The New York Times recently published a deep dive into some of the questionable tax practices of the Trump Organization going back to the days of Donald’s late father Fred Trump and his transfer of many millions of dollars in assets to his children through methods of dubious legality. [1] The gist of the story is that first, the Trump family conspired to defraud the U.S. government of millions of dollars in estate and other taxes over the years and that, second, Donald’s tales of “starting with just a small loan” from his father is a complete fabrication.
On the other hand, economist Paul Krugman [2] and others have pointed out the difficulty in differentiating, especially in the Trump’s case, between tax evasion, which is clearly illegal, and tax avoidance, which sits in a messier limbo between legal and ethical lines. This post will look at these two terms in more detail, especially as they relate to the Trump Organization.
I do need to point out here that much of the Times story was not new to me, although they did clearly find new evidence and details on the Trump tax strategy. Tax journalist David Cay Johnston has been following the “funny money” trail of the Trumps since way before political office came into the picture. I first ran into the modus operandi of the Trumps in the mid-1990s while working on some integration issues with a New York tax publisher that my employer had acquired, and I learned then that Trump had stiffed this relatively-small company out of money owed through Mafia-like intimidation. As many other vendors and investors found out the hard way, Donald Trump does not pay his bills.
Legality versus morality in taxation
In an earlier post, I explored the overlapping “spheres” of legality and morality using this Venn diagram:
The idea here is that some business practices, let’s say concerning tax compliance, use primarily the language of morality to describe how they are supposed to work, and are conceptually inside the red circle above, while others are much more clearly defined in legality terms, inside the blue circle, and still others rest in the fuzzy overlap between the two. The focus of that post was that we get into trouble when we try to either completely separate the two “spheres,” or alternatively try to force their complete congruence, asserting that “If it is immoral, then it must be made illegal,” or conversely, “If it is NOT illegal, then it MUST be moral.” Neither are true.
At the heart of tax law compliance in the developed world is the fair voluntary reporting of financial transactions by business entities and individuals. Most businesses do this all the time. Taxes are estimated regularly based on internal accounting, voluntarily paid to the government, and settled up later upon filing annual tax returns. The nation’s financial system would simply not work without this voluntary compliance.
Tax avoidance occurs when companies and individuals begin to press the tax rules toward their limits. Most of us do this on occasion. As individuals we “feel” how much we can safely deduct for home office expenses or cash charitable contributions without raising red flags from the tax auditors. The “legal rules” are pretty loose, and we can have an honest debate as to how much we can stretch credulity to where, at some point, we get into the moral language of “lying.” Most of the time, lying is not illegal, but it does quickly get us into the morality questions like “Who am I?” or “Am I a person who lies?”
Tax evasion, on the other hand, is the point where your lies about money cross the ill-defined frontier into the legality sphere, where fraud becomes the operant word. You won’t be prosecuted for simple tax avoidance. Even if the IRS decides that you went too far in your deductions, the worst that will happen to you is a civil tax penalty, which is the moral equivalent of a traffic ticket. “Good people” pay IRS tax penalties all the time.
But you can be criminally prosecuted for tax evasion that is deemed by the courts to be fraud. At a minimum, your civil tax penalties can be beefed up considerably into criminal fines even if you escape incarceration. So, where are The Trump Organization and the Trump family in this Venn diagram?
Defining the line between avoidance and evasion
My late father was a tax accountant for most of his career, and he commented to me one time that he knew where the line was between tax avoidance and tax evasion. But he never explained to me exactly where he drew that line. I assume that he had a personal “moral line” that he would not cross in his interactions with clients.
The reality is that Congress has intentionally left the line between tax avoidance and tax evasion very fuzzy over the years, and recent Republican Congresses have intentionally hamstrung the Internal Revenue Service, both by budget constraints and political pressure, from sharpening that line. As a result, the wealthiest taxpayers pay an estimated 25% less than what they legally owe, an amount in total lost tax revenue that, in total, would pay for the federal SNAP food program alone.
Ordinary taxpayers, on the other hand, have a much harder time getting away with clear tax evasion and even borderline tax avoidance on much smaller amounts. Other than the inherent unfairness of that system, we can use that reality of differential enforcement to come up with a definition of the difference between avoidance and evasion.
Ordinary taxpayers get dinged for excessive deductions or undeclared income with either civil penalties or criminal prosecution because enough similar examples have wound their way through the courts that prosecutors know where to draw that line. Enough appeals have worked their way through the courts that any attempt at tax evasion using one of the most common methods has a pretty clear case record. Most attempts are so blatant as to never see a courtroom at all. When more wealthy taxpayers have the means to challenge these longstanding precedents, however, they may work their way up a level or two in the appeals process, but the IRS and Justice Department enforcement agents hold most of the “bargaining power.”
At the same time, this history of tax law precedent puts an important onus on the tax preparers advising their clients. The assumption of the courts will be that there is a certain point where the tax adviser “should have known better” as a certified professional. At that point, the only question of evidence will be in how much the tax client was aware of the issue and was “in on” the intentional tax evasion.
Big-dollar tax avoidance and evasion
This takes us up, then, to the “creative accounting” exercised in big-dollar tax avoidance and tax evasion schemes, such as in multi-million-dollar estates like Fred Trump’s, or the complex international business deals like Donald Trump has entered into. Unlike the well-trod ground of small-potatoes tax evasion, what we are often missing here is “settled case law,” through to the appeals courts and even to the Supreme Court on these “innovative” tax strategies.
Without that “settled law,” there are often openings for aggressive tax advisers to set up complex business entity ownership relationships, and to move income and assets around these entities in ways that skirt capture for taxation purposes. In the case of the Fred Trump estate, for instance, a key strategy was to undervalue assets and to gradually transfer their ownership to the Trump children through a maze of LLCs and partnerships. One of these entities, called “All County Building Supply & Maintenance,” acted as if it were a third-party maintenance servicing vendor, but it was really a way to inflate costs to tenants and to shift cash assets to Fred Trump’s children.
The real estate development business is rife with this kind of “creative accounting,” so in one sense, the first excuse that “everybody does this” has some truth to it. Small conspiracies persist because they often exploit weak spots in legal enforcement. Add to this the lack of a clear trail of “settled law” court decisions defining the “avoidance versus evasion” line as compared to what exists with smaller frauds, and enforcement of “big dollar” tax fraud remains difficult.
Indeed, the passage of time in the case of the Trump Organization probably necessitates that criminal prosecutions here are unlikely. However, working from the settled case law that does exist, there likely remains millions of dollars of civil penalties and interest (perhaps hundreds of millions of dollars) that could be recouped from the Trumps, although this will likely wend its way through various state and federal courts for many years.
I have made the case before that the Trump Organization is much smaller in reality and much more financially-fragile that he often touts. There are likely shady business partners and hidden liens buried everywhere in the 500-odd business entities that make up the Trump Organization. The Donald will see bankruptcy court again, and some big tax bills may be the tipping point.
Differential tax enforcement has clearly aggravated the growing income inequality in the United States. Near the top of easiest social inequities that a future Congress could address would be to chart a clearer path to tax code enforcement at the top of the income scale. This would require both more financial resources toward basic enforcement (which would easily pay for themselves) as well as a focused effort to “settle the law” on the most abused tax loopholes.
Notes:
- Barstow, David, et al. “Trump Engaged in Suspect Tax Schemes as He Reaped Riches From His Father.” The New York Times, 2 Oct. 2018.
- Krugman, Paul. “Trump and the Aristocracy of Fraud.” The New York Times, 4 Oct. 2018.