments to seniors under Social Security).  The report also recommends "triggers" that will automatically cut benefits: "budget limits with automatic triggers are attached to the drivers of fiscal imbalances: health care, Social Security, and tax expenditures."

 

Clearly, Social Security reduction is one of the drivers of the Peterson-Pew group thinking, but Social Security is not a "driver of fiscal imbalance."  Social Security is a good program, serves very important societal needs that a large majority of Americans support, represents no part of the growth in the deficit (even if one thinks that the deficit is a central problem), and can resolve any shortfalls it has with VERY minimal tax increases by making the payroll tax fairer (increasing or removing the cap).

The military expenditures, however, are a driver of fiscal imbalance. Spending on defense went down under Clinton, then up sharply under Bush II because of the wars of choice in Iraq and Afghanistan and huge inputs to defense spending beyond those.  Those costs, of course, continue and will do so until we get out of the war zones.  The total defense request for FY 2011 is $895 billion.  US Economy: Military Budget (About.com)  We get about 1.1 trillion from individual taxpayers. US Statistics of Income for Individuals 2008.  That means that more than 80% of the taxes received from individual taxpayers support our military expenditures.  Now that's a driver of imbalance.  George Bush increased our military expenditures back to about 5.5% of GDP.  Think what could be done if we reduced the military expenditures back to where they were under Clinton, or lower.

 The other is the President's commission, headed by Bowles (Democrat) and Simpson (Republican).  The two "bipartisan" heads of the commission released their talking points--and not unexpectedly, they think Social Security benefits should be cut.  See  Co-Chairs Proposal November 2010.  The argument is that we must sacrifice to bring our budget in line with our tax revenues and that means cutting "spending we can't afford".  

The co-chairs suggest simplifying taxes, broadening the base, and lowering rates.  That's what the 1986 reforms spearheaded by Rostenkowski in the House and Packwood in the Senate did--but back then, the rates were much higher, the Code was more riddled with special exemptions, and we didn't have the ridiculous anti-tax, anti-government loony fringe in Congress that never saw a tax it doesn't hate.  It's not clear that base broadening and rate cutting is a prescription for success now.  It certainly isn't clear that the result would be a fair distribution of the tax burden.  The Bowles-Simpson program would reduce progressivity even further by leaving only 3 rates and eliminating the AMT--that would mean that the ridiculous rate compression that we have had would become even worse.  Billionaires and ordinary workers making $50,000 a year would pay rates not far apart, when instead we should be re-instituting a rate structure with more distinctions to acknowledge the world as it is today.    Most of their tax savings are health and mortgage--of course, without real health reform (single payer, single provider), that will mean that workers who bargained for health benefits as part of their pay package will lose even more of their wages, which have already been stagnant or declining for the last decade.  Not a good deal for ordinary Americans.  Now there are some good ideas here--like ending the mortgage interest deduction for mortgages on vacation homes and capping the mortgage on which interest can be deducted at $500,000.  Our current mortgage interest deduction is a significant tax expenditure of primary benefit to the wealthy, and there is no justification for that.

the corporate tax provisions are the corporatist agenda personified.  They want to permanently extend the R&D credit and cut the corporate rate from 35% to 26%.   They want a territorial tax system. 

• Extending the R&D credit is a waste of money--as bad or worse than the mortgage interst deduction.  Corporate R&D expenditures are seldom the kind of innovative,  basic research that can transform an economy--that's more often done in government or university labs and that's where we should be spending R&D dollars.  The credit amounts to a giveaway.  Let corporations deduct their business R&D expenses, and that's all they need.  Much of their R&D is just repackaging an existing product and not real innovation.  The credit isn't really an incentive--whatever corporations need to do they will do whether its a credit or a deduction. 
• Cutting the rate to 26% doesn't make sense--corporations already pay an effective rate lower than that, and they will continue to hire expensive tax attorneys to cut their taxes unless there is no tax.  We'd be better off considering Joseph Dodge's suggestion in the Fall 2010 aBA Tax Section NewsQuarterly--tax corporations on their book income, no ifs, ands or buts allowed, and at the same time eliminate the capital gains preference.
• Territorial taxation will permit US multinationals to pay almost nothing in taxes in this country, as they continue to offshore their operating businesses.

The co-chairs argue for "tort reform" as a way to reduce costs and they have similar proposals to "cap" damages for medical malpractice. Again, this is just the corporatist agenda.  Tort reform isn't needed and is in fact harmful to ordinary people's rights to redress when they are wronged.  Tort actions are often the only existing method to cause a corporate entity to compensate those who suffer because of its recklessness and greed in putting out an unsafe product.  Studies have shown that there is no epidemic of bad tort cases.  None of the "tort reform" proponents have established that tort reform benefits anyone except wrongdoers.  If a doctor amputates the wrong limb, why shouldn't the doctor and hospital pay punitive damages of some significant amount.  We could put those punitive damages into a public fund rather than having them go to the victim, but it invites moral hazard to limit the malpractice claims to protect doctors and hospitals.

The co-chairs argue for setting an arbitrary target for growth in health care costs (GDP+1%). we might well say, as a society, that we think it is reasonable to spend more on health care to provide a better quality of life for all, and to spend less on other things.  Arbitrary caps and triggers give the appearance of reasonable cost-saving measures, until you realize the result is care that is not provided that could have been without too great a sacrifice.  Other suggestions seem equally short-sighted--capping long-term medicaid payments and cutting spending for graduate medical education are both likely to result in long-term detriments.  but some seem reasonable--such as considering a public option!

The co-chairs have Social Security written all over their cut recommendations, even though they indirectly acknowledge that their call to "reform" Social Security has nothing to do with deficit reduction (see page 43 where they note that this is a call to "reform Social Security for its own sake, not for deficit reduction").  They suggest"ensuring" that Social Security is sound over the long run. They want to use chained CPI to measure adjustments, resulting in significantly less benefits.  They want a more progressive formula for benefits, and higher ages for retirement (normal retirement at 69 by 2075).  All state and local workers would be added to the program by 2020.  They suggest lifting the cap, so that the tax applies to 90% of wages by 2050. 

 Later on they say that we have to "enact tough discretionary spending caps".  why?  If we want to spend more of our GDP through government programs that allocate resources to initiatives that serve the public interest, why should we cap those programs?  It's a question of priority setting.  Arbitrary caps, whether at 20% of GDP or 21% or whatever, make no sense whatsoever.  They just sound easy.   What needs to be done is to determine whether we want sound health care in a reasonable system (single payer public option, extending Medicare as a program of choice for more, etc.) or whether we want the majority of Americans to continue to suffer a declining standard of living because of putting our priorities on corporate insurer profits instead of people's needs for health care.   Setting arbitrary spending caps is like deciding that you will only buy items that are located in the first isle at the grocery store so that you can make the trip more efficient.  You'll get out in record time, sure, but you won't have any of the things that you need for a balanced diet, and your health will suffer so that you'll be much worse off in the long run because of your arbitrary decisionmaking.

