Let the Mishegaas Begin

The TaxProf Blog reports here on the pending Tax Court case of Michael and Marla Sklar, who are trying to deduct their children's private school tuition based on the IRS's closing agreement entered into with the Church of Scientology. In essence, the Sklars are arguing that the tuition they pay is deductible because (i) the religious instruction their children receive is the same as that received by Scientologists, and (ii) that there is an administrative inconsistency in the Service's treatment of Scientologists and its position vis a vis the Sklars.

My sense is that the Service has the far better argument here. Indeed, I have always wondered why the Service entered into a consent agreement with the Church of Scientology in the first instance. However, the purpose of this post is not to discuss tax law. Rather, it is to highlight the great opportunity for humor that the Sklar case presents.

The TaxProf's recent post was triggered by an article in the National Law Journal entitled Scientology Settlement Puts IRS in a Kosher Pickle. In his concurring opinion in the Sklar case when it was before the Ninth Circuit, Judge Silverman mused "Why is Scientology training different from all other religious training?" He went on to state that "The sole issue before us is whether the Sklars' claimed deduction is valid, not whether members of the Church of Scientology have become the IRS's chosen people."

Clearly, this is a case that is ripe for non-sexual double-entendre. In this regard, the case of Paul V. Hornung, 47 T.C. 428 (1967) comes to mind where the Tax Court stated in part:

In making this argument, petitioner shifts into a shotgun formation, contending that his accomplishments in the championship football game constitute educational, artistic, scientific, and civic achievements within the meaning of section 74(b). We believe that petitioner should be caught behind the line of scrimmage on this particular offensive maneuver.

(By the way, am I showing my age? Do I have to point out to the young that Mr. Hornung was one of the greatest running backs in pro football history?)

In any event, I hereby announce a contest for the most clever double-entendre commentary concerning the Sklar case. Commentary can be as short as one line.

The deadline is the date the Sklar case becomes final and non-appealable. I am the sole judge of the quality of the entries and my decision as to the winner is final and non-appealable. The prize: The pure satisfaction of having your witticism broadcast far and wide over the blogisphere.

Calling Arliss Michaels

On November 1, the Supreme Court heard oral arguments in the cases of Commissioner v. Banks and Commissioner v. Banaitis. (The Circuit Court opinions in the two cases can be found here and here.) Two revenue rulings issued by the Service this week highlight the importance of these two cases.

Both Banks and Banaistis address the question of whether that portion of a settlement or award paid to the claimant's lawyer in the form of a contingent fee is part of the claimant's gross income. The position of the Service is that the contingent fee portion of the settlement is gross income and is merely deductible by the claimant. If the Service's position is sustained, any legal fee paid in the course of a lawsuit concerning, for instance, the breach of an employment contract, will generally get added back into income when computing the claimant's liability for alternative minimum tax. Since such fees are not deductible for alternative minimum tax purposes, they are, in essence, not deductible at all.

The issue before the Court is vividly summarized by Alexis Garamfalvi of the Medill News Service of Northwestern University as follows:

Plaintiffs sitting across wide conference room tables from a flotilla of lawyers probably don't always consider how large a bite Uncle Sam will take out of the amount they are being offered to settle a lawsuit. Even fewer of them consider that they may be taxed on a large chunk of the settlement they never see - the perhaps 33 percent going to their lawyer. Of course, their lawyer is paying taxes on that amount too. So, trial lawyers aren't the only beneficiaries of our increasingly litigious society. Uncle Sam is smiling too.

Garamfalvi illustrates the problem by pointing out that if the Service prevails, Banaitis, who settled an employment claim against the Bank of America for $8.73 million, would be left with only $1.98 million, or 22.7 percent of the settlement amount.

In Rev. Rul. 2004-109 the Service addressed the question of whether upfront bonuses for signing or ratifying an employment contract are wages for purposes of FICA and FUTA. Two specific situations were considered. In one, a baseball prospect was given a "signing" bonus. To earn the bonus, the player needed only to show up for spring training. In the second example, various union members who were employees at the time a collective bargaining agreement was ratified became entitled to a "ratification" bonus. In both cases, the bonuses were not contingent upon whether the bonus recipients subsequently rendered services.

Rev. Rul. 2004-109 concluded that both sorts of payments constitute remuneration for employment and were thus subject to FICA and FUTA. The Service explicitly revoked Rev. Rul. 58-145, 1958-1 C.B. 360, which had held that a signing bonus did not constitute remuneraton for services and thus did not constitute wages for withholding tax purposes.

