Reality Bites: The New York Indictment of the Trump Organization Falls Flat
On October 17, 1931, Al Capone was sentenced to 11 years in prison for federal tax evasion. Capone reportedly boasted long before that: “The feds can’t collect legal taxes from illegal money.” In convicting Capone for tax evasion, prosecutors famously proved him wrong. The New York County District Attorney’s indictment of the Trump Organization and its Chief Financial Officer for tax evasion-related offenses does not pass Capone-style muster. It fails because the indictment is based on collecting taxes from legal wealth, and whether we like to believe it or not, our current tax system (both federal and state, since most states mirror the federal system) has been considerably defanged from reaching the amassed wealth of our richest citizens and corporations. The Trump Organization indictment does not rest on criminally acquired proceeds, but rather the allegedly intentional misreporting of lawful transactions based on an interpretation of the tax code. Because our tax law is now rife with exceptions to account for payments categorized other than salaries, bonuses, or wages, this indictment is very vulnerable to fail before a New York jury. Reality bites for these prosecutors.
Tax fraud is easy to prove against drug dealers and extortionists. It is a lot more difficult to prove when levied against big corporate entities who engage in “legal” business and employ expensive accountants and lawyers to help them “book” or account for their revenues and expenditures according to a tax code made impotent through exceptions and notorious “loopholes.” More importantly, today’s income tax is basically dead as applied to companies and wealthy individuals. It is dead because income is largely tied to wages and not accumulated wealth (otherwise known in economic terms as “labor” and “capital”). (See Edward J. McCaffery, “The Death of the Income Tax (or, The Rise of America’s Universal Wage Tax,” Indiana Law Journal, Vol. 95, Issue 4, Art. 5, Fall 2000.) In other words, companies like the Trump Organization can avoid millions in taxes by transferring wealth in legal forms other than wages, and not have to pay tax. This is what Donald J. Trump has done for decades. And he clearly is not alone in this practice. The “one-percenters” all do this – with legal protection.
Thus, when the N.Y. District Attorney claims that the Trump Organization and Allen Weisselberg under-reported wages, and therefore also the tax owed, they have a real problem ahead of them. Prosecutors charge that these wealth transfers were unreported wages. However, the available classifications in the tax code of corporate-based benefits to executives of companies – such as loans, business expenses, gifts, and other non-taxable transfers – are legion. What the District Attorney sees as taxable wages, tax lawyers and accountants see as non-taxable wealth. Crimes are based on intent and willfulness, and the Trump-related defendants have a powerful arsenal in their response: the tax law itself allowed them to do it. Capone had it backwards: tax can be collected from illegal business; it is a lot harder to collect from legal ones.
At its essence, the New York County Trump-related indictment is limited to a single theory of tax fraud: tax evasion based on improperly categorized income paid to the Trump Organization’s CFO, Allen Weisselberg (with a few untargeted references to various benefits received by other members of the CFO’s family who were also employees but not charged in the indictment). This Indictment charges that during a period of about 15 years, the CFO failed to report over $1.7 million in income to him from the company. It accuses the CFO of willfully failing to report certain corporate benefits as income for the purpose of evading federal, state and city tax, and it charges his employer, the Trump Organization, for evading payroll and related taxes on these same amounts. The facts alleged to support these theories are that the CFO received “off-the-books” benefits from his employer: including rent payments, utilities and parking garage payments; children’s private school tuition payments; “holiday entertainment” money; and intentionally failing to report the CFO’s residence in New York City to evade New York City-resident tax. Some of the counts in the Indictment are fashioned as old-style “grand larceny” crimes based on theft of money owed to the tax authorities.
The problems that the prosecutors face on this tax evasion theory are rooted in the tax code itself. By this post, I do not intend to critique the pervasive failures of the modern U.S. tax system, which would require a lot more words and effort. Instead, I focus on why the current Indictment against Weisselberg and his employer faces substantial legal hurdles of proof. We need not rely on mere speculation to assert that many executives receive benefits from their corporate employers that are not reported as “wages.” This is common practice. What is more difficult to decide, and which is a common debate in IRS tax conferences between tax collectors and taxpayers, is when a benefit should be classified as income versus some other non-taxable event. This is usually the meat and potatoes of New York’s big law firms, which receive millions of dollars in fees negotiating against the IRS in civil tax audits and litigating in our tax courts.
The reason that lawyers reap huge fees in these disputes is because our lawmakers have riddled our tax law with exceptions that swallow the rule. While the term “income” seems pretty clear to most lay people, the tax code makes it a black hole. And this is the hole that the local New York prosecutors are relying upon to build their criminal prosecution.
For example, the New York indictment alleges, among other things, that the Trump Organization’s CFO was given a New York City apartment in which to reside and work out of during his years of employment, and that the CFO and other Trump executives knew that these payments were unreported taxable income to the CFO. This allegation seems straightforward, but the tax code says otherwise. Defense counsel for the Trump Organization and Weisselberg are sure to argue a “convenience to the employer” loophole under the tax code. The Trump business could argue that it demanded Weisselberg accept lodging near Trump Tower so that he could be available to Trump at a moment’s notice, and that Weisselberg was required to perform a significant portion of his duties in this apartment. In other words, the apartment was for the convenience of Trump – the unyielding boss – rather than for the benefit of Weisselberg, the tortured CFO. This could be characterized as a necessary business expense that the employer required, and the CFO needed to accept as a condition of his employment. The tax code allows arguments like these, and at the very least, these arguments are eminently debatable.
