Corp. effective tax rate v. 35% Federal rate

This post broadens and elevates Saul’s astute findings about AMBA’s tax rate accounting machinations to a macro perspective, i.e., corporate effective tax rates versus the statutory 35% Federal corporate tax rate.

Actually, this major issue was addressed by the U.S. Government Accountability Office (GAO) at the request of U.S. Sen. Carl Levin (Michigan) and Tom Coburn (Oklahoma) in 2012, who back then headed the Senate’s Permanent Subcommittee On Investigations that subsequently held hearings on tax reduction ploys used by Microsoft, Apple and Hewlett-Packard. On May 30, 2013, the U.S. GAO released its report, CORPORATE INCOME TAX - Effective Tax Rates Can Differ Significantly from the Statutory Rate, finding that big profitable U.S. companies paid an average effective tax rate of just 12.6% of their reported worldwide profits in federal income taxes in 2010, well below the 35% Federal corporate tax rate.
http://www.gao.gov/assets/660/654957.pdf
Even if accounting may not be your cup of tea, this is a worthwhile read. The report’s bottom line was that profitable U.S. corporations as a whole were not paying their fair share in taxes, and there was a need for comprehensive tax reform. Although the GAO had no access to individual companies’ confidential Schedule M-3 filings and had only aggregate data drawn from them, the GAO was able to separate out profitable and unprofitable companies. While the unprofitable companies generally paid no tax, their losses drove down aggregate corporate profits that, in turn, made it look like the money-makers were paying a higher rate. For example, in 2010, Schedule M-3 filers reported $1.1 trillion in net book income and $300 billion in losses. The GAO calculated that when money losers were lumped in with profitable companies, the effective U.S. tax rate for 2010 rose from 12.6% to 16.6%. When federal, state, and foreign income taxes were tallied up, the profitable companies paid 16.9% of their reported worldwide income. After claiming all the exclusions and deductions allowed by the U.S., the GAO calculated that the profitable companies paid 21% of their taxable income, still a far cry from the 35% Statutory Federal tax rate. To date, Washington has failed to take any corporate tax reform action.

Next, regarding zero and negative corporate tax rates, this is nothing new and not uncommon. A 6/2/2011 article reported that major corporations, e.g., GE, American Electric Power, Dupont, Verizon, Boeing, Wells Fargo, FedEx, Honeywell, IBM, Yahoo, United Technologies and Exxon Mobil paid negative tax rates according to Citizens for Tax Justice (CTJ).
http://www.motherjones.com/mojo/2011/06/ge-exxon-10-other-ma…
Subsequently, in November 2011, CTJ released its report, Corporate Taxpayers and Corporate Tax Dodgers 2008-2010, that examined 280 of the largest and most profitable U. S. corporations and found:
http://www.ctj.org/corporatetaxdodgers/CorporateTaxDodgersRe…
• The good news is that 71 of our companies, 25 percent of the total, paid effective three-year tax rates of more than 30 percent. Their average effective tax rate was 32.3 percent.
• The bad news is that an almost equal number of companies, 67, paid effective three-year tax rates of less than 10 percent. Their average effective tax rate was zero.
Even worse news is that 30 companies paid less than zero percent over the three years. Their effective tax rate averaged –6.7 percent.

What I found useful in the above CTJ report was the section of “How Companies Pay Low Tax Tax Bills” beginning on page 11 and the company-by-company notes (starting on page 53) regarding what to look for and at for reasons why certain companies paid low taxes.
• Accelerated depreciation.
• Stock options. Of our 280 corporations, 185 reported “excess stock-option tax benefits” over the 2008-10 period, which lowered their taxes by a total of $12.3 billion over three years. The benefits ranged from as high as $1.5 billion for Apple over the three years to tiny amounts for a few companies. Just 25 companies enjoyed almost two-thirds of the total excess tax benefits from stock options received by all of our 280 companies, getting $8.1 billion of the $12.3 billion total.
• Industry-specific tax breaks.
• Offshore tax sheltering.

Here are more ways that companies manage to pay zero or negative rates, according to the following 2/19/2014 article.
http://www.usatoday.com/story/money/business/2013/10/23/big-…

Offshore transfer payments. Companies slash their tax bills by (a) setting up foreign subsidiaries to make raw materials and components in countries with low tax rates, (b) purchasing these parts from the foreign units at well above cost, that in turn (c) makes a large profit, which escapes U.S. taxes, as long as it remains in the foreign country.

