Last month, the New York Times featured an article on how G.E.’s Strategies Let It Avoid Taxes Altogether. With Tax Day, just around the corner, I wanted to take a closer look at how much corporations were exactly paying in taxes.
The starting point for this exercise begins with the Instructions for Form 1120, where the Internal Revenue Service lists the income tax rates for U.S. corporations.
|Tax Rate Schedule|
|If taxable income is:|
|Over||But not over||Tax is:||Of the amount over|
|50,000||75,000||$7,500 + 25%||50,000|
|75,000||100,000||13,750 + 34%||75,000|
|100,000||335,000||22,250 + 39%||100,000|
|335,000||10,000,000||113,900 + 34%||335,000|
|10,000,000||15,000,000||3,400,000 + 35%||10,000,000|
|15,000,000||18,333,333||5,150,000 + 38%||15,000,000|
$18.3 million in taxable income is a relatively low threshold, at least when referring to major corporations. How many of them pay any where close to the 35% tax rate? Let’s take a look. Unlike the new York Times article, I will show my calculations so that you can comment on my methodology.
|Earnings from continuing
operations before income taxes
|Benefit (provision) for income Taxes||(1,050)||1,148||(1,102)|
However, General Electric explains: “Because GE tax expense does not include taxes on GECS earnings, the GE effective tax rate is best analyzed in relation to GE earnings excluding GECS. GE pre-tax earnings from continuing operations, excluding GECS earnings from continuing operations, were $12.0 billion, $12.6 billion and $14.2 billion for 2010, 2009 and 2008, respectively. On this basis, GE’s effective tax rate was 16.8% in 2010, 21.8% in 2009 and 24.2% in 2008.”
|Income before provision for income taxes||18,540||12,066||8,947|
|Provision for income taxes||4,527||3,831||2,828|
Apple explains: “The Company’s effective tax rates were 24%, 32% and 32% for 2010, 2009 and 2008, respectively. The Company’s effective rates for these periods differ from the statutory federal income tax rate of 35% due primarily to certain undistributed foreign earnings for which no U.S. taxes are provided because such earnings are intended to be indefinitely reinvested outside the U.S. The lower effective tax rate in 2010 as compared to 2009 is due primarily to an increase in foreign earnings on which U.S. income taxes have not been provided as such earnings are intended to be indefinitely reinvested outside the U.S.”
|Earnings before taxes||10,974||9,415||10,473|
|Provision for income taxes||2,213||1,755||2,144|
Hewlett-Packard comments: “Our effective tax rates were 20.2%, 18.6% and 20.5% in fiscal 2010, 2009 and 2008, respectively. HP’s effective tax rate generally differs from the U.S. federal statutory rate of 35% due to favorable tax rates associated with certain earnings from HP’s operations in lower-tax jurisdictions throughout the world. HP has not provided U.S. taxes for all of its international earnings because HP plans to reinvest some of those earnings indefinitely outside the United States.”
|Earnings before income taxes||4,507||1,731||3,995|
|Income tax expense||1,196||396||1341|
Boeing explains: “Our effective income tax rate was 26.5%, 22.9% and 33.6% for the years ended December 31, 2010, 2009 and 2008, respectively. Our effective tax rate was higher in 2010, compared with 2009, primarily because pre-tax book income in 2010 was higher than in 2009 and because of an income tax charge of $150 million recorded during the first quarter of 2010 as a result of the Patient Protection and Affordable Care Act, as modified by the Health Care and Education Reconciliation Act of 2010. This was partially offset by a tax benefit of $371 million recorded during the fourth quarter of 2010 as a result of settling the 1998-2003 federal audit. Our effective tax rate was lower in 2009, compared with 2008, primarily because tax credits, such as research and development credits, represented a higher proportion of earnings before taxes due to the year-over-year reduction in earnings.”
|Income before income taxes||3,350||2,024||3,324|
|Income tax provision||715||591||846|
Dell explains: “Our effective tax rate was 21.3%, 29.2%, and 25.4% for Fiscal 2011, 2010, and 2009, respectively. The decrease in our effective income tax rate for Fiscal 2011 as compared to Fiscal 2010, was primarily due to an increase in the proportion of taxable income attributable to lower tax jurisdictions during Fiscal 2011. The differences between our effective tax rate and the U.S. federal statutory rate of 35% principally resulted from our geographical distribution of taxable income and permanent differences between the book and tax treatment of certain items. The increase in our effective income tax rate for Fiscal 2010 from Fiscal 2009 was primarily due to an increased mix of profits in higher tax rate jurisdictions. Our foreign earnings are generally taxed at lower rates than in the United States. We continue to assess our business model and its impact in various tax jurisdictions.”
