Not ‘manifestly criminal’

by Jeff Neal
via Harvard Law Today

An examination of new revelations about President Donald J. Trump’s taxes published recently by the New York Times reveals nothing clearly illegal, but does offer a window into the finances of the real estate developer and former reality TV host.

Among the newspaper’s findings: President Trump paid no income taxes in 10 out of 15 years, and owed only $750 each of the first two years of his presidency. The still unresolved IRS audit he has cited as the reason for not publicly releasing his tax returns involves a $72.9 million tax refund he received in 2010. The commander-in-chief also faces a “gathering storm” of debts while many of his businesses were already suffering substantial losses even before the onset of the coronavirus pandemic.

Harvard Law Today spoke Monday with two tax experts about the Times’ reporting. Keith Fogg is a clinical professor of law at Harvard Law School, where he directs the Federal Tax Clinic. Prior to his time in academia, he worked for more than 30 years with the Office of Chief Counsel, IRS. Thomas J. Brennan is the Stanley S. Surrey Professor of Law at Harvard Law School, where he focuses on tax law and policy and teaches about taxation of business corporations. Both cautioned that they had not reviewed the president’s tax records directly.

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Harvard Law Today: What jumps out to you from reading the New York Times reporting?

Fogg: Actually, I wasn’t surprised at all. I expected that he would have losses and that he wouldn’t have much taxable income. From a procedural standpoint, the thing that’s most surprising is that his audit is still stuck somewhere and hasn’t really moved during the four years of his presidency. It’s very unusual that it would come to a standstill like this.

Brennan: Three things come to mind. One is amazement that they have what seems to be so much information. It’s just the surprise of it. It’s fascinating. But the first substantive thing that I thought of is what often happens with reporting about taxes, that tax numbers can be very, very different from economic numbers. And it’s hard to tell what the economic picture is from the tax picture. And this led to my third reaction, which is that I would love to see the underlying documents. They won’t necessarily tell the full economic picture, but the more direct information you have, the better chance you have trying to piece things together.

HLT: Do IRS audits typically take as long as the one focused on President Trump’s taxes?

Fogg: Although we haven’t seen the audit report, the New York Times speculates that this goes back to a transaction with his casino from which he supposedly walked away. If he walked away completely, he could claim a huge loss on the casino. But if he retained an interest, he could not. The New York Times says he retained a 5% stock interest. That’s what the audit is about: whether he did or did not retain some interest. When the IRS is auditing a big company like this, it can take a long time. So, that part of it is not that shocking to me. What does surprise me is that he said he was under audit in 2016, when he was running for president, and that he’s still under audit, and that the process hasn’t moved forward to the next step, which would be sending him a notice of deficiency, saying that he owed $73 million, and giving him the opportunity to go to tax court. That’s where this is unusual.

Brennan: My guess, based on the reporting, is that there are significant, difficult factual questions involved, in as much as it may not be clear exactly what it was, if anything, that Mr. Trump received, at the time of the loss, and what the value of that something was. That said, there are difficult factual questions in valuation questions all the time in tax situations, and it doesn’t usually take 10 plus years to figure them out. If it’s difficult to figure out and just can’t get resolved, you’d usually go to tax court or to federal district court and the judge would make a decision.

HLT: Are there federal laws against releasing individual taxpayers tax information?

Fogg: The Internal Revenue Code basically says, ‘You can’t disclose tax information.’ This covers both the IRS and the Joint Committee on Taxation, the congressional body that also needs to review tax issues exceeding $2 million. So, they’re prohibited from disclosing taxes, tax returns or tax return information. The president’s tax returns are also going to the state of New York, where they would have similar disclosure laws. Anyone at the IRS who gave you or me a copy of Mr. Trump’s returns would be committing a criminal act. But he also has to give his tax returns to certain other institutions. For instance, if he’s asking for a loan, many banks would require him to turn over his tax returns so they could verify that he’s qualified for the loan that he’s asking for. Different laws would keep the banks from turning over tax returns.

Brennan: The Internal Revenue Code prohibits unauthorized disclosure by federal employees and people who might receive information from federal employees. And that’s taken extremely seriously by the IRS. It’s a felony to disclose the information. There are also less severe penalties for tax return preparers. It’s a very real possibility that somebody who obtained this information might face some significant sort of penalty. It really depends how they came across the information. In addition, someone who knowingly receives the information from a federal employee — somebody at the IRS, for example — and then discloses it in the way that the federal employee is not allowed to faces the same penalties. Those penalties do not apply to private entities, such as a bank, to which a taxpayer might voluntarily disclose their own tax return information in order, for instance, to get a mortgage.

HLT: Is there anything that you saw in the New York Times reporting that reflects potential criminality?

Fogg: There’s nothing in the report that suggested criminality to me. And because of the statute of limitations, issues from that long ago wouldn’t be prosecuted today unless he committed acts today that would further a crime. The big issue was whether he properly claimed this loss from the casinos or whether he retained enough of an interest that he’s not entitled to claim that loss. And it’s a big loss. So that’s why it’s generating a big tax liability. Claiming it, and being wrong in claiming it, doesn’t mean that it was criminal.

Brennan: There’s nothing manifestly criminal to me. It’s always really hard to say what the underlying facts are. As far as they’ve reported, we know that there are really substantial losses, but those could have come about from depreciation deductions legitimately taken over years, for example. In order to really evaluate whether something is a legitimate tax deduction or not, and certainly whether it goes all the way to the point of being criminal or not, you need a lot more facts and context.

