The recent New York Times reporting on Donald Trump's tax returns has attracted attention, and raised issues that will provide fodder for years. While significant attention has been paid to evidence of illegal tax planning, conflicts of interest, or a systematic bias in the tax law, the reporting raises general points about evaluating the effectiveness of a business's decisions regarding their operations and tax planning. These dynamics are relevant to any business, regardless of scale or tax planning expertise. Some things to consider.

1. Profit and loss netting is neither uncommon nor particularly aggressive.

A highlight of the report is that Trump consistently used losses from unprofitable activities to offset income from profitable ones. This netting often resulted in an overall loss which he then used to reduce taxable income in other years. While this may sound excessive, the use of losses to offset profits within, or across tax years, is not illegal, particularly aggressive, or, in and of itself, indicative of sophisticated tax planning. It simply reflects a basic tenet of the law that business are taxed on their net taxable income. The real question from a compliance perspective is whether the deductions used to generate those losses are allowable. Based on the Times' reporting, the main contention appears to be that Trump actively engaged in claiming some deductions that are not allowed as business expenses, either by deducting personal expenses against business income, or engaging in transactions with related parties that lacked true economic substance. Without seeing the actual details of those transactions, it's difficult to actually assess their deductibility, but it does point out the potential for abuse when business activities are closely comingled with personal ones. 

2. Depreciation is not costless. 

I have a write-off, a lot of it is depreciation, which is a wonderful charge ... I love depreciation. --Donald Trump during a 2016 debate

Even if Trump improperly claimed personal expenses as business deductions, their contribution to his overall losses are likely to be lower than deductions he recorded from depreciation of his real estate assets. Briefly, depreciation is a business expense related to the use of previously purchased assets. So, for example, if you purchase a building for $100 million, the tax law says that rather than deducting the cost of the building against income in the year of purchase, you deduct a portion of the cost in future years against whatever income (if any) the building generates. In that sense, you can think of depreciation expense as a tax deduction that has been pre-paid. However, because the future deductions are not associated with actual cash payments, there is a perception that depreciation is savvy planning that reduces taxes without spending any money. But that logic ignores the fact that the only way to get the deduction is to actually expend economic resources on, for example, a building. So depreciation is not free. It represents real costs incurred by the taxpayer that have to be financed in some way.  

3. How are the losses being financed? 

In a perfect world, all business expenses would be financed from the revenues of the business.  If expenses are larger than revenues the owner has three options: Self-finance, raise outside equity financing, or debt finance. None of these are particularly controversial, but they all have drawbacks, particularly if the losses persist. With self-financing, other assets have to be liquidated. With equity financing, investors will require the owner to a give up greater amount ownership in the company. With debt financing, the owner eventually has to pay back the loans. This requires refinancing, which just kicks the can down the road, or liquidation of the businesses assets. If those assets are not sufficient to cover to debts, depending on the terms of the loan, the owner may be forced to liquidate their personal assets. 

This last point is particularly relevant, as it appears Trump has assumed personal liability for at least a portion of his business debt. This can reflect a straightforward tax planning strategy to maximize the use of the losses. Briefly, the tax law requires that a taxpayer can deduct losses only to the extent that they have basis in the business. A taxpayer can increase their basis by investing their personal property in the business, or by assuming a share of its debts. So by assuming personal liability for some of these debts, Trump potentially increases the amount of losses he can deduct against other income. However, it also means that if the business assets haven't appreciated enough to pay off the debt used to purchase them, then he will either have to sell off assets from other businesses, or use his personal funds to do so.

In summary, the reported information suggests that Trump's businesses have been experiencing significant losses, at least partially driven by real estate acquisitions that haven't generated commiserate revenues. The persistence of these losses might call into question the sustainability of his current business model, and suggest that he will require new sources of financing. The question external financers will have to ask is whether there is enough potential of future income to make extending financing desirable.