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A Tax Guru Explains Why Donald Trump May Finally Be in Trouble

Harry Litman

As the Republican nominee in 2016, Donald Trump repeatedly promised that he, like every other Oval Office contender in recent memory, would release his tax returns. As we now know, he likely had no intention of doing so. In fact, Trump has fought tooth and nail to keep his tax records hidden—from prosecutors, Congress, and the American people—only to be ruled against, in the end, by the right-wing Supreme Court he helped seat.

On December 30, the House Ways and Means Committee released six years of Trump’s tax returns to the public. A good chunk of the populace is dying to know what dark secrets may lurk in those documents. The Trumps have long been associated with fraud, after all. As president, in April 2018, Donald Trump agreed to pay $25 million to settle a class-action lawsuit against Trump University, a scammy house-flipping seminar operation that then–New York Attorney General Eric Schneiderman said defrauded thousands of people. Six months later, the New York Times published a blockbuster investigation detailing years of tax dodging and “outright fraud” by the Trump family. Last month, the Trump Organization was found guilty of criminal tax fraud, though Trump himself was not charged.

Now that the public has finally gotten its grubby mitts on Trump’s taxes, some very smart people are combing through them, and few are better suited than veteran tax attorney Steven Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center who has served both in private practice and in the federal government, helping Congress draft tax policy for financial institutions, financial products, and capital gains, among other things.

In the latest episode of the Talking Feds podcast, excerpted below with permission, Rosenthal talks with host-creator Harry Litman—a law professor who served as deputy assistant attorney general under Janet Reno during the 1990s, and then as the US attorney for Western Pennsylvania—about what makes Trump’s returns look janky, the legal perils the former president might face, and whether the IRS, which House Republicans neutered a decade ago and are preparing to neuter again, has a fighting chance against unscrupulous rich people and their white-shoe tax lawyers.

At the heart of the matter is what many have wondered: Will Trump ever actually be held to account for his tax avoidance? And if so, how might that happen? 

This interview has been edited for length and clarity.

You’ve just written an op-ed in the Washington Post, “Trump’s taxes are Exhibit A in the case for why the IRS needs a big upgrade.” Let’s zero in on the taxes: hundreds of millions of dollars in losses. How does that even happen?

Trump’s losses are staggering. He has [claimed] zero or negative adjusted gross income since 1985. As a consequence he pays little or no taxes. Sometimes he’ll pay what is known as the Alternative Minimum Tax, but he’s been losing money for decades.

And that’s real money, right? But for that, he’d be hundreds of millions of dollars richer—that’s not a conjuring?

That’s the $64,000 question, Harry. Trump reports tens to hundreds of millions of dollars of losses if you go back to the ’80s and ’90s, and the question, both as an enforcement matter and as a tax policy matter is: Are those losses genuine? Our system taxes income, and if you have a zero or negative income for the year, you pay no taxes and that’s fine. But what happens if you have a zero or negative income because you’ve inflated your losses? Well, that’s not fine.

Can you tell from the cache of returns that were just listed: Do they have any kinds of red flags about whether they’re phony? I gather they are very poorly documented, these losses?

Yes, poorly documented, and no, we really cannot tell whether the losses have been inflated. There was congressional oversight of his most recent six years of tax returns and the Joint Committee on Taxation—Congress’ nonpartisan technical experts—went in. They couldn’t tell whether the losses were legitimate. They directed the [IRS] agent to pursue a little harder some of the issues. I worked at the JCT in the ’90s. They’re very good tax lawyers there and if they couldn’t tell on the face of things, I don’t think anyone could.

But isn’t it incumbent on the taxpayer to demonstrate [the losses they claim]? 

We have what is known as a voluntary tax system. Voluntary in the sense that we expect each taxpayer to give the IRS a good-faith estimate of their tax liability. And they are supposed to have receipts. Documentation varies from deduction to deduction—charitable, business, and the like—but it’s hard to say what kinds of documentation Trump provided. The IRS did not have much in their working papers.

Now, one of the big takeaways from my review of the congressional oversight of the IRS audit is how feeble a job the IRS was doing. They only assigned one agent to one of Trump’s presidential returns—his first—in the third year of Trump’s presidency. And they only got to the other presidential returns after Trump left office. That one agent in effect outsourced the audit of a lot of income and deductions to Trump’s tax lawyers and accountants that prepared the return. The IRS couldn’t figure it out, so they said, “These are reputable accountants. I guess we’ll trust them.”

We’ve got the returns now. What we don’t have, though, is the underlying documentation. So presumably [Trump] presented support for that and you could do a forensic analysis. We don’t know what that might look like, right?

Yes, except I’m not sure the agent ever asked for it. I think the agent was so overwhelmed, they just said let’s trust Trump’s preparers to get these numbers right.

