More companies are finding legal ways to reduce the amount of pretax income they report to the IRS.
Congress has passed a bill that would award corporate America billions of dollars in new tax breaks. But corporate America has already found plenty of breaks in current tax laws.
Thirteen years after Congress passed a tax-reform law intended to make every company pay its fair share, government and corporate records show that many profitable corporations are again paying little or no federal income tax.
The top federal income-tax rate for corporations is 35 percent. On paper. Yet even as they brag to shareholders about rising profits, companies are finding legal ways to reduce the amount of pretax income they report to the Internal Revenue Service.
They establish financial subsidiaries in tax havens. They indulge in tax shelters so complex government auditors can't always understand them. They shift profits to low-tax countries by manipulating prices when doing business with their own overseas branches. And they take full advantage of the tax breaks that Congress has awarded over the years while dispatching lobbyists to plead for more.
Of 2.3-million U.S. corporations, more than half paid no federal income tax between 1989 and 1995, according to a General Accounting Office study. Many of these were mom-and-pop operations. But four out of every 10 companies with more than $250-million in assets or $50-million in gross receipts paid less than $100,000 to Uncle Sam in 1995.
"You could probably make the case that a lot of small companies don't make much money," says Sen. Byron Dorgan, a North Dakota Democrat who has made a pet cause out of fighting corporate tax avoidance. "But it's pretty hard to make the case that a lot of large companies aren't making a lot of money."
Yet that's exactly the case many large companies try to make to the IRS, at a time when the United States is enjoying an extended economic boom and the stock market is flirting with new records. Sure, after long years of deficits, the economy is producing big federal budget surpluses _ $3-trillion projected over the next decade. But the bulk of that revenue is coming from individuals, not companies.
Annual federal revenue from personal income taxes is up 60 percent over the past six years, while revenue from corporate income taxes has increased 30 percent. For the five years through 1998, the government calculates that corporate profits increased 43 percent.
Companies these days are paying a smaller share of their profits to the government _ 31 percent in 1998, compared with 41 percent in 1989, the peak of the last business cycle, according to data in the newest Economic Report of the President.
That doesn't mean they are doing anything illegal. Executives are just using every bit of flexibility in the tax code to maximize their write-offs and minimize their taxable income, even as they play up their profits to investors.
In annual reports, companies tell shareholders how much they made before taxes and how much federal tax they must pay immediately _ figures the GAO uses to calculate a company's effective tax rate. Although it is an imperfect method, the GAO considers it the most accurate because it excludes taxes that the companies report to shareholders but can put off paying for years.
Take General Motors Corp., the largest corporation in the United States as measured by revenue. It reported $4.61-billion in worldwide pretax income in its 1998 annual report. "Your company is in better financial shape than it has been in many years," chairman John F. Smith Jr. assured shareholders in June. But for 1998, the automaker owed the IRS just $36-million _ 0.8 percent of its global pretax income. The same year, GM paid about two-thirds that much in compensation to Smith and his four top lieutenants _ a total of $23.9-million for their salaries, bonuses, stock options and other remuneration.
Why was GM's tax bill so small? First, the company paid lots of taxes overseas, which can be credited against U.S. taxes.
Only 13 percent of GM's current tax payments for 1998 went to federal, state or local tax collectors. The rest was paid to foreign governments. The company told shareholders it paid only 2.9 percent of U.S. profits to the federal government in current taxes.
Then there's the difference between the amount the company reported to its shareholders, whom it wants to impress with high profits, and the amount the company reported to the IRS, which it hopes to keep at bay. Among other things, such differences usually reflect the fact that tax laws allow companies to write off investments in equipment more rapidly than shareholder accounting methods do. In GM's case, there also were tax credits left over from the early 1990s, when the company ran huge losses and logged large employee benefit payments on its books. GM won't say how much of a credit it claimed for those or other items in 1998.
GM points out that on top of the tax payments it made last year, it owed $145-million that it was allowed to defer. Assuming it eventually pays those taxes, its effective tax rate would rise to 14.7 percent for last year. But money paid tomorrow doesn't hurt as much as money paid today. To have $145-million for the IRS five years from now, for example, GM would need to set aside just $114-million now in an investment paying 5 percent interest.
Congress has created ways for companies to put off tax payments and collect tax credits that reduce future IRS bills. The tax code also lets companies take deductions for using up their equipment faster than it ages, a practice called accelerated depreciation.
Enron Corp. had $197-million of pretax income from its U.S. operations last year but, because of a variety of tax strategies, owed just 15 percent of that to the government. The company also had deferred tax credits, which reduced its effective federal tax rate to 8 percent.
"Any taxpayer _ a company or an individual _ is going to make sure they pay what is legally required and not more," said Steve Kean, an Enron executive vice president.
The corporate provisions of the 1986 Tax Reform Act passed partly because of popular outrage over reports that some big companies were paying less in taxes than their janitors were paying.
Tax reform lowered the top tax rates for companies and individuals but eliminated many loopholes that wealthy individuals and corporations had used to avoid paying the statutory rates. The top corporate income tax rate was lowered to 34 percent from 46 percent, then raised to 35 percent in 1993.
The reform has had some effect; corporate income taxes will provide 10 percent of total federal revenue this fiscal year, up from 8 percent in 1986.
But corporate tax payments aren't keeping pace with corporate profits, and critics argue that a major reason is that companies are becoming more global, creating vast opportunities to shift profits to lower-tax countries while moving their tax deductions to the United States.
One way to do this is by playing with the price that one branch of the company charges another branch for goods and services. Say a U.S.-based company makes computers with parts from its subsidiary in a low-tax East Asian country. It can reduce its reported U.S. income _ and increase its subsidiary's profit _ by overpaying for those components. Or it can undercharge for exports to its overseas operations. Either way, the overall company can show a healthy profit while telling the IRS that not much of it is earned in the United States.
Because overseas profits are taxed only when they come back to the United States, the company can put off paying a chunk of its federal tax bill. And foreign companies with U.S. subsidiaries can minimize U.S. taxes because their non-U.S. profits aren't subject to U.S. tax.
The IRS estimates that transfer-pricing abuses cost the government $2.8-billion in lost revenue each year. Other estimates are much higher.
Corporations also take advantage of federal rules that let them shift profits to financial subsidiaries set up in low-tax locales such as Liechtenstein. The practice came about in 1996 after the Treasury allowed companies to choose whether a distant financial subsidiary would be considered part of the U.S. operation or part of a foreign branch. Treasury officials didn't foresee that this allowed U.S. companies to shift income to the financing unit, minimizing U.S. and foreign taxes.
Congressional staffers estimate that the practice will cost the government $10-billion over 10 years.
In the post-tax-reform world, companies are finding all sorts of complex new tax shelters, whose legality is tested only if IRS auditors find them in corporate tax returns.
But companies know that the safest tax savings come from Congress, and, with tax-reform enthusiasm fading, lawmakers are again bestowing valuable favors on business.
But business lobbyists would have liked more than even Congress was prepared to give. Explains Dorothy Coleman, tax policy director for the National Association of Manufacturers: "We thought that with the surpluses as large as projected, about one-third of the tax cuts should go to business."
By the numbers
The top federal income-tax rate for corporations is 35 percent.
Of 2.3-million U.S. corporations, more than half paid no federal income tax between 1989 and 1995, a federal study said.
Forty percent of companies with more than $250-million in assets or $50-million in gross receipts paid less than $100,000 in taxes in 1995.
Annual federal revenue from personal income taxes is up 60 percent in six years; revenue from corporate income taxes is up 30 percent.