ataxingmatter

IRS Scrutiny of 501(c)(3)s

As most everybody is aware by now, the IRS has been under considerable strain for a number of years from budget and staff reductions that have left it underfunded, understaffed, and under pressure.  This is part of the right's effort to "shrink the government to a bathtub and drown it."  If the main organization for helping Americans understand their tax obligations is understaffed, it is likely that many people will become irritated with the agency and blame it (and taxes) for all their problems.  If the main organization for enforcing the U.S. tax laws fairly has too few people to audit the most likely scoflaws and too little money to prepare guidance and rulings to make it harder for scofflaws to scoff at the law, then many people will become irritated with the agency and blame it (and taxes) for their problems while many other people (especially the privileged rich) will continue to scoff at the law by overstating their basis when they sell capital assets, hiding assets in tax havens, and just hiring lots of expensive tax attorneys and accountants to come up with schemes for wiggling through the loopholes in the Code to avoid more taxes.

And of course, if the main organization for ensuring that tax-exempt organizations are not abusing their tax exempt status by using "dark money" to allow the domestic elite and foreign powers to influence and control federal elections and legislation, then odds are the rich and elite and foreign powers will wield more and more influence and control over who gets elected and what kind of legislation they pass.  Odds are we will see even more of the kinds of absurd legislation disenfranchising the poor and minorities by making it harder to vote, harder to get a State-issued I.D. card, harder to wait in line for hours at the polls (if you will be fired for not reporting to work), etc.

None of this is any surprise.

None of it is good government.

All of it is supported by the current radicalized uber-right-wing Republican Party hacks that are running many state governments and hold the majority right now in the U.S. Senate and House of Representatives.

As the New York Times editorial board noted, "[c]laiming a 'social welfare' tax exemption has become a tool for powerful political operatives like Karl Rove, the Republican campaign guru.  His Crossroads GPS group, which has 501(c) status, has spent $330 million on ads and candidates since it was created in 2010."  See Editorial,  Dark Money and an I.R.S. Blindfold, New York Times (Apr. 28, 2016).  And of course, with all the ranting about it being a problem to pick a group with "Tea Party" or "Progressive" in their name for closer scrutiny (when any common sense analysis will tell you that such a group is quite likely to be engaged in forbidden lobbying activities), "the IRS has groiwn ever more gun-shy about enforcement."

So the latest bill wreaking havoc on democracy, put forward by Republican Peter Roskam in the House of Representatives, would eliminate the current law that requires those who donate more than $5000 to a nonprofit to be disclosed to the IRS (though redacted for public versions of organizations' tax forms)..  See, e.g., Richard Rubin, House Republicans Seek to Block IRS Collection of Non-profit Donor Data, Morningstar, Apr. 28, 2016. That means a foreign corporation or a foreign sovereign power could contribute enormous sums to shape the legislative and regulatory regimes in our country, and there would be NO WAY TO POLICE THE PROBLEM. 

Further, it is hard to understand why any donor to a tax-exempt organization should be entitled to anonymity.  The organization is able to avoid paying any taxes on the funds received, and--especially under the current malevolent eye from Congress towards the IRS--the IRS is hamstrung in enforcing the law against political campaigning with 501(c)(3) funds.  What we should do instead of allow complete anonymity and the power plays that encourages is the opposite:  the name of every donor who gives anything more than some de minimis threshold amount to any tax-exempt organization should be publicly available, and the amount given should be publicly available.  After all, if money is "speech", "speech" is supposed to be heard.  Remember the old saying about the tree that fell in the forest and whether there would even be any sound if there were no eardrum available to hear it.  That's certainly the case with speech.  If giving money is a form of speech, than the gift and giver shouldn't be hidden under a bushel but should be broadcast far and wide for anyone who wants to know.

Note that the bill would also mean that the 'dark' groups under 501(c)(4) wouldn't even have to provide information about the number of large versus small donors that it has. 

By the way, if you have any doubts that Peter Roskam has no interest in the best interests of ordinary Americans, remember that back in November he was one of the gang of four that proposed pre-empting the rule expected from the Labor Department to impose a "best interest" standard on retirement advisers.  They were so worried (weepy face) that some professionals who handle money for retirees might refuse to do it any more if they weren't allowed to continue paying more attention to lining their own pockets rather than providing sound advice to their clients.  See Teresa Tritch, A New Threat to Your Retirement, New York Times (Nov. 19, 2015) (with a swarmy picture of Peter Roskam).

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Fortune 500's Massive Use of Offshore Tax Havens

Levin Floor Statement on IRS Publication 17 Resolution

Going Dark--not just an SEC issue, when companies keep their tax classification secret

Today's Times includes an interesting piece by Floyd Norris about the problem of companies that are neither private nor public but have (or claim to have) few enough public investors that the SEC allows them to "go dark"--quit reporting their financial statements, or anything else for that matter, to the public at large or even their few public investors--even though at least some of their shares continue to be publicly traded.  See Floyd Norris, Going Dark, and Putting Blindfolds on Investors, New York Times (July 13, 2013), at B1.

