Tax Bills Doom Tax-Free 1031 Exchanges Of Cryptocurrency

Whether you can make a tax-free swap of cryptocurrency is controversial. A 1031 exchange is a swap of one business or investment asset for another. Under the tax code, most swaps are taxable as sales. That’s why the IRS says bartering is taxable to both sides, whether for goods or services. Section 1031 is an exception to the rule that swaps are generally fully taxable. If you can manage to come within 1031, you can change the form of your investment without (as the IRS sees it) cashing out or recognizing income. But can you swap one cryptocurrency for another, or for other property?

Gold plated souvenir Bitcoin coins are arranged for a photograph in London on November 20, 2017. Bitcoin, a type of cryptocurrency, uses peer-to-peer technology to operate with no central authority or banks.  (Photo credit: Justin Tallis/AFP/Getty Images)

The IRS says cryptocurrency is property not currency, so you might think you could qualify. But whether 1031 applies to cryptocurrency is debatable. Some tax advisers say no, while others offer more positive views, that in some cases 1031 can apply, provided that you are careful. But this debate may not be relevant much longer. Both the House tax bill and the Senate tax bill propose to restrict 1031 exchanges to real estate. The real estate industry is breathing a sigh of relief that 1031 exchanges are being kept for them.

Most exchanges must merely be of “like-kind.” Surprisingly, you can exchange an apartment building for raw land, or a ranch for a strip mall. Classically, an exchange involves a simple swap of one property for another between two people. But the odds of finding someone with the exact property you want who wants the exact property you have are slim. For that reason, the vast majority of exchanges are delayed or “Starker” exchanges (named for the tax case that allowed them). In a delayed exchange, you need a middleman who holds the cash after you “sell” your property and uses it to “buy” the replacement property for you.

This three-party exchange is treated as a swap. The intermediary must meet a number of requirements. That’s one reason delayed exchanges of cryptocurrency may not qualify. There are also two timing rules you must observe in a delayed exchange. Within 45 days of the sale of your property, you must designate replacement property in writing to the intermediary. Then, you must close on the new property within 180 days of the sale of the old.

Until the law changes, what about 1031 exchanges of cryptocurrency? The IRS has been asked about this, but has so far remained mum. A simultaneous Bitcoin for bitcoin swap might be fine. But a Bitcoin for Ripple or Etherium trade might not qualify. Section 1031 does not apply to trades of stocks or bonds, and the IRS could rely on this to nix any cross-species trade of cryptocurrency. In the past, some gold coin swaps have been OK, while silver for gold is not. So some observers think the IRS would consider different cryptocurrencies more like silver and gold.

There are also reporting issues. You can’t qualify for 1031 unless you claim it. If you want to see what you have to report to the IRS on your tax return, check out IRS Form 8824. Both the House and Senate tax bills call for restricting Section 1031 to real estate. The two tax bills are filled with controversy, but not over this point. In that sense, the debates over 1031 exchanges of cryptocurrency may not be relevant much longer.

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Harvey Weinstein Tax Would Prevent Sex Harassment Settlement Write-Offs

In business, lawyer’s fees and legal settlements are usually tax deductible. In fact, even punitive damages are tax deductible, no matter how bad the conduct. In general, only fines and penalties paid to the government are not. Even some of those can be, where the fines have a remedial rather than punitive purpose. Every time a big corporate wrongdoer pays punitive damages or settles a big regulatory mess, there are calls to eliminate the tax deduction for punitive damages, but so far none has passed. That these issues are again in the public eye is underscored by the latest tax bills.

In this March 2, 2014 photo, Harvey Weinstein arrives at the Oscars in Los Angeles. The recent sexual harassment and assault allegations against Weinstein set off a wave of charges against other men and led to an obscure provision in the Senate tax cut bill. (Photo by Jordan Strauss/Invision/AP)

The Senate’s tax cut bill, which is expected to come up for floor debate after Thanksgiving, includes what some are calling a Harvey Weinstein tax. It isn’t a tax exactly, but it would deny tax deductions, which amounts to a tax. The legal fees and legal settlements in sexual harassment cases often end up as deductible business expenses. The idea is to deny tax deductions for settlement payments in sexual harassment or abuse cases, if there is a nondisclosure agreement. Notably, this ‘no deduction’ rule would apply to the lawyers’ fees, as well as the settlement payments. In some ways, it is a far bigger deal to deny tax deductions for the attorney fees. (The House bill, which passed on a party line vote last night, doesn’t include such a provision.)

