|Borowitz and Trump's "Tax Return Dodge" 8/2016|
BY PAUL G.
Having just completed my 2015 Tax Return, I am in the mood to talk about the Trump tax situation.
It is possible that there are mysteries in his return that we will never know about, but we can be reasonably sure now what we would see in the remote case they ever come to light.
What income will be reported on Trump's return?
Trump’s return will be the summary of the results of the 500+ entities in which he has an interest. Each of these entities (called pass-through entities) files their own tax returns that we surely will never see and reports their results, in summary form on an IRS form called a K-1 (”Partner’s share of income, deduction, credits…”).
So, for example, the operations of one of his real estate holdings would report their net rental real estate income/loss and 20 or so other items that need to be detailed for Trump to properly reflect them in his return. More explanation is required for that thought.
The entity itself pays no tax; all of its operations flow through to its shareholders. But not all of the shareholders are in the same tax position so more detail is required. Take charitable contributions. If the entity earns $100 from rentals and pays $10 in contributions its net income is $90. But if a shareholder has made lots of other contributions on their own tax return (not talking about Trump here), they may not be able to deduct the $10. So the K-1 shows the two items separately.
Trump’s return will show the income from all of these entities with some additional detail for things like contributions and capital gains. We won’t see the detail to the contributions (who they were given to), but only the amounts. But it is really summary level and not helpful.
Did I say income? Well, it is certainly going to show lots of losses. That doesn’t necessarily mean that the properties lose money in the real world; but they do when using tax accounting. This is especially true with real estate, where interest is deductible and depreciation is factored in. Depreciation is the accounting concept that says an asset such as a building (but not land), loses value over time and the owner can reduce the income from the property by this artificial amount.
Since real estate tends to increase in value because of economic reality, we have a benefit to the owner paid for by the government. Fair or not, that is the reality of the tax code and it is a major consideration in real estate investing. And Trump has lots of it (real estate).
So when all of the entities are added up, the net result is a loss which can offset much, if not all, of his other income. And with little income (generated from his real estate holdings), there is little tax that Trump owes.
Salary? Does Trump take a salary from his companies? That would be an interesting question that the return would expose. He certainly should if he is performing services and in fact there are rules to ensure that. But he would have to pay social security and Medicare tax on it, and we know he is tax averse, so I would expect these amounts to be small.
Dividend and Interest? These might be clues to his actual wealth, but probably not. Other disclosures seem to indicate that he has little in stock holdings and he likes to pay interest, not receive it.
Gains on the sale of property? This might be somewhat interesting, although virtually all of the activity is likely to come from his K-1’s. And here, another tax provision is likely heavily used: Section 1031 – Like kind exchange.
If you have real estate and would otherwise sell it for more than you paid, you have a gain on the sale (and have to consider the depreciation you took to increase the gain – fair is fair) . Easy. But if you find another property you like, you can treat the sale and purchase like a trade and defer the gain until you sell the next property. Successful real estate investors rarely (?) pay tax on sales of property as they continually trade up. They have a great lobby or this tax loophole would have been gone long ago.
A reflection of his net worth? An income tax return gives virtually no insight into someone’s net worth; it is a report on tax related income items. Some things might give a hint: dividends received – where detail is provided – could be used to figure out the number of shares of stock held and therefore its value; many of the significant pass-through entities can be tied to underlying properties (which is how Forbes calculates Trump’s net worth) but overall, the return won’t show how rich or poor he is (remember, losses are not necessarily bad.
Charitable contributions? I think it is safe to say, we won’t see many on his return that were paid by him directly. We know how he prefers to use OPM through his foundation to satisfy his obligations in that area. So no bombshells are likely. And since he probably shows very little, if any, income, he wouldn’t get a tax benefit from making contributions. Since he is “smart”, he clearly wouldn’t want to waste his money without a government subsidy.
What is the story with the audit?
If there is any disclosure that I would enjoy, it would be the nature of the tax audit. It is virtually certain that Trump’s own return is not really being audited; his return is the collection of the 500+ other entities, and at least some of them are under audit. These are business audits and they do take a lot of time to complete, but they seem to be quite extended.
So what are the issues being raised?
Obviously, Trump believes in negotiating so it is likely he takes “aggressive” positions on his tax returns and bargains with the IRS when they find the items and disagree with the treatment. What kind of issues are being raised? For example, are businesses paying his personal expenses and deducting them? I can’t imagine they are not as we can clearly see he completely mixes his business with his personal activities. Is it a little or a lot? That would be a reasonable question but personally, I do not like subsidizing his lifestyle.
Given the slipshod accounting of his trivial foundation, I can’t see Trump overpaying for accounting services (aside from tax planning), and it is likely there are lots of mistakes in the actual accounting. Did he take aggressive positions on trades (1031), recognition of gains or claiming credits he might not have been entitled to. If there is any story to be found, it would be the nature of the IRS adjustments under audit. He surely won’t be paying less tax after the audit.
So in the end, do we learn much form his returns that we don’t already know or reasonably guess? Not really. We need the detail from the entities and so far, vigorous reporting hasn’t yielded too much in that area and the return would show ever less.
Paul G. is a CPA, a retired partner at KPMG, and the Global Chief Technology Officer for a sports start-up. He is a long time reader of The Juan Percent and the father of Sirinya's best friend from college.