US President Donald Trump speaks to the press as he makes his way to board Marine One from the South … [+]
AFP via Getty Images
I haven’t seen President Trump’s tax returns. I’m going to start there. No matter how many times I’ve been asked today to offer my “take” on the returns, I can’t give a more honest answer than, “I haven’t seen the returns.”
I have, however, read the very detailed article from the New York Times
NYT
So here are some answers to common questions raised by some of the headlines that are sure to come your way this week. I’ll update my answers as the story progresses.
Is it a crime for the New York Times to have the returns?
I’ve been asked this a lot. Some taxpayers believe that their tax returns are private… which is only partially true.
No Internal Revenue Service (IRS) employee has the right to simply browse through taxpayer records: it’s against the law to inspect tax returns without being authorized to do so. Congress, saying that it “views any unauthorized inspection of tax return information as a very serious offense,” passed the Taxpayer Browsing Protection Act of 1997 (Public Law No. 105-35), which made such an inspection a crime.
And the Internal Revenue Code mandates, in section 6103, that “returns and return information shall be confidential” except when otherwise specifically authorized.
Under section 7213 of the Tax Code, unauthorized willful disclosure of any return or return information by a federal employee (and certain other persons) is a felony; and under section 7431 of the Tax Code, civil damages may also be appropriate for willful of negligent violations, depending on the circumstances. In addition, if convicted of such a crime, a federal employee can be suspended or fired. But those rules apply to federal employees, not private citizens. A private citizen – like a spouse and or an ex-spouse – may legally have access to a taxpayer’s tax return. And, once your tax return information is disclosed to a third party, that information is no longer protected under federal tax laws.
According to the Times, the paper “obtained tax-return data extending over more than two decades for Mr. Trump and the hundreds of companies that make up his business organization, including detailed information from his first two years in office.” The Times declined to provide the records for review to a lawyer for the Trump Organization “in order to protect its sources.”
So, I don’t know if they obtained the records legally, but simply having someone else’s tax or financial information isn’t a crime.
I thought you once said you couldn’t find out anything from a tax return?
That’s what President Trump said in 2016, claiming, “You don’t learn anything from a tax return.”
But that’s not what I said. I wrote just the opposite in 2016, noting that “a tax return is not just a bunch of numbers. It’s a snapshot of your financial life.” Not only do you have a better understanding of where taxable income comes from, but you can also see potential failures in losses and worrisome positions with investments and loans. When it comes to taxpayers who itemize, you can learn about charitable deductions (not simply how much but where it’s distributed), real estate taxes, real estate holdings, and more. You can also glean information about the existence of offshore accounts, household employees, rental properties and more.
I have, however, tweeted that “Tax returns (even officially filed ones) aren’t dispositive when it comes to wealth.” I stand by that. One of the flaws of reviewing tax returns on their own is that they are not a reliable measure of a person’s net worth.
It sounds like Trump’s returns really are under audit. But I thought you agreed that he could not release his tax returns while under audit?
No, if Trump wanted to release his tax returns – even in the middle of an audit – he could. There’s no prohibition against it. Former IRS Commissioner Koskinen agreed that was the case in 2016. Whether it’s a good idea or not is another matter: many tax pros, like me, weren’t so sure that making a tax return public while it’s under audit was a good idea.
It feels like this audit has gone on forever. I understand statute of limitations (sort of), but why would you ever push it off?
The Times said that records show that there is an audit of Trump’s 2009 refund. The refund claim has remained in committee, “unresolved, with the statute of limitations repeatedly pushed forward.”
By statute, the IRS can’t examine your returns forever. There are deadlines and the IRS has to resolve exams and other issues within a certain period of time. If the IRS doesn’t resolve the issue by the end of the period, they’re done. BUT. Sometimes, there’s an advantage to extending the time – but it is generally done by agreement in writing (you may have seen Form 872, Consent to Extend the Time to Assess Tax before).
If you don’t sign the consent, the IRS can go ahead and issue its findings. Once that happens, the clock starts running again on your options which typically – at this point – mean heading to court if you don’t agree. So, if you think that you might be able to reach a settlement, you might sign the consent to buy a little more time. You might also do it to keep the matter out of court (which could be what’s happening here).
I tried to look it up after reading the story but could not find Line 56 on Form 1040. What is it?