In Rev. Rul. 2004-110 the Service addressed the backend of the employment relationship. There, an employment contract for a period of several years had a provision that it could be terminated with the mutual agreement of the parties. The parties agreed that the employee would accept a payment from the employer in consideration of his agreement to cancel the contract before the expiration of the stated term. The ruling holds that the payment was part of the remuneration paid for the employee's employment because "[t]he employee [did] not provide clear, separate, and adequate consideration for the employer’s payment that is not dependent upon the employer-employee relationship and its component terms and conditions." Thus the payment was ordinary income, not capital gain income, and was subject to withholding, FICA, and FUTA.

While the precise questions addressed in the two revenue rulings are different from the question before the Court in Banks and Banaistis, they will frequently pop up in similar situations.

For instance, pro athletes typically have professional agents negotiate their contracts for them. Under Rev. Rul. 2004-109, all of the remuneration under those contracts are wages subject to withholding, FICA, and FUTA. If the Service prevails in Banks and Banaistis, as a practical matter, pro athletes will not be able to deduct the consideration paid to their agents since virtually all of these athletes are subject to the alternative minimum tax. Of course, this dramatically increases the transactional costs that they incur in the course of the negotiation.

In the case of "termination" payments, a similar warping of the negotiation process takes place, putting the employee at a severe disadvantage when negotiating the end of an employment relationship gone sour.

Knee Jerk Under-Reaction

One of the problems with blogging is the pressure to react swiftly to new developments. Often, this leads to comments which may a little too heated than would be the case if some time had passed to allow measured reflection.

However, after further consideration of the Court of Appeals' opinion in the Conte case, I think that the opposite might have occured. Upon reflection, I think that my comments were not critical enough of the Court's action.

The Court's opinion squarely presents what might be called a "theoretical defect." That is, the majority opinion undercuts the principle of the objective interpretation of contracts. Instead of determining what the parties meant by certain terms in a contract (i.e., what constitutes cause), factfinders in employment contract disputes are limited to:

determin[ing] the objective reasonableness of the employer’s decision to discharge, which means that the employer act[ed] in objective good faith and base[d] its decision on a reasoned conclusion and facts reasonably believed to be true by the employer.

However, the Court's reasoning is also faulty with respect to the perceived need of businesses to be able to act with certainty when discharging employees.

First, except for top actors and professional athletes, employers almost always have the upper hand when negotiating an employment agreement. Even a little knowledge of game theory will tell you that if the employee holds out for better terms, he or she is risking 100% of a limited and irreplacable resource, his or her time. The employer, on the other hand, more often than not has the luxury of walking away from the negotiating table and simply seeking another employment candidate. Thus, the employer is in a position to demand a contract with more and larger escape hatches. Where, as in Conte, the employer agrees to a contract with a limited set of escape hatches (i.e., the employer could only terminate the employee for cause), the courts should presume that the employer knew what it was doing and enforce the contract according to its objective terms.

Second, and perhaps more importantly, is what I will term the "HR Problem." It is simply this: Most employers with even a modest number of employees have, at the least, a "human relations" staffer if not a "human relations" staff or department. As a consequence, there is an institutional dossier regularly kept on the employee's job performance. Every failure to perform can be reflected in this dossier--every instance of tardiness, every instance where the employee lost his or her temper, every act of performance with any job task that someone acting for management thought was less than par. Of course, this dossier will have a management spin on it, with each story told from the perspective of the employer. Few employees keep a analogous record of their successes.

In the event that the employer decides to terminate the employee, the employer is well armed for any lawsuit alleging that it breached the employment contact. Each failure of the employee recorded in his or her personnel file (and even the best employee will have some failures) will be the subject of close scrutiny and thus magnified. After the fact, given a detailed, but employer-biased, employment history, duly recorded in the ordinary course of business, most factfinders will likely conclude that the employer acted reasonably.

I am not moved by the argument that a rule allowing the factfinder to examine whether there truly was cause for termination would cause the courts to act "as a super personnel officer, or of second-guessing a company’s decisions." Most cases, after all, result in a compromise settlement. I suspect that this is as true of employment contract disputes as it is with other sorts of litigation. The Court's opinion seriously weakens the employee's ability to negotiate a honorable termination of the contract. After all, in most cases, it will be the employer who has shuffled and then cut the cards. And, given the disparity in negotiating power, it will be the employer who gets to deal the cards as well. At the least, the employee should be entitled to have an impartial arbiter determine whether the shuffle was clean.

Subjective Objective

As a general matter of principle, I do not post comments on cases that I am either involved in or have been involved in. Since this is my first substantive posting in over a year, I will make an exception to that rule. In further defense, I would note that the matters at issue during the period of my involvement are no longer at issue. The various disputes between my client, Michael Conte, Ph.D., and Towson University continued to fester after my representation of Dr. Conte ended. Litigation ensued and the Court of Appeals of Maryland issued an opinion in that case today.

