Warning for investors in film tax credits

Film tax credits are definitely big business. I doubt that they are very helpful to economies of the states that provide them, but they do probably help some otherwise commercially nonviable films get made.

Here's the warning: when investing in film tax credits, whether directly or by accepting them as security for loans, make sure your film and its business structure actually qualify. If the credit is disqualified because of an audit or other failure of paperwork, the taxpayer who received it will be the one to repay it.

There is no ambiguity in Bitcoin taxation.

Many people would like there to be ambiguity about Bitcoin taxation. That would be quite convenient, as many people would not like to pay taxes on their income from trading in Bitcoins. However, this is just one of the many subjects on which the tax law is already quite clear. If the IRS doesn't mess up enforcement (as it has done with equity carried interests), it has all the tools it needs.

Under U.S. tax law, most taxpayers have the U.S. dollar as their "functional currency." (It is possible to have a different functional currency, in which case that currency should be substituted for each mention of the "dollar" in this post.) If a taxpayer buys an asset for dollars, and later sells the asset for more or fewer dollars than it paid, it will have a gain or loss, respectively. It doesn't matter what the asset is: it can be as solid as an apartment building or as abstract as a fractional interest in the royalty stream from a musical recording. In fact, all currencies other than the taxpayer's functional currencies are such assets. Thus, it seems clear that a Bitcoin is such an asset.

It can be a bit tougher to track a Bitcoin than some other types of property. For example, if you sell stock, your broker will normally provide you (and the government) with a statement disclosing what you have done. Many, although far from all, other types of income, are subject to information reporting requirements. Even when no other party is required to report a transaction to the government, the taxpayer participating in the transaction is expected to report it. In an audit, the IRS will look at bank and other records to determine whether the taxpayer has failed to report any income. It does not seem any harder to find unreported income from selling Bitcoins than from selling, say, antique baseball cards.

That leaves only a "Hail Mary" argument against taxation of Bitcoin profits: that the Bitcoin is in fact the taxpayer's functional currency. That probably creates a definitional issue: the tax definition of "currency" probably excludes non-government issued assets. Furthermore, in the current state of the world economy, it is difficult to see how a taxpayer could carry on enough activities using Bitcoins to make them an actual functional currency. More to the point, the IRS shouldn't care: if your functional currency could somehow be Bitcoins you no longer would have taxable gain or loss when you disposed of Bitcoins, but you would have taxable gain or loss each time you disposed of dollars.

Another de facto tax haven eliminated

It appears that the nontaxable London pied a terre favored by many international oligarchs may no longer be available for tax-free wealth accumulation: nonresidents will pay capital gains tax on their U.K. real estate capital gains.

That certainly seems to be a reasonable quid pro quo for the benefits nonresident property owners enjoy when they acquire property one of the world's more desirable real estate markets. The opportunity to park immense amounts of wealth where it will be protected by a highly stable and nonconfiscatory government is certainly worth the small price of paying tax on increases in value; the fact that it is pleasant and convenient to visit adds further value.

The law change is an indication that the U.K. has realized it has some pricing power. There just aren't too many suitable places for the hugely rich to buy hugely expensive property.

Will this development drive the U.K. real estate market down? Probably not. The United States has had a similar regime in place for decades. California's recent "millionaire tax" tax increase may also be instructive: California raised its tax on very large incomes without experiencing a notable exodus of either wealthy taxpayers or businesses. Extremely desirable places to live can, and should, price themselves in accordance with demand.

Proposed 501(c)(4) "dark money" regulations fail to regulate.

Under the magnificently permissive regulations currently in effect, organizations formed and operated for political purposes have been enjoying the benefits of tax-exempt status under Internal Revenue Code section 501(c)(4). Notwithstanding the statutory requirement that the organizations operate "exclusively" for nonpolitical purposes, the Treasury decided that operating "primarily" for nonpolitical purposes means the same thing. That has given 501(c)(4) organizations carte blanche to devote 49.9% of their funds to the most blatantly political activities while remaining tax-exempt.

Now, the Treasury has proposed a new 501(c)(4) regulation to clarify the situation. Does the regulation address the "primarily" issue? No. The Treasury states only that it is "studying" that issue. Rather, the proposed regulation creates a specific set of definitions for what constitutes prohibited "candidate-related political activity." Regrettably, that definition excludes quite a lot of things any normal observer would consider candidate-related political activity. The result: an ill-intentioned 501(c)(4) organization can freely devote 49.9% of its funds to anything it wants, and can spend the other 50.1% on things most normal human beings would consider impermissible political activity.

Just to be clear: an organization that used to be limited to spending 49.9% of its money on evil will now be able to spend 100% of its money on evil. Nice job, Treasury.

I have a sense that the definitions in the regulations may be slanted in favor of the disguised-electioneering type of 501(c)(4) organization and against the actual public benefit type. I don't know enough about how those groups spend their money to have a credible opinion, but it is very interesting that a generally progressive-leaning group is objecting that the regulation could affect such nonpartisan activities as voter registration drives.

