Donald J. Trump proudly acknowledges he did not pay a dime
in federal income taxes for years on end. He insists he merely
exploited tax loopholes legally available to any billionaire — loopholes
he says Hillary Clinton failed to close during her years in the United
States Senate. “Why didn’t she ever try to change those laws so I
couldn’t use them?” Mr. Trump asked during a campaign rally last month.
But
newly obtained documents show that in the early 1990s, as he scrambled
to stave off financial ruin, Mr. Trump avoided reporting hundreds of
millions of dollars in taxable income by using a tax avoidance maneuver
so legally dubious his own lawyers advised him that the Internal Revenue Service would most likely declare it improper if he were audited.
Thanks
to this one maneuver, which was later outlawed by Congress, Mr. Trump
potentially escaped paying tens of millions of dollars in federal
personal income taxes. It is impossible to know for sure because Mr.
Trump has declined to release his tax returns, or even a summary of his
returns, breaking a practice followed by every Republican and Democratic
presidential candidate for more than four decades.
Tax
experts who reviewed the newly obtained documents for The New York
Times said Mr. Trump’s tax avoidance maneuver, conjured from ambiguous
provisions of highly technical tax court rulings, clearly pushed the
edge of the envelope of what tax laws permitted at the time. “Whatever
loophole existed was not ‘exploited’ here, but stretched beyond any
recognition,” said Steven M. Rosenthal, a senior fellow at the
nonpartisan Tax Policy Center who helped draft tax legislation in the
early 1990s.
Moreover, the tax experts said the maneuver trampled a core tenet of
American tax policy by conferring enormous tax benefits on Mr. Trump for
losing vast amounts of other people’s money — in this case, money
investors and banks had entrusted to him to build a casino empire in
Atlantic City.
As
that empire floundered in the early 1990s, Mr. Trump pressured his
financial backers to forgive hundreds of millions of dollars in debt he
could not repay. While the cancellation of so much debt gave new life to
Mr. Trump’s casinos, it created a potentially crippling problem with
the Internal Revenue Service. In the eyes of the I.R.S., a dollar of
canceled debt is the same as a dollar of taxable income. This meant Mr.
Trump faced the painful prospect of having to report the hundreds of
millions of dollars of canceled debt as if it were hundreds of millions
of dollars of taxable income.
But
Mr. Trump’s audacious tax-avoidance maneuver gave him a way to simply
avoid reporting any of that canceled debt to the I.R.S. “He’s getting
something for absolutely nothing,” John L. Buckley, who served as the
chief of staff for Congress’s Joint Committee on Taxation in 1993 and
1994, said in an interview.
The
new documents, which include correspondence from Mr. Trump’s tax
lawyers and bond offering disclosure statements, might also help explain
how Mr. Trump reported a staggering loss of $916 million in his 1995 tax returns, portions of which were first published by The Times last month.
United
States tax laws allowed Mr. Trump to use that $916 million loss to
cancel out an equivalent amount of taxable income. But tax experts have
been debating how Mr. Trump could have legally declared a deduction of
that magnitude at all. Among other things, they have noted that Mr.
Trump’s huge casino losses should have been offset by the hundreds of
millions of dollars in taxable income he surely must have reported to
the I.R.S. in the form of canceled casino debt.
By
avoiding reporting his canceled casino debt in the first place,
however, Mr. Trump’s $916 million deduction would not have been reduced
by hundreds of millions of dollars. He could have preserved the
deduction and used it instead to avoid paying income taxes he might
otherwise have owed on books, TV shows or branding deals. Under the
rules in effect in 1995, the $916 million loss could have been used to
wipe out more than $50 million a year in taxable income for 18 years.
Mr. Trump declined to comment for this article.
“Your
email suggests either a fundamental misunderstanding or an intentional
misreading of the law,” Hope Hicks, Mr. Trump’s spokeswoman, said in a
statement. “Your thesis is a criticism, not just of Mr. Trump, but of
all taxpayers who take the time and spend the money to try to comply
with the dizzyingly complex and ambiguous tax laws without paying more
tax than they owe. Mr. Trump does not think that taxpayers should file
returns that resolve all doubt in favor of the I.R.S. And any tax
experts that you have consulted are engaged in pure speculation. There
is no news here.”
