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William Byrnes (Texas A&M) tax & compliance articles

Archive for November, 2019

Comments and Recommendations to the OECD Proposal for a “Unified Approach” under Pillar One

Posted by William Byrnes on November 15, 2019

Excerpt from SSRN here: A withholding based system will not be trapped in the tar pit of formation and implementation in the development of a new international tax regime, thereafter mired in the lack of institutional knowledge and capacity of resources for audit and MAP. A withholding based system offers a contrasted simplicity in relation to its implementation, including: (a) better procedural certainty for taxpayer and tax authority based upon current withholding regimes for services, (b) better revenue estimation for tax authorities, (c) less complex and expensive audits by tax authorities of taxpayers, (d) better tax risk management for taxpayers, (e) an established procedural system for relief of double taxation, and finally, (f) less cause for requiring MAP. Among proposals most likely to congeal into a uniform approach by March 2020, a withholding based system already has numerous adherents representing various economic strata.  Read the complete Excerpt from SSRN here

Thus, rather than running away from a withholding based system into a ‘brave new world’, the OECD should embrace it and shape its current contours of definitional income and source issues and range of rates. Thereafter, the respective OECD and UN committees may leverage economic theory and regulatory impact analyses, as was done in 1923, to modulate the withholding based system via the inclusive process of the OECD and UN MTCs while working within the context of the ALP bedrock of the OECD and UN TPGs to address Article 7 and Article 9 allocation issues resulting from intangible-based residual. Read the complete Excerpt from SSRN here

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Brand Rights: What type of taxable income? Royalties or Business Income?

Posted by William Byrnes on November 13, 2019

The Tax Court recently decided a case, Slaughter v. Comm’r (find all the citations in 1 Taxation of Intellectual Property § 1.06 (2019), involving annual royalty payments to an author wherein the IRS argued that instead of treating the payments as royalties that are not subject to self-employment and Medicare tax, the payments should be treated as net earnings from self-employment. The dispute that the Tax Court faced was whether there is a distinction, for self-employment tax purposes, between an author’s royalty income derived from her writing and any royalty income derived from her name and likeness. The author contends that one portion of her royalty payments is derived from her writing, which is a trade or business, and that another portion is derived, not from her writing, but rather solely from her name and likeness which are personal attributes which are not part of any trade or business. The IRS argued that the entire payments the author received from her publishing contracts were derived from her trade or business as an author, thus subject to self-employment tax.

To provide context to the dispute, Karin Slaughter is a bestselling crime author: over 35 million books sold in 37 languages. The Tax Court stated the following details of her publishing contract are standard in the publishing industry. Her contracting publishers receive more than just the right to print, publish, distribute, sell, and license the works and manuscripts written, or to be written. The publisher also secures the right to use the author’s name and likeness in advertising, promotion, and publicity for the contracted works. The author is required to provide photos and be available for promotional activities. The contracts include noncompete clauses that vary in scope, from requiring that the specified manuscript be completed before others, to prohibiting the author from entry into another contract until her writing obligations are met. Publishers also secure the right to advertise other works in the author’s books, qualified by the requirement that the author’s consent to the specific advertisements. Several of the contracts allow for, but do not require, a share of advertising proceeds to be paid to the author as a condition of her consent. Finally, the contracts include an exclusive option for the respective publisher to negotiate the contract for the author’s next works.

The author also receives more than just her advances and royalties. For instance, some contracts include a marketing guaranty requiring the publisher to spend a minimum amount on marketing for the author’s books. Although the publishers fund the marketing plan, the author’s agent retains the authority over its development. Another example is the author’s option to purchase the publisher’s plates at a reduced cost for any book that goes out of print and that the publisher refuses to reissue or license. In that instance, the rights in the work also revert to the author.

On her Federal income tax returns, the author deducted as a business expense the cost of leasing a vehicle to attend media interviews and promotional events. She also deducted the cost of hosting her own promotional events. For marketing purposes, many of her meetings were scheduled in New York City. While there, the author often attended meetings, conducted media interviews, and participated in publishing industry events such as trade shows. During the years in the issue she also met with a fellow writer to collaborate on a script for a possible television series. To facilitate her various activities, the petitioner rented an apartment in New York City and deducted the rent. Petitioner also deducted the cost of business gifts to agents, editors, publishers, and others.

