Amazon is under fire for not paying federal income taxes. Here's how it got its tax burden down to less than $0.

• Amazon has been drawing fire from politicians across the political spectrum for paying little to nothing in federal income taxes.
• The company reported that it didn't owe any federal taxes for the income it generated in 2017 or 2018. 
• Amazon doesn't disclose the precise tax breaks it uses to reduce its tax burden.
• But its annual report indicates it relied primarily on breaks related to stock-based compensation and research-and-development expenses and benefitted significantly from the 2017 tax cuts.
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Amazon has become a frequent punch bag for politicians from Donald Trump to Bernie Sanders for the amount of taxes it pays - or lack thereof.

The company didn't pay any federal taxes on its income for either 2017 or 2018 - in fact, it recorded a net credit for each year - despite reporting a combined profit of more than $13 billion for those two years, according to its annual reports. Even in prior years, when it did owe Uncle Sam, its effective tax rate was significantly lower than that of comparable corporations and far less than the official corporate tax rate, according to research done by the Institute on Taxation and Economic Policy, or ITEP.

"Determining exactly what Amazon paid in federal income tax is tricky," said Steve Rosenthal, a senior fellow of the Urban-Brookings Tax Policy Center, which studies federal taxation. But, he added, "We know it paid relatively little."

So how does Amazon do it? How does it make billions in profit yet keep its taxes so low?

It's not entirely clear. Amazon doesn't release its tax returns and the information it does disclose to investors offers a somewhat murky and confusing picture of its tax practices.

Still, even if the precise breaks Amazon is using aren't known outside of Seattle, the information it has released does lead to some broad conclusions. The company appears to have mostly benefitted from three primary tax breaks involving:

• • The treatment of stock-based compensation
  • Research-and-development expenses
  • Investments in property and equipment

As much as politicians may be complaining about Amazon's low or zero tax rate, there's no indication that it's doing anything nefarious.

"By all indications, the company is using the tax breaks that have been made available to it by presidents and the Congress," said Matt Gardner, a senior fellow at ITEP. 

Read this: Amazon will pay $0 in federal taxes this year - here's how the $793 billion company gets away with it

Amazon got a big break from the 2017 tax cut

The biggest reason the company didn't pay Uncle Sam any taxes last year has to do with the fact that the e-commerce giant relies heavily on stock-based compensation to pay its workers and executives. A tax break related to that compensation allowed it to reduce the amount it set aside for taxes for last year by $1.1 billion and for the year before by $917 million, the company said on its annual reports. Amazon doesn't spell out how much of that amount it applied to its federal taxes alone, but much of those sums likely went in that direction.

A second big reason that Amazon didn't pay any federal taxes the last two years was the 2017 federal tax cut. The various provisions of that law allowed Amazon to reduce the amount it allocated for taxes by $789 million in 2017 and by $157 million last year, the company said in its annual report. Primarily, those benefits had to do with the tax cut's reduction in the basic corporate tax rate from 35% to 21%, which helped Amazon reduce the outstanding taxes it owed that it had deferred from previous years, it said.

But it's likely Amazon tapped into another provision of the law that allowed companies to immediately use the money they spend on long-term assets such as property and equipment to reduce their taxable income - essentially, they were able to recognize the long-term depreciation of those assets right away. Typically, companies would have to amortize that deduction over the expected life of those assets.

Amazon didn't say how much it benefitted from the accelerated depreciation provision. But it almost certainly played a role in reducing its taxes, if only because of the vast sums the company has spent on long-lived assets. In 2017, Amazon spent $11.9 billion on property and equipment, and it spent another $13.4 billion on such things last year.

The third big factor that helped Amazon slash its tax bill was a collection of tax credits. Those credits helped it reduce its tax provision by $419 million in 2018 and by $220 million the previous year, according to its annual reports. It's not clear how much of a benefit Amazon received from particular tax credits nor did the company spell out what portion of those credits were assigned to its federal, state, or international taxes. But it did say that much of its federal ones are related to the credit the US government gives for research-and-development expenditures.

