Launched in 2000 as a partnership between American and British telecom giants, Verizon Wireless became one of the biggest cell phone companies in the United States, earning hundreds of millions of dollars a year in profits in Florida alone.
Verizon Wireless didn’t pay corporate income tax itself in Florida. That’s because the company’s corporate owners – Verizon Communications Inc. and Vodafone Group Plc – set their wireless business up in such a way that its profits passed up to them instead.
But when Florida tried to tax those owners, one of them – Vodafone – argued Florida couldn’t make it pay, according to litigation records.
The strategy allowed Vodafone to save at least $23 million in Florida income taxes through 2014, when Vodafone sold off its stake in Verizon Wireless and Verizon Communications became the sole owner.
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Other companies have used similar “pass-through” businesses to siphon profits out of Florida without paying corporate income tax on them, according to separate litigation records. They include a Boston-based private equity firm, a big commercial real estate investor, and the investment arm of the Canada Pension Plan.
About 38 states around the country have passed laws that prevent corporations from passing tax-free profits out of a state this way, according to Bruce Ely, a tax attorney at the law firm Bradley Arant Boult Cummings in Birmingham, Ala.
Florida has not.
“I’m always befuddled as to why all the states don’t do that,” Ely said. “That’s a no-brainer.”
Small becomes big
The most jarring statistic about the Florida corporate income tax is this: Only about 1 percent of all Florida businesses pay anything.
There are a few reasons for that. For instance, Florida policymakers allow companies to engage in profit-shifting and other strategies and offer generous tax breaks that make it possible for some companies to reduce their taxable income to nothing.
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But by far the main reason that so few businesses pay anything is that Florida chooses to exempt entire classes of companies from the tax.
These types of companies are known as pass-through businesses because the federal government exempts their profits from the federal corporate income tax. Instead, their profits pass through to shareholders who pay federal personal income tax on those profits.
Florida follows the federal government’s lead and exempts pass-through businesses from the state corporate income tax, too.
Except Florida does not have a personal income tax, either.
That makes Florida nearly unique in the country. There is only one other state that has a corporate income tax — but not a personal income tax — that does the same thing: Alaska.
“It makes Florida the perfect scenario for the use of a pass-through,” Ely said.
There are different forms of pass-through businesses. Two of the most common are “subchapter S” corporations, which were created in the 1950s, and “limited liability companies,” which emerged a few decades later. They are often cast as a way to help entrepreneurs and small businesses, offering the lawsuit protections of a corporation without the tax consequences of the corporate income tax.
The tax advantage has fueled an explosion of pass-through businesses over the years. In October 1996 — less than two years before the Florida Legislature passed a law exempting LLCs from the corporate income tax — there were fewer than 4,000 LLCs operating in Florida, according to legislative records. Today, there are more than 1.4 million.
Most pass-through businesses are small. But many are not. Some are enormous.
Until very recently, for instance, the country’s largest wine and liquor distributor — Miami-based Southern Glazer’s — was a subchapter S corporation exempt from state income tax. Southern is the third-biggest private company in Florida, according to Florida Trend magazine, with $19 billion in annual revenue. It’s principally owned by the Chaplin family of Miami, one of the wealthiest families in the United States.
Executives at Southern Glazer’s did not respond to requests for comment. According to the company’s accounting firm, Grant Thornton, Southern Glazer’s recently decided to convert to a regular corporation — in part because of the 2017 Tax Cut and Jobs Act signed by President Trump, which cut the federal tax rate for regular corporations by 40 percent.
“The truth is, most companies doing business in Florida — except for the big, giant Fortune 500 guys — are pass-throughs,” said David Brunori, a senior director at the accounting firm RSM.
Altogether, exempting pass-through businesses from the state’s corporate income tax saves their owners — and costs the state — an estimated $1 billion a year. That’s nearly as much as Florida spends on community colleges.
Passing profits out of Florida
Florida law is explicit on one point: Big, traditional corporations are not allowed to use pass-throughs to shield their own income from state tax.
Here’s the thing: They do.
Verizon Wireless is a particularly big example. From 2000 until 2014, Verizon Communications owned 55 percent of the cell phone company, which was set up as a pass-through partnership. Vodafone owned the other 45 percent.
It was a cash cow: Verizon Wireless earned billions every year — hundreds of millions of which came from Florida, according to litigation records. But because Verizon Wireless was a partnership, it was exempt from Florida income tax. Its profits passed up to its two owners instead.
