TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Tuesday, November 7, 2017

Aprill: The Tax Consequences Of Legal Defense Funds

LDFEllen Aprill (Loyola-L.A.), Tax Consequences of Legal Defense Funds:

President Trump and a number of his associates have established legal defense funds (LDFs) in connection with various Congressional investigations, the investigation by Special Counsel Mueller, and in anticipation of possible legal action.  Legal defense funds for government officials have a long history.  The U.S. Senate and the House have detailed rules regarding LDFs for their members.  The most famous LDFs were the two Clinton LDFs.  Over the years, the Office of Government Ethics (OGE) has given some guidance on LDFs for members of the executive branch, particularly with regard to the solicitation and receipt of gifts. For example, it informed President Clinton that, although he was not subject as president to rules limiting the acceptance of gifts, because he and his wife established his first LDF, he and his agents were subject to laws forbidding executive branch official from soliciting gifts for that LDF.  OGE guidance regarding LDFs is far less complete than the Senate and House rules.  Recently, OGE issued an advisorythat an LDF must prohibit contributions from anonymous sources. 

By far, the most common structure for LDFs of prominent officeholders is a trust.  The House and Senate rules require that an LDF be a trust. These LDF trusts are generally established in one of two ways.  In the first way, the beleaguered officeholder creates the LDF trust, transfers a small amount to the LDF trust as its initial funds, solicits contributions to it, and receives its benefits by having the trustee of the trust pay legal bills in connection with the investigation or proceeding.  In the second way, friends or family of the person establish the LDF trust on behalf of the official (or former official).  President Clinton had one of each type.  In both models, the government official (or former government official) is the beneficiary of the trust.  There is an option to treat the LDF trust as a political organization that offers a number of tax advantages, but appears not to have been adopted widely.  It is also important to know that there is no tax guidance, directly or by analogy, regarding LDF trusts for former government officials.

Overview of Tax Issues
LDF trusts raise questions as to tax treatment of the trust,  whether the trust can take advantage of special rules applicable to political organizations, whether contributions to the LFD trusts can be deemed gifts excluded from the official’s income, whether donors to LDF trusts are subject to gift tax liability,  whether the government official must report amounts distributed from the fund for legal expenses as income, and the extent to which deductions are available to the government officials for amounts expended from the trust on his or her behalf. ...

... [T]he tax consequences of an LDF trust for the trust itself, whether the beneficiary, and contributors to it will turn on the particular language of the trust document and particular facts regarding the trust beneficiary’s situation, such as status as current or former government official, the motivation for donors to contribute to it and whether it has registered as a political organization under section 527.

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