The authors income grew eightfold due to her brand as an author. That brand is monetized by the author’s ability to attract and engage readers, speak in front of a crowd, and recommend other authors within her publishing house. Petitioner’s promotional activities and writing have created a very successful brand and body of work. In petitioner’s case, her brand includes her name and likeness as well as her reputation, goodwill, and existing readership. She maintains contact with her readership through social media, websites, and a newsletter.

The author’s advisors concluded that any amount paid to the author for the use of her name and likeness was “investment income,” i.e., payment for an intangible asset beyond that of her trade or business as an author. The author’s name is a brand.  The author’s expert concluded that the actual writing of a manuscript is but a small percentage of the value a publisher seeks from an author. An author’s work may sell on the basis of the author’s name and readers’ expectations for a particular kind of story, rather than for the quality of the writing. Thus, the author contended that the amount paid for her writing is what a publisher would pay a nonbrand author, and the residual amount is a separate and distinct payment for her brand.

The Tax Court held that the author’s brand became part of her trade or business. The Tax Court focused on the following elements of her behavior. The author was engaged in developing her brand with continuity and regularity. The author set out in a businesslike fashion to obtain stationery, a reputable agent, and a publishing contract. The author worked with a media coach and publishers to develop a successful brand. She has spent time meeting with publishers, agents, media contacts, and others to protect and further her status as a brand author. She attended interviews and promotional events and works to develop and maintain good relationships with booksellers and librarians. The author uses social media, websites, and a newsletter to maintain her brand with her readership. The Tax Court noted that royalties earned from her brand are not solely a result of her publishers’ actions.

The Tax Court then turned the fact that the author deducted advertising costs, the cost of a car used, in part, to attend promotional activities around Atlanta, and gifts sent to her contacts in the publishing world. Such expenses, stated the Tax Court, demonstrate that petitioner’s trade or business extends beyond writing to its promotion. If the author takes such promotion and brand-related expenditures on her Schedule C trade or business expenses, then the income derived from the brand to which those expenses relate must also be trade or business income. The Tax Court found on behalf of the IRS.

The Tax Court stated that there was not a particular case on point regarding an author’s income from the business of writing and that attaching to royalties for the sales of an author’s books. The Tax Court distinguished other cases decided in favor of the taxpayer regarding athletes and image rights, albeit these cases arguably are applicable to Karen Slaughter’s situation. For example, in Garcia v. Comm’r, the issues were to what extent to which payments made to the taxpayer under the endorsement agreement were compensation for the performance of the taxpayer’s personal services and the extent to which the payments were royalties for the use of the taxpayer’s image rights. The Tax Court stated that

Courts have repeatedly characterized payments for the right to use a person’s name and likeness as royalties because the person has an ownership interest in the right.”

The Court therein cited Goosen v. Comm’r that the characterization of a taxpayer’s endorsement fees and bonuses depends on whether the sponsors primarily paid for the taxpayer’s services, for the use of the taxpayer’s name and likeness, or for both. The court held that the payments made by the company were allocated 65 percent to royalties and 35 percent to personal services.

In Kramer v. Comm’r, the Tax Court found that royalties paid primarily for the grant of the exclusive right to use the taxpayer’s name to sell sports equipment, and only secondarily for the personal services rendered by taxpayer under the royalty contract. Herein the Tax Court concluded that commercial success for sales upon which the royalty income derives depended upon accompanying aggressive promotional activities. For Mr. Kramer, the Tax Court concluded that only the portion of the royalties that reflected compensation for the personal services constituted “earned income.” In Boulez v. Comm’r, the Tax Court said if a taxpayer has an ownership interest in the property whose licensing or sale gives rise to the income, then that income should be characterized as a royalty as opposed to personal service income. Therein the Tax Court cited the Fifth Circuit decision of Patterson v. Texas Co, wherein the Court of Appeals adopted the definition of a “royalty” as

“a share of the product or profit reserved by the owner for permitting another to use the property.”

