What Would Trump’s Tax Returns Tell Us?

The release of President Trump’s tax returns is the talk of the town now that Democrats have secured control of the House, but what’s in those returns is anyone’s guess.

Speculation is rampant over whether the incoming House Ways and Means Committee chair will try to use section 6103 to order the Treasury Department to hand over Trump’s returns and examine them for conflicts. If the president’s returns are released, they might not tell the full story of how his business empire operates. And if they do tell the full story, it may not be the story some of Trump's detractors are hoping for.

The only Trump returns that have been made public so far are a leaked 1995 New York state individual income tax return that showed an eye-popping loss used to offset income and a 2005 federal Form 1040 that showed he paid $38 million in tax at a rate of about 24 percent. What those returns don’t tell us is how his operations are structured, who lent him money, or who his business partners are.

Lawyers, accountants, and law professors speaking with Tax Notes said that even if Trump’s returns are released publicly, those questions could remain unanswered. However, speaking mostly on the condition of anonymity because of political or professional sensitivities, they helped explain what we might see in a batch of returns from a real estate and international business owner .

Lots of LLCs

Trump has disclosed that he owns a combination of over 500 limited liability companies, partnerships, cooperatives, and corporations. 

A typical real estate fund may hold hundreds of individual pieces of real estate in separate LLCs. Those LLCs could be disregarded for tax purposes, meaning they are owned by one person or entity and aren’t required to file a federal tax return. 

Those separate LLCs could in turn be owned by other LLCs — all real estate in, say, Mississippi, could be owned by separate LLCs that could be wholly owned by one LLC.  

Above the wholly owned LLCs could be a limited partnership that has multiple owners and files a Form 1065, “Partnership Tax Return.” Information from that return would go to the partners in a Schedule K-1 and would then be used to fill out their individual returns.

The ultimate partners in the partnership receiving the income from the LLCs everywhere could comprise individuals, trusts, other partnerships, and even C corporations.

While they are frowned upon for the double taxation aspect, C corporations can act as “blockers,” whereby the corporation would file a tax return. By receiving a dividend, a foreign investor may not have effectively connected income that would require a U.S. tax return to be filed.

The arrangement is not a nefarious plot but a legal structure that allows for investor flexibility.

Practitioners were quick to point out to Tax Notes, however, that while the structure may be common for real estate funds, it’s unlikely that Trump has a real estate fund. Funds often involve investments from other regulated investment companies, state pension funds, and retirement plans and often involve financing from large banks.

Practitioners said Trump has been something of a lone wolf, and that after his casino and other risky ventures went south in the early 1990s, some lenders and investors have reportedly been hesitant to work with him.

They also said it’s not even clear how much of his business is composed of real estate anymore.

We know he owns and sells some real estate, even if that amount is shrinking. A recent lawsuit filed over pollution of the Chicago River showed that Trump owned and operated the Trump International Hotel and Tower Chicago. 

According to reports on Trump’s financial disclosures, he earned nearly $6 million in rent and condo sales from operating the Chicago building between 2015 and 2016, and three separate management companies he owned received fees in the millions. 

A USA Today investigation reported that in 2016, Trump’s companies owned more than 430 individual properties and noted that 4 percent of Trump properties were sold to LLCs before he secured the Republican nomination for president. After Trump was named the GOP nominee, the number of property sales to LLCs spiked to 70 percent.

Best of Both Worlds

There is a possibility that lawmakers could get a better sense of how Trump has earned his money from a review of his tax returns, but the flexibility allowed in his choice of business structures may obscure much of that information.

One question is how much real estate the president still owns and how much of his income now comes from licensing deals and property management. Trump has shown a propensity to blur the lines in past statements, including in a 2007 deposition. 

The case was brought by Trump for defamation against his biographer, and at one point Trump was asked to read a handwritten note he wrote to journalist Peter Slatin about a story in Forbes saying Trump was a minority owner of a partnership with a Chinese group that owned property in New York.  

“Peter, you’re a real loser,” Trump said in the note, and claimed he owned 50 percent of the partnership, not a minority stake. The attorney deposing him said that on paper Trump actually owned a 30 percent minority stake, but Trump claimed that the way the partnership was set up meant it really equaled a 50 percent ownership.

Trump explained he was a limited partner and therefore wasn’t on the hook for the money invested if the deal failed. Instead, the Chinese general partners that owned 70 percent of the business would bear the burden and he would walk away without owing or losing anything.

“So if the 70 percent owner puts up all of the money, I really own more than 30 percent,” Trump said in the deposition. “And I’ve always felt I own 50 percent from that standpoint.”

The deposing attorney pointed out that the partnership agreement stated the general partners would receive distributions up to the capital they invested, as well as a priority return, before Trump received a cent. Trump countered that he was given management fees in the millions apart from the distribution order.

Wait, Where’s the Tax?

There's also good reason to expect Trump to have paid a low tax rate. 

To a W-2 wage-earning employee, seeing a wealthy individual pay such a low percentage in taxes stings, but that doesn’t mean any laws were broken. To the contrary, it’s usually the result of net operating losses, depreciation deductions, or the favorable tax treatment given to capital gains.

Real estate has historically received favorable tax treatment through the code, and Congress increased that favoritism in the Tax Cuts and Jobs Act (P.L. 115-97) signed into law by Trump in late 2017.

The TCJA imposed new business interest deduction limitations by revising section 163(j), but it’s elective for real estate businesses if they meet specific requirements.

Like-kind exchanges were largely scaled back, and now only real estate qualifies. A 20 percent passthrough deduction was added to the code that applies to LLCs that imposes strict rules limiting the deduction to wages paid to employees and unadjusted basis in property, and some business types are barred from using it. Real estate investment trust dividends, which derive income from real estate rental income, aren’t subject to any of those limitations.

