Law and the Multiverse Mailbag IX

In today’s mailbag we have a question about Superman, diamonds, and taxes.  As always, if you have questions or post suggestions, please send them to james@lawandthemultiverse.com and ryan@lawandthemultiverse.com or leave them in the comments.

Martin asks “if Superman crushes carbon and makes diamonds, is that taxable income?  I would think if he made it into a ring and gave it to Lois the government might want a percentage.”

There are two questions here.  First, are the diamonds taxable income for Superman (or Clark Kent) and second, are they taxable income for a recipient such as Lois Lane?

The answer to the first question is “probably not.”  A traditional, almost fundamental principle of income tax is that a gain in value must be realized before it can be taxed, although the definition of “realized” has expanded over the years, somewhat eroding the principle.  The Internal Revenue Code provides that one example of income is “gains derived from dealings in property.” 26 USC 61(a)(3).  ‘Dealings’ are not defined in the statute, but § 1001(a) defines the computation of “the gain from the sale or other disposition of property.”  It seems clear that improving the value of the carbon is not such a taxable event, since there is neither a sale nor disposition of the property of any kind.  An analogy might be made to a painting that appreciates in value; the increase in value is not taxed until the painting is sold, given away, etc.

If the diamonds are given to Lois Lane, however, that is obviously a gift, which has its own set of special rules.  In the US, gifts are generally not taxable income for the recipient.  26 USC 102(a).  But there is a gift tax that is ordinarily paid by the giver.  26 USC 2501(a)(1) and 26 USC 2502(c).  However, there is a significant exclusion for gifts that currently stands at $13,000 per-recipient per-year.  Thus the question is, presuming the diamonds were given as a gift today, would they exceed the exclusion?

Obviously this depends on the size and quality of the diamond and the state of the diamond market, but for example the diamond given to Lana Lang in Superman III appears to be about 3.5 to 4 carats and of very good quality.  Looking at stones for sale on Blue Nile, a similar diamond would cost somewhere between $150,000 and $400,000, depending on the particulars, which is far beyond the gift exclusion.  So how much would Superman be on the hook for?  The answer is “a lot.”  For example, if the ring were valued between $150,000 and $250,000, then the gift tax would be $38,800 plus 32% of the excess beyond $150,000, so potentially as much as $70,800.

But is the fair market value of the diamond simply that of an ordinary diamond of like size and quality?   The general rule for computing the value of gift of property is given in 26 C.F.R. § 25.2512-1: “The value of the property is the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.”  The unusual origin of the diamond is almost certainly a relevant fact, and if diamonds created by Superman are rare, which seems to be the case, then this particular diamond would command a significant premium, and the tax would be correspondingly higher.

This is a problem, since Clark Kent probably doesn’t make enough money to pay the tax, and Superman probably doesn’t want to get tangled up with the IRS.  It is possible to perform a “net gift” for which the recipient pays the tax, but it is unlikely that Lana has the money for that either.  She could sell the ring to pay the tax, of course, but that would defeat the purpose of the gift.  Alternatively, Superman could give her several diamonds with the intention that she keep one as a ring and sell the others to pay the taxes on all of the diamonds.  As complicated as that would be, it might be the only way to keep things above-board.

Note: No discussion of gift tax is complete without mentioning the unified credit of 26 USC 2505. It may not solve the problem here, however.  First, the value of the diamond may easily exceed the credit, especially if Superman gives them out on a regular basis.  Second, Superman may have made other gifts that already used up the credit; he has certainly been around long enough to have done so.

That’s all for this week!  Keep your questions coming in!

42 Responses to Law and the Multiverse Mailbag IX

  1. Superman tangled with the IRS in “Superman Owes a Billion Dollars!”, found in Superman Vol 1 #148. A description is found at this link.

    http://dc.wikia.com/wiki/Superman_Vol_1_148

    • The IRS might be a little less forgiving today; Superman probably couldn’t actually claim the population of the Earth or even the United States as dependents. Furthermore, although Superman is found not to have a net tax liability in that comic, he would still have to file a return, which would create the kind of paper trail that most superheroes should try to avoid.

      • Which begs the question: would the government issue an SSN for Superman as a naturalized citizen? What if they then learn that Superman is Clark Kent, somebody who has a job at the Daily Planet and thus has an income and has to file his own taxes and thus has his own SSN? Is that tax fraud? Can you legally file under two separate identities?

      • As a follow up to my last post, could Superman pay taxes if he incorporated himself? I mean if he registered “Superman” as a company that made industrial diamonds and claimed that all the income from the diamonds belonged to the company and not to him personally then he could legally file a tax return for “Superman” and still keep his identity a secret. Right?

