Phil has left the building

Phil LoBue, the taxpayer in the famous Supreme Court stock option case, was reportedly quite a character.  He was born in Sicily and lived in Leonia, New Jersey, across the river from the Big Apple, where he worked.  One of his proteges in the sales industry later wrote in a memoir that LoBue was "small, loud, and generous" and referred to himself as "the smallest Mafioso."  The colleague also wrote: "Before I left for my first trip to Europe, Phil had given me an envelope containing $100 with careful instructions where to spend it."  He didn't elaborate.

LoBue used to show up at various gatherings of chemical company executives, including a 1948 dinner put on by the New York Board of Trade (photo right).  He reportedly was a regular at the Chemists Club, a swanky industry hangout in midtown Manhattan.

Although employee stock options are often intended to engender company loyalty, it doesn't always work out that way.  Certainly it didn't with LoBue.  A February 3, 1947 story in the New York Times noted that Phil was leaving Michigan Chemical to start his own chemical sales firm.  As you may recall, LoBue exercised his options in 1946 and 1947, and so he wasn't an employee-stockholder of Michigan Chemical for long.

LoBue was born in 1901.  In 1931 he married Edna Reidel, who was five or six years younger than he.  The couple had two children, Bonnie Ann and Philip, both of whom are still alive and living in northern New Jersey.  They are 71 and 68, respectively.  Edna worked for 14 years as a secretary for the comptroller of AT&T.

The elder LoBue -- the taxpayer in the famous case -- died in 1970, at age 68.  Edna remarried and outlived her second husband as well.  She died in 2008 in New Jersey at the age of 101.

In the back with the boxes, a tax issue

Commercial cargo jets, like the ones flown by FedEx, don't have windows on the sides.  The packages don't need to see the view.  But the aircraft do come equipped with a few "jumpseats" -- two in the cockpit and a few more in the cargo hold, often just behind the cockpit door.  These seats are reserved for unusual customers who have to accompany their freight to its destination -- when livestock is being transported, for example -- and they're also used by government aviation inspectors, maintenance personnel, and reportedly even Secret Service agents from time to time.

When no one is using the seats on official business, the cargo carriers reportedly allow some of their employees to occupy them for personal travel, without charge. It's not glamorous, and the routing is usually quite inconvenient (Portland to Seattle via Memphis, anyone?), but in some situations, it beats paying full fare or staying home. When employees take advantage of this perk, can they exclude its value from their gross income under section 132 of the Code?

This very question was presented to the IRS in the mid-1980s.  The agency audited a cargo carrier (believed to be FedEx), and the IRS agent conducting the audit asked the national office for a "technical advice memorandum," one of the nonprecedential types of IRS guidance I talked about the first night of class.  (Actually, it was the company's employees who would have to pay the income tax, but the company needed to know whether the flight values were wage income for tax withholding and Social Security tax purposes.)

The technical advice memo (8741007)  was issued on June 5, 1987.  In it, the national office ruled that the fair market value of the employees' personal travel was gross income to them, because it did not fit into the definition of a "no-additional-cost service" as defined in section 132(b).  As you will recall, that definition requires that the service be "offered for sale to customers in the ordinary course of the line of business of the employer in which the employee is performing services."  The IRS reasoned that the employer did not offer customers the same "service" that the employees were enjoying when they were sitting in the jumpseats.  "Because the jumpseats are not offered for sale to customers," the IRS reasoned, "their use by employees is not the result of unsold capacity."

To paraphrase the IRS ruling, FedEx was not in the business of passenger transportation, but rather in the business of freight transportation.  FedEx had argued, in effect, that the "service" it provided in its business was air transportation, period.  To the taxpayer, transportation of people and transportation of packages were the same thing -- transportation of matter, as it were.  That argument fell on deaf ears.

Taxpayers of means often don't take defeat at the hands of the IRS lying down, however.  Instead, they get on the phone with their lobbyists and friends in Congress.  Sometimes, they get special legislation passed to make their tax issues go away.  And so it was in this case.  Take a look at Code section 132(j)(7), which took effect Jan. 1, 1988.  Gong!  Problem solved, at least prospectively.

"Surf riding" with Arthur B.

The Royal Hawaiian Hotel in Waikiki, where Arthur Benaglia worked (and ate and slept), has a rich history.  It's told in a nice book full of photos called "The Pink Palace," by Stan Cohen, published in 1986.