Dr. Conte was the director of the Regional Economic Studies Institute at Towson University. He held that position pursuant to the terms of a written employment agreement.

The employment agreement provided that he could only be discharged for "cause." Cause was defined to "include" eight specific grounds set forth in the written document. The University terminated Dr. Conte's contract alleging "incompetence" and "wilful neglect of duty"—two of the grounds that constituted "cause" enumerated in the written agreement. Dr. Conte filed suit for breach of contract in the Circuit Court for Baltimore County.

At trial held before a jury, Dr. Conte prevailed and obtained a judgment for over $900,000 for breach of contract. The jury had been instructed that the "University [had] the burden to prove by a preponderance of the evidence that one or more of the [causes in Dr. Conte's] contract existed for [his] termination." (Emphasis added by the Court of Appeals.) The Circuit Court rejected a request by the University to instruct the jury that the University was nevertheless permitted to terminate Dr. Conte for "common law cause" or cause that goes to the "essence of the contract."

The Court of Appeals considered a spectrum of three different provisions concerning the right of employers to terminate an employee.

At one end of the spectrum is the at-will contract of employment. Here, the employee is subject to termination "for any reason, even a reason that is arbitrary, capricious, or fundamentally unfair." Manifestly, the written contract between Dr. Conte and the University did not allow such an unbridled right of termination.

Somewhere in the middle of the spectrum is the so-called "satisfaction contract" in which:

[T]he employer has the right to terminate the contract and discharge the employee, whenever he, the employer, acting in good faith is actually dissatisfied with the employee's work. This applies, even though the parties to the employment contract have stipulated that the contract shall be operative during a definite term, if it provides that the services are to be performed to the satisfaction of the employer. It is not necessary that there exist grounds deemed adequate by the trier of facts for the employer's dissatisfaction. He is the judge as to whether the services are satisfactory. However, this dissatisfaction, to justify the discharge of the employee, must be real and not pretended, capricious, mercenary, or the result of a dishonest design. If the employer feigns dissatisfaction and dismisses the employee, the discharge is wrongful. The employer in exercising the right of dismissal because of dissatisfaction must do so honestly and in good faith.

(Emphasis by the Court of Appeals.)

However, the contract between Dr. Conte and the University was a "just cause" contract. That is, it could be terminated only for cause as set forth in the written document itself. The Court held that in reviewing a breach of contract claim for wrongful termination under a "just cause" contract:

[T]he proper role of the jury is to review the objective motivation [of the employer], i.e., whether the employer acted in objective good faith and in accordance with a reasonable employer under similar circumstances when he decided there was just cause to terminate the employee. The jury's inquiry should center on whether an employer's termination was based upon any arbitrary, capricious, or illegal reason, or based on facts not reasonably believed to be true by the employer. But the fact-finding prerogative will remain with the employer, absent some express intention otherwise.

In other words, the jury need not determine whether there was actually "cause" for termination as set forth in the contract. Instead, the inquiry is only whether the employer, in good faith, thought there was cause for termination at the time it terminated the employee. As noted by Chief Judge Bell in his dissent, underlying the majority opinion is the "the strong judicial policy against interfering with the business judgment of private business entities." (Judge Eldridge also dissented, but on other grounds.)

However, the majority opinion was also based in large measure on the question of whether the "fact-finding perogative" to determine if cause for termination exists rests with the employer. Presumably, a contract could be drafted that states that whether or not cause for termination exists is a matter of objective fact and that, in the event of a dispute, either a judicial tribunal or an arbitrator can make a determination as to whether appropriate grounds for termination existed.

I think that Chief Judge Bell has the better part of the argument here. Succinctly put, the majority opinion offers "little, if any, distinction between the test [it enunciates] for the review of 'just cause' contracts and that applicable to satisfaction contracts." Quoting Toussaint v. Blue Cross & Blue Shield of Michigan, 292 N. W. 2d 880, 896 (Mich. 1980), he notes that:

Where the employee has secured a promise not to be discharged except for cause, he has contracted for more than the employer’s promise to act in good faith or not to be unreasonable. An instruction which permits the jury to review only for reasonableness inadequately enforces that promise.

For some years, courts have been under fire by conservatives and pro-business groups for allegedly "legislating" and dictating what the law is based upon their normative views of what the law should be. In the Conte opinion, the Court ruled in favor of an employer being allowed to exercise its "business judgment," thus preventing a independent third-party from making an objective factual analysis that might lead to a contrary conclusion. I'm not going to hold my breath waiting for conservative, pro-business criticism of the decision.