The specifics for the military budget don't seem to make a lot of sense. Freeze pay for 3 years.  Replace military with private contractors. (Hey--that's not exactly worked since Reagan started it and the Bush I and Bush II regimes accelerated it.  We paid at least double for every Blackwater mercenary that we paid for regular soldiers, even while we had to deal with the repercussions of out-of-control mercenaries killing innocent civilians in Iraq.)  They call for reducing expenditures on base support, facilities maintenance and R&D--the latter by 10%.  Now, I'm for reducing military costs, but I doubt if deferring maintenance or cutting R&D is the best way to do it.  Much of military R&D expenditure has  civilian uses--we need to boost real, basic, R&D in lots of ways, instead of giving tax breaks to corporations for jusgt recylcing a patent to a slightly new variant (as we do with drug development).

Bowles and Simpson also want to freeze all federal salaries for 3 years and cut 10% of the federal workforce.  That sounds like a recipe for disaster, on top of the existing unemployment and underemployment.  The freeze on salaries might be sustainable, but wholesale firing of thousands?  No way can that be in the best interest of the country.

Oh, --"sell excess federal property".  I suppose that would be Arctic wilderness areas, roadless areas and other natural resources that natural resource extractive companies would just love to "develop."  ???

Not surprisingly, the Heritage Foundation, which is notorious for arguing for reduction of social security and other safety net programs, thinks the co-chairs' recommendations are a "good first step".  Bowles-Simpson Co-Chair Report (11/10/10) (arguing that the "entitlement programs" are the "major drivers" of government spending and that "reining in government spending" will close the deficit). 

This emphasis on the deficit seems to be off track.  It has little or nothing to do with getting the US economy back on a good, sustainable track that will provide a decent standard of living for Americans, with sound support for a strong middle class, the backbone of the country.  Deficits aren't the "evil of all evils" that these commissions and their backers make them out to be.  ordinary people are being called to sacrifice even more, when they are bearing already heavy burdens from the financial crisis,high unemployment and high rates of foreclosures.  In the name of deficit reduction, these "experts" want us to forego tort remedies against institutions that cause life-long harms that cannot be made whole.  In the name of deficit reduction, they want us to work longer and retire with less benefits, while there is no provision for eliminating the capital gain preference giving those who have income from capital assets an easy pass on taxes.

When people and businesses aren't spending, the government needs to spend.  That money is the fluid that drives the economy.  If it isn't there, we will have a double dip recession or worse.  cutting back government expenditures in the drastic ways called for here (10% of federal workers fired, etc.) will have a negative impact on the economy that will ripple through ordinary Americans' lives.

ABA TAx Section Pronouncement on Carried Interest

The American Bar Association Section of Taxaction has issued a letter on Comments on Carried Interest Proposals in senate Amendment 4386 to H.R. 4213 (Nov. 5, 2010). 

 As many are aware, a letter from the officers of the ABA Tax  Section is one that has been developed by a relatively small group of participants and submitted to the council of officers for approval.  Most members have little opportunity, if any, to comment on the statement, though one can assume that in many cases the statements are likely to represent the views of a majority of the membership.  The leadership is not likely to step lightly into territory that they do not think would be supported by a majority of the membership.

This letter went to the current chairs and ranking members of the House Ways & Means Committee and the Senate Finance Committee, with copies to staff directors as well as the Chief of Staff for the Joint Committee on Taxation.

The letter makes  recommendations about the proposed statute, which would apply to service partners in investment service partnerships to characterize income allocations as ordinary compensation income and defer losses, and impose self-employment tax on the service partner interests in such partnerships.

Preliminarily, it reiterates a position stated in prior comments that taxation of carried interest adds "burdensome complexities" and "alters fundamental principles of partnership taxation" and should therefore be reconsidered.  Not a surprising position for tax lawyers.  We are in most cases as self-interested as the next guy or gal.  This provision would result in increased taxes for fund managers in partnerships that have claimed a significant rate and deferral preference for their income from services compared to the ordinary treatment of wages paid for services to less advantaged workers.  And of course there is a good bit of work for tax lawyers developing partnership agreements and doing adquisition and other tax work for private equity funds and other investment partnerships that have taken advantage of this "loophole" to create significant wealth for these managers. These service partners may earn this kind of compensation in the hundreds of millions of dollars annually.  It is very big business. 

Nonetheless, there is an essential fairness issue at stake.  If you are relatively rich and a part of the financial institution world of investment partnerships, you can earn a very very good "salary" for your work but get deferral advantages compared to ordinary workers and preferential rate treatment, paying much less in income taxes than ordinary workers.  It is hard to see how, in conscience, Congress can avoid enacting a carried interest provision that will undo that unfair advantage.  And since it will likely raise revenues in an era of much complaint about deficits and debt ceilings, what's not to like?

Secondly, the letter suggests that, if a carried interest provision is nonetheless to be adopted, the proposed statutory language is inadequate to the task.  It urges modifications to the scope of the proposal and to the treatment of qualified capital interests. Among other things, as to scope

• the letter claims that the proposal does more than tax the compensation element as ordinary income, because of the application of loss deferral and manadatory gain recognition for C corporations.  Yes, the proposal does do more than just deal with the rate issue, since it also addresses deferal and required gain recognition.  Why is that inappropriate?  The letter doesn't say.
• The letter includes in the "scope" discussion the recommendation that "small businesses" be exempted from the provision because of the purported burden of compliance.  This is similar to the attack on many other business tax provisions--the argument that "small businesses" should be exempt because it is too complex for them.  But that is questionable here.  Businesses that use the service partner loophole already have been dealing with complex partnership allocation and distribution provisions.  This proposal has been gathering steam for some time, so that they should be prepared to deal with it.  They are well aware of the preferential treatment that the partnership arrangement currently provides and quite likely chose partnership form in order to get that treatment (among other advantages), despite the complexity.  They generally will have a firm that handles the tax matters for the partnership anyway, so this does not really add to the burden on the business.  This has the appearance of a red herring argument--as it usually is  when "you should eliminate the tax because the burden of compliance is too much" arguments are used against everything from the estate tax to the demand for 100% expensing. 
• the letter criticizes the provision that treats all tiered partnerships as "bad" assets for these purposes.  It suggests instead a look-through approach.  There may be merit in that though there is a trade-off in the increased complexity due to the look-through rules.  Again, note that when it is to get a benefit for taxpayers, proponents tend to disregard the added complexity...
• the letter argues for a provision to end the service partnership taint if the interest ceases to be an investment service partnership interest.   Taints often carry over to ensure appropriate treatment of income over the long term, but it is possible that a cut-off provision would be appropriate.  But again, there is a trade-off in complexity and lack of information about the circumstances in which interests would change into and out of investment service partnership interests.  Without such information, it might be better to stick with the bright-line taint rule.

