What does it *mean* for a corporation to evade taxes?

March 28, 2012 8:10 AM

I have a question that I feel stupid asking, but I don't know how more elegantly to put this: what does it *mean* for a corporation to not pay its taxes? What exact taxes are being bailed on?

I do political organizing for generally progressive causes, and while it's in a completely different policy area than corporate tax-dodging, it certainly couldn't hurt my work to more fully understand what is actually happening when a corporation dodges its taxes. I've read most of the stuff about the obscene results (e.g. GE paying an effective negative tax rate for years on end) - but I guess what I'm not understanding can be boiled down questions like:

- When right-wingers say "Corporations don't pay taxes, people do," what does that actually mean?
- When a corporation pays taxes, what is being taxed? The profit left over after contracted salaries have been paid? A certain share of profit before income is calculated? Are we talking about the overall collective income taxes of employees, similar to how, before Citizens United, for a corporation to "give money" to a candidate referred to its employees collectively making donations? Am I completely misreading this?
- I can understand how individuals can avoid taxes through shelters and other trickery - but how does that actually work for a corporation qua corporation?

Thanks for your help on this, and sorry if this is still vague - I just realized I've read probably dozens of articles and blog posts on corporate tax-dodging, and still have an extremely facile understanding of what exactly that phrase indicates.

posted by Ash3000 to law & government (21 answers total)

First of all, before anyone who knows more about corporation taxation than I do (that is, more than zero) chimes in on the details, a corporation is a person, in law at least. It might be unable to do some of the things a human being can, and it might have no body to be kicked nor soul to be damned, but in law it's a person. The idea that it doesn't or can't pay taxes because it's not a "person" is fatuous. Now somebody else can be specific about what GE (or recently in the UK, Goldman Sachs) isn't paying.
posted by Logophiliac at 8:28 AM on March 28, 2012

Corporations pay tax on their net income, just like individuals. Net income, for this purpose, would reflect income net of salaries, as you note, but also all their other costs: R&D, interest, utilities, advertising, etc. Corporations also pay the alternative minimum tax, excise taxes, the employer's share of employment taxes, use taxes, franchise taxes, a million and one other taxes.

State and local taxes are, in their way, exceedingly complicated, but they're also applied more directly than federal taxes; generally corporations don't zero out their state and local taxes.

So what's going on? More often than not, it's intercompany amounts--interest, royalties, etc. paid to affiliates in lower tax jurisdictions. For instance, it's not uncommon to have a Luxembourg affiliate make a loan to a US corporation. The US corporation deducts the interest on the note. Maybe the interest is a little high, but an investment banker or accountant will give "comps"--comparables--that show it's at arm's length. On the other side, the Luxembourg tax authorities think that the loan is owned in the US, so Luxembourg does not tax the interest coming in. So, US corp deducts the interest payments (reducing the tax paid on its US income), and Luxembourg doesn't view the debt as being in Luxembourg, so no tax is paid there. Instant deductions! There are all sorts of other strategies where one company makes loans to another where there are favorable tax treaties--so US borrows from Ireland and Ireland borrows from HK, and you end up with something like .5% tax overall.

Similarly, US Co develops a patent, and takes R&D credits for it. Before the patent is commercialized, it's sold/transferred to a Luxembourg company. When the patent becomes valuable, the US co pays royalties to the Luxco; the royalty payments are deductible, and the Luxco doesn't pay taxes on the income it receives.

These are just two strategies companies use to manage their income, and--I hasten to add--they are legal under current law. There are a million ways that sophisticated parties are managing their income. For instance, no airline owns any of their airplanes. They're all on lease from investors. Why? Because the airlines can't use the depreciation deductions the airplanes generate (because they don't actually make money; there's no rule they can't use them). So who owns the planes? Companies (including financial companies) that have income they need to shelter. Again, perfectly legal.

This is all a gross simplification. David Cay Johnson (NYT) writes well about tax issues. He has a couple of books you might find interesting.

