Prior to 2004, corporations were required to reconcile their book net  income with tax net income reporting on Schedule M-1 of their income tax  returns by comparing the book and tax return amounts of a limited  number of income and expense items. Effective rates differ from statutory tax rates in that they attempt  to measure taxes paid as a proportion of economic income, while  statutory rates indicate the amount of tax liability (before any credits)  relative to taxable income, which is defined by tax law and reflects tax  benefits and subsidies built into the law. The statutory tax rate of 35  percent applying to most large U.S. corporations is sometimes referred to  as the “headline rate,” because it is the rate most familiar to the public. A common measure of tax liability used in estimates based on financial  statement data has been the current tax expense—either federal only or  worldwide (which comprises federal, foreign, and U.S. state and local  income taxes); however, some studies have used the total tax expense,  and others have used cash taxes paid during the year. The typical measure of income for effective tax rate estimates based on  financial statements has been some variant of pretax net book income. The inclusion of unprofitable firms, which pay  little if any actual tax, can result in relatively high estimates because the  losses of unprofitable corporations greatly reduce the denominator of the  effective rate. The Average Effective Tax Rates for Profitable Large Corporations Were Well Below the Statutory Rate and Well Below the Effective Rates for All Large Corporations in Tax Years 2008 through 2010

For tax year 2010, profitable Schedule M-3 filers actually paid U.S.  federal income taxes amounting to 12.6 percent of the worldwide income  that they reported in their financial statements (for those entities included  in their tax returns). The Average Effective Tax Rates Based on Book Income Are Lower When Unprofitable Corporations Are Excluded

All of the effective tax rates based on book income for profitable filers are  lower than the equivalent measures computed for all Schedule M-3 filers,  shown on the right side of figure 4, because the inclusion of losses  reduces the aggregate income for all Schedule M-3 filers. The Average Effective Tax Rates for Profitable Corporations Were Well Below the Federal Statutory Rate Even When Foreign and State and Local Income Taxes Were Included

Past empirical studies comparing average effective tax rates across  countries have focused on worldwide taxes (which add foreign and state  and local income taxes to federal income taxes in the numerator). 2. 26 U.S.C. 26  U.S.C. Agency Comments

We provided a draft of this report to IRS on April 25, 2013, for review and  comment. After reviewing the draft report, IRS provided technical  comments which we incorporated as appropriate. Among the differences reported on  this line are those relating to differences in inventory accounting. Section 902 of the Internal Revenue Code (IRC) permits a U.S. corporation that owns at least 10  percent of the voting stock of a foreign corporation to take an indirect credit for foreign income taxes  associated with dividends that it receives from that foreign corporation.
Why GAO Did This Study

Proponents of lowering the U.S. corporate income tax rate commonly point to evidence that the U.S. statutory corporate tax rate of 35 percent, as well as its average effective tax rate, which equals the amount of income tax corporations pay divided by their pretax income, are high relative to other countries. However, GAO's 2008 report on corporate tax liabilities ( GAO-08-957 ) found that nearly 55 percent of all large U.S.-controlled corporations reported no federal tax liability in at least one year between 1998 and 2005.
Given the difficult budget choices Congress faces and its need to know corporations' share of the overall tax burden, GAO was asked to assess the extent to which corporations are paying U.S. corporate income tax. In this report, among other things, GAO (1) defines average corporate ETR and describes the common methods and data used to estimate this rate and (2) estimates average ETRs based on financial statement reporting and tax reporting. To conduct this work, GAO reviewed economic and accounting literature, analyzed income and expense data that large corporations report on the Schedules M-3 that they file with Internal Revenue Service (IRS), and interviewed IRS officials.

What GAO Found

Effective tax rates (ETR) differ from statutory tax rates in that they attempt to measure taxes paid as a proportion of economic income, while statutory rates indicate the amount of tax liability (before any credits) relative to taxable income, which is defined by tax law and reflects tax benefits and subsidies built into the law. Lacking access to detailed data from tax returns, most researchers have estimated ETRs based on data from financial statements. A common measure of tax liability used in past estimates has been the current tax expense--either federal only or worldwide (which comprises federal, foreign, and U.S. state and local income taxes). The most common measure of income for these estimates has been some variant of pretax net book income. GAO was able to compare book tax expenses to tax liabilities actually reported on corporate income tax returns.
For tax year 2010 (the most recent information available), profitable U.S. corporations that filed a Schedule M-3 paid U.S. federal income taxes amounting to about 13 percent of the pretax worldwide income that they reported in their financial statements (for those entities included in their tax returns). When foreign and state and local income taxes are included, the ETR for profitable filers increases to around 17 percent. The inclusion of unprofitable firms, which pay little if any tax, also raises the ETRs because the losses of unprofitable corporations greatly reduce the denominator of the measures. Even with the inclusion of unprofitable filers, which increased the average worldwide ETR to 22.7 percent, all of the ETRs were well below the top statutory tax rate of 35 percent. GAO could only estimate average ETRs with the data available and could not determine the variation in rates across corporations. The limited available data from Schedules M-3, along with prior GAO work relating to corporate taxpayers, suggest that ETRs are likely to vary considerably across corporations.

What GAO Recommends

GAO does not make recommendations in this report. GAO provided a draft of this report to IRS for review and comment. IRS provided technical comments which were incorporated as appropriate.