Why does Amazon Pay Zero Taxes
By: David Merrill
Tags: Politics, Economics, Taxes, Capitalism, Amazon

Yes, individuals can deduct a few expenses such as mortgage interest, medical and so forth. But usually this doesn’t exceed say 10 or 15% max. Where Corporations can deduct all of their expenses. In fact for individuals if they somehow find too many deductions and it gets too high there is something called the alternative minimum tax (AMT) which they will end up having to pay. This rule keeps individuals from deducting too much.

So, in the case of Amazon, a notoriously low margin business, where frequently their income statement looks something like this:

$100 - $100 = $0

They end up paying very little taxes just due to their low margin.

The government encourages risk

If their is no profit. There is no federal income tax.

One reason that Silicon Valley and the explosion of venture capital and startups exists here in the United States is due to the tax code. This is a good thing in that we now have companies like Amazon, as well as Apple, MicroSoft, Google, Facebook, SalesForce, Tesla and I could go on and on.

All of these companies have one thing in common. At the very beginning they made no money. Sometimes for many, many years.

Amazon, by design, was one of these companies for longer than just about any other. Jeff Bezos’ entire philosophy for Amazon was to sell every item for as low a price as possible, where the margin was as close to zero as possible, so that he could undercut competition and capture as much market share as he could.

Or simply put, he decided Amazon would grow their customer base instead of trying to make a profit.

Net Operating Losses (NOL)

The tax code also allows these startup companies to roll forward those losses they have in the early years.

So, for example if the first five year of Amazon profit/(loss) looks like this $(3M), $(2M), $(1M), $(0M), $1M. Then even in year five when Amazon finally made a profit of $1M they would pay no federal income tax because they can use past losses to offset current profits for up to twenty years. In fact, in this example, Amazon in years 1–4 Amazon had a $(6M) loss, and used up $(1M) of that loss in year five. But still have a $(5M) NOL to use up in future years.

This is another reason Amazon pays so little in taxes. They had losses for so long and built up such big NOL’s that they were able to use those to offset their taxes even once they started showing a profit.

Interesting aside. A lot of those NOL’s were from their early years. They were founded in 1995. Only in the last couple of years has Amazon started to show a significant profit, having made over $11B each of 2018 and 2019 and already having net income of $14.1B through September 30, 2020. So, likely will have close to $20B profit in 2020.

But the tax rule is you can only carryforward NOL’s for twenty years.

Analysts have been talking about this. Their theory, as to why Amazon has been showing profit lately, is that Amazon’s success has taken off at a trajectory where they cannot spend fast enough to keep their margin close to zero. I wonder if these past two years they weren’t using up all of their NOL’s as they are getting close to expiring. To be honest the analysts probably have it right or they wouldn’t have made $20B in profit in 2020. But I still bet a conversation back in 2016 or 2017 happened where someone said we should let up a little on the pressure to spend every penny. To take advantage of these expiring NOL’s the next couple of years.

Depreciation, Share Based Compensation and R&D Expenses

Ok, those were the major reasons that Amazon pays so little but I just want to cover a couple of other reasons that are pretty significant to Amazon as well.

To understand Depreciation first you need to understand that their are actually two sets of books for accounting. One for taxes and one for financial reporting. The one for taxes is kept and used for filing tax returns. The one for financial reporting is kept for filing financial reports such as the quarterly and annual 10-Q and 10-K’s filed to the Securities Exchange Commission. These are the reports used by analysts to tell you what earnings, revenue, PE ratio’s, and all of the other financial ratios you hear being thrown around. Including income and loss.

So, when you hear some idiot say something like this.

“Which means they paid about 1.4% of their total net income in federal income taxes.” ~ quote by this guy right here

They are actually comparing apples to oranges in a way. Since, the tax amount comes from the tax books and the income amount comes from the financial reporting books.

Depreciation

Ok, so I told you all of this to explain depreciation book-tax differences to you. (In common accounting speak, book refers to the financial reporting books, and tax refers to the tax books.)

As we all know Amazon spends a lot of money on infrastructure. After all, how do they get that package to you so fast. Lots and lots of infrastructure, massive well equipped and automated warehouses, with tons of high tech, bleeding edge equipment. Not to mention, planes, trucks, vans and the tons of office spaces for their hundreds of thousands of employees.

