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.

Gone Fishin'

I do not typically post to my weblog during working hours. However, I just came across an opinion that's so newsworthy that it's clearly an exception to the general rule.

In Townsend Industries, Inc. v. U.S., the Eighth Circuit overruled a District Court judgment for the government and held that the amounts paid by an employer for an annual fishing trip for its employees were ordinary and necessary business expenses and not additional compensation for the employees.

The employer was the manufacturer of a product that allows offset printers to produce two-color documents in a single pass through the printing press. For the last forty years, the manufacturer, Townsend Industries, had gathered its personnel for an annual, two-day meeting at its headquarters involving its corporate staff and some factory workers. Following that meeting, the company has sponsored a four day expense-paid fishing trip to a resort in Ontario, Canada.

While there was only one specific organized business function during the four day period, business discussions were conducted on an on-going basis during the trip. While employees were not compelled to attend, nearly all of the company's employees who testified stated that they felt obligated to attend and that they viewed the trip as part of their employment duties for the company. And, there was substantial evidence of specific business discussions that took place over the course of the trip. (Time and space do not allow me, for instance, to detail at length the discussion concerning the importance of the factory workers removing burrs on metal parts or the discussion of the relative merits of molleton and aqua-flowparts. I found the latter particularly fascinating. You'll just have to take my word for it or read the opinion yourself.)

Given the detail provided, the Court concluded "that Townsend had a realistic expectation to gain concrete future benefits from the trip based on its knowledge of its own small company, its knowledge of the utility of interpersonal interactions that probably would not occur but for the trip, and its knowledge of its own past experience. As such, the trips and their expenses qualified as working condition fringe benefits under Section 132 and a bona fide business expense under Sections 162 and 274 of the Internal Revenue Code."

Despite my somewhat humorous treatment of the opinion, I think that it's actually fairly significant. The number of hours that Americans work has been sliding steadily upward over the last 20--25 years. And, with both spouses typically working full time, the centrality of the workplace in peoples' lives has grown apace. Quasi-social events paid for by employers, whether as extensive as those offered by Townsend or only an occasional company barbeque, will become increasingly necessary to build in the business world what is referred to in the military as "unit cohesion." There is no reason that the Internal Revenue Code cannot take cognizance of this changing social reality.

Crafting Advice

Well, it's been over a month. Moving to a new office was far more complicated and difficult than I anticipated, but I'm back. And just in time to comment on a new development with respect to any lien asserted against tenancy by the entirety property when the tax liability is that of only one spouse.

In Notice 2003-60, the IRS has just issued its first post-Craft detailed guidance on collection from property held in tenancy by the entirety where only one spouse is liable for outstanding taxes. The guidance first articulates six general principles and then discusses them in nine questions and answers.

The principles are as follows:

Same As It Ever Was The federal tax lien has always attached to all property held by a taxpayer. This was the case even before Craft and Craft does not represent new law. By way of example, the Service cannot rescind an accepted offer in compromise or terminate an accepted installment agreement, since the Service presumably entered into the arrangements with knowledge of what the law was. But a pre-Craft lien that is in effect post-Craft will be as effective as a lien that went into place after the opinion was handed down.

The Rules Don't Change in the Middle of the Game Notwithstanding the "same as it ever was" principle, the Service will not act to enforce any pre-Craft liens if third parties, prior to Craft, reasonably relied upon the belief that state law precluded the attachment of a lien against only one spouse. This rule would apply only in "full bar" states (such as Maryland) in which creditors of only one spouse have no claim whatsoever against tenancy by the entirety property.

A Repo Man Is Practical The administrative sale of entireties property presents practical problems that limit the usefulness of seizure and sale procedures. Those practical problems are not presented when the entireties property is cash and cash equivalents, thus the fact that cash or cash equivalents are held in a tenancy by the entirety will not deter a levy. And, the entire property can be foreclosed upon with the Service only obtaining the equity of the delinquent spouse.