As to "qualified capital interests", the letter urges a much broader view of qualified capital (amounts as to which allocations will not be treated as compensation income).  For example, it includes the following recommendations (among others):

• The letter urges that a partner who purchases an interest from an existing partner be allowed to treat the purchase price for the interest as qualified capital, rather than merely acceding to the amount of the qualified capital account of the transferor partner.  Note that the norm for capital accounts for purchased interests is that a purchasing partner takes the transferor partner's capital account.  It is not clear why the ABA believes that the additional complexity a purchase-price-capital account determination would make would be reasonable, nor why purchase price should "count" as qualified capital when the transferor partner had a more limited qualified capital account.  Remember that purchasers of interests from interest holders do not add capital to the enterprise--they are merely putting money in the pocket of the interest holder that, presumably at least, the interest holder would eventually have received from the partnership. 
• The letter argues against the treatment of qualified capital as limited to the original capital contribution if the partnership will make disproportionate allocations of income to original service partners once investors join the partnership.  In other words, under the proposed statute, the capital bookup for appreciation in real estate property held by the partnership and allocable to the service partner during startup is not treated as qualified capital when the investors join, but the letter proposes that it should be.   The letter argues that "the value in a partnership at any such time is economically indistinguishable from value held outside the partnership that a partner could contribute in exchange for qualified capital."  Doesn't that miss the point?  If the original partners contribute equally but one provides all of the services for the real estate purchased with that original contribution, then surely the increase in value allocable to the service partner is attributable to the services provided as well as capital.  Tax rules often take an "all or nothing" stance, accomplishing with "rough justice" what would otherwise require intricate bifurcation rules or rough injustice results (here, that none of the increment in value to the service partner would be treated as payable for the services of the service partner).  The fact that a purchased item worth 250 would be "economically indistinguishable" from a purchased item originally worth 100 that has increased to 250 with services from the purchaser misses the point of attempting to account for the compensation received by the servicer the way we account for compensation of others.  And note that the letter's recommended position would result in a significant long-term advantage, in that much more of the "disproportionate allocations" that the service partner will receive henceforward would be attributed to qualified capital rather than payment for services.
• the letter also objects to the inconsistent application of section 752, the rule relating to the treatment of increases and decreases in liabilities, which are viewed (outside of this new statute) as contributions and distributions, respectively.  The proposed provision does not treat increases in the service partner's share of partnership liabilities as a contribution of money to the partnership (created increases in qualified capital), but does treat decreases in a partner's share of partnership liabilities as distributions out of capital, thus reducing the qualified capital account.  The statutory inconsistency reflects many other anti-abuse rules in the Code, such as the ones that disallow loss recognition but permit gain recognition.  While consistency is generally preferable, the ABA tax section should have provided some discussion of the likely rationale for not treating increased liability responsibility as a contribution of qualified capital in these cases, rather than merely arguning for consistency for consistency's sake.

The letter ends with a restatement of concern about increasing complexity.

Spending, Borrowing and Tax Cuts

As of course everyone is aware by now, many of the "Tea Party" candidates were elected to office last week, and many Republican officials have taken the resurgence of the party as an indication of support for what they view as the advocacy group's platform (shaped, in significant part, by funding from Dick Armey's group and the Koch brothers' agenda).

The result is that there is more talk about how to strangle "big government" while at the same time providing tax cuts to as many as possible.  So Senator Elect Mike Lee of Utah, who won with Tea Party support, refuses to say what programs carried out by the federal government he thinks are bad, other than agreeing when PBS's Woodruff mentioned others' attacks on the federal Department of Education that we could get rid of that since (to paraphrase) education should be a matter for states and local governments.  See the video of Woodruff's interview with Sen. elect Lee at the PBS website: Tea Party Sen.-Elect Vows Vote Against More Debt

One suspects that the reason education is easy to attack is that the Republicans-- since the Department's creation --have been attacking it, never with much specifics but always insisting that the problem is that it takes control away from local school districts.   But what kinds of things does the Department do that are so bad?  Looking at its website today, one finds several interesting items.

• "Ready-to-learn" TV Grants--The department provided $27 million in three five-year grant awards to telecommunications entities-- Window to the World Communications, the Corporation for Public Broadcasting and the Hispanic Information and Telecommunications Network-- to support projects that "improve educational opportunities for young learners through innovative technology".  The grant recipients will develop outreach materials and resources for families, preschool and early elementary teachers intended to improve literacy and math skills in children from 2 to 8 years old.
• Education Statistics--the Institute for Education Sciences/National Center for Education Statistics collects and analyzes education data of interest across the nation, on both elementary and secondary schools, see, e.g., Characteristics of the100 Largest Public Elementary and Secondary School Districts in the United States: 2008-09 (Nov. 4, 2010), and on higher-education institutions, see, e.g., Employees in Postsecondary Institutions, Fall 2009, and Salaries of Full-Time Instructional Staff, 2009-10 (Nov. 3, 2010).  The statistics allow us to compare reading or math scores of eighth-graders across the country or teacher compensation in various states.  Is this information useful and perhaps even necessary for educators and school districts today?  Probably.  Would states provide this kind of statistical research if the federal government did not?  Possible some of it, but certainly not evenly across all the states and not as comprehensively.  That is one of the comparative advantages of a single federal rather than many state bureaucracies--the ability to collect and analyze comprehensive data of relevance to all of the states.
• Federal student aid--The Department provides information and tools to help students find grants, student loans and scholarships, and to assist student counselors in helping students navigate the aid network.  See, e.g., the portal for "Student Aid on the Web".  How many students are able to attend college because of federal student aid who otherwise would not be able to go?  In what way could states provide the same type of benefit, when students may well leave their own state to go elsewhere and states already are hard pressed to fund their own public universities (leaving most of them to scrounge for donor aid for 70% or more of their funding)?

Those are just a skim of the surface of the kinds of activities the Department undertakes.  Yet Sen. Elect Mike Lee of Utah thinks we could just eliminate it.  Wonder what real deliberation and investigation, if any, he is basing his opinion on.....

Lee also says that the government should make "across the board" cuts of up to 40% in order to prevent any further borrowing.  He would like to cut federal salaries by 10% and fire federal workers. And he has indicated his willingness to join the renegade band of Republicans that have indicated they will not vote to increase the debt ceiling.  These programs alone would likely launch us back into the Great Recession or in fact into a Great Depression.  When citizen spending has stopped, government spending is what keeps the economy rolling.  Especially beneficial is government spending that creates infrastructure that will support future job growth.  But the kinds of cutbacks--and immediate limitation on borrowing--proposed here would be nothing short of disastrous. 

 Especially with the simultaneous push by Republicans to extend all of the Bush tax cuts, even to those wealthiest individuals who mostly save them (and invest them abroad) so that failing to extend new cuts to them will make not a whit of difference to the economy. Senator Orrin Hatch (Lee's senior senator from Utah, also Republican) "warned Nov. 8 that any effort by Democrats to separate permanent tax cut extensions for the middle-class from permanent extensions of the top tax rates will fall flat in the Senate."  BNA Daily Tax REalTime (Nov. 8, 2010, 7:14pm).  It's the same old argument that failing to enact a new tax cut for the wealthiest Americans would press small businesses and hurt jobs, even though the "small businesses" affected are minuscule.  Hatch sticks to the party line that any failure to pass a new tax cut bill for the wealthy is "a tax increase plain and simple that would be used to fund more Washington spending, while discouraging private sector job growth."

If we'd had stellar private sector job growth as a result of the enactment of the original 10-year Bush tax cuts, one might think Hatch's argument held some water.  But job growth throughout the Bush regime was anemic--not really keeping up with population growth.  So the argument doesn't have a leg to stand on.

