Yes, Let's Make Entrepreneurship and Business Formation Even Harder
I am on the road this week in Alabama and Tennessee, but I felt the need to comment on one issue of the day. These thoughts will be a bit rushed:
Well, it looks like the awesome team of Trump and Clinton may manage to take yet another shot at reducing entrepreneurship. It's all a result of the report that the Donald had a nearly billion dollar tax loss decades ago, and that - gasp - this tax loss might have shielded his income from taxes for years. Hillary's supporters are already demanding changes to the tax code and Trump, as usual, cannot muster an intelligent defense on even a moderately technical topic.
As someone who built a business over 10 years, I can't think of anything that would do more to screw up the already languishing rate of new business formation than to somehow limit the deductability of business losses on future years' taxes.
I lost money for years in my business -- trying to get it going, trying to grow it, engaging in more than a few failed experiments of new services. I would have been much less likely to do so had I known that I couldn't offset future profits on my taxes with current losses.
I will add that making changes to the deductability of losses will only lead to some screwed up accounting behavior. For example, had I known that the losses would not have been deductible, I probably would have found excuses to capitalize a lot of my expenses, reducing paper losses early and getting tax deductions later in the form of depreciation. I probably could have saved some of the deductions but only with a lot of extra bookkeeping and accounting effort. Is this really the way we want to revive the economy, by shifting sucking up more of entrepreneurs' time on useless paperwork games with the IRS/
CC:
Businesses should not pay any income tax at all. Since all businesses are owned by someone who must pay taxes on the profits passed on to them, it is double-taxation. Property tax can be justified (maybe sales tax) because the business is costing the local gov something. The effect of the tax system is to cause huge amounts to be spent accounting for every little thing: each piece of equipment must be depreciated, for example. It causes businesses to distort their efforts to avoid taxes. Worst of all, it is the cause of much (not all) crony capitalism, such as the tax breaks given to movie production companies. Other crony capitalism is aimed at suppressing competitors (e.g., Uber). The tax burden is not evenly distributed due to these tax breaks as well as special provisions in the tax code. It acts as a drag on the economy.
October 3, 2016, 7:52 amDan Wendlick:
I find this criticism especially odd coming from someone whose family finances are carefully structured through a set of overlapping and interlocking trusts and non-profit foundations, acting to both shield the Clintons from tax liability and obscure the sources of their income.
October 3, 2016, 9:04 amMondak:
I got KILLED on taxes from 2015. The thing is, I didn't actually TAKE any of the money out of the company. I knew things were looking slow for 2016. I have been able to keep all my employees without laying anyone off but all my "profits" which I've already been taxed on are gone. I absolutely lost my shirt this year in 2016, but have signed lots of business for delivery in 2017. If I were not able to balance this out with money we will make in 2017 I would go under just because of taxes being "one way".
October 3, 2016, 9:15 amDon:
Your time is meaningless, citizen. Only bureaucratic time matters.
October 3, 2016, 10:22 amOrion Henderson:
I feel your pain.
October 3, 2016, 11:35 amErikTheRed:
This is especially egregious because of the way they whack you annually on savings... errr.. "profits." Trying to grow a business is brutal enough without them constantly going after the pile of cash you try to build to cover it just because you pass a magic date every year without spending it. And yes, there are ways to deal with this once you hit a certain size and involve lawyers and whatnot, but it's brutal on the little guys (where most of the fallout for these regulations actually lands).
October 3, 2016, 11:37 ammorganovich:
the other tax that needs to go away is the capital gains tax. so, you put capital that you already paid taxes earning, at risk, for some productive end, and for this, you pay a tax?
cap gains is the tax that most directly affects growth. always remember: when you tax something, you get less of it.
it's endlessly bizarre to me that the same people who understand and argue that about, say, carbon, then claim it has no effect on investment (cap gains tax) or the amount of low skill labor demanded (min wage laws). selective application of economics seems endemic in modern politics.
October 3, 2016, 4:41 pmmorganovich:
not to mention the fact that hillary is out stumping for a higher inheritance tax while putting all her assets into those foundations and trust to ensure that chelsea pays none.
