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Student Blog: Protecting the Wealth Tax’s Achilles Heel: Incentivizing Fair Taxpayer Asset Valuation

by Kevin Brown, RBFL Student Editor

The desirability and practicality of taxing net wealth has become a hot topic in the United States over the past few months due to support for such a tax by democratic presidential candidates such as Elizabeth Warren.[1]That being so, several European countries have already implemented (and some have subsequently repealed) a wealth tax in the past few decades. In almost all of those cases, administrative issues related to asset valuation resulted in governments narrowing the scope of the wealth tax or else unsustainable noncompliance on the part of taxpayers.[2]

How can European experiences with taxing net wealth inform the implementation of an efficient and effective wealth tax in the United States? What issues unique to the United States arise related to implementing a wealth tax? If it is possible to survive constitutional challenges to such a law, would a wealth tax be administratively feasible?[3]Are there ways to use the existing regimes of taxing estates, gifts, and income to solve the valuation-related problems[4]posed by the wealth tax?

My research seeks to collect and survey current scholarship in an effort to answer these questions.

Further, my article will address methods of incentivizing taxpayers to appropriately value their assets, especially ones that are typically difficult to value[5](think: IP, goodwill, art, partnership rights, &c). Despite the buzz about taxing wealth, many discussions stop short of actively addressing how to face the valuation problem.

As a coda to my research, my article will propose one possible method of incentivizing taxpayers to realistically value their assets.[6]If that sounds ambitious, I will at the very least suggest a framework wherein taxpayers who dramatically undervalue their assets under the wealth tax face penalties within the income tax upon a realization event.

It may be helpful for some readers if I provide a brief distinction between income and wealth. Definitions abound, but, in a broad sense, income is the increase in wealth that comes within an individual’s control. Wealth, alternatively, is just the aggregate value of everything an individual owns at a given time.

As an example, imagine Abe and Beth. Abe is paid $100,000 each year for his work as a stunt man and has no other assets. Beth has $1,000,000 in an investment that pays her a 10% yearly return of $100,000. Abe and Beth earn the same amount taxable income (the $100,000 that comes under their control every year), but Beth clearly has more wealth. Beth’s $1,000,000 is safe from the income tax, however, because Beth simply lets it sit and grow.

Taxing wealth would allow the Treasury to tax each year a portion, say 2% (i.e. $20,000), of the $1,000,000 Beth owns. Such a tax is controversial, not only because it has never been implemented in the United States before, but also because it poses practical and theoretical difficulties. Namely, it motivates Beth or hide or misrepresent her wealth and imposes a tax on an individual’s assets without a traditional realization event (like a sale, exchange, gift event, or inheritance). Under a wealth tax, the investment would be taxed just for sitting there and growing.

 Thus, imposing a wealth tax would change both the behavior of the tax base and would send ripples through settled areas of the law of taxation. My research does not seek to find affirmative answers to all the issues raised, but it does seek to collect and analyze current scholarship on the topic and to propose an original method of better incentivizing a taxpayer subject to a wealth tax to properly value her assets.

[1]Ultra-Millionaire Tax, Warren for President(Jan. 24, 2019), https://elizabethwarren.com/plans/ultra-millionaire-tax.

[2]Alexander Krenek & Margit Schratzenstaller, A European Net Wealth Tax, Austrian Institute of Economic Research4 (2018) (“Evaluation difficulties are one of the most common arguments against a recurrent net wealth tax.”).

[3]Letter from Bruce Ackerman, Sterling Professor of Law and Political Science, Yale U., et al, to Senator Elizabeth Warren (Jan. 24, 2019) (addressing constitutionality of Senator Warren’s proposed wealth tax).

[4]See Anthony J. Casey & Julia Simon-Kerr, A Simple Theory of Complex Valuation, 113 Mich. L. Rev. 1175, 1188 (2015) (surveying methods courts employ to address valuation problems); Nathan Matthews, The Valuation of Property in the Early Common Law, 35 Harv. L. Rev. 15, 29 (1921) (“[T]here is hardly any branch of law which is not concerned more or less with property values.”).

