Recently, I was pleased that the Omaha World-Herald mentioned my coverage of the most recent Warren Buffett-Donald Trump blow-up. I was less pleased by this sentence in the story “Berkshire paid $10.5 billion in income taxes last year”. That is wrong. It is understandable though. Like a certain presidential candidate, publicly held companies don’t release their tax returns. The companies do, however, tell my buddy EDGAR a lot about their income taxes including what they paid in total to the federal government, the states, and foreign countries.
Ask EDGAR
EDGAR is not actually a friend of mine. EDGAR stands for Electronic Data Gathering, Analysis and Retrieval, a service provided by the SEC, which I really like because it is, you know, free, to the users anyway. You can learn a lot about companies from EDGAR including how much, in total they paid in income taxes, as noted above.
The total income taxes paid is not, however, a featured number and it is not broken down, so I really can’t tell how much the companies pay in federal income taxes. The number that gets focused on is the “income tax expense” which is what goes into computing “net earnings”. There is a fairly elaborate explanation as to why the “income tax expense” differs from the hypothetical 35%, that people who don’t look at all think corporations pay. There is no explanation for why it differs from the amount paid, although it is possible to tease out some of the major differences.
I think a lot of quite sensible people after hearing about how “income tax expense” is arrived at would conclude that it is a “made-up number”, because its connection to what is paid or even, in some cases, whatever will be paid is pretty tenuous.
We’ll start with Berkshire Hathaway since that is the one that sent me down this rabbit hole. I should probably mention that a rather large portion of my unimpressive net worth is in Berkshire Hathaway stock.
About Berkshire Hathaway’s Income Tax
In computing its reported earnings under Generally Accepted Accounting Principles BH provided for a deduction from reported earning (pretax $34.9 billion) of $10.5 billion in income taxes – 30%. This is explained in some detail in Note 15 (Income Taxes), where you will find that the largest element in the difference in the provision from the hypothetical 35% is the special treatment of dividends received by corporations.
In Note 13 (Supplemental cash flow information) you will find that the amount actually paid for income taxes was $4.5 billion- 12.9%. The relationship between the provision and the amount paid is similar in the previous two years.
How’s That?
The biggest item that creates this difference is that BH can write off equipment more quickly for tax purposes than it does for book purposes. The tax provision in the income statement is based on what the tax would be with slower write-offs. Over time for any particular asset this difference will turn around, but BH year in year out places more property in service than it retires (at least on a dollar basis). So its deferred tax liability, which is mostly due to depreciation differences continues to grow.
It is not just Berkshire that has a such a sharp difference between the amount of the provision for income taxes and the amount paid. Let’s run through the S&P 500 companies that have weighted market capitalization greater than Berkshire Hathaway. There are six Apple, Microsoft, Exxon Mobil, Johnson & Johnson, Amazon and Facebook.
Apple – Provision 26.4% – Paid 18.3%
Apple on pretax earnings of $72.5 billion had a provision for income taxes of $19.1 billion, an effective rate of 26.4%. The major reason that that differs from the $25.4 billion “expected” from a 35% rate is $6.5 billion attributable to indefinitely invested earnings of foreign subsidiaries. It paid 13.3 billion – 18.3%.
There is not a real clear road map to tease out the $5.8 billion difference between the provision and the amount paid. Less than a billion of it is in the change in deferred taxes. A couple of billion might be in “Uncertain Tax Provisions”, another somewhat mind-boggling concept. In computing “income tax expense”, accountants will assume that the company will catch the auditor from hell who will smoke out all the shaky positions and that there will be a deficiency. In other words “income tax expense” contains an audit cushion of sorts.
Back in the day, companies could use the audit cushion to fine tune net income to make them seem like they were growing smoothly. Maybe they still do that, but the rules make it harder.
There is one more item that shows up in companies like Apple. When stock is issued to employees from the exercise of options, Apple gets a tax deduction. The benefit of that deduction is pulled out of the provision, increasing it, and treated as contribution to capital. The idea is that you can’t have reported earnings even indirectly as a result of issuing stock. Unlike the deferred taxes, that amount will never reverse. So for 2015 Apple has $748 million in its tax provision that will never be paid.
Microsoft – Provision 15% – Paid 19.7%
For the year ended June 30, 2016 Microsoft reported $19.8 billion in pretax income and a provision of $3.0 – 15%. Unlike Apple and prior years for Microsoft, there was no tax benefit from stock-based compensation booked to capital. Almost all of the difference between the 15% and the hypothetical 35% is the result of foreign income being taxed at lower rates. Microsoft actually paid more than the provision – $3.9 billion – 19.7%. I have not been able to trace down the reason for the difference.