If Trump’s returns show little or no tax paid, it would likely outrage many Americans on the hook for income and payroll taxes on their wages, but that would be something to take up with Congress.

Naming Names

One of the most interesting questions is whether Trump's tax returns will expose potential conflicts of interest by listing lenders and other business partners.

Trump’s sons have said publicly that Russian investments make up a large portion of the family’s funding. But it’s unclear whether Trump’s business tax returns would reveal the names of lenders or foreign investors.

As Daniel I. Weiner and Lawrence Norden of the Brennan Center for Justice at the New York University School of Law have pointed out, it’s possible that neither Trump’s personal income tax returns nor his business returns would shed light on where the revenue or debt came from.

“While many types of business interest are tax-deductible, and thus the interest payments would be reflected on a return, payments to different creditors can be aggregated together, and the creditors themselves need not be named,” according to an article by Weiner and Norden. “So if, for example, a Trump-owned company had made interest payments to a Russian state bank, neither the name of the bank nor even the specific amounts paid would necessarily appear on the company’s return.”

However, practitioners said that if a domestic partnership sells real estate and has foreign partners, withholding may be required. The withholding requirements in the 1980 Foreign Investment in Real Property Tax Act under section 1445 and partnership withholding for foreign partners with effectively connected income under section 1446 could be insightful.

Whether a partnership also filled out forms 8804, 8805, and 8813 for foreign partners could be helpful in determining its business dealings with foreign nationals. For that insight, practitioners pointed to Schedule B on Form 1065 to see which of those forms were filed.

One practitioner said that depending on a business’s structure, foreign financial institution filings under the Foreign Account Tax Compliance Act could provide useful information. If a nonfinancial foreign entity is majority-owned by U.S. persons, disclosure and withholding information on money earned outside the United States provides insight, for example, if a U.S. taxpayer controlled entities offshore to fund U.S. real estate ventures.

It’s possible that Trump’s ownership positions are held in U.S. entities or trusts, but it’s also possible that one or more of his interests in U.S.-based real estate entities could be warehoused in an affiliate overseas, according to one practitioner. That could raise withholding and FATCA issues, the practitioner added. 

The partnership tax return could show Trump as one owner and would list the name of the other owners, but those other owners would likely be LLCs or other types of shell companies. Tracking down the actual owners using publicly available resources could be challenging, if not impossible.  

International Planning Strategies

Using tax returns to answer questions about foreign business dealings would be complicated by the fact that the planning strategies are almost endless for U.S. companies engaging in real estate and licensing transactions overseas. 

Some taxpayers block the profits earned in other countries from current income taxation in the United States through the use of foreign-controlled corporate entities to reinvest the money in other overseas projects. However, those blocked profits could be subject to anti-deferral rules under subpart F and new section 951A, referred to as global intangible low-taxed income, according to Jerry August of Chamberlain Hrdlicka White Williams & Aughtry. August did not speculate specifically about Trump's business operations.

Real estate deals are often heavily leveraged, so it’s common to see a special purpose vehicle (SPV) formed to borrow money. That SPV is owned by a joint venture with the U.S. taxpayer, either as a general partner or a limited partner, as well as partners from other countries, August said. 

An SPV is sometimes used when large commercial lenders want to prevent the entity it’s loaning to from filing for bankruptcy. The SPV borrows the money, and the partnership that owns it owes the money even though the SPV is technically on the hook for repayment. In other instances, an SPV is structured to issue notes primarily to institutional investors to invest the proceeds mainly in mortgage loans. These so-called commerical real estate collateralized loan obligations are growing in popularity and are more flexible than real estate investment conduits, practitioners noted.

If the U.S. taxpayer chooses to use a corporation as its partner in the foreign joint venture, income from the real estate could be partially stored offshore and used to pay down debt on the deal. 

Sometimes a foreign hybrid entity is used that is taxed as a corporation for foreign tax purposes but allows for passthrough treatment so items like depreciation can still be deducted. The U.S. taxpayer would get foreign tax credits on the entity-level tax but still receive items of income and loss that would be subject to U.S. tax.

Structures are formed by the parties’ economics in the deal: the debt involved, ownership percentages, preferred allocations, etc. Other payments also play a role, like whether a partner will receive promoter’s fees for putting the deal together.

Practitioners said in that context, a taxpayer would likely receive Schedule K-1-type filings from foreign-based entities and Forms 5471 from blocker corporations. But for a clearer picture of a taxpayer’s overall business operations, financial statements would be more helpful than tax returns.

One common theme among practitioners who spoke with Tax Notes was that although the real estate industry made out well under the TCJA, the treatment of foreign businesses owned by U.S. taxpayers has been turned upside down.

Just the First Step

What information is captured in the president’s returns remains to be seen, and it’s possible we’ll never find out. And if the returns are released and appear overly complicated, that doesn’t mean anything improper took place.

Some practitioners said they’d be surprised if the returns reveal actual fraud, saying that instead they suspect the president’s reluctance to release them has more to do with their showing that Trump is worth less than he claims.

But some disagreed with that speculation.

David Cay Johnston, the author of several books on Trump and the recipient of the president’s 2005 federal tax return, cautioned that approaching Trump’s returns as if he were a normal real estate developer misses the point.

“Donald is not a businessman; he’s not a wealth creator,” Johnston said. “He’s a cash extractor.”

Johnston added that the release of Trump’s returns would be a great first step but would require much more digging into the businesses that appear on those returns to learn the details of their operations.