Monday, October 03, 2016

When You're Rich, You Can Pay Less In Taxes Even If You're Not Smart

by Neil H. Buchanan

The blockbuster political story of the weekend was the revelation in The New York Times of some tantalizing information about Donald Trump's taxes.  The bottom line: Trump apparently lost almost one billion dollars in 1995, and he could have used that one-year loss as a way to pay zero dollars in taxes -- not just in 1995, but for a total of eighteen years.

Trump's apologists immediately tried to spin this story as evidence that their man is, as Rudolph Giuliani put it, "a genius."  (Whatever expertise Giuliani may or may not have, by the way, clearly does not include knowledge of the tax laws.  But why let that stop him?)

The Trump camp's story is that only a savvy businessman who knows more than everyone else about the tax code could have done what Trump did to avoid paying taxes.  We should all be so lucky, Trump's people say, as to have this man running our country like he runs his business.

This is utter nonsense.  Based on what we currently know, two things seem most likely.  Either Trump engaged in actual tax fraud, or he used some simple and well-known provisions of the tax code that uniquely benefit wealthy people, business owners, and especially people in the commercial real estate trade.

Either way, Trump is no genius.  And remember, the starting point for all of this is that he lost nearly a billion dollars in one year.  The only question is how that huge loss can be used to reduce taxes for someone like Trump.  But we should not lose sight of the fact that losing huge amounts of money is not consistent with Trump's preferred self-image as a great business mogul.

Before I get into the elements of the tax story here, it is worthwhile to recall why this news is such a huge deal now, only five weeks before Election Day.  Trump has been under pressure for months to follow tradition and release his tax returns.  He has refused, offering a series of evasions and lies as he has continually tried to change the subject.

Reporters have been asking me (and many other tax professors) for months why Trump is being so stubborn.  The answer is that what he is doing makes no sense, unless there is something bad in the returns.  But it would have to be truly bad, because the innocent explanations -- maybe he had not paid any taxes, maybe he had no charitable deductions, and so on -- did not seem to justify the secrecy.

Indeed, any reasonable person advising Trump would have told him that dragging out the story makes it worse.  The old line, "It's the coverup, not the crime," would have been especially apt.  If Trump had released his tax returns on May 4, which is the day after he effectively clinched the Republican nomination, this would all be old news by now -- if, that is, there is nothing bad in the returns.  (For all we know, by the way, Trump might in fact have received that advice -- and promptly ignored it.)

Inevitably, something like what just happened was going to happen.  That is, because Trump has refused to provide complete information, he now finds himself the subject of speculation based on a trickle of very incomplete information.  And that incomplete information, as I noted above, is not enough to eliminate the possibility that he moved well beyond "smart tax strategies" into full-on criminal evasion.

But let us be generous and accept the idea that this new information proves only that Trump might have reduced his taxes to zero through completely legitimate means.  What are those means?  Again, the salient larger point is that Trump's business losses could be used to his advantage in ways that are simply not available to the middle class.

In an Associated Press story yesterday, I was quoted as saying that a person "can be middle class and be ten times smarter and not be able to do the things he did."  To put the point even more bluntly, even Stephen Hawking cannot turn the tax code into a piggy bank for the middle class, whereas anyone with even one semester of tax law under his belt could do what Trump did.

Trump, then, simply benefited from tax provisions that are visible to the naked eye.  If Trump is a genius for using well known tax provisions to reduce his taxes, then everyone who takes the mortgage interest deduction should apply for membership in Mensa.

Recall, by the way, that although Trump often claims that he alone knows the tax code better than anyone else, he also (as the story in The New York Times makes clear) has admitted that he is not a details-oriented person.  As I wrote in a column back in July, Trump claims (no surprise here) that "I have great people" doing his taxes.  If there was any genius at work, it was not emanating from Trump's head.

But as I noted above, the innocent version of this story simply involves Trump's tax lawyers using plain-vanilla provisions in the tax code that are no mystery to anyone.  By the middle of my one-semester introduction to tax law course, I have covered nearly all of these issues.  Every other basic tax class in the country surely does the same.  The real estate-specific elements are easy to pick up in any practitioner's manual.