Note that most legal settlement agreements of any type have some type of confidentiality or nondisclosure provision. So that limitation is not much of a qualifier. Under current law, employers deduct legal fees and legal settlements relating to their trade or business. Business expenses must be “ordinary and necessary”.  However, an expense can be ordinary even if it occurs once in a career. And it is considered necessary if it is appropriate or helpful, even if it turns out not to be a good idea. Deductibility is controlled by nexus to a trade or business, or to income producing activity.

In the case of celebrities, the connections between income and publicity seem symbiotic. So, when celebrities pay whopping fees or even legal settlements, they may be deductible too. Trade or business expenses are worth more than investment expenses. Yet, you get no deduction for personal legal expenses. That means the legal expenses of a divorce, a dispute over a fight at the local pub, or defending a rape or paternity charge, yield no tax deduction. Yet, what is personal and what is investment or business can be debated.

Although Harvey Weinstein’s and Kevin Spacey’s actions may seem purely personal, on the job harassment can be viewed in several ways. Many harassment cases arguably arise out of personal activity that could be considered outside the course and scope of employment. Legal claims are often made against a company and its employees. If a supervisor harasses another employee, the conduct may be personal and outside the course and scope of the supervisor’s employment. Yet, it arises out of a working relationship, and often involves company property, business trips, and business activities.

Under current law, that usually makes the payments tax deductible. Tax deductions can even be available in some criminal cases. In Clark v. Commissioner, a man was wrongfully accused of assault with intent to rape during his employment. His legal expenses were deductible because he had been working within the course and scope of his employment, and because he had not committed the rape. But not every expense is deductible. In Cavanaugh v. Commissioner, James Cavanaugh was CEO and sole shareholder of Jani-King, a successful janitorial-services franchisor.

He vacationed in St. Maarten one Thanksgiving with his girlfriend, Jani-King employee, Claire Robinson. It wasn’t a business trip, but they were accompanied by Cavanaugh’s bodyguard, and another Jani-King employee. While on the trip, Robinson suffered fatal cardiac arrest after ingesting a large amount of cocaine. Her mother sued Cavanaugh and Jani-King. Jani-King’s board worried that losing the case would trigger a backlash from franchisees, so settled for $2.3 million. Cavanaugh contributed $250,000, which Jani-King reimbursed. Jani-King deducted it all as a business expense.

The IRS challenged the deductions, but the Tax Court agreed with the IRS, suggesting that some corporate lawsuits are personal and nondeductible. The employees were on vacation, not on Jani-King business. And they were far from company property. For Cavanaugh, only the consequences of the suit—not its origin—were business-related.

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Under Tax Bill, Should You Take 2017 Payment, Or Defer Til 2018?

The Tax Cuts and Jobs Act here is a complex 429 pages, so you may want to start with a summary of the plan. It isn’t inked yet, and make no mistake, there’s jockeying going on in Washington. All that adds considerably to the usual year-end tax shuffle. Even without the mad scramble caused by a major tax bill at year-end, as the holiday season approaches, many taxpayers start thinking about their taxes. People who are about to come into a sizable sum have extra reasons to plan. You might be settling a lawsuit, selling your company, or selling a nice cache of highly appreciated bitcoin or other cryptocurrency. You might be collecting a fat consulting contract, and timing the payment of an outsize invoice. You might be exercising stock options, which involves buying stock, but can trigger taxes on that purchase.

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If you work for pay and are entitled to money now, the IRS can disregard requests to be paid later under the doctrine of ‘constuctive receipt.’ It can make something taxable now, even if you don’t receive it until later. However, there is often considerable tax planning that sellers, litigants, and others can do. Sales can be inked now, but closed later. Even litigation can be settled, but with payments later. You still might worry about the tax doctrine of constructive receipt. Yet the seller or plaintiff holds legal rights, and is free to condition an agreement on the payment in the later year. As long as the sale or settlement agreement is not signed until the agreed payment terms are clear, the timing stated in the sale or settlement agreement should control the taxes.

