Raw Nerves and Tax Returns

By GEORGE J. CHURCH

Explanations keep changing. Numbers do not jibe. Documents are missing or unavailable. And now come suggestions from the U.S. park police that White House counsel Bernard Nussbaum interfered with their investigation of his associate Vincent Foster's suicide last July -- in ways other than removing a file about Whitewater Development Corp. from Foster's office. Small wonder, given this bumbling, that the White House cannot keep the Whitewater affair quiet.

In fact, new questions keep popping up even as special counsel Robert Fiske prepares to launch his probe into all aspects of the mess. The latest: Did Bill and Hillary Rodham Clinton, back in Arkansas days, underpay their federal income taxes by much more than they have previously admitted? A TIME examination of bank records, interviews with some leading participants and consultations with tax experts indicate that is at least enough of a possibility to warrant a close look by Fiske and his probers.

Meanwhile, if the press and congressional Republicans appear to be hounding the Clintons over what seem like minor arcane details, the White House must take much of the blame. Its response to the Whitewater mess has been not just bumbling but secretive -- giving out partial and conflicting information, coyly withholding documents, hunkering down in a way that encourages suspicion. And if the White House cannot establish that it is leveling with press and public on small matters, it will be hard-pressed to win trust on great affairs of state.

Certainly the tax question hits a raw nerve. Presidential adviser Bruce Lindsey, a former Arkansas lawyer designated to field inquiries about Whitewater, angrily implies that TIME wants to write "a story that the Clintons are tax cheats." (Wrong: any underpayment could have been the result of excessively casual bookkeeping or following bad advice.) Lindsey also brandishes a folder containing copies of canceled checks that he says document all the Clintons' tax deductions related to Whitewater, which he insists are legitimate. But he refuses to make any public, complaining that the press would only report such information wrongly. The White House, he says, will show Whitewater documents only to Fiske or his probers.

| So a definitive answer to the tax question may have to await the end of Fiske's investigation -- which, at least at the start, presumably will focus on an earlier matter: Did Madison Guaranty, a busted savings and loan, funnel money improperly either into Bill Clinton's Arkansas campaigns or into Whitewater, a real estate venture in which the Clintons were equal partners with James McDougal, the owner of Madison Guaranty, and his former wife Susan?

The White House in large part has itself to blame for the tax questions coming up now. They arise largely because Lindsey tried yet again to explain how the Clintons could have lost $68,900 in Whitewater, as attorney James Lyons claimed in a 1992 report issued on their behalf, when they had not documented that they had invested anywhere near that much. Lindsey told the Associated Press that slightly more than $41,000 of the loss consisted of interest the Clintons paid on Whitewater-related loans and deducted on their federal income tax returns. Lindsey told TIME that the rest of the money the Clintons invested included accountants' fees, real estate taxes and "other expenses" but that the bulk of it was accounted for by repayment of principal on loans the Clintons had taken out to finance the project.

Like earlier statements, this one only raised new problems. James McDougal has told TIME that Lyons also counted, as a contribution to Whitewater and thus an eventual loss to the Clintons, a check for $20,744.65 that actually represented repayment by Bill Clinton of a personal loan. The loan, says McDougal, was for campaign expenses and had nothing to do with Whitewater. Lindsey insists the loan payment was Whitewater-related but says he does not know exactly how the proceeds were used.

A different but serious problem is whether all the interest deductions were proper. Seven tax experts consulted by TIME express strong doubts. One is Lawrence M. Stone, a former Treasury Department tax attorney who has taught tax law at both the University of California, Berkeley, and Yale and co- written a book on federal taxation that one of Clinton's tax advisers calls "an industry bible." His opinion: "If the worst assumptions are true, the Clintons underpaid their federal taxes by at least $11,000" during the years 1978-79-80 alone. That would be in addition to $2,156 the Clintons earlier admitted underpaying in 1984 and 1985; adding interest, the Clintons have repaid $4,000.

The debate involves some of the most obscure arcana in the tax code: interest capitalization, mirror loans and Section 351 Transfers, to name a few. But here are some guideposts:

THE CRITICS' DOUBTS

On Aug. 2, 1978, when Bill Clinton was Arkansas' attorney general, the Clintons and McDougals bought 230 acres of land on the White River that they intended to develop for vacation homes. The price: $203,000, all borrowed -- $20,000 from Union Bank of Little Rock for a down payment; $182,611.20 advanced by Citizens Bank Trust of Flippin, a tiny Arkansas town, as a mortgage loan. On Sept. 30, 1979, after Bill Clinton was elected Governor, the couples transferred the land to the newly formed Whitewater company, which they owned fifty-fifty.

White House adviser Lindsey now says the Clintons paid, and deducted from their federally taxable income, "about $10,000" of interest in 1978. Records examined by TIME, however, indicate that the banks received at most $5,752 in interest that year. So how could the Clintons have claimed they alone paid $10,000, even if they paid the McDougals' half-share as well as their own? Frank Burge, who was then chief lending officer for Citizens Bank, says he cannot explain it.

In 1979, says Lindsey, the Clintons paid, and deducted, "about $12,000" in interest. That is a more believable figure, given that records indicate the banks took in $20,302. Even so, the two-year figures show the Clintons' claiming payments of about $22,000, or far more than a half-share -- in fact, more than 84% -- of the roughly $26,000 the banks received.

More problems are raised by the Clintons' 1980 tax return (the White House refuses to make public their 1978-79 returns). The 1980 return shows combined gross income of $87,556 and interest payments of $13,350: $4,350 to Citizens Bank, $9,000 to "James McDougal." McDougal says both were for interest incurred in 1978-79, which would bring total interest payments claimed by the Clintons for those years to $35,350, or more than the banks received.

