Last week, I covered President Donald Trump’s controversial settlement of his lawsuit against the IRS involving a contractor’s illegal leak of his tax returns. The settlement established a $1.776 billion fund to compensate victims of lawfare and weaponization.
While it is supposedly open to any victim, it is questionable whether former Trump attorney and now critic Michael Cohen would get any payment from this fund. Cohen has been disbarred and was sentenced to three years in federal prison for various crimes including tax fraud and perjury.
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But the settlement agreement also quietly included a provision which forever barred the federal government from investigating or prosecuting Trump, his family, and his entities. This included a ban on auditing their past tax returns. This has drawn outrage from Democrats and skepticism from some Republicans.
Let’s look at the language in the settlement agreement, the current laws on tax return audit limitations, and how Trump could benefit from the federal government staying away from his past income tax returns.
Under the settlement, the federal government is forever barred from prosecuting or investigating Trump, his family, and his business entities on matters involving the tax leak, “lawfare and/or weaponization” (terms which have not been clearly defined), and any pending and could be pending matters, including tax returns filed before the settlement date.
By law, the IRS already has time limits to audit a tax return. Generally, it is three years from the time the return is filed. But the IRS can have up to six years to audit if income is underreported by more than 25% or if there is an underreporting of $5,000 or more of income attributable to certain foreign financial assets. And in criminal tax cases, the IRS can audit any year.
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One large tax audit involving Trump involves the Trump International Hotel and Tower in Chicago where he claimed massive losses. He initially wrote off $658 million in 2008 claiming the investment was “worthless” due to the recession and poor sales. In 2010, he transferred ownership to a different entity and claimed an additional $168 million in losses over the following years on the property. The issue here is that the IRS claims that the second write-off in 2010 was a double deduction. If the IRS is correct, then Trump is likely to be liable for $100 million in late taxes.
Another unresolved audit involves a tax refund of $72.9 million for 2010 which was the total federal income tax he paid from 2005 to 2008.
One may wonder why Trump didn’t direct the IRS to stop the audit while he was president. By law, the president cannot direct the IRS to terminate an audit or audit a particular taxpayer. The statute in question was created to prohibit executive branch influence over taxpayer audits and investigations. The prohibition also extends to all cabinet members with the exception of the attorney general, who just happened to sign off on the settlement agreement.
Whether these audits would be permanently closed under this settlement agreement is unclear. While the agreement states that all current pending matters are forever barred from prosecution, it can be argued that these audits are outside the scope of the settlement agreement because they were ongoing before the leak and the leak appears to have made no impact on the audit.
Is Trump trying to hide something? So far, there have been no credible allegations of illegal tax evasion or filing of false tax returns. Even the New York Times’s article on President Trump’s hidden tax returns make no claims that Trump engaged in criminal tax fraud.
What about the most recent six years which are not barred by the audit statute of limitations but will not be audited under the settlement agreement? Trump’s income tax returns for most of those years have not been leaked and will likely not be released to the public while he is president. However, Trump and his family in recent years have been involved in cryptocurrencies which, due to their perceived anonymity, has attracted the attention of the IRS. However, the Trumps claim that they turned to cryptocurrencies out of necessity because major banks have stopped doing business with them after the January 6 riots at the U.S. Capitol.
Lastly, states are not bound by the settlement agreement. Since most state income tax calculations rely on the numbers reported on the federal income tax returns, states can audit Trump’s federal tax returns if they choose to do so.
By its nature, a settlement agreement tends to close every current and potential claim in order to close the matter once and for all. But considering the controversial settlement terms including the $1.776 billion compensation fund and Trump’s refusal to voluntarily release his tax returns, this agreement may be bad optics since it looks like Trump is trying to hide something.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at [email protected]. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.