These rules usually mean that sellers and litigants are free to enter into agreements in 2017 that call for payments in 2017, in 2018, or some of each. Even without tax rate and other changes, there is usually a tax deferral advantage to a January payment. Taxes are normally due in April for the prior year. In that sense, a delay of a month from December to January can make tax payments due a whole year later, in the following April. And then there is tax reform. In the sausage-making of tax reform, try to analyze if you are better off in 2017 or 2018. If you can, run the numbers both ways. Potential lower rates for some (such as flow-through income), and repeal of the alternative minimum tax are two big changes that could impact many. These two potential changes alone could fuel some “pay me next year” requests.

IRS Forms 1099 generally arrive in January, for payments made in the prior year. Is it better to get paid late in the year, so any Forms 1099 come right away? If you are paid in January, you won’t receive a Form 1099 for 12 months. However, this issue should generally not impact the timing decision. However, if the taxes due on the sale or the legal settlement are not obvious, additional time can be another reason to push the deal into 2018. Sale or settlement money in December 2017 means a tax return due in April 2018. If a tax opinion must be prepared before tax returns can be filed, having over a year before tax returns are due is better than only having a few months.

Another factor can be timing moves. Some sellers or plaintiffs want to change residences before receiving funds, for tax and other reasons. No-tax states such as Nevada, Washington, Texas and Florida may beckon. That may suggest a delay. Of course, consider too that the tax bill kills state tax deductions, making California and other high tax states extra expensive. Even if you move, there is no way to guarantee that the state you are leaving will not try to claim a piece of the sales proceeds or the legal recovery. And if you are selling California real estate, for example, even moving away won’t help. That can be taxed by California even if you live on Mars! In contrast, if your sale is of intangible property (say shares of stock in a company), that generally should be sourced at your state of residence, so moving can help. And time (such as a payment in 2018) may help with that.

As you consider 2017 vs. 2018 payments, get some advice and run some numbers. Some people may even want to opt for some payments in 2017, and some in 2018. Whatever you do, remember that one size rarely fits all. So think it through, and consider the non-tax as well as the tax aspects of your deal. Be careful, and try to make sure you know what you are getting before you sign.

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Paradise Papers Expose Rich And Famous Using Tax Havens  

Forget Panama. The newest big leak showing how the powerful and ultra-wealthy stash money and assets in offshore tax havens is the Paradise Papers. It will hardly be paradise to those whose names and details are being teased out of the morass. The leak contains a massive 13.4 million documents, mostly from a single offshore finance firm. As with the leak of the Panama Papers, the Paradise Papers come from the German newspaper Süddeutsche Zeitung. The paper called in the International Consortium of Investigative Journalists (ICIJ) to oversee the investigation. The Guardian is among nearly 100 media partners involved in investigating the treasure trove of documents.

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There could be a feeding frenzy with all of this information, which will take time to unfold. So far, arguably the best summaries of the players and the stakes are on the ICIJ website about secrets of the global elite. Even so, there are going to be dry details of trusts, foundations and offshore companies, the vast majority of which may be perfectly legal. Key questions now will be about specific individual cases, and whether there is anything that is not. A number of politicians may be among the most compromised. They could include Wilbur Ross, President Trump’s Commerce Secretary, who is said to have  business links with the Putin family.

As with the Panama Papers, one issue for those being compromised is whether they will now face tax compliance issues in their own countries. For Americans, the rules are very clear: disclose, disclose, disclose. You must file a tax return each year with the IRS, and the U.S. taxes all income wherever you earn it. Filing false returns is even worse than failing to file. Failing to file is a misdemeanor, while filing falsely is a felony. You have to file, but make your return is complete and accurate.

Hiding things nearly always looks bad. You might have good reasons to hide things from competitors, an ex-spouse, etc. But don’t hide from the government. The recent indictment of Paul Manafort and Richard Gates accuses them of secret deals and accounts. Not long ago, soccer stars Ronaldo Messi and Cristiano Ronaldo also faced criminal tax problems, in large part over secrecy and shell companies. Messi’s name had also come up in the Panama Papers. In short, even if there is a good reason to hide ownership of a legal entity from the public, make sure the ownership is not hidden from the government.