Thus, when the crime is based on the failure of the Trump Organization and Weisselberg to declare these payments as “income” for tax purposes, the defense lies in the tax law itself. Upon cross-examination of the government’s tax experts at trial, the prosecutors might eat crow. A jury might find it hard to convict, on proof beyond a reasonable doubt, that the defendants intended to steal from tax authorities when defense lawyers show that the law arguably allows for this very kind of exception. (See e.g., IRS Regs. Sec. 1.119-1(b): (1) The lodging must be part of the business premises, which generally means where the employee performs a significant portion of his duties; (2) the employer must provide the lodging for the employer’s convenience rather than for the employee’s convenience; and (3) the employer must require the employee to accept the lodging as a condition of employment.)
To help bolster its tax cheat claims, the New York Indictment reveals that prosecutors also will rely on Trump Organization business records themselves. The indictment speaks about Trump’s “internal spreadsheets that tracked the amounts [the Trump Organization] paid for Weisselberg’s rent, utility, and garage expenses.” The Indictment notes that these spreadsheets were used by the Trump business to “reduce[ ] the amount of direct compensation that Weisselberg received in the form of checks or direct deposits to account for the indirect compensation that he received in the form of payments of rent, utility bills, and garage expenses.” (Indict., para. 7, p. 5.) In other words, the Indictment argues that Trump’s own records prove that its executives knew that by making these payments they were adding to Weisselberg’s taxable wages. But hold on a minute. We all have heard the legion tales of Mr. Trump’s miserly ways. Is it not at least plausible that Trump used these corporate benefits as an excuse to reduce Mr. Weisselberg’s wages? And, in any event, “compensation” or taxable wages under the federal and New York tax codes have a specific meaning defined by law. There is no tax consequence from the fact that these “internal” records were used by the Trump Organization to offer lower wages or salaries to its employees. The measure of fair compensation as determined by the Trump Organization is not relevant to whether the amounts qualify as taxable income under the tax code. Prosecutors seem to be dangling these disconnected facts as a red herring to distract from the analysis of controlling tax law.
In short, the New York Indictment underwhelms – big time. It is not Capone-esque, not even close. Our criminal law requires clear intent of wrongdoing. That is why it was easy for prosecutors in 1931 to convict Capone after showing his receipt and spending of hundreds of thousands of dollars in illegal income, which was never declared. When you don’t report any income and you are spending like a millionaire, the proof is in the pudding. However, Capone did not have fancy lawyers and accountants keeping records and reviewing IRS tax rulings and regulations to find the possible “loopholes” in the code. He simply never filed because he thought legal taxes could not be owed on illegal income.
The modern-day New York prosecutors think that they can prove a similarly styled tax evasion against the Trump business and its CFO based on specific payments made to benefit its CFO that were categorized on tax forms other than on lines reporting wages, salary or other compensation. However, this tax reporting was not done in a vacuum. At the same time, it categorized these payments in other forms, the company and Weisselberg were reporting nearly $1 million per year of W-2 and Form 1099 income on which taxes were paid. The specific payments alleged in the indictment, which were not reported as part of these annual wages, all can be tied to debatable exceptions in the tax code: such as the earlier explained lodging payments, or the “holiday entertainment” cash, or even the “gifts” of payments to children’s private school tuition. The fact that “bonus” compensation was allegedly reported under Form 1099, usually reserved for independent contractors, could even be justified by arguing that Weisselberg may only have been given discrete projects and accounting tasks with respect to other Trump entities’ books and records (other than the Trump Organization), and therefore his payment was based on this specific allocation of time. Thus, even reporting this compensation differently from wages can be reasonably argued. In short, the tax code is packed with lawful ways to report all of the Indictment’s allegedly miscategorized payments as non-taxable events or lesser-taxed forms of compensation.
As I stated at the outset of this post, our income tax does not tax accumulated wealth. It has largely become a tax on wages withheld from paychecks – and little more. Because there is little teeth in the law to tax the use of wealth – like corporate assets such as real estate – the tax code substantially fails to tax the wealthy. Taxes on wages are easily collected, easily raised, and easily hidden. Because this is the state of our tax code, the New York prosecutors’ attempt to punish the Trump executives criminally for using the code in the very way that it has steadily morphed – allowing compensation to be hidden in non-taxable wealth – is not a blueprint for conviction. Prosecutors cannot create a new tax code; they must prosecute tax crimes on the merits of the one that our legislators provided. And this tax code does not sustain the kind of “pervasive” tax evasion charges brought against the Trump Organization here.
The Trumps might not have paid taxes, but the real crime is that our income tax does not effectively tax wealth. You cannot punish the taxpayer when the tax code was set up for this very thing. Once again, Trump flew the coop. Reality bites.