Smart Stocks for Investors Who Hate Taxes

Nobody likes to pay taxes. But what gets people really upset is finding out that somebody else isn't paying taxes.

That message came through loud and clear earlier this week, when the Citizens for Tax Justice and the Institute on Taxation & Economic Policy released a new study that looked at how much major corporations pay in corporate tax. Although most news sources have focused on the populist anti-corporate angle in reporting on the study, investors should see the results as a mark of a company's success and competence in navigating the complex set of U.S. tax laws to its maximum advantage -- and consider the report's list of "corporate tax dodgers" as a watchlist for further research.

Why corporate taxes inspire such anger
The corporate income tax is a particularly divisive issue. Some people believe that corporations shouldn't have to pay income tax at all; after all, other business forms, including partnerships and limited liability companies, avoid entity-level tax and merely pass through their taxable income to their investors. Critics argue that corporate tax combined with the tax on dividends and capital gains amounts to double taxation, unfairly penalizing equity investors in comparison to debt financing, for which businesses get tax deductions on interest.

At the other end of the spectrum, though, are those who see the 35% statutory corporate tax rate as something that every corporation ought to pay. Yet because of the impact of credits, deductions, and other tax preferences -- the same things that keep many individual taxpayers from ever paying anywhere close to their marginal tax rate -- many companies dramatically reduce their tax bills. In fact, when you look at short periods of time, as the CTJ/ITEP study did, you'll even find periods during which credits outweigh tax liability, creating negative effective tax rates.

Here's a quick look at some of the 30 companies that achieved that dubious distinction between 2008 and 2010, according to the survey:

  • Utilities made a strong showing on the list, with Duke Energy (NYS: DUK) , American Electric Power, and NextEra Energy all showing up with negative tax figures. Pepco Holdings led the list with an effective tax rate of -57.6%, while PG&E had a negative tax bill of more than $1 billion.

  • At No. 2 on the list was General Electric (NYS: GE) , whose tax attributes already got plenty of attention earlier this year.

  • Blue-chip stocks from many industries showed up among the 30, including glass-tech leader Corning (NYS: GLW) , aircraft-maker Boeing (NYS: BA) , and chemical giant DuPont (NYS: DD) .

  • Despite government bailouts, only one major bank made the list: Wells Fargo (NYS: WFC) , with a reported effective tax rate of -1.4%. It was identified as the company with the largest total tax subsidies, however, at nearly $18 billion -- likely due in large part to its acquisition of Wachovia and its attendant tax-losses.

Policymakers can argue the pros and cons of making certain changes to the tax laws. But for investors who are more interested in the system we have now, the study is invaluable in pointing to winners and losers.

Why pay more?
The key information the study provides is its industry-by-industry breakdown of tax rates. For instance, among financial stocks, you might expect to see most companies making fairly attractive showings. But JPMorgan Chase (NYS: JPM) pays effective taxes of more than 30%. At least in theory, that's a huge headwind that favors Wells Fargo -- and is a major point in favor of choosing it over JPMorgan Chase.

Of course, the major caveat in acting on this study is whether you believe that tax reform will ultimately happen. If big changes occur, then winners under the old system could become losers under a new one, and vice versa. But if you think any reforms will make only minimal changes to the status quo, then you can fairly expect adroit tax-managing corporations to keep up the good work.

Where activism and investing conflict
Tax strategies to minimize tax may offend your sense of fairness, but they're part and parcel of managing a business well. Until serious reform gets closer to fruition, companies that have rewarded shareholders in the past with their tax-smart moves will likely keep doing so.

If you want to cut your own taxes, head over to the Fool's Tax Center. There, you'll find lots of advice to help you give less of your money to the IRS.

At the time thisarticle was published Fool contributor Dan Caplinger is freakishly looking forward to his favorite season: tax time! You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Wells Fargo, NextEra Energy, and JPMorgan Chase, and has written puts on NextEra Energy. Motley Fool newsletter services have recommended buying shares of Corning. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. You'll never find The Fool's disclosure policy taxing.

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