Among the staggering revelations to emerge from the Enron Corp. debacle: The now-bankrupt Houston energy company wiped out much, if not all, of its tax liability despite reporting nearly $2 billion in profits from 1996 through 2000.
Some analysts believe the company may have paid a small amount of tax--and Congress has begun an investigation to find out. But one thing is clear: Enron is hardly alone in finding creative ways to slash taxes. Scores of highly profitable U.S. corporations pay little or no federal tax despite ringing up billions in profits and facing a tax rate of 35%. How? By aggressively using tools as diverse as tax shelters, deferred taxes, balancing current income against past-year losses--and handing out stacks of stock options.
That is the conclusion of a study by the Institute on Taxation & Economic Policy, a liberal Washington research group. It found that 52 of the 250 biggest U.S. companies paid effective tax rates of 10% or less in 1998, the last year for which such economywide data are available. Nearly half of those paid no tax or got refunds.
BusinessWeek asked one of the study's authors, Robert McIntyre, to update the numbers to reflect 1996-2000 taxes and earnings. His findings: Such companies as General Motors (GM ), Navistar International (NAV ), El Paso Energy (EP ), and Colgate-Palmolive (CL ) appear to have slashed their taxes over the period.
ITEP's results are controversial. It based its calculations on the tax liability that companies reported to shareholders but adjusted for options, deferred taxes, and other items. While Navistar International Corp. and General Motors Corp. agree with the basic analysis, others do not. Colgate-Palmolive Co. contends it paid millions in federal taxes but won't provide specifics. El Paso Energy Corp. says it paid $437 million in federal taxes on $1.3 billion in earnings and argues ITEP didn't properly account for recent acquisitions.
Truth is, figuring out how much tax a company actually pays is almost impossible. Tax returns are not public. And financial statements often hide tax payments. Says Robert Willens, an accounting expert at Lehman Brothers Holdings Inc.: "Tax disclosure is just inscrutable."
Nearly all corporate tax avoidance is perfectly legal. Some companies, such as Navistar, the Warrenville (Ill.) maker of trucks and engines, used past losses to reduce current tax liability. "This is like a bank account," says Controller Mark T. Schwetschenau, who adds the company has reinvested the cash-flow windfall into new equipment. GM used credits earned during the unprofitable early '90s to lighten taxes later in the decade.
Similarly, Goodyear Tire & Rubber Co. (GT ) trimmed its tax liability in part by writing off a failed pipeline investment. Still, Goodyear says it paid more taxes than ITEP reported. "It just doesn't show up anymore because we restated the numbers," explains a spokesman.
But the hugely profitable General Electric Co. (GE ) managed to slash its tax bills, too--in part by deducting more than $2 billion for options compensation. When an employee exercises an option, a company can deduct the difference between the price the worker pays and the stock's market value. By deducting the cost of options, companies are reducing their taxable income by about a quarter.
GE was also able to push much of its taxable income into future years, mostly through its financing arm, GE Capital. Known as deferral, this technique is commonly used, allowing many businesses to delay paying taxes indefinitely on some income, such as overseas earnings. But GE says ITEP incorrectly "accepts the premise that deferred taxes aren't taxes."
These companies are not alone. From 1995 to 2000, corporate earnings jumped by more than a third, but taxes rose by only about 17%. As a result, the spread between book income and taxable income is widening. Harvard University economist Mihir A. Desai estimates that just among companies with assets in excess of $250 million, book earnings in 1998 exceeded taxable income by a staggering $287 billion.
Many financial experts believe the biggest reason may be the burgeoning use of shelters. Such techniques may shift income offshore or turn taxable equity into tax-deductible debt. Desai figures that more than half the difference between tax and book income is generated by shelters, the careful shifting of earnings from one year to another, and outright fraud.
Enron used one device, called trust preferred securities, that was widely sold by Wall Street in the '90s. They were reported to the Internal Revenue Service as tax-deductible debt, but disclosed to shareholders as equity. This allowed Enron to carry as much as $3 billion less debt on its books, while slashing its tax bill. The IRS challenged these transactions in 1996, but dropped its case a year later. Enron would not respond to requests for comment.
Of course, if tax deductions are available for the taking, sophisticated lawyers, accountants, and financial officers will grab them. They owe shareholders nothing less. The trouble is, the tax code has become so riddled with loopholes that tax avoidance has become a profit center of its own. Enron may be a dramatic example of how a company can use legal loopholes to dodge taxes, but it is far from the only one.
By Howard Gleckman in Washington, Dean Foust in Atlanta, Michael Arndt in Chicago, Kathleen Kerwin in Detroit, and bureau reports