The Slaughter case is ripe for appeal. The weight of jurisprudence perhaps rests on the author’s side regarding whether the royalties should be apportioned and that a portion derives from her brand rights that are not personal service income. Like for the tennis star Mr. Kramer, aggressive promotional activities are necessary to grow the sales of the product. There can be no brand, such as a trademark, without promotion of it. But the promotional activities are not the business of the author but rather those of the publishing company to sell books.

Yet, the weight of the facts perhaps rest on the side of the IRS. If the author’s accountants claimed the full amount of the expenses, such as for the New York apartment, on the author’s Schedule C as a trade or business expense, then correspondingly, as the Tax Court presents, income associated with those expenses is also Schedule C. It does not appear that the accountants undertook any diligence, by example not reading the contracts and not seeking any support records for the guestimate by the author of her time apportionment. It does not appear the accountants undertook any research and analysis other than to dismiss that any cases applied. It does not appear that the accountants undertook any planning research, or at least, the author rejected paying for such advice because it is common practice for authors, artists, and athletes of this income level to operate via a Sub S corporation or LLC. The pass-through business is a well-understood mechanism for mitigating Medicare tax, though with its own host of issues regarding compensation versus distributions.

For more analysis and coverage on this and other related issues, see William Byrnes’ treatise Taxation of Intellectual Property and Technology (2020 edition), a 1,000-page analytical treatise to the federal tax consequences of the development, purchase, sale and licensing of intellectual properties and intangibles.  Primary author William Byrnes leads a team of America’s leading tax senior counsel to analyze tax risk challenges for business and investment decisions concerning intellectual property, technology, intangibles, and the digital economy.

Nine seats remain for the Spring (4 teams of 3 students each) to join the current 4 teams January 13 – April 20 semester for the TRANSFER PRICING course taught by Dr. Lorraine Eden, Prof. William Byrnes, TP Aggiesand several industry experts. The courses count toward the INTERNATIONAL TAX online Master curriculum of Texas A&M for tax attorneys, accountants, and economists. Taught live twice weekly using Zoom involving teams working to design positions and solutions for real-world post-BEPS client studies each week, supported by originally authored materials, videos and audio casts, PPTs, and a robust online law & business database library.  For more information, contact Texas A&M Admissions https://info.law.tamu.edu/international-tax

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Release of Taxation of IP & Technology Update for 2020

Posted by William Byrnes on November 11, 2019

Taxation of Intellectual Property and Technology 2020 edition is a 1,000 page analytical treatise to the federal tax consequences of the development, purchase, sale and licensing of intellectual properties and intangibles.  Primary author William Byrnes leads a team of America’s leading tax senior counsel to analyze tax risk challenges for business and investment decisions concerning intellectual property, technology, intangibles, and the digital economy. This 2020 update published in November (next update published in June 2020) contains:

  • Expands this treatise beyond 1,000 pages of analysis and planning research.
  • Provides in-depth analysis of the 2019 final and proposed regulations that impact intellectual property and intangibles, including GILTI and FDII.
  • Analyzes the new Cloud Computing Regulations.
  • Expanded analysis of the 2018 Supreme Court Wayfarer decision and its impact on interstate digital business models and trademark holding companies.
  • Analysis of several 2019 decisions cases including AmazonAlteraSlaughterhouse.

Major revisions this update, by chapter, include:

  • GILTI regulations. The final and newly proposed GILTI regs are analyzed in depth in § 2.04[8].
  • FDII regulations. The proposed regulations are explained in depth in § 2.04[9].
  • Cloud Computing Regulations. The proposed regulations are explained in depth in § 2.05[3] and § 10.02[2][c][iii][G].
  • International Transactions. Chapter 12 has been substantially revised and additional analysis of the Service Regulations as well as the Cost Sharing Regulations in light of Amazon and Altera.
  • Economic presence tax nexus and digital services tax. See analysis within Chapters § 11.09, § 14.07[6] and § 15.05[1].
  • Wayfarer’s Impact. On taxation of holding companies, see § 4.06. On tax nexus and sales tax, see Chapter § 11.04.
  • Taxation of Emerging Technologies for Cloud Computing, Blockchain, and Artificial Intelligence. See Chapter § 10.02[2][c].
  • Slaughter v Comm’r. IRS argued that the author’s promotion for the publisher which builds her brand is her trade or business and thus her royalties are net earnings from self-employment. Analyzed and critiqued in Chapter § 1.06[4].

