Originally published on Forbes.com.
Well, when we have allegations about a president and a porn star, what is there for me to think about? Taxes of course. I’m thinking about what I would have done if I had prepared the 2016 tax return of Stephanie Clifford a.k.a Stormy Daniels; a.k.a Peggy Peterson. Thanks to a lawsuit filed in the Superior Court of the State of California for the County of Los Angeles, there are a lot of details available.
I’ve been able to come up with three possible positions I would have taken on Stormy’s return. This is the type of thing that would have made for a great tax season at Joseph Cohan & Associates in the 1980s, when we could still smoke in the office and before the Clarence Thomas hearings had introduced an almost Victorian propriety into office environments. First, a little background.
The Filing
Attorney Michael J. Avenatti tweeted out a copy of the complaint that was filed yesterday (March 6, 2008). According to Wikipedia, Mr. Avenatti is an attorney, entrepreneur, commentator and race car driver. He is also, according to this story by Suzy Frisch, a thorn in the side of KPMG, making me like the guy right away.
The plaintiff is Ms. Daniels, whom in the interest of being colorful and meaning no disrespect, I will refer to as Stormy. Defendants are Donald J. Trump (a.k.a David Dennison) and Essential Consultants LLC (I did confirm that there is such an LLC formed on 10/17/2016, but I haven’t sprung the twenty bucks for more details or rung up National Registered Agents Inc. in Dover). There are also defendants known as Does 1 through 10, who Stormy believes were agents, principals or alter egos of the President and the LLC.
Allegations
I’ll just give you the juicy ones. It is alleged that Stormy began an intimate relationship with Mr. Trump in the summer of 2006 that extended well into 2007. During the affair there was a “meeting” in a bungalow at Beverly Hills Hotel. (I think that might have to do with jurisdiction). After the release of the now-infamous Access Hollywood tape, she decided to tell her story, but was then contacted by Michael Cohen, who presented her with a “Hush Agreement.” (The “Hush Agreement” is attached to the filing. I read it carefully to come up with a good tax theory.)
The Legal Claim
The agreement is signed by Stormy and Cohen (on behalf of Essential Consultants LLC), but not by Trump. Nonetheless, as per the agreement, $130,000 was wired to Stormy’s attorney. According to the complaint filed in January 2018, Cohen, using intimidation and coercive tactics forced Stormy to sign a false statement denying her relationship with Trump. If you dig into the agreement, you will see that Stormy’s exposure is not just about having to pay back the $130,000. For each breach of the agreement she can be held liable for a million dollars in liquidated damages or undefined actual damages if they can be proved.
The theory is, because Trump did not sign the agreement, it is not a binding contract. Therefore Stormy is free to tell her story.
Now Mr. Avenatti is a Super Lawyer and I don’t even play one on TV, but one of the sections of the exam that I had to pass to become a CPA was Business Law. About the only thing that I remember from my studies for that exam are the elements of a contract—offer, acceptance and consideration. (Further research indicates that I am missing “mutual intent to be bound.”) So I would say there is a contract there, but what do I know?
What Was Stormy’s Tax Obligation?
One possibility, pretty unlikely, is that Stormy’s attorney – Keith M. Davidson & Associates – is still holding the $130,000 in its trust account awaiting a copy of the agreement signed by Trump. If that were the case, I think there is a pretty good position that Stormy did not have income in 2016 even though her attorney was holding the money. I’d put it as more likely that she probably received about $100,000 after attorney’s fees.
A pretty conservative position to take would be that the settlement was an extension of the trade or business of being a porn star. That would give her $130,000 in gross income, but it would have the advantage of making the attorney’s fee an ordinary and necessary business deduction along with whatever other expenses she might have incurred, say, mileage for example. In addition, she could possibly deduct contributions to her SEP or Keogh plan, but there would also be self-employment tax.
It is not determinative, but I would consider whether Essential Consultants LLC had issued Stormy a Form 1099. Arguably, it was not required to do so if it did not view the payment to her as having been made from a trade or business. On the other hand, I don’t want to even think about having to do that return, although I would be very surprised if it turned out that nobody had deducted the $130,000.
I’ve got two other theories, but for those, we need to dig into the agreement.
From The Agreement
The agreement states that Stormy had come into possession of certain confidential information, some of which is in tangible form. It also states that Stormy claims that she was damaged by Trump’s action, including tort claims proximately causing injury to her person. Then comes what I think is the heart of the agreement: Clause 2.3 (DD is Donald Trump and PP is Stormy).
DD desires to acquire, and PP desires to sell, transfer and turn-over to DD, any and all tangible copies of Property and any and all physical and intellectual property rights in and to all of the Property. As a condition of DD releasing any claims against PP related to this matter, PP agrees to sell and transfer to DD all and each of her rights in and to such Property. PP agrees to deliver each and every existing copy of all tangible Property to DD (and permanently delete any electronic copies that can not be transferred), and agrees that she shall not possess, nor directly nor indirectly disclose, convey, transfer or assign Property or any Confidential Information to any Third Party ….
Further on there is a release of claims, which presumably includes the tort claims about injury to her person.
Other Positions
The worst possible position would be for the $130,000 to be ordinary income not related to business, because then the attorney fees would be an itemized deduction subject to the 2% of AGI reduction and the alternative minimum tax. I’m definitely not liking that. The most favorable and aggressive position, which would take quite a bit of side support, would be that the main thing about the agreement was a release of the tort claims related to “injury to her person.” And those injuries need to be physical injuries. That would make the payment tax-exempt. I think I would have had somebody else discuss that angle with Stormy about the injuries being physical that is. All in all, I think it would be too aggressive a position.
Most of the agreement is about the “Property” and that is the approach I would be inclined to go with. I would take the position that the “Property” was a capital asset in Stormy’s hands. I doubt there would be any basis in it, but the attorneys fees would be expenses of the sale. So a capital gain of around $100,000 is what I would go with. I’d be happy to defend it on audit.
I think exploring this issue would be an interesting question for an exam in an MST program. I don’t think it is likely to show up on the CPA exam.
Other Coverage
Erik Pederson has something on Deadline Hollywood.
Presidential historians are looking into this as we speak, but the early consensus is that no sitting U.S. commander in chief ever has been sued by a porn star. Along with just about everything else that’s happened in the past 14 months, that apparently has changed.
Jessie Karangu of Sinclair Broadcast Group has something.
The lawsuit refers to the agreement Daniels and Cohen made as a “hush agreement” and also refers to Daniels and Trump with alternate names. In each document of the agreement, there is allegedly a blank space where Trump’s signature should be.
Michelle Fabio has Stormy Daniels, Donald Trump, And The ‘Hush Agreement’ That Won’t Shut Up on this platform on the Media & Entertainment Channel.
Maybe I’m still in Oscar mode here, but this sounds like the making of a blockbuster film to me.
Popcorn, anyone?
There is a lot more, but it appears that nobody has thought about the tax implications of the payment, which are really the most interesting part, when you think about it.