Americans face particularly unforgiving rules. If you have an interest in any foreign bank, securities, or other financial accounts, it is important. A signature power is enough, even if it is not your money. For all of these, you must file an annual FBAR if the aggregate value of the accounts at any point in the calendar year exceeds $10,000. Penalties can be huge. Much of the Swiss bank controversy of the last 10 years came down to these important disclosure forms. The IRS has reported that the Swiss and offshore bank controversies have netted the U.S. government over $10 billion. FBAR penalties can swallow the entire balance in offshore accounts. Even criminal penalties are possible, and they can include up to 10 years in prison.

The Paradise Papers, for Americans at least, should be yet another reminder that the IRS requires worldwide reporting and disclosure. The consequences of noncompliance can be severe, and the chances of squeaking by are winnowing. FATCA, the Foreign Account Tax Compliance Act, requires foreign banks to reveal American accounts holding over $50,000. Some asset disclosures may be duplicative with FBARs, but it is best to over-disclose. There is never a penalty for going overboard in disclosures. With a treasure trove of data, the IRS now has the ability to check. The resources of the U.S. government are vast, and using entities that look secret can make innocent activity willful.

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Tax Bill Kills State Tax Deduction, So California’s 13.3% Prompts More Exits

The Tax Cuts and Jobs Act is out, and you can wade through the 429 pages here. As this helpful summary of the plan states, it would eliminate the state and local tax deduction. If you pay high state income taxes–think California, New York, and many other places–you’ll care about this. Tens of millions of Americans claim this tax deduction, writing off their state and local taxes to reduce their federal income tax. Lots of taxpayers, Republicans and Democrats alike, could even rethink where they want to live. After all, it already hurts to pay high state taxes. No deduction is some serious lemon juice in that state tax paper cut.

California taxes, a whopping 13.3% on top of the IRS, already invites some investors and business people to move. Many people want to make money in California, but to move before it is taxed by the Golden State. Year after year, no state has a bigger and more persistent cadre of would-be tax fugitives than California. Some Californians look to flee the state before selling real estate or a business. Some get the travel itch right before cashing in shares, a public offering, winning a lawsuit, or settling litigation. Some carefully orchestrated deals and moves can work. But, many leavers have unrealistic expectations about establishing residency elsewhere, and have a hard time distancing themselves from California.

They may not plan on California’s taxman chasing them. A California resident is anyone in the state for other than a temporary or transitory purpose. A California resident also includes anyone domiciled in California who is outside the state for a temporary or transitory purpose. The burden is on you to show that you are not a Californian. If you’re in California for more than 9 months, you are presumed a resident. Yet if your job requires you to be outside the state, it usually takes 18 months to be presumed no longer a resident.

Your domicile is your true, fixed permanent home, the place where you intend to return even when you’re gone. Do you maintain a California base in a state of constant readiness for your return? You can have only one domicile, and it depends on your intent. How do you measure intent? Objective facts, and many are relevant. Start with where you own a home. If you own several, compare size and value. Consider if you claim a homeowner’s property tax exemption as a resident. Where your spouse and children reside counts too, as does the location where your children attend school. And the details matter. If you claim not to be a California resident, make sure you are paying non-resident tuition for college students.

Days inside and outside the state are important, as is the purpose of your travels. Where do you have bank accounts and belong to social, religious, professional and other organizations? Voter registration, vehicle registration and driver’s licenses count. Where you are employed is key. You may be a California resident even if you travel extensively and are rarely in the state. Where you own or operate businesses is relevant, as is the relative income and time you devote to them.

You can own investments far and wide, but you can expect them to be compared. Where you obtain professional services matters, including doctors, dentists, accountants and attorneys. Fortunately for California tax advisers, the mere fact that you hire a California tax lawyer to advise you about your California tax exposure doesn’t mean you’re a resident! Many of these points are probably not too significant one by one.

Yet they can have a cumulative effect. If you leave California, sell your residence or at least rent it out on a long-term lease. Getting a post office box in Nevada does not make you a Nevada resident. You will end up with bills for taxes, interest and penalties, or worse. If you are going to move, you need to actually do it. Like other high tax states, California is likely to probe how and when you stopped being a resident. Plan carefully.

