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Did These Companies Fool the IRS?

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No one wants to pay any more in taxes than they have to. But with the government's fiscal situation becoming increasingly dire, policymakers have started focusing on the huge dilemma of where to get higher tax revenue without threatening an already fragile economic recovery.

With that as background, the timing of last week's revelation that General Electric paid nothing in U.S. income tax last year should come as no surprise. But lost in the outrage over one of the nation's largest corporations apparently contributing nothing to the public coffers is a much simpler fact: Companies pay widely varying amounts of tax, both from year to year and from industry to industry.

No foolin'
As fellow Fool Morgan Housel discussed this week, the fact that financial stocks like GE, Citigroup, and AIG have paid very little in taxes recently looks less like a conspiracy and more like the result of an obvious fact: Financial companies posted immense losses during the banking crisis. With any income tax, no income should mean no tax.

Moreover, low effective tax rates aren't limited to financial stocks. According to figures compiled by CNBC, Wynn Resorts (Nasdaq: WYNN  ) had an effective tax rate of 6% in 2010, quite a bit less than the nominal 35% tax rate on corporate income as well as the average actual tax rate of 20%. Pfizer (NYSE: PFE  ) also had a relatively easy time with its tax bill, clocking in at just 12%. In a separate analysis from MF Global, companies like Carnival (NYSE: CCL  ) and Blackstone (NYSE: BX  ) paid less than 2% in taxes, while Transocean (NYSE: RIG  ) came in at 14%.

On the other side of the coin, though, many companies actually pay huge amounts of taxes. Both video-streaming sensation Netflix (Nasdaq: NFLX  ) and upscale grocery chain Whole Foods (Nasdaq: WFMI  ) paid 40% in taxes last year.

What's behind tax rates
As any corporate tax lawyer can tell you, trying to minimize taxes for a company that does business globally is an intricate game. Many different strategies exist that can help you cut your overall tax bill. Incorporating in low-tax jurisdictions can help, especially if you can maneuver your operations to have income flow to offshore subsidiaries that get taxed less harshly while pushing expenses to higher-tax areas where the related deductions have the most value. Also, a patchwork of tax credits and incentives entice companies to take on certain projects to take advantage of them.

Granted, from an outsider's perspective, all of this is so convoluted that it can appear that corporations are trying to pull a fast one. Online retailer Amazon.com has drawn plenty of criticism for refusing to collect sales tax on behalf of the vast majority of states in which it doesn't have a major physical presence.

But as reform advocates would agree, the burden is on lawmakers to make clear rules that fit well with the overall international tax framework. Trying to piece together the jigsaw puzzle of tax rules that exist throughout the world would be a hard enough task even if all the countries involved cooperated with each other. Given that many countries rely on their status as tax havens for their economic survival, it will be even harder for the U.S. to take the steps needed to make the corporate tax system work.

Don't let the tax tail wag the dog
From an investor's perspective, you shouldn't let taxes dominate your thinking. As Bespoke Investment's Paul Hickey discovered, most of the companies that have paid the highest tax rates have also put in the best performance for their shareholders, while shares of low-tax companies haven't done nearly as well.

In the end, the key to a successful company is for its business to be profitable. Figuring out how to keep as much of those profits away from the IRS is worth the effort, but first you have to make sure the company will keep making money. If a company can't make a profit, paying lower taxes is a poor consolation prize for shareholders.

Add these low-tax companies to your watchlist to see how they do going forward. And for more on getting your taxes in tip-top shape, be sure to check out the Fool's Tax Center.

Fool contributor Dan Caplinger would never fool you about something as important as taxes. He doesn't own shares of the companies mentioned in this article. Pfizer is a Motley Fool Inside Value recommendation. Amazon.com, Netflix, and Whole Foods Market are Motley Fool Stock Advisor selections. The Fool owns shares of Transocean. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy keeps you on your toes.


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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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