Trump’s Web of Companies May Have a Way to Avoid the Obamacare Tax
Behind the stainless steel and glass of Chicago’s Trump International Hotel & Tower lies a skeleton of 180,000 cubic yards of high-performance concrete. Below that, 57 rock caissons, some as thick as 10 feet and as long as 80 feet, anchor the skyscraper to the ground and bedrock. The building’s ownership structure is complex, too.
A limited liability company owns the building, and then another company owns that owner—followed by three more that own the owner’s owner, according to the latest federal financial disclosure from President Trump. Other companies appear to handle specific tasks, managing the building’s commercial, residential, and hotel businesses. And then there are companies that own those companies. The trail ends at the Donald J. Trump Revocable Trust, which collects income from the president’s worldwide businesses for his benefit. A flowchart of the structure “would go from the ceiling of a ballroom to the floor,” says Ronald Wiener, a tax lawyer specializing in partnerships.
The arrangement is not unusual among people who own their own large businesses, and it may have helped Trump avoid a specific federal tax on tens of millions of dollars in income from the Chicago property. Similar structures may provide the same benefit across Trump’s global holdings, all perfectly legally. This might be the best part, from the president’s perspective: The tax in question was created by the 2010 Affordable Care Act—or, as Trump has called it, the “Obamacare nightmare.”
It’s “smart planning,” says Michael Kosnitzky, a tax partner at Pillsbury Winthrop Shaw Pittman LLP who reviewed some of the ownership structures Trump has disclosed. While evidence is far from complete, available documents suggest Trump may have legally avoided $1.2 million in taxes on the Chicago hotel alone over just two years. Similar savings from many other properties could amount to tens of millions of dollars.
All the companies in these structures are pass-through entities, meaning they don’t pay income taxes themselves but pass earnings to their owners, who’re then responsible for the taxes—unless those owners are themselves pass-through entities.
Somewhere along this chain, Trump employs a particular kind of pass-through structure—an S corporation—in a way that almost certainly gives him a multimillion-dollar tax benefit, Kosnitzky says. Other tax experts, including Wiener, agree that Trump has probably avoided paying many millions of dollars in “net investment income tax,” a 3.8 percent levy that applies to the highest earners.
White House spokeswoman Natalie Strom referred questions about this story to the Trump Organization, which manages Trump’s businesses. Allen Weisselberg, the organization’s chief financial officer, didn’t respond to requests for comment.
During the 2016 campaign, Trump touted his tax-avoidance savvy. “That makes me smart,” he said in September about disclosures that he’d paid no U.S. income tax in 1978 and 1979. But because Trump has refused to release his tax returns, the evidence of his sophistication—his 1040 forms and supporting schedules—remains largely out of sight. Trump says he’s under a federal audit and won’t make the documents public until the IRS ends that review.
Here and there, however, he’s left clues about his tax strategies in the public record. One emerged in a 2013 deposition. A lawyer asked, “When you develop your projects in Las Vegas or Chicago, do you do them in your personal name, or do you set up some kind of limited liability company for that project?” Trump said, “I use corporations.” Specifically, he said, “a subchapter S corporation.”
Another hint came in 2007, in a book with Trump’s picture on the cover. “The big advantage of an S corporation is the ability to reduce self-employment taxes,” says the book, which purports to reveal how to do business Trump’s way. Its title: Trump University Asset Protection 101. While its recommended strategy focused on a different tax, the reference reflects an appreciation for the tax-cutting power of the S corporation. (Trump’s 1040 for 2005, which was leaked earlier this year, showed $1.9 million in self-employment taxes.)
Named for a section of the tax code, S corporations offer some liability protection to owners, as limited liability companies do. But their main draw, according to James Browne, a tax lawyer at Barnes & Thornburg LLP in Dallas, is to serve as a vehicle for getting around two taxes: a self-employment tax on wage income that helps fund Medicare, and the net investment income tax. Both are levied at 3.8 percent, on top of other taxes, for individuals with incomes above $200,000 (or $250,000 for a married couple).
The investment tax represented an attempt to equalize the treatment of wage income and investment income. For years, business owners had sought to avoid the Medicare self-employment tax by paying themselves low salaries and taking most of their income as a share of their companies’ profits. Former senator and vice presidential nominee John Edwards and former House Speaker Newt Gingrich, a one-time presidential contender, drew headlines last decade after they were found to be taking relatively low salaries from S corporations. The Affordable Care Act added the net investment income tax to capture income from profits.
But because of the way it was drafted, the investment income tax didn’t apply to an active owner’s share of an S corporation’s profits. Passive investors—those who had no role in running a company—would owe the tax on their share of the profits. But active owners who also paid themselves “reasonable” compensation for running their companies, and paid the 3.8 percent wage tax on that, could avoid the new tax. Their investment income would still be subject to other taxes.
There’s no official guidance from the IRS on what constitutes reasonable compensation. So the chief of a successful S corporation might pay herself a comfortable six-figure salary, and pay the Medicare tax on that, while earning seven or eight figures in business income that escapes the ACA’s investment tax. “I’m fairly certain” Trump is using that very strategy, says Kosnitzky, who does tax planning for wealthy individuals and families and private businesses such as hedge funds. “He takes a reasonable salary, and the remaining profits are paid out as an S corp dividend without the imposition of either the net investment income tax or Medicare tax. So he saves 3.8 percent on this income.”
The extent of any savings is difficult to pin down. The financial disclosure Trump filed in June says his various holdings produced well over $500 million of income over a 15½-month period. But that number appears to conflate income (essentially profits) with revenue. Also, the filing provides amounts only in ranges; it says the Chicago hotel’s income exceeded $5 million.
A consolidated income statement on file with the Cook County property assessor’s office shows the hotel reported about $11.7 million in net operating income for nine months of 2014, the most recent year available. A 3.8 percent tax on that income would have amounted to almost $445,000. Another document at the assessor’s office lists “actual net income” for the hotel properties at more than $32 million in 2013 and 2014. A 3.8 percent tax on that amount would net $1.2 million.
IRS rules allow an LLC with U.S. owners to choose to be taxed as an S corporation. This year the S corporation loophole will allow about $16.7 billion in tax avoidance, according to 2016 estimates from the U.S. Department of the Treasury. President Obama’s administration asked Congress to fix the problem, but it didn’t. “The S corporation loophole survives because there are successful car dealers, insurance agencies, and other pillars of the local establishment in every congressional district whose owners employ it,” says Edward Kleinbard, a tax law professor and former chief of staff for the congressional Joint Committee on Taxation.
Now that he’s president, Trump says he no longer has an active management role in the 500 or so companies listed on his disclosure; he retained his ownership stake via his trust but stepped down from all leadership roles. In other words, he’s become a passive investor—perhaps making him liable for the investment tax, according to Martin McMahon Jr., a retired tax law professor from the University of Florida. (Or maybe not: IRS rules allow investors to use prior years’ experience to bolster claims for “active” status even in years when they’re inactive.)
The question will be moot if the investment tax is repealed. Congress has failed to deliver on Trump’s larger goal for Obamacare. But even without a full repeal, a one-page outline of the administration’s tax policy goals this year targeted one particular piece of the law: “Repeal the 3.8% Obamacare tax that hits small businesses and investment income,” it said. —With Nathan Howard and Hui-yong Yu