The problems only begin there, though. Tax experts such as Tom Ochsenschlager, a partner at the accounting firm Grant Thornton, say it would be improper if the Clintons took a deduction in 1980 for any reimbursement of interest paid by McDougal in an earlier year.

Further, McDougal in an interview insists the $13,350 of interest paid (or reimbursed) in 1980 was the only cash of their own that the Clintons put into Whitewater. Ever? Yes, says McDougal: "Those two figures I've given you, those interest payments -- that's it. Period. End of discussion." If he is correct -- and the White House fiercely disputes him -- that would mean the Clintons could not possibly have lost anything like the $68,900 they say they invested in Whitewater, since they put less than a fifth that much into it.

McDougal further asserts that while "Bill was totally oblivious to money," Hillary was "grasping" in her approach, and took tax deductions to which she knew the couple was not entitled. Referring to the $13,500 in Whitewater- related interest payments that he concedes the Clintons paid for 1978-80, McDougal says, "Those were legitimate write-offs on their returns. Everything after that was not." Asked why the Clintons could not have simply made an honest mistake, McDougal said, "You don't make a mistake for eight years running or whatever it was. Year after year after year, and you're a lawyer? . . . Oh, yes, she knew what was going on." Speaking for the Clintons, Lindsey replied, "That's absolutely not true. They were entitled to all the tax deductions that they took."

There are also a clutch of questions centering on the transfer of the land into Whitewater. The White House is vague about the basis on which that was done; Lindsey says he has been told the transfer was not taxable but knows no details. Another lawyer whom Lindsey consults on Whitewater says he thinks it was a nontaxable "351 transfer" (the reference is to a section of the tax code), but he adds, "Well, I mean, nobody knows." In any case, Lindsey declines to provide the Whitewater tax returns, which would settle the question.

Some tax experts contend that if Whitewater assumed the mortgage loan on the property, then only the corporation, not its individual owners, could deduct any subsequent interest payments. In some cases, that tax consequence could be avoided through a device called a "mirror loan" or a "back-to-back loan"; Lindsey says he thinks the Clintons used such an arrangement but is not sure. Partner McDougal, however, says he never heard of any such thing. Experts consulted by TIME assert that if there were such a loan arrangement, it should have left a paper trail on the Clintons' tax returns that is nowhere visible.

In any case, tax stamps indicate that when Whitewater took over the land, it raised the stated value of the acreage to $250,000, from the $203,000 the Clintons and McDougals had paid to buy it. Federal law permits capital-gains . taxes on the $47,000 increase to be deferred until the property or corporate stock is sold, or even to be eliminated if the increase in stated value reflects some actual costs incurred by the corporation. McDougal and his lawyer Sam Heuer say Whitewater did in fact add to the purchase price a portion of the $40,000 McDougal eventually paid for improvements such as roads, plus $20,000 in interest.

"Capitalizing" interest in this way is perfectly proper. But in the opinion of tax experts consulted by TIME, the same interest cannot also be deducted by the individuals owning the corporation. Lindsey's figures at least raise a question whether the Clintons did such double dipping.

THE WHITE HOUSE REBUTTAL

The counter-argument from Lindsey and other Clinton aides rests heavily on tax-law technicalities, flat contradictions of McDougal and hypotheses on what probably happened -- suggesting that the First Couple have not kept the aides who try to defend them well informed. Fundamentally, though, they insist all the deductions were legal and proper.

Lindsey, for example, says he has hard evidence that the Clintons really did pay about $10,000 interest in 1978 and about $12,000 in 1979 and that the evidence consists of checks. Why so much more than their half-share? Well, say White House advisers, maybe the Clintons paid a greater share of the mortgage interest because the McDougals paid for all the roads and other improvements. McDougal says there was no such arrangement. And some tax experts suggest that if there had been, the Internal Revenue Service might look askance at a deal that gave one party most of the deductions (spending on roads and other improvements is not deductible).

In any case, how come the Clintons seem to have claimed they paid more interest than the banks received? Lindsay says he has no explanation except that his documents show otherwise.

The $13,350 that the Clintons deducted in 1980? A tax lawyer whom Lindsay has consulted on Whitewater argues that the party that pays the money is entitled to the deduction, regardless of whether the mortgaged land was conveyed into the Whitewater corporation a year earlier. Not so, counters tax lawyer Stone. "The IRS doesn't care who is liable on the debt. In Clinton's situation, Whitewater became the equitable owner of the land and was therefore solely entitled to any 1980 deductions."

McDougal's insistence that the Clintons put only $13,350 into Whitewater? ^ He is "just wrong," says Lindsey. McDougal's memory is in fact questionable: he admits to undergoing treatment for severe manic-depression after he was ousted from Madison Guaranty in 1986.

Deducting interest already capitalized by Whitewater? That would have created a tax problem, says Lindsey, only if Whitewater had generated a capital gain, which it never did. (No argument there; the development was a dismal failure.) In that case, says Lindsey, the IRS would have insisted that the interest had been improperly capitalized and must be added to the taxable gain; no gain, no problem. Not so, replies tax expert Bruce Miller, chief managing partner in San Francisco for Kenneth Leventhal & Co., an accounting firm specializing in real estate: "You can't both deduct it and capitalize it, even if you lose money. The law is very clear."

What difference does it all make anyway? The amounts of money involved are small. The possibility of legal penalties is smaller still, since any underpayment may well have been inadvertent, resulting largely from what even Lindsey concedes was at times casual bookkeeping. The political embarrassment to the White House will be great if a President who has asked many Americans to pay higher taxes can be shown to have underpaid his own. But the penalty in loss of public trust if that revelation is forced out of an unwilling and obfuscating White House could be the greatest of all.

With reporting by Richard Behar and Suneel Ratan/Little Rock, Nina Burleigh/Arkadelphia and James Carney/Washington