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You’re likely seeing lots of tax terms in the news today that you’ve never cared to learn.
Reporters are using terms like “N.O.L.,” “fiduciary” and “debt parking” in articles highlighting Donald Trump’s 1995 income tax returns, which The New York Times first reported on this weekend.
These terms, and their definitions, illustrate the complexity of our tax codes. Since the Republican presidential candidate’s tax returns will probably continue to be a regular topic in the news this week, we thought it was a good time to brush up on some of the more frequently used terms.
So, let’s do the jargon:
Net operating loss (N.O.L.)
The crux of the Times’ story, which looked at three pages from Trump’s 1995 tax documents, is how the businessman likely used the net operating loss tax provision to offset his taxable income years later.
David Cay Johnston, the author of “The Making of Donald Trump,” and an investigative journalist focused on taxes, discussed the concept with us this morning:
Congress has a provision that allows you, if you have mismanaged your business or had misfortune, to take those losses and spread them over the business over a number of years. You can go back two years, and forward for 15, but this is not for capital investment. This is for the business having an operating loss. Now if you own real estate and you mismanage it, that’s one of the ways that you can drive down its value.
The bigger the loss, the longer a person can cancel out taxable income. The New York Times’ tax consultants estimated that Trump’s declared $916 million net operating loss likely let him avoid taxes for the entire 18 years allowed.
Trump would not be the only one who knows how to use tax laws for his benefit. The N.O.L tax provision is “ particularly prized by America’s dynastic families, which, like the Trumps, hold their wealth inside byzantine networks of partnerships, limited liability companies and S corporations,” according to the Times.
Limited liability companies (LLC) and S corporations (S Corp)
You may be familiar the acronym LLC, since it is often used in the names of businesses. But for clarity’s sake, an LLC is a “pass-through entity,” which means any profits or losses associated with the business are passed along to the business owners, who then report them on their personal income taxes. The LLC classification also protects business owners from personally taking on any liability, such as lawsuits, associated with the business.
S corporations is a tax designation that lets companies avoid being taxed twice. Instead of the corporation and shareholders having to pay taxes, only the shareholders have to. Like with LLCs, a company’s profits and losses are passed along to the personal income taxes of the shareholders.
In response to the Times’ reporting, Trump’s campaign released a statement that said Trump had a “has a fiduciary responsibility to his business, his family and his employees to pay no more tax than legally required.”
Former New York City Mayor Rudy Giuliani, a Trump supporter, called Trump “a genius” for knowing how to use the tax laws in his favor. And if he hadn’t, “he would of have been in a lot of trouble.”
“If you have a set of laws, you live by those laws,” Giuliani told CNN. “And the reality is, you are ignoring completely the fiduciary obligation he has to all the people around him to run his business at the lowest possible expense.”
A fiduciary, or “trusted person,” is responsible for acting on behalf of an organization, company or people to protect their financial interests — not the fiduciary’s financial interests. But in the case of Trump, he is offsetting the loss on his personal income.
“There is no such thing as a fiduciary duty as a businessman to oneself,” said Richard Painter, a corporate law professor, told the Times.
Debt forgiveness and debt parking
Trump had $832 million of debt from his casinos and other assets and real estate tax code would have allowed him to count that as a deduction. But if that debt is forgiven, it is counted as income. Bankruptcy judges or banks can write off, or forgive, losses if a creditor can no longer collect on a debt.
Trump would not have been able to write off his massive losses, as described as the Times, if his debt was forgiven. The newspaper said Trump may have used tax exemptions specifically for real estate developers to deduct his debt without paying income tax.
Tax expert John Hempton, offered another possible tactic — debt parking.
Debt parking, as described by Hempton, is when a person in debt gets a separate party — whether that’s a person or a new entity — to buy the debt from the current creditor. The party then sits on the debt and never forces the person with the debt to pay. In turn, the person in debt wouldn’t have any forgiven debt to report as income.
This term comes from the proposed tax reforms of Trump and his rival Hillary Clinton. Both candidates have said they will eliminate carried interest, which contributes to the income of private equity managers.
“The big issue this cycle is the carried interest loophole that allows hedge fund managers to count some of their income as capital gain, which is taxed at a lower rate,” political scientist Bert Johnson told us earlier this year. This issue has come up before — 2012 Republican presidential candidate Mitt Romney benefited from carried interest thanks to his time at financial firm Bain Capital.
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