Paul L. Caron
Dean


Wednesday, July 8, 2009

Does Judge Sotomayor Have a Tax Problem?

Following up on this morning's post, Judge Sotomayor's Law Practice: A Tax Dodge?:  the issue was first flagged by Glenn Reynolds (Tennessee), and he notes that he "was just following Ralph Winter’s advice from my Business Associations class in law school:  When you see a business arrangement that doesn’t seem to make any sense, just say 'it’s probably for tax reasons,' and you’ll be right nine times out of ten."  At my invitation, Linda Galler (Hofstra) expands on the potential tax issues surrounding Judge Sotomayor's sideline legal practice:

While I am supportive of Judge Sotomayor's nomination to the Court, and do not think that the facts in the New York Times article suggest that there is a problem large enough to preclude confirmation, I do think there is an interesting tax issue. There is also an interesting non-tax issue, which I will address first.

Most law firms have strict policies prohibiting partners and associates from engaging in legal work “on their own.” This is because conflicts of interest problems can be created. For example, the New York Times article indicates that Judge (then attorney) Sotomayor reviewed contracts for an insurance salesman. What kind of contracts were they, and who was the other party? If the other contracting party was an insurance company that was represented by the judge’s law firm, or later sought representation, the firm could have found itself in an awkward position. This suggests three possible alternatives: (1) the firm had a policy and Judge Sotomayor violated it, (2) the firm had no policy, or (3) Judge Sotomayor wasn’t really practicing law out of her home so getting the firm’s permission was never an issue for her.

Which brings us to the tax issue. The judge presumably did not bring her clients into the firm because she could not justify charging them the fees generally charged to other clients. Otherwise, she (like most lawyers) would have represented the client through the firm. If that is the case, then she was either doing the side legal work for free or for almost-free. Does the amount of work that she did and the income that she brought amount to a trade or business, justifying Schedule C (above the line) deductions? If she had represented the clients through the firm, then expenses either would have been the firm’s expenses (perhaps deductible by the firm but not by Judge Sotomayor) or, if she paid them herself, they would have been deductible below the line since she was an employee.

Her position as to this issue is slightly stronger with respect to the side work that she did when she was employed by the district attorney’s office because she could not have gotten permission to represent the clients “at work.” The question remains, however, whether her side activities amounted to a trade or business.

Moreover, what were the expenses? If they were minimal, who really cares. But suppose she was taking home office deductions. If my earlier presumption is correct, then the receipts from her side practice were likely to have been trivial or insignificant at best. Maybe she claimed to run a law practice out of her home so that she could take home office deductions when she was really (just) an employee whose employer provided her with an office, and the home office deductions would then have been improper. (Employees generally are not permitted to deduct the costs associated with home offices, no matter how much work they actually perform at home. But people who run businesses out of their homes often can.)

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Comments

Indeed. I'm going to bet she had an improper home office deduction, just because it is one of the most frequently abused deductions. She may no longer have copies of her tax returns, but the IRS will have them on microfilm, and can retrieve them for $57 per year. The IRS can also provide an electronic transcript of her returns for free. So there's no excuse not to at least look into this, assuming she gives the Judiciary committee approval to pull the records.

Posted by: Opus17 | Jul 8, 2009 10:32:24 AM

This was in NYS, where professions are highly regulated (I know I am a PE, not a lwayer). For my PE firm, I had to apply to the Office of the Professions, and get a "Certificate of Authorization" in addition to my license. I also chose to incorporate it as an "S" Corporation. Maybe the rules were different for lawyers back then.

Either way, it shows that something does not smell quite right. Where are the clients and other business records? And the excuse that "it was a long time ago" is simply that - an excuse.

Posted by: kdackson | Jul 8, 2009 10:41:36 AM

Well, given this administrations track record, I think we should start out with the presumption that she has a tax problem.
I also think it won't matter one bit.

Posted by: Borris | Jul 8, 2009 11:39:55 AM

Huh. I just read Smallbone Deceased by Michael Gilbert, a classic British mystery from 1950, which is set in a London law office. (Someone opens the deed-box for the Abel Stokes Trust, and finds a missing trustee instead of the papers.)

One of the red herrings in the plot is a junior associate who is running his own practice on the side and stealing clients from the firm.

Of course, a wise Latina would never do that, right?

Posted by: Rich Rostrom | Jul 8, 2009 11:42:32 AM

Contrary to Opus 17, I'm betting she didn't report the income--on Schedule C or anywhere else.

Posted by: Cobby | Jul 8, 2009 12:08:24 PM

Another possibility is simply that she had some very limited income from this activity, not enough to cover her true costs or anything, and was very scrupulous about reporting the gross income and offset it with some hodge-podge of expenses. I can understand that someone might just throw something together that's in the ballpark along with a random name just to get it over with. Presumably if she was actually planning to build a practice she would have done more.

