Gov. McDonnell didn’t violate federal anti-bribery law (yet), but did he commit tax fraud?
That’s the question I asked my Federal Income Tax students a few years ago when the governor was first indicted (this week the Supreme Court vacated his conviction and remanded for a new trial). About two-thirds thought the answer was “yes” — and they were mostly the ones who got the best grades.
The tax logic is pretty straightforward. “Accessions to wealth, clearly realized, and over which the taxpayer[] ha[s] complete dominion” are income. Whether it’s a free wedding for your daughter or a shiny Rolex, getting valuable goods or services generates taxable income. Tax law does have an exception for “gifts,” but the leading Supreme Court case interpreting the gift exception looks remarkably like the McDonnell facts (as alleged by the Government). Two men are in an ongoing business arrangement, and one gives the other a very generous “gift” not in exchange for any particular return performance, but in order to build goodwill and encourage future exchanges. Held: income; gifts are only transfers that are made out of “detached and disinterested generosity.”
In some ways this result could raise some of the very same concerns the Supreme Court expressed the other day in McDonnell. Under the tax definition of “income” and “gift,” nearly all transfers from influence-seekers to elected officials could count as income for the officials (though low-value in-kind transfers, like hot dogs at a social event, would usually be excludable as “de minimis” fringe benefits). By definition, the influence seeker is attached and interested. Will tax law criminalize “everyday politics”? (BTW, just for the sake of argument, I’ll put aside possible critiques of the Court’s vision of a first amendment that seems to treat constant influence peddling as not only tolerable but a core value to be protected.)
This time the answer is “no,” or, since this a final example, “probably not.” It’s only tax evasion, after all, if you don’t pay the tax you owe. So as long as officials report what they get, and pay taxes on it, no problems. Where it gets tricky is if officials believe that sometimes people genuinely give them things without ulterior motives, and want to treat those transfers are tax-free. This is the deep oddity of the tax law of gifts: the transferee must know what is in the mind of the transferor (and, to me, a reason to eliminate most of the gift exclusion, but that’s a topic for another time). Still, in most contexts it will be pretty clear that the “gift” is really transactional, as in the facts alleged in the McDonnell indictment.
This leaves the puzzle of campaign contributions. By the principles I’ve just mentioned, and another major piece of judge-made law (the “assignment of income” doctrine) most campaign contributions look an awful lot like income for the candidate. Let’s set aside the Bernie Sanders $27 donor and assume that many contributors are hoping to elect a candidate who will vote in favor of the contributor’s preferences. Seen from a very high level of abstraction, this looks a lot like payment for services. Even though the money is going to a campaign committee, not to the candidate’s personal account, the assignment of income doctrine says it’s the candidate’s income: we tax income to “the one who earned it.” Recent stories accuse both major-party presidential candidates of having failed to report contributions to their family foundations as income actually earned by the candidate.
The IRS carved out campaign contributions from tax under this theory in a series of revenue rulings, mostly in the early 1970s — surely not coincidentally, roughly at the same time as the FECA (in Rev. Rul. 71–449, among other places — sorry, no free version I could find). The revenue rulings are not especially clear on their underlying rationale, though they do emphasize that campaign funds cannot be used for the personal enrichment of the candidate. Except that, you know, the elected position usually comes with a paying job.
So maybe the IRS is just a bright-eyed democracy optimist, like Lisa Simpson before her trip to the swamp: its lawyers think that campaign contributors really just want to see a better America, and “donation” recipients aren’t obliged to perform any service in return. That is, since there is no explicit quid pro quo, there isn’t income. Or maybe they’re legal formalists: there is no contractual right, or even a claim of promissory estoppel, that runs between contributor and candidate. The IRS has in the past asserted that these kind of informal “gift exchanges” generate income, though.
A more pedestrian explanation is that the IRS is just sticking with an old litigating position, in which it had asserted that transfers of value to campaigns do not produce full market value in exchange. (That was a position they took in the context of the estate & gift tax regime; it’s set out, among other places, in RR 72–583). But the fact that candidates get a bargain does not make their income any less taxable.
For me, the most likely explanation is probably a pragmatic or quasi-constitutional one akin to the Court’s McDonnell decisions. Taxing campaign contributions routinely would divert a third of each campaign war chest to the public fisc, likely making it more difficult to raise funds. See, e.g., GCM 38930 (Dec. 3, 1982) (“[T]he tax system should not be used to reduce or restrict political contributions.”) So we could think of every campaign for office as in part federally funded — they’re receiving a tax expenditure, in the form of the (not statutorily authorized) campaign-finance exclusion.
If that’s not sounding like a tax expenditure you would get behind…indeed, if you’re thinking, “hey, maybe it would be an excellent idea to tax campaign expenditures, at least once they exceed some threshold,” I will recommend you to a nice student note along those lines by a friend of the blog. Or, if you’re someone who prefers “command and control” regulation over price instruments, maybe I’ve just made the case for campaign expenditure limits as a way to limit Congress’ campaign matching grant. Come to think of it, I’ve written an article like that already.
