| ||The Role of Prescription in the Interpretive Problem of Basis Determination |
Anthony P. Polito*
* Visiting Professor of Law, Boston College Law School (1999-2000); Associate Professor of Law, Suffolk University Law School; Massachusetts Institute of Technology, S.B., 1986; Harvard University, J.D., 1989; New York University, LL.M., 1995. The author thanks James Repetti for valuable comments on an earlier draft.
[Editors’ Note. Every so often an apparently pedestrian tax case captures the hearts and minds of literate tax advance-sheet readers, some of whom enshrine it in tax journals like The Tax Lawyer, and perhaps later in treatises and case books. Owen v. United States, 34 F. Supp.2d 1071 (W.D. Tenn. 1999), is one of those cases. ** In the last issue, we published Alvin D. Lurie’s use of Owen as a vehicle for reflection on what the Supreme Court really decided when it dealt with Buehla Crane and her inherited apartment building. See Alvin D. Lurie, Crane’s Ghost Still Spooks Tax Law: cf. Owen, 53 Tax Law. 363 (2000). Below, Anthony P. Polito utilizes Owen as a window through which to examine interpretive problems in the context of tax law materials.]
The Millennium has arrived for calendar makers, but not for the income tax law. The much ballyhooed arrival of Y2K has not alleviated the problems that perennially plague the tax law. Return of capital issues, especially when viewed as interpretive problems, pose a particularly intractable set of difficulties in line-drawing. One problem in particular that illustrates the issue is the treatment of the taxpayer’s own promissory note in determining nontaxable return of capital. Return of capital issues most commonly appear by the name of basis issues, as in Owen v. United States, 1 a recent case that is emblematic of the return-of-basis conundrum. This Article uses an extended discussion of the interpretive problem presented by that case to explore the line-drawing problem presented by return of capital issues.
John Owen and Glenda McCormick, who used the cash method of accounting, asserted that they owned some office condominiums to which they had made substantial improvements. 2 The asserted cost of the improvements was approximately $225,000, but they did not pay in cash. They issued promissory notes to the company doing the construction. 3 In 1987, before they had made any payments on the notes, they sold the condominiums. How should the notes figure into computing basis for determining gain or loss?
Return of capital is a line-drawing problem that arises because of the inherent limitations of transactionalism. The transactionalist tax system, which has resigned itself to its inability to conform to either idealized accretionism or idealized consumption taxation, must attempt to separate the value a taxpayer receives in a transaction into two distinct streams: the non-taxable return of the taxpayer’s capital on the one hand, and taxable gain (or the possibly-deductible loss) on the other hand. Because streams of value are not uniquely so divisible, return of capital issues pose a class of line-drawing problems for which it is difficult to find a principled solution. Basis is a concept notably lacking in normative content.
The intractability of this problem is particularly acute when the issue is posed as an interpretive problem. Given the mass of material that constitutes the federal income tax law, how should a judge or other interpreter decide the correct answer to the basis question? It is a question that cannot be escaped. An answer must be found if the tax law is to be applied, and the tax collected. That was the position in which Judge Turner found himself in Owen. He resolved that problem by concluding that the taxpayers could not increase the basis in their office condominiums by the amount of their as-yet-unpaid promissory notes. Commentators have not been shy to pronounce that his decision was wrong, 4 implying that as an interpretive problem there is a correct resolution to the basis question.
Basis controls the timing of accounting for income, but it lacks a principle that determines that timing. Basis, therefore, is a concept notably lacking in normative content. How does one determine the correct answer to the interpretive question posed to Judge Turner in Owen? This Article attempts to resolve that interpretive question using the various tools available to a judge. In the end, it identifies many tools that can rationalize a resolution of the interpretive problem ex post but that will not determine its result ex ante.
In the absence of clear direction from Congress, the best answer is resolved by prescription. Because basis lacks normative content, resolving basis as an interpretive problem must look to the shared understanding of the pertinent interpretive community. Not all arguments that can be rationally constructed are equally valid within such an interpretive community. Judge Turner’s decision in Owen is incorrect in the fairly modest sense that it conflicts with the received understanding of the interpretive community.
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**, Owen has been dissected in Alvin D. Lurie, Crane’s Ghost Still Spooks Tax Law: cf. Owen, 53 Tax Law. 363 (2000); Susan Kalinka, In Defense of Owen and the Supporting Cast, 84 Tax Notes (TA) 166 (July 5, 1999); Deborah A. Geier, And the 1999 Award for the Worst Opinion in a Tax Case Goes to…, 83 Tax Notes (TA) 1642 (June 14, 1999); Susan Kalinka, Owen v. United States: Crane v. Cash Method of Accounting, 83 Tax Notes (TA) 1231 (May 24, 1999); Burgess J.W. Raby & William L. Raby, ‘Paid’ and the Cash-Basis Taxpayer, 83 Tax Notes 875 (May 10, 1999). [Back to text.]
1 34 F. Supp.2d 1071, 1079 (W.D. Tenn. 1999). [Back to text.]
2 See id. at 1077-78. [Back to text.]
3 For purposes of analytical simplicity, the promissory notes issued by Owen and McCormick—as well as all other promissory notes discussed—are assumed to be bona fide debt instruments. This assumption is relaxed in Part VI. [Back to text.]
4 See, e.g., Deborah A. Geier, And the 1999 Award for the Worst Opinion in a Tax Case Goes To…, 83 Tax Notes (TA) 1642 (June 14, 1999); Susan Kalinka, Owen v. United States: Crane v. Cash Method of Accounting, 83 Tax Notes (TA) 1231, 1232-34 (May 24, 1999). [Back to text.]