The underlying theme of all those factors is that Amazon - like most other companies - basically keeps two sets of accounting books, one that it releases publicly for investors and one that it files with the Internal Revenue Service. The amount of profit it reports to investors is often quite different from the income it reports to federal tax collectors, frequently due to the timing with which it's allowed or required to recognize certain expenses.

The cost of stock compensation is calculated two different ways

Take stock-based compensation. Under the rules of the Financial Accounting Standards Board, which governs how corporations calculate their revenue and expenses for investors, companies have to report the value of the restricted shares and options they give to workers and executives as an expense on their income statements.

Companies recognize the expense of such stock-based compensation as it vests - essentially when employees can take full possession of their shares or options and can sell or exercise them. But the cost that shows up on companies' income statement for those shares and options is what they were worth on the day they were granted, which typically is months or years prior to when they vested.

The IRS, meanwhile, requires companies to recognize such compensation as an expense after employees exercise their options or when their restricted shares vest. But the cost the IRS directs companies to use is the value the employees actually see when they exercise their options or the worth of the restricted shares at the time they vested - not, for either kind of stock-based compensation, their grant-date values.

For a company like Amazon whose stock has been appreciating rapidly, the difference between those amounts - the grant-date value and the value at time of exercise or vest - can be huge. Four years ago, Amazon's stock was trading at around $530 a share. As recently as last month, it was selling for more than $2,030 a share. For each restricted share Amazon granted four years ago that just vested, it could have a nearly $1,500 difference between the stock-based compensation cost it reports to investors and what it will report to the IRS as an expense for this year.

Multiplied times the millions of shares Amazon awards each year, those differences between the expense of stock-based compensation it recognizes on its income statements and the amount it claims on its tax returns can add up to huge amounts. Amazon's income statement for last year included $5.4 billion of stock-based compensation expenses. That represents the grant date value of shares that vested in 2018. But the actual value of the shares that vested last year - the number it ostensibly reported to the IRS - was $11.4 billion, the company said in its most recent annual report.

Amazon's excelled at reducing its tax burden

Assuming that Amazon did deduct that latter amount from the profit it reported to the IRS, its tax return income would have been considerably less than what it reported to investors.

Although Amazon hasn't always been able to use such breaks to zero out its federal taxes, it's generally been much more successful at reducing its tax burden than other companies.

Over the eight year period from 2008 to 2015, the e-commerce giant paid an effective federal tax rate of 11%, according to ITEP. At the time, the statutory corporate tax rate was 35%. The average Fortune 500 company paid an effective rate of 21% and companies in the retail and wholesale sector paid an average tax rate of 31%, according to ITEP.

"Amazon was substantially more successful in reducing their effective tax rate during this period than most other publicly traded Fortune 500 companies were," said Gardner.

And it may not pay much in federal taxes for the foreseeable future. Companies can save up tax credits they aren't able to use in particular years and apply them to future tax returns. Amazon has stockpiled a bunch of such benefits - some $3.7 billion worth, according to its annual report. 

No one is suggesting that what Amazon is doing is illegal. As Gardner noted, the tax breaks it's taken advantage of were approved by numerous presidents and the Congress.

And the company does pay some taxes. It now collects sales taxes around the country. It pays state and international taxes. It even paid the federal government some $565 in taxes last year that it had deferred from prior periods. 

In a statement posted to Twitter, Amazon said it had paid $2.6 billion in corporate taxes since 2006. It noted that Congress had given companies tax breaks to encourage them to invest in their businesses and workers, which it said it had done.

"We pay every penny we owe," the company said.

But given the company's size and profitability, the fact that it's paying so little in federal taxes is a concern, said Gardner.

"It makes a meaningful impact on income-tax collections," he said. "A billion that Amazon doesn't pay," he continued, "is a billion that some other company or individual has to make up in some way.

"The fact that it's legal, doesn't make it good."

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