How to Do Taxes Like Donald Trump

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Much ado was made about Donald Trump’s tax return where he lost close to a billion dollars in one year. The speculation was that he might have not paid taxes for the next 18 years.  The fact is, we really don’t know from that one return whether he paid taxes or not for the next 18 years.  If he made a profit of a billion dollars the next year, he would have been paying taxes from the following year onwards.  He just would be allowed to use the loss in 1995 to offset gains for up to 18 years due to the tax laws.

Unfair?  Unpatriotic?  Hardly.  The issue is that we have an income tax in America, which taxes, well, income.  If you have lots of income, you pay lots of taxes.  If you have little income, you pay little taxes.  People have decided that you should pay more (a greater percentage in taxes) if you make lots of income because 1) you can afford to do so, 2) somehow you are evil and should be punished if you make lots of income, and 3) everyone else deserves some of your money since you make so much.  This is a called a progressive tax code that charges one percentage for the first so many thousand dollars, then a higher percentage for the next so many thousands, and so on.  For those who make a lot of money, they only get something like forty cents for each additional dollar they earn.  Note this probably doesn’t encourage business owners to stay in the office and work a few more hours to open additional factories and create more jobs since they will only get to keep forty cents on the dollar once they reach the income threshold.  This means fewer jobs may be created because of the tax code.  It also really encourages high-income individuals to find ways to pay less in taxes.

Part of the income tax code, because it taxes income, is that you only pay taxes on your net income, when you make income.  Your net income, for an investor, is the amount you gain when you sell stocks or other assets.  You don’t pay taxes while you still own the stocks, buildings, etc…, even if they go up in value during the year, because you don’t have access to the money – it’s only on paper.  At the end of the year you add up all of the gains for the stocks you sold for a gain (those you sold for a higher price than you paid).  You then add up all of the losses from the stocks you sold at a loss (you got less back than you paid).  You subtract the total loss from the total gain, and that is your income – money you have that you didn’t before.  You pay taxes on that amount.  Even if you make a billion dollars on your gains, if you lose a billion dollars on other stocks you sell at a loss in the same year, your net income is zero and you pay no taxes.

For example, let’s say you have 1000 shares of XYZ stock that you bought at $10 a couple of years ago.  You decide to sell the shares because they’re now at $20 per share, making a profit of $10,000.  The same year, you sell 400 shares of ABC stock that you bought at $40 per share, which are now trading at $20 per share, taking a $8,000 loss.  In total, you have made $2,000 because you made $10,000 on one transaction but lost $8,000 on another.  In the end, you have $2,000 more in your pocket, not $10,000.

But let’s say that you had another stock, DEF, and you also had a loss of $10,000 on that stock.  Now you have a net loss for the year of $8,000.  Because you have no income that year, you pay no taxes, as Trump did in 1995.  But let’s say that the next year you sell a stock and make $12,000.  You really have only gained $4,000 since you lost $8,000 the previous year.  It would, therefore, be unfair that you needed to pay taxes on a $12,000 income when you were only $4,000 ahead over the two years.  The tax law, therefore, lets you roll the loss for the previous year forward and use it against the gain you make the next year.  You really only made $4,000, so you only pay taxes on the $4,000 gain.  Trump, therefore, would not need to pay taxes again until he had made at least enough in profits over the next several years to offset the billion dollar loss he took in 1995.  In other words, he did not pay taxes until he actually made income – fair enough.

Trump said that he didn’t pay taxes because he was “smart.”  He was being smart, and you should be too.  Here’s what he probably did, as should any investor:

Note:  This assessment of the tax code is believed to be true at the time this is written.  Before you do anything, verify the following statements against the tax code since things do change or, better yet, check with an accountant.

  1.  When you need to sell stocks to raise money for something, look at your gains and losses.
  2. Try to pair gains and losses together so that they offset each other.  For example, if you need to raise $50,000, and you have a stock worth $25,000 with a $10,000 gain, and you have another stock worth $25,000 with a $11,000 loss, sell them both together in the same tax year.  That way you won’t pay taxes on the gain while you have a big loss sitting in your portfolio.
  3. Remember that you can also deduct up to $3,000 in stock losses against regular income.  In the example above, the extra $1,000 in losses could be deducted from income for the year.
  4. DO NOT sell a stock at a loss and then buy it back within 30 days.  Likewise, don’t sell a stock at a loss if you’ve bought more shares of the same stock within 30 days.  This is called a wash sale, and you probably won’t be able to deduct the loss if you do so.  The same holds true if you buy something “substantially equivalent” to the thing you took the loss on (for example, you take a loss on a Vanguard S&P500 fund and then buy shares in the SPDRs within 30 days).
  5. Note you can take gains and then buy shares back immediately all you want.  You might want to do this if you sell a big loser and have a big gainer in your portfolio that you want to keep.  Sell them together, then buy back the shares of the gainer immediately to reset your cost basis.  Note you could have also rolled the loss forward into future years if you had not sold the gainer, but this might make your taxes simpler to just take the gain and the loss together.

Other smart things to do:

  1.  Put stocks that pay dividends and bonds (which pay interest) into tax deferred or tax-free accounts like IRAs and 401k plans so that the income and dividends won’t be taxed every year.
  2. Fill your taxable accounts with mainly long-term growth stocks (or index funds) which will not generate a lot of income until you sell them.  Note this rule only applies if you do not need current income for expenses.  If you’re living off of your investment account in retirement, it might be better to be living from the income in your taxable account while your 401k continues to grow.

So there you have the secrets of Trump.

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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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