|Income before income taxes||25,013||19,821||23,814|
|Provision for income taxes||6,253||5,252||6,133|
Microsoft explains: “Our effective tax rates in fiscal years 2010 and 2009 were 25% and 27%, respectively. The fiscal year 2010 rate reflects a higher mix of foreign earnings taxed at lower rates. Our effective tax rates in fiscal years 2009 and 2008 were 27% and 26%, respectively. While the fiscal year 2009 rate reflects a higher mix of foreign earnings taxed at lower rates, the rate increased from the prior year because the fiscal year 2008 rate reflects the resolution of tax positions relating to our agreement with the Internal Revenue Service (“IRS”) settling the 2000-2003 examination, partially offset by the European Commission fine which was not tax deductible. As a result of the settlement and the impact on subsequent years, we paid the IRS approximately $4.1 billion during fiscal year 2009.”
|Income before income taxes||1,497||1,161||901|
|Provision for income taxes||352||253||247|
Amazon explains: “We recorded a provision for income taxes of $352 million, $253 million, and $247 million in 2010, 2009, and 2008. The effective tax rate in 2010, 2009 and 2008 was lower than the 35% U.S. federal statutory rate primarily due to earnings of our subsidiaries outside of the U.S. in jurisdictions where our effective tax rate is lower than in the U.S.”
“Our effective tax rate is subject to significant variation due to several factors, including variability in accurately predicting our taxable income, the taxable jurisdictions to which it relates, business acquisitions and investments, and foreign currencies. We have current tax benefits and net operating losses relating to excess stock-based compensation deductions that are being utilized to reduce our U.S. taxable income. We used substantially all of our federal net operating loss carryforwards in 2010 and have available federal tax credits of $227 million. As a result of new U.S. legislation that became effective in December 2010, we are able to accelerate our depreciation deductions for qualifying property acquired in the fourth quarter of 2010. This accelerated depreciation deduction will continue for qualifying property acquired in 2011.”
So, what does the tax picture look like for a company that generates substantially all their revenues in the United States? It’s not a pretty picture, especially if the company is located in a state that imposes state corporate income tax.
|Income before income taxes||267,696||192,192||131,500|
|Provision for income taxes||106,843||76,332||48,474|
As Netflix notes, “In 2010, our effective tax rate differed from the federal statutory rate of 35% principally due to state income taxes of $15.6 million or 5.8% of income before income tax. This was partially offset by Federal and California research and development (“R&D”) tax credits of $3.3 million. Our effective tax rate for the year ended December 31, 2010 was relatively flat as compared to our effective tax rate for the year ended December 31, 2009.”
“In December 2010, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 was signed into law. One of the major components of this legislation is the reinstatement of the Federal R&D Credit retroactively to January 1, 2010. As a result, we recorded a Federal R&D Credit of approximately $1.8 million as a discrete item in the fourth quarter of 2010.”
“In 2009, our effective tax rate differed from the federal statutory rate of 35% principally due to state income taxes of $10.4 million or 5.4% of income before income tax. This was partially offset by Federal and California R&D tax credits of $1.6 million. The increase in our effective tax rate was primarily attributable to a cumulative benefit recorded as a discrete item in the second quarter of 2008 for prior period R&D tax credits.”
Although OpenTable is a smaller company than Netflix, it does have international operations, which so far have not been profitable. Still, it was able to pay less than the 35% tax rate in 2010 by taking advantage of available deductions and tax credits.
|Income before taxes||18,159||9,030||1,094|
|Income tax expense||4,080||3,963||2,118|
OpenTable explains: “2010 compared to 2009. Income tax expense for the year ended December 31, 2010 was $4.1 million compared to income tax expense of $4.0 million for the year ended December 31, 2009. Our effective income tax rate in 2010 was 22.5% down from 43.9% in 2009 due to the benefits resulting from research and development tax credits, California Enterprise Zone tax credits, and the federal Domestic Manufacturing Deduction which were partially offset by the tax impact of certain stock-based compensation charges and state income tax expense.”
“2009 compared to 2008. Income tax expense for the year ended December 31, 2009 was $4.0 million compared to income tax expense of $2.1 million for the year ended December 31, 2008. Our effective income tax rate in 2009 was 43.9% down from 193.9% in 2008 due to a decrease in permanent differences, the largest of which was non-deductible stock-based compensation expense.”
Self-Defeating Corporate Tax Policies
As we can see, American multinationals with significant international operations are not paying the 35% tax rate. So, the federal government must determine the corporate tax rate at which it maximizes tax revenues. The current corporate tax rate is sub-optimal in the sense that it is sufficiently high enough to discourage companies from repatriating their foreign income back to the United States. Even worse, to receive such beneficial treatment, such income must be indefinitely reinvested outside the United States. Talk about a job and tax killer. First, the United States encourages companies to shelter their income in a lower tax jurisdiction overseas. Then, it discourages them from spending the money domestically. This problem will only exacerbate as international revenues of “American” companies outstrip those from the home country.
One solution is to offer a tax holiday, such as Section 422 of the American Jobs Creation Act of 2004—Incentives to Reinvest Foreign Earnings in the United States. That section permitted a temporary deduction “equal to 85 percent of the cash dividend…received…from controlled foreign corporations,” which equals a 5.25% tax on qualified dividends. Whether we adopt another tax holiday or a push for more permanent structural tax policy changes, we should all recognize that we are not on the right path right now, both in terms of maximizing corporate tax revenues and boosting domestic job growth.