On Friday afternoon, just at the time of the week when people unveil unhappy news releases in order to minimize media coverage, the McCain-Palin campaign released Sarah and Todd Palin's federal income tax returns for 2006 and 2007. The returns do not include as taxable income any of the per diem allowances or travel expense reimbursements that the State of Alaska paid for travel by Sarah or Todd Palin, or by three of their children (Bristol, Willow, and Piper Palin), in 2007. At roughly the same time as it released the returns, the campaign also handed out an opinion from a Washington, D.C. tax lawyer that purports to address at least some aspects of the propriety of the omission of the travel money from the 2007 tax return.

Since then, one commentator has reported that there is now a "wonky debate" as to the correctness of their omitting the travel money from their tax returns. We disagree. There is no serious debate (at least, none that has been brought to our attention) about the fact that at least the amounts paid for the children's travel -- $24,728.83 in 2007, according to the Washington Post -- are taxable. The campaign's tax lawyer has got at least that much of the law, and perhaps more, wrong.

The opinion is from Roger M. Olsen, an M Street solo practitioner who was a tax official in the Reagan administration. His specialty appears to be the criminal side of the federal tax laws. Olsen's three-page letter never comes out and directly says "It's my opinion that the travel payments the Palins received were not taxable to any of them." 1 Instead, it bobs and weaves a fair amount and never lands squarely on point:

Unless employees have reason to know that the W-2 is incorrect, the IRS expects employees to rely on the employer's W-2 as prepared & filed with the IRS, as Governor Palin did. The income tax aspects of fringe benefits are complex and highly technical, and not subject to second-guessing by laymen. The State of Alaska is confident that its position is correct. Its employees were entitled to rely on that determination. So was Governor Palin. Finally, under State law, the spouse of the Governor (or other family members on occasion) is entitled to payment of travel costs by the state when conducting official State business. I find no reason or rule of law that would lead me to a different conclusion as to his receipt of such State payments. Such payments for family members traveling on state business would not properly be included as taxable income on Governor Palin's federal tax returns.

Let's take the two paragraphs in order. The first one never actually says the payments weren't taxable income. It says that the Palins were "entitled to rely" on what the state did and didn't include on the W-2. What is that supposed to mean? If Olsen is saying that the federal tax consequences of payments from one's employer are conclusively determined by one's employer's treatment of the payments on the W-2, that's just flat-out wrong. Granted, the employer's omission of the payments might help the employee defend against any civil or criminal penalties that might be asserted, but no one with any credibility has suggested that the Palins have committed any fraud or behaved negligently. (The "tax cheat" headlines pouring out of the blogosphere over the last day or so are idiotic.) The Palins, who had their tax returns done by HR Block, simply got it wrong. And the fact that the state payroll office got it wrong, too, doesn't erase the Palins' unpaid tax liability.

On to the second paragraph just quoted. After one totally irrelevant sentence about state law, and another sentence referring back to the baffling first paragraph, Olsen finally does say -- or comes close to saying -- that the amounts the Palins received for travel were not taxable (not to Governor Palin, anyway). But here, there is no doubt that he's at least partly wrong. There is no question whatsoever that the payments for the Palin children's travel -- $24,728.83 -- were indeed taxable to Governor Palin. The money paid for Todd Palin's travel -- $18,761.37 -- might possibly turn out to be tax-free, but it would be quite a stretch. And the per diems and other travel payments to the governor herself ($16,951) may or may not be taxable, but certainly not because state law or the state payroll office says so.

The children's travel payments are clearly taxable income. In our earlier post on this back on September 10, we theorized that Section 274(m)(3) of the Internal Revenue Code required that the payments be reported as income. Just yesterday, Bryan Camp, a tax professor at Texas Tech Law School, uncovered an obscure regulation 2 (at least, it was obscure to us) that renders Section 274(m)(3) inapplicable to the Palins' situation. But that regulation puts them back under the tax regime for deductions for business travel under older law (pre-1986), 3 and under that older set of rules, there is still no way they can exclude the payments for the children.

