Tax issues related to the Trump Foundation continue to grab headlines. The Washington Post’s David A. Fahrenthold has tirelessly examined the organization, and recently discussed “four new cases of possible self-dealing [that] were discovered in the Trump Foundation’s tax filings.”
Any allegation of self-dealing sounds inherently bad, but the discussion of the Trump transactions skips over some nuances that may bear on the legality of the candidate’s conduct. In fact, it appears that commentators are using self-dealing to mean different things at different times. In this post, I want to explain what self-dealing means under the tax code (specifically, Section 4941), so that commentators can better assess what’s going on with the Trump Foundation.
Under Section 4941, special self-dealing taxes apply when a “private foundation” engages in a transaction with any “disqualified person” (loosely speaking, this would include any person close to the private foundation). The Trump Foundation is treated as a private foundation under the tax code, and Donald Trump is a disqualified person under the statute. Consequently, the Section 4941 self-dealing taxes potentially apply to transactions between Trump and his foundation.
Notably, nothing in the tax code formally prohibits acts of self-dealing between private foundations and disqualified persons. Rather, Section 4941 simply imposes a tax on self-dealing transactions, even if those transactions are undone. (The taxes become especially large if they are not undone. See Footnote 1 (FN1).) Consequently, if the Trump Foundation tax return shows a payment for an act of self-dealing involving Trump, that fact, standing alone, does not establish that Trump or the Foundation violated the tax law. Somewhat counter-intuitively, that disclosure would actually show that the Trump Foundation complied with Section 4941, by paying the required taxes. FN2.
Acts of self-dealing that were not reported would present a different issue. Again, the act of self-dealing by itself will not violate the tax law, but the failure to report the transaction and pay taxes on it will. In this way, analysis of conduct under the tax law differs from how we usually assess the legality of actions. We are accustomed to examining whether particular acts are proper (e.g., was it legal to drive 73 miles per hour? was it legal to slip the government employee $5000 in connection with procuring a contract?), but insofar as the tax aspects of Trump’s transactions with the foundation go, that analysis won’t take us very far. The issue is whether the transactions were properly reported and whether taxes were paid, not whether the transactions themselves were good or bad. (Section 4941, in fact, reaches some entirely noble transactions, such as where a disqualified person sells a valuable piece of property to a private foundation for a bargain-basement price. See Treas. Reg. § 53.4941(d)-2(a)(1).)
When a private foundation engages in numerous acts of self-dealing, questions may arise beyond the tax consequences associated with specific transactions. One may properly wonder whether such a private foundation really qualifies as tax-exempt under Section 509 of the the code. But again, as with the cases of self-dealing, it’s important to understand that provisions like Section 501(c)(3), whose standards are incorporated in Section 509, do not, in a legal sense, restrict the activities of an organization.
For example, commentators frequently state that Section 501(c)(3) prohibits a nonprofit from engaging in campaign-related activities. But that’s not quite right. An organization like the American Red Cross can go ahead and throw a fundraiser for a political candidate without “violating” the tax law. The Red Cross would violate the tax law only if it later represented itself as Section 501(c)(3) organization for the period after it had had engaged in campaign intervention and lost its status. Along the same lines, the NFL faces no criminal consequences or penalties for purposely destroying its Section 501(c)(6) tax exemption for publicity reasons, unless it claimed a tax exemption after that destruction.
For private foundations, the relationship between self-dealing transactions and the organization’s tax-exempt status is a little bit tricky because, once an organization is a private foundation, it essentially continues to qualify as such until it tells the IRS otherwise, or until the IRS terminates its status. See Section 507. Thus, even if the Trump Foundation reports numerous acts of self-dealing on its tax returns, it technically remains a private foundation, though possibly not a tax-exempt one. It would of course be sensible for the IRS to revoke the tax-exempt status of an organization that engaged in acts of self-dealing that negated its charitable objectives, though the consequences of that action are sufficiently severe that the IRS apparently almost never exercises its authority. See Colleen Murphy, “Trump Foundation Skirting IRS Self-Dealing Ban: Tax Lawyers,” Bloomberg BNA Tax Report (Sept. 21, 2016).)
