By Andrew Cohen
When the New York Times recently published details about nearly 20 years of President Trump’s tax information, the reaction predictably reflected our polarized political times.
Supporters said the facts point to a savvy businessman who smartly maneuvered within the rules as many in his position would try to do. Opponents said details such as audit battles, massive write-offs, and paying just $750 in taxes in both 2016 and 2017 expose a pattern of illegal behavior.
Trump reportedly cited a $916 million loss in 1995, wrote off $26 million in unexplained consulting fees as a business expense between 2010 and 2018, and claimed $70,000 for hairstyling while host of the television show The Apprentice. The Times said he paid no federal income taxes in 11 of the 18 years it examined, cited losses at his golf courses exceeding $315 million since 2000, and received $73 million in revenue from interests in other nations during his first two years as president.
Taxes and tax law can be tricky to grasp, but Professor Mark Gergen has deconstructed their intricacies to students for 35 years. Berkeley Law’s Robert and Joann Burch D.P. Professor of Tax Law and Policy, he is teaching Taxation of Modern Financial Products this semester and will teach Partnership Tax and Corporate Tax next semester.
Gergen, the school’s associate dean for faculty development and research, assesses some of the revelations about Trump’s tax returns and their broader implications.
Q: How easy is it for the wealthy to manipulate the tax code to reduce their liabilities?
Gergen: It is very easy for the wealthy to avoid tax on capital income. The actual effective tax rate on capital income is less than 10%. There are perfectly legal tactics a wealthy person may use to monetize unrealized appreciation to fund consumption. While these involve some expense, it is less than the tax on the unrealized appreciation. The basis step-up at death means this gain is never subject to income tax.
President Trump did something that is much more difficult, which is to find ways to avoid tax on labor income (which includes his income from the television show and endorsement deals). This required taking very aggressive tax positions. My impression is that he crossed over the line from legal tax avoidance to illegal tax evasion at some points.
Q: Do you anticipate meaningful tax law reforms if Joe Biden is elected, and if so what would they likely address?
Gergen: This is a hard question to answer. There has only been truly significant tax reform once in my lifetime. This was in 1986 and it required a bipartisan effort. Other tax bills generally make changes at the margin and close particular loopholes that do not benefit a politically strong constituency.
Whether or not Biden is elected, many of the worst changes in the 2017 Republican tax bill are scheduled to expire over the next few years, so there will be reform on these margins unless the Republicans somehow manage to control both houses of Congress and the Presidency. Something similar happened in the first decade of this century. Many of the Bush tax cuts had sunsets to satisfy revenue neutrality benchmarks Congress has established. These cuts expired without legislation.
Q: The president’s returns showed major business losses while writing off considerable expenses. Is that a red flag, or not necessarily?
Gergen: Some of President Trump’s write-offs are indefensible, if true. An example is the deduction of the cost of hair cuts or styling. It is clear that this is not a deductible expense because the value was not limited to his work. There is a prophylactic rule that allows people to deduct expenses for clothing and personal grooming, which usually are personal, only if there is no personal benefit. The cost of makeup that was removed after a show would be deductible under this rule. The cost of a haircut or hair styling is not.
The consulting fees he paid his daughter are curious. When rates were highly progressive it was not unusual for high-income individuals to try to characterize transfers to their children as a business expense rather than as a gift because the child would be in a lower bracket.. The difference in tax rates is saved. But his daughter was in as high a bracket as President Trump. She may have been in a higher bracket.
Q: Given that his real estate services company reported losing $134 million since 2000, what role does depreciation play in his tax return claims?
Gergen: The losses seem to be a combination of actual losses (net negative cash flow from a business), debt-financed depreciation, and the interest deduction on the debt. It is debt-financed depreciation and the interest deduction that makes real estate a tax shelter, if you can get around the passive loss rules and the at-risk rule.
As a real estate developer President Trump could get around the passive loss rules. If he personally guaranteed the debt, then he could get around the at-risk rules. But generally this type of tax shelter defers tax and does not avoid it. In the 1990s, Trump took a very aggressive position to avoid tax when the debt was forgiven. He appears to have gotten away with this though the position was a weak position that would not have stood up in court had the government litigated the case.
This time around he has taken a very aggressive position to convert what should have been a long-term capital loss into an ordinary loss that he carried back to claim a refund on taxes he paid on his labor income from the television show and endorsements. If the facts are as reported by the New York Times, this position will not stand if the government takes the case to court.
Q: Why was the president’s IRS audit stalled, and what conflict of interest concerns exist if he is reelected?
Gergen: There are supposed to be systems in place to ensure the IRS and Treasury are not subject to political pressure in the enforcement of tax law. The handling of Trump’s returns in the 1990s makes one wonder. He seems to have gotten away with taking a position that would not have stood up if challenged to save millions in taxes. Additional reason to wonder is that the positions he took in this century are still under audit.
As for why he hasn’t gotten away with taking an aggressive position this time, it may have to do with a rule that requires the IRS to notify and consult with the nonpartisan Joint Committee on Taxation when a return claims a large refund, which is what Trump did.
Q: What’s the main takeaway for you from all of this?
Gergen: It raises a concern that the wealthy and powerful are able to get away with taking very aggressive positions, and even taking dishonest positions (which President Trump is reported to have done), because the government doesn’t have the resources or perhaps the will power to resist. Our tax system is already stacked in favor of the wealthy in many ways. What Trump has tried to get away with, and appears to have gotten away with in the past, suggests tax law is not enforced even-handedly.