Tax Law Access in the 21st Century - Guest Post

I am pleased to publish a guest post from Ari Hershowitz of Tabulaw who also blogs at http://blog.tabulaw.com/. Ari is focused on finding and making useful, free legal materials from the government that can be combined with technology to make legal research far more efficient and useful and allow for sharing of information among practitioners. You can see a beta of this for federal tax purposes at tax26.com and a good example of what is involved in one of Ari's recent blog posts - "Open Source the Tax Code" (6/17/11).

This is a great example of how technology can and should modernize tax practice. Thanks, Ari. Read on for his post ...

I am inspired by Professor Annette Nellen's writings on innovative tax policy and practice, and by the vibrant community she has created around these issues on 21stcenturytaxation.com. It is a privilege for me to be asked to share my thoughts on the potential role of technology in these efforts, and I am grateful for her advice and insights for this article.

At tax26.com, we are experimenting with technologies to improve navigation of tax law. I welcome your feedback, thoughts and participation, and hope that our work can support the work of the "tax innovation community" on 21stcenturytaxation.com.
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The Internal Revenue Code (IRC) is more than half a million lines long: 520,226 lines to be precise, made up of 3,939,919 words and 28,330,811 characters. If you don't believe me, you can count them yourself.*

This article sets out a proposal for textual and technological changes to simplify understanding and use of the Tax Code. These changes are meant as a foundation--and not a substitute--for the important policy and legal decisions that most tax experts mean when they discuss simplifying the code.

Layers of Complexity

The IRC is not only long, it is complex, as readers of 21stcenturytaxation.com well know. This, for example, is a map of all U.S. Code references to and from 26 U.S.C. 501. Add to these references the related federal regulations, IRS rulings, guidance and other interpretive materials, and it's no wonder IRS Commissioner Shulman gets his taxes done by a professional tax preparer. The Hill quoted him last year as saying, "I've used [a tax preparer] for years. I find it convenient. I find the tax code complex so I use a preparer." (quoting an interview on C-Span).

President Obama made simplifying the Tax Code a centerpiece of his State of the Union Address, saying, "It makes no sense, and it has to change."

But the President couldn't have meant removing all of the complexity in the Tax Code. Much of that complexity arises from the policy goals and myriad transactions that it is designed to address; by analogy, no one would want an airplane design to be simple at the expense of being able to fly in rainy weather. I'll call this essential complexity the "transactional" layer.

Other complexity arises from redundant or overly circuitous paths to reach a policy goal that could be implemented more simply, without loopholes, exemptions, extensions, etc. This is where I suspect President Obama's State of the Union statements were aimed, to the extent he expects to be able to move tax reform legislation. I'll call this the "implementation" layer.

A third, underlying, layer of complexity comes from the legislative drafting process itself. I'll call this the "textual" layer.

We shouldn't underestimate the challenges of simplifying the tax code for any of these three layers. However, I believe that there are uncontroversial technical reforms in the textual layer can greatly clarify the policy issues at stake in the other two layers. There is also a great deal that the private sector can do to improve the search, visual display, and organization of existing tax law. As a whole, this "text reform" can be seen as cleaning up the map or getting better GPS software before embarking on the journey of broader tax reform. A new map can't decide where to go, but it can help you get there.

Below, I propose 5 steps for this map to improve navigation, accessibility and clarity of tax law.

Text Reform: 5 Steps

1. Use plain language
The first proposal is not technological, but is fundamental. To the extent possible, tax legislation should be written in plain English. The Plain Writing Act of 2010 nudges Agencies in that direction. When it passed, John Klotsche, former Chairman of Baker and McKenzie's Executive Committee, identified the potential significance of this Act, if the IRS takes up the challenge to use plain language in forms, guidance and other (non-regulatory**) communications. Your thoughts: has the Agency adequately done so? Klotsche suggested that Congress should use plain language for tax law, too, and I agree.
Using short simple words is part of plain language, but it is not enough. Consistency is also important. For example, as Professor Nellen points out in this post, the word "small" (business, seller, employer) is defined in a variety of ways throughout tax law and regulations.
2. Accurate and instant updating of tax law

Changes to tax law and rulings should be done in electronic formats that can be automatically updated with the changes. This will require adding "hooks" to existing tax law and clearly identifying those hooks when making changes.

Such a system has been experimentally implemented for regulations, so that the electronic version of the Code of Federal Regulations (e-CFR) is now updated within two days of any Federal Register notice. This system was put in place through coordination of the National Archives and Records Administration's Office of the Federal Register, in conjunction with the Government Printing Office (GPO). The technical know-how exists to do the same for legislation, though it may require some changes to the legislative drafting process, and cooperation among institutions.

3. Redlining legislative and regulatory proposals

Circular230 w. edits, courtesy Annette Nellen

Hand-in-hand with automatic updating, is a process to produce automatic redlining of legislative proposals and regulations. Again, this will require some technical changes behind the scenes, but imagine the improvements in accountability and clarity when proposed changes are displayed visually, and when you can navigate from one change to the next, as easily as you can "Find" a phrase in a Word document.

4. Visual timeline of legislative history
Once the first steps are in place, it becomes possible to create a visual history of legislation, regulations and other sources of law; essentially to get a "snapshot" in time of the state of the law. True, this is not fundamentally new, since this is legislative history research is all about. But our visual system is particularly adept at identifying changes and this is one more element in clarifying the state and trajectory of the law.