New domestic and internationally focused chapters are in development by treatise author Prof. William Byrnes (Texas A&M Law) for 2020, including on the valuation of intangibles, tax considerations for entrepreneurs, and country analysis chapters. His team of internationally recognized expert practitioners provide strategic and tax risk analysis: Carlos Perez Gautrin, Yair Holtzman, Iselle Coronado-Torres, Jeffrey Trey, Arinjay Kumar Jain, Leonardo Macedo, Venetia Argyropoulou, Pamela Ann Fuller, William Seeger, Lucia Valenzuela, and Charles Lincoln. Please contact William Byrnes with chapter proposals. Taxation of Intellectual Property Publication Update (2019)

Nine seats remain for the Spring (4 teams of 3 students each) to join the current 4 teams January 13 – April 20 semester for TRANSFER PRICING course taught by Dr. Lorraine Eden, Prof. William Byrnes, TP Aggiesand several industry experts. The courses count toward the INTERNATIONAL TAX online Master curriculum of Texas A&M for tax attorneys, accountants, and economists. Taught live twice weekly using Zoom involving teams working to design positions and solutions for real-world post-BEPS client studies each week, supported by originally authored materials, videos and audio casts, PPTs, and a robust online law & business database library.  For more information, contact Texas A&M Admissions https://info.law.tamu.edu/international-tax

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Byrnes & Bloink’s TaxFacts Intelligence Weekly – Actionable Analysis for Financial Advisors

Posted by William Byrnes on November 9, 2019

2020’s Tax Facts Offers a Complete Web, App-Based, and Print Experience

Reducing complicated tax questions to understandable answers that can be immediately put into real-life practice, Tax Facts works when and where you need it….on your desktop, at home on your laptop, and on the go through your tablet or smartphone.  Questions? Contact customer service: TaxFactsHelp@alm.com800-543-0874

Texas A&M University School of Law has launched its International Tax online curriculum for graduate degree candidates. Admissions is open for Spring (January) semester for the transfer pricing courses.  Texas A&M University is a public university of the state of Texas and is ranked 1st among public universities for its superior education at an affordable cost (Fiske, 2018) and ranked 1st of Texas public universities for best value (Money, 2018). 

199A Rental Real Estate Safe Harbor Excludes Certain Businesses

Not all taxpayers will be able to take advantage of the Section 199A safe harbor for rental real estate. While the safe harbor does apply to residential rental real estate, taxpayers are not entitled to rely upon the safe harbor if the taxpayer uses the property as a residence during the tax year. Notably, if the real estate is rented or leased under a triple net lease, the safe harbor remains unavailable under the final rule. When satisfying the “hours of rental real estate services” criteria, only certain activities are counted toward the 250-hour threshold. Activities such as rent collection, advertising the rental, property maintenance, negotiating leases and managing the real property generally count toward the threshold. However, the taxpayer’s activities as an “investor” are not counted. Similarly, if any property within the rental real estate enterprise is classified as a specified service trade or business, the safe harbor is unavailable for the entire business. For more information on the final safe harbor rule, visit Tax Facts Online. Read More

DOL Proposes New Electronic Disclosure Rules for Pension Plans

In response to the Trump administration’s executive order, the DOL has proposed a safe harbor rule that would allow pension plans to satisfy disclosure obligations electronically. As currently proposed, the rule only applies to pension plans. It would allow plan sponsors to email required documents to participants, beneficiaries and any other individuals entitled to receive disclosures–so long as the individual has provided an email address (which can be a work email address). Any documents required under Title I of ERISA could be furnished electronically, including notices of material modification or blackout notices, except for documents that must be furnished upon request. While employers are not yet entitled to rely upon this rule until it is finalized, it provides important insight into potential future developments surrounding pension disclosure obligations. For more information on the requirements that apply to pension plans, visit Tax Facts Online. Read More

District Court Rules Small Business Qualified Retirement Plan Not Exempt in Bankruptcy

