Donald Trump is an Idiot

20573038010_490c18fa3f_bBefore you fire up your email to insult my mother’s choice to have children (or congratulate my good taste), here me out. This blog is devoid of politics, trust me. What I share in this post is in no way indicative of who I support for POTUS. This blog is about personal finance, financial independence, lifestyle, and TAXES. Check the top of the page; it is clear as day.

The latest news comes from Trump’s 1995 tax return. I could care less that some people think he is a good businessman who lost $916 million in one year. What bothers me is the mental morons calling Trump’s actions “genius”. Wrong! Or Trump calling his actions “brilliant”. Wrong! By the end of this post I will show you how The Donald threw away $300 million in cash. His accountant should be flayed, quartered, and beheaded for his incompetence. If Donald Trump knew how badly he screwed up on his tax return he would be spitting nails.


Structure

I did not see the tax return published in the New York Times. My only information is third party comments in the news. Using such information calls my intelligence into question. But it will provide an awesome example of how we can use the tax code to really save and make money.

This is what looks like happened. Trump started several companies that filed for bankruptcy. He structured these companies as sub chapter S corporations so all the gains and losses flowed to his personal tax return. That is the first problem.

The structure of these businesses are probably why the IRS is auditing him. Deductions exceeded his revenue causes a net operating loss (NOL). This is not unusual. In a simplified way, it means his taxable income dropped below zero due to the business loss on his personal tax return.

NOLs currently are carried back two years and forward twenty. Back in 1995 it was slightly different. (If memory serves, back in 1995, NOLs had to be used in 18 years; three years carried back and 15 forward after the NOL was created. Don’t quote me on that. I’m writing at home without the help of tax guides from 1995.) (I verified the info.) Under current tax law, Trump needed almost a billion dollars in income from 1996 to 2015 or the NOL would expire unused.

The IRS is probably looking at the NOL because the NOL must be reduced by the amount discharged in bankruptcy court. You don’t get to double dip. If Trump tried to ram certain gains through on his tax return prior to the NOL expiring and if he did not reduce the NOL by the amount of debt discharged the IRS has solid footing to audit.




Lost Opportunity

Let’s not belabor the point. We will assume Trump had a real $916 million NOL back in 1995. Because he set the companies up as S corporations, the gains and losses ended up on his personal tax return (pass-through on Schedule K-1 from the company to Page 2 of Schedule E on his personal tax return). This is really bad. On his personal tax return, the NOL must be used by year 18 or it is cancelled and is worthless.

The problem starts with the structure. If Trump organized his businesses as regular corporations, also known as a C corporation, the NOLs would have remained with those corporations. We talked about the tax benefits of S corporations on this blog in the past. My recommendations remain correct for small business owners. For large businesses, like Trump Airlines where I suspect a large part of the NOL originated, the regular corporation is better. There are a lot of reasons why, but we will only focus on the NOL.

C corporations with a NOL have a valuable asset. If another corporation buys the company with a NOL, the acquiring company can use the NOL to offset their taxable income. Since Trump is in New York I will use an estimate of 40% combined federal and state tax rate for C corporations for easy figuring. A $916 million NOL could save an acquiring corporation over $350 million in taxes! If Trump had structured the deal correctly he would have recouped $250 – $300 million from a company willing to buy solely on the value of the NOL, without consideration for any remaining assets, goodwill, or client base.

Time value of money says selling the NOL for cash now beats tax breaks spread over 18 years. The tax breaks will only help if he has income. An acquiring corporation with plenty of profits are sure to benefit sooner than Trump could himself without risk of a partially cancelled NOL. Also, cash in hand is worth more than a possible tax benefit. The risk is shifted to the buyer when the business with the NOL is sold.

Of course, the IRS is fully aware people like the Wealthy Accountant know how this stuff works, even if Trump and his accountants don’t. Section 382 of the Internal Revenue Code (IRC) limits this little trick if 50% or more of a company with a NOL changes ownership. Since the buyer will acquire 100% of Trump’s company with a NOL, the acquiring company will use a formula to determine the amount of NOL they can use each year.

The bottom line is if Trump structured the deal properly he could have cashed in big-time due to the NOL. Big NOLs have value which can increase the amount of money the acquired company’s shareholders get. The best possible outcome would have been $300 million to Trump back in 1995. It is more accurate to say Trump would likely have received closer to $150 million. I guess if you are really rich, $150 million isn’t enough to worry about. It would make a difference for me if anyone cares.

29168164412_de376a7e62_bProblems and Solutions

But WA, you said in the past we should have an S corporation for our business. I did and I am correct. I never thought Trump would read my blog and think he is a small business.

Donald worried if he had a profit as a C corporation he would pay more tax. Wrong! General Electric generates billions in profits annually and frequently pays few to no income taxes in the U.S. Trump is so small compared to GE I could handle his whole tax situation myself with one helper. (No kidding! I’d have to quit everything else I do to get the work done, but it is possible.)