One of the many items that collectors covet from the heyday of the hotel are the dining room menus, whose covers were true works of art.  Nowadays, some of them, by an artist named John Melville Kelly, can run $50 or more.

Too cheap to spring for one of those, I did pick up a while back a matchbook of unknown vintage from the Royal Hawaiian-Moana complex:



When I look at it, I like to imagine myself lighting up a cigar on a beachfront veranda at the hotel and enjoying a mai tai and some laughs with my wife, and Arthur Benaglia with his wife Elise, and maybe a couple of celebrity guests, circa 1935.  Arthur served as the general manager of the Royal Hawaiian for nearly two decades from its opening in 1927.  (An older Royal Hawaiian Hotel, founded by real Hawaiian royalty in the 1800's, had been on a different site nearby.)

Research reveals that Arthur was an experienced hand at the hotel business when he got to Hawaii.  Born in Milan, Italy, he had grown up in a hotel family, and he worked at inns in Switzerland, Germany, England, and Scotland before moving to Canada at age 18.  In London, he was trained at the Hotel Carlton by someone named Escoffier, identified in one account as "founder of the modern French cuisine."

Young Arthur worked for a while in Montreal, but then he became a hotel manager, running the Vancouver (B.C.) Hotel and the wonderful Empress Hotel in Victoria.  He eventually took over management of the Banff Springs Hotel, which was then under construction.  From there he moved to New Orleans, where he managed two hotels, one of them being the New Roosevelt Hotel on Canal Street.  Then he boarded a cruise ship for the long trip from San Francisco to Hawaii, where he stayed for quite some time.

Hawaii historians remember Benaglia as a masterful manager of people, with exquisite taste, top skills as a promoter, and an intimate knowledge of every detail of the Royal Hawaiian, since he had been there since it was just a hole in the ground.  The guy really knew his stuff.

After leaving Hawaii during World War II, Arthur worked briefly in Los Angeles, and then he assumed management of the Plaza Hotel on Central Park in New York.  He died of a heart attack six months after arriving in Manhattan, in June 1944 -- in his apartment at the Plaza, of course.  He was 61 years old when he passed on.

UPDATE, 5/22: We ran into Arthur again in connection with a recent vacation to the 50th State.

Present value makes the world go 'round...

... the financial world, at least.

If you were with me as we calculated the present value of future receipts, consider the fact that one can compute the present value of even an infinite stream of future receipts.  As explained in Chirelstein's appendix, at 5%, the present value of $1 a year forever is $20.

How can one calculate the value of an infinite annuity?  If we do it manually, it's going take a long time.  We can take the present values of $1 every future year, and add them all up.  We'd start with year 1, then year 2, year 3, etc., and keep going until we drop or until we see that it's useless to continue.  Here are the first 10 years -- and let's use $100 annual receipts:

PV of $100, 1 year from now: $95.24
PV of $100, 2 years from now: $90.70
PV of $100, 3 years from now: $86.38
PV of $100, 4 years from now: $82.27
PV of $100, 5 years from now: $78.35
PV of $100, 6 years from now: $74.62
PV of $100, 7 years from now: $71.07
PV of $100, 8 years from now: $67.68
PV of $100, 9 years from now: $64.46
PV of $100, 10 years from now: $61.39

Adding those all up, we get to $772.16, with many more years to go.  But as you can see, the amounts get smaller as time marches on, and that trend will continue for as long as we want to play this game.  Here's year 15:

PV of $100, 15 years from now: $48.10

Here's year 30:    PV of $100, 30 years from now: $23.14

Here's year 50:    PV of $100, 50 years from now: $8.72

Here's year 100:    PV of $100, 100 years from now: $0.76

Eventually, the present values get so small that you can hardly see them, and as it turns out, they eventually disappear from the naked eye. For example, the present value of a $100 payment to come in 250 years from now is $0.0005.

In the end, the present value of the infinite stream is $2,000.  In other words, if one deposits $2,000 in a 5% account, one will get $100 a year to spend, every year, forever, leaving the original $2,000 in place to keep going.

When the annual payment is $100 and the present value is $2,000, it is sometimes said that the "multiplier" is 20.  That is, the present value is 20 times the annual payment.  The multiplier is just the inverse of the discount rate.  1 divided by .05 = 20.

Now here's where Wall Street comes into the picture.  When discussing the price of a stock that's traded on a national exchange, people often refer to the company's "price-earnings ratio."  And that's just another name for the multiplier.