HLT: The Times reported that the president deducted some $70,000 for haircuts. Is that an allowable deduction for entertainers or business people?

Fogg: I’m sure that some amount of haircutting is deductible in the context of entertainers. It seems high when you look at it, but yes, he should be able to deduct some things related to making him look the way he wants to look.

Brennan: In a basic tax course, you teach a lot of old cases about close calls and interesting hypotheticals with regard to where something falls on the spectrum of being a personal versus a business expense. If you’re required to wear particular clothing to your job, when you can deduct that expense depends. A uniform is deductible, but the nice clothing you might wear elsewhere is probably not. If it’s just a haircut you would otherwise be getting, you probably can’t deduct that. But if it’s some particular thing that’s really adding to your business, then, arguably, it would be deductible. This is something that’s very fact intensive.

HLT: The Times report raised the possibility that the president may have been paying his daughter, Ivanka Trump, simultaneously as an employee and as a consultant, possibly to avoid certain tax implications. What did you make of that, assuming it was accurate?

Fogg: Assuming the Times’ suggestion is accurate, which is a threshold issue, it would be very odd that he would pay her as both an employee and a consultant. Not necessarily impossible, but quite unusual. The second issue is the reasonableness of what he paid her. For it to be deductible, he would have to show that the amount he paid her was a reasonable amount in exchange for the services she rendered. That is an area that you could see audited, particularly in a family situation where giving her that money could be a way to avoid the gift tax, a method of moving money generationally in a way that creates a deduction for the corporation and reduces his tax liability. If she received that money, she would have been paying income tax on it.

Brennan: Somebody can be acting in multiple capacities with respect to another person or entity, so you might be an employee and also a consultant. It’s not the most common thing to do but there’s no reason in principle why you couldn’t do that. The question with regard to Ivanka Trump is how exactly did this benefit anyone. Paying money to Ivanka would give him a way to transfer money now. But would it make a difference if you paid a salary to her as an employee or paid it as compensation to her as a consultant? In both cases, he’d probably take a deduction for the payment, because he’d say this is an employee or consultant. It’s true that he wouldn’t have to pay wage taxes, such as Social Security and Medicare. But as a self-employed person, she’d have to pay her share of those things. So, it’s not clear to me on the information we have right now how it would be hugely tax advantageous.

HLT: Is this kind of tax situation just normal for a businessperson of Donald Trump’s wealth and complex holdings?

Fogg: I haven’t seen enough tax returns of people like Mr. Trump to have a good sense of what’s normal. And I haven’t seen his returns either, just the reporting in the New York Times. It also depends on what business you are in. He’s in real estate, which has some beneficial tax provisions that might not exist in some other industries. However, I would expect him to be using accountants and lawyers to find the maximum number of benefits. I would also expect him to have a lot of losses. And I wasn’t surprised that he only paid $750 in federal taxes in 2016 and 2017.

Brennan: The Times reporting compared the tax that Mr. Trump is paying to what the .01% highest income people are paying. But, of course, that’s incredibly misleading. What you would like to know is how he compares to a similarly situated person who’s heavily into real estate, but also has a reality TV show. In other words, you’d like to really compare apples to apples. Real estate developers often borrow significant amounts of money from banks and other entities invested in real estate and take legitimate depreciation deductions, which can reduce their income, sometimes to negative levels. And some day, in principle, they will have income to offset that, assuming the real estate hasn’t fallen in value, because they’ll either sell it or they’ll default on the loans. So, what you’d like to know is whether this is the profile you’d expect for people similarly situated to Mr. Trump, if there are any such people.

HLT: Does any of this argue for any kind of reform of the tax code?

Fogg: I don’t know if the tax code needs to be changed, but I think it would be a good idea to have a law that requires major presidential candidates to disclose their tax returns, then we wouldn’t be spending as much time as we are speculating about his returns. We have developed a practice over 50 years that would be good to codify. I think the lesson from Donald Trump would be: Let’s just make it a requirement so people can draw their own conclusions rather than having to speculate.

Brennan: Are there problems with our current tax code? Yes, many. It’s voluminous and is riddled with all sorts of special provisions that cause people to distort their behavior in all manner of ways that are highly suboptimal. And we can reform it in many, many ways that would improve things. But I generally think reforms that are on one-off, ad hoc incidents are likely to make it worse, because they’ll be ad hoc reforms rather than fundamental reforms.

I can’t say for sure what exactly the full story here is. But if it’s true that Mr. Trump has successfully gotten a lot of depreciation deductions over the years, and is successfully deferring gains into the future because our tax code is structured for it to work that way, I don’t think that’s anything new or particularly problematic. It may be an extreme case of it.

To my mind, the system seems to be working. He’s under audit, and the IRS is working through whether the things he’s done are legitimate or not. I trust that the IRS will come to good judgments about this. And then if it goes to our court system, the court system will make good judgments about this. I would worry much more if there were no audit, and if this was all completely under wraps, and no one knew anything.

So, I would like to see fundamental reform to the tax system. But I wouldn’t want to see a reform motivated just by trying to close particular loopholes or perceived loopholes that President Trump was benefiting from. I’d rather see something that was more holistically based.

That said, as a citizen and voter, I would like to see candidates, or at least serious candidates past a certain point in the process, disclose their tax returns for at least the past couple of years. I think that would be helpful in trying to evaluate what’s going on, and would avoid the sort of morass and mess that we seem to be in at the moment.