In August 2022, President Joe Biden signed the Inflation Reduction Act into law. One of its provisions —a minimum 15% corporate tax — is designed to ensure corporations with $1 billion or more in average annual earnings pay taxes on profits even if they reduce their taxable income. The law took effect in 2023.
A corporation’s taxable income is how much money a company makes in a year after subtracting any deductions.
Income sources include:
- Sales revenue
- Investment income
- Rent
- Capital gains
Deductions can include:
- Any business expenses
- Salaries and wages
- Depreciation value
- Advertising costs
- Charitable contributions
In some cases, corporations find additional ways to reduce their taxable income. The methods include net operating losses, accelerated depreciation, tax credits, and profit shifting. The Inflation Reduction Act addresses these methods, but only partially.
In 2016, the Government Accountability Office found that more than two-thirds of all active corporations had no federal income tax liability, including 42.3% of large corporations.
Net operating losses
A corporation has a net operating loss when its business expenses and deductions are greater than its taxable income. Put simply, it’s when a company spends more than it makes. US tax law allows firms to carry over net operating losses from previous years to report lower taxable income for the current year.
For example, if a corporation’s taxable income is -$3 million, not only would it not be liable for taxes in the current year, but a portion of that loss could also be carried over to the following year’s tax returns to reduce taxable income.
Corporations are limited at carrying over 80% of their net operating losses. This is one of the main rules that allowed 19.5% of profitable businesses to pay no federal income tax in 2012.
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Accelerated depreciation
When a business purchases an asset, it can deduct its value over the life of the investment from its taxable income. Under the tax code, corporations can deduct a greater percentage of an asset’s value in the early years of the investment, which lets the business take advantage of the tax deduction sooner. This is called accelerated depreciation.
For example, a business buys a machine for manufacturing. The machine has a life of five years, and its value decreases over that time. Rather than deducting the cost of the machine over five years, they can deduct the cost of the machine in the initial year of investment from their taxable income.
This provision, which allows companies to immediately write off the full costs of investment, was established in the 2017 Tax Cuts and Jobs Act.
Tax credits
The most significant liability-reducing tax credit allows companies to deduct a portion of all money spent on research and development from their tax obligations. The White House estimates that credits for research activities cost the government nearly $25 billion in fiscal year 2023, and that it will increase to almost $40 billion by fiscal year 2032.
Profit shifting
The Tax Cuts and Jobs Act moved the US to a mostly territorial tax system. Under a territorial system, a company is taxed based on where it earns its income.
US-headquartered corporations often move their profits to subsidiaries in countries with low tax rates without moving much of their operations. A 2013 Congressional Research Service (CRS) report found that American businesses reported 43% of their overseas earnings in five preferred tax countries — Bermuda, Ireland, Luxembourg, the Netherlands, and Switzerland — in 2008 despite hiring just 4% of their workforce in those countries and making just 7% of their foreign investments there. In 2012, American businesses reported $1.2 trillion in profits overseas, half of which came from those five countries and two other tax havens: Singapore and the British West Indies.
A CRS report estimated that about $80 billion is lost in corporate tax revenue every year due to profit shifting. For context, that’s nearly 10% of what the government spent on Medicare in fiscal year 2023.
How have corporate taxes changed?
US corporate tax rates have declined over time. Meanwhile, the corporate tax base shrank due to declining profitability and international profit shifting, according to the CRS. These various methods of lowering taxable income means a large portion of business income sidesteps corporate taxes.
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