Much has been said about whether it made sense to reduce the tax rate paid by corporations in 2017. Perhaps many corporations enjoy an even larger tax cut than we realize. A considerable amount of rhetoric has been bandied about in recent years concerning this subject.
Recently the IRS commissioner, President Joe Biden and various Democrats have been complaining about the so-called “corporate tax gap” — the difference between what corporations are supposed to pay and what they actually pay.
I recently read an article discussing this issue from an accounting perspective. When a corporation prepares a set of financial statements, it has to account for its income and expenses. One major expense typically is income tax expense, which is referred to as the “tax provision” in accounting lingo.
For most of my career, the amount reported in the tax provision was based largely on the tax reported in the tax returns filed by the corporation. At the risk of oversimplifying the situation, if a corporate taxpayer took an aggressive tax return position that was unlikely to be sustained upon examination by the tax authorities, the expense associated with that position frequently was not recorded on the financial statements unless the tax authorities audited them and assessed additional tax.
That changed in 2007 when the Financial Accounting Standards Board required companies to account for “uncertain tax positions.”
Those rules are complex, but their gist is that, if a corporation takes an aggressive tax position, it must increase its income tax provision by the amount of tax it would pay if the tax authorities audited the tax return, were aware of the issue and had a complete understanding of the underlying situation.
Generally, the IRS has three years to examine a taxpayer’s returns until the statute of limitations expires. When the statute of limitations expires before the tax authorities examine a tax return, a corporation reduces its current year tax expense by the amount saved from taking the aggressive position.
Earlier this year, a firm called Calcbench analyzed the financial statements of 467 of the S&P 500 companies. In particular, Calcbench looked to see how much these companies’ 2020 income tax expense was reduced because the statute of limitations had expired for prior year returns in which aggressive positions were claimed.
Those 467 corporations reported additional profits of approximately $235 billion in 2020 because the tax authorities did not overturn aggressive tax return positions and are now precluded from doing so because the statute of limitations has expired.
This amount compares with $164 billion 10 years earlier when the corporate rate was 35% rather than the current 21% rate.
The higher tax rate means that, 10 years ago, the S&P 500 took fewer aggressive positions than they do today to achieve a certain level of tax savings. The incremental level of aggressive tax positions is in essence a clandestine tax cut.
Since 2010, the number of corporate tax returns examined by the IRS has dropped by close to 50%. Furthermore, based on my personal experience, the current generation of IRS agents are not as well trained as their predecessors and they do not catch as many issues. That means that more corporations are able to utilize aggressive positions without being challenged by the IRS.
S&P 500 companies probably have the most complicated returns, hire the best tax advisors and have the most resources to engage in aggressive tax planning.
Of course, not every company engages in aggressive tax planning, but doing so can enhance a company’s earnings and its stock price, so there is a large incentive to do so.
Over the past decade the IRS budget has been cut and the number and quality of IRS examinations has declined commensurately. The IRS commissioner recently testified that the gap between the amounts of taxes owed by taxpayers exceeds the amounts paid by perhaps as much as $1 trillion annually. It is hard to estimate these amounts, as there is a considerable amount of subjectivity that goes into providing these estimates.
Although the-trillion dollar amount may be at the upper end of the range of estimates, the actual amount is still substantial in relation to the government’s overall revenue.
The financial statement analysis objectively lends credence to the argument that the IRS needs funding restorations. Opponents of such restorations attempt to scare voters by saying if the IRS gets additional funding, they will be coming after you. It appears that the IRS could collect additional taxes exceeding $200 billion annually by merely focusing on the S&P 500.
This is considerably more than what they would collect by focusing on smaller taxpayers like you and me.
Jim de Bree is a semi-retired CPA who resides in Valencia.
