The Routledge Companion to Tax Avoidance Research Perspectives on the Tax Avoidance Culture

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The Routledge Companion to Tax Avoidance Research

Nigar Hashimzade, Yuliya Epifantseva

Perspectives on the tax avoidance culture

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The publisher does not give any warranty express or implied or make any representation that the contents will be complete or accurate or up to date. The publisher shall not be liable for an loss, actions, claims, proceedings, demand or costs or damages whatsoever or howsoever caused arising directly or indirectly in connection with or arising out of the use of this material. Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 Perspectives onthetaxavoidance culture OrdowerHenry 2 1 to holdsway asaculturalprecept. Yet, Judge Hand’s to diminish one’s of intentional tax structuring endorsement taxes continues United Statesandmuch ofEurope. thelatterhalfoftwentieth century,During arobust emergedinthe taxplanningindustry 3 duty toincrease one’s taxes.” whichwillbestpay the not boundtochoosethatpattern Treasury; there isnoteven apatriotic nition that thathistaxes“[a]ny shallbeaslow hisaffairs onemay aspossible; soarrange heis business-purpose requirement reorganizationbusiness-purpose ontothetax-deferred statute: tax planning. In holding for the government v. in Helvering , Gregory a corporate- Hand grafted taxes. DespiteJudge Hand’s tax-avoidance-favorable rhetoric, hetookapurposive approach to gressive taxes. estateandgift Lessfrequently planningaddressed excise-and consumption-based exposure tothesteeplyprogressive incometaxes, but someproducts alsoreached similarlypro- high incomeandwealth taxpayers. Mostoftheproducts focusedonreducing taxpayers’

ance Adjudication”,25 Gregor Helver Cultur H. Ordower, “The Culture of Tax Avoidance”, 47, 55SaintLouisUniversity LawJournal 55–9(2010)(“Ordower, (dissent). To demand more in the name of morals is mere cant.” any public dutytopay more thanthelaw demands: taxes are enforced exactions, not voluntary contributions. one’s asto keep taxes affairs aslow aspossible. Everybody doesso, orpoor; rich and all doright, fornobodyowes remained consistent abouttax: “Over andover have againcourts saidthatthere isnothingsinisterinsoarranging transactions contemplated as corporate transactions contemplatedascorporate ‘reorganizations. dent, toitsprosecution. egregious To dodgetheshareholders’ taxes is notoneofthe totheconduct of theventurefor reasons germane inhand, notasanephemeralinci- But theunderlyingpresupposition isplainthatthereadjustment shallbeundertaken ing v., Gregory 69F.2d 809, 810(2dCir. 1934), aff’d. v. asGregory Helvering, 293U.S. 465(1935). Judge Hand e” inthefollowing). y, id., 811. Assaf Likhovski, “The Duke and The Lady: v. Helvering of andtheHistory Gregory Tax Avoid- PERSPECTIVES ONTHETAX AVOIDANCE CULTURE Cardozo LawReview 953(2004). Introduction to the culture of taxavoidanceIntroduction to theculture of Legislative, administrative, and judicial ambiguity 2 They developed taxminimizationproducts andsoldthemto 1 Tax Hand’s Judge tooktoheart Learned planners admo- Henry Ordower Henry 3 26 Commissioner v. Newman, 159 F.2d 848, 851 (2d Cir. 1947) 3 Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 return. sidewalk andkeeps ontheannual itwithoutincludingtheamountinincomereported tax monplace. Muchofthetaxevasion istrivial Donald Trump sustainedavery largenetoperatingloss elections. hadanyhis unwillingnesstodisclosetaxreturns impactontheoutcomeinpresidential technique to diminish his taxes or the disclosure of Trump’s very large net operating loss and minimization oftaxes aged investments. forasmany aseighteenyears.income fortaxpurposes The taxlossprobably camefrom lever- 12 11 10 dates engagedinsubstantialtaxplanning. interest technique MittRomney usedthecarried have enabled theirclientstodeferoravoid tax. The lasttwo Republican Party presidential candi- have toassisttheirclientsinminimizing taxes designedtax-efficienttransactionalstructures and tive, reprehensible. have Participants inthetaxplanningindustry beenimpressively creative. They “tax gap.” linebetweenof asharp avoidance andevasion to, contributes orperhapscauses, growth inthe taxavoidance surrounding to blur astherhetoric andevasion conflatestheconcepts. Absence neverthelessreport is unlawful. The cultural demarcation between avoidance and evasion tends or wouldten dollars that the amount is too small to be of any agree significance. Failure to diminution. 9 8 7 6 5 4

1031&nlid=54282593&ref=cta&_r=1. A tax law equates the concept of tax avoidance dictionary with tax planning resulting in also infra note30andaccompanying text. discussion ofthetaxgapbelow underheading “Tax gapandthetax avoidance culture” andtaxexpenditures, see “tax expenditures,” whichreferstofeatures ofthetax law thatenable taxpayers toreduce theirtaxliability. See “Tax gap” I.R.C. See discussionunderheading “Some examplesofsimpletaxplanning”, website.nsf/web/presidentialtaxreturns). since 1970. Tax Analysts, “Tax Project: History Presidential Tax Returns” (available atwww.taxhistory.org/www/Presidential candidatesha ber Buettner, “Donald Trump Used Legally Dubious Method to Avoid Paying Taxes”, NewYorkTimes (31 Octo - The thereby eliminatingthecancellationofindebtednessincome. D. Barstow, R. McIntire, P. Cohen, S.uncertain, but CraigandR.Trump’s creditorsmay have exchangedtheirdebt for anequity interest in Trump’s partnerships, in Trump’s incomeinalateryear ofanequalamountwhenthedebt was dischargedwithoutpayment issimilarly by on the leveragedloss incurred the lenders investments from the tax loss for Trump may have forced inclusion ing isscant, remains sotheaccuracyofreturn inquestion. Whether thepossible separationoftheeconomic nytimes.com/2016/10/02/us/politics/donald-trump-taxes.html?_r=0. on The information Trump’s- taxreport Taxes forNearly Two Decades”, The NewYorkTimes (1October Times Found, The D. to sectionsoftheCode. and atwenty year underIRC§172(b)). carryforward This chapterwilluseIRC§followed by anumber torefer thelossbackthree andforwardcould carry 15 operating deductionsover isanetoperatingloss). incomefortaxpurposes Taxpayers atthetimeof Trump’s loss Section underheading Described Id., 786. A.Richard Westin, Acceptance oftaxavoidance andeven sometaxevasion Barstow, S. Craig, R. BuettnerandM. Twohey, “Donald Trump Tax Records Show HeCouldHave Avoided

2016), 11 Probably most would eitherbeunawareAmericans oftherequirement the toreport §61includes “all incomefrom whatever source derived” isincludable. sothatthetendollars

9 172 oftheInter 12 Trump’s suggeststhat victory voters applaudthosewhoavoidAmerican taxes. refers torevenue lostasaresult of taxpayers’ accuratelyandcompletely, toreport failure asopposedto Ifonelacksthesophisticationorwealth forcomplextax planning, exclusion 5 available at www.nytimes.com/2016/11/01/us/politics/donald-trump-tax.html?emc=edit_na_2016 Tax planningthatviolatesnolaw isneitherillegalnor, from Judge Hand’s- perspec 8 Unknowninterest is whether the disclosure that Romney used the carried WG&L T

– aleg nal Revenue Codeof1986, asamended(the “Code”), 26U.S.C. A. §172, (theexcessof ve nolegalobligation todisclosetheirtaxreturn, but disclosure hasbeencustomary “Some examplesofsimpletaxplanning”, Example2below. (Valhalla, Dictionary ax 2002), 784. itimate practice Perspectives onthetaxavoidance culture

y ears asataxdeduction.ears allow rules atwo Current year carryback

4 – anindi

– ascontrastedwithtaxevasion 27 7 vidual findsaten-dollarbilllyingonthe thatmay have beenavailable tooffsethis Example4: Sales andUse Tax. 10 intheUnitedStatesiscom-

2016),

– illegitimate tax tax – illegitimate available atwww. 6 and and Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 Successful tax planning may make an investment profitable when the investment would have embedded intotheeconomicculture. because Trump doesnotpay taxes by saying, “It would besquandered, too, believe me.” seemed to justify his nonpayment of taxes whenClinton remarked US infrastructure onfailing perhaps Donald Trump was notpaying taxes, Trump retorted, “That makes mesmart.” other hand, Clinton, whenHillary theDemocraticParty presidential candidate, suggestedthat minister emphasizedtheneedforstronger anti-avoidance (notanti-evasion) legislation. Onthe probably incorrectly. Even astheinterviewer of thepractice, focused onthelegitimacy thefinance ning adequately, theassistantfinanceminister usedtheterm “tax avoidance” pejoratively and device ofthepredecessor tointroduce Laborgovernment’s criticism toaddress failure taxplan- wastes thetaxrevenue itgets. taxpayers Implicitistheobservation thatsmart avoid taxavoidance supports rhetoric andpossibly even taxevasion ashearguesthatthegovernment evade report theincomedoesnotreport. report bit withsmall from well planningopportunities may serve tojustifyself-helplevel theplaying fieldjusta 18 17 16 15 14 13 19 own asthegrowing number ofenactments generalanti-avoidance (GAARs)evidences. rules ing taxin Australia thatisclearlyagainstthelaw.” assistant financeministerstated, to avoid theiraffairs pay “[I]fpeopleare- deliberatelystructuring to legallyacceptable taxavoidance. Inarecent aboutthePanama interview Papers, the Australian mixtaxavoidancening andindiscriminately withtaxevasion by assigningnegative connotations light of such disclosures. may link loss of tax revenue Resulting rhetoric tax plan- to legitimate legal andpossibly unlawful taxstructuring. Somepoliticiansinevitably express theiroutragein figures invested offshore through opaqueentitiesimplyquestionable behavior resulting inboth

ciples oftheRule of Law? A Prebble andJ. Prebble, “Does theUseofGeneral Anti-Avoidance RulestoCombat Tax Avoidance- Breach Prin pdf. Ongeneralanti-avoidance (GAARs), rules seePart Dofthisbook; Ordower, Culture, seenote1at94; R. States, alsohaving GAARsortheirequivalent) available atwww.imf.org/external/pubs/ft/tltn/2016/tltn1601. (January IMF LegalDepartment C. Ordo 3: Deductions. Charitable Itemizers”, 67Tax Lawyer 517, 533(2014)andsectiontitled “Some examplesofsimpletax planning”, Example fromble gifts Trump. SeeH. Ordower, ofServices: Contributions GiftPlanningforNon- “Charitable Charitable donees sothatthegovernment willnot squandertherevenue, but- there islittleevidence oftax-plannedcharita that One mightsurmise Id. makes-me-smart/. ber R. pdmfid=1000516&pdisurlapi=true) %2flegalnews%2furn%3acontentItem%3a5JG5-BDP0-0063-32XD-00000-00&pdcontentcomponentid=6141& lexis.com/document?crid=97eb19b4-0716-463c-bc3f-dac7ff9227b4&pddocfullpath=%2fshared%2fdocument and Evasion”, 2016 WTD 66-21 (ReleaseDate: APRIL Leigh Salesintervie leaked from papers amajorPanamanian lawrepresenting firm business andinvestment interests worldwide). Rogue Industry That Hides Their Cash”, available thefindingsof (describing athttps://panamapapers.icij.org/ Consor The International or improperWhether one views tax planning as a legitimate activity, tax planning has become Troubling recent disclosures from thePanama Papers Waerzeggers andC. Hillier, “Introducing aGeneral Anti-Avoidance Rule (GAAR)”, IMF Technical Note,

Rubin, “Donald Trump on Not Paying Taxes: ‘That Makes Me Smart’ – federalincometax 2016), wer, Culture, seenote1at53. available athttp://blogs.wsj.com/washwire/2016/09/26/donald-trump-on-not-paying-taxes-that- ‑ scale e w ofKelly O’Dwyer, “Assistant Treasurer Says Australia Cracking Down on Tax Avoidance vasion. The individual whofindstheten-dollarbillandknows sheshould Trump would inorder toredirect makegifts largecharitable taxrevenue tocharitable tium ofInvestigative Journalists, “The Panama Papers: Politicians, andthe Criminal es sinceonlyfoolishtaxpayers give therevenue tothegovernment.

