Corporate taxes' bark often worse than their bite

When Illinois lawmakers raised the corporate income tax rate in January from 4.8 percent to 7 percent through 2014, giant equipment-maker Caterpillar Inc. was the first to protest.

Comments by its chief executive, expressing worries about the state's business climate and suggesting Illinois may not be the best place to call home, set off a chain reaction. The tax increase became a symbol of the state's fiscal crisis and other states began wooing Illinois corporations more aggressively.

But an examination of public filings shows there's a significant difference between the official tax rate and the actual bite into corporate earnings. Many large Illinois-based companies pay a very small portion of their global earnings to state and local governments nationwide. In 2010, a majority of Illinois' top 50 publicly traded corporations paid less than 2 percent of their earnings in income taxes to states and municipalities across the country, with some paying nothing at all or receiving refunds.

"For multistate, multinational corporations, I don't think the state corporate income tax in Illinois … could be a deciding factor" in whether to leave the state, said Therese McGuire, a professor of management and strategy at Northwestern University's Kellogg School of Management.

The tax system is complex and permits companies, and individuals, to legally minimize obligations through deductions and other means. So it's not surprising that companies would have different effective rates and that some would pay nothing.

Nevertheless, the debate in Illinois has been focused on its increased rate. The prospect of the state losing some of its largest employers has prompted legislative leaders to convene a panel to consider overhauling the way the state collects income taxes from businesses and how it doles out tax breaks to those who threaten to leave. The first meeting will be July 19.

"Critical to our discussions is a review of the disparities that may exist between those businesses that now pay their fair share of taxes and those that do not pay any," Illinois Senate President John Cullerton and House Speaker Michael Madigan, both Chicago Democrats, wrote in an emailed statement to the Tribune.

Separately, Gov. Pat Quinn plans to form a committee this summer to look at ways of making the state's tax structure fairer for individuals and businesses, budget spokeswoman Kelly Kraft told the Tribune on Friday.

Getting a clear picture of tax liabilities is difficult because company income tax returns are private. And while publicly held companies provide information on their state tax burden nationwide, they do not break out figures for individual states. But through interviews and an examination of public filings, the Tribune found that Illinois' tax code enables companies with far-flung operations and global sales to shoulder a very small portion of the state's tax burden.

Peoria-based Caterpillar, with $42.6 billion in sales and revenue last year, is one of them. The company does 70 percent of its sales outside the U.S. and saw sales plummet by 37 percent in 2009. Its state and local income tax burden that year was minus 3.3 percent of global earnings, which means it was owed money back. In 2010, a year when its sales began to recover, its liability was just 0.7 percent.

While the impact is small, the company says it has an effect. "Any government policy action that increases the cost of producing, for example, our mining trucks in Decatur, Ill., means that it will be more difficult for us to sell those trucks against competitors," a company spokeswoman said in a written response to questions.

Also painful, the company said, was the state's increase in the personal income tax rates, from 3 to 5 percent, through 2014. This will cost its 23,000 Illinois employees about $42 million a year and could hurt recruitment efforts, according to the company.

Another big company that doesn't pay much to Illinois is Chicago based Boeing. That's because the company has "a minuscule amount of sales in Illinois," according to Chaz Bickers, a company spokesman.

"With our commercial aviation business, most of our sales are recorded in Washington" state, Bickers said. "We really don't have any other factors that would deem us terribly taxable in Illinois."

The company, which had $64.3 billion in 2010 revenue, reported its state and local income tax burden to be 1.8 percent of 2010 earnings. Bickers said the figure is artificially low because Washington state, where a sizable chunk of its operations is based, collects a business and operations tax, rather than income tax. Boeing says it contributes to Illinois in another way: by purchasing about $750 million in products and services in Illinois from about 850 companies in 2010 alone.

When companies like Caterpillar and Boeing do business in more than one state, they must determine how much of their income is attributable to each state for tax purposes. Illinois previously calculated corporate income taxes based on three factors: a company's in-state property, its in-state payroll and its in-state sales. But in 1998, in a bow to large manufacturers, the state changed the rules and gradually moved to a single factor: income from sales to Illinois-based customers.

