Pretty Powerful Stuff
January 3rd, 2006 | by Gee Guy |This article was reprinted in the Tribune the other day. While I have an accounting degree, I haven’t paid attention to tax issues for a long time. I know what a 1031 exchange is, but I have to admit that the import of this Rule change escapes me. (The proposed changes were online, but have since been taken down.)
My point, though, is not that the Rule change is or isn’t desireable. My point is how State Revenue Director Bucks seems to ignore the real issue. Most of the comments are to the effect that this should be handled by the legislature, not the executive. His response? ‘It’s a good law.’
It is implicit in the U.S. Constitution and explicit in the Montana Constitution (see Article III, Sec. 1) that one branch of government is not to exercise the powers of another. Yet here we have the DOR willing, apparently without compunction, to make a substantive legal change.
I have long railed against the Montana Administrative Procedures Act, which combines legislative, executive, and judicial power in the executive branch. This is merely one more example.
7 Responses to “Pretty Powerful Stuff”
By Aaron Weissman on Jan 3, 2006 | Reply
Geeguy; I am not an accountant, but the proposed rule changes seem, to me, to be extremely minor. In a nutshell, 1031 exchanges allow you to defer the tax on an asset sale until you sell an asset purchased with the funds from the sale of that asset. If the funds were used to purchase an asset in another State, those taxes would then be due to that state.
A loophole then existed if those funds were used to purchase assets in a State with no income tax. The rule change allowed the DOR to recapture that income.
I don’t like executive branch overreaching either, but it seems to me that this particular example is not that egregious. It seems to meet the intent of the original law, and only applies in an extremely limited set of circumstances.
By Gman on Jan 3, 2006 | Reply
Aaron, you’re right to a degree. It makes sense to tax nonresidents for something residents are taxed for. But, it constitutes a change in Montana’s tax policy. Montana is going from not taxing to taxing outbound 1031s of a nonresident. The only other states (that I’m aware of) doing it are California and Oregon. That puts Montana at a competitive disadvantage with neighboring states also trying to attract investment capital. In 2001 the Legislature passed a law defining “Montana Source Income” (MCA 15-30-101(18)) to go after pass-through entities (e.g. S- and C-corps). The intent of the legislation was not to go after nonresident outbound 1031s. So, really this is something that ought to be addressed by the legislature. Let them decide whether they want to tax something they haven’t been in the past.
By Chad on Jan 3, 2006 | Reply
Alright, I have to admit that I’m confused.
Gee Guy writes:
Gman responds in a comment to another commenter:
The article quotes a number of people that say that Mr. Buck is attempting to change tax law and tax policy and that the proper venue for something of this nature is the legislature.
Yet, the eighth paragraph of the article reads:
The law in question existed as HB 143 in 2001. (Please tell me that I don’t have to point out that this, as a bill, was passed by the Montana legislature). This bill, once it was signed into law, changed Section 15-30-101 Paragraph 17 Subparagraph ii, MCA, to define Montana Source Income as follows:
So that right there is your law. And it has been since 2001. And it appears to comply with the state constitution. So now that Mr. Buck has decided to do his job, and actually propagate knowledge of and uphold this law, it’s become time for an outcry? I think that the arguments advanced by Gee Guy and the three or four folks quoted in this article who claim that Mr. Buck somehow usurped legislative power by complying with a law enacted by the legislature are wrong on their face.
As for Gman, I cannot see how nonresident outbound 1031s are not targets of this law since it states that it is effective if the sale of property occurred while a resident of the state. The “while” clause would not be necessary otherwise.
The travesty isn’t that Mr. Buck and his administration isn’t complying with the spirit and letter of the law, as it is quite clear that he is. It’s that it took him (and/or his predecessor, if applicable) nearly five years to do so.
By Chad on Jan 3, 2006 | Reply
Can someone who posts here please fix my blockquote error? I must have screwed up a tag somewhere.
Thanks
By Gman on Jan 4, 2006 | Reply
A major part of the problem with Dpt. of Revenue’s rule is that it’s incomplete. Under current law, Montana ties to the federal definition of adjusted gross income, and the state does not realize any tax from gains on these transactions at the time the exchanges are made. So, Montana needs its own definition of gain in order for the rule to work.
In reality, however, the rule isn’t the big issue. It’s interpretive and Director Bucks has the prerogative to promulgate an interpretive rule. Where the rubber meets the road is the collection mechanism — how the Dpt. of Revenue (DOR) actually “taxes” nonresident outbound 1031s. The State of Montana cannot tax the Montana source gain until there is a taxable event (actual sale of the property). Once someone exchanges out of the state, there could be numerous subsequent exchanges (serial exchanges) over the course of the property owner’s life. In order for this to be an effective tax policy, the DOR will have to track those exchanges and determine when the taxable event occurs. Talk about an administrative nightmare. What will be the cost of administering the law be versus the benefit of it? During the 2005 Session, Sen. Elliott introduced HB 799 (http://data.opi.state.mt.us/bills/2005/billhtml/HB0799.htm), which created a tax lien on outbound 1031s. Initially, the draft legislation created a withholding requirement — obviously problemmatic in light of the federal deferability of the gain. In essence, there is no gain realized. HB 799 failed on a bipartisan 13-7 vote in the House Taxation Committee (which has 10 Ds and 10 Rs). If you look at the fiscal note for HB 799, it would have raised $25,000 in 2007. How do we justify the administrative burden? The cost outweighs the benefits. Furthermore, we are an net importer of exchanges — much more investment capital is coming in than going out. The income generated by that investment capital is taxed. This rule could discourage people from exchanging into Montana because of the tax penalty (tax lien) they would experience exchanging out.
The current process of rulemaking doesn’t allow for a thorough analysis of the economic impact of the changes being made to Montana’s tax policy. This reason in itself is why all this should go before the legislature as a complete bill that: 1. clarifies the definition of Montana Source Income; 2. creates a Montana-specific definition of gain; and 3. creates a collection mechanism. Let the legislature determine if this is what it wants. That’s where the true prerogative lies.
By Gman on Jan 4, 2006 | Reply
The fiscal note for HB 799 is at http://data.opi.state.mt.us/bills/2005/FNPDF/HB0799.pdf .
By GeeGuy on Jan 4, 2006 | Reply
Chad, I appreciate the insight from someone who obviously understands this more than I do. It sounds like, from a substantive point of view, the legislature changed the law, not the executive. But if the law is “plain, clear, and unambiguous,” why the need for an interpretive rule?
I must confess that I have a pre-existing bias against this sort of harm. I have a client who was significantly damaged by a “change in interpretation.” The evidence discovered showed that the then DOR specifically considered taking that issue to the legislature and opted not to in order to avoid public input. Yet their hearing officer upheld their right to change “interpretations” without public input. The system is rigged.
On this issue, though, my own ignorance combined with the lack of time to really investigate and consider it renders me unable to refute your point, Chad, so I can only thank you for your input.