How to Learn to Stop WorryingAnd Love Tax Practice

By Lee A. Sheppard

I tell law students that they will not get rich planningtax shelters. I tell them that they will have one houseinstead of two, three cars instead of seven, and one wifeinstead of two. I tell them that if they want to get richquick they should not be in any business that bills by thehour, but that they should become investment bankersinstead.

One student responded, ‘‘But Goldman Sachs doesn’ttake just anyone.’’

So now I tell that story, and I never fail to get balefullooks from students and howls of laughter from theirteachers.

The truth is that investment bankers think you’reschmucks. And they’re never gonna stop thinking that.When this talk was being planned, there was a bigkerfuffle among local practitioners about a prominentlawyer who left a white-shoe law firm to go to a bank.

So what? Either way, you’re working for bankers,directly or indirectly. And the irony of the way thingswork these days is you might have more power to say noto crazy ideas inside a bank than outside it. The ostensi-bly independent outside lawyers are dependent on thebanks as clients, while the bank’s internal lawyers canstop horrible things from seeing the light of day.

No matter where you are, you’re stuck with workingfor bankers, because the whole economy has been financial-ized.

You work for people who bemoaned the discontinu-ance of the long bond because they wouldn’t have themto play games with any more. Most of your clients aregoing to be banks of one sort or another, whetherregulated as such or not.

Every large enterprise is a quasi-bank now. GeneralMotors and Ford make cars as collateral for loans. Theymake no profit on the cars, and on the good days whenthey make money, the profit comes from lending. GeneralElectric is a conglomerate that is mostly a bank. Thelending operations and huge portfolios that many largecorporations have mean that they are morphing intobanks or investment companies. Meanwhile, since no onemakes anything in America anymore, the role of financialintermediaries in the economy has become larger.

How does this affect tax practice? The tax law hasnever figured out how to tax financial intermediaries —insurance companies were even allowed to write theirown tax rules — but it didn’t matter when they were notthe biggest part of the economy. What differentiatesfinancial intermediation from other activities is the nearly

complete control the participants have over the source,timing, character, and amount of their income.

When it comes to financial types of income, every-thing we thought we knew about character and taxownership and source and timing is wrong. That is whythe designers of subpart F wisely declared this slipperystuff passive per se rather than wrestle with it. Couplethat with fairly sloppy auditing of banks on the part ofthe IRS, and it is a wonder that any financial intermedi-ary pays any tax at all.

On top of that, there are derivatives. By separatingeconomics from legal ownership, derivatives are turningthe income tax on its head. Formal labels don’t matter atall, yet the tax administration is still being run by guyswho grew up on nonsensical corporate formalities. Thefeline PRIDES ruling is not just an isolated instance ofstupidity, but prima facie evidence that these guys justdon’t get it. (Rev. Rul. 2003-97, 2003-34 IRB 380.) This lackof understanding is horrible for the system, but it is anabsolute playground for practitioners who understandderivatives.

This is powerful stuff. The attacks on the income taxmounted by right-wing kooks are nothing compared towhat financial intermediation is doing to destroy it.Washington is mostly clueless on the degree to whichfinancialization and derivatives are undermining theincome tax.

What should the systemic response be? First, end thepiecemeal response to this or that security or financialcontract. This is only making the problem worse.

Do bankers and issuers have the right to expect the taxlaw to accommodate everything they want to sell? Nope,not unless we raise the fee for a letter ruling to $20million. Policymakers need to step back and decide howto treat derivatives before granting any more piecemealfavors.

By separating economics from legalownership, derivatives are turning theincome tax on its head.

Second, forget legal ownership. The law should saythat whoever has the economics pays the tax, and wedon’t care who the titleholder is.

Third, eliminate the realization requirement. Markeverything to market that can be priced. Timing iseverything, and taxpayers should not be allowed to timethe recognition of their income.

What about liquidity? Anyone big enough to holdinvestments outside of a tax-free pension account isliquid enough to pay tax. What about price? Wall Streetprices everything every day. There is a price that is goodenough for government work.

Fourth, move toward source taxation in internationalrelations. This, of course, is completely opposite thecurrent preference for residence-based taxation, in whichsource countries give up tax jurisdiction in treaties.

Residence-based taxation is obsolete. Put it this way:What are hedge funds but domestic investors that mas-querade as foreign? Oh, but they’re partnerships, and

Lee Sheppard is a lawyer and contributing editor toTax Notes. This piece was prepared for a panel on thefuture of the legal profession at the New York State BarAssociation Tax Section annual meeting on January 25.

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their domestic investors pay tax. Not necessarily. Onlythose investors who acknowledge their domestic statuspay tax.

Yes, source is slippery for financial income, but resi-dence for financial intermediaries is even more artificial.Europe is in an upheaval now because companies havelearned to abuse the treaties, especially nonresident sta-tus. Countries can’t afford to give preferential treatmentto investors as nonresidents anymore, not now that everyinvestor can qualify as such. The countries that insist onnot bargaining away their withholding taxes in treatynegotiations have a better understanding of this questionthan Americans do. (Then again, America needs to bereally, really nice to foreign investors to be allowed tocontinue to consume their savings.)

