Donald Trump’s Latest Tax Problem Is More Common Than You Think

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Donald Trump’s taxes have been a centerpiece of the election cycle — but the particular tax issues he’s faced have likely been beyond the pale for average Americans. Questions about releasing his returns, how much he’s donated to charity and whether his nine-figure losses should have offset his federal income tax responsibilities are not the kind of things most of us have to deal with as the April 15 tax deadline looms.

That changed a bit earlier this week, however, with a story in the New York Times that looked at how Trump was able to avoid reporting hundreds of millions of dollars in taxable income in the 1990s. It turns out the issues he may have been dealing with aren’t necessarily so different than those faced by millions of Americans — albeit on a much larger scale.

How Canceled Debt Affects Your Taxes

The issue revolves around canceled debt. When someone owes a bank some money, and they are no longer able to pay that money back, they may negotiate with the bank for a cancellation of all or a portion of that debt. This can happen in foreclosures, short sales and even when people owe money on their credit cards that they can’t afford to pay.

Let’s say, for example, you owe $25,000 on a credit card, but you simply can’t afford to pay it all back, and the interest and fees make it unlikely that you’ll ever be able to pay it back. You call up the bank and explain the situation and they agree to do a deal wherein you pay them $10,000 and they forgive the remaining $15,000. In addition to the credit consequences (that $15,000 in canceled debt will likely be documented on your credit report) there are tax consequences too. The IRS treats canceled debt like this as income, which means you’ll have to pay taxes on it, just as you would for your salary. People in this situation will often get a form called a 1099-C in the mail which documents this tax liability. Sometimes these forms come many years after the debt is forgiven. We’ve written about 1099-C problems extensively in the past and many people have no idea about potential tax liabilities when they are negotiating debt forgiveness with a financial institution. In fact, nearly 6 million Americans get 1099-Cs in the mail every year.

Trump’s Canceled Debts

So what does any of this have to do with Trump? A New York Times story by David Barstow, Mike McIntire, Patricia Cohen, Susanne Craig, and Russ Buettner published earlier this week looked at how the mogul allegedly dealt with his canceled debts in connection to overall losses in his casino business.

“As that empire floundered in the early 1990s, Mr. Trump pressured his financial backers to forgive hundreds of millions of dollars in debt he could not repay. While the cancellation of so much debt gave new life to Mr. Trump’s casinos, it created a potentially crippling problem with the Internal Revenue Service. In the eyes of the I.R.S., a dollar of canceled debt is the same as a dollar of taxable income. This meant Mr. Trump faced the painful prospect of having to report the hundreds of millions of dollars of canceled debt as if it were hundreds of millions of dollars of taxable income.”

So what did Trump do? According to the Times, he may have been able to offset those tax liabilities by using a stock-for-debt swap provision that existed in the tax code at the time. Here’s how the Times describes it:

“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.”

According to the Times, Trump allegedly stretched this strategy one step forward by swapping debt with partnership equity in his then-flailing casinos.  

Trump, who is no fan of the New York Times, declined to comment for the article. (His campaign also did not respond immediately to Credit.com’s request for comment.) Trump’s spokesperson, Holly Hicks, did send the Times this statement in an email: “Your email suggests either a fundamental misunderstanding or an intentional misreading of the law… Your thesis is a criticism, not just of Mr. Trump, but of all taxpayers who take the time and spend the money to try to comply with the dizzyingly complex and ambiguous tax laws without paying more tax than they owe. Mr. Trump does not think that taxpayers should file returns that resolve all doubt in favor of the I.R.S. And any tax experts that you have consulted are engaged in pure speculation. There is no news here.”

Socks-for-Debt-Swaps?

So how does all of this this relate to the average American who may have gotten a 1099-C in the mail and is facing a steep tax bill because of canceled debt? Well, given Congress banned stock-for-debt swaps in 1993 and equity-for-debt partnerships back in 2004 in order to eliminate the potential for abuse, no one will be able to replicate the strategy The Times alleged Trump to have used. Nevertheless, imagine if this option were available to everyday Americans. What might it look like?

Let’s go back to our earlier example: the $25,000 credit card debt. Let’s say the bank has agreed to forgive the whole thing, but you don’t want to get stuck paying income taxes on that $25,000. Since you’re an average American who doesn’t have stock to trade away and can’t do a “stock-for-debt swap,” let’s call this a “sock-for-debt swap.” You send the bank a cardboard box full of your old socks and tell them that they are worth $25,000. They bank doesn’t really care, because they’ve already forgiven the debt and written it off their books, but you get to tell the IRS that the bank hasn’t really “forgiven” anything. You traded that credit card debt for $25,000 worth of fabulous, beautiful, old socks. So you’re in the clear.

What to Do if You Get a 1099-C

The reality is most Americans can’t make much of an argument when they get a 1099-C in the mail. Still, there are a few steps you can take if you are really in dire straits and can’t afford to pay.  

Consumers might be able to avoid paying taxes on canceled debts by claiming the insolvency exclusion. Per the IRS, a taxpayer is insolvent when their total liabilities exceed his or her total assets. You may also be able to avoid paying if the debt was discharged in bankruptcy. You can go here to learn more about what to do if you get a 1099-C.

