Originally published on Forbes.com.
The New York Times tax archaeology team has solved another mystery. How Donald Trump got to keep the $900 million net operating loss that they uncovered in their last expedition. I have to give them credit for making some pretty arcane stuff sound exciting. They write of an “audacious tax-avoidance maneuver” a “tax avoidance maneuver, conjured from ambiguous provisions of highly technical tax court rulings” and a maneuver that “trampled a core tenet of American Tax policy” using “mathematical sleight of hand”.
Not A Trump Apologist
The New York Times seems to be determined to turn me into a Trump apologist, so I should make it clear that I am not. I learned everything I needed to know about Donald Trump the presidential candidate by going to his rally in Worcester nearly a year ago.Trump reminded me a bit of the worst managing partner I ever had. Why his opponents need to go rooting around for tax peccadilloes is beyond me. Really, just listen to the guy. Regardless responding to a presidential candidate who is dumbing down the country by helping to erode tax literacy is probably not the best path.
Is There An Accountant In The House?
What is most disturbing to me about the Times piece is that they don’t seem to have anybody involved who can think in debits and credits. Here is why I think that. Yesterday’s story reads.
Mr. Trump avoided reporting hundreds of millions of dollars in taxable income by using a tax avoidance maneuver so legally dubious his own lawyers advised him that the Internal Revenue Service would most likely declare it improper if he were audited.
A story by Richard Hylton in the New York Times in 1990 gives a better summary of what was going on economically than the current Times story – Trump, $47 Million Short, Gives Investors 50% of His Prize Casino
Under the settlement, the $47.3 million in interest on the junk bonds that Mr. Trump failed to pay Thursday will be added to the $675 million in the principal he owes on the property. The rate of interest on that debt will be reduced from the original 14 percent to 12 percent, two percentage points of which Mr. Trump can pay in new junk bonds.
The bondholders, whose investments are secured by a first mortgage on the casino, will receive 50 percent of the stock in the Taj and will be given three of the seven seats on its board, leaving Mr. Trump with control. But for Mr. Trump to keep control the Taj must come within 15 percent of a budget approved by the bondholders. If the casino fails to produce enough cash under Mr. Trump’s management, he will lose control of the board.
That is the economics. Trump gets more time to pay and a lower interest rate and the bondholders get an equity kicker. Superficially there is no debt discharge income at all. In other words, the principal of the debt was not reduced, as the Time article seems to imply.
Old Bonds New Bonds
The letter from Willkie Farr & Gallagher explains the tax accounting. The “Old Bonds” are replaced with “New Bonds” and the bondholders receive an interest in the Taj partnership which had previously been just Trump and his own corporation. The partnership interest is immediately transferred to a corporation controlled by Trump, but subject to a control shift in the event of default.
The “New Bonds” are publicly traded which is what created the debt discharge exposure. Even though the face amount was not reduced the “New Bonds” would trade at a substantial discount. The lawyers opined that it was a reasonable position to hold that there was no debt discharge.
…..in our opinion there is substantial authority for the Company and the Partnership to take the position that the Partnership interests were issued by the Partnership in satisfaction of a portion of the Old Bonds
They go on to note that there can be no assurance that the Service will not challenge that position or that a court would not uphold such a challenge. That latter part is what the Times story and other commentary use to make the whole thing seem wild and crazy.
Still Missing Some Pieces
I spoke with Mike Greenwald of Friedman LLP to get his take on the story.
Based on the article, with no other details, I believe it is safe to conclude that the transactions are more complex than reported.
We are unlikely to see any similar techniques today because the relevant loopholes have been closed.
It appears that there are a few potentially relevant tax issues not addressed by the legal opinion letter. There may have been other guidance related to the transactions that has not surfaced or wasn’t part of the public filings
I have to agree with Mike on the legal letter. Among the issues that are left out are those of partnership taxation. Even though there was no debt discharge, there would have been a deemed distribution to Trump for the difference between the face amount of the old bonds and the fair market value of the new bonds. On a forward going basis income that was used to pay down debt would be disproportionately allocated to Trump and losses would be allocated to the corporation which thanks to the bondholders would have positive tax basis capital.
I’m sorry I can’t explain that more clearly without going on at some length, but the bottom line is that the rules of partnership taxation would prevent this transaction from being quite the free lunch that the Times experts claim.
Expert Claims Unsupported
John L. Buckley who was chief of staff for Congress’s Joint Committee on Taxation is quoted as saying “He’s getting something for absolutely nothing”, “He deducted somebody else’s losses” and “He is double dipping big time”.
Those statements are just not supported by what happened. After the resturcturing Trump still had an upside-down partnership interest with what is known in the trade as a “minimum gain”. In other words, if he walked away with nothing there would be a large gain recognition. He managed to kick the can down the road in this transaction and it is possible with refinancing and like-kind exchanges, he has kept kicking it, but this restructuring did not make him “Olly olly oxen free“.
Something Intelligent From The Trump Campaign!
The Times quotes Trump Hope Hicks, Trump’s press secretary, who makes the most intelligent remarks I have ever heard from the Trump campaign
Your email suggests either a fundamental misunderstanding or an intentional misreading of the law. Your thesis is a criticism, not just of Mr. Trump, but of all taxpayers who take the time and spend the money to try to comply with the dizzyingly complex and ambiguous tax laws without paying more tax than they owe.Mr. Trump does not think that taxpayers should file returns that resolve all doubt in favor of the I.R.S . And any tax experts that you have consulted are engaged in pure speculation. There is no news here.
What is most disconcerting to me about this particular Times piece is that it does not really appear that Trump was getting away with that much. He did not get a principal reduction from the bondholders, so requiring him to pick up ordinary income at that point would have really been kicking him when he was down. And he did give up equity in return for the more favorable debt terms. Unlike the Son of Boss shelters that would be coming later, everything about this was real. There were real casinos that lost a ton of money. After the restructuring there was as much principal as there had been beforehand and some equity had been surrendered.
Joe Kristan Nails It
I won’t do my normal other coverage review, which has turned my slow response to the news cycle into a feature rather than a bug, other than to mention Joe Kristan’s piece – Shocker: taxpayer takes favorable position on uncertain tax issue!
Brutal assault on reason watch.* In an election year that has generated more dumb than was known to exist on the planet, the New York Times has chipped in a little more ….
The New York Times says, in effect, that Trump took a position his lawyers said was good enough that he didn’t have to disclose it to avoid penalties. That a taxpayer would take such a position when there is a lot of money at stake should surprise or offend no one.