Archive for the ‘taxes’ Category

End Federal Deductibility of State and Local Taxes by BUSINESSES

January 20th, 2018 No comments

New York State is thinking of moving to use payroll taxes  instead of individual income tax in order to tax labor income and also get deductibility for federal taxes. That made me think: why do we allow businesses to deduct state and local taxes on their federal tax returns? Read more…

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IRS: The Mess of the “Trade or Business” Definition

January 15th, 2018 No comments

My last post proposed that libel lawsuit income be incorporated or put on Schedule C, but I was wrong in making it seem simple. The law is a real mess here. The problem is the definition of “trade or business”. The tax code, in section 162, says that expenses for a “trade or business” are deductible as what is known as an “above the line” deduction, meaning that it is part of the computation of adjusted gross income, in Schedule C, before “itemized deductions”. In section 212, the tax says that expenses for “other income” are deductible— but this is known a “below the line” deduction, part of “itemized deductions” in Schedule A. Section 67 says that these other income expenses are part of “miscellaneous itemized deductions”, formerly subject to a 2% of income floor, now after the 2017 bill denied entirely (see the bill’s section 11045 amending section 67— though this contradicts section 212, which is unamended, I think).

Thus, it was good for the taxpayer before if his income was from “trade or business”, because he wasn’t subject to the 2% floor for expenses and now it is crucial, since his expenses aren’t deductible at all.

So what is a “trade or business”? Neither statute nor regulation has ever defined this term, crucial though it is to a lot of things. It has a tax common law meaning from various court cases, and a sorry sort of common law it is. The classic case is the 1987 Groetzinger. In Groetzinger, the IRS didn’t want to let a professional gambler deduct expenses. Gambling was clearly his occupation, so the Supreme Court said the IRS was wrong, a correct result. The Court said:

We accept the fact that to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer’s primary purpose for engaging in the activity must be for income or profit. A sporadic activity, a hobby, or an amusement diversion does not qualify….

We would defer, instead, to the Code’s normal focus on what we regard as a common-sense concept of what is a trade or business

We therefore adhere to the general position of the Higgins Court, taken 46 years ago, that resolution of this issue “requires an examination of the facts in each case.” 312 U.S., at 217 …. But the difficulty rests in the Code’s wide utilization in various contexts of the term “trade or business,” in the absence of an all-purpose definition by statute or regulation, and in our concern that an attempt judicially to formulate and impose a test for all situations would be counterproductive, unhelpful, and even somewhat precarious for the overall integrity of the Code. We leave repair or revision, if any be needed, which we doubt, to the Congress where we feel, at this late date, the ultimate responsibility rests.

So this is  a lame precedent. The Court says it is trying not to create a new test and that the meaning should depend heavily on the context and there shouldn’t be any general test. Moreover, the holding is that professional gambling is a “trade or business” even though gambling for recreation would not be. The holding is not that other money-producing activities would not be a “trade or business”; that’s just extension of the court’s reasoning to completely different contexts such a lawsuit.

Nonetheless, courts talk about the Groetzinger Test as it were a rigid mandatory test, because they want something convenient to use.

The cited case Higgins, as it happens, is an old wrongly decided case. Mr. Higgins had lots of stock investments, a major business, and wanted to deduct such things as the salary of his investment manager. The court said that running a portfolio isn’t a “trade or business” so he couldn’t deduct the expenses. It continues as precedent anyway, never overruled I think.

I thought we might argue that Congress never validated this rule, but unfortunately Congress did pass a couple of statutes around 2000 making expenses deductible for certain kinds of lawsuits. Using expressio unius reasoning, this implies that you can’t deduct expenses for other kinds of lawsuits, though Congress never thought about it, I expect.

So what we have with the 2017 bill is a trial lawyer’s nightmare: a bill that discourages lawsuits by imposing a prohibitive tax rate on plaintiffs by disallowing deduction of expenses.

The question remains of whether the IRS can fix the problem by issuing new regulations. I am inclined to think it can, but since it hasn’t done it before, maybe it has some reason to want not to. I’ll have to figure this out.

Another angle is that if it is Schedule C income, then there is self-employment (Social security) tax to be paid, but if it is Other Income, there is, I think, no self-employment income.

There must be a huge amount of one-off income-generating opportunities, many much more limited in time, scope, and energy than a lawsuit. Are they all Other Income? Maybe if I buy something and resell it, I can put that as Capital Gains instead and deduct the costs somehow there on Schedule D. I think brokerage fees are there, for example.

The situation with a lawsuit is perverse. Suppose I did put the proceeds from my libel suit into an LLC and sold 50% of the shares to Joe, and had the LLC pay the legal fees as they came along.  Could Joe deduct half the legal fees, even though I can deduct none? Or is this not a trade or business for Joe, either? Actually, does this mean all passive investors in companies with pass-through taxation are unable to deduct expenses? That sounds crazy.