While 401(k) funds are generally exempt from a bankruptcy debtor’s estate, a recent district court ruling highlights a situation where a small business owner may lose the exemption. In this case, the taxpayer maintained a pension plan pursuant to a prototype plan document offered by his financial institution that had been approved via an IRS opinion letter, as is commonly the case. The court, however, found that amendments to the prototype plan document rendered the opinion invalid. Further, it found that the plan inappropriately benefitted the taxpayer and his spouse, rather than providing benefits to employees, in violation of IRS nondiscrimination rules. Because of this, the plan was deemed to be disqualified despite the fact that the taxpayer relied upon advisors to manage the plan. Because the taxpayer was owner of the small business responsible for the plan, he was deemed to be materially responsible for the qualification failure, therefore causing the plan assets to lose the typically available bankruptcy exemption. The court noted that this probably wouldn’t have been the case if the taxpayer had been an employee participating in a non-qualified plan. For more information on the treatment of 401(k) assets in bankruptcy, visit Tax Facts Online. Read More

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Transfer Pricing case studies based course Jan 13 – Apr 20 (Zoom based, small team groups)

Posted by William Byrnes on November 7, 2019

Nine seats remain for the Spring (4 teams of 3 students each) to join the current 4 teams January 13 – April 20 semester for TRANSFER PRICING taught by Dr. Lorraine Eden, Prof. William Byrnes, TP Aggiesand several industry experts. The courses count toward the INTERNATIONAL TAX online Master curriculum of Texas A&M for tax attorneys, accountants, and economists. Taught live twice weekly using Zoom involving teams working to design positions and solutions for real-world post-BEPS client studies each week, supported by originally authored materials, videos and audio casts, PPTs, and a robust online law & business database library.  For more information, contact Texas A&M Admissions https://info.law.tamu.edu/international-tax

Texas A&M Law offers the premier online program in international tax with a multidisciplinary, risk-management-focused approach. Our unique, industry-based online curriculum is vetted by and focuses on the needs of multinational corporations, large firms and governments. A degree from Texas A&M University, a Tier-1 research institution and one of the largest U.S. public universities, is recognized worldwide. Texas A&M’s online International Tax Program is specifically designed for tax professionals, both lawyers and non-lawyers, whose careers demand an understanding of international taxation and related issues.  For more information, contact Texas A&M Admissions https://info.law.tamu.edu/international-tax

The International Tax graduate program is an online, 24 or 30 credit hour graduate degree that can be completed in less than two years. The degree program offers a competitive advantage to any tax professional, including lawyers, accountants, finance executives and economists, that advises multinational clients on business and investment, or that works within a tax (risk management) department.

    • Industry-Responsive Curriculum:  A tax-risk management approach with a focus on tax data management and risk analysis based on the results of in-depth industry research.
      • Hanover Research, on behalf of Texas A&M, interviewed one-on-one and then validated by anonymous survey over 100 tax executives from multinational corporations, large firms and government. As a result, the program is designed with faculty and degree candidates that are multidisciplinary, including both tax lawyers and non-lawyer tax professionals, engaged together in teams.
    • Incredible Student Experience:  Texas A&M law offers small class sizes to ensure each student gets personal attention. These small class sizes allow ​you to forge strong connections with your classmates and to learn from each other’s experiences.
    • Faculty Expertise & Leadership:  The curriculum has been developed and is led by Professor William Byrnes, an international tax authority and globally recognized online education pioneer focused on student outcomes. The program’s faculty are multidisciplinary (e.g. lawyers, economists, accountants, data scientists) and include renowned authors, academics, tax executives of multinational corporations, and tax advisors from large firms.