Norris is focused on the way that allows companies to take advantage of those (purportedly) few public investors by activities that "smell[] like insider trading." Id.  He reports on Equity Inns, a hotel owner acquired by Goldman in 2007, which had (and has) publicly traded preferred shares outstanding, apparently amounting to about 1% of the assets.  They'd been issued with par value of $25 and paid a dividend of  8.75% or 9%--now they are trading at less than $10 and Goldman has halted the dividend payments.  Norris notes that Goldman was the purchaser and the lender on the deal, so "it could restructure the debt in ways that would essentially give the debt holders--Goldman, that is--the ability to get everything, leaving the preferred shareholdes with nothing." Id.  The preferred share price declined, and then started to rise, and then  Goldman announced that an affiliate had acquired 35% of the outstanding preferred. Preferred shareholders, perhaps feeling cheated, are trying to get the SEC to require public accounting, since the company has more than 300 shareholders of record.  The company is trying to get the SEC to give it an exemption, with its lawyer claiming that "the issuer of the preferred shares ... was simply a real estate investment trust [REIT, in tax parlance] with a small economic interest in 130 hotels and no employees."  The SEC asked for public comment.  Norris adds that "public filings would make it easier to see what was going on, but Boldman would still have all the cards and might find ways to assure that the preferred holders received little or nothing from their investment."  Norris also points out the oddity that the company's Web site seems to discuss its status as a REIT, but Goldman claims that it "gave up its REIT status years ago and disclosed that in financial statements that are not public."

So here's my thought.  What reason can there be for not requiring publicly available information on federal income tax classification for all businesses that operate in this country? 

I've never found the justifications offered for confidentiality of business tax returns convincing in the first place: they usually claim that "trade secrets" would be revealed, but one suspects that the secrets they don't want revealed and perused over by journalists, tax practitioners (especially academics) and just plain citizens are those showing just how much they are taking advantage of tax expenditures/subsidies to make huge profits for their owners/managers while starving their workers. 

Those proffered rationales about trade secrets certainly don't support allowing any company to have one of the tax-privileged classifications such as partnership or S corporation or REIT or RIC status without having that status be public information.  Certainly the investors in those preferred shares of the Goldman affiliate at least have a right to know its tax status.  Beyond that, the public has a right to know just who is using what tax status (and how they are using it).  How can people reasonably participate in public dialogues about tax policy if they are so ill-informed about major players in the system? As it is, in the case of the Goldman-purchased company, there is no way for any lay person to substantiate or disprove Goldman's claim about REIT status.  And there are very large privately held companies, like Mars, Inc., that do not reveal their tax status--and won't even if you send them an inquiry asking them about it. 

In this post-Citizens United period, when corporations can spend money to directly influence election campaigns under the Supreme Court's absurd "first amendment" holding that corporations are persons, too, there is even less justification for secrecy about tax status than there might have been before.  This is one thing that could be easily legislated--a bill that creates a public registry of all businesses by federal income tax classification. It seems to me that sustaining democracy is much more important than sustaining tax-status secrecy.

Related articles

Apple's Tax Rates--just what does Cook's "way I look at this" mean???

Private prison firms, casino operators, and outdoor advertising as REITs--time to get rid of tax subsidies for RE industries

IRS Rethinking REIT Conversions Is Good News

REITs Not So Neat at the IRS

Hedge Funds Have Bought Lamar Advertising Co (LAMR), ITT Educational Services, Inc. (ESI) & More

Jack Cummings, General Utilities Repeal, and Treasury's Rollover

Jack Cummings (aka Jasper L. Cummings, Jr.) writes in the November 12, 2012 Tax Notes at 797-808 about "The Demise of the Liquidation-Incorporation Doctrine."  This is a must-read not only for corporate-tax policy wonks, but also for those who want to understand at least one of the reasons for the decrease in corporate taxes over the last few decades.

In the major rewrite to the tax code achieved in 1986, Congress legislatively undid the result of General Utilities, a case that allowed appreciated assets to leave corporate solution without taxation.  That is, Congress enacted provisions, particularly section 311(b), that purports to eliminate the ability of corporations to make distributions of appreciated property to shareholders without paying the tax toll on the appreciation while in corporate solution, except for certain situations covered by section 332 (i.e., complete liquidation into a corporate parent) and section 368 (i.e., bootless corporate reorganizations) that explicitly provide for non-recognition of gain in target corporate assets.  The policy grounds for nonrecognition in those provisions is that a domestic corporate parent or acquirer receives the corporate assets in kind, allowing a deferral of the recognition until the assets' later sale or distribution out of corporate ownership.

But the best-laid plans of mice and men oft go astray.  And General Utilities repeal has gone astray at least in part with the avid assistance of Treasury and IRS, which Jack Cummings ably explains in his article.

Since 2000 we have witnessed another response to General Utilities repeal, this time with the aid of Treasury and the IRS: the conversion of the C reorganization (and sometimes the A reorganization) into a tool to avoid General Utilities repeal as well as dividend taxation, through the upstream reorganization plus reincorporation.

Today a corporate tax director who wants to move Business A out of Subsidiary X, leaving it with Business B, can do so by (1) making sure that X is a "checkable entity"; (2) checking the box to liquidate X into a disregarded entity; (3) having X transfer Business A to Parent; and (4) checking the box to reincoporate X.  After those easy steps, which can be entirely invisible to the outside world, X may be more bnubile, more easily spun, or sold with less tax cost, because any gain in Business A need not be recognized. 