For example, take a look at this entry on Yahoo! Finance for Dow Chemical:

Over on the right, do you see the line "P/E (ttm)"?  That stands for price/earnings (trailing 12 months).  What Yahoo! has done is compare the share price of the stock (P), $27.07, with the earnings per share of the company for the most recent 12 months (E), $2.18.  In this case, the stock price is 12.41 times annual earnings ($27.07/$2.18), and so the multiplier is 12.41.

Given that multiplier, the discount rate that the market is apparently applying to that stock -- the inverse of the multiplier -- is 1 divided by 12.41, or 8.06%.  The P/E ratio is a rough way of saying that the discount rate that investors are using in pricing that stock is 8.06% a year.

The P/E ratio shown there is crude in one respect -- it looks backward at the last 12 months of earnings, which is public knowledge because of the company's regular filings with the SEC.  In fact, a smart investor is looking to the future, not the past.  He or she is trying to predict, and then present-value, future receipts.  The past may be some indicator of future earnings, but there are certainly no guarantees.  And so it's not entirely certain what discount rate the market is actually using.  But P/E based on the last 12 months tells us something.

Most importantly, the fact that the P/E ratio is calculated and published for every public company, in real time, shows that investors are keenly interested in present value.  Present value is what that ratio is all about.

Cloak, dagger, and tax code

Wow, here's a unique gig for a tax type: tax attorney for the CIA.  But you'll need three years' practice experience, and you can't tell anyone you're applying.

More about that statute of limitations

At our first class meeting, I mentioned that taxpayers sometimes dig themselves a deep hole with their tax liabilities.  Sometimes they'll owe a decade or more of back taxes to the government.  When the IRS finally gets around to coming after them for it, the tax ruins them financially.

In response to a question, I added that there was a general three-year statute of limitations for the IRS assessing tax deficiencies -- extended to six years if the taxpayer omits a substantial amount of gross income from his or her tax return (as opposed to claiming improper deductions).  But how can the taxpayer be on the hook for more than six years' worth of income taxes?

It's easy to understand once you see how the statute of limitations (Code section 6501(a)) works.  The time for the IRS to assess income tax against the taxpayer generally runs for "3 years after the return was filed."  Therefore, if a taxpayer doesn't file a return, the statute doesn't even begin to run.  This is confirmed by Code section 6501(c)(3).

And as was also mentioned in class, if the taxpayer files a false or fraudulent return with the intent to evade tax, the tax due on that return may assessed against the taxpayer "at any time" -- that is, the statute never runs.  See Code section 6501(c)(1).

Ted Drescher, the guy

A couple of years ago, an alert member of my Income Tax class prowled around on the internet and turned up some interesting information about Ted Drescher, the person.  And of course, that got me going, and I unearthed some other details about him.  They really have no significance from a substantive perspective, but some people just love the human stories behind tax cases, and if you're one of those, you might enjoy what we found.

It turns out that Ted was the grandson of Johann Jacob Bausch, one of the founders of (and the brains behind) Bausch & Lomb.  Ted's mom was Bausch's daughter, Anna Julia (~1869-1959); she married Willibald Drescher (1861-1937), who like Anna's dad was an immigrant from Germany.  (That may be Willie in the left foreground of this photo.)  Ted (named after his grandfather on his father's side) was Anna and Willie's only son; they also had two or three daughters.  When J.J. Bausch died in 1926, he left grandson Ted (then in his early 30's) 100 shares of the company in his will.

Here's an interesting story about Ted's childhood home in Brighton, New York, which is adjacent to Rochester.

At one point, the company got in trouble in a criminal antitrust case, and Ted was one of the officers hit with a civil suit over the same matter years later.  But the civil case was dismissed.

Ted was also a bit (scroll down) of an inventor.

Interestingly from our perspective, Ted never did live to collect on that annuity of his.  He died of a heart attack in 1953, at age 58, meaning that his beneficiaries (probably his widow, Rolena (d. 1986), and two daughters, Anna (d. 1993) and Marjorie (1926-2009)) would have gotten the death benefit specified in the policy.  Ted's mother was the last surviving child of J.J. Bausch; she died in 1959 at age 90.

Ted's buried with at least 15 other members of the Drescher clan in Mount Hope Cemetery in Rochester.  That's the same cemetery in which lie the remains of Susan B. Anthony and Frederick Douglass.