Comparati

2016) (listing12countr ve Study”, 21(2010). 55SaintLouisUniversity LawJournal 18 Inmany places, taxavoidance hastaken onalifeofits Henry Ordower Henry 28

14 04, While thestatementwas political, arhetorical 2016)(Doc2016–7195)(available at https://advance. ies but notincludingIndia, Ireland, andtheUnited 13 thatmany politiciansandotherpublic

”, The Wall (26 Septem- Street Journal

– perhapse 16 15 Trump’s Trump ven 17 19

Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 reporting and compliance mayreporting beeven more difficult. amountto includeinincomemay thecorrect voluntary bedifficultandsecuring determining totheexchange,is unambiguouslygrossincometobothparties althoughinmany instances unambiguous eligibility rule. unambiguous eligibility taxpayers reflects substantialnoncompliance by taxpayers anda relatively straightforward and incometaxcredit applicable tolow-income,rate fortheearned employed or self-employed and lower-income taxpayers thanthere isatthehigher-incomeend. For example, thehighaudit (whether ornotenforced). Yet there isprobably ofapplicable law lessuncertainty formiddle- minimize taxes iscommon. Sometechniquesare legal, somequestionable, clearlyillegal others may ambiguousstatutesasthelegislatures to interpret have intendedthem. to combat what theytax administrators perceive tax planning and for courts to be inappropriate taxstructuring. andinappropriate appropriate concerning That ambiguitymakes itdifficultfor taxoutcomescreate ambiguity ducing substantiallyidenticaleconomicoutcomesbut differing ing economicincentives through transactionspro tostructure the tax systemandopportunities - been economically unsound without the tax benefits. 25 24 23 22 21 20 to confront thevaluation issue, insteadfindinganexclusionfrom income toward thehigherendofincomespectrum, may thetaxcollector andthecourts choosenot is evading, notavoiding, tax. middle- andlower-income taxpayers oftenisfraudulent A intended ornotforeseen by theenabling legislation. flaws and ambiguities, includinglegislatively sanctionedtax incentives exploited in ways not thenon-taxeconomicconsequencesoftransaction;altering and(3)unintendedstatutory tax incentives;offering tax outcomes without alternatives that generate differing (2) structural objective. Tax opportunities: exploitthree planners related typesoftaxstructuring (1)legislation primar

household w employer are excludable from gross income). codifiedthe Congress result inthecase I.R.C. §119. Benaglia v. the taxgapunderheading “Tax gapandthetaxavoidance culture” below. parent care forhisorherchildren. Nomoney changeshands, justbabysitting services. Seealsothediscussionof andcandraw forotherchildrennities where having inapooloffamilies parents hours another logcaring hours gov/uac/four-things-to-know-about-bartering-1). Consider acommonbabysitting exchange in many commu- IRS, note 137. individual reaches the qualifying age. And, see, the discussion of the tax gap, in text accompanying and following ing incomefrom may benefitswhenthe services diminishorcausetheindividual nottoqualifyforsocialsecurity incometaxcredit underIRC§32ontheirincomefromthe earned services. - andnotreport And underreporting economic interests even ifthey never income. getcaughtunderreporting toclaim Someforego theopportunity In thecaseofsomelow incomew www.irs.gov/PUP/individuals/EITCComplianceStudyTY2006-2008.pdf. Income “Compliance EstimatesfortheEarned Tax Credit Claimedon2006–2008Returns” (2014), available at §32 were accepted as filed, 94.8 In thetaxyear panying text, anddiscussedbelow intextaccompanying note107. (2)and(3)becomethesubjectofgeneralspecialanti-a Categories 55–8. pr the1970sand1980s,During promoters frequently soldtaxsheltered investments to taxpayers intheU.S. that At allsocioeconomiclevels, andwithrespect toalltaxes, attentiveness to toopportunities oduced no independent economic return absent the associated tax benefits.oduced no independent economic return Ordower, Culture, see note 1at “Four Things toKnow About Bartering”, IRS Tax Tip 2012-33(17February y investment objective ratherthansomethingincidentaltoanothereconomicinvestment Commissioner, 36B.T.A. provided 838(1937)(holdingmealsandlodging fortheconvenience ofthe orker oralaborer whoreceives payment theincome incashanddoes notreport s 2006–2008, only1.6 23 Perspectives onthetaxavoidance culture 22

Barter exchange of services for services or services forproperty orservices forservices exchangeofservices Barter Similarly, by income from toreport performed failure services per orkers, totheirbest theirincomefrom toreport iscontrary failure services cent were subjected toanofficeorfieldaudit. Revenue Internal Service,

per cent of the returns claiming an earned incometaxcredit underIRC claiminganearned cent ofthereturns 29 21 24 Both the existence of legislation deliver Boththeexistenceoflegislation - Indifficult valuation instances, generally

– taxe 20 Capturing tax benefits becomes a Capturing vasion ratherthantaxavoidance. voidance rules, seenote19andaccom-

2012), 25 orfixing value at available atwww.irs. Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 between theinterest thegovernmental unitwould pay at amarket rateandtheamountitmust issues enables thegovernmental debtor topay abelow-market rateofinterest. zero. 32 31 30 29 28 27 26 exemplify suchinefficientchoices. ambiguous andwasteful legislative choice. Tax exempt bondsforstateandlocalgovernments fault ofthetaxpayerEconomic inefficiency built intosubsidiesisnotthe but represents an off thanheorshewould have hadchosentodeliver beenifthelegislature thesubsidydirectly. similarly, thatobservation remains valid even ifthetaxpayer whocaptures thesubsidyisbetter relatively consistentwiththelegislative intentisunremarkable anddifficulttocriticize. And that the subsidies will become misdirected.risk Capture of the tax-based subsidy in a manner Whenever delivers thelegislature subsidies foranactivity through thetaxsystem, there isa example ers, benefiting relatively high-incometaxpayers, are unquestionably legal. The interest” “carried planningthatviolatesthelaw,impermissible althoughitgenerallyremains unenforced. The oth- ning.groups Onlythesales/usetaxexamplebenefitingawiderangeofincome represents The following present foursimpleandcommonexamplesofeffective paragraphs taxplan- commentators, includingbothUSpresidential candidatesin2016 behavior. fromnerships incometomore ordinary favorably taxed capitalgainisacceptable, nonfraudulent to usethetaxsystemdeliver subsidies, identifyingtheminbudgeting astaxexpenditures. of tax avoidancethe public is critical discussion in the legislature but continues the legislature no commitmenttoaconsistentanti-avoidance plan. Legislative ambiguitytendstodominateas trate thateliminationoftaxavoidance requires actionby but has the legislature thelegislature simple changes in the law to eliminate the opportunities, but it has not. illus- The opportunities enacted. There isnothingremarkable aboutthefouropportunities. couldmakeThe legislature and unjustified. Legislative hasbeen recommended eliminationoftheopportunity but not

the UnitedStatesfrom taxingtheinterest stateandlocalgovernments pay ontheirobligations. South Carolina its recipient/lender). I.R.C. amounts oftaxexpenditures eachyear). center/tax-policy/Pages/Tax-Expenditures.aspx (definingthetaxexpenditure conceptandestimatingthe ofthe US Department See Example 2, belo See interest examplebelow underheading “Some examplesofsimple taxplanning”, Example2. when received, valuation exceptionsrendering simple andstraightforward unlesscertain apply). Seethecarried income). Rev. Proc. 93-27, 1993-2C.B. 343(treating thereceipt ofaprofits asnon-taxable interest forservices part, 943F2d815(8thCir. 1991)(holdingaprofits interest tohave value andnotincludable indeterminate in See note50andaccompan The exemption from gross income of interest paid on bonds a state or local government 26 Likewise, conversion of interests” ofincome from in theform services “carried - inpart infr infr §103 (exempting interest paid by a state or local government on its obligations from the gross income of 28 note 40 and accompanying text which describes an opportunity arising from the failure to determine value. from to determine the failure arising an opportunity a note 40 and accompanying text which describes a note50. 27 has been the subject of legislative discussion on account of it being viewed by some v. Baker, 485 US 505 (1985), dispelled a common misconception that the Constitution prohibited w, profits interest inapartnership. Treasury, “Resource Center: Tax Expenditures”, available atwww.treasury.gov/resource- Some examples of simpletaxplanning Some examplesof ying text.Campbell v. Commissioner, 59 TCM (CCH) 236 (1990), aff’d. in part, rvs’d. in Example 1: tax exempt bonds 1:taxexempt Example 31 Henry Ordower Henry 30 29 and legislators asexcessive andlegislators 32 The difference The 30 Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 whether invested inthegovernment obligation orafullytaxable obligation. by stategovernmental unitsandthatthestatutesimplycodifiedconclusion. or (b) substituting a tax credit for the exclusion. (a) providing a direct interest subsidy to state and local governments rather than the tax subsidy, could eliminatethatinefficiency indelivery ofthesubsidyina number of ways, including 1.67 government receives a3 investor approximately getsareturn equaltoan11.67 40 taxpayers. Iftherateisset forthe30 governmental unitmust set itsratehighertosellthebondsbelow-maximum- bonds. Generally, there are insufficient buyers paying rate, taxatthemaximum marginal sothe among investors. These governments must chooseaninterest rateatwhichthey canselltheir rate ontheirobligations totheinvestors’ inratespaid ordiscriminate taxcharacteristics differing rate taxpayer shouldbe7 local bondissuergetsthe4 bonds andtaxable investments produced identicalafter-taxinvestment and thestateor returns remaining aftertax. The taxexempt rateofinterest forthattaxpayer shouldbe6 taxable bondspaying 10 bondholder would receive oninvested theidenticalreturn profiles fundswithcomparable risk governments delivered through thefederalincometaxsystem. Ifthesubsidywere efficient, the pay atthetaxexempt rateisintendedasasubsidytoorrevenue withthestateandlocal sharing 38 37 36 35 34 33 without enactmentofalegislative remedy, isthefavorable taxationofprivate equityandhedge One prominent exampleofsuccessfultaxplanningthathasreceived legislative attention, albeit avoidance inconsistentwithbut incidentaltotheintendedsubsidy. bracket taxpayer intended thanwhatthelegislature getsataxsubsidygreater