October 3, 2016, 4:42 pmTim Godfrey:
Coyote,
Trump is benefiting from one of those special tax rules for the well connected.
Specifically, the US tax code allows Trump to deduct business losses against personal income from other sources because his business loses are in real estate. The rest of the unwashed can only deduct business losses against future business income.
From your link:
"Real-estate developers can generate losses more easily than other taxpayers. They can take deductions for depreciation of their property and can also deduct interest when they borrow. Unlike investors in other businesses, they can use those losses to offset other income."
You should be railing against this special treatment in the tax code and asking that all businesses be treated the same when it comes to business losses.
October 3, 2016, 5:35 pmobloodyhell:
}}} Is this really the way we want to revive the economy, by shifting sucking up more of entrepreneurs' time on useless paperwork games with the IRS/
It's certainly fine with the Dems, they hate small business. Bastards make profits off of other peoples needs!!
==============================
P.S. anyone else have Facebook attempt to claim that they have a "malware" on their system and want you to run THEIR "scanner" for it before allowing you to sign into FB?
Did you fall for it, if so?
I cannot speak for you, but I have a perfectly valid freaking AV on my system, if it needs "scanning", it'll be by that program, and FB can go fornicate themselves.
Proof it's a ** s c a m **?
October 3, 2016, 6:02 pmFB also claimed my phone just magically contracted an AV out of nowhere at the exact same time.
ToddF:
I don't think there will be any effort to change this. It's just fodder to manipulate the stupid into being angry. This would kill any cyclical business, like mineral extraction, auto companies, airlines, ect.
October 3, 2016, 6:55 pmToddF:
She's not appealing to you, the educated, with this. She's appealing to the stupid, who have no idea of what you speak of.
October 3, 2016, 6:56 pmToddF:
All business' can deduct losses, not just real estate. Don't be a chump. And last time Iooked, airlines and auto companies can wrack up staggering losses, just as real estate can.
October 3, 2016, 6:57 pmTim Godfrey:
I quoted the WSJ article. It is very clear and it points out that only real-estate developers can use losses to offset income from other sources. Being able to deduct losses from the future profits of the same business is not the issue and every business needs that ability to function. What is not necessary is giving the likes of Trump special treatment because he happens to flip real estate for a living.
October 3, 2016, 7:46 pmToddF:
All business' can deduct losses from one division to offset the income from others, not just real estate. Don't be a chump, relying on the reporting of those who have the least idea of how the US tax code works, journalists.
All business' can also deduct interest costs, not just real estate. Don't confuse personal taxation with corporate.
October 3, 2016, 7:54 pmmx:
By that logic, why tax wages? Surely we don't want to hurt employment, right? And why have sales taxes? Consumer spending is the lifeblood of the economy and we don't want to give people reason not to buy stuff. Property taxes are right out; shelter is a basic human need, and when you tax something, you get less of it.
What form of taxation does this argument not work for?
October 3, 2016, 8:27 pmTim Godfrey:
We are talking about personal income tax - not business tax. Trump was able to use his real estate losses to offset the money he made as a TV personality. No other type of business owner gets that privilege according to the WSJ.
October 3, 2016, 8:52 pmmx:
I haven't seen any serious proposals to somehow eliminate the deductability of real business losses. The problem here is that Trump told the IRS he lost over $900 million dollars (probably more, since we don't even know the highest figure from previous years). This is, of course, a truly staggering amount of money for someone who claims to be such a great businessman to lose, greater than the GDP of a number of countries.
Trump's business abilities aside, the real question is how much of those loses were real economic loses, as in Donald Trump had that much money and then lost it because his businesses failed, and how much are paper loses. See, e.g. http://brontecapital.blogspot.com/2016/10/some-comments-on-new-york-times-story.html. There are a number of ways in he could have parked debt or exploited other loopholes specific to real estate development (https://www.washingtonpost.com/news/powerpost/wp/2016/10/03/five-big-questions-from-trumps-tax-return-revelations/) that would have generated such a huge tax loss without actually producing the same economic loss.
If this is a situation where he actually put $900 million of his own
money into a business, lost it all in the usual way because the normal
expenses of the business vastly exceeded revenue, and so he generated a
real loss of $900 million, then yes, he's earned that tax loss and can
use it to offset income in future years. But if he's used loopholes to generate those loses that wouldn't have been available to you or other small businesspeople, then yes, looking at changing the tax code there seems appropriate.
