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Microsoft's $528 million Washington tax break

The Redmond company makes products here but records software sales to PC makers and high-volume customers through an operation in Nevada, where there is no corporate tax. So Washington is missing out on revenue it could use for badly needed infrastructure needs – like replacement of the 520 bridge.
Bill Gates in Davos, Switzerland. (World Economic Forum)

Bill Gates in Davos, Switzerland. (World Economic Forum) None


When I heard that Microsoft Chairman Bill Gates had invoked the phrase "creative capitalism" at last month's World Economic Forum in Davos, Switzerland, it reminded me how Microsoft avoids paying taxes on Washington-made software by selling it through Nevada. Since 1997, I estimate, the company has avoided paying more than $528 million in state taxes while racking up $92 billion in profit and distributing more than $42 billion in dividends to shareholders. Microsoft's creative capitalism has deprived Washington state a lot of tax revenue it needs to pay for critical infrastructure such as replacing the aging 520 bridge that many of its employees use to get to and from corporate headquarters in Redmond.

In 2004, I wrote about Microsoft's tax practices in Seattle Weekly. Since then, the process has continued unabated as Microsoft's revenues have continued to grow.

Here's how the practice works: Microsoft's product teams, based mostly in Redmond and Issaquah, build software products such as Windows Vista, Windows Server, SQL Server, and Office. But sales of these products to PC manufacturers and corporate customers are conducted from a License and Operations office in Reno, Nev., where there is no corporate income tax. Microsoft records the revenue for these sales (traditionally about 31 percent of overall revenue) in Nevada and does not pay the Washington business and occupation tax required on software reproduction.

I estimate that for the past 11 years, Microsoft has used this practice to save $48 million annually, cumulatively more than half a billion dollars. If the Washington Legislature had not reduced the software tax rate from 1.5 percent to 0.484 percent in 1998, Microsoft's tax savings would be more than triple that. As the company's revenues have grown, so have the savings. Last year, I estimate, it avoided $76.7 million in taxes.

In 2004, Microsoft General Counsel Brad Smith told me, "The reality is that in the scheme of things, the impact is not very significant – either for the company or for the state government or the state economy. ... The law is actually structured in such a way so as to permit a company to do precisely what we are doing."

Maybe, but maybe not. As the lost tax revenue adds up, it's up to Attorney General Rob McKenna and the Washington Legislature to decide whether Microsoft should be required to pay taxes for selling software from Nevada that was created by 35,510 employees on its 11.2 million square feet of real estate here in metro Puget Sound.

Software license codes are unique in that they can generate hundreds of millions of dollars in revenue by unlocking hundreds of thousands of copies of software for a PC manufacturer like Dell or a large company like General Electric. While shipping a DVD with a replication code might not attract the same kind of scrutiny that trucking timber products or delivering an airplane does, Microsoft accomplishes an astonishing sleight of hand by recording the licensing revenue in Nevada from products made here in Washington.

There will be a lack of equity and fairness as long as state leaders allow Microsoft to operate with a different set of rules than other businesses that pay the taxes on all of their Washington-made products. More importantly, the state will be left without vital revenue from its most successful company. How large does our infrastructure deficit have to become before our elected leaders find the political will to challenge this practice?

Jeff Reifman is a communications and technology consultant, freelance writer and activist. He blogs at JeffReifman.com or follow him @reifman on Twitter.


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Comments:

Posted Sat, Feb 2, 6:02 p.m. Inappropriate

Microsoft's Traffic on our Roads: A great article!

I wonder if the calculations for B&O; tax include Washington State Sales Tax as well?

When one considers how crowded our roads are Microsoft needs to pay it's fair share as well.

Maybe an $8.00 toll across 520 isn't so bad!
Auggie

Posted Sun, Feb 3, 10:16 a.m. Inappropriate

Now that's ironic: I actually pay more B&O; than Bill!

-Douglas Tooley
Lincoln, Tacoma

Posted Sun, Feb 3, 10:19 a.m. Inappropriate

THE NUMBERS: Microsoft earns $1.76 per share and they pay out dividends of $.44 per share. So the payout is about 25 percent of the net profit. Yahoo Finance is telling me that IF MSFT had a profit of $92 billion (your figure) then the payout in dividends should be somewhere around $23 billion, not $42 billion.

