How to use this Page

Imagine you’ve been on an out-of-town business trip. Your employer paid for your airfare, but allowed you to keep the frequent flyer points generated by the trip. Some time later, you redeem the points (perhaps along with additional points generated by other business trips) for a free flight to a vacation destination. You might wonder, “Do I have taxable income, either when the points are credited to my account or when I redeem the points for personal travel?”

Under the US federal income tax, it is reasonably clear that there is taxable income in this story, although there is plenty of room to argue about the timing of the taxable event, or that the fair market value (of either the points or the later reward) should be included in income.

Despite the technical “taxability” of employees who benefit from frequent flyer programs, the Internal Revenue Service (IRS) announced a “don’t-ask-don’t-tell policy” in 2002, which stated that “the IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent flyer miles … attributable to the taxpayer’s business travel.”

Seemingly faced with problems of valuation, enforcement, and taxpayer understanding, the IRS simply declared that it had no intention of enforcing the law, rather than dealing with the issues that would have been created by a serious attempt to administer the taxation of frequent flyer benefits.

Twelve years later, the 2002 announcement still accurately reflects the supine position of the IRS. Regardless of one’s views on the merits of either taxing or not taxing employee-retained frequent flyer benefits, from a rule-of-law perspective, it is troubling that this question has been resolved by a statutorily unauthorized de facto administrative exemption, rather than by a legislative enactment.

The IRS is far from alone among tax administrators in having performed poorly with respect to frequent flyer benefits, despite having had more than three decades to grapple with the problem since frequent-flyer schemes were introduced in the 1980s. The efforts of the Canada Revenue Agency and of the Australian Taxation Office have differed from those of the IRS, but today, all three countries retain the same bottom line: virtually no tax on frequent flyer benefits is collected anywhere, and respect for the rule-of-law (on the part of both taxpayers and the tax agencies themselves) has been eroded.

So what ought to be done? A tax policy purist would suggest that either the tax administrator or the legislature should develop workable rules for valuation, and for third-party information reporting of that value (by either employers or airlines). The development of workable rules would not be easy, but it could be done. If such rules were adopted, the tax administrator could and should enforce the taxation of frequent flyer benefits. It is unlikely, however, that either an agency or a legislature would take on the difficult and thankless task of developing and adopting the necessary rules. If neither the tax agency nor the legislature is willing to get serious about the taxation of frequent flyer benefits, the second-best approach would be for the legislature to solve the agency-as-scofflaw problem by turning the IRS’ de facto administrative exclusion into an explicit statutory exclusion.

Featured image credit: Airplane flight. Photo by Robert S. Donovan. CC BY-NC 2.0 via booleansplit Flickr.

The post Up in the air over taxing frequent flyer benefits appeared first on OUPblog.

        

Related Stories

• One second in the life of an artist
• World AIDS Day reading list
• Shakespeare folio number 233

 

Maryland State Comptroller of the Treasury v. Brian Wynne requires the US Supreme Court to decide whether the US Constitution compels a state to grant an income tax credit to its residents for the out-of-state income taxes such residents pay on out-of-state income.

Brian and Karen Wynne live in Howard County, Maryland. As Maryland residents, the Wynnes pay state and county income taxes on their worldwide income. The Maryland income tax statute provides that Maryland residents who pay income taxes to states in which they do not live may credit against their Maryland state income tax liability the taxes paid to those states of nonresidence. However, the Maryland tax law grants no equivalent credit under the county income tax for out-of-state taxes owed by Maryland residents on income earned outside of Maryland.

When the Wynnes complained about the absence of a credit against their Howard County income tax for the out-of-state income taxes the Wynnes paid, Maryland’s Court of Appeals agreed. Maryland’s highest court held that such credits are required by the nondiscrimination principle of the US Constitution’s dormant Commerce Clause. The absence of a credit against the county income tax induces Maryland residents like the Wynnes to invest and work in-state rather than out-of-state. This incentive, the Maryland court held, may impermissibly “affect the interstate market for capital and business investment.”

For two reasons, the US Supreme Court should reverse. First, Wynne highlights the fundamental incoherence of the dormant Commerce Clause test of tax nondiscrimination: any tax provision can be transformed into an economically equivalent direct expenditure. No principled line can be drawn between those tax provisions which are deemed to discriminate against interstate commerce and those which do not. All taxes and government programs can incent residents to invest at home rather than invest out-of-state. It is arbitrary to label only some taxes and public programs as discriminating against interstate commerce.

Suppose, for example, that Howard County seeks to improve its public schools, its police services or its roads. No court or commentator suggests that this kind of routine public improvement violates the dormant Commerce Clause principle of nondiscrimination. However, such direct public expenditures, if successful, have precisely the effect on residents and interstate commerce for which the Court of Appeals condemned the Maryland county income tax as discriminating against interstate commerce: Better public services also “may affect the interstate market for capital and business investment” by encouraging current residents and businesses to stay and by attracting new residents and businesses to come.

