Warnings: This Tax Incentive Is Distorting the Profit Picture

U.S. stocks are edging higher this morning, with the S&P 500 (SNPINDEX: ^GSPC  ) and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) up 0.22% and 0.14%, respectively, at 10:05 a.m. EDT.

Through a tax lens, darkly
Corporate earnings must fall, because profit margins cannot remain near historical highs -- this has been among the bears' refrains during the rebound in earnings (and stock prices) in the aftermath of the credit crisis. That's a broad, straightforward argument that invites plenty of complex, nitty-gritty questions regarding how the structure of corporate profitability has evolved over past decades and, consequently, whether or not one should expect margins to revert to their mean.

On a near-term basis, however, there is a clear reason why U.S. company profits may be inflated: a tax advantage.

In a terrific piece of reporting, The Wall Street Journal's Scott Thurm found that one of the major contributing factors to the 6.7% rise in S&P 500 earnings during the first quarter was an extension of the research credit and other tax breaks in January, as companies set aside 5.6% less money for taxes.

The previous extension of the tax credit expired in 2011, so companies were unable to benefit from it last year, flattering 2013's year-on-year comparisons.

The article cites several specific examples in which the tax credit made a dramatic impact on companies' effective tax rate, including Intel (NASDAQ: INTC  ) and Google. In the case of Intel, the chip maker's tax rate fell to 16.3% in the first quarter from 28.2% in the prior year period. The company itself said the extension of the research tax credit was responsible for the "substantial majority" of the decline.

Unless this tax credit is renewed -- it's set to expire this year -- it will produce headwind for year-on-year comparisons next year. That's unwelcome when the consensus already calls for heady 12.5% growth in S&P 500 earnings per share in 2014.

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