I have also supplemented my Laws of Tax Planning with Laws of Tax Practice to help other practitioners and I am now starting my Laws of Tax Policy to lay out principles I think should be used in making and enforcing the tax laws. That third group is the height of arrogance on my part, but it's my blog and I'll be grandiose if I want to.
The Prime Directive
If you don't have documentation, at least have a plausible story.
This is my restatement of the Cohan Rule. At Joseph B Cohan and associates, young staff accountants thought the rule was named for our eponymous founder, who still came into the office from time to time, or his son Herb who was our managing partner. Actually it is named for George M Cohan who appealed a Board of Tax Appeals decision to the Second Circuit. The 1930 decision the court noted
In the production of his plays Cohan was obliged to be free-handed in entertaining actors, employees, and, as he naively adds dramatic critics. He had also to travel much, at times with his attorney. These expenses amounted to substantial sums, but he kept no account and probably could not have done so. ......The reason this is the prime directive rather than one of the laws is that even though I use it as a kind of motto, it only occurred for me to include it here recently and it is too significant to be the seventeenth law.
Absolute certainty in such matters is usually impossible and is not necessary; the Board should make as close an approximation as it can, bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making. But to allow nothing at all appears to us inconsistent with saying that something was spent.
Legislation on various topics has eroded the Cohan rule (See the 16th law), but it still has life in it.
1. It is what it is. Deal with it.
This law originates with a response I used to have to less experienced staff and sometimes clients when one of them would say about a particular tax rule "That doesn't make sense". My response was "That's not a requirement".
I expanded the applicability of the law more broadly to accepting the way clients, staff, bosses etc are. It's not that people never change, but if you have observed them not change enough, you should just live with them being the way they are. An article I read once summed it up nicely when it said that accountants must learn to accept that most clients are crazy. The accountant shared an anecdote of a very successful client who kept a car and driver at the office at all times in case he needed to go somewhere, but rarely went anywhere. The same client would walk through the office searching for stray paper clips which he would return to their boxes.
Doug Spiker becomes the first outside contributor to this project with a restatement of the First Law.
I can tell you what. I can't tell you why!
He expanded on the thought writing me: After years of trying to answer my clients when reasonably asking "Why?", I finally gave up. I can't explain the logic of an illogical tax code. I can't explain the rationale of a Congress that has lost all reason.
2. Sometimes it's better to just pay the taxes.
If you are trying to maximize your life style or build wealth, looking at ways to save taxes is helpful. Mainly this law is derived from reading case law of bad schemes gone awry, but the application is broader.
An example of an application of this law is the rage by owners of real estate whose ship comes in who no longer want to own real estate to exchange into a Walgreens to avoid capital gains tax. Imagine someone has had their real estate ship come in and they have sold a property with negligible basis for $5,000,000. An alternative to having $4,000,000 in after tax dollars to do with as you please is to exchange into a Walgreens. Then you have a property with a long lease that yields a cap rate in the 5% vicinity. On a per square foot basis it is worth maybe $2,500,000. You need to ask yourself if what you had was $4,000,000, would you buy what is, in effect, a Walgreens bond with some downside protection. If not, it is better to pay the taxes.
3. Any clever idea that pops into your head probably has a corresponding rule that makes it not work.
Tax planning, particularly at the more ethereal level is something of an arms race between clever people coming up with cute ideas and legislators and regulators cleaning up behind them or sometimes anticipating their villainy. When something pops into your head, there is a good chance that yours is not the first head into which it has popped.
4. Execution isn't everything but it's a lot.
I derived this law mainly from reading cases, but also from some real life experience. One batch of cases where it shows up a lot is family limited partnerships. The ones that get blown up usually have people showing no respect for the entities that they established. A classic remark in one of the cases was by one of the partners saying "I just could not wrap my head around the fact that it was not my money". Accountants have a delusion that they can fix all the problems with journal entries. When it goes to court, journal entries mean nothing.
If a structure calls for different entities, they should all be actually formed and each should execute its own transactions.
5. A tax plan that ignores AMT or SALT is not much of a tax plan.
The alternative minimum tax although presented as a possible add on to the regular tax is actually an entire parallel system with generally fewer deductions and a lower rate. It is relevant not only because of the tax itself, but also because it can serve as a limit on tax credits.
SALT is state and local income tax. It is not unusual to have people who do planning based on federal tax principles get nasty state and local surprises. Talk to Robert Redford about his New York problems.
6. Don't do the math in your head.
This is something of a corollary of the fifth law, but it is more than AMT that makes it relevant. There are such a host of thresholds and phase-outs that really the only way to answer a question about the tax effect of a transaction is to run pro-forma returns.
This was my favorite review note. You could argue that it is more of a compliance thing, but planning and compliance must be integrated. It stands for Read The Instructions. The "F" has been silent since the Clarence Thomas hearings.
8. Both Before And After Thinking Outside The Box Take A Good Look Inside The Box
9. Tell The Preparer What The Plan Is
10. Once The Tax Is More Than You Can Pay It Might Not Matter How Much More
Determining the "correct tax" and determining how much of the "correct tax" you have to pay if you cannot pay all are two entirely distinct and separate fields of tax practice. If your tax is far and away above your reasonable collection potential, time and energy spent lowering the "correct tax" is time and energy wasted.
11. Pigs Get Fed - Hogs Get Slaughtered
The short version is "Don't be a chazzer".
12. Any New Business Concept Will Be Pitched As A Tax Dodge
13. When An Idea Makes You Think Of A Seinfeld Episode, It Is Not Going To End Well.
14. If something is a listed transaction, just don't do it.
15. If somebody calls you up to talk about your unpaid federal taxes, just hang up.
16. Being right without substantiation can be as bad as being wrong.
17. Don't be a "last minute Louie" make your deadline ten days early.
There are quite a few Tax Court petitions that get kicked out for being a day late or require complicated arguments about postmarks and the like. It is also possible to misunderstand what the precise deadline is. It also reflects pleasant memories of, after a long tax hard tax season, playing bridge and going drinking at 5:30 on April 15.
I was started to think that this list was getting to long. I mean Yahweh was content with Ten Commandments and Woodrow Wilson with Fourteen Points. Then I remembered the Ferengi Rules of Acquistion. There are 285 of those. I'll probably stop before I get there.
Laws Of Tax Practice
1. Bring Back A Check
This was Herb Cohan's instruction whenever someone was going out "into the field". A corollary of this enunciated by a consultant is that somebody who has not paid in you two years is not really a client. Bruce Carlin, God rest his soul, used to say that receivables do not improve with age.
2. When The Prospect Tells You His Last Two Accountants Were Assholes It Won't Be Long Before You Become The Next Asshole
The ideal prospect is one whose accountant died.
3. Any reasonably complex tax matter involving significant dollars, regardless of whatever else it might be, is a white collar jobs program.
Laws Of Tax Policy
1. Make tax policy the Switzerland of the culture war.
Having sensible tax laws is pretty challenging. Injecting issues from the culture wars particularly those concerning gender and sexual morality creates needless drama and complexity. Examples of this was the IRS postion on gender reassignment surgery being cosmetic and the Kansas law denying deductibility for abortions. The dispute about the contraception requirement in the Affordable Care Act is a particularly egregious example.
There are plenty of venues to argue about these issues without mucking up tax administration.
2. Anything worth giving a tax incentive for should be worth spending money on.