If you were an executive of a U.S.-based company, would you acquire a firm overseas and reincorporate there to avoid paying U.S. taxes? Is that ethical?
A pharmaceutical company moved its headquarters to Ireland, sharply reducing its tax rate. A billboard company reclassified itself as a real estate concern, meaning it will no longer pay corporate taxes. And a big oil producer split itself in two, cleaving off a multibillion-dollar division that now operates tax-free.
Across corporate America, companies large and small are finding new ways to address one of the business world’s oldest irritations: paying taxes.
By exploiting existing loopholes and devising new ones, some of the country’s best-known companies are making it harder than ever for the federal government to replenish its already depleted coffers.
As a result, business income tax revenue remains stagnant at about 2 percent of gross domestic product even as corporate profits hit records.
Business taxes now make up less than 10 percent of federal revenue, and in some years as little as 6.6 percent. That is sharply down from the years after World War II, when about 30 percent of federal revenue came from corporate taxes.
The decline is the result of the rise of untraditional business structures, the effects of a more globalized economy and a labyrinth of subsidies and tax credits. And though the erosion has happened gradually over decades, the surging popularity of inversions — acquisitions of overseas companies that allow American corporations to reincorporate abroad — is raising concerns that an already precarious situation is growing untenable.
“There’s been a long, slow, steady decline,” said William G. Gale, co-director of the Urban-Brookings Tax Policy Center and an economic adviser to President George H. W. Bush. “It’s a confluence of a bunch of things, and it’s increasingly difficult to figure out how to effectively tax corporations.”
Lawmakers in Washington are calling for an overhaul of the corporate tax code. Upon becoming chairman of the Senate Finance Committee this year, Senator Ron Wyden, Democrat of Oregon, said it was time to revamp the “dysfunctional, rotting mess of a carcass that we call the tax code.” But political gridlock makes the possibility of any quick action all but nonexistent.
While officials may not be in the mood to cooperate, they are taking notice of recent developments. Three tax-avoidance tactics in particular have grabbed the attention of lawmakers and the White House, though the root of the problem runs much deeper.
Most prominently, the number of inversions is at an all-time high, fueled by a rush of health care companies striking deals for overseas rivals.
AbbVie, which will become one of the 50 largest companies in the world through its $54 billion takeover of the Irish drug maker Shire, became the largest American company to strike an inversion. But more than a dozen other firms have made similar moves, most likely costing the government nearly $20 billion over the next 10 years, according to the Joint Committee on Taxation.
Republicans and Democrats have called for legislation to end inversions, even in the absence of broader corporate tax reform. But the threat of new laws to curb them only seems to be quickening the pace.
“Wall Street is whispering in the ears of all these corporate executives saying, ‘Congress might shut this down, you’ve got to do it now,’ ” said Rebecca J. Wilkins, senior counsel at the Institute on Taxation and Economic Policy.
Another corporate structure being exploited now more than ever is the master limited partnership. These partnerships are part of a broad class of companies known as pass-through entities because they pass all profits along to shareholders and are therefore exempt from paying corporate income taxes.
Dozens of these have been created in the last two years, reducing the Treasury’s income by about $1.6 billion annually, according to the Joint Committee on Taxation. Last year, the oil and gas company Phillips 66 spun out its pipeline assets into a master limited partnership, shielding millions of dollars in profits from taxation.
In response to the uptick in master limited partnerships, the Internal Revenue Service temporarily halted new approvals of the structure this year, and the Treasury Department said it was examining the effects on future tax revenue.
Another type of pass-through entity, the real estate investment trust, is also experiencing record popularity. Like master limited partnerships, real estate investment trusts pass profits along to investors, exempting them from corporate taxes.
But loose standards have allowed an ever wider variety of businesses to reclassify themselves as real estate investment trusts, broadening the universe of businesses avoiding taxes altogether. CBS Outdoor, the billboard company, relisted as a REIT this year.
And in a recent ruling, the I.R.S. allowed Windstream, a telecommunications firm, to spin off its underground cables and assorted real estate into a separate publicly traded company. Tax experts believe the ruling opens the door for a new wave of such transactions from a broad range of businesses.
Corporate advisers say that companies are pursuing these structures because, in the face of slow organic growth, executives are looking for additional profits wherever they can find them.
“It’s self-help tax reform,” said Kyle E. Pomerleau, an economist at the Tax Foundation. “If Congress is not willing to reform the corporate tax code, companies are going to do it for themselves.”
Despite the outsize attention in Washington being paid to the tax-avoidance techniques, they represent only a small part of the reason corporate tax revenue has declined so precipitously.
“Inversions are the very small end of the tail,” Mr. Gale said. “They just happen to be the part that’s wagging right now.”
The more fundamental issue is a series of systemic changes to the tax system and the shifting international tax landscape.
Over the years, a growing portion of the United States economy has shifted away from traditional corporations and into lower-taxed structures like partnerships and S-corporations, which are exempt from paying income taxes. This has put a growing swath of the economy beyond the reach of the I.R.S.
“It’s gotten much easier to never put money into the corporate sector, or to move it around internationally once it is in the corporate sector,” Mr. Gale said.
Only 6 percent of businesses are traditional corporations subject to the corporate income tax, according to the Congressional Research Service. That is down from 17 percent in 1980. The result is that less than half of the government’s business income comes from corporations, down from about 80 percent in 1980.
And while most S-corporations are small to midsize businesses, as was intended, some of the country’s largest private companies, including Bechtel, one of the country’s largest engineering firms, are also organized as S-corporations to avoid corporate income taxes.
“A lot of the income that used to be earned at the corporate level is now being moved to the S-corp level,” Mr. Pomerleau said.
And for those traditional corporations that are subject to the United States corporate tax rate, which at 35 percent is the highest in the world, there are myriad ways to avoid paying anything close to that. By taking advantage of a warren of credits, deductions and exemptions, corporations pay an average effective rate of just 12.6 percent, according to the Government Accountability Office.
Much of the tax avoidance comes as multinational corporations take advantage of overseas subsidiaries to shuffle money, intellectual property and assets into lower-taxed jurisdictions. In 2010, a majority of overseas profits reported by American firms were recorded in just 12 low-tax countries like the Netherlands, Bermuda, and Ireland, according to Citizens for Tax Justice.
That skewed distribution of profits is a result of the changed global tax landscape, where many countries have sharply lowered their corporate rates while the United States has not.
Those attractive overseas rates — and the fact that, unlike the United States, other countries do not tax international earnings — are among the reasons that companies are rushing to strike inversion deals.
“We cannot compete with zero,” Ms. Wilkins said.
Republicans and Democrats in Congress and the White House all agree the country is overdue for comprehensive tax reform. The last big revision of the tax code came in 1986. Before that, the previous rewrite was in 1954. But ideas on how to proceed vary wildly, diminishing the likelihood of any rapid reforms.
“There’s no primitive law of nature that every 30 years they will revise the tax code,” Mr. Gale said. “I don’t see much in terms of comprehensive tax reform happening with this Congress and this administration. It feels like they’re done talking to one another.”