Share and Share Alike Generally, the value of each party's interest in tenancy by the entirety property will be deemed to be one-half of the total value of the property.

Whither Thou Goest, So I Will Go If tenancy by the entirety property is encumbered by a lien, the lien will be deemed to attach a one-half interest in the property taken by any transferee unless the transaction that effected the transfer extinguished the lien.

Of the nine q & a's, two deal with liens that arose prior to Craft, with the remainder dealing with liens that arise post-Craft.

Initially, the Service states that, as a matter of administrative grace, in so-called "full bar" states (states where property titled as a tenancy by the entirety cannot be attached by any creditor of only one spouse) it will not assert its lien rights against the class of creditors protected under I.R.C. Section 6323(a)--essentially, bona fide transferees for value who took their interest without knowledge of the lien. However, the Notice also makes it clear that in so-called "partial bar" states, transferors will not be so graced.

In cases of divorce, the Service will generally treat a spouse who received full title to formerly tenancy by the entirety property as having obtained the interest of the other spouse as an exchange for value. Of course, this would not extend to a transaction that the Service concludes is fraudulent. And, as is seen below, this rule only applies to pre-Craft transfers.

The Service's position with respect to property received via gift is somewhat unclear. It appears that it will only honor a transfer to a related party when there is some overriding equity on the side of the donee. Generally, no such overriding equity need be present if the donee is an arm's length third party, such as a charity.

The second question deals with deals the Service entered into with taxpayers pre-Craft. Here, the Notice takes the common sense approach that a deal is a deal and what is done is done. However, the Notice states that decisions as to uncollectibility can revisited in light of Craft.

The next four q & a's deal with the continued attachment of the lien in the case of subsequent events. Thus, notwithstanding a subsequent transfer to a third party in an arm's length transaction, the lien will continue to attach to one-half of the property. Similarly, neither a transfer incident to a divorce nor a subsequent mortgage will terminate a lien.

However, in all of these cases, the Notice sets up the possibility of some hard-nosed planning. Specifically, the Notice recognizes that death terminates the deceased spouse's interest in tenancy by the entirety property. The Notice states that if the deceased spouse is the spouse against whom the lien is filed, the property will no longer be encumbered by the lien. Of course, the converse is also true. That is, if the non-delinquent spouse dies, the entire property becomes subject to the lien. This brings new meaning to the phrase "Till death do us part."

A lien will continue to attach to property that is transferred in a transaction that "breaks the unity" of ownership if the deliquent taxpayer dies after the transfer. Thus, a lien will follow property conveyed pursuant to a divorce, because the divorce breaks up the unity of ownership. The lien will continue in effect even if the delinquent spouse dies after the divorce. Similarly, the lien follows property that is foreclosed upon, unless the delinquent spouse dies before the foreclosure. (Thinking about those planning possibilities?).

The final three q & a's deal with the ways in which the Service can turn its lien into cash. Interestingly, the Notice states that an adminstrative sale is "not a preferable method" of dealing with property, such as realty, that is not easily divisible, since it might be difficult to realize anything from the sale of a one-half tenant by the entirety interest. (For instance, how would a prospective purchaser value the likelihood of succeeding to the entire property if the delinquent spouse dies second versus losing the entire property if the delinquent spouse is the first to die.) Cash and cash equivalents, of course, do not pose this problem and the Service will just go in and take its share of these assets.

However, the Service believes that foreclosure, as opposed to an administrative sale, can be used to convert the delinquent spouse's interest into cash. The difference between an administrative sale and a foreclosure is that in the latter proceeding the entire property is sold and the proceeds divided. Thus, the Service does not face the problem of a sale at a depressed price due to the fact that the buyer is purchasing a somewhat speculative commodity.

Finally, the Notice discusses issues pertinent to discharge and subordination. In essence, the Service takes the position that the value of the lien is one-half of the equity to which it attaches. Thus, in the event of an insolvency proceeding, the Service gets one-half of the value of the property after payment of any senior encumbrances.

