I’m always excited to find stories in the news that touch on the tax law and policy I study and teach. Usually in my classes, we might spend about 10 minutes on such an item before moving on to the day’s lesson. The New York Times’ recent revelations about President Donald Trump’s taxes supply enough material for an entire semester. While most people will view the fact that Trump paid almost nothing in income taxes over the past 15 years as a political matter—does this hurt or help him? Is he actually bad at business?—those of us who teach tax law see a treasure trove of policy questions highlighting the strengths and weaknesses of our current tax system. If I were to build a class around Trump’s taxes, here’s how I’d do it.
One top-line issue is whether Trump was entitled to claim a loss (and if so what kind of loss) when he abandoned his interest in his failing casino business—which ultimately formed the basis for a $72 million refund request to the Internal Revenue Service that is still pending. Taxpayers should be allowed to deduct economic losses they suffer if they have basis in the amounts lost. Generally speaking, this means that they have already paid tax on the money lost. This is why you can’t deduct a loss when a stock you own goes from $100 to $150 and then back down to $100. You never paid tax on the $50 of gain when the price rose, so you can’t deduct the $50 loss when it falls back again. Basis is a core tax concept, and one that students often struggle to grasp.
A related issue is whether taxpayers should be allowed to deduct a loss in one year against gains from another year, whether in the past or going forward. Much has been made of the fact that Trump paid little or nothing in taxes most years, often because he claimed massive losses incurred in previous years. Assuming all his deductions are legitimate—if he actually lost more money than he made—that’s the right result. Imagine that you earned $100 in Year 1 and then lost $300 in Year 2. If each year is treated separately, you’ll end up owing tax on $100 even though you lost $200 overall. Considering the two years together would lead to no tax owed, consistent with your overall economic result. So we must decide what the appropriate accounting period should be for measuring income and loss.
The next question is whether taxpayers should be allowed to use losses from one venture to offset gains in another, as Trump has done with his casino and other business losses to help him avoid paying taxes on his considerable earnings from The Apprentice. A tax regime that cabins gains and losses to specific activities is typically referred to as schedular, and a number of different elements of our tax system (including capital loss limitations, gambling loss limitations, and the rules governing passive activities) reflect this approach.
Another issue arises with Trump’s $70,000 deduction for haircuts—this could be a whole lesson. Generally speaking, individuals cannot deduct the cost of their living expenses such as food, clothing, and haircuts, commonly referred to as personal consumption. However, if a business incurs this spending in pursuit of profit, the rules often allow such expenses to be deducted. The result is that some folks get to deduct their personal consumption, while others do not. Moreover, it creates an incentive to cheat.
Raise your hand if you know someone whose business owns the car he or she uses. While there are certainly cases where a business needs to own a car (think a UPS truck), in far more cases, individuals use their “business” vehicles to run to the store, drive their carpool, and commute. Whether legitimate or illegitimate, the current rules afford opportunities for some taxpayers to run their personal expenses through their business to claim a deduction to which they are not necessarily entitled. In Trump’s case, he deducted his hairstyling as a business expense, while you and I simply cannot. He also allegedly claimed that the Seven Springs estate he owns in Westchester County, New York, was being held for investment—even though one of his sons once described it as a “family compound” where they spent lots of time—entitling Trump to significant deductions that are unavailable to others who own second homes. While this last example does not involve running an expense through a business, it is yet another attempt to deduct personal consumption.
Next, the large consulting fees paid to Ivanka Trump raise interesting assignment of income questions. It seems odd that Ivanka would earn both a salary as an employee of the Trump Organization (and potentially a share of profits as an owner) and fees as a consultant. There are several potential tax reasons for this arrangement. Often, people attempt to assign income to family members in lower tax brackets to avoid taxes while keeping the money in the family. Given the amounts at issue, however, that doesn’t seem to be the case here. But the transfers could have something to do with avoiding payroll, estate and gift, or even state and local taxes. Or they could have some entirely nontax motive, including the possibility that Ivanka actually provided separate consulting services worth the amount of the payments.
And then there is the charitable donation associated with Seven Springs. By signing a deal with a land conservancy not to develop most of the land where the residence is located, Trump was able to claim a $21.1 million charitable tax deduction. While charitable giving may conjure up images of support for the poor, the truth is that large sums flow to universities, museums, and the arts, institutions often favored by and benefiting the wealthy. A number of different theories support a deduction for charitable donations. One is that the donor has given the funds away and therefore shouldn’t be taxed on them. Another is that there are positive externalities of such giving that the donor cannot capture. The deduction creates a financial incentive for the donor to engage in welfare-increasing behavior. But the charitable deduction raises a host of questions, including whether charitable giving should be viewed as a form of personal consumption, much like taking a vacation, that should be nondeductible, and whether an incentive is really necessary to induce giving. People give for a variety of reasons, including social status, and it is not clear that giving would cease or decline dramatically absent the deduction.
In this case, Trump created an easement that prevents his land from being developed, thus preserving this natural resource for future generations and presumably lowering the property’s value. But after some initial plans for the property fell through, it’s not at all clear that Trump was still planning to develop the land or how much value was given up. The higher the initial property value, the greater the value of the donation, and the greater the tax savings. As a practical matter, this deduction is only available to the wealthy because it requires vast amounts of undeveloped land. It is also an area rife with the potential for fraud because valuations are difficult to determine. It might be interesting to compare the valuation used for determining the easement with the one used for determining property taxes on Seven Springs. In any event, many of the most complicated parts of the tax code and regulations are anti-abuse provisions, designed to prevent such cheating.
Finally, there is the question of tax administration. By and large, taxpayers confess their incomes to the IRS, leading to an imperfect “trust, but verify” system. Much of the tax process is now automated, with the bulk of the audit process done by matching information returns, like the W-2 and 1099, to what the taxpayer reports. This works well for individuals, but not so well for businesses and the wealthy, whose income and expenses are often not reported by third parties to the IRS. The IRS has seen its funding cut, impeding its ability to audit. The mandatory Joint Committee on Taxation review of refund claims in excess of $2 million—that’s what Trump is currently facing for the $72 million refund he wants—is a great example of a procedural check meant to ensure the integrity of the system.
While much hay has been made of Trump’s returns and the fact that he has paid almost nothing in taxes over a long period, there is so much we don’t know that it is difficult to reach conclusions on whether he merely pushed the limits or in fact stepped over the line. Nonetheless, his efforts to harness the tax system for his own ends in so many creative ways shine a bright spotlight on the tax code, casting a number of different provisions and policy decisions in stark relief. And, yes, this will be on the exam.