Of course, none of this is tax, legal, or investment advice, and I am not your advisor in any capacity.
posted by Admiral Haddock at 8:40 AM on March 28, 2012

I believe the "Corporations don't pay taxes, people do" is meant as a reminder that corporations are made up of people, so while it is tempting to think of corporations as a big box of money that can be taxed, it's really a big box of money that belongs to people. I am a GE shareholder. When GE is taxed I am also, in a very tiny way, being taxed. Somewhere in my various retirement funds I probably own a tiny chunk of Exxon. You probably do too.

Check out the wikipedia entry on Corporate Tax in the United States.
posted by ghharr at 8:47 AM on March 28, 2012

The other thing to remember is that the Pre-Tax Income a company reports in its annual report is not the same as the Pre-tax income a company reports to the IRS - because IRS rules on the rate at which you amortize certain capitalized costs are very different from what the GAAP rules are for those same amortization rates. This is a big source of the difference between taxes paid and taxes accrued for. Especially in Oil and Gas Industry

The argument that Corporate Taxation is double taxation on individuals is also predicated on an argument that dividends and capital gains are already taxed.
posted by JPD at 8:53 AM on March 28, 2012

Also I'm pretty sure you can't use that Lux. structure to shelter US income, but rather shelter income coming from a third country you want to repatriate to the US. That's why most US multinationals have a HoldCo located in a tax-friendly country that holds the equity in their non-US subs.

Also that's why a lot of companies don't bring in cash from overseas - structured correctly its basically tax-free as long as it stay off-shore.
posted by JPD at 8:57 AM on March 28, 2012

A corporation is not a person just because a law or statute says it is. It may have the exact same rights as a person under the law, but it is not sentient, or potentially sentient, or once sentient, or have any of the other qualities that distinguish a person from a sofa.

When a corporation pays a tax, it is unaware of any loss or benefit gained from paying the tax. It doesn't say to itself "Unfortunately, I have $1 million less now than I did yesterday because of this tax."

The $1 million payment though is a loss to the sentient creatures (people) that otherwise could have used that money to do something different. (Its not important what they do, just that they can't. That would also include someone who was happy to pay the tax because they think the taxing authority will put it to good use.)

That is what is meant by the use of the phrases "...corporations don't pay taxes, people do..."

The people here are everyone that has a stake in the corporation. Naturally, this includes the shareholders that are now entitled to $1 million less of dividends and/or gains in the equity value of the company. It also includes the employees who may have gotten a $1 million salary increase, the potential employees that were not hired, the customers who had to pay an extra cent to buy the widget to cover the tax, vendors who are delayed payment a day, bondholders whose interest coverage ratio has just declined a fraction, and everyone else with some sort of stake in the company who are now out some percentage of the $1 million.

Of course the Left wing's rant that GE Corp specifically didn't pay any taxes is false. Putting away the issue described above for a minute (ie Corps. don't pay taxes, people do), certainly everyone of GE's 131,000 US employees paid some sort of tax. Likely all paid social security taxes and I would guess that over 95% paid some sort of income tax. While the Left likes to malign GE for not paying taxes on its profits, it might give them comfort that its very existence allows for 130,000 people to be taxed. Moreover, the $7.5 billion of dividends it paid last year were taxed and anyone that bought and sold GE shares for a profit were taxed or generated a tax liability to be paid in future periods. Sales taxes were collected and passed along to the taxing authorities no doubt as well. There are probably hundreds of other taxable events made possible by GE's existence.
posted by otto42 at 9:17 AM on March 28, 2012 [2 favorites]

I've always taken "corporations don't pay taxes, people do" to mean that the cost incurred to the corporation by taxes is ultimately passed on to any of a variety of people: the shareholders as lower dividends, the employees as lower salaries, and the customers as higher prices.
posted by Nothlit at 9:18 AM on March 28, 2012 [3 favorites]

