A Closer Look at the New York Times Trump Tax Scandal

Monday, November 19th, 2018 at 9:29 am by Daniel Fernandez

Last month, The New York Times released a lengthy article following months-long reporting into the operations of Fred Trump’s real estate empire. The Times reviewed over 100,000 documents including lawsuits, financial paperwork, tax returns, and depositions. The investigation revealed numerous suspect tax practices, ranging from clever tax planning to tax avoidance and “instances of outright fraud.” The 14,000-word article details how Fred Trump built his real estate empire and used creative tax planning to minimize his and his family’s tax burden. It illustrates unusual valuations of property, runarounds for cancellation of indebtedness income, partnerships formed for the purpose of reducing taxes, and ground leases paid to children. The article is largely targeted at the ways Fred Trump used tax planning to enrich his children throughout their lifetimes, while avoiding the hefty 55% estate tax and its accompanying gift tax. Specifically, it seeks to demonstrate how dependent Donald Trump’s finances were on his father’s wealth. It goes on to describe several methods Fred Trump used to transfer wealth to his children, including taking out loans with inflated interest rates from trusts he set up for them, to forming tax shelters through his real estate holdings. The highlight of the piece is the alleged “sham” corporation Fred Trump formed to disguise millions of dollars in gifts to his children. It’s worth taking a closer look at this scheme and considering further tax implications that the Times piece did not.

In 1992, the Trumps incorporated All County Building Supply & Maintenance (“All County”). According to the Times, it had no corporate offices and the address listed was John Walter’s, a family member and longtime confidant of Fred Trump. Walters and each of the Trump children owned 20% of All County. Fred Trump spent millions of dollars in supplies, such as boilers and stove tops, to maintain and improve his properties. Instead of directly purchasing these supplies from vendors, All County acted as a middle-man by buying supplies at regular rates and selling them to Fred Trump. In the process, All County greatly inflated the prices of these supplies, often with markups as high as 100%. So, why was Fred Trump buying these supplies just to sell them back to himself at even higher rates? The article suggests that the purpose was to funnel money to his children, the owners of All County, while avoiding the 55% gift tax which he would have had to pay had he just handed the money over to them. Using this method, Fred Trump was able to diminish his estate while bringing value to his children with the lowest possible tax burden. It was a remarkably simple plan, and as we peel back the layers we see even more potential savings beneath the surface.

Because the goal of the Times article is to dispel the myth that Donald Trump was a self-made billionaire, the emphasis of the tax schemes depicted is on the cloaked transfer of wealth from Fred Trump to his children. After all, the avoidance of the so called “death tax” motivated much of Fred Trump’s financial arrangements as detailed. Fortunately for the Trumps, the tax savings from the strategies employed may have stretched beyond the avoidance of the gift and estate tax. One such implication was the effect on federal income taxes. The transactions between Fred Trump and All County appear to be a classic tax shelter. Tax shelters are investments that typically produce losses that can offset other income, reducing tax liability. Because the tax code is so favorable to real estate developers, the best way to take advantage of these tax schemes is through real estate transactions. Often, a tax transaction may be structured in a way that perfectly follows the letter of the law, but upon closer scrutiny reveals underlying motives that render the agreement illegitimate. Leasebacks for instance, have tied up the courts for decades in case-by-case attempts to look past the form of such transactions to determine their actual substance.

In this case, Fred Trump was realizing an expense in the amount of the inflated price of the supplies he was purchasing from All County. Consequently, he was able to deduct those extra costs against his other income, producing an extra tax savings. If the transaction had not gone through All County, Fred Trump would have paid the real price of the supplies and could have only deducted that lesser amount against his earnings. Under this scheme, he gained extra deductions for costs that he was really just paying his children, and in the process reduced his taxable income. This illustrates a tax avoidance technique called income shifting. Without more details, it’s impossible to know to what extent the Trumps took advantage of this aspect of the scheme. All County would still be paying taxes on that extra amount it received for the fabricated markup; however, if All County was taxed at a lower marginal rate than Fred Trump, there would be a real opportunity for tax savings.

The line between allowable tax planning and these so-called tax shelters is drawn on the substance of the transaction. Assuming the tax code had been followed precisely, the validity of the arrangement here would have fallen on the substance behind All County. If All County was nothing more than a front, as the Times article seems to suggest, then there is little chance a court would allow the tax benefits produced from this form, due largely to the economic substance doctrine, which disallows tax benefits that lack economic substance or a legitimate business purpose. On the other hand, if the Trumps could prove All County served an actual purpose and existed beyond the paperwork, it is possible there was no wrongdoing throughout any of this ploy, regardless of the benefits.

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