At a hearing last month, Senator Warren asked why Amazon didn’t pay any taxes despite having huge profits. In my opinion, much was missed. So, what is correct the answer? It depends on how persnickety you want to be.
First answer: I don’t know how much in federal income taxes Amazon paid, and, anyone that does for sure that is not authorized by Amazon and talks about it publicly is committing a crime. So, hopefully whoever is asking this is just guessing, based on financial statement information, how much in federal income taxes Amazon paid. That guess can be off for a few reasons. But, its the best guess we have.
Second answer: Amazon paid few federal income taxes because they had no taxable income. We don’t tax book profits, we tax taxable income. It would be illegal for Amazon to pay taxes on its book profits. Amazon is following the law.
Final, longer, and less persnickety answer: Amazon paid little in taxes despite having high financial accounting income (especially in 2018) for several reasons. The biggest reason is pretty simple. When companies pay their employees with restricted stock, as Amazon does, the tax code allows them a deduction for the value of the restricted stock when the employees have full access to that stock, and can actually sell it (on the vest date). At the same time, employees have to pay taxes on the market value of that stock. The financial accounting for restricted stock, in my opinion, gets the economics wrong. Here, the expense recorded is the value of the restricted stock at the grant date. But, if the stock appreciates between the grant date and the vesting date, financial accounting does not require any more expense, meaning, all stock price increases that happen related to restricted stock between grant date and vesting date will result in a tax deduction, but, not a financial accounting expense. The difference is permanent, and it results in less taxes paid that financial accounting profits would indicate.
So, for example, if Amazon grants $10 billion of stock in 2017, and it vests in 2020 with market value of $30 billion (price did approximately triple in that time period), Amazon gets a tax deduction for $30 billion in 2020, but, only recorded financial accounting expense of $10 billion. As a result, the value of financial accounting expense is understated, and book profits overstated, by $20 billion. Book income is artificially high, so, a company will look profitable for financial accounting, because the financial accounting does not capture the economics of the situation, but the tax code does get it right. The fact of the matter is that compensating employees is a properly deductible expense, and just because financial accounting does not require the full cost of that compensation to be recognized, does not mean companies are doing anything wrong. And, to be clear, companies are following the tax law, and GAAP. GAAP just gets it wrong. Which is rare. Usually when you see a gaping hole between book income and taxable income, it is some allowance Congress has made. Not this time.
Why does financial accounting get it so wrong? This is actually an interesting story. The FASB has tried to make it so the accounting for share-based compensation matched the economics more than once. But, companies, fearing the huge hit to earnings, applied their pressure through Congress, and, in the end, it has simply never happened. This story is relevant today because if, for example, we were to have a tax on book income, as Senator Warren and President Biden have proposed, this same kind of pressure would become more common—book earnings, now having the real cash consequence of being taxed, would be subject to more pressure from companies, and, Congress.
So, ironically, because of political pressure on the FASB, the financial accounting consequences for equity based compensation have made Amazon the posterchild for a tax that would increase political pressure on the FASB.
