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Costly Misconceptions of Law and Legal Services: The Small Business Owner vs. the Chicago Personal Property Tax

  • Kenneth P. Fisher and Gail S. Humphreys

Abstract

Inaccurate perceptions of the law by ordinary citizens, especially when resolution of conflicts caused by such perceptions is usually handled by lawyers, can lead to cynicism and distrust of government, the legal system, and the lawyers who participate in the system. The authors present some results of research into the functioning of a particular part of the system in a particular place to show how all participants keep the situation from being changed.

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1 One hundred and one business owners consented to personal interviews that lasted from 20 minutes to 2½ hours. The mean length was about 50 minutes. We defined “small” as any business with fewer than 20 employees which was actually operated by the owner. Shortly after the study began, it was decided to add the further limitation that the businesses be retail firms. Thus, while there are a few service firms in the study, the prime focus is on retail establishments.

2 The full report of the American Bar Foundation's study of Use and Nonuse of Lawyers and Legal Services by Small Business Entrepreneurs in Chicago is in preparation, with publication expected next year.

3 The following pages present a view of the system from the perspective of the small business owner. The quotations are taken directly from our interviews with private entrepreneurs during our study of the use of law and legal services by small firms. If, in reading this section, the reader has some confusion about how the personal property tax procedure really works, that confusion is not entirely unintentional, for it mirrors that felt by the business owners.

4 III. Rev. Stat. ch. 120, § 499 (1971), provides for ad valorem taxation of all real and personal property and all bases of intangible value of corporations and associations used, held, owned, or controlled by persons residing in the state. On November 3, 1970, an amendment to the 1870 Illinois Constitution was approved (effective January 1, 1971, six months before the new 1970 constitution became effective), which provided that “the taxation of personal property by valuation is prohibited as to individuals.” Ill. Const. art. IX-A (1870, amended 1970) (emphasis in the original). In keeping with the will expressed by the electorate in approving this amendment to the old constitution, the new constitution was drafted to provide that “[a]ny ad valorem personal property tax abolished on or before the effective date of [the 1970) Constitution shall not be rein-stated.” Ill. Const. art. 9, § 5(b)(1970), as cited in Note, “The ‘Individual' Exemption from the Illinois Personal Property Tax,” 9 J. Mar. J. Prac. & Proc. 424 (1975-76). The meaning of the term “individuals” was the subject of lengthy litigation and additional legislation, the ultimate result of which was the exemption of natural persons and sole proprietorships.

A better understanding of the small business owner's actions with regard to the tax requires some historical background. Many small business owners, prior to their business ownership, had lived in Cook County when the personal property tax applied to private individuals as well as to joint business ventures. The theory that wealth should not escape taxation by virtue of its investment in personalty rather than realty was, however, difficult to effect in practice. Personal property is obviously easier to conceal and harder to assess than real estate. The administration of the tax in Cook County was notoriously inefficient-relatively few individuals ever paid the tax or even returned the property inventory forms. Thus it came to be the common wisdom that any re-quest for personal property information should be promptly discarded. Of course, not all owners are acquainted with this folklore, but those who are not are usually fortunate enough to have a business associate, accountant, or lawyer who will be glad to explain that the initial tax should not be paid. And once an owner has been through the routine he knows that he can ignore the schedule and the tax bill and pay a much reduced tax after his case goes to suit (see discussion in sec. B, infra at 556-59).

5 The assessor's tendency toward generous assessments and the high'tax rate both contribute to the unduly high tax, but the main factor is a 50 percent penalty—discussed in the next section—which is added to the assessment of each taxpayer who does not file a schedule. Two factors should be noted here: (1) the penalties may have the effect of increasing the tax bill by 50 percent each year, and (2) there is no recognizable notation on the taxpayer's bill that any penalty has been added. It appears as part of the assessment, so that from year to year according to the tax bill, the value of the business has increased by 50 percent. Of course, this seems outrageous to the owner.

6 Early in our interviewing, a hardware store owner outlined the procedure to us. From then on, when business owners acknowledged that they used a lawyer to handle the personal property tax but provided no further information, we asked them whether their procedure followed the one outlined by the hardware store owner. The question was asked in this fashion: “Is it the same process we have observed with other owners—you get the bill, ignore it, receive a summons, and then have your lawyer get the bill reduced?”

7 Lawyers who charge their clients one-third of the reduction they obtain would have a strong incentive to advise their clients not to file the tax form. The addition of the 50 percent nonfiling penalty maximizes the initial tax bill; thus, when the penalty is waived, the resulting contingent legal fee would be increased by more than 50 percent.

8 We also observed personal property tax cases being tried in the Cook County Circuit Court—in both the Municipal and Law Divisions—and we interviewed judges from both divisions.

9 It is interesting that the registered agent—usually the firm's lawyer—is often more cooperative than the owners in providing information to the assessor. A member of the assessor's staff surmised that this may be because the agent is a lawyer who would like to represent the firm in personal property tax matters and thus wants his client on the tax rolls as soon as possible.

10 Illinois Department of Local Government Affairs, Form No. OFA 180 for fiduciaries, partnerships, and associations; Form No. OFA 181 for nonservice corporations and tangibles of service corporations; and Form No. OFA 100 for capital stock of service corporations.

11 The current Cook County personal property tax rate varies from 8 percent to 15 percent, depending on district, and the state equalized assessment is supposed to approximate 33 percent of market value, yielding a theoretical effective tax rate ranging from 2.67 percent to 5 percent of market value of tangible and intangible personal property. This is unrealistic, however, because this rate could be as much as half the net profit of a healthy firm. In practice, therefore, administrative procedures depart substantially from the market value concept, e.g., inventory and equipment are taxed at 35 percent of depreciated book value, a figure that may bear no relationship to market value.

