Raising Taxes Stalemates Action to Raise Debt Ceiling

By Thomas A. Davis, Esq., Davis & Harman LLP, Washington, D.C.

The failure to raise the current debt ceiling, and the potential catastrophic impact that failure would have on the U.S. economy, looms over Washington like few issues have in recent times. At stake, is the inability of the U.S. to make payments on its obligations here and abroad unless the debt ceiling is raised. Until this issue is resolved, most other legislative action has been put on the back burner.

The current amount of debt the U.S. can legally incur is $14.3 trillion. It is estimated by the U.S. Treasury that the government will reach this limit in early August of 2011. After that time, the U.S. will not be able to fully pay its financial obligations unless Congress acts to raise the ceiling. Raising the debt ceiling is necessary to pay what is already due. The U.S. is now required to borrow about 40 cents for every dollar of expenditures due. The Treasury will not be able to borrow that 40 cents if the debt ceiling is not raised. Never has the Treasury failed to meet any obligation as a result of a debt limit impasse.

Over the years, Congress has routinely raised the debt ceiling, but this time around circumstances are different. The fall 2010 congressional elections sent 87 new Republican members to the House of Representatives, giving the majority to the Republicans. Most of them won because they campaigned on a platform of stopping the insatiable spending appetite of the federal government and putting the government’s financial house in order.

The Republicans also gained six seats in the Senate, giving them a total of 47. Most of those new Republican Senators also campaigned on a message similar to that of the new House members.

At about the same time the new members of the House and Senate were in Washington attending orientation sessions, the National Debt Commission, a bi-partisan group appointed by President Obama which included current and former Senators and House members, released a report entitled “The Moment of Truth.” The report found that “our nation is on an unsustainable fiscal path.”

Under the circumstances, members of both parties and on both sides of the Capitol are all saying the same thing – we have to deal with the budget deficits. They also say that we cannot let the federal government default on its obligations, obligations for such things as Social Security payments, Medicare payments, salaries for military personnel, and interest on the national debt. While most legislators agree that default would have extremely catastrophic worldwide consequences and must not happen, they are far from agreement on how to solve the “unsustainable” deficits.

In order to raise the debt ceiling, the Republicans say that some $2.7 trillion of spending must be cut over the next ten years. They maintain that none of the $2.7 trillion should come from any tax increases. The reduced spending would have to come in part from reduction in projected spending on entitlements such as Medicare and Medicaid.

On the other hand, the Democrats say that the deficit reduction should come from spending cuts and higher taxes on the wealthy. They are less inclined to cut entitlements, and certainly not as much as the House Republicans have proposed. The President has said he wants a plan that reduces the debt by $4 trillion over 12 years. This plan would probably mean cuts to Medicare and Medicaid, something that would be hard for the Democrats in Congress to accept.

While not the only hurdle to be cleared, the Republicans and Democrats are at an impasse over reducing any part of the deficits by raising revenues from taxes. The Republicans favor tax reform legislation next year, but insist that reform not be used to produce additional taxes on the American people and businesses. The Democrats insist that tax increases on wealthy Americans have to be included in the solution.

The differences appear more serious than usual because there is no obvious compromise if both sides stay wedded to their positions. House Speaker John Boehner has consistently said that tax increases will not be used to pay down the deficits. Most of the large number of new Republican members say there must be spending cuts, no tax increases, and a constitutional balanced budget provision. In fact, many of these members have signed a “no tax increase” pledge. While the Speaker can probably steer a solution through the House acceptable to his members, it is unlikely that a Senate controlled by the Democrats will accept such a bill. If the Senate responds by passing a bill which includes tax increases, it will be hard for the Speaker to get his members to vote for that bill.

It takes two to tango, and at this point in the process finding a way to get the decision makers to the dance floor, much less dance, will be difficult. Hopefully the stakes are high enough to make it happen.

WINNINGS OF NONRESIDENT ALIEN SUBJECT TO 30% WIHHOLDING TAX

In 2006, the taxpayer, a nonresident Korean national, won 138 slot machine jackpots of $1,200 or more, with total winnings of $431,658. The casino withheld a total of $30,460. A report provided by the casino showed he had losses which exceeded winnings by $4,663 in 2006.

In 2007, he had 43 slot machine jackpots of $1,200 or more totaling $103,874. The casino withheld a total of $1,632. The report provided by the casino showed that he had losses that exceeded winnings by $45,130 in 2007.

The gentleman from Korea challenged the 30% withholding tax in the U.S. Tax Court. He argued that the winnings were not subject to the tax because of the Treaty of Friendship, Commerce, and Navigation. The Court found that the most-favored nation treatment under the treaty does not extend to South Korean nationals the more favorable tax treatment regarding exemption from U.S. income tax of gambling winnings as provided for in some bilateral income tax treaties that the United States has entered into with other foreign countries.

The Korean national also argued that even if the treaty did not exempt him from the withholding tax on gambling winnings, his gambling activities were personal services taxable as income effectively connected with a U.S. trade or business. Therefore, the income should be subject to tax in the same manner and at the same rates as that of a U.S. tax person, which would allow him to deduct his gambling losses up to the amount of his gambling winnings. Since he had losses in excess of winnings in 2006 and 2007, the Korean national would not owe any U.S. income tax.

The Tax Court first agreed that the phrase “trade or business within the United States” generally includes the performances of personal services within the U.S. However, the Court found that the Korean national had not addressed the factors in the regulations under Section 183 of the tax code, which relates to activities not engaged in for profit, and he did not persuade the Court that his primary purpose for engaging in the gambling activity was for income or profit. Thus, he had not shown that his gambling activities were a trade or business within the U.S. [Sang J. Park, et al. v. Commissioner, 136 T.C. 28]

Editorial Note – It is interesting that the Court found that the taxpayer’s gambling activities was not a business by applying Sec. 183 of the tax code, the same section used to determine whether a horse related activity is engaged in as a business for profit.

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Editor-in-Chief

Thomas A. Davis, Esq

Davis and Harman

Washington, DC

www.davis-harman.com

AHC Tax Bulletin Advisory Board

Robert B. Dale, III, Esq

Yount, Hyde & Barbour, PC

Middleburg, VA

www.yhbcpa.com

B. Paul Husband, Esq