There is no principled basis for labeling as discriminatory under the dormant Commerce Clause equivalent tax policies because they affect “the interstate market” of households and businesses. Direct government outlays have the same effects as do taxes on the choice between in-state and out-of-state activity. If taxes discriminate against interstate commerce because they encourage in-state enterprise, so do direct government expenditures which make the state more attractive and thereby stimulate in-state activity.

Second, the political process concerns advanced both by the Wynne dissenters in Maryland’s Court of Appeals and by the US Solicitor General are persuasive. Mr. and Mrs. Wynne are Maryland residents who, as voters, have a voice in Maryland’s political process. This contrasts with nonresidents and so-called “statutory residents,” individuals who are deemed for state income tax purposes to be residents of a second state in which they do not vote. As nonvoters, nonresidents and statutory residents lack political voice when they are taxed by states in which they do not vote.

Nonresidents and statutory residents require protection under the dormant Commerce Clause since politicians find it irresistible to export tax obligations onto nonvoters. The Wynnes, on the other hand, are residents of a single state and vote for those who impose Maryland’s state and local taxes on them.

In reversing Wynne, the Supreme Court should decide narrowly. The Wynnes, as residents of a single state, should not receive constitutional protection for their claim to a county income tax credit for the out-of-state taxes the Wynnes pay. However, the Court’s decision should not foreclose the Court from ruling, down the road, that credits are required to prevent the double income taxation of individuals who, for income tax purposes, are residents of two or more states. Such dual residents lack the vote in one of the states taxing them and thus require constitutional succor which the Wynnes do not.

Dissenting in Cory v. White, Justice Powell (joined by Justices Marshall and Stevens) argued “that multiple taxation on the basis of domicile” is unconstitutional. Since the Wynnes are taxed by only one state, the Supreme Court need not now confront this issue again. However, the Court should decide Wynne in a fashion which allows the Court to revisit this question in the future by holding that credits are constitutionally required to prevent the double taxation of dual residents.

The post The US Supreme Court should reverse Wynne – narrowly appeared first on OUPblog.

        

Related Stories

• Stop and search, and the UK police
• Time to see the end
• Casey Kasem and end-of-life planning

 

Tweet

By Edward Zelinsky

As they scramble for tax revenue in a challenging environment, the states increasingly turn to so-called “Amazon” laws to force out-of-state internet and mail order retailers to collect tax on their sales. The Illinois General Assembly is the most recent state legislature to pass an Amazon statute. New York, Colorado, Rhode Island, North Carolina and Oklahoma have already enacted such laws while Amazon acts are pending in other state legislatures.

While they differ in important respects, all of these proposed and enacted laws share the premise that goods which are taxed when purchased in a conventional, bricks-and-mortar store should also be taxed when bought from an online or mail order retailer. This premise is compelling.

It is neither fair nor efficient for a sales tax to discriminate between close economic substitutes, taxing one but not the other. A sales tax should not tax green apples while exempting red apples. Such discrimination is inequitable to growers of green apples and distorts consumer choice by artificially increasing the after-tax price of green apples relative to the competing (and tax-free) product, i.e., red apples.

This is in essence the sales tax status quo under the U.S. Supreme Court’s decision in Quill Corp. v. North Dakota. Quill held that, under the U.S. Constitution’s dormant Commerce Clause, a state can require a retailer to collect and remit tax on its sales only if the retailer is physically present in the taxing state. Under this rule, firms like Amazon, Overstock.com and similar mail order firms need not collect tax on their sales since they lack physical presence in most states.

As a matter of law, when an electronic or mail order retailer does not withhold tax, the buyer of online or mail order merchandise is required to self-assess and pay the tax to his home state. In practice, it is virtually impossible for the states to enforce this obligation. Goods ordered over the internet or by mail order are thus effectively tax-free while the same goods are subject to sales tax when purchased in a conventional store physically present in the taxing state.

This de facto tax discrimination between conventional and electronic sales is no more fair or efficient than a sales tax which taxes green apples but not red apples.

The states (supported by bricks-and-mortar retailers) have asked Congress for federal legislation permitting the states to require out-of-state retailers to collect taxes on their electronic and mail order sales, even if such retailers lack in-state physical presence. So far, Amazon and its allies have successfully lobbied Congress to resist the states’ pleas.

Frustrated by Congress’ inaction, state Amazon laws are a form of self-help, designed to require out-of-state retailers to collect state taxes on their sales despite Quill. The Amazon laws of New York, North Carolina and Rhode Island create statutory presumptions that in-state affiliates create sales tax jurisdiction over the out-of-state internet firms with which such affiliates are associated. Taking a different approach, Colorado’s Amazon law requires internet retailers to report their Colorado sales both to the Colorado purchasers and to the Colorado Department of Revenue.

For two reasons, these state Amazon laws are neither a practical nor a legal solution to the problem of untaxed internet and mail order sales. Laws like Colorado’s, which require reporting by out-of-state firms, are unconstitutional under Quill, as the U.S. District Court for the District of Colorado recently held. Laws like those of New York, Rhode Island and North Caroli