Custom and the rule of law in the administration of the income tax

Duke Law Journal

Volumn 62, Issue 3, 2012, Pages 829-855

  Zelenak, Lawrence ^a  

^a DUKE UNIVERSITY   (United States)

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EID: 84872221310     PISSN: 00127086     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (72)

1. For a classic statement of the tension between custom and the rule of law, see generally Stanley Diamond, The Rule of Law Versus the Order of Custom, 38 SOC. RES. 42 (1971).
2. I.R.S. Tech. Adv. Mem. 95-47-001 (July 11, 1995).
3. Tom Herman, Frequent-Flier Miles May Become IRS Target, WALL ST. J., Nov. 28, 1995, at A3.
4. Robert D. Hershey, Jr., IRS Backs Down on Frequent-Flier Miles, N.Y. TIMES, Nov. 28, 1995, at B14 (quoting Frank Keith) (internal quotation marks omitted).
5. Darrell L. Oliveira, The Taxability of Frequent Flyer Credits Earned by Employees: Why the IRS Has Remained Silent on the Issue, 4 U. PA. J. LAB. & EMP. L. 643, 643-44 (2002) (describing continued IRS inaction through 2002).
6. I.R.S. Announcement 2002-18, 2002-10 I.R.B. 621.
7. The tax status of frequent-flier miles resurfaced early in 2012, in a nonemployment context, when the Los Angeles Times reported that Citibank had issued Forms 1099-MISC to persons to whom it had given frequent-flier miles as rewards for opening accounts
8. David Lazarus, Tax Man Leaves Fliers up in the Air, L.A. TIMES, Jan. 24, 2012, at B1.
9. David Lazarus, Taxing Airline Miles Flies in the Face of Reason, L.A. TIMES, Jan. 31, 2012, at B1 (quoting Michelle Eldridge) (internal quotation marks omitted).
10. I.R.C. § 61(a) (2006).
11. Joseph M. Dodge, How To Tax Frequent Flyer Bonuses, 48 TAX NOTES 1301, 1302 (1990) ("This situation falls squarely under the expanded 'inconsistent events' formulation of the 'tax benefit rule' as formulated by the Supreme Court. .. ." (quoting Hillsboro Nat'l Bank v. Comm'r, 460 U.S. 370, 386-87 (1983).
12. Jonathan Barry Forman, Income Tax Consequences of Frequent Flyer Programs, 26 TAX NOTES 742, 743-44 (1985) (arguing that frequent-flier benefits are fringe benefits and are unlikely to be excluded as a "working condition fringe")
13. Lee A. Sheppard, Collecting the Tax on Frequent Flyer Benefits, 59 TAX NOTES 1140, 1141 (1993) (describing a frequent-flier benefit as a "fringe benefit taxable as compensation").
14. See generally I.R.C. § 382 (Supp. IV 2011) (setting forth the anti-loss-trafficking rules).
15. Rev. Rul. 57-374, 1957-2 C.B. 69; see also infra text accompanying note 36.
16. I.R.C. § 61(a) (2006).
17. BORIS I. BITTKER, MARTIN J. MCMAHON, JR. & LAWRENCE A. ZELENAK, FEDERAL INCOME TAXATION OF INDIVIDUALS ¶ 3.03[1] (3d ed. 2002) ("These items are not exempted from tax by specific statutory provisions, but congressional silence on the subject is clearly tantamount to an affirmative grant of immunity.").
18. For consideration of the possibility that what begins as a customary deviation may acquire the force of law over time, see infra notes 37-45 and accompanying text
19. See I.R.C. § 6053(a), (c)(3)(A), (c)(4) (2006) (providing that a food or beverage establishment employing more than ten employees on a typical business day must, if the tipping of employees is "customary," allocate among employees who customarily receive tips "an amount equal to the excess of-(i) 8 percent of the gross receipts. .. over (ii) the aggregate amount [of tip receipts] reported by such employees to the employer").
