Recently, a study identified dozens of large companies that did not pay income taxes in 2020. While such studies make headlines and may seem shocking, the reality is far more mundane: taxable profits (or losses) are determined by tax laws, while book profits (or losses) are determined by accounting standards. There are real, legitimate reasons why tax laws deviate from accounting standards, resulting in book gains but tax losses for a given company in a given year.
Tax laws and accounting regulations are not the same thing – Congress writes tax laws and accountants write accounting regulations
Book income refers to the income that a company reports in its publicly submitted annual financial statements and is defined in accordance with generally accepted accounting principles (GAAP). The Financial Accounting Standards Board (FASB) sets rules and guidelines to create a standard by which investors can value various companies.
Taxable income refers to the amount of income that a company declares on its tax return. The rules defining taxable income were developed by members of Congress to generate income for government activities and to encourage or punish certain conduct.
Companies do not use “loopholes”, they follow the rules issued by Congress
Much like homeowners using the mortgage interest deduction or parents using the child tax credit, businesses use deductions and credits issued by Congress to encourage or discourage certain behaviors.
For example, Congress introduced accelerated depreciation to encourage investment. That is, when a company buys a machine or builds a factory, the tax rules allow for faster and larger prepayments than the accounting rules allow. Accelerated depreciation leads to short-term gaps between book and taxable income over the period in which the tax deductions are higher. Trade tax credits such as those for research and development costs (R&D) also lead to gaps in tax and book income.
If some companies paid little or no income tax in a given year due to depreciation allowances or the R&D tax credit, the only way to benefit from such provisions was by investing in capital or conducting R&D, economically beneficial activities derived from those enacted by Congress Tax regulations have been recognized.
Tax regulations were written to offset the effects of business cycles
If some companies failed to pay corporate income tax because they carried past losses, it should be considered a normal feature of US tax law and not a cause for concern. Deductions for loss carryforwards ensure that businesses are taxed on their profitability over time and not penalized for losses that do not coincide with calendar years. Tax losses can be carried forward for 20 years with restrictions, so that many companies can carry forward losses from the financial crisis or other company-specific downturns.
There is symmetry in the tax code: a deduction for one is a tax liability for the other
Temporal differences in the deduction of share-based employee remuneration from the book compared to taxable income also contribute to book tax gaps. In the time between the issue and the deduction of the remuneration from the book income and the forfeiture for the employee and the deduction from the taxable income, the share value may have changed. Book income is higher than taxable income if the share value has increased on vesting and vice versa if the share value has decreased.
However, what is deducted for the corporation is taxable for the employee who receives it. A complete analysis must take into account that recipients of stock-based payment will pay personal income tax on that income.
Large companies are audited at the highest rates and Congress is keeping an eye on corporate refunds
The largest companies have relatively high audit rates – of the 619 companies with assets of over $ 20 billion in 2019, 50 percent were audited by the IRS, compared to an overall audit rate of 0.7 percent. In addition, the Joint Tax Committee must review all C company reimbursements above $ 5 million.
Large companies also pay taxes in other countries
Foreign profits also create a wedge between taxable income and book income, as state corporation tax applies to a portion of foreign income under the Tax Cuts and Jobs Act’s tax base erosion and profit shift barriers, such as Income (GILTI).
Note, however, that U.S. corporation foreign income is fully subject to corporation tax in the foreign country in which it is earned. U.S. tax law provides companies with tax credits for the taxes they pay to foreign governments on their overseas income, which helps reduce the double taxation that arises when both a foreign government and the U.S. government attempt to share the same overseas income to tax.
Think long-term: an accurate analysis of corporate taxes requires a horizon of several years
A year-long snapshot of the corporate tax situation paints an imprecise picture of the taxes paid by companies. Provisions such as accelerated depreciation introduce short-term gaps in accounting and taxable income due to timing differences, but the same nominal deductions are made for both calculations over the life of an asset. Past loss deductions help smooth out tax liability over time to avoid penalizing companies with volatile earnings patterns.
Over a period of several years, the time differences between book and tax revenues largely disappear, making the two key figures more consistent.
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