{"id":10862,"date":"2021-03-09T08:34:00","date_gmt":"2021-03-09T14:34:00","guid":{"rendered":"http:\/\/blog.uwsp.edu\/cps\/?p=10862"},"modified":"2021-03-09T08:34:01","modified_gmt":"2021-03-09T14:34:01","slug":"corporate-taxes-the-difference-between-the-corporate-tax-rate-and-taxes-paid","status":"publish","type":"post","link":"https:\/\/blog.uwsp.edu\/cps\/2021\/03\/09\/corporate-taxes-the-difference-between-the-corporate-tax-rate-and-taxes-paid\/","title":{"rendered":"Corporate Taxes: The Difference Between the Corporate Tax Rate and Taxes Paid"},"content":{"rendered":"\n
\"GM
GM Headquarters<\/figcaption><\/figure>\n\n\n\n

Another topic that generally gets discussed\na lot in economics (and politics) is corporate taxes. It\u2019s also one of the more\ncomplex subjects, because it is not always easy to determine what a company\nactually pays<\/em> in taxes. It can be done, but it\u2019s not necessarily easy. The\nprimary objective of this blog is to provide some insight on that using General\nMotors as the example.<\/p>\n\n\n\n

One of the most important changes from the 2018 tax bill was the significant reduction in the federal corporate tax rate. The statutory (legal) corporate tax rate was lowered from 35% to 21%. The statutory tax rate is the legal percentage established by law. Does that mean every company will pay a 21% tax rate on its pre-tax income? Well, no. Lowering the statutory rate certainly lowers the taxes paid by a company. However, the effective<\/em> corporate tax rate, the rate that a company actually pays on pre-tax profits, can be very different from the statutory tax rate. The effective rate can be different from the statutory rate due to tax credits and deductions. And now, an attempt to explain that using General Motors as the example.<\/p>\n\n\n\n

General Motors is a public company,\nmeaning that it has sold stock to the general public. Public companies are\nrequired by law to disclose their financial statements to the public, which\nincludes information on how the company has been financed, cash flow, revenues,\nnet income, and expenses \u2013 including taxes. Because the company sold its stock\nto the public, the public has a legal right to know about the financial\nperformance of the company. Detailed financial information, including the\nfinancial statements, is contained in the company\u2019s \u201cForm 10-K\u201d which is\nbasically a financial report that must be filed annually with the Securities\nand Exchange Commission. <\/p>\n\n\n\n

The financial statements include the income statement, which shows the revenue and profit for the firm for a given year. Listed below is selected information taken from the income statements for General Motors for 2020, 2019 and 2018. <\/p>\n\n\n\n

General Motors pre-tax income and income tax expense <\/em><\/strong>
(in millions of dollars)<\/em><\/strong><\/p>\n\n\n\n

\"General<\/figure>\n\n\n\n

Based\non the information presented in the income statement, it looks like GM paid\nover $1.7 billion in taxes in 2020, $769 million in 2019, and $474 million in\n2018. Did they? Well, no. The income tax expense indicated on the income\nstatement is NOT what the company paid in taxes in a given year.<\/p>\n\n\n\n

Here\nis where corporate taxes start getting a little complex. Income statements are\nprepared by companies using certain rules and guidelines (Generally Accepted\nAccounting Principles) established by the accounting profession. The idea is to\nmatch revenues with the expenses incurred to derive those revenues \u2013 this\ndetermines the \u201cbook\u201d income, the amount of income shown on the income\nstatement. However, tax laws can be different from the accounting rules used to\nprepare the income statement. The \u201ctaxable\u201d income on a company\u2019s tax return\ncan be very different from the \u201cbook\u201d income reported on the income statement. We\u2019ll\nreturn to the GM example and attempt to explain the difference for GM.<\/p>\n\n\n\n

The income tax expense reported on GM\u2019s income statement reflects a matching of revenues with expenses per accounting standards. The income tax expense will also reflect the mix of federal, state, local and foreign income taxes when revenues are matched with expenses. However, the income tax expense does NOT reflect what a company actually pays in taxes. <\/p>\n\n\n\n

Companies\nare required to disclose information that indicates how much they paid in\nincome taxes. However, it might take a little ciphering to figure out the exact\namount paid. As part of their required financial disclosure, U.S. public\ncompanies must disclose a statement of cash flows for a given year and include\n\u201cnotes\u201d to the financial statements. \u201cNotes\u201d are provided as an addendum to the\nfinancial statements in the company\u2019s Form 10-K to explain certain items in\ngreater detail, including taxes. The statement of cash flows is meant to\nprovide more detail on how a company\u2019s net income differs from its cash flow. The\namount of taxes paid by a corporation can be determined by analyzing the\nstatement of cash flows and the notes to the financial statements.<\/p>\n\n\n\n