It also helps in these situations to pull a copy of your credit report. They can help you understand and confirm the dates and amounts listed on the form. You can pull your credit reports for free each year at AnnualCreditReport.com and view your free credit report summary, updated every 14 days, for free on Credit.com.

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Why Credit Makes People So Freaking Mad: A Theory

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No one really likes reading about credit, credit scores and credit reports. As editor of a publication devoted to teaching people about these things, it’s a fact that I’ve had to learn to live with, and it’s not a surprising one. There’s plenty for people to get mad about. Credit is confusing, credit report errors can be hard to fix, and the whole business is generally considerably less fun than watching a kitten escape from one kennel into another one occupied by his/her puppy friend.

I think there’s more to the story, however. There’s often a disconnect between the credit business and the people they report on and score. It’s not that people don’t understand the value of credit reports and scores. They get it. If you haven’t paid some of your bills in the past, banks will think that there’s a greater risk that you won’t pay your bills in the future, so they charge you higher interest rates. It makes sense, and all things being equal, you might understand why, from a bank’s perspective, credit scores are really all about accountability. Except all things aren’t equal.

Credit’s Not a Two-Way-Street

The credit business is a one-way street. Banks can penalize us for failing to pay our bills on time, but what happens when a bank — or any business for that matter — fails to deliver on promises it has made to us? What’s our recourse?

This subject came up in a recent Credit.com editorial meeting. We were discussing a story from Consumerist about a reader who was owed nearly $1,800 by Comcast for almost two years. They wrote:

“Nearly two years after Consumerist reader Robert shut down his business-tier service with Comcast, he’s still fighting with the nation’s largest broadband provider over a $1,775 early termination fee that should not have been assessed. Comcast even admits the money shouldn’t have been debited from Robert’s bank account, but now says it’s his responsibility to sort the mess out with his bank.”

So, Comcast reportedly admitted that it owed him the money, but rather than pay him, the cable company decided to direct the consumer to enlist the help of his bank to try to get the money from them — however that might work. The dispute dates all the way back to 2014, and according to the story, Robert endured multiple rounds of back-and-forth with Comcast before learning that he would ultimately have to try to force them to pay.

The Consumerist reporter, Chris Moran, reached out to Comcast for comment, and they told him “through some error the refund check never generated,” and that a new check would be received within 7-10 days, though they’d reportedly issued similar explanations and guarantees in the past (before telling Robert to ask the bank to help him get his money back). Which brings me to my point …

Let’s assume Comcast does send Robert his money. (I reached out to Comcast, and a spokesperson confirmed that the check was cut.) Let’s say they were to even pay him back with interest (which, if compounded monthly at a 20% APR— not an unreasonable penalty rate— would add up to about $2,639.27 over 24 months … it gets worse for them if you start assessing monthly late charges, too). That’s all fine and good. But what will the long term consequences of this behavior— which arguably demonstrates a high likelihood for default of one form or another in the future?

Well, of course, there are no consequences. And that, my friends, is why people tend to get so angry about credit scores. Because one little late payment by me or you can mean years of higher interest rates (try out this lifetime cost of debt calculator we put together if you need proof), but a company can hold onto your dough for years, and the only consequence for them is that at some point a reporter might shame them into paying you back.

We’re All Creditors

When you think about it, we’re all creditors. We buy goods and services— like cable, cell phone service, internet, etc.— and big companies deliver those services to us. When they fail to do that effectively or at all, we become creditors. We’ve essentially given them money for services they haven’t delivered.

Case in point: My internet service provider/cable company. For the past few months, the internet in my house has been slow and at times, non-existent. How bad, you ask? Let’s ask my 8-year-old daughter how she feels when she can’t watch “Liv and Maddie” on Netflix (this happens about every other day).

“It’s annoying, it’s frustrating and I don’t like it,” she says. “If I have to, I will go to the cable company.”

They don’t want that.

Here’s the thing, if I was slightly less lazy, I’d be on the phone with said ISP and lodge a complaint. I haven’t done that because, as I said, I’m lazy, and beyond that I’m reasonably sure no improvements will come of it (unless of course they manage to up-sell me to their faster service. In addition to being lazy, I am also cheap). But in this case I’m willing to just suck it up. I reckon I’m missing out on about 5% of my service, give or take (though a whining 8-year-old can make it seem like 25%).

I could, I suppose, withhold 5% of my bill payment, in lieu of services not rendered, but the ISP would just carry that balance over to the next month, I might get hit with finance charges, and ultimately, my failure to pay that amount could result in my credit getting dinged, and I might end up paying more for goods and services in the form of higher interest rates as a result.

But do the service providers of the world suffer similar consequences when they fail to deliver or, as was the case with Comcast, allegedly withhold money from a consumer? No. There’s no algorithm that takes this information in and translates it into a score that can impact their bottom line, as credit scores do with us. (You can check your free credit scores, updated monthly, on Credit.com, to see how your bottom line is being affected.)

That, I believe, is one of the biggest reasons why credit seems to make people so mad: Consumers are held to one standard, and companies to another.

This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.

[Offer: If you need help fixing errors on your credit report, Lexington Law could help you meet your goals. Learn more about them here or call them at (844) 346-3296 for a free consultation.]

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