I'm Coming Back

I am currently in the process of refreshing and redesigning this weblog. I expect to be fully back on line in a week.

Why We Do What We Do

I receive regular e-mails from a private mailing list run by an attorney in Los Angeles. (I won't identify the attorney because the list is, as I said, private.) The list generally focuses on issues in tax law of relevance to practitioners in partnership and real estate tax.

One of the frequent discussion topics is reform of the federal tax system. As part of that discussion, there is a thread that regularly appears, albeit in different guises. Specifically, comments by some of the participants indicate that they have a suspicion that what they do on a daily basis is of waste of their not insubstantial intellectual resources. Recently, I offered some observations on those comments.

I said that the thread and two other, seemingly unconnected developments, have only heightened the feeling that I think I share with others on the mailing list that what we do, day to day, is somewhat of a waste of our talents. (I noted that the talent, in my case, was rather moderate, but that is was rather significant for most other members of the group.)

The first "unrelated" development was the opinion in the Blakelee Realty case which I commented on here. That opinion upheld the publication requirement imposed on LLCs in that state.

Something has continued to bother me about the opinion which, as I said, in a narrow sense (i.e., courts should not step on leglislative perogatives), might be correct, but in a broad sense (can anybody really defend the underlying policy behind the requirement without a smirk) is totally unjustified. Yet, substantial intellectual capital was expended by the litigants and the court in determining the issue of whether or not the Emperor really had no clothes.

The second "unconnected event" was the appearance of a new organization called the Public Library of Science. This organization will publish on-line journals containing referred papers concerning various aspects of scientific research. Access to the journals will be free and open to the public. It is hoped that the effort will spawn a host of competing publications that will replace the subscription based system currently in place for the publication of scientific papers. The costs of those subscriptions significantly limits the access of researchers, particularly in poorer countries, to research material.

Now, as I said, these two events would seem to be totally unconnected. Yet, somehow they connected by being so different.

On the one hand, the Blaklee Realty case represented an expenditure of significant intellectual effort to determine whether the state could extract money from one group and give it, on the flimsiest of pretexts, to another. The intellectual capital expended, on all sides, including that of the members of the court, adds little to the sum of human knowledge and, except for the newspaper publishers and their families, happiness.

On the other, PLOS represents an expenditure of effort which will, over time, greatly increase the diffusion of real knowledge and, as a result, improve the human condition.

This brings me back to the tax code issue. I believe that taxes are necessary. Indeed, I would argue that a fair and equitable tax system contributes to the improvement of the human condition. And yet I still get the feeling that what we do on a daily basis is not all that socially beneficial.

Perhaps what I am missing is that, in a larger sense, lawyers, including tax lawyers, are really no different than plumbers. Plumbing is, after all, not a glamorous profession. However, indoor plumbing and modern waste management has contributed mightily to human health and, indeed, civilization. Our sanitation system would break down in no time if there were no plumbers.

Viewed in that light, maybe what we, as lawyers, are are the plumbers of the social contract, making certain that social order is maintained.

In any event, I invite comments.

Don't Say I Didn't Warn Ya'

I've had this weblog for less than a year and I can already say "I warned ya'."

Specifically, in March I had a posting titled Hey, Let's Be Careful Out There! In the posting I discussed the theoretical possibility of a claim against a blogger for defamation and said:

Many, if not all, homeowner policies include within the definition of "personal injury," an injury caused by defamatory comments. Umbrella policies generally mirror that coverage. At the least, weblog authors should make certain that their homeowner's policies provide coverage. Additionally, since umbrella coverage is relatively cheap, they should consider acquiring an umbrella policy with significantly higher limits.

I added that if it could be argued that the blog were being used for business, there should also be appropriate coverage under a business insurance policy.

For those who don't follow the blogs that discuss politics, there is currently a furor on-going as a result of a threat of a slander lawsuit against well-know blogger Atrios by the lesser-know blogger Donald Luskin. Luskin blogs on the site of National Review Online. Mark Kleiman gives a thorough account of the dispute here.

The consensus opinion of bloggers who have commented on the affair seems to be that (i) Luskin is primarily attempting to publicly identify Atrios, who publishes under a nom de plume, (Luskin's attorney has written an e-mail to Atrios threatening to subpoena Blogger, which hosts the Atrios weblog, to force it to disclosed Atrios' identity) and (ii) that as a secondary goal, Luskin hopes to chill further commentary by Atrios and others by exposing them to burdensome defense costs.

