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TAX CONSEQUENCES - BUSH LOAN
FROM HARKEN ENERGY CORP. (HEC)

On August 15, 2002 Democrats.com published an article asking the question, "Did George W. Bush Evade Income Taxes on His Harken Loans?".  MakeThemAccountable has also obtained a memorandum from a well respected CPA that explains why Bush's taxes must be investigated.  

Here are the four main points:

1. Bush was given options to buy stock in Harken Energy at prices below the stock’s market value.  When he sold the stock, did he properly report the gain on the sale?  It should have been reported as ordinary income, not as a capital gain (which has a more favorable tax rate).

2. Bush was given below market interest rate loans to buy this stock.  Did he report as income the difference between the market rate and the rate he paid, as required?

3. The above loans had no risk associated with them, which the IRS has ruled are not loans at all, but dividends, which must be reported as ordinary income.  Did Bush report them as such?

4. Did Bush report as a taxable transaction the return of some shares to Harken in 1994, presumably because the market value of the stock was below the option price?  Even if no tax was due, the transaction should have been reported.

MEMORANDUM

FROM:    The Anonymous CPA

DATE:     JULY 13, 2002

RE:         TAX CONSEQUENCES-BUSH LOAN HARKEN ENERGY CORP. (HEC)

FACTS

Starting in 1986, George W. Bush (GWB) began borrowing money from HEC to purchase shares of HEC, a publicly traded company.  He was offered these loans as a means to exercise certain stock options he held as a director and consultant to HEC to buy HEC at a 40% discount to market price.  These loans were at below market rates of interest (5%).  In addition, the loans were secured only by the stock purchased with the proceeds and there was no personal liability to GWB as of 1989.  Therefore, it was impossible for GWB to lose money on the stock purchase, since the sole collateral for the note was the HEC stock.  If the HEC stock appreciated, he could have sold the stock and realized the profit.  However, if the HEC stock went down or the company went bankrupt, HEC’s sole recourse was the HEC stock, even if it was worthless.  The total amount of the loans to GWB was $180,375 to purchase 105,000 shares of HEC.  The 40% discount on the purchase also means that GWB had a $72,150 discount from the market price at the time he exercised his options.  GWB eventually returned the HEC stock in 1994 in satisfaction of the loan; the presumption being that the market price of GWB stock in HEC was less that $180,375.

TAX CONSEQUENCES

The exercise of these director stock options at a discount usually results in taxable income at the time of exercise.  In this case, GWB should have reported as ordinary income the $72,150 discount he received on the HEC stock purchases between 1986 and 1989. 

The below market rate loan to GWB to purchase the HEC stock had no risk to him whatsoever.  In effect, if the stock went up he would realize a gain and if the stock went down HEC could not collect personally from GWB.  To be a valid loan, the courts and the IRS have consistently taken the position that the borrower must have some risk associated with the loan.  In a related party transaction such as a loan to a director or officer, it is well settled that the substance of the transaction is controlling and not the form.

In this case, the form of the transaction was a note, but in reality there was no real liability to GWB.  No lending institution would have made such a loan.  In this case,  the IRS and the courts would probably take the position that this was a sham transaction and GWB should be taxed on the “loan proceeds” of $180,175 at the time he received the money to buy HEC stock.  Upon audit by the IRS, it is likely that they would reclassify this loan as a preferential dividend.  Although the statute of limitations is only three years for most taxpayers, there is no statute of limitations for fraudulent sham transactions.  It is therefore still possible for the IRS to assess the tax to GWB, although they could not impose criminal penalties since that statute of limitations is only 6 years.

The fact that GWB received a below market rate loan should have also caused taxable income to be realized.  Internal Revenue Code (IRC) Section 1272 provides for taxability of such transactions, and if GWB did not report these amounts during the loan period, he would also be liable for additional tax assessments.  The taxable amount is computed by using a formula showing the discounted value as compared to IRS published fair interest rates.

Finally, the debt extinguishment in 1994 by the return of HEC stock is also a taxable event for that year and in that year, if not reported by GWB on his form 1040, would have resulted in a false return, since each taxpayer signs his form 1040 under penalty of perjury.  Even if the transaction would not cause any additional tax, the return would be considered false.  There is much precedent for this position because the failure to report a transaction on a form 1040 could hide some significant information that could obstruct the IRS from auditing the taxpayer.  In fact IRC Section 7206(1), the criminal statute for false returns, makes it a crime merely to omit a significant transaction, even if it results in no tax liability.

The Leona Helmsley tax prosecution is a clear example of this circumstance, since she received a refund for omitting several transactions, but was still convicted of filing a false return.

It is very likely that GWB violated many tax laws emanating from these loans, but the only way to validate this suspicion is to review the tax returns for the years 1986-1994.  Congress, and particularly the Senate, which is controlled by Democrats, could subpoena these returns.  However, this memorandum should provide a good basis to question GWB about how he reported this transaction for tax purposes.  There is a strong likelihood that his tax returns are false as a result of the aforementioned possible omissions.

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Last changed: December 13, 2009