Here are a few things Trump could have done if he did it my way. When he had a profit in his C corporation he could use a tax inversion to funnel U.S. profits to a low tax country for usage of the Trump brand. Another neat trick is using the foreign tax credit with the partially tax-free nature of dividends received by a regular corporation. For example: A U.S. C corporation excludes 70% of dividends received from another corporation if they own less than 20% of the stock, a common occurrence. If the C corporation owns British Petroleum it gets the foreign tax credit and the dividend exclusion, a legal form of double dipping. Several years ago a public company used this strategy to reduce its federal taxes to zero and was taken to Tax Court by the IRS. The IRS lost.

A Lesson in Business

Trump is not a good businessman in my opinion; he threw away a couple hundred million due to stupidity. He inherited a sizable amount of wealth and left the bank holding the bag when things soured on business deals; that is where he got his wealth. Trump is good at protecting himself. When it comes to taxes he screws himself more than the IRS ever will. If he played it fast and lose, the IRS will tear him a new one in audit when it never should have been an issue. If he paid me to advise him he wouldn’t have to worry about the NOL; he would have cashed his check twenty years ago.

And no, Donald, I am not accepting new clients.




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Keith Schroeder

5 Comments

  1. fmdd01 on October 5, 2016 at 6:33 am

    I hear what you’re saying about monetizing an NOL but what about sec. 382. Seems like that section was designed with NOL traffickers in mind so might be difficult to sell the company for its NOL at the end of the day.

    Also sec. 7874 wasn’t enacted way back in 1995 but these days Congress and the IRS has made it quite difficult to pull off an inversion successfully!!

  2. Keith Schroeder on October 5, 2016 at 7:40 am

    fmdd01, I covered Section 382 in the article. Section 382 limits how much of the NOL the acquiring firm can use each year, but does not restrict their using the portion allowed. NOLs are considered when a company considers purchasing a competitor. The rules were more generous in 1995 than today. I estimate Trump could have brought in over $150 million on the sale of his bankrupt company with the massive NOL.

    Inversions are still happening! There is a lot of complaining, but the IRS and Congress have done nothing to curtail inversions. The EU decision against Apple will do more to stop inversions than the U.S. Congress. It is mostly political talking points at this time. The inversion would have helped Trump; the foreign tax credit would have put millions in his pocket tax-free. From what I saw in the news, Trump and his tax team are not geniuses when it comes to taxes. Quite the opposite.

  3. scott on October 6, 2016 at 10:46 am

    I am not sure I agree with the statement: “Time value of money says selling the NOL for cash now beats tax breaks spread over 18 years.” It completely depends on your assumptions. Lets take this second statement as the benchmark for the value of selling the NOL, “It is more accurate to say Trump would likely have received closer to $150 million.”

    Now, lets take that $916M loss and spread it out evenly over 18 years. That gives us $50.9M per year (916 / 18 = 50.9). A $50.9M deduction will save Donald $20.35M in taxes each year for 18 years (assuming a 40% tax rate (50.9 x 0.4 = 20.35)). What is the present value of $20.35M of savings each year for 18 years. Assuming a 5% discount rate PV = $240M. Assuming a 7% discount rate PV = $205M. Assuming a 10% discount rate PV = $167M. Assuming a 12% discount rate PV = $147M.

    All four of those scenarios compare favorably with your $150M figure. Of course you could assume “The tax breaks will only help if he has income”. But I could just as well assume that Donald and his accountants had reason to believe they could reap the benefits of the NOL carryforward in a much shorter time period than 18 years thus increasing the PV of the carryforward substantially.

    So, based on the math here (which was done quickly and could be wrong) should we really be concluding that “His accountant should be flayed, quartered, and beheaded for his incompetence”. While we could argue over assumptions, your proposal to sell the NOL for $150M hardly seems to be a slam dunk solution.

    • Keith Schroeder on October 6, 2016 at 2:45 pm

      Scott, selling Trump’s NOL for $150 million would be a slam dunk. A skilled businessman like Trump should easily get more. I have facilitated enough NOL company sales to see this work real time. My argument is simple: Trump might use the NOL, but would get the full value of the sale from the company with the NOL. Using the low figure, Trump would have $150 million he could invest in a S&P 500 index fund. The S&P 500 has increased over 4.6 times since 1995. Including dividends would turn that into over 5 times. Using tax loss harvesting, something a master of business and the tax code should have no problem doing, means most profits would be tax deferred. His original $150 million would be worth $750 million now. In real life Trump probably would have received $200 – $225 million. This translates into a current value of $1 billion $1.125 billion in value.

      I love the way you think though, Scott.I make it look like a simple decision in the post because I have limited time to write and I try to focus on one point. If I get bogged down in every tax possibility I would never get anything published.My assumption (always a bad thing to do) is Trump will not have $51 million is tax gains every year. Gains from sales of assets are usually tax lower anyway and the NOL is more valuable to another corporation so those don’t count. He could even have merged two of his companies to utilize the NOL better, if he is that profitable elsewhere. I stand by my original assessment; Trump should not be using S corporations the way he is. It is costing him money.

  4. JT on October 27, 2016 at 5:21 am

    Love the detailed analysis, Keith. Wish you were taking on new clients!

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