If Atrios has a homeowner's policy, he can likely successfully frustrate the second goal. Moreover, if his insurance carrier comes to the rescue soon enough, Atrios may well even be able to block a subpoena directed to publicly identifying him. (Without going into the issue in any greater length, suffice it to say that Luskin's slander claim appears to be nothing more than a pretext to create a public ruckus with a widely-respected commentator in order to inflate his own pathetic public profile.)

Of Course I Trust You, But I Like to Cut the Cards

By and large, I attempt to provide commentary concerning developments in the law rather than merely link to other sites. However, I will make an exception today because there has been a valuable dialogue between two weblogs, By No Other and Corporate Law Blog concerning provisions that should be contained in contracts that are the product of back and forth drafting by each side. Both weblogs suggest provisions to assure each of the parties to the contract that no changes have been made by the other party(ies) without being highlighted by "redline." The postings are, in chronological order, here, here, and here. By No Other's nuanced discussion of the differences between, and the uses of, representations and warranties is particularly noteworthy.

I have never put a provision in a contract such as those suggested by the authors of the weblogs (D.C. Toedt in the case of By No Other and Mike O'Sullivan in the case of Corporate Law Blog). I suspect that I will now begin to do so. Of course, there is actually a better way to assure against surreptitious contractual provisions--become the scribe of the negotiation. It may cost your client a few bucks more, but by controlling the drafting process you provide fairly strong protection against someone slipping a fast one by you.

The 21st Century Trumped by the 19th

Last week a New York appellate court sustained a ridiculous statute, but was arguably correct in reaching its conclusion. The decision was handed down by the Appellate Division of the New York Supreme Court in the case of Blaklee Realty Co. v. Pataki. The case had been closely watched by LLC practitioners around the country.

The facts are simple. In New York, in order to form an LLC, one must publish the LLC's articles of organization or substantially identical information for six successive weeks in two local newspapers in the county in which the principal office of the LLC is located. Thereafter, one must file an affidavit with the Secretary of State of New York attesting to the completion of the publication requirement. Failure to fulfill the publication requirement or the filing of the affidavit within 120 after formation of an LLC precludes an LLC from prosecuting or defending an action in a New York state court. An LLC that fails to comply with the publication requirement can still bring or defend a lawsuit providing that before it does so it complies with the requirement.

The cost of compliance runs about $1,600. As a consequence, it is considerably more expensive to form an LLC in New York than in any other state.

The ostensible purpose of the law is to "inform[] members of the public of specific important information regarding the newly organized company." No one actually believes that, nor was there any attempt to marshal facts in support of that proposition. New York and its economy are simply too large to allow the publication of a legal notice in a local newspayer to provide any real notice. And, in the age of the Internet, there are any number of cheap and more effective ways of providing such information (e.g., a public database available via the web, a listserve that distributes, for free, the requisite information concerning new LLCs, etc.).

But the ostensible purpose of informing the public is a mere pretense. There is a dirty secret behind the statute, a dirty secret that LLC practitioners around the country are all aware of--the purpose of the filing requirement is purely and simply to provide a subsidy to the newspapers around the state that rely on fees from legal notices for their support. Those newspapers form a powerful lobby in Albany. Their support of or opposition to a state legislator can spell the difference between success or failure in a close election. (And, the fact that, at the time the notice requirement found its way into the state, the son of the publisher of the largest of these newspapers was the leader of one of houses of the New York legislature probably did not impede the passage of the provision.) Furthermore, the provision itself provides little or no effective notice about "specific important information regarding the newly organized company." It would have worked, if at all, in an era when economies were essentially local and the various local papers provided most of the essential information needed for what we today refer to as "economic transparency." In fact, the history of the publication requirement was traced by the court to the 19th century when limited partnerships first appeared.

The plaintiffs brought a declaratory judgment action, seeking to have the publication requirement declared unconstitutional. The lower court agreed, holding that the requirement violated due process because it places a restriction on an LLC's access to the state's courts that is not reasonably related to the state's claimed purpose of informing citizens about the formation of LLCs with which they may have dealings; that, even if the required publication can be done after a lawsuit has been commenced, prejudice is still manifest since litigation commenced before publication will be delayed at least six weeks; and section 206 violates an LLC's right to equal protection by conditioning its access to the courts on a publication requirement that is not imposed on New York corporations.

The appellate court reversed the lower court and upheld the constitutionality of the statute, finding that the statute had a rational basis because there was a "reasonably conceivable state of facts that could provide a rational basis for the classification." Moreover, the court noted that the state did not have an "obligation to produce evidence to sustain the rationality of a statutory classification. '[A] legislative choice is not subject to courtroom factfinding and may be based on rational speculation unsupported by evidence or empirical data.'" In other words, a statutory purpose need only have the most tenuous relationship to reality to have a rational basis.