5. Streamline, organize and codify IRS Rulings and Guidance
The IRS can use subject-matter tags and other categorization tools to better classify the subject matter of its official rulings and guidance. In the particular case of letter rulings, the process for submission and response can be further formalized to allow relevant legal determinations to be more easily extracted, categorized and read alongside the relevant supporting precedent.

Practitioners can also tag, comment and provide analysis of tax law sources, a process we hope to facilitate at tax26.com.

Future
Any technology must be adopted alongside an equal dose of judgment, and progress toward these five steps cannot replace the good judgment of a tax professional. At the same time, using plain language and integrating better structure into tax law can make the law simpler to navigate, understand and follow.

Ultimately, this should also result in more accurate tax compliance and wider access to free and useful tax research tools. These tools should also help maintain transparency into the future: changes proposed by Congress, Treasury and the IRS, will be easier to trace, through redlining or the equivalent, leading to more informed participation and deliberation. This process, in turn, should increase the chances that any changes adopted are truly warranted and easy to understand.

*Really, you can count the lines in the IRC text. Just download the text version of the Code and, if you have a Macintosh or other Linux-based computer, type this (from the command line):

        $ wc Title_26.txt

**Section 3 of the Act specifically excludes regulations.

By Ari Hershowitz, http://blog.tabulaw.com/

California budget deal and taxes

As reported today, the current version of the California budget does not include the renewal of earlier tax rate increases, but relies on spending cuts and expected increased tax collections. (See Mercury News article and LA Times article (6/28/11).) The budget would also include a law change to try to get Internet vendors to collect California sales/use tax rather than relying solely on customers to self-assess use tax (see my post (and comments) of 6/27/11).

I'm glad to see the increased revenues (from improvement in the economy, but amount is still uncertain) and no tax rate increases. I have suggested for some time now that California's tax problems lie with the tax base rather than the rates (which are among the highest of states other than our property tax rate of 1%). For example, rather than increasing the already high sales tax rate that applies to an eroding tax base (tangible personal property), the rate should be lowered and the base broadened (modernized) to include many types personal services, digital downloads and entertainment. Revenue from the broadened base could be used to both lower the rate and start creating exemptions for business equipment (to avoid pyramiding and improve the state's business tax climate). The personal income tax can be improved by removing unnecessary and ineffective deductions, exemptions and credits. For example, reduce the home mortgage deduction so it only covers interest on a loan on your principal residence (not also a second home and an equity loan) and only up to loans better tied to the median home price (rather than $1.1 million). For more on improving the personal income tax - click here.

Remember, a tax system is more likely going to meet principles of good tax policy if it has a broad base (so few deductions, exemptions and credits) and a low rate. Unfortunately, is it usually easier to increase the rate, which exacerbates the base problems, rather than remove special deductions, exemptions and credits. But the hard work needs to be done.

What do you think?

Sales Tax Collection on Internet Sales

The drama continues ...

States continue to try to find ways to get Internet retailers to collect sales tax from in-state customers rather than relying on customers to self-assess and pay their use tax. (Of course, there are exceptions, such as I just posted about the other day where South Carolina carved out an exception for Amazon and other large Internet vendors willing to make a large investment in the state.)

The pending bill in California, passed in June by Assembly and Senate, is ABX1 28. It would broaden the definition of retailer engaged in business in California, for sales tax purposes to include:

"retailer engaged in business in this state any retailer entering into agreements under which a person or persons in this state, for a commission or other consideration, directly or indirectly refer potential purchasers, whether by an Internet-based link or an Internet Web site, or otherwise, to the retailer, provided the total cumulative sales price from all sales by the retailer to purchasers in this state that are referred pursuant to these agreements is in excess of $10,000 within the preceding 12 months, and provided further that the retailer has cumulative sales of tangible personal property to purchasers in this state of over $500,000, within the preceding 12 months, except as specified. This bill would also provide that a retailer entering into specified agreements to purchase advertising is not a retailer engaged in business in this state and would define a retailer to include an entity affiliated with a retailer under federal income tax law, as specified. This bill would further provide that these provisions would not apply if the retailer can demonstrate that the referrals would not satisfy specified United States constitutional requirements, as provided."

So it is similar to the 2008 New York legislation that makes an Internet retailer subject to sales tax collection based on in-state activities of "associates" (those with a link on their website where they get paid if someone places an order by starting with that link). One big caveat, likely directed to help eBay and its users, is the $500,000 amount. Otherwise, eBay is like an "associate" for those selling items on eBay (because eBay gets a commission on the sale) causing hundreds of thousands of eBay users to have to collect California sales tax.

Also, the rebuttal approach of New York is greatly modified. The vendor would need to show that requiring them to collect California sales/use tax would be against the Due Process and/or Commerce Clauses of the US Constitution.

Will this bill be signed by Governor Brown? Perhaps. If yes, Amazon is likely to cancel its associate agreements as it has threatened to each time this type of legislation comes up in California (see 3/3/11 CBS article), and as it has done in states other than in New York (New York offered amnesty, don't know if that was the reason why Amazon started collecting sales tax in New York - see 3/9/11 post).

