Lapsed Tax Breaks Risk Corporate Profits

Companies and analysts speak out on frustration around unpredictability of tax rates, as Congress allows breaks to expire, only to later renew them retroactively.

The tax credit for corporate research and 54 other breaks in the U.S. tax code expired Dec. 31. They’ve been replaced by confusion and frustration.

As U.S. corporations such as Intel Corp. and General Electric Co. report earnings this month, they’re warning shareholders and analysts that they can’t assume Congress will reinstate lapsed breaks retroactively, though lawmakers have done just that four times in the past eight years.

Corporations say they’re unable to offer analysts and investors consistency in predicting what their tax rate will be in any given year and must explain fluctuations that can cause profit to vary by hundreds of millions of dollars.

Ron Dickel, Intel’s vice president of global tax and trade, said the company is trying to dispel the commonly held belief in Congress that retroactive extensions are harmless.

“That’s not true because it causes such mass confusion with the analysts who are trying to understand what the effective tax rate is going forward,” he said in an interview.

Intel’s fluctuating tax rate—27 percent projected for 2014, 23.7 percent in 2013, and 26 percent in 2012—was driven by the absence or presence of the research credit, which is worth 1.5 percentage points on the rate, or about $189 million.

The accounting difficulties are one of the first consequences of congressional inaction on expiring tax provisions. The lapse-and-revive dynamic has become a consistent pattern in Congress, one that lawmakers grasp and haven’t been able to reverse.

“Unfortunately, I think, it’s become a way of life, tax life, and not in a good way,” said Representative Kevin Brady, a Texas Republican who is a member of the Ways and Means Committee.

Companies have been lobbying Congress for years to make many of the breaks permanent, forming multi-industry coalitions that haven’t succeeded.

For Intel, which is struggling to increase sales in a personal-computer market estimated to decline for a third consecutive year, the lapse of the tax credit compounds a profit squeeze.

“The tax rate is going up because of the R&D credit, which is not within their control,” said Mike Shinnick, a fund manager at Salt Lake City-based Wasatch Advisors Inc., whose firm owns Intel shares. “There’s quite a headwind there. It’s not their fault.”

 

Capital Markets Not Working Well

Companies with expired research credits are more likely to have inaccurate earnings forecasts, said Jeff Hoopes, an Ohio State University professor who has studied how markets react to the credit’s lapse.

“Capital markets are not working as well when these credits are expired,” he said. “Basically, people see these earnings, they don’t understand them as well, and that translates into higher trading costs.”

Under U.S. accounting rules, once a tax break expires, companies must assume it’s gone. If it’s later reinstated, companies receive a one-time boost to earnings.

“It is definitely one of those sore spots for public companies that continually have to fluctuate their reporting,” said Jeff Malo, a partner at WTP Advisors, a tax consulting firm based in White Plains, New York.

U.S. companies last encountered this situation in January 2013, when Congress passed legislation retroactively extending the breaks for 2012 and prospectively for 2013.

That meant companies’ fourth-quarter earnings for 2012 included no benefit from the breaks and first-quarter earnings for 2013 included five quarters of the breaks. Barring quick congressional action, first-quarter earnings for 2014 will include no benefits, making year-to-year and quarter-to-quarter comparisons of earnings and tax rates difficult.

“It puts the burden on management to have to explain to the investors and the analysts what’s going on,” said Angela Evans, Americas leader for accounting and risk advisory services at Ernst & Young LLP.

The disclosures will begin appearing in companies’ earnings guidance for 2014 and will be part of earnings reports for the year’s first quarter.

Intel, based in Santa Clara, California, used the research credit to lower its effective tax rate by 1 percentage point in 2011 and then couldn’t use it at all for 2012. The company, the world’s largest chipmaker, took five quarters’ worth of credits at the start of 2013. That lowered its quarterly tax rate to 16.3 percent, down from 28.2 percent in the same period of 2012.

Intel plans to spend $10.5 billion on research and development (R&D) in 2014, the same as last year.

Dickel said the uncertainty surrounding the credit undermines the goal of encouraging companies to conduct their research in the U.S.

Intel, which once had all its research in the U.S., now does more than 80 percent in the country.

“When we’re deciding where we’re going to put our R&D jobs, not having a permanent credit is very frustrating to our management,” he said.

 

Turning on and Turning Off

Along with the $7 billion annual research tax credit, Congress allowed dozens of other breaks to end Dec. 31. These include a tax credit for hiring disadvantaged workers used by retailers and restaurants and the credit for energy-efficient appliances taken by Whirlpool Corp.

Global financial-services companies such as GE, Citigroup Inc., and Goldman Sachs Group Inc. lost the ability to defer U.S. taxes on income they earn overseas.

Ford Motor Co. recorded a $221 million tax benefit in the first quarter of 2013 because of the retroactive provisions, including the financial-services break and the research credit. Citigroup said it received a $45 million tax benefit.

GE reported last year that its quarterly income tax rate for the first three months of 2013 was 12.3 percent, down from 16.9 percent the year before, primarily because of the lapsed financial services break.

Jeffrey Bornstein, GE’s chief financial officer, told analysts on a Jan. 17 conference call that the company was “good through the end of November,” and that the tax rate would start being affected in December.

Congress hasn’t acted for several reasons.

Lawmakers including Dave Camp, the Republican chairman of the House Ways and Means Committee, are more focused on pushing significant changes to the tax code than on reviving the breaks. Extending them now would lessen the political pressure for broader changes.

Camp’s Senate counterpart, Democrat Max Baucus of Montana, is President Barack Obama’s choice to be ambassador to China, meaning that some aspects of tax policy are on hold until Oregon Democrat Ron Wyden takes over the Finance Committee’s helm.

Wyden has said he wants to make sure renewable energy breaks are extended. He has been less clear about his plans for the others.

Republicans such as Senator Orrin Hatch of Utah, his party’s top member on the Finance Committee, say they want to examine the breaks individually and may allow some to expire.

Among the most criticized of those known as “extenders” are the production tax credit for wind energy and accelerated depreciation for improvements to motor-sports tracks.

While Congress debates, accountants recalculate.

“Given the option of not having to deal with it,” Evans said, “I’m sure corporate America would prefer that the extenders be extended or made permanent versus this turning off and turning on.”

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