My (simpleminded) understanding of the tax code is you can’t write off losses that exceed your basis in a business enterprise, yet it appears that a well-known individual has for years taken losses in businesses that far exceed the investments he made in them. How did he pull that off? Inquiring 5-year-old minds want to know.
In: Economics
The New York Times story is deliberately misleading by conflating the multiple different types of taxes that a person and business can pay.
The first area that it conflates taxes is by conflating the taxes of corporate entities with personal taxes. A corporation only pays taxes on profit. If the corporation loses money every year then it has no profit, pays no taxes, and also makes no non-salary distributions to its owners. A corporation can sustain long term losses if its owners continuously invest new money into it.
Any salary that a loss making corporation pays is taxed against the individuals who were paid. High income individuals rarely pay income tax, instead they pay something called “alternative minimum tax” instead. Most people in the US only pay about 50% of their stated theoretical tax rate due to the effect of tax deductions. If you’re in one of the top income tax brackets and deductions would bring you below an effective tax rate of 26% then you pay AMT *instead* of income tax.
AMT is the exact same thing as income tax, except that you don’t get to take any deductions. However, the IRS treats it as a completely separate thing and it shows up separately from income tax on your tax returns. IE, most high income individuals pay $0 in income tax, and 26% in AMT. It is both factually true to say that those individuals paid no income tax while also being a substantively lie.
To put this into practice, lets pretend you own two corporations, A and B, and act as the CEO for both. A pays you $100 per year in salary and makes $500 per year in profit, which it pays to you as a dividend. B pays you $100 per year in salary and loses $100 per year.
A pays taxes on its $500 in profit. A’s taxes have nothing to do with you.
B pays no taxes as it took a loss and can offset its present loses in future years. B’s taxes have nothing to do with you.
You earned $200 in salary income and $500 in dividends. You need to pay money on that $700. In our fictitious world, the threshold at which AMT kicks in is $100 and you have deductions that would otherwise bring you below an effective tax rate of 26%. You pay no income tax. Instead, you pay AMT on $700 and so pay $185 in taxes.
The NYT story is presenting corporation B’s tax returns as though they are the personal tax returns of you, its owner, when corporation B’s taxes have nothing to do with you at all. Its also ignoring that you, legally, cannot pay income tax because you meet the thresholds to be taxed under AMT. So while it is true that you paid no “income tax” you did pay AMT, which is the exact same thing.
Some people on the internet will occasionally take the position that taking tax deductions is immoral. In the history of worldwide taxation there has never been a single person who has not taken every deduction that they are entitled to, including the people who like to take this position.
A lot of his investments are in real estate. Normally you can’t deduct losses that are funded with debt unless you are personally on the hook, or “at risk” for repaying the debt. There is a special exception from the “at risk” rules for loans which are secured by real estate.
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