Much has been said about whether it made sense to lower corporate tax rates in 2017. Perhaps many companies are enjoying an even bigger tax cut than we realize. There has been a lot of rhetoric on this subject in recent years.
Recently, the IRS Commissioner, President Joe Biden, and various Democrats complained about what is known as the “corporate tax gap” – the difference between what companies are supposed to pay and what they actually pay.
I recently read an article that covers this topic from an accounting point of view. When a company prepares annual financial statements, it must be accountable for its income and expenses. A significant expense is typically the income tax expense, which in accounting language is referred to as “tax provision”.
For most of my career, the amount posted in the tax provision was largely based on the tax reported on tax returns filed by the company. Also at the risk of simplifying the situation if a corporation taxpayer took an aggressive tax return position that was unlikely after review by the tax authorities, the costs associated with that position were often not recorded in the financial statements unless the tax authorities kept one Review by them and assessed additional tax.
That changed in 2007 when the Financial Accounting Standards Board asked companies to consider “uncertain tax positions”.
These rules are complex, but the essence of them is that if a corporation takes an aggressive tax position, it must increase its income tax provision by the amount it would pay if the tax authorities were to review the tax return, were aware of the issue, and have had a thorough understanding of the underlying situation.
Generally, the IRS has three years to review a taxpayer’s returns before the statute of limitations expires. If the statute of limitations expires before the tax authorities examine a tax return, a corporation reduces its tax expense for the current year by the amount saved by taking on the aggressive position.
Earlier this year, a company called Calcbench analyzed the financial statements of 467 of the S&P 500 companies. Specifically, Calcbench looked at how much these companies’ income tax expense was reduced by in 2020 as the statute of limitations on previous year’s returns on which aggressive positions were claimed had expired.
These 467 companies reported additional profits of around 235 billion US dollars in 2020 because the tax authorities did not overturn aggressive tax return positions and this is now prohibited due to the expired statute of limitations.
This is compared to $ 164 billion 10 years ago when the corporate tax rate was 35% instead of the current 21%.
The higher tax rate means the S&P 500 took less aggressive positions 10 years ago than it does today to seek some level of tax savings. The incremental extent of aggressive tax positions is essentially a stealth tax cut.
Since 2010, the number of corporate income tax returns audited by the IRS has decreased by nearly 50%. Additionally, in my personal experience, the current generation of IRS agents are not as well trained as their predecessors and do not pick up as many problems. That means more companies will be able to take aggressive positions without being challenged by the IRS.
S&P 500 companies have likely the most complicated returns, hiring the best tax accountants, and having the most resources to do aggressive tax planning.
Of course, not every company engages in aggressive tax planning, but doing so can improve a company’s profits and its stock price, so there is a huge incentive to do so.
Over the past decade, the IRS budget has been cut and the number and quality of IRS reviews has decreased accordingly. The IRS commissioner recently testified that the gap between the amounts of tax owed by taxpayers exceeds the amounts paid by perhaps as much as $ 1 trillion annually. It is difficult to estimate these amounts because these estimates involve a significant degree of subjectivity.
While the trillion dollar amount may be on the high end of the estimates, the actual amount is still significant relative to total government revenue.
Analysis of the financial statements gives objective credibility to the argument that the IRS needs restoration funding. Opponents of such restorations are trying to scare voters by saying that if the IRS gets additional funding, they will go after you. It appears the IRS could collect over $ 200 billion in additional taxes annually by just focusing on the S&P 500.
That’s way more than they’d collect if they focused on smaller taxpayers like you and me.
Jim de Bree is a semi-retired CPA living in Valencia.