Then Vodafone’s lawyers argued that Vodafone didn’t have to pay any Florida income tax on its share of the profits, either. The European telecom had no operations of its own in Florida, and Vodafone’s lawyers claimed Florida could not legally tax a company whose only presence in the state was through a minority stake in another company.
Vodafone initially paid state income tax on its share of Verizon Wireless’ Florida profits. But then it filed a refund claim to get it all back. When the Florida Department of Revenue balked, Vodafone sued.
The two sides eventually settled. Records show Florida agreed to accept half the amount it said Vodafone owed. Florida ultimately wrote Vodafone at least two refund checks covering five tax years — giving the company $23.3 million.
Vodafone cashed out of Verizon Wireless in 2014, selling its share to Verizon Communications for approximately $130 billion.
“Vodafone does not undertake artificial arrangements to avoid tax,” a Vodafone spokesman said. “We paid all taxes required under state and federal law prior to our 2014 disposal of our minority interest in Verizon Wireless.”
A spokesman for Verizon Communications declined to answer when asked by the Orlando Sentinel if that company paid Florida income taxes on its share of the Verizon Wireless profits when the cell-phone company was still a partnership with Vodafone.
Following the playbook
TA Associates, a Boston-based private equity firm, used the same playbook as Vodafone.
TA, which has raised more than $30 billion and invested in more than 500 companies since its founding, used to own a 45 percent stake in Millennium Health, one of the nation’s largest drug-testing companies. Millennium was set up as a limited liability company.
Millennium Health earned an estimated $9.2 million in profits in Florida during its 2015 fiscal year, according to litigation records. If Millennium had been a regular corporation, it would have had to pay approximately $500,000 in Florida income taxes this year. But because it was a tax-exempt LLC, it was able to pass its profits up tax-free to its owners.
But then, like Vodafone, TA Associates claimed Florida was not allowed to tax any of its 45 percent share of Millennium’s Florida profits. And, like Vodafone, TA Associates struck a settlement deal when the state tried to make it pay. The terms of that settlement are confidential.
A spokesman for TA Associates declined to comment. The company no longer holds a stake in Millennium Health.
JLL, one of the world’s largest real-estate services firms, made a similar argument on profits it earned through a subsidiary from real-estate investments in Florida that were held in limited liability companies. So did a corporation owned by the Canada Pension Plan Investment Board, which has invested in a number of pass-through companies that do business in Florida — including senior apartment communities, a garbage-hauler and the parent company of Legoland Florida. They also negotiated settlements with the state.
Most other states have addressed this tactic — primarily by passing laws that force a pass-through business to withhold and pay income tax on behalf of any of its out-of-state owners. Experts say such withholding laws avoid Vodafone-like fights where a state winds up in court battling a company that claims it can’t be taxed by the state.
“The state doesn’t have to go chasing down all those out-of-state people to make sure they pay their taxes,” said Jim Ervin, a partner and tax attorney in the Tallahassee office of Holland & Knight.
A spokeswoman for the Florida Department of Revenue said the agency is not aware of any studies that have ever looked at how much revenue Florida could raise through such a law.
Central Florida giants
Some of Central Florida’s biggest businesses are using tax-exempt pass-throughs.
In 1999, for instance, one year after the Florida Legislature passed the law exempting limited liability companies from the corporate tax, records show Walt Disney World converted one of its sales and marketing businesses into an LLC. Disney would not say whether it did so for tax purposes.
The corporate owners of Orlando-based Red Lobster – the world’s largest seafood restaurant chain, with more than 700 restaurants, 50,000 workers and nearly $3 billion in annual sales – have also structured the company as an LLC.
Those owners – a San Francisco-based private equity firm and a Thailand-based seafood supplier – declined to answer when the Sentinel asked them if they pay Florida corporate income taxes on their share of Red Lobster’s profits.
“The main reason you will ever form an LLC is for tax purposes,” said Brunori, the senior director at accounting firm RSM.
Former Florida state Sen. Ron Klein sponsored the 1998 law that exempted LLCs from the Florida corporate income tax.
Klein, a Democrat from South Florida, said he never expected large corporations that set up LLCs would be able to use them to cut their own taxes.
“It has burgeoned into a very large tax loophole,” said Klein, who is now a lobbyist.
jgarcia@orlandosentinel.com; 407-540-5996; @Jason_Garcia
