An Overview of Pass-through Businesses in the United States

January 21, 2015

Key Findings

  • Pass-through business income is taxed on the business owners’ tax returns through the individual income tax code. 
  • Pass-through business income faces marginal tax rates that exceed 50 percent in some U.S. states. 
  • Pass-through businesses face only one layer of tax on their profits compared to the double taxation faced by C corporations. 
  • The number of pass-through businesses has nearly tripled since 1980, while the number of traditional C corporations has declined. 
  • Pass-through businesses earn more net business income than C corporations. 
  • Pass-through businesses employed more than 50 percent of the private sector work force and accounted for 37 percent of total private sector payroll in 2011. 
  • Although pass-through businesses are smaller than C corporations on average, they are not all small businesses. Many people work for large pass-through companies. 
  • The majority of pass-through business income is taxed at top individual tax rates. 
  • Tax reform aimed at improving the competitiveness of U.S. businesses needs to address the individual income tax code due to the economic importance of pass-through businesses. 

 

Introduction

One of the goals of tax reform is to improve the competitiveness of U.S. businesses and grow the economy. A promising way to do that is by lowering taxes on saving and investment through business tax reform. Much time is devoted to improving the corporate side of the tax code, but corporate-only business tax reform misses a significant portion of business activity.

The United States currently has a large number of pass-through businesses, or businesses that pay their taxes through the individual income tax code rather than through the corporate code. These sole proprietorships, S corporations, and partnerships make up the vast majority of businesses and more than 60 percent of net business income in America. In addition, pass-through businesses account for more than half of the private sector workforce and 37 percent of total private sector payroll. Pass-through businesses are represented in all industries in the United States.

Given that pass-through businesses are a significant part of the U.S. economy, tax reform should address the individual income tax code along with the corporate tax code.

What Are Pass-through Businesses?

Table 1. Major Types of Pass-through Businesses

Legal Form

Description

Sole Proprietorship

An unincorporated business owned by a single individual that reports its income on schedule C of the 1040 tax form.

Partnership

An unincorporated business with multiple owners, either individuals or other businesses.

Limited Liability Company (LLC)

A type of business that has limited liability like a traditional C corporation.

S Corporation

A domestic corporation that can only be owned by U.S. citizens (not other corporations or partnerships) and can only have up to 100 shareholders.

 

Sole proprietorships, S corporations, limited liability companies (LLCs), and partnerships are also known as pass-through businesses (Table 1). These entities are called pass-throughs, because the profits of these firms are passed directly through the business to the owners and are taxed on the owners’ individual income tax returns.

This is in contrast with traditional C corporations, which pay tax at the entity level through the corporate income tax. Their owners (shareholders) then pay tax on this income again when they receive a dividend or sell their stock and realize a capital gain.

Another difference between pass-through businesses and traditional C corporations is that owners of pass-through businesses pay the full tax on their business’s income every year as the business earns it. Contrast this with owners or shareholders of C corporations, who can defer the taxation on their share of corporate income as long as the corporation retains its earnings or if the shareholder does not realize a capital gain on his stock.

What Taxes Do Pass-through Businesses Pay?

Since pass-through businesses pass their income and losses directly to their owners, these businesses face the same marginal tax rates as individuals. These rates start at 10 percent on the first $9,075 of taxable income ($18,150 married filed jointly) and rise to 39.6 percent on taxable income over $406,750 ($457,601 married filed jointly) (Table 2).

Table 2. 2014 Federal Income Tax Brackets and Rates, Pass-through Businesses

Rate

Single Filers

Married Joint Filers

10%

$0 to $9,075

$0 to $18,150

15%

$9,076 to $36,900

$18,151 to $73,800

25%

$36,901 to $89,350

$73,801 to $148,850

28%

$89,351 to $186,350

$148,851 to $226,850

33%

$186,351 to $405,100

$226,851 to $405,100

35%

$405,101 to 406,750

$405,101 to 457,600

39.6%

$406,751+

$457,601+

Source: Internal Revenue Service.

 

In addition, sole proprietorships and partnerships pay the self-employment (SE) tax. SE taxes are levied on self-employment income in order to fund both Social Security and Medicare and are ultimately equivalent to what wage earners pay in payroll taxes.[1] The SE payroll tax is a combined 15.3 percent on the first $117,000, 2.9 percent on the next $83,000, and 3.8 percent on any income above $200,000 ($250,000 for joint filers) (Table 3).

Table 3. Payroll and Self-Employment Taxes for a Single Filer, 2014

Taxable Earnings

Social Security

Medicare

Total

$0–$117,000

12.40%

2.9%

15.3%

$117,000–$200,000

0%

2.9%

2.9%

$200,000 and over

0%

3.8%

3.8%

Source: Social Security Administration.

