It is not unusual for large U.S. corporations to pay no U.S. income taxes despite making billions of dollars in profits. In fact, one study of corporate securities filings found 55 of America's largest companies paid no income taxes in 2020 despite generating hefty profits, while netting $3.5 billion in aggregate tax rebates. Nearly half of those companies paid no U.S. income taxes for three successive years.
How do profitable corporations get away with paying no U.S. income tax? Their most lucrative (and perfectly legal) tax avoidance strategies include accelerated depreciation, the offshoring of profits, generous deductions for appreciated employee stock options, and tax credits.
- Large companies use a maze of tax breaks and deductions to minimize and often eliminate their corporate income tax liabilities.
- Recent efforts to limit profit shifting to lower-tax countries have not been cost-effective.
- Accelerated depreciation, tax credits, and the expensing rules for employee stock options are other ways large companies cut their tax bills.
- The Inflation Reduction Act of 2022 imposed a new alternative corporate minimum tax, while doling out $369 billion in additional tax credits over a decade.
Corporate Tax Rate and Receipts in the U.S.
The Tax Cuts and Jobs Act (TCJA) of 2017 set a flat 21% U.S. corporate income tax rate, replacing the 35% top marginal rate in effect previously.
Proponents of lower corporate taxes had long complained about the 35% U.S. rate as one the highest among advanced economies. Starting in 2018, the TCJA reduced the combined federal and state U.S. corporate income tax burden to the middle of the pack in rankings by the Organization for Economic Co-Operation and Development (OECD) based on the effective tax rate.
By other measures, the Tax Cuts and Jobs Act delivered a much more generous windfall for U.S. corporations. Corporate income tax receipts fell from 1.9% of the gross domestic product (GDP) in 2015 to 1% of GDP in 2020. The OECD average stood at nearly 3%.
In 2018, U.S. corporations paid a 7.8% average cash effective tax rate on their U.S. income, versus 18% for the income they earned on the territory of the 10 largest U.S. trading partners.
The Real Tax Rate vs. the Official Rate
The difference between the 21% statutory corporate income tax rate and the effective rate based on the cash taxes companies actually pay is the result of generous tax breaks doled out by U.S. Congress.
The 379 profitable Fortune 500 companies paid an average effective federal income tax rate of 11.3% on their 2018 income.
One of the rationales for lowering the corporate income tax rate in the debate over the TCJA was that the cut would be offset by the elimination of tax breaks and loopholes for large companies. While the new law dropped some tax subsidies, it introduced many new ones.
The Inflation Reduction Act of 2022 imposed a 15% minimum income tax on corporations earning at least $1 billion annually. The 2017 TCJA eliminated the prior version of the corporate alternative minimum tax.
Corporate Tax Loopholes in the U.S.
Clearly, corporations have become extremely savvy at finding ways to pay less in taxes. For example, when Congress passed the CARES Act in response to the COVID-19 pandemic in 2020, payments to families under the legislation stole the headlines. The restoration of the carryback provision for corporations' net operating losses (NOLs) not just for 2020 but also for 2018 and 2019, on even more generous terms than those that prevailed before elimination in the TCJA, received considerably less notice.
Listed below are several key corporate tax-avoidance strategies. The Business Roundtable, a lobbying group representing the CEOs of the largest corporations, notes many of the tax breaks that can leave some companies owing no federal income tax for some years continue to enjoy strong bipartisan support.
The TCJA moderately reduced but did not eliminate the enormous savings corporations realize by shifting profits from the U.S. to countries with lower tax rates. This can be done by shifting intellectual property to a subsidiary in a tax haven and charging U.S. corporate affiliates more to use it, among other tactics.
Profit shifting to lower-tax countries reduced taxable income reported in the U.S. by $300 billion annually, the Congressional Budget Office estimated in 2018, and changes under the TCJA were expected to slow the annual profit shifting by $65 billion.
At the statutory 21% U.S. tax rate, this $65 billion in reported profits not shifted abroad as a result of the TCJA would produce annual tax receipts of about $13.7 billion. Of course, as already noted, the effective tax rate for U.S. corporations is significantly lower.
Offsetting such potential savings under the TCJA were the costs of a shift to a system reducing U.S. taxes on the earnings of overseas subsidiaries, while offering a tax break on foreign income derived from intangible assets in the U.S. Those provisions were expected to save U.S. multinationals $422.1 billion in U.S. taxes over a five-year period through 2024.
The TCJA did impose two new taxes on the overseas earnings of U.S. multinationals. Those companies' global intangible low-taxed income (GILTI), defined as overseas income in excess of a 10% return on tangible assets overseas net of depreciation, is now subject to U.S. taxation at a 10.5% rate, rising to 13.125% in 2026.
Another TCJA "stick" designed to curb profit shifting, the base erosion and anti-abuse tax (BEAT), imposes a minimum tax of 10.5% on the sum of a corporation's taxable income and its tax deductible payments to foreign subsidiaries other than for cost of goods sold. BEAT applies only to companies with annual gross receipts averaging more than $500 million over the three prior years that also make more than 3% of their total deductible payments to foreign affiliates.
