Corporations, just like you and I, cut taxes and thereby reduce government revenues or shift costs to others. Corporations legitimately cutting costs are not evil, just endlessly innovative.
But citizens and state officials need to eliminate loopholes abused by powerful corporations and overcome the armies of attorneys and lobbyists that resist closing the loopholes.
In states with income taxes corporations cut taxes by getting approval from the IRS to reorganize corporate structures into Real Estate Investment Trusts. REITs are defined in IRS section 856 as “any corporation, trust [etc.] … that acts as an investment agent specializing in real estate and real estate mortgages.”
Eisenhower’s administration and Congress created REITs as a way for small investors to purchase stock in a corporation that owns real estate such as office skyscrapers and shopping malls. REITs must have at least 100 individual shareholders.
If REITs pay at least 90 percent of their profit as dividends, they do not have to pay corporate income taxes. Instead the federal government receives equal revenue by taxing dividends as ordinary income.
It’s a constructive win-win arrangement that allows individuals to buy real estate shares like they buy mutual funds.
Business quickly avoided federal income taxes by putting investors into corporations that pay lower taxes. The formerly responsive federal government quickly eliminated that loophole.
Corporations are using REITs to cut state taxes and shift burdens to citizens who are taxed to make up the difference or accept reduced services.
Wal-Mart is not a company I envision as a REIT. But a Wall Street Journal article in 2007 by Jesse Drucker used court records to describe how Wal-Mart set up a REIT in North Carolina to own its stores and rent them to Wal-Mart.
Wal-Mart’s REIT got approval from the IRS by selling one percent of the shares to 100 investors, all of whom were Wal-Mart executives, some in other states. Ninety-nine percent of the shares were owned by one subsidiary corporation.
“Wal-Mart, in about 25 states, has been paying most of that rent to itself—and then deducting that amount from its state taxes,” said Drucker. “It has saved Wal-Mart from paying several hundred million dollars in taxes.”
North Carolina, and other states, do not tax dividends paid by corporations to themselves on the assumption they are simply transferring money. North Carolina’s treasurer recovered the $33 million in assessments over four years, an assessment the attorney general defended against Wal-Mart attorneys all the way to the state supreme court.
A 2007 issue of Missouri Law Review published an article by Jennifer Stonecipher, who is currently a defense attorney in Kansas City, that described the difficulty states were having filing lawsuits and passing legislation to correct abuse in REITS.
“Clear and specific legislation is necessary to close the loophole and end the unfair shifting of state tax burdens,” she said.
Corporations are still using the loopholes. Correction Corporation of America, a for-profit company that operates prisons for federal and state governments, converted to a REIT in February 2013.
American Tower, an owner and operator of thousands of communications towers in wireless and broadcast industries, converted to a REIT in 2012. Its competitor, Equinix, announced it was converting to a REIT and was not worried about potential legislative changes, according to Anton Troianovski in the WSJ on October 11, 2012
“Our advisors have told us that even if they wanted to change the policy around REIT conversions, it would take years because of the bureaucracy,” said CEO Steve Smith.
State bureaucracies succumb or don’t resist because lobbyists argue closing loopholes is a tax increase and many legislators have pledged to oppose tax increases.
Lobbyists also insist “state governments don’t have a deficit problem, they have a spending problem.”
Hapless legislators must replace revenue lost by the abuse of REITs by cutting spending for education, health, human services and law enforcement or increase individual taxes.
This story is a reminder citizens and their state governments must be vigorous, loyal opposition to corporate interests that abuse useful legislation, force states to cut important services or shift costs to individuals.