Asymmetrical Information

I'm no fan of BusinessWeak. It's commonplace to see shabby reporting in many business publications. Too many writers with punchy text and not enough writers with business experience.

I'm no fan of BusinessWeak. It's commonplace to see shabby reporting in many business publications. Too many writers with punchy text and not enough writers with business experience.

Good Explanation.

FYI: NOLs can be carried back 2 years (5 years for 2001-2003 losses) and forward 20 - both for individuals and corporations.

Individuals who own pass-through entities (S corporations and partnerships) report the businesses income or loss on their 1040s. It is fairly common for an S corporation shareholder to have an NOL from business losses - assuming they con get past the "passive loss" rules, etc.

If the corporation could eliminate its tax, but didn't, you would wonder about the competence of its management. At least the shareholders would.

Good summary of a complex tax accounting issue. Two quick points: Both individuals AND corporations may carryback an NOL 2 years and forward 20 years. (You may elect to forgo the carry back.) Second, the way the NOL is computed for individuals and corporations differs, but both methods are trying to achieve the purpose you described -- to make sure the right amount of income is taxed in the long run.

The allowance of an NOL carryback or carryforward is a basic matter of tax fairness. It just isn't fair to tax someone (whether individual or corporation) on income in one year without recognizing the loss that was generated the prior year. But groups like CTJ are not about fairness or justice. They are about trying to increase their power.

Actually, individuals can have NOL's. A big loss on a partnership or LLC investment can generate one, for example. I'm not sure of the details.

As far as CSX goes, it's interesting that they did in fact report profits in 2001 ($293 million) and 1998 ($537 million, $428 million without non-recurring items).

So instead of just saying, "well the poor dears lost money so why should they have to pay taxes?" we might ask where all those hundreds of millions went when it was time to fill out the tax return.

The broad answer is that the tax code contains a number of deductions and credits for corporations that are not normally part of standard (GAAP) accounting. These include taking depreciation at an accelerated rate, and other items.

Some of these are reasonable, some not, and not everyone agrees on which are which.

What Business Week might have done is tell us exactly what tax breaks were involved. It would be interesting to hear Snow's views on reasonableness vs. unreasonableness.

What those who oppose "distortions" in the tax code might ask themselves is why these particular distortions are OK.

Of course, there's the fiction that the depreciation schedule has anything to do with the actual loss in asset value.

But, the real problem is that the tax system penalizes capital expenses compared to marginal ones.

The expense should be taken the year that it is paid.

"The expense should be taken the year that it is paid."

Why? The idea is that depreciation takes a capital outlay and turns it into an expense over the life of the item purchased. If you buy a million dollar machine that's going to be used for five years it's simply inaccurate to claim that you have a million-dollar expense the first year and no expense the next four. You can quibble with the depreciation schedules allowed in the tax code, but the general idea of depreciating, rather than expensing, capital equipment, is sound.

And if you're going to quibble you might provide some facts.

Bernard,

Your obviously correct when talking about GAAP. However, the question is what about in terms of figuring out the taxes you pay is a different arguement.

For example, (yes I know this is a gross-simplification, but go with me on it) let's say a company projects a profit of $1000 for the whole year. Let's say it's near the end of the year and the company happens to have $1000 in it's bank account. It decides that it wants to spend the money. If the company spends it on say a big party for it's employees (costing $1000), it will have a profit of $0, bank balance of $0 and taxes owing of $0. If the company spends the $1000 on computers, what happens? Well it still has a bank balance of $0, but it has a profit of $800 (assuming 5 yr. straight-line depreciation on the computers) and taxes owing of $200 (assuming 25% tax for simplicity). The company, of course, has no money to pay these taxes, but wouldn't have had to if it had been "smart" enough to use the money for a party rather than capital assets.

Good summary.

Forget to mention: I've heard that people who should know have been saying that corporate taxes have fallen through the floor in recent years, even during the boom, implying that there's some sort of widespread evasion going on. Maybe that's where this came from?

The primary differences between GAAP and tax accounting are timing differences. With the exception of depreciation, most of these timing differences are in the Government's favor -- that is, the tax code tends to recognize revenue sooner and defer the recognition of expenses longer than does GAAP.

The purpose of the tax code is to raise money for the government. The purpose of GAAP is to provide a "fair" measure of income. These goals are often inconsistent. When there are book/tax differences, they are often the consequence of Congress' search for more tax revenue. Eventually these timing differences reverse themselves. When they do, the IRS gets less money.

Which is what makes listening to the CTJ so frustrating. Many times, when CTJ complains about profitable corporations getting away without paying any taxes it turns out the corporation had recognized and paid taxes in a prior year.

Crux of the story is that a liberal group shamefully distorts facts in effort to slander an honest man. Media sympathetic to liberal group runs story without checking.