Posted by: phwest | Jul 8, 2009 12:11:04 PM

She could have dodged her taxes since 1973 and the media and Dems would cover for her anyway. Taxes are to be ordered to be paid by the elites, not actually be paid by them.

Of course, if she was a Bush appointee, if she stiffed the local candy store out of a penny for sales tax it would be a national scandal.

Posted by: Brian G. | Jul 8, 2009 1:03:42 PM

Some rules for me, but not for thee. As someone else mentioned, in an administration of tax dodgers, Sotomayor will fit in quite nicely and her nomination will not be derailed. After all, who can blame the "wise Latina" for not paying taxes when most of us had to go through years of schooling just to learn the definition of gross income? :P

Posted by: Chris Bolts Sr. | Jul 8, 2009 1:34:42 PM

Interesting -- thanks for the follow-up, it clarifies the earlier post.

Posted by: scarpy | Jul 8, 2009 1:40:59 PM

Maybe the rules were different for lawyers back then.

I wouldn't doubt it. Rules are written by lawyers, and so will often protect other lawyers. I remember I was looking at starting a personal business (in Florida). A business was required to register a fictitious name (and pay the corresponding fee), unless the business name contained your FULL name. "Bob Smith Photography," for example, would be exempt from the fee, while "Smith Photography" required payment of the fee. Last-name-only still constituted a fictitious name, with one exception: law firms.

Yes, this is a side-rant. I have no idea if NY State had an exception for law firms in the 80's. But I sure wouldn't bet against it.

Posted by: Stephen | Jul 8, 2009 1:57:31 PM

How many business cases has reviewed on appeal?

Posted by: DAVOD | Jul 8, 2009 2:52:33 PM

Good Lord! STFU, please. Surely we do not want Sotomayor pulled and replaced with somebody smarter and more dangerous. They are out there, you know.

One would think that after the way we hosed them with the Myers/Alito switch, this sort of gambit would be of limited effectiveness. I guess not: never underestimate the stupidity of the stupid party.

Call it to mind, for it had been so slick. The Miers nomination burned up opposition resources, especially the resource of media and public attention, for what semed like months. Meirs finally bowed out; up pops Alito, a dream appointment for the conservaticve side, and he's confirmed inside of a week. Be careful what you ask for.

Posted by: Lou Gots | Jul 8, 2009 2:57:15 PM

I think the Administration and Sotomayor need to circle the wagons or else start talking and making sense. Telling us she doesn't have the tax returns isn't an appropriate answer. Maybe some people call this trivial but this is about integrity and Supreme Court Justices need 100% credibility.

Posted by: Clinton | Jul 8, 2009 3:11:46 PM

Professor,

"Trade or business" is specifically defined in title 26. Cna you give us that definition. I am no fan of Sotomayer, but I can almost guarantee you she wasn't running a "trade or business"

Thank you for you insight. Otto

Posted by: Otto | Jul 8, 2009 3:26:22 PM

There is the issue of the New York City Unincorporated Business Tax, levied on solo practice attorneys.

Posted by: Mark | Jul 8, 2009 3:38:52 PM

Tax Law in two concepts.

All income is taxable, unless the IRC says it's not.

Nothing is deductible, unless the IRC says it is.

The rest is details.

Posted by: Al | Jul 8, 2009 3:41:06 PM

Did she carry her own malpractice insurance? Or was the firm on the hook if her moonlighting turned sour?

Posted by: tim maguire | Jul 8, 2009 3:48:26 PM

Home office - definitely. A number of ADAs at the time tried to do that. Some got away with it; some were audited.

Posted by: anon | Jul 8, 2009 5:53:54 PM

I just can't believe she was able to work on the side and work at the same time work at the DA's office or for a law firm.

Posted by: Clinton | Jul 9, 2009 9:20:15 AM

She should be prosecuted the same as anyone. She did something illegal and must pay the price. and, of course, her nomination should be voided. she cannot judge herself, let alone others!

Posted by: Pete | Jul 9, 2009 1:07:43 PM

HEH HEH HEH. Get out the fire hoses. This broad will need some coolin' off. Sleep well yer disHonor.

Posted by: anthony | Jul 9, 2009 5:12:58 PM

"Professor,

"Trade or business" is specifically defined in title 26. Cna you give us that definition. I am no fan of Sotomayer, but I can almost guarantee you she wasn't running a "trade or business"

Thank you for you insight. Otto"

AHAHAHAHAHAHA!

Trade or business is one of those terms that is used, but not defined in the statutes. It's mostly a creature of the Courts.

A trade or business is a for profit activity conducted with continuity and regularity. She certainly meets the continuity and regularity parts. Not enough info to determine for profitness.

Posted by: TTC | Jul 10, 2009 4:13:04 PM