So, if Amazon (and perhaps other large Internet vendors) cancel their contracts, what does California gain? For my answer, see 3/9/11 post, and consider:

• Wouldn't additional efforts to educate consumers about their use tax obligations make more sense?
• Is it time for California to take a new look at the Streamlined Sales & Use Tax Agreement and considering modifying our tax law system to match it and then strongly encouraging Congress to reverse the Quill decision for states that have adopted it? Vendors would have some free software tools available to help with compliance and there would be greater uniformity among states for vendors. However, there would not be the most sought after uniformity - one rate per state.

What do you think?

What's Next - California Deliberative Poll

There is something fascinating going on in Torrance this weekend - a Deliberative Poll (click here). There are over 300 randomly selected California voters gathered at a hotel for 2 days to learn about and discuss problems and possible solutions to California's governance and budget problems.

I'm fortunate to be seeing some of this. I'm not in one of the 20+ groups, but here Sunday to serve on a panel to help answer tax questions that groups may have in evaluating and constructing reforms.

A report is to be prepared on the results and The McNeil/Lehrer Newshour is actively involved to produce something about the activities and results (to air sometime in September 2011).

I think this is a great idea to help people get more information, understand concerns of their fellow citizens better and hopefully catch the attention of lawmakers that there definitely seems to be interest in reforms to governance and finance structures in the state.

What do you think?

Corporate Tax Reform at the State Level

In the past year, a few states - Georgia, Maryland, South Carolina and Vermont, have released reports from tax commissions on tax issues and reforms. Commonalities include expansion of the sales tax to include services, increased accountability and transparency for tax expenditures (particularly tax credits) and discussion of separate versus combined reporting for corporations.

I have brief article on these reports focused on the corporate reform - State Examination of Corporation Tax Reform, AICPA Corporate Taxation Insider, 6/23/11.

How do you think state corporate taxation should be changed?

IRS Increases Standard Mileage Rate - Good Tax Policy?

The IRS released Announcement 2011-40 to let people know that starting July 1, 2011, the standard mileage rate for claiming such an expense will increase as follows:

• Business - 55.5 cents/mile (up from 51 cents)
• Medical and moving - 23.5 cents/mile (up from 19 cents)
• Charitable - remains at 14 cents/mile because provided for in the tax statute so IRS can't change it

Obviously, this is good in that gasoline prices are higher than at the start of the year when the rates were last adjusted. And, in measuring income, a business should be able to deduct its expenses of generating that income. ...

But, I just raise the point, of whether there should be any discussion about the goals our tax system is to support. There are economic and social goals - not have provisions that operate against business formation and expansion, and support people being able to have enough money to live (so not taxing all income). Should Congress and President Obama articulate any environmental goals, such as reducing carbon emissions? The US doesn't have a target for greenhouse gas emission reductions, although several states (such as California) do. Should the mileage rate be kept below cost to encourage reduced consumption? Of course, that would also mean that those who use actual costs rather than the mileage rate would also need to reduce their deduction.

Does the US have any environmental policy relevant here? President Obama wants to reduce some of the special deductions available to oil companies (Greenbook FY 2012, page 38, 39, 65, et seq). We have a variety of tax incentives for renewable energy. In 2008, legislation was passed requiring a carbon audit of the Internal Revenue Code (see my 11/26/08 post).

The principles of neutrality and simplicity would suggest no special deductions or modified deductions. That would need to be weighed against ensuring that economic, social and environmental goals are supported by government rules and actions. That is, not having policies that encourage renewable energy and ones that promote use of driving and buying gasoline.

Will such topics make their way into tax reform discussions?

And ... what about that carbon audit of the Internal Revenue Code? Apparently, the study was delayed because no funds were appropriated to do the study in the original enacting legislation. That was addressed in 2009 - see Grist article of 12/11/09. In September 2010, a $1.5 million contract was awarded to the National Academies of Science for the study. We'll wait and see - what a delay from 2008!

Texas, South Carolina and Internet sales tax collection

A story in the Statesman.com on 6/20/11 describes a "deal" Texas lawmakers are considering that would likely entice Amazon to have a distribution center in Texas and create at least 5,000 jobs and invest at least $300 million (Harrell, "Amazon, state talk deal: 5,000 jobs in exchange for exemption on collecting sales tax"). The deal part comes in that any company that provides the jobs and investment won't have to collect sales tax for next 4 1/2 years.

South Carolina is one step ahead because S. 36 became law on June 8, 2011 without the governor's signature. Under this new law, "owning, leasing, or utilizing a distribution facility, including a distribution facility of a third party or an affiliate, within South Carolina is not considered in determining whether the person has a physical presence in South Carolina sufficient to establish nexus with South Carolina for sales and use tax purposes." Wow!

