Our American tax system often seems unfair. Most people seem to think that their tax rates are too high and that others are not paying enough. Many decry the loopholes that wealthy people have been known to use, such as offshore tax shelters.
Anger about unfairness in taxation extends to the corporate world as well. Here are some ways companies have been taking advantage of our current tax laws.
One particularly egregious corporate loophole effectively rewards companies for wrongdoing. When companies get sued, they're allowed to deduct the amounts they have to pay in damages to compensate their victims against their taxable income. In effect, this forces taxpayers to share in the financial fallout of their actions.
As if this weren't bad enough, companies can even deduct punitive damages that juries or judges assess in order to deter companies from repeating similar behavior in the future. Punitive damages often dwarf the actual damages involved in a lawsuit, and the larger the amount, the greater the tax savings associated with being able to write off punitive damages.
There are some types of wrongdoing that companies can't deduct. Criminal fines and penalties owed to the government aren't eligible for deductions, and settlements that characterize payments as criminal penalties for tax purposes aren't tax-deductible. Still, despite periodic efforts to change the law, corporations continue to enjoy tax-deductible status for many of their legal liabilities -- even when they're found at fault for what they've done.
In 2014, Carnival Corp. (NYSE:CCL), one of the world's largest cruise lines, posted a profit of $1.2 billion, but it provisioned only $9 million for income taxes. Thus its fiscal year tax rate was less than 1%.
It's not a mistake, nor is it the result of prior-year losses. Cruise lines effectively skirt any and all U.S. corporate income taxes that you might expect them to pay. Thanks to advantageous tax policies, cruise lines like Carnival make their homes in Panama and other jurisdictions, making them foreign companies that simply pick up mostly American passengers. In Carnival's case, only a small portion of its income derived from its Alaskan Tours product is taxable under U.S. corporate tax law.
You'd be excused for thinking Carnival is an American company. After all, its largest office is located in Miami. There you'll find many of its shoreside employees, from credit card fraud specialists to its corporate executives. But what you won't find at the American offices is a tax bill; Carnival and many other cruise lines are structured to ensure that their profits aren't American, even if their operations are.
Does paying your income tax make you a bit hot under the collar? Then prepare to be really miffed, because some companies are getting a killer tax break through a method commonly known as tax inversion deals.
A tax inversion happens when a domestic company purchases a foreign company in a country with a lower marginal corporate tax rate than the United States and then redomiciles its headquarters in the foreign country. The United States' peak marginal corporate tax of 40% is the second-highest in the world, so it's advantageous for many U.S.-based businesses to purchase comparably-sized companies in overseas markets to lower their effective tax rate. The bigger the company, the more sizable the tax break should be.
Take, for example, the recently announced buyout of Allergan (NYSE:AGN) by Pfizer (NYSE:PFE). Despite new U.S. Treasury Department rules that attempt to restrict tax inversion deals, Allergan shareholders will still own more than 40% of the combined entity, and Pfizer is paying for the deal with Pfizer shares (11.3 Pfizer shares per Allergan share, to be exact). In other words, the deal should pass muster with the Treasury Department's new rules. The resulting merger will lower Pfizer's effective tax rate from 25% to between 17% and 18% in the year following the merger and will likely save the company more than $1 billion before operational synergies are tackled.
Despite lawmakers' best efforts, tax inversion deals remain a smart way for businesses, especially healthcare companies, to cut their tax liability and hang on to more of their profits.
You want a mind-boggling loophole? Consider this: Many big American companies are opting not to bring home revenue they generate abroad -- because it will be taxed. According to some studies, more than $2 trillion is being stored abroad, and that means that more than $600 billion in taxes is not being collected. That $600 billion would go a long way in America, don't you think? It could pay for a lot of infrastructure repairs, for example.
What these companies are doing is not illegal, and some would argue that they're serving their shareholders well by spending less on taxes. But there's a downside for them, too, as money not brought home cannot be spent here on further growth -- perhaps on R&D, additional workers, advertising, or acquisitions.
Many feel that our current corporate tax rate of 35% is too high, but others, such as Senator Elizabeth Warren, have pointed out that because of various tax breaks and loopholes, many corporations pay far less than 35% -- and that corporations' share of the country's total tax revenue was recently just 9%, far lower than the roughly 33% it was in 1950. Indeed, many companies pay little or nothing in taxes. According to a study by Citizens for Tax Justice, companies including General Electric, JetBlue Airways, Mattel, Qualcomm, Prudential Financial, and Xerox paid less than 10% in taxes in 2014. Warren also notes that, on average, the American corporate tax rate is in line with international averages.