74 Tax Notes 367

Tax Notes

JANUARY 20, 1997

LENGTH: 483 words

DEPARTMENT: Special Report (SPR)

CITE: 74 Tax Notes 367

HEADLINE: 74 Tax Notes 367 - Response, The Roads Not Traveled: Professor Johnson Responds

AUTHOR: Johnson, Calvin H.

University of Texas Law School

GEOGRAPHIC: Texas

TEXT: 20 JAN 97

In my article, 'The Illegitimate 'Earned' Requirement in Tax and Nontax Accounting,' 54 Tax Law Review 373 (1995), I argued that compensation is income when received, even though the recipient has not yet performed the services. Deferring recognition of the income until it is earned understates the true economic value of the income. In their article, 'Toward a Sound (Neutral) Tax Policy for Prepaid Income From Services,'(see above) Professors Seago and Callihan argue that compensation received before the services are performed cannot be income until the compensation is earned. In our common hypothetical, Lawyer F receives an immediate retainer of $1 million for services to be performed over the next five years. I would book and tax the $1 million immediately. Professors Seago and Callihan would book and tax the $l million over the next five years as earned, albeit with an interest augmentation in recognition of the fact that both F's services and the cash he receives have a net present value of exactly $1 million.

Their rationales do not persuade me. They argue that F's net worth is not increased by the $1 million when received, because F gave up other opportunities. They argue that before the receipt, F had an asset, 'human capital,' equal in value to the net present value of opportunities that F had. By taking the retainer, F has given up the other opportunities. The $l million cash was not a gain, but just an exchange of the cash for human capital.

Neither opportunity cost nor human capital can be maintained consistently as a reason not to book or tax income. I work for the University of Texas, say for $10 a day. Given my education and experience, I could make more. Assume that I realistically had opportunities to make $100 a day someplace else. My human capital, measured by my opportunities, is $100 a day. My contract with Texas requires me to give up those opportunities.

Applying their theory consistently, opportunity is a cost, and sale of human capital justifies exemption. Consistently, every time I am paid my $10 I have no income. The opportunity cost and disposal of a human capital asset blocks the income. Moreover, since my costs and value of the human-capital asset are greater than my paycheck, every paycheck is an economic loss, under their theory, of $90 a day. I am not unique; anyone would have no income or a loss because every paycheck means that other opportunities were forgone. The roads not traveled would prevent any paycheck from being considered income. This is not a timing issue. Opportunity costs and zero basis assets, no matter what their nature, do not ever block income before earning, after earning, or ever.

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Sincerely,

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Calvin H. Johnson

University of Texas Law School

Austin, Texas

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