But there are some caveats for obtaining this South Carolina benefit:

• The distribution facility must be placed in service after 2010 and before 2013.
• During this time period you must make a capital investments of at least $125 million and create at least 2,000 fill time jobs with a "comprehensive health plan."
• After meeting the above, you must maintain at least 1,500 full-time jobs with the health plan until 1/1/16.
• For Internet sales made, you must give this notice to the buyer: "YOU MAY OWE SOUTH CAROLINA USE TAX ON THIS PURCHASE BASED ON THE TOTAL SALES PRICE OF THE PURCHASE. YOU MAY VISIT WWW.SCTAX.ORG TO PAY THE USE TAX OR YOU MAY REPORT AND PAY THE TAX ON YOUR SOUTH CAROLINA INCOME TAX FORM."
• By February 1 of each year, you must provide via first class mail or email to each person to whom tangible goods were delivered in the state a statement of total sales. "The statement must contain language substantially similar to the following: 'YOU MAY OWE SOUTH CAROLINA USE TAX ON PURCHASES YOU MADE FROM US DURING THE PREVIOUS TAX YEAR. THE AMOUNT OF TAX YOU MAY OWE IS BASED ON THE TOTAL SALES PRICE OF [INSERT TOTAL SALES PRICE] THAT MUST BE REPORTED AND PAID WHEN YOU FILE YOUR SOUTH CAROLINA INCOME TAX RETURN UNLESS YOU HAVE ALREADY PAID THE TAX.'" The nature of the goods must not be included.

Observations:

• If these states can improve use tax collection by their consumers, they will still collect the sales tax on transactions by the vendor with in-state buyers. And it will have increased revenue from sales tax paid by the workers and property taxes on the facilities, as well as increased personal income tax in South Carolina (Texas doesn't have an income tax).
• Will this type of deal send a message to Congress that states are not that interested in getting remote vendors to collect sales tax?
• As one person quoted in the Texas article notes - are these the best type of jobs for Texas - will it help advance their economy?
• Why not offer some other type of incentive (if these states really thinks this is the only way to get business investment) and require that the vendor collect sales tax from in-state customers? Why not an incentive to help the vendor set up systems to be able to collect the sales tax?
• Why not implement better technology approach to collecting the sales tax (I've suggested ones before - here and more recently).
• How will this open the door to other businesses requesting exceptions from the Quill physical presence standard in Texas and South Carolina?

State income taxation of mobile employees - why the focus on source rather than residency?

When an employee is sent to another state to work on a project, help a client, etc., the employer needs to know when that state will start requiring the employer to withhold state income tax from that worker. The rules vary from state to state. In Oklahoma, withholding would be required once the worker earns more than $300 in a calendar quarter. In Maine, withholding is required once the worker is there more than 10 days. (For a list of most state laws on this topic, see COST testimony of 5/25/11, pages 9 and 10.)

Some states, such as New Jersey and Pennsylvania have reciprocity agreements such that generally, the person who resides in one state but does some work in the other state will only be taxed in their state of residence. But typically, a form must be filed to alert the state of the employee's presence.

With increased mobility of workers and states eager to be sure they are collecting all of the tax they are legally entitled to, states have been more focused on employees visiting their state.

The inconsistencies and the resulting complexity, uncertainty and lack of transparency has led to:

• H.R. 1864 (112th Congress) - would provide uniformity among the states and use a 30 day threshold before the employee is taxable in the state. The House Judiciary Committee held a hearing on this bill on May 25, 2011. H.R. 2110 (111th Congress) also used a 30-day threshold, while H.R. 3359 (110th Congress) used a 60-day threshold, which states disliked due to possible loss of revenue. (See COST testimony of 5/25/11, pages 11 - 13.)
• MTC's Model Mobile Workforce Act - calls for uniformity and a 20-day threshold before an employee would be subject to tax and withholding in a state.

In the 5/25/11 testimony of Patrick T. Carter, Director, Delaware Division of Revenue, on behalf of the Federation of Tax Administrators, he notes:

"Beyond the policy concern of intruding into state authority, the dominant concern of states is the 30 day rule contained in H.R. 1864. It will effectively convert state income tax systems to residency-based tax systems and goes well beyond what is necessary to deal with the burden and compliance issues present in the current system. It will allow an individual to work in a jurisdiction for over 12.5 percent of a work year and be absolved of any liability to the state in which he/she worked."

The FTA supports uniformity, but with a lower threshold.

My question - What should the proper focus be for determining when a state may subject a non-resident employee to a state's income tax?

General theories would suggest either (or some combination of):

• Residence-based taxation - tax where you reside (your home state).
• Source-based taxation - tax where the income is earned.

For most employees, residence-based is the easiest. What is the employee's address? In what state are they registered to vote? Where do their kids go to school? Where is his/her car registered?

Source-based is not always easy. Today, many employees have a 24/7 work window and can easily multi-task. For example, assume Sam works for BigCo as a software expert. His work includes software development, assessment of client needs and assistance with installation. Sam lives in California. This month, BigCo sent Sam to Oklahoma to assist a client for 10 days. Sam is at the client's from 8 - 5 each day (except for the weekend). While not at the client location, Sam is doing some research related to that work, but also assisting with some project of the home office and spending time on email and phone calls with clients in three other states. In addition to a salary, Sam's compensation also includes: bonus, stock options and a car allowance resulting in $400 of monthly income (a non-accountable plan). Sam flew to Oklahoma, he did not drive.

How much of Sam's income is attributable to the 10 days he was in Oklahoma? (There is some guidance on the stock option including some OECD information.)

Let's talk theories....

Why subject Sam to income tax in Oklahoma? What benefit will he get? Sam can't vote in Oklahoma (he is registered in California). Sam most likely can't get his kids registered in any Oklahoma public school while he is there (he won't have proof of residency such as utility bills). Sam isn't going to claim any government benefits while in Oklahoma.