This post is somewhat longer than most of my postings, but I thought that it would be helpful to set forth the position taken in the Notice in some detail. Over the next week or two, I hope to offer some additional commentary on the Notice.

Changes

The law firm that I had been with since this before weblog unveiled will be dissolving at the end of the month. Thereafter, I will be at Fisher & Winner, LLP just a block up the street.

Spy v. Spy

In Robinson v. U.S., the United States Court of Appeals for the Federal Circuit allowed the employer a substantial deduction for the "bargain element" inherent in stock distributed to an employee, even though the employee had filed a Section 83(b) election that valued the bargain element at zero. The opinion has been praised by Janell Grenier at Benefitsblog (see here). Regardless of the merits of the decision as a matter of tax law, the facts are vaguely reminiscent of an installment of Spy v. Spy.

The Robinsons owned all of the stock of a related group of corporations known as Morgan Creek. In 1995, they granted the COO, Gary Barber, 10% of the stock in the enterprise. Barber paid $2 million for the stock and filed a Section 83(b) election stating that the bargain element in the transaction, that is the fair market value of the stock in excess of what he had paid for it, was zero. As required by the regulations under Section 83, he sent a copy of the election to the corporation, namely himself acting as the COO.

In 1998, the Robinsons and Barber had a falling out. To resolve the dispute, in June of 1998, Morgan Creek redeemed Barber's stock for $13.2 million. Morgan Creek (presumably after the closing on the purchase of Barber's stock) issued him a revised W-2 for 1995 reflecting additional compensation of $26,759,800 (i.e., a stock valuation of $28,759,800, less the $2 million paid for the stock by Barber) as a result of the bargain element inherent in the 10% of the company's stock he received in that year. And, of course, Morgan Creek claimed an ordinary deduction for compensation paid to Barber in 1995 of the $26,759,800 bargain element.

The Service argued that Morgan Creek was barred from taking the deduction since the corporation's deduction was limited to the amount included in Barber's income. Since Barber had included nothing in his income, the Service's position was that Morgan Creek was not entitled to any deduction. The Court of Appeals, reversing the Claims Court, disagreed, holding that the term "included" means not the amount actually shown on the employee's return, but also the amount that, as a matter of law, should have been included on the return.

I will leave the analysis of the legal questions involved in the decision to commentators like Grenier. Instead, I will focus on the human factors behind the case.

I don't know whether in 1995 the parties addressed the Section 83 issues inherent in the stock grant to Barber. I'm willing to bet that they did not and that Barber, finding a vacuum, seized upon it to structure the transaction to confer some tax benefits on himself. Later, however, in the course of what must have been acrimonious negotiations over Barber's departure from the company, the company (read: the Robinsons) realized that it could settle its dispute with Barber and, as soon as the ink was dry on the contract, amend the 1995 returns to obtain tax benefits that would substantially fund the settlement. Thus, Morgan Creek paid Barber $13.2 million, but its amendment of the 1995 income tax returns resulted in federal income tax benefits of over $8.85 million, plus interest from 1995. Of course, Morgan Creek will likely enjoy additional state income tax benefits as well. Assuming the state tax benefits to be about $2 million, the company virtually broke even on the deal, since Barber had paid $2 million for the stock. (The arithmetic: $8.85 million, plus $2 million, plus $2 million, plus interest, comes pretty damn close to $13.2 million.) Barber, on the other hand, could end up with additional tax on $26,759,800, plus substantial penalties and interest from 1995, and a long term capital loss in 1998, that he may or may not be able to use, of about $15 million. Not a pretty picture.

The case illustrates the virtue of having both sides (i) recognize that there are Section 83(b) issues inherent in any grant of an equity interest to an employee, and (ii) agree to a consistent (and reasonable) position with respect to the manner in which the "bargain element" is to be reported.