This is what the statute says an organization must be to qualify as a 501(c)(4) organization: "operated exclusively for the promotion of social welfare." The regulation should be short and easy to write.

Tax exemption for parsonage allowance held unconstitutional

Get ready for some entertainment. A U.S. District Court in Wisconsin has held, in Freedom From Religion Foundation, Inc. et al. v. Lew et al., that the tax exemption for parsonage allowances religious entities provide to their clergy is unconstitutional.

Parsonage benefits come in two flavors: actual housing provided to clergy and cash allowances for housing. The Freedom From Religion Foundation sued to have both types held taxable. They lost on the first, as the court found it to be comparable to housing "provided for the convenience of the employer," which is tax-free even for non-religious employees. That makes some sense: the parsonage allowance certainly has its historical roots in the days when a clergyman was expected to live on church premises in order to be accessible to the congregation.

On the cash allowance issue, however, the Freedom From Religion Foundation won. The court pointed out that the allowance was paid in cash and was no different from cash paid to any employee that the employee used to obtain housing. Furthermore, a clergyman who used it to buy a house would benefit both from appreciation of the house and from the federal tax deduction for home mortgage interest. Thus, the exemption was a clear and unconstitutional subsidy to religious organizations.

Commentary: it is difficult to imagine a clearer case of an unconstitutional subsidy to religion. Nevertheless it is surprising that the Freedom From Religion Foundation won. The courts, on average, are highly reluctant to disturb the prerogatives of mainstream religion. Usually when a court is faced with an obvious result that it doesn't like, it finds a procedural way out. The biggest surprise in the case, and the most likely ground for reversal, is that the court held that the plaintiffs had standing to sue.

The entertainment: this is exactly the type of decision that drives some television personalities wild. Furthermore, it is not purely a figment of their imagination: this is a genuine reduction in the advantages enjoyed by organized religion. Do not expect a moderate reaction.

Man bites dog: prosecutor punished (slightly) for misconduct

It is big news that in the case of In re Anderson, not only was the innocent defendant released after serving 25 years in prison but the prosecutor whose misconduct caused the conviction was punished. Not much of a punishment: 10 days in prison. Nevertheless, it's something.

Here is a link to an interesting article reminding us that if this type of misconduct is not the rule, it's not the exception either. Punishment for the prosecutor, however, is astonishing: one source states that this is the first time ever that a prosecutor has been punished for conduct leading to a wrongful conviction, and while I am not in a position to check that, I have certainly never heard of it before. The fact is that prosecutors can do pretty much anything they want without repercussion.

Furthermore, even prosecutors who do not themselves commit misconduct benefit from the misconduct of other prosecutors. A defense attorney, in evaluating a plea deal, must take into account the possibility that the prosecutor will cheat and get away with it: for example, a subtle threat to a defense witness might be enough to cause that witness to refuse to testify, dramatically altering the outcome of the case. Even if the prosecutor personally would not make that threat, (a) defense counsel cannot be sure of that and (b) the witness may realize that he had better refuse to testify even if the threat is unspoken. Thus, without ever personally doing anything wrong, the prosecutor derives an overwhelming negotiating advantage.

Is this a tax issue? Absolutely. In fact, it's more of an issue in a tax case than in a murder case such as Anderson. In a murder case there is often hard evidence, such as physical objects and DNA evidence, that can be used to prove innocence once they are found. That is, there is a legitimate possibility of demonstrating both innocence and prosecutorial conduct based on physical and perceptual evidence. Also, when such items are hidden, it is normally fairly clear: either the prosecution has shown an item of physical evidence to the defense or it has not. In a tax case, normally involving circumstantial evidence obtained under pressure from witnesses who are at risk for being named as coconspirators and therefore must act to protect the prosecution, there is no similar possibility.

Tangible property regulations year-end deadline

The recently-issued tangible personal property regulations spend a couple of hundred pages attempting to make clear what expenditures with respect to tangible property can be deducted and which must be capitalized. As the tax community looks forward to a lot of extra work to cope with this "clarification," there is one election that may reduce the administrative burden very considerably. The election, a so-called "de minimis" election for certain property acquisitions, generally allows the taxpayer to treat the acquisitions the same for tax and book purposes.

As detailed by TaxGroup Partners, the election can be made after the end of the year, but in a fairly spectacular trap for the unwary, it is permitted only if the taxpayer has established certain policies before the beginning of the year. That means a lot of taxpayers must take action before 31 December 2013. If you are one of them (or know one of them), the time to start thinking about the election is now.

Attacking capital gains treatment for private equity carried interests -- or not

Although the case of Sun Capital Partners III v. New England Teamsters was decided a few months ago, its implications are still percolating into public discourse. The New York Times reminds us that if a private equity investor is engaged in a "trade or business" for pension purposes, it may be engaged in a trade or business for income tax purposes. If it is engaged in a trade or business, its carried interest profits are taxable as ordinary income instead of capital gains.