Sam is going to buy food and other items while in Oklahoma and will pay sales tax. He will likely pay a transient occupancy tax on his hotel charges. He will pay gasoline excise taxes when he fills his rental car. So, Oklahoma is getting some tax from the limited benefits it will provide to Sam while he is there (use of roads and fire and police protection if needed).

AND, Sam's employer is most likely paying income tax in Oklahoma. The fees paid by its Oklahoma customers may be sourced to Oklahoma (depending on the sourcing rules of the state, which the state can change to ensure that it is sourced to Oklahoma). Oklahoma can also structure its apportionment rules to ensure that it captures some of BigCo's aggregate state income taxes. The arrangement between the Oklahoma customer and the work it is getting is really between the customer and BigCo, not with Sam. If Oklahoma is concerned that the Oklahoma business gets a deduction for payments make to BigCo, then be sure the business statutes are designed to tax BigCo on its income derived from the Oklahoma customer. Sam is just in the middle. The customer is not paying Sam directly.

So, why the focus on pushing for source-based income tax of visiting employees (beyond a particular threshold) rather than residency-based? H.R. 1864 already exempts employees, such as entertainers, who can easily attribute income to their in-state activities (the concert they played in the state). Although again, when the entertainer is an employee, seems that the state should be more interested in being sure the employer's income from the concert gets taxed in the state.

What makes sense for the modern workforce and tax system? In terms of simplicity, imposing income tax on employees only in their state of residence seems best. Yes, a few employees might not have a home, but rules can be created for these few. In terms of overall tax design, I think the best arguments are for having individuals pay income tax to the state where they get the bulk of their government benefits funded by income tax - education, roads, courts, property protection, etc.

What do you think?

Tax 2025

Last week I attended a 2025 Horizons forum sponsored by the AICPA. This is a project where the AICPA is updating its vision 2011 and considering how the world is changing and how that affects the work of CPAs. It is an interesting and important project. This visioning is needed in many professions and areas - including our tax law.

I have blogged on this before (3 years ago!) and written about it - how trends need to be considered in reforming our tax law (6/16/2008 and a more recent Tax Notes essay). I started a project even longer ago than that post on economic, social, technological, environmental and intergovernmental trends and what they meant for how the tax laws need to be updated. After attending the 2025 Horizons event, I'm reminded and motivated to get the full article updated and published.

One trend I think is underway, but a bit under the radar screen is that more people will become self-employed entrepreneurs doing business globally. Yesterday, my nephew in high school told me one of his summer classes at school is how to start an Internet business - great! If he or fellow students pursue this, they will soon find out that the tax law is not necessarily helping them. At the state level, there is confusion as to what is a service versus a taxable good, how to source software and services, and more. At the federal level, they will find they likely don't qualify for a home office deduction even though operating out of their home, and retirement plans are too confusing.

I'll write more later - ideally that longer article I need to update and get more data on.

What trends do you see that affect the work of CPAs or the tax system?

Maybe There is Too Much Process - Guest Post

I'm pleased to publish a guest post from Peter Reilly, CPA, who blogs at Passive Activities and Other Oxymorons. Peter always provides insights into current tax cases and IRS rulings. His guest post here is about a recent case that indicates weaknesses in our tax system and the need for change. The case deals with a procedural issue and is 45 pages long - that alone should indicate a problem with our law; read on to learn more. Thanks, Peter.

There is a great anecdote in Mark Twain’s Innocents Abroad. As the group is visiting the Holy Land there is an interaction between an older man deeply versed in Scripture and a young man totally free of any biblical education. The young man, however, had been deeply impressed by the rapid stage coaches of Ben Holiday which had people “flying” from St. Louis to San Francisco in a matter of fifteen days (a journey that only a few years before had taken at least three months). The older man mentions Moses and the young man says “Moses who”. The older man than points to the desert and explains how Moses led the people of Israel out of Egypt over 300 miles of difficult desert in a period of 40 years. The young man sniffs and says “300 miles- 40 years. Ben Holliday would have fetched them through in 36 hours” (The full text is my bizzaro blog).

One of the tropes of the tax protester movement is that the income tax is voluntary. When they bring their nonsense to court they are often slammed, but I really think the amount of process involved in determining and collecting federal income tax can make it, as a practical matter, voluntary. A recent Tax Court decision, Joan Thomassen, TC Memo 2011-88. drives this point home. It was an innocent spouse case. Purely as an innocent spouse case it is of some interest.

Dr. Thomassen was a devout Catholic who attended Mass almost daily. Petitioner converted to Catholicism in connection with her marriage. The Thomassens had 10 children.

During the years at issue Dr. Thomassen maintained a successful practice as an orthopedic surgeon. Petitioner was a homemaker and part-time professional cellist. Petitioner was not involved in any way with her husband’s medical practice.

Dr. Thomassen controlled the family’s finances. He made the decisions with respect to major purchases and investments. His office nurse paid the Thomassens’ principal household bills. Dr. Thomassen gave petitioner money to pay miscellaneous household and family expenses, but the amounts he gave her were often insufficient. Rather than ask Dr. Thomassen for additional funds and risk his ire, petitioner would borrow money from her mother or sell personal items to meet the shortfall.

During the years at issue petitioner was psychologically abused by Dr. Thomassen. Dr. Thomassen was subject to fits of rage and extremely controlling behavior, which worsened as he came under increasing scrutiny from the Internal Revenue Service.

