He still doesn't get it

Let me start by saying that I am no fan of Supreme Court Justice Clarence Thomas – quite the opposite. He's an embarrassment, and has been since the day he was inflicted on the American legal system as a cruel joke by the Bush family. A bill of particulars regarding Thomas's unsuitability for the High Court would make up a large volume.

But of all the questionable things he's done, the judge is being attacked lately by Oregon's own sainted senator, Ron "Gatbsy" Wyden, for an alleged wrong that Thomas didn't do. Wyden, whose long tenure as chair of the Senate Finance Committee has produced little of real value, is a big grandstander, more than anything else. In this case, he keeps using his office to insinuate that Thomas cheated on his income taxes over the forgiveness of a six-figure loan to him by Anthony Welters, who Thomas says is his friend. That transaction stinks to high heaven, obviously, but old Ron keeps insisting there's a tax angle to it. This week he and another senator wrote another nasty letter about it to Thomas's lawyer, in which they doubled down on their tax theory:

Your client’s refusal to clarify how the loan was resolved raises serious concerns regarding violations of federal tax laws. As you are aware, the failure to repay the entire principal of the loan would have generated a significant amount of taxable income for Justice Thomas. The tax code makes clear that in instances where debt is canceled, forgiven or discharged for less than the amount owed, the borrower must report the amount canceled or forgiven as income on federal tax returns. At the moment, Justice Thomas has done absolutely nothing to address the perception that he may have failed to report hundreds of thousands of dollars in forgiven debt on his federal income tax returns and pay the income taxes owed.

Take it from somebody who has taught courses on federal income tax for nearly 40 years: Wyden's barking up the wrong tree. I wrote about this last fall, when he first whipped out his poison pen on the issue, here. I'll repeat the gist of it now in case somebody in the senator's motley entourage might stumble across this post. They obviously didn't read it the first time, although it was picked up pretty prominently on TaxProf Blog:

Alas, the Times marred its story with some faulty analysis of the tax consequences of the transactions to Thomas. Somebody gave the Times reporter, Jo Becker, the mistaken impression that even if Welters forgave the loan strictly out of generosity and affection, Thomas would have taxable income from the cancellation of the debt. That's just wrong. Cancellation of debt as a gift is not income to the borrower for tax purposes. If you owe your father money, and on your birthday he rips up your IOU to show he loves you, that's not income to you. It's a gift. The test is the lender's motivation in forgiving the debt.

And so unless Thomas promised or delivered something to Welters in return for the debt cancellation, it was most likely a gift, and there is no tax scandal, as much as the Times reporter thinks she has one.

If you don't believe me, take it from Professors Boris Bittker and Lawrence Lokken, the undisputed leading commentators on federal tax:

Creditors occasionally forgive claims as an indirect way of making gifts to relatives, friends, and nonprofit organizations. If a proud grandparent who loaned money to a favorite grandchild for college tuition is overcome by emotion on graduation day, tears up the promissory notes, and announces that the debt is forgiven, the transaction is so clearly outside the proper ambit of Kirby Lumber that even the most assiduous revenue agent is not likely to assert that the grandchild has income on the cancellation of the debt. The transaction is tantamount to a gift by the grandparent to the grandchild of enough cash to enable the latter to pay the debt in full, and bears no resemblance to the financial adjustments that give rise to debt discharge income. 

Now, I suppose there's a chance that there was some sort of quid pro quo provided by Thomas to Welters in return for the money – let your imagination run wild – in which case the forgiveness of the loan would in fact be taxable to Thomas. But there's no allegation of that. Wyden keeps acting as if all cancellation of debt is taxable as gross income, and that's simply incorrect.

There's the possibility that Welters was liable for federal gift tax on forgiving the debt, but that's not what Wyden is pontificating about.

Will somebody please tell him? He, the mighty chair of the Senate Finance Committee, has basic income tax analysis wrong. It's Tax 101. Legend has it that Wyden flunked the bar exam three times before giving up trying to pass it. This episode certainly does not cast doubt on that story.