(Un)Appealing Deference to the Tax Court

The U.S. Tax Court (Tax Court), which hears the vast majority of litigated federal tax cases, occupies an unusual place in the federal government. It is a federal court located outside of the judicial branch, but its decisions are appealable to the federal courts of appeals. This odd structure, coupled with the court\u27s history as an independent agency in the executive branch, can give rise to important questions, such as the standard of review that should apply to its decisions. In particular, should the courts of appeals treat Tax Court decisions the same as those of district courts in tax cases, or should they apply a more deferential standard analogous to review of agency decisions, as the U.S. Supreme Court held in 1943 in Dobson v. Commissioner? Answering the standard-of-review question implicates issues of both law and policy. Contrary to some scholarship, this Article argues that, as a doctrinal matter, no vestige of the Dobson rule remains and that courts of appeals must apply the same standard of judicial review that they apply to district courts in nonjury cases. The Article further argues that appellate review theory supports that result. The Dobson rule was a largely instrumental one designed by U.S. Supreme Court Justice Robert Jackson to reduce the volume of tax litigation. Although tax litigation is unusually decentralized and the Tax Court has unique expertise, those differences do not support departing from the policies underlying appellate review. Appellate courts therefore should not defer to the interpretations of the Tax Court any more than they do to those of the district courts

Stranger than Fiction : Taxing Virtual Worlds

Virtual worlds, including massive multi-player on-line role-playing games (game worlds), such as City of Heroes, Everquest, and World of Warcraft, have become popular sources of entertainment. Game worlds provide scripted contexts for events such as quests. Other virtual worlds, such as Second Life, are unstructured virtual environments that lack specific goals but allow participants to socialize and engage virtually in such activities as shopping or attending a concert. Many of these worlds have become commodified, with millions of dollars of real-world trade in virtual items taking place every year. Most game worlds prohibit these real market transactions, but some worlds actually encourage it. Second Life, for example, grants participants intellectual property rights in their creations. Although it seems intuitively the case that someone who accepts real money for the transfer of a virtual item should be taxed, what about the player who only accumulates items or virtual currency within a virtual world? Is valuable loot acquired in a game taxable, as a prize or award is? And is the profit in a purely in-game trade or sale for virtual currency taxable? This is an important set of questions, given the tax revenues at stake. Although the Internal Revenue Service has not yet attempted to tax transactions within virtual worlds, it is aware of the issue, and there is pressure on the government to determine how to resolve it, given that the economies of some virtual worlds are comparable to those of small countries. The Joint Economic Committee has announced that it is studying the issue. Most people\u27s intuition probably would be that accumulation of assets within a game should not be taxed even though the federal income tax applies even to non-cash accessions to wealth. This Article argues that federal income tax law and policy support that result. Loot drops in game worlds should not be treated as taxable prizes and awards, but rather should be treated like other property that requires effort to obtain, such as fish pulled from the ocean, which is taxed only upon sale. Moreover, in-game trades of virtual items should not be treated as taxable barter. If courts uphold game agreements that purport to provide players with a mere license to use the game, in-game trades do not constitute realization events and thus are not taxable. therwise, tax policy considerations suggest that Congress should provide nonrecognition for these exchanges. By contrast, in virtual worlds that are intentionally commodified, such as Second Life, tax doctrine and policy counsel taxation of even in-world sales for virtual currency, regardless of whether the participant cashes out. However, as in game worlds, participants should not be taxed on purely in-world trades of non-currency items. This approach would allow entertainment value to go untaxed without creating a new tax shelter for virtual commerce

IRS Reform: Politics As Usual?

The IRS is still reeling from accusations that it “targeted” Tea Party and other non-profit organizations. Although multiple government investigations found no politically motivated behavior—only mismanagement—Congressional hearings were quite inflammatory. Congress recently followed up those hearings with a set of IRS reforms. Congress’s approach is reminiscent of the late 1990s, when highly publicized Congressional hearings regarding alleged abuses by the IRS resulted in a major IRS reform and restructuring, although the allegations subsequently were largely debunked. This Article argues that the recent allegations against the IRS also were overblown. It looks to the aftermath of the 1998 IRS reform, which included a major downturn in enforcement, for lessons for the present day. The Article concludes that Congress as a whole can do a better job of keeping politics from undermining tax administration

Avoiding Scandals Through Tax Rulings Transparency

In 2014, the International Consortium of Investigative Journalists broke the “LuxLeaks” scandal, revealing numerous tax rulings that the press termed “sweetheart deals” granted to multinational companies. Many countries offer tax rulings because they provide certainty to taxpayers and the government on the tax consequences of a planned transaction. Yet, secrecy that is followed by leaks and criticism is a recurring aspect of these rulings, both in the United States and Europe. LuxLeaks, which revealed secret rulings from the small European country of Luxembourg, was international headline news. It helped trigger widespread reforms. Tax authorities, including those of European countries and the United States, now automatically share information about cross-border advance rulings with other countries’ tax authorities. But Luxembourg’s tax rulings otherwise remain confidential. The United States treats a type of tax ruling, the Advance Pricing Agreement (APA), similarly: it exchanges information about APAs with other countries but does not otherwise disclose them. How transparent should tax rulings be? Secret rulings protect taxpayer confidentiality but also impose costs on various stakeholders. This Article (1) draws on the repeated scandals involving tax rulings to develop an original typology of these costs; (2) catalogues the levels of possible rulings disclosure, connecting each level with the costs it would address; and (3) examines potential arguments against rulings transparency. The Article concludes that, despite government resistance, best practices call for public disclosure of anonymized tax rulings—both letter rulings and APAs—heavily redacted, if necessary

Tax Compliance and the Reformed IRS

The Internal Revenue Service Restructuring and Reform Act of 1998 directed the IRS to transform itself into an agency focused on customers. What affect will such a focus on service have on compliance? This article analyzes not only the post-IRS reform statistics on enforced compliance but also considers the more important question of the likely impact of IRS friendliness on so-called voluntary compliance. Although some have suggested that a kinder IRS might prompt increased voluntary compliance, this article argues that it likely will not, based on the literature examining the impact on voluntary compliance of tax collector service to taxpayers and the use of a softer tone in correspondence with taxpayers. By contrast, the literature reflects the possibility that the perception of procedural fairness on the part of the IRS might increase compliance. This suggests that the IRS can benefit from treating taxpayers fairly but that it would be unwise for the IRS to focus on service at the expense of enforcement. (A related paper considers the interplay between norms and enforcement in tax compliance.

Statutory Speed Bumps: The Roles Third Parties Play in Tax Compliance

Recent legal and economic scholarship has recognized that the government can use structural systems as an efficient way to reduce prohibited behavior. The federal tax system employs structural mechanisms, such as withholding taxes, to foster compliance. The use of structural systems to reduce tax evasion need not be limited to tax administration, however. The Article argues that substantive federal income tax law can - and in many contexts does - foster compliance by harnessing the structural incentives of third parties. Although this phenomenon has gone largely unnoticed, third parties are routinely used by the tax system to verify the bona fides of taxpayer claims in diverse contexts involving reimbursed amounts and other receipts. Yet, third parties do not always behave in ways that are helpful for tax enforcement. The Article therefore identifies contexts in which a third party may have an incentive to collude with the taxpayer. The Article argues that these contexts are ones that the government needs to scrutinize closely and, in certain cases, obstruct with legislation. By contrast, the government can afford to free ride on the incentives of a third party in contexts in which the transfer of funds from the third party to the taxpayer is a zero-sum game