That is consistent with my long-held view that the government could attack capital gains treatment of carried interests without new legislation if it chose to do so. The most interesting part of the article is its near-prediction that the government will not choose to do so. The article suggests that the reason the government will not pursue the additional taxes is that it is scared to take on well-funded taxpayers (which is unfortunately credible). The reason may equally likely be a combination of anti-tax policy and regulatory capture, in which the government's policy makers have simply decided that they do not wish to impose additional taxes upon private equity.

Raoul Weil arrested in Italy

Raoul Weil has been arrested in Italy on U.S. tax charges. He was a high executive of UBS and is accused of participating in UBS' abetting its clients' evasion of U.S. taxes. This raises two reactions:

1. Why did he go on vacation in a country that extradites to the United States? It seems careless. Of course, he may know something we don't: it will be interesting to see whether the Italians actually end up extraditing him.

2. The only true immunity from prosecution at this point lies in being a high executive of a U.S. bank.

Presumably the U.S. government has a full set of cooperating witnesses lined up to testify against Mr. Weil, but there may be significant questions about U.S. legal liability for conduct taking place elsewhere. It is not clear that a Swiss banker, operating in Switzerland, has an obligation to help the United States enforce its tax laws.

A fairly normal enforcement decision

The always observant Felix Salmon notes yet another case in which the government (in this case the SEC) is vigorously pursuing an individual while the institution that apparently actually created the problem is left undisturbed. He suspects that the government is targeting the individual because he cannot afford to fight the case. That is unfortunately normal, and not only for the SEC. Taxpayers without very deep pockets should beware of it.

Possibly meaningless changes in Irish tax law

Various news outlets are reporting that Ireland has changed its tax law, but there is doubt whether it will actually result in international businesses' paying more tax globally. Apparently it will still be possible for a company incorporated in Ireland to recognize all of its income in a no-tax jurisdiction such as Bermuda.

That leaves two questions: why would Ireland change its law and why would it do so in a relatively ineffective way?

I believe the answer is "crumbs." Major multinational companies, when they choose to take advantage of the peculiarities of the Irish tax law, often seem to leave a few dollars (or Euros) behind. That can easily be done by not fully "zeroing out" the income that is subject to Irish tax, or it can be done by actually carrying on some job-creating business in Ireland. Ireland does not want to be seen as a tax-avoidance jurisdiction, but it likes those crumbs.

Are people really renouncing U.S. citizenship over FATCA tax reporting?

The Los Angeles Times reports on the difficulties U.S. tax reporting requirements ("FATCA") can impose on expatriates:

Los Angeles Times article

So are people really giving up U.S. citizenship in order to avoid FATCA requirements? Anecdotally, no, if only because the U.S. tax cost of doing so is prohibitive. (An expatriating taxpayer is in many cases treated as selling all of his or her property in a taxable sale the day before expatriation.)

Expatriates are, however, very unhappy about the highly burdensome foreign reporting requirements that apply to even very small foreign accounts. The penalties, even for an inadvertent violation with no tax deficiency, can be enough to destroy a family's finances.

I can't speak for foreign banks, but after the reporting squeeze the U.S. and Swiss governments put on Swiss banks, it's no surprise if a foreign bank does not wish to deal with U.S. customers.

The FATCA requirements are surely not troubling money launderers in the least; there are plenty of jurisdictions that will not make disclosures to U.S. authorities, and I don't think money launderers usually are greatly concerned about filing accurate tax returns.

Meanwhile, the U.S. government is literally trying to dictate how other countries run their banking systems. This is exactly the kind of policy that undermines the perceived legitimacy of the U.S. tax system in the eyes of both the world and of U.S. taxpayers.

Of course, it's a desirable goal to detect money laundering and foreign jurisdiction tax evasion. However, all an excessively broad reporting requirement does is allow bad people to hide in a thicket of unnecessary reports filed by good people.

FATCA compliance should be completed by filling out two lines (per account) on a standard tax return. Additional reporting requirements should apply only where they make sense. Penalties where there is no tax evasion should be limited to an amount that reflects a reporting error, not an international money laundering conspiracy.

Introduction of Michael Kerekes

Greetings to all who come here. My name is Michael Kerekes, and until a few minutes ago I was the last person on the Internet who did not yet have a blog.

I intend to discuss primarily tax matters, from momentous issues of tax policy to silliness on the part of both taxpayers and governments.

When someone says it better then I could, I will post a link:

Example of someone saying it better than I could:

For those of you who did not click through, it's a comic about those who might allow the government to remain shut down, to default on its debt, or both. What is currently going on falls clearly into the "silliness" category, but it unfortunately also falls into the "dangerous" category.

In the long run, there will be a lot of tax angles to this mess. Currently, we are dealing primarily with the possibility that there will be a repeal or reduction of the medical device tax. 

Generally, medical device manufacturers receive tremendous value from society in the form of patent protection. Specifically, the Affordable Care Act that is to be partially funded by the tax will create millions of potential new clients for medical devices. Thus, the tax seems to be a fair way to cover a relatively modest part of the cost of the Act. If the medical device tax is repealed, someone else will have to pay for that funding. Who can more fairly be asked to do so?