To be continued.

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Taxes and Attorney Fees: Make Lawsuit Income Schedule C Income by Regulation

January 13th, 2018 No comments

Update January 15: See the next post for essential connection with this one.  I now think I might be wrong in a lot because of not knowing the “trade or business” law well enough.  Read with caution! I’ll read some cases and revise as necessary. My conclusion that IRS regs can be revised easily, without objection, may or may  not survive.

Apparently the 2017 tax bill eliminates deductions for attorney fees by eliminating miscellaneous itemized deductions (see Professor Gregg Polsky’s Slate article). I knew a lot about this at one time, because I was thinking about taxation of my Citigroup qui tam suit if I won. I’m now intending just to donate the proceeds to charity via a transfer of the lawsuit to a foundation if I get closer to winning, though I was hoping to deduct some fees for 2017 even though no income had yet been generated.  So I discovered the unsatisfactory legal treatment of contingency fees. Personal injury lawsuit income isn’t taxed at all, so the problem doesn’t arise, but income from libel suits and tax, SEC, or government contract whistleblower suits is taxable, and contingent fees are commonly 40%. Read more…

Categories: law, lawyers, taxes Tags:

Avi-Yonah Short Summary of Tax Bill and Donaldson Long Summary

January 13th, 2018 No comments

I really like  Professor Reuven Avi-Yonah’s   HOW TERRIBLE IS THE NEW TAX LAW? REFLECTIONS ON TRA17. It is short and clear and fair. His  four points are that (a) The $150 billion deficit increase isn’t as awful as one might think, (b) The bill  did cut taxes on the rich more than on the poor, but mainly via the 20% pass-through deduction,  (c) The bill has a lot of “good government” features, such as the increased standard deduction, and (d) the big problem is the 20%pass-through deduction, which will create a bunch of problems.

Donaldson’s Understanding the New Tax Law is also good, a longer summary, rather than a commentary.  As I recall, it notes:

1. No NOL carrybacks for corporations any more.

2. 60% max cash charitable deductions instead of 50%.

3. Professors lose the incredible sabbatical unreimbursed employee expense deduction for their rent, utilities, and meals while on sabbatical that I have enjoyed a number of times.

4. NOL carryforwards continue forever rather than just 20 years, saving  recordkeeping without really changing anything else.



Categories: academia, taxes, Uncategorized Tags:

Additions for My State Tax Paper: Reciprocity, Sullivan, and Pease

January 11th, 2018 No comments

For: Getting Around the State and Local Tax Deduction Limit (January 9, 2018). Available at SSRN:


(1)  Suppose we accept that fairness (or whatever) means that state taxes should be deducted from income for federal taxation, because they pay for public goods just like donations to private charities.  Suppose John Doe has an income of $1,000,000, West Dakota has a tax rate of 10%, and the US has a tax rate of 30%, so West Dakota tax is $100,000 and US tax is $300,000 sans deductibility.  Then if we add deductibility  of state taxes from federal income, 30% of $900,000 is just $270,000 and John Doe saves $30,000 on his federal taxes.

But suppose, instead, that we don’t do that. Instead, we add deductibility of federal taxes from state income. The result is that since 10% of $700,000 is $70,000, John Doe saves $30,000 on his state tax bill. Read more…

Categories: a.research, taxes, Uncategorized Tags:

Why the Idea of State Tax Credits and Donations Replacing Deductibility Won’t Work and How to Fix That

January 4th, 2018 No comments

The new tax bill limits the deduction for state and local taxes to $10,000.  This comes after the alternative minimum tax (AMT) already limits them if someone has enough capital gains and deductions to qualify for it, which a lot of people do.  Can states do anything to help their taxpayers? Read more…

Categories: a.research, taxes, Uncategorized Tags:

Pass-through Taxation and C-corp election; Schumpeterian motivations; politics; the financial accounting problem for earnings definition

January 2nd, 2018 1 comment
​​  This is quite a technical post, but some people will be interested.

On Mon, Jan 1, 2018 at 1:02 PM, Someone wrote me about the question of whether the Passthrough tax cut isn’t a big deal ,because even without it, if we slash the rate of taxation on C-Corporations a partnership could elect to be taxed AS IF it was  a C-corporation.  It turns out there are interesting complexities involved.

Read more…

How Much of S-Corp Income is Labor Income and Hence Subject to Medicare Taxes?

