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Big Gay Al's Big Gay Tax Shelter: Arguing for Gay Marriage Through The Tax Code

(My apologies to South Park for the title.)

Here's a thought: would conservatives really support the Federal Defense of Marriage Act if it had a multi-million dollar price tag?

I'm sure some would. But if the FDMA could be made costly, more of those conservatives who don't care who you sleep with so long as the bed isn't taxed might be willing to stand up and tell their socially (and often sexually) obsessed brethren to sit down. For liberals looking to work with a few strange bedfellows, the strategy should have some appeal. The question is, how do you make a definitional statute too expensive to support?

Two words leap into my mind: tax arbitrage.

This rather lengthy post (continued after the jump) is a summary of a project I�ve been working on for a few weeks: the creation of a tax shelter that could be used by homosexual couples in long-term relationships. The shelter�s primary purpose would be to convince conservatives that failing to give legal recognition to the reality of homosexual relationships comes at a real price, and that this price may be too high to pay.

(Disclaimer: The idea below is very much a thought project: I'm putting forward these ideas as an academic exercise and perhaps to spur conversation among activists. My readers who are familiar with split interest tax shelters are highly encouraged to comment, as I'd like advice on how far to run with the idea. If there's a potential essay or article in this, all the better. But I�m not suggesting anyone actually try this, certainly not without the help of a trained tax lawyer. Obviously, what follows is not legal advice.)

The Premise
Very little has been written about using the FDMA to abuse the tax code, but it seems a fruitful avenue of exploration. A search for "defense of marriage act & tax shelter" on Lexis today gave me a single hit. The more permissive "defense of marriage act & 26 U.S.C." (the latter being the section of the United States Code that deals with taxes) yields 19 results, but they all seem to concentrate on the tax advantages of marriage forbidden to same sex couples. SSRN contains two articles that come close to the issue. Theodore Seton's The Assumption of Selfishness in the Internal Revenue Code: Reflections on the Unintended Tax Advantages of Gay Marriage discusses various tax advantages that a homosexual couple might exploit for their own benefit, but its focus is almost solely descriptive. On the other hand, Anthony Infanti's Homo Sacer, Homosexual: Some Thoughts on Waging Tax Guerrilla Warfare suggests that homosexuals might stage tax protests by attempting to file joint tax returns en masse, but focuses on civil disobedience more than tax exploitation.

However, these articles hint at the greatest asset that same sex couples possess: love. When it comes to tax law, many clauses of the Internal Revenue Code positively discourage love--or at least anything that allows for cooperative behavior in the face of the tax collector. Love tolerates very few arm's length transactions, and yet the FDMA requires the tax man to say, "No, no love here! These two men, these two women, they have nothing to do with one another!" Certainly, an activist can capitalize on such willful blindness.

The Objective
To my mind, the ideal political tax shelter combines three qualities. First, the amounts of money involved should be large enough to force FDMA proponents to sit up and take notice. This immediately poses a significant obstacle for a homosexual tax shelter: simply put, there aren't that many homosexuals, and only a foolish strategist would count upon even a small minority of them entering into a complicated tax scheme. Hence, my plan requires looking further than the tax dodges that Seton proposes. The ideal political tax shelter is corporate, not personal, leveraging arbitrage opportunities from a homosexual couple with the sheer size of a business entity.

Second, a couple engaging in this kind of tax shelter should not benefit particularly handsomely. My sense is that the risk of political backlash is higher were gay couples to make large amounts of money�or evade massive amounts of tax�through the exploitation of the tax rules. Rather, I would suggest that the funds taken from the public fisc should be channeled towards large corporations who offer health and other benefits to same sex couples. [1]

Finally, the shelter must rely to the greatest degree possible on the lack of legal recognition of same-sex couples. Not only is this focus necessary for the political punch of the program, but as we will see, the defense of the plan depends upon the intransigence of the Federal Defense of Marriage Act.

The Statutory Background
I hope my more legally-aware readers will forgive a quick stroll through the statute books for the sake of non-lawyers. First, there's the Defense of Marriage Act, enshrined near the front of the Code at 1 U.S. �7:

In determining the meaning of any Act of Congress, or of any ruling, regulation, or interpretation of the various administrative bureaus and agencies of the United States, the word "marriage" means only a legal union between one man and one woman as husband and wife, and the word "spouse" refers only to a person of the opposite sex who is a husband or a wife.

(emphasis mine) In other words, no I.R.S. agent in the land can look at Steve and call him Adam's wife. The mighty Internal Revenue stands impotent before Representative Bob Barr's baby.

Now take a look at 26 U.S.C. �167(e)(1), a part of the Code which limits the deduction of split-interest transactions:

(e) Certain term interests not depreciable.
(1) In general. No depreciation deduction shall be allowed under this section (and no depreciation or amortization deduction shall be allowed under any other provision of this subtitle) to the taxpayer for any term interest in property for any period during which the remainder interest in such property is held (directly or indirectly) by a related person.