Of course, we can't be sure, because he won't release the tax returns that would provide any details on where the loss came from. We don't even know if the IRS actually allowed the $900 million loss.
October 3, 2016, 8:54 pmToddF:
All business' get that. Trump's included. Just because a segment of your business is real estate doesn't mean that gets treated differently.
October 3, 2016, 9:06 pmQ46:
Taxation on market transactions, especially labour, yields highest revenue to Government... that answers why inome and sales are taxed.
Taxation on market transactions causes the highest deadweight loss to the economy by reducing economic efficiency and production and thereby lowering the standard of living of the population... that answers why these should not be taxed.
October 4, 2016, 5:58 amJoe:
Tim - I am a tax professional with extensive experience in the real estate arena. Todd's statements are generally correct. Both you and the WSJ article are misinterpreting and/or mischaracterizing the passive loss rules with respect to real estate. In Trump's case, he is able to deduct the losses currently from the development activities because he is active in the business as opposed to having the losses suspended until the activity is terminated. The exception the WSJ is refering to is the real estate professional, which would also apply; though since he is active in the development, the first exception is the applicable exception. The third point is that someone who is passive is allowed to take the losses in the year of the termination of the activity. That triggering event would have occurred in 1992-1993 or 1994 when the property went back to the lender. As such, the "special exception for real estate developers" would have no effect on the deductibility of those losses (except the timing of the loss).
In summary, based on the publicly available facts, the losses claimed by Trump would be allowed in all cases, irrespective of whether trump is "active" , a real estate professional or a passive investor.
fwiw - I am making no comment on the computation of the NOL since I do not have sufficient facts in which to make any comment. Likewise I can not comment on whether there was any cancellation of debt income or exclusion of cancellation of debt income due to either insolvency or due to bankruptcy, reduction of tax attribute carryovers, gain or loss on the deemed sale, recourse v non recourse debt and the related tax consequences, etc, since the facts which would allow proper analysis are not publicly available.
October 4, 2016, 6:51 amCC:
Even after corp pay taxes, I personally have a burden of almost 35% (fed, state, sales, property). Add corp property tax, use tax, and income tax, and the total tax burden is what, 45%? Pretty heavy drag on the economy. The problem with corp tax is that it 1) is arduous to compute compared to personal --that is lots of money is wasted, 2) it distorts decisions away from what is best for business, and 3) it inspires crony capitalism where the gov gives special tax breaks to certain businesses such as the film industry.
October 4, 2016, 7:42 amjoe:
Much commentary has been made of the special loophole for real estate and depreciation. Real estate depreciation is no loophole under any theory of taxation. 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.
October 4, 2016, 8:33 ammarque2:
Taxing wages does have a negative effect on employment. Sales taxes do reduce sales of stock items. Property taxes are one of the easier ones to track, and yes do cause people to build houses in interesting spots. Lake Tahoe area real estate and real estate prices are an interesting thing to look at in regards to taxes and where the property is more expensive (in general, in Tahoe, you pay more for property in the low tax state)
If your point is, that there has to be some tax so the Federal government can do it constitutionally mandated activities, of which there are actually quite few, then I am with you.
October 4, 2016, 10:52 ammorganovich:
mx-
you appear to have grasped the argument, but not the point. ANYTHING you tax, you get less of. you may not like it, but this is an economic fact. you can no more change it than the law of gravity.
thus, to tax anything, you need a DAMN GOOD REASON.
this is a good reason to keep taxes low. their damage easily swamps many forms of government "good".
look at the rate of return you get on social security tax for a great primer here. even if they pay me what they say they will (and the won't, they're bankrupt) it's a negative nominal rate of return. i'd be better off with the money in a mattress.
if we presume that some taxes are necessary because there are government services (protecting rights, enforcing contracts, national defense) that are needed, we must then ask: what is the least harmful way to get these benefits.
cap gains are the most harmful tax there is for future growth. they literally strangle the engine of growth right at the source.
some other taxes are less harmful.
personally, i think moving to the most "user pays" model possible works best.
pay for defense with a property tax. ditto courts and police. shelter may be a need, but protecting it carries real costs. if the users of that protection are not going to pay them, then any other system is distortion. that amounts to a subsidy coupled to some other disincentive. (eg to work or invest, so you get overconsumption of housing and under investment in growth resulting in a far poorer society in the future)
if you want state roads, charge a use tax or a gas tax or some such.
if you want an FAA, tax airplane tickets. if you want an FDA, tax pharmaceuticals.
this, at least, makes the cost paid by users reflect the real price of the good.
