Firms Pass Up Tax Breaks, Citing Hassles, Complexity

July 23, 2012
Wall Street Journal
JOHN D. MCKINNON

For years, politicians have used targeted tax breaks to try to influence corporate behavior, offering lower tax bills as an incentive to hire more workers, boost energy efficiency and buy more equipment, among other things.

But executives, particularly at small and medium-size companies, complain that many of the tax deductions are either too cumbersome or too confusing. In some cases, the cost of obtaining the tax benefit is greater than the benefit itself—a wrinkle that has helped spawn a cottage industry of tax-credit consultants. Also problematic is the threat of pushback from the Internal Revenue Service.

The result: many companies are saying "no, thanks" and are likely paying more taxes than legally required. And corporate breaks that Washington hopes will boost the economy often prove ineffective.

"I usually avoid these targeted tax incentives, because it costs so much just to be compliant that it's not worth messing with," says John Raine, CEO of Raine Inc., an Indiana firm that manufactures belts and holsters for the military and other customers. "I can't run a business based on what area the federal government is trying to juice."

As Republicans and Democrats are gearing up to overhaul the corporate tax code next year, simplification has become a bipartisan rallying cry for several reasons.

Both sides agree the code's complexity is unfair: While small and medium-size companies such as Raine forgo the headaches and the tax savings, bigger companies can more easily afford the specialized accountants and lawyers needed to claim the best breaks and gain a cost advantage.

Many critics, particularly congressional Democrats, also say U.S. multinationals often use complex tax breaks to lower their tax bills too much or dodge taxes overseas. Some economists think the perception of unfairness may cause some companies and wealthy individuals to avoid complying with tax rules.

Complexity is costly. Compliance costs for U.S. businesses and individuals have been rising, and now reach at least 1% of GDP, or about $150 billion last year, and possibly much more, according to congressional researchers.

The Byzantine nature of the tax code also adds to concerns about U.S. competitiveness in a global economy in which many other countries have eased tax rates and rules in recent years.

So if everybody agrees complexity is a pain, why does it persist? In part, both the White House and Congress can't seem to resist fine-tuning the tax code to satisfy their diverse goals. And once a break is created, the IRS must issue rules to prevent people from taking inappropriate advantage.

Tax consultants estimate that eligible businesses obtain as little as 5% of the main domestic tax breaks that they are entitled to claim. That means firms are leaving tens of billions of dollars on the table every year. Out of 1.78 million corporate tax returns in the U.S., only about 20,000 claimed any of the three dozen main business tax credits in the code, according to IRS estimates.

One example of the tough-to-take breaks is the federal Work Opportunity credit. It was designed to reward companies for hiring workers from several disadvantaged groups, including welfare and food stamp recipients, youths seeking summer jobs and ex-felons. The break typically lowers a company's taxes by up to $2,400 per employee. For businesses hiring unemployed veterans, it can be worth as much as $9,600 per worker.

The credit frequently goes unclaimed, largely because it is such a hassle. It requires extensive paperwork for each worker for whom it is claimed and the paperwork can often take a year or more to process. Sarah Hamersma, a University of Florida professor, estimates that companies claim the credit for just 20% to 35% of all eligible workers.

J.J. Pledger, chief financial officer for the Twisted Root gourmet burger chain in the Dallas-Fort Worth area, said he spent the better part of a day last year trying to figure out how his company could obtain the credit. Mr. Pledger, a CPA, knew the credit likely would be available for a number of his company's 200 or so annual hires. But the more he read, "it seemed like the documentation of the tax credit could be really hard to administer," he recalled. One concern was all the personal information needed from job applicants. "So I put it on the back burner…. It seemed too daunting."

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