 How, pray tell, do people like Lee expect the government to service its current debt when they are against borrowing and against enacting a tax cut that fairly targets the middle class and poor for cuts while not cutting taxes for the rich, while simultaneously supporting drastic austerity measures like salary cutbacks and firings that will set the economy into a tailspin?  How would communities cope with the unemployment caused by the proposed massive firings of, and cutbacks in salaries to, federal and state employees, based on the bogus claims that public employees are overpaid compared to private workers?  When students need federal loans to continue at school, how will they get them with no employees to administer the program?  When there is a disease outbreak or potential epidemic, how will it be handled if the Center for Disease Control has cut back its staff by 40%?  The Republican answer seems to be --we'll see; no plan for now.

Now, we all recall the fact that the debt ceiling had to be increased numerous times during the Bush regime--in part because of the wars of choice in Afghanistan and Iraq and in part because of the more than one trillion-dollar ten year cost of the original 2001 Bush tax cuts.  When the discussion of the Bush tax cuts took place in Congress, the Republicans said they would pay for themselves.  They didn't and won't, as even staunchly partisan Republican economists admit.  The GOP limited the tax cuts to ten years (with the gimmick of the 2010 sunset), however, in order to avoid admitting the real cost of the cuts.  Now we are in 2010 and have to deal with it.  There are choices to be made.  It seems to me that following the Utah senators approach would cement the problematic economic pathway we adopted under Bush--benefits from stock market growth for the wealthiest, stagnation for the rest.

So do those Tea Party candidates who are supporting indiscriminate across-the board cuts to the federal budget of a size to

Mayo Foundation v. US considers Medical Residents and Payroll Taxes: employee or student status paramount

The Supreme Court heard oral argument today in Mayo Foundation for Medical Education and Research v. United States, No. 09-837, a case asserting that the "student exception" in 26 U.S.C. section 3121(b)(10) exempts stipends paid to medical residents from FICA taxes.  For a case analysis, see Mayo Foundation, Legal Information Institute, Nov. 8, 2010. 

Briefly, the case revolves around the categorization of medical residents as "students" or as "employees."  The original case in Mayo was decided at the district court level under old regulations (a case called Mayo I by the Eighth Circuit) and concluded that the student exemption applied.  The IRS did not appeal Mayo I, and decided administratively not to contest the claim of excemption for medical residents prior to April 1, 2005.  As of that date, however, the IRS regulations were amended to provide that medical residents who work 40 or more hours per week are considered full-time employees who are not eligible for the student exception because their services "are not incident to and for the purpose of pursuing a course of study."  T.D. 9167, 2005-1 C.B. 261, 69 Fed. Reg. 76404 (Dec. 21, 2004).  26 C.F.R. section 31.3121(b)(10)--2(e) Ex 4; -2(f); -2(d)(3)(iii) (final regulations effective Apr. 1, 2005).  

The Mayo Foundation challenged the regulations, questioning whether Treasury can "categorically exclude" medical residents from the definition of student, merely because they are also full-time employees.  The district court ruled that the regulation was invalid.  Mayo Found. for Med. Educ. & Research v. United States, 503 F. Supp. 2d 1164 (D. Minn. 2007); Regents of the Univ. of Minn. V. United States, 2008 WL 906799 (D. Minn. Apr. 1, 2008) (concluding, at 1171-77, that the full-time employee exception to the application of the student exception was "arbitrary, capririous, and unreasonable").  The government appealed both decisions, even though the 11th, 2d, 7th and 6th Circuits had already ruled on cases under the pre-2005 former regulations that the FICA statute as construed under the former regulations did not permit a categorical treatment of medical residents as ineligible for the student exception. See 486 F.3d 1248 (11th Cir. 2007); 563 F.3d 19 (2d. Cir. 2009); 557 F.3d 412 (6th Cir. 2009); 545 F.3d 564 (7th Cir. 2008).

The Eighth Circuit's June 12, 2009 decision reversed, noting an "avalanche" of litigation on this issue that has "exploded across the country" and concluding that the appropriate answer was to defer to the IRS regulation that treats medical residents who work more than 40 hours a week as subject to the employment taxes.  

The Supreme Court granted a petition for writ of certiorari in Mayo Foundation on June 1, 2010 (2010 WL 149135) and held oral argument today.   BNA reports in Daily Tax RealTime (Nov. 8, 2010 at 2:51) that "the justices ... appeared to be looking to set out a clear rule for applying the student exemption to the Federal Insurance Contributions Act" (FICA) during the argument.  As Chief Justice Roberts commented in the hearing:  "The only way you can draw the line [for an apprentice who is both an employee and a student] is to have somebody say: This is going to be the line.  And if anybody is going to say it, it ought to be the IRS."  BHA, op.cit.

David Cay Johnston on the Child-Care Credit

David Cay Johnston, former tax reporter for the New York Times, now does a column in the weekly Tax Notes called "Johnston's Take."  This week, he examines Alan Viard's claim that the child-care credit is a boon for working parents.   Download Who Benefits from child-care credit.110810 

Viard is an American Enterprise Institute economist/scholar in residence, joining Paul Wolfowitz, Lynne Cheney and other prominent names from the Bush right-wing support squad.  He has touted the child care tax credit and gotten some supporters.  For example,  legislation was introduced in the House this spring to increase the credit and remove the income limitation, so that even well-to-do couples could get the full credit (current law limits credit to $600 for familes with income above $43,000).  See Martin Vaughn, House Plan Targets Child Care Tax Credit, Wall St. Journal, May 11, 2010.

Johnston argues that the incidence of the child tax credit, like the corporate income tax, is uncertain.  (The corporate tax may be borne by shareholders, but it may also be passed off to employees, vendors or customers.  That, of course, is if there is any tax paid at all....)  The credit is not so obviously a benefit to those who ostensibly receive its benefit.  Johnston works through some simple formulas to show how wages decline with the availability of the credit--both because employers can pay less (since the government is in effect picking up part of the tab) and more employees come into the labor market because of the credit (which lowers wages because of the increased supply of labor).

 

New Feature: Friday Animations--Wall Street Gorges

IN the interest of proving that I am not a troglodyte (Is that the way to spell it?), I hereby declare Fridays to be "animation days".  We'll see what entertaining, educational, or just plain worth watching videos we can find with a tax/economic theme that would be interesting to readers of A Taxing Matter while, hopefully, animating the concerns about democratic egalitarianism that this blog expresses.

Today being the first entry in the Animation Days feature, it seems worthwhile to kick off with something on Wall Street, fat bonuses--projected to amount to about $144 BILLION for this year, and the fate of ordinary Americans whose houses are being foreclosed on with robo-signers.  All tied neatly in the following package from Next Media Animation (Taiwanese, with English substitles, which is an interesting comment in itself):

http://www.nma.tv/2010/11/05/wall-street-gorges-on-record-bonuses/

and your bonus, to help lighten your election blues (for the vast majority of Democrats/liberals and other lefties) or throw a few serious moments into your election celebrations (for the teapartiers and GOP victors in the House and many state races):

    

http://www.youtube.com/watch?v=2TEia3QZ1ec&feature=player_embedded

private equity doesn't do us much good; avoiding taxes does us considerable harm

[edited 11/8 8:45 pm to correct typo in Weidner article title to $70 billion instead of $70 million--oops!]