Line 56 – total tax after adjustments but before taking into consideration taxes like self-employment and household employment taxes – existed in 2014. But if you’re looking for it now, you’re out of luck: there is not a Line 56 on IRS Form 1040 for tax years after 2018 because of form revisions due to, among other things, the Tax Cuts and Jobs Act (TCJA).
Okay. Let’s talk tax specifics. First, what is depreciation, really?
Trump has previously touted the benefits of depreciation, suggesting that the losses on his tax returns do not translate into losses in a portfolio. There’s some truth to that because depreciation is a tax and accounting construct: you don’t actually “lose” value each year on property when you depreciate it.
For federal income tax purposes, depreciation is a deduction that allows you to recover the cost or other basis of certain property. It can be tricky but generally, you begin to depreciate your property when you place it in service for the first time. The IRS considers property “placed in service” when it is ready and available for use, not when you actually begin using it. So, for example, if you buy a car for your business, it’s ready and available once it belongs to you, not necessarily the first time you take a ride. You depreciate the cost of the item over its useful life (based on the kind of property) unless an exception applies.
Here’s how it works. Let’s say you bought commercial property for $1 million in 2000. You don’t generally get to claim the deduction in year 1 even if you paid cash for the entire thing. Instead, you have to depreciate the property over its useful life (in this case, that’s 39 years) – which means that you deduct a little bit every year until its useful life is over.
And when you sell or otherwise transfer depreciated property, you may have to recover the depreciation, which can drive up your tax bill. It can be complicated.
This is why the Times noted that “Depreciation, though, is not a magic wand…” It doesn’t simply create losses out of thin air. You can read more about depreciation here.
Okay, got it. Now, how does cancellation of debt income work?
According to the Times, Trump failed to pay back at least $287 million since 2010. Normally, a failure to pay back that kind of debt would result in a taxable event.
If you have cancellation of debt for less than the amount you owe, the amount of the canceled debt is considered income and may be taxable unless an exclusion applies. The most common exclusions include bankruptcy, insolvency, and qualified principal residence indebtedness.
If you don’t qualify for an exclusion, you typically have to report the income and pay the tax in the year of the forgiveness.
The Times claims that Trump was able to offset some of the income with losses, and extend paying tax by taking advantage of a provision under an Obama-era bailout that allowed income from canceled debt to be deferred over a period of time.
And in a few words, how do business losses work?
That’s a tall order. But here’s the gist: business losses are sometimes called net operating losses (NOL). An NOL generally results when your tax deductions exceed your taxable income. If that number is negative in one year – but has been positive in other years resulting in tax payable – that doesn’t quite seem fair. The NOL exists so that you can balance that inequity. In other words, you can use the loss in one year to lower your taxable income and reduce your tax burden in another year.
(Don’t confuse capital losses with an NOL: they are not the same thing.)
Under existing tax laws, if you have an NOL, you first carry back the entire NOL amount for a number of years and if you still have an NOL remaining after you carry those losses back, you can carry the losses forward. You can also opt not to carry back an NOL and only carry it forward for up to 20 years. A carry forward means that you can apply the loss towards your income in a future year.
NOLs can be tricky (you can read more here), and it’s not unusual for the rules to change during an economic crunch.
According to the Times, Trump claimed huge business losses — a total of $1.4 billion from his core businesses for 2008 and 2009. Before the bailout, those losses could only be carried back two years. But the bailout extended the look back to four years: the Times says that allowed Trump to recover taxes he paid when The Apprentice was profitable. That resulted in a large refund: that’s the issue that allegedly resulted in the refund audit.
So what happened with the refund?
If you pay too much in tax, you may be entitled to a refund – but you already know that.
That’s simply what the Trump camp claims happened here. But the Times piece seems to suggest that it’s more complex: by piling on losses (the legitimacy of which may be in question), he was able to generate a tax refund of $72.9 million (tax paid for 2005 through 2008, plus interest).
Ok, I get the refund bit. Then why was there an audit?
By law, refunds of more than $2 million for individuals ($5 million for corporations) require approval from the IRS, and a report is sent to the Joint Committee on Taxation. That can result in an audit: that’s what apparently happened here.
I’ve literally never heard of abandonment when it comes to taxes. What is it?
