What do Barack Obama, Elizabeth Warren, Hillary Clinton, Kamala Harris, Jimmy Carter and Franklin Roosevelt all have in common? They are all losers. So are Dick Cheney, Newt Gingrich, Jeb Bush and George W. Bush. At least, according to their tax returns.
All of these politicians have attempted to generate income through trading stock, renting real estate or conducting a trade or business but, in at least one year, have failed to post a profit associated with these undertakings, and instead generated a loss. And, just like more than one million U.S. taxpayers in 2018 have done, all have claimed some type of loss as a deduction on their tax return.
The recent revelation of Trump’s tax returns has started a national discussion regarding the deduction of losses. The tone of most news coverage seems to regard deducting a loss as if it were some shady tax planning scheme that requires a Swiss bank account and an expensive accountant in the Cayman Islands. Claiming losses, whether generated by rental real estate, as part of a business, or resulting from the sale of stock, is a fundamental part of our tax system. If you don’t make money, you don’t pay taxes.
The deduction of losses is geographically universal. Nearly every state in the union and every country on earth allows the deduction of losses on a tax return, and permits such losses to offset income in other years. This has essentially always been in our tax code — even the individual tax Form 1040 from 1916 allowed for the deduction of “Losses sustained during the year in transactions entered into for profit.”
The deduction of losses is nearly universal among businesses too. Especially for businesses that have been operating for a long time, it is common to have claimed a loss in one year and used that loss to offset income in another. For example, the New York Times has persistently had net operating loss carryforwards on its balance sheet for the past decade, resulting in outcomes like the income tax refund of $22,757,000 it received in 2011.
Two years prior to that, the Times had a tax refund of $23,692,000. It received a tax refund in years as recent as 2018. (Incidentally, while the New York Times clamored for Donald TrumpDonald John TrumpNorth Korea unveils large intercontinental ballistic missile at military parade Trump no longer considered a risk to transmit COVID-19, doctor says New ad from Trump campaign features Fauci MORE’s tax returns, it had tax disclosure issues of its own. In a study conducted by one of the authors of this op-ed and the Tax Justice Network, the New York Times was found to have been non-compliant with a tax disclosure requirement in the U.K. The U.K. requires companies to report on their tax strategy, tax planning and tax risk. The New York Times simply ignored the requirement.)
Why do we allow losses to be deducted? There are a variety of rationales, but doing so encourages entrepreneurs to take risks, and it also makes the tax system not as one-sided. If the government gets some of your profit when you succeed, it seems reasonable for the government to also take pity on you and leave you alone when you fail (or even give some back when you fail). It is also important to allow losses from one year to offset income in another year. Otherwise, two businesses that earn identical profits over time, but, with different patterns of earnings and losses, can be subject to two very different tax liabilities.
Some of the uproar about Trump’s tax returns is that his persistent losses prove he is an inept business person — a literal loser in business. And it could be even worse if bad business decisions resulted in personal indebtedness to a person or entity whose goals are at odds with those of the U.S. This perspective is not without merit, and it would be useful to know who this debt is owed to. Moreover, large losses in his core real estate businesses are a far cry from his self-touted image of a thriving entrepreneur.
However, the trouble with judging a business by its tax returns is that it is hard to distinguish a company that takes advantage of legitimate deductions (if the Trump deductions are legitimate; the IRS and the Joint Committee on Taxation are apparently looking into that) that produce losses from a company that loses money because it’s being poorly run. The rules for tax accounting are different from financial accounting rules – the rules which investors use to judge if a business is profitable – especially in ways that would affect the Trump empire.
For example, financial accounting rules and tax rules for depreciation are very different, with much larger deductions generally being allowed for tax purposes. Remember that Amazon, Apple and Google are regularly hitting your news feed for paying little to no income taxes. How successful would those companies look if we only considered their tax returns? At a minimum, a tax return does not provide a full picture of a company’s financial health. Time will tell whether the Trump empire is a going concern.
Regardless of whether one may change their view of Trump as a businessperson or a taxpayer in light of the losses he’s taken, the fact remains that deducting losses against income is no crime. If a business loses more money than it makes, it does not owe taxes and its losses can often reduce a tax liability in other years. It is how our tax system works, and how basically every other tax system on earth works. It’s a perfectly acceptable, legal and economically rational practice. Anyone insinuating otherwise does not understand the tax system and is simply lost.
Andrew Belnap is an assistant professor at the University of Texas at Austin’s McCombs School of Business. Jeff Hoopes is an associate professor of accounting at the University of North Carolina’s Kenan-Flagler School of Business and the research director of the UNC Tax Center.
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