Innovation and Constraints on Tax Shelters

Article excerpt

"General Electric [(G.E.)], the nation's largest corporation, had a very good year in 2010." (1) It reported $14.2 billion in profits with $5.1 billion coming from its operations in the United States. (2) More important than the massive profits G.E. collected are tax implications so substantial they cannot be left out. G.E. ended up paying zero dollars in taxes and actually claimed a tax benefit of $3.2 billion along with the profits it earned in 2010. (3) "While General Electric is one of the most skilled at reducing its tax burden, many other companies have become better at this as well." (4)

A 2011 study, released by the Institute for Policy Studies, revealed that at least twenty-five top United States companies paid more to their chief executives in 2010 than they paid to the federal government in taxes. (5) The study focused on the regulatory filings of the one hundred companies with the highest-paid chief executives. (6) According to the study, the companies, including Verizon, eBay, and Boeing, averaged $1.9 billion in profits and paid their chief executives an average of more than $16 million per year. (7) A variety of shelters, loopholes, and tax reduction strategies enabled the companies to evade the 35% corporate tax rate and receive an average of $304 million back in tax benefits. (8) For instance, "Verizon, which earned $11.9 billion in pretax United States profits, received a federal tax refund of $705 million. The company's chairman ... received $18.1 million in compensation." (9)

While company spokespeople disputed any noncompliance and insisted they were fully paying their fair share of taxes, the findings from the study suggest that the current United States corporate tax policy is more conducive to tax avoidance than innovation. (l0) A representative for Verizon claimed that the $18.1 million compensation was only a target that will be paid in full contingent on the rise of the company's stock and when his bonus is fully vested in three years. (11) The representative also said that the report is misleading because it fails to mention the billions of dollars in deferred taxes that Verizon will pay over time. (12) A Boeing spokesperson explained that the reason for the decline in the company's taxes in recent years is due to the huge investments it has made in U.S. Manufacturing--it has added five thousand U.S. manufacturing jobs that were incentivized by tax benefits. (13) The representative further stated that Boeing "paid hundreds of millions in cash taxes and incurred an additional $1 billion in deferred taxes that it will pay at some date in the future." (14) While it is not clear which specific accounting strategies each of these companies utilized to their advantage, it is clear that the tax shelter industry has grown rapidly over the past several years. The complexity of the Internal Revenue Code (I.R.C.) is a primary impediment that hinders the ability of the federal government to develop effective responses that will curb corporate tax loopholes.

Part I of this article gives an overview of the most frequently used corporate tax strategies, including partnership pass-through principals and carried interest. Part II discusses tax avoidance techniques put to use in a high-profile transaction that demonstrate there are few challenges that lie in the way of taking advantage of loopholes. Part III explores various existing penalties for tax-avoidance strategies and analyzes the utility and potential harm each penalty imposes on the current tax system. Part IV considers different propositions that have been introduced as a response to the tax shelter industry. Lastly, Part V evaluates tax arbitrage patterns in hopes of raising awareness and enabling detection of an industry that has escalated far beyond what was intended by Congress.

I. OVERVIEW OF FREQUENTLY USED CORPORATE TAX STRATEGIES

A. Partnership Pass-Through and Carried Interest

There are several strategies and loopholes that companies can take advantage of to secure high wages for their top executives and reduce company taxes paid to the government. …