Dr. Thomassen experienced almost weekly outbursts. At some point he was diagnosed with bipolar disorder. Petitioner tried to please her husband to avoid triggering his outbursts.
As a consequence of his difficulties with the IRS, Dr.Thomassen was often sought out by process servers. He instructed the children not to answer the telephone or the door, so as to avoid process servers. One teenaged daughter, who was eventually diagnosed with bipolar disorder, inadvertently answered the door, contrary to Dr. Thomassen’s instructions, resulting in the successful service of papers on her father. Faced with the prospect of his ire, she attempted suicide.

Petitioner at one point sought counseling from her priest concerning Dr. Thomassen’s behavior towards her. The priest counseled petitioner that she needed to be patient.

The process servers must have finally caught up with the good doctor. He prepared or had prepared 6 years worth of returns which showed 0 gross incomes. Mrs. Thomassen signed the returns as instructed.

The IRS did not agree with the returns and Dr. Thomassen ended up arguing with them in Tax Court. It did not go well:

During the proceedings Dr. Thomassen repeatedly advanced frivolous tax-protester arguments. The central dispute in the litigation concerned Dr. Thomassen’s refusal to provide substantiation of claimed expenses for his medical practice and other business activities because he contended that providing financial records and information to the Government violated his constitutional rights and religious beliefs. On June 2, 1975, in the face of Dr. Thomassen’s refusal to put on any evidence, the Court dismissed the cases for lack of prosecution and entered separate decisions in each of the three docketed cases sustaining the determined deficiencies and additions to tax in their entirety.

All in there was about $250,000 in tax and of course a good bit of penalties.

Then the collection guys swung into action. They put liens on real estate and the court ordered that it be sold. There was an order directing that Mr. Thomassen be evicted from their Newport Beach home. In response to the public sale and eviction order on May 10,2006 Mrs. Thomassen filed Form 8857, Request for Innocent Spouse Relief.

By the time the decision was rendered in this case, Mrs. Thomassen had passed away. Her estate won the case and was granted the innocent spouse relief with the abuse factor weighing heavily in her favor. They of course lost on the financial hardship factor, with her being dead and all.

Normally I would applaud this decision, but here is what troubles me about this case. You may have noticed that I left out what the return years involved were. That is because they are the punch line. The returns involved were 1964 to 1971. The IRS has taken over 40 years to try to collect from Dr. Thomassen (who is also deceased) and they couldn’t get it done. This is the most egregious case I have seen. Another example would be In Re: Bryen, 106 AFTR 2d 2010-5835 decided August 2010 and concerning taxes from the early eighties.

I don’t know what the reform is that would solve this problem. I think it might be to better integrate the tax determination and collection process. As it is now you can appeal a deficiency to tax court. After the tax court has decided that you owe the money you can file an offer in compromise. It the IRS does not accept your offer; you can appeal that to Tax Court. Susan Fay Mostafa made it for 14 years doing it that way. There is a great fear of the IRS and a desire to constrain abuses, but for those of us who think you should do as accurate as possible a return every year and organize your life so that you live on your after tax income, this type of thing is very annoying.
-- Guest blogger - Peter Reilly, Passive Activities and Other Oxymorons,

More on regulating tax return preparers

I posted a few days ago about a good number of recent developments in the IRS program to regulate paid tax return preparers (6/10/11). Since then, a few more developments:

• The IRS Return Preparer Office launched a Facebook site - here.
• Email was sent to some number of preparers today asking them to take about 30 minutes to complete a survey by June 22. "The purpose of this job analysis study is to identify the tasks performed by tax return preparers and the knowledge/skills required to perform these tasks. The results of the study will be used by Prometric to create Test Specifications for the return preparer examination."

The survey sounds like a good way to gain a sense of what a return preparer should know and have access to. Questions include what research tools and authorities are used, what software tools are used, the importance of a variety knowing a variety of rules and forms to calculate taxable income and tax liability.

The exam would be way too long and probably no one would pass it closed book and closed to accessing a commercial tax research tool/database such as RIA Checkpoint. So, should the exams just test very basic items such as filing status, personal and dependency exemptions, asset basis and transfers, Schedule C items, reporting information from pass-through entities, passive activity loss limitations? Which credits?

Or, should it provide takers with access to the Internal Revenue Code, regulations, IRS rulings and court cases (in a searchable database) and ask a range of questions to see what they know and how they do researching the law? I'd suggest the later as that is the key skill needed today. Taxpayers at all levels of income can have a variety of complex matters.

Also, the IRS program is focused on preparing returns. Today, people using a preparer likely are not spending their own time figuring out if they are able to use or should be using a variety of rules that exist for planning purposes, such as the numerous provisions for higher education and retirement plan savings. How much should preparers know about this aspect of the tax law?

Did you take the survey? If yes, your reaction? Other comments?

PTIN - The Ever Evolving Story

The IRS program to regulate all paid return preparers continues to unfold. The IRS has selected the company to administer testing and this week they issued Notice 2011-48 soliciting input (due 7/7/11) on what should be on the exam and how it should be structured.

I have a short article in The AICPA Tax Insider on recent developments on this program including issuance of the final Circular 230 regulations, issues raised by GAO and TIGTA, and how the IRS will use the PTIN data. See PTIN - The Continuing Sequels.

In tax reform discussions, we don't often hear much about the administration of the tax system, but is is relevant in that a good administration system will better enable the tax to meet principles of good tax policy.

