Tax Deductions, Credits, and the Supreme Court

[IBCoupe]

http://www.scotusblog.com/2010/11/argum ... agan-axis/

Case before the Supreme Court has a couple issues:
1. Arizona has a 13-year-old tax credit for taxpayers who give money to an organization that hands out scholarships to attend religious private schools. According to the U.S. & Arizona State governments, this is peachy keen because the money going to these organizations never actually went to the Arizona coffers - it's not State money, so there's no constitutional trouble with the discrimination. According to the challengers, this credit only exists because the State taxed it in the first place - in contrast with a deduction, where the government says, "Spend the money however you want; we're not going to tax you," the government here said, "You don't have to pay us if you pay this other organization that happens to discriminate." Is this a case of State-sponsored religious discrimination?
2. If the government is right, and no State money is involved because it's private money flowing from one private citizen to a private organization to a private school, can a taxpayer even bring suit against Arizona for misusing tax dollars?

It's a nifty article that shows how Elena Kagan is coming into her own in the Court, and how she's tag-teaming with Kennedy in a pretty cool way.

[srellim234]

I'm in no way a legal scholar but that article is really a fascinating read. Thanks for posting that link.

Is Denniston's writing style always that easy to follow and easy for a layman to understand? I'll definitely have to start reading him a little more often if it is.

[IBCoupe]

I'm in no way a legal scholar but that article is really a fascinating read. Thanks for posting that link.

No problem. The bit about Kagan and Kennedy caught my eye, but the tax law stuff was interesting enough to make me finish the article. I figured I'd share.

Is Denniston's writing style always that easy to follow and easy for a layman to understand? I'll definitely have to start reading him a little more often if it is.

I find everybody at SCOTUSblog is that way. It's a great site, and I just noticed they have a podcast... I'm gonna set that up on iTunes when I get home.

[96Qowner]

Interesting. I tend to agree that the credit only has meaning if there was a tax obligation in the first place.

But there must also be a difference between an organization that qualifies for charitable donations and a government body that does the same, and part of that difference has to be founded in the means of funding. In one case, the organization is directly financed with government funds. In the other case, an organization is financed by private entities through tax deductible funding. The purpose of this difference is to enhance direct donations to causes that the government should not involve itself in, like the Boy Scouts or the YWCA, but which it recognizes as "charitable".

I also wonder, if tax credits are really government funds, doesn't all currency belong to the government, since it creates it in the first place?

[IBCoupe]

You raised a couple of good points that also came up in court.

First, you suggested that there must be a distinction between government spending and private parties that invite individual tax credits, and it sounds like that's something that Arizona tried to argue, to which Justice Kagan responded:

Kagan shortly picked up on that line of questioning, suggesting that if a state could not constitutionally give a tuition voucher only to a student going to a Catholic school, “why is the state allowed to use intermediaries to do” the same?

This, to me, is a pretty incisive question: if the State invites you to give your money (specifically the money you would otherwise pay to the government in taxes for the government to go and spend in the way that it will) to a private tuition organization that discriminates, is that really all that different from the State subsidizing those private organizations?

Your second point was similar to one that the Justices raised: if tax credits really are just government money in a different lights, what does that mean for other kinds of money? Now, you took it further and asked if all money was government's because it makes it, but I'd say the fact that it distributes the money means that it's not the government money.

The reason a tax credit is the government's money, it is argued, is that the government has the power to levy taxes, and it's only through that taxes that the government imposes a debt on its citizens. But rather than collect on the taxpayer's debt, a tax credit allows some of the debt to be discharged to a third party. Here's how the lawyer (a Phoenix tax law professor) explained it to some of the more skeptical justices:

The lawyer said that the money that is involved in the Arizona program is money raised by a tax; without a tax, there would be no tax credit.

Justice Alito then wondered if he would say the same about a tax deduction; the question, and similar questions by other Justices, would give Bender a chance to explain further. He said there is a difference between a deduction and a credit. Under a tax deduction scheme, he said, that is money that a taxpayer never owes or pays to the government; the choice of where those particular dollars go is made by the taxpayer, not the government. After the money is gone, the government allows a deduction on it.

By contrast, the lawyer said, a taxpayer who owes the government a tax obligation cannot keep that money or give it away to anyone or spend it on anything else but the tax bill. Under the Arizona program, he continued, a taxpayer fills out a tax return, knows what money he owes the government, then transfers some of those dollars, through the credit, to a tuition organization that decides who gets a scholarship funded by the credit. That, he insisted, is what makes it a “government spending” program.

[audtatious]

I find the whole "tax credit" deal a bunch of bull as the money was never the Gov's in the first place.

I heard about this going on briefly during the news but have not had time to follow up on it. Marking this thread for weekend reading.

[IBCoupe]

Except that Congress has the legal authority to collect taxes.

So... it is the government's money, because it's a tax burden the government is allowing you to pay to someone else, instead of to them.

[audtatious]

I never said they didn't. My whole point is that a "tax credit" is the Gov giving you money when in effect they are simply taking less of what is already yours. So, no, it's not the Gov's money.

[IBCoupe]

I never said they didn't. My whole point is that a "tax credit" is the Gov giving you money when in effect they are simply taking less of what is already yours. So, no, it's not the Gov's money.

A tax credit isn't the government taking less of what is already yours, and that's the point of the argument. A tax credit is the government letting you choose where your tax dollars go by directly giving it to another organization. You don't get to keep the dollars they don't collect. The government has still taken it from you; it was still their debt to collect.

[audtatious]

Sorry, I was not speaking in the confines of your OP but in regards to personal taxation and credits.