Accepting an Invitiation

The SW Virginia Law Blog on the 20th noted two articles in the Virginian-Pilot (here and here) that reported that "[i]nsurance companies licensed to do business in Virginia can only underwrite group policies to cover family members defined as spouses or dependent children," thus excluding gay or lesbian partners and children of such a partner that the non-biological partner nevertheless considers as his or her progeny.

SW Virginia Law Blog then suggests that the problem was not one of state law, but rather of federal law, more particularly federal tax law, and it put out a request to other blogs that focus on business and tax issues, including yours truly, to offer their view of the locus of the issue. Well, here goes.

There is obviously a federal tax slant to this issue. As the SWVa Law Blog correctly noted, medical insurance benefits paid by an employer that provides insurance to a non-family member of the employee (meaning non-married "significant others" and children of such individuals) is taxable to the employee, unless the significant other or his/her child is (are) dependents of the employee. However, the authority cited by SWVa Law Blog, CCA 200117038 makes it clear that a plan may provide benefits to such individuals, even though the benefits are taxable.

I am not admitted to practice in Virginia, but I suspect that the concept that is at the core of the problem the news articles focus on is that of "an insurable interest." This is a well-known concept in insurance law. In essence, one can only be the owner of a policy of insurance that insures against some hazard occuring to some other individual if the owner has an "insurable interest" in the person insured. Thus, I cannot obtain a policy of insurance on the authors of the SWVa Law Blog because, even though I like reading their publication, I do not have an insurable interest in their lives. Going one step further, insurance companies have been found to be liable for damages for the tort of "insuring" when they enter into contracts of insurance with an individual with no insurable interest in the named insured party. (The damages are usually derived from the premature death of the named insured due to the active intervention of the policy owner. In simple English, someone buys a life insurance policy on someone else's life and then knocks them off to obtain the proceeds. I am willing to bet, however, that for every lawsuit for the tort of insuring, there have been fifty murder mysteries based on the practice.)

The question originally posed by the SWVa Law Blog was whether this was an instance of state law creating a due process or equal protection issue. To the extent that my hypothesis as to the derivation of the rule discussed in the newspaper articles is correct, I believe that the application of the state law does create a Constitutional issue. There would seem to be no question but that an individual has a strong interest in seeing to it that the medical needs of the others in his/her household are met. A state law that attempt to stretch the concept of "insurable interest" to bar the issuance of such coverage is nothing more than an attempt to limit the free association of individuals based upon their marital status or sexual orientation by making it difficult or more expensive for them to obtain medical insurance for everyone in their household.

Manic's Better Than Depressed

I previously commented on the case of Keeley v. Commissioner, a Tax Court summary decision that denied relief from the 10% penalty imposed on a premature withdrawal from a qualified plan. The relief had been sought because the taxpayer suffered from clinical depression and contended that he was entitled to relief because he was disabled. The Court denied relief because the taxpayer's condition did not require that he be institutionalized or have constant supervision.

I criticized the opinion, noting that it relied on a regulation that was more restrictive than the Code required and that was inconsistent with current treatment modalities.

Tuesday, in the case of Mary L. Coleman-Stephens v. Commissioner, the Tax Court reached an entirely different conclusion based on essentially identical facts. Because Keely was a summary disposition and could not be relied upon as precedent, the Court in Coleman-Stephens did not seek to harmonize its conclusion with that of the prior opinion.

Since Coleman-Stephens, like Keely, is a summary disposition, taxpayers cannot rely upon it for authority. Given the relative small amounts involved in these cases (Coleman-Stephens involved only $510 in taxes), they are unlikely to get appealed to the circuit court level. The Tax Court ought to step in and issue a formal opinion, even if it's only a memorandum decision, addressing the issue. Better yet, the Service might issue a ruling stating that it now concludes that the regulation is overly broad and, to the extent that it requires institutionalization or some other type of custodial care before the penalty can be avoided, it will be disregarded.