        In fact, Spiderman could do the same thing, couldn’t he? If the Avengers paid him $1000 a week and all he needed was a little bit of money to get by then he could form Spiderman Inc. and pay Peter Parker as his official photographer. If he gave the bulk of the money to charity then I doubt if anybody would get any more suspicious than usual. Would that work?

      • In theory something along those lines might work, but the law frowns on what’s called “alter ego.” That is, where the corporation is just the person by another name and there isn’t really a separate corporate entity. So in the Spider-Man example that wouldn’t really be keeping with the spirit of the law. Ass a result, an audit might lead to Spider-Man being liable for the corporation’s income, and his identity might be discovered as well.

        In the Superman case, that would be more workable since he’s not ultimately trying to shuttle income to his secret identity. However, in order to pay the gift tax on gifted diamonds he’d have to make money by selling diamonds. At that point he’s running a business, which brings with it a bunch of other issues. I’m not sure Superman would want to spend time on that. Theoretically the business could hire people to handle all that stuff, but that’s starting to sound like “Superman, CEO,” which might make for an interesting comic, actually, but it’s a needlessly complex solution to the immediate problem. I think it’s simpler to give the recipient enough diamonds to pay off the gift tax themselves and leave Superman free to do his superhero thing.

      • What if Spiderman got income from other sources? I mean, he could appear on Letterman or the Tonight Show and demonstrate his wall crawling skills. In fact, he tried doing that in Spiderman #1 but they paid him with a cheque and he couldn’t cash it because he couldn’t prove to the people at the bank he was Spiderman. So now if Spiderman makes a lot of money as Spiderman, much more than he would as Peter Parker, maybe the government would be okay with him filing a tax return as Spiderman. Don’t some actors, super models and musicians do something similar? I mean when a lot of money is involved is there an advantage of creating a corporate identity even, for example, when people know who Madonna really is?

  2. What if:

    Clark is obviously a US citizen (I know, but as far as the government is concerned with their awareness, he is, birthplace Smallville). What if he–as Superman–handed Bruce Wayne or a trusted party a handful of nice homemade diamonds, and asked that their final net profit be deposited in some offshore account, to fund his private life? Or, similarly, if he cruised over the Earth from orbit, found gold or other precious metal deposits with his x-ray, telescopic and microscopic vision, and dug them up for a similar purpose (come to think of it, he could probably even do that on other planets and moons in the solar system).

    Would that derived income for him be something he should report? I’m thinking of the current kerkuffle with Swiss banks and US citizens not reporting income, as it may apply to Superman. Or, in theory, others who can do similar things–if John Stewart or Hal Jordan suddenly realized they need a job-free way to underwrite their Earth lifestyle, as being a Green Lantern doesn’t include a paycheck, I’m sure the power ring could show them where under the Earth to find a hella large gold rock(s) worth millions.

  3. What would Superman’s liability be if he just gifted Lois the coal, and he then turned the coal into a diamond? As the coal was already the property of Lois before it was turned into a diamond, its value is likely to be negligible.

    • That’s a good point. The gift tax only applies to “the transfer of property,” and gratuitous services rendered would not qualify. I suppose there are few ways in the real world to transform essentially worthless material into something extremely valuable with relatively little effort, so the tax code doesn’t bother trying to tax gratuitous services. I suppose autographs come closest in terms of the effort:value-added ratio.

      It’s worth pointing out that, smart as this approach may be, it’s not what Superman actually does in the comics and movies. Maybe he should hire a tax attorney.

      • Does Lois need to be present for him to make the gift to her? Couldn’t he simply stand around on the pile of coal and declare: “I make a gift of this piece of coal to Lois Lane.” Then, turn it into a diamond and then hand over the gift? What elements are needed for a gift to be made?

      • I’m afraid that wouldn’t work. There are other elements, but a gift must be delivered to the recipient (actually or symbolically) and the recipient must accept the gift. See, e.g., Botchford v. Comm’r of Internal Revenue, 81 F.2d 914 (9th Cir. 1936). So the conversion to diamond would definitely have to be done after giving the coal as a gift.

  4. Could Superman offset the value of the diamonds he gives to Lana by giving a few of greater value to charities?

  5. If I was Superman’s accountant, I would make the argument that Superman is essentially making industrial diamonds with his hands. A real diamond’s value comes from the fact that it took millions of years to form in nature. Superman’s diamonds are no different than any other man-made gems.

