Originally published on Forbes.com.
WalletHub’s statement, last week, that the S&P 100 pay 28% in total income taxes was not as wildly wrong as I thought it would be given how bad their numbers are. I came up with 25.3% and I am courageously going to show my work on this speadsheet, so you can comb through it and mock me for any error I may have let creep in. I include links to my source for the tax paid. I have a check on pretax income and tax provision (or “income tax expense” or whatever else you want to call it) as I, with minor exception, agree with the percentages that WalletHub computed.
The problem is not with the computation, it is with the key number being used for the computation- “income tax expense”. The amount paid is disclosed by public companies, although it is not as easy to find as the income tax expense. The text of WalletHub’s introduction flat out states that they are computing the percentage paid and resulting coverage has reinforced this notion.
Amplifying The Error
For example, we have Bob Bryan with “These are the giant US companies that paid the least in taxes last”
We’ve compiled a list of the 18 firms that WalletHub found which reported positive income and paid less than a 20% overall tax rate in 2015.
Included on the list is Walgreens Boots Alliance with an overall tax rate of 19.9%. WBA did have a tax provision of $1.056 billion on its pretax income of $5.311 billion, but it actually paid $1.3 billion, which is 24.5%. Intel, also on the list, paid 24.2%. Merck with a provision of 17.4% actually paid 33.3%. Eli Lilly with an expense of 13.7% paid 34.7%. Chevron with an income tax expense of $132 million on $4.842 billion actually paid $4.645 billion. I’ll let you do the math on that one.
Not on the list are Apple which paid 17% while its provision was 25.6%, Berkshire Hathaway which paid 13.0% while its provision was 30.1%, ATT which paid 8.9% while its provision was 33.9%. There are more. My favorite is Facebook which has income tax expense of $2.506 billion on its pretax income of $6.194 billion and actually paid $273 million. Once again I’ll let you do the math.
William White looking at both sides gives us Corporate Tax Rates:10 US Companies Paying the Highest Taxes, 10 US Companies Paying The Lowest Taxes. I won’t belabor this one. I’ll just give you the best example. He puts General Electric at the top of the high paying list at 79.2% which comes from income tax expense of $6.485 billion on $8.186 billion of pretax income. As it happens GE paid $2.486, which is a lot of money, but only 30.4% of its pretax income.
The Number
I spoke with two of the four experts that WalletHub consulted. Being accounting professors, they knew that the income tax expense on financial statements and the amount actually paid are “two very different things”. I also spoke with Matthew Gardner of the Institute on Taxation and Economic Policy. He summed up the problem pretty well. The “income tax expense” is an easy number to find. In looking at the tax burden of a corporation, though, it is probably not the right number.
To really understand the tax provision you need a course in advanced accounting. The design of the system is to force companies to fairly present the results of their operations not to disclose how much they are paying in taxes. There are three concepts that can cause the provision to sharply deviate from the amount actually paid. They are deferred taxes, income tax benefit of stock options, and uncertain tax positions. I’ll give a very brief explanation of those three.
Better To Owe It To You Than Cheat You Out Of It
The income tax provision is required to include what I would call an audit cushion. In figuring income tax expense, you have to assume you are going to catch the auditor from hell and that you won’t be able to outsmart her and that the IRS lawyers will be better than your lawyers.
Pay Me Later – Maybe A Lot Later
The timing of income and expense is different in GAAP accounting and tax accounting. In computing the income tax expense you, in effect, prepare a return as if they were the same and the difference in tax is set up as an asset or a liability. If it is an asset it has to be evaluated for whether it will be really used in the future. To take an extreme example Berkshire Hathaway has over $60 billion as a deferred tax liability and it keeps growing. So that 35% you thought Warren Buffett has paid through his company. There is about $20 billion of it that has not been paid yet.
The Stock Options
This one is really weird and has both me and Mr. Gardner scratching our heads. The GAAP deduction for stock options can be a lot lower than the tax deduction and that is something that never reverses. Since you should not be able to increase your earnings by dealing in your own stock GAAP forces the benefit of that deduction to be reversed in figuring income tax expense with the offset being a contribution to capital.
