How Corporations and Billionaires Use IRS Codes to Minimize Their Tax Burden

The question of why corporations and billionaires often pay little to no income tax is a complex one, rooted in the convoluted and often poorly written IRS code. This code, crafted by Congressional staffers and influenced by lobbyists, is subject to interpretation by tax professionals and large corporations who are incented to minimize their tax liabilities. The result is a legal framework that allows for significant tax avoidance, which, while not illegal, is a subject of increasing scrutiny.

The Problem with Tax Law

The first challenge is the process by which tax laws are created. Congressional staffers and lobbyists draft the laws, which are then passed by elected representatives and signed into law by the President. Given the complexity and the interests at play, it is often believed that the best and brightest in the tax industry are not the ones crafting these laws. Instead, they are either already highly compensated consultants or moving towards consultant roles within corporations.

These consultants can spend millions of dollars and hours to find the most efficient ways to minimize taxes for their clients. This practice of minimizing taxes, legally known as tax avoidance, is widespread and accepted within corporate structures. However, it is important to distinguish between tax avoidance and tax evasion, which is illegal.

How Tax Avoidance Works

Tax avoidance essentially involves legal strategies to reduce one's tax liability. A common method is to create a series of financial transactions that maximize the available deductions or losses. For example, corporate entities can use techniques to report significant losses, which they can carry forward to offset future gains.

One straightforward yet effective method is to strategically lose money in a given period and report those losses. This strategy is commonly referred to as 'money loss tax avoidance.' Here's how it works in practice:

Lose Money in the First Year: A corporation can invest in equipment or assets, which can be expensed over a period. By strategically losing money in the first few years, the corporation can offset future profits with these losses. Generate Profits Later: Once the losses are carried forward, future profits can be reduced or nullified. This strategy, while effective, requires long-term strategic planning and investment. Profit offset: When carried forward losses are offset against future gains, the corporation can achieve a tax-free period, or at least a significant reduction in the tax burden.

A Practical Example

Let's consider a simple example to illustrate this strategy:

Year 1: A new company invests 200 million in plant and equipment with a 10-year useful life. In the first year, there is no revenue, and the investment is expensed at 20 million. Thus, the earnings for the year are negative 20 million, and no tax is payable. Year 2: Revenue of 20 million but cost of goods at 10 million. The loss from the previous year (20 million) is carried forward, so the earnings are again negative 10 million, and no tax is payable. Year 3: Revenue of 50 million and cost of goods at 25 million. The investment is expensed at 20 million, resulting in positive earnings of 5 million. However, the remaining 20 million loss carries forward. Year 4: Revenue of 100 million and cost of goods at 50 million. Continuing the expense, the positive earnings from the 3rd year (5 million) plus the carry-forward loss (25 million) means only 30 million is taxable, and taxes are due. Years 5-10: The investment continues to be expensed, and profits are offset by the accumulated losses. In the 10th year, the full 20 million can be expensed, resulting in a profit of 30 million, which is taxed. Year 11: No further investment expenses, 100 million in revenue, 50 million in cost of goods, resulting in a profit of 50 million, subject to tax.

By converting the example to billions, the principle remains the same. The key is strategic loss carryforward to offset future gains, ensuring that tax liability is minimized.

The Implications and Criticism

While this strategy is a testament to the complexity of tax law, it is also a source of frustration for many who believe that corporations should pay their fair share. Critics argue that the current system unfairly benefits the wealthy and large corporations at the expense of the general taxpayer. The Forbes article on how big corporations avoid paying taxes highlights this issue.

Additionally, the concept of legacy losses from highly variable earnings, like commissions, was simplified in the 1986 tax reform act. Progressives who advocate for higher tax rates often neglect to mention that some of the benefits of these reforms were also lost.

The current tax avoidance strategies, while legal, have sparked debates and calls for reform. Understanding how these strategies work can provide insights into the complexity of the tax system and why it remains a contentious topic in policy discussions.