The Biden administration has proposed changes to corporate tax laws to fund improvements to infrastructure across the U.S., such as roads and bridges.
Some proposed changes are designed specifically to generate more tax revenue from the nation’s largest companies, such as Amazon, Nike, Netflix, HP and FedEx – all examples lawmakers have highlighted as firms that pay relatively modest tax bills despite annual profits in the billions of dollars according to public financial statements.
Accounting professor Scott Dyreng of Duke University’s Fuqua School of Business conducts research on several strategies big corporations use to keep their tax bills low. He explains some of those tactics in this Fuqua Q&A.
Do these companies really pay no income taxes?
We cannot truly know the answer to that question because tax returns are private. So when people say, for example, ‘Amazon paid no taxes,’ they are likely referencing tax cost estimates included in a company’s disclosed financial accounting statements, such as annual 10K filings with the U.S. Securities Exchange Commission (SEC).
Amazon is an example that comes up repeatedly, so I took time to review financial statements from 2012 to 2018, which show Amazon reported $25.4 billion in domestic pretax profits and paid about $2 billion in federal taxes. That’s an 8-percent rate. Although this is a rough calculation, and quite low relative to the official corporate tax rate of 21 percent, it is not negative or zero.
Why do people believe these large companies aren’t paying?
People often look at the pre-tax profits of a company in their SEC filings and compare those figures to the company’s “current provision” for U.S. income taxes.
Every year, many companies report large profits and very low or even negative taxes. For example, Salesforce reported about $2.5 billion in pre-tax U.S. profits in 2021, but reported a current federal tax expense of negative $12 million.
How do these companies end up with relatively low tax rates?
There are lots of ways companies can reduce their tax burdens. For example, some companies generate large deductions from capital investments (e.g. FedEx paid very little tax in 2018 because deductions from capital expenditures offset most of the tax bill). Many companies generate tax credits for investments in research and development or sustainable energy.
Many companies, including Amazon, Google and Salesforce, also cut their tax bills by using restricted stock units (RSUs) for a portion of employees’ compensation. When granting the RSU to an employee, a company is not allowed to claim a tax deduction until the shares vest. If share prices are rising, the value of the shares at vesting can be much more than the value at grant date, and the tax deduction is therefore larger than the value on the date they were granted.
Suppose a Salesforce RSU vested four years after it was given to an employee. For example, it was given at a price of $90 in June of 2017, but when it vested in June of 2021, the price was $238 (see Salesforce stock prices here). The employee would have to pay taxes on the $238 just like they had been paid in cash, and Salesforce would receive a deduction for $238, as though they had paid the employee in cash.
Everything seems fine there, but what’s interesting is the way the amounts are reflected differently in financial accounting versus in tax deductions. Salesforce would record financial accounting expense equal to the price at the date of grant ($90).
Accounting rules do not require an additional compensation expense if the share price increases. As a result, Salesforce never records the difference of $148 in compensation expense on the financial statements, which makes it look like it has really high financial accounting income.
The reason for the tax deduction is that share-based compensation dilutes the value of existing shareholders the same as if cash had been paid to the employee. To that end, the employee pays taxes just as if he or she had been paid in cash, and the company receives a tax deduction just as if the payment had been cash.
What tax impacts could this have on the employee?
The tax burden to the employee is exactly the same as if the employee had been paid cash. And the tax deduction to the company is exactly the same as if the company had paid cash. The difference is that the accounting treatment results in a lower recorded compensation expense on the firm’s financial statements.
So, in the end, the company isn’t saving taxes relative to what it would have owed if it paid employees in cash. Instead, the company is reporting artificially high income in its financial reports.
This high income is not an accounting trick. The companies are following the rules. There is a long, contentious history about how to account for share-based compensation. Current accounting rules, which resulted from that contentious debate, are not perfect.
The accounting results in a situation where, if stock prices are rising quickly (like Salesforce, Amazon, Tesla, and others), the compensation expense recorded on financial statements is likely lower than the economic cost to the company. The opposite occurs, too, but doesn’t make headlines. If stock prices are dropping, the compensation expense will be more than the tax deduction, resulting in extraordinarily high tax rates for the company.