Here is the scenario. Joe was issued a stock option a long time ago. The company took the value of the option, which was probably negligible as a book deduction but had no tax deduction. Years later the company’s value is way up (think Facebook). Joe exercises the option and immediately sells the stock. Joe picks up income for the fair market value of the stock and the company gets an equivalent deduction, without putting out any cash.
You can make a case for this being sound tax accounting. Imagine that the company instead of giving Joe the stock that he sold to Harry had issued stock to Harry and used the proceeds to pay Joe. The company and Joe would be in the same tax position. They don’t do it that way, because the company’s GAAP earnings would be a lot lower.
Regardless, of the merits of the tax policy, the accounting adjustment makes the company look like it is paying a lot more tax than it really is. Facebook has had substantial provisions over the last few years, but, given the significant carryovers they disclose, it is quite possible that they have never actually paid any federal income tax, which brings us to why we don’t know whether they have or not.
The Other Number
Public companies are required to disclose the total amount of income tax actually paid. They do not have to provide a breakdown. It is a required disclosure, but not part of the statements, so you sometimes have to hunt for it. It can be at the bottom of the statement of cash flows, in the income tax note, in the note on the cash flows or in some sort of supplemental schedule.
Public companies have to disclose why the income tax provision differs from the hypothetical 35%. They do not have to explain why it differs from the amount paid.
I think in looking at what companies are contributing to the community through tax payments and what their real income tax burden is, the amount paid is a better indication than the “income tax expense”. Although it is not broken down, at least the total is disclosed. And I would say that if you are talking about what was paid. You should use the number that was paid.
Why Is This Important?
If like a lot of people you care about income and wealth inequality getting out of hand, understanding how income taxes actually work might be a useful thing. If you look at some of the top people on the Forbes 400 like Warren Buffett, Bill Gates and Mark Zuckerberg, you will note that much of their net worth is in the companies that they built and is in the form of unrealized appreciation. That is wealth growth that they have never paid income tax on and probably never will.
Yes. But their corporations pay income taxes. I mean look at WalletHub. WalletHub says Facebook paid 40.5% of its income in taxes, Berkshire Hathaway 30.1%, and Microsoft paid 34.1%. Only as it turns out that is not what they paid. Facebook paid 4.4%, Berkshire 13.0% and Microsoft, being real sports, paid 23.8%. That is all in federal, state, and foreign.
They all pay a lot less than my friend James (not his real name) who gave me permission to use his return as an example. He makes about $125,000 a year and all in including federal, state and self-employment tax pays over 30% of his income in taxes.
Like my blogging buddy Joe Kristan, I’m not that concerned about inequality. People having too much does not bother me. It is only people not having enough that I find troubling. But. There is this concern that we’ve lost the world where “Every child had a pretty good shot to get at lease as far as his old man got”. Not that we ever totally had it, but it sure worked that way for many of my classmates.
The current presidential candidates represent two factions of our elite. One is those born with access to capital who have some entrepreneurial flair. The other is the kids who got good SAT scores and worked hard in school and didn’t screw up too much. It seems like a variety of circumstances are constricting the options of poor smart kids who work hard. If they are lucky, they grow up to be adjunct professors and remain poor. Perhaps they will study STEM subjects and have a few golden years before whatever they do is outsourced. Public accounting has been good to me – next generation, maybe not so much.
]To the extent we think what corporations are paying in taxes might be relevant to all this, we should probably look at what they are actually paying. Just saying.
About The Numbers
My spreadsheet lists the same companies as WalletHub and computes the percentage relationship between income tax expense and earnings as they did. It also includes the amount paid. The ticker symbol has a link to the source for the amount paid, which can be in a variety of places on a company’s 10-K. If the link sends you to a long document there is a column that gives you a page number.
It is really 99 companies, not 100, because Simon Property Group is a REIT, which does not pay corporate income tax. I have striven for accuracy, but if an error crept in you should mock me mercilessly. I doubt there is any substantive problem in the numbers. WalletHub did not use the most recent numbers for fiscal year companies and I have followed their lead in that, although my links are to the most recent 10-K which includes prior year numbers.
You may not be able to open the spreadsheet. If so, you have my apologies. I am working on getting it into a more convenient form