Q46 claims that taxing transactions causes the greatest "deadweight loss" but this is not so. the biggest deadweight loss over multiple periods comes from taxing investment. in many cases, taxing a transaction is the BEST and least harmful way to tax.
but all tax reduces the amount of what is taxed demanded. it is the precise fact that this applies to all forms of tax that should make us far more careful in imposing them.
October 4, 2016, 11:34 ammx:
There's some informed speculation from David Cay Johnston as to what Trump may have done: http://www.thedailybeast.com/articles/2016/10/03/art-of-the-steal-this-is-how-trump-lost-916m-and-avoided-tax.html?via=desktop&source=twitter
As I understand it, Trump did run up a significant debt, but his lenders also forgave a large portion of the loans. Ordinarily, forgiven debt counts as income (it has to work this way, or everybody would just structure their income as forgiven loans and pay no taxes). But Trump used a new at the time tax rule to avoid taxes on the forgiven debt in exchange for forgoing some of the depreciation on the buildings. This would ordinarily cost him a pretty penny, as the depreciation deductions are valuable assets that come with the real estate, but Trump spun the real estate off into a publicly traded company, Trump Hotels and Casino Resorts, sticking shareholders with the tax consequences while he got all the benefits. Then he enriched himself to the tune of $82 million out of the company, which he could get tax free because he kept the massive NOL for himself. Nobody knows exactly how these payments were reported because he won't show us the return, and this is assuming the debt was really forgiven, instead of just parked forever, which would have allowed him to avoid even more in taxes.
So yeah, this seems radically different from the ordinary case where Coyote invested some of his capital in his business, had some loses because that's what happens when you experiment and try new things, and then used those losses to offset future profits.
October 4, 2016, 12:10 pmmarque2:
I think you are confusing passive/active income rules. Yes, if your loss is a passive loss, it can no longer be fully written off your personal income (it can be written off over time, very slowly). With real estate the rules are a bit different, because if you invest in a home, or merely live in a home, you are passive, and can only offset passive losses, but if you actively manage it, you are active, and can write losses off your income. In fact the IRS forces you to take depreciation, no choice in the matter.
It is not a loophole, it is just a realization that there are two categories of investors in real estate, active and passive, depending on what you do, whereas a stock, or bond can only be passive.
October 4, 2016, 12:18 pmDan:
Funny that it was the NY Times who "broke" the story. In 1993, they paid a combined $1.4B for the Boston Globe and Worcester Telegram. Ten years later, they sold them both for $70M. You know they took a tax deduction on that $1.3B+ haircut!
October 4, 2016, 5:11 pmNot Sure:
From the headline of the linked article:
This is how Donald Trump’s accountants and lawyers most likely used the tax code to avoid paying income tax for almost two decades.
What's wrong with using the tax code to minimize the amount of tax you have to pay?
October 4, 2016, 6:14 pmmx:
Nobody thinks there is an affirmative duty for him to pay more tax just
for fun, but if he's so confident that he paid exactly what he owed and
not one penny less, then experts reviewing his returns would surely
agree. The fact is that we don't really know what he paid or what strategies he used to reduce his tax bill, from perfectly ordinary deductions everybody takes to shady offshore debt parking schemes. However, given the significant amount of errors and blatant self-dealing we've already found in the tax records he does have to make public, those of his foundation, he has not in any way earned the benefit of the doubt here. .
He tried to make a tax-free contribution to the Florida AG's campaign fund (when she was investigating him for fraud) and spent charitable funds to settle his corporate debts and buy large portraits of himself to hang in his businesses. That's just what we know about, from the small amount of tax filings he had to make public. Criminal tax evasion is hard to prove, because it requires intent, but some of this stuff is, at a minimum, well on its way there. If that's what's in the public filings, what's he keeping private?