Posted in Courses, international taxation, Transfer Pricing | Tagged: , | Leave a Comment »

The Battle to Legalize Marijuana Comes Down to Tax Deductions and the 16th Amendment

Posted by William Byrnes on November 6, 2019

Every day I comb through my Law360 Tax Authority list of articles in order to update one of my tax treatises.  I found a really interesting one though today for my Money Laundering treatise.  It’s about fitting an elephant through a keyhole.  With enough pressure, it can be done, but by breaking down the entire door.  The case is Northern California Small Business Assistants Inc. v. Commissioner, 153 T.C. No. 4 (Oct. 23, 2019).  The Law360 Tax Authority analysis is here: https://www.law360.com/articles/1215134/tax-court-decision-may-open-up-new-challenges-to-280e

My commentary this week… (well, it will be for a debate in my Spring Fed Income Tax course actually)

Of course, it’s not a violation of 8th because not a penalty, albeit I appreciate the (losing) argument.  Yet, at this stage, cross-aisle agree both federal Cannabis-leaf-hempand state, marijuana, at least at defined dosages, it is more like Valium on Schedule IV then Vicodin Schedule II.  The Schedules allow for dosage amounts. Only ardent prohibitionists I think (I am no expert) want the Schedule I classification to remain.  I am sure state leaders, the financial industry (because of the AML provisions of the BSA), the IRS, and the AG industry want it reduced to at least Schedule II but preferably Schedule IV where it belongs.  Or break it up by THC levels into Sch II, III, and IV.

But I think that the DEA is the real problem. I do not understand why the DEA will not remove marijuana from the blacklist (Schedule I) unless the DEA needs it on Schedule I to maintain its significant funding for global marijuana crop eradication programs because govt agencies never shrink themselves by giving up jurisdiction or budget. But I do not believe that the FDA, HHS, et al who inform the DEA want to keep it at Schedule I.  Read the DEA’s current policy regarding CBD and THC-Cannabis.  The medical pharmacological evidence is building of the benefits for various ailments, see the 2017 National Institutes of Health meta analysis (Medicinal Cannabis: History, Pharmacology, And Implications for the Acute Care Setting).  All pharma has side effects so the fact that some participants who ingested the THC Cannabis (“got high”) reported being dizzy is very mild (‘don’t operate heavy machinery or drive’ warning labels mandatory). Prolonged and heavy use of any pharma, any drug like caffeine (of which I have much experience, but not willing to kick the habit yet) and alcohol, is probably going to be harmful to very harmful to just out-right early death.  I am not saying something new – everyone in the debate already knows all the arguments for and against.  So it’s either the teetotaler lobby, the DEA not wanting to give up ‘the war against marijuana”, or a combination, keeping marijuana on Schedule I.

So lots of pressure on Treasury to fix two insurmountable issues to marijuana state-licensed businesses from being federally legit and compliant. The BSA problem for AML compliance (keeps this a cash business) and the IRC 280E problem (makes marijuana industry a federal tax evader or unprofitable because effective rates of taxation of state and federal are in many cases greater than 100% of net income).  And Treasury wants to fix it.  But its hands are technically tied because the DEA will not delist marijuana from Schedule I.  That forces 280E and AML rules to kick in.  I’d be happy for Treasury to ignore the law but it’s too dangerous for Treasury or any agency to pick and choose what laws to adhere to. Of course, the discretion of enforcement is a totally different issue.

The AML issue Treasury issued, albeit the former prohibitionist AG basically said DOJ is not playing ball, a soft guidance explaining to banks how to distinguish good and bad marijuana dollars (the Marijuana SAR guidance). (See marijuana SAR results for 2018) For 280E though, Treasury would need to tell the IRS to ignore 280E marijuana stated licensed businesses fraudulent filed returns to circumvent the prohibition of deductions.  It would be really hard to administer the audits.

If Treasury cannot do it, but wants to do it, that leaves the Tax Court.  The Tax Court judges have over the past two years have concluded that marijuana should be removed from Schedule I so that 280E is not an issue.  In this case, once again the conclusion is:

“Congress, rather than this Court, is the proper body to redress petitioner’s grievances. We are constrained by the law, and Congress has not carved out an exception in section 280E for businesses that operate lawfully under State law.”

It’s only doing so because the IRS Counsel (must I think) express this in arguments to the Court, begging the Court for a way out of this mess. So the Tax Court has written that Congress or an agency needs to fix the problem.  It hasn’t been fixed.   And then this case where a powerful voice on the Tax Court said to the DEA and Congress: ‘do not force us to rectify the problem because you are not going to like the theoretical hoop we must jump through to do it.’

