Google’s Off-Shore Tax Dodge

Introduction

Evidently, Goggle’s slogan “do no evil” does not apply to its U.S. tax obligations. By using a complicated offshore tax strategy, Google lowered its overseas tax rate to just 2.4%, making it the leading tax dodger among the largest technology companies.

Over three years, Google avoided approximately $3.1 billion in U.S. taxes, according to a recent article in Bloomberg.

Google is not alone: Microsoft, Facebook and a host of other multinational corporations engage in similar schemes.

The Ploy

Here’s a simplified version of how multi-nationals avoid U.S. taxes on their overseas profits:

  1. A multi-national forms a subsidiary in Ireland where its tax rate is just 12.5%.
  2. Then virtually all the Irish income is eventually shifted to another subsidiary located in a tax haven, such as the Cayman Islands or Bermuda, which imposes no taxes on company profits.
  3. The tax-haven subsidiary charges the Irish subsidiary “royalties”, causing a transfer of profits from the Irish subsidiary (thus escaping the 12.5% Irish tax) to the tax haven subsidiary. Once the profits hit the tax haven subsidiary, they become impossible to track because of a lack of disclosure requirements.

The Result

Multi-nationals are taxed under U.S. law when and if profits are repatriated, which may never occur. These companies, with billions stashed off shore, are constantly lobbying for a special tax rate (usually 5%) as an incentive to repatriate their profits.

Consequently, they avoid U.S. taxes when they earn profits, accumulate untaxed billions overseas for years, and then demand a preferential tax rate to repatriate their off-shore earnings.

IRS’s Blessing

IRS and Google entered into a special arrangement, called an advanced pricing agreement, that fixed the value of Google’s search and advertising intellectual property for foreign transfer purposes, thereby blessing Google’s use of this tax dodge. Google is taxable in the U.S. on this amount.

Of course, Google wanted the value as low as possible and, presumably, hired an army of financial advisors to make its case. Because the agreement is secret, the fairness of the deal cannot be scrutinized.

Conclusion:

Google’s off-shore tax dodge demonstrates how the international tax system allows multi-national corporations to effectively circumvent tax obligations to the U.S. government and throughout the world.

Although the Obama administration tried to address the problem, according to the Center for Responsive Politics, heavy lobbying pressure from General Electric, Johnson & Johnson and Starbucks caused Treasury to drop the proposal.

Considering a Roth Rollover?

Introduction

The Roth IRA (Roth) is a non-taxable money machine: income is accumulated and distributed tax-free, and it may be left to your heirs. Starting in 2010, taxpayers may rollover a traditional IRA into a Roth without previous income restrictions.

The rollover is generally taxable at ordinary income rates, but the resulting tax may be averaged over two years (2011 and 2012).

As of September 27, 2010, employees with 401k or 403b accounts may make a Roth conversion, provided their employers allow it.

Distribution Rules

Distributions are tax-free if they occur after age 59.5 and the contributions, including rollovers, have remained in the Roth for at least five years. If this requirement is violated, earnings generated from the contributions are taxable.

Also, if the owner is under age 59.5, there is an additional 10% penalty for early withdrawal.

IRA Comparison

Distributions from an IRA are taxable and mandatory after age 70.5. Once distributions commence, the pay-out period becomes fixed; consequently, an IRA may become a depleting resource.

In contrast, the Roth distributions are tax free and there are no compulsory distributions during the owner’s life. If an owner over age 70.5 lives another twenty years, and allows a Roth to accumulate, it could double or triple in value, while during that same time period, an IRA may have been drained by mandatory distributions.

Decision Points

The key Roth rollover considerations involve whether a taxpayer: (i) is willing to pay a hefty tax now for uncertain, but potentially substantial, benefits down the road; and (ii) has the cash outside of retirement plans to pay the tax. In my experience, the answer to both inquiries is often “no,” so in the end, a Roth rollover is not feasible for most taxpayers.

Nevertheless, if you are healthy, in a high tax bracket, have sufficient cash outside your retirement plans and do not need the funds immediately, a Roth rollover may make sense. The basic gamble is that your income taxes will increase substantially in later years and receiving tax-free income from a Roth is worth the tax-cost of conversion.

Also, if IRA assets have diminished in value and you expect them to rebound over the long term, converting now means paying a smaller tax, with the post-rollover appreciation shifting to the Roth.

Disadvantages

Clearly, the biggest disadvantage is paying taxes currently for an arguable prospective benefit. The funds used to pay Roth rollover taxes may be needed in subsequent years for support or medical expenses.

In some circumstances, maximizing taxable income may be desirable, especially when large deductible medical expenses may reduce taxable income substantially.

Conclusion:

If you have the stomach to pay taxes now for an unpredictable, but potentially significant, future benefit and you have cash resources independent from your retirement plans to pay the taxes, consider a Roth conversion in 2010.

Keep in mind that, moving forward, your actual tax rate may not be lower and you may incur substantial medical or other deductible expenses that could offset taxable income generated by a traditional IRA.

George Steinbrenner and Estate Tax Repeal (part 2 of 2)

Who Pays?

The estate tax is paid by the richest families. In 2008, according to estimates by the Urban Institute’s Tax Policy Center, the wealthiest 1 percent of households paid over 80 percent of the $23 billion the tax raised; the top tenth of a percent alone accounted for 46 percent of the total.

Thus, approximately 50% of the tax is paid by 1 in 1,000 estates.

Capital Gains

Although the estate tax is repealed, heirs will pay capital gains taxes on appreciation of the assets received through inheritance if and when they sell the assets.

The gift tax “carry-over basis” rules apply to inherited assets, meaning the heirs also inherit the decedent’s basis.

Note: There is a complicated scheme to increase the basis on certain assets, approximating the $3.5 million exemption that applied in 2009.

The federal capital gains rate is currently 15%, but increases to 20% in 2011. Most states levy a separate capital gains tax.

So while the Steinbrenner clan may escape a $500 million estate tax, they could be liable for $200 million or so in capital gains taxes in the future.

Fairness

Not all billionaires are opposed to the estate tax. Warren Buffet and Bill Gates, Sr. believe that those born in the U.S. have huge societal advantages that make their fortunes possible.

Buffet call it “winning the game of ovarian roulette.” Gates also credits American society for the ability to earn a fortune and argues that society has a just claim, via the estate tax, on those assets.

Conclusion

Congress needs to enact a realistic and fair estate tax law. Individual exemptions of $3.5 million and a top tax rate of between 35% and 45% would eliminate the estate tax on 999 of 1,000 estates and still recover 50% of the tax.

If Congress does nothing, billionaires dying in 2010 will totally escape the tax, but starting in 2011 those with estates of more than $1.0 million will face steep tax levies.