One Tough Veil

With the possible exception of claims for intentional infliction of emotional distress, I doubt that there is no action that is bruited around more often and results in fewer successful prosecutions than attempts to pierce the corporate veil. The recent opinion in the case of Iceland Telecom, Ltd. v. Information Systems & Network Corp. illustrates the rather restrictive limits placed on this doctrine, particularly in Maryland.

Iceland Telecom brought the action against Information Systems & Networks Corp. ("ISN"), ISN Global Communications, Inc. ("Global"), and an individual, Arvin Malkani ("Malkani") for breach of contract and unjust enrichment. Neither ISN nor Malkani were parties to the disputed contract. Iceland Telecom sought to hold them liable for the obligations of Global via the application of the piercing the corporate veil doctrine, seeking to apply either the "instrumentality" theory or the "alter ego" theory, or because Global allegedly acted as the agent for ISN and Malkani.

To say the least, Global was operated on a fairly informal basis. It never held stockholder or director meetings. Two of the three individuals who the extant corporate documents indicated were directors (Malkani's mother and sister) apparently did not know that they were directors. ISN picked up most of Global's expenses and Malkani, Global's president, had his salary paid directly by Global. Global shared ISN's office space, with the rent being paid by ISN without any contribution from Global. Indeed, Global used ISN's phone numers, office furniture, and some of its office staff.

Significantly, in the negotiations leading up to the execution of the contract, it often appeared that Iceland Telecom was dealing with ISN. For instance, Malkani, negotiating on behalf of Global frequently referred to that company as ISN. In fact, the court specficially stated that Iceland Telecom "thought it was dealing with ISN." However, the written contract executed by Iceland Telecom identified Global as the other contracting party.

Nevertheless, the court concluded that neither the piercing the veil doctrine nor the agency doctrine applied to this case. The court emphasized that the Maryland courts had set the bar high with respect to the ability to pierce the corporate veil (quoting Dixon v. Process Corp., 38 Md.App. 644, 645 (1978) to the effect that it is a "herculean task" for a creditor to attempt to "rip away the corporate facade.") The court rejected the approach outlined in the well-known 4th Circuit case of DeWitt Truck Brokers v. W. Ray Fleming Fruit Co., 540 F.2d 681 (1976) where the court, applying South Carolina law, allowed the corporate veil to be pierced because of such factors as the lack of corporate formalities, gross undercapitalization, and the non-functioning of officers or directors other than the sole shareholder. Instead, the court concluded that, under Maryland law, nothing short of actual fraud would suffice to sustain a veil piercing effort.

Iceland Telecom's attempts to rely on an agency or an agency by estoppel theory to impose liability were similarly unavailing. Iceland Telecom had, after all, entered into a written contract that had clearly identified the other party as being Global. There was no evidence that it believed that Global was acting as ISN's agent nor that it entered into the contract upon reliance upon a belief that Global was acting as ISN's agent. Thus, neither of these two "agency" theories could apply.

Even though I've used it as authority, I've always thought that DeWitt Truck Brokers was problematic. After all, most, if not all, closely-held corporations have significant gaps in their adherence to corporate formalities. The rationale behind veil piercing should be anchored in the rational expectancies of the various actors. A plaintiff should not be able to look beyond the limited liability shield of a limited liability entity if it entered into a contract with full knowledge that there were limited liability walls in place. Only if the plaintiff suffers loss that is unexpected (e.g., being told that the entity was solvent, when, in fact, the owners were draining it of assets) should it be able to avoid the limitations in collectability that it tacitly acknowledged when it entered into the deal.

Seeing Double?

Subscribers may have noticed that they have been getting two copies of each posting. The reason is that for several months I have attempted to use a subscription service called Bloglet. While subscription requests found their way to Bloglet (via the subscription box on the right), for some reason the postings were never circulated. In response, I created a mailing list and copied all of the addresses in Bloglet to that list. Each posting was directed to circulate to the list.

This weekend, Bloglet suddenly began working again. Of course, subscribers began getting each posting twice, once from Bloglet and once from my mailing list. I will cure the problem tomorrow and subscribers will be back to getting only one copy of each posting. One other housekeeping note.

I have finally figured out how to syndicate this weblog via RSS coding. By the end of the week there should be a way to click and get the RSS syndication information.

More on Verne

David Giacalone at ethicalEsq has offered some comments on my posting Putting Strains on My Friends about the Verne opinion. Although I agree with most of what he has to say (he does a good job, for instance in detailing most of the salient facts that were not presented in the opinion), I have one area of disagreement.

Specifically, Dave states that "[i]f Verne never held himself out as being an attorney and he reminded his clients that they might want to consider getting legal advice or having additional documents drafted for their business, he may have been giving them just what they wanted and needed -- and chose -- given their situation and their willingness to risk future problems." (Emphasis is Dave's.) I'm not at all certain that this clears Verne under the circumstances.

One of the lessons I learned in law school is that it is less important to know the answer to a question than it is to know the correct questions to ask. Theoretically at least, lawyers are by training supposed to be able to ask the right questions. Accountants, as to the majority of issues that go into operating agreements, for instance, simply do not have this training.

I think that Dave is on the right track when he suggests various elements of cost benefit analysis that should go into the decision as to whether Verne should be penalized for his actions or omissions. However, in many cases, even highly skilled and experienced counsel do not have the knowledge to make the appropriate cost benefit analysis. By way of example, assume that most small businesses, such as Verne's clients, typically rely on a form LLC operating agreement that does little more than restate the default provisions in the state's LLC act. Is the lawyer who prepares such a document (i) underlawyering, (ii) overlawyering, or (iii) getting it just right. As I suggested in my first post, I really don't know the answer to this question.

Government Undercover Uncovered

I don't ordinarily use my postings to announce links to specific websites, but I'll make an exception today.

MIT just opened its Open Government Information Awareness site. The site offers a remarkable amount of information about all three branches of the federal government. The amount of information now at your fingertips is simply daunting. By way of example (and certainly not in limitation), the site gives a list of contributors to the campaigns of members of Congress, a detailed listing of the expenditures of those members, and their financial disclosure filings.

Well designed sites such as this raise any number of questions. For instance, given the proliferation of bloggers of all stripes (both in topic choice and political viewpoint) and the ready accessibility of information, the market for commercial alternatives, newspapers for instance, would seem to be seriously eroding. The implications are huge.

In Baltimore, I grew up with three daily newspapers, The Sun (often known to residents as The Morning Sun), The Evening Sun, and The News American. We're now down to just The Sun. Since you can get The Washington Post, The New York Times, and The Wall Street Journal delivered to your home or office, The Sun becomes a secondary (or, given the web, a tertiary) source of national and international news. It is thus limited to being a primary source only of local news. And, even here, is challenged by The Washinton Post with respect to statewide coverage. Give The Sun the competition of a few good local bloggers and it's out of business. I suspect that the knowledge of its tenuous position by its reporters was one of the reasons they made significant concessions in their most recent contract negotiations with the paper.

2003 State Tax Update

The Spring issue of Tax Talk, the newsletter of the Section of Taxation of the Maryland State Bar Association has two summaries of tax legislation passed in the recent session of the Maryland General Assembly. One is by Evelyn Pasquier, the other by the Comptroller's Office.

H.B. 438 is worthy of note because it imposes upon various officers and owners of corporations and LLCs personal liability for unpaid vessel excise that the business entity is required to collect and pay over. The language is identical to a similar provision with respect to sales tax that I argued, to no avail, constituted a violation of due process. It’s significant because previously the sales tax provision stood alone in its sweeping imposition of personal liability. (OK, I'm a sore loser.)

