CPA to Tax Policy Wonks - Can You at Least Look at Our Numbers ?

Originally Published on forbes.com on October 2nd,2011

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Also, as you know, it’s very hard if not impossible to figure out a corporations’ tax position from 10K filings (or other public reports).

That is a quote from a comment response by Forbes contributor Len Burman.  Professor Burman describes himself as follows:

I am the Daniel Patrick Moynihan Professor of Public Affairs at theMaxwell School ofSyracuse University, a research associate at the National Bureau of Economic Research and the Center for Policy Research, and an affiliated scholar at the Tax Policy Center (TPC). My research focuses on federal tax and budget policy.

It is very difficult to shock me, but that statement managed it.  The reason I find it shocking is that because if it is true my profession (I am a CPA) is pointlessly torturing a generation of young professionals. They not only have to experience the excruciation of deferred tax computations and the related disclosures, but also the relatively new rules on accounting for uncertain tax positions.  I’m sure there is somebody who loves accounting for uncertain tax positions in the way that I love minimum gain computations and all the other wonders of Subchapter K, but for the most part it is mind numbing.  I  have to sit throughcontinuing professional education classes on these issues to maintain my license.  Just the thought of doing them makes my teeth numb.  To think that the results of that effort does not produce something that can be understood by the Daniel Partrick Moynihan Professor of Public Affairs is disheartening.

In the interest of having our discussions of tax policy a little more informed by what is actually happening, I would like to show you what is available in a 10-k.  Since everybody on forbes.com loves to talk about Warren Buffett all the time, I will use Berkshire Hathaway. Also I have also run through those numbers once in a piece in which I concluded that if Warren Buffett is being taxed twice the add-on should be 7% not 35% for analytical purposes. Here is the link to the financial statements if you want to follow along:

The Not So Hard Part

The income tax disclosures begin on page 53 (page 55 of the adobe file in the link).  It starts right off with the deferred taxes which is one of the more difficult concepts to understand.  We’ll get back to that.  In the middle of the page is a summary of the income tax expense that is used in arriving at BH’s net earnings under generally accepted accounting principles.  For 2010 that expense $5.607 billion.  If the world were real simple that would mean that on March 15, 2011 BH would have mailed in checks totalling $5.607 billion mostly to the US Treasury ($4.546 billion) and the balance to states and foreign jurisdictions.  How does that number related to the 35% which is usually thrown around ?  The next paragraph explains that.  35% of BH’s pre-tax income for 2010 would be $6.668 billion.  There are 6 items that explain the difference the largest being the dividends received deduction of $477 million.

The Hard Part

Do the disclosures tell us what BH actually had to pay for 2010 (as opposed to in 2010) ?Kind of.  In the middle paragraph the $5.607 billion is broken down between current and deferred.  Current is what actually goes ontax returns, except for uncertain positions.  Then we do a make-believe computation of what the tax returns would be like if tax rules and generally accepted accounting principles were the same.  Those adjustments can and do go in both directions. In the case of BH for 2010 the net is $1.939 billion in deferred tax liability.  In my oversimplified version of reality that would mean checks being issued on March 15, 2011 totalling $3.668 billion (Corporations are of course required to make quarterly estimated tax payments and most if not all the payments will of course be electronic.)  That $1.939 billion is recorded as a liability and forms part of the total of $35.558 billion in deferred tax liability.  The first paragraph gives you a summary of the types of things that have built up that liability the largest being $24.746 billion attributable to differences in the treatment of property, plant and equipment.

The Part That is  Too Hard Even for Deloitte and Touche:

BH has accumulated $4.1 billion in overseas earnings that it does not expect to repatriate any time soon.  If it did it might owe some more taxes, but that is really hard to figure out, so no liability has been set up for it.  Here is the explanation:

We have not established deferred income taxes with respect to undistributed earnings of certain foreign subsidiaries. Earnings expected to remain reinvested indefinitely were approximately $4.1 billion as of December 31, 2010. Upon distribution as dividends or otherwise, such amounts would be subject to taxation in the U.S. as well as foreign countries. However, U.S. income tax liabilities could be offset, in whole or in part, by tax credits allowable from taxes paid to foreign jurisdictions. Determination of the potential net tax due is impracticable due to the complexities of hypothetical calculations involving uncertain timing and amounts of taxable income and the effects of multiple taxing jurisdictions.

Of Course It is Still Not Hard Enough

A relatively recent addition to generally accepted accounting principles are standards of accounting for uncertain tax positions.  To go back into my simplified world view imagine you were my client and there was a deduction we decided you could take but there was some uncertainty.  You ask me to run the return with and without the deduction.  Whatever tax the deduction saves you put that much money in a separate account.  If you are audited and lose you have the money to pay the bill.  If you win the audit or the statute expires, you can have a party or do whatever you want with the money.  Standards of accounting for uncertain tax positions put corporations under a regime something like that in computing GAAP income.  If an uncertain deduction goes on a return, income tax expense for financial reporting is computed as if the deduction was not taken and a liability is set up.  There is of course a whole complicated set of rules around this.  One of the most important ones is that in making the assessments you absolutely cannot ask the question – “Who is ever going to figure that out ?”.  The people charged with assessing the likely outcome of every uncertain tax position have to assume that the IRS is going to send in the “A-Team” on every single issue and that they won’t miss anything. (By the way you might be surprised to know that a similar rule applies to CPAs when they are giving tax advice.).

You need to turn to page 54 (56 of the adobe link) to see how this plays out in BH’s case.  As of 2010, they have $1.005 billion in “unrecognized tax positions”.  About a fourth of that relates to deferred taxes so only $774 million of it would affect their overall tax rate.  In my simple cookie jar example it means that when BH says what their income tax expense is they are counting as expense the billion or so that they put in the cookie jar in case the auditors adjust their return. Of course large corporations are being continuously audited, so it is safe to assume that those benefits might be subject to challenge.  On the other hand, there is a good chance that they will win on many of them.

How Many Returns is That ?

Any big corporation is going to have a huge pile of returns with multiple jurisdictions and the like but if we imagine a company that only had federal income taxes it would have to prepare three returns in order to get all the disclosures in order.  There is the one that it actually sends in.  Then it needs to recompute that using GAAP principles to determine income before taxes.  Then it has to do one where uncertain tax positions are resolved in favour of the taxing authorities with interest and penalties tacked on.  All this information will be in the 10-K.

So Do They Tell Us What They Actually Paid ?

Actually they do.  On page 49 (51 of the adobe file) they tell you.  During 2010 BH actually paid $3.547 billion in income taxes.  That number is probably a horrendous mishmash of payments to many different jurisdictions and relating to many different years.  Some of it will probably be refunded or applied to future years. You will note though that it is pretty close to the $3.668 billion check I imagined Mr. Buffett signing on March 15, 2011 to pay the company’s 2010 tax expense .  The amount of taxes actually paid is a required disclosure of supplemental cash flow information.

Why I am Writing About This ?

There are a lot of unknowns in discussing tax policy.  We do not need to multiply them by ignoring the things that are known.  If someone is writing about the tax burden of a public company, they should at least look at the significant amount of information that has been provided by the company at significant expense and then been audited to death.  I happen to think the taxes paid number in the cash flow disclosures is probably the best analytical tool to use in discussing the impact of corporate taxes.  You have to hunt around for it sometimes.  It will always be there or if it is not there will be someone in the basement of an accounting firm being flogged by peer reviewers.  If you think auditors are bad – don’t get me started.