The story in The New York Times emphasizes that Trump's huge loss in 1995 could have been turned into a "net operating loss" that, under the tax rules at the time, could have been spread over as many as eighteen years to reduce taxable income to zero.  (That rule, by the way, has since been expanded by Congress to twenty-two years.)

In principle, of course, there is nothing in the code saying that middle class people cannot use the net operating loss provision for themselves.  But what constitutes a net operating loss is business-related, so most people who do not own their own businesses are effectively excluded from the benefits of that provision.  Again, even Stephen Hawking could not figure a way around that.

The tax code is rife with many such provisions that effectively target benefits at rich people, especially people who own property.  For example, the concept of "like-kind exchanges" (also covered in a one-semester introduction to tax law) allows wealthy property owners to delay paying taxes for years or decades, but its provisions are written such that everyday taxpayers are unable to use those provisions in the way that someone like Trump can.

Many people own no property at all, and the vast majority of those who do own property own their own home.  If a homeowner is forced by circumstances to sell when the market is down, however, she cannot even deduct the loss in the year of the sale, much less spread that loss over decades.

I am not saying that that provision should necessarily be changed, but I am saying that we should understand that Trump's supposed genius involves using tax provisions that only a tiny number of people could ever use to their advantage.

Given the size of Trump's losses, it seems likely that his properties were going down in value at the time.  (It is an open question how he managed to get out from under his debt, which he used to buy his properties, without having to declare the cancellation of indebtedness on his taxes.)  But it is also possible that his losses were from operating his casinos, which were themselves in the process of failing.

But this again provides a good example of how the tax system treats rich people better than everyone else.  A person who gambled in one of Trump's garish casinos would, under longstanding tax rules, not be able to deduct his net gambling losses on his taxes, even in the year of the losses.

In other words, when Trump lost money on his gambling operations, the tax code allowed him to use those losses to reduce his taxes to zero, while his unlucky customers were actually losing their own money and getting no tax benefit from doing so.

Because of all of these rules, it is not even accurate simply to say that "rich people" get special benefits built by a compliant Congress into the tax code.  If a person is lucky enough to have a salaried job with annual pay of, say, $500,000 or even five million dollars, she would count as rich in most people's eyes.  But even such a fortunate person, no matter how smart she might be, would not have access to the tax advantages that I am describing here, any more than a middle-class worker with a $50,000 salary does.

Finally, it is important to point out two further considerations.  First, Trump frequently repeats an all-purpose excuse that he has a business or "fiduciary" responsibility to take advantage of all available legal strategies to maximize his income.  In the first presidential debate, for example, he said: "I take advantage of the laws of the nation, because I’m running a company. My obligation right now is to do well for myself, my family, my employees, for my companies."

We are talking, however, about Trump's personal tax returns, not business returns.  He operates under no legal requirement to make his already-rich family even richer, especially by abusing labor or bankruptcy laws.  Many wealthy people use their wealth for the public good, by paying their taxes and by engaging in philanthropy.  Nothing in the tax story tells us that Trump is required to do what he is doing.  This is a matter of choice on his part.

Second, and more interestingly, Trump is saying that his supposed (but actually nonexistent) tax savvy uniquely qualifies him to be president.  But as I argued in my column in July, and as tax professor Adam Chodorow similarly wrote in Slate yesterday, Trump is not adopting a "To Catch a Thief" approach to tax law.

What I mean here is that Trump could, if he wanted to, say something like this: "I alone know all of the ways in which it's possible to game taxes in ways that allow rich people to get away with the tax equivalent of murder.  This must stop, and here is my plan to do so."

Trump's underling Chris Christie has asserted something along those lines, but even a former advisor to Republican presidential candidates was quoted in another New York Times article saying that Trump "hasn’t proposed anything to address these loopholes."

This is not like war, where Trump claims (absurdly) that he cannot tell the enemy how he is going to defeat them, so we have to trust him.  Trump could do everyone a service not only by releasing his tax returns but also by instructing his "great people" to tell everyone how the tax code is rigged against honest people who do not own commercial real estate.