The Palins, living as they do in Alaska, are governed by Ninth Circuit law. The key case on deductibility of family travel expenses in this circuit is Stratton v. Commissioner, decided in 1971. In Stratton, a State Department foreign service officer's own travel expenses were ruled deductible, but his wife and children's travel expenses were held to be nondeductible. The court of appeals declared, in a passage that would seem quite applicable to the Palin children, if not also to Todd Palin:

Mrs. Stratton and the children are not employed by the Department. There is no mandatory requirement either by statute or regulation, that they accompany the employee on home leave. The reason that the family customarily does accompany the employee is no doubt due in large measure to the fact that the Secretary of State is authorized to pay their travel expenses to and from this country. 22 U.S.C. Sec. 1136 (1964). However, the fact that these expenses are so paid does not clearly indicate that the Department, as a matter of policy, or that Congress in adopting Sec. 1136, felt that the family's reorientation to the American way of life was necessary to the conduct of Stratton's trade or business as a foreign service officer. At best, it represents an accommodation by the Department to enable the family to fulfill its personal needs in reacquainting itself with the homeland at the same time that the employee is renewing his knowledge for business reasons. Finally, the asserted "public relations" duties of Mrs. Stratton are unspecified and, without further support in the record, must be considered to be incidental to her husband's business within the meaning of [the regulations]. 4

The Palin children cannot be performing more than incidental services for the state -- if they provide any at all. Under Stratton, then, there is no "business purpose" for their travelling between Juneau and Wasilla, and thus their travel payments are taxable.

Which brings us to Todd Palin, the state's "First Dude." Could his travel meet the test of the regulations? They state (pardon the sexist language -- they're old regulations):

Where a taxpayer's wife accompanies him on a business trip, expenses attributable to her travel are not deductible unless it can be adequately shown that the wife's presence on the trip has a bona fide business purpose. The wife's performance of some incidental service does not cause her expenses to qualify as deductible business expenses. The same rules apply to any other members of the taxpayer's family who accompany him on such a trip.

And the Stratton case makes clear that the spousal services must assist the employee spouse's business of being an employee, not the employer's overall business. Can whatever Todd Palin does for the State of Alaska as an unpaid volunteer meet this test? Can he even make that claim with a straight face?

As for Governor Palin herself, questions have been raised as to how she could be "away from home" for tax purposes -- that is, away from her principal place of business -- when she was in Wasilla. Olsen's opinion baldly states that her "tax home" was Juneau, the state capital, but that is hard to square with the fact that the governor spent the majority of her time in Wasilla and in Anchorage, where she works at a state office building. If Olsen is wrong and Anchorage was her "tax home," reimbursements for time spent in Anchorage and vicinity would appear to be taxable.

Even if Juneau is her "tax home," there is also the real possibility that her frequent trips between Juneau and Wasilla are simply long-distance commuting, which is a completely nondeductible, personal expense. In that case, all allowances and reimbursements for gubernatorial travel between the two cities would be taxable. 5

There is more to brood about on the Palins' returns, to be sure. Last year Todd Palin claimed losses from his snowmobile racing "business" as a tax shelter against his fishing income. He also claimed deductions for use of a portion of the Palins' residence in his fishing business -- deductions that are difficult to claim legitimately, and which may be further complicated if, as reported, the state reimbursed the Palins for use of that home as a travel allowance.

But leaving all of that aside, the Palins should have reported as taxable income, at the very least, the $24,728.83 of travel reimbursements for the children. That income would have been taxable to them at somewhere between 25 and 28 percent, and so they are in the hole to the government for more than $6,000, plus interest since at least April 15 at the rate of between 5 and 6 percent a year. They should file an amended return and pay the resulting tax and the interest. And if somebody at the IRS took a good, hard look at the payments for Sarah and Todd, we would bet that there would be some additional tax due there as well.

UPDATE, 10/6, 3:26 a.m.: An important fact has emerged that makes what first appeared to be an honest mistake by the Palins into a potentially more serious matter. It now appears that State of Alaska finance officials did not follow their own official policy on tax reporting and withholding on long-term per diems in the case of Governor Palin's per diems. We have details here.

UPDATE, 10/8, 3:08 a.m.: It has come to our attention that the dollar figures in the Washington Post story covered a 19-month period, not just 2007. Regardless, much of the money was paid during that year, none of it was reported, and most of it should have been. The state should have withheld income tax on it and reported it on the governor's W-2 -- and should be doing so now.

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