Concerned about Trump-family tax gaming? His law may prompt others to dodge.
Revelations this week about the Trump family’s tax maneuvers nearly three decades ago are shining a new light on the president’s tax package. Does it really reform the system, making it simpler? For 9 in 10 Americans, the answer is yes. The near doubling of the standard deduction and the elimination of some deductions mean that they won’t have to itemize to get the biggest tax break. But for business owners and the wealthy, the new tax law preserves many current loopholes and adds new ones. That complexity will give the top 1 percent of income earners new ways to aggressively lower their tax bills, reminiscent of the ways the Trump family – according to a New York Times investigation – used existing loopholes to slash theirs. One provision in the new law is a 20 percent deduction for business owners who report their firm’s income on their individual tax return. It has both Republican and Democratic lawmakers concerned. Says Ken Vacovec, who heads a Boston-area tax law firm: “When people can manipulate things, they do – to their advantage.”
Why We Wrote This
Perhaps it isn’t surprising that the head of a small-government administration supports tax loopholes as well as tax cuts. Should it be troubling that his tax changes may make aggressive tax avoidance more likely?
When Americans file their taxes next spring, most of them will find the process easier. The new tax law offers such a generous standard deduction that there will be less incentive to spend time looking for deductions and other tax breaks.
The savings in time and effort could save the nation $3 billion or more in compliance costs, by one estimate. That’s what tax reform is supposed to do: Simplify things and close the loopholes.
But for a small group of Americans, the opposite is true. President Trump’s new tax law introduces new loopholes, and experts say that will encourage business owners and the wealthy to game the system in some of the same ways that Mr. Trump the businessman and his father reportedly did over the course of several decades.
Why We Wrote This
Perhaps it isn’t surprising that the head of a small-government administration supports tax loopholes as well as tax cuts. Should it be troubling that his tax changes may make aggressive tax avoidance more likely?
This infusion of complexity runs opposite to the typical theory of tax reform.
“Reform should be about eliminating loopholes and, to the extent possible, lowering tax rates,” says Steve Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center, a Washington-based research and analysis group. “When we load the tax system up with so much rubbish, it weighs the system down and the aggressive and the abusers try to get away with as much as they can.”
Many of the tax loopholes have been around for decades. In a long and detailed exposé published Tuesday, The New York Times described a series of highly questionable financial maneuvers that Trump’s father, Fred Trump, used during the 1980s and ‘90s to move money to his children and avoid taxes. Although some of the maneuvers appear illegal, according to tax experts, the loopholes themselves are not. In some cases, the Trumps merely used these loopholes so aggressively that they may have crossed the legal line, these experts add.
The Trumps claim no line was crossed. “There was no fraud or tax evasion by anyone,” a Trump lawyer told the Times. “The facts upon which The Times bases its false allegations are extremely inaccurate."
What is clear is that Trump has used loopholes repeatedly in his business career. In fact, when the Times reported one month before the 2016 election that the GOP candidate used a huge loss to avoid paying income taxes for up to 18 years, his campaign issued a statement touting his acumen: “Mr. Trump knows the tax code far better than anyone who has ever run for President and he is the only one that knows how to fix it.”
New openings for avoidance
For most Americans, Trump’s tax-cut package passed late last year will simplify things. In exchange for a near-doubling of the standard deduction, it trims several deductions, such as for state and local taxes (capped at $10,000), and eliminates others, such as unreimbursed business deductions, moving expenses, and alimony.
“Ninety percent of people will use the standard deduction this year, according to estimates,” says Nicole Kaeding, director of federal projects at the Tax Foundation, an independent tax policy nonprofit in Washington. “For most individuals, this will make the tax code easier and also make it easier for the IRS to administer.”
Of course, simplicity isn’t the sole criterion for whether the tax code is fair. Some complexity is inherent in any system, for example, that tilts toward the popular idea that rich people should pay at higher rates.
But many provisions, in practice, allow the very wealthy to pay at a lower rate than the less-rich do.
And for business owners and the wealthy, many tax loopholes were retained and some were added. One tax loophole the new law didn’t eliminate, for example, is “stepped up basis,” which the Trumps and other people have used to pass assets to children without the heirs having to pay for the appreciation in the asset.
The new tax law also slashed the corporate tax rate from 35 percent to 21 percent. That’s likely to make the US a more competitive place to set up business. But it also offers an enormous incentive for wealthy individuals to reclassify their labor and interest income (where the top tax rate is effectively 40.8 percent) to corporate profits, where it will be taxed at nearly half that rate.
“As we know, when people can manipulate things, they do – to their advantage,” says Ken Vacovec, head of a tax law firm for businesses and wealthy individuals in the Boston area. “We’ve had people talk to us about splitting up their businesses, moving things to different corporations, even to the point where they have different owners of corporations, so they could take advantage of some of these issues.”
The poster child for this complexity is Section 199A of the Internal Revenue Code.
The new provision offers up to a 20 percent tax deduction for owners of so-called pass-through businesses. These are firms whose owners use their individual income tax return to report their business income. And the 199A break was passed by Congress to offer small business a tax cut similar to what large corporations were getting.
But the reality is that many pass-through businesses are also quite large. By 2024, according to estimates by Congress’s Joint Committee on Taxation, 61 percent of the benefits of the Section 199A will flow to the top 1 percent of taxpayers.
The new deduction “is heavily tilted toward the wealthy, loses much-needed revenue, and opens massive new avoidance opportunities that weaken the integrity of the tax system,” the Center on Budget and Policy Priorities (CBPP) concluded in a blog post in May.
Concern about the deduction is coming from Republicans as well Democrats, says Nicole Kaeding of the Tax Foundation. And the Internal Revenue Service has issued guardrails to try to limit the type of pass-through firms that qualify for the deduction. But those safeguards are inadequate, she argues. “Congress should actually repeal that provision.”
The IRS, outgunned?
Trump supporters have cast doubt on the Times’s reporting of the Trump family’s tax maneuvers, arguing that such a high-profile figure would have received lots of IRS tax scrutiny. According to Trump’s lawyers, his tax returns from 2009 on are still being audited by the agency. So how could reporters detect something the IRS missed?
Yet tax experts suggest that cuts in the agency’s funding, plus the sophistication of the alleged tax dodges, make it hard for the agency to sniff out suspicious activity. In inflation-adjusted terms, the agency’s enforcement budget is down 23 percent since 2010 and it has lost more than a quarter of its enforcement staff, the CBPP points out.
“The IRS is wildly outgunned,” says Steve Wamhoff, director of federal tax policy at the Institute on Taxation and Economic Policy, a think tank in Washington. “You can’t keep cutting IRS funding and not expect more things like what The New York Times wrote about the Trumps. That’s bound to happen even more now.”