Mr.
Trump financed his three Atlantic City gambling resorts with $1.3
billion in debt, most of it in the form of high interest junk bonds. By
late 1990, after months of escalating operating losses, New Jersey
casino regulators were warning that “a complete financial collapse of
the Trump Organization was not out of the question.” By 1992, all three
casinos had filed for bankruptcy, and bondholders were ultimately forced
to forgive hundreds of millions of dollars in debt to salvage at least
part of their investment.
The
story of how Mr. Trump sidestepped a potentially ruinous tax bill from
that forgiven debt emerged from documents recently discovered by The
Times during a search of the casino bankruptcy filings. The documents
offer only a partial description of events, and none of Mr. Trump’s tax
lawyers agreed to be interviewed for this article.
At
the time, Mr. Trump would have been hard-pressed to pay tens of
millions of dollars in taxes. According to assessments of his financial
stability by New Jersey casino regulators, there were times in the early
1990s when Mr. Trump had no more than a few million dollars in his
various bank accounts. He was so strapped for cash that his creditors
were apoplectic when they learned that Mr. Trump had bought Marla Maples
an engagement ring estimated to be worth $250,000.
It
is unclear who first glimpsed a way for Mr. Trump to dodge a huge tax
bill. But the basic maneuver he used was essentially a new twist on a
contentious strategy corporations had been using for years to avoid
taxes created by canceled debt.
The
strategy, known among tax practitioners as a “stock-for-debt swap,”
relies on mathematical sleight of hand. Say a company can repay only $60
million of a $100 million bank loan. If the bank forgives the remaining
$40 million, the company faces a large tax bill because it will have to
report that canceled $40 million debt as taxable income.
Clever
tax lawyers found a way around this inconvenience. The company would
simply swap stock for the $40 million in debt it could not repay. This
way, it would look as if the entire $100 million loan had been repaid,
and presto: There would be no tax bill due for $40 million in canceled
debt.
Best
of all, it did not matter if the actual market value of the stock was
considerably less than the $40 million in canceled debt. (Stock in an
effectively insolvent company could easily be next to worthless.) Even
in the opaque, rarefied world of gaming impenetrable tax regulations,
this particular maneuver was about as close as a company could get to
waving a magic wand and making taxes disappear.
Alarmed
by the obvious potential for abuse, Congress and the I.R.S. made
repeated efforts during the 1980s to curb this brand of tax wizardry
before banning its use by corporations altogether in 1993. But while
policy makers were busy trying to stop corporations from using this
particular ploy, the endlessly creative club of elite tax advisers was
inventing a new way to circumvent the ban, this time through the use of
partnerships.
This
was the twist that was especially beneficial to Mr. Trump. Wealthy
families like the Trumps often own real estate and other assets through
partnerships rather than corporations. Mr. Trump, for example, owned all
three of his Atlantic City casinos through partnerships, an arrangement
that allowed casino profits to flow directly to his personal tax
returns when times were good.
But
what if times were bad? What if Mr. Trump’s casino partnerships could
not repay hundreds of millions of dollars they owed to bondholders? And
what if the bondholders were persuaded to forgive this debt? Wouldn’t
that force the partnerships — i.e., Mr. Trump — to report hundreds of
millions of dollars of taxable income in the form of canceled debt?
Enter
the tax advisers with their audacious plan: Why not eliminate all that
taxable income from canceled debt by swapping “partnership equity” for
debt in exactly the same way corporations had been swapping company
stock for debt?
True
enough, the I.R.S. and Congress had clearly signaled their disapproval
of the basic concept. Fred T. Goldberg, who was the I.R.S. commissioner
under George Bush, recalled in an interview that the I.R.S. frowned on
partnership equity-for-debt swaps for the same reason it objected to
corporate stock-for-debt swaps. “The fiction is that the partnership
interest has the same value as the debt,” he said. Lee A. Sheppard, a
contributing editor to Tax Notes, wrote in 1991 that trying to find a
legal justification for this tactic was akin to proving “the existence
of the Loch Ness monster.”
