President Joe Biden’s plan to tax profits reported by corporations to investors will likely distort incentives for financial reporting, provide shareholders with less transparency and raise difficult implementation issues.
Biden’s infrastructure proposal would apply a minimum tax of 15% on profits that corporations report publicly on their financial statements, known as “book income.” The goal of the proposal — which is similar to legislation previously backed by Sen. Elizabeth Warren (D-Mass.) — is to tax companies, such as Amazon.com Inc., that report large profits to investors but pay little or no federal government. income tax.
But tax and accounting professionals said companies’ taxable income is often much lower than their accounting income due to credits and deductions allowed by the tax code, such as write-offs for operating losses. sharp. And if the problem is the tax code, the administration should focus its attention there, they said.
“If Congress thinks the tax code is broken, they should fix it instead of finding something else to tax, which would break that other thing,” said Jeff Hoopes, associate professor and accounting researcher at the University of North Carolina. Kenan Flagler School of Commerce.
He and others said taxing companies’ reporting on their financial statements would likely encourage those companies to manage their earnings, leading to less useful information for investors. It could also encourage companies to seek changes to financial accounting standards to narrow the gap between accounting income and taxable income, they said.
These potential consequences and the challenges of implementing this type of tax are issues the Biden administration will have to grapple with as it moves forward with its proposal. Getting the plan through Congress will be complicated. House Speaker Nancy Pelosi (D-California) hopes the House can pass the package by July 4.
Amazon CEO Jeff Bezos in a declaration said the company supports Biden’s focus on infrastructure investment and an increase in the corporate tax rate to pay for it.
Everything in the details
The Biden administration offered new tax details in a report released on Wednesday. The tax would apply to companies with net book income of $2 billion or more, or 180 companies, according to the report. Biden campaigned on a much smaller $100 million threshold that would have subject more businesses to the tax.
About 45 of the companies meeting that higher threshold would have owed the minimum tax in recent years under the Biden proposal, with the average seeing an increase in liability of about $300 million per year, according to the administration. Those estimates assume other parts of the plan, particularly international tax provisions aimed at preventing companies from shifting profits overseas, are enacted, a Treasury official said in a call with reporters on Wednesday.
To assess their liability, companies would calculate the 15% tax on their book profits and their regular tax liability. They would compare the two numbers and pay the difference to the IRS if the accounting income tax was higher. Companies would get a credit for taxes paid above the minimum accounting tax threshold in previous years for general business tax credits – including research and development, clean energy and housing tax credits — and for foreign tax credits, the administration said.
Allowing some credits reduces the bite of the minimum tax, said Erica York, an economist at the Tax Foundation’s Center for Federal Tax Policy.
But there are still complicated details that the administration must iron out. For example, the tax code allows accelerated depreciation, which allows companies to write off more of an asset’s costs in the first few years of use. When calculating book income, these expenses are generally spread evenly over the life of the asset. The proposal did not specify how the new tax will account for these types of timing differences, York said.
“The minimum book income tax is something that sounds really appealing but ends up being quite difficult to implement,” said Victor Fleischer, a professor at the University of California, Irvine School of Law. Fleischer served as Democratic chief tax adviser to the Senate Finance Committee from 2016 to 2017.
Because it’s so difficult, it may be harder to move forward than some of the other changes proposed in Biden’s infrastructure plan, Fleischer said. “I won’t say it’s impossible, but it would be a tough road,” he said.
Manage profits down
The Biden administration would not be the first to try to levy corporations that use tax breaks to reduce or completely eliminate their federal tax bills.
The corporate alternative minimum tax, which was eventually repealed under the Republican-led tax law of 2017, was an attempt to address this issue. Under such a tax, corporations calculate their taxable income twice – once to determine their normal liability applying all permitted credits and deductions and a second time under AMT rules, which prohibit certain tax breaks. . Companies then pay the highest tax.
A corporate minimum tax was first introduced into the tax code in 1969. It was overhauled under the Tax Reform Act of 1986 and called the Alternative Minimum Tax. The 1986 Act also added a book income adjustment to the AMT from 1987 to 1989. Under this rule, if a company’s net book income exceeded its taxable income under the AMT rules, 50 % of the difference was added to the income of the AMT.
To research showed that in response to accounting income adjustment, firms manipulated their financial reports to reduce their AMT burden.
Businesses would likely react similarly to Biden’s new accounting income tax, Hoopes said. “Not only has this happened before, but we tried it, and it didn’t work.”
Financial accounting numbers will be less meaningful to investors if companies manage their earnings, which will force them to make less informed decisions, he said.
Inject more politics
There are concerns that Biden’s proposal could spur more companies to push for changes to financial accounting standards, known as generally accepted accounting principles, or GAAP, that would reduce accounting income, Fleischer said. Companies might not be embarrassed to report lower profits to shareholders if it means they have to pay less tax, he said.
Companies would then likely put more emphasis on unofficial or non-GAAP earnings numbers to tout their performance as more optimistic than the sanctioned numbers suggest.
“If you think non-GAAP is popular now, watch what happens when they start going down that road,” said David Zion, research analyst at Zion Research. “That would be non-GAAP on steroids.”
US accounting standards are set by the Financial Accounting Standards Board, a private sector nonprofit organization based in Norwalk, Connecticut, recognized as a standards setter by the US Securities and Exchange Commission.
Independent standard setting is the cornerstone of US markets. If companies tie their cash taxes to the income they report in their financial statements, each new FASB rule is tinged with questions about the tax implications, said David Gonzales, senior accounting analyst at Moody’s Investors Service.
“It would add another wrinkle to financial statement decisions to say, ‘oh, if we change that in the financial statements, how will that affect the amount of income tax this company pays? he said.
Zion said this gives accounting decision makers a lot of power.
“You would have effectively had the FASB setting tax policy, and the last time I looked, nobody elected them to do that job,” he said.