Do not regard the government as the enemy.You have a job because of the government. The tax law

doesn’t really need lawyers to interpret it. If tax law werecertain and simple and not complicated, accountantscould do it all instead of just most of it.

You should especially not hate this administration.This administration is not enforcing the law. Given theintangibles expensing regulations and unjustified interestdeductions for publicly traded hybrid securities and theutter failure to police cross-border arbitrage, it is surpris-ing that any corporation pays any tax at all. We injournalism believe that some corporations would simplybe embarrassed to put a goose egg on their returns, sothat’s why they pay something.

The failure to enforce the law is not necessarily aRepublican or Democratic thing. I vividly recall discus-sions about who should be IRS chief counsel after Clintonwas elected, and the message was that business wouldnot tolerate anyone who would do the job too well. Thatis why there has never been a woman chief counsel. Thepresent chief counsel, a loyal Republican, makes a showof going after tax shelters while not enforcing the law inany other area.

Every time the tax administratorpromulgates one of those nonsensicalfacts-and-circumstances tests, that’smore billable time for the lawyers.

The corporate income tax is a white-collar jobs pro-gram. Don’t whinge about uncertainty. You get paid foruncertainty. Every time the tax administrator promul-gates one of those nonsensical facts-and-circumstancestests, that’s more billable time for the lawyers. Of coursethe clients will go away less than happy. But they’re notparticularly happy to have to hire you in the first place.

When planning, think like a litigator.You have to poke holes in your own deals. If you don’t

do it, I will. Or on a good day, the government will.Poking holes in your own deals is easier said than

done. In planning, people seem to hold hands andcollectively wish problems away. The person who pointsout problems with the proposed deal is denounced as notbeing a team player and is advised to seek other employ-ment. And that’s how tax planning gets into trouble.

Problems are ignored and waved away, only to rear theirugly heads again when the desired result is challenged.

If everyone else all over town is signing off on atransaction, do you have to sign off on it too? Is it yourethical obligation to go as far as possible to reduce yourclients’ tax liabilities?

It was Max Weber who reasoned thatcapitalism depends on everyonethinking he doesn’t have enough. Weall have enough.

I would say no, and that is the perspective of someonewho spent time in Washington. You have a relationshipwith the government, whether you know it or not. Taxlawyers are part of the compliance system. Tax compli-ance takes place in practitioners’ offices. Tax practitionersare not advocates for clients’ return positions. A taxreturn is an attested disclosure document, not an openingoffer. Every bit of advice you give ultimately ends up ona tax return, which also means that most of it is notprivileged.

Moreover, your personal credibility with the govern-ment matters. You flip them off one day, you may have tobe back before them the next day asking for a favor onbehalf of another client. Having a rap as someone whosigns off on bad transactions will not help you representclients before the government. (Wolfman, Holden, andHarris, Standards of Tax Practice, 6th ed. (Tax Analysts).)

Be grateful for what you have.Tax lawyers are at the top end of the service-provider

class, and janitors are at the bottom end. Tax lawyers areat the top, up there with the astrologers and interiordecorators, because the rentier class values their servicesin keeping their money away from government. (Who’sleft in the middle? The fortunate white-collar workerswhose jobs are not being done in India and the fortunateblue-collar workers whose jobs are not being done inChina.)

Yes, there are people that you are heavily exposed to— clients, investment bankers, hedge fund managers —who have vastly more money than you ever will. Do notthink you have to compete with them. Do understandthat the concentration of wealth will only get worse.

In the bullpens in the brokerage firms, trainee brokersare encouraged to put up a picture of the fancy car orhouse or boat or what have you that is the subject of theirmaterial desires. This is regarded as an incentive to makemoney. Likewise, employers like for their employees tobe married and mortgaged, not merely because they aresquares, but also because they know that those obliga-tions keep the employees chained to the desks. It wasMax Weber in The Protestant Ethic and the Spirit of Capi-talism who reasoned that capitalism depends on every-one thinking he doesn’t have enough. We all haveenough.

Don’t take life too seriously.Everything you need to know about America and

American values is encapsulated in the Coke machinescene from Stanley Kubrick’s masterpiece, Dr. Strangeloveor: How I Learned to Stop Worrying and Love the Bomb.

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In this scene, Peter Sellers (who also plays the titlecharacter) plays Group Captain Lionel Mandrake, aseconded British officer who is trying to use a pay phoneat a military base to call the White House to give thepresident the secret code to call off imminent nuclearArmageddon. He finds he is short of change, so he triesto persuade an American colonel, played by KeenanWynn, who has just arrested him, to shoot the locks off anearby Coca-Cola vending machine to get at the coinswithin.

The colonel initially demurs, with the words ‘‘That’sprivate property.’’

That ought to be enough. That already is everythinganyone needs to know about America — where theargument that a proposed solution might deleteriouslyaffect moneymaking automatically stops the discussion— but Kubrick drives the point home. So when thecolonel finally relents — concluding that saving theworld might be worth a little property destruction — hesternly warns the Sellers character:

Okay, I’m gonna get your money, but if you don’tget the president of the United States, you knowwhat’s gonna happen to you? You’re going to haveto answer to the Coca-Cola Company.

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