Is Trump like Conway Twitty?

I didn't watch any of the Trump Show yesterday, but like a lot of people I did read the indictment to see exactly what they charged him with. Right away I appreciated their bringing in the Playboy model and the National Enquirer – nice touches by the prosecution. 

I'm still brooding about the indictment today, though, because as I understand it, what makes this a felony is that Trump allegedly was planning to use his false bookkeeping entries – calling the payoffs "legal fees" paid pursuant to a "retainer" – to commit other fraud crimes. One of the things the prosecutor mentioned in his press conference was potential state tax crimes.

Now, I don't know diddly about New York State tax law, but on the assumption that it's a lot like federal tax law, which I do know something about, I'm still wondering how mislabeling the payments to the lawyer, Michael Cohen, would have helped Trump on his taxes. Specifically, I am wondering, wouldn't he have been able to deduct the hush money even if he told the truth about what it was?

You're allowed to deduct the "ordinary and necessary" expenses of your business. That includes illegal businesses. On the business side of your life, the types of expenses that are disallowed on public policy grounds, and Congress has spoken to this specifically, are fines, kickbacks, and certain kinds of bribes and other illegal payments. I'm assuming the payments Trump made were not fines or kickbacks. So that leaves bribes.

The section of the federal tax law disallowing business expense deductions for bribes is Section 162(c). It has three paragraphs. Paragraph 1 deals with payments to government officials and government employees, so that doesn't apply. Paragraph 2 governs certain other types of illegal payments, but it may be a stretch to fit the Trump hush money into that category:

any payment (other than a payment described in paragraph (1)) made, directly or indirectly, to any person, if the payment constitutes an illegal bribe, illegal kickback, or other illegal payment under any law of the United States, or under any law of a State (but only if such State law is generally enforced), which subjects the payor to a criminal penalty or the loss of license or privilege to engage in a trade or business....

Are payments to cover up sexual peccadillos a crime, or grounds for losing a license of some kind that Trump needed? I'm no criminal lawyer, but I don't see it. And anyway, if the payment itself was already criminal, there would be no need for the prosecutor in the Trump case to be referring to any kind of tax crime.

That leaves paragraph 3 of Section 162(c). It relates to kickbacks, rebates, and bribes under Medicare and Medicaid, also not applicable here. There are other types of expenses that are disallowed as deductions – payments to settle sexual abuse cases, for example – but they don't apply here, either.

So I'm not seeing anything in the federal tax law that specifically denies a business deduction for a hush money payment to a private person. Now, of course, to take a deduction, there has to be a connection to your trade or business, but couldn't Trump show that? By paying off Daniels, McDougal, and the doorman, he arguably would have avoided damage to his campaign, and to his brand. Presumably he has made a lot more money as President and former President than he would have made if he had lost to Hillary Clinton.

Paying money to protect your business reputation may give rise to a tax deduction. There have been several prominent cases in which the IRS has challenged such deductions, but the government's success rate in these cases is less than 100 percent.

One case they lost involved country singer Conway Twitty, whose real name was Harold Jenkins. He opened a chain of restaurants named Twitty Burger, and they bombed. To avoid damage to his reputation in the music industry, he paid the investors back, even though he didn't have to, as a legal matter. The Tax Court allowed Twitty a business deduction. The judge wrote, in part:

Although, as [the IRS] argues, the chances of a successful lawsuit against Conway Twitty by any of the investors or the Securities and Exchange Commission was remote we agree with [Twitty] that the possibility of extensive adverse publicity concerning [his] involvement with the defunct corporation and the consequent loss of the investors' funds was very real. We do not believe it is necessary for us to find that adverse publicity emanating from Conway Twitty's failure to repay the investors in Twitty Burger would have ruined his career as a country music singer. Rather, we need only find that a proximate relationship existed between the payments and [Twitty's] business. We find that such relationship exists. 

Given this precedent, it's hard for me to see how Trump would have been denied a deduction for hush money payments, even if he told the truth about them. Now, again, that's under federal tax law, not New York State tax law. But I'm not coming away with a good feeling about the prosecution's position here.

On a different front, do you think Stormy Daniels, Karen McDougal, and the doorman reported as income any money they got for not talking about Trump? It wasn't a tax-free gift, given the obvious quid pro quo. Enquiring minds might want to know.

UPDATE, April 6:  Good comments herein by fellow tax prof Gregg Polsky, and followup by me here.