Last week I mentioned that, in anticipation of Murder Among the Mormons I was reading Victims. And I talked about Mark Hofmann’s tax planning.
I’m only a little bit further through the documentary today (I finished the first episode), but I’ve made a bunch of progress on the book. And, reading it last night, another tangential tax issue leaped out at me.
See, it turns out that when Hofmann needed to borrow money from First Interstate Bank, Elder Hugh Pinnock of the Seventy put in a good word for him. Pinnock assumed that Hofmann was a legitimate documents dealer who had a big deal in the works. And the bank apparently assumed that either Pinnock or the church itself was guaranteeing the loan.
(Pinnock may have aided in this misunderstanding: he reported that, in recommending the loan, he said something like, “We have lots of assets,” or perhaps “I’ve got assets–the Church has assets. You’ll be paid.” Now, as a practical matter, Pinnock should never have said anything like this. But also, if the bank wanted Pinnock or the church to guarantee the loan, it should have had them effect an actual guarantee.)
When it became clear that Hofmann didn’t have and wouldn’t have the money–and, in fact, that he was probably headed to jail–Pinnock felt bad. He decided to repay Hofmann’s loan himself, all $171,243.47 of it. And to repay the loan, he sold stock that he held, stock that represented “nearly all of his liquid assets.”
Which brings up two tax issues. The first is, by selling his stock, Pinnock potentially (and, honestly, probably) realized taxable gain. To the extent the stock was worth more when he sold it than it had been when he bought it, he would have owed up to 20% on his gains in federal income taxes. While Victims doesn’t lay out his basis in the stock, imagine he bought it for $100,000 and its value rose to $180,000 before he sold it. He would have $180,000 cash with which he could pay the bank, but he would also have an $80,000 capital gain. So he would owe $16,000 of taxes by virtue of his selling his shares to pay Hofmann’s debt. (Note that he’d have the same tax consequences if he transferred the securities directly to the bank rather than selling them.)
But at least he’d be able to deduct the amount he paid, right? So that takes us to our second tax point here: he wouldn’t. Most expenditures by individuals are not deductible unless the deduction is explicitly permitted by the Internal Revenue Code. Pinnock could arguably say that it was a trade or business expense, meant to protect his reputation. That would almost certainly be a losing argument, since “trade or business” is a term of art and his trade or business was, at that point, being a religious leader.
But let’s assume he could somehow shoehorn it into being an expense related to his trade or business. Even then, it’s not deductible. Quite often I teach Welch v. Helvering, a 1933 Supreme Court case. In the case, a salesman’s employer goes bankrupt. To preserve his reputation with customers, Mr. Welch voluntarily paid off his former employer’s debts. Notwithstanding his motivation being for business purposes, the Court held that he couldn’t deduct the expenses because paying another’s debts was not a common and accepted business practice.
So in paying Hofmann’s debts, Elder Pinnock faced a double tax dilemma: he simultaneously realized taxable income and was unable to reduce it by any type of deduction.
And that ends today’s installment of what-is-it-like-to-read-Mormon-history-as-a-tax-law-professor.