Several conscious acts by Treasury and the IRS have led to this new escape hatch from General Utilities repeal: the 1996 reg. section 301.7701-1,-2, and -3 check-the-box rules; the 2000 repeal of the Bausch & Lomb doctrine; the 2007 adoption of the 'no recharacterization' regulation [Reg. section 1.368-2(k)], which is the subject of this article; and IRS ruling practice that confirms all the beneficial results of those changes. Id. at 797.

Cummings assesses a likely logical path that the Treasury and IRS may have followed to become comfortable with the reg's statement that these transactions would not be subject to recharacterization, and then concludes:

 [T]he principal practical consequence of the rule, when combined with chief counsel's lenient attitude toward complete liquidations, is to permit a subsidiary to make a distribution to its parent without recognizing gain under section 311 or 361(c), and without the parent receiving a section 301 or 356 distribution.  ...  Those consequences may provide clarity, but they provide a very taxpayer-friendly clarity that writes out of the tax law the step transaction doctrine in cases of incomplete liquidation, even though the doctrine remains stated in reg. section 1.331-1(c) and section 346.  Id. at 801.

But the step transaction is one of those regulations that states a doctrine established by the Supreme Court in multiple reorganization decisions.  The step transaction doctrine surely can reveal Controlled to be the reorganization successor of Subsidary, and Congress has not provided otherwise.

Reg. section 1.368-2(k) has [therefore] left the law in a confused state, or perhaps in a near perfect state for spinoff planners who want electivity by form.  Id. at 802.

Cummings discusses a number of "basic principles" -- including Congressional intent that section 332 control the nonrecognition and basis results of liquidations; Congressional support for a "substantially all" criterion for reorgs; Congresional treatment of related corporation reorganizations as "special"; Congress's declining to provide that C reorgs cannot be recharacterized; and the reiteration of the liquidation-reincorporation rule in regulations -- and concludes that they "counsel strongly against writing a no-recharacterization rule." Id. at 806.

Whatever benefrits of certainty Treasury thought it would achieve by eliminating the cross-chain reorganization possibility have been swamped by the uncertainties it left or created ..., the closing agreements the IRS still has to seek, and the gutting of section 311 it has facilitated (not to mention further encouraging the notion that any consolidated group that pays tax on an excess loss account must have a stupid tax director).  Id at 806.

Cummings concludes that the various "simplifications" discussed in the article are troubling:

[These simplifications] have led to the unexpected consequence that well-advised subsidiary corporations need never recognize section 311 gain. Perhaps that is good tax policy.  . . .  But usually when that type of tax policy is made it involves the action of Congress, not Treasury, particularly when Congress has indicated a contrary intention by repealing General Utilities.  Id. at 808.

Tax practitioners and academics alike have thought that the open, communicative relationship among Treasury and IRS officials and the tax bar, demonstrable at any ABA tax section meeting, is generally good.  It permits the bar to share with government officials real situations that may have escaped attention in a regulatory or legislative development, thus making officials aware of any potentially harmful impact of those proposed regulatory or legislative changes.  At the same time, it allows the bar to comprehend the underlying rationales for proposals, thus providing a sound foundation for policy discussions.

But there are also real problems for tax administration if that relationship grows too cozy at the same time that there exists a continuing revolving door between service at the Treasury or IRS and significant positions as officers in the ABA or state bar associations and as commenters and panelists on regulatory or legislative proposals.  Many of those officials remain in office, while many of their former teammates have resumed their careers and are frequent commenters on regulatory developments. 

The taxpayer-friendly developments in the liquidation and reorganization areas under the Bush administration are a predictable result of that sometimes-too-cozy relationship and the corporatism inherent in much corporate tax lobbying.  Regulatory developments -- in particular the regulations regarding recharacterization and gain and loss recognition in the reorg context and the many tax-saving opportunities opened by the check-the-box regs and the decision to recognize "upstream" reorganizations (like A reorg mergers of a subsidiary into a parent) --represent an overture to corporate taxpayers that is not merited by the current economic realities, the longstanding application of the step transaction doctrine in these contexts, nor even the actual language of the tax code. 

Related articles

• Senate Hearing on Offshore Profit Shifting and the U.S. Tax Code
• Cash D Reorgs and Basis

Citizens United and Concepcion: Big Money, Speech, Taxes, and Individual Freedom

[edited 4/28 to add Angry Bear link]

Money isn't speech. 

In spite of that, the Supreme Court continues to expand its initial holding that treated expenditures of money to purchase speech as equivalent to speech and therefore protected by the Free Speech clause in the Bill of Rights, literally giving away elections and issue education to the top dollar, which will generally be the wealthy elite and the big corporations that own and manage. 