20. See United States v. Fior d'Italia, Inc., 536 U.S. 238, 240 (2002) (upholding the IRS practice of assessing FICA taxes owed by a restaurant on tips unreported by its employees, based on an estimate of aggregate tips received by all employees of the restaurant, without any attempt by the IRS to assess income taxes against individual employees with unreported tip income).
21. I.R.S. Publ'n 531 (Feb. 23, 2012), available at http://www.irs.gov/pub/irs-pdf/p531.pdf.
22. I.R.S. Announcement 2002-18, 2002-10 I.R.B. 621.
23. Rev. Rul. 57-374, 1957-2 C.B. 69.
24. Prop. Treas. Reg. § 1.101-8, 57 Fed. Reg. 59,319, 59,320 (Dec. 15, 1992). The proposed regulations were never finalized because the addition of § 101(g) to the Code in 1996 provided detailed statutory rules for the exclusion of accelerated death benefits. See Health Insurance Portability and Accountability Act of 1996, Pub. L. No. 104-191, tit. III, subtit. D, § 331, 110 Stat. 1936, 2067 (codified as amended at I.R.C. § 101(g) (2006)).
25. See Lee A. Sheppard, The Goldberg Variations, or Giving Away the Store, 58 TAX NOTES 530, 533 (1993) ("'By reason of the death of the insured' means what it says-death." (quoting I.R.C. § 101(a)(1))).
26. See also James P. Holden, Lee Sheppard's Grumpy Attack, 58 TAX NOTES 1130, 1131 (1993) ("[T]he section 101(a) exclusion for payments 'by reason of the death of the insured' is broad enough to permit payments made by reason of imminent death. .. .").
27. Comm'r v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955) (describing certain benefits as taxable because they were "accessions to wealth, clearly realized, and over which the taxpayers have complete dominion").
28. Alice G. Abreu & Richard K. Greenstein, Defining Income, 11 FLA. TAX REV. 295 (2011).
29. I.R.S. Announcement 2002-18, 2002-10 I.R.B. 621.
30. Rev. Rul. 70-330, 1970-1 C.B. 14.
31. See Rev. Rul. 70-498, 1970-2 C.B. 6 (holding that "the value of these [2,500 donated] books is includible in the taxpayer's gross income").
32. See Rev. Rul. 70-498, 1970-2 C.B. 6 ("It is well established that gross income is not limited to cash received, but may also include the fair market value of property received.").
33. Rev. Rul. 57-374, 1957-2 C.B. 69. For additional analysis-free rulings, see, for example, Revenue Ruling 81-209, 1981-2 C.B. 16, which held, without explanation, that a lawyer's client does not realize gross income when interest earned on the client's funds held in the lawyer's trust account is paid to a designated tax-exempt entity pursuant to a program established by the state supreme court, and Revenue Ruling 63-77, 1963-1 C.B. 177, which held, also without explanation, that the reimbursement of the interview-travel expenses of a prospective employee by a prospective employer is not includible in the gross income of the prospective employee.
34. The IRS did come close once. In 1978 IRS Commissioner Jerome Kurtz indicated that, if Congress did not soon provide a statutory solution to the problem of taxation of a miscellany of employee fringe benefits, he would direct his agency to begin to enforce the full scope of § 61. Taxing Perks-If Congress Won't, IRS' Kurtz Will, FORBES, July 24, 1978, at 20. The threat was never carried out, however. For developments in the taxation of fringe benefits following Kurtz's 1978 threat, see infra text accompanying notes 62-66.
35. Vesco v. Comm'r, 39 T.C.M. (CCH) 101 (1979).
36. Zager v. Comm'r, 72 T.C. 1009 (1979), aff'd sub nom. Martin v. Comm'r, 649 F.2d 1133 (5th Cir. 1981).
37. See Dean v. Comm'r, 35 T.C. 1083, 1090 (1961) ("We have heretofore given full force to interest-free loans for tax purposes, holding that they result in no interest deduction for the borrower, nor interest income to the lender. We think it to be equally true that an interest-free loan results in no taxable gain to the borrower. .. ." (citations omitted)).