I have to admit that my previous post was ill-tempered and not enormously helpful--and on preview it seems to have started some hares running. However, Admiral H makes a good point--all the setups he mentions (and zillions of others) are within the law. There used to be a distinction made between tax avoidance, which was legal, and tax evasion, which was not. If that distinction gets made in US law, it might benefit you to read up a bit on how tax law is shaped to make that sort of scheme possible within the law. I doubt that GE is doing anything unlawful like simply making false tax returns, so they are in my terms engaged in avoidance rather than evasion.
But a corporation is a person and the idea that it is unaware of any benefit from not paying tax is simply irrelevant.
posted by Logophiliac at 9:25 AM on March 28, 2012

Other, perfectly legal reasons companies may owe no tax include:

- consolidation. Big companies like GE have lots of different branches doing lots of different things. Generally, the branches in the US will be consolidated together for tax purposes. So if the money-lending branch (GE Capital) lost money in one year, that will offset the profits from say the light bulb division. So even though some parts of the business rake in money, this could be offset by other divisions.

- loss carrybacks and carry forwards. Say GE as a consolidated whole has 500m in profits in the US in 2009. They will report and pay taxes on that. Then in 2010 the consolidated GE has a 500m loss in the US. GE can elect to "move" that loss back to 2009, and eliminate the profit that year. They file an amended return and get a refund of the taxes paid in 2009. This leads to zero taxes in both 2009 and 2010, even though there were profits in 2009. The tax law lets them even out the profits and losses over multiple years.

- disposing of assets. For tax purposes, assets haven represent either a "gain" or a "loss". Loss assets reduce your net income when you sell them, gain assets increase your net income. (this is super simplified). Companies can hold on to assets and then get rid of them when it makes the most tax sense. If a company will have a big net profit one year, they can sell loss assets to reduce the profit. Or sell gain assets in a year there is a net loss to take advantage of the loss.

All of these are perfectly legal, intended uses of the tax code.

Note that I know nothing about GE's actual profits or losses. GE was used for illustration purposes only.
posted by ohio at 9:25 AM on March 28, 2012

Moreover, the $7.5 billion of dividends it paid last year were taxed and anyone that bought and sold GE shares for a profit were taxed or generated a tax liability to be paid in future periods.

The catch is that this ignores significant holdings of exempt and foreign investors who would pay no tax on their gains (and dividends are received without tax by exempts). Exempts would include pension plans and big foundations like Harvard, etc.

And, of course, items taxed as gain and "qualified dividends" generally are taxed at preferential rates for individuals, whereas the corporate tax rate is 35%. So if $100 of value is not taxed as income to the corp, but is tax as dividends to the shareholders at 15% (or some amount less than that because big pension plans got a slug of it), instead of the fisc collecting $35 in taxes, it collects maybe $10.

And, as another poster noted above, a lot of sophisticated (legal) tax planning results in cash being held off shore. This cash is not being used to pay dividends or create US jobs (although presumably affects the balance sheet and thereby the stock price).

but it is not sentient, or potentially sentient, or once sentient, or have any of the other qualities that distinguish a person from a sofa.

My sofa does not enjoy a First Amendment right, but I digress.
posted by Admiral Haddock at 9:40 AM on March 28, 2012

Admiral Haddock's description of inter-company transactions is fantastic; my multi-national corporation does similar things. Another part of the puzzle is loss carry-forward and loss carryback. If a company had losses several years ago, it can carry those forward and use them to offset gains now. So if GE Capital took a bath during the financial meltdown, a bunch of those losses can be used to reduce profit currently and a multi-billion dollar profit in 2010 vanishes. (Crap; on preview, ohio has made this point well.)

A point that is worth reiterating is that it is totally incorrect to say that GE "paid no federal taxes," as many of the news articles say. GE may not have paid federal income tax, but it surely paid payroll/FICA/social security taxes, Medicare tax, and unemployment tax related to its employment (of 130,000 people in the US) at a minimum.

There is lots of room for debate about whether the current system of labyrinthine tax regulations - which directly incentivize creative tax avoidance strategies - is good or not, but anger at corporations who do their best within the law to minimize their bill seems misplaced.
posted by AgentRocket at 9:40 AM on March 28, 2012

"But a corporation is a person and the idea that it is unaware of any benefit from not paying tax is simply irrelevant."

