U.S. corporations may have to pay more taxes to fund President Biden’s $ 2.3 trillion infrastructure plan. How much they owe and to whom it is likely to remain a mystery.
Public corporations in America disclose all of their tax payments and their tax rate. But they have resisted plans to break down how much they are paying to the federal government, states, or overseas. Companies say the additional disclosure would be costly and potentially misleading.
“This is an area most companies would prefer to lurk in the shadows, especially those that fail to pay their fair share of taxes. The less details, the better,” said David Zion, head of Zion Research Group, accounting and tax research firm that serves investors.
Corporate taxes are currently in the limelight as President Biden’s infrastructure proposal calls for an increase in the corporate tax rate from its current 21% to 28%.
The plan also provides a minimum tax of 15% for businesses with incomes greater than $ 2 billion. The tax would be aimed at companies reporting high profits but low tax payments. Approximately 180 US companies meet the income threshold, and the Treasury Department estimates 45 would have to pay undisclosed taxes.
Here’s what we know about corporate taxes and why we don’t know anymore.
What do companies disclose about taxes?
US public companies are required to disclose cash taxes they pay during a period of time. Many companies report an annual number rather than a quarterly number because the rules do not specify the time period. The number is usually given at the end of the companies’ cash flow statement or in the footnotes.
Corporations are also required to disclose their pre-tax net income for US and foreign operations and their tax expense or benefit on the income statement. Companies do not have to divide their foreign activities according to country. You also list your short-term and long-term deferred tax assets or liabilities on the balance sheet.
US GAAP companies must disclose an effective tax rate that balances their statutory domestic tax rate with their actual tax expense. The effective tax rate they usually quote in the footnotes is essentially the ratio between their tax expense and their pre-tax income or the profit they have disclosed to investors. Corporations do not need to disclose exactly which business and jurisdiction the entire tax expense is attributable to, said April Little, partner at professional services firm Grant Thornton LLP.
America’s corporate tax disclosure requirements are similar to those in other countries, as US GAAP rules on this matter are closely aligned with International Financial Reporting Standards (IFRS), which are applied in approximately 165 countries around the world.
Nevertheless, the international activities of the companies often cloud the picture. “Once you start adding incremental overseas jurisdictions, you may have a preferential or favorable tax structure in a particular jurisdiction that significantly reduces the amount of tax you may pay there,” Ms. Little said.
In 2016, the Treasury Department forced US multinational corporations with annual worldwide sales exceeding $ 850 million to provide certain tax and other financial information from country to country. Tax authorities in more than 90 countries have a similar requirement first proposed by the Organization for Economic Co-operation and Development. Companies only need to provide this information to the Internal Revenue Service or its local equivalent, not in publicly available records.
What do standard setters and regulators do?
The Financial Accounting Standards Board, which sets accounting standards for US companies and nonprofits, has been discussing plans for years to require companies to disclose more information about their tax charges. The first proposal came in 2016 and suggested that companies should differentiate between their U.S. and foreign income taxes, among other things.
The FASB updated its proposal in 2019 and requested more disclosure. She urged public corporations to split the amount of federal, state, and foreign taxes they pay. The proposal also suggested that companies should disclose these figures on a quarterly basis.
More than four years after the first proposal, the FASB is still working on the issue. The board last discussed the matter in February 2020, just before focusing on issues related to the Covid-19 pandemic. The FASB plans to revisit the proposal at an upcoming board meeting, but the date has not yet been set, according to a spokeswoman.
The Securities and Exchange Commission enforces the accounting standards established by the FASB for public companies. The SEC could, but rarely does, override the FASB as they typically work together to align themselves with the creation of accounting rules. A request for comment was not responded to.
Why don’t companies want to disclose more about their taxes?
Corporations have resisted the FASB’s efforts to get a breakdown of their federal, state, and foreign income taxes. Companies are often cautious about extensive disclosures because they can lead investors and regulators to scrutiny, which is why finance managers rarely publicly discuss their stance on tax disclosure.
Drug company Eli Lilly & Co. said the breakdown could be misleading as the deadlines for paying income taxes vary. Domestic payments could also be offset by accrued but unpaid foreign taxes, which could create a mismatch when comparing the U.S. to foreign taxes, wrote Donald Zakrowski, the company’s vice president of finance and chief accounting officer, in a letter to a spokeswoman by Eli Lilly said the company made no comment beyond his letter.
Robert Traficanti, the bank’s global head of accounting policy, said in a 2019 letter to the FASB that disclosing income tax expense by tax jurisdiction would require changes to financial processes and procedures that would likely increase costs. Citigroup did not respond to a request for comment.
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Drug maker Pfizer Inc.
Investors and other users of financial statements may not use the information disclosing US and foreign income taxes to compare global companies. “Two companies with different countries of residence would not provide consistent data sets for comparison,” wrote then controller Loretta Cangialosi in a letter to the FASB in 2019. Pfizer said the letter still reflected his position.
Additional disclosures would not only inform investors but also those who enforce tax laws. “You don’t want the annual financial statements to be a breadcrumbs trail to the IRS,” said Jack Ciesielski, accounting expert and owner of RG Associates Inc., an investment research firm and portfolio manager.
How does tax accounting make disclosure difficult?
Tax disclosure is also opaque as companies calculate some key financial metrics differently for their financial statements and tax base.
Many companies use the accrual method to account for their taxes. You need to balance the differences between tax accruals for an IRS filing and the accounting accrual base in your financial statements. Accrual accounting is conceptually the same under tax law and GAAP, as companies generally recognize income when they earn it. However, the requirements differ on issues such as asset depreciation and other expenses.
Companies often write off assets in their financial statements on a straight-line basis, which means that an asset will wear out evenly over its lifetime. However, in order to comply with the IRS, companies must adhere to a specific scheduling, calculation, and amortization method known as a modified accelerated cost recovery system. Many GAAP depreciation methods result in low end-of-life residual value on assets while the IRS system leaves no value, said Michael Shaub, professor of accounting at Texas A&M University. This means companies can get the entire cost of an asset back for tax purposes but not financial reporting.
For the sake of clarity, some investors would like the FASB to require companies to reconcile their GAAP pre-tax income with taxable income on their tax returns. “That would explain a lot about the differences between the two fundamentals of accounting and give some insight into the strategies used,” said Ciesielski.
Write to Mark Maurer at firstname.lastname@example.org
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