FT Alphaville " All the best tax breaks are Made in America While in some countries avoiding tax is a national pastime, in America the government offers all manner of mechanisms to reduce one's bill. From deductions on mortgage payments, to the low rates on long-term capital gains that private equity moguls benefit from, to generous accelerated depreciation methods on a wide range of property. Thinking the last one we mentioned isn't terribly exciting? Well, it is. Let us explain it to you. Before we do that, though, we'd like to note how this came to our attention. It was via a story on Reuters on Monday that reported on a study done by the Citizens for Tax Justice (CTJ) - an organisation that describes themselves as a: ... public interest research and advocacy organization focusing on federal, state and local tax policies and their impact upon our nation. CTJ's mission is to give ordinary people a greater voice in the development of tax laws. Against the armies of special interest lobbyists for corporations and the wealthy, CTJ fights for: ♦ Fair taxes for middle and low-income families ♦ Requiring the wealthy to pay their fair share ♦ Closing corporate tax loopholes So it's an interest group/lobby, shall we say, that's fighting Shredder and the Foot Clan other interest groups and lobbyists. Here's the headline table from their report: All of these companies are in the Fortune 500 and there they are not paying US federal taxes over a four year period. The back of the report has notes on some of the main sources of the tax breaks in use, on a company-by-company basis. Trying to disentangle US federal taxes from tax disclosures in 10-Ks is like pulling teeth, so it's quite an admirable effort. One of the things that stands out in the notes to the analysis is the use of accelerated depreciation methods for calculating one's tax bill, which is why it's worth understanding exactly what that method is. To get really basic about it, say that we start a company, Alphaville Inc, and we buy a machine (the "Blogprinter") for £100,000. The machine uploads all of our blog entries over the week, then prints them out and binds them in a nice book. We sell the books. Let's look at our income statement for tax purposes (read: NOT ACCOUNTING), shall we? The below also contains some miscellaneous Alphaville expenses. The above assumes a standard straight-line depreciation method over about six years and zero salvage value for the Blogprinter, hence an expense of £16,000 in the first year of operation. Under the US tax code, we could have used an accelerated depreciation methodology, so our accounts would have looked more like this: Two points: 1) Alphaville's tax bill went from £20,786 to £15,986 - nice work team! 2) Our financial accounts, as opposed to our tax accounts, will look a lot like the first box rather than the second, so we're still in line for that £48,501 of net income bonus. The whole "accelerated depreciation thing" is just for tax. On the financial accounts, i.e. 10-K, we'd report a tax liability reflecting the difference between straight-line and accelerated depreciation. The tax liability is a little sign post that we'll have more tax to pay in the future than we would have had if we'd used straight-line depreciation for our tax filing. Using accelerated depreciation doesn't get one out of paying tax forever. It's just that it front-loads it, and by a hell of a lot in some cases. One of the more direct benefits of the system in place in the US - of the Modified Accelerated Cost Recovery System (MACRS), to be specific - is that it doesn't take any expected salvage value into consideration. Just buy the Blogprinter, lob on the costs incurred installing it, and depreciate that entire amount, front-loading a lot of it (according to specific tables given by the IRS). That is, even if we knew we could sell the dilapidated printer for £20,000 at the end of six years, we'd still get £100,000 worth of cost reflected under MACRS. Plenty of other countries have accelerated depreciation methods for at least some types of investment, it's not just the US. But why have this at all? A developing country might want to offer accelerated depreciation on certain investments made by foreigners in order to encourage them to spend their money. Or, any country in a bit of an economic slump may want to have such a system to encourage investment in any asset that can be put to productive use. There's also an argument that this is especially important when inflation is high, as the tax benefits later in the life of the asset won't be worth much. This is, in fact, one of the bits of the tax code that Republicans and Democrats in the US are actually in agreement on. They even want to make it more generous. Over to the Reuters article: ... both President Barack Obama and Republicans have backed an expansion of the tax break through bonus depreciation, which gives companies an even faster and larger first-year write-off. Many policymakers backing accelerated depreciation have cited the need to jump-start the economic recovery. There is a bit of whinging going on though from companies that can't use the tax break because the types of investments they make don't fall under MACRS. There are, however, enough companies using this, and other kind portions of the tax code, such that: The U.S. government's corporate tax receipts have been dwindling for decades, in part because of a plethora of special tax provisions in the code. Revenue from corporate income taxes fell from between 5 percent and 6 percent of gross domestic product in the early 1950s to about 1.3 percent of GDP in 2010, according to the Tax Policy Center, another tax research group. That's a statistic that can be pulled apart in many ways, no doubt. The key question remains, though: what is the trade off between encouraging investment through tax policy and ensuring that the tax burden is spread in a way that is consistent with the desires of the society in question? Hefty. We'd like to leave you with one last geeky tax point - amusement parks qualify for MACRS. What do you think: FT AlphaWorld or FT AlphaLand? Or one on each coast? And FT AlphaLand Paris! Tokyo... we'd need an island for that, wouldn't we? Related links: Companies use popular provision to avoid income taxes - Reuters Big No-Tax Corps Just Keep on Dodgin - Citizens for Tax Justice This entry was posted by Lisa Pollack on Thursday, April 12th, 2012 at 16:26 and is filed under Capital markets. Tagged with depreciation, IRS, tax.