Over the weekend, the New York Times reported that they had obtained a copy of Donald Trump’s 1995 New York state tax return (whoever sent it committed a felony). It showed that he claimed a net operating loss (NOL) of about $900 million that year.
What followed was a collective explosion of talking heads over the weekend, with the theatrics inversely proportional to the pundit’s knowledge of tax policy.
To state the obvious, political reporters don’t know a damned thing about taxes. I know this–believe me (to channel my inner Donald). Part of what I do for a living is prepare people’s taxes in the Washington, DC area. As an Enrolled Agent, I run into all sorts of clients. The most political (that is, horse race/hot take) clients compete with performing artists for the least amount of knowledge when it comes to taxes. I’ve even had some of them forget to bring their W-2s to a tax session.
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That ignorance was on display in vivid colors over the weekend. We were told that this tricky NOL was some sort of “loophole” that only super-rich bad guys like Donald Trump got to use. We were told that this relieved him of having to pay taxes for 18 years, a laughably arbitrary, made up number that is the tautological output of simple arithmetic and wild assumptions.
In fact, a net operating loss is very common in businesses. As Alan Cole of the Tax Foundation pointed out this morning, about 1 million taxpayers had an NOL in 1995. It results from business deductions exceeding business income in a particular year. Under tax rules, this loss can be carried back up to two years, and carried forward up to twenty years. If this is a “loophole,” what are these political reporters suggesting? That a business loss should simply be eaten by the taxpayer? That Uncle Sam should be a full partner in your profits but not in your losses? How is that fair?
We also heard that real estate depreciation–of all things–was a loophole! Could anything be more mundane and ordinary on business tax returns than depreciation deductions? Under the consumption tax base that I and virtually all conservatives support, depreciation would be supplanted by first year full expensing (which, ironically, would cause NOLs in most cases when it comes to structures). But real estate depreciation is no loophole under any theory of tax. Cost recovery for the acquisition of a business asset is universally allowed and always has been. In the case of real estate, the recovery periods are painfully long–forty years, thirty-nine years, or twenty-seven and one-half years, depending on the use of the building. Oh, and there’s no inflation adjustment to the basis, so the real value deducted is far less than the nominal write-off. Taxpayers are also required to capitalize the land portion of real estate and cannot depreciate it.
Trump’s not the only presidential candidate this year who once had a big loss on his taxes. In 2015, the Clintons realized a capital loss of nearly $700,000. That will be available in perpetuity to offset capital gains they might incur. Unlike an NOL, a capital loss can slowly be used to offset other income, albeit at a slow $3000 per year net of any other gains offset.
It’s not difficult to see how political reporters got played like a fiddle here. Most of them have never actually run a business, much less learned about the tax rules surrounding them. Most went from college to a series of simple, W-2 jobs (with the occasional freelance gig) in traditional media organs. These mainstream media companies have been cutting back and laying off these reporters in recent years, which has caused a kind of lustful fetish of class envy and selective transparency demands of late. The incessant demand for Trump’s tax returns–while not displaying the least interest in the donors to the Clinton Foundation–is a good demonstration of this bizarre coping mechanism.
So what caused Trump’s NOL two decades ago? If I had to guess, it would be suspended passive losses being unlocked. Starting with the 1986 Tax Reform Act, tax sheltering was widely curtailed. The tax shelters before that time mostly consisted of investor-only (“passive”) partners acquiring an interest in a partnership that threw off losses year after year. The partner then got to deduct his pro-rata share of the losses on his personal tax return, offsetting wages and other income.
Tax reform changed that by putting “material” and “active” participation tests on partners if they wanted to be able to claim a loss on their taxes. Investor-only partners like Trump would not qualify. In cases like his, passive losses are banked on the tax return and are rolled forward to the next year. There’s only two ways Trump could use these “suspended” passive losses–start realizing passive income that can be offset, or (as I believe happened in 1995) dispose the interest in the partnership. When a partnership interest is disposed of, any suspended passive losses are unlocked that year, like a volcano finally unleashing its lava.
In Trump’s case, his partnership investments tended to be in the area of real estate. Real estate, as anyone who has ever closed on a mortgage knows, means big numbers. Commercial real estate transactions can easily toss around figures in the tens of millions of dollars. No doubt Trump had a bunch of them. The time period of the tax return (1995) is roughly coincident with some of the toughest cutting of losses that Trump endured in his business dealings. It’s entirely possible he chose 1995 to stop the bleeding and hit the reset button on his tax losses.
The main point is that none of this is unusual in the high stakes investment business Trump plays in. It only seems scandalous to someone whose idea of a complicated tax return year is when they get a stray 1099-MISC in the mail for a freelance column in Washingtonian Magazine.