Just Taxes Blog by ITEP

Corporate Tax Avoidance Is Mostly Legal—and That’s the Problem

Corporate Tax Avoidance Is Mostly Legal—and That’s the Problem

December 19, 2019

Steve Wamhoff
Steve Wamhoff
Director of Federal Tax Policy

Corporate Tax Dodging Happens Because Congress Allows It to Happen

As usual, corporate spokespersons and their allies are trying to push back against ITEP’s latest study showing that many corporations pay little or nothing in federal income taxes. One way they respond is by stating that everything they do is perfectly legal. This is an attempt by the corporate world to change the subject. The entire point of ITEP’s study is that Congress has allowed corporations to avoid paying taxes, and that this must change.

Anyone who reads ITEP’s corporate study will find detailed explanations of how Congress must change the law to ensure that corporations pay. Alright, we get it, the study is a little long. For your convenience, we also provided a two-page executive summary, and you will find that the recommendations on the second page all involve Congress changing those very laws that corporations use to avoid taxes.

People who read our reports know full-well that we are not suggesting that corporations are breaking the law. If we believed that was the case, we would call only for better enforcement of existing laws. The fact is, the existing law, including the changes brought by the Trump-GOP tax law, is a mess crying out for the types of reforms that we suggest.

What Is Legal?

That being said, the question of what is or is not legal is not entirely cut and dry. The techniques a person or company could use to not pay taxes fall into a few different categories.

Clearly Legal
When a company uses the expensing provision enacted as part of the Trump-GOP tax law to deduct the full cost of equipment in the year purchased, that obviously is legal, even if it allows the company to pay nothing at all for several years.

Most corporate tax avoidance falls in this category. Even some practices that seem particularly shady, like accounting gimmicks that make profits appear to be earned in tax havens like Bermuda or the Cayman Islands, are generally practices that the courts have long allowed.

Which is another way of saying, if you are looking for someone to blame for corporate tax dodging, mainly you should look to members of Congress.

A Legal Gray Area
On the other hand, there are plenty of instances where companies make claims on their tax returns that may be challenged by the IRS, perhaps successfully. It’s possible that the IRS will step in and block some of the tax breaks that companies claimed for 2018, meaning some companies will eventually pay more for the year.

Of course, the current tax system often favors the corporations when they step into legal gray area. For example, if a company sells the patent for an invention to its offshore subsidiary for what seems like an artificially low price, and then pays royalties to the offshore subsidiary at what seems like an artificially high rate, the effect is to shift profits offshore. But how often can the IRS prove that the company is doing something wrong?

If the patent is for a new invention (which often happens in the world of tech or pharmaceuticals, for example), the IRS may be hard-pressed to find a comparable transaction between other companies that would prove that something is off about this arrangement.

We recently discussed this question with Ed Kleinbard, a law professor at the University of Southern California who formerly ran the Joint Committee on Taxation, which is Congress’s official revenue estimator. As Kleinbard explained:

“To say that corporations are acting ‘legally’ when they take steps to slash their tax bills betrays a fundamental misunderstanding of how things work. Corporate tax law, particularly international tax law, is an area filled with ambiguities in the law, the relevant facts, and how those facts apply to the law. Corporations thrive in this fog of uncertainty, because they control not just the facts, but how those facts are presented to the IRS, and because they can afford armies of experts to shape the narratives and argue their cases. The results might be ‘legal,’ but they often are far afield from what Congress expected.”

Clearly Illegal
If you decide to simply stop reporting income to the IRS, that is a crime. If you decide to hide income from the IRS, by not reporting it or by funneling it into a secret account in the Cayman Islands or Bermuda that you do not report to the IRS, that is a crime. Big publicly traded corporations usually are unlikely to engage in anything like this. A CEO is not going to risk prison, particularly when there are so many legal ways for corporations to avoid taxes. Corporate apologists often seem to pretend that ITEP is accusing corporations of engaging in practices like this that are clearly illegal and even criminal, which is obviously a red herring.

Are Corporations or Their Leaders Morally Culpable?

The question some people seem to be asking is simply, who is at fault? As already explained, corporate tax dodging happens because Congress allows it. And it really makes no difference who is to blame because the question going forward is how to fix our tax laws.

But if corporate leaders want to pretend that they play no part in the mess of a tax code we face today, well, that’s just dishonest. Members of Congress are responsible for the mess, but they get their bad ideas from corporate lobbyists.

We saw this during the debate leading to the passage of the Trump-GOP tax law. As a recent New York Times profile of FedEx’s role in the 2017 tax debate made clear: companies made extravagant, rosy promises about job creation and capital investment bonanza that would follow if Congress cut taxes according to their instructions—promises that remain, so far, largely unfulfilled. Corporate leaders like Tim Cook and his acolytes promised that corporate tax cuts would boost economic growth, which has not happened. Put another way, corporations aren’t just following the law—in many cases, they wrote the law.