Personal Finance

Trump lawyer may get a tax break from the $130,000 Stormy Daniels payment

Key Points
  • A lawyer for adult-film actress Stormy Daniels claimed she had an "intimate relationship" with Donald Trump more than a decade ago.
  • Daniels is suing to get out of a 2016 nondisclosure agreement wherein she received a $130,000 payment from a company set up by Trump's lawyer Michael Cohen.
  • The payment could be subject to income taxes.
Trump's lawyer used Trump Organization email to arrange payment to Stormy Daniels
Trump's lawyer used Trump Organization email to arrange payment to Stormy Daniels

Amid all the headlines over a $130,000 payment porn star Stormy Daniels received from an attorney representing President Donald Trump, there's one party not mentioned.

That would be the Internal Revenue Service. Uncle Sam will likely want to collect taxes on the money.

Daniels, whose real name is Stephanie Clifford, filed suit on March 6 against Trump in a Los Angeles court, seeking to void a nondisclosure agreement that would keep her from discussing an "intimate relationship" she says she had with the president more than 10 years ago.

Her lawyer claimed that the agreement isn't valid because Trump never signed it. (The lawsuit and the nondisclosure agreement are available here, via NBC News.)

As part of this agreement, dated Oct. 28, 2016, Daniels allegedly received $130,000 from a company called Essential Consultants LLC. Trump's attorney Michael D. Cohen has reportedly admitted to facilitating a payment in that amount to Daniels.

Further, Cohen reportedly used a home equity line of credit to make the payment, which means he could have deducted the interest on his taxes.

"The first thing going into it is, 'What is this settlement for?" said Jeffrey Levine, CEO and director of financial planning at BluePrint Wealth Alliance in Garden City, New York.

"When you get into the reasons why you receive money in a settlement, the taxation will depend on the reason behind it," he said.

Here are the taxes and breaks that may be involved in these kinds of transactions.

HELOC deduction

Cohen reportedly tapped a home equity line of credit in order to transfer the $130,000.

He would have also been eligible to take a tax break related to the funds, too.

Here's how: Prior to the Tax Cuts and Jobs Act — the new tax law — you could deduct the interest you paid on up to $100,000 of home equity lines of credit and home equity loans, regardless of how you used the money.

As of 2018, you'll no longer be able to do this. That's because the new tax law allows borrowers to deduct the interest only if they're using the loan to improve their home.

Income taxes

Stormy Daniels’ lawyer says the porn star is prepared to return her “hush money”
Stormy Daniels’ lawyer says the porn star is prepared to return her “hush money”

Money you've received for personal physical injuries or sickness in a settlement such as an auto accident typically comes free of taxes, as do proceeds for emotional distress stemming from those injuries.

Other settlements, including punitive damages and interest on the proceeds themselves, are generally taxable to the recipient.

Tax attorneys say that a payment made with the expectation of something in return — for instance, someone's silence — is likely to be considered taxable to the recipient.

"A payment like this with all of these confidentiality concerns? This is a commercial transaction, and it's just income," said Robert W. Wood, a tax lawyer and managing partner at Wood LLP in San Francisco.

The IRS did not immediately return a phone call asking about the tax treatment of the payment.

Deducting legal costs

Chris Ryan | Getty Images

For the payor, there's the question of whether the settlement cash is deductible on his or her return.

"This is where it gets complicated: For an individual, a settlement like that is almost never deductible," said Levine at BluePrint Wealth Alliance. "That's a personal expense."

However, the owner of a business that made such a payment could try to argue that the settlement is an "ordinary and necessary" business expense and is deductible.

Whether the owner of a company can argue for deductibility for these costs could depend on whether the legal matter itself is personal or related to the business.

"There are tax cases in which someone will argue they had to spend $1 million on legal fees because a nasty divorce threatened the business," said Wood of Wood LLP. "No matter if you're trying to protect the business, the genesis is personal and you can't deduct it."

Although the Daniels case doesn't pertain to sexual harassment, business owners should be aware of a new provision under the tax law that limits firms' ability to deduct settlements related to sexual harassment or abuse.

These payments are not deductible if they're subject to nondisclosure agreements. Businesses also cannot claim a deduction for attorneys' fees related to sexual harassment and abuse cases.

Gifts versus income

Nicolas Hansen | GlobalStock | Getty Images

Anyone can make a gift of up to $15,000 each year per recipient free of taxes, but any payment over that amount would require the giver to file a gift tax return.

In this case, the recipient doesn't pay income tax.

"If we were good friends and I gave you cash — not because of a contract but because of our close friendship — then that's a gift," said Bruce Steiner, who is of counsel at Kleinberg Kaplan Wolff & Cohen in New York.

The determination of what's considered a gift versus what's income is based on the nature of the payment.

"A gift is made from detached and disinterested generosity," said Wood of Wood LLP. "A payment for remaining quiet and settling whatever dispute there is — that's viewed as taxable income to the recipient."

Lawrence S. Rosen, the attorney representing Cohen, and the White House did not immediately return calls and emails seeking comment.

Michael Avenatti, the lawyer representing Daniels, declined to comment.

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