(emphasis mine) For the moment, leave aside what this section actually does. A little further on, in �167(e)(5)(B), we're told that "related person" has the meaning described in �267(b) or (e). So what does �267(b) have to say about related persons? Well, if we assume that we're not talking about trusts, corporations or (business) partnerships, it really only tells us that related persons are "[m]embers of a family, as defined in subsection (c)(4)". Which finally leads to:
The family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants

(emphasis mine) Where does this lazy walk down statutory lane get us? Well, it appears as an initial matter that so long as a homosexual couple is not otherwise related under �267(b) or (e) (i.e. they're not in a business partnership), the IRS cannot consider them related for purposes of �167(e).

A First Pass At A Shelter
So why does this matter? As is obvious from the face of �167(e)(1) (added to the Code in 1989), the depreciation rules can be manipulated by related parties to defer taxes. For instance, suppose that a father purchases shares of stock for $1,000. He gives the shares to his daughter, but retains the right to the dividends for a period of ten years. The present value of the dividends is $600. [2] Under the depreciation rules in �167, the dividend stream is now a depreciable asset. So long as the returns are lower than $100 (or even more if the dividends qualify for more than straight-line depreciation), this will generate a loss for the taxpayer that he can offset against other income.

This strategy would be a loser in an arm�s length transaction. Sure, the father can defer some income, but he�s out $1,000 in the first year. The assumption, however, is that related parties will be able to use their resources for the benefit of each other in ways not fully caught by the tax laws: has the father really �given� anything away to a close relative? And this is a rather simple transaction. For slightly more complicated attempts at abusing split-interests in the tax code, see Paul Youngs, Note: The Taxation of Split Interests: How Are They Treated? How Should They Be?, 76 U. Det. Mercy L. Rev. 165 (1998).

I�ve concentrated on using split-interests in constructing my tax shelter for two reasons. First, �167(e)(1) cannot be applied to a same sex couple. Second, a shelter based on this section seems to be easily scalable. The trickier bit�and the part I�m still struggling with�is how to transfer the tax benefit available to the couple to a corporation. (Reader suggestions are very welcome.) One possibility I�ve been considering involves a bond issue from a major Corporation to non-spouse A, who gives the bond (but not the right to dividends) to non-spouse B, who in turn sells an option on that bond back to the corporation. Perhaps the Corporation can issue the bond at lower than market interest, thus appropriating A�s tax benefit. This is hardly ideal: the structure is of limited scale and might run afoul of the sham transaction rules. Most of the other plans I�ve kicked around thus far�creating an incorporated entity controlled by one partner, possible agricultural investments allowing for depreciation of land�also possess considerable weaknesses. Obviously, the construction of the tax shelter itself will be the �heavy lifting� section of any article that springs from this post. I�m still working on it, but if any of my readers have suggestion for shelter creation, I�d be interested in hearing it.

Tentative Conclusion
As mentioned above, I�ve not yet finished an outline of a shelter that meets my three ideals. Nevertheless, I sense that the stumbling block is more my inexperience�they don�t teach you how to write shelters in law school�than any particular theoretical limitation. While any plan would have to be injected with enough economic substance and business purpose to survive judicial scrutiny, tax shelters based upon the FDMA have one immediate advantage: it�s impossible to argue that Congress didn�t intend to limit the scope of the word �spouse� throughout the U.S. Code. Most tax shelters take advantage of �unhappily drafted� portions of the Code and the law of unintended consequences, but the FDMA isn�t ambiguous at all: it does exactly what it says on the tin.

In other words, progressive activists and advocates employing this type of tax shelter could enjoy a number of relatively unfamiliar frissons. First, they would get the pleasure of watching social conservatives squirm between allowing homosexuals to manipulate their tax liability and admitting that maybe this �spouse� word should have a few multiple meanings. Second, they might enjoy widening the rift between social and fiscal Republicans by reminding them that purely symbolic legislation can have unintended consequences. And finally, they might even get giddy spouting Scalia-esque pieties on the importance of a literal reading of statutory text.

[1]: A particularly cunning shelter designer might create a structure that approximates for the couple any tax benefits that might accrue were the federal government to recognize same-sex relationships. The contours of such a plan, however, are well beyond both the scope of this post and my skill.

[2]: I have shamelessly stolen taken this example from one of Prof. Tax�s past exams. The exam question was actually the inspiration for this idea, so I hope it's taken as a sort of homage.


I have no idea if this is viable, but it certainly makes entertaining reading. I have occasionally wondered about how effective a political party might be here in the UK which was economically right wing but socially liberal. (I suspect they might do spectacularly well - and certainly better than the Conservatives currently do.)
:-) Isn't that New Labour? Sounds like a party for The Economist's readers. (If by "socially liberal" you mean "likes gay folks and doesn't think people ought to be thrown into Gitmo without some sort of due process.")
New Labour are regarded as being highly illiberal, at least in the sense that Bateleur uses the word. That's mainly in relation to the second half of your equation, though - they do generally come across as pro gay, womens, ethnic minority, etc. rights. But in terms of the right to protest, not getting locked up without trial, and so on, they can't really be called socially liberal. Then again, neither can their main rival, IMO.

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