Have you ever wondered how big companies avoid big tax bills? Here is the story

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  • Do these companies really pay no income tax?

We can’t really know the answer to this question because tax returns are private. So when people say, for example, ‘Amazon paid no taxThey are probably referring to tax cost estimates included in a company’s disclosed financial statements, such as annual filings of 10K with the United States Securities Exchange Commission (SEC).

Amazon is an example that comes up over and over again, so I took the time to review 2012 to 2018 financial statements, which show that Amazon reported $ 25.4 billion in pre-tax domestic profits and paid about $ 2 billion in federal taxes. That’s an 8 percent rate. While this is a rough calculation and quite low compared to the official corporate tax rate of 21%, it is neither negative nor zero.

  • Why do people think these big companies don’t pay?

People often look at a company’s pre-tax profits in their SEC filings and compare those numbers to the company’s “current allowance” for US income taxes.

Every year, many companies report large profits and very low or even negative taxes. For example, Salesforce reported about $ 2.5 billion in pre-tax profits in the United States in 2021, but reported a current federal tax burden of minus $ 12 million.

  • How do these companies end up with relatively low tax rates?

There are many ways businesses can reduce their tax burden. For example, some companies generate large deductions on capital investments (eg. FedEx paid very little tax in 2018 as capital expense deductions made up most of the tax bill). Many companies generate tax credits for investments in research and development or in sustainable energy.

Many companies, including Amazon, Google, and Salesforce, have also lowered their tax bills by using restricted stock units (RSUs) for a portion of employee compensation. When granting RSU to an employee, a company is not allowed to claim a tax deduction until the shares are vested. If the share price increases, the value of the shares on vesting may be much higher than the value on the grant date, and the tax deduction is therefore greater than the value on the grant date.

Suppose a Salesforce RSU is acquired four years after it is assigned to an employee. For example, it was priced at $ 90 in June 2017, but when acquired in June 2021, the price was $ 238 (see Salesforce stock prices here). The employee would have to pay tax on the $ 238 as if he had been paid in cash, and Salesforce would receive a deduction of $ 238, as if he had paid the employee in cash.

Everything looks good there, but what’s interesting is how the amounts are reflected differently in financial accounting compared to tax deductions. Salesforce would record a financial accounting charge equal to the award date price ($ 90).

Accounting rules do not require additional compensation expense if the share price rises. As a result, Salesforce never records the $ 148 difference in compensation expense in the financial statements, making it look like it has very high financial accounting revenues.

The reason for the tax deduction is that stock-based compensation dilutes the value of existing shareholders in the same way as if money had been paid to the employee. To this end, the employee pays taxes as if it had been paid in cash, and the business receives a tax deduction as if the payment had been in cash.

  • What tax impacts can this have on the employee?

The tax burden for the employee is exactly the same as if the employee had been paid in cash. And the tax deduction for the business is exactly the same as if the business had paid cash. The difference is that the accounting treatment results in a lower compensation expense recorded in the company’s financial statements.

So, in the end, the company does not save in taxes compared to what it should have if it paid its employees in cash. Instead, the company reports artificially high income in its financial reports.

This high income is not an accounting trick. Businesses play by the rules. There is a long, controversial history of how to account for stock-based compensation. The current accounting rules, which have resulted from this controversial debate, are not perfect.

Accounting results in a situation where, if stock prices rise rapidly (like Salesforce, Amazon, Tesla, and others), the compensation expense recorded in the financial statements is likely less than the economic cost to the business. The reverse is also happening, but does not make the headlines. If stock prices fall, the compensation expense will exceed the tax deduction, resulting in extraordinarily high tax rates for the company.

(C) Duke University

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