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Americans Renouncing Citizenship Hits New Record; Tax Bill Won’t Change That

The number of Americans handing in their passports forever is statistically small, but there has been another notable spike. The total for the first quarter of 2017 was 1,313. The number on the second quarter’s list went up to 1,759, which is the second highest quarterly number ever (second only to the fourth quarter of 2016, which had 2,365 published expatriates). The total for the third quarter of 2017 was 1,376, putting the annual tally on track to top 2016’s record. Some observers may want to blame President Trump for the spike, but it is much more likely that longstanding tax issues are the real culprits. And the tax reform now being considered is hardly a game-changer. These ‘published’ numbers are probably lower than the real ones, for a variety of reasons. 

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The total for calendar 2016 was 5,411, up 26% from 2015, which had 4,279 published expatriates. The 2015 total was 58% more than 2014. These lists of those who expatriated may not seem big, but how complete these lists are remains unclear. Despite the official list, many leavers are not counted. Curiously, both the IRS and FBI track Americans who renounceThe reasons for renouncing can be family, tax and legal complications, and some renouncers write why they gave up their U.S. citizenship

One organization suggests renouncing U.S. citizenship not because of Trump, but because of American taxes. The newest list in the Federal Register names individuals who renounced U.S. citizenship, or who terminated long-term U.S. residency (green cards), during the third quarter of 2017. Expats have long clamored for tax relief, something the GOP tax bill does not appear to address. One law motivating some is FATCA, the Foreign Account Tax Compliance Act. FATCA has been ramped up worldwide, and requiring an annual Form 8938 filing if your foreign assets meet a threshold. It was enacted in 2010, and took years to implement. FATCA was painstakingly implemented worldwide by the U.S. Treasury Department, spanning the globe with an unparalleled network of reporting. America requires foreign banks and governments to hand over secret bank data about depositors. Non-U.S. banks and financial institutions around the world must reveal American account details or risk big penalties.

Some renounce because of global tax reporting and FATCA. Dual citizenship is not always possible, as this infographic shows.  America’s global income tax compliance and disclosure laws can be a burden, especially for U.S. persons living abroad. Their American status can make them untouchable by many banks. Many foreign banks do not want American account holders. Americans living and working in foreign countries must generally report and pay tax where they live. But they must also continue to file taxes in the U.S., where reporting is based on their worldwide income. A foreign tax credit often does not eliminate double taxes. Moreover, enforcement fears are palpable for the annual foreign bank account reports called FBARs. They carry big civil and even potential criminal penalties. The civil penalties alone can consume the entire balance of an account.

Ironically, leaving America can be costly. America charges $2,350 to hand in your passport, a fee that is more than twenty times the average of other high-income countries. The U.S. hiked the fee to renounce by 422%, as previously there was a $450 fee to renounce, and no fee to relinquish. Now, there is a $2,350 fee either way. The State Department said raising the fee was about demand and paperwork, but the number of American expatriations kept increasing. Moreover, to exit, one generally must prove 5 years of IRS tax compliance. And getting into IRS compliance can be expensive and worrisome. For some, a reason to get into compliance is to renounce.

Even the exit can be expensive. If you have a net worth greater than $2 million, or have average annual net income tax for the 5 previous years of $162,000 or more, you can pay an exit tax. It is a capital gain tax, calculated as if you sold your property when you left. A long-term resident giving up a Green Card can be required to pay the exit tax too. Sometimes, planning and valuations can reduce or eliminate the tax, but the tax worry can be real, even for those who will not face it.

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IRS Tax Lessons For Everyone From Paul Manafort Indictment

The criminal charges filed against former Trump campaign manager Paul Manafort and Richard Gates are serious. They are only accusations at this point. All criminal defendants are presumed innocent until they are proven otherwise in a court of law. Still, the 12-count 31-page indictment here is a daunting list of accusations. Manafort and Gates stand accused of conspiracy against the United States, conspiracy to launder money, failing to report foreign bank and financial accounts, acting as an unregistered foreign agent, and making false statements. It’s tough to unpack most of those charges. Even so, there’s a lot in it from which regular taxpayers can learn about how to handle their own taxes and the IRS.