All of this infrastructure they can expense through depreciation.

But David, didn’t you say that they deduct all their expenses above. And that’s why their margin is so low? So, isn’t this factored into your explanation above?

Well no, because another way congress has juiced the tax code is by allowing companies to depreciate their buildings and equipment faster under the tax set of books then under the financial reporting set of books.

So, for example if they buy a piece of equipment for $1M under the financial reporting books they might depreciate over a ten year period and record $100K of expense each year. But the tax code might allow them to depreciate it over five years so they can record $200K of expense on their tax returns and lower their taxes.

I point this out. Because this is a major way that Amazon is able to manage their taxes. If it looks like they might be close to making some money in the next year or two, they might go on an infrastructure spending spree. We see them announce these all the time, where they are about to spend a few billion more building out their warehouses and shipping capabilities.

This is an easy way for them to manage their taxes and the only result is a much more massive company at the end of it.

R&D Expenses

Amazon also spends a lot of money developing new technologies. Think of their website, Amazon Prime, AWS and all of the technologies surrounding those.

Again you say David, if all of their expenses are included in that equation you showed me above aren’t these R&D expenses already captured in your explanation above?

To understand this one you’ll have to understand the difference between a tax deduction and a tax credit. Above all of those expenses end up being deductions and reduce their income. A tax credit allows them to subtract these expenses from the actual amount of tax paid.

So, two examples:

A deduction. A company makes $100 and has $80 in deductions. They end up with $20 on which they pay taxes. At a 40% tax rate they pay $8 in taxes.

A credit. A company makes $100 and has $60 in deductions. They end up with a $40 on which they pay taxes. At a 40% tax rate they pay $16. But let’s say that missing $20 is able to be applied in this example as a credit. Which gets directly applied to the tax owed. So, they end up with negative $4 in taxes. That’s right they get $4 back from the government.

So, yeah, you can see tax credits are much more valuable than deductions. As the government again is trying to incentivize growth. In this case they want to encourage companies to go out and develop new technologies.

America wants Silicon Valley on that wall, they need Silicon Valley on that wall… so, congress puts things like R&D tax credits in the tax code.

Stock Compensation

If you’ve read articles similar to this about why Amazon doesn’t pay taxes you’ve probably seen this explanation. This is a favorite one to explain Amazon’s lack of taxes.

And while I agree. It’s not the biggest reason at all. So, we’ll cover this quickly.

Employees receive stock options. Say they receive an option for $20K. They don’t end up giving out any actual cash, since the employee is receiving a part of the Company. But they still get to record that $20K as expense (albeit over a few years).

This is one major way that Amazon can have a loss but yet have a positive cash flow. In case, over the past couple thousand words you were wondering how Amazon can keep losing money and still exist as a Company. Well, it’s things like this (along with in the early stages of the Company of course just receiving cash directly from investors to fund the losses).

So, is this all a problem? If it is a problem, what’s the solution?

So, first of all, I actually agree with a lot of the things that the tax code has. I don’t mind that the tax code tries to incentive risks and allows for things like the net operating losses. I don’t mind that they want to incentivize research and development that hopefully, leads to new technologies.

I think a lot of these types of incentives are what leads the United States to be one of the better places in the world to do business, and is what has made us so prosperous.

But I do think there is a limit. Amazon has reached it. And so for that matter have Google, Facebook and all of the other tech behemoths.

Put an AMT on companies of a certain size

My simple solution is to do what Congress did to individuals with the alternative minimum tax (AMT) that I discussed above.

We would apply the AMT to revenue. i.e. what we tax individuals on. Just being fair here.

I don’t want to discourage startups or the risks taking by those involved in funding startups. So, we could make a cap of say $1B in revenue. To be honest we could make it $10B. We could start at $10B, see what that does and if needed lower it in the future. Some studies would have to be done here to figure out the cap as well as the AMT percentage.

Then simply apply a percentage of say 1% to every company that has over $10B in sales and if they had calculated less taxes then in this example $100M in federal income taxes then they would have to pay the difference.