To illustrate: A rules applicable to private activityrules bondsunderI.R.C. §§103(b)(3), 148etseq. arbitrage bondsnotexempt) andtolimittheirabilitylendborrowing power forprivate usewithspecial age theirexemption from taxunderI.R.C. underI.R.C. §115withanti-arbitragerules §103(b)(2) (interest on tax exempt investmentsdeduction for interest paid to carry under I.R.C. §265(a)(2), governmental units to lever- Congr Provisions”, JXT-60-12 (2012), Joint Committee on University ofLawReview905,western 920(2014). existing law. H. Ordower, inUSIncome “Schedularity Taxation andItsEffecton Tax Distribution”, 108 North- Compare I.R.C I.R.C. 39.6 Tax ratesar mental unitwiththesamerating. witha so thatacorporation AAA ratingfrom Standard andPoor’s shouldpay thesameinterest rateasagovern- ofthebonds topositionthebondsforsaleinmarkets atacompetitiveenable theunderwriters interest rate and Fitchcontrol thebulk ofthebondratingbusiness. Their ratingsofthecreditworthiness ofthebondissuer In thecaseofpublicly issuedgo ithadnopowerIt ispossible concludedhistorically thatCongress totaxtheinterest paid percent taxpa

per

per cent subsidy to her return oninvestmentcent subsidytoherreturn thatthestatuteprobably didnotintend. §103; andseeSouthCarolinav. Baker, seenote32. ess didrein inthe ability oftaxpayers toleverage theirinvestments in tax exempt bondsby denying a cent maximum incomeofindividuals rateimposedontheordinary underI.R.C. §1. e hypothetical tosimplifytheillustration, but inthisinstance the40 . §104(a)(2), recoveries codifying injury excludingpersonal from grossincomeandoriginally yer receives ataxexempt bonus of$10by buying thebond. The 40

taxpa Taxation, “The Federal Revenue Effectsof Tax-Exempt andDirect-Pay Tax Credit Bond yer subjecttoa40

per per per

per cent interest receives $100oftaxable interest incomeandhas$60 cent. Stateandlocalgovernments, however, may notsettheinterest available atwww.jct.gov/publications.html?func=startdown&id=4470. Perspectives onthetaxavoidance culture cent subsidy, andthe40 vernment and corporate bonds,vernment andcorporate Standard andPoor’s, Moody’s Investor Services cent interest subsidy. Likewise, theratefora30 Example 2: carried interests 2:carried Example

per

per cent taxpayer (thatis, 7 cent marginal rateoftax cent marginal 31 37 But Congress does not do so But Congress

per per cent taxable return. The stateorlocal cent taxpayer receives an additional

per

per cent rateisroughly thecurrent 34 cent yielding$70), the whoinvests $1,000in

per

per 38

– afor and the higher cent marginal- cent ifexempt marginal-rate 36 Congress Congress m oftax

per 35 cent cent 33

Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 of incomerealized asitisincluded inthepartners’ by thepartnership incomes. with respectrules preserves to those profits the character and source interests under partnership allocation tothemanagerofadistributive share ofthepartnership’s taxable incomeandgain treat profits interests received ashaving forservices no value when received. Thepartnership’s manager. Decisionallaw referred toasa interest”“carried intheliterature, capitalgaintothe oftenyieldslongterm though themanager’s increases. interest inthepartnership tion oftheamountmanagerwillreceive awaits thepartnership’s dispositionofitsassetseven amount allocatedprecedes therealization ofgainby thepartnership,- andany finaldetermina andallocates10–20 periodically in cash, but itisnot. theincrease inthevalue determines ofitsassets Insteadthepartnership incometothemanagerifitwere feeandgenerateordinary asaperformance paid characterized gain therefore is also long term capitalgain gain therefore isalsolongterm its investment inwhichithasinvested. inthestockofacorporation The manager’s share ofthe private equityfundparticularly, thatincomewillbecapitalgainwhenthe fundultimatelysells fund managers ontheir interests.”fund managers “carried 46 43 42 41 40 39 45 44 assets-based fee is ordinary incometothemanager.assets-based feeisordinary butions ofcashwithrespect tothoseprofits interests reduce themanager’s adjustedbasisinthe value ofthefundasaninterest intheprofits ofthepartnership. receiving with the managers 1 or 2 ate as limited partnerships annually asamanagementfeeandanadditionalamountof10to20

I.R.C. §1411. rate of20 porate taxpayers, net capital gain is taxed at significantly lower income, rates than ordinary a maximum currently capitalgainbecomesnet gaintotheextentitexceedscapitallosses. Long term IRC §702(b). Rev Campbell v. tifying HedgeFunds: A reaches thehighestvalue withrespect towhichthemanagerreceived anallocationearlier. H. Ordower, “Demys- the manageroftenmay notreceive allocationundertheprofits any further interest untilthepartnership’s value Customarily ar09.html. Disguised Payments forServices, 2015-32IRB(10 August In 2015, theIRSissuedproposed regulations amendingtheI.R.C. §707regulations toprevent conversions. IRS, No. 08-18, available atSSRN: orhttp://dx.doi.org/10.2139/ssrn.1295443. http://ssrn.com/abstract=1295443 College ofLaw, Public Law Research Paper No. 337; FSUCollegeofLaw, Law, Business For anexplanation, seeG. D. Polsky, “Private EquityManagementFee Conversions” (4November Pri 295, 304–5(2010). H. Or ests shouldbetaxable asopentransactions). “Taxing to Partners Service Achieve Equity”, Horizontal 46Tax Lawyer 19(1992)(arguingthattheprofits inter- shouldhavefund managers incomefrom ordinary theirprofits interests intheprivate equityfunds); H. Ordower, Review V. Fleischer, “Two and Twenty: Taxing Profits Partnership inPrivate EquityFunds”, 83New York University Law As aninterest inandafunctionoftheprofits ofthepartnership, thatadditionalamount, social security tax and the Medicare tax but is nowsocial security subject to the net investment income tax of 3.8 to receive adistributive share ofthepartnership’s income). when received, valuation exceptionsrendering simpleand straightforward unlesscertain apply, leaving thepartner income). vate insomeinstancessoughttoconvert equityfundmanagers themanagementfeeintocapitalgainaswell. . Proc. 93–27, seenote26, 1993–2C.B. 343(treating thereceipt ofaprofits asnontaxable interest forservices dower, “The RegulationofPrivate Equity, Hedge, andStateFunds”, ofComparative Journal Law 58American 1 (2008) (analyzing various argumentsfortaxingaprofits 1(2008)(analyzingvarious interest but concludingthattheprivate equity

per Commissioner, seenote26(holdingaprofits interest tohave value andnotincludable indeterminate in , the manager’s does not decrease if the partnership’s interest in the partnership assets lose value, but cent ratherthan39.6

Design Pr 43 andaprocedural Revenue announcementfrom theInternal Service imer”, 323, 7UCDavisBusinessLawJournal 359(2007).

per per cent for ordinary income.cent forordinary I.R.C. §1(h). Capitalgainisalsofree from the cent ofthatamounttothemanager’s capitalaccount. The Henry Ordower Henry 39 46 Private equity and hedge funds customarily oper- Private equityandhedgefundscustomarily rather than ordinary incomefrom ratherthanordinary services.- Distri 32 41

allocationalsowould be The performance 2015), available atwww.irs.gov/irb/2015-32_IRB/ 42

percent 40 Inmostinstances, theannual

per of the capital in the fund cent oftheincrease in I.R.C. §1222. For noncor-

45 & EconomicsP Inthecaseofa

percent

2008). under FSU aper 44

Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 long term capitalgainhavelong term foundered. agers. Yet theproposals tostopthisseemingconversion compensationincomeinto ofordinary oftaxavoidanceunsanctioned form thatbenefitssome very wealthy private equityfundman- that some members of Congress view of Congress the favorablethat some members tax treatment as unjustified market value oftheproperty onthedateofgift. reimburses 39.6centsthrough thededuction. of 39.6 charitable gifts charitable if the distributions exceedthemanager’sif thedistributions basis. manager’s andyieldgainfrom interest thesaleorexchangeofthoseinterests inthepartnership 57 55 54 53 52 51 50 49 48 47 Taxpayers in the United States who itemize their deductions 56 taxpayer’s rateoftax. maximum marginal cost tothetaxpayer multiplied by by theamountofgift gift the ofmakingthecharitable change the tax outcome without the need for Congress toact, change thetaxoutcomewithoutneedforCongress havesome commentators of the suggested that the president and the Department Treasury can favoringthissmallbut wealthyrules taxpayer groupofprivate fundmanagers. Very recently, dential candidates expressed their intention to fix the carried interest problem.dential candidatesexpressed theirintentiontofixthecarried value of the donated property but also need not recognize and include in income the previously appreciated property to charity, market thedonornotonlygetsadeductionequal tothefair no taxbenefitfrom theircontributions.

Proposals to alter the rules for private equity fund managers on carried interests suggest oncarried Proposals forprivate equityfundmanagers toaltertherules of theproperty). Tr the separationofchurch andstateundertheFirst Amendment totheUSConstitution. revenue through organizations, thededuction to charitable institutions and churches, including religious despite Charitab Ordo a deductionatthelower rate. Or, I.R.C. I.R.C. taxpayersnoncorporate more totheextentdeductionsaggregate thanthestandard deductionamount). I.R.C. be lower imposedeven thancurrently onnetcapitalgains. Trump alsoplannedtoreduce therateoftaxonallbusiness incometo15 Presidential candidate Trump interest opportunity. expressed his intention to eliminate the carried However, W. ending-tax-break-for-ultrawealthy-may-not-take-act-of-congress.html?_r=0. NewYorkCongress,Times (6May FairGame”, The interest through action); regulatory G. Morgenson, “Ending Tax Break forUltrawealthy May Not Take (arguing the PresidentAct of has the powerssrn.com/sol3/papers.cfm?abstract_id=2773329 to change the carried D. house.gov/issue/carried-interest. See, I.R.C. §731. In addition, ofproperty, gift thedollaramountofacharitable otherthanmoney, isthefair J. Hemel, “The President’s Power to Tax”, 103 eas. Reg. §1.170A-1(c), market ofproperty isthefair value 26CFR§1.170A-1(c)(deduction forcontribution Elmore, “Clinton Would Ask Treasury Interest Preference”, toEndCarried 2016 TNT 116-3(15June ifthedeductionwould causethetaxpayer’s maximum ratetodecline, ofthedeductionwillyield allorpart “Ways andMeansCommitteeDemocrats, Interest”, Carried available athttp://democrats.waysandmeans.

wer, ofServices”, Contributions “Charitable seenote18, at 519–21. per §63(a)(taxable incomedefined). deduction). contribution §170(charitable §63(d)(allowing deductions, certain underI.R.C. gifts includingthedeductionforcharitable §170, for le contribution deductionsraisedifficultpolicyissuessincethey to enablele contribution donors redirect government Example 3: charitable deductions for gifts of appreciated of assets for gifts deductions 3:charitable Example cent bears only 60.4 cents of each charitable gift dollar because the federal treasury dollarbecausethefederaltreasury gift only60.4centsofeachcharitable cent bears 52 in determining theirtaxable income. indetermining Perspectives onthetaxavoidance culture 48 56 54 There isapparently nolegislative willtochangetax Accordingly, ataxpayer subjecttothemaximum rate

Cornell Law Review (forthcoming),Cornell available at http://papers. 2016), 55 47 33 Taxpayers whodonotitemizedeductionssecure available atwww.nytimes.com/2016/05/08/business/ 57 53 Ifadonorwhoitemizesdeductionsgives deductiondiminishesthe The charitable 51 49 may deduct the amount of their and, asnotedearlier, bothpresi-

per cent sothattherateoftaxwould 50

– a legislatively

2016).

Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 and deductionmay even begreater. property whichwould generatecapitalgain, in exceptions, islimitedtoheradjustedbasisinthedonatedproperty. in two instances. Inthecaseofproperty thatwould incomewhensold generateordinary taxrates.their marginal Canadapegsthecredit rateofincometax. tothemaximum marginal thatgives withoutregard donors contributions asubstantiallyequaltaxcredit to toallcharitable benefit is available tothehighestincometaxpayers. Compare theCanadianmodelforcharitable increases asthedonor’s rateoftaxincreases deduction sothatthemaximum marginal charitable money they contribute. The value toadonorfrom thegovernment gift subsidyofthecharitable deductionandavoidcharitable thetaxonappreciation inthevalue ofproperty otherthan appreciated property receive contributing donors subsidythrough adirect contribution the unrealized gaininthevalue ofthedonatedproperty. 65 64 63 62 61 60 59 58 practical exclusively forsomehigh- ormoderatelyhigh-incometaxpayers andare notavailable intheprevious three described examplesare taxplanningopportunities While thepermissible have uponthesaleofproperty. incurred additional subsidyoftheavoided capitalgainthatthetaxpayer $20taxonthelong-term would of $1. The taxpayer getsthedeductionsubsidyof$40, asinthepreceding paragraph, plusan bracket taxpa is limitedtothetaxpayer’s adjustedbasisinthedonatedproperty. purpose, propertyorusetoitscharitable isnotrelatedpersonal inservice thedeductionalso charity $40 foreach$100gift. Ifthedonoralsoreceives andnontaxable anintangible benefitfrom the even highlyappreciated property. intangible sought to deny the benefit or require the donor to recognize gain on the donated property for ventory anddepreciation recapture property, forexample

I.R.C. Includes I.R.C. I.R.C. webpage, www.cra-arc.gc.ca/chrts-gvng/menu-eng.html. acts/I-3.3/page-113.html#docCont. For anexplanation, seeCanadaRevenue Agency’s andgiving”“Charities Sec. Review 58, have naming rights azero 66(2012) (charitable value rulings). undercurrent W. taxable onthegainandtaxpayer wouldgift. notcapture thebenefitofgainexclusionfrom acharitable benefit. Ifthetaxpayergives theproceeds ofthesaletochurch, thetaxpayer ratherthanthechurch willbe dently toselltheshares tothebuyer inorder forthetaxpayer deduction/exclusion tocapture thefullcharitable deductionequal tothevaluecontribution oftheshares onthedateofgift. The church must indepen- agree give theshares tothechurchsothattaxpayer first gift oftheproperty before saleyieldacharitable hasmadea the caseofataxpayer obligation whohasareligious totithe, sellingacloselyheldcorporation thetaxpayer must I.R.C. Amounts willberounded forpur tional effectsoftherealization requirement, seeOrdower, “Schedularity”, seenote36, at910–12. sale orotherdispositionofpr I.R.C. §1001(codifyingtherealization theamountofgainorlossrealized requirement onthe anddetermining haslimited thedeductionforappreciatedCongress property tothetaxpayer’s adjustedbasis Consistent withtheapparent legislativegiving, intent to encouragecharitable charitable Drennan, “Where Generosity and Pride Abide: Naming Rights”, Charitable 80 118.1(1)oftheIncome Tax Act (R.S.C. 1985, c. 1(5thSupp.), available

– naming §170(e)(1)(B). §170(e)(1)(A), inventory applyunderI.R.C. exceptionsforcertain categories §170(e)(3). ratefornet capitalgain, §1(h)(settingthemaximum marginal withlimitedexceptions, at20 yer gives corporate stock to charity thathasavalueyer of$100andanadjustedbasis stocktocharity gives corporate §1231gain. Example 4: sales and use tax 4:salesanduse Example rights to a building,rights for example operty andincludingthegainorlossinincome).operty - For adiscussionofthedistribu poses oftheillustration. 61 Henry Ordower Henry 60 64 Thus, thecostofdonationtodonorisonly if the charitable recipient’s ifthecharitable useofdonatedtangible 34

– the – avoidance orevasion? 58 For example, value to the donor of the charitable gift value gift to the donor of the charitable

– thetaxpa at http://laws-lois.justice.gc.ca/eng/ 65 However, hasnot Congress 63 59 Similarly, inthecaseof assumethe40 University of Cincinnati Law yer’s deduction, with

per

percent cent). In

62 – Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 A a statutory obligation,a statutory oftenwithanexemption amount, andpay toreport onallconsumers tax the obligation tocollectthetaxatpointofsaleandpay itover tothestate. Eachstateimposes the consumer’s and pay toreport failure theusetax. Judicial decisionsonlyrelieve vendors of is more thantaxavoidance. Nolegislation, administrative actionorjudicialdecisionsanctions sales tocollectthestate’s usetaxonsalesforshipmentintothestate. orothertypesofaffiliated manybusinesses tosolicit outofstatevendors usingin-stateservicers income taxreturn, have but thoseefforts metresistance andlimitedsuccesswithcollection. use taxvoid thatthephysical presence testcreates. on theirpurchases. from outofstatevendors inorder toavoid having topay usetax salestaxorthecomplementary who havesumers computer and credit card access often favor purchasing goods over the internet tunities toavoid orevade someoftheirtaxes. Without regard totheirincomeorwealth, con- to thebulk oftaxpayers, moderate-andlow-income taxpayers have beenoffered limitedoppor- 73 72 71 70 68 67 66 69 ing the collection and reporting obligationing thecollectionandreporting tostand. in a challenge to the denied certiorari “Amazon laws,” thus allowing a state decision uphold- the state. imposing anobligation tocollectusetaxes onvendors thatdonothave aphysical presence in of sale on shipments into the shopper’s state, decisions prohibit as US Supreme Court states from in theshopper’s stateofresidence, thevendor neednotcollectthestatesalesorusetaxatpoint rely onvoluntary andpayment reporting by theconsumer. the vendor shippingintothestate, collectionoftheusetaxisimpracticalbecausestatemust modify thephysical presence limitation. the physical presencedecision affirming test, itstatedin

g (16–458) tooverrule Quill. 2016 STT217-9(9November (release date7November Quill Corp (8)(vi)). 134S.cert.denied, Ct. 682, 187L. Ed. 2d549(2013)(upholdingclick-through nexusunderNYCLS Tax §1101(b) Overstoc R42629.pdf (discussingclick-through nexusforusetax). Sales:of Internet Constitutional Analysis”, (9 CRSReport April of Taxation inachallengetotheNew deniedcertiorari Supreme Court York law inOverstock.com, Inc. v. New York StateDept. that usealocalaffiliatetosolicitsalesinthestate. N.Y. Tax Law §1101(b)(8)(i)(C)(I)(McKinney, 2013). The New The nickname “Amazon la available atwww.house.leg.state.mn.us/hrd/pubs/usetax.pdf. N. Quill Corp Except foritemslike automobileswhichtheb paid atpointofsalebut notmore thantheamountofusetaxpayable inthestateofuse. items shippedintothestate). whopaidasalestaxinthestateofpurchase Consumers receive acredit forthetax theitemsintostateforusein (includes whopurchaseconsumers itemsoutsidethestatebut bring toaconsumer.services) usetaxatthesamerateon Statesthatimposeasalestaxalsocomplementary Sales taxisanadd-onavendor isr Unlike theprevious three examplesoftaxavoidance, theconsumer’s topay failure theusetax to residents ofthestate). merce Clause and refusing to impose the obligation on anout of state vendor tocollectthe state’s use tax onsales Some stateshave totheirstate soughttocollecttheusetaxthrough anattachmentform rowing number ofstateshave enacted “Amazon laws” toclosethevoid. Manzi, Use Tax CollectiononIncome Tax inOtherStates, Returns MinnesotaHouseofRepresentatives (2015), York andotherstateshave imposinganobligation tocollectusetaxes enactedlegislation onretail vendors 68 k.com, Inc. v. N.Y. StateDep’t of Taxation tothesalesand The rapidgrowth inpart retailers isattributable ofsalesby internet

. v. Dakota, North seenote68, at318. totheSupreme Court Notethat11statesjoinedinanamicus brief . v. Dakota, North 504U.S. thephysical 298(1992)(reaffirming presence test requirement oftheCom- & Fin ., 134S. Ct. 682(2013). SeegenerallyE. K. LunderandC. A. Pettit, “ 66 Unlessthestatemay imposetheobligation tocollectthestate’s usetaxon

2016) urg ws” isareference totheonlineretailer Amazon.com. Perspectives onthetaxavoidance culture ing the Court to grant certiorari inBrohlv. certiorari togrant ing theCourt The DirectMarketing Association equired tocollectonin-statesaleswhenitsellsgoods(andsometimes 73 uyer must register, sothatthestatemay collectthetaxatregistration.