Harvesting losses. Most of the companies with effective tax rates of zero, or even negative, are money losers. While a company pays taxes, since it loses money, it has a negative effective tax rate due to the way the number is calculated. A company that has lost money in the past accumulates credits that can be used to offset tax bills in future years. These reserves can be very lucrative and give profit a boost by lowering the effective tax rate. Companies with these tax loss reserves include General Motors and Crown Castle… GM, for instance, released credit from its reserve, taking it down from $45 billion to $11 billion. Investors must be aware, though, that once that $11 billion reserve is used up, the company’s tax rate returns to the statutory rate. All this follows tax rules, but investors need to be aware. This is not illegal, but the reserve will run out.

Accounting rules. For example, Verizon’s low effective tax rate, coming in at a negative 4.8%, was largely due to accounting. The company’s sped-up depreciation, severance and pension costs were large credits that contributed to pushing the company’s taxes down, according to Jonathan Schildkraut of Evercore. But there was also a distortion caused by the company’s 55% interest in Verizon Wireless. Vodafone, which owned 45% of Verizon Wireless, paid taxes on its share, but the entire profit was reported on income. Adjusting for this, Verizon’s effective tax rate was closer to 30%, according to Verizon. Verizon was buying Vodafone’s stake, which would eliminate the issue in the future. Similarly, real estate investment trusts (REITs) have low effective tax rates because they pass profit to shareholders, who then pay the taxes.

BTW, since corporate taxes is one of the issues in the ongoing U.S, presidential race, here’s a relevant article, 7 things you absolutely must know about corporate taxes:
http://money.cnn.com/2014/08/14/news/economy/corporate-taxes…

1. Corporate tax revenue accounted for 10% of all federal tax revenue last year.

2. Only 6% of businesses file under the corporate tax code.

3. Corporate tax breaks cost U.S. coffers about $150 billion in 2013.

4. The U.S. has the highest tax rate among developed economies.
BUT, although most U.S. corporate income is subject to a 35% federal tax rate, the “effective” rate companies pay is often lower after accounting for a company’s tax credits, deductions and exemptions. What’s more, companies owe U.S. tax on profits they make in the U.S. and abroad, minus whatever foreign tax they’ve paid. But a company can put off paying U.S. tax on foreign profits indefinitely, so long as it doesn’t bring those profits back to U.S. shores and reinvest them in the business.

5. U.S. corporations are not taxed equitably.

6. Many big U.S. companies are swimming in untaxed cash.
Since U.S. multinationals only owe U.S. tax on foreign earnings when they bring them back to the United States, there’s serious incentive to put off that day of reckoning. End result: Many companies have built up a serious offshore cash stash, e.g., Apple with more than $100 billion sitting outside the U. S., Microsoft $93 billion and Pfizer an estimated $69 billion.

7. The pace of U.S. companies looking to leave has picked up dramatically.
Between 1983 and 2003, 29 U.S. companies reincorporated abroad in a process known as “inversion.” From 2004 to 2013, there have been 47.

I’ll conclude with a “wrenching” solution to all these corporate tax machinations, proffered in a Forbes article, The Basic Thing To Know About The Corporate Income Tax: Companies Don’t Pay It.
http://www.forbes.com/sites/timworstall/2013/05/23/the-basic…
The conclusion is therefore that we do indeed need to change the corporate tax system substantially. The most obvious solution being simply to abolish the corporate income tax altogether and just tax shareholders at their normal marginal income tax rate on the dividends and capital gains they make from their stocks.
Yes, I know, it sounds like a wrenching change to the way that the world works. But as above, it simply isn’t true that the companies pay the tax at present. So why continue with the fiction that they do?

Regards,
Ray
(not an accountant)

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Great article and it’s consistent with many others I’ve read which did an analysis of tax rates. It is also worth noting that our (U.S.) tax scheme is unique from all the others due to our elaborate and extensive use of deductions. When comparing effective tax rates across nations, ours is totally unremarkable.

[Political aside: To me, it’s funny to see politicians argue that we need to reduce the U.S. corporate tax rate to ‘bring money home’. First, as long as our corporate tax rate is anything above zero, we’ll never be competitive in that regard. Second, even if that money is ‘brought home’, that doesn’t mean it will be used/invested here.]

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