September 7th, 2013 No comments

Here are a couple of comments I posted at Taxprof:

T.C. Summary Opinion 2013-62 (McAlary, is amazing. Professor Schwidetzky has it absolutely right. Suppose Dr. Roe earns high labor income some years, low in others. He becomes an S-corporation, with zero capital. That’s not supposed to change his tax situation, right? But in deciding his S-corporation labor income for tax purposes, the court didn’t use that tax principle, even though it’s Tax Court. Instead, it used the corporation law principle of something like the business judgement rule— how low a salary wouldn’t be ridiculous for that industry? So it calls for expert witnesses to tell the court how much other doctors make in labor income, even though it knows exactly how much *this* doctor made.
If Dr. Roe puts in some capital for office expenses, that only makes things a little harder. It’s actually far far easier for an expert witness to accurately estimate a cost of capital than someone’s market wage. But we can put in a simple safe harbor for tax purposes. Just require the taxpayer to keep track of how much capital he puts in and give it a return of 5% over the IRS late-payment rate each year.
For a safe harbor, we need a notice-and-comment regulation or an IRS declaration of enforcement policy. Otherwise, even just a court ruling would be OK. This decision is a S(mall) one though, so it can’t be appealed. Even if it could be, the taxpayer would be well advised not to appeal it, because the IRS was extremely modest in its tax demand, and amici following the ideas here would ask the court to more than double it. (Can a court do that in a tax case?)

I found a history of this tax issue at
which shows, I think, that an old IRS revenue ruling is the source of the problem, by saying that “reasonable compensation” had to be paid by the corporation rather than trying to define which part of a corporation’s profit was return to labor rather than return to capital. Another way to put this is that the IRS didn’t require that *capital* was limited to a “reasonable return”. Of course, using words like “reasonable” gives wiggle room so that a taxpayer could say that of his corporation’s $500,000 profit, $100,000 was a reasonable salary, $50,000 was a reasonable return to capital, and the rest was a gift from heaven and shouldn’t be taxed at all.
I didn’t look at the Glass Blocks case at , but it seems the IRS has accomplished the Immigration feat of being both incredibly lax with most people and incredibly picky with a few. The poor taxpayer’s labor income was clearly negative, but the IRS “reasonable compensation” method doesn’t let people have negative labor income. The simple method of saying everything is labor income except for an estimated return to capital would have avoided making him pay.
(One caveat is that this involves Medicare and Social Security. It seems to me that a negative-income taxpayer should be treated as making no dollar contributions to the funds for purposes of his later eligibility, but as having put in those quarters of work,which was the way charitable work was treated, It hink, back when my mother kept track of her hours as secretary of the civic symphony).

Categories: a.research, taxes Tags:

Anti-Injunction Act and Obamacare

September 5th, 2013 No comments

For future reference on the latest Anti-Injunction Act caselaw: Agreeing on one thing: The Anti-Injunction Act does not apply
The following contribution to our post-decision symposium on the health care cases is written by Alan Morrison, Associate Dean for Public Interest, George Washington Law School. There’s been a lot of action in the appeals courts too— see Mersino and Hobby Lobby.

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The Meaning of “Value” for Gift and Estate Tax Donee Limitation in Tax Code 26 U.S.C. § 6324(B): An Amicus Brief for Marshall v. Commissioner

August 14th, 2013 No comments

I’ve posted a new draft of The Meaning of “Value” for Gift and Estate Tax Donee Limitation in Tax Code 26 U.S.C. § 6324(B): An Amicus Brief for Marshall v. Commissioner and submitted the brief. I wonder if I should try to make a law review article out of this? The topic would be how “value” is used in law. Here’s the abstract: Read more…

Categories: a.research, discounting, taxes Tags:

“Delay until They Die”

July 29th, 2013 No comments

Professor Fleischer’s May 16 “A Dickensian Delay at the I.R.S.” at the NYT isn’t looking so good. He said,

Long delays are evidence of ineptitude and a reluctance to tackle difficult issues, not evidence of a political conspiracy. It may be the case that a couple of I.R.S. employees went rogue, as the acting I.R.S. commissioner, Steven T. Miller, suggested on Wednesday before he was ousted from the job.

Aggressive investigation of those individuals may be appropriate. But firing Mr. Miller, as President Obama did on Wednesday, is mere tokenism. The witch hunt obscures the institutional failures that Congress could actually correct.

By now we have heard the testimony of the Cincinnati people, who say Mr. Miller’s IRS was lying when it tried to blame them, Read more…

Why the Rich Are Underpaid

June 27th, 2013 No comments

Prof. Tabarrok at Marginal Revolution talks about Prof. Mankiw’s discussion of taxes, the top 1%, and productivity. I had a thought: The most productive employees are paid too little, including the most productive CEO’s. Read more…

Categories: a.research, business, contracts, taxes Tags:

Out of 1,791 IRS lawyers, 38 made big contributions to Democracts and 2 to Republicans—Meaningful?