[5]SeeMarsack's Estate v. Comm'r, 288 F.2d 533, 535 (7th Cir. 1961) (asserting that under the IRC “[a]scertainment of the fair market value of property may, at times, be difficult, but except in rare cases, it is not an impossible task”).

[6]It is worth noting that 18 “ultra-millionaires” signed a June 24, 2019 letter supporting a tax on the net wealth of ultra-wealthy individuals, suggesting that at a class of highly net worth individuals willing to pay a wealth tax does exist. SeeJonathan Curry, Ultra-Wealthy Call for Warren-esque Wealth Tax, Tax Notes Federal(Jun. 25, 2019).

Student Blog: Extra Requirements for Tax Exempt Status of Educational Organizations?

by Ainsley Tucker, RBFL Student Editor

Tax law often requires interpreting words that seem clear until the right controversy comes along—and interpretation can be costly. When tax law and administrative law collide, agency deference adds yet another layer to the puzzle. The District Court for the District of Minnesota recently heard a case examining the interplay between the U.S. Tax Code and the Treasury Department’s interpretive regulations in assessing tax liability for sophisticated tax-exempt organizations.  

At stake in Mayo Clinic v. United States (2019): an $11.5 million tax refund. At issue: the meaning of “educational organization” under U.S. tax law. The controversy over interpretation arose because both the Internal Revenue Code (“the Code”) and the Treasury Department present tests for defining “education organization”—and the Treasury Department’s interpretive regulation (“the Regulation”) requires additional factors. Treasury regulations establish proper statutory interpretation of the Code.[1]Tax-exempt organizations rely on both the Code itself and the clarifying regulations in determining tax liability. Thus, the question before the Court: which definition controls?

Mayo Clinic needs to worry about paying taxes, despite being “tax-exempt,” because tax-exempt organizations generally owe federal taxes for income substantially unrelated to their charitable missions (“UBIT”) unless they are “qualified organizations.” Qualified organizations, which include “educational organizations,” are exempt from certain forms of UBIT. Mayo Clinic contends it is an education organization because it operates numerous teaching hospitals, grants medical degrees, and its official charitable mission is to “provide the best care to every patient through integrated clinical practice, research, and education.”[2]

The Code presents a four-part test for defining education organizations, the “faculty-curriculum-student-place” test.[3]The Regulation adds two mandatory requirements to the Code’s definition: 1) education is the organization’s primary function, and 2) any non-educational activities are merely incidentalto the educational activities.[4]Employing a Chevron analysis, the Court concluded that the Regulation overstepped its agency authority by including the two additional factors.[5]As a matter of statutory construction, Congress had “spoken clearly” by omitting the Regulation’s two additional factors from the Statute but including them in subsequent sections.[6]Therefore, the District Court invalidated the Regulation and held that Mayo Clinic was an “educational organization” entitled to its tax refund.  

The United States has appealed the decision to the Eighth Circuit, where the case will continue to raise questions of the relative ease with which tax-exempt organizations, particularly academic medical centers like Mayo Clinic, may be able to call themselves “educational organizations” in the future, how much deference courts may give to U.S. Treasury Department regulations, and the importance of a tax-exempt organizations’ self-identification for tax purposes. At stake: millions of tax dollars. Stay tuned.

Sources:

[1]IRM 32.1.1.2 (Aug. 2, 2018) (from Part 32: Published Guidance and other Guidance to Taxpayers, Ch. 1 § 1), at https://www.irs.gov/irm/part32/irm_32-001-001.

[2]Mayo Clinic, Form-990 (2008)

[3]26 U.S.C. §170(b)(1)(A)(ii)

[4]Treas. Reg. § 1.70A-9(c)(1) (1973) (26 C.F.R. § 1.170A-9(c)(1))

[5]Mayo Clinic v. United States, No. 16-cv-03113, slip op. at 6-7 (D. Minn Aug. 8, 2019).

[6]Id.