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June 9, 2006
Tax Consequences of $25 Million Bounty on al-Zarqawi
Eugene Volokh raises a question I wish I had thought of: what are the tax consequences of the $25 million bounty that the U.S. Government will pay to the person(s) who provided the information leading to the death of Abu Musab al-Zarqawi?
Tax lawyer Richard Riley's take sounds right to me:
If the recipient of a bounty like this is a U.S. citizen or permanent resident (a more common example would be a reward paid by the IRS for turning in somebody who didn't pay their taxes, which the IRS is indeed authorized to pay), then the bounty is definitely "gross income" subject to income tax. I think it is probably NOT subject to social security (FICA) tax or "self-employment tax" and NOT subject to withholding of income tax, because it is not "wages" nor is it income from the recipient's own business or professional activities. It's the kind of income that would be reported to the recipient and to the IRS on Form 1099-MISC Box 3, "Other Income." It should be reported by the recipient as income on Form 1040, line 21 ("Other income"). The IRS instructions say that is the line for reporting "prizes and awards," gambling winnings, and other miscellaneous non-business, non-wage income.
Since a bounty paid by the U.S. government is "U.S. source income," if the recipient is a foreign national, then the payment would be subject to U.S. withholding tax (not employment tax withholding, but withholding tax nonetheless) at the rate of 30% unless the rate is reduced by treaty. U.S. tax treaties with most of our trading partners would allow a reduced withholding rate. But we don't have a tax treaty with Iraq right now, so technically it's subject to 30% withholding. If the $25 million bounty is paid and the recipient is an Iraqi, I wonder if he or she will complain when the check is only $17.5 million?
Anthony Infanti has more here. Comments are open.
June 9, 2006 in Celebrity Tax Lore | Permalink
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Now that famous headchopper Zarqawi has moved on to his reward, Eugene Volokh raises the truly important question: A reader... [Read More]
Tracked on Jun 9, 2006 3:28:00 PM
Comments
One could quibble over whether this was an agreement for before tax or after tax $25 million and if it was for before tax, then the amount should be grossed up to cover the tax.
I think that there is also room to argue over whether this is really U.S. source income. In theory we have a coalition over in Iraq, of which the U.S. is only one party, in addition to an Iraqi government per se. If the bounty comes from the coalition or the Iraqi government, even if funded through grants from the U.S. then this is not U.S. source income, and involves services outside the United States and to the extent that the recipient is a non-U.S. person, the amount would be tax free.
Posted by: ohwilleke | Jun 9, 2006 12:20:58 PM
I don't care if the recipient is a resident, non-resident, whether the payment is US source, or foreign source, or if its FDAP or not. If someone actually decides that we need to reward our informants by having uncle sam take a third out before turning over the funds, then that person deserves the same fate as zarqawi.
are we really going to tell our spy to "make sure to file your income tax return" and disclose "Al Qaeda Informant" under "other income"? the 6103 confidentiality provisions would take on a whole new meaning.
I'm as big a tax law geek as anyone else, but I pray to god that no one is actually serious about withholding taxes from the 25 million. this is an idea that only a tax lawyer could suggest.
Posted by: andy | Jun 9, 2006 12:24:12 PM
Does Iraq levy an income tax? If they do, is there a provision that allows for foreign source tax credits?
Posted by: Justin | Jun 9, 2006 1:24:12 PM
As Anthony Infanti points out, there will probably be no withholding tax because this is personal service income which is earned abroad by a non-resident. Accordingly, the income should be tax free.
Posted by: Philip | Jun 9, 2006 2:54:15 PM
Professor - Thanks for posting my comment - and for thinking it may be close to right!
Andy - I don't really disagree with anything you say. Even so, don't we need to determine how the payment should technically be treated before we decide if there are policy reasons for treating it differently? I guess if I had the ear of the State/Defense officials paying the bounty, as well as the Treasury and Justice officials responsible for tax administration and tax enforcement, I'd suggest the following: Assuming the informant was an Iraqi, let's pay him or her the full amount of $25 million. Let's quietly accrue on the books of the U.S. government a "grossed-up" payment of $35.7 million, and if anybody asks about it we can say we wanted to pay out the full $25M and we bore the grossed-up cost in the larger interest of the United States. The extra $10.7 million was well worth it. Then, Treasury and Justice, in the exercise of their administrative and prosecutorial discretion, can just decide not to worry too much if tax returns (Form 1042, Form 1040NR, etc) never appear at the Service Center in the mail.
Posted by: Richard Riley | Jun 9, 2006 6:24:35 PM
The payment was for services, since the informant presumably only worked to locate Zarqawi at the direction of the United States and had substantially no economic risk or reward in the product of his efforts except in its proper delivery to the United States government. Tobey, Atkinson.
The services, which consisted of searching for Zarqawi and transmitting information about his wherabouts to the government, produced foreign source income because they were performed entirely outside of the United States notwithstanding that the information was received in the United States. Piedras Negras.
Under Piedras Negras principles the income, if effectively connected to a trade or business of informing, should not be effectively connected to the conduct of a trade or business within the United States.
If the informant is considered to have produced the information on his own and sold it, he would have a nontaxable foreign source gain.
If he is considered to have only granted the United States a license to use information he owns (perhaps by reason of retaining economically significant book and movie rights), he would have foreign-source royalty income because he granted the United States a license to use the information in Iraq (the only place where it would have any value).
So the informant should be able to avoid U.S. income tax.
Posted by: Anand Desai | Jun 9, 2006 8:02:03 PM
this reminds me of the fiasco caused by the IRS announcing that whoever caught McGwire's 61st home run ball would probably be liable for a gift tax if he returned the ball to Mcgwire. Since the ball was worth more than a million (well over the exemption amount at the time, I believe), the noble fan, according to the IRS, would face a six figure gift tax upon returning the ball to mcgwire.
luckily, charles rossotti saved the day:
"Sometimes pieces of the tax code can be as hard to understand as the infield fly rule," said IRS Commissioner Charles Rossotti amid a flurry of condemnation that reached as high as Capitol Hill and the White House. "All I know is that the fan who gives back the home run ball deserves a round of applause, not a big tax bill."
now, i'm sure that rossotti was technically wrong-- if a gift of property worth a million dollars is made to a private person, it certainly falls within the letter and spirit of section 2501. as an admitted textualist, it hurts me to say this, but i think sometimes common sense must prevail over statutory language, and this should be the case with respect to the Zarqawi's informant's tax situation.
i'm wondering if there really is some type of paper trail to deal with, regardless-- isn't the 25 million going to be paid out of some uber-secret military slush fund? i could see how we would have to deal with the gross-up and the concomitant administrative headache if Rummy is planning to walk over to Treasury and ask them to cut him a check for 25 million (payable to "Cash," of course), but hopefully getting the funds to the informant is done a bit more covertly than that.
Posted by: andy | Jun 10, 2006 3:30:29 AM