This idea--that money is the same as the speech that money can buy--is at heart a radically anti-freedom idea.  By equating money with the speech that it can buy, the Supreme Court has ensured that genuine speech rights will wither away, and that money will be able to buy elections and legislation to suit the source of the money.  The Court failed to understand that while speech can be bought by money, that purchased speech is merely one mechanism for distributing speech.  Speech is much more than the purchased speech that is bought by money.  If you don't limit the ability of money to purchase election speech, you are in effect disenfranchising all other types of speech that can't compete with purchased speech.  By equating the speech itself with the money that purchases it and claiming that the Free Speech clause applied to the money expenditure, the Court empowered purchased speech and empower Big Money, while it disempowered individual speech and made non-purchased speech practically irrelevant.

Since the Supreme Court's Citizen United decision expanding on this "money can purchase speech, therefore money used to purchase speech is protected in the same way that speech is protected" idiocy, it has been quite clear that Big Business carries a gigantic Big Stick that influences elections through anonymous issue ads and direct campaign contributions. 

The people are misled, since the ads are often purportedly sponsored by groups with titles that suggest little people working for the common good. 

The politicians aren't misled, because they get the Big Money that will allow them to flood the airwaves with similar stuff and they know where it comes from.

The result is that Big Money, from the few super-rich and the big corporations that they own and manage, can heavily influence critical legislators on deregulation and tax provisions favorable to the rich and Big Business. 

• There is a reason that the fringe right elected to Congress in 2010 is pushing for repeal of the health reform and Dodd-Frank financial reform provisions--those reforms require Big Business to operate in ways that protect individual freedoms and limit the way that those Big Businesses can push their costs off into externalities to create socialization of losses, privatization of gains  (e.g., high premiums paid only to find delay or denial from health insurance companies, risky casino speculation in derivatives from interconnected banks that lay their losses off on the public while raking in cheap financing provided by the public). 
• There is a reason that Big Business got its wish list in the 2003 tax legislation pushed through by the Bush Administration, and then got more and more of its new wish lists in the following years Bush tax legislation and in the Republican  provisions fought for in the "compromise" on stimulus funding in the first year of the Obama administration.  Those tax provisions provide tax reductions for corporations that increased the deficit and required additional borrowing (including bonus expensing, the active financing exception permitting deferral of income for certain controlled foreign financing subsidiaries, new cross-crediting provisions that permitted U.S. multinationals to subsidize their foreign operations by reducing their US tax rate, and many others).

Imagine an issue ad by "People in support of Removing Bad Regulation" that puts out misleading, non-factual claims about how Big Business X (maybe a resource-extractive business) will be done in if the "bad" regulation is continued, and that all kinds of little people will be harmed if Business X is harmed.  The facts are otherwise.  Big Business X engages in extraordinarily harmful mining practices that level the mountains, leave toxic debris in streambeds, and put miners in harsh, unhealthy conditions that don't meet anybody's standards of a decent working environment while preventing unionization to allow collective bargaining and bombasting the region with warnings about how jobs would drop if any of these bad practices are regulated.  And Business X is actually providing all the funding for "Little People".  And Buiness X also contributes $400,000 to several  congressional politicians who are on key committees that oversee Business X's industry.  It engages in both of these activities anonymously. 

How would people react if they knew that Business X was funding the ads that appear to be from a local concerned citizens' grassroots organization and at the same time was contributing huge sums of money to key politicians voting on those issues.  They would be more likely to ask questions and more likely to doubt the veracity of the information in the ads, knowing the source of the money behind them.

So there has been a movement in support of individual freedom that demands that at the least we must have disclosure of the Big Money behind the purchased speech that has disemplowered the free speech of the people.  Yet, Senate Republicans defeated a Disclose Act proposal in Congress last year through the now common route of requiring a supermajority of 60% to get to a vote, even though 59% of the Senate voted for cloture.  See Open Congress on Senate bill; seel also Disclose Act (wikipedia). 

Now the Obama administration is apparently considering an executive order that would require those Big Businesses seeking federal contracts to disclose their purchase of direct or indirect campaign contributions.  In other words, when they buy election-related speech that clearly serves as a quo inviting a quid from the elected officials aided by such speech. they should disclose it so that we the public can evaluate whether they get the invited quid.

Big Business doesn't want to lose its anonymity--especially when it comes to getting the lucrative federal contracts even though it may be supporting fringe politicians who claim to want to cut government spending.   (And of course, Big Business will likely use its money to support those politicians who talk about cutting government spending but mean only cutting spending for programs that form part of the social net for vulnerable citizens, not cutting spending on lucrative military contracts or other lucrative federal spending programs that create instant billionaires, like Eric Prince and his Blackwater security contracts in Iraq).

Big Business doesn't want to engage in real speech, but in purchased speech that can be hidden from the public with the use of misleadingly labeled front groups like the fictitious organization in my hypothetical.  And it intends to use all the formidable weapons in its arsenal to ensure it can continue to pour money into election campaigns without revealing its role. So Josten, head of the U.S. Chamber of Commerce, a major organization supported especially by the U.S.'s biggest multinational corporations, says "all options are on the table" to ensure that Big Business can contribute anonymously.  See Lichtblau, Lobbyist Fires Warning Shot over Donation Disclosure Plan, NY Times, Apr. 26, 2011.  Josten threatens that "all options are on the table."  Big Business will apparently do almost anything to protect its right to spend to elect its politicians of choice while not letting real voters know what it is doing.