38. I.R.S. Announcement 2002-18, 2002-10 I.R.B. 621.
39. This rule is, in part, a response to the difficulty or impossibility of administering a tax based on subjective values. See, e.g., Rooney v. Comm'r, 88 T.C. 523, 528 (1987) (taxing barter income at fair-market value rather than at the lower subjective value claimed by the taxpayer); Treas. Reg. § 1.61-21(b)(1) (1989) (requiring that taxable fringe benefits be included in gross income at their fair-market value).
40. See infra notes 70-82 and accompanying text
41. See RICHARD SCHMALBECK & LAWRENCE ZELENAK, FEDERAL INCOME TAXATION 78 (3d ed. 2011) (describing the difficulty of enforcement where information reporting is not required).
42. See, e.g., Lawrence A. Zelenak & Martin J. McMahon, Jr., Taxing Baseballs and Other Found Property, 84 TAX NOTES 1299, 1299-1300 (1999) (describing the strongly negative reaction of politicians-presumably inspired by their sense of public sentiment-to the possibility that a baseball fan would realize gross income from catching a valuable recordbreaking home-run baseball).
43. The history of the taxation of fringe benefits offered here is highly selective. More thorough accounts can be found in Wayne M. Gazur, Assessing Internal Revenue Code Section 132 After Twenty Years, 25 VA. TAX REV. 977, 980-95 (2006).
44. Susan R. Finneran, Fringe Benefits or "Condition of Employment": Uniformity, Certainty, and Compliance, 78 NW. U. L. REV. 198, 223-57 (1983).
45. See supra text accompanying note 14
46. O.D. 514, 2 C.B. 90 (1920). The ruling is unusual in its exclusion of cash; the employer's direction that the cash be spent on food puts the "supper money" at the borderline of cash and in-kind benefits.
47. O.D. 946, 4 C.B. 110 (1921).
48. See, e.g., O. 1014, 2 C.B. 88, 89-90 (1920) (holding that employer-provided group term life insurance was not included in the gross income of a covered employee); Rev. Rul. 59-58, 1959-1 C.B. 17, 18 (excluding from gross income the value of holiday hams and turkeys received by employees "[i]n view of the small amounts involved, and since it may reasonably be contended in many cases that such items constitute excludable gifts"; the latter explanation implied that in some cases the gift characterization would not be reasonable).
49. Brief for the United States at 39, Rudolph v. United States, 370 U.S. 269 (1962) (No. 396).
50. See Prop. Treas. Reg. § 1.61-16(a), 40 Fed. Reg. 41,118, 41,119 (Sept. 5, 1975) (listing benefits that are included in and excluded from gross income).
51. Fringe Benefits: Withdrawal of Discussion Draft, 41 Fed. Reg. 56,334, 56,334 (Dec. 28, 1976).
52. Act of Oct. 7, 1978, Pub. L. No. 95-427, § 1, 92 Stat. 996, 996.
53. Act of Dec. 29, 1979, Pub. L. No. 96-167, § 1, 93 Stat. 1275, 1275; Economic Recovery Tax Act of 1981, Pub. L. No. 97-34, tit. VIII, § 801, 95 Stat. 172, 349.
54. Rev. Proc. 84-14, 1984-1 C.B. 431.
55. Deficit Reduction Act of 1984, Pub. L. No. 98-369, div. A, tit. V, subtit. C, § 531(a), 98 Stat. 494, 877 (codified as amended at I.R.C. § 132 (2006 & Supp. IV 2011)).
56. The tax administration problems presented by frequent-flier miles have much in common with the problems presented by the miscellaneous fringe benefits addressed by § 132. Why, then, did Congress also not eliminate the frequent-flier customary exclusion in the 1984 legislation by providing a statutory basis for the exclusion? The answer seems to be that frequent-flier programs were too recent a phenomenon in 1984 for their customary exclusion to have become well established, and thus to have come to the attention of Congress.