It is completely relevant. When many on the left think that taxing corporations is somehow not a loss of value because the entity being taxed does not perceive the loss, then it is relevant to point out that actual people perceive the loss.

Ash3000 is apparently organizing for progressive causes. Maybe it would be helpful to his cause to realize that taxing Widget Co. at an X+1 rate instead of the current X rate will make the Fabrication Division unprofitable forcing the layoff of 300 employees (and the loss of the personal income tax revenue from those employees to the IRS.)
posted by otto42 at 9:42 AM on March 28, 2012

It seems doubtful that either side of this question could be put so simply. Since the tax code generally only taxes profits to begin with, we start with scenario that a corporation has $100 of net income after paying all of its expenses. Taxing that $100 at 36% versus 35% is not going to make that company unprofitable. It will simply mean that it has $64 dollars left of profits, rather than $65.

But, of course, that could be a big difference in the real world. If the cost of a critical new factory is $65, the company may not be able to compete as well, and that could result in a loss of business, and a loss of jobs.

Take the opposite case--the company has $100 in net income, but there's no tax. Where does that money go? Maybe some portion to salaries, some portion to distributions, some portion to retained earnings or capital expenditures. Other than amounts paid as salaries to the highest earners (being taxed at 35%), the resulting tax collection is significantly less.

Assuming that it matters, as Otto is saying, that the corporation is not a sentient being, maybe it's preferable that corporations don't pay tax. But the government needs money to function, and gains/dividends/most salaries aren't taxed high enough to make up the shortfall, notwithstanding the fact that the company has added a second shift; employees on the line (who are very happy to have a new job, and who go spend their money dutifully) aren't taxed at a high rate. The investors who hold the stock are happy because their stock price is up, but they're holding their shares for a long time, and get the benefit of tax deferral (or can bequeath their stock to their kids when they die, and the kids get a step up in basis, and no tax is collected at all (subject to the estate tax limitations).

So, what to do? Raise taxes on gains/dividends/salaries (boo!). Cut services (boo!). Borrow money to run the government (boo!).

It's incredibly complex, and the consequences are far-reaching. I don't think there's anyone who believes the current system "works"--people on the right think taxes are too high, people on the left think that there are too many loopholes. We're well overdue for an overhaul, but the overhaul is also going to be unsatisfactory to everyone.

So that's something to look forward to.
posted by Admiral Haddock at 10:13 AM on March 28, 2012 [2 favorites]

Maybe it would be helpful to his cause to realize that taxing Widget Co. at an X+1 rate instead of the current X rate will make the Fabrication Division unprofitable forcing the layoff of 300 employees (and the loss of the personal income tax revenue from those employees to the IRS.)

in that the plant is a sunk cost and that taxes are on income not revenue this is a massive oversimplification of the situation. Taxes can't make a plant unprofitable, they can make further investment in the plant a poor decision.

Another important thing to bring up is that Corporate taxation just doesn't actually matter that much - its only 9% of total tax revenue. Even back in the old days it was about 20% of total tax revenue.
posted by JPD at 10:56 AM on March 28, 2012

... but it surely paid payroll/FICA/social security taxes, Medicare tax, and unemployment tax related to its employment (of 130,000 people in the US) at a minimum.

That's not really accurate, though, because those taxes aren't owed by the corporation, but by the individual employees themselves. Procedurally they're withheld by the company from the individual's pay, but the company itself doesn't owe them.
posted by odinsdream at 11:09 AM on March 28, 2012

Otto42 generally raised some concerns about corporate tax, but I would take issue with a few of the ways that he phrased the arguments.

1) Only profits are taxed. A profitable division will never become unprofitable from taxation. It will only become less profitable. Changing tax rates can, however, shift incentives on how to allocate money.

