Lowering Profits Seen as Tactic to Ease New US 15% Corporate Tax

There’s an emerging quirk to the new tax aimed at forcing some big companies to pay more: They can still keep paying less—simply by reporting lower profits. 

The corporate alternative minimum tax that took effect last year requires large, profitable US companies to pay at least 15% in taxes on the “book income” they report on their financial statements. That’s supposed to make it harder for them to pay little or nothing by using tax deductions, credits, and other advantages to reduce their taxable profit, as many have done in the past.

But the rules dictating the information reported on corporate financial statements give them lots of leeway in determining how much they report in certain expenses. CAMT gives them an incentive to boost those costs, lowering their income subject to the new tax—and thus their overall bill.

That possibility concerns regulators, particularly as they prepare long-delayed rules on how the minimum tax should be calculated and applied.

The opportunity for companies to increase costs in order to reduce their CAMT liability is something the IRS has thought about ever since the tax was enacted, said an IRS official working on the CAMT rules who was not authorized to discuss the matter publicly.

Two other insiders echoed the sentiment. One, a former Treasury Department tax official, said that companies citing unusual cost increases when calculating their income subject to CAMT would be of interest to the government.

Few corporate filers have disclosed much about their CAMT impact. The first tax returns covering periods in which it was in effect have only recently begun to trickle in. The IRS hasn’t publicly said if any merit an audit, or whether it’s concerned about companies inflating costs to reduce their CAMT bill.

But last year, some companies that have enjoyed low effective tax rates in the past recorded big charges or sharp increases in discretionary costs that they acknowledge had a positive effect on their taxes.

Defense contractor RTX Corp., for instance, took a $2.9 billion charge for a jet-engine recall, and said in its annual report that the charge had a favorable impact on its effective tax rate, lowering it to 11.9%, below what is supposed to be the new minimum.

RTX didn’t respond to requests for comment, and it didn’t say anything in its annual report about any effect that CAMT might have on it.

Some argue companies owe it to their shareholders to do what they can to minimize their tax liability.

“They’d be irresponsible not to,” said Peter Barnes, a tax attorney at Caplin & Drysdale. “This is not illegal, not underhanded or wrong.” 

Others say the potential use of such tactics to effectively pay less than 15% illustrates the flaws in CAMT. Previous tax laws may not always have gotten companies to pay, they say, but those who enacted CAMT have merely traded one set of problems for another—trying to impose a tax on a measure of income that’s derived differently for a different audience and purpose. 

“I don’t think even they know all the problems they’ve created,” said Michelle Hanlon, an accounting professor at the Massachusetts Institute of Technology. 

An IRS spokesperson declined to respond to requests for comment on the agency’s response to CAMT.

Blurring the Lines 

CAMT was enacted in 2022 to address the fact that even after the 2017 tax-law overhaul cut the corporate rate to 21%, many were still using the tax code’s benefits to pay much less. One study from the Institute on Taxation and Economic Policy said 55 big, profitable companies had paid no US income tax at all in 2020.

The new minimum tax’s goals were to increase corporate accountability and raise new revenue—an estimated $222 billion over 10 years. President Joe Biden has proposed raising the CAMT rate to 21%, which would raise another $137 billion.  

CAMT kicks in when companies use traditional deductions and other tax breaks to effectively pay far less than the standard 21% corporate income tax on their profits. If their effective tax rate falls below 15% of financial-statement income—the income they report to investors, adjusted for things like depreciation and mortgage-servicing income—the corporations are expected to pay at least that much.

While they have to lay out their CAMT liability for the IRS when filing their taxes, they aren’t specifically required to tell investors about CAMT’s impact.

To some tax observers, the new tax structure created a problem: Taxable income and financial-statement income are very different things, and the observers believe that blurring the lines between them was bound to have unintended and unwanted effects.

“Academic accountants, we thought this was a terrible idea,” said Jennifer Blouin, a professor of financial management and accounting at the University of Pennsylvania’s Wharton School.

Taxable income is simply the bottom-line profit on which a company is taxed—gross receipts minus cost of goods sold and business expenses, adjusted for various deductions and credits.

Financial-statement income has a different purpose—to tell investors and other stakeholders about a company’s financial health. To enable companies to offer as much information as possible, the accounting rules governing financial statements give companies discretion that they don’t have with taxable income.

Sometimes costs are difficult to pin down, or transactions don’t fit into hard-and-fast rules. So companies are allowed to use estimates and their own judgment in determining costs like restructuring expenses and legal reserves, and to choose between different approaches to accounting for some costs. CAMT gives companies an incentive to use that discretion.

“A lot of this stuff, you can just do whatever you want to do,” said Matt Gardner, a senior fellow at ITEP. “This does seem like an area where there’s room for maneuvering.”

