WSJ: The Gift and Generation-Skipping Taxes May Save John Edwards

Wall Street Journal, Surprising Tax Lessons From John Edwards's Indictment, by Laura Saunders:

Could two obscure taxes paid by a wealthy heiress save a former politician from prison? Quite possibly, say tax- and election-law experts. The curious tale offers a lesson for ordinary taxpayers as well.

In June, former senator and presidential candidate John Edwards was indicted by a North Carolina grand jury on charges of violating campaign-finance laws. The six-count indictment involves more than $925,000 in secret payments allegedly made by two donors to conceal his mistress, Rielle Hunter, during his 2007-08 presidential campaign. ...

Although the indictment doesn't name the donors, it says "Person C" gave about $725,000 and "Person D" gave more than $200,000 to hide the pregnant Ms. Hunter. Lawyers involved in the case identify ... Person C as Rachel "Bunny" Mellon. Mr. Baron died in 2008. Ms. Mellon, 100 years old, is the daughter of a founder of Warner-Lambert pharmaceuticals, as well as the widow of philanthropist Paul Mellon. ...

Ms. Mellon paid both gift and generation-skipping taxes on the amounts she gave Mr. Edwards—underscoring that they were personal gifts and not campaign contributions. In 1932, Congress imposed taxes on gifts to prevent end runs around the estate tax, and later it added the generation-skipping tax to forestall end runs in the form of bequests to much-younger heirs. Ms. Mellon's alleged gifts to Mr. Edwards triggered generation-skipping tax because he was more than 37½ years younger than she.

The rate for gift and generation-skipping taxes at the time was 45%—and you must pay a separate gift tax on generation-skipping tax. Thus, the effective tax rate on such gifts can be greater than 100%. Attorney Howard Zaritsky of Rapidan, Va., estimates the heiress paid $799,000 in tax to make her $725,000 gift. "It's pretty clear the tax exceeded the gift," he says.

If Ms. Mellon paid the gift taxes, does that mean the donations weren't campaign contributions, and Mr. Edwards didn't violate campaign-finance laws? The law is cloudy, and the case is unprecedented.

But as written the law takes seriously the "specific intent" of donors, says election-law expert Richard Pildes of New York University. Thus Mrs. Mellon's gift tax could help Mr. Edwards's case. On a blog, Mr. Pildes said: "The money spent here was almost certainly not a 'contribution' within the meaning of the election laws" for a criminal case. ...

"Most people never think about the gift and generation-skipping taxes, but in this case, scrupulous attention to the law could make a big difference," says Paul Caron of the University of Cincinnati Law School.

Prior TaxProf Blog coverage:

• Will the Gift Tax Save John Edwards? (June 3, 2011)
• John Edwards and the Gift Tax: A Dissenting View (June 8, 2011)
• Why the Gift Tax May Save John Edwards: The New York Precedent (June 8, 2011)