If you have been paying attention to the news lately, you have probably heard a lot about corporations using a tax strategy called inversion. Even the President has made his feelings known on the matter recently calling the corporate tax strategy unpatriotic.
So what are corporate inversions?
Corporate inversion is a tax strategy used by companies in one of several ways in order to reduce their overall tax rate on all of their income earned outside the United States.
Those earnings are taxed in the country they are earned and in the USA. The United States is Credit: Opensourceone of the few countries in the world that does this. If that seems unfair, it is. It also discourages business expansion in the country, as well as encourages American countries to look for loopholes to reduce their burden.
This double taxation is not limited to corporations. Ex-Pats living abroad are also double taxed. Any income they earn in their new country are taxed there, and in the United States. That has lead many American citizens living abroad to reluctantly renounce their American citizenship just to get out from under the thumb of a country where they know longer live.
So why would Corporations go through the trouble of inverting some of their earnings?
Because the United States has one of the highest corporate tax rate in the world, so as individuals do, corporations look for ways to reduce their overall taxable income legally through the IRS tax code. This strategy can save billions of dollars each year in tax liability for large corporations that qualify.
Some refer to the methods used for corporate inversions one of many tax loopholes in the code, however, it is legal, whether considered a loophole or not.
However, corporations are entities for profit and just as with individuals, they look to pay as little taxes as possible. We all do this whether we realize it or not.
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How do Companies Use Tax Inversion?
If a United States corporation has earnings overseas, there are several ways they can invert those earnings to pay a lower tax rate.
One method is to reincorporate in a country with a lower corporate tax rate such as Luxembourg or the Netherlands. Those are just two of many options given that just about every other country has a lower corporate tax rate.
To implement a this strategy a corporation might allow a foreign company within a specific country to buy up its current assets and operations in that country.
Therefore, the assets and operations are transferred, and the old corporation can be dissolved.
Now the new corporation can bypass US taxes on income that is earned outside the United States.
However, tax rates are not the only consideration. Other countries may have less strict corporate governance rules.
Another method is to simply relocate all operations into another country even though the majority of your business is in the United States. The only requirement to avoid US taxes in this scenario is that a majority of your employees must be based outside the United States.
Some politicians in the United States imply that countries that pursue this legal strategy are not being patriotic by avoiding paying taxes.
Economic patriotism has a fascist twinge to it in my opinion. And remember, the earnings that are being taxed overseas are taxed in the home country first. So requiring them then be taxed in the United States is double taxation and erodes much if not all of the profit from doing business overseas.
Whenever I hear a politician saying that paying taxes is patriotic, I cringe for a couple of reasons. First, these same politicians do everything in their own self-interest just as we do. I am reminded of a situation that came to light several years ago involving our current Secretary of State, John Kerry. It seems he was caught docking one of his yachts in Rhode Island instead of Massachusetts to pay a lower tax rate.
By the way, how many of you like to be preached to about what is right or wrong by people and “paying your fair share” that own yachts and multiple homes in various locations? While they are trying to shame all of us and corporations, they are employing the same strategies to reduce their burden.
The point being, corporations and individuals looks for ways to reduce our tax burden. We all do it.
Recently, Walgreens was essentially shamed into not pursuing an inversion strategy which would have saved them about $2 billion a year in corporate taxes. Not only did they lose out on those savings, but the stock was punished the day after they announced it costing billions more in market cap.
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The solution is staring everyone in the face. Lower the corporate tax rates in the United States. Companies would repatriate those earnings back to boosting both tax revenue and employment in the country. Lower corporate tax rates spur economic growth. That is not just my opinion, it is economic fact.
So why isn’t this being done? Shameless politics.
Both sides agree that they would like to lower the corporate tax rates, but somehow it never gets done.
Still, there are hold outs. Democrats argue that corporations really don’t pay upwards of 40% corporate income because of various legal deductions and other loopholes.
While that may be the case, wouldn’t it be a lot simpler to just lower the rates and get rid of the deductions?
And while we are at it, do the same thing with individual tax rates. How many people would give up most or all of their deductions for a reduced overall tax rate. Net, net, it would be a wash on amount of taxes paid, but it sure would simplify all of our lives.
Our tax system, whether for individuals or corporations, should not be so complicated that it requires professional help for most people or businesses to complete their tax returns.
However, ignorance plays a role too. If anyone floats the idea that the home mortgage deduction will go away under a new tax plan, ignorant people start screaming. They don’t understand that their proposed overall tax rate would be much lower thereby negating the need for a home mortgage deduction.
But ignorance is here to stay and so to is our bloated, complicated and inefficient tax code I fear.
The latest corporate inversion strategy is just a symptom of a bad tax code and an increasingly ineffectual legislative and executive branch in the USA. While there is only so much an individual in Congress can do, for the life of me, I cannot understand why a President does not want to govern from the center, getting as much consensus legislation through that is good for the country, rather than constantly being under the thumb of the people that paid their way into office. Those are the type of Presidents that survive with a positive reputation in the history books.
I would like to think that the politicians could put down their talking points and actually do some things like corporate or individual tax reform that makes sense to everyone, but I am not holding my breath.
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