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How would you calculate penalties and interest on tax arrears of $29 billion dating back as far as 2004? That’s one of the many questions facing the U.S. government as it endeavors to extract a record sum from Microsoft in the largest audit the IRS has ever attempted.

Why it matters: Microsoft seems decidedly sanguine. “We believe we have always followed the IRS’ rules and paid the taxes we owe,” wrote Daniel Goff, a senior tax executive, in a corporate blog post when the ruling was revealed this month.

• “As of September 30, 2023, we believe our allowances for income tax contingencies are adequate.”

Between the lines: Microsoft won’t reveal exactly what its “allowances for income tax contingencies” are. But they’re included in a $19.8 billion balance-sheet charge for “unrecognized tax benefits and other income tax liabilities,” so they have to be lower than that.

• In other words: Once this has gone through the IRS appeals process and then through a court appeal, Microsoft expects to owe less than $20 billion.

The big picture: ProPublica’s Paul Kiel had the full story of what Microsoft got up to in Puerto Rico back in January 2020. (These cases move very slowly.)

• Microsoft had a small factory in Puerto Rico that burned software onto CDs. That factory then somehow paid $31 billion over 10 years for the rights to all that software, and in return received all the profits — some $70 billion. Thanks to a deal with the Puerto Rico government, it paid almost no tax on that $70 billion.
• According to the IRS, Microsoft sold the software rights to its Puerto Rico subsidiary at a well below-market price, thereby avoiding tens of billions of dollars in taxes.
• Under tax law, the sale transaction had to be “arm’s length” — but one Microsoft executive put in writing that it was “a pure tax play.”

What to watch: Don’t hold your breath for a final verdict — this is going to take many years yet before it’s resolved.

The bottom line: If you owe $29,000 to the IRS, your options are limited. If you owe $29 billion to the IRS, you can seemingly delay any payment more or less indefinitely.

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