2) Taxation NEVER destroys value. It is a transference of value from one party to another. Every dollar "removed" from the economy comes back somewhere else as spending. Many anti-tax arguments seem to characterize every dollar taken as being sucked out of the economy, never to return. This is basically an economic fact. -- Or every dollar taken to be spent 50% on "good" things and "50%" wasted-- but the thing is that for every person who decries waste, half might have one program in mind as "waste" and half may have another. This is basically a political disagreement.
posted by Maxwell_Smart at 11:10 AM on March 28, 2012

Nothlit: "I've always taken "corporations don't pay taxes, people do" to mean that the cost incurred to the corporation by taxes is ultimately passed on to any of a variety of people: the shareholders as lower dividends, the employees as lower salaries, and the customers as higher prices"

This is my understanding as well. I think it's entirely wrong, because it naively assumes that business owners will put increased after-tax profits into paychecks and infrastructure rather than their own pockets, but that's what people like Grover Norquist are stumping.
posted by mkultra at 11:12 AM on March 28, 2012

Odinsdream, there are two components to those taxes: a component withheld from wages (i.e., nominally paid to the employee but remitted to the gov't--this is what appears on your W-2), and a SECOND component that is due from the employer as an employer. This is a significant factor in why a lot of shady employers want to characterize employees as "independent contractors." An IC is going to pay the same amounts (more or less) to the gov't as FICA, FUTA, etc. but the employer won't have to pay the separate employer's share of those taxes.
posted by Admiral Haddock at 11:13 AM on March 28, 2012

Many anti-tax arguments seem to characterize every dollar taken as being sucked out of the economy, never to return.

I'd venture to guess that people who think taxes "Destroy Value" also think a dollar of government spending has a less stimulative effect on the economy then the dollar spent by a private entity.

I personally don't agree with that, but it is logically consistent.
posted by JPD at 11:16 AM on March 28, 2012

This is my understanding as well. I think it's entirely wrong, because it naively assumes that business owners will put increased after-tax profits into paychecks and infrastructure rather than their own pockets, but that's what people like Grover Norquist are stumping.
posted by mkultra at 11:12 AM on March 28 [+] [!]

Whether the extra $1.00 of increased profits from lower taxes is used to pay for a new employee, a new factory, or it goes into the pockets of the owners is irrelevant. In each case the stakeholder derives the benefit of the extra $1.00.

This doesn't mean the benefit is stimulative, nor does it have to be. The extra employee might be incompetent, the factory might be inefficient and the owner might spend the extra dollar on hookers and blow.

The point being that only people can perceive the benefit of the extra profits from a lower tax or perceive the loss from an increase in the tax rate. Since a corporation can not appreciate more hookers and blow and only a human can, it is said people pay taxes and corporations do not.
posted by otto42 at 11:51 AM on March 28, 2012

I'm not sure if the point you're making is semantic, or philosophical, or what. If a corporation doesn't "pay" taxes because it cannot perceive the loss, then it would seem to follow that a corporation cannot have expenses, because it cannot perceive "cost." This is clearly true; a corporation is just a legal entity and has no powers of perception. But so what? A corporation can be a fiduciary, even though a corporation has no sense of honor. A corporation has, as I noted above, a right to free speech under Citizens United, even though it has no power of independent thought (and a longer standing right to commercial speech). Corporate-level rights and obligations are inherent in its legal organization, and have been as long as a corporate form has existed. I'm not aware of any jurisdiction that exempts corporations (and similar legal entities) from tax on the basis that they don't "perceive" profits. I'd be curious to hear if you know of any. Do they exist, or are you arguing from principles?

If you're instead talking semantically--that regardless of the nominal payor (e.g., the corp), it is the shareholders (and other stakeholders) who bear the effect of the tax (smaller dividends, less gains, fewer jobs), I can't disagree--though the same could be said of all corporate expenses. It's the shareholders, the employees, the customers who suffer with high rates of tax--but they all suffer when utilities charge high rates, too, and suppliers, etc. Should public utilities be free, too, if taxes are to be done away with?

And, of course, regardless of the argument you're making, the "brains" of the corporation are the human members of its board of directors, who can perceive (and who can exercise judgment as fiduciaries, etc.).

Taxes may be higher or lower, and there are policy arguments on either side, but I confess I've never heard anyone assert that a corporation shouldn't be taxed because it is not sentient and cannot perceive taxes.
posted by Admiral Haddock at 12:51 PM on March 28, 2012