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'Unconscionable' to tax income without allowing expenses, losses

Although the significant loss Donald Trump reportedly declared on his 1995 income tax return may be partly the result of government loopholes, the ability to carry that loss forward is a basic requirement of tax equity and is far from unfair, Toronto tax litigation lawyer David J. Rotfleisch writes in The Globe and Mail.

As Rotfleisch, founding tax lawyer at Rotfleisch & Samulovitch Professional Corporation, explains, the New York Times reported that Trump declared a $916-million loss on his 1995 income-tax returns, which was carried forward to subsequent tax years and was used to reduce income.

However, he notes, this is “not really” an unfair loophole for the rich — and Canadians are able to the same.

“There are two different tax issues at play here. The first is the nature of the tax loss, that is to say how the tax loss is computed,” explains Rotfleisch.

“The New York Times reported that deductions such as ‘business expenses, real estate depreciation, losses from the sale of business assets and even operating losses to flow from the balance sheets of partnerships, limited liability companies and S corporations’ flow into the personal tax returns of the owners.”

From a simple tax-policy point of view, he says, the deduction of business expenses and operating losses follows basic accounting rules. All expenses incurred in the course of earning taxable income are, and should be, deductible.

“It would be unconscionable to tax income and not allow related expenses,” writes Rotfleisch.

Similarly, he adds, if you earn income from one business and have a loss on another, those losses should reduce income — this applies to everyone, from U.S. presidential candidates to Canadian entrepreneurs.

Depreciation is an accounting concept and a non-cash expense, so it does not immediately impact cash flow, Rotfleisch explains in the article.

“Permitting a deduction for taxes has a real reduction of tax liability. All of these deductions are permitted by the Canadian tax system. However, in Canada, a rental loss cannot be created or increased through a depreciation claim,” he says.

Rotfleisch adds, while Canada does not have limited liability companies and S corporations, “it does require a flowthrough of partnership income (or losses) to the partners, so in that respect, Canada’s tax system is the same as that of the United States.

“From a policy point of view, if income from partnerships did not flow into the income of the partners, the partners could defer paying tax on their earnings by leaving them in the partnership. Again, if income is taxable in the hands of the partner, then losses must be deductible too.”

Although it can be argued that depreciation is a loophole, Rotfleisch says “it is a government-sanctioned and well-known loophole used by everyone with depreciable assets.”

For Trump not to have claimed the maximum depreciation to which he was entitled “would have been foolish tax planning,” Rotfleisch writes.

When it comes to the ability of Trump to carry his loss forward to subsequent years, as Rotfleisch explains, from a policy point of view, not to allow someone who incurs a business loss to utilize that loss against future income would be “fundamentally unjust.

“Who would make a business investment if the income was taxable, but any loss was of no use? And if a business owner’s losses in a given year exceed all income, then the only uses of those losses is a carryover or a sale of the loss itself to a third party, which has far more potential for abuse,” he says.

In Canada, he explains, a business loss can also be carried back three years and forward 20 years, to be used to offset income earned in those years.

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