An interesting tidbit in the tax disclosure is that the $19.8 billion pretax income is made up of foreign income of $20.1 billion and a loss in the United States of $0.3 billion.
Exxon Mobil showed pretax income of $22.0 billion and a tax provision of $5.4 billion – 24.5%, apparently, but in the tax notes Exxon brings in the tax provision of entities in which it has a non controlling interest, somehow getting it to work out to 34%. Like Microsoft the bulk of Exxon Mobil’s pretax income ($21.8 billion) is foreign. Exxon Mobil’s payment for income tax was $7.3 billion, but they don’t explain how the non controlling interests fit into that, so I don’t think I can give you a percentage, since the denominator is not clear. Regardless, the discrepancy between Exxon Mobil’s provision and its payment is probably not that large.
Johnson & Johnson Provision 19.7% – Paid 14.9%
J&J reported $19.2 billion in pretax income and a provision for income taxes of $3.8 billion – 19.7%. It paid $2.9 billion – 14.9%. Most of the spread between the provision and the hypothetical 35% is due to foreign earnings. The difference between the provision and the amount paid may be in deferred taxes and unrecognized tax positions, but the trail is difficult to follow.
Amazon – Provision 60.5% – Paid 17.4%
Amazon is an interesting case. The company reported pretax income of $1.6 billion and a tax provision of $ 950 million, which works out to a whopping 60.5%. This is mainly explained by the fact that there were losses in foreign subsidiaries dragging down pretax book income but not taxable income. They paid a more reasonable $273 million – 17.4%. Amazon actually has a net deferred tax asset (That means that on net it has more write offs from book income that have not been taken for tax purposes than visa versa). That asset going down accounts for some of the difference between the amount paid and the provision. The reserve for uncertain tax provisions also increased.
Amazon included federal net operating losses as deferred income tax assets, so it may be a while since they have paid any federal tax.
Facebook Provision 40.3% – Paid 4.4%
Facebook reported $6.2 billion in pretax income and an “income tax expense” of $2.5 billion – 40.3%. It actually paid $273 million – 4.4%. The dramatic spread between the provision and the amount paid is the tax effect of stock compensation of $1.7 billion that does not run through the income statement.
Facebook has $2.7 billion in federal net operating loss carryovers. I think that it is likely that Facebook, at least since it went public, has never actually paid any federal income tax, in spite of substantial provisions. Facebook provides the best case for “income tax expense”being “a made up number”. In a case like this “income tax expense” really has almost nothing to do with what might actually be paid, ever.
Who Is Getting Paid?
Companies disclose the breakdown of their tax provisions, but not of the amount paid. There might be a way to infer the breakdown, but I have not figured it out. Maybe one of my commenters will embarrass me with an obvious answer. It will be worth it.
FASB has issued a proposed accounting standard that would require more detailed tax disclosures. Included in those disclosures would be the “amount of income taxes paid to any country that is significant to the total income tax paid”. PWC in its release on the proposed standards coyly notes:
Although many of the proposed disclosure requirements codify existing SEC disclosure requirements, certain of the new disclosures will make information public that was not previously available. Companies should consider how the additional disclosures may be utilized and interpreted by various stakeholders
Do Income Tax Provisions Make Any Sense?
The best thing about income tax provisions from my point of view is that they are a kind of white collar jobs program. Tax provisions allow the people in the tax department to work with the auditors. A lot of intellectual firepower goes into getting those numbers right. The origin of these rules is a concern about having reported earnings clearly reflect results operation. As you can see, though, they have become pretty detached from what a company actually pays in income taxes.
This creates a kind of apples to oranges problem when you compare someone like Warren Buffett or Mark Zuckerberg to Donald Trump. The net worth of founders like Buffett or Zuckerberg (I know that Buffett did not actually found Berkshire Hathaway, but he certainly molded it into what it is now) is largely in the unrealized appreciation of their stock in their companies. Commentators observing that will say – “Oh but their corporation has to pay 35%”. Only it turns out that the provision for income taxes is generally lower than 35% and more often the amount actually paid is even lower, often a lot lower. And we know the total amount paid, but not the breakdown making how much is paid in federal tax something of a mystery.
Things will get interesting if the FASB proposal is implemented. You might not go digging in EDGAR to find out whether Facebook ever paid anything, but you can count on me to.