How Large Corporations Avoid Paying Taxes

Despite producing billions of dollars in profits, it is fairly uncommon for huge US firms to pay no US income taxes. In fact, according to one review of corporate securities filings, 55 of America’s top corporations paid no income taxes in 2020 while producing enormous profits, garnering $3.5 billion in total tax refunds. For three years in a row, over half of those corporations paid no US income taxes.

Profitable blue chips Nike, Inc. (NKE), FedEx Corp. (FDX), and Salesforce, Inc. were among those who have not paid income taxes for at least three years (CRM).

How do successful firms avoid paying US income taxes? Accelerated depreciation, profit offshore, substantial deductions for valued employee stock options, and tax credits are among their most profitable (and totally legal) tax evasion methods.

Key Takeaways

• Large corporations employ a tangle of tax incentives and deductions to reduce, and in some cases eliminate, their corporate income tax responsibilities.
• Recent attempts to curb profit shifting to lower-tax jurisdictions have proved ineffective.
• Accelerated depreciation, tax credits, and employee stock option expensing laws are additional ways major corporations reduce their tax payments.
• The Inflation Reduction Act of 2022 imposed a new alternative corporate minimum tax, as well as $369 billion in extra tax credits over a ten-year period.

Corporate Tax Rate and Receipts in the U.S.

The Tax Cuts and Jobs Act (TCJA) of 2017 established a flat 21% corporate income tax rate in the United States, eliminating the previous 35% top marginal rate.

Proponents of reduced corporation taxes have long contended that the United States’ 35% rate is the highest among advanced nations. Beginning in 2018, the TCJA decreased the total federal and state corporate income tax burden in the United States to the middle of the pack in OECD rankings based on the effective tax rate.

By some metrics, the Tax Cuts and Jobs Act provided a much more lucrative windfall for American firms. Corporate income tax collections are expected to fall from 1.9% of GDP in 2015 to 1% of GDP in 2020. The OECD average was close to 3%.

In 2018, US firms paid an average cash effective tax rate of 7.8% on their US profits, compared to 18% on income made on the territory of the ten biggest US trade partners.

The Real Tax Rate vs. the Official Rate

The gap between the 21% statutory corporate income tax rate and the effective rate based on cash taxes paid by businesses is the consequence of considerable tax benefits granted by the United States Congress.

On their 2018 earnings, the 379 successful Fortune 500 businesses paid an average effective federal income tax rate of 11.3%.

One of the arguments for decreasing the corporate income tax rate during the TCJA discussion was that the reduction would be compensated by the removal of tax benefits and loopholes for big corporations. While the new legislation eliminated certain tax breaks, it added numerous new ones.

The Inflation Reduction Act of 2022 established a 15% minimum income tax on firms with yearly revenues of at least $1 billion. The earlier version of the corporate alternative minimum tax was repealed by the Tax Cuts and Jobs Act of 2017.

Corporate Tax Loopholes in the U.S.

Clearly, companies have gotten highly adept at reducing their tax burden. For example, when Congress approved the CARES Act in reaction to the COVID-19 pandemic in 2020, payments to families featured prominently. The reintroduction of the carryback provision for companies’ net operating losses (NOLs) not only for 2020, but also for 2018 and 2019, under even more favorable conditions than those that existed before to the TCJA’s removal, garnered much less attention.

Several important business tax-avoidance tactics are listed below. Many of the tax benefits that may leave certain firms paying no federal income tax for some years continue to have strong bipartisan support, according to the Business Roundtable, a lobbying organization representing the CEOs of the biggest corporations.

Offshoring Profits

The TCJA lowered but did not eliminate the massive savings firms enjoy by moving earnings from the United States to nations with lower tax rates. This may be accomplished by, among other things, moving intellectual property to a company in a tax haven and charging U.S. business affiliates extra to utilize it.

The Congressional Budget Office predicted in 2018 that profit shifting to lower-tax nations lowered taxable income reported in the United States by $300 billion each year, and modifications under the TCJA were likely to cut the yearly profit shifting by $65 billion.

At the statutory 21% U.S. tax rate, this $65 billion in reported earnings not transferred overseas as a consequence of the TCJA would generate about $13.7 billion in yearly tax revenues. Of fact, as previously stated, the effective tax rate for companies in the United States is substantially lower.

The expenses of shifting to a system that reduces US taxes on profits of overseas subsidiaries while granting a tax benefit on international income generated from intangible assets in the US offset such potential savings under the TCJA. These measures were predicted to save multinational corporations in the United States $422.1 billion in taxes over a five-year period ending in 2024.

The TCJA does levy two new taxes on U.S. multinational corporations’ offshore revenues. GILTI (global intangible low-taxed income), defined as overseas income in excess of a 10% return on tangible assets abroad net of depreciation, is presently taxed in the United States at a rate of 10.5%, increasing to 13.125% in 2026.

The base erosion and anti-abuse tax (BEAT), another TCJA “stick” meant to discourage profit shifting, levies a minimum tax of 10.5% on the total of a corporation’s taxable income plus tax deductible payments to overseas subsidiaries other than for cost of goods sold. BEAT applies only to firms who have had yearly gross sales of more than $500 million in the previous three years and have paid more than 3% of their total deductible payments to overseas affiliates.