& Fin ., 20N.Y.3d 586, 987N.E.2d 621, 965N.Y.S.2d 61(2013), 35

72 2016). And, intheSupreme Court’s mostrecent

that Congress has the powerdictum that Congress to 2015), 67 Ifavendor hasnophysical presence available atwww.fas.org/sgp/crs/misc/

71 ‘Amazon Laws’ The Supreme Court 70 Those laws require and Taxation 69

Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 to wide-scalenoncompliance. penalties,criminal alongwiththelackofeffective enforcement atconsumerlevel, contributes opportunities offerisevasionopportunities inthecaseofconsumers’ topay failure usetax. evasion, an illegal act, not lawful tax avoidance. Thus, the invitation to avoid taxes that the other moderate- andlow-income individuals. income individuals andprotects theirtaxavoidance whilelurkingwith possible penaltiesforthe between theusetaxexampleandprivate equityfundexampleisstarkasitfavors high- on out of state purchases of goods that they use in the state. 79 78 77 76 75 74 is interestedin Congress in revisiting of the deeply rooted the structure expectations the statute tothelongevityattributable oftheexemption forstateandlocalbondinterest. Noconstituency groups. but doesnot. couldeliminatetheasymmetry Congress Perhaps Congress’s inactionis of thesubsidyismanifest. exempt interest inexcessofany competitive market rateofinterest. The inefficiencyindelivery substantialvaluetaxbracketThe subsidytransfers tohighmarginal taxpayers whoreceive tax that interest ratesubsidy, however, selectedaninefficientand Congress wasteful taxstructure. governments by makinginterest ontheirobligations free from federalincometax. Infacilitating the taxexempt bondexample, chosetoreduce Congress theborrowing costforstateandlocal The tax outcomes in the examples in the previous and rationality. sections lack symmetry In on theiroutofstatesales. at pointofsale. may beunaware oftheirusetaxobligation whenoutofstatevendors donotcollectthetax at allincomelevels exploitit. payers exploit it. The one affecting all typesof taxpayers involves tax evasion when the taxpayers the oneaffectinghigh-income and high-wealth taxpayers involves no illegality when the tax- civil penaltiesare rarely imposed. compliance obligations. penaltiesontheconsumer,The statutesmay imposenocriminal and 80

ing Estates and Trusts)”, Tax Bulletin ST-913 (TB-ST-913) (19 February pay). As tocivil penalties, see, forexample, the New York State approach in “Use TaxFor example forIndividuals (includ- obligation withalinkatthebottomofwebpage. See, e.g., www.tigerdirect.com/sectors/help/taxinfo.asp. Recently v accountingtoday.com/blogs/debits-credits/States-Use-Tax-CCH-62331-1.html. M. Cohn, “dodging” suggeststaxavoidance, not evasion oracceptable evasion. Sales Accuses (Alec)BaldwinofDodging Tax”, NewYorkTimes C2(28October The This is Id., statingtheob For example, NYCLS Tax §1110(imposingacompensatingusetaxequaltothesalestax). Yet hasnotacted tomake across Congress thesubsidymore taxpayer efficientorsymmetrical Yet ambiguity regarding consumers’ obligation to pay the use tax persists. Many consumers tax gap, below underheading “Tax gapandthetax avoidance culture”. reporting taxes,to withholdingonincomeandsocial security interest anddividend income Noncompliance on pubs_and_bulls/tg_bulletins/st/use_tax_for_individuals.htm. not to say that high-income individuals do not evade sales and use taxes. See, e.g., G. Bowley, “Lawsuit

“More StatesExpect Taxpayers toReport Their Use Tax”, AccountingToday (13 April – makingtheincometaxandsocial secur endors haveendors retreated from of the consumer’s such advertising and substituted complex description tax , NYCLS Tax and toreport forfailure penalties but notonconsumers §1817(imposingcriminal Tax purpose inlegislative ambiguity asymmetry: benefit 77 Frequently, vendors openlyhave advertised thatthey didnotcollectthetax ligation to pay use tax and offering asimplified computationofusetaxbasedonincome.ligation topay usetaxandoffering use tax is not indicative of noncompliance on other taxes, are subject although wage earners 78 And even theusetaxstatutesleave ambiguityregarding consumers’ 80 79 This ambiguityoncomplianceobligations intheabsenceof 76 Henry Ordower Henry indecisionallaw, originated While bothopportunities 36 ity taxmore difficult to evade. Seethediscussionof 74 Failure and pay to report is tax

2016), available at www.tax.ny.gov/

– thesubjectofthir

2016). 75 This distinction This Use of the term Useoftheterm

2012), d-party d-party www. Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 basis intheproperty of appreciated property or by gift limiting the deduction to the taxpayer’sa charitable adjusted could beeliminatedbytaxpayers requiring toinclude appreciation inincomewhenthey make amongtaxpayergroups.tax benefitsymmetrically contribution Theexcesssubsidyforcharitable capital gain and most income from services as ordinary income capital gainandmostincomefrom asordinary services capitalgain.long-term intaxingsomeincomefrom aslong-term This asymmetry services vices from incomeclassificationgenerallyapplicable theordinary toincomefrom into services subject toa3.8 a partnership, when thetaxpayer’sgross modifiedadjustedincomeexceeds$250,000, now is basis in the case of certain typesofproperty,basis inthecaseofcertain standing andentrenched inthetaxlaw. hasactedtolimitthedeductiontax While Congress taxpayers, especiallythosewhoown highlyappreciated, investment intangible property, islong- the subsidyexemption intends. currently and easilycouldtaxthestatelocalbondinterest andshare revenue withthestatestoprovide investment income. that removed theaccompanying Medicare taxadvantage from converting incometo service tion infavor bracket ofhighmarginal taxpayers ofany exclusionfrom ischaracteristic income dentally amongtaxpayers basedupontheirindividual taxratebrackets. - That typeofdiscrimina wasteful oftaxrevenue, isgenerallyavailable but the opportunity onlyinci- anddiscriminates examples, contribution est andcharitable designasitis withthestatutory onemightdisagree market fair value contribution deductionisuncomplicated.charitable Inboththebondinter- might enable the taxpayer to gain additional advantages context, in the charitable but the basic available rules. contribution charitable Nothing questionable occurred. Additional tax planning rate taxpayers. example, contribution Inthecharitable thehighbracket taxpayer usedgenerally investments. The taxbenefitsimply was incidentaltothatinvestment choiceforhighmarginal to allinvestors, andtheinvestor was free tochoosebetween themandamongotheravailable than ataxable, bond. Bothtaxexempt andtaxable bondsprobably were available andopen tor isavoiding taxes oninterest incomeby astraightforward selectionofataxexempt, rather investment andreceived structuring theunintended, but unavoidable, excessbenefit. Theinves - bracket taxpayer seemsunassailable. The taxpayer invested inthebondwithoutany unusual offers, even hasmodifiedthestatuteonseveral thoughCongress occasionstolimitthesubsidy 87 86 85 84 83 82 81 amelioration of the asymmetry resulted fromamelioration oftheasymmetry taxlaw changesunderthe Affordable Care Act istrative decisionsmay have created theasymmetry, alegislative fix would besimple. Minimal as a profits interest in compliance with the administrativeruling. tax planningthantheotherexamples. interest todefiningthepartnership iscritical Structure

In theprivate equityfundexample, very high-incometaxpayers convert incomefrom ser- Similarly, bracket, deductionthatfavors highmarginal contribution thecharitable itemizing I.R.C. (similarly onwages) but notoninvestment income. I.R.C. Patient Pr Rev income from services Under I.R.C. I.R.C. andpr Arbitrage rules examples, contribution In thebondinterest andcharitable taxplanningforthehigher- . Proc. 93–27, seenote44, 1993-2C.B. 343. §1411(taxonnet investment income). §1401(b)imposinga2.9 §170(e). otection and Affordable Care Act of2010, 123Stat. 119 (2010). §1(h), netcapitalgain ofindividuals istaxed atamaximum rateroughly halfthemaximum ratefor

per cent Medicare tax. 86

– ifachar – 20 ivate activity bondrules. I.R.C. §103(b). Investment income, capitalgainreceived includinglong-term through

per cent ratherthan39.6 Perspectives onthetaxavoidance culture

per itable deductionisworth atallinthetaxlaw. preserving cent hospitalinsurancetaxonself-employment income; I.R.C. §3101(b) 87 82

it has done nothing permanent to distribute the todistribute ithasdonenothingpermanent per 37 cent. 83 encouragesmore sophisticated 84 While judicial and admin - 81 85

Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 IRS’s budget andfrequently cutstheIRS’s budget. flawed tax. not provide thegovernment’s administrative agencytheresources tocollecteven necessary the mayThe legislature want many tocorrect oftheflaws inthetaxlaw, does but thelegislature tax avoidance. ing nolegislative resolve toeliminatetheflaws, are unlikely thetaxlaws tointerpret toprevent willdolittletoprevent thatthelegislature understanding theexploitationandcourts,- observ the additionaltax collection ismany timestheamountspent, operations ofthetaxcollector. Despitestatisticsthatshow thatforeachsumspentontheIRS, other, perhapslessobvious techniquestoexploitflawsrules andlesspermissible inthetax forthe wealthythe continuingtoactencouragestaxplanners ofthelegislature failure toseek adjustments might eliminate any misdirection of the benefit and unanticipated revenue loss, offer taxbenefitstohighincometaxpayers isvisible. Inaddition, whenstraightforward statutory taxburdens andsymmetrically. todistribute fairly purpose Insteadonlylegislative intentionto tothepresumptiveruns contrary andinefficiency continuing legislative asymmetry permitting benefit were notobvious whenitenactedthestatuteproviding tothelegislature thebenefit, tomisdirect a ortheopportunities have anexcessbenefitoriginally beenareason foroffering ferent taxpayers that results in inefficient delivery of intended tax subsidies. Even if there may ples, intaxtreatment acompellingpolicy ofdif- reason forasymmetry itisdifficulttoimagine use by allowing sometaxpayers toavoid of theirtaxresponsibility. alloraportion Intheexam- resolve thatmisdirect government toeliminatetaxplanningopportunities revenue toprivate whenelected. planned toeliminatetheopportunity presidential thatthere candidatesagreed issomethingwrong withtheconversion andsaidthey capitalgain. incomeintolong-term service BoththeRepublican andDemocratic2016U.S. examples, contribution charitable somethingdoesseemwrong intheconversion ofordinary tation oftaxlaw hasyieldedavaluable taxplanningopportunity. Unlike thebondinterest and tions, profits forthereceipt includingopentransactionreporting interests ofpartnership profits interests of possiblein partnership despite an array solu- the tax planning opportunity to higher-bracket taxpayers. untaxed untilthetaxpayer sellstheappreciated property provides benefitfrom greater deferral bracket increases. Similarly, therealization requirement thatallows unrealized gaintoremain amount of taxsavingsor deductioninyieldingagreater asthe taxpayer’s incometax marginal 94 93 92 91 90 89 88 taxing part ofthepartnership’s income.taxing part tothemanagerasordinary allocationanddistribution

tax-season-ahead-2015. (3 November P. advocate-delivers-2012-annual-report-to-congress. and Identity Theft, IR-2013-3(9January IRS, For discussionofthe cour incomeandcapitalgainunderanewposed 75/25splitofordinary section D. Ordo See note50. I.R.C. realized gainandlossincludingitingross income). §1001(measuring Perhaps reflecting thelegislature’s ambiguitymostclearly hasbeenits reluctance tofundthe The three planningexamplesforhigh-bracket taxpayers highlightthelackoflegislative In theprivate equity, profits interest partnership example, judicialandadministrative- interpre Bonner, “ Weisbach, Interest Problem”,“The Carried 124Harvard LawReview1773, 1774–5(2011)(discussingapro- “National Taxpayer Advocate Delivers toCongress;Annual Report Focuses on Tax Reform”, IRSFunding wer, “Taxing Partners”, Service seenote40, at36–7.