So, the theoretical argument that could gain some traction about the denial of all deductions by 280E is that it imposes the tax rate (say 37%) on revenue which may violate the intention of the 16th Amendment.  This is what Gustafon is musing about at page 23. I agree.

At page 26 the point is driven home (pun coming..):

Very different would be an attempt by Congress to tax gross proceeds from the sale of a capital asset, without allowing a taxpayer to account for his “basis” in the property in calculating his taxable gain.”

So imagine Congress imposes the ordinary tax rate on the sale price of an individual taxpayer’s sale of the home.  Say 37% on $500,000.  Taxpayer not allowed the basis reduction of the acquisition cost of $450,000 three years ago.  TP owes $185,000 tax (and also the additional 3.8% Net Investment Income Tax), on the $50,000 – expenses of the transaction gain.  Of course, this is absurd because property requires financing and the remaining would be less than any mortgage secured loan.  Same scenario but now shares in Apple bought at $220 last year by our home owing taxpayer and 13 months later sold for $250.  Economic collapse.  TP rebellion.  Not a pretty civil scenario.

Well, 280E does not deny deductions for the cost of goods (of the narcotics like marijuana or heroin – I do not think marijuana should be a black-listed scheduled narcotic).  But why not?  Because, simply put, an ‘income’ tax on business ‘income’ should be imposed on the ‘income’ and not on the revenue which is not a business’ income.  A tax imposed on a business revenue is something other than an ‘income tax’.  Excise tax maybe, but not an income tax.  See Judge Gustafson explain this at page 26-27.

Likewise, a congressional attempt to tax the gross receipts of a business engaged in sales should fail. A taxpayer who purchased 100 widgets at a cost of $10 each and sold them at a price of $9 each would have gross receipts or sales of $900, which after being reduced by the “cost of goods sold” (“COGS”) of $1,000 (analogous to basis in the Blackacre example) would yield a loss of $100. Given that obvious loss, Congress could not tax the gross receipts of $900 as if it were “income”. Rather, as the Court of Appeals for the Tenth Circuit has explained: “To ensure taxation of income rather than sales, the ‘cost of goods sold’ is a mandatory exclusion from the calculation of a taxpayer’s gross income.””

Can Congress levy a tax on revenue under the 16th?  We know the answer is no because that is why COG is allowed to be above the line to derive an income, and then 280E applies.  Well settled.  See page 27.

The taxation of “income” must take account of the “basis” in a capital asset and of the COGS of inventory–not merely as an exercise of “legislative grace” but as mandatory under the Sixteenth Amendment of the Constitution.”

So some expenses are allowed being COG, and other, operating expenses, not allowed.  Already 280E is in a quagmire of discriminating between good and bad expenses to fit into the 16th.  Thus, the Tax Court could force a bushel of marijuana through a 280E keyhole using the pressure of the 16th Amend if it must to deal with this situation.  Gustafson’s push through the keyhole is the second part of his sentence highlighted below at page 29.

“Congress taxes something other than a taxpayer’s “income” when it taxes gross receipts without accounting for basis or COGS--and, I would hold, when it taxes gross receipts without accounting for the ordinary and necessary expenses that are incurred in the course of business and must be paid before one can be said to have gain.”

The argument requires stretching the keyhole with a lot of 16th Amend pressure (though I personally quite like the 16th argument) and Appellate Circuits may want to keep the keyhole rather small and deflate that pressure.  But I think that the 1st, 9th, and 10th judges have to live in states where education or other government funding is significantly helped by the state-legal licensed marijuana industry.  Judges look at neighbor farmers who cannot sell to China about to go belly up with their grains and soybean – where marijuana can save the farm.  I have no litigation or controversy experience but I imagine some Appellate judges know these situations from reading or table talk.

So if the stretch of the 280E keyhole is not totally implausible by using the 16th Amend, a panel may just agree to send a message like the Tax Court to the DEA and failing that, Congress.  Anyway, the Supremes can sort out the ramifications of using the 16th to stretch the 280E keyhole.  And by that time, maybe the DEA did what the public pressure wants it to do, and is the right thing to do based on medical evidence being generated, move marijuana, based on amount of THC, to the relevant schedules of II through IV.

Anyway, my take on this case.  Look forward to our Spring debate.

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