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The release of President Donald Trump’s 2005 tax returns Tuesday prompted questions from our viewers about how tax rates work in America.
Trump supporters pointed to the return as proof he paid taxes while opponents noticed the president’s tax rate was lower than the average American's effective tax rate.
We also got a lot of questions about whether the release of Trump’s taxes is a crime.
WHAT WE FOUND
To find the answers we spoke to Sloan Speck. He’s a tax law professor at the University of Colorado Boulder.
One big reason tax rates vary is because the Internal Revenue Service taxes different kinds of income at different rates.
Most American are wage earners and fall into one of the seven income tax brackets that range from 10 to 39.6 percent.
Wealthy Americans, however, often have capital gains and dividend incomes.
This is money you earn when you sell stock for a profit or money you get for being a shareholder in a company.
These kinds of income have three tax brackets, but they only go up to 20 percent.
“It’s a way of arranging one’s business affairs that minimizes one’s taxes,” Speck said.
The second reason is a tax strategy Speck called “buy, borrow, die.”
Step one is to buy a bunch of stocks or real estate.
The IRS makes you pay taxes when you sell them, but it doesn’t tax them when you own them no matter how valuable they become.
The second step is to borrow money.
Banks accept stocks and real estate as collateral for a loan.
For example, you could ask for a $1 million loan and promise the bank $2 million in stocks if you don’t pay them back, Speck said.
Why is this a good idea?
You don’t pay income taxes on that $1 million loan.
You use the loan to pay for your lifestyle, and it has the added benefit of lowering your income taxes because it’s a debt.
The third step is for your heirs.
When you die, there’s a special provision in U.S. tax code that forgives the taxes on your capital gains.
“You borrow tax free and when you die that potential tax goes away forever,” Speck said.
Basically, you pay interest on your debt instead of paying income taxes.
And your kids can sell some of your assets that they got tax free to pay off your debts and everyone walks away ahead.
The third reason the wealthy are taxed at a lower rate applies only to people in Trump’s line of business.
When you buy commercial or residential real estate, the IRS allows you to take a portion of that cost off your taxes each year for a certain number of years.
It’s called depreciation, and it’s supposed to account for the wear and tear on a building.
“Often you’re getting a tax deduction that’s bigger than the economic loss that you have each year,” Speck said.
This is part of the reason Trump appears to have paid no taxes in 1995.
One thing Speck noted as important in Trump’s 2005 return is his alternative minimum tax payment.
Congress passed this rule in 1969 to capture income taxes from people who employ the three strategies above.
It’s basically a supplemental tax you pay on top of your income taxes if you have a lot of deductions, Speck said.
If this rule didn’t exist, Trump would have paid about $7 million in taxes instead of $38.5 million.
Trump’s tax reform plan calls for abolishing this tax.
As to whether Rachel Maddow and David Cay Johnston broke the law when they made Trump’s return public, Speck said it’s not clear.
U.S. Code states it’s against the law for people to publish tax information they receive without the consent of the taxpayer.
“Any violation of this paragraph shall be a felony punishable by a fine in any amount not exceeding $5,000, or imprisonment of not more than 5 years, or both, together with the costs of prosecution,” according to the code.
However, the First Amendment gives journalists special protections.
The New York Times won a landmark case at the Supreme Court in the 1970s, which made it legal for media outlets to publish classified information.
No case has been brought against a journalist for publishing tax returns in part because no modern presidential candidate has refused to release his or her tax returns.
If the Trump administration decides to go after Maddow and Johnston, Speck thinks the case would go to the Supreme Court.
U.S. taxes are complicated. Whether you think they’re fair or not depends largely on your personal situation and your philosophy about how America taxes and spends. The release of two pages of President Trump’s tax return from more a decade ago won’t begin to settle this debate, but it’s helpful to understand the tax code so you know how it works and how it applies to you and everyone else.
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