‘Demanding T 92

2015), available atwww.journalofaccountancy.com/news/2015/nov/irs-commissioner-demanding- ts’ role, seeOrdower, Culture note1, at86–7. ax Season Likely Ahead’, IRS Commissioner Tells AICPA”,of Accountancy Journal 88

2013), Henry Ordower Henry available atwww.irs.gov/uac/newsroom/national-taxpayer- 38 89 94 Yet hasnotactedtoeliminate Congress The legislative messageremains murky. 93 Congress resists Congress increasing the

710 oftheCode). 90 and

91 –

Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 to eliminatethetaxcollectionvoid. lection mechanism. At thesametime, hasyet Congress toactontheSupreme Court’s invitation tax they are obligated topay. evade Consumers payment because thestateslackany effective col- in theavoidance ofthestatesalesandusetax, are consumers evading, notjustavoiding, theuse Clause the stateinwhichproperty purchased willbeused?Judicial decisionsundertheCommerce tax. Why shouldsalesandusetaxcollectiondependuponthephysical presence ofthevendor in taxpayers, andmoderate-low-income taxpayers toescapepaying seizethe opportunity a at large. oftheculture oftaxavoidance. Itissimplypart ecutions ofconsumers. The evasion behavior seemsaccepted andacceptable tothecommunity evading theusetaxasscofflaws ormorallycorrupt, andthere have beennousetax evasion pros- of sale. Despitewidespread evasion by ofusetaxes, consumers noonehaslabeledindividuals of states havenumbers enacted “Amazon laws” to collect use taxes on out of state sales at point ties andfundedenforcement andpayment tocompelconsumerreporting ofusetax. Increasing to collectusetaxfrom theconsumerandhave penal- notenactedsubstantialcivil andcriminal havelegislatures notencouragedstate revenue tousetheirauditfunction aggressively authorities 99 98 97 96 95 the interest income. between the borrowing andthe investment, thereby deductingthe interest paidbut excluding bond investor may borrow fundstoinvest intaxexempt bondsbut notdisclosethe connection going toalocalvendor. orelsewhere ashechooses.partnership The consumerorders goodsfrom outofstateratherthan for aninterest inprofits ratherthan animmediateandtaxable cashfeethathemay invest inthe unrealized gainintheproperty willnotbetaxed tohim. The private equityfundmanageropts appreciated property, ratherthansellingtheproperty anddonating theproceeds, becausethe isdeductible andmaymay becausethegift decidetogive choosetomakegift acharitable tax exempt bondamonginvestments becauseoftheinterest exclusion. donor The charitable sales andusetaxdoesinvolve taxevasion ratherthanavoidance. The bondinvestor choosesthe examples intheprevious sectionsinvolves taxplanning, althoughthelastexamplerelating to tothetransactionthanmighthaveparties resulted withouttaxplanning. Eachofthefour tures thatyieldsmore-favorable foratransactionofthestructure taxoutcomesforoneormore Tax planningthatdoesnotinvolve- theselectionamongpossible struc taxevasion isprimarily deduction thanthelaw permits. consumer, albeitimplicitly, because theyothers may the to the consumer by offer a substantially tax-free encouraging price pretations taxrules. produce asymmetrical retail vendors Certain may enjoy anadvantage over

And inthelastexample, isavailable anopportunity toalltaxpayers, notjusthigh-income I.R.C. I.R.C. See note73. Some adver US Const. ar Like Congress, have state legislatures not provided the tools to prevent use tax evasion. The Sometimes theplanningleadstomore questionable manipulationand possibly evasion. The 95 ordaining suchdependencemay theConstitutioncorrectly, interpret but thoseinter- §170(f)(8), (11)(substantiation requirements, generally, and appraisalrequirements forproperty donations). taxexempt §265(a)(2)(disallowing bonds). adeductionofinterest tocarry incurred tise ontheirwebsites thatthey donotcollecttax. And seenote78supraandaccompanying text. t. I, §8, cl. 3. Tax avoidance: among structures alternate selecting 98 donormayThe charitable overvalue thecontribution, claimingalarger 96 nottoreport. from because, Butthelastexamplediffers theothers Perspectives onthetaxavoidance culture 99 The private equityfundmanagermay monetizetheprofits 97 39 Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 but nottheeconomicsubstance. disregards transactionalstepsthatwould unnecessary tothedoctrine alterthetaxtreatment lary there may bethatwould reach thesameeconomicoutcome. And the “step transaction” corol- willcontrolstructure the taxoutcomenomatterhow many permutations possible structural suggest thattaxplanningshouldbeofnoavail. The substance ofthetransactionratherthanits trol thetransaction’s taxcharacterization. that the substance of a transaction, determined Supreme Court rather than its form, should con- pany anddirect themostlogical structure. Earlyinthedevelopment oftheincometax, theUS add value totheinvestment ataxadvantage onlyby thatotherwisewould capturing notaccom- the receipt ofadividend according tothetransaction’s substance. amendedthe LaterCongress dend insubstance. disregarded andtaxedThe Court thereorganization theshareholders on form asataxdeferred, andheldthatatransactionstructured trine divisive reorganization was adivi- find its way totheSupreme Court., InGregory appliedthe theCourt “substance over form” doc- rejecting the taxpayer’s of her gain, characterization and the novelty of the question allowed it to forwhichthetaxpayerfit withinthetaxcharacterization opted. hadsomedifficulty Thecourts taxed capitalgain. stepsinthetransactionwereThe unnecessary transparent, but together they whatwouldsole shareholder incomedividend beanordinary tocharacterize asmore favorably tax liability. ment by theamountoftaxtaxpayer avoids orby thereinvestment value ofthedeferred to private parties. Thus, taxplanningaugmentsthetaxpayer’s from economicreturn theinvest - potentialoractualtaxrevenues,value ineachinstanceby transferring hencetaxexpenditure, fund’s value. The consumerwould acquire thegoods. The taxplanningenhancedtheeconomic on thegain). The private equityfundmanagerwould receive 20 donorwouldcharitable give (perhapsonlytheamountnetoftaxes money payable tothecharity absent thetaxplanning. The bondinvestor would getamarket oninvestment. ratereturn The evading theusetax. Ineachtransaction, thenon-taxeconomicoutcomewould bethesame ship. interest- by inthepartner borrowing againstitwithoutrecoursesothatheisnotfullyatrisk 105 104 103 102 101 100

Helvering v.Helvering Gregory Often thetaxplannedinvestment includesnonobvious that variations orindirect structural See note2. Annual Tulane Institute102(1970). Tax R. D the deductionforinterest paid). est paidexceedsthenontaxable insidebuildup invalue, aneconomicallyunsound investment intheabsenceof annuity product atax-deferred isnotdeductible whereinterest theotherwise taxdeductible paidtocarry inter - arecognitioneconomic substancetosupport ofloss); later, v. Knetsch UnitedStates, 364U.S. 361(1960)(holding Higgins v. Taxpayer”, 48Marquette LawReview41(1964). Weiss v the investment. inOrdower, shelters Seediscussionofdeferral Culture, snote1, at58etseq. liable forincreased taxes taxupondispositionof when thetaxbenefitsendedorforamountofdeferred ing taxpayer reduced hisorhertaxliabilityinearlyyears oftheinvestment but absentratechangeswould be Many UStaxshelter within tw Rev. Proc. 93-27, seenote26, notdisposeoftheinterest 1993-2CB343(requires partner thattheservice 100 And theconsumer, by thepurchase notreporting inthestateofresidence anduse, is . Hobbet, “The Step Transaction andItsEffecton Corporate Doctrine Transactions”, 19Proceedingsofthe ., Stearn 265U.S. 242(1924); J. B. Donaldson, “When Substance-Over-Form Argument Is Available tothe 101 Smith, 308US473(1940)(holdingthatasaleby ashareholder lacked tohiscontrolled corporation o years). s from but thelatterhalfoftwentieth didnoteliminate tax. deferred century The invest- 105 involved its an example of anindirect designed to permit structure 104 Henry Ordower Henry 102 The holdingsinearly “substance over form” cases 40

per cent oftheincrease inthe 103

Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 corporations toavoidcorporations theincidenceofworldwide taxationunderUStaxrules; totheireconomicsubstance. contrary take forms like Useoffundamentalstructures offshore ing discussionofsubstanceover identifiesonetypeoftax avoidance form intransactionsthat GAARs. Tax avoidance manifestthemselves structures ofcontexts. inawidevariety The preced- oftransactions.terization The doctrine’s limitationsdonotbodewell forthefuture successof designedtocircumventwell lessfavorable fortaxstructuring tolimitopportunities taxcharac- lature deemsbeneficial. Accelerateddepreciation, tures provide toplantransactionsexploitlegislatively opportunities sanctionedtaxbenefits. profit centeras minimization oftaxes becameanindependentgoalformanagers. Ascompetition The tax function that used to play role a supporting in the business world developed into a is possible todoso? The existenceofthesubsidiesindeedstimulates thetaxplanningindustry. would asmuch notseektogetapieceofthosesubsidiesandstretch as taxplanners therules incidental tothelegislative intentlike thetaxexempt bondexamplepreviously given. using anintendedbenefitinthe way intendedittobeused and thelegislature even in ways over substance or step transaction analysis or a GAAR should not prevent the taxpayer from legislative subsidizationofanactivity through thetaxsystemisunexceptional, sothataform goods and, presumably, alsoforthoseusingthedurable goods. Tax planningconsistent withthe tion andsaleofdurable goodsaswell asprovide employment for thosewhoproduce thedurable charge. purchase of durable Encouraging goods is intended to stimulate the market for produc- tax recovery andeconomicwaste owner ofthedurable goodsuseofthedepreciation taxsavings fortheadditionaltimebetween taxpayer’s tradeorbusiness. The timingmismatchofeconomicwaste andtaxrecovery gives the way ofadeductionsoonerthanthe goodseconomicallywaste asthey produce incomeinthe taxpayersin durable goods by permitting to recover by the cost of those goods for tax purposes by includinganactive business requirement separations. incorporate atransactioninthatmanner tomischaracterize applicable statutetoeliminate the opportunity 115 114 113 112 111 110 109 108 107 106 housing, flaws in tax rules like the structure of charitable contribution deductions flaws contribution rules like in tax of charitable the structure bonds;

The UnitedStateshaslonguseditstaxsystemtodeliver subsidiesforinvestments- the legis As a precursor to the modern GAARs, As aprecursortothemodern Against thebackdrop ofthebroad ofsubsidiesdelivered array through thetaxsystem, why I.R.C. I.R.C. I.R.C. I.R.C. rowed funds). I.R.C. I.R.C. I.R.C. et seq., circumstances. toimposetaxontheUSowners undercertain oftheforeign corporation holder. Specialanti-avoidance apply, rules includingthecontrolled provisions, foreign corporation I.R.C. §951 tion’s itsincometoUSshare- distributes incomeisnottaxable intheUnitedStatesuntilcorporation §1.1-1(b). If, however, theUSowner operatesabusiness through aforeign corporation,- theforeign corpora The UnitedStatestaxes itsdomesticcor See note19, generalanti-a tobeengagedactively corporation intheconductofabusiness). andthedistributed both thedistributing The curr 110 112 special rules forspecificactivities, specialrules including real estatedevelopment, §§168, 179. property). personal oftangible §179(electiontoexpensepurchase andplacementinservice costs). drilling §263(c)(exceptiontocapitalization for intangible §42(low-income housingcredits). §168 (depreciable lives than economic lives); shorter I.R.C. §465 (exemption for bor- rules from at risk §103, discussed above inExample1. §170, discussedabove inExample3. oilandgasextraction, ent statuteprevents holdingonlyliquidassets. thespin-offofacorporation I.R.C. §355(b)(requiring voidance rules. Perspectives onthetaxavoidance culture 113