57. See Paul Grimes, Practical Traveler: Coupons and Other Bonuses for the Airborne, N.Y. TIMES, Oct. 11, 1981, § 10, at 3 (describing "bonus incentive plans based on the number of trips you take or miles you fly" recently introduced by many airlines).
58. See Rev. Rul. 57-374, 1957-2 C.B. 69 (stating that when an individual refuses to accept an all-expense-paid vacation, the value of the trip is not included in gross income); see also, e.g., Rev. Rul. 81-209, 1981-2 C.B. 16, 17 (holding that a lawyer's client does not realize gross income when interest earned on the client's funds held in the lawyer's trust account is paid to a designated tax-exempt entity pursuant to a program established by the state supreme court); Rev. Rul. 63-177, 1963-1 C.B. 177, 178 (holding that a prospective employer's reimbursements to individuals for interview expenses are not includible in gross income). All three rulings are still in force.
59. Hernandez v. Comm'r, 490 U.S. 680 (1989).
60. Rev. Rul. 93-73, 1993-2 C.B. 75.
61. I.R.S. Notice 2008-83, 2008-2 C.B. 905.
62. For a review of some of the reactions to the notice, see Lawrence Zelenak, Can Obama's IRS Retroactively Revoke Massive Bank Giveaway?, 122 TAX NOTES 889, 889-93 (2009)
63. American Recovery and Reinvestment Act of 2009, Pub. L. No. 111-5, div. B, tit. I, subtit. C, pt. VII, § 1261(a)(2)-(3), 123 Stat. 115, 343.
64. I.R.S. Notice 2010-2, 2010-1 C.B. 251.
65. See, e.g., J. Mark Ramseyer & Eric B. Rasmusen, Can the Treasury Exempt Its Own Companies from Tax? The $45 Billion GM NOL Carryforward, 1 CATO PAPERS ON PUB. POL'Y 1, 5 (2011) (characterizing the ruling as an unauthorized gift from the Obama administration to the United Auto Workers).
66. See Gregg D. Polsky, Can Treasury Overrule the Supreme Court?, 84 B.U. L. REV. 185, 239-43 (2004) (hypothesizing a number of situations in which taxpayers might be motivated to challenge the validity of the so-called "check-the-box" regulations governing tax classification of entities as partnerships or corporations, despite the generally taxpayer-favorable character of the regulations).
67. See I.R.C. § 6501(a) (Supp. IV 2011) (providing for a three-year statute of limitations).
68. I.R.C. §§ 1311-1314 (2006).
69. Even if a taxpayer were to mount a successful challenge to a particular deviation, the litigation would likely have little or no effect on the application of the challenged deviation to other taxpayers. If the IRS prefers not to enforce the law on the books in a particular context, the mere existence of a judicial opinion (even if it is from the Supreme Court) does not compel the IRS to abandon its nonenforcement policy with respect to any taxpayer other than the taxpayer involved in the litigation. As always, the absence of third-party standing leaves the IRS free to pursue a policy of nonenforcement. And because the effect of the nonenforcement policy is overwhelmingly taxpayer favorable, other taxpayers will not be lining up to take advantage of the judicial precedent.
70. The enactment of § 132 followed six years after the threat. Deficit Reduction Act of 1984, Pub. L. No. 98-369, § 531(a), div. A, tit. V, subtit. C, 98 Stat. 494, 877 (codified as amended at I.R.C. § 132 (2006 & Supp. IV 2011)). But it is not clear that the threat caused the enactment.
71. See, e.g., DANIEL OKRENT, LAST CALL: THE RISE AND FALL OF PROHIBITION 316 (2010) (describing and quoting President Herbert Hoover's inaugural address, in which Hoover stated that underenforcement of Prohibition laws by state and local authorities was "destroy[ing] respect for all law").
72. See, e.g., Alberto R. Gonzales, "Anchor Babies" Aren't the Problem with Immigration, WASH. POST, Aug. 22, 2010, at B2 (claiming that the Obama administration had failed to enforce the immigration laws and that this failure "breeds. .. disrespect for the rule of law").