I.  Private Equity, leveraged buyouts, and carried interest

On MarketWatch, David Weidner's "writing on the wall" column for Nov. 2, 2010 comments on "Paying for Wall Street's Prosperity: Loophole could cost taxpayers $70 billion".  What loophole?  That "carried interest" provision that lets hedge fund and private equity managers get their compensation income with the tax benefits of capital gains rather than ordinary rates.  This isn't chicken feed.  There are lots of private equity deals, and private equity deals have a huge impact on ordinary Americans--for one thing, they frequently purchase by leveraging the company they buy, so that it has considerable debt the interest on which is deductible, lowering the company's tax bills, at the same time that they frequently "restructure" so that the successor company is likely to fire lots of employees, sell some assets, and then do an IPO a few years down the road to bring in cash to pay off the debt.  And many of them will fail--including bankruptcies and going out of business. The benefit (deferral and capital gains preference) goes to the private equity firms that make fortunes out of the deal.  The burden is--surprise, surprise--borne by the ordinary Joe who gets fired or sees his company driven to insolvency or at the least faces job insecurity during the time that the private equity firm is whipping his company into shape for selling at a profit.  The burden is also borne by taxpayers generally and the kinds of public goods we would like to fund with tax money (from parks to disease research, from environmental enforcement to insider trading enforcement, from new roads to better cargo searches, etc.)--as Weidner notes, all those equity deals result in firms that pay less income tax per dollar of pretax income--about 14.2% less, in fact-- than their counterparts that haven't been taken over by private equity firms, because of the way the private equity firms profit by leveraging their purchase with the company's own cash flows.

So there's a pretty good argument that private equity firms are harmful to the economy, not helpful.  They for sure don't create jobs (and often cause job loss).  And there's prety good evidence that we create a tax break (by allowing the interest deduction for leverage used to allow private equity firms to buyout the company ) that isn't justified.  And then there's that tax break for carried interest.  Why are we giving so much to companies that give us back so little?  Weidner's answer--they've got lobbyists. $51.5 million over the last four years  spent on lobbying, compared to a mere 7.7 million from 2003 to 2006.  Blackstone and KKR spent $3.78 million this year alone. Id.  (And they've got the ability to contribute money even more targeted to electing the Congress they want, after Citizens United.  $10.6 million for the midterms, through Oct. 25, Weidner reports, based on OpenSecrets.org. data.)

II.  the "Increase Our Taxes" Blog

There's a blog I just discovered, titled "increaseourtaxes.com".  Uneven items, but some worth looking at.  For example, see the post on "Tax Cuts and the Well Off", which shows graphically (from the Tax Foundation) the impact of Obama's proposed changes--mainly in higher amounts of tax from those earning a million or more, or "California and the Politics of Taxes " (nov. 1, 2010), which notes the problems that occur when "voters want services but do not want to pay for them".   IN conclusion, he shows how all efforts to avoid taxes devastastes society.

"This is what happens when you try to avoid paying taxes.  Politicians, hemmed in by public opinion, look even slimier as they cut deals to balance a budget.  Voters kick those politicians out but don’t change the rules of the game, so the new politicians look just like the old ones, just like in Animal Farm. Revenue is raised indirectly and inefficiently, distorting the economy, reducing overall income and tax revenue, and eventually requiring the government to furlough teachers and fire fighters and cut popular services.  Refusing to pay more in taxes hastens the end of exactly what we want to pay taxes for."

If Dems go Down--outlook for taxes, financial industry, military and war, unions and public employees...

I voted this morning in the mid-term elections.  Did you?  I am nonetheless a frustrated citizen who is deeply worried about the future of my city, my state, and my country.   And while I am deeply disappointed in the Dems' ability to translate progressive ideas in to working legislation and change, I am even more deeply disappointed in the loss of a moderate GOP voice and the way most of the GOP candidates embrace the corporatist agenda.

While I understand and even empathize with some of the anger and frustration expressed by the Tea Party groups, I am very worried about their impact on this election in light of their apparent lack of comprehension about the essential problems facing us and their failure to understand that it was the four decades of Reagan-inspired policies of deregulation, militarization, privatization and tax cuts that got us deep into these problems culminating in the Great Recession of the Bush Administration and the too-lax TARP bailout provisions for banks.  (The bank bailout was, I believe, necessary by that point, but it could have been handled--as I argued at the time--by methods that would have exacted a much higher price from bank managers and shareholders, without the Paulson-originated, bank-friendly provisions that allowed bankers to retain (privatize) their gains while casting on us (socializing) their losses.) 

The Tea Partiers, in other words, have muddled ideas that forecast wrong-headed policies on taxes, finances, income inequality, the role of unions in protecting the U.S. middle class, and the role of the big multi-national corporations in influencing government to favor their own businesses and the rich who own or manage them (via lobbying and especially since the Supreme Court's Citizens United case, via the use of huge sums of money to influence elections and essentially buy legislation made to order).  The Tea Party groups in particular misinterpret the corporatist agenda that pits large corporations and their wealthy managers and shareholders against the vast majority of hard-working, middle class Americans and that casts unions (in spite of their undeniable flaws and failures)  almost as evildoers, rather than what they actually are--the only successful means that the middle class has to create a level playing field so that workers can get their fair share of productivity gains mostly produced by them.  Further, the Tea Party groups seem incapable of recognizing that their visibility and influence is being bought by those very powers that consistently work to suppress middle class gains--the anti-tax, anti-union, pro- "free market" purported think tanks and lobbyists and wealthy businessmen and the right-wing media empires of huge corporations such as the Sinclair stations, the Murdoch media empire (Wall Street Journal, Fox News, etc.)-- such as the Koch brothers and Dick Armey's so-called Freedom Works. 

"Free market" is in quotes because there is no such thing as an absolutely free market: to the extent that we shift the balance too far towards business "freedom" and too far away from consumer--and environment--protecting restraints, we take away everyone's freedom to live decent lifestyles in a sustainable economy within a sound environment.  Markets are wonderful, but the ability of businesses to compete "freely" in fact requires a number of restraining and opposing influences to avoid the inevitable development of self-perpetuating monopolies and oligarchies from asymmetries of information combined with the natural biases and follies of humans (including the corruption from money and power, the self-interested actions that can cause significant detriment to others from sheer greed), not to mention the vulnerability of ordinary people left to suffer from the brute-force harms of such "free" markets.   Government regulation/remedies (administrative and judicial) and worker unions are two necessary restraints on unbridled corporatism. 

So let's hypothesize that many of the right-leaning GOP and Tea Party candidates are elected.  Here's my prediction of the policies that will be pushed by this right-wing coalition. 