12 On the first occasion that the tax bill includes the nonfiling penalty, use of this office formula will yield an adjusted tax bill that is lower than the assessor's base tax without the penalty (i.e., a $1,000 tax§bill with a $500 penalty will be reduced to $750). But our observations have led us to suspect that the next year's tax assessment for nonfilers is based on the previous year's initial tax bill, not the adjusted figure. If a taxpayer continues to fail to file, each new tax bill will include an additional 50 percent penalty on the previous year's amount. As a result, by the third year the tax initially billed will have increased to $3,375, for which the office formula reduction will yield an adjusted tax bill of $1,687.50.

13 The office formula provides for a 50 percent reduction of the capital stock tax in all Municipal Division cases, regardless of whether a schedule was filed. We have not dealt with the capital stock tax in detail because most of the small merchants in our sample are not assessed on their capital stock. In theory, the capital stock of a corporation is its intangible value, i.e., the difference between the market value of the corporation as a going concern and the market value of its tangibles and real estate. Some of the items of capital stock are good will, cash, bank deposits, mortgages, stocks, and bonds. In practice, the assessor estimates a firm's market value by computing a five-year weighted average of net profit and capitalizing it at a predetermined rate for each industry. The state's attorney uses a 10 percent capitalization rate for all firms; e.g., an average net profit of $10,000 per year would imply a market value of $100,000. In the case of small retailers the capital stock is often zero after the tangibles are deducted.

14 In his 1957 study of law practice in Chicago, Carlin reported:

A lawyer who has more or less left the practice of law indicated the importance of doing favors for Assistant State's Attorneys in handling personal property tax matters-at least during the time when he was more active:

The State's Attorneys expected you to take care of them (lunch, send a gift). Mostly so in the personal property tax area. This was years ago. ———used to try those cases. I wouldn't give him anything. Now he's on the bench. The people without influence pay the load. The people with political influence are taken care of beforehand. There's a horrible personal property tax situation.

Jerome E. Carlin, Lawyers on Their Own: A Study of Individual Practitioners in Chicago 68-69 (New Brunswick, N.J.: Rutgers University Press, 1962).

15 A nonsuit is the only disposition of a case that does not require a court appearance by the owner or his lawyer. It is possible to file an appearance on the return date and try to get a pretrial conference in court before the session begins, but this is not always feasible if the assistant state's attorney in court on that day is very busy with other conferences. The court appearance itself is nothing more than a confirmation of the agreement reached in the pretrial conference. Although the taxpayer or his lawyer must be present, no real participation is required.

16 The assistant state's attorneys seemed to feel that the administrative remedies available in the assessor's office are not really effective; in fact, we received the impression that the filing of an accurate return may be an exercise in futility. We should keep in mind, however, that the assistants of a Republican state's attorney might not be the most impartial sources of information about the practices of a Democratic assessor.

17 The Illinois Department of Local Government Affairs coordinates the administration of all property taxes authorized by state statute (including the personal property tax in Cook County), computes the “multipliers” required for tax equalization among the counties, and provides the assessments that local jurisdictions need to levy the capital stock tax on service corporations.

18 The shortcomings of the personal property tax have become a topic of current interest as we near the January 1, 1979, deadline for replacement of the tax: Ill. Const. Art. IX, § 5(c)(1970). It has been argued that section 5(c) is not a limitation but merely a mandate to the General Assembly and is thus not enforceable. Malcolm S. Kamin, Constitutional Abolition of Ad Valorem Personal Property Taxes: A Looking Glass Book, 60 Ill. B. J. 432 (1972).

(c) On or before January 1, 1979, the General Assembly by law shall abolish all ad valorem personal property taxes and concurrently therewith and thereafter shall replace all revenue lost by units of local governments and school districts as a result of the abolition of ad valorem personal property taxes subsequent to January 2, 1971. Such revenue shall be replaced by imposing statewide taxes, other than ad valorem taxes on real estate, solely on those classes relieved of the burden of paying ad valorem personal property taxes because of the abolition of such taxes subsequent to January 2, 1971. If any taxes imposed for such replacement purposes are taxes on or measured by income, such replacement taxes shall not be considered for purposes of the limitations of one tax and the ratio of 8 to 5 set forth in Section 3 (a) of this Article.

Even though the provision may not be enforceable on the General Assembly, it is feared that lengthy litigation of that point would tie up tax revenues in escrow. Accordingly, a proposed amendment to the Illinois Constitution would rescind the mandate for replacement. As this article goes to press, it seems likely that the amendment will not be approved by the electorate.

In the event that the amendment is in fact defeated, the General Assembly may pass House Bill 2418, which abolishes the ad valorem personal property tax and substitutes an increase in the state income tax on corporations (2½ percent); partnerships, associations, estates, and trusts (1½ percent); and public utilities (1½ percent of gross receipts). The choice is not an easy one. Although an income tax is probably preferable to a personal property tax, a co:porate tax of 2½ percent appears to us to be several times as great as the amount of personal property tax now actually paid by small business owners.

The authors wish to acknowledge the generosity and extensive cooperation of the small business owner respondents, the Office of Financial Affairs of the Illinois Department of Local Government Affairs, the office of the Cook County Assessor, the office of the Cook County State's Attorney, and the judges of the Cook County Circuit Court.

Costly Misconceptions of Law and Legal Services: The Small Business Owner vs. the Chicago Personal Property Tax

  • Kenneth P. Fisher and Gail S. Humphreys

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