It
is among the least controversial parts of the federal tax code, almost
as old as the income tax itself: A business, big or small, can escape
taxation if it lost money in a
previous year, a rule that helps
businesses weather tough economic times, and hopefully thrive again.
But in the early 1990s, as his overleveraged and indebted properties faltered and he teetered on the edge of personal bankruptcy, Donald J. Trump
sought to take this ordinary provision to an enormous scale and escape a
foundering business — and avoid taxes for years going forward.
In 1995, according to documents published on Saturday
by The New York Times, Mr. Trump claimed almost a billion dollars in
operating losses that could be used to avoid future federal income
taxation. The eye-popping figure would amount to almost 2 percent of all
so-called net operating losses claimed by all American taxpayers that
year.
The
maneuver would have protected him for up to 18 years’ worth of income
taxes, easing his path to his new career: leveraging his name and knack
for publicity while minimizing the risks to his fortune. Trump-branded
apartment buildings, golf courses, men’s wear and steaks were followed
by his lucrative hit reality television series.
“I
was able to use the tax laws in this country and my business acumen to
dig out of the real estate mess,” Mr. Trump said on Monday in a campaign
appearance in Colorado. “Few others were able to do what I did.”
Because
he has broken with decades of American political tradition and
steadfastly refused to release any full personal income tax returns,
much about what Mr. Trump did remains unclear. But the disclosure of his
1995 tax maneuver has led to a rare moment in which the arcana of tax
policy turned into a national political issue.
And
much like the admission by Mitt Romney in 2012 that he had paid an
effective income tax rate of less than 14 percent in some years while
amassing a $250 million fortune, the disclosure of Mr. Trump’s ambitious
tax maneuver was seized on by Democrats as an illustration of the huge
advantages tax rules can bestow on the wealthy.
More
than 500,000 individual taxpayers took advantage of the same tax rule
as Mr. Trump in 1995, according to the Internal Revenue Service. The
average loss they claimed, however, was just $97,600. Mr. Trump’s $916
million loss accounted for almost 2 percent of the national total.
“He
likes to say he does things in a big way, but I doubt he would boast
about having what was likely the biggest net operating loss in the
economy,” said Lily Batchelder, a law and public policy professor at New
York University.
The
rule that let Mr. Trump shelter almost $1 billion in income from
taxation dates to 1918. It was enacted to prevent businesses from being
penalized by the administrative convenience of calendar-year taxation:
If a company loses $100,000 one year, and makes $100,000 the following
year, the law allows the company to pay nothing in taxes, as it has only
broken even.
There
is nothing unusual about business losses appearing on a personal tax
return. Most American businesses are organized as “pass-throughs,”
rather than corporations, meaning their profits are passed through to
their owners, and taxed as personal income. Losses are passed through,
too.
“It’s
good policy,” said Alan Cole, an economist at the conservative Tax
Foundation. “This is just the astounding edge case that has everyone’s
eyes bulging as they look at that number.”
But
the rule also reflects an inequity in how income earned through labor
is taxed compared with income earned through capital. Mere wage earners
cannot avail themselves of the provision Mr. Trump and other business
owners use to avoid taxes.
“As
individuals, we generally don’t get this,” said David Herzig, a tax law
professor at Valparaiso University School of Law in Indiana. “If you
experience a loss in one year, you don’t get to carry it forward or
carry it back.”
Ms.
Batchelder said that it would be a boon to working families if they
could carry over their deductions or spread out their taxable incomes
over many years the way businesses do with their operating losses.
“Virtually every taxpayer would be better off if they were able to pay
tax on their average income rather than their income in a given year,”
said Ms. Batchelder, who was deputy director of the White House National
Economic Council under President Obama.
It
remains unclear exactly how Mr. Trump lost such a huge sum. But the
rough outline of his business decline is well established. By the early
1990s, Mr. Trump had amassed hundreds of millions of dollars in personal
financial liability and had lost money on casinos, his Plaza Hotel
property in Manhattan and his airline, though precisely how he reflected
those losses on his taxes is not known.
But
the federal government has made it particularly easy for real estate
investors to avoid taxes. Investors, for example, can walk away from a
property and record the investment as a loss — even if they were playing
with borrowed money. While a profit from that same property would be
treated as a capital gain, losses are treated as “operating losses”
under a tax code provision that dates back to the Great Depression. Those losses can be deployed far more flexibly than capital losses to shield other income from taxation.
“He
was forced to sell many of his investments in the early 1990s, at
pennies on the dollar, teetering on bankruptcy,” Edward Kleinbard, a tax
expert at the University of Southern California, said of Mr. Trump.
“There were real economic losses from those investments — borne entirely
by the lenders. Yet nonetheless he was able to emerge with a large net
operating loss to carry forward, attributable primarily to losing other
people’s money.”
Mr.
Trump has defended his tax maneuvers over the years not only as legal
and appropriate, but as proof of his business acumen. But whether the
government agreed with that assessment is an open question. A letter to
Mr. Trump from his lawyers, which the campaign released in March,
indicated that the government may have examined those claims, several
tax lawyers said.
The
letter said that an audit of Mr. Trump’s tax returns for 2002 through
2008 was “closed administratively by agreement with the I.R.S. without
assessment or payment, on a net basis, of any deficiency.” That language
suggests, the experts said, that the government may have reduced what
Mr. Trump was able to claim as a loss without requiring him to pay any
additional taxes.
The
revelation that Mr. Trump could have avoided paying federal income
taxes for 18 years is likely to thrust into the spotlight a tax
provision that has received little attention from Congress for decades.
Members of both parties have argued in recent years for new limits on
the use of past losses to offset profits. Democrats have called for
reducing the number of years such a shield can be used.
House Republicans have proposed a change that would prevent taxpayers from using past losses to avoid income taxes entirely.
Mr.
Trump did not include that proposal in his own tax plan. He did propose
a large tax cut for businesses, including real estate investment firms,
although Mr. Trump has not clarified the size of those cuts. His
campaign continues to publicize competing versions of the plan.
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