October 4, 2016, 10:34 pmDanSmith:
Clinton knows better but she's borrowed the class warrior crap from Bernie in order to get his supporters. He was in my state yesterday and the sound bite was get the rich to pay their"fair share".
October 5, 2016, 4:25 amNot Sure:
"The fact is that we don't really know what he paid or what strategies he used to reduce his tax bill, from perfectly ordinary deductions everybody takes to shady offshore debt parking schemes."
October 5, 2016, 1:53 pmYou don't really know? Okay.
Joe:
Not sure - "The fact is that we don't really know what he paid or what strategies he used to reduce his tax bill"
I conur with your statement. I am a tax professional and did considerable amount of work in the early 80's through the mid 90's dealing with a lot of real estate foreclosures, workouts, debt forgiveness, etc. The article dailybeast may or may not be a reasonable educated speculation on the what transpired to create such a large NOL which wasnt reduced by the amount of debt forgiveness. However, the really isnt sufficient information publically available to ascertain if the dailybeasts speculation is correct or simply pure speculation (the particular article jumps from assumption of facts not in the public arena to inuendo's . In order for the tax stategy outlined in the article, Trumps' fact pattern has to fit into a very narrow set of circumatances to work (which is beyond the scope of this discussion)
Suffice it to say, there is not sufficient information publicly available to reach any conclusion.
On another note, one of the two parties involved (the IRS or Trump ) has likely conceeded the issue (ie either the IRS has accepted the NOL or trump has acknowledged the overstatement of the NOL). Otherwise there would have been litigation which would have resulted in a reported decision, either tax court or district court.
October 5, 2016, 3:08 pmNot Sure:
Joe-
The comment was not mine- I copied it from mx's prior post. I am not a tax professional, so it would be silly for me to try to make any definitive statement of fact on this subject. That said, I would like to note that it is public knowledge that the IRS has not, of late, been particularly supportive of entities who are on the Republican side of the left/right axis, begging the question: If a major Republican figure like Trump has been playing fast and loose with tax rules, why was he allowed to get away with it?
Just sayin'.
October 5, 2016, 6:37 pmRewired actuary:
You fault Trump for not giving a "simple" explanation, but as you can see from the comments below, no simple explanation is possible. The Clinton campaign wants the next five weeks to be about Trump's taxes, rather than her incompetence and lies. What is the chance that the IG's report of $6B of State Department contract files missing or incomplete during her term will be brought up? She screws up everything she touches, and when she lies about it, she's given a pass by our lapdog media.
The IRS examined his return. If he had done something illegal, why would they give him a pass?
October 6, 2016, 4:17 amFred_Z:
This thread is very interesting to me as I am an active real estate developer and residential rental owner-operator in Canada where we have similar rules for active and passive income.
Like the US "passive" income get fewer tax breaks and is therefore taxed at a higher rate or on worse terms or both.
It is taxed more, so there is and will continue to be less of it. Why?
Passive income arises from careful investment in things that do well and is based on an odd mix of intelligence and luck. My experience is that it is more cleverness than luck. Why are we suppressing cleverness by overtaxing it?
October 6, 2016, 6:37 amRene Vice:
The problem is that we have become such a divided country: on one hand, you have entrepreneurs who actually are forced to understand tax laws and the benefits that are derived from current laws; on the other hand, you have millions of people who have spent their entire life working for someone else and don't have a clue as to "how" you go about starting and sustaining a business. Yes, I truly believe there should be a way to simplify our tax system. No, I don't believe we should punish the hardworking, dedicated men and women who are trying to hold a business together in this environment. Enter the politician! He or she has the perfect solution - it's just that their solution is aimed at gaining votes, not sensible reform. I've been a small business owner my entire life, and at this point, I wouldn't recommend it to any young person. The deck is stacked against you, from labor laws to tax laws. And, as the Coyote Blog so eloquently points out, as long as there is money at stake, there will be someone at some tax firm dedicated to figuring out how to game the system.
October 10, 2016, 11:34 am