    A Superman diamond might have much higher value to a collector, but by that reasoning, so would his cape. Could the IRS go after Superman if he gave his cape to someone? Could a person be so famous (or infamous) that everything he or she owns is so extremely valuable (simply by virtue of the person owning it) that he or she couldn’t give anything away without paying taxes on it?

    • That’s the point I intended to post. The value of gemstones is based on rarity and marketing. A synthetic ruby is not remotely as valuable as a “real” ruby, despite being indistinguishable without microscopic examination. The value of a gemstone is fairly arbitary.

      The problem is that, as far as I know, it is not yet possible to create a synthetic, gem quality, diamond. Therefore, how is anyone to know what the market value would be?

      Which brings up what Superman could do to the world diamond market if it was known that he was capable of creating diamonds effectively at will. I’ve heard this was mentioned in “Superman, true Brit”, where he turned all the coal in Britain into diamonds, leaving diamonds worthless and no coal to burn.

      • It is possible to make synthetic gem-quality diamonds. A few companies are in the business (e.g. Apollo Diamond). It’s still an expensive process, however, particularly for larger stones.

        The special status of being a “Superman diamond” may be the dominant factor in the price, but I’m not sure. I’m an attorney, not a diamond appraiser.

    • Superman’s cape probably isn’t a very good example, considering it’s (depending what continuity you’re working with) made from Kryptonian fabrics and nigh-indestructible… Here’s something more real-world: If a sports star (let’s say Michael Jordan at the height of career) offered someone a sip of his Gatorade, Gatorade is fairly cheap, yet it’s not hard to imagine people who would pay tens or even hundreds of thousands for Michael Jordan’s Gatorade. Which value would be considered for tax purposes?

  6. Does the gift tax not have some exclusions for works of art? If Robert Bateman painted a picture of a little girl’s kitty and gave it to her, would he be on the hook for the taxes as if he had sold a similar painting? Your interpretation seems to be that if a collector is willing to pay more than $13 000 for your work then you can’t do anything for free as a gift to a friend.

    • See above for the discussion of gratuitous services. The gift tax only applies to transfers of property (e.g. an artist giving a pre-existing painting to someone).

      • What would the difference be between turning canvas and paints into a painting for someone versus turning a piece of coal into a diamond for someone? In both cases, the base materials probably originally belong to the person doing the gifting and aren’t particularly valuable on their own, in both cases the change is intended specifically for that person as a part of the gift, in both cases the finished product is potentially quite a valuable item, and in both cases it’s not really ‘given’ until the finished product.

      • Rephrasing my question somewhat: From what I gather, Superman giving Lois a diamond as a gift, which he happens to have made from crushing coal at some point in time, is a taxable event. Contrarily, Superman crushing coal into diamonds as a gift to Lois is a non-taxable event. What would be legally necessary to prove that the gift is the latter rather than the former?

        Is it sufficient to simply intend it at the time of crushing? Assuming that intent exists, does the time between the crushing and the giving matter (instantaneous vs a few hours/days vs a few weeks/months)? Does Lois need to be physically present for the actual crushing?

        If it’s simply not possible without Lois being the owner of the coal before it becomes diamonds, are there ways for Superman to make the coal Lois’s property (either as a gift or in some other manner) without her knowing what it is, so that he can then turn it into diamonds while maintaining a certain level of surprise?

      • One more: Could he put a chunk of coal in a box, giftwrap it, hand it to Lois as a gift, then as she’s opening the box superspeed grab the coal, crush it into a diamond, and put it back faster than Lois can see?

      • Martin Phipps

        I think Pat is right. I think Superman turning coal into diamonds should be considered art rather than science and the diamonds technically remain worthless until appraised by an expert. So if Superman creates a diamond and goes to an expert who appraises the diamond at a certain value then he would be liable for that amount if he gives it to Lois but if he gives Lois a diamond that he just made he could truthfully claim that what he had given her was crushed coal. It would be the same as an artist claiming that he gave away a painting that wasn’t his best work and therefore worthless only to have it appraised as his greatest masterpiece.

      • The recipient wouldn’t need to be present for the crushing, no. You can accept a gift without being present. For example, calling someone up and offering to give them money via wire transfer; neither the giver nor the recipient nor the money (which is just electrons in this case) are physically present together.

        Realistically, the IRS is not going to know if Superman gives her the ring outright rather than giving her coal and then crushing it in front of her, superfast or otherwise. But strictly speaking, I think in order to keep everything above-board and avoid gift tax issues the coal has to be gifted first. Superman’s sense of morality would probably compel him to take that route, even if it risked the surprise. If surprise were vital, then he could use the net gift approach and give enough additional diamonds to pay the tax.

