It was Benjamin Franklin who once said, “In this world nothing can be considered certain except death and taxes.” As one of this nation’s founders and an architect of our Constitution, such insight is impressive, and to this day, those words are still relevant.
The recent debate over the debt ceiling brought the issue of taxes and spending back into the spotlight. During the heated process, I wondered what Ben Franklin would have thought if he had heard what transpired in Washington in recent weeks. Perhaps, he would have suggested they all go fly a kite.
Some of the discussion included whether we need to revisit revenues and whether the tax code needs an overhaul due to its complexity, which is burdensome to many taxpayers and has led to some distorted results.
We all appreciate the fact that the current tax law is complex. We can reminisce about the past when a tax return could be prepared with a pencil and a calculator with no need to rely on software or a tax preparation service. And then we advanced to simplification. It was 25 years ago when President Reagan signed the Tax Reform Act of 1986 and heralded tax reform and simplification. This legislation instituted two tax rates for individuals: 15 and 28 percent.
The past 25 years have provided a continuing trend of adding more complexity through additional tax rates, deductions, limitations on deductions, and an avalanche of credits targeted at various items of social policy. The result is that many taxpayers and advisers cannot make heads or tails out of much of the rules and regulations.
It was in the early years of my career when the tax simplification came into effect. I recall my colleagues and myself wondering that if that trend continued to broaden the tax base and lower tax rates, whether it would result in putting tax professionals out of a job. The thinking was that the simplification process would be an ongoing positive trend, and the resulting simplification would render certain jobs obsolete.
In a period of just a few years, many changes occurred, including the addition of a new tax rate (31 percent) by President George H.W. Bush after his “no new taxes” pledge, and by President Clinton (36 and 39.6 percent rates) during his first year in office. Subsequent years saw additional limitations on deductions and the addition of new tax credit program, all of which had a significant impact on the tax code in its size, complexity and application.
Whether as a result of complexity or for other reasons, taxpayers often end up offside. We see headlines with celebrities and others with respect to tax issues and liabilities for taxes owed. In the past month or so, because of ongoing major golf tournaments, there was reporting of the tax issues affecting some of the golf professionals. In June, the U.S. Tax Court issued its decision in a tax case with a well-known golf professional and upheld the IRS assessment of additional tax, interest and penalties. It also was reported earlier this year that another golf professional has a case in process regarding his U.S. tax liability.
I won’t get into whether the players or the IRS had a bogey or a hole-in-one or whether a mulligan should be allowed. The specific details of the cases get into the issues of how to apply the tax code to endorsement income that is earned from sponsoring companies for activities that occur both in the United States and throughout the rest of the world. It is an example that the tax code can, at times, be difficult to apply.
In the recent cases mentioned, the issues come down to a technical interpretation of rules related to how to characterize income — in a nutshell, what income relates to services and what is considered a royalty for use of the individual’s name and likeness. Both the IRS and the taxpayer agree it is all income. However, there is a difference in the U.S. treatment and taxation of services income and the treatment and taxation of royalty income in an international tax context. In addition, the issue of how the income is allocated or apportioned across activities that occur in the U.S. and activities outside the U.S. can be difficult. Even when these questions are answered, there is the issue of how and when a tax treaty is applied to determine which country has taxing rights to portions of the income.
All of these issues come into play in the cases of athletes and entertainers that play and perform in many countries and earn a myriad of different types of income for performing, endorsements and other activities. The IRS attempted to provide some guidance in a 17-page legal technical memorandum released in June 2009 (Generic Legal Advice Memorandum 2009-005).
The difficulty in many of these tax situations is that agreements that may cover activities that occur in many countries do not always specify the amount earned in a particular jurisdiction and how that income is characterized. In such situations, it is a best practice that the contract should specify what portion of fees or compensation is for activities in a particular jurisdiction. This impacts not only the recipient’s taxation of income in a jurisdiction, but also may impact the deductibility of the payments as well as what, if any, withholding tax is to be made by the payer. This advance planning may allow a taxpayer to avoid the rough or landing in a bunker.
The changing tax code becomes a challenge to taxpayers and tax professionals. The changes are sometimes more than just changing the pin placement on a green. They are more akin to whether one tees off from the whites, blues or blacks in the tee box. Each one adds on more complexity to one’s tee shot and can increase the risk that an errant shot may be made.
The complexity of the tax code often can lead to shooting over par even when it was not the intent at the start. The recent cases involving professional athletes indicate that individuals and their advisers may not always get it right from the IRS’ standpoint. Granted, many taxpayers may take certain positions where there is an element of fog limiting the visibility on the playing surface. Simplification of the tax code may allow for the opportunity for more clarity and to allow for an even par round.
Our system is still based on self-assessment and compliance. Just like golf, the U.S. tax system is based on the individual taxpayer applying the rules to his or her situation. The integrity of the system is based on clear rules and a high level of compliance and self-assessment. This way everyone shoots a good round. Let’s hope this is kept in mind by the leaders in Washington when tax reform discussions occur as part of the bigger debt/deficit crisis solution.
Bill Roth is a tax partner with the local office of international accounting firm BDO USA LLP. The views expressed are those of the author and not necessarily those of BDO. The comments are general in nature and not to be considered as specific tax or accounting advice and cannot be relied upon for the purpose of avoiding penalties.