While the IRS is trying to find Lois Lerner's emails and revising its rules governing inversions — the practice of multinational corporations (MNCs) moving their headquarters to avoid paying taxes — it has also endorsed a maneuver that will cut taxes for major telecom companies by billions of dollars. In what may seem an innocuous decision, the IRS has said telephone lines can be considered real estate for tax purposes, enabling MNCs in the U.S. to legally avoid corporate income tax on substantial portions of their overall profits.
In a transaction approved by the IRS in a private letter ruling, Windstream Holdings, Inc., a little-known U.S. telecom company, will spin off its fiber and copper networks, and other traditional real estate, to an independent, publicly traded real estate investment trust (REIT). This REIT will then lease these assets back to Windstream for approximately $650 million per year. In exchange for the transfer, Windstream's shareholders will receive shares in the REIT commensurate with their holdings in Windstream.
Under the rules of the Internal Revenue Code, a REIT pays no income tax on rent, so long as its assets consist primarily of real estate — which now includes telephone lines — and the rent is promptly distributed to the REIT's shareholders. This ruling permits a telecom to transfer its phone lines, tax-free, to a REIT. The rent payments then become a deductible for the telecom and the rent, in effect, is distributed to the telecom's shareholders, allowing it to avoid corporate tax altogether.
While the general public would never consider phone lines to be real estate, this private letter ruling sweepingly defines real estate to be any asset that cannot be moved. The decision also means Congress's intent for REITs to facilitate the acquisition of office buildings and shopping malls has now been stretched, perverted even, to siphon off the profits of large, public corporations at the expense of the government's ability to collect taxes from said corporations.
More importantly, from a policy perspective, this strategy is symptomatic of the overriding need to fundamentally reform the way the federal government imposes taxes. Such reform would not only deter large corporations from creating unnecessary REITs, conducting inversions, and executing other tax avoidance maneuvers, but also begin to reverse the general public's cynicism toward our tax laws that undermines our economy and society.
While the president recently deemed such strategies wrong and even unpatriotic in a public radio address, they will continue until the income tax can be replaced with a simpler consumption tax — such as the value added tax used by almost all developed countries — as the primary means of collecting government revenue. But until the same political party leads Congress and sits in the White House and our tax system reaches the point where it can no longer raise sufficient funds to meet our entitlement programs and national defense needs, we will have to get by with the enactment of legislative "loophole" closers.
To some extent, the REIT loophole can be closed quickly with a provision clarifying that real estate is limited to land, buildings and their more basic structural components. However, this would be little more than sticking a finger in a leaking dyke, and lawyers will soon find other tricks within our overly complex Internal Revenue Code to allow clients to avoid paying taxes. For the time being, let's hope our legislators will take some immediate action to stop the erosion of our corporate tax base.
Williamson is executive director of the Kogod Tax Center at the Kogod School of Business at American University.