        As to whether you have to know what a gift is to accept it: I don’t think so, since it would be very strange to say that a giver could take back a present so long as it was still wrapped. Further, the gift tax is ordinarily the burden of the giver, so it’s not like you can foist a high tax bill on someone by surprising them with a gift that is unexpectedly valuable but hard to sell. On the other hand, you could perhaps surprise someone with a gift that is hard to sell but carries with it great responsibility (e.g. a literal white elephant).

  7. Shanya Almafeta

    I was reading the other day and came up with a question about exotic weaponry. In it, the villain had imported a dangerous artifact into the US because it seemed to be nothing more than an art piece of dubious value, despite the fact that it was the mystical equivalent of a thermonuclear bomb.

    Say the gentleman is apprehended by Captain Amazing, before the device was used. The day is saved – but it still looks like a worthless piece of art. The big question: What does the prosecution have to do to prove that that a tasteless statue of a fish (or anything else exotic and seemingly harmless) is, in fact, a artifact capable of causing mass destruction?

    • David Johnston

      Same as with any technical issue. You find an expert willing to testify that Dagon idols are hazardous to the neighbourhood and the defendant gets another expert to testify that the idol is perfectly mundane and then we see who the judge/jury find more impressive. With luck, the prosecution will actually present a bystander who can proffer testimony about what the bad guy said it would do in his monologue. If the courts of course have not reached the point where they are willing to acknowledge that there are any qualified experts in the distinction between bad art and evil artifact…well the government could probably come up with some reason not to give it back if they tried real hard.

  8. > But strictly speaking, I think in order to keep everything above-board and avoid gift tax issues the coal has to be gifted first. Superman’s sense of morality would probably compel him to take that route, even if it risked the surprise.

    Honestly, I would his sense of morality wouldn’t even register for something like a gift tax. I mean, he’s not a lawyer. Why would he even think that giving someone a gift of any sort would put him thousands of dollars in the hole? I’ve heard that ‘ignorance of the law is no defense’ but how can that possibly be the case when there are volumes and volumes and it’s always changing (Title 26 alone appears to be something like 16,845 pages long, and even though Superman could quickly read it, why would we imagine he could understand or remember it all, or that it would even occur to him to do so) and there are multiple, valid interpretations even among people who DO know the laws. It would seem to me that just about anything you do could be illegal in some way or another, and there doesn’t seem to be a quick or easy way to check.

    • It’s true that the rule that ignorance of the law is no defense does tend to strain credulity at times, but the alternative is worse. If ignorance were a defense, then people would have a strong incentive to remain ignorant of the law, which seems like a bad thing. What’s more, how could the prosecution prove non-ignorance? Few criminals leave behind memos saying “I’m aware that my criminal enterprise is illegal, but I am proceeding despite this.” So although the rule may not reflect reality, it is very practical.

      • HappyFunNorm

        Lawmakers appear to be fond of making rules that involve judgement of ‘a reasonable person’ and it seems reasonable to make the same rules apply across the board.

        A reasonable person should know that murdering someone will be illegal, whereas a reasonable person would not know, or even expect that, say, it’s illegal to play Dominoes on Sunday in Alabama (http://www.dumblaws.com/law/1), or some of the odd specifics of the gift tax in the case of Superman.

      • You have stumbled upon the malum in se / malum prohibitum dichotomy. As you might guess from the use of Latin, this is a very old issue. A full discussion of this is beyond the scope of this blog, but many books on the philosophy of law address the topic, if you’re interested in further reading.

        As for applying the reasonable man standard across the board: there are lots of good reasons why that would be a bad idea. It’s very useful to distinguish between different mental states, and using the same standard for everything would lead to a tremendous oversimplification.

        Imagine if the same mental state (negligence, if we’re talking about reasonableness) were the standard in all crimes. For one thing it would be much harder to distinguish between different degrees of murder, and so either a lot of what would be manslaughter becomes first degree murder or a lot of what would be first degree murder becomes manslaughter, depending on which direction you want to simplify things in. Either way a lot of people are going to be unhappy.

        But in any case, the practical concerns still win out. If the defense of ignorance had to be judged under a reasonable man standard for every law, then there would be a tremendous amount of additional litigation hashing that out. Every case where ignorance was found to be an excuse would lead to a perverse incentive to remain ignorant, and non-ignorance would be almost impossible to prove, effectively striking down the law. And ultimately the legislatures would start adding “ignorance shall be no defense to any charge made under this title” to every law they pass and the whole point would be moot.

      • HappyFunNorm

        Sorry, I’m not sure how to reply to your next reply, so I’m back up a level.