Wow. All right, so I’m thinking if he’s vulnerable or lying in some way, or even exposed, the biggest scheme here—if there are schemes revealed—would be these statements of losses. He said in the Hillary debate: It shows I’m smart that I’m not paying taxes. But [he also said] the losses show he was creating jobs. Does that hold up? Do you even understand the argument there?

I understand the argument, and it’s fascinating. Trump will say he pays few taxes because of the magic of depreciation. We allow taxpayers to take a deduction for wear and tear of their property, and with real estate those deductions are accelerated, front-loaded, and so real-estate investors often can lower their taxes. But there’s a few things wrong with the argument that what he’s done is perfectly lawful or smart. One is, depreciation doesn’t seem to explain much of the losses he’s had. I’ve looked especially closely at the losses he reported—almost $1 billion—in the 1990s, and there he just sidestepped a whole bunch of income recognition.

What he did was borrow money, and when you borrow you don’t have income because there’s an offsetting liability. And when he spent that money, he could take deductions for his expenditures. However, when Trump later was relieved of the liability [debt], he was supposed to report income and he didn’t. I’d say about half of his $1 billion of losses should have been offset by what is known as “discharge of indebtedness income.” Consequently, it’s not so much economic losses that are inflating his [claimed losses] but aggressive tax reporting, taking positions that others might not take.

Trump will say, “Hey, this is just a lawful application of the rules.” But in my view, it really is stretching the rules beyond what we might recognize as lawful—or at least, if challenged by the IRS, likely to lose—and interests and penalties would apply.

That’s really interesting. Do you think it’s clear why he tried to hide [his returns] so vigorously for so many years? Was it to cover up…Well, go ahead.

So Michael Cohen, his longtime lawyer, testified to the House Financial Services Committee, and he said that Trump did not want to release his taxes because he’s afraid that some hotshot think-tank guy would take them apart and show some liability and he’d have to pay interest and penalties to the IRS.

He was scared of Steve Rosenthal!

At the time, I was the only one looking at his taxes, so I take some comfort from that. But yeah, Trump outmatched the IRS. That was the big problem. The IRS has been auditing Trump forever, but their audits don’t go anywhere—they’re just outgunned. And so Trump can hide the ball and take aggressive positions and the IRS largely, I think, just lets him go.

I saw a lot of that when I was in law practice and defending taxpayers: You play Whac-a-Mole. The IRS raises an issue, you whack it down. It raises another issue, you whack it down, and eventually the IRS goes away—not because there wasn’t any liability but because the IRS couldn’t figure out what the true liability was. That’s a big problem. The IRS’s own operating manual specifies how presidential audits should be done, and so everyone sort of expected they were being done on an expedited basis as the manual directs, and being done thoroughly and hopefully fairly. But what we found was they weren’t being done much at all

That’s really stunning. If I got a call from an auditor, it would be pretty frightening. Is it a matter of sophistication? Of horsepower? Of resources? How can the federal government be outgunned by a single taxpayer?

The reason why you, Harry, would be in trouble if the IRS caught you or contacted you and found an adjustment, is your taxes are open and shut. You have a W-2. You might get some 1099s from your bank and your broker—lots of good information reporting and compliance is like 98 or 99 percent.

Trump’s business empire is comprised of LLCs and subchapter S pass-through businesses. He has more than 500! And the tax rules for pass-through businesses, especially partnerships, are really, really hard. And then, these partnerships and pass-throughs, one owns another so it’s often hard for anyone to get to the bottom of the tax claims. Because Trump’s affairs are arranged in such a complicated fashion, the IRS really struggles to figure out what’s going on—even relying on Trump’s lawyer and accountants the IRS, I don’t think, got very far. Trump is notorious for obstruction and delay, and if Trump applied to the IRS agent what he applies to the rest of us, I pity the poor agent.

Remarkable. So the other big ticket area that a vigorous and strongly armed audit would look into is his expenses, right? It sounds like you see a lot of possible fishy treatment of expenses?

Potentially, and that’s one of the areas the Joint Committee on Taxation suggested the agent pursue, but at one point the JCT quoted the agent as saying that, in effect, the cost-benefit just wasn’t there. The IRS lacked the resources to pull it off.

At some level, a lot of those are nickel and dime—you know, whether or not Trump actually took a deduction for the $70,000 haircut or whether or not he took a deduction for the Stormy Daniels settlement. That’s small potatoes. Trump generates losses in the hundreds of millions of dollars to offset his income later. So the fact that he’s taking personal deductions buried somewhere in the sprawling empire of 500 pass-through entities, we’re not going to find it very easy. 