Same old story, chapter number 10,000 and counting.

Peggy Noonan is wrong when she says that abortion is the glue that holds the Democrats together. The real glue is the belief that Republicans are evil and malevolent. Constantly planting stories which impugn the character of GOP leaders is necessary to keep the Democratic faithful from leaving the plantation.

Manish,

The first thing your second company should do is fire its CFO. Managing cash flow is part of his job. Maybe he should have financed those computers. The fact is that the corporate income tax is a tax on profits and they made more profit than the first outfit.

David,

Could you cite some of the timing differences that favor the government and compare their magnitude with those that favor the company? Your "exception" of depreciation is pretty big. It seems to me that "deferred taxes" is normally a liability, suggesting that the balance is in favor of the company, not the government.

And of course it's not just timing differences. Aren't options tax-deductible, for example?

And, I ask again, where did all that profit go?

Stan,

Why is it a "slander" to point out, truthfully, that CSX paid no taxes in certain years? And by the way, how much did they pay in those other years? Snow is nominated for Secretary of Treasury, a job with responsibility for the tax code. I, for one, would like to hear him explain whether and why he thinks the preferences CSX took advantage of are good policy.

And Business Week is hardly a liberal magazine. They could hardly contain their praise for Bush's tax proposals, for example. Of course, dittohead logic is that doing anything less than loud singing in praise of Republican ideas is simply liberal bias.

Bernard: deferred taxes can be either an asset or a liability; I've seen it both ways. I don't know which is statistically more frequent, but it's certainly not uncommon.

Jane,

Yes. That's true. In fact, it can be both. CSX shows it as both a current asset and a long-term liability. From 1997 through 2001 the numbers (in millions) are:

Year Asset Liability
97 162 2939
98 128 3173
99 135 3227
00 121 3384
01 162 3621

So it looks like, for CSX at least, the timing differences have been extremely favorable to the company, whether you look at the absolute numbers, or the year-to-year changes.

just one more reason corporations shouldn't be taxed!!!!

and ending taxation of corporations will send lots of lawyers and accountants into poverty (which is a good thing for all of society)

btw, business week is not now, nor has it ever been, a good or respectable publication. Nearly every story or opinion column militates for higher taxes and regulation, and spins all stories in a manner that the NYT would be impressed with...

it's worse than WORTH for cripes sakes! (WORTH: the magazine for limousine liberals that want the government to take more of their money, believe corporations are evil, and need a good lead on multimillion dollar estates)

fing brain dead...

Jane--

A brilliant exegesis on why its silly to retroactively propose political litmus-based tests ("the hell with the shareholders-- I'm up for Treasury Secretary-- let's pay taxes even if we don't owe them, damn it!")

There is, of course, an explanation for why CSX didn't pay taxes those years (and thus a VERY good reason to question the choice of Mr. Snow). Simply, with respect to the years in question, we can presume CSX didn't have net taxable income. Because (at least in a tax accounting sense) it didn't make a profit. Because MAYBE... its... not all that well-run a company... (it certainly appears to be a less well run company, BTW, than Paul O'Neill's Alcoa was).

Because of this, maybe CSX executives shouldn't be considered candidates for running the Treasury of the United States, when they apparently can't even run a railroad. (Ditto Enron executives, BTW, for ANYTHING.)

My question to you, Jane-- why settle for the foreign service? If I'm elected President-- you can be Treasury Secretary.

A quick look at Moringstar and MSN show that CSX posted operating profits and income tax expenses for every year going back to 1993 (Morningstar goes back farther than MSN.)

I assume that these are not consolidated with the Conrail statements, and they (Conrail) carried large tax right-offs.

To wit, when CSX bought Conrail (42%, actually, 58% went to Norfolk Southern) in 1997, included in the price was the tax write-off. CSX purchased the tax reductions from the shareholders, compensating them for perviously incurred losses.

I'm making a few guesses and simplifications, but the facts are that CSX was not running a loss and there is no reason to believe that they didn't pay for the benefit they received.

Lazy, sensationalist reporting. On an ethical level, a CEO is an representative, not the government. To have ignored legal means to reduce the tax burden on his shareholders would have been patently unethical. Had he not utilized these tax write-offs, he would have been grossly negligent. That would have caused more concern than discharging ones duty.

Oh yeah, CEO's have nothing to do with actually doing the taxes, they just sign the Financial Statements.

"A quick look at Moringstar and MSN show that CSX posted operating profits and income tax expenses for every year going back to 1993 (Morningstar goes back farther than MSN.)"

The tax expense that firms report in their financial statements is not the same as the taxes they actually pay.

"I assume that these are not consolidated with the Conrail statements, and they (Conrail) carried large tax right-offs."