Now more than two-thirds of Illinois corporations filing returns pay no income tax to the state, in some cases because they had no profits on in-state sales. In other cases, mom-and-pop business owners pay any profit to themselves as increased pay or a bonus, which then gets taxed at the lower, personal-income rate, said John Bennecke, managing director at True Partners Consulting.

The result is a system in which companies that can't uproot customers or expensive infrastructure -- such as utilities and the city's financial exchanges -- bear the brunt of what this year became the third-highest state corporate income tax rate in the nation.

"We have natural gas distribution pipes in the ground, and we can't pick them up and move them to another state," said Steven Eschbach, vice president of investor relations for Integrys Energy Group, which owns Peoples Gas and North Shore Gas.

Integrys' state and local income tax burden for 2010 was 5.1 percent of global earnings, tying the electronic health records company Allscripts for the second-highest effective rate among the region's largest companies, according to the Tribune analysis. At the top was CME Group, owner of the Chicago Mercantile Exchange and the Chicago Board of Trade, at 5.8 percent. All tax-burden figures in this story include an allowable federal deduction.

CME declined to comment for this story, but its executive chairman, Terrence Duffy, has lobbed the most vocal threat to relocate jobs after the state increased its rate from 4.8 to 7 percent through 2014. Corporations also pay a 2.5 percent tax on income called the personal property replacement tax, which is collected by the state and flows to local governments.

"I'm going to do what's in the best interests of shareholders," Duffy was quoting as saying at the company's annual meeting, adding that "if that means opportunities are greater elsewhere, then we're going to look at those opportunities."

In effect, the company pays income taxes on fees collected from every trade -- an average of 12.2 million per day -- except for the ones made face to face on the floor of its New York Mercantile Exchange.

In contrast, many other big-name firms experience significantly less impact from the state tax, in some cases because their in-state earnings are low or nonexistent, in others because they receive tax credits as incentives for keeping jobs and research endeavors in Illinois. Or sometimes, both circumstances apply.

Infant-formula maker Mead Johnson Nutrition has a low state and local tax burden, 0.2 percent, because only 17 percent of pretax income came from the United States, and within that segment, a lot of sales occur in other states.

"Illinois is a relatively large state, but other states have significantly higher sales because there are more births," said chief financial officer Pete Leemputte.

Mead Johnson said its Illinois tax bill also will be reduced "to some extent" due to credits the company received in exchange for moving its headquarters to Glenview from Evansville, Ind., in 2009.

A number of large companies, including electronics manufacturer Molex and U.S. Cellular, say the tax increase would not materially affect their earnings. Others say they will look for ways to soften the blow.

LKQ Corp., which sells recycled auto parts, said it expects "to pay more with the recent increase. But we are looking at ways to mitigate this." A spokesman declined to elaborate.

The way Illinois tax provisions play out, placing a heavy burden on some and much less on others, is "capricious," said J. Fred Giertz, an economics professor at the University of Illinois at Urbana-Champaign.

And "the way the state operates, there is an incentive for people to cry," he said, noting that threats to leave often are rewarded with tax breaks.

In one of the costliest instances, Quinn in May announced a financial incentive package of more than $117 million over 10 years to persuade smartphone company Motorola Mobility to keep its corporate headquarters in Libertyville and retain about 2,500 jobs. In return, the company agreed to invest $600 million in the state.

Case-by-case concessions are "not good tax policy," Giertz said. "Economists would argue for a lower, more consistent, broader-based tax."

But Quinn defended such deals as critical to the state's economic health. Motorola Mobility "would have (invested) the $600 million in another state," Quinn said earlier, adding that the company had been looking at California and Texas as potential headquarters.

While Illinois income taxes generally make up a small portion of expenses for major corporations, and corporate income tax revenues accounted for only 4.5 percent of the state's general fund revenues in 2010, 18 of the state's 50 largest public companies have been granted state tax credits in the past decade.

The uneven tax burden for different sorts of companies has prompted accusations of unfairness, which the Illinois legislative panel plans to address.

The forums will give businesses a chance to explain their concerns, said John Patterson, a spokesman for Cullerton.

"We will talk about issues with the corporate tax structure, economic development tax incentives and the way utility taxes are applied in the state," he said.

Asked whether a rollback of the corporate income tax increase would be weighed, he said, "I have a strong feeling it will somehow be discussed."

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