 Meanwhile, of course, the Supreme Court continues on its tear of decisions that uphold Big Businesses' rights to conduct business as they want, no matter what impact that has on the freedoms of individual citizens of this country that fought a revolution to ensure those freedoms.  AT&T Mobility v Concepcion is only the latest foray in this direction.  In this case, the Court holds that we little people have no right to join together in a class-action against corporations that have misled us, even when the contract through which we became the corporation's customers was a contract of adhesion and the relinquishment of the right to a class-action is an interpretation by the corporation of the arbitration "term of contract" that we signed to get the service that the corporation provides.  Contracts of adhesion are "take it or leave it" contracts.  Most customers don't have the ability, let alone the money, to figure out what the terms mean.  Even if someone did finally persevere and reject a contract of adhesion because the terms took away individual freedoms, that person would find no better contract at any other service provider, since they all incorporate essentialy the same corporate-friendly terms in their contracts of adhesion.

The Supreme Court's inability to understand that the constitutional protection of individual freedoms was intended to prevent just this kind of corporate tyranny will be costly for this nation.  I predict that more and more people will get angrier and angrier about the extraordinary empowerment of Big Business and the extraordinary disemplowerment of ordinary people through this kind of corporatist agenda. 

For another Bear's perspective on the AT&T case, see Beverly Mann, The Fine Print, Angry Bear, Apr. 28, 2011.  It begins this way:

It’s hardly a secret that Chamber of Commerce types have co-opted a bare majority of the Supreme Court as their proxy in their war against business litigation, and that the most potent categorical weapons are arbitration as a forced substitute for lawsuits and the effective elimination of class actions.

In a manipulative, far-reaching opinion that the Court issued Monday, the five corporate proxies killed both birds with one stone.

And it includes a good description of how this decision turns our past understanding of arbitration  on its head.

Breyer, though, writing for the four dissenters, pointed out that Congress’s actual stated purpose was to require courts to treat arbitration agreements as contracts, for the purposes of enforcing them and, when required under contract law, voiding them—and that that is what the text of the FAA says.

Scalia also said that class arbitration defeats the purpose of arbitration. Which I suppose is true if the purpose of arbitration, or at least arbitration as the only option under law, is to undermine any real threat of meaningful penalty for corporate wrongdoing.

IRS Expands, Makes Permanent Large Corporate Taxpayer "Compliance Assurance Process"

The IRS announced in IR-2011-32 that it was making the complaince assurance process (CAP) for large corporate taxpayers permanent and expanding it to other corporations.  The process is designed to allow the IRS and corporate taxpayers with assets of $10 million or more to work out potential problems prior to the time of the filing of the return, helping to avoid problems on audit.  The program started in 2005 with 17 taxpayers, and has expanded to 140 corporate taxpayers at this time.

With the CAP program growing in popularity, it is being expanded to include two additional components. A new pre-CAP program will provide interested taxpayers with a clear roadmap of the steps required for gaining entry into CAP. A new CAP maintenance program is intended for taxpayers who have been in CAP, have fewer complex issues, and have established a track record of working cooperatively and transparently with the IRS.

“CAP is a program where the tax system is at its best -- when the taxpayer and the IRS are transparent and issues are resolved before a return is filed,” Shulman said.

I admit that I am skeptical about this program, as I am skeptical about the contractual process "advanced pricing agreements" whereby the IRS signs off on taxpayer proposals for transfer pricing.  A the recent discussion of corporate offshoring and other activities demonstrates, corporate taxpayers are able to afford sophisticated tax advice, and they use that advice to avoid taxes wherever possible.  They know their own situation intimately, and may well be in a position to cast transactions that are primarily tax avoidance arrangements as though they were germane to the business.  The IRS may be understaffed and short on time, and may not give these processes the time they demand.  The worry, at least, is that the IRS will satisfy itself that the company is a good tax citizen and then not focus on that taxpayer much at all once the CAP program is in place.  If the corporate taxpayer has fooled the IRS in the process, that makes for a tidy tax package for the corporation, but not such good news for the fisc. 

Does this happen much of the time?  I don't know.  And it is very hard for an outsider to assess the program without reviewing confidential tax information.  So that is another worry--that these types of relationships with taxpayers are behind the scenes and it is hard to hold the IRS accountable.

Corporate taxes: the SOTU, actual (effective) tax rates, and more

In the State of the Union address (see, e.g., PBS website for SOTU address and additional links), President Obama claimed that the United States can stay on top if only it can "out-innovate, out-educate, and out-build" other countries.  It is interesting that we describe our goals merely in terms of besting others, but that is the sometimes questionable legacy of American "exceptionalism." 

 Let's consider, in that context, how corporations, and the corporate tax, figured in the speech.  

 First, acknowledging the importance of government support for new areas of promising research and innovation, Obama stated that he would ask Congress "eliminate the billions in taxpayer dollars we currently give to oil companies. I don’t know if you’ve noticed, but they’re doing just fine on their own. So instead of subsidizing yesterday’s energy, let’s invest in tomorrow’s."  That sounds like a good start.  For decades, Big Oil has been coddled by the tax system while pushing its externalities--air, water, and land pollution--off on ordinary people.  It's time that the oil industry made it on its own.

