Notice to politicians crying for more tax money: you might want to start by examining the House of Mouse.

Newsweek reports that Extreme Makeover: Home Edition, which is aired by ABC, a subsidiary of Disney, has been advising contestants to take a questionable interpretation of U.S. federal tax laws on their personal income tax returns. As a result, contestants who have been receiving hundreds of thousands of dollars worth of "makeovers" for appearing on the show have paid no taxes on their gains, even though prizes and awards are considered to be taxable income.

Endemol USA, the producer of Extreme Makeover: Home Edition, which picks cash-strapped families for a seven-day makeover of their homes, styles its 10-day contracts with the families as leases for the use of their houses, with a rental fee of $50,000. Then, according to Newsweek, Endemol pays no cash to the families but claims that the improvements left behind are the "rent" (even if worth more than $50,000) and thus should not be taxable.

Endemol's interpretation relies on Section 280A(g) of the Internal Revenue Code, which provides that individuals who rent their residence for fewer than 15 days during a tax year do not have to treat the rent as income but also do not get a deduction for any depreciation related to the rental period. There is little doubt that the provisions of Section 280A(g) apply to Endemol's rental contract -- but there is substantial doubt about whether the entire amount paid by Endemol can be characterized as rental income.

Although the Internal Revenue Code does not expressly define the term "rental income" for this purpose, the term would normally be interpreted to represent the fair value of the rental property. Thus, any excess above the fair rental value would be a prize or award to the owners, which would be taxable in the tax year of receipt. In addition, because the position that the entire amount is rent seems to have so little merit, the owners of the property may be subjected to various penalties, such as a negligence penalty, despite the written opinion provided to them by Endemol.

Newsweek reports that one recipient of an "extreme home makeover," who was deployed in Iraq at the time of the show, was extremely dissatisfied with the quality of the work, which was estimated to be worth up to $250,000, but he was unwilling to complain as long as it was all free. However, if he is audited and assessed additional taxes, he plans to sue Endemol USA. Considering the current turmoil at Endemol, we might advise him not to wait until the last minute to sue....

We note that some individuals in the 2004 U.S. election cycle have claimed that the top individual rates provided in the tax laws need to be increased to "soak the rich" and hopefully increase federal revenues. We tend to believe that the problem isn't that the laws give away too much on the top end but that too many people engage in "creative" tax planning of the type advocated here by Endemol, thus lowering revenues below the level actually mandated by the tax code.

We also note that the IRS is in a no-win situation. If it takes no action, it permits individuals to get away with a dubious tax dodge. If it audits the show's winners, though, it will receive negative publicity for targeting people, such as the person profiled by Newsweek, who served in Iraq and have no savings -- since, after all, the tax burden is borne by the contestants, not by Endemol. However, we believe that the most troubling element of the 1990s tax shelters and tax frauds (such as offshore credit cards for U.S. individuals) was a decline in the belief among Americans that taxes were a shared burden and an increase in the belief that some people can legally evade taxes, despite the Code, or that dubious interpretations are the same as "loopholes" in the tax code.

Is it wrong to support the IRS?