Trump, of course, has done no such thing.  He is not bragging about paying no taxes to move us to action on real tax reform.  He is bragging because he wants us to say, "What a smart guy!  I sure wish I could be like him."  But he is not smart.  He is the poster child for the pampered beneficiaries of the most narrow special-interest tax breaks, and he has shown no interest in changing that.

10 comments:

David Ricardo said...

As usual the media has the wrong story with respect to Trump’s NOL and his ability to use it to not pay taxes. In the abstract, using an NOL carryforward or carryback is fair and reasonable and incorporates the multi-year aspect of taxes.

Suppose for example that Trump had made $915 million in 1996 and used his 1995 NOL to offset his tax liability. Looking at his tax situation over the two year period of 1995-96 his total taxable income was zero and his tax liability was zero. Seems fair. All individuals have a similar situation with respect to capital gains, an unlimited loss carryforward until the loss is used up. And Mr. Buchanan is correct, there is no tax ‘genius’ here, all it takes is the ability to lose $925 million by a supposedly ‘genius’ businessman.

There are neat questions here, the biggest one being how could one lose that amount of money. One scenario is the Trump used non-recourse debt to finance real estate purchases and got basis for it, then used the insolvency provision in COD income statute to not have to have COD income, assuming non-recourse debt relief was otherwise COD income. That would depend upon the tax laws of 1995 but who wants to go to the trouble of checking and we still don’t know any details.

One thing is near certainty. Trump probably had other years of personal NOL’s that could be carried back or carried forward and probably has paid little or zero tax in the last 20 years and likely has made zero or little charitable contributions. That is the reason he will not release his returns, and never will.

Fred Raymond said...

1) Giuliani wants us to believe that anyone as wealthy as Trump does their own taxes? He couldn't focus long enough to add up his own utility bills. He has great people for that!

2) Trump is such a savvy businessman that he lost 900M (owning casinos!!) in one year? And I would want someone like that running ANY thing for me, at all, ever?

3) I’m assuming that Trump has been IRS audited and consequently what he did is legal. At any rate, it does seem that he could have done this whole tax dodge 100% within the law. Hooray for our tax law.

4) No matter what this bigmouth bully does, millions of people are going to vote for him. That's the scary part, even if he loses: there is a large demand for him in the electorate.

Diane Klein said...

This is EXACTLY the sort of piece I've been looking for - 100 hours of TV newspeople reading from teleprompters, without understanding the underlying tax law, isn't worth a thing. I hope this gets a wider airing - I'll do what I can!

Unknown said...

Thanks, Neil -- very nice post. Any thoughts on Trump and this debt parking theory? http://brontecapital.blogspot.com/2016/10/some-comments-on-new-york-times-story.html?spref=tw&m=1

Shag from Brookline said...

This, from an IRS Publication:

"In general, contributions to charitable organizations may be deducted up to 50 percent of adjusted gross income computed without regard to net operating loss carrybacks. Contributions to certain private foundations, veterans organizations, fraternal societies, and cemetery organizations are limited to 30 percent adjusted gross income (computed without regard to net operating loss carrybacks), however. Exempt Organizations Select Check uses deductibility status codes to indicate these limitations."

might have dissuaded The Donald as a tax genius from making charitable contributions after 1995.

Also, Trump surrogates reference a fiduciary duty Trump has for his investors, with investors broadly defined to include employees, with regard to payment of income taxes. Also, these surrogates claiming Trump's tax genius say that Trump is best qualified to reform the federal income tax system. Trump does have a tax proposal of sorts out there but it does not seem to reform how Trump has gamed the system. And we don't know if Trump's 1995 federal return was audited do we?

I hope David provides more commentary as he is obviously up on his taxes, whereas I went into semi-retirement in 1998. I hope this post does not go quickly into moderation.

David Ricardo said...

Obviously there is almost nothing we can say about the Trump returns with certainty, but there are some things we can say with near certainty.

1. The fact that Trump appears to have been audited frequently, maybe every year means it is highly likely he had substantial NOL’s in other years. A negative AGI is a bright red flag to the IRS in terms of examining a tax return. Again, this is evidence but not proof that he paid little or not Federal Income Tax over the last 20 years.

