Donald Trump must confront major tax issues when deciding what to do with his real estate empire and other businesses in order to avoid conflicts of interest as he assumes the presidency.
What will happen if he decides to divest his businesses or simply pass them outright to his children?
Trump has hinted at his plans for separating from his businesses but has yet to formally announce them. On Nov. 30, in a series of tweets, he said: “I will be holding a major news conference in New York City with my children on December 15 to discuss the fact that I will be leaving my great business in total in order to fully focus on running the country in order to MAKE AMERICA GREAT AGAIN!”
The president-elect added that while he isn’t mandated to do so under law, “I feel it is visually important, as President, to in no way have a conflict of interest with my various businesses.”
How Trump deals with his holdings could result in different outcomes, practitioners told Bloomberg BNA.
Estate and Gift Tax Implications?
One of Trump’s options is to gift his businesses outright to his children, but Richard Behrendt, director of estate planning services for Annex Wealth Management, points out that may not be the wisest idea.
“He would pay a pretty hefty tax bill if he decided to do so,” Behrendt said Wednesday. A 40 percent tax rate applies to gifts greater than a lifetime exemption amount of $5.45 million per individual in 2016.
That number is indexed for inflation and will increase to $5.49 million in 2017. There is also an annual exclusion for gifts of $14,000 that can be used once a year per gift given—meaning he could make annual gifts of $14,000 to each child and pay no gift tax.
Essentially, Trump and his wife together could pass almost $11 million to the children tax-free, but “that’s almost like me giving a pack of gum away in relation to their estimated net worth,” Behrendt said. “I would be very surprised if they would want to pay 40 percent federal gift tax on the amount between the $11 million exempt amount and” the other billions of dollars in assets, he said.
Determining Trump’s exact net worth requires additional information, but Forbes estimates that number to be about $3.7 billion. On its face, that would amount to a $1.48 billion transfer tax bill.
The more “palatable” option may be to put the assets into a blind trust where he still has beneficial ownership but has given up control and oversight, Behrendt said.
Making a family member—like his daughter Ivanka—the trustee would “be more smoke than an actual transfer,” he said. “I think if you were really going to do that and be really transparent, you would hire some third-party professional, either an attorney or a professional trustee,” and give them control. That has been the more traditional route taken by presidents since Lyndon B. Johnson in 1963.
However, Trump has signaled he may grant control of his businesses to his children in the type of “blind” trust that Behrendt and others have criticized.
What About Passive Losses?
Congress enacted tax code Section 469, which addresses passive activity losses, in the Tax Reform Act of 1986. The statute was aimed at stemming the use of passive losses to dodge taxes.
“At the time of enactment, people with sources of high taxable income that could not directly be tax-massaged very much (e.g., salaried professionals such as doctors, dentists, and lawyers) were buying investments that were designed to generate large tax losses, without commensurate economic losses,” Daniel N. Shaviro, a tax professor at the New York University School of Law, said in an October blog post.
“These losses were used to offset the positive taxable income, hence ‘sheltering’ it,” said Shaviro, who was a legislation attorney at the Joint Committee on Taxation at the time and helped draft rules to prevent such use in 1986.
The 1986 passive loss rules said if a taxpayer invests in a passive activity—meaning one in which he or she doesn’t “materially participate” or is a rental activity—then that person can’t deduct any resulting passive losses against nonpassive income, such as a salary.
During a 1991 House Budget Committee hearing, Trump testified on behalf of the real estate industry to request relief that included relaxation of the passive loss rules. Congress in 1993 enacted a special exception to the rules, permitting people who qualified as real estate professionals to avoid having their rental real estate activities treated as passive.
As Trump becomes president, it is possible that the passive loss rules could apply to him if he ceases to “materially participate” in his rental real estate and other businesses—which most would assume—Shaviro told Bloomberg BNA Tuesday. However, that extra tax bill seems “trivial” compared to the position he is in “to be benefiting his businesses by what he does every day in office,” he said.
Do Loss Carryforwards Count?
Lawrence A. Zelenak, a tax professor at Duke University School of Law, said he suspects the passive loss rules won’t be “a big deal” for Trump for two reasons.
The first is that he can still use loss carryforwards, which apply the current year’s net operating losses to future years’ profits to reduce tax liability. In October, the New York Times released Trump’s 1995 state tax returns, which showed $916 million in net operating losses. The Times reported that those losses may have allowed him to avoid paying federal income tax for as many as 18 years.
Future losses from real estate activities would be passive. But assuming Trump still has loss carryforwards from earlier years in which he wasn’t subject to Section 469, those “would continue to be available to offset income, and they may well be sufficient to zero-out his taxable income for years to come,” Zelenak said Wednesday. “The fact that he’s not materially participating anymore wouldn’t make any difference.”
In addition, the rules don’t prevent Trump from using passive losses to offset income from other passive activities, he said.
“If he had some what are now passive real estate ventures that are throwing off taxable income and others that are throwing off losses, even under the passive loss rules he could still use the losses from” the unprofitable ventures to offset the income of the profitable ones, Zelenak said. “What he can’t do is use losses from the passive activities to offset nonpassive activity income, so if he’s got book royalties or accepts a presidential salary, those wouldn’t be offsettable.”
Trump has said he won’t accept the $400,000 annual presidential salary while in office.
What If He Divests?
Another route Trump could take is to divest, or sell, his business holdings.
If he decided to do so, Trump could receive a significant tax break. Tax code Section 1043 says that “an officer or employee of the executive branch, or a judicial officer, of the Federal Government” who is compelled by federal law to sell property or business holdings in order to comply with conflict-of-interest requirements can get a “certificate of divestiture.”
The certificate acts as a waiver, allowing the eligible person to defer paying capital gains tax on any sale as long as the money is reinvested in any obligation of the U.S. or diversified investment fund approved by regulations issued by the Office of Government Ethics, according to the statute. Permitted investments include U.S. treasuries or highly diversified mutual funds.
The Office of Government Ethics in a series of Nov. 30 tweets said it had informed the president-elect’s attorneys that divesting his business holdings is the best option to resolve ethical concerns about conflicts of interest as Trump assumes the presidency.
A Dec. 7 New York Times article said that the president-elect intends to keep a stake in his business and resist calls to divest.
During a daily conference call with reporters, Trump transition team spokesman Jason Miller said Wednesday that issues regarding Trump’s business holdings will be addressed at the Dec. 15 news conference. “Regarding the Trump organization and the president-elect’s transfer away from that, that will be something that will be talked about in more detail in a week,” he said.
“The president-elect will be transferring from running his business to being solely focused on his job as president of the United States,” Miller said.
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