Just Taxes Blog by ITEP

A 2017 Tax Provision Could Have Restrained Trump’s Tax Dodging, But Congress Just Weakened It

A 2017 Tax Provision Could Have Restrained Trump’s Tax Dodging, But Congress Just Weakened It

September 29, 2020

Steve Wamhoff
Steve Wamhoff
Director of Federal Tax Policy

President Trump and Republicans in Congress passed up almost every opportunity to shut down special tax breaks and loopholes for real estate investors when they enacted their 2017 tax law. They did, however, include some welcome provisions to limit how business owners use losses to avoid taxes, and these provisions could potentially limit the sort of tax dodging perfected by Trump. Unfortunately, Congress temporarily reversed these limits with some provisions tucked into the CARES Act that was enacted in March, and this may help Trump and others like him to continue avoiding taxes.

The 2017 tax law is mostly a giveaway to wealthy Americans and foreign investors, but it does contain a handful of provisions that raise revenue to offset some (a small fraction) of the tax cuts provided in the law. Under the budget procedures Congress had set up to pass the bill, the overall cost could not exceed $1.5 trillion over 10 years, and the law’s drafters included some revenue-raising provisions to stay within this limit.

Two of those revenue-raising provisions limit how business losses are reported.

The first provision applies to all types of businesses. It bars them from carrying losses back to offset income in previous years (the former rule allowed taxpayers to carry losses back two prior years) and bars businesses from using losses to offset more than 80 percent of their income in any given year.

The second provision, which is probably much more relevant to Trump, imposes an additional limit on the owners of pass-through businesses who want to report losses. A pass-through is a business whose profits are reported on the personal income tax returns of its owners and is not subject to the corporate income tax. Most, if not all, of the companies through which Trump conducts business are probably pass-through entities.

This part of the 2017 law bars taxpayers from using pass-through business losses to offset more than $250,000 of non-business income, or more than $500,000 of non-business income in the case of a married couple. If Trump were subject to this provision, it could limit the use of losses that is central to his tax avoidance. Trump will likely have non-business income exceeding $500,000 annually in the future.

As an ITEP blog post from earlier this year explains, this part of the 2017 tax law is surprisingly sensible because the business losses reported by the rich often exist only on paper. And that certainly seems true in Trump’s case. Business owners claim losses whenever their expenses exceed their revenue, but what counts as a business expense? Trump has deducted large “consulting fees” paid to family members, as well as seemingly personal expenses like the use of his private plane and his hair styling, as business expenses.

Tax rules on these types of expenses can be hazy. These deductions may be legal, which is an indictment of the tax code, or they may be illegal, which is an indictment of Congress’s decision to underfund the IRS and make it nearly impossible to enforce the rules.

There are other ways that losses can exist purely on paper. For example, owners of rental property can claim deductions for depreciation, which is premised on the idea that the property loses its value over time, even though the property is actually appreciating.

There are plenty of reasons to restrict the ways in which wealthy individuals report business losses, and the 2017 law surprisingly did something sensible on this front. But Congress rolled these reforms back, at least temporarily, earlier this year.

When drafting the CARES Act to address COVID-19 and the recession, lawmakers inexplicably inserted language to suspend these limits not only in 2020 but also retroactively for 2019 and 2018. This gives well-off business owners the ability to use their losses to wipe out their income not just this year but also during the previous two years, meaning they can file amended returns for 2018 and 2019 and receive refunds from the IRS.

The retroactive change seems particularly unwarranted given that any business losses in years before 2020 clearly have nothing to do with the COVID-19 crisis. (As ITEP has explained, the rules for losses put in place by the CARES Act are even more generous than what existed before the 2017 law was enacted.)

While the CARES Act provides much needed relief, undoing the loss limits for wealthy business owners was entirely unnecessary and unhelpful. Waiving the passthrough loss limit is especially egregious because it only helps those with other types of income exceeding $250,000 or $500,000. Congress’s official revenue estimators, the Joint Committee on Taxation, found that 82 percent of the benefits would go to those with incomes exceeding $1 million in 2020.

Congress can change course again. The HEROES Act, which is the most recent legislation passed by House Democrats to respond to COVID-19, would restore the loss limits that were enacted in the 2017 law. The debate over that part of the HEROES Act may have seemed arcane but it may turn out to be central to stopping the type of tax avoidance that Donald Trump has made famous.