Select information from the \u201cNote\u201d on income taxes in the General Motors Form 10-K is presented (in millions of dollars) below. Explanations for the numbered lines are presented below the table.<\/p>\n\n\n\n

\"General<\/figure>\n\n\n\n

Line\n1: The total current income tax expense is the actual tax expense incurred\nin a given year that must be paid.  In\n2020, 2019, and 2018, the total current income tax expense for GM was\n$849 million, $902 million, and $586 million, respectively. These were the\ntotal amounts in income taxes that GM was required to pay.  Total current income tax expense included\nU.S. federal income taxes, state and local income taxes, and foreign income\ntaxes. The federal income tax portion was $84 million and $42 million in\n2020 and 2019, respectively. In 2018, GM did not pay federal income taxes and\nreceived a tax credit (or refund) of $104 million. Note these amounts are\nsignificantly lower than the income tax expense shown on the income statement.<\/p>\n\n\n\n

Line\n2: Deferrals arise because of the difference between the accounting standards\nused to prepare the financial statements and the tax laws used to prepare the\ncompany\u2019s tax return. For example, a very common difference occurs when a\ncompany depreciates (allocates) the cost of property, plant, and equipment over\ntime. For the financial statements, the objective is to match revenues with the\ncosts incurred to derive those revenues. Straight-line deprecation (an equal\nallocation of cost over the life of the property, plant, and equipment) is\ncommonly done in preparing financial statements. However, tax laws may allow\naccelerated depreciation, which results in a greater allocation of cost (a\ngreater tax deduction) in the early years that the property, plant, and\nequipment is used. This results in income tax expense on the financial\nstatements exceeding taxes paid. <\/p>\n\n\n\n

Rather than depreciating (allocating) the cost of property, plant and equipment over a certain number of years as required previously, the 2018 tax cuts allow companies to fully expense (take a full deduction for) spending on property, plant and equipment (capital spending) through 2022. In other words, an immediate tax benefit for the full amount spent. <\/p>\n\n\n\n

Deferred\nincome tax expense implies that the taxes will have to be paid later. In the\nexample used above, in the later years that the property, plant, and equipment\nis used the amount of straight-line depreciation will exceed any accelerated\ndepreciation. That would result in the current income tax expense (which must\nbe paid) exceeding the income tax expense on the income statement. However, tax\nlaws can change, so deferred income tax expense does not always indicate what\nwill be paid in the future. In addition, the amount listed as a deferral does\nnot take into account the time value of money. If you owed $100 in taxes, would\nyou rather pay it now or in 10 years?<\/p>\n\n\n\n

Deferred\nincome tax expense plus the current income tax expense equals the total income\ntax expense on the income statement.<\/p>\n\n\n\n

Line 3: The total income tax expense is the income tax expense reported on GM\u2019s income statement. It takes into account the matching of revenues and expenses per accounting standards and the U.S. federal income tax rate, state and local income tax rate rates, and foreign income tax rates. It is NOT the tax paid in the current year. <\/p>\n\n\n\n

Line 4: The effective tax rate is the total current income tax expense divided by the total pre-tax income reported on the income statement. In other words, it is the percentage of total pre-tax income that must be paid in taxes in the current year. In 2020, 2019 and 2018, GM\u2019s effective tax rate on total pre-tax income was 10.5%, 12.1% and 6.9%, respectively.<\/p>\n\n\n\n

Line 5: The effective federal tax rate on U.S. pre-tax income is the U.S. federal current income tax expense divided by U.S. pre-tax income. In other words, it is the percentage of U.S. pre-tax income that must be paid in U.S. federal income taxes in the current year. In 2020 and 2019, GM\u2019s effective federal tax rate on U.S. pre-tax income was 1.2% and 1.1%, respectively. The company did not pay federal income taxes in 2018. Note the effective federal tax rate on U.S. pre-tax income is significantly below the statutory rate of 21%. Although companies must disclose income taxes paid, they do not have to disclose why and how their effective federal income tax rate differs from the 21% statutory rate.<\/p>\n\n\n\n

Although the statutory U.S. federal income tax rate is 21%, the effective rate may be significantly different for many U.S. companies. A 2019 study by the Institute on Taxation & Economic Policy <\/em>examined the 2018 effective tax rate for 379 profitable firms included in the Fortune 500. For the 379 companies, the study analyzed the effective U.S. income tax rates on their pretax U.S. profits in 2018. The findings included:<\/p>\n\n\n\n

Economic\nand political discussion on corporate taxes will likely increase in the future.\nThe 2018 tax cuts increased the U.S. budget deficit in a period of economic\ngrowth, and the economic impact of COVID-19 caused the budget deficit to\nincrease dramatically. When the economic rebound occurs and growth returns to\nsome degree of normalcy, discussions may ensue on how to effectively balance\ngovernment spending with government revenues through taxes.<\/p>\n\n\n\n

 For further information:<\/p>\n\n\n\n