Now that this broad imposition of liability has been extended with respect to another tax, there is a possibility that it might be further extended. For instance, the failure to collect and pay over withholding taxes might create personal liability by virtue of an individual's status rather than, as is currently the case, the individual's dereliction of duty.

Putting Strains On My Friends

While some of my best friends are accountants, I may be straining our friendship with this posting.

The Ohio Supreme Court, in the case of Columbus Bar Assn. v. Verne, recently enjoined an accountant from "preparing legal documents that constitute the unauthorized practice of law." Verne, the accountant in question, had formed an LLC on behalf of two of his clients by drafting and filing articles of organization with the Secretary of State. The articles used, as a baseline, forms that were available in the secretary of state's office.

In the real world, the practice of law by accountants, insurance agents, stock brokerage houses, and banks is rampant. A few good lawsuits resulting in liability might encourage a reduction in the unlicensed practice of law.

The opinion correctly focuses on the types of advice that clients need that are particularly within the province of attorneys, namely those issues that ought to be reflected in an operating agreement. However, in its conclusion, the Court focuses on the one area in which Verne’s transgression was relatively benign: the drafting of the articles of organization. Thus, the order merely enjoins him from "preparing legal documents."

In fact, as the opinion reveals, Verne's sins that caused his clients serious harm were not found in the simple document that he drafted, but in the complex document that he didn't even think about. Verne failed as a lawyer because he apparently did not even attempt to explain to his clients the importance of addressing and memorializing the various elements of their deal. The order does not focus on this problem. And, perhaps, it cannot. After all, it would come dangerously close to an infringement on free speech rights to block Verne from opining, to clients or prospective clients, as to the relative merits of different types of entities and the issues that should be addressed in organizing a business.

Going one step further, however, a more difficult issue underlies this case. What should it cost to form a relatively simple business deal? In this sense, law faces the same economic problem that medicine faces. In medicine, doctors often order or perform too many tests in order to reduce their exposure to malpractice claims. In forming a business, lawyers face the problem of how detailed an operating agreement (or shareholders' agreement or partnership agreement or lease or etc.) needs to be in order to meet the needs of the client and, to cover all of their bases, there is a tendency to "overlawyer" a deal.

Of course, "overlawyering" is in the eyes of the beholder.

Although no facts as to this are set forth in the opinion, I'm willing to bet that Verne's clients' business involved little initial capital and they were operating on a shoestring. How much upfront capital should they be willing to spend to draft the "appropriate" documents addressing all of the "pertinent" issues? Appropriateness and pertinency are, after all, fluid concepts. Maybe the default provisions in the Ohio LLC statute were sufficient for their purposes. Of course, Verne probably lacked the training (and certainly lacked the appropriate license) to give his clients the requisite information that would have allowed them to make a knowing choice with respect to these matters. Thus, his real crime was not the document he drafted, but the document he didn't draft.

Two other points about the opinion.

First, I had not previously been to the Ohio Supreme Court's website. The opinions give not only the "book" official citation (that is, a citation to the hard bound volumes of published opinions) but an official "cyber" citation as well. All courts should emulate this practice.

Second, the Court's opinion cited as authority Henning & McQuown, Ohio Limited Liability Company: Forms and Practice Manual (December 2001). A disclaimer: I have a slight (very slight) financial interest in that publication, but (and?) I was happy to see it relied upon as authority.

An Act of Faith

One of the best things about participating in Bar activities is that you get exposed to a group of people who have a high degree of pride in their profession. That is, for them, being a lawyer is not merely a job, but a calling as well.

Now most of those who populate these meetings are what I call "average smart guys." That is, they're people who are well-educated and very bright, but not necessarily on the intellectual level of a Brandeis or Holmes. (By the way, on my best days, I rate myself at the lower rungs of the "average smart guy" scale.) Occasionally, however, you get the opportunity to meet people who go to the top of the scale and then beyond.

