Beyond the Little Dutch Boy: An Argument for Structural Changes in Tax Deduction Classification

One of the most active disputes in tax law today is the question of the proper tax consequences for a successful plaintiff, a portion of whose taxable damage award is paid to his or her attorney pursuant to a contingent fee arrangement. At issue is whether the plaintiff is taxable on the portion of the award that is payable to the attorney. One aspect of this problem was resolved prospectively by the adoption of the American Jobs Creation Act of 2004, but the problem continues to exist in other areas. The United States Supreme Court resolved a split in the United States Circuit Courts of Appeals with respect to the taxation of contingent attorney\u27s fees in Commissioner v. Banks, but that decision provides no comfort for the plight of taxpayers because the government prevailed. Moreover, the attorney\u27s fee dispute is only one small example of a much larger problem. Instead of dealing with the root cause of the problem, the focus (both in the courts and in Congress) has been on whether to provide a fix for the specific plight of the taxpayers who have raised issues in court. The courts and Congress, like the Little Dutch Boy, may be willing to plug one hole, but the broader problem is a structural fault in the dam of the tax law system—namely, the improper classification of a significant number of expenditures as itemized deductions. This Article argues that the current list of nonitemized deductions wrongly excludes a number of items, especially some that are directly connected to the production of income. This erroneous exclusion imposes an unwarranted and severe tax burden in far more circumstances than the attorney\u27s fee problem on which Congress exclusively focused in the American Job Creation Act of 2004. The harsh consequences resulting from the misclassification of a number of items are exacerbated by the stringent limitations currently imposed on many itemized deductions; but even a repeal of those limitations, which is unlikely to occur, will not cure all of the harm that a wrongful classification causes. This author hopes that highlighting several examples of misclassification will induce Congress to implement a commission to study the entire classification system, rather than to rest on its laurels for solving one small part of the problem in the American Job Creation Act of 2004

The Operation of the Individual Mandate

In this article, Kahn describes the technical operation of omportion portions of the individual healthcare mandate, including the application of the penalty provision. Kahn finds that there are problems with the technical drafting of that provision and that serious gaps and ambiguities abound

The Misconstruction of the Deductions for Business and Personal Casualty Losses

Losses suffered on an individual\u27s personally used property generally are not deductible. Even after the changes made by the 2017 Tax Cuts and Jobs Act, in two circumstances an exception to this rule applies when such losses arise from.fire, storm, shipwreck, or other casualty, or from theft. The principal issue that arises is determining the meaning of the term other casualty. Taking what they deemed to be the common elements in the three explicitly identified casualties, the courts and the Internal Revenue Service determined that an event will qualify as an other casualty only if it is sudden, unusual, and unexpected. This current definition of other casualty does not support the appropriate purpose of that provision. Applying this incorrect standard leads to unfair results in that the courts and the Service disallow deductions for some losses that should be deductible. Instead, courts and the Service should look to the purpose of allowing a casualty and theft loss deduction. The key issues are whether a loss of property as a result of an outside force constitutes a personal consumption and whether the event causing the loss is one that is part of the ordinary vicissitudes of life. If not, allowing a deduction complies with the congressional purposes for allowing one in the two circumstances in which the deduction is currently allowed. While most scholarship concerning the casualty and theft loss deduction is on personal losses, the definition of other casualty can be important to business and investment losses as well. The determination that a business or investment loss did or did not occur as a result of a casualty can affect the timing and characterization of the deduction of that loss. Whatever definition is adopted for personal losses purpose should not be used to determine the timing and realization of a business or investment loss because the role of the casualty characterization in applying the realization requirement is very different. There has been little, if any, commentary on those issues and a major contribution of this piece is to shed light on them

