What You Can Do About U.S. Corporate Tax Loopholes

by: The Value Investor

Officially the US corporate income tax rate runs at 35%, among the highest rates worldwide. In reality a lot of companies pay much less in taxes. Why is this? The answer is simple. Armies of corporate lobbyist in Washington have created huge corporate tax loopholes.

How large are the loopholes? What are they? Who is benefiting and who is not? How do we solve this system?

Estimated taxation

While the official US statutory corporate income tax rate stands at 35% the Government Accountability Office estimates the effective tax rate is 25.2%. This whopping 10 points difference makes the US tax rate competitive with other developed nations.

The US Congressional Budget Office estimates that US corporate tax receipts for 2011 came in at $181 billion. Using the 25% effective tax rate estimate from the Government Accountability Office this means the US taxpayers are missing out on an annual $71 billion in tax receipts.

Example of loopholes

There are many loopholes for corporations and cost estimates for the tax payer fluctuate wildly. The following is just a small overview of the most important and bizarre loopholes.

One of the most important loopholes is the deferral of income from foreign controlled corporations. US corporations can leave profits abroad and can defy paying US taxes until they transfer those profits back into the US (also known as "repatriation"). Many corporations are key to leave the money indefinitely abroad until a solution is found. Credit Rating Agency Moody's estimates that corporations which hold some $1.2 trillion in cash balances, have stored some $700 billion overseas, making this one of the most costly loopholes.

Other loopholes are the fact that companies can deduct punitive damages (or settlements) from their income, flexible ways of accounting (mostly the LIFO inventory system), modified accelerated depreciation schemes (corporate jets can be depreciated faster than a commercial airline) etc.

In fact the "alternative minimum tax", a tax specifically designed to let US corporations pay a minimum tax rate (as they already enjoy a lot of tax breaks and take advantage of loopholes) has been severely weakened over the past decades. Dozens of profitable companies now actually do not pay any taxes at all!

Big Corporations

The loopholes favors the large corporations who have the financial resources. Estimates are that 83 out of the top 100 US firms have shell companies in offshore locations with the sole purpose of tax evasion. Some of the largest tax evaders are General Electric (NYSE:GE) which received $4.7 billion from the IRS on reported profits of $10.4 billion for the period 2008-2010. PG&E Corp (NYSE:PCG) received $1.0 billion on reported profits of $4.8 billion, while Verizon Communications (NYSE:VZ) received $1.0 billion on reported profits of $32.5 billion. Other receivers were Pepco Holdings (NYSE:POM), Computer Sciences (NYSE:CSC), CenterPoint Energy (NYSE:CNP), American Electric Power (NYSE:AEP), Duke Energy (NYSE:DUK) and Wells Fargo (NYSE:WFC).

On average the 280 companies investigated in the report of "Citizens for Tax Justice" paid an effective tax rate of 18.5%, or $251 billion in corporate taxes" on their reported profits of $1.35 trillion for the three year period of 2008-2010. In fact they should have paid almost double that amount.

What's so bad about this?

In 2011 US Federal income tax receipts totaled some $181 billion according to the Congressional Budget Office. The 280 companies in the report of Citizens for Tax Justice paid $85 billion in corporate taxes in 2010 on nearly $488 billion in earnings, for an effective tax rate of 17.5%, half of what they should have paid.

Just the sample of these 280 companies should have paid around $170 billion in taxes, but somewhere they have found $85 billion in loopholes. While there are valid arguments that a tax rate of 35% is very high, the effective tax rate of 17.5% for that group implies that small and medium businesses pay a much higher tax rate as the effective tax rate is estimated at 25.2%. These companies do not have access to expensive consultants, accountants or foreign shell companies on exotic locations. This is crucial as all economists agree that small and medium businesses are crucial to get employment growing again.

The distorted tax code creates competitive advantages for the largest corporations and impacts the market place in a severe manner.

Unnecessary work, public frustration and corruption.

Let's make life easy. While theoretically the American public is missing out on $71 billion per annum in lost tax receipts, a system in which corporations pay 35% without any loopholes is not competitive in today's global economy.

Lets simply lower the US corporate income tax rate to 25%, making it competitive with other developed nations, while eliminating all loopholes in the tax code. The unfairness between small and large business would vanish immediately and provide a boost to small and medium sized businesses.

Furthermore businesses do not have to hire highly skilled accountants and consultants anymore doing useless work for greater society. Furthermore frustration of the wider public would diminish and even cases of outright fraud would be prevented.

What you can do?

Unfortunately we live in a political system in which such a solution is not a reality. Therefore you should vote with your feed. Next time you do business with some of these companies remember:

When you ship a parcel. Chose for United Parcel Services (NYSE:UPS) which pays a 24.1% tax rate, which is still far from the statutory rate of 35%, but is much better than FedEx (NYSE:FDX) which pays a mere 0.9%

Go clothing shopping at Nordstrom (NYSE:JWN) which pays 37.1% in corporate taxes while Macy's (NYSE:M) pays a mere 12.1%

And don't forget to get you groceries at Whole Foods Market (NASDAQ:WFM) paying 36.3% while Supervalu (NYSE:SVU) pays a mere 13.0%

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.