U.S. tax receipts from GILTI and BEAT were expected to total $198.2 billion over TCJA's first decade through 2027.
Adding up the credits and the debits, the TCJA's attempts to curtail profit shifting appear to be costing the U.S. Treasury significantly more than what they save. Meanwhile, the business of tax havens has been largely unaffected. In 2019, corporate profits reported in Bermuda were more than four times the size of the island country's annual GDP.
When companies acquire capital assets like buildings or factory equipment they can then deduct their depreciation cost from profits over a period of years deemed to represent those assets' useful life. Accelerated depreciation allows a company to write off more of the cost faster, providing a larger deduction up front against taxable income.
The 2017 Tax Cuts and Jobs Act allowed companies to deduct the full cost of such qualifying investments in the year they were made from 2018 through 2022. Bonus depreciation declines to 80% in 2023, 60% for 2024, 40% in 2025, and 20% in 2026 before elimination in 2027.
The congressional Joint Committee on Taxation estimates accelerated depreciation of equipment will save companies more than $130 billion in federal taxes between 2020 and 2023.
The U.S. tax code is riddled with a variety of tax breaks for businesses estimated to cost the Treasury more than $100 billion annually, though that's a small proportion of total U.S. tax expenditures of about $1.6 trillion annually, including associated spending and foregone payroll and excise tax receipts.
The list of industry-specific credits is long; it includes the $18.2 billion cost in fiscal 2022 of the "credit for increasing research activities," $10.7 billion the same year in foregone revenue from the credit for low-income housing investments, $2.3 billion for the orphan drug research tax credit, and so on, right down to the distilled spirits credit for liquor wholesalers. The energy investment credit cost $6.6 billion in 2022, not to be confused with the $4.7 billion energy production tax credit or the $230 million cost of the marginal wells credit. The "tax credit for certain expenditures for maintaining railroad tracks" cost the U.S. federal government $110 million in fiscal 2022.
All of this is on top of state and local tax incentives for businesses estimated to cost $95 billion annually. Federal government outlays on everything from direct payments to farm producers to the cost of operating the Export-Import Bank add up to tens of billions of dollars in direct government subsidies for business.
Some argue the prevalence of U.S. corporate tax breaks is in line with other countries. Others have noted that the U.S. tax code offers corporations uncommonly generous tax breaks for research and development, client entertainment and certain legal expenses.
Deductions for Employee Stock Options
In their book income financial reports, listed companies subtract the estimated cost of stock options granted to employees as stock-based compensation, by estimating the value of the options granted.
On their U.S. federal tax returns years later, the same corporations deduct the typically higher cost of exercised employee stock options from corporate taxable income based on the value of the options when exercised.
The disparity between the estimated cost of employee stock options at the time of issue and their value for expensing purposes at exercise contributed to a large and recently increased book-tax gap between the net income large companies report to investors and the taxable income on their reports to the Internal Revenue Service (IRS). The expensing of employee stock options saved Fortune 500 companies $10.9 billion in taxes in 2018, including nearly $9 billion for the top 25 beneficiaries and $1.6 billion for Amazon.com, Inc. (AMZN) alone.
Supporters of the current system note that while corporations deduct the value of employee stock options from taxable income taxed at a 21% maximum rate, the employees cashing them out typically pay taxes on their value at the top marginal personal income tax rate of 40.8%, leaving the Treasury ahead when whose receipts are considered.
Tax Provisions in the Inflation Reduction Act of 2022
The Inflation Reduction Act of 2022 reinstituted the alternative minimum corporate income tax at 15% of book income for large corporations. The book, or financial, income used to assess the tax would be adjusted for depreciation and wireless spectrum rights recovery, carryover losses up to 80% of financial income, as well as domestic business tax credits that could offset up to 75% of the tax liability and foreign business credits up to the allowance for foreign taxes paid on the financial statements.
The new alternative minimum tax was expected to apply to approximately 150 of the largest U.S. companies and raise $222 billion in U.S. federal tax revenue over a decade, representing an increase of 4.7% in corporate tax revenues.
The law also imposes a new 1% excise tax on corporate share repurchases, which was expected to raise $73.7 billion over a decade.
The Inflation Reduction Act also increased IRS funding by nearly $80 billion over a decade; the Biden Administration publicly committed not to use the funds to increase auditing of taxpayers earning less than $400,000 annually. Increased tax enforcement for the highest earners and corporations was expected to generate $204 billion in additional tax revenue over a decade.
The law provides $369 billion in tax credits over a decade to businesses and individuals for investments in renewable power, clean transportation and energy security.
The Bottom Line
The U.S. tax code has conflicting aims. Its objective of equitably maximizing federal tax receipts is frequently at odds with a variety of tailored tax breaks pursuing diverse policy goals.
So long as efforts to make large corporations pay their fair share must coexist with tax credits and deductions encouraging a wide range of favored activities, corporate lobbyists and tax lawyers will remain in demand.