Catching The Ball: An Income Tax Nightmare

You don’t need to be a fan of the New York Yankees to congratulate their Captain, Derek Jeter, for becoming only the 28th player in the 135 year history of Major League Baseball to reach a career milestone of 3,000 hits. At a time when so many other professional sportsmen have chosen to inject their bodies with artificial steroids, Mr. Jeter’s performance decline in the twilight of his career is apparent testimony to his decision to rely solely on his natural skills.

Unfortunately, Mr. Jeter’s dramatic quest for his 3,000th hit led to another drama, one that is currently playing out in the offices of the Internal Revenue Service. The IRS, as always, is simply applying the tax law in the manner that it has been written by politicians. The details of this particular drama, though, may lead us to wonder whether those very politicians ever anticipated this particular situation.

During a week in which President Obama repeatedly called for the closure of tax loopholes for the very wealthy, a working class fan who caught a baseball found himself immersed in a debate about tax fairness. His gracious actions, and their resulting tax implications, reveal much about our government’s fiscal policies.

See the Ball, Catch the Ball

On July 9th, Derek Jeter began a baseball game against the Tampa Bay Rays with a career total of 2,998 hits. He would eventually hit successfully in all five batting appearances that day, ending the game with 3,003 in total.

His second appearance, though, led to the historic event that allowed him to ascend to the 3,000 hit level. And he met the challenge in a most dramatic fashion, socking a home run that soared into the stands instead of simply grounding a ball through the infield.

The nature of his hit set off a series of events that ultimately involved the Internal Revenue Service. A 23 year old cell phone salesman named Christian Lopez caught the ball and returned it to Mr. Jeter after the game as a keepsake. Jeter and the Yankees, grateful that he didn’t sell the ball at auction, rewarded him with game paraphernalia, autographs, and free tickets for future games.

How much could Lopez have earned by selling the ball at an auction? There’s no way to know for sure, but Bloomberg speculated that he might have received as much as $250,000. It may have sold for a far higher amount; Barry Bonds’ record breaking 756th career home run ball, for instance, actually sold for a whopping $752,467 in 2007.

Enter The Tax Man

Although Mr. Lopez did not pay or receive any money as a result of these events, he is now in need of expert tax advice. That’s because his brief catch represented a compensatory activity that resulted in his receipt of an item with resale value. In other words, to put it simply, he did some work and received compensation, thus making him liable for income taxes on his receipt.

Wait a minute … he gave the ball back to Mr. Jeter, didn’t he? Yes, but his generous gesture represents a personal gift, and donors of personal gifts must pay taxes on gifts of items with values exceeding $13,000 under American tax law. In other words, the loss that he incurred by “gifting” the ball back to Mr. Jeter cannot fully off-set the value that he received by catching the ball earlier that day.

Furthermore, the fan’s receipt of the merchandise and tickets may itself represent the collection of taxable compensation. Thus, he may need to pay income taxes on his receipt of those items, whether or not he ever actually resells them. And although a number of organizations have stepped forth and volunteered to pay some or all of his tax obligations on his behalf, such acts may themselves represent taxable gifts, leading to additional tax obligations for the firms or Mr. Lopez.

Back in Washington

Meanwhile, while these events were unfolding, President Obama continued his tussle with Republican Congressmen over the tax code. The Congressmen continued to insist that the federal government already overtaxes the American people and should not attempt to balance the federal budget through additional tax increases, while the President responded that many wealthy Americans are beneficiaries of tax loopholes that can be equitably closed.

One group of beneficiaries, the President notes, consists of wealthy managers of hedge funds. Such individuals generally pay a relatively low 15% capital gains tax on their “carried interest” earnings, an amount that is less than half of the current 35% top marginal tax rate that Mr. Lopez may end up paying on his earnings and gifts.

It may take months for Mr. Lopez to sort out all of the tax implications of his moment of glory. Hopefully, though, our representatives in Washington will not wait that long to reassess the practical implications of their taxation policies on fans who catch baseballs in the stands.

