A hot topic this election season has been Donald Trump’s federal income taxes, or, should I say, lack thereof. Over the course of the 2016 presidential race, Mr. Trump has said he is “smart” for not paying his federal income taxes. So, here’s the million-dollar question - how does Mr. Trump get away with not paying federal income tax?
Donald Trump’s Taxes
Only fragmentary information about Mr. Trump’s taxes is public knowledge since he has not released his tax returns. It is primarily speculation as to whether Mr. Trump does not pay federal income taxes, but it is likely that he enjoys significant tax reductions due to loopholes in the Internal Revenue Code (IRC).
As a general rule, income earned throughout the year is taxed, and thus, an individual or business entity must pay taxes unless that individual or business has earned no income. There are, however, loopholes in the IRC that reduce federal income tax. Mr. Trump has said he knows “our complex tax laws better than anyone who has ever run for president.” Over the years, it appears that Mr. Trump has used his business losses and charitable donations to significantly reduce his taxes.
Donald Trump’s Business Losses and Carryovers
Business losses are deductible and, in some cases, may be used to reduce taxes for past or future years. Certain business owners, including Mr. Trump, can use these deductions to reduce personal income tax.
In general, when a business has more losses than profits; there is a net operating loss (NOL). An NOL may be used to reduce the business’s taxes for past or future years. Reducing taxes for prior years is called a carryback. Businesses may reduce taxes from the two years prior to the loss. Carryovers allow taxpayers to apply NOLs against taxable income for 20 years into the future. For instance, if a business lost $1 million in 1996, that business may use that loss to reduce its taxes for the next 20 years. After the 20-year period is over, the business cannot use the loss.
It appears that Mr. Trump has been using a nearly $1 billion business loss from 1995 to reduce his own federal income taxes under pass-through rules. Certain businesses operate as pass-through entities, such as LLCs, S-Corporations, and partnerships. In other words, the businesses’ income gets passed through to the business’s owners and they either get taxed on the profits or take deductions for the losses. The Trump Organization operates as an LLC pass-through organization. Under the carryover rules above, Mr. Trump was able to offset his own federal income taxes since the 1995 business loss. Thus, it is possible that Mr. Trump has not paid - or has paid very little- federal income taxes for the past 20 years.
Donald Trump’s “Charitable” Donations
Mr. Trump most likely uses charitable donations as another tax reduction method. In general, charitable donations of money or property may be deducted. Mr. Trump claims he has given over $102 million in charitable donations. Since Mr. Trump has not released his returns, it is unknown exactly to what charities he has donated or how much these donations have been. But, there are reports that most of the $102 million comes from “conservation easements” that allow landowners deductions for agreeing to not construct buildings on their land. Mr. Trump has been accused of constructing gulf driving ranges, instead of buildings, on his land for deductible charitable donations.
Although we can only speculate what Mr. Trump’s tax returns would really say, it does appear that at least one of Mr. Trump’s insinuations is correct. Mr. Trump - or at least his tax advisors - thoroughly understand IRC loopholes.
Authored by Robin Sheehan, LegalMatch Legal Writer