The big news this weekend was the leak of Donald Trump’s 1995 tax returns to The New York Times. The returns showed that in that year, Trump claimed $916 million worth of business losses; those losses, said the Times, “could have allowed him to legally avoid paying any federal income taxes for up to 18 years.”
Liberal social media dissolved into an ecstatic puddle.
A few sensible people tried to explain that while the story might have well shown Trump was a bad businessman, it didn’t really show any sort of interesting tax shenanigans. And since we had long known Trump lost a bunch of money in Atlantic City, a story that has been amply and ably covered, it didn’t even really offer much news.
At issue is the “net operating loss”: When you net out your expenses against the money you took in, it turns out that you lost a bunch of money. In tax law, these NOLs can be offset against money earned in other years.
To judge from the reaction on Twitter, this struck many people as a nefarious bit of chicanery. And to be fair, they were probably helped along in this belief by the New York Times description of it, which made it sound like some arcane loophole wedged into our tax code at the behest of the United Association of Rich People and Their Lobbyists.
They called it “a tax provision that is particularly prized by America’s dynastic families, which, like the Trumps, hold their wealth inside byzantine networks of partnerships, limited liability companies and S corporations.”
Every tax or financial professional I have heard from about the New York Times piece found this characterization rather bizarre. The Times could have just as truthfully written that the provision was “particularly prized by America’s small businesses, farmers and authors,” many of whom depend on the NOL to ensure that they do not end up paying extraordinary marginal tax rates — possibly exceeding 100 percent — on income that may not fit itself neatly into the regular rotation of the earth around the sun.
Take a simple example, offered to me by Joe Kristan, a CPA. A meatpacking business loses a million dollars in one year, and then the next year it makes a million and a half. Without the ability to carry forward the losses, it would pay perhaps $600,000 worth of state and federal income taxes, on $500,000 worth of actual money it could spend to pay those taxes.
Did this scenario correspond to real-world clients of his firm? Absolutely, he said; it’s common in commodity businesses, where prices can fluctuate wildly from year to year.
“There are definitely tax provisions narrowly targeted to various industries that you could take issue with,” says Ron Kovacev, a tax partner at Steptoe and Johnson. “The NOL is not one of them.”
I mean, the Times story is true as far as it goes: Losing $900 million dollars may save you $315 million or so on future or past taxes. But astute readers will have noticed that it is not actually smart financial strategy to lose $900 million in order to get out of paying $315 million to the IRS.
Are there perhaps ways to generate paper losses that could inflate the size of your NOLs? Well, the tax law surrounding real-estate development is an arcane and wonderful thing, and it offers more scope for, let us say, artistic interpretation of your income picture than most industries. Those rules gave Trump more scope to, for example, delay paying taxes on any debt forgiveness he got, than he would have if he’d been a manufacturer of stereo equipment.
But ultimately if he got substantial forgiveness, he’d probably have to pay taxes on it, clawing back a lot of the benefit of the NOLs. As Kristan put it: “You have to die to eventually get out of the taxes. And few people are willing to take that step.”
Rich people do manage their income to minimize their taxes, and some of the means they use to do so should probably be written out of the tax code. But the wealthy individual who manages to make a lot of money while paying absolutely no taxes on it is more a creature of myth than reality.
That myth, like many myths, has some basis in fact: It used to be eminently possible to do, thanks to loopholes in the tax code that allowed people to take advantage of real-estate losses, among other things.
Those loopholes, however, were mostly closed by that notorious liberal crusader Ronald Reagan, during the 1986 tax reform package.
If Trump managed to pay no taxes for years, the most likely way he did this was by losing sums much vaster than the unpaid taxes. This is fair, it is right, it is good tax policy. There are many valid indictments of Trump as a candidate and as a businessman. But on the charge of unseemly tax avoidance, if this is all the evidence we have, then the grand jury would have to return . . . no bill.
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