On the other hand, you have a mandatory audit for presidents, so I think probably you want to get to the treatment of their stuff. Steve, is this sophisticated enough that we think it actually had to have been unscrupulous (or Trumpy) accountants who devised it, or is it the sort of thing that we posit Trump himself would have the wherewithal to do—”Ah, just call these losses this“—and being able to monkey around?

Well, monkeying around by labeling personal expenses as business expenses does not take any sophistication. Trying to sidestep income from relief of liability through restructuring your debt requires sophistication. Trying to take a $700 million loss for abandoning a partnership interest takes some planning help.

So you don’t think Trump devises this all by himself with his Wharton degree?

Yes and no. No, he doesn’t come up with a plan. But Trump doesn’t like to pay taxes. I practiced for 20 years and saw a lot of planning—a client would ask, “What are my options here? How can I lower my taxes?” Well, that’s the value-add tax planners bring to the table. And you could say, “We could try this approach or that approach; this is more aggressive, more likely to be picked up by the IRS and challenged than that.”

One of the phenomenal things from that $916 million loss he generated that I discovered from looking through the bankruptcy filings was that his own lawyer said he could take the position that he had no income on the restructuring of his debt, but if challenged by the IRS he would not likely prevail. It’s sort of strange for a lawyer to say that, but you can sort of imagine behind the scenes there was some concern that Trump would blame the lawyers.

One thing that I suspect went on is… Lawyers cannot advise clients on taking a course of action based on the likelihood of getting caught. They can only say what’s the likely outcome if it’s challenged. But the clients, the taxpayers, can play whatever hide-and-seek games they might like. They could say, “Well, just give me an argument that I can use so that it doesn’t look like it’s a willful omission of income or disregard of the law, so I don’t have any penalties or exposure to any criminal sanctions.” That goes on a lot. When the IRS is so poor at auditing, the chances of actually having to defend aggressive positions are rather low, and so playing hide and seek actually is quite profitable. That’s discouraging for our voluntary tax system.

What happens now that these returns have seen the light of day? Is he in some kind of peril? Do we anticipate investigations? Or does this explanation of “We’re just outgunned” suggest that he’s gotten away with the problems that are in these last six years of taxes.

Well, the problems in the last six years are much more minor than the ones earlier—not a coincidence; last month, Trump’s tax accountant explained that he directed the Trump Organization to make their tax returns squeaky clean once Trump took office. So I suspect that Trump cleaned up his act some. Trump may be nuts, but he’s not stupid.

If you go back to those big losses in the 1990s, the statute of limitations ran out. It looks as if the IRS just never adjusted any taxes for the positions Trump took. But the big $700 million loss claimed in 2009—Trump was under audit for that year at the time he entered office in 2017. And that audit remains open. Looking at the presidential years, the agent seemed to be slow in part because they hadn’t resolved the earlier cycle.

I think the peril to Trump is the very concerns that he expressed: Now that everyone knows there’s a $700 million adjustment potential out there and the whole world is looking at it, and people are writing articles, that could inform the audit. Matter of fact, one of the charming (to me) or amusing circumstance was, as the IRS was opening these tax audits of Trump’s presidential years, they were reading the New York Times story as to the shenanigans Trump was up to, and so the IRS agent structured his investigation and audit based on the New York Times investigation. It’s a sort of a shame that New York Times reporters, in effect, are doing the job for the IRS, but that’s where we’re at.

Setting Trump aside, what, if anything, can be done to shore up the whole system such that the IRS is not outgunned?

Well, we all knew this situation existed—that taxpayers with these pass-through entities, with complicated returns, were effectively audit-proof. But in the last Congress there was an extra $80 billion given to the IRS—half of which was for enforcement, and President Biden promised to use that money to target sophisticated taxpayers or corporations and rich individuals. The bad news is the House Republicans have pledged they want to rescind that enforcement money

Because they just think the IRS are part of the deep state or whatever?

That’s a little bit of a puzzlement. You go back 30 years, when I was working on the Hill, and there was bipartisan agreement that the tax laws should be enforced. Today’s Republican Party is much more wary of the IRS and the institutions. When the House Republicans last took over the House, in 2010, they immediately started gutting the IRS budget. Ten years later, the IRS had, in real terms, 23 percent less money and 26 percent less enforcement resources.

That $80 billion was to reverse those large setbacks. But now that the Republicans have taken over the House again, will they resume their course of stripping the IRS of resources? Certainly they’re planning on going down that path.

One of the troubling things to me is the rhetoric: those politicians who want to strip the IRS of resources and then later complain that the IRS functions poorly and demonize their employees. What is the response? Well, many of these anti-IRS people want to strip [even more] money from the IRS. That vicious cycle has been a real problem. I hope it keeps the money.

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