“Because we are in a low-margin industry and invest in innovation and infrastructure, we don’t make as much pretax profit as other tech companies, so our taxes are lower.” – Amazon spokesperson
Few would argue that one of the most disruptive companies in recent history has been Amazon (AMZN). Founded a little over 25 years ago in Jeff Bezos’s garage (how cliché!), the venture has grown to be one of only a handful to crest $1 trillion in market capitalization. The company generates over $250 billion in annualized revenue, employs over 750,000 people and has enough Amazon Prime subscribers to populate the 14th largest country in the world. Most of us think of Amazon as a retail platform, but its business also includes video and music streaming services, film production and distribution, Alexa, Amazon Web Services, Whole Foods and others. The explosion of this innovation machine onto the world stage over the past couple of decades has been absolutely amazing by any measure.
Lately, however, the company has been receiving attention for a different kind of achievement – its $0 Federal income tax bill. Around this time last year, British data journalist Mona Chalabi posted the below graphic on social media highlighting the disparity between the recent rise in Amazon’s profits and the company’s tax bill.
Not surprisingly the post and many others like it have spread virally amongst those who are using it as an illustration of how our economic system is broken. Oddly enough, the sentiment that Amazon is “not paying their fair share” of taxes has been trumpeted by prominent members of both political parties.
(I’d like to pause and call attention to the fact that I just identified something Biden, Sanders, and Trump all agree on - this post is already a great success!)
Amazon’s tax bill (or lack thereof) is an interesting topic and one that is soliciting a wide variety of responses. Some critics are painting Amazon and Jeff Bezos as bad actors, some are simply pointing to a tax code that they believe needs reform and some think that as long as the company is operating within the confines of the law there is no problem. Overall, though, a common sentiment seems to be that Amazon and others like it are simply not paying their fair share. So what exactly is going on here? Is Amazon really making billions and not paying any taxes? If so, how is that even possible? Let’s dive in.
One point to make on the front end is that Amazon’s tax returns are private, and public financial statements do not include specific breakdowns of how much tax is being paid at what level. That said, one thing we do know for sure is that Amazon is, in fact, paying taxes. The nearby chart from the Wall Street Journal shows total taxes rising steadily in recent years to $1.2 billion in 2018. That said, none of these taxes went towards Federal income tax, but rather were paid towards state and local taxes, payroll withholdings and various international tax liabilities. So the first clarifying point I’d make is that those characterizing Amazon as “paying no taxes” should more accurately specify that the claim pertains to Federal income tax only.
In turning our attention then to Federal income tax specifically, we find that there are multiple contributing factors that are leading to the absence of tax liability for the company. Let’s look at each in turn.
Amazon, more so than most companies, aggressively reinvests its profits back into the business. As such, it has spent the better part of its first 25 years of existence operating at a loss or near breakeven. The tax code allows corporations to carry these losses forward and apply them to future taxable income. Amazon’s net operating loss carryforward sat at $627 million at the end of 2018. Given the size of the company it shouldn’t take much at all for these losses to be used up, and as we’ll discuss below the deductions and credits they’re taking to reduce taxable income are having a much greater impact than these loss carryforwards.
One of the ways Amazon plows money back into the business is by investing heavily in fixed assets such as property, plant and equipment. Over the past ten years the company has built out data centers, distribution networks and even solar and wind farms to power its facilities – all to the tune of nearly $200 billion. Historically the company would be required to capitalize these investments and take depreciation expense over many years, but part of the 2017 tax overhaul made a provision for “bonus depreciation” whereby a company can fully expense a capital investment that it otherwise would have had to capitalize and depreciate over many years, perhaps even decades. Given its high levels of capital investment, this has worked tremendously to Amazon’s benefit over the past two years. The allowance of bonus depreciation is not permanent and will phase out slowly between now and 2027.
Amazon, like most other publicly-traded companies, compensates its executives with both cash and stock. Stock based compensation is interesting because, although it doesn’t cost the company any cash, the value of the stock is still deductible as an expense at its fair market value once the shares are vested. The higher the stock price at the time of vesting, the higher the tax deduction for the corporation. Many look at this system as a sham of sorts, but in reality the issuance of new shares “cost” the company’s shareholders just as much as if the employee had been compensated with cash. Furthermore, it’s widely held that tying executive compensation to the company’s share price is an effective way to align key employee’s incentives with those of the shareholders. A final point to make is that just like cash compensation, for every dollar the company is deducting as compensation expense, the employee is picking up as ordinary income. This means payroll taxes as well as state and federal income taxes are still being paid on that dollar, and probably at higher effective rates – it’s just showing up on the employee’s tax return instead of on Amazon’s.
R&D Tax Credits
Finally, and perhaps most interestingly, Amazon has benefited greatly from the Research and Development tax credit built into our country’s tax code. The R&D tax credit stems from legislation that was passed in 1981, and since that time the credit has evolved in nature and been extended fifteen different times before being made permanent in 2015. The intention of the R&D credit is to incentivize innovation throughout the economy and ultimately keep technical jobs here in the US. Activities that qualify for the credit are broad, but they essentially cover the development of improved processes and systems that are intended to result in better performance, quality and reliability of our economy’s goods and services. When a company spends money on qualifying activities they are awarded tax credits for up to a certain percentage of the expenditure (between 5-10% on average). This credit is in addition to the deduction they are getting for incurring the expense on their income statement. Amazon, being the technological innovator that it is, has qualified for massive amounts of these credits over the years, and as of the end of 2018 had accumulated $1.4 billion in unused tax credit carryforwards.
So now that you understand how Amazon has reduced its tax bill, the next question to ask is why they have been given the opportunity and whether or not it is right to do so? A question I will explore in detail in next week’s post!
Disclosure: I/we have no positions in AMZN, and no plans to initiate any positions within the next 72 hours. I/we are not receiving compensation for this article.
Author David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.
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