I am curious about the discrepancy; seems like the numbers (even "back of the napkin" calculations) should be closer than that.

Note also that MSFT can legally move the entire company (or just their headquarters) to Nevada. That is entirely legal. If Balmer even whispered that possibility the Washington legislature would pass a law exempting MSFT from an entire universe of troublesome taxes. Gregoire would take a bow.
kieth

Posted Sun, Feb 3, 3:51 p.m. Inappropriate

RE: THE NUMBERS: The dividend payout number in the article is right and its a pretty simple calculation if you look in the right places ... try MSFT investor website instead of Yahoo Finance (http://www.microsoft.com/msft/FAQ/dividend.mspx) and notice the special dividend of $3 in 2004. That's the difference maker, when you multiply the aggregate total dividend payout of dividends by MSFT (they only started the practice in 2003) of $4.61/share by the number of shares outstanding ~ 9.3 billion (which has stayed relatively constant due to share buybacks and the lack of large share-driven acquisitions), you get ~ $42.87 billion paid to investors in dividends. Pretty close to the $42 billion mentioned in the article.

sleepy

Posted Mon, Feb 4, 3:13 p.m. Inappropriate

Is this the whole story?: Seems you've done a fair bit of research on the matter. However, I have to wonder if you done a complete job at researching your article? What about other impacts of Microsoft using Western Washington as its headquarters? As you pointed out, there are over 35K full time employees that live in the area. All of these employees have to sleep, eat, etc. They either have mortgages or pay rent. They all have to buy food, clothing, transportation, entertainment, etc. All of those purchases and properties generate tax revenue for the local governments. How much exactly does Microsoft impact the state?

Every year they donate millions of dollars in cash and hundreds of millions in software, all matched by Microsoft. Most of which goes to local organizations in the Puget Sound region. Take 2002 as an example. And this amount increases every year. How much exactly does Microsoft impact the state?

There's thousands of other vendors, contractors, and companies. who work to support Microsoft and their employees. All of these people and companies have rents or mortgages to pay. They all have things they need to buy. All generating tax revenue for the state. How much exactly does Microsoft impact the state?

If you want to go back in history, you have to then include all of the employees who ever worked at Microsoft who've had an impact to the state. All of the people who Microsoft made wealthy, retired, and the companies that they have started and all of those employees. How much exactly does Microsoft impact the state?

If you want to nit-pick about a common practice (exactly how many companies have their financial entities in Reno? Did you think to research that one?), why don't you expose the whole story?
Unfit

Posted Mon, Feb 4, 3:50 p.m. Inappropriate

CORRECTED NUMBERS.: Sleepy, thank you. I now recall the special dividend.

kieth

Posted Thu, Feb 7, 8:35 a.m. Inappropriate

Millions for Roads, Are You Sure?: I do think it is presumptuous to think that Microsoft's $528 million would go directly to projects like 520 replacement. If I were Microsoft's top management I would want to know where the tax money was going--just like they want to know how money is distributed within the company. I think if companies and citizens alike had a clearer understanding of where their tax money went--and if they had a choice about where it went--then they wouldn't be so quick to find ways to avoid taxes. Too often I think hard earned tax money gets taken from business and citizens and dissolved into vague projects, committees, and initiatives with no accountability. If you want Microsoft and other businesses in the area to become more transparent with their fiscal practices then I think so should our state's government. People don't like paying taxes because they aren't confident their money is spent well not because they are cold-hearted capitalists with no conscience.

freemont

Posted Thu, Feb 7, 2:43 p.m. Inappropriate

Response to commenters: I've written a summary response to comments from this article on my blog.

Top Reader Defenses of Microsoft's Tax Dodges

Posted Tue, Feb 12, 2:49 p.m. Inappropriate

You can't just use. . .: . . . the current dividend level to do this math.

Microsoft didn't pay regular dividends for quite a while. Then they kicked off their current quarterly dividend program with a $3/share chunk. The author is adding up all the dividends over the last 11 years, not talking about the current annual dividends.
Carol M.

Posted Tue, Jan 13, 1:49 p.m. Inappropriate

It'll be nice to get some tax relief once obama is in office.

jasonla

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