Abandonment occurs when a taxpayer deliberately gives up ownership of property (including interest in a partnership). The IRS looks at a few factors when considering whether property has been abandoned, including ownership before abandonment, if there is intent to abandon, and actual steps to abandonment.
The Times believes that Trump abandoned his ownership in his Atlantic City casinos, generating losses. He walked away from them in 2009, telling the Securities and Exchange Commission that he was “hereby abandoning” his stake.
If a loss is considered an abandonment loss, then it’s generally deductible as an ordinary loss: that means the full value of the loss can be deductible. That’s huge.
But instead, if it’s considered a sale or exchange – meaning that you got something back in exchange for walking away – it’s treated as a capital loss. Those are limited to $3,000.
Trump’s abandonment losses for 2009 – which resulted in the refund – were reportedly $700 million. To quote Jon Lovitz’ character, Ernie Capadino, in A League of Their Own: This would be more, wouldn’t it?
Ok, now explain to me the difference between the tax treatment of a home and an investment property.
That’s a pretty easy one: you generally cannot fully deduct expenses associated with maintaining your home, while you can with an investment property. Good examples of limited deductions include real estate taxes and mortgages, which are capped for homes (but not typically for investment properties).
The Times suggests that Eric Trump has characterized the Seven Springs property as a “home base” in a Forbes article. Do you know what they are talking about?
To be honest, I didn’t. But I found the article for you. It’s here.
Can you really write off hairdressing expenses?
Maybe.
You can’t deduct an expense just because it’s desirable or makes you look more professional: that applies to hairstyles, makeup, accessories, and more.
The same is generally true for uniforms and costumes (believe it or not, this post referencing ABBA’s costumes remains one of my most popular to this day).
To claim a deduction for business expenses, section 162 of the Tax Code requires that the expense is “ordinary and necessary.” According to the IRS, an ordinary expense is one that is common and accepted in your trade or business. The IRS defines a necessary expense as “one that is helpful and appropriate for your trade or business.” (You can read more about business expenses here.)
As a tax attorney, I can’t claim that hairdressing expenses – even if I need to look professional inside of a courtroom – are ordinary and necessary. But could someone who appears on television? Maybe. But only for the television/appearance bits – not for personal comfort or other unrelated business use.
(Note that any unreimbursed job expenses for employees have been eliminated for the tax years 2018-2025 as a result of the TCJA, but business expenses remain deductible for the self-employed and businesses.)
Can you write off lawyer’s fees?
The same rules generally apply to hairdressing expenses as legal expenses. Yes, for real. Legal expenses must also be ordinary and necessary in your trade or business to be deductible.
Believe it or not, even fees paid to a criminal defense lawyer may be deductible. While lawyers and judges have quarreled about the details over the years – even carving out public policy exceptions – the rule stands that if the action otherwise means the criteria for a valid business expense, it’s deductible.
There is, however, one notable exception: no deduction is allowed for legal expenses incurred in purely personal litigation.
Can you explain why the “20 PERCENT SOLUTION” is even an issue?
Again, I haven’t seen the returns and I can’t speak to the validity or appropriateness of the consultancy payments. But what caught my eye – and I’m sure other tax professionals as well – is the alleged consistency of the size of the payments (20%) no matter the transaction. There may be a valid reason for such a thing and that’s an example of where additional documentation is key.
One of the things that I tell my clients is that your records should always support your deductions: rounding or guessing isn’t enough. And that’s especially the case when those numbers indicate a pattern. Numbers that look too good to be true are almost always a red flag. The IRS knows as well as you do that your office phone bill isn’t always $100, and your office cleaners don’t earn 10% of your monthly receipts.
What else should we be on the lookout for?
It can be fun to play armchair (tax) detective, but as you read through articles this week, do me two favors:
- Be thoughtful about what you’re reading. Rely on trusted sources, and where possible, match tax items to code sections or court cases. Don’t assume something is true just because your favorite pundit says so.
- Be patient, but not necessarily dismissive. Again, the Times claims to have the returns: most other tax writers, like me, do not. So we’re relying on what we believe to be good information – and it’s not everything. But that doesn’t mean that you should dismiss it all out of hand. The Times raises some valid questions that shouldn’t be ignored. As I read through the article – and your questions – I’m reminded of something that departing IRS-CI Chief Don Fort used to stress: voluntary compliance is the basis of our tax system, and no one is above the law.