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Tuesday, November 29, 2005

Crane on Liabilities and the Need to Keep the Income Tax Base Closed

Cranech_1Charlotte Crane (Northwestern) has published Liabilities and the Need to Keep the Income Tax Base Closed, 25 Va. Tax Rev. 31 (2005). Here is the Conclusion:

In the last few decades, the tax law has developed a far more sophisticated awareness of the need to time properly items of income and expense. Included in these developments have been acceptance of the idea that alterations in the treatment of one taxpayer (for instance, the acceleration of income from prepayments or the deferral of deductions for anticipated costs) may be appropriate in order to adjust for an inability to treat properly another taxpayer (who, for instance, we suspect will be able to accelerate deductions or avoid income.) These approaches, manifested especially in sections 404 and 461, have been understood to be necessary in order to "keep the tax base closed," that is, to make sure that the earnings on every fund are included in the tax base.

In developing this approach, however, there has been too little attention paid to the fact that such approaches result in sometimes enormous disparities between values taxpayers own and the values attributed to taxpayers in their tax accounting records. While such disparities have always existed under a realization-based income tax, most of the attention paid to correcting the errors has been focused on unrealized gain and the taxpayer's control over the triggering of losses.

The pressures on the rules defining the income tax base resulting from disparities in values recorded for tax purposes because of the deferral of allowances for real costs have not been so consciously examined. It should be no surprise that taxpayers faced with this overinclusion of value in the tax base have developed transactions that have strained the rules associated with accounting for liabilities, now that there are so many more unaccrued liabilities, and the potential for so much more mismeasurement. It is past time to make better sense about exactly what these rules should be.

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