The Check Is Not in the Mail

This week marked the final final final 2022 tax filing deadline for everyone who filed an extension back in April and doesn’t have the good fortune to live in an area affected by certain hurricanes, floods, wildfires, earthquakes, or other natural disasters. If you live in parts of Louisiana affected by seawater intrusion, for example, or certain counties in Massachusetts and Maine that were hit by Hurricane Lee, you’ve still got until February 15, 2024. You haven’t even begun to procrastinate!

Regardless of when you file, it usually means closing the book on that particular year. But sometimes, the IRS decides to audit you and look for more. Usually, the extra tax is just a few thousand dollars. Sometimes, it’s a lot more, which is why the words “IRS audit” strike so much fear into so many hearts. And sometimes it’s a lot more, as software giant Microsoft just disclosed to shareholders.

Companies like Microsoft that operate globally can structure operations to report income in all sorts of places. Naturally, they’ll want to report as much as possible in countries with low taxes. Why pay the old 35% corporate tax on income here in the U.S. if they can pay, say, 12.5% in Ireland?

That incentive leads to classic tax dodges like the “double Irish Dutch sandwich,” which sounds like an oddball corned-beef-on-a-stroopwafel fusion you’d order at a trendy Boston deli. In reality, it involves: 1) establishing an Irish holding company to own intellectual property rights to a product or service, 2) registering the holding company in a tax haven like the Bahamas, 3) licensing the IP to a Dutch holding company, 4) selling the product or service to customers in high-tax countries, 6) routing the profits back to a different Irish company, then 7) passing them on to the Bahamas where they’re effectively tax-free. (Before you ask: no, it won’t work for you.)

Incredibly, that whole sleight-of-hand is legal, as long as you don’t get too greedy. (Remember the old Wall Street adage: bulls make money, bears make money, pigs get slaughtered.) There’s an entire body of law called “transfer pricing,” where lawyers who think regular tax work isn’t boring enough hash out the rules for pricing transactions within and between businesses under common ownership or control. And that leads us to our story.

Last week, the IRS sent Microsoft a series of Notices of Proposed Adjustments, politely requesting $28.9 billion in extra tax from 2004 through 2013. The Service argues that because Microsoft subsidiaries helped pay to develop certain intellectual property, they rightfully owe tax on the related profits. You don’t need more explanation. It would just give you a migraine.

The back tax represents about 14% of Microsoft’s gross revenue for the year. It’s twice as much as they’ve invested in artificial intelligence. But don’t expect them to send a check anytime soon. Microsoft argues that newer tax laws could shave $10 billion from the bill. They’ve promised to appeal the notices with the IRS, which will consume years of bureaucratic gear-grinding. Then, they’ll “contest any unresolved issues through the courts” if necessary, which will eat up more years. My money says that Skynet will be self-aware by the time the whole thing plays out. At that point, it’ll take a Terminator to collect the actual tax.

Your taxes aren’t nearly as complicated as Microsoft’s, and your bills aren’t nearly as big. That means you’ll never face down the business end of a deficiency notice asking for more money than the gross national product of Yemen or Cambodia. But that doesn’t mean that paying more doesn’t hurt. You know who to call!