Montana Viewpoint


March 1, 2004

All through the ten years I’ve been on the Taxation Committee, I’ve heard business lobbyists say, “businesses don’t pay taxes, people pay taxes,” meaning that businesses just pass the tax along to the consumer. While lower taxes can marginally reduce product cost and increase profit, the amount of effort being put out by big corporations to reduce their taxes sure seems like overkill.

The share of corporate taxes as a percentage of total state tax collections has decreased considerably over the past 25 years. This has led some tax analysts to propose doing away with state corporate income taxes. Their rationale is that it takes too much effort relative to the amount of tax collected. This to me seems like admitting defeat to corporate strategies of tax avoidance, much of which is accomplished through changes in state and federal legislation anyway. After all, if laws are passed to allow loopholes, laws can be passed to close loopholes.

According to Michael Mazerov of the Center on Budget and Policy Priorities, total state corporation tax collections have gone from about 10% of total state revenues in 1979 to a little over 6% in 2000. Much of this is due to some pretty innovative “tax planning” on the part of corporations. Of course, as U. S. Appeals Court Judge Learned Hand wrote, “There is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible.” But then too, as a government tax guy I know says, “tax planning is not the same as fraud...usually.”

Different states have different ways of figuring corporate taxes. In Montana, it’s pretty straightforward. The starting point is the amount of taxable income reported to the IRS. Then a firm uses a formula to determine what percent of the firm’s total business activity was in Montana, and multiply their Federal Taxable Income by that percentage to find their Montana Taxable Income. (There are also some deductions and additions that may apply.) The Montana tax rate for corporations is 6.75% which is 29th from the top of state corporate income tax rates. Six states have no corporate tax on income per se, but do tax corporations in other ways.

For Montana, the ability to minimize corporate taxes by minimizing net reported profit gets exercised largely at the federal level. When Montana audits corporate tax returns we are pretty much just verifying that the allocation formula the company uses is accurate. We don’t audit the federal return, but we can request that the feds do so. The most common Montana audit finding is that a company has incorrectly tried to exclude some of its income from Montana taxation by calling it “non-business income,” which might be income from the sale of an asset not related to the business.

Non-business income is taxed only in the company’s home state, so the income isn’t subject to being allocated to Montana. The odds are good, too, that the company won’t be paying any tax on the non-business income, period, because no matter where a corporation does the bulk of its business, it can set up a holding company in a tax free state, such as Delaware. In fact, the generic term for them, no matter where located, is a Delaware Holding Company, or DHC. Some Delaware headquartered companies doing business in Montana are NorthWestern Energy, Staples, ConAgra, and Burger King.

Since the federal government taxes income earned only in the United States, and does not allocate worldwide income like Montana can, it makes setting up corporate headquarters in an “Offshore Tax Haven” country such as Bermuda very attractive. Bermuda, along with some 30 other countries that most of us have never heard of, does not tax corporate income, and for a comparatively miniscule fee, will allow a company to incorporate there. That company then becomes the parent company of an American firm, and the profits are channeled from the American subsidiary to the Bermuda parent company. This is but one of the ways companies shelter income from U.S. taxation.

About 15 years ago Montana offered companies a “water’s edge election” which allows them to report only U.S. income in exchange for paying a slightly higher tax rate—an additional quarter percent. This is obviously not a hard decision for most companies who file water’s edge; the increased tax rate is still a savings from what it would be if it were worldwide. In other words, a company can choose the cheaper of two ways to file taxes.

How many corporate tax dollars are lost to Montana by companies filing water’s edge? We don't know. Companies electing water’s edge filing don’t tell us what their worldwide earnings were. We do know, roughly, how much is lost to the American people through offshore holding companies--estimates range from $250 billion to $300 billion a year.

But whatever the amount, it costs the American citizen either more taxes or fewer services. If “businesses don’t pay taxes, people pay taxes,” maybe the reason corporations try to lower their taxes is that they’re trying to eliminate the middle man. That way the feds can bill us citizens direct.

Jim Elliott
Phone: 406-444-1556
Mail: State Senate Helena, MT 59620