What The New York Times Got Right (And Wrong) Regarding Fred & Donald Trump

This article by Bernie Kent was originally published on Forbes.com.

The New York Times has done a detailed investigation into the transfer of money and property by Fred Trump and his wife to Donald Trump and his siblings. Two of the conclusions that are apparent from their investigation:

1. Donald Trump’s claim that he is entirely self-made and that he only borrowed $1,000,000 from his father is far from the truth, and
2. Fred Trump engaged in numerous questionable tax schemes to pass wealth to his children and avoid Federal estate and gift tax

I have two major quibbles with what is otherwise a thorough and enlightening piece of investigative journalism:

1. While Donald Trump clearly benefited greatly from his father’s largesse, he has added significant wealth to the fortune he inherited, and
2. Although many of the wealth transfer techniques utilized by Fred Trump to reduce his estate and gift tax appear to be illegal, the authors went overboard in their discussion of discounts for gifts of minority ownership interests in closely-held businesses, GRATs and step-transactions.

What portion of Donald Trump’s wealth came from his father?

The New York Times details multiple transfers of wealth from Fred Trump to Donald Trump in many different ways in numerous transactions over many years. The article says that Donald has received at least $413 million in today’s dollars. Fred Trump also helped bail Donald Trump out of his financial difficulties in the early 1990s. This is an incredible amount of wealth to inherit. However, President Trump’s net worth is $3.1 billion in the current Forbes 400 listing. After two divorces and lavish expenditures, Donald Trump’s net worth is more than seven times the current value of what he has inherited. The Times article states, “Had Trump done nothing but invest the money his father gave him in an index fund that tracks the S&P 500, he would be worth $1.96 billion.” This is a meaningless comparison.  The US stock market has been one of the best places to invest. Over the last 35 years it has appreciated by 12% a year. Why should we compare Donald Trump’s net worth increase to the S&P 500? The S&P has no expenses, no taxes and is highly volatile. Donald Trump has large expenses, may have paid taxes and is also highly volatile. All kidding aside, it is unrealistic and inappropriate to use the S&P 500 to determine how Donald Trump’s inheritance might have grown.

Estate and gift tax rates

By applying a 55% tax rate, the New York Times article understates the potential estate and gift taxes that were avoided. The maximum gift tax rate was always higher than 55% prior to 1984. It was as high as 70% from 1977 to 1981. In addition to the 55% Federal estate tax due at Fred and Mary Trump’s death in 2000 and 2001, there would be a New York estate tax of 16%.

Valuation is an art, not a science

The valuation of businesses, real estate and other assets that are not publicly traded is often the major issue in most estate and gift tax returns. Since there is no clearly defined market price for these assets, taxpayers often hire independent appraisers to determine the value for estate and gift tax purposes. One commonly used valuation method is to capitalize expected future earnings. Taxpayers may better understand their future business prospects than appraisers. They may have a conservative view of future profits and provide that information to the appraiser in addition to the historical data. An independent appraiser needs to use this data in addition to other available data sources to come up with an appraisal. Appraisers have unavoidable conflicts when they know that the person hiring them wants a particular result (i.e. a low value for estate and gift tax purposes and a high value for charitable contributions). In egregious cases, the IRS can assess penalties for over or under valuation. The New York Times article makes a good case for under valuation of real estate transfers and an over valuation of a charitable gift of real property by Fred Trump.

Discounts for minority interests and lack of marketability

When the article discusses marketable and minority discounts, the case against Fred Trump is much weaker. Look at the following paragraph from the article:

"Use of minority discounts enabled the Trumps to slash Mr. Von Ancken's valuation in a way that was legally dubious. They claimed that Fred and Mary Trump’s status as minority owners, plus the fact that a building couldn’t be sold as easily as a share of stock, entitled them to lop 45 percent off Mr. Von Ancken's $93.9 million valuation. This claim, combined with $18.3 million more in standard deductions, completed the alchemy of turning real estate that would soon be valued at nearly $900 million into $41.4 million.

According to tax experts, claiming a 45 percent discount was questionable even back then, and far higher than the 20 to 30 percent discount the I.R.S. would allow today."

I have spoken to many attorneys, CPAs and Internal Revenue Service estate tax personnel who have frequently seen appraisals with marketability and minority discounts of 45% or more. The “20 to 30% discount  that the IRS would allow today” are settlements between the taxpayer and the IRS which take into account the hazards of litigation. A well documented appraisal could support a 45% discount, but the taxpayer is usually willing to settle for a smaller discount to avoid additional expenses and to take into account the possibility of losing at trial. A 45% discount is not “legally dubious” in my experience.

Step-transactions and GRATs

The article states, “…Fred Trump had exercised total control over his empire for more than seven decades. With rare exceptions, he owned 100 percent of his buildings. So the Trumps set out to create the fiction that Fred Trump was a minority owner. All it took was splitting the ownership structure of his empire.”

It was not necessary to change the ownership structure in the way described in the article in order to obtain the minority discounts. As long as equal gifts were made to three or more children, even if those gifts constituted 100% of the ownership, each gift in and of itself would be a gift of a minority interest in the LLC. There is nothing nefarious about making gifts of minority interests thus reducing the value of the underlying fractional interest. The valuation is required to be made looking at the percentage of ownership gifted to each beneficiary separately, not the total percentage gifted. This is true even where the entire interest is given at the same time to related parties. The IRS has concurred with this principle.