What is a Net Operating Loss (NOL)?
Simply, an NOL is when a company’s allowable deductions exceeds its taxable income. For example, let’s say that a company has allowable deductions of $100,000 and taxable income of $50,000. The company has an NOL of $50,000.
There are two ways to use the NOL. First, the company is allowed to carry it back up to 2 years. If the company has an income and has paid taxes in either of the previous two years, they can apply the NOL to either of those years and get a refund of taxes paid. Second, the company can carry the loss forward and apply it to future years in which the company has taxable income. The NOL can reduce the taxable income to zero, resulting in not owing income taxes for that year. An NOL can be carried over for up to 20 years.
In Donald Trump’s situation, there is not enough information known yet to know how this all applies. Let’s break it down:
It’s been estimated that he had a loss of roughly 900 million dollars. To the average person like you and I, I can’t imagine what that number even means. Now, let’s just make an assumption that his companies profited $50 million per year in the next 20 years. His NOL would take approximately 18 years to be used up. Simply, he would be able to use the NOL carry forward for 18 years. (900 divided by 50 = 18). However, if he had shown a profit of $900 million in the following year, his NOL carry forward would have been used in the first year after the loss occurred.
I think that at this point there should be a brief discussion of tax avoidance vs. tax evasion. Everyone should be trying to maximize their deductions as much as legally possible. This is tax avoidance. If you are intentionally understating your income, or over stating your deductions, or blatantly not paying income taxes, that is tax evasion. The IRS has a problem with tax evasion. Google Wesley Snipes and others under tax evasion to see what happened to them.
In one of my tax classes; to quote Judge Learned Hand: “Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands”. This is quoted from the case of Gregory v. Helvering.
So that anyone reading this doesn’t think that I’m only protecting Donald Trump, It has been in the news this last week that Hillary Clinton used the same benefit on her 2015 tax return, claiming roughly $699,000 capital loss carryover. The only difference between the two seems to be the scale in which they used the carryover.
So, in conclusion, were their actions legal? If taken within the confines of the law, You Betcha! Were they ethical? If used within the confines of the law, You Betcha! Are they fair? You Betcha!
Individuals like you and I have ways to reduce our tax burdens as well. There are a number of tax credits available to us if we qualify such as Child Tax Credits, Earned Income Credits (just to name two). Those are not carried over, but will reduce your tax bill, and in some cases get you a refund even if you have a zero tax liability. Some carryovers that may be available to individuals are Capital Gains Loss carryovers. More tragically, now that Hurricane Matthew has hit the east coast, if the area is declared a disaster area, and a person’s insurance does not cover the damage, those people may be able to carryover their repair losses to future years.