Sometimes giant corporations use clever methods to dodge taxes. Here are some of the ways they do it.
Ostensibly, the U.S. corporate tax rate is the highest in the world, at 35%. However, according to research (pdf) by the Government Accountability Office, the effective rate after tax breaks and various accounting tricks is actually between 12 and 16% (though other economists have argued that it’s somewhere around 25%).Update: Clarifications
A few things that needed to be clarified, as a pointed out by a reader (thanks for the feedback!):
- Often, foreign subsidiaries of U.S. corporations are not included on the firm’s domestic tax return, but are taxed as separate entities. The law then allows these subsidiaries to repatriate funds to their parent company at a time of their choosing – but the tax rate on earnings from foreign investments can be as high as 64% total. As a result, corporations are hesitant to repatriate earnings.
- The usage of the term “scheme” in this article doesn’t imply dishonesty: all methods describe below are legal by the U.S. tax code.
To be fair, nobody likes to pay taxes, including corporations. But a 2015 Pew survey shows that 64% of Americans were “bothered a lot by the feeling that some corporations do not pay their fair share of taxes.”
In a research report (pdf) on the topic, the non-profit Citizens for Tax Justice (CTJ) found that out of 280 major corporations in the Fortune 500, 78 paid zero taxes in at least one year between 2008 and 2010.
Additionally, 30 companies paid a negative tax rate, essentially receiving money from the government through subsidies.
When corporations dodge taxes and avoid paying the full tax rate they often use one of the following methods:
Using Tax Inversions To Dodge Taxes
Some companies simply relocate their corporate domicile to a lower-tax nation in order to dodge taxes. In the U.S., a tax inversion can happen when a company merges internationally with another and takes the domicile of the lower-taxed nation.
Inverted corporations enjoy lower tax rates and favorable rules for moving funds about. But an attempted 2016 inversion between Pfizer and Allergan, worth $150 billion, drew the angry scrutiny of the US Treasury department, which instituted new rules revoking many inversion benefits.
Tax Sheltering Abroad – aka. “Dutch Sandwiches”
Estimated in 2015 to be worth at least $100 billion in annual taxes, sheltering involves various methods with which corporations shift their profits from domestic operations to subsidiaries abroad, removing their U.S. tax liability.
For example, companies such as Google use transfer pricing schemes where patents for their products are held by a subsidiary that’s located in a low-tax country but reports income in Bermuda or Cayman Islands, which then leases it to a second subsidiary in the country it’s ostensibly located in.
When the parent company uses that patent, it pays the second subsidiary for the rights to use the patent – effectively transferring the profits to the subsidiary, which only pays the low local tax (which is also lowered because the second subsidiary can list the cost of leasing as a deductible expense.)[contextly_auto_sidebar id=”szRE7D3C0azSeAE05Ukk8fwUniWn0dO3″]
This arrangement is called a “Double Irish,” and is sometimes augmented by making it a “Dutch sandwich,” where the money paid for licensing is sent through the Netherlands, allowing it to avoid Irish taxes on royalties due to an exception for EU countries.
IBM, which has been working hard to reduce its tax rate, reported that more than 205,000 of its employees worked for its Dutch subsidiary, according to Bloomberg – even though only 2% actually worked in the Netherlands. The rest work in one of 40+ companies owned by the Dutch holding company.
Many companies give employees options to buy company stocks in the future at a good price. When the employee takes advantage of this, the company can take a tax deduction for the difference in stock price when the option was issued, and when it was cashed in.
By low-balling the estimate of the initial stock price, companies can take a large tax deduction on the sale, and also report a big profit to shareholders, according to CTJ (pdf).
Maybe the least surprising method that corporations dodge taxes: taking advantage of the plethora of tax breaks that exist in the U.S. federal code.
According to CTJ, there are tax breaks – introduced through the years for instance by congressmen looking out for local industries – for:
Research (very broadly defined)
Drilling for oil and gas
Providing alternatives to oil and gas
Making video games
Moving operations offshore
Not moving operations offshore
Maintaining railroad tracks
Building NASCAR race tracks
A 2013 Government Accountability Office paper reported (pdf) that corporations were given $181 billion in tax breaks in 2011 – the same amount that corporations paid in taxes. In other words, tax breaks cut overall revenue from corporate taxes in half that year.
In their 2008-2010 report, CTJ reported that 25 companies received more than half of all the tax breaks for that period. Those companies included Wells Fargo, AT&T, Verizon, General Electric, IBM, Exxon Mobil, Boeing, Goldman Sachs, Procter & Gamble, and Coca-Cola.
Companies can usually get tax deductions for capital investments such as equipment far faster than those assets actually wear out, the CTJ reported.
And due to rules introduced in 2008 after the financial crisis, corporations can usually gain a tax deduction for as much as 75% of their investments immediately.
These kind of deductions counted for $76 billion worth of lost federal tax revenue, according to the GAO.