Telcos and Taxes

windstreamWindstream recently got approval from the IRS to restructure their company and spin off their copper and fiber networks as a REIT. This stands for Real Estate Investment Trust, a form of investment that has been around since 1960. REITs were created by Congress as a way to bundle together income producing real estate in such a way as to create a marketable security.

By IRS rules, REITs must invest 75% of the value of their company in real estate assets, cash and cash equivalents and government securities. What the IRS has done with this ruling is to declare that copper and fiber networks are real estate. This seems like an odd ruling since common sense would tell you that copper and fiber are not real estate in the traditional sense.

The whole purpose for Windstream to do this is to avoid taxes. They estimate that being treated as a REIT will save them about $100 million per year in income taxes. Wall Street immediately boosted Windstream’s stock and also boosted the stock of other telcos on the assumption that they will all follow suit. The stocks of telcos, CLECs and cable companies rose on the news.

The number of REITs has grown significantly in recent decades. In 1971 there were only 34 REITs and by June of this year they have grown to 210. The classification of Windstream as a REIT is not without precedent since American Tower and all of its cellphone tower assets were classified as a REIT a few years ago. The IRS had recently clarified that the definition of real estate for purposes of REITs to include land, permanent structures and structural components. One can only assume that the IRS believes that wire networks are structural components.

Large corporate tax avoidance has been in the news lately with a number of corporations undertaking ‘inversion’ to become classified as foreign corporations to avoid paying US income taxes. In the last few weeks the Walgreens drugstore chain had announced that they were going to undergo inversion but then changed their mind after they got a lot of public pressure. Congress has been looking to close the inversion loophole.

And now, all of a sudden it is the telcos that are going to be avoiding taxes. I must say that this dismays me personally. For several decades I have tried to do my best to buy local and to buy American whenever I can. In my mind, an American company that refuses to pay its fair share of income taxes might as well be a foreign company and I try to vote with my pocketbook and boycott such companies whenever I can.

I’ve always felt that American corporations ought to pay their full share of income taxes just like the rest of us. The corporations that are taking advantage of these tax loopholes all became successful due to being in the US. It’s our American laws and the American business environment that helped these companies get started and thrive. It feels un-American when a corporation suddenly turns their back on all of us to save from paying their fair share of taxes. Obviously corporations are in the business of maximizing their return to shareholders, but at the same time I think corporations have a moral obligation to be good citizens and do their fair share to support the country that supports them.

I understand that there are multinational corporations that do business all over the world. It’s not entirely clear where a company like Apple ought to pay taxes since they manufacture their phones overseas and sell many of them overseas. But there is no ambiguity with a company like Windstream. All of their poles and copper and fiber are sitting in the United States and deriving revenues that are all from the United States.

I understand that Windstream has not taken the inversion option and declared themselves to be a foreign corporation. But they might as well have done so since they instead are taking advantage of a very questionable loophole that has the same effect as being a foreign corporation. The percentage of federal tax revenues that the federal government receives from corporations has dropped precipitously over time from a high of nearly 40% during the 1940s and projected to be only 13.5% for 2015.

I say shame on Windstream. This might be good for their shareholders as witnessed by the boost in their stock price after the announcement. But in the long run this is bad for the country and bad for all of us. If Walgreens had decided to take the inversion and declare themselves to be a foreign corporation I was prepared to move my pharmacy business to CVS. I’ve always voted with my pocketbook and I wish more people would do so. But it’s going to be hard to vote with your pocketbook if all of the major telcos declare themselves as REITs. Unfortunately the vast majority of us don’t have any options for telecom services other than these giant companies.

3 thoughts on “Telcos and Taxes

  1. It’s a funny thing about real property rights in that you can take a cable and if it’s just laying their its personal property but when its attached to a building it’s now considered part of the building and it has become real property.

    Under the current corporate structure of windstream shareholders are taxed two times on their investment. 1st when Windstream the “corporation” earns income Windstream is taxed on that income and it reduces the net income and lowers the return on the investment of the shareholders. 2nd The shareholders are taxed again when Windstream pays out its earnings to its shareholders as dividends. The shareholders then have to show this as taxable income on their personal income even though this same income was taxed previously as an (at risk) investment in Windstream.

    Taxes will still be paid by the shareholders of Windstream. Let me explain to be a REIT, a company must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends.

    Doug thank you for taking the time to write about this issue concerning REATs and cable cos. Just a quick correction you wrote “Large corporate tax evasion has been in the news lately with a number of corporations” The difference between tax avoidance and tax evasion:

    Tax avoidance is the legitimate minimization of taxes, using methods approved by the IRS. Businesses avoid taxes by taking all legitimate deductions and by sheltering income from taxes, all legal and under the Internal Revenue Code or state tax codes.

    Tax evasion, on the other hand, is the illegal practice of not paying taxes, by not reporting income, reporting expenses not legally allowed, or by not paying taxes owed.

    • You are right that this is tax avoidance and not tax evasion. I will correct that in the blog. I would also agree that using REITs is legal as is using inversion since in both cases the IRS allows it. But that doesn’t make it right from a societal standpoint.

      I can’t really blame any given company from taking legitimate tax deductions. I actually spent a few years doing corporate taxes and I understand all of the many tax games that can be used to reduce tax bills. You want to find the smartest guy in many companies you look at the tax guy. This stuff is complicated and arcane.

      My problem is probably more with the IRS and Congress than with companies. Congress approves the various loopholes and the IRS then approves the use and application of them. Certainly when Congress created REITs in 1960 this is not what they had in mind.

      One would think that the IRS’s role would be to maximize taxes for the federal government, and yet this one change alone is going to cost billions in lost federal taxes once it’s spread throughout the industry. Any tax code is the fairest to everybody if all segments of society pay their fair share. But when I read about taxes I see that industry after industry keeps finding similar loopholes to this one. That is what has dropped the overall contribution from corporations down to the 13.5% I’ve cited.

      In my opinion the pendulum has swung too far towards benefitting corporations over people. This particular issue is a highlight of that. Some really smart tax guy probably saw what American Tower had done and took a shot at applying it to networks. Let’s face it. It’s a big stretch to classify a fiber network s real estate. I can’t understand how the IRS could go along with that other than to think that the pressure is there to give breaks to corporations. Why that might be is a topic way past the scope of this blog.

      Thanks for the comments.

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