Everyone knows they didn’t get Al Capone for all the heinous acts he did as a gangster; they got him on tax evasion. Tax issues may well turn out to be the Achilles’ heel for the Trump Organization and some of its top players. Capone failed to report and pay taxes on his illicitly acquired gains. The 45th president’s real estate and licensing company now stands charged with failing to report and pay taxes on a variety of fringe benefits to key employees after an investigation by the New York State attorney general and the Manhattan district attorney. Trump’s lawyers have called the charges petty and contend they are politically motivated. Others view them as designed to put pressure on the organization’s longtime chief financial officer to turn state’s witness. As a tax professor, I see them as a fantastic opportunity to talk about tax policy and the cat-and-mouse games that people play to avoid paying their fair share.
The indictment alleges state—as opposed to federal—crimes, but the underlying basis of the claims is federal income and payroll tax fraud, with a dash of state and local tax fraud thrown in as well. Among other things, prosecutors allege that the Trump Organization funneled approximately $1.76 million in compensation to CFO Allen Weisselberg, with neither the organization nor the CFO reporting the payments, thus allowing Weisselberg to avoid about $900,000 in taxes and improperly claim another $130,000 in improper tax refunds.
Let’s start from the employer’s perspective. Compensation is generally deductible. However, it is also subject to payroll taxes, including social security and Medicare. Typically, the employer pays half the tax, while the employee pays the other half. The employee half, which the employer withholds, is what you see reported on your pay stub. If the employer can disguise compensation as some other kind of deductible expense, it avoids the payroll taxes, saving approximately 14 percent that would have gone to the government. From the employee’s perspective, disguising compensation as a routine business expense avoids not only the payroll taxes, but also the income taxes that should be owed. Not bad work if you can get it.
This leads us to the exciting world of fringe benefits, noncash payments for work done. Clearly, if your employer pays you $100,000 as a cash salary, you owe taxes on $100,000. But what if you could convince your employer to pay for your housing expenses, provide you a luxury car, and cover your children’s private school tuition, as Weisselberg is alleged to have done? Unfortunately for you, Congress is not totally out to lunch. The tax code provides that “compensation for services, including fees, commissions, fringe benefits, and similar items” are income.
That these benefits should be considered income is made crystal-clear by the fact that Weisselberg’s agreed-upon salary was allegedly reduced dollar-for-dollar by the amounts paid on his behalf. It is as if the Trump Organization paid Weisselberg and he paid his own expenses, but they decided to cut out the middleman. Even if the CFO had never touched the money, he constructively received it when it was spent on his behalf. (The same cannot be said for the alleged off-the-record cash payments he received.)
In some cases, such as with employer-provided health insurance, Congress has expressly excluded fringe benefits, with the exclusion acting as a form of government subsidy. Other examples include certain forms of parking, small life insurance policies, and so on. The general idea is that these activities produce positive externalities that employees don’t capture, such that a subsidy is necessary to maximize the public good.
In other cases, Congress has decided that the employer is providing the benefit not as compensation but rather so that employees can do their jobs. Employer-provided housing, like the rent-free apartment allegedly paid for by Weisselberg’s employer, is typically considered income. However, there are limited circumstances where employer-provided housing should be tax-free. For instance, imagine a fishing vessel out at sea for a few months that provides onboard cabins for the crew. Unlike Weisselberg’s apartment, the shipboard housing is for the employer’s convenience—that is, it’s necessary for the crew to do its job. Such housing should not be considered income. (In Weisselberg’s case, it appears that the Trump Organization’s decision to pay for his housing was also designed to obscure the fact that Weisselberg lived in New York City, thus allowing him to avoid local New York City taxes, but this is a different issue.)
Where to draw the line between a legitimate business expense and something designed to reward employees (often referred to as personal consumption by tax experts) can be difficult. Should we allow deductions only for 1-ply toilet paper, deeming 2-ply a luxury that taxpayers should not subsidize? How nice a chair or desk is truly necessary? If a business needs a car, does it truly need a fancy one? Suffice it to say that fringe benefits can raise some interesting public policy questions and that there can be some close calls. However, the fringe benefits alleged to have been provided in the Trump Organization case—apartments, private-school tuition—fall well outside any fuzzy area. Personal expenses are not deductible if incurred directly and must be treated as taxable income to the employee if paid for by an employer, subject to all appropriate taxes.
While these charges may seem relatively minor given the larger allegations of tax fraud associated with Trump’s statements to borrowers and tax authorities about the value of his various properties, they amount to serious violations of the basic tax rules, if demonstrated to be true. Tax laws are supposed to apply equally to all. That the Trump Organization and its employees are alleged to have committed graver sins should not take away from what appears to be blatant cheating that undermines the fairness of the tax system.