– atemporar purchase ofdurable goods; porations, citizensandresidents ontheirworldwide income. Treas. Reg. 107 the “substance over form” hasnotworked doctrine 41 y useofgovernment fundswithoutaninterest 115 forexample, encouragestaxpayers toinvest 114 andmany othertaxexpendi- 106 109 and tax exempt 111 108 low income intentional Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 Taxpayers substantialpenalties. insomeofthosecasesincurred that artificially generatedloss. that artificially sales. The taxpayer’s economiclossfrom transactionswas thestructured lessthan5 thatthetaxpayerstraddles andgilts usedtooffsetmuch ofthetaxpayer’s gainfrom real property releasedSupreme itsopiniondisallowing Court ataxpayer’s nettaxlossfrom foreign currency loss generatingtransactionsinvolving financialproducts. For example, in June andGAARsinrecent years topreventprinciples taxavoidance through constructed artificially in deploying general anti-avoidance tools. continue to apply economic substance The courts are effective. andrules principles Taxing have agenciescertainly enjoyed somelimitedsuccesses taxavoidance overreachthe taxplanners instructuring transactionsandgeneraltaxavoidance tations of thosetoolsinstaunchingtax avoidance inall its forms. There are instances in which nomic substanceandGAARsare futile. Ratherthediscussionisintendedtohighlightlimi- efits ismost blatant andoutrageous. ambiguity astothelegislative intentionexceptininstanceswhichtheabuse ofthetaxben- willing investors fortheactivity. may Courts bereluctant todisallow taxbenefitswhere there is resources inactualproduction. whether intendedforthespecifictransactionornot, probably withalossofpotentialcreative haveeffort beenandcontinue tobedevoted transactionstocapture taxbenefits, toconstructing grew andcontinues togrow,within thetaxplanningindustry amountsofcreative enormous 120 119 118 117 116 ment unavailable withoutthesubsidy. Even therelatively economicsubstancerequire new statutory - investors sothatnecessary anduncertain maybecause withoutthesubsidyactivity be isrisky Some taxsubsidies, usedasintended, render transactionsprofitable thatotherwisemightnotbe may notbeeasy. isinconsistentwiththedeliverythat thechosenstructure ofthesubsidythrough thetaxsystem structures. Even whentaxavoidance canbeidentifiedinatransactionalstructure, concluding misuse ofthatsubsidy, however, oftenproves elusive, incomplextransactional as itsuseisburied options andothercomplexfinancialproducts were disallowed inthe “son-of-boss” initiative.

The preceding paragraphs do not argue that efforts to use general tax principles like eco- to use general tax principles do not argue that efforts The preceding paragraphs The delivery ofsubsidiesthrough thetaxsystemcreates ambiguityastolegislative purpose. in shampartnerships). United States capitallosses). term sophisticated,in certain that allowed capital loss generating structures them to deduct their expenses as long- I.R.S. GAAR, theapplicationofIrish appeal challenging s. 811oftheRevenue Act of1997). (dismissing the b0757edc371032e802572ea0061450e/bf972756bfa84ce880257fdb0053ec31?OpenDocument McNamee v. I.R.C. activity” (author’s translation).]Footnote quotedfrom Ordower, Culture, seenote1, 48. inbusiness,personnel taxplanning industries, from andthestateremain far economicproduction maximization perspective, taxavoidance competitionand leadstoinefficientallocationof resources disrupts asconsiderable gebunden von wird.”) Nutzenmaximierung erberatung undStaatfern wirtschaftlicher [“From aneconomic zurineffizientenund führt Allokation von Ressourcen, weil beträchtliches inUnternehmen,Personal Steu- 2008 K.-D. Drüen, Freedom [Entrepreneurial and undSteuerumgehung “Unternehmerfreiheit Tax Avoidance]”, 117 must yieldinsituationswhichthesubsidyisintendedtoguaranteeprofitability and Steuer Announcement 2004-46, 2004-21I.R.B. asettlementinitiative 964(offering fortaxpayers whoengaged §7701(o)(economicsubstancerequirement asaconditiontoclaimingtaxbenefits). The Revenue Commissioners[2016]IESC33, available atwww.supremecourt.ie/Judgments.nsf/1 und [STUW] 154,Wirtschaft volkswirtschaftlich 158 (“Steuerumgehung betrachtet den Wettbewerb v. Woods, 571 U.S., 134 S. Ct. 557, 187 L. Ed. 2d 472 (2013) (upholding penalties for overstating basis 118 116 Similarly artificial loss generating transactions using currency lossgeneratingtransactionsusingcurrency Similarlyartificial Distinguishingtheintendeduseofataxsubsidyfrom the Henry Ordower Henry 42 120

2016,

per the Irish theIrish cent of 119

Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 constitutions tolimitthestate’s abilitytoincrease revenue tomeetstateexpenses, administrative tothemasthe agencyby referring “IRS Code.” trative agencies as enemies. lay Federal blame for the tax laws legislators they enacted on the tax the wane. There isconstantanti-taxnoise, andmany seemtoview stateandfederaltaxadminis- duty to paythat there the taxes is a patriotic one owes. Commitment to that duty seems to be on he provided boostforthetaxavoidance arhetorical culture. ButHandsurely would have agreed ance Instead they amountsofprofessional gleanfrom resources theenormous devoted totaxcompli- payers atallincomelevels ofthetaxingfunction. losesightofthenationalandlocalimportance lector, andanintricate, complexandofteninconsistentbodyoftaxlaw andinterpretation, tax- reduction planning; of anti-tax rhetoric. and they hear a continual barrage political ladder, majorparties’ presidential candidates, engageinaggressive andcontroversial tax nomically weak, low-income income taxpayers; thatdoemergetargetingdisproportionally theenforcementeco- efforts they experience the professional assistance. Taxpayers thatare seelegislatures unwillingtofundtaxenforcement; 124 When Judge Handmadeclearthat “there isnoteven dutytoincrease one’s apatriotic taxes,” 130 129 128 126 125 123 122 121 127 of taxprofessionals, are unable (orunwilling)todistinguishlegal taxavoidance from illegaltax tax avoidance becomesever embeddedintheUnitedStates. more firmly evasion andtaxavoidance leaves aconceptualmuddle. Itseemslittlewonder thattheculture of Revenue hasbeendemonizedandthreatened withimpeachment. will notincrease taxes. tax substitutessuchasrevenue-based policing. andlocalgovernmentalstate andlocaltaxagenciestoincrease collectionefforts unitstorely on

With decliningrecognition ofanobligation topay taxes, adiscredited anddisdainedtaxcol- Moderate- andlower-income taxpayers, withouttaxlaw trainingandwithouttheservices vote-averted-by-promise-of-irs-commissioners-testimony/. own economicinterests, justbecauseofanti-taxrhetoric. taxpayers even repeal oftheestatetax they support never willhave topay, arepeal thatmay totheir becontrary Compare nying text. incomecr See discussionofthehighauditratefor theearned Drüen, gov/new.items/d05878.pdf. GAO H. Or The 1980Hancock Amendment inMissour time.com/time/specials/packages/article/0,28804,1859513_1859526_1859516,00.html. him thepresidency in1992. See Top Political 10Unfortunate One-Liners, Time, available athttp://content. belie Some commentators (15 September M. DeBonis, code-hint-it-wasnt-the-internal-revenue-service/. (13 April M. v.Helvering , Gregory seenote2. Research Paper No. 2016–14, available atSSRN: https://ssrn.com/abstract=2854372. and ConstitutionalLimitations”, 61Howard L.J. (forthcoming), SaintLouisUniversity SchoolofLegalStudies 127 andavoidance Y. H. Lee, “Who Wrote the ‘IRS Code’?Hint: It Wasn’t Revenue theInternal Service”, Washington Post , “Tax Policy ofEstimatestheCostsFederal Summary Tax System” (2005), available atwww.gao. dower, K. Warren andO. Sandoval, “Out ofFerguson: Misdemeanors, MunicipalCourts, Tax Distribution “Unternehmerfreiheit”, seenote116.

2015), Trump’s remarks, see notes 15and16accompanying text. Many moderate-andlow-income “Impeachment Vote Averted by Promise ofIRSCommissioner’s Testimony”, Washington Post

2016), available atwww.washingtonpost.com/news/fact-checker/wp/2015/04/13/who-wrote-the-irs- 128 available atwww.washingtonpost.com/news/powerpost/wp/2016/09/15/impeachment- 124 thattoavoid paying goalofthosewhocanafford taxes istheprincipal Tax andthetaxavoidance gap culture Insomestates, voters through initiative ballotshave amendedstate ve thatGeorgeH. W. Bush’s violationofhispledge “Read my lips, nonew taxes” cost Perspectives onthetaxavoidance culture i, Mo. Const. art. X, §§16–23, forexample. 126 43 129 they learn that some at the very top of the they learn edit underI.R.C. §32, seenote22andaccompa- 122 The CommissionerofInternal 123 Politicians pledgethatthey 130 Conflation of tax 125 motivating 121

Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 its taxpayers donotpay even ifnotpaying violates thelaw. ofdetectionandpunishmentseemsremote.if therisk Given nottopay theopportunity atax, of detection and punishment on the basis of risk sion opportunities minimization may escapetaxpayers’ orthey understanding may choosetoevaluate thetaxeva - every toavoid opportunity tax. The increasingly distinctionbetween blurred legalandillegaltax wealthier individuals toavoid taxes, thatthey ofmoderatemeansalsoshouldseize itonlyisfair significant legaltaxsubsidies. They may betaxpayersright for whoconcludethatifitisall addition to categorized taxexpenditures, addition tocategorized what otherwisemightbetheirtaxliability, strainscollectionoftaxrevenue. toreport failure In tive, thatenable sophisticatedstructures high-incomeandhigh-wealth taxpayers todiminish culture of tax avoidance. Whether with simple, straightforward and obvious techniques, orcrea- taskslikesary homerepairs whentheworker prefersundetectable cashpayments. avoid completionofneces- obligations complexandtime-consumingreporting oftenfacilitates ifnotsimpleinattentiontorarely enforceduncertainty taxprinciples. Useofcashpayments to andgoodsalsomay intoarealm forservices oftaxpayer fall ure exchangesofservices toreport generally available interest deduction, mortgage evasion. incomecredit, With the limitedexceptionsoftheearned 137 136 135 134 133 132 131 employment taxare nearlyfivegreat asthe employment times as taxbecausethere isthird-party ofinclusionsintaxbasesareunderstatements commonplace. topayThe estimatesoffailure self- to nonreporting and the overstatingto nonreporting to $458 of deductions for 2008–2010 runs income and overstatereport deductions. The IRS estimates that the amount of the revenue lost is asubstantialamountofpotentialtaxrevenue thatescapestaxationbecausetaxpayers to fail creative costsandcomplexfinancialproducts), drilling (suchasintangible taxplanners there also incometaxcredit, interest deductionandtheearned mortgage somethefocusofattentionfor rate tobeonly83.1 but despitetheobligation donotreport todoso. The IRSestimatesthevoluntary compliance escapetaxation.permanently Taxpayers regularly engageineconomicactivities andtransactions andacquaintances. casually andopenlyaboutsmall-scalenoncompliancewithfriends and-file noncompliance tends to be socially acceptedand acceptable behavior as taxpayers chat arefrom few attachestosuchbehavior. andnosocietalopprobrium underreporting Instead, rank- income,personal income, corporate estateandgift, exciseandemployment taxes. Repercussions active but sometimesquestionable withtaxplanning, reporting anditconsistsofallfederaltaxes: This is the “tax gap.” The tax gap measures noncompliancewiththetax laws, as opposedto 132

Failure topay usetaxonoutofstatepurchases seemstobeinthatconfusedcategory. Nonpayment oftaxes otherwiseowed supplementslawful taxplanningasanelementofthe There are nottopay numerous opportunities taxes. nonstatutory Many ofthosenonpayments Id. of Effects Tax Policies onCompliance”, ofBusinessandManagementReview73(2014). Journal 2International ics 189(1974); S. E. Agbi, “The Sizeofthe Tax Evasion Problems onSelf-Employment Income: An Examination nomics 323(1972); S. Yitzhaki, “A generally M. G. Allingham and A. Sandmo, “Income Tax Evasion: A IRS, See note30for T See Cohn, I.R.C. Childcare cr I.R.C. §32anddiscussionatnote 22. and, if they enough to have ahome mortgage, are fortunate sufficient income tocarry the “The Tax Gap: Tax GapEstimatesfor Tax Years 2008–2010”, available atwww.irs.gov/uac/the-tax-gap. See §163(h)(2). “More States”, note77. edits underI.R.C. §21; childcredit underI.R.C. §24. reasury estimatesoftaxexpenditures.reasury

per cent. 137 reporting,Absent withholdingorthird-party exclusionsfrom and

Note onIncome Henry Ordower Henry 135 someavailable toawiderangeoftaxpayers like the Tax Evasion: A 44 133 these are not the taxpayers who may capture

Theoretical

Theoretical 131

Analyis”, ofPublic Econom- 3Journal – self-help various small family cred- smallfamily various Analysis”, 1

billion tax minimization Journal ofPublic Eco- Journal annually. 134 Fail- 136

Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 income taxaswell asapplicable employment taxes. Where thetransactionsinvolve payments forservices, involves toreport failure nonpayment of undiminished byto deduct the full amount of the payment the value to charity of the benefit. the amountpaidorataxpayer receiving contribution abenefitinconjunctionwithcharitable taxpayer for contribution auctiontoclaimacharitable whopurchases anitematacharitable basis are alsocommon and reduce the amount of tax paid. For example, it is not unusual for a withholding oftheemployment tax. 141 138 is wages that are tax withholding subject to third-party whose source of income primarily income andwealth tothoseleastable toavoid orevade taxpayment. Generally, individuals Tax avoidance andtax evasion oftax burdens shift the distribution from thosewith greater 140 investment reporting information incomesubjecttothird-party Collection of income tax in the United States is critical tomeeting revenueCollection ofincometaxintheUnitedStatesiscritical needs. Whether resources, ithasnotfollowed Europe’s modelofthevalue-added taxtoproduce federalrevenue. thatpreviouslyservices were costfree andhasincreased deficitspending toprovide needed to replace revenue shortfalls. throughout theproduction process anddistribution andwage taxes collectedfrom employers States andEurope. InEurope, governments rely heavily onregressive value-added taxes collected the lastseveral decades, ratesofincometaxhave maximum marginal declinedintheUnited hasconcentratedontheincometax. historically With limitedexceptionslike theusetaxonoutofstatepurchases, avoidance andevasion oftax ment of tax. Tax avoidance and tax evasion do not diminish governmental need for tax revenue. acceptable behavior. detect taxevasion the perception scarce that andfortifies avoidance and even evasion oftax is ance onthecitizenry. Congress’s reluctance tofundtheIRSmakes theresources to necessary taxes as an acceptable choice whenever possible and imposes no moral obligation of tax compli- completelyandhonestly. toreport failure Rathertheeconomicculture emphasizesavoidance of reporting. The culture inmany countries, includingtheUnitedStates, doesnotstigmatizethe inadequate substituteforhonestandcompletetaxpayer information andthird-party reporting of individuals incomeandpay toreport occasionallydetectthefailure taxes but are avastly identify andtrace. Indirect methodsoftracingpayments bythespendingbehavior observing anti-compliance attitudes. claim andthepayment may forservices involve smallamounts, they reflect anti-taxationand incash,for ahouseholdservice thetransaction. reports andneitherparty While thecharitable ofgoodsorservices.cash orthebartering pay Oftenindividuals exchangehouseholdservices that taxgapresults from theunderground economy where transactionsconsistofpayments in 139

While the United States has introduced new and increased governmental fees for various The taxavoidance culture hasexerted downward pressure ontheprogressive taxrates. Over Without thebankingsystemassistingflow ofpayments, thetransactionsare difficultto I.R.C. I.R.C. For lo IRS, “Tax Gap Estimates for Tax Years 2008–2010”, Table claim the earned incometaxcredits towhichtheyclaim theearned are entitledunder I.R.C. §32. Seenote23. gap%20estimates%20for%202008%20through%202010.pdf. w wage taxpayers, sincethetaxpayers incomefrom toreport may failure services bedetrimental may not §6041–§6049. §3402. Conclusion Perspectives onthetaxavoidance culture 138

Similarly, overstatements ofdeductible amountsandtax – satisfying revenue needs – satisfying 45

2, 139 available at www.irs.gov/PUP/newsroom/tax%20 With respect toincometaxes, much of 141 are leastable toavoid pay- 140 and Downloaded By: 10.3.98.104 At: 08:12 28 Sep 2021; For: 9781315673745, chapter3, 10.4324/9781315673745.ch3 flourish. avoidance intheUnitedStatesisunlikely tochangeandtaxavoidance andevasion likely to behavior. anti-taxandanti-reporting to legitimize Inthatlegislative context, theculture oftax income taxes. taxpayers todisclosetheiroffshore investments onwhichthey were notpaying applicable federal voluntary andpayment reporting ofunpaidtaxtotheUnited States. Itencouragedmany US The initiative tradesfreedom prosecution from fortaxevasion criminal andsomepenaltiesfor the culture of tax avoidance. of many andsuchnon-compliancehasbecomeanacceptedpart smalltransactionsislow risk by Congress perception oftheIRSinUnitedStateshasresulted inthedemonization oftheagencyboth context, thetaxadministratorisanadversary, notanagentworking forthebenefitofall. That Accordingly, ifonecangetaway withnotpaying, non-payment isallright. Inthatcultural that, ismorereporting aculturaldetermination onsomelevel, taxes andmalevolent. are unfair ingly anenforcement problem, andintentional, non-reporting but ofdetection, low risk false no compellingobligation andpay toreport honestlywhenonewill notgetcaught. While seem- 146 Tax Compliance Act (FATCA) net-worth andhigh-incomeindividuals doexist. The recent enactmentoftheForeign Account anti-tax pressures remains uncertain. to collectadditionalincometaxfrom Limitedefforts high- along with deficit spendingwill suffice tosatisfy revenue needs intheUnitedStateslight of economic growth withtheaccompanying revenue produced from taxingtheincomegenerated 148 145 144 143 142 147 10 tax expenditures. At the time ofpassage, FATCA was estimated to generate $8.7 offoreignUS persons financialaccounts was anticipatedtogenerate revenue tooffsetadditional income, coercing financial institutionsabroad toidentifyanddisclosebeneficial ownership by the foreign accounts. SincetheUnitedStatestaxes itscitizensandresidents ontheirworldwide todiscloseUSbeneficial that donotagree those and ownership report owners’ incomefrom by reporting foreign financialinstitutionsandimposes sanctions ontheinstitutions information to disclose their offshore their income fromers assets and report thoseassets. FATCA relies on withstrongsecreting assetsoffshore banksecrecy injurisdictions laws andcompelthosetaxpay-

y Yet, otherthanmajoroffshore investors subjecttoFATCA, toreport detectionoffailure frequently-asked-questions-and-answers-2012-revised. (2014), available atwww.irs.gov/individuals/international-taxpayers/offshore-voluntary-disclosure-program- Service”, seenote 127. the Codeas “IRS Code.” M. Y. H. Lee, “Who irs-commissioner/. frequently ofCongress disavow Members Wrote the to theirresponsibility forthetaxlaws‘IRS Code’?Hint: in referring It Wasn’t Revenue theInternal Post (24May S. not a Although itisinfact IRS, See generallyIRS, JCX-5-10 (23February Amendment 3310, The Incentives“Hiring toRestore Employment Act,” UnderConsiderationBytheSenate, Joint Committeeon For tives toRestore Employment Act of2010, Pub. L. 111-47, 124Stat. 71(18March Generally refer voluntary-compliance-efforts-top-10-billion-more-than-100000-taxpayers-come-back-into-compliance). into Compliance”, IR-2016-137, Oct. 21, 2016(available athttps://www.irs.gov/uac/newsroom/offshore- ears. Dinan, “House Republicans SlashIRSBudget, Move Toward Commissioner’s Impeachment”, TheWashington eign accountslessthananinflation-adjusted$50,000are notsubjecttothe FATCArules. reporting “Offshore Voluntary Compliance Efforts Top $10 Billion; More Than 100,000 Taxpayers Come Back 144 The IRSoffered anoffshore voluntary complianceinitiative underthatlegislation. 148 146

2016), andsegmentsofthepublic atlarge. rejecting Congress itsown taxagencytends red toasFATCA, addedasarevenue offsetprovision, Title V, 124Stat. 97, Incen- oftheHiring available atwww.washingtontimes.com/news/2016/may/24/house-kicks-path-impeaching- “Offshore Voluntary Disclosure Program Frequently Asked Questionsand Answers” Taxation, “Estimated Revenue EffectsoftheRevenue Provisions ContainedinSenate

2010), voidance but evasion. 147 available atwww.jct.gov/publications.html?func=startdown&id=3649. 142 Absent ethical compulsion which seems largely absent, there is doesseektoidentifyhigh-net-worth UStaxpayers Henry Ordower Henry 46

2010).

billion 143 whoare over 145

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