This Sunday the Wall Street Journal dedicated a front page story to federal tax incentive programs including WOTC and the R&D credit. The article discusses the political reasons behind the use of these kinds of programs and the challenges businesses face in actually making these programs work for them:
For years, politicians have used targeted tax breaks to try to influence corporate behavior, offering lower tax bills as an incentive to hire more workers, boost energy efficiency and buy more equipment, among other things.
But executives, particularly at small and medium-size companies, complain that many of the tax deductions are either too cumbersome or too confusing.
In some cases, the cost of obtaining the tax benefit is greater than the benefit itself—a wrinkle that has helped spawn a cottage industry of tax-credit consultants. Also problematic is the threat of pushback from the Internal Revenue Service.
The result: many companies are saying “no, thanks” and are likely paying more taxes than legally required. And corporate breaks that Washington hopes will boost the economy often prove ineffective.
“I usually avoid these targeted tax incentives, because it costs so much just to be compliant that it’s not worth messing with,” says John Raine, CEO of Raine Inc., an Indiana firm that manufactures belts and holsters for the military and other customers. “I can’t run a business based on what area the federal government is trying to juice.”
As Republicans and Democrats are gearing up to overhaul the corporate tax code next year, simplification has become a bipartisan rallying cry for several reasons.
Both sides agree the code’s complexity is unfair: While small and medium-size companies such as Raine forgo the headaches and the tax savings, bigger
companies can more easily afford the specialized accountants and lawyers needed to claim the best breaks and gain a cost advantage.
Many critics, particularly congressional Democrats, also say U.S. multinationals often use complex tax breaks to lower their tax bills too much or dodge taxes overseas. Some economists think the perception of unfairness may cause some companies and wealthy individuals to avoid complying with tax rules.
Complexity is costly. Compliance costs for U.S. businesses and individuals have been rising, and now reach at least 1% of GDP, or about $150 billion last year, and possibly much more, according to congressional researchers.
The Byzantine nature of the tax code also adds to concerns about U.S. competitiveness in a global economy in which many other countries have eased tax rates and rules in recent years.
So if everybody agrees complexity is a pain, why does it persist? In part, both the White House and Congress can’t seem to resist fine-tuning the tax code to satisfy their diverse goals. And once a break is created, the IRS must issue rules to prevent people from taking inappropriate advantage.
Tax consultants estimate that eligible businesses obtain as little as 5% of the main domestic tax breaks that they are entitled to claim. That means firms are leaving tens of billions of dollars on the table every year. Out of 1.78 million corporate tax returns in the U.S., only about 20,000 claimed any of the three dozen main business tax credits in the code, according to IRS estimates.
One example of the tough-to-take breaks is the federal Work Opportunity credit. It was designed to reward companies for hiring workers from several disadvantaged groups, including welfare and food stamp recipients, youths seeking summer jobs and ex-felons. The break typically lowers a company’s taxes by up to $2,400 per employee. For businesses hiring unemployed veterans, it can be worth as much as $9,600 per worker.
The credit frequently goes unclaimed, largely because it is such a hassle. It requires extensive paperwork for each worker for whom it is claimed and the paperwork can often take a year or more to process. Sarah Hamersma, a University of Florida professor, estimates that companies claim the credit for just 20% to 35% of all eligible workers.
J.J. Pledger, chief financial officer for the Twisted Root gourmet burger chain in the Dallas-Fort Worth area, said he spent the better part of a day last year trying to figure out how his company could obtain the credit. Mr. Pledger, a CPA, knew the credit likely would be available for a number of his company’s 200 or so annual hires. But the more he read, “it seemed like the documentation of the tax credit could be really hard to administer,” he recalled. One concern was all the personal information needed from job applicants. “So I put it on the back burner…. It seemed too daunting.”
Businesses “hate it [the Work Opportunity credit] because of the amount of time it takes,” says Gary Ripsco, a San Diego consultant for a firm called National Tax Credit that now is helping Twisted Root start claiming the credit. It should be worth about $75,000 to Twisted Root, Mr. Ripsco figures.
In the latest global rankings of national tax systems by the World Bank and PricewaterhouseCoopers, the U.S. came in 142nd out of 183 countries for the time it takes a hypothetical small manufacturer to calculate its corporate income tax (the higher the rank, the more time it takes).
Both the IRS commissioner, Doug Shulman, and the IRS taxpayer advocate, Nina Olson, routinely refer to complexity as the system’s biggest problem.
Treasury Secretary Timothy Geithner describes the numerous U.S. targeted breaks as the tax code’s “overwhelming source” of complexity.
The tax thicket has been growing for years. In 1987, there were 128 major tax breaks for both individuals and companies, of which about 100 survive now. Another 100 or so have been created since then.
Many tax breaks, including the Work Opportunity credit, have recently expired but tax experts expect Congress to renew them retroactively by the end of the year, as it has in the past. Meantime, companies are unsure whether they can plan on it.