June 19th, 2013 No comments

What does it tell us if 38 IRS lawyers make big contributions to Democracts and 2 to Republicans, when there are 1,791 IRS lawyers total? The question came up today at Volokh COnspiracy. Isn’t 40 out of 1,791 too small a proportion?

No. Surprisingly, if a sample is chosen randomly, what matters is that the sample be big enough, not how big the population is. Thus, if 40 out of 500 is big enough, so is 40 out of 10,000. That’s why pollsters don’t use samples more than about 1,000— if they’re really random samples, it doesn’t help much go to higher. Read more…

Categories: politics, statistics, taxes Tags:

The Christian View of the Income Tax: Theonomist vs. Liberal

June 19th, 2013 2 comments

Gary North, noted “Christian Reconstructionist” has just published a scholarly rebuttal to a tax article by liberal Christian Susan Hamill (see here from Taxprof). This is cute, and I am glad it got published. It’s an example of how policy scholarship does have to depend on underlying ethical principles, and religious ones are just as much in need of good scholarship as atheistic ones. Read more…

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Charitable Giving of Obama, BIden, McCain, Palin

January 27th, 2009 No comments

From Taxprof, it seems Biden is even stingier than Obama in his charitable giving.

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Geithner’s Tax Cheating

January 22nd, 2009 No comments

I just retired from the IRS this past summer. I can verily state we would have been fired on the spot if unreported income was discovered on our tax return. It is shocking that Timothy Geithner would head the IRS, the same organization that would have fired me for ANY unreported income. I am sure shock waves are rippling through my former IRS office right now to think that the new head of the IRS failed to pay $30,000 in taxes. (a comment here)

Tim Geithner really is a man in the spirit of Bill and Hillary Clinton: rules are for little people, but they don’t apply to me.

Oh, those hapless Republicans! They don’t realize that what they have here– a knowing (that is, known since before the nomination was made public), deliberate, attempt to put a tax cheat in charge of tax enforcement– is the ticket to victory in 2010.

I know everybody says good things about Geithner, but keep in mind two other things:

1. He was at the New York Fed while it totally botched oversight of the financial system.

2. Cheaters never cheat just once.

Categories: corruption, obama, politics, taxes Tags:

Alcohol Taxes

January 7th, 2009 No comments

Philip Cook has a good post at VC on alcohol taxes. I might use it in G406.

As a thought experiment, consider increasing the alcohol tax by 10 cents per drink and then distributing the proceeds annually to every adult, $50 each. All but 7% would come out ahead on this deal. Given the preventive effect of higher alcohol prices, even that group would benefit from lower auto insurance rates and in other ways.

Categories: g406, social regulation, taxes Tags:

Average Tax Rates by Income

January 7th, 2009 No comments

Prof. Mankiw reports CBO average tax figures by income level (all federal taxes included, including social security tax I suppose):

Lowest quintile: 4.3 percent
Second quintile: 9.9 percent
Middle quintile: 14.2 percent
Fourth quintile: 17.4 percent
Percentiles 81-90: 20.3 percent
Percentiles 91-95: 22.4 percent
Percentiles 96-99: 25.7 percent
Percentiles 99.0-99.5: 29.7 percent
Percentiles 99.5-99.9: 31.2 percent
Percentiles 99.9-99.99: 32.1 percent
Top 0.01 Percentile: 31.5 percent

Categories: Economics, taxes Tags:

The Charity Gift to an Individual-What Is It?

January 5th, 2009 No comments

From Tom Smith at The Right Coast:

Something you can do these days is give someone the gift of having given a gift yourself to some charity. So you might get a card that says, We have given a goat on your behalf to the village of Ubuti in East Ubutistan. As a follow on, you might get a picture of the villagers posing with their new goat, which is from you, sort of.

I’m not saying this is not a nice thing. It is a nice thing. What puzzles me is just what it is. Not from a legal point of view. I’m not aware it raises any legal issues, interesting or otherwise. I just think it’s a little baffling what it is. Is it a gift? Somebody says to you, instead of giving you something you don’t really want or need, I have elected to give some people something they really do want and need. But then what does that have to do with me? Supposedly, the person sort of forgoing the gift gets the credit for it, but what credit is there, really? I didn’t give anybody a gift. Nobody asked me if I wanted to forgo a gift in order to enable the goat giving. I just get a card that says, you just gave a goat to someone, to which I might reasonably respond, I did? Maybe the idea is that the giver thinks I am such a good person I would prefer to have a goat given than to get a gift myself. Well, thanks! If you get a gift of this sort, do you write a thank you note for it?

A commentor noted that the donor, but the not the quasi-recipient, gets the tax break.

Categories: Economics, living, taxes Tags: