Probably? Understanding tax law's uncertainty

University of Pennsylvania Law Review

Volumn 157, Issue 4, 2009, Pages 1017-1074

  Lawsky, Sarah B ^a  

^a GEORGE WASHINGTON UNIVERSITY   (United States)

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EID: 65949120729     PISSN: 00419907     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (223)

1. FRANK H. KNIGHT, RISK, UNCERTAINTY AND PROFIT 11 (Univ. of Chi. Press 1971) (1921).
2. Gary S. Becker, Crime and Punishment: An Economic Approach, 76 J. POL. ECON. 169 (1968).
3. David A. Weisbach, An Economic Analysis of Anti-Tax-Avoidance Doctrines, 4 AM. L. & ECON. REV. 88 (2002). For further discussion of these doctrines, see infra Section II.A.
4. Alex Raskolnikov, Crime and Punishment in Taxation: Deceit, Deterrence, and the Self-Adjusling Penalty, 106 COLUM. L. REV. 569, 599-605 (2006).
5. See, e.g., Yoram Keinan, Playing the Audit Lottery: The Role of Penalties in the U.S. Tax Law in the Aftermath of Long Term Capital Holdings v. United States, 3 BERKELEY BUS. L.J. 381, 419-21 (2006) (using cost-benefit analysis to argue that tax-compliance legislation should focus on increasing the likelihood of detection rather than on increasing penalties);
6. Eric A. Posner, Law and Social Norms: The Case of Tax Compliance, 86 VA. L. REV. 1781, 1782 (2000) (developing a "signaling model" for tax compliance in which individuals are said to comply with tax laws in order to signal that they have a low discount rate and are therefore unlikely to "cheat" in future transactions).
7. Raskolnikov, supra note 4, at 579-80.
8. David A. Weisbach, Disrupting the Market for Tax Planning, 26 VA. TAX REV. 971, 972 (2007).
9. The need to understand these assumptions is, of course, not unique to tax law. See, e.g., Neil H. Buchanan, Playing with Fire: Feminist Legal Theorists and the Tools of Economics, in FEMINISM CONFRONTS HOMO ECONOMICUS 61, 74-79 (Martha Albertson Fineman & Terence Dougherty eds., 2005) (highlighting assumptions on which certain economic models rely and warning both that economic models include values within their frameworks and that the tools of economics are not, pace economics' scientific apparatus, a source of value-neutral answers);
10. Cass R. Sunstein, Cost-Benefit Analysis Without Analyzing Costs or Benefits: Reasonable Accommodation, Balancing, and Stigmatic Harms, 74 U. CHI. L. REV. 1895, 1896 (2007) (pointing out, through an analysis of a Seventh Circuit holding by Judge Posner that a particular accommodation is not "reasonable" under the Americans with Disabilities Act, that "cost-benefit analysis can ⋯ operate as a vessel for unreliable intuitions rather than a way of disciplining them").
11. See, e.g., Becker, supra note 2, at 176.
12. See infra subsection III.A. 1.
13. There has been some discussion of the distinction between frequentism and subjectivism (Bayesianism) both in the context of risk assessment by regulators such as the Environmental Protection Agency, see, e.g., David E. Adelman, Scientific Activism and Restraint: The Interplay of Statistics, Judgment, and Procedure in Environmental Law, 79 NOTRE DAME L. REV. 497 (2004);
14. Matthew D. Adler, Against "Individual Risk": A Sympathetic Critique of Risk Assessment, 153 U. PA. L. REV. 1121, 1142, 1206-20 (2005);
15. Matthew D. Adler, Risk, Death and Harm: The Normative Foundations of Risk Regulation, 87 MINN. L. REV. 1293, 1297-98, 1340-88 (2003), and in the context of evidence law, in particular the use of scientific evidence in the courtroom,
16. see, e.g., Gregory Mitchell, Mapping Evidence Law, 4 MICH. ST. L. REV. 1065, 1094, 1095 & n. 52 (2003). Additionally, the distinction between frequentist and subjectivist interpretations has been used to call into question the behavioral law and economics claim that people do not "correctly" or " rationally" incorporate information about probabilities into their decision making.
17. See, e.g., Charles Yablon, The Meaning of Probability Judgments: An Essay on the Use and Misuse of Behavioral Economics, 2004 U. ILL. L. REV. 899.
18. For example, Terrence R. Chorvat, Ambiguity and Income Taxation, 23 CARDOZO L. REV. 617 (2002), discusses the effect of ambiguity on substantive tax policy, in particular the taxation of risk-taking, but he does not address the effect of ambiguity on tax compliance. Several legal scholars have applied behavioral law and economics (i.e., the idea that people "incorrectly" incorporate information about probabilities into their decision making) to tax law.
19. See, e.g., Christopher C. Fennell & Lee Anne Fennell, Fear and Greed in Tax Policy: A Qualitative Research Agenda, 13 WASH. U. J.L. & POLY 75, 129-36 (2003) (pointing out gaps in tax-aversion research and analysis);
20. Lee Anne Fennell, Death, Taxes, and Cognition, 81 N.C. L. REV. 567, 572-93 (2003) (using behavioral law and economics to explain puzzles related to the estate tax);
21. Edward J. McCaffery & Jonathan Baron, Thinking About Tax, 12 PSYCHOL. PUB. POL'Y & L. 106, 107-08 (2006) (reporting a set of experiments that suggest that "ordinary people think about tax" inconsistently with "ideal rationality"). But these articles address issues that arise subsequent to this Article's topic - that is, what the putatively correct probability means.
22. One notable exception to this general failure to define probability is Raskol-nikov, who breaks down the probability of punishment into the probabilities that an offense will be detected; that it will be selected for prosecution; that the government will prevail at trial on the substantive issue, decide to seek a penalty and convince a court to impose it; that the judgments favoring the government will survive appeals; and, finally, that the government will actually collect the penalty from a taxpayer. Raskolnikov, supra note 4, at 581. Indeed, the probability that a penalty will be imposed can be decomposed into an arbitrarily large number of probabilities. He focuses on the probability of detection, noting that audit is not sufficient to discover a "bad" transaction and that the probability of a penalty should be broken down into the probability of audit and the probability that the position is discovered if a return is audited.
23. Id. at 583.
24. These transactions are held impermissible under the court-created doctrines discussed below. See infra Section II.A.
25. We assume, for example, that the coin is not weighted so that the chance of the coin turning up tails is 75%; in that case, the expected value of the coin toss would be only twenty-five cents.
26. This answer assumes, of course, that the person has no particular taste for or against risk or coin-flipping games.
27. This assumes, of course, that for incomes x and y, if x > y, then U(x) > U(y). In other words, it assumes that the utility function is strictly increasing.
28. See generally KNIGHT, supra note 1, ch. 7.
29. Saying that the probability is one out of six is the same as saying that the odds are five to one against.
30. Sven OveHansson, Philosophical Perspectives on Risk, 8 TECHNÉ 10, 11-12 (2004).
31. Actually, she would probably say something like, "The odds are three to one that the Giants will win Sunday," which is the same thing. Or she might say, "The Giants money line is -300."
32. See, e.g., BRUNO DE FINETTI, 1 THEORY OF PROBABILITY 194-95 (Antonio Machi & Adrian Smith trans., John Wiley & Sons 1974) (1970) (explaining how to evaluate the meaning of probability statements in the forecasting of sports results);
33. RICHARD JEFFREY, SUBJECTIVE PROBABILITY 1-2 (2004) (providing an introduction to betting and probabilities);
34. LEONARD J. SAVAGE, THE FOUNDATIONS OF STATISTICS 30 n.† (1954) (discussing and providing examples of the "personal" view of probability, another term for which is "subjective probability").
35. See, e.g., Lina Eriksson & Alan Hájek, What Are Degrees of Belief?, 86 STUDIA LOGICA 183, 187 (2007) ("[T]hink of the football team owner who flamboyantly places a bet at ridiculously short odds on his team winning, as a display of his loyalty.").
36. See, e.g., Cheek v. United States, 498 U.S. 192, 202 (1991) ("[T]he issue is whether, based on all the evidence, the Government has proved that the defendant was aware of the duty at issue, which cannot be true if the jury credits a good-faith misunder-standing and belief submission [i.e., a subjective standard], whether or not the claimed belief or misunderstanding is objectively reasonable [i.e., an objective standard].").
37. See infra text accompanying notes 97-100.
38. Gregory v. Helvering, 293 U.S. 465, 469 (1935). The Court in Helvering struck down a transaction that adhered to the letter of the law because the transaction violated "the plain intent of the statute," and thus to uphold the transaction would have been to "exalt artifice above reality."
39. Id. at 470.
40. See, e.g., Saturday Night Live: Steve Martin's Monologue (NBC television broadcast Jan. 21, 1978) ('You can be a millionaire and never pay taxes! You can be a millionaire and never pay taxes! You say, 'Steve, how can I be a millionaire and never pay taxes?' First, get a million dollars. Now, you say, 'Steve, what do I say to the tax man when he comes to my door and says, "You have never paid taxes"?' Two simple words. Two simple words in the English language: 'I forgotl'").
41. This "tension between technical compliance with the Internal Revenue Code" and judicial anti-abuse doctrines has been characterized as "[p]oignant[]" by the Court of Federal Claims. Jade Trading, LLC v. United States, 80 Fed. Cl. 11, 13 (2007).
42. See, e.g., Frank Lyon Co. v. United States, 435 U.S. 561, 573, 583-84 (1978) (describing the analysis to use when determining whether a transaction is a sham for tax purposes);
43. see also Black & Decker Corp. v. United States, 436 F.3d 431, 440-42 (4th Cir. 2006) (same).
44. See, e.g., ACM P'ship v. Comm'r, 73 T.C.M. (CCH) 2189, 2214-17 (1997) (explaining that the economic-substance test requires a fact-based determination as to whether the transaction is "rationally related to a useful nontax purpose that is plausible in light of the taxpayer's conduct and useful in light of the economic situation and intentions"), off'd in part and rev'd in part on other grounds, 157 F.3d231 (3d Cir. 1998).
45. Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1352 (Fed. Cir. 2006).
46. See, e.g., Klamath Strategic Inv. Fund v. United States, 472 F. Supp. 2d 885, 895 (E.D. Tex. 2007) (describing the business-purpose test as a "subjective inquiry").
47. See, e.g., id.
48. See, e.g., Black & Decker, 436 F.3d at 441 ("To treat a transaction as a sham, the court must find [(1)] that the taxpayer was motivated by no business purposes ⋯ and [(2)] that the transaction has no economic substance ⋯." (bracketed alterations in original)
49. (quoting Rice's Toyota World, Inc. v. Comm'r, 752 F.2d 89, 91 (4th Cir. 1985))).
50. See, e.g., Coltec, 454 F.3d at 1355 ("[A] lack of economic substance is sufficient to disqualify the transaction without proof that the taxpayer's sole motive is tax avoidance.").
51. ACM P'ship v. Comm'r, 157 F.3d 231, 247 (3d Cir. 1998).
52. See Joshua D. Blank, What's Wrong with Shaming Corporate Tax Abuse, 62 TAX L. REV. (forthcoming 2009) ("At the time corporations entered into [tax-shelter] transactions, no tax rules explicitly prohibited them⋯. The IRS, and at least some courts, however, concluded that these transactions were corporate tax shelters because they violated broad judicial tax standards.");
53. Kyle D. Logue, Tax Law Uncertainty and the Role of Tax Insurance, 25 VA. TAX REV. 339, 362-68 (2005) (discussing judicial anti-abuse doctrines and noting that "the tax law can be characterized by significant substantive uncertainty");
54. Weisbach, supra note 3, at 89-90 ("[A]nti-avoidance doctrines can be analyzed through a rules/standards analysis. Anti-avoidance doctrines are standards⋯.");
55. see also David A. Weisbach, Formalism in the Tax Law, 66 U. CHI. L. REV. 860, 865-67 (1999) (discussing rules versus standards in tax law).
56. See Louis Kaplow, Rules Versus Standards: An Economic Analysis, 42 DUKE L.J. 557, 618 n. 180 (1992) (noting that the tax law governing sham transactions consists of relatively "open-ended" standards).
57. See, e.g., I.R.C. § 6664(d)(3)(A)(ii) (2006) (stating that a taxpayer's belief that her tax treatment of an item is correct is reasonable only if the belief relates "solely to the taxpayer's chances of success on the merits of such treatment");
58. Treas. Reg. § 1.6662-4(g) (4) (i) (1995) (stating that a taxpayer has a reasonable belief that "the tax treatment of an item is more likely than not the proper tax treatment" if "[t]he taxpayer ⋯ reasonably concludes ⋯ that there is a greater than 50-percent likelihood that the tax treatment of the item will be upheld if challenged by the Internal Revenue Service").
59. For example, in fiscal year 2007, the audit rate was 1.03% for individuals overall and 0.66% for business returns overall. The IRS focused its resources on high-earning corporations and individuals, but even those audit rates were not overwhelming: the audit rate for large corporations (i.e., corporations with assets of at least $10 million) was 16.8%, and the audit rate for individuals with income of more than $1 million was 9.25%. The audit rate for very large corporations (i.e., corporations with assets of at least $250 million) was 27.2%. IRS, FISCAL YEAR 2007 IRS ENFORCEMENT AND SERVICE STATISTICS (2008), http://www.irs.gov/pub/newsroom/irs-enforcement-and-service-tables-fy-2007.pdf.
60. Although it is difficult to determine precisely how many audits are resolved by a court decision, we can get a very rough sense of the ratio of audits to cases by comparing their relative numbers in a single year. In 2007, for example, according to a West-law search, there were 1228 federal trial-level income-tax-related decisions. (This was the number of documents returned when searching for income tax decisions in 2007 in district courts, the Court of Federal Claims, and the Tax Court. The specific search was [da (2007) & "income tax"] in the databases FTX-DCT, FTX-FEDCL, and FTX-TCT.) This number is both over- and underinclusive if we are trying simply to determine the number of substantive income-tax issues resolved by a trial-level court in 2007;
61. for example, it includes cases requesting enforcement of tax summonses and it does not include some jury cases. Nonetheless, it provides an order of magnitude. By comparison, in 2007 the IRS audited 1,550,922 returns. IRS, DEP'T OF THE TREASURY, INTERNAL REVENUE SERVICE DATA BOOK 2007, at 23 tbl.9. Thus, in 2007, there were approximately 1200 times more audits performed than trial-level tax decisions.
62. See I.R.C. § 6664(d) (3)(A)(ii) (2006) (stating that a taxpayer's belief as to the legality of her tax position is reasonable only if that belief "does not take into account the possibility that a return will not be audited").
63. This rendering of the tax continuum is mine, but the idea of the tax continuum appears in both EXECUTIVR TASK FORCE, COMMISSIONER'S PENALTY STUDY, IRS, REPORT ON CIVIL TAX PENALTIES, at VIII-38 to -39 (1989), and Logue, supra note 37, at 352-62, 360 fig. 1. The general idea of a probability continuum may be traced back at least as far as Keynes: The so-called magnitudes or degrees of knowledge or probability, in virtue of which one is greater and another less, really arise out of an order in which it is possible to place them. Certainty, impossibility, and a probability, which has an intermediate value, for example, constitute an ordered series in which probability lies between certainty and impossibility. In the same way there may exist a second probability which lies between certainty and the first probability. When, therefore, we say that one probability is greater than another, this precisely means that the degree of our rational belief in the first case lies between certainty and the degree of our rational belief in the second case.
64. JOHN MAYNARD KEYNES, A TREATISE ON PROBABILITY 35 (MacMillan & Co. 1948) (1921).
65. Cf. Michael Abramowicz, Predictive Decisionmaking, 92 VA. L. REV. 69, 69-72 (2006) (advocating the government's increased use of predictive, as opposed to normative, decision making).
66. See I.R.C. § 6707 (2006) (imposing a penalty for failure to file a return with respect to a reportable transaction).
67. For further discussion of reportable transactions and penalties related to those transactions, see infra text accompanying notes 88-97. The reportable transaction system may also be effective in part because people do not want to draw the IRS's attention to their tax returns and thus may overweight the downside of having to file the additional form. Cf. Tom Herman, Fear of the Home-Office Deduction, WALL ST. J., Jan. 16, 2008, at D3 (explaining that many taxpayers do not take the home-office deduction because they overweight the chance that taking the deduction will cause their returns to be audited).
68. Treas. Reg. § 1.6011-4(b)(2) (as amended in 2007). These transactions are sometimes called "midco transactions," after the "middle" (intermediary) company. See, e.g., Sam Young, No Immediate Relief from "Midco" Transaction Notice, Official Says, TAX NOTES TODAY, June 25, 2008, 2008 TNT 123-5 (LEXIS).
69. I.R.S. Notice 2001-16, 2001-9 I.R.B. 730.
70. This scenario might arise, for example, when the seller has a high basis in the stock and the target has a low basis in the assets.
71. See Treas. Reg. § 1.6011-4(c) (4) (as amended in 2007).
72. The liquidation would be tax free. See I.R.C. § 332(a) (2006) ("No gain or loss shall be recognized on the receipt by a corporation of property distributed in complete liquidation of another corporation.").
73. See Treas. Reg. § 1.6011-4(c) (4), ex. 2 (as amended in 2007) ("An example is a transaction in which [the intermediary] is a corporation that does not file a consolidated return but which buys [another corporation's (T)] stock, liquidates T, sells assets of T to [a buyer], and offsets the gain on the sale of those assets with currently generated losses.").
74. Letter from David S. Miller, Chair, Tax Section, N.Y. State Bar Ass'n, to Eric Solomon, Assistant Sec'y (Tax Policy), Dep't of the Treasury, and Douglas Shulman, Comm'r, Internal Revenue Serv. 3 (May 23, 2008), available at http://www.nysba.org/AM/Template.cfm?Section=Mission-Statement4 (click "Tax Section Reports 2008" link on left side of page; then click "1156" link).
75. See I.R.S. Notice 2008-20, 2008-6 I.R.B. 406 (identifying the components of an Intermediary Transaction Tax Shelter).
76. Treas. Reg. § 1.6011-4 (c) (4).
77. The IRS, in its corporate-tax-shelter check sheet, tells its examiners that the presence of a tax-indifferent party is one of nine characteristics of corporate tax shelters. Internal Revenue Serv., Examination Guide - Abusive Tax Shelters and Transactions § III.E.2,
78. reprinted in TAX NOTES TODAY, May 27, 2005, 2005 TNT 102-14 (LEXIS).
