Republican presidential candidate Donald Trump is seen during a press conference at Los Pinos on Aug. 31, 2016 in Mexico City, Mexico.
Photo by Hector Vivas/LatinContent/Getty

Trump stretched tax loopholes 'beyond any recognition'

The fact that Donald Trump didn't pay federal income taxes for many years is not in dispute -- because the Republican presidential candidate admitted it during a nationally televised debate. There is some question, however, about whether or not Trump's exploitation of tax loopholes was entirely legal.

The New York Times reported last night that the answer may not cast the GOP nominee in a positive light.

[N]ewly obtained documents show that in the early 1990s, as he scrambled to stave off financial ruin, 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.

Thanks to this one maneuver, which was later outlawed by Congress, Mr. Trump potentially escaped paying tens of millions of dollars in federal personal income taxes. It is impossible to know for sure because Mr. Trump has declined to release his tax returns, or even a summary of his returns, breaking a practice followed by every Republican and Democratic presidential candidate for more than four decades.

The Times spoke to Steven Rosenthal, a senior fellow at the nonpartisan Tax Policy Center who helped draft tax legislation in the early 1990s, who agreed that Trump pushed the legal envelope to the breaking point.

"Whatever loophole existed was not 'exploited' here, but stretched beyond any recognition," Rosenthal said.

At issue are Trump's curious choices as his business enterprises floundered in the 1990s. Trump, unable to pay his debts, convinced many of his creditors to forgive loans -- money that's supposed to be counted under federal tax law as taxable income. The New York Republican, however, gambled on a creative approach to accounting, embracing a complex and "audacious" tax-avoidance maneuver: Trump swapped debt for "partnership equity" -- a practice that is now strictly illegal.

The strategy, known among tax practitioners as a "stock-for-debt swap," relies on mathematical sleight of hand. Say a company can repay only $60 million of a $100 million bank loan. If the bank forgives the remaining $40 million, the company faces a large tax bill because it will have to report that canceled $40 million debt as taxable income.

Clever tax lawyers found a way around this inconvenience. The company would simply swap stock for the $40 million in debt it could not repay. This way, it would look as if the entire $100 million loan had been repaid, and presto: There would be no tax bill due for $40 million in canceled debt.

Best of all, it did not matter if the actual market value of the stock was considerably less than the $40 million in canceled debt. (Stock in an effectively insolvent company could easily be next to worthless.) Even in the opaque, rarefied world of gaming impenetrable tax regulations, this particular maneuver was about as close as a company could get to waving a magic wand and making taxes disappear.

John Buckley, who served as the chief of staff for Congress's Joint Committee on Taxation in 1993 and 1994, told the Times that Trump's scheme violated a central principle of American tax law: "He deducted somebody else's losses."

Don't try this at home. Trump has tried to get away with tax maneuvers the typical American should not attempt.

Postscript: On a related note, Vox talked to some tax-law experts this week about Trump's controversial charitable foundation, and they said there's almost certainly grounds to investigate the Republican for criminal tax evasion. This is, of course, a separate matter, distinct from Trump's creative accounting in the 1990s, which was also dubious.