        How can Mens Rea ever be established, then, without knowledge of the law? In general, I guess as well, but specifically for this example if Superman intends to give Lois a pretty present would seem to have a vastly different intent that giving her a vastly expensive one. If the law expects Superman to be knowledgeable of all these gift giving nuances, does it also expect him to be an expert at appraising gems?

        I guess, if I found a pretty stone and gave it to my girlfriend, and it turned out to be some rare artifact or precious metal, would I now be on the hook for paying the gift taxes?

        Sorry for getting pretty far off topic…

      • Mens rea refers not to whether the defendant literally intended to commit a crime but whether they intended to do the prohibited act or cause the prohibited result. For example, a typical formulation of “purposely” is “A person acts purposely with respect to a material element of an offense when his conscious object is to cause the result or engage in the conduct that comprises the element.” N.H. Rev. Stat. § 626:2. There’s no requirement that the defendant have committing a crime as his conscious object.

        So, for example, a person can kill another, fully believing that his act is legally justified and that he is not committing a crime. Indeed, it may even be the case that if he knew he was committing a crime he wouldn’t have done it. But what matters is whether he intended to kill the other person, not whether he intended to commit the crime of murder. So if it turns out that he is not actually legally justified in his actions, then he will still be guilty of murder (or perhaps manslaughter, depending on the facts).

  9. The taxable value of the diamond is based on what? You are going by the value as decided by professionals in the market. Why do they get to decide what the true value of a diamond is?

    Could Superman sell 3.5 karat diamond for a dollar; therefore making the whole argument moot?

    • The Code of Federal Regulations provides some guidance here: “The value of the property is the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts….Thus, in the case of an item of property made the subject of a gift, which is generally obtained by the public in the retail market, the fair market value of such an item of property is the price at which the item or a comparable item would be sold at retail. For example, the value of an automobile … is the price for which an automobile of the same or approximately the same description, make, model, age, condition, etc., could be purchased by a member of the general public.” 26 C.F.R. § 25.2512-1.

      Diamonds are generally obtained by the public in the retail market, so the taxable value of the diamond would be that of a diamond of like size and quality purchased at retail. It’s possible that its status as a “Superman diamond” would make it exceptional, however, in which case some sort of expert appraisal would be necessary.

  10. As I recall, Superman also stole the coal, or at least failed to pay for it. Would this make the diamond stolen property? Would the post-transformation value of the coal make it grand theft?

  11. Good discussion and some neat points, especially about the timing of the crushing. O_O

    Couple points that came up on this to me, first a thought on handling the situation, second not so much:

    1. If Superman was on the hook for this money, couldn’t he just make another diamond and pay the IRS using that somehow?

    2. Is even the IRS dumb enough to actually go to /Superman/ and say, “Hey there, most powerful man in the world who protects us all purely out of goodwill and could probably become supreme ruler of the earth in 9.52 seconds if he wanted to, you owe us a ton of money because you gave a gift to your girlfriend?”

  12. This is the greatest thing I’ve ever read.

    Involving Superman and the hypothetical laws that make having superpowers less enjoyable.

  13. Pingback: Superman’s Diamonds Revisited | Law and the Multiverse

  14. John Pack Lambert

    I guess my question comes from my main exposure to Superman being the TV show “Lois and Clark: The New Adventures of Superman”, but it also fits with the state of the comics from about 1995 to 2010, so it has multiple applicabilities.

    If Clark Kent (and therefore in theory Superman) is married to Lois Lane at the time he gives Lois the coal that he then turns into a diamond valued in excess of $13,000, does that change anything from a legal perspective.

    Alternately, if he is married to Lois and they hold their property jointly, is there a way for him to create a diamond for Lois to use that would not create a tax liability. I mean, if legally Lois and Clark share their property, than can Clark actually legally gift something to Lois?

  15. I would think that any reasonably on the ball tax prosecutor would balk at the “give her the coal, then make her coal a diamond” dodge. It’s so obviously a “fig leaf” attempt to avoid tax, that I would expect the tax court to rule that it clearly was Superman’s intent all along to giver her the diamond.

    Then again, who would have thought that the financial ratings agencies who rated all those junk CDOs “AAA” KNOWING they were junk and HAD to be junk (and getting PAID for the ratings) would get away with saying “our ratings are ‘opinions’ and not to be taken as a binding judgement as to the safety, etc of any instrument as an investment”, thus abosolving them of criminal and civil liability for their fraud?

    Back to Lana and the diamond: whatever the gift tax due on the diamond, would not it still be the case (as specified in the article) that the tax is not due until the value is REALIZED at sale?

    All Lana has to do is not sell the diamond, and no taxable event occurs, right?

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