79. Treas. Reg. § 1.6011-4(c) (4).
80. T.D. 9000, 2002-2 C.B. 87, 88.
81. There are, of course, problems with this interpretation, as discussed supra text accompanying notes 23-24. For example, as mentioned above, perhaps the speaker does not like to bet or doubts that the bet will ever be paid off because courts rarely review tax positions. But these objections to the betting interpretation do not affect this Section's analysis.
82. These strong beliefs seem to arise frequently in scenarios about World War II and about sports. See, e.g., BEVIN ALEXANDER, HOW HITLER COULD HAVE WON WORLD WAR II, at x-xii (2000) (exploring opportunities that could have led Hitler to build an "unassailable" continental empire);
83. GAVRIEL D. ROSENFELD, THE WORLD HITLER NEVER MADE: ALTERNATE HISTORY AND THE MEMORY OF NAZISM (2005). Another example is Saturday Night Live: Bill Swerski's Super Fans (NBC television broadcast Jan. 12, 1991): Bill Swerski: Now, gentlemen, let me ask you this: What if Da Bears were all 14 inches tall, you know, about so high? Now, what's your score of today's game? Carl Wollarski: Against Da Giants? Bill Swerski: Yes, give 'em a handicap. Carl Wollarski: Bears 18, Giants 10. And that would finally be a good game. Pat Arnold: Yeah, it would be a good game. Mini Bears 24, Giants 14. Todd O'Conner: What about Ditka? Would he be mini, too? Bill Swerski: No, he would be full-grown. Todd O'Conner: Oh, then, uh ⋯ Mini Bears 31, Giants 7. Carl Wollarski: Oh, hold on. Then I change mine, too. I thought it was Mini Ditka.
84. See generally DAVID LEWIS, COUNTERFACTUALS (1973) (explaining the "possible worlds" approach).
85. See Treas. Reg. § 1.6664-4(c) (as amended in 2003) (describing the minimum requirements for relying on tax advice).
86. See Treas. Reg. § 1.6664-4(c)(1) (as amended in 2003) (mandating analysis of "all facts and circumstances" as a prerequisite to reasonableness). The reliance must also be in good faith.
87. Id.
88. I.R.C. § 6664(d)(3)(B)(iii) (2006). For further discussion of the tax advisor's role, see infra Section III.B.
89. See, e.g., Itzhak Gilboa et al., Probability and Uncertainty in Economic Modeling (Penn Inst. for Econ. Research, Working Paper No. 08-002, 2008), available at http://ssrn.com/abstract=1088122.
90. See, e.g., Mark J. Machina & David Schmeidler, A More Robust Definition of Subjective Probability, in 2 THE ECONOMICS OF UNCERTAINTY 745, 746-47 (John D. Hey ed., 1997) (describing Frank Ramsey's work on the subjective approach to probability).
91. Becker, supra note 2, at 177.
92. Id. at 186, 187 tbl.2.
93. Erling Eide, Economics of Criminal Behavior, in 5 ENCYCLOPEDIA OF LAW AND ECONOMICS: THE ECONOMICS OF CRIME AND LITIGATION 345, 346 (Boudewijn Bouckaert & Gerrit De Geest eds., 2000).
94. See, e.g., SAVAGE, supra note 22.
95. See, e.g., Gilboa et al., supra note 65, at 2.
96. See Louis Kaplow, Optimal Deterrence, Uninformed Individuals, and Acquiring Information About Whether Acts Are Subject to Sanctions, 6 J.L. ECON. & ORG. 93 (1990).
97. Id. at 93.
98. While Kaplow grounds his model in terms of harmfulness, he equates harm and illegality. See id. at 96 ("If and only if an act is harmful is it illegal, in which case there is some probability that the act will be detected and the individual penalized.").
99. Id. at 97. Both the benefit and the sanction are measured in monetary equivalents.
100. Id. at 98.
101. Id. at 101-02.
102. See Daniel Shaviro, Disclosure and Civil Penalty Rules in the U.S. Legal Response to Tax Shelters, in TAX AND CORPORATE GOVERNANCE 229 (Wolfgang Schon ed., 2008).
103. I.R.C. §6662(a)-(b) (2006).
104. Id. §6662(d)(1)(A).
105. Id. §6664(c)(1).
106. Treas. Reg. § 1.6664-4(b) (as amended in 2003).
107. I.R.C. §6662(d)(2)(B)(i).
108. See, e.g., Jasper L. Cummings, Jr., The Range of Legal Tax Opinions, with Emphasis on the "Should" Opinion, 98 TAX NOTES 1125, 1128 (2003) (collecting sources approximating what is meant by "substantial authority").
109. I.R.C. §6662(d)(2)(B)(ii).
110. See, e.g., Cummings, supra note 84, at 1127 (collecting sources approximating what is meant by "reasonable basis").
111. American Jobs Creation Act of 2004, Pub. L. No. 108-357, §812(a), 118 Stat. 1418, 1577-80 (codified as amended at I.R.C. § 6662A).
112. I.R.C. §6662A(b)(2)(B).
113. Id. §6707A(c)(1).
114. Treas. Reg. § 1.6011-4 (b) (as amended in 2007).
115. Id. §1.6011-4(b)(6).
116. Id.
117. T.D. 9350, 2007-38 I.R.B. 607, 608.
118. Treas. Reg. § 1.6011-4(b) (2).
119. See supra text accompanying notes 48-58 for additional discussion of listed transactions.
120. I.R.C. §6707A(c)(2) (2006).
121. Id. §6662A(b)(2).
122. As discussed supra text accompanying notes 83-86, a taxpayer can also escape the general accuracy-related penalty if she had substantial authority for the item or if she disclosed the item and had a reasonable basis for her position. In other words, either substantial authority or good faith and reasonable cause are sufficient to avoid the general accuracy-related penalty, whereas both are required to escape the reportable transaction accuracy-related penalty, in addition to the taxpayer's reasonable belief that her treatment of the tax item was more likely than not correct.
123. I.R.C. §6664(d).
124. Id. §6664(d) (3) (A) (i).
125. In contrast, Cheek v. United States, 498 U.S. 192 (1991), was a criminal case in which a tax protester was charged with willfully failing to file tax returns and willfully evading tax. The Court found it possible "for a defendant to be ignorant of his duty based on an irrational belief that he has no duty" and held that this ignorance could negate willfulness.
126. Id. at 203. A good-faith belief, in other words, could be objectively unreasonable. This holding was based on case law that defined "willfully" in the context of criminal tax statutes.
127. Id. at 200-01.
128. For further discussion of the objective/subjective distinction, see supra text accompanying notes 24-25.
129. I.R.C. §6664(d)(3)(A)(ii).
130. A more detailed guide to degrees of certainty is available, but it may not be intended completely seriously. See A Detailed Guide to Tax Opinion Standards, 106 TAX NOTES 1469 (2005) (stating, inter alia, that a 44% chance of success should be interpreted to mean "[i]f we get the rightjudge"; a 14% chance, "[m]aybe Enron would do this"; and a 5% chance, "[y]ou must not understand the legislation").
131. Shaviro, supra note 78. Kyle Logue also argues against a fault-based penalty regime, but his argument is based primarily on the nonadministrability of a fault-based regime, and although his analysis nominally uses optimal tax theory, his suggestions for changing the penalty regime are based on the application of a fault-based regime to the real world. Kyle Logue, Optimal Tax Compliance and Penalties When the Law Is Uncertain, 27 VA. TAX REV. 241, 280-93 (2007).
132. Shaviro, supra note 78, at 230.
133. Id.
134. Id. at 231.
135. Id.
136. Id. at 237-38.
137. Kaplow, supra note 71, at 99-100.
138. The variables used here are also used in Kaplow's model. Id. at 97.
139. This equation assumes that unpaid taxes result in societal harm, which might not be true.
140. Whether they should codify these doctrines is an issue of much contention. See, e.g., Donald L. Korb, Codification of the Judicial Economic Substance Doctrine, in TAX STRATEGIES FOR CORPORATE ACQUISITIONS, DISPOSITIONS, SPIN-OFFS, JOINT VENTURES, FINANCING, REORGANIZATIONS AND RESTRUCTURINGS 2008, at 377, 392-95 (PLI Tax Law & Estate Planning Handbook Series No. 14, 322, 2008) (describing the advantages and disadvantages of codifying the economic-substance doctrine).
141. See supra Part II.A.
142. See supra notes 37-38 and accompanying text.
143. 31 C.F.R. pt. 10 (2008).
144. American Jobs Creation Act of 2004, Pub L. No. 108-357, §§ 812, 815, 118 Stat. 1418, 1577-80, 1581-83 (codified as amended in scattered sections of I.R.C.).
145. See the discussion of fault-based penalties supra subsection III.A.I.
146. 31 C.F.R. § 10.35(c)(1).
147. Id. §10.35(c)(2).
148. Id. § 10.35(c)(3).
149. Id. §§ 10.50(a), 10.60(a).
150. See supra text accompanying notes 63-64.
151. I.R.C. § 6664(d) (3) (B) (2006).
152. Department of the Treasury, Circular No. 230 (rev. April 2008), available at http://www.irs. gov/pub/irs-utl/circular-230.pdf.
153. See, e.g., Michael L. Schler, Effects of Anti-Tax-Shelter Rules on Nonsheller Tax Practice, 109 TAX NOTES 915, 918-22 (2005) (arguing that the costs of Circular 230 exceed its benefits);
154. Juan F. Vasquez, Jr. & Jaime Vasquez, Section 10.35(b)(4)(ii) of Circular 230 Is Invalid (But Just in Case It Is Valid, Please Note that You Cannot Rely on This Article to Avoid the Imposition of Penalties), 7 HOUS. BUS. & TAX L.J. 293 (2007) (arguing that Circular 230 has adversely affected taxpayers).
155. See Deborah H. Schenk, The Circular 230 Amendments: Time to Throw Them Out and Start Over, 110 TAX NOTES 1311, 1312-13 (2006) (stating that Circular 230 is "overkill" and has "unintended negative effect[s]").
156. See supra Section II.B.
157. See, e.g., Nigel Harvey, Improving Judgment in Forecasting, in PRINCIPLES OF FORECASTING 59, 69-71 (J. Scott Armstrong ed., 2001) (summarizing studies on "outcome and cognitive feedback").
158. See the discussion of the counterfactual problem supra Section II.B.
159. This is the basic idea of Bayesianism: begin with a prior distribution and then update one's analysis as new information becomes available. Cf. Michael Risch, How Can Whelan v. Jaslow and Lotus v. Borland Both Be Right? Reexamining the Economics of Computer Software Reuse, 17 J. MARSHALL J. COMPUTER & INFO. L. 511, 524-28 (1999) (arguing that a correct economic model of judicial decision making in copyright-infringement cases takes into account the information that judges have before them at the time of the decision and not just information available to the parties ex ante).
160. See, e.g., ACM P'ship v. Comm'r, 73 T.C.M. (CCH) 2189, 2215 (1997) ("The doctrine of economic substance becomes applicable, and a judicial remedy is warranted, where a taxpayer seeks to claim tax benefits, unintended by Congress, by means of transactions that serve no economic purpose other than tax savings."), aff'd in part and rev'd in part on other grounds, 157 F.3d 231 (3d Cir. 1998).
161. See, e.g., Klamath Strategic Inv. Fund v. United States, 472 F. Supp. 2d 885, 898 (E.D. Tex. 2007).
162. 330 F. Supp. 2d 122 (D. Conn. 2004), aff'd, 150 F. App'x 40 (2d Cir. 2005).
163. Id. at 210.
164. Id. at 209.
165. See 31 C.F.R. § 10.35(b) (2008).
166. Treas. Reg. § 1.6664-4(c)(1)(i) (as amended in 2003).
167. Long Term Capital Holdings, 330 F. Supp. 2d at 210.
168. 31 C.F.R. §10.33(a)(1)(i)-(ii) (amended 2004).
169. Id.
170. 31 C.F.R. § 10.35(c)(1)(iii) (2008).
171. Id. §10.35(c)(1)(ii).
172. Id.
173. See Thomas R. Stewart, Improving Reliability of Judgmental Forecasts, in PRINCIPLES OF FORECASTING, supra note 128, at 81, 96-97.
174. Id.
175. See Hal R. Arkes, Overconfidence in Judgmental Forecasting, in PRINCIPLES OF FORECASTING, supra note 128, at 495, 496-98.
176. Harvey, supra note 128, at 65-66, 74.
177. I.R.C. §§6664(d)(3)(B) (2006).
178. Arkes, supra note 146, at 500-02.
179. Id. at 502-04.
180. Id.
181. See, e.g., Abramowicz, supra note 44, at 103 (citing "preliminary research" that shows that information markets have predictive power).
182. See, e.g., ANDREW BAUM & DAVID MACKMIN, THE INCOME APPROACH TO PROPERTY VALUATION 53 (3d ed. 1989) ("Valuation [can be] summarised as the estimation of the future benefits to be enjoyed from the ownership of a freehold or a leasehold interest in land or property, expressing those future benefits in terms of present worth.");
183. ALFRED M. KING, VALUATION 91 (2002) ("In the final analysis, an investment in any asset is worth no more than the present value today of the income to be derived in the future from that investment."). To take into account the fact that future cash flows are not guaranteed, the discount rate may be adjusted for future cash flows. Alternately, one could lay out multiple risk-free scenarios and then weight each scenario by one's estimated probability of that scenario's occurring.
184. See KING, supra, at 95-100.
185. See, e.g., Kesten C. Green et al., Methods to Elicit Forecasts from Groups: Delphi and Prediction Markets Compared, FORESIGHT, Fall 2007, at 17 (collecting sources stating that the Delphi technique improves decision making when compared to techniques used in traditional group meetings).