Once of the people who I've had the opportunity to meet and who is beyond the category of "average smart guy" is Susan Pace Hamill. (Ok, she's not a guy, but you get the idea.)

Susan was with the I.R.S. when LLCs were in their infancy and, I suspect, did a great deal to advance their acceptance within the Service. Subsequently, she became a professor at the University of Alabama School of Law. More recently, she has caused a bit of stir by publishing an article in the University of Alabama Law Review entitled An Argument for Tax Reform Based on Judeo-Christian Ethics. (Susan also has a Masters in Theology from the Beeson Divinity School.)

The article focuses on Alabama's tax system, labeling it unfair to the poor. It is easy to see, however, that a similar analysis would apply to most state and local tax regimes in this country, since, to a great degree, they all rely on regressive taxes. And the President's welfare bill for the wealthy? Although not a theologian, I think that to ask the question is to answer it.

In an editorial piece in the New York Times on Tuesday, Adam Cohen outlined the impact that Susan's article has had on tax policy in Alabama, moving even an arch-conservative governor to back tax reform. But don't hold your breath waiting for the alleged conservatives in the White House to get religion.

Hatchett Link

You can link to the opinion in Hatchett v. U.S. by clicking the title.

A Hatchett Job

The Sixth Circuit just issued an opinion applying U.S. v. Craft. It is certain to send shivers down the spines of title insurance companies.

The case, Hatchett v. U.S., arose out of an assessment that grew from the tax fraud of Mr. Hatchett, formerly a prominent Detroit trial attorney. While the Craft case was wending its way to the Supreme Court, the Hatchetts had been contesting the government's attempt to enforce its lien against Mr. Hatchett by attaching their tenancy by the entirety property.

The Sixth Circuit admitted that the Supreme Court in Craft had enunciated "a new rule of federal law" since, prior to that decision, "several federal and state courts, including [the Sixth Circuit], as well as the IRS, had assumed that entireties property was excluded from the definition of 'all property and rights to property' as defined by the tax code." However, the Court applied the rule found in Reynoldsville Casket Co. v. Hyde, 514 U.S. 749, 752 (1995), that: "[W]hen (1) the Court decides a case and applies the (new) legal rule of that case to the parties before it, then (2) it and other courts must treat that same (new) legal rule as 'retroactive,' applying it, for example, to all pending cases, whether or not those cases involve predecision events."

The problem with Sixth Circuit's application of the rule is that it assumes that the litigation contesting the lien is the applicable "case" for purposes of the Reynoldsville Casket rule. The problem this raises is not obvious, but is extremely troublesome.

Assume that a tax lien was filed prior to the date the Craft decision was handed down. The parties subsequently (either before or after Craft, I don't think that it matters) sold tenancy by the entirety property to a third party bona fide purchaser for value. The third party's title insurer issued title insurance because, after all, the IRS's administrative practice in the state in which the property was located was not to attempt to levy against tenancy by the entirety property to enforce a lien against one spouse and the title insurer, correctly it seems to me, assumed that the lien did not attach to the property.

Now, the IRS attempts to assert its lien against the property. After all, Craft holds that the lien was good when it was initially filed and when the third party purchased the property. Presumably, the third party (or its title insurer) will attempt to judicially challenge the lien. However, by applying the Reynoldsville Casket rule to the "case," that is, the filing of the challenge to the lien, the third party loses because the case was instituted subsequent to Craft.

If the foregoing analysis holds, there are numerous tax liens that title insurers thought were dead, at least as to tenancy by the entirety property that had been conveyed, but which can presumably spring back to life. Thus, if the hypothetical third party in my illustration attempts to subsequently convey the property, should (or will) a title insurer issue a policy without a specific exception? And, if an exception is noted, will a lender participate in the purchase?

The Sixth Circuit's website is down this evening. When it comes back up, I will post a link to the Hatchett opinion.