As I said at the outset, the result here is ridiculous. It is, after all, widely known that the publication requirement is nothing more than a corrupt practice willingly engaged in by the state legislature and the various local newspapers. However, the actual holding is probably correct. After all, there was no evidence introduced concerning the fact that the publication fees are nothing more than a form of bakshish mandated by the legislature to ingratiate its members with the local newspapers. In order to overturn the statute on the record before it, the court would have had to have made an essentially legislative determination that newspaper publication was essentially expensive and ineffective, especially when compared to 21st century alternatives. In other words, a clearly "false" result is upheld, because to do otherwise would blur the division of labor between courts and legislatures.

Filing Fee Update

Steve Gevarter has informed me that a note on the SDAT website [here] makes it clear that the increase in the annual fee "is effective for any return, regardless of year, filed after 12/31/2003 . . . ." (Italicized emphasis mine, emphasis in bold by SDAT.)

File Those Delinquent Returns Now

Beginning January 1, 2004, the annual filing fee for a corporation in Maryland will be increased from $100 to $300. There is currently no filing fee for LLCs, LPs, LLPs, etc. Beginning January 1, 2004, there will be imposed on these entities the same $300 fee imposed upon corporations.

If an entity required to file a tangible personal property return fails to do so, it will ultimately have its charter revoked. In order to obtain reinstatement, it must file all delinquent returns and pay any tax due.

I belong to a private listserve for Maryland tax practitioners. Recently, I posted on the listserve the following question with respect to the filing of these returns:

I may be one of the only attorneys on this list who remembers when the annual filing fee in Maryland for a corporation was $40. It was subsequently increased to $100. (I assume that anyone older than me is so old that they can no longer remember such things.)

In any event, when the filing fee was increased, SDAT took the position that the filing of any tangible personal property tax return after the date of the increase would cost $100, even if the year for which the return was due was a year where the cost would have been only $40 had return had been timely filed.

Does anyone know whether a similar rule will apply after December 31, 2003? In other words, if a corporation has not filed required tangible personal tax returns in pre-2004 years, will filing them after December 31, 2003 cost $300 for each delinquent year rather than $100. (And, taking this to its logical conclusion, will filing returns for LLCs, LLP, etc., after December 31, 2003 for pre-2004 years will invoke a toll charge of $300 per year rather than being a freebie.)

Evelyn Pasquier and Karen Syrylo both responded that my assumption was correct. As Evelyn said:

The statute says that the new fees for annual reports are applicable to "all annual reports filed after December 31, 2003." I don't think there is any sustainable argument that reports for pre-2004 years carry the lower fee if they are filed on or after January 1, 2004. If one has a corporation or an LLC, LLP, etc., that has not filed its 2003 (or earlier) annual report, I think one would be well advised to get it filed before the end of the year. (By the way, I, too, remember the $40 fee.)

While I, of course, find it impossible to believe that Evelyn is old enough to remember the $40 annual fee, I believe that her and Karen's analysis is correct. I am currently in the process of filing articles of revival for a corporation that has failed to file its last seven annual reports. The cost for filing those reports now is $700. If we were to wait until January 2, the cost would skyrocket to $2,100. The moral: He who hesitates may not be lost, but he most certainly does lose.

Isn't It Romantic?

I had digressed from my usual haunts to jump into the Novak/Place/Wilson controversy. I will now return to somewhat more familiar ground and discuss a case that caught my attention. Although not, strictly speaking, a tax or business case, it is worthy of some note.

In June, Judge Schneider of the Bankruptcy Court for the District of Maryland was presented with a case where the debtor had a diamond engagement ring. The Court ordered the ring returned to the ex-fiancé rather than sold, with the proceeds distributed to the debtor's creditors. In reaching his conclusion that the ring was a "conditional gift" to be returned upon the failure of the condition subsequent (i.e., the consumation of the marriage), Judge Schneider took judicial notice of the views of such scholars of etiquette and manners as Amy Vanderbilt, Judith Martin (a.k.a., "Miss Manners"), and Emily Post. The case can be found here.

More On Consent

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Dying By The Sword

Even the big guys blow one now and then.

The Rouse Company, a nationally known developer with thousands of square feet of shopping malls to its credit, failed to renew the lease on its headquarters office on time. The lease had three 10 year renewal options at far, far below market rent. In order to exercise the initial option, Rouse had to give notice to renew by December 31, 2002 for an option period beginning April 1, 2004. The spread between the rent under the option and market is somewhere over $2M. The Baltimore Sun has the story here and here.

