Now My Advice For Those Who Die: Declare The Pennies On Your Eyes

The reaction to my reporting on Reimbursementgate — which, yes, has now been given a proper name, ending in “-gate,” in keeping with the rule that requires all political scandals to end that way – has made a few things abundantly clear. First, people on both ends of the political spectrum are angry, and rightly so; they feel duped, cheated, and fiscally violated.

The second thing that has become apparent, however, is that some of the anger is misplaced or (perhaps more accurately) that some are angry at the right people, but for the wrong reasons.

On some level this is understandable; a lawmaker being reimbursed for “consulting” herself or for doing absolutely nothing are certainly egregious abuses of any kind of reimbursement system. Likewise, it makes perfect sense to become enraged by the hubris it takes for lawmakers to increase their own statutory “reimbursements” by $15,000 this year only to vote down a $6389 increase in School for the Deaf funding.  It seems that, even in an era where everything from the environment to individual privacy is a deeply divisive issue, the prospect of a bunch of elected officials padding their salaries under the guise of “reimbursements” is something so objectionable that we can all hate it equally without fear of losing our political bona fides. It is a post-modern answer to Rodney King’s eternal question: yes, we all can just get along … if you give us a common enemy to hate.

Advertisement

All the same, no matter how rational our anger at specific abuses may be, we must not let it cloud our vision of the larger picture: the problem is not with how certain lawmakers abuse the system, but that the entire system violates Amendment 70 by giving legislators income above and beyond their statutorily defined salaries. End of story.

It is in this big-picture context that an interesting catch-22 arises, specifically in the area of taxes.  In the form of a question, it is this: have the legislators who have received these payments paid taxes on them? (I touched on this in the “Sunlight” post, but I failed to really explore the importance of the question’s answer.  That’s on me.  Sorry.)  The thing is, the question presents a no-win situation for legislators.  On the one hand, if they have been paying income taxes on the money, then, by definition, the money is income (of course), and the receipt of that extra income is a violation of Amendment 70.  Literally, by properly following tax rules, they admit that they have violated the Arkansas Constitution.  Ouch.

On the other hand, if they have not been paying taxes, then, in addition to receiving extra income, they are also violating federal tax laws.  The federal rule, in a nutshell, is that only reimbursements received as part of an “accountable plan” are not included in a person’s gross income.  An accountable plan is an arrangement that meets all of the following requirements:

1. Business connection.  The arrangement provides advances, allowances or reimbursements of an employee’s business expenses paid or incurred in the performance of services as an employee.
2. Substantiation. The employee must submit information to the payer sufficient to satisfy the “adequate accounting rules” with respect to travel, entertainment, business gifts, or use of listed property. For other reimbursed expenses, information must be submitted that is sufficient to enable the payer to identify the specific nature of each expense and to conclude that the expense is an employee business expense. Each of the elements of an expenditure or use must be substantiated.
3. Return of excess amounts. The arrangement must require that an employee return to the payer within a reasonable time the amount of the reimbursement or allowance that exceeds the substantiated expenses. A reasonable period of time is defined under a safe harbor as an expense or advance substantiated within 60 days and any excess advance returned within 120 days of when the expense is paid or incurred.

It’s not really walking out on a limb to suggesting that, even if the legislators’ claimed expenses satisfy prong one, they fail prongs 2 and 3 miserably.  Substantiation requires adequate records or sufficient evidence corroborating the taxpayer’s own written or oral statements as to amount, time and place, and business purpose; if no expenses are substantiated, then every dime paid under the plan is part of the taxpayer’s gross income.  On the other hand — not that it matters here, where nothing is really substantiated — if some expenses are substantiated, but the overage is not returned within a reasonable time, the overage is part of the taxpayer’s gross income.

Which brings me back to my point: if the amounts are included on the W2s, as they should be, and taxes are paid on those amounts, it’s illogical to suggest that the amounts are not extra income.  On the other hand, if the amounts are not included on the W2s, then we’ve got much bigger problems on top of the blatant Amendment 70 violations.  No matter how you filet this fish, it stinks.

***

One other tax-related note: the home office expenses being claimed by many (most?) of the legislators are almost certainly invalid.  The IRS rules for taking a home office deduction are absurdly strict, and the only deduction applicable here that might be allowed would be where some part of the home was used “exclusively and regularly” as a place where the legislator met constituents in the normal course of his or her trade as a lawmaker.  “Exclusively” and “regularly” are not amorphous concepts either.  The exclusivity requirement means that the part of the house used for meeting clients cannot be used for ANYTHING else, so those home offices that you also use to pay bills or carry on other non-legislative work cannot be deducted.  Similarly, the regularity requirement means that merely occasional or incidental work is not enough to warrant a deduction.

Even if a legislator could somehow satisfy the exclusivity and regularity requirements, however, they are still not entitled to deduct home office expenses unless they are actually meeting constituents at the home AND the constituents’ use of the legislator’s home is substantial and integral to the conduct of the legislator’s business.

But let’s go crazy and assume that, somehow, by the Grace of a Republican God, a legislator managed to satisfy all of the above requirements and was entitled to a deduction.  Would he be entitled to a tax-free reimbursement for whatever amounted he contracted with his LLC for?

If you’ve been paying attention, you know what this answer is going to be.  No, he would not.

As the IRS sees it — no doubt looking through thick nerd glasses — a single-member LLC, which is what the majority of lawmakers who bother to form a business create, is not a distinct entity from the single-member. (Obviously, the exceedingly lazy legislators who don’t even create a separate business entity, like John Burris, and merely call themselves “doing business as ____” would be a single entity.)  That is, Stephen Meeks and Stellar Consulting LLC are the same “person” according to tax law.  Since you can’t very well contract with yourself, you could not create a binding agreement for $1200/month in office rent.

At best, assuming you could satisfy the home-office-deduction tests, you would be entitled to a deduction calculated by the IRS formula, which is based on the percentage of the home that is used for business.  Except the amount you can deduct is limited to the gross income from the business use of the home.  So, again, unless a legislator wanted to say that he or she was generating extra income from the state by conducting legislative business at home, there would be no gross income, and there would be no tax deduction.  Of course, since I am willing to wager that none of the home offices claimed by legislators meets the exclusivity test, this last part barely even matters.  Still, it’s interesting to see how the catch-22 fleshes out no matter which way the legislators answer the initial tax question.

[Full disclosure: Tax law ain’t my bag, so I’ve enlisted a bit of help from a couple tax attorneys.  Any mistakes in the explanation above, however, are all mine.]

Advertisement

2 COMMENTS

  1. As one who has recently passed the CPA exam, I really like this post. You’ve got them both ways, no doubt. Anybody familiar with IRS form 3949-A????

Comments are closed.