The Wall Street Journal reported yesterday that:

Publicly traded companies reduced their U.S. taxable income by at least $34.8 billion in 2004 through potentially abusive tax transactions without taking a similar hit on profits reported to shareholders, new Internal Revenue Service data show.

The vagaries of accounting rules and tax laws allow public companies to keep two sets of books: one for shareholders and another for the Internal Revenue Service. Not surprisingly, companies tend to report higher profits to investors than to the tax man.

As Jesse Drucker, the WSJ journalist who I know and who has done good work in this area before notes:

For 2004, the IRS started requiring companies to give it more detail about the reasons behind that gap. Companies that year reported roughly 40% higher profits to Wall Street -- known as book income -- than to tax authorities. The IRS also asked companies to reveal what portion of the difference between taxable income and profits reported to shareholders was attributed to deals the IRS defines as having some hallmarks of questionable tax shelters, known as "reportable transactions."

As the report notes:

All told, U.S. public companies included in the data reported about $554 billion in pretax profits to Wall Street in 2004, but only about $394 billion to the IRS

Jesse is right to note that the public need to know who has big gaps. The reason is simple. He reports:

Companies being audited by the IRS with book income that was much higher than their taxable income were more likely to be ordered to pay bigger back-tax bills, according to a 1998 paper by Lillian F. Mills, now a University of Texas accounting professor. The bigger the gap, she found, the higher the adjustment.

Other studies have concluded that companies with big gaps are more likely to be aggressive with their accounting, which can result in restatements and legal problems that can hurt share prices. A 2005 study by Michelle Hanlon, a University of Michigan accounting professor, found that big-gap companies had less-consistent earnings than those with smaller gaps.

But this is perhaps the most telling comment:

"Transparency is an important underpinning of our financial markets, [but] transparency is quite limited in the area of tax, which remains largely a black box,"

I couldn't agree more. And I should add that I am working on a new tax gap report for the UK, right now.