On "out-educating" other countries, the President noted that elimination of the subsidies to banks built into the loan programs.  That, of course, is a good move, but leaves a lot on the table still to be done to provide educational opportunity to all Americans.  Both innovation and education would be well served by a significant investment in university research, rather than the fickle "R&D" tax credit that rewards companies often for just tweaking an existing product and not for the basic, innovational research that opens new frontiers.

On building, the President noted the need for infrastructure improvements from bridges to roads to  wireless technologies, essential for businesses and communities to grow in a global world.  But how can you invest in infrastructure if you do not ensure that you have the tax revenues to pay for it?  And the will to do that seems to be missing, both in the White House and in Congress.

On the issue of business success, President Obama first sounded a familiar and appropriate note--the problem that lobbyists for businesses have "rigged the tax code to benefit particular companies and industries. Those with accountants or lawyers to work the system can end up paying no taxes at all. But all the rest are hit with one of the highest corporate tax rates in the world. It makes no sense, and it has to change."  It is clearly true that the many provisions that operate as loopholes for particular businesses (take the section 199 domestic production credit, for example) should be eliminated.

But then Obama went on to say that what was needed was simplification.  That's highly questionable.  Most of the complexities in the Code came in response to tax shelter transactions or other overly aggressive interpretations of the Code that assisted companies in cutting their tax bills.  Each shelter requires a response in terms of more specific code language, leading to more complex provisions as the only way to combat the tax minimalization norm.

Obama suggests that we can get rid of corporate loopholes and use the savings to lower the tax rate for corporations.  Maybe.  But perhaps our goal should be to disincentivize aggregation of corporate entities in conglomerates that have no loyalty to country or worker, rather than allowing them to continue to move assets abroad.  We should consider what provisions are necessary to allow workers to share in the profits that they help create.

 Like most people preaching corporate tax reform these days, the President appears to be on board with the "received wisdom" that it is important that the US help big multinational corporations located in the US to compete in other countries and that the US statutory rate is a problem in that regard.  

You can check out prior postings  to see my arguments against the competitiveness argument.

Quite a few of the experts who write about corporate tax think the corporate tax rate should be reduced to zero.  Their arguments are often laced with plenty of talk about how investment income ought to be favored or, another version of same, how capital invested in corporations shouldn't be taxed because it supports entrepreneurialism.  That argument is inapplicable, however, for all except that part of the capital that is invested in a corporation from the outset or made as a new contribution to capital of the corporation:  the "startup" capital actually supports whatever entrepreneurialism may be going on in that corporation, and new capital contributions may or may not support entrepreneurialism.  (Even startups may not be entrepreneurial, but some at least are.)  Most investments in corporate stock are not even invested in the corporation--they are just secondary market purchases between investors, so there is no new investment going into the corporate entity.  There appears to be very little reason  to treat gains from secondary market trades in corporate stock more favorably than labor income for tax purposes--those resources will be invested in something or spent, so we don't need the tax law to incentivize the investment.

The arguments for eliminating corporate tax otherwise usually boil down to a statement along the lines that "people are the only ones that really pay tax, so corporations shouldn't be taxed."  That is an a priori conclusion (based on determining that people are the only "real" taxpayers), but somehow it passes for astuteness amongst many tax experts.   It is claimed to be based on economic reality--that only people earn income; that it is people that run corporations but there is no "person" that is the corporation; that the corporate tax can be and is passed on from the entity to others that are people--customers, vendors, employees, shareholders.  While there is a kernel of truth to each of those rationales, there is also a much larger story that they do not capture.  The idea that "only people earn income" ignores the reality of corporate entities of infinite duration that may hoard millions in cash rather than pass it to the shareholder/owners.  The idea that the corporation itself isn't a person (which is only relevant, of course, with the corollary that only people pay tax) has been undercut by the expanding scope of the Slaughterhouse Case decisions that treat a corporation as a person for constitutional purposes--including the recent Citizens United case that allows corporations to spend money to influence election campaigns, though they cannot (yet) vote.  Though the incidence is not fully certain, one might think that it is most aptly described as passed on to shareholders since there are less corporate earnings to be distributed).  If one says that similar passing along occurs whenever one person hires another (family with nanny pays nanny out of service income of family even though they pay taxes on that income; nanny treated as gettting compensation income on which nanny also pays taxes), one is warned that this is playing games and not the way proper economic analysis treats the situation since it is "inherently" different when it is an "entity" that can't "actually" do services except by the actions of the people who own and operate it, so should not be treated as earning income or paying taxes.

 One could also say that corporations don't talk so they shouldn't have First Amendment rights.  That wouldn't get us far with Citizens United on the books. 

As a result, whether corporations are taxpayers or not and whether they have First Amendment rights or not is a matter of law.  Right now, our statutory law says corporations are taxpayers and our constitutional law (as interpreted by the Supreme Court) says they also have First Amendment rights.