1. Taxes:  likely passage of various bills reducing corporate taxes either temporarily or permanently, including 100% expensing, repeat of the 2004 almost tax-free repatriation of foreign profits, further extension of tax-free restructuring provisions (the Bush Treasury through regulations practically gave away the store, and there appears to be a wholesale commitment to continuing the rush to make gain recognition as a part of a tax-free reorg a thing of the past, and make loss recognition as a part of a tax-free reorg a thing of the present); likely attempt to make the Bush tax cuts permanent for everyone including the wealthiest amongst us or at least to extend them for another 2 years until the 2012 election possibly restores a GOP president to make them permanent; likely renewed attempt to repeal or sharply reduce the estate tax that even in its pre-Bush form was paid by a tiny minority of estates each year and paid at a very low effective tax rate by many of those few that paid it; discussion of tax cuts by the GOP/Tea Partiers won't address the role these cuts play in creating deficits or in reinforcing a harmful level of income inequality that threatens the very heart of democratic governance.  We definitely won't get legislation cutting the carried interest entitlement out of a right-dominated Congress--the capital gains and deferral advantages that private equity and hedge fund managers glean through their interpretation of the partnership rules for "profits-only" interests would be allowed to continue, generating multi-million dollar low-taxed income and encouraging a continuing distortion of the allocation of endeavor towards this high-income, low-tax-producing work and away from other endeavors that would be better for the economy (such as engineering rather than financial engineering, etc.).  In other words, we can expect a resurgence of the many-times-now-proven-wrong-"freshwater"-economic-free-marketarian and Laffer-style budget and tax ideas, carried out even more extremely!
2. Dodd-Frank financial institution regulation:  attempt to undo or deeply eviscerate many of the protections for the financial system disliked by the Big Banks, particularly the (limited) ban on proprietary trading, potential for naked credit default regulation, and  the existence and powers of the Consumer Financial Protection Agency (which is the primary part of the bill that addresses the way that big banks use their clout to collect from customers at every opportunity while making it enormously hard for customers to fight back when they are treated unfairly by the banks)
3. Social Security:  drive to dismantle post-war protections for the poor and elderly, through partial or whole privatization and reduction of benefits; use of the worries about the deficit as the power for wielding the ax cutting old age security benefits (in spite of refusal to forego any of the Bush tax cuts which will cost $5 trillion over ten years, if extended). Job creation will be touted as a rationale for most of this, though it is a very unlikely outcome.  (There will be no further stimulus package of public infrastructure spending which would have a decent chance of saving, creating jobs.)
4. Health care:  drive to dismantle the progress made towards a fairer health insurance system out of a distorted understanding of the way that non-insured individuals require insured individuals to cover their expenses and a failure to comprehend the way that health insurance companies benefit from the ability to arbitrage 50 states' rules to select those that serve them best and serve ordinary Americans least
5. Environmental and Global Warming Efforts: drive to dismantle anything already done to address the significant harms from global warming and environmental pollution (including toxic chemicals in our land, air and waterways); attempt to open the Arctic National Wildlife Refuge to oil drilling; attempt to give all the rest of the US reserves to the oil companies along with even more tax cuts for the natural resources extractive industry (which will be touted as "incentives" for development); attempt to peel back protections for endangered species, particularly wolves and small creatures whose protections are seen by the right as "threatening" lucrative developments in wilderness settings; attempt to ensure that the National Forest Service serves the forestry industry with even more roads and cheap sales, rather than putting forest and wilderness protection goals above commercialization/privatization of the national forests
6. Gun laws:  attempt to peel back gun registration provisions--moving even closer to the absurd "wild west" model apparently sponsored by activist right-wingers on the Supreme Court providing for open carrying of handguns in bars, coffee shops, stores and public meeting places
7. Unions/public employees:  attempt to ensure that the corporatist agenda succeeds in the workplace by continuing the process of distorting American's views of the role of unions in protecting workers from corporatist power and by weakening even further American workers' ability to organize and by giving employers even more "rights" in the context of a union drive; in particular, at the state level we can expect drives to cut public employee pension benefits and cut state funding of pension plans, and at the national level we can anticipate continued demonization of federal employees as lazy bureaucrats protected by public employee unions from merited discipline and firing
8. Elections:  refusal to pass laws forcing full disclosure of all corporate donations related to elections on the corporations' financial statements, SEC filings and on publicly available filings of all 501/527 organizations receiving corporate donations; refusal to write disclosure rules forcing public information regarding major individual or other noncorporate donors to organizations engaged in election campaigning
9. Military/war:  little or no commitment to removing the impediments for gay servicemen and women;no commitment to cutting military expenditures and even likely some support for pushing the Pentagon to continue with expenditures that it has already determined are inappropriate and wasteful; little commitment to pushing for a pull-back from foreign invasions/occupations and even possible push for renewed "surges" in Afghanistan; likely commitment to increasing military support for Israel in spite of its continuing violation of international law on colonization of occupied territories; likely push for aggressive response to Iran, including warmongering

Worth noting:  if the election results in the GOP controlling the House and the Dems the Senate (and presidency, of course), we will likely have gridlock.  The GOP agenda won't be likely to be enacted because of that gridlock.  Accordingly, everything above is in terms of where their attempts, commitments will be, not what they will succeed in doing.  But what will they actually do?  Mark Thoma, Economist's View, Gridlock? Not in Politics (Nov. 2, 2010), speculates that they will "take advantage of this by introducing legislation they know won't pass but scores political points by forcing Democrats to vote against it...then use the noise machine to talk about how terrible this is for America.  We'll see Tax Cuts for Working Americans (where you give a few pennies to the masses, much, much more to the upper echelon, then, since there are so many people getting small breaks, claim that the majority of the tax cuts go to the middle and lower classes), the Deregulation of Apple Pie Act (which somehow turns into an attack on the FDA, financial regulation, etc., etc.,), we'll see poison pills attached to legislation that must be passed to operate government...."  Thoma also castigates the Dems (appropriately, I think) for failing to "take its arguments to the public and convince them that they were, in fact, fighting for their interests. ... Instead, they allowed the other side to take the initiative and demagogue the policies without much of a challenge."  When will the Dems ever learn?

Why taxes are important

The so-called tea party adherents and many libertarians, treat taxes as robbery, thinking that "it's mine and the government has no right to it."  That crazytalk, which most would realize if they ever had the opportunity to live in the brute-force world of no taxation.  It would be oligarch rule or the wild west without the civilizing influence of towns with governments and sheriffs to keep order.

With midterm election day just around the corner, maybe it's worth reminding everybody about the reason that all advanced countries have strong tax systems.  It's likely the case that none of us really enjoys paying taxes, and some of us complain about them all the time.  But most of us recognize that taxes are a necessary part of supporting a democratic government and a civil society.  Without a tax system, the rich and powerful would be able to do whatever they wanted.  There'd be no FBI or SEC to investigate their wrongdoing, no cops to arrest them, no courts to bring them to justice, no prisons to put them in.  Most of the rest of us would be subjected to conditions closely resembling slavery--or at least the conditions of the early twentieth century, when mineworkers could be bullied, beatup and even killed by "Pinkerton" thugs hired by mineowners, when union representatives might be murdered to keep them from inspiring workers to join together to fight the owners for reasonable wages and benefits, when old people had nothing but the charity of neighbors and families to live on, because companies didn't provide pensions and there was no Social Security organization in government.