Why would you assume they are not consolidated? CSX financials include Conrail after the acquisition.

Why do you think Conrail carried large write-offs? In fact they were profitable in 96,97, and 98.

"Lazy, sensationalist reporting."

Lazy posting, I'd say. You don't back up any of your guesses or assumptions. Further, I am not accusing CSX of illegal behavior, and I don't see anything that says BW is either.

I think the notion that Snow is somehow unworthy because his company minimized its tax bill is silly.
But I also think the structure and fairness of the tax code is a reasonable issue to raise with someone nominated to be Secretary of the Treasury. And if CSX's tax history highlights some issues, so be it. We've heard a lot from Bush lately about things in the code being "wrong." Others are entitled to comment on this topic as well.

Umm, Bernard -- the tax expense they report in their financial statements isn't the expense they pay that year. But over the long run, it's the same. If it's not, the SEC will have something to say.

Bernard:

Sorry for the delay in responding to your request for specific examples of timing differences that benefit the government.

I think one of the best examples is the Uniform Capitalization Rules of Internal Revenue Code Sec. 263A. (At least I think that's the cite, I am home from a long day at the office and don't want to bother looking it up.) This code section requires businesses to capitalize into inventory "period costs" that are normally expensed for financial accounting purposes. (This code section requires for tax purposes what Worldcom did on its financial statements. In other words, if you followed Sec. 263A in preparing a company's financial statements you would be guilty for fraud.) Depending on many factors, this tax requirement can have a very large tax cost to a corporation.

Another example? Over the last several years, the tax law has evolved to make it more difficult for a contractor to defer the revenue from long-term contracts. Again, the result is that the revenue from these contracts are generally recognized earlier for tax than they are for book.

In CSX's case, I have no idea which way the timing differences usually run. The point is, CTJ is (or should be) aware that a corporation may show a profit for tax purposes earlier than it does for books and that there may well be nothing unethical or wrong for a corporation to report no taxable income in a year that it reports income on its financial statements.

If Congress wants to have taxable income tie directly to the financial statements, Congress could always change the law. If a company follows the law, it is unfair to castigatge its executives as unpatriotic. No company (or individual) has a moral duty to pay more than the law requires -- we call doing so a charitable contribution!

(I have had clients who have benefited from CTJ's public criticisms. In both cases, CTJ's complaints were way off base. Since I am unwilling to identify the clients, I should not have mentioned this -- tuff.)

Jane,

Over the VERY LONG run. CSX net deferred tax has grown every year, at least since 1997, the first year I looked at. And they did teach you about time value of money at Chicago, didn't they?

David,

Thanks for the response. What are "period costs?"

Let me repeat that as long as CSX was within the tax laws I have no problem with their behavior, or Snow's. I merely think this might be an opportune moment to have a look at how corporate taxes really work, rather than at how we pretend they work.

Well, as you know, I'm against the corporate income tax, so I think we should take a VERY long look at it. But that doesn't change the basic silliness of this story.

Bernard - A "period cost" is an expenditure made within a period THAT PRODUCES NO LASTING BENEFIT. An example would be the light bill in corporate headquarters. While it may be necessary to provide the executives with lights, few would argue that payment of the monthly bill would create an asset that should be carried on the books of the company. It was just an expense of doing business. By contrast, buying some lumber to be used in making furniture does create an asset. The lumber becomes part of your work-in-progress (or supplies) inventory. It is an expenditure that the company will benefit from in a future period.

Sec. 263A requires a portion of the executive suite's light bill to be recorded as "inventory" and eventually expensed as part of the cost of goods sold. It makes no accounting sense. It just raises revenue for the government.

Bernard,

Mea culpa, I realized on the ride home that my accounting had failed me. You are right about the difference between taxes paid and taxe declared on the income statements. And yes, unles the company winds up, those differences are usually never resolved.

That being said, and given that I think we all agree the tax code stinks, Snow still did the right thing. He's a representative of the shareholders, not a tax crusader. To have done anything else would have been to literaaly rob his shareholders of money there were owed. That would have been scandelous.

Reform the tax code, but until then, don't condem the people who work within it.

Jane,

While fishing for work at BW, have you considered fishing for work at Treasury? Lots more clout that BW or State, and helps your resume should you decide to go back to the Street.

Fire off, seriously, fire off a slimmed down version of your text to committee staff and to Treasury and to Grassley's staff. Yes, committee staff, maybe even Grassley's staff and surely the folks at Treasury already know this stuff, but the ability to get the argument on paper (slimmed down) is one they will all admire. Snow is new. He will want to make changes. Ya never know, could be a schedule C opening somewhere.

yes!!!

get someone into treasury who knows why taxes are bad!!

better yet, work for irs... fire anyone that collects anything!!!

you can always cook up a sex harrassment complaint!

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