2. It is highly interesting that Trump’s big loss in 1995 is in ‘other income’. This category is rarely used and it means that Trump’s big loss did not come from a personal business or partnership/Subchapter S income. What exactly was the vehicle that generated Trump’s loss? Mr. Buchanan or anyone have any guesses?

3. Trump’s taxable interest implies taxable bond holdings of about $100 million to $150 million in 1995. Not chump change but not billions either.

4. His capital loss carryforward of -$3 k suggests large capital losses in 1995 or before. Not exactly the sign of an astute investor.

The big question here is ‘basis’. I have seen a large number of situations where even expert preparers have not checked for basis and have taken losses that should have been suspended for lack of basis. Might not be the case here, but certainly something that needs to be looked at. And that might be where the IRS is focusing.

Bottom line, in the parlance of my people this return makes Trump as a businessman look like a smuck, a characterization confirmed by his other utterances.

David Ricardo said...

Answering my own question in point 2 above.

Here is the current law on where to enter an NOL carry forward

Deducting a Carryforward

"If you carry forward your NOL to a tax year after the NOL year, list your NOL deduction as a negative figure on the “Other income” line of Form 1040 or Form 1040NR (line 21 for 2015). Estates and trusts include an NOL deduction on Form 1041 with other deductions not subject to the 2% limit (line 15a for 2015).

You must attach a statement that shows all the important facts about the NOL"

So what does this mean? It means that if that was the rule in 1995 it is likely the huge loss that Trump shows in 1995 did not occur in 1995 but occurred in earlier year(s). If this is true, since part of the loss would have been used to offset income in the year the loss occurred, the loss was even bigger than what was reported. In fact it may be that Trump did the almost unthinkable and lost over $1 billion in some year prior to 1995.

What a great business leader!!

Shag from Brookline said...

Because of reduced funding over the years by Congress for IRS audits, the tax lottery odds favoring an aggressive taxpayer have increased significantly. More audits could significantly increase tax revenues; that could serve as simple tax reform by increasing compliance.

Regarding private foundations, my experience pre-semi-retirement in 1998 focused on a wealthy taxpayer funding a foundation with highly appreciated assets, often corporate stock, as part of an estate plan as well as obtaining a current income tax charitable deduction for such funding. In the case of corporate stock, voting control of a corporation might be maintained for an extended period of time as required distributions annually from a private foundation are a relatively small percentage of the FMV of the corporate stock funding the foundation. I'm curious as to the form of contribution initially made by Trump to his foundation. Would a tax advisor have recommended cash? I doubt it.

Shag from Brookline said...

The title for this post reminds me of the time back in the early 1970s when after a Board meeting of a client, its Marketing VP was not happy that the founder/CEO/Chair shot down his marketing proposal. He told me of an old Italian saying that if you're rich, you're not only smart but good looking too.

By the way, on a daily basis more commentary surfaces on the financial background of Trump.

Keep in mind that "The Art of the Deal" by Trump via another was published in 1987, prior to Trump's 1995 tax returns. Trump trumpets "his" book in his campaign in support of his claim that he can make America great again. The 1995 returns are sort of a sequel to "his" book, raising questions about how artful were his deals. Trump was born on third base and "stole" second base - and perhaps first base as well.

David Ricardo said...

Why can't we have an honest media and reporting? Why???

Trump says he used the tax laws 'brilliantly'. No, he didn't. A tax loss carryforward is generated by even the most basic tax prep software. The use of the carryforward happens automatically, the tax prep software looks to see if there is one, and if so puts it in the tax return. No human touch needed.

All that is needed is the level of incompetence necessary to generate the tax loss in the first place. If Trump gained basis form OPM, so be it, again that just happens.And the critical thing, Trump has never disputed any reports or speculation that he has not paid federal income taxes. Nope, not Trump nor his toadies Rudy and Chris. Oh, he paid property taxes, payroll taxes and sales taxes. Yeah, so did we all. Anyone know of a place in public policy that says if you paid those taxes it's ok not to pay income taxes? Me neither.

Why can't the new organizations report this correctly?