The Individual Mandate Tax Penalty

In 2010, President Obama signed legislation that significantly altered the healthcare and health insurance markets in the United States. An integral part of that reform is the individual mandate, a provision that requires individuals to purchase and maintain healthcare insurance. Failure to maintain such coverage subjects an individual to a tax penalty. The Supreme Court upheld the constitutionality of that provision under Congress’s taxing power. Despite the Supreme Court upholding the individual mandate, fundamental questions remain. This Article addresses the question of whether the use of a tax penalty to encourage taxpayers to do something that the government desires is normatively a bad policy. Many commentators have contended that a tax penalty is economically equivalent to the current tax system’s use of deductions and credits to encourage behavior. This Article argues that despite some similarity, there are major differences between the two that should lead Congress to reconsider the desirability of using a tax penalty approach in the future. This Article also considers whether the use of the Internal Revenue Service to administer and enforce a penalty that has little to do with the correct baseline of income will have an adverse effect on general tax compliance. This Article explores the individual mandate tax penalty in detail. It explains the mechanics of the tax penalty provision and points out several ambiguities in the provision that will likely require clarification. It also explores whether the extent of some of the problems in the healthcare system at which the mandate is aimed have been exaggerated. The Article concludes that Congress should reexamine the pros and cons and unintended consequences of using a tax penalty to induce behavior before going down a similar road

Hedging the IRS -- A Policy Justification for Excluding Liability and Insurance Proceeds

Uncertainty about tax results is an ever-present obstacle to business transactions despite the extensive number of Internal Revenue Code sections and Treasury Regulations. Some insurance companies now provide an insurance product to protect taxpayers against adverse tax consequences from proposed transactions. Ironically, this new insurance product, labeled “tax insurance,” poses uncertain tax consequences itself This Article argues that if the adverse tax consequences arise (that is, the taxpayer has additional tax liability) and the insurance company is contractually required to cover that liability, the tax insurance proceeds are not includable in the insured’s gross income. As part of the reasoning that underlies this conclusion concerning tax insurance, the Article examines and develops a novel approach that provides a tax policy justification for excluding general liability insurance proceeds from the insured’s income. The Article concludes that the same justification also applies to exclude tax insurance proceeds from the insured’s gross income. The Article also examines whether the premiums paid for tax insurance coverage are deductible business expenses. Finally, the Article examines the appropriate tax treatment of other types of tax indemnity arrangements

Personal Deductions – An Ideal or Just Another Deal ?

The allowance of many personal deductions, such as the deduction for medical expenses or charitable contributions, has been criticized on the contention that such deductions are not appropriate elements of an income tax system, but rather are merely devices by which Congress has expended federal funds to further some nontax program or other goal. The tax revenues that are not collected because of these provisions have been characterized as “subsidies” or as camouflaged direct expenditures of the government. This view has attained such prominence that Congress requires the federal government to publish annually a “budget” that lists those tax provisions that the issuing department concludes are so-called “tax expenditures.” The premise of these tax expenditure budgets is that the provisions listed in them do not implement the principles that justify using income measurement as the basis for allocating the federal tax burden among the populace. This view rests on a notion that there are immutable principles that underlie the adoption of an income tax system and that some agreement can be reached as to the identification of those principles. The adoption of the tax expenditure concept has had enormous effect on the inclusion and deletion of provisions in the tax law. This article examines four personal deductions that have been characterized in the publication of “budgets” by several government agencies as tax expenditures, and therefore as not conforming to income tax principles. The four deduction are: medical expenses, theft and casualty losses, charitable contributions, and the interest deduction for mortgages on a personal residence. The thesis of this article is that all of those deductions, in fact, do conform to progressive income tax principles and therefore cannot properly by characterized as governmental expenditures. In other words, each of those deductions performs a useful task in the proper measurement of income for tax allocation purposes when the entire structure of the income tax and the principles that underlie it are taken into account. While the determination of whether the deductions discussed in this article are expenditures is not conclusive of the issue of their survival in the tax law, it can have a significant impact on their survival or on the terms on which they might survive. Moreover, the validity and usefulness of the entire tax expenditure concept is open to question, and a demonstration that a number of items have been wrongly identified as expenditures by the government agencies that list those items weakens whatever confidence one might otherwise still have in the concept