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OpEdNews Op Eds    H3'ed 3/20/09

The Serious Shortcomings Of The Guidance Issued On Tuesday By The IRS.

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            In addition to the safe harbor provisions requiring you to give up your claim for refunds if you want to avoid the horrible hassle of a potential IRS challenge and rejection, the provisions also have another requirement that is, to put it mildly, very onerous.  You must deduct from your theft loss any potential SIPC recovery (which will of course increase the amount of ill gotten tax money the IRS will be able to keep). Well, right now many Madoff investors, maybe even most of them, cannot know whether they will get a SIPC recovery nor how much it would be.  The position now occupied by so many Madoff investors is that they will get a greatly diminished or no SIPC recovery if the SIPC Trustee continues to follow his (illegal, I think) cash in/cash out basis of determining net equity, but will get a full SIPC recovery if the Trustee is ultimately required by litigation or legislation to follow the governing legal principle of “legitimate expectations,” under which investors’ net equity is calculated on the basis of the amounts shown on their November 30th statements.  (This is discussed in a prior blog.)

 

            And then there is this to cap off the onerous aspects of the IRS’ guidance - -  guidance which provides the typical MadoffSurvivors investor with recovery of a relatively small percent of his losses, allows the IRS to keep some of its ill-gotten tax gains that were an interest free loan and are often attributable to the SEC’s complicity, and that imposes adverse requirements on the investor if he wishes to use the safe harbor provisions to avoid possible hassling and rejection by the IRS:  Tax day is less than a month away.  The investor therefore has less than a month to decide what to do -- to decide whether to use the onerous guidance -- unless he gets an extension for filing.  Why do I think there could well be a lot of requests for extensions? -- at least there could be a lot of requests for extensions unless, as one tax expert has warned me, such a request will cut off one year of your carryback.

 

            As said, I dearly hope to be wrong about lots or all of what has been written here.  And what the hey, I read the materials closely, and wrote this, between two and six in the morning, thereby dramatically increasing the possibility of being mistaken.  But my fear is that I’m not factually mistaken, especially since five tax experts were asked to tell me if they found errors, and I equally fear that the IRS’ guidance is really a sort of wolf in sheep’s clothing for the small man.  And unless I am really, really wrong about some of what has been written here, the need for enactment of a bill like Congressman Ackerman’s, a bill allowing refunds of taxes paid on phantom income going back many years, preferably at least back to 1992 when the SEC became an aider and abettor of Madoff’s Ponzi scheme, is now more essential than ever, since the small man obtains only modest help, and suffers extensive adverse consequences, from the IRS’ supposedly helpful “guidance.”

 

            Before I end this posting, let me make one additional comment, with regard to whether one should be allowed to recover income tax paid on phantom income.  The comment is based on a thought which occurred to me at 1:30 a.m. on the night after I wrote everything preceding this.

 

            When I was in my second year of law school in Ann Arbor in 1961-62, we had an unforgettable tax professor named L. Hart Wright (the father of the famous journalist Robin Wright.)  Elhart (which is what the students called him among themselves then and now, 47 years later) had a remarkable teaching style.  So I can still hear him, in response to students’ inadequate answers to some hypotheticals, boomingly quoting the 16th  Amendment, which allows Congress to levy an income tax.  An income tax, he would plangently say, can be levied on “all ‘incomes, from whatever source derived.’”

 

            Think about that for a moment.  The 16th Amendment to the Constitution gives Congress power to levy an income tax on all “incomes, from whatever source derived.”  (Emphasis added.)  It turns out that, to the extent that people did not physically withdraw appreciation in their accounts from Madoff, they never had any income from him.  That is why the appreciation in one’s account is called phantom income. By not honoring claims for refunds of taxes paid on phantom income that turns out to never have existed, the government is continuing to levy a tax on non income rather than on income.  The 16th Amendment does not allow this; it allows only a tax on income, not a tax on non income. To disallow refunds of taxes paid on non income is to violate the Constitution.  (Thus, at least back in the day when I was teaching and was expert in constitutional law, in the 1960s and 1970s, the IRS’ demand that one give up the right to seek refunds of taxes paid on such non income as the price of using its safe harbor provisions would have been called an “unconstitutional condition.”)

 

Yes, there is a constitutional argument here, and I, at least, think it correct.  So, nearly forty-eight years later I offer a belated thanks to Elhart -- who, ironically, did a lot of work for the IRS -- for plangently and therefore indelibly impressing on our feeble minds that an income tax lies only on “all ‘incomes, from whatever source derived.’”  (Emphasis added.)*

  

* This posting represents the personal views of Lawrence R. Velvel.  If you wish to comment on the post, on the general topic of the post, or on the comments of others, you can, if you wish, post your comment on my website, VelvelOnNationalAffairs.com.  All comments, of course, represent the views of their writers, not the views of Lawrence R. Velvel or of the Massachusetts School of Law.  If you wish your comment to remain private, you can email me at Velvel@VelvelOnNationalAffairs.com.   

VelvelOnNationalAffairs is now available as a podcast.  To subscribe please visit VelvelOnNationalAffairs.com, and click on the link on the top left corner of the page.   The podcasts can also be found on iTunes or at www.lrvelvel.libsyn.com 

 

In addition, one hour long television book shows, shown on Comcast, on which Dean Velvel, interviews an author, one hour long television panel shows, also shown on Comcast, on which other MSL personnel interview experts about important subjects, conferences on historical and other important subjects held at MSL, and an MSL journal of important issues called The Long Term View, can all be accessed on the internet, including by video and audio.  For TV shows go to: www.mslaw.edu/about_tv.htm; for conferences go to:  www.mslawevents.com; for The Long Term View go to: www.mslaw.edu/about­_LTV.htm.

 

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Lawrence R. Velvel is a cofounder and the Dean of the Massachusetts School of Law, and is the founder of the American College of History and Legal Studies.
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