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Oct. 3 — If anything is clear from the release of Trump's 1995 state tax returns, it's that so much is still unknown, leading to rampant speculation that the $916 million in business losses reported on his returns may be related to questionable tax avoidance strategies.
The New York Times made Trump's returns public on Oct. 1. According to the Tax Foundation, the documents indicate that Trump—and his then-wife Marla—earned wages and salaries of $6,108; interest income of $7,386,825; dividend income of $26,051; business gains of $3,427,092; real estate losses of negative $15,818,562; and “other income” of negative $915,729,293.
The last part is “almost certainly” what is known as a net operating loss carryforward, the foundation said. An NOL carryforward is a technique that applies a current year's net operating losses to future profits, which reduces income tax liability. Robert J. Kovacev, a tax partner at Steptoe & Johnson LLP, said NOLs are “a pretty standard tax deduction.” He said the Times article made it seem like NOLs are a tax loophole but “businesses large and small claim operating loss deductions and there’s nothing unusual or sinister about it.”
Since Trump's returns have been brought to light, some have accused the Republican presidential nominee of everything from using tax shelters to engaging in a technique known as “debt parking.”
“The big overall question is were these real Donald Trump losses or were they paper losses,” said Philip Hackney, an associate law professor at the Louisiana State University Law Center. And if they were paper losses, “did he manage to keep that deduction even though he didn’t really use the money?” Hackney, a former Internal Revenue Service official, said Oct. 3.
The Times reported that Trump's losses may have allowed him to avoid paying federal income tax for up to 18 years—in 1995 a taxpayer could carry back an NOL for three years and carry forward an NOL for 15 years.
Robert Willens, a tax consultant in New York, said most of Trump's losses were likely debt-financed, noting that he “doesn’t put a lot of equity into his deals.”
If one assumes that the debts that financed the operating losses were forgiven in subsequent years, then he would have had taxable income equal to the amount of forgiven indebtedness, Willens told Bloomberg BNA Oct. 3. “Having just that one year of losses may not give an accurate picture of the entire transaction from beginning to end because presumably there’s going to be a lot of gross income that arises from the forgiveness, compromise or cancellation of the indebtedness,” he said.
The only way to avoid income tax in that scenario would be if the debt cancellation occurs in bankruptcy or while the taxpayer is insolvent, Willens said. Trump has declared bankruptcy several times in the past.
That being the case, “the question of what happened to debts that he presumably escaped in bankruptcy looms over the loss claim here,” said Daniel N. Shaviro, Wayne Perry professor of taxation at New York University Law School.
In an Oct. 3 blog, he agreed that Trump's net operating losses could have been reduced, while not creating taxable income, if the debt cancellation occurred in bankruptcy. But “we can pretty much rule it out because then the Trump campaign could have pointed out that he didn't spend all the years since using NOLs for someone else's losses against his own income,” Shaviro said. In this scenario, the losses would actually have been sustained by the banks and others that loaned money to Trump.
The presidential candidate's campaign never specifically addressed that concern in an Oct. 1 statement responding to the Times article. In the statement, his campaign said: “Mr. Trump is a highly-skilled businessman who has a fiduciary responsibility to his business, his family and his employees to pay no more tax than legally required.”
The Trump campaign did not respond to requests for comment for this story.
Due to the campaign's lack of response, Shaviro—while noting all theories at this point are purely speculative—says it's plausible that Trump may have avoided reducing his net operating losses, and thus maintained future income tax benefits, through one of two methods.
He could have made a tax code Section 108(b)(5) election to reduce the basis of depreciable property before taking a hit to his NOLs.
However, Hackney said: “That wouldn’t be super useful tax planning because eventually you’d lose all those depreciation deductions that you would have had, so it would have equaled out in some fundamental sense.”
The other option, according to Shaviro, is what's referred to as “debt parking,” or “dubious tax planning” that entails parking debt somewhere “where it wasn't formally forgiven but in actual economic effect was, thereby getting to continue deducting other people's losses.”
To achieve this end, a related entity would come in, buy the debt for pennies on the dollar but wouldn't officially forgive the debt, Hackney said. The discharge of indebtedness wouldn't occur and there would be no taxable income as a result, he said, adding that the seller also never has to repay the debt. Debt parking starts getting the taxpayer into “tax evasion territory,” Hackney said.
In a Oct. 3 phone interview with Bloomberg BNA, Shaviro said in Trump's case, the lending banks would have been adversely impacted because they wouldn't have been repaid their loan, but at the same time they likely weren't expecting the money back due to Trump's bankruptcy problems. Since they knew they weren't getting that money either way, they may have agreed to such a transaction because it was useful having Trump as a front man, Shaviro said.
However, taxpayers who weren't involved in these transactions could also take a hit, he said. “If you’re deducting other people’s losses by playing games with the debt parking, the losers there would be the U.S. taxpayers who did pay their taxes,” he said. “It’s one thing to say I lost $1 billion but then I made $1 billion back. It’s another to say other people lost $1 billion and I got to deduct that and not count the recovery.”
While many have attributed Trump's losses to money troubles resulting from mismanagement of his Atlantic City casinos and other failed ventures in the early 1990s, Mark Cuban, billionaire and owner of the National Basketball Association's Dallas Mavericks, has said people shouldn't be so quick to jump to that conclusion.
In a recent phone interview on CNN, Cuban said the losses could be related to the purchase of a tax shelter. “It's just as possible, because we don't have any details behind this front page of his New York and New Jersey returns, that this is a tax shelter,” he said. “We’re presuming it’s a real estate deal that went bad, but it could just as easily be a tax shelter for him to avoid income taxes.”
Cuban, who is a known Hillary Clinton supporter, said Trump could have actually purchased an insurance company with that money and then taken “a huge tax write-off to offset the income.” Shaviro said, as of now, these claims aren't outside the realm of possibility since there isn't evidence that has been released to refute them.
Clinton also chimed in with her thoughts at an Oct. 3 rally in Ohio. “It doesn’t look like he paid a dime for nearly two decades,” she said. “Trump represents the same rigged system he claims he’s going to change,” she added.
Tax practitioners and professors agreed that none of these questions will be fully answered until Trump releases his tax returns.
“This is all complete speculation,” Shaviro said. “We have no idea what the $900 million NOL really is” and won't know unless his campaign releases more information, he said.
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