Remember that the statutory rate is the rate applicable under the statute to "taxable" income rather than economic income.  Taxable income is almost always much lower than economic income, since there are both income exclusions (e.g., certain life insurance) and deductions and credits (e.g., the R&D credit, the section 179 "expensing" deduction) that make taxable income considerably less than economic income.  As a result, most taxpayers--and especially most wealthy people and big corporations--don't pay anywhere near the statutory tax rate on their economic income.  My favorite example in my basic income tax class used to be Dick Cheney.  There was a year when he had millions of municipal bond interest income (excluded from taxable income): obviously, his taxable income was much lower than it would have been without that exclusion, so he paid tax on an amount that was considerably less than his economic income.  In another year, he took advantage of the so-called "Katrina charitable contribution provision" that permitted taxpayers to completely reduce their taxable income to zero with their charitable contributions (which didn't have to do anything to aid Katrina victims or New Orleans).  You can imagine that there'd be someone who typically made $200,000 a year in contributions and who might make $600,000 that year (and not make the $200,000 a year for the next two years) and be much better off taxwise.   Of course, the fact that wealthy people own the lion's share of the financial assets of the country gives another advantage here--they can contribute stocks and get deductions for amounts that they've never paid tax on!  And on and on... 

Obama was correct on one thing:  the federal income tax is riddled with provisions that benefit big corporations, especially Big Oil which benefits from "percentage depletion" and others that enjoy considerable benefit from the modified accelerated depreciation provisions (dating back to Reagan's time) and various bonus depreciation and expensing provisions that don't reflect the economics and have added complexity to the Code since then.  Scaling back those provisions--eliminating the many subsidies for Big Oil and modifying the provisions for accelerated expensing and depreciation would be a good move.

The corporate expertise in taking advantage of loopholes or in "inventing" them (tax strategy patents, anyone?) results in US corporations pay very little in federal income tax.  David Leonhardt discussed that recently in an article about The Paradox of Corporate Taxes, New York Times, Feb. 1, 2011.  While noting that companies have various reasons for having low tax bills, including significant losses carried forward from earlier years to offset years of profits and  significant purchases of equipment or buildings that are allowed to be "expensed" under today's capitalization and depreciation rules, another reason that many are successful is that they have developed significant expertise at avoiding taxes.  Leonhardt reports that GE, for example, paid less than 15% of its corporate profits in taxes between 2005 and 2009.

G.E. is so good at avoiding taxes that some people consider its tax department to be the best in the world, even better than any law firm’s. One common strategy is maximizing the amount of profit that is officially earned in countries with low tax rates. ...

Companies that pay relatively high rates tend to be those that are not expanding rapidly and that are not as ingenious as G.E., at least on taxes. The average total tax rate for the 500 companies over the last five years — again, including federal, state, local and foreign corporate taxes — was 32.8 percent. ...The problem with the current system is that it distorts incentives. Decisions that would otherwise be inefficient for a company — and that are indeed inefficient for the larger economy — can make sense when they bring a big tax break.

But Leonhardt's numbers may make corporations look like better taxpayers than they actually are.  Citizens for Tax Justice recently published a study suggesting that the contribution to tax revenues from US corporations is even lower than generally reported.  According to CTJ, GE didn't pay anywhere near the 14.7% that Leonhardt claims.  "GE's effective tax rate for its U.S. profits was actually just 3.4 percent over that period. Our figure is based on what GE says that it paid in U.S. corporate income taxes (called "current" taxes) divided by what GE says its pretax U.S. profits were (all from GE's annual 10K reports to shareholders, filed with the SEC)."   See  U.S. Corporations Are Paying Even Less in Taxes Than Recently Reported, Citizens for Tax Justice (Feb. 4, 2011).  CTJ suggests that  there are several reasons why some reports misreport the US income taxes paid by corporations.

• First, some analysts are misreporting how the worldwide taxation system works and thus larding the corporate taxes paid to the US with taxes that corporations pay to other countries.  While the US system includes worldwide income in taxable income, it also gives corporations a tax credit for taxes they have paid on their foreign income to other countries, up to the amount of tax that would have been paid in this country.  So those taxes shouldn't be counted as part of the US taxes paid. As CTJ explains, "to understand how the U.S. corporate income tax is working, one must focus on U.S. taxes paid on U.S. profits. No one expects Congress to do much about taxes that U.S. corporations pay to the governments of France, Germany, or Japan!"
• Second, only the "current" taxes in financial statements (available generally in SEC filings for reporting companies) are relevant.  Taxes that are listed as "deferred" may be due and payable but they don't count as taxes yet.  As CTJ notes," "Deferred" is a euphemism for "not paid." Corporations can defer (delay) paying taxes if, for example, they enjoy tax breaks for accelerated depreciation, which allow them to take deductions for capital investments sooner than they would if the rules were simply based on the actual life of the investment. A company could eventually pay taxes that it has "deferred." But that doesn't happen very often."
  
  
  

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?

Shulman on complexity, uncertain tax positions

Doug Shulman, the Commissioner of Internal Revenue, spoke today at the New York Bar Association Tax Section's annual meeting.  See Prepared Remarks (Jan. 26, 2010).

Among other issues, he addressed the ever-present question of complexity and the hot topic of tax accrual workpapers and information about uncertain tax positions. 