[IBCoupe]

Ah, my mistake. To that larger point: that Congress has the legal authority to levy taxes upon you, those taxes that are levied upon you are legal - it's not your money. If a bank forgives some of your debt, it's not that they are letting you keep your money, it's that they're letting you keep their money.

When the government says "You don't have to send us that check," it's not that you are suddenly keeping money that was yours, it's that the government isn't taking its money from you.

[audtatious]

I disagree. If it's not your money, then who's money is it? Payroll taxes are an estimation of taxes based upon what you may owe for the year. At the end of the year (April in this case), you calculate your real taxes and you either pay more or get money back. If you receive money back you are not getting the Gov's money but are getting back YOUR money that was overpaid to the Gov. A tax credit is a sum deducted from the total amount a taxpayer owes, it's not a credit where the Gov generously gives you money. You only get it back if you overpaid.

[IBCoupe]

Incorrect. A tax credit is simply a shifting of your tax burden from being a debt owed to the government to being a debt owed to a third party. A tax credit is given to you on the basis of your already having discharged the debt to someone else; you don't get a tax credit for sitting on your money. You don't get a tax credit unless you lose the money. You're absolutely right in saying that the Government isn't generously giving you money in a tax credit; the dollar amount still leaves your bank account - it just doesn't go to the government's.

You appear to be conflating the terms "tax refund," "tax deduction," and "tax credit."

[audtatious]

Both tax credits and tax deductions are methods that the IRS gives to reduce the amount of tax you owe. A deduction is an expense or an amount of money which lowers your taxable income. It is subtracted "off-the-top" from the amount of money you made throughout the year, your gross income. Tax credits are dollar-for-dollar reductions which are subtracted from your tax liability (The Gov is returning money you have already paid taxes on, thus, a credit)

So, yes, to receive a credit you have paid "somewhere" or have special circumstances like EIC. In one case you have paid once and in another case you are given a special credit ("unpaid" as you have not paid to have a real credit) to lower your tax. In a way we are both right but for the most part the Gov is never giving you their money. The Gov does not make money to give.

[IBCoupe]

The government levies upon you a debt. Saying it's your money is misleading, because even though it's money that has your fingerprints, you still must pay. In the same way that the $2.50 in your pocket has your fingerprints on it, you still owe the ice cream stand for your triple fudge brownie. It's not your money because you have an outstanding debt to them.

[audtatious]

I'm not saying you don't pay. Payroll taxes are taken out monthly as a means to meet the expected tax obligation. You then file taxes and either have to pay more as the amount was not enough or you get the money you overpaid to the Gov back. Credits and deductions are just a portion of the final return to determine your real obligation. It's that simple and the Gov is not giving you their money, they are giving you back your money.

It's only an outstanding debt if you owe. It's not an outstanding debt if you overpaid in the first place.

[IBCoupe]

I see what you're saying: because a tax credit results in a larger refund, it must be that the government issues you a tax credit to give you back your own money.

Except that a tax credit doesn't involve the government paying you back your own money. A tax refund is that. If you want the government to give you your money back, I can get you a really big refund. That's easy: just elect to withhold more. The point I'm making is that the amount you get back is in greater part a function of how much you paid, not how much the government deemed you owed.

Suppose you're someone who has more than one job - in April, you might find yourself in the position of having to send in a check. Under your reasoning, is a tax credit still the government giving you back your own money, if you still have a net debt? No - suddenly the nature of the tax credit has changed because it doesn't result in a refund, just a smaller bill.

Once again, I'm going to point to the fact that you only get a tax credit if you send the dollar amount elsewhere. It's possible in some circumstances to see the government giving you back your own money, and thus it's possible for your reasoning to be superficially valid. I think if you really look at the way it works, however, you'll find that the refund is more a function of your withholding than it is the tax credit. That's why the reasoning doesn't work as well outside of your narrow example.

[audtatious]

Yet, you get credits when you prepare/file your tax refund which allows you to receive more of the money you paid throughout the year back from the Gov. Thus, not their money in the first place. If the amount you paid to the Gov is more than the amount owed (after credits and deductions) then you are receiving back what you overpaid.

So, form 1040. Line 6c #4 = child tax credit section. 47 = Foreign tax credit. 48 = Credit for child and dependent care expenses. 49 = Education credits. 50 = Retirement savings contributions credit. 51 = Child tax credit. 52-53 are more credits. Some are credits based upon what you have paid whereas others are generic credits because you have children or whatever. The total of these credits are directly subtracted from your gross income to determine what is eligible for taxation by the Gov. Realize you have already been paying the Gov monthly without any of these credits and the amount you paid is Y. Subtract deductions and credits from Gross and you have X. Look at the tax chart, based upon your adjusted gross income, and the amount of tax you should have paid is Z. If Y is greater than Z then you OVERPAID your taxes and get a refund (Thus, line 72 of 1040 states "This is the amount you overpaid"). Thus, you get your money back.

[IBCoupe]

That's a fancy illustration of exactly what I've said, but it doesn't change what a tax credit is. Your logic still doesn't hold up when people qualify for tax credits but don't qualify for a refund. In that situation, the credit is no different, it's just the withholdings that have changed. Thus, your refund is a function of your withholdings, not your deductions & credits.

I'm not arguing that a refund isn't your money. I'm arguing that a tax credit isn't an operation that gives you money back - you only get your money back if you already paid too much, which you'd be entitled to otherwise. Had you no children, you wouldn't have had the tax credit, but you also wouldn't have had children and child-related costs. You'd still have expended roughly the same dollar amount. The only difference is that it would go to the government, if you've got no kids.

[audtatious]

Never said it wasn't. I was stating you are getting back your money via a refund. You are being credited on your taxes for something the Gov should not have taken taxes out on, thus, not their money in the first place.