On
the campaign trail, Mr. Trump boasts of his mastery of tax loopholes
and claims no other candidate for the White House has ever known more
about the tax code. This background, he argues with evident disgust,
gives him special insight into the way wealthy elites buy off
politicians and hire high-priced lawyers and accountants to rig the tax
system — just as, he claims, they rig elections.
That insight was on display in 1991 and 1992 when he was laying the groundwork to make a multimillion-dollar tax bill disappear.
Before
proceeding with his plan, Mr. Trump did what most prudent taxpayers do:
He sought a formal tax opinion letter. Such letters, typically written
by highly paid lawyers who spend entire careers mastering the roughly
10,000 pages of ever-changing statutes that make up the United States
tax code, can provide important protection to taxpayers. As long as a
tax adviser blesses a particular tax strategy in a formal opinion
letter, the taxpayer most likely will not face penalties even if the
I.R.S. ultimately rules the strategy was improper.
The
language used in tax opinion letters has a specialized meaning
understood by all tax professionals. So, for example, when a tax lawyer
writes that a shelter is “more likely than not” going to be approved by
the I.R.S., this means there is at least a 51 percent chance the shelter
will withstand scrutiny. (This is known as an “M.L.T.N.” letter in the
vernacular of tax lawyers.) A “should” letter means there is about a 75
percent chance the I.R.S. will not object. The gold standard, a “will”
letter, means the I.R.S. is all but certain to bless the tax avoidance
strategy.
But
the opinion letters Mr. Trump received from his tax lawyers at Willkie
Farr & Gallagher were far from the gold standard. The letters
bluntly warned that there was no statute, regulation or judicial opinion
that explicitly permitted Mr. Trump’s tax gambit. “Due to the lack of
definitive judicial or administrative authority,” his lawyers wrote,
“substantial uncertainties exist with respect to many of the tax
consequences of the plan.”
Document
Donald Trump's Lawyers' Warnings on Tax Maneuver
Mr. Trump's own lawyers at Willkie Farr & Gallagher
cautioned him about using a a tax avoidance maneuver in the 1990s.
One
letter, 25 pages long, analyzed seven distinct components of Mr.
Trump’s proposed tax maneuver. It found only “substantial authority” for
six of the components. In the stilted language of tax opinion letters,
the phrase “substantial authority” is a red flag that the lawyers
believe the I.R.S. can be expected to rule against the taxpayer roughly
two-thirds of the time. In other words, Mr. Trump’s tax lawyers were
telling him there were at least six different reasons the I.R.S. would
probably cry foul if he were audited. In anticipation of that
possibility, the lawyers even laid out a fallback plan that would have
allowed Mr. Trump to spread the pain of a large tax hit over many years
if the I.R.S. ultimately balked.
It
is unclear whether the I.R.S. ever challenged Mr. Trump’s use of this
specific tax maneuver. According to a financial disclosure statement
prepared by Mr. Trump’s accountants, he was under audit by the tax
authorities as of 1993, only a year after he avoided reporting hundreds
of millions of dollars in taxable income because of this legally suspect
tactic. But the results of that audit are unknown, and the agency
declined to comment on Monday.
Regardless
of whether the I.R.S. objected, Mr. Trump’s tax avoidance in this case
violated a central principle of American tax law, said Mr. Buckley, the
former chief of staff for Congress’s Joint Committee on Taxation, who
later served as chief tax counsel for Democrats on the House Ways and
Means Committee.
“He
deducted somebody else’s losses,” Mr. Buckley said. By that, Mr.
Buckley meant that only the bondholders who forgave Mr. Trump’s unpaid
casino debts should have been allowed to use those losses to offset
future income and reduce their taxes. That Mr. Trump used the same
losses to reduce his taxes ultimately increases the tax burden on
everyone else, Mr. Buckley explained. “He is double dipping big time.”
In
any event, Mr. Trump can no longer benefit from the same maneuver. Just
as Congress acted in 1993 to ban stock-for-debt swaps by corporations,
it acted in 2004 to ban equity-for-debt swaps by partnerships.
Among the members of Congress who voted to finally close the loophole: Senator Hillary Clinton of New York.
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