What do you think about the new IRS program to regulate paid return preparers?

Tax Reform and Small Businesses

I'm pleased to be guest blogger at Franchise Help for a few posts that will address the current tax reform discussions as relevant to franchisees. Here is my first, introductory post from June 6 - here.

Health Care, the Modern Workforce and Tax Reform

McKinsey Quarterly for June 2011 includes an article - How US health care reform will affect employee benefits. It summarizes a survey of 1,300 employers McKinsey did on employer and employee health insurance reactions related to federal health care reform. The report notes:

• After 2014, 30% of employers will likely stop offering health insurance to their workers. They note that this is a higher percentage than what the CBO estimated.
• Over 85% of employees will stay at their jobs even if their employer no longer provides health insurance coverage. Approximately 60% of these workers though, would expect the money no longer spent by the employer on health insurance to be used to boost employee pay.

[For a Reuters article on the report - click here.]

Will this affect health care reform? Can we truly have health care reform if health care is still so tied to employment? What about the modern worker who is a self-employed entrepreneur - what will their health insurance cost - I don't think they were considered in health care reform, yet, likely a growing employment trend.

The exclusion for employer-provided health care is one of the largest tax expenditures at $117 billion for 2011 (and higher beyond 2011 - JCT report page 47). And this is just the income tax cost, not the payroll tax cost. This tax expenditure survived health care reform intact, despite the inequities of it (this is a very large cost that could be modified so that the dollars are distributed more equitably among all individuals). Will it (should it) survive tax reform intact?

What do you think?

Budget Deficit and Related News

The Congressional Budget Office (CBO) reports that the budget deficit for the first 2/3 of this fiscal year is $929 billion! This is $6 billion less than the comparable period last fiscal year. At this rate, in another 155 years, there will be no deficit! ;-)

A helpful Congressional Research Service (CRS) report from April 2011 explains the deficit and causes and notes that it will slowly decline from $1.4 trillion today to $729 billion in 2021. That is a lot of deficit, increased debt and increased interest expense. (Reducing the Budget Deficit: Tax Policy Options (R41641).)

For years, the IRS has been required to include pie charts in the 1040 instruction booklets. One showing sources of revenues and the other key expenditures. Today, probably very few look at these pie charts because the instruction booklets are not mailed to people, many people use tax prep software or a paid preparer and they are buried in the booklet. So, I will show the revenue charts from the last two instruction booklets. The dollar sign shows the piece of the pie that represents borrowing. In FY 2008 it was a 15% slice and in FY 2009, it was a 40% slice!

Related news:

• The Patriotic Millionaires group reminds Congress that they want to be taxed more - see entertaining video here.
• Congress continues to hold hearings on tax reform - see list here.
• Various government studies have been issued on various aspects of tax reform including one on territorial taxation from the Joint Committee on Taxation and one on charitable giving from the CBO. I'll post more on these reports and others later.

Reducing the deficit will take more than spending reform and the deficit numbers above are without extension of the 2001/2003/2010 tax cuts. So tax reform will also be needed to reduce the deficit, debt and pay interest expense.

What tax reforms do you support?

House Hearing on Business Tax Reform

On June 2, 2011, the House Ways & Means Committee, continuing its series of tax reform hearings, held one on Business Tax Reform and Job Creation. Per Chairman Camp, the purpose of the hearing was to:

"consider a number of issues related to business taxation as part of comprehensive tax reform. These issues include differences between tax accounting and financial accounting, the treatment of inventories and depreciable property, and trade-offs between marginal tax rates and targeted business tax preferences. The Committee must investigate the purposes behind these various rules and provisions, and whether such rules and provisions serve their intended purpose. The fact that the United States is an outlier with respect to the rates at which it taxes business income, combined with the complexity of the rules governing business taxation, make it important for the Committee to explore whether tax reform that broadens the base and lowers marginal rates could benefit the U.S. economy and American workers."

I'm glad he offered that explanation because otherwise, to me, the hearing sounded like it might be looking at what incentives should be added to help increase hiring.

The Joint Committee on Taxation report (JCX-34-11) for the hearing explains many of the areas Chairman Camp mentions in his statement above. Chairman Camp notes the need to review business tax preferences to see if they are serving their intended purpose. Well, in the area of credits, the committee will be busy. Here is the list of 32 general business credits for 2011 that are listed in the JCT report:

1. Rehabilitation credit (sec. 47)
2. Energy credit (sec. 48)
3. Advanced coal project credit (sec. 48A)
4. Gasification project credit (sec. 48B)
5. Advanced energy project credit (sec. 48C)
6. Work opportunity credit (sec. 51)
7. Alcohol fuels credit (sec. 40)
8. Research credit (sec. 41)
9. Low-income housing credit (sec. 42)
10. Disabled access credit (sec. 44)
11. Renewable electricity production credit (sec. 45)
12. Empowerment zone employment credit (sec. 1396)
13. Indian employment credit (sec. 45A)
14. Employer Social Security credit (sec. 45B)
15. Orphan drug credit (sec. 45C)
16. New markets tax credit (sec. 45D)
17. Small employer pension plan startup cost credit (45E)
18. Employer-provided child care credit (sec. 45F)
19. Railroad track maintenance credit (sec.45G)
20. Biodiesel fuels credit (sec. 40A)
21. Distilled spirits credit (sec. 5011)
22. Advanced nuclear power production credit (sec. 45J)
23. New energy efficient homes credit (sec. 45L)
24. Energy efficient appliance credit (sec. 45M)
25. Alternative fuel refueling property credit (sec. 30C)
26. Mine rescue team training credit (sec. 45N)
27. Agricultural chemicals security credit (sec. 45O)
28. Differential wage payment credit (sec. 45P)
29. Carbon dioxide sequestration credit (sec. 45Q)
30. Alternative motor vehicle credit (sec. 30B)
31. Plug-in electric drive motor vehicle credit (secs. 30 and 30D)
32. Small employer health insurance credit (sec. 45R)