‘Creative Tax Management’

Lowering book income wouldn’t even necessarily hurt a company’s standing with investors. Many already spotlight unofficial measures of earnings when reporting to the market—measures that don’t follow US generally accepted accounting principles, and that strip out the same kinds of one-time and non-cash costs that allow for judgment or estimates.

So a company could record a cost to reduce its income for CAMT purposes but take it back out of the non-GAAP earnings it shares with investors.

Such a prospect is “logically so sound that I can’t believe some company wouldn’t try this,” said Matt Kelly, owner of Radical Compliance, a corporate-compliance consultant. “Creative tax management springs eternal in the corporate mind. Of course companies would do this. Why would they not?” 

At RTX, for instance, 2023 financial-statement income from continuing operations declined 39% from 2022, from $5.2 billion to $3.2 billion, because of the $2.9 billion charge for its engine problem. But the company’s reported income on a non-GAAP basis rose 4%, from $7 billion to $7.3 billion, after the engine charge and other items were stripped out. 

The Securities and Exchange Commission is investigating RTX’s disclosures over the engine problem that led to the recall and has subpoenaed RTX accounting and financial information. Neither the company nor the SEC has said whether the inquiry touches on CAMT.

Drug maker Pfizer had especially large increases in discretionary costs in 2023—restructuring charges and acquisition-related costs soared 114%, and the company recorded $3 billion in impairment charges for intangible assets. Those costs were stripped out of Pfizer’s non-GAAP earnings reported to investors, which were $8.4 billion higher than its official earnings for the year—the biggest such disparity for Pfizer since 2010. 

In its annual report, Pfizer cited the restructuring and impairment expenses in explaining why it had a $1.1 billion tax credit for the year. The company attributed the higher expenses to corporate restructuring projects and costs related to business combinations. 

Pfizer said in a statement that it “abides by all tax laws in the jurisdictions in which it operates and pays all taxes due.” The company didn’t mention any impact from CAMT in its annual report.

Separately, Pfizer’s taxes are under scrutiny from the Senate Finance Committee, which has demanded information from the company about its tax practices, though the committee’s focus is on whether Pfizer is shifting profits to lower-tax countries. It has given no indication that CAMT is part of its probe. 

What Might Deter Companies

In some cases, companies might be able to reduce income enough to escape CAMT entirely. Only companies with average annual financial-statement profits of at least $1 billion over the three previous years are subject to CAMT, with separate requirements for US companies that are part of foreign-parented groups. A company just over that threshold, and paying less than 15%, could record costs to keep its profit lower and thus avoid CAMT for that year.

Even buying a big piece of equipment could make the difference, said Andrew Schmidt, an associate professor of accounting at North Carolina State University. “Anybody that is going to be right there next to the cutoff is going to be trying very hard,” he said.  

It may still be too early to tell who’s using such tactics. A Treasury official said the department isn’t aware of any companies that have increased their costs to try to get around CAMT, but that it wouldn’t be surprising. 

The potential for outside scrutiny—from the SEC, the company’s independent auditor, or Wall Street analysts—could deter companies from trying it. The Treasury official said the agency has spoken to audit-firm professionals about the issue, and they suggested that auditors would struggle to sign off on a company’s decision to incur or increase costs solely to lower its CAMT liability.

“The auditor will be looking at stuff like that,” said Nick Tricarichi, a partner in KPMG LLP’s Department of Professional Practice.  

Another potentially complicating factor in assessing companies’ response to CAMT: Tax payments under CAMT can create losses that can be used to offset future taxes, so it might be difficult to gauge CAMT’s impact based simply on a company’s taxes in the current year. 

Some feel the lack of regulations on CAMT and the resulting uncertainty—more than 18 months after the tax took effect—have contributed to the sense that there’s enough wiggle room under the rules to lessen a company’s liability.

“It’s quite possible that there is more earnings management now, before the detailed rules are issued,” said Jeffrey Gramlich, an accounting professor at Washington State University. 

The regulations are expected in the coming months. The IRS and Treasury are grappling with the huge size and complexity of the package of rules, as well as with the Supreme Court ruling last month giving courts more power to question agencies like the IRS over how their regulations interpret the law.

This month, Sen. Elizabeth Warren (D-Mass.) and other members of Congress urged Treasury to issue the CAMT regulations quickly to help “proactively thwart off corporation-led efforts to frustrate the intent of the law.” She didn’t mention any specific efforts, though in 2022 the same lawmakers urged Treasury to rebuff corporate lobbying that was trying to limit CAMT’s scope.

When the regulations do come out, they’re more likely to have a broad anti-abuse provision rather than rules aimed at specific potential tactics like raising costs, the former Treasury official said. Still, getting those rules out will fortify the agency’s authority to look at any obvious gamesmanship, the former official said.

IRS audits will eventually help determine whether companies are trying to reduce income as a means of limiting their CAMT liability. But that’s likely to take a long time.

“We’re in the first half of the first inning,” Kelly said.