On one hand, the Baltimore metro area would suffer economically if Rouse, as it intimates it might, leaves town. On the other hand, there's a certain schadenfreude at the sight of a large commercial landlord being hoist by the same petard that it probably hurled at numerous small fry tenants over the years. I wonder how many times Rouse allowed its tenants to re-up at below market rents simply because someone neglected to send a timely notice of renewal. I'm betting none.

Kol Nidre and Robert Novak

This evening, I will be going to the Kol Nidre service at my shul. The name of the service comes from the first two words of the first prayer which requests divine release from one's vows. Thinking about Kol Nidre, it occurred to me that Bob Novak, who will not be attending services on Sunday evening, should be relieved of some of his vows.

One of the problems that investigators face in looking into the background behind the disclosures concerning Valerie Plame is that journalists, such as Novak, believe that there should be a journalist's privilege that allows them to maintain in confidence the identities of their informants. While there is no such legally cognizable privilege under federal law, a number of states have created such a privilege in one form or fashion by statute, generally referred to as "shield" laws. However, many journalists, and I assume Novak to be in this group, will maintain confidences even they face incarceration due to the absence of an applicable shield law.

While not recognizing that a privilege exists, the formal policies of the Justice Department recommend exercising caution in cases that might require information from journalists who obtained the information from confidential sources. The policy apparently directs that attempts be made to obtain information from alternative sources before seeking information from journalists. Thus, in the Plame case, the federal investigators are looking at a rather large pool of suspects, only two or three of whom are the actual leakers. This increases dramatically the time, energy, and resources that have to be expended in the course of the investigation.

The investigators' task would be incredibly simplified if only Novak (or Andrea Mitchell or any of the other five journalists who spoke to the confidential sources) were released from their vows to maintain confidentiality and could identify their sources. This feat is far easier to accomplish than it might first appear to be.

At the outset, it should be obvious that any "journalist's privilege," quite aside from questions concering whether it exists and its scope, does not belong to the journalist at all. It is a privilege that belongs to the confidential source. Thus, 30 years after the fact, we still don't know the identity of the legendary Deep Throat. Deep Throat's identity will be disclosed by Woodward and Bernstein, however, after his or her death, presumably because Deep Throat gave permission to make disclosure after that event. That is, he or she waived the privilege effective upon a subsequent event, releasing Woodward and Bernstein from their vow of confidentiality. In the present case, if one or both (or all?) of the confidential sources agree to waive their right to confidentiality and to allow disclosure of their identities and the information they shared with any or all of the journalists, the journalists would be free to disclose the identies of the confidential sources and the information they passed on. Hence the solution.

President Bush, through his counsel, prepares a form of waiver. In essence, the waiver would say: "I [Name of Administration Official] hereby waive any right that I might have to require Robert Novak or Andrea Mitchell to hold in confidence any communication that I might have had or any information that I might have transmitted to either of them concerning Robert Wilson or Valerie Plame. Mr. Novak and Ms. Mitchell are urged to give all law enforcement authorities full and complete details of any such communication or information, including the date(s), time(s), and manner in which such communication was made or information conveyed and the details of the communication or informtion. Nothing in this waiver should be deemed to be an admission that any communication between me and either Mr. Novak or Ms. Mitchell ever occurred with respect to Mr.Wilson or Ms. Plame." Watch how this works.

President Bush announces that all relevant White House, State Department, Defense Department, and Vice Presidential staff will be required to sign the waiver or face immediate discharge. Immediately following the announcement, the President, together with the Vice President, Secretary of State, and Secretary of Defense, publicly execute waivers for themselves. Within 48 hours, all possible sources will have either executed waivers or been terminated from their posts. At that point, we will know the source(s) of the leaks since either Novak will be relieved of any vow of confidentiality or the the investigation will focus on those individuals who refused to execute the waiver. The search can then focus on the question of whether there are more people involved then merely the individuals who actually made the disclosures.

Of course, I would only recommend this course to the President if he really wants to discover who was behind the disclosures.

Update on Mental Illness as a Disability

I have previously commented on two Tax Court Summary Opinions, Keeley and Mary L. Coleman-Stephens (my comments are here and here) that discuss when psychological depression constitutes a "disability" for purposes of obtaining relief from the 10% penalty on premature withdrawals from qualified plans. The two cases reach different conclusions on facts that are essentially not distinguishable. I had criticized the Service's position because it was bottomed on regulations that I believe exceed the rule-making authority under the statute.

There is now an excellent article on the topic by Sarah B. Lawsky of Cadwalder, Wickersham & Taft, LLP, entitled Redefining Mental Disability in the Treasury Regulations. Lawsky makes several points that I had missed.

