Corporations couldn’t wait to "check-the-box" on huge tax break

Sept. 26, 2011 — A simple rule meant to cut paperwork for U.S. companies has grown into one of the biggest multinational tax breaks around, costing the United States and other governments billions of dollars in lost taxes each year.

It thrives thanks to determined business support, including a campaign two years ago that forced the Obama administration to retreat from altering it, and tax professionals worldwide who exploit its benefits.

The rule is dubbed “check-the-box.” It allows U.S. companies to strip profits from operations in high-tax countries simply by marking an Internal Revenue Service form that transforms subsidiaries into what the agency calls a “disregarded entity.” Others have labeled them “tax nothings.”

Check-the-box allows companies to avoid the normal 35 percent U.S. corporate tax on certain types of income. The Treasury Department estimates that annual revenue losses from check-the-box have hit almost $10 billion. Other countries are also said to lose billions as income is shifted to places with low or no taxes, although there is no official estimate.

The impact of check-the-box goes beyond the drain on government coffers. The rule, along with other tax provisions, has helped fuel explosive growth in foreign investment by American corporations. Since 2004, the earnings that U.S. companies keep overseas have doubled to about $1.8 trillion, U.S. Department of Commerce data show.

These “unrepatriated” earnings, which are not subject to tax while held abroad, figure prominently in Washington’s debate about corporate taxes. While President Barack Obama has proposed clamping down on loopholes, business groups and allies in Congress are rallying for a tax holiday on overseas profits and a sharp reduction in the corporate tax rate.

Their argument: The high rate creates a disincentive to invest in jobs at home. U.S. companies with the most profits accumulated abroad tend to invest heavily in research and development that can spur job creation.

Check-the-box is but one of many forms of “tax arbitrage” — the art of exploiting differences in countries’ tax systems. It can reduce taxes all by itself or figure into more complex transactions. As the Financial Times and ProPublica reported Monday, the IRS in recent years has clamped down on what it views as abusive arbitrage deals involving foreign tax credits.

But check-the-box lives on. It is not among loopholes targeted by Obama’s new plan. Its untouchable status — the government has twice tried to kill it and balked — provides a case study in how a billion-dollar tax break was born by mistake, then protected by the power of the business community.

Now, check-the-box is “an open invitation to arbitrage,” said David Rosenbloom, director of the international tax program at New York University’s School of Law.

Birth of a tax break

The original idea was innocent enough — to cut red tape by making it easier for companies to decide how to categorize their subsidiaries.

In the mid-1990s, U.S. companies were creating a growing number of domestic entities. The new rule said that, by simply checking a box on IRS Form 8832, businesses could declare them as corporations or partnerships.