Corporate Inversions: What They Are and How They Cost You Money

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No doubt you've been hearing about corporate "inversion" lately, whereby a U.S. company merges with an overseas entity, then restructures its operations so that its new home base is in the foreign country - which, almost always, has a lower corporate tax rate. The move, however, has no effect upon the company's business functions here in the U.S.

A recent study by the Congressional Research Service shows that inversions are on the rise, as companies try to exchange the U.S. top corporate tax rate of 35% for a much lower foreign rate like the U.K.'s 20%, which takes effect next year.

Over the past decade, 47 U.S. companies have lowered their taxes in this way, despite the passage of the American Jobs Creation Act of 2004. That law sought to cut down on such activity by requiring, for one thing, that foreign shareholders own at least 20% of the new company. Considering that only 29 inversions took place in the two decades prior to 2004, the AJCA doesn't seem to have been even a mild deterrent.

U.S. taxpayers, shareholders lose
Companies use inversions to save big in other ways, too. By incorporating overseas, they will now have access to huge cash stockpiles - money earned by their foreign operations, but not brought into the U.S. because of the tax bite. American corporations held $1.95 trillion in these offshore accounts as of March 31 of this year.

Another way to cut down on the corporate tax bill is to place tax-deductible debt, loans, and other liabilities onto the U.S. subsidiary's balance sheet, thus trimming U.S. taxes owed. This technique, known as "earnings stripping", by the way, is entirely legal.

A fantastic deal for inverted corporations doesn't bode well for U.S. taxpayers, though. The Obama administration is concerned about the loss of tax revenue, which it estimates to be around $20 billion over the next 10 years. In a recent post on the White House blog , it is crystal clear who will be expected to make up that lost revenue: U.S. workers.

While that may sound more like a threat than a prediction, it's probably a bit of both. The National Priorities Project notes that the corporate share of the nation's tax burden has lightened steadily over the past few decades, with a commensurate rise in the heft of the individual taxpayer's bill.

Shareholders will pay a price for an inversion, as well. When any merger occurs, it is considered a taxable event - but, unlike in a domestic union, there will be no cash payout to help offset the capital gains tax generated by the transaction. Because of this, investors holding shares of such companies as part of their long-term estate-planning strategy will find themselves paying a capital gains tax that they otherwise would not have incurred.

In an effort to curb the inversion craze, the Stop Corporate Inversions Act of 2014 has been introduced, and would halt many inversions by making them less lucrative. For example, it would change the 20% ownership rule to 50%, and would prevent inversion deals when there is no real transfer of corporate control from the U.S. to the foreign location.

There may not be much congressional enthusiasm for such a move, however. At the end of July, Senate Republicans blocked a bill that would have ended the tax break that allows U.S. companies engaging in inversions to deduct their costs of moving offshore.

One of the reasons the GOP criticized the bill was because they believe that the country's tax laws should be less punitive, which would encourage companies to move to the U.S. Interestingly, the hobbled legislation included tax breaks for corporations moving to U.S. shores - the cuts would have applied to U.S companies only.

With such underwhelming interest in evening out the federal tax allocation between corporations and individuals, President Obama has indicated that he may act on his own to change the system. Could the days of corporate inversions be on the wane? We should know soon.

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The article Corporate Inversions: What They Are and How They Cost You Money originally appeared on Fool.com.

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