Filing Your Tax Return: Competition or Monopoly?

In America, an extremely heated public debate rages on about the role of the federal government in managing and paying for health care services. On one side of the argument, Republicans have rushed to the defense of House Representative Paul Ryan and his proposal to convert the Medicare system into a private sector voucher plan. And on the other side, the Democratic Governor of Vermont has taken the first concrete steps  towards implementing a Canadian-style single payor government system for an entire American state.

Interestingly, though, similar debates are also taking place about other sectors of the economy. For instance, let’s consider the Do-It-Yourself (DIY) income tax electronic form preparation and filing industry. Although many states have developed their own internet-based government systems for citizens to file their income tax returns, the Internal Revenue Service of the federal government has instead opted to encourage private corporations to compete with each other to provide this service to taxpayers.

Last week, however, the United States Department of Justice (DoJ) filed a lawsuit to block a corporate acquisition that would utterly transform the competitive market for such tax return preparation services. Was it an example of an unwarranted government intrusion into a private sector market place? Or, alternatively, did it represent an appropriate case of government oversight and regulation?

Seventeen Competitors … Or Only Three?

At first glance, the market for DIY income tax preparation services appears to be a highly competitive one. After all, the Internal Revenue Service promotes seventeen organizations that offer tax filing services to the public … and those are only the firms that are willing to provide free assistance to citizens with relatively low Adjusted Gross Incomes! Many other firms across the nation sell competitive services as well, although they decline to provide any free filings.

It is indeed a broadly diverse list, ranging from the national for-profit industry giant HR Block to the tiny start-up I-CAN! program of the nonprofit Legal Aid Society of Orange County, California. Nevertheless, it is important to note that 90% of all electronic tax filers across the nation have opted to utilize the services of only three organizations: Intuit, HR Block, and 2nd Story Software.

Intuit, of course, is a $3.5 billion global technology company. And HR Block prepares one out of every seven tax returns that are filed in the United States. 2nd Story, though, is a relatively small, privately owned firm that has made its mark by being a “maverick” on service pricing.

In October 2010, HR Block announced a plan to acquire 2nd Story and its TaxACT filing service, a move that would effectively consolidate 90% of the federal income tax filing market into the hands of a pair of industry giants. After studying the merger for more than seven months, the DoJ filed a lawsuit last week to block the transaction in order to preserve private market competition.

Broader Ramifications

The questions raised by the DoJ’s action, of course, extend far beyond the DIY income tax filing industry. Does the federal government possess the right to prevent private corporate mergers in the name of preserving competition, even for industries that actually support a large and diverse collection of competitive service organizations? Can it justify taking such actions by noting that the largest competitors in the industry have amassed significant shares of the total market?

These broad questions are relevant to regulatory policy in many economic sectors, including — perhaps most importantly, considering the current debate over federal policy regarding Medicare — the health insurance industry. After all, in many population centers across the United States, the market share of the two or three largest private health insurers now exceeds 90%. The entire state of Rhode Island, for instance, is only served by three commercial insurance companies, with Blue Cross Blue Shield serving 70% to 80% of the self-insured large group and fully insured markets, and with the national industry giant United Health serving another 10% to 20% of these clients.

While the debate over national health care policy raged through Congress last year, many Democratic proponents of a “government option” supported a proposal to trigger such an option where ever private insurance markets are non-competitive as a result of insurer consolidation. If the DoJ succeeds in establishing that a large market share in the hands of a duopoly of tax return preparation providers is in fact non-competitive, could it then reassert the need for a “government option” health insurance plan in states like Rhode Island by utilizing the same rationale?

Similar questions can be asked about the federal government’s sponsorship of Amtrak in the public transportation industry, of the U.S. Postal Service in the package delivery industry, and of many other government programs and services as well. To prevent free-for-all disputes from flaring up in each of these ostensibly unique industries, it may be helpful to begin such debates by achieving some level of consensus about the appropriate role of government in maintaining market competition.