WASHINGTON, DC – OCTOBER 30: Former campaign manager for U.S. President Donald Trump, Paul Manafort, leaves U.S. District Court after pleading not guilty following his indictment on federal charges on October 30, 2017 in Washington, DC. Manafort was indicted on charges of funneling millions of dollars through overseas shell companies. (Photo by Win McNamee/Getty Images)

Report Your Income, don’t file falsely. You must file a tax return each year with the IRS if your income is over the requisite level. And remember, the U.S. taxes all income wherever you earn it. Filing false returns is even worse than failing to file. Wesley Snipes was convicted of three misdemeanor counts of failing to file tax returns, while filing falsely is a felony. You have to file, but make your return as complete and accurate as you can.

Don’t Obstruct the IRS. The indictment charges Manafort and Gates with giving false answers. Whether it is the FBI or the IRS asking questions, don’t lie to the government. And don’t engage in evasive and obstructionist behavior during an IRS audit. Many taxpayers in a civil audit seem to think they can outsmart the IRS or manipulate the government to come out ahead. That doesn’t mean you have to agree with everything the IRS says in an audit. Yet, there is an established way of proceeding, and an above-board way to communicate with the IRS. Deception and obstruction are not the way.

Transparency is Good, Secrecy is Bad. Hiding things nearly always looks bad. You might have good reasons to hide things from competitors, an ex-spouse, etc. But don’t hide from the government. The indictment of Manafort and Gates accuses them of secret deals and accounts. For other examples, just look at how much trouble soccer starts Ronaldo Messi and Cristiano Ronaldo had over their secret tax structures. The secrecy itself was a major reason they faced criminal tax problems. Messi and his father had companies registered in the UK, Switzerland, Uruguay and Belize. It did not help that Messi’s name also came up in the Panama Papers. Even if there is a good reason to hide ownership from the public, make sure the ownership is not hidden from the government.

Careful With I Didn’t Understand. ‘Gee, I didn’t understand that,’ seems to feature in many criminal tax cases. But the defense does not always work. One of Messi’s primary defenses in his criminal tax evasion trial was that he did not understand. He said he signed many documents without reading them. If Manafort or Gates try to use this defense, it may not work for them either.

Don’t Be Willful. Willfulness means you acted with knowledge that your conduct was unlawful. According to the IRS, willfulness is a voluntary, intentional violation of a known legal duty. You may not have meant any harm or to cheat anyone, but that may not be enough. The failure to learn of filing requirements, coupled with efforts to conceal, may mean that a violation was willful. Even willful blindness, a kind of conscious effort to avoid learning about reporting requirements, can be enough. Accountability and transparency are nearly universal lessons.

Report Foreign Accounts. If you have an interest in any foreign bank, securities, or other financial accounts, pay attention. Even a signature power is enough, although it is not your money. For all of these, you must file an annual FBAR if the aggregate value of the accounts at any point in the calendar year exceeds $10,000. Penalties are huge. Much of the Swiss bank controversy of the last 10 years—which netted the IRS over $10 billion—came down to these little forms. FBAR penalties can swallow entire accounts (yes, 100%), and criminal penalties can include up to 10 years in prison. The indictment says that Manafort and Gates told their tax professionals they did not have foreign accounts. The indictment says both men willfully failed to file the forms.

Disclose Foreign Assets Too. The IRS requires worldwide reporting and disclosure, and the consequences of noncompliance can be severe. FATCA, the Foreign Account Tax Compliance Act, requires foreign banks to reveal American accounts holding over $50,000. Some asset disclosures may be duplicative with FBARs, but it is best to over-disclose. There is never a penalty for going overboard in disclosures. With a treasure trove of data, the IRS now has the ability to check. The resources of the U.S. government are vast, and using entities that look secret can make innocent activity willful.

Watch Your Lifestyle. It’s bad enough if you are skirting your tax obligations. But, if you are doing that and simultaneously living lavishly, it can look even worse. The indictment of Manafort and Gates says that the pair hid assets for their personal use. According to the indictment, Manafort “used his hidden overseas wealth to enjoy a lavish lifestyle in the United States, without paying taxes on that income.” The indictment says that Manafort “spent millions of dollars on luxury goods and services for himself and his extended family through payments wired from offshore nominee accounts to United States vendors.” The indictment claims that he did not report and pay taxes on the income.

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