As Oliver Wendell Holmes said, taxes are the price we pay for a civilized society.  Luckily, there is an increasing attention to this issue in the blog world, to counter the "taxes are evil" mantra of the neo-conservative and libertarian right.

See e.g. (in addition to the information here on ataxingmatter):

I Heart Taxes  (see, e.g., Baby, Taxes Drive Your Car, regarding federal funding for satellites making the GPS system possible)

Kay Bell, The Good Side of Taxes

The Tax Literacy Project

Taxes support democracy.  Taxes fund government services and goods, including court systems and national defense, which protect your life, your property, and your constitutional rights.

Taxes support economic growth.  Governments use taxes to encourage economic growth in numerous ways such as maintaining a stable currency, enacting and enforcing laws that protect both workers and employers (their life and property), and helping to build and maintain large and dependable energy, transportation and communication systems.

Taxes support your daily quality of life.  Taxes help you and your family buy a house, breathe clean air, have safe food and drugs, and travel safely and efficiently on highways, trains, and planes.  Taxes help pay for your health care (in the form of tax benefits or direct care) and they pay to educate you and your family.  Taxes help you at work (e.g. enforce contracts, provide safe workplace) and help you at play (e.g. national parks).

The Mortgage Loan Foreclosure Mess: Yves Smith on the Banks' Gluttony; Problems with MERS and Sloppy Securitizations

Edited noon 11/1/10 to clarify discussion of certificates as qualified mortgages in a REMIC.

Yves Smith has an op-ed in the Oct. 31, 2010 New York Times on the mortgage mess.  See Naked Capitalism, here, for full op-ed.

As noted, the mortgage crisis goes much deeper than just bank use of robo-signers for documents.  When the securitization process took off in the early 2000s, banks became sloppy.  Loan product was needed, so niceties like documentation became an expendible.  Subprime loans were more grist for the mill--the faster mortgage lenders could process them, banks could buy and securitize them, the more money they could all make.  Since they were selling off the mortgage loans, they didn't care how good they were.  And since they were often selling them via securitizations that they "sponsored", they didn't want to have to do all that legal busywork that location-specific transfers of mortgages and notes required, including payment of recording taxes in the county where the land was located every single time a loan was moved from one owner to another, though they still wanted to collect all kinds of fees from servicing the mortgage loans that they "sold" via securitization.

Just a little aside on the way these REMIC securitizations worked (edited noon 11/1).  Often, original mortgages and notes were put in a trust and pass-through certificates were issued by the trust--this is the case in particular when Ginnie, Freddie, or Fannie aggregated a pool of mortgage loans and issued certificates representing ownership interests in that pool of loans which are treated as obligations secured by interests in real property under Treas. Reg. 1.860G-2(a)(5).  Certificate holders were "beneficial owners" of the mortgage assets of the trust for tax purposes, though the Trust, or the trustee on behalf of the trust, would hold legal title to the mortgage loans.  The certificates, representing interests in mortgages, could then be contributed to a REMIC, or mortage loans could be contributed directly into a REMIC trust.  REMIC regular interests  are also treated as qualified mortgages under Section 860G(a)(3)(C), and they could therefore be contributed to another higher-tier REMIC, resulting in "re-REMICing".  The state law entity status for a REMIC doesn't matter--trust, partnership or mere segregated pool of assets (no state law entity at all) could all elect REMIC treatment for mortgage loans under the Federal income tax rules for REMIC securitizations, if they satisfied the federal tax code requirements. 

The requirements generally were that the REMIC had to hold only certain assets consisting of "qualified mortgages" and "permitted investments" (covering certain cash flow investments, qualified reserves, and foreclosure properties); it had to issue only permitted REMIC interests consisting of  "regular interests" that were treated as debt for tax purposes under the tax code and one class of "residual interest" that was treated as the owner of the REMIC under the tax code  (special tax rules applied to require the holders of the residual interest to report certain amounts of income with respect to the REMIC on their tax returns ); and it had to satisfy an "arrangements" test to ensure that the residual interest was not held by inappropriate organizations and that appropriate information was provided.  Qualified mortgages had to satisfy a loan to value ratio and had to be contributed to the REMIC either at startup or within 90 days under a fixed-price contract OR be substituted for defective loans within 2 years of startup.  If a loan were discovered to be defective after that, it would need to be sold out of the REMIC within 90 days, or the REMIC would hold a "bad" asset that could cause the REMIC to lose its qualification as a REMIC.  (There is a de minimis rule that lets a REMIC hold an insignificant amount of bad assets, but that generally would not cover a REMIC with lots of mortgages that fail to qualify.)  If a REMIC is disqualified, it is almost certainly a "taxable mortgage pool" under section 7701(i) of the Code that is subject to corporate taxation without the ability to be consolidated with other members of the same affiliated group.

Earlier private REMIC securitizations--the ones that were done in the late 1990s, for example--were careful to include detailed representations in the pooling and servicing agreement that the Depositor/Sponsor would assign the mortgage loans to the trustee for the benefit of the certificate holders--including the original note endorsed to the Trustee, the original mortgage, assignments of the mortgage, original assignment of leases and rents (for commercial properties), and original lender's title insurance policy.  The trustee was to hold such documents in trust for the certificate holders.  The following is an illustrative sample of representations that would have been included in a commercial REMIC pooling and servicing agreement regarding the transfer of mortgage loans from a current owner to the depositor/sponsor who would transfer them to the trust.

X is the sole owner and holder of the Mortgage Loan and will have, on the Closing Date, good and marketable title to the Mortgage Loan;

X has full right and authority to sell, assign and transfer the Mortgage Loan as contemplated by the Mortgage Loan Purchasing Agreement; all of the obligations of X with respect to the Mortgage Loans are legal, valid and binding and enforceable against X except as may be limited by bankruptcy, insolvency or reorganization (or other similar laws affecting the enforcement of creditors' rights, generally) and by general principles of equity; the execution and delivery of the documents contemplated by the Mortgage Loan Purchase Agreement has been duly authorized and such execution and delivery....will not constitute a violation of any federal, state or local law or the rules of any regulatory authority.

As of the cut-off date, the information pertaining to the Mortgage Loan set fortyh in the Mortgage Loan Schedule is true and correct in all material respects; X is in possession of a file on each Mortgage Loan containing, among other things and to the extent applicable, the note, loan agreement, mortgage or deed of trust, and all amendments, allonges or the like thereto, records of payments, correspondence, and borrower's address and each such file will be transferred to the Trustee, and X has not withheld any material information with respect to such Mortgage Loan...

The assignment of the related Mortgage to the Trustee constitutes the legal, valid and binding assignment of such Mortgage...

But when the banks got greedy in the early 2000s, they applied that brand of "financial innovation" that was bragged about as bringing us the nirvana of a service-oriented, financial transaction-dominated economy that would grow and grow and grow.  (Of course, it did at first, making lots of money for the financial institutions and particularly for investment banks.  But then it crashed, costing taxpayers while banks continued to make money out of cheap (taxpayer-made-possible) credit coupled with low interest to depositors and high fees for anything and everything.)  Two things began to happen. 