1. Complexity

Shulman was not addressing tax law simplification--as the speech notes, "that's a speech for another day."  He was talking about the fact that the IRS now administers a great deal of the country's social policies--from purported economic stimulus and global competitiveness policy (e.g., lowering of US "manufacturers" tax rates through the section 199 deduction; lowering of US banks' tax rates on foreign income through the "active financing exception" to subpart F income; lowering of most businesses taxes through expensing and acceleration of deductions for equipment through bonus depreciation) to aide to low income families (e.g., earned income tax credit, etc.).  The IRS even administers our environmental policy (or lack thereof) in large part (see the numerous provisions for special treatment of natural resources extractive industries).

One worthy initiative Shulman discussed is the attempt to "better understand the entire complex economic picture of the enterprise controlled by the wealthy individual and to assess the tax compliance of that overall enterprise."  To do so, the IRS has created a group that will focus its expertise on high wealth individuals and the entities through which they control that wealth.  Similarly, the IRS has focussed on offshore tax evasion, developing expertise and coordinating the various efforts at disclosure, legislation, and cooperation with other governments.  The IRS Is also "looking for and finding points of leverage...where multiple people not paying taxes can be detected such as f]inancial institutions...[and] promoters of evasion schemes."  To further all of these objectives, the IRS Is working on a protocol for joint audits with treaty partners, an effort that should limit multinational corporations' opportunities for arbitrage.  Shulman says more specialized attention will also be given to transfer pricing issues.

2. Uncertain Tax Positions and Tax Accrual Workpapers:

Readers will recall from prior postings (here, here, and here) that the First Circuit Court of Appeals recently ruled in Textron that tax accrual workpapers are not protected by the work product privilege, since they are prepared for accounting purposes and not for litigation. 

Companies, of course, want to have their pie and eat it too.  They want to be able to claim that they are adequately reserving for potential losses in respect of their "uncertain" tax positions for accounting purposes, while preventing any disclosure about those determinations for tax purposes under a claim that the evaluations of their uncertain tax positions are prepared "in anticipation of litigation" under the civil procedure rule protecting work product from disclosure to the opposing party. 

I've argued that the work product claim for such documents is absurd on its face under the seminal Supreme Court case--those evaluations are required for accounting purposes and not for legal purposes so the documents are business documents and not protected legal documents.  Further, the mere fact that determinations about uncertain tax positions have to take into account the possibility of success if the position were ever litigated cannot be sufficient to turn those determinations into protected work product because EVERY tax position that is not certain must be evaluated for its likelihood of success on the merits to determine whether there is a requirement to disclose or sufficient authority to take the position on the return in the first place.  That mere evaluation does not mean that the evaluating document is prepared in anticipation of litigation or even that litigation is expected.  In most cases, in fact, it is not.

Under the Supreme Court Arthur Young case, it is also clear that accounting determinations are not protected documents.  The IRS could demand tax accrual workpapers in connection with every audit.  But the IRS has a policy of restraint, under which it will typically not request tax accrual workpapers.  If a company has engaged in a number of listed transactions (transactions that have been identified by the IRS as potentially abusive tax shelters), then the IRS will request a copy of all tax accrual workpapers. 

Shulman said that the IRS has also been "taking a hard look at transparency regarding business tax issues" because of the many changes in accounting for income taxes and tax risk.  He announced a "major step" in reporting requirements for uncertain tax positions, unveiling Ann. 2010-9 (available on BNA).  He noted that too much time is wasted in corporate audits "searching for issues rather than having a straightforward discussion with the taxpayer about the issues." In order to get more complete information earlier, the announcement provides for reporting uncertain tax positions at the time a return is filed by covered taxpayers (generally those with assets over $10 million who file FIN 48 about establishment of tax reserves OR, even if FIN 48 reporting isn't required, a position that the taxpayer expects to litigate or that the taxpayer knows the IRS has a general administrative practice of not examining).  Disclosure would describe each uncertain position and the maximum tax liability if the position is not sustained.   The statement would be required to reveal the Code sections implicated, the reasons for determining that the position is uncertain, whether the position involves a permanent exclusion or inclusion or timing benefit (or both), whether it involves a computation of basis, and whether it involves a determination of the value of property, among other matters.

Beale here:  This position is something I have argued for in the past (see my article on Before the Return).  One cannot argue that such additional disclosure is improper, since it is necessary to arrive at all of those determinations in order to file a tax return incorporating the position.  One cannot argue that such disclosure is burdensome, since public companies already prepare this information for their financial statements or, again, for filing their tax returns.  One cannot argue that this disclosure is unreasonable, since taxpayers who make returns are basing those returns on their assessments of success regarding those uncertain tax positions--all information that goes into the return should, I argue, be disclosable to the IRS, so having a brief description of an uncertain position and the dollar amount at stake is minimally intrusive and maximally helpful.

Shulman indicates that, as part of this proposal, the IRS will continue its policy of "restraint" in asking for tax accrual workpapers. 

Beale here:  I am doubtful whether this continuation of the policy of restraint is reasonable.  A company that has a large number of uncertain positions with high dollar figures should be required to share its tax accrual workpapers with the IRS.  Since these are business documents and not tax documents, there is no reason that the IRS should hamstring itself in applying a "policy of restraint" regarding acquisition of information that could be central to the IRS's ability to find noncompliance or its ability to understand the positions taken by the taxpayer.