186. Gene Rowe & George Wright, Expert Opinions in Forecasting: The Role of the Delphi Technique, in PRINCIPLES OF FORECASTING, supra note 128, at 125, 126-27.
187. Id. at 128-29.
188. Daniel Ellsberg, Risk, Ambiguity, and the Savage Axioms, 75 Q.J. ECON. 643, 650 (1961).
189. Interestingly, if you would also prefer to bet $100 that a black ball will be drawn from the second urn, rather than betting $100 that a black ball will be drawn from the first urn, you apparently (if we do not take the risk/uncertainty distinction into account) think both that drawing a red ball from the second urn is more likely than drawing a red ball from the first
190. Id. at 651-63. Specifically, it violates two axioms proposed by Leonard Savage: (1) there must be complete ordering of actions - that is, as between two actions, either Action I is preferred to Action II, Action II is preferred to Action I, or there is indifference between Action I and Action II, and that transitivity applies to this ordering (complete ordering of actions);
191. and (2) if Action I and Action II have the same pay-off for a given event, the choice between these two actions should not be affected by this event (the "Sure Thing" principle).
192. Id.
193. Several formal definitions of ambiguity aversion have been suggested. See, e.g., Larry G. Epstein, A Definition of Uncertainty Aversion, 66 REV. ECON. STUD. 579, 583-86 (1999);
194. David Schmeidler, Subjective Probability and Expected Utility Without Additivity, 57 ECONOMETRICA 571. 578-84 (1989).
195. See, e.g., Jeff T. Casey & John T. Scholz, Boundary Effects of Vague Risk Information on Taxpayer Decisions, 50 ORGANIZATIONAL BEHAV. & HUMAN DECISION PROCESSES 360 (1991);
196. Dipankar Ghosh & Terry L. Grain, Structure of Uncertainly and Decision Making: An Experimental Investigation, 24 DECISION SCI. 789 (1993);
197. Anat Horovitz & Uzi Segal, The Ambiguous Nature, of Ambiguity and Crime Control, 2 N.Y.U. J.L. & LIBERTY 541, 542, 548 n. 19 (2007);
198. see also infra text accompanying notes 173-175.
199. See supra Section LA.
200. See, e.g., Raskolnikov, supra note 4, at 584-85.
201. Id. at 584.
202. See id. (claiming that the audit rate is "well known and well documented" and that the portion of the detection probability that involves the probability of audit is thus not problematic).
203. See Sarah B. Lawsky, Fairly Random: On Compensating Audited Taxpayers, 41 CONN. L. REV. 163, 166-70 (2008).
204. Press Release, Internal Revenue Serv. Media Relations Office, IRS Updates National Research Program for Individuals (June 6, 2007), available at http://www.irs.gov/pub/irs-news/ir-07-113.pdf.
205. Id. at 189.
206. See James Tackett et al., Profiling Fictitious Tax Data, 116 TAX NOTES 953, 955 (2007) (discussing this rule, known as "Benford's Law").
207. Id.
208. See Sandra Block, Software Can Save When Filing Your Taxes, USA TODAY, Feb. 29, 2008, at 3B.
209. John Rizzo, Intuit TurboTax and H & R Block TaxCut, MACWORLD, Mar. 4, 2008, http://www.macworld.com/article/132338/2008/03/ taxprep-desktop.html?t=203.
210. See, e.g., Harvey, suf/ra note 128.
211. See Ghosh & Grain, supra note 160, at 800 ("These results support the predictions that the lower the mean and lesser the ambiguity of the probability distribution, the higher the intentional noncompliance.");
212. cf. Tom Baker et al., The Virtues of Uncertainty in Law: An Experimental Approach, 89 IOWA L. REV. 443, 446-47 (2004) (showing via experiment in a nontax context "that uncertainty with regard to either the size of the sanction or the probability of detection increases deterrence").
213. Ghosh & Grain, supra note 160, at 800.
214. James Aim et al., Institutional Uncertainly and Taxpayer Compliance, 82 AM. ECON. REV. 1018, 1024-25 (1992).
215. See supra Part II.
216. See supra notes 128-129 and accompanying text.
217. See OFFICE OF TAX POLICY, DEP'T OF THE TREASURY, THE DEFERRAL OF INCOME EARNED THROUGH U.S. CONTROLLED FOREIGN CORPORATIONS 69 (2000),
218. quoted in Adam H. Rosenzweig, Harnessing the Costs of International Tax Arbitrage, 26 VA. TAX REV. 555, 580 n. 46 (2007);
219. see also Rosenzweig, supra, at 627 & n. 142.
220. Casey & Scholz, supra note 160, at 362.
221. Id. at 371.
222. Id. at 387.
223. See, e.g., Lawsky, supra note 165, at 189 n. 118 (collecting sources supporting this proposition).