First, she notes that the overly restrictive definition of psychological disability at issue in Keeley and Coleman-Stevens is incorporated by reference in many sections throughout the Internal Revenue Code. Thus, the definition's mischief is more significant than I had thought.

More significantly, however, she traces the definition back to a provision that was enacted in 1958. This provision was identical to a definition of mental disease found in the Social Security regulations at that time. However, the definition found in the Social Security regulations has been modified extensively to keep pace with changing concepts of mental illness and new treatment modalities. The Treasury Regulations, by contrast, have been essentially frozen in amber for over 40 years.

Lawsky makes a compelling case that not only can the Service revised the regulations, but that the regulations should be revised in order to better reflect legislative intent in the area.

We Are The Other People?

In CCM 200338012, the Service addessed the question of whether a single-member LLC was liable for the unpaid withholding taxes of a business under Code Section 3505. That section imposes liability upon an "other person" who pays the wages of the employees of a delinquent taxpayer. The memorandum is, to say the very least, confusing.

I think (but I'm not certain) that the facts are as follows: LLC, which is a disregarded entity, filed employee withholding tax returns in its own name and using its own EIN. The LLC then files for bankruptcy. Under the authority of IRC Sections 6325 and 6331, coupled with the concept articulated in Treas. Reg. Section 301.7701-2(a) that a disregarded entity is disregarded for all income tax purposes, the Service has the ability to assess all unpaid employee withholding taxes against the sole member. However, the memorandum seems to say that the Service can only go directly against the assets of the LLC if either (i) some form of piercing the "corporate" veil or nominee theory applies or (ii) the provisions of Section 3505(a) apply and the LLC is an "other person" within the meaning of that section.

The memorandum does not discuss the veil piercing or nominee questions on the facts before it, but (I think) it rejects the application of Section 3505(a) because it seems to conclude that the LLC was merely the agent of the individual taxpayer. Thus, it appears that the Service feels that it cannot attach the assets of the LLC directly.

Note the weasel words that I use: "seems to conclude," "it appears." The reason is that I cannot figure out what the Service is saying. Indeed, I'm even somewhat unclear as to the facts. The last sentence of the penultimate paragraph is particularly baffling: "Having disregarded the LLC for federal tax purposes and having treated it like the taxpayer/single member owner for purposes of assessment, we doubt the efficacy of now treating the LLC as an 'other person' for purposes of collection." Huh? Does Section 3505 apply or not? Or is the memorandum hedging on the point so that it can later take a litigation position that, on similar facts, Section 3505 applies. (Yes, I know, these CCM do not bind the Service, cannot be cited as authority, etc. But, of course, we do it all the time.)

Is the Service saying that (a) it need not rely upon Section 3505 because the LLC was, effectively, the taxpayer and an assessment may be made directly against the LLC, as well as the individual owner or (b) that it is somehow estopped from enforcing its assessment directly against the LLC's assets, absent a piercing or nominee situation. I had thought that the Service had previously taken the position that if a business used the LLC form (as a diregarded member, of course) and paid employee taxes under a separate EIN, both the LLC and the individual owner could be assessed. Do any readers disagree with this conclusion? Does the Service in CCM 200338012 disagree with this conclusion?

Any comments that could shed light on these questions are welcome.

Technology Hell Week

On or about 12:45 A.M. on Friday, the 19th, the electricity in my house went out due to a lady named Isabel. Showers, dinner, and laundry thereafter were at my aunt's condo. The electricity was not restored until about 8:00 P.M. on Wednesday the 24th.

On Tuesday, the 23rd, the electricity at my office went out early in the morning due to a construction error made by contractors attempting to beautify the sidewalk in front of my office building. It was restored at 5:00 A.M. on the 26th.

On the evening of the 23rd, I discovered that the dial-up modem on my laptop was defective.

On Thursday, the 25th, while preparing to leave for an extended Rosh Hashanna week-end, the telephone service at my house (but, surprisingly, not the DSL), went out.

I think that I survived, but check back in on Monday.

Administrative Catch-Up for Subscribers

On Monday, I had a lengthy posting concerning Notice 2003-60 that sets forth the Service's position on how the Craft decision will be applied. Apparently Bloglet, which operates the subscription service, did not pass on the posting. You can find the posting here.

Meeting of the Uncles

The IRS and various state tax administrators, including Steve Cordi of Maryland, announced that they have established a new nationwide partnership to combat abusive tax avoidance. Under agreements with individual states, the IRS will share information on abusive tax avoidance transactions and those taxpayers who participate in them.

Even though I represent taxpayers, I've long believed that state audit efforts have not been sufficient. (Of course, I also believe that federal audit efforts are insufficient to assure tax compliance.) Now, if they can only create a successful offer in compromise program at the state level.