Another targeted break, the tax deduction for energy-efficient buildings, often requires computer modeling costing as much as $50,000. That leaves business owners weighing whether the credit is worth the expense.
USAA Real Estate Co., a large building owner, tried “many, many times” to find renovation projects that could be supported by use of the deduction, says managing director Brenna Walraven. “In every case we modeled, [the benefit] was less than the $50,000 to $60,000…. In the last six months we haven’t even thought about it,”she says.
To be sure, some targeted business breaks are popular. A temporary tax measure known as “bonus depreciation” allowed companies to write off their investments in goods such as manufacturing machinery and computers in the year in which they are bought rather than over time. The White House estimates the subsidy, which lasted through December, saved companies roughly $55 billion in corporate income taxes over each of the past two years.
The break was one reason total corporate federal taxes paid fell to 12.1% of profits earned from activities within the U.S. in fiscal 2011, which ended Sept. 30, according to the nonpartisan Congressional Budget Office. That is the lowest level since at least 1972, and well below the 25.6% companies paid on average from 1987 to 2008.
One reason government officials favor the breaks is that they are a politically expedient way to pursue policy goals—and potentially less trouble than a fundamental easing of business tax rates and rules. Because of political pressure to hold down budget deficits, U.S. lawmakers often design tax breaks in ways intended to narrow the number of beneficiaries.
“The more complicated it is…the more [businesses] are going to say it’s not worth the candle” to apply, said Dean Zerbe, a former Senate staffer who is now national managing director of alliantgroup, a tax consulting firm.
Because of low subscription rates for many tax breaks, a cottage industry of tax-credit consultants such as alliantgroup has sprung up. Fees tend to range from 15% to 30% of savings, according to consultants, but can be lower for large deals and occasionally higher.
But even with the availability of outside help, many businesses hesitate.
At Stone Brewing Co., a beer maker in Escondido, Calif., executives hired a consultant a couple of years ago to sift through the company’s records and claim another break, the tax credit for corporate research. But the process still consumed a lot of time for Stone’s employees.
“When they called us back, and said, ‘When do you want us to start on 2011?’ I actually declined,” said Craig Spitz, the company’s chief financial officer. “Whatever credits we might get, it didn’t seem to be worth the man-hours that our production department would need to spend.”
A tax credit that Congress enacted in 2010—for small businesses providing health-care coverage—was claimed by only about 170,300 employers, out of an eligible pool of between 1.4 million and four million businesses, according to the Government Accountability Office.
“The calculation was ridiculous,” says Barbara Webber, property manager for Presidential Estates in Quincy, Mass., an owner of apartment complexes. Despite an accounting background, she said, “I struggled with it.” In the end, she says, she didn’t qualify due to IRS wage restrictions.
Recently, the IRS and the White House have sought to simplify some of the most vexing tax-break provisions.
For example, the IRS dropped a requirement for filing hand-signed original forms to claim the Work Opportunity credit. The administration’s budget proposes simplification and expansion of the research credit, the health-care credit and the energy-efficiency deduction, among others.
More broadly, President Barack Obama in February proposed overhauling the U.S. corporate-tax code by lowering rates and limiting deductions. But the plan met with criticism from business groups that said it would favor some industries while penalizing others. He also has proposed a number of new breaks recently, including a new-jobs tax credit.
Mitt Romney, the likely Republican presidential nominee, calls for simplification of the tax system. But he hasn’t proposed eliminating any breaks and has floated the possibility of a new investment tax credit as well as another year of the bonus depreciation provision.
The chairman of the House Ways and Means Committee, Rep. Dave Camp (R., Mich.), has said he wants to simplify the individual and corporate tax codes next year by lowering rates and reducing or eliminating many tax breaks. But he has provided few specifics.
While many companies say it is too complicated to claim tax breaks, the ones who try can find themselves embroiled in complex disputes with the Internal Revenue Service.
One source of increasing contention is the federal research credit. Critics say the IRS sometimes demands more documentation than the rules require, and more than most corporate accounting systems can readily provide, in part because of overly aggressive claims by some firms in the 1990s. The result is sometimes lengthy litigation.
Bayer Corp., the U.S. unit of Germany’s Bayer AG, BAYN 0.00% finds itself in just such a morass. In a dispute playing out in federal court in Pittsburgh, the IRS has disallowed 17 years worth of Bayer Corp.’s claims for the research credit—$175 million in all—on the grounds that Bayer hasn’t adequately documented its expenditures or tied them to specific innovations.
Bayer said in court that it has provided adequate documentation and has gone to great lengths to gather the extra documentation that the government is demanding, but that it will take many years to fully comply with the IRS demand.
The dispute dates back to 1998. As it drags on, company officials worry it is leading their German parent to look elsewhere to conduct new research projects at a time when global competition for research and development, or R&D, dollars is heating up, according to court testimony.
Bayer Corp. said in a statement that it considers many factors when deciding where to conduct R&D, including “support such as R&D tax incentives.”