That is a lot of credits! The result:

• A more complicated tax system.
• Inequities in that some activities and industries are favored over others.
• Inefficiencies in that the free market is distorted and investment in some activities is favored over others.
• Lack of transparency as to what your true tax rate is.

I'll post again later on this hearing because there were some interesting statements made by those who testified on June 2 - mostly executives of large corporations. For example, Walter Galvin, Vice Chairman and former CFO of Emerson stated:

"First, U.S. tax policy should be equitable so as not to distort business decisions. Equitable tax policy treats all business income equally, notwithstanding the industry, how a company is structured, or whether it is headquartered in the U.S. or offshore.

"Second, tax reform should be revenue neutral. Our fragile economy would likely react negatively to a large money-grab through higher corporate taxes.

"In closing, we can’t create jobs at home if we punish those who headquarter here rather than overseas. There is no reason why American companies should not be able to compete and win anywhere in the world. But we need a level playing field."

Sounds like a vote for removing the 32 credits and other provisions (tax expenditures) that distort behavior.

What do you think?

Texas Governor Vetoes Affiliate Nexus Bill HB 2403

HB 2403, an "affiliate nexus" bill that passed in the Texas legislature, was vetoed by Governor Perry on 5/31/11. In his veto message, the governor noted the need to have a broad discussion on how sales tax should work in the 21st century. He said:

"I have serious concerns about the impact and appropriateness of House Bill No. 2403. In particular, I believe this legislation risks significant unintended consequences. My strong preference is to conduct a thorough policy discussion with Texas lawmakers, consumers, retailers and technology experts – and with other states and even the federal government – about interstate commerce and the structure of state sales taxes in the 21st century. That conversation is underway, and I believe that a consensus can and should be reached that balances the competing interests, respects federalism, and is fair and equitable. I call on the legislature to review this issue further while we reach out to our federal delegation and our friends in other states to build consensus."

Several states have enacted affiliate nexus laws for sales tax including New York, Arkansas and Nevada. California has a proposal - AB 155.

A few items I find interesting with the Texas activity and affiliate nexus in general:

• Existing law in Texas provides that Texas Code 151.103 defining retailer doing business in Texas includes someone who advertises in Texas. That doesn't sound right.
  
• The use of an affiliated entity is referred to as the "business-model loophole."
• Supporters view HB 2403 as within the legalities of the Quill decision. They say that HB 2403 would "not violate [Quill] because it would apply only to companies present in Texas through their subsidiaries, which perform related business functions. It would not affect businesses lacking a physical nexus to the state." But, they (and other states that have done this) still need to get past the justification for treating the corporations as connected without an agency relationship or some operational or financial reason why the separate legal structure should, in effect, be ignored. While HB 2403 calls for at least a 50% ownership connection, in SFA Folio Collections, Inc. v. Timothy F. Bannon, Commissioner of Revenue Services, 585 A2d 666 (Conn. 1991) SFA was a wholly-owned sub of its parent that did have nexus in the state. Yet, the court found that nexus of the parent could not be attributed to the sub.
• Supporters say the HB 2403 approach is better than the legislation that finds nexus for Internet vendors via the New York/Amazon/Associate approach. They go on to question the validity of such legislation. "HB 2403 would not use the “affiliate” definition of nexus because this likely would violate Quill. Adopting affiliate nexus would mean considering a business to be engaged in business in Texas if it entered into an agreement with a resident Texan entity and the resident received a commission for referring potential customers to the retailer by any means, including a link on a website. There is not enough evidence that this commission-based relationship would constitute physical presence." Wow - I wonder if this is going to get mentioned in the ongoing litigation in NY on the constitutionality of the NY/Amazon law.

The saga continues. I think the Governor's suggestion for a broad discussion on sales tax in the 21st century is a good one. While there have been some discussions, more is needed to get all parties to the table and be realistic on finding viable, legal solutions. Such solutions should also consider how technology can be used to improve sales tax assessment and collection

For more background on this big saga including news that always seems to have the word "Amazon" in it, see a post by Janet Novack of Forbes (2/27/11).

For my technology suggestion - see page 6 of my testimony submitted to a February 2011 California Assembly Revenue & Taxation Committee hearing.

What do you think about these issues?

Tax Practitioners and Tax Reform

I'm honored to be a guest blogger this week on Peter Reilly's blog - Passive Activities and Other Oxymorons. A great blog where Peter delves into the details of current rulings pointing out why the conclusion was reached, any oddities about the ruling, and the relevance for practitioners and taxpayers.

The topic of my guest blog on 6/2/11 - "Why Tax Practitioners Should Work for Tax Reform" - take a look - here. I hope you post a comment there.