Guest Writer: Mark C. Cooke

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The Problem with Tax Systems

The problem with tax systems is non-abrogative exploitation. In other words, it’s the shades of grey that force systems to evolve. Or, rather, force them to devolve. The more ”creative interpretation” that exists, the more statutory language is required. However, the larger the law (and it might be relative to sheer word count alone), the more chance for opportunistic use. Closing the so-called loopholes by adding language, then, often creates exactly what it tries to dissuade.

The best examples come from tax benefit programs. In order to give a benefit you must determine who should receive it, how they should receive it, and on what cycle. Ideally, the law will describe the penalties for those who abuse the system, too. In the absence of the latter, though, the statutes should speak with great specificity to who is eligible and how they qualify. Laws that lack clear language result in an increase in abuse and a multiplication of language to cover every possible permutation.

The Homestead Exemption – also known as the principal residence exemption, legal residence exemption or qualified homestead – suffers from this circumstance almost universally. It was intended to give a property tax exemption to homeowners who reside at a single address. Nonetheless, various methods have been employed to secure reductions/exemptions on multiple properties by the same owners and always within a ”creative interpretation” that doesn’t fall over into the realm of criminal fraud. Legislative remedies have been employed, only to tax (pun intended) the creative efforts of those same creative interpretivists.

Estates and Trusts have been used successfully to this end. Sufficiently complicated, the statutory remedies are often long and convoluted. However, any concept involving fractional ownership has likely been employed. Parents’ co-signing on a child’s residence and then qualifying on both properties is the least offensive seeming. However, it has been used by parent’s that also buy investment properties around universities, renting out space to others, and receiving exemptions nonetheless.

The extreme example comes from landlords who use a real estate instrument known as a land contract. Often in these cases, because the exemption savings are significant, the property owner will enter into a land contract with a tenant. Variations exist, but usually the contract stipulates that the lease of property is for a year, and title conveys after rent has been paid for thirty years. Alternatively, it may convey one percent ownership, as long as the tenant resides on the property. Either way the landlord can amend the title to meet the two criteria? fractional ownership and residence. Thus, the loophole is exploited.

Variations are as frequent as circumstances for people’s lives. Elderly exemptions are granted even if the elderly do not meet the residence requirement. When the real estate market fell, one state allowed those trying to sell a property to have multiple exemptions, as long as they still lived in the state and all but one property were actively on the market. Both of these sound like great humanistic additions, but they have opened the door for a great deal of abuse that now qualifies in a terrible shade of grey.

The best solution is to have a clear and simple statute around the exemption. That statute should also have sufficient penalties and a statute of limitations long enough to disincentivize would-be opportunists. Another solution is to have the tools to check for potential abuse. The real solution, though, is to use both of these actively. There is no greater loophole than the lack of political will to prosecute those that abuse the system.


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Mark Cooke
Mark C. Cooke, Ph.D. is the Chief Innovation Officer for Tax Management Associates, Inc., a privately held firm dedicated to revenue enhancement solutions for state and local government.