How Tax Loss Carryforwards Actually Work For Trump, Businesses And Individuals

The latest criticism of Republican presidential nominee Donald Trump relates to the amount of taxes he hasn't paid to the government.

The New York Times reported that the billionaire real estate mogul and entrepreneur recorded a $916 million loss in 1995. There was nothing illegal with what Trump had done, and as further noted by the New York Times, "more than 500,000 individual taxpayers took advantage of the same tax rule as Mr. Trump in 1995, according to the Internal Revenue Service."

In essence, Trump made use of the accounting term tax loss carryforward. Business owners, like Trump, report a negative profit (i.e., a loss) for tax purposes, which then reduces future tax payments.

Related Link: Donald Trump Keeps Contradicting Himself, This Time On "Sources"

How Does It Work?

Given the large number of zeroes in Trump's scenario, it may be more appropriate to use easier and round numbers as exemplars to the scenario. Suppose a small business owner reports an annual income of $1,000,000 but their expenses total $1,300,000 — the company lost $300,000 for the year.

The next year, business improved drastically and the company now reported a profit of $500,000. At a 30 percent corporate tax rate, the company is on the hook to pay $150,000 in its fair share of taxes.

However, the company can apply year one's $100,000 tax loss when it completes year two's tax filings. The company's tax burden has dropped by year one's amount of $300,000 to $200,000.

The tax bill drops accordingly to 30 percent of $200,000, which is $60,000.

Bttom Line

Bottom line, tax loss carryforwards create a much needed cushion for businesses to continue operating in the face of losses. Perhaps in the above example the business owner would have called it quits, closed his business and fired his employees if it wasn't for a notable tax benefit acting as an incentive to continue operations.

There is nothing wrong, illegal or unethical about what Trump has done. In fact, Trump's opponent in the presidential race, Hillary Clinton, took advantage of the exact same tax strategy and declared a carryforward loss of $699,540 on her 2015 tax return. Granted, Trump's losses were in the hundreds of millions of dollars while Clinton's were in the hundreds of thousands of dollars. Both candidates looked out for their own financial interests in paying the lowest amount of taxes that is legally possible — something Main Street can almost unanimously agree with.

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