1. For convenience, the assignment/allonge was "indorsed in blank"--meaning that the sponsor wouldn't actually complete the document that transferred the mortgage loan to the trustee because it was "not practical to record mortgages in the name of the trustee" so the sponsor "retains record ownership subject to an obligation to transfer it to the trustee upon its request."  James Peaslee & David Nirenberg, Federal Income Taxation of Securitization Transactions (3d Ed. 2001) at 86 n.64 (concluding that this would be done only when the sponsor was "creditworthy" and so the fact that legal title wasn't conveyed should "not be very significant").  Of course, the boom in mortgage lending, securitization glut, and ultimate bankruptcy of key sponsoring banks such as Lehman and Bear Stearns suggest that this "practical" issue had substantial consequences, at least for the legal proceedings even if not for the IRS tax status of entities (where legal title is not necessarily determinative of tax beneficial ownership).  The danger, of course, is that bankrupt sponsors that retain legal title might be treated as owning the mortgage loans and the securitization vehicles to which the loans were purportedly transferred would be left with nothing, with the result that there would be questions whether the securitizations were legitimate (and if a REMIC, whether it had been disqualified from REMIC status because it had too many defective assets and therefore owed corporate taxes).

2.  The reason it was "not practical" to record the mortgage in the name of the trustee was that there are almost always local law mortgage recording taxes to be paid every time a transfer is made.  And of course, recording such taxes would be costly for a securitization--lawyer fees, servicer fees, the recording taxes themselves, document delivery and verification, etc.  That would cut into the profits from the securitization for the sponsor (who might well also be the servicer).  By keeping the legal title with the original sponsor, in spite of the pooling of the mortgages in a securitization, there would be no transfers until it was time to put the documents in somebody's hands for foreclosing.  That led to another financial innovation--the Mortgage Electronic Registry System (MERS), invented and owned by Chase, CitiMortgage, Bank of America, HSBC, Mortgage Bankers Association, Fannie, Freddie, various mortgage companies and title insurance companies. 

MERS apparently exists primarily to permit banks to avoid multiple transfers  and multiple mortgage recording taxes in local jurisdictions where the property is located with each purported assignment of the mortgage.  MERS claims that it serves to provide a consistent database that reduces errors caused by frequent assignments and reassignments of mortgage loans.  See MERS fact sheet (pdf available at home page).  But it seems to do the opposite--eliminate the actual assignment even though securitization has moved the mortgage loan from originator to bank sponsor to servicer or whatever, and avoid the ability of anyone to know who actually owns the mortgage loan from looking at county property records.  MERS indicates that it records the mortgage (in its name) and that it can foreclose on mortgage loans as the "nominee for all parties" --or the bank that claims to "own" the loans can foreclose on them.  See MERS statement about JP Morgan Chase (Oct. 13, 2010).  The fact sheet further indicates that MERS expects its standing to foreclose as the agent for the noteholder to be upheld in litigation and reiterates that MERS holds legal title (which is the reason that only one recording tax has to be paid, if MERS is held valid) and that it will transfer the legal title to the servicer/sponsor bank for foreclosing if requested.  (This transfer usually takes place, by the way, by the servicer bank personnel signing the indorsement from MERS to the servicer bank as an officer of MERS--another kind of robo-signing that the industry has perfected.) This does mean that many Servicers/Sponsors may have interacted with borrowers as though they held legal title when they did not.

As Yves Smith notes, "While a standardized, centralized database was a good idea in theory, MERS has been widely accused of sloppy practices and is increasingly facing legal challenges."  On the website, I see that MERS claims that it always has possession of the full documentation and that its arrangements for bank personnel to act as personnel of MERS are perfectly legitimate.  Yet I can't help wondering, if MERS always has possession of full documentation, why are there groups that advertise their ability to create documents, as Yves Smith also notes regarding "Lender Processing Services"?  Further, the idea of letting anyone represent themselves as an employee of MERS when they actually are an employee of a party that might have a reason for commiting fraud by inappropriately claiming to own a mortgage seems at least a questionable practice and one that should not be tolerated when it compromises the integrity of the mortgage system.  If I were a judge dealing with one of these foreclosure cases, I would have serious qualms about accepting such a document as "proof" that a particular bank had a right to foreclose.

As noted, under the rules before MERS, the  trust established with original mortgage loans would hold legal title, and the trust  would be entitled to act on the mortgage loans on behalf of the REMIC as beneficial owner.  That's especially important, since pooled trust certificates may not be held in a single REMIC vehicle--in fact, they are often scattered in various REMICS, and in REMICs of REMICs (REMICs squared and cubed, which may themselves be "re-REMICed" in the same deal or in later deals).  But if the trust doesn't actually hold legal title--because legal title is left with MERS from the first, in spite of the documents tracing a transfer from the sponsor to depositor to trust--that means that the trust actually holds in trust no mortgage loan but only its rights under the various documents and agreements it has entered into with MERS (and that borrowers have, probably unknowingly, signed off on in borrowing to buy property from a lender that is securitizing through MERS) to be able to acquire legal title if needed and then assign it, possibly, to the Servicer who will act on the foreclosure on the trust's behalf. 

Do each of those assignments get appropriately recorded (and taxes paid)?  Does this electronic database satisfy the state and securities law requirements?  If not, the important tax question is whether this limited actual legal right supports a REMIC's claim to "hold" qualified mortgages (aside from the question of whether these mortgages were "qualified" in  the first place, in cases where appraisals were rigged and borrowers' ability to pay was unexamined)?    It seems that the legal title should not be determinative for REMIC status.  If the loans are defective and do not qualify as "qualified mortgages" for REMIC status, however, it is possible that some REMICs would have "bad" assets that would disqualify the REMIC if the loan is not sold within 90 days of discovery of the defective loan problem. Moreover, if a bankruptcy court were to determine that a sponsor or other entity actually owned  (not just as legal title, but as beneficial owner in the tax sense) mortgage loans that had been thought to be included in the REMIC pool (and thus the court order allocated all funds connected with that loan, or foreclosure rights and sales proceeds, to parties other than the REMIC investors), it would appear that the decision removing the loan from the pool would create a loss to REMIC investors but would not in itself jeopardize REMIC status.  If the problem of non-existent documents and unverified loan quality was substantial, however, is there some possibility that the sham transaction doctrine could be applied to the REMIC to cause it to lose REMIC status ?  That's a hard call but seems unlikely given the highly "constructed" nature of the REMIC as a special tax entity under the Code--any entity or even a non-entity can be given REMIC status if it meets the requirements, regular interests are treated as debt even if they wouldn't independently be considered debt under general tax principles, residual interests are treated as equity even though they may have no entitlement to proceeds and primarily represent a liability to includes certain "phantom income" amounts in income, the sponsor may continue as servicer and continue to hold the mortgage loans (in a segregated pool) even when they are REMICed, tiering of REMICs results in a final allocation of mortgage payments that may differ considerably from the initial allocation in the first-tier REMIC, servicer and trustee actions are taken under the pooling and servicing agreement with respect to the mortgage loans according to whatever the documents permit or require (such as servicer advances to which it has reimbursement rights), etc.