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Wednesday, January 30, 2008

Tax Profs Debate Proper Tax Treatment of Furniture Giveaway to Red Sox Fans: Income or Purchase Price Reduction?

Red_soxOn Monday, I blogged the IRS's recent ruling concluding that customers who purchased furniture last spring and had their entire purchase price refunded after the Red Sox won the 2007 World Series did not have income and instead received a nontaxable reduction in the purchase price of the furniture.

Here is some commentary by Joel S. Newman (Wake Forest) and Brian Galle (Florida State) from the TaxProf Email Discussion Group (reprinted with permission):

Joel S. Newman

I think the IRS letter ruling is crazy.

  1. Surely it’s not a gift. No detached and disinterested generosity. The store was doing it for the PR.
  2. I agree that, when a store puts an item on sale, the bargain element is not income. Often, the price was reduced because the item wasn’t selling at the higher price. Therefore, there is no bargain; it’s just a readjustment of fair market value. But a 100% discount? Come on.
  3. Here’s what I think happened. Buy one, get one free. For every item of furniture you buy, you get a “lottery ticket.” Let’s say that, during the period in question, if you had bet on Boston winning the World Series, a bookie would have been willing to pay out 10-1. So, for every $100 of furniture you buy, you get a $10 “lottery ticket.” Then, when the Sox win the Series, you can cash in your $10 ticket for $100­equal to the full amount of the purchase price of the furniture. Analyzed this way, there is no income when you buy the furniture, but there is income when your lottery ticket pays off.

Has Red Sox nation infiltrated IRS?

Brian Galle:

The 100% discount only looks big ex post. Ex ante, the expected value of the discount was 100% times the probability of Red Sox victory (which, as a Yankee fan, I would until 2004 have been pleased to predict as 0%). So, at the time the promotion was offered, from the perspective of the store, it was no different than, say, a 10%-off sale.

Of course, this leaves us with the question whether the ex ante perspective ought to be relevant. As a purely normative matter, I would say it at least might be relevant. Since I’m mainly concerned with ability to pay (for complicated reasons I leave for exposition elsewhere), I would only tax bargain sales where failure to tax would create neutrality problems, as with 83(a) or Old Colony Trust.

Taxing the discount in this case might create, rather than remove, distortions. The sure 10% bargain and uncertain 100% bargain are almost certainly economically equivalent for the vendor. As the store in fact did here, any sensible vendor would insure against the big loss in order to smooth incomes and outflows; at actuarially fair insurance rates insurance against the 100% bargain costs the same as a 10% discount. So any differential taxation on consumers likely wouldn’t be neutral, at least to the extent that it translated back into pricing decisions by the vendors.

On the other hand, it’s a bit hard to figure out what consumers will do. Consumers are more difficult because they are unlikely to be able to insure and may have varying risk preferences (for instance, depending on the consumer’s existing wealth, the relative spread between the certain and uncertain bargains may have larger or smaller significance). We might think some of these risk preferences are irrational (Zarin, anyone?), and perhaps ought to be corrected by the tax system. But then, that may cause some second-order distortions – for example, encouraging consumers to rely on government to correct their misperceptions rather than working to do so themselves.

So, in short like most of the taxation of risk problems, I think this is a hard one.

http://taxprof.typepad.com/taxprof_blog/2008/01/tax-profs-debat.html

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Comments

I wonder how many of these people will report the gain on this furniture if they ever sell it.

Posted by: Dundon | Jan 30, 2008 10:24:35 AM

But, since you can deduct gambling losses against winnings, and the cost equals the winnings, wouldn't it be a wash?

Posted by: Kathy Gilroy | Mar 15, 2008 5:16:30 AM