In a sense, the tax code is agnostic when it comes to bad conduct, aside from the creation of criminal consequences for failures to file tax returns, pay taxes, and so on. FN3. An expenditure that violates State or Federal law, for example, may be perfectly deductible under the tax code as an ordinary and necessary business expense, unless Congress specifies otherwise. (See., e.g., Section 162(c) or Section 280E, which denies deductions for some illegal sales of drugs.). And noble transactions, like self-dealing that helps a charity, may be taxed heavily.
Of course, the fact that the tax code is agnostic on taxpayer transactions hardly establishes that other laws are. The tax code might not criminalize self-dealing between Trump and his foundation, but other laws might. However, it seems that those other laws have not received the attention that they should have, whereas Section 4941’s self-dealing rules may have received too much focus. I hope that commentators will broaden their analysis so that we can better understand the activities of the Trump Foundation and any potential violations of the law.
- If a transaction between Trump and his foundation is described in Section 4941 of the tax code and was properly reported, those facts, standing alone, mean nothing regarding the legality of the transaction. Even highly noble transactions can come within Section 4941.
- Instances of self-dealing described in Section 4941 that are not reported, and for which taxes are not paid, present potentially serious questions about compliance with the tax law.
- Numerous willful acts of self-dealing would not necessarily cause the Trump Foundation to lose its tax-exempt status, though the IRS may revoke the tax-exempt status of the foundation for its engagement in self-dealing transactions.
- Self-dealing transactions described in Section 4941, even if lawful under the tax code, may violate non-tax laws.
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FN1: Given the size of the taxes imposed on transactions that are not undone, it will make sense for an organization to reverse its act of self-dealing and pay the smaller tax. Alternatively, if, for whatever reason, the organization absolutely wishes to continue self-dealing in the future and wants to avoid paying the Section 4941 taxes, it can terminate its private foundation through the procedures described in Section 507. Continuous acts of self-dealing may create problems under nontax laws, however, depending on the facts.
FN2: To be sure, the statute strongly discourages and thus in a colloquial sense prohibits self-dealing, c.f. Section 4975 (“Tax on prohibited transactions”), but formally speaking, Section 4941, and even Section 4975, operate through a tax mechanism, rather through directly commanding private foundations to act (or not act) in a particular way. Congress could have, and maybe should have, set forth actual regulatory requirements for nonprofit organizations outside of the tax code. However, given the key role that the tax exemption plays for those organizations, Congress used the tax code encourage or discourage particular behaviors and did not prescribe actual prohibitions or requirements. This makes the private foundation rules “an odd blend of regulatory and tax legislation.” Bittker & Lokken, Federal Taxation of Income, Estates and Gifts, Ch. 101.1.
Had Congress regulated private foundations through nontax statutes, it may have affirmatively prohibited acts of self-dealing rather than follow the current “odd” approach. The conceptual tensions revealed by the self-dealing rules remind one of the so-called “individual mandate” under the Affordable Care Act, which is itself codified in the tax code. See Section 5000A (“Requirement to maintain minimum essential coverage”). As the Supreme Court observed in NFIB v. Sebelius, that statute, though providing that a taxpayer “shall” purchase health insurance and imposing a “penalty” otherwise, did not actually render the failure to purchase health coverage “unlawful.” See Nat’l Fed’n of Indep. Bus. v. Sebelius, 132 S. Ct. 2566, 2596–97 (2012) (“While the individual mandate clearly aims to induce the purchase of health insurance, it need not be read to declare that failing to do so is unlawful. Neither the Act nor any other law attaches negative legal consequences to not buying health insurance, beyond requiring a payment to the IRS.”). Similar analysis applies to the taxes imposed on self-dealing transactions under Section 4941.
FN3: Of course, the tax code encourages or discourages behavior through the use of deductions, credits, and so on. The tax code is thus hardly neutral on many pressing policy issues. However, in terms of legally prohibiting or criminalizing conduct, the tax code, outside of Subtitle F, largely leaves taxpayers alone and simply focuses on attaching tax consequences to various transactions. For further discussion of these issues and how they bear out in the administrative deference context, see my forthcoming essay in the Missouri Law Review, “Why Lenity Has No Place in the Income Tax Laws.”