Custom and the Rule of Law in the Administration of the Income Tax
Zelenak, Lawrence, Duke Law Journal
From the early years of the federal income tax to the present, the Internal Revenue Service (IRS) has engaged in what might be termed "customary deviations" from the dictates of the Internal Revenue Code, always in a taxpayer-favorable direction. A prominent current example is the IRS's "don't ask, don't tell" policy with respect to employee-retained frequent flier miles; in a 2002 announcement (which, as of 2012, is still in force), the IRS indicated that such miles were technically within the scope of the statutory definition of gross income, but that the IRS had no intention of enforcing the law. This Essay describes and evaluates the phenomenon of administratively-created customary deviations from the Code. After defining the concept of customary deviations and explaining why such deviations are sometimes attractive to tax administrators, the Essay offers a brief historical survey of customary deviations, paying particular attention to the pre-1984 treatment of a miscellany of fringe benefits of employment, and to a spate of recent announcements that the IRS would not enforce the Code's anti-loss-trafficking rules in certain contexts. The Essay also explains how the development of customary deviations has depended on the absence of third-party standing in tax litigation, and how the lack of any judicial check on unauthorized giveaways by tax administrators threatens rule-of-law values. It concludes with a proposal for legislation aimed at retaining the practical advantages of customary deviations while assuaging rule-of-law concerns.
TABLE OF CONTENTS Introduction I. The What and Why of Customary Deviations II. A Highly Selective Historical Survey of Customary Deviations III. The Absence of Third-Party Standing, the Survival of Customary Deviations, the Rule of Law, and a Different Approach Conclusion
A recurring theme in discussions of the relationship between custom and the law is the tension between the practical advantages of custom and the threat custom may pose to rule-of-law values. (1) This Essay considers how that tension has played out over almost a century of administration of the federal income tax. It begins with a prominent example of the conflict between tax law and custom.
The attorneys in the Chief Counsel's Office of the Internal Revenue Service's (IRS) who are charged with writing private letter rulings and other forms of unpublished guidance usually labor in obscurity--but not when the taxation of frequent-flier miles is at issue. A story published in the Wall Street Journal on November 28, 1995, explained that an IRS technical advice memorandum (TAM) (2)--which had been issued months earlier without attracting any interest from the media--implied that business travelers had taxable income when they were allowed to retain for personal use frequent-flier miles generated by air travel paid for by their employers. (3) According to the Wall Street Journal, a "storm of protest [was] gathering" over the implication of the TAM. (4) In a remarkably quick response, on the same day the story appeared in the Wall Street Journal an IRS "senior spokesman" told the New York Times, "We have no particular compliance activities geared toward the taxation of frequent flier miles and we don't anticipate any.... I want to make sure that people don't overreact." (5) With the storm of protest averted, taxpayers and their employers continued not to report the value of employee-retained frequent-flier miles on Forms W-2 and 1040, and the IRS continued to look the other way. (6) All remained quiet on the frequent-flier tax front until 2002, when the IRS bestirred itself to issue an announcement affirming the status quo:
There are numerous technical and administrative issues relating to these benefits on which no official guidance has been provided, including issues relating to the timing and valuation of income inclusions and the basis for identifying personal use benefits attributable to business (or official) expenditures versus those attributable to personal expenditures. …