Tax rates vary from person to person depending on where you live and your annual income. The same variations exist in the world of corporate taxes. On paper, the United States has the highest overall tax rate of any of the world’s developed economies. The federal rate is 35 percent, but corporations are also subject to state and sometimes local taxes depending on where they are incorporated. Most companies, however, don’t actually pay the 35 percent corporate tax rate because of certain tax breaks. In fact, in 2012, the effective tax rate was just 12.1 percent, the lowest it has been since World War I.
That 35 percent tax rate is still daunting, and with tax breaks also offered in foreign countries, many corporations are finding ways to change their citizenship. While the process is called an “inversion,” it’s really just a complicated tax evasion scheme. This is how an inversion works: an American corporation buys a smaller foreign rival from a low-tax country. Instead of the larger, American company remaining as the parent, the smaller company becomes the parent corporation. The newly incorporated combination (the “inverted company”) is a foreign company even though it is actually headquartered in America and controlled by Americans.
As a newly created foreign company, the inverted company is no longer subject to American tax rates. Instead, it is subject to the lower rate of that foreign country. According to the Congressional Research Service, 76 U.S. corporations have shifted their tax domiciles out of the United States since 1983. Forty-seven have occurred in just the last decade and many more are currently in the works. For example, Medtronic Inc., a major U.S. medical manufacturer, is looking to buy Covidien Plc, which is based in Ireland. Other examples of “Top American corporate tax avoiders,” according to Fortune magazine, include Perrigo PLC, Endo International, and Actavis PLC.
According to the Joint Committee on Taxation, inversions will create a $19.5 billion loss in taxes during the next 10 years. The big question, then, is how to fix this problem. Congress can address the issue in two ways: reduce the overall corporate tax rate, or make it more difficult for American-born corporations to switch their citizenship. There has been some back and forth debate over the taxation rate for the past few years, with no actual progress. One major factor to consider in the debate is payroll taxes. There has been a marked change in where federal revenues come from in the last 60 years. Between 1952 and today, payroll taxes increased from 9.7 percent of federal revenue to 34.5 percent. As Nick Jacobs, a spokesman for the Financing Accountability & Corporate Transparency Coalition, said:
You can advocate all you want for lower corporate tax rates, but if corporations pay less, the burden has to shift to somebody, and that means individuals and small, domestic businesses.
As for the other option, some restrictions are already in place, but so far they do not appear to be working well enough. In 2004, President Bush signed legislation into law that was intended to deter American companies from dodging U.S. taxation, but it hasn’t stopped inversions. Now, there is legislation pending that would add more force to the existing law. The bill contains some adjustments to the original law, but has these two major changes:
• One empowers the IRS to treat the inverted company as American for tax purposes if it continues to conduct significant business activity within the United States.
• The second is a “headquarters” test that would require companies to move most of their executives and management overseas if they want to escape U.S. taxation.
Proponents of the bill say it will save billions of dollars by reducing inversions to a trickle, if not completely stopping the practice. Opponents, on the other hand, are convinced that the bill does not do enough to correct the underlying problem: the U.S. corporate tax code. While the bill may prevent American corporations from going overseas seeking reduced taxes, it does nothing to encourage new business (and, thus, more jobs) from starting up in the U.S.
Despite the opinions of its detractors, most Americans seem to favor the bill. While it may not be a perfect solution – it still does not address the underlying corporate tax issues that prevent new companies from choosing to be United States domiciliaries – it is a step in the right direction. The law would help keep American companies American and put a stop to their tax-dodging practices. If you need more information on this subject, contact Rebecca Gilliland, a lawyer in our firm, at 800-898-2034 or by email at Rebecca.Gilliland@beasleyallen.com.
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