Over the first decade of the TCJA, tax collections from GILTI and BEAT were estimated to equal $198.2 billion in the United States.

Adding up the credits and debits, the TCJA’s efforts to limit profit shifting seem to be costing the US Treasury much more than they save. Meanwhile, the tax haven industry has been virtually unscathed. Bermuda’s business earnings in 2019 were more than four times the amount of the island’s yearly GDP.

Accelerated Depreciation

When a company purchases capital assets like as a building or industrial equipment, it may deduct the cost of depreciation from earnings over a number of years assumed to reflect the useful life of such assets. Accelerated depreciation enables a corporation to write off more of the cost more quickly, allowing a higher deduction against taxable revenue up front.

The Tax Cuts and Jobs Act of 2017 permitted businesses to deduct the entire cost of such eligible investments from 2018 through 2022. Bonus depreciation is reduced to 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026 before being phased out in 2027.

Accelerated depreciation of equipment is expected to save businesses more than $130 billion in federal taxes between 2020 and 2023, according to the Joint Committee on Taxation.

Tax Credits

The United States’ tax code is riddled with a variety of tax breaks for businesses that are estimated to cost the Treasury more than $100 billion per year, though this is a small portion of total U.S. tax expenditures of about $1.6 trillion per year, including associated spending and foregone payroll and excise tax receipts.

The list of industry-specific credits is lengthy, including the $18.2 billion cost of the “credit for increasing research activities” in fiscal 2022, $10.7 billion in lost revenue from the credit for low-income housing investments the same year, $2.3 billion for the orphan drug research tax credit, and so on, all the way down to the distilled spirits credit for liquor wholesalers. The energy investment credit will cost $6.6 billion in 2022, not the $4.7 billion energy production tax credit or the $230 million marginal wells credit. The “tax credit for certain expenditures for railroad track maintenance” cost the United States federal government $110 million in fiscal 2022.

All of this is on top of state and local tax breaks for firms, which are anticipated to cost $95 billion each year. Direct government subsidies for industry total tens of billions of dollars, ranging from direct payments to agricultural farmers to the cost of managing the Export-Import Bank.

Some believe that the frequency of corporate tax incentives in the United States is comparable to that of other nations. Others have pointed out that the US tax structure provides companies with very significant tax advantages for R&D, client entertainment, and some legal expenditures.

Deductions for Employee Stock Options

Listed firms deduct the anticipated cost of stock options issued to workers as stock-based compensation in their book income financial reports by assessing the value of the options granted.

Years later, the same firms deduct the generally greater cost of exercised employee stock options from corporate taxable income depending on the value of the options when exercised on their U.S. federal tax returns.

The discrepancy between the projected cost of employee stock options at the time of issuance and their value for expensing purposes upon exercise led to a substantial and lately rising book-tax gap between the net income major firms declare to investors and the taxable income on their IRS filings (IRS).Employee stock option expensing saved Fortune 500 businesses $10.9 billion in taxes in 2018, with the top 25 recipients saving almost $9 billion and Amazon.com, Inc. (AMZN) alone saving $1.6 billion.

While companies deduct the value of employee stock options from taxable income taxed at a maximum rate of 21%, workers cashing them out often pay taxes on their value at the top marginal personal income tax rate of 40.8%, leaving the Treasury ahead when whose receipts are considered.

Tax Provisions in the Inflation Reduction Act of 2022

The Inflation Reduction Act of 2022 reinstated the alternative minimum corporate income tax for major firms at 15% of book revenue. The book, or financial, income used to calculate the tax would be adjusted for depreciation and wireless spectrum rights recovery, carryover losses of up to 80% of financial income, domestic business tax credits worth up to 75% of the tax liability, and foreign business credits worth up to the allowance for foreign taxes paid on the financial statements.

The new alternative minimum tax was estimated to apply to around 150 of the top U.S. corporations and collect $222 billion in federal tax revenue in the United States over a decade, representing a 4.7% increase in corporate tax revenues.

The legislation also levies a new 1% excise tax on corporate share repurchases, which is estimated to generate $73.7 billion over a ten-year period.

The Inflation Reduction Act also raised IRS budget by roughly $80 billion over a decade; the Biden Administration officially said that the monies would not be used to enhance audits of taxpayers earning less than $400,000 per year. Increased tax enforcement for the wealthiest individuals and companies was predicted to yield an extra $204 billion in tax revenue over a decade.

Over a decade, the legislation gives $369 billion in tax credits to companies and people for investments in renewable energy, sustainable transportation, and energy security.

The Bottom Line

The tax system in the United States has contradictory goals. Its aim of fairly enhancing federal tax collections usually clashes with a range of specific tax benefits pursuing various policy objectives.

Corporate lobbyists and tax attorneys will be in high demand as long as attempts to have huge firms pay their fair share coexist with tax incentives and deductions that encourage a broad variety of preferred activities.

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