 

Owners of sole proprietorships and partnerships are subject to the SE payroll tax on most of their net business income.[2] S corporation owners are subject to SE payroll taxes on the portion of their net income paid out in wages. Specifically, an owner of an S corporation can designate his income as either a profit distribution or wages. The income designated as  wages is subject to the SE tax while the non-wage income is not.[3]

S corporation income earned by a passive shareholder—an S corporation owner that does not actively participate in the day-to-day activities of the business but still receives income [4]—is not subject to the SE payroll tax. However, a passive shareholder is liable for the 3.8 percent Net Investment Income Tax that was passed as part of the Affordable Care Act.[5] This tax applies to investment income when a taxpayer’s modified AGI exceeds $200,000 ($250,000 for joint filers).

Pass-through business income can also be subject to the Alternative Minimum Tax (AMT), which increases the effective tax rate paid by business owners.[6]

In addition, pass-through businesses pay state and local income taxes, which vary from zero percent in states without personal income taxes to 13.3 percent, the top marginal income tax rate in California.[7]

Combined, the top marginal income tax rates faced by pass-through businesses can exceed 50 percent in some cases. For example, the top marginal tax rate faced by sole proprietors in California tops 51.9 percent (see Table 4). The top marginal income tax rate for active shareholders of S corporations is slightly lower, since they do not pay the payroll tax on non-wage, business income (California’s top rate is 48.8 percent). [8] Passive S corporation shareholders in California face an effective marginal rate of 52.6 percent.

Table 4. Top Marginal Tax Rate for a Sole Proprietorship in California

Top Marginal Federal Income Tax

39.60%

Top Marginal State Income Tax

13.30%

Self-employment Tax

3.80%

Deduction for State/Local Income Taxes and Self Employment Taxes (Less Pease)

-4.80%

Total

51.90%

Source: Author’s calculations.

 

 

The average top marginal income tax rate on sole proprietorships and partnerships in the United States is 47.2 percent, and 44.5 and 48.3 percent, respectively, for active and passive shareholders of S corporations.[9]

Tax Differential with Traditional C Corporations

Due to the different tax treatment of pass-through businesses and C corporations, the two business forms face a tax burden differential (see Table 5). C corporations are first taxed at the entity level at the 39.1 percent combined federal and average state tax rate.[10] Then, when those profits are realized by the owners (shareholders) as either dividends or capital gains, the owners pay taxes on that income again. The double-taxation of corporate income creates a disparity between the total tax burden on the income of pass-through businesses and C corporations.

Pass-through businesses facing the top marginal tax rate (combined with the average state rate) face an average rate of 47.2 percent compared to an average total tax rate of 56.5 percent on C corporate income realized at the shareholder level.

 

Table 5. Total Tax Burden on Business Income, C Corporation vs. Pass-through Business

 

Traditional C corporation

Pass-through business

Entity-Level Tax

39.1%

0.0%

Individual-Level Tax

28.6%

47.2%

Total Tax Rate

56.5%

47.2%

Note: Assumes C corporation distributes dividends. Pass-through business is a partnership.
Source: Author’s calculations.

 

Although traditional C corporations pay a higher overall tax rate on their income, there are specific advantages to the C corporate form that make it worthwhile for some businesses, specifically the ease of raising money, less restrictive shareholder rules (compared to an S corporation), deferral of domestic taxation on foreign income, and the ability to retain earnings without triggering shareholder taxation.[11]

The Number of Pass-through Businesses Filing Tax Returns Has Greatly Increased Over the Past Thirty Years

The number of pass-through businesses in the United States has increased considerably since the Tax Reform Act of 1986, which substantially lowered individual income tax rates.[12]

Between 1980 and 2011, the number of pass-through business tax returns has increased by 175 percent from roughly 10.9 million returns to about 30 million returns (Figure 2).[13] The number of sole proprietorships increased from 8.9 million in 1980 to 23.4 million in 2011. The number of partnership businesses grew from 1.3 million returns to 3.2 million returns.

S corporations experienced the fastest growth during this period. From 1980 to 2011, the number of S corporations filing tax returns grew from approximately 545,000 returns to over 4.15 million; an increase of 660 percent, more than three times the rate of growth experienced by pass-through businesses overall.

The number of C corporations filing tax returns during this period steadily declined from 2.2 million returns in 1980 to 1.6 million returns in 2011.

Pass-through Businesses Are the Most Common Business Form in the United States

Pass-through businesses are the most common business form in the United States. Of the 27.7 million firms in 2011,[14] about 94 percent of them were pass-through businesses according to the Census Bureau (Figure 3).[15]

Sole proprietorships comprise the majority of all business forms. According to Census data, 73.1 percent of all businesses were sole proprietorships (20.3 million firms). 13.1 percent of all businesses were S corporations (3.65 million firms), and about 8 percent were partnerships (2.2 million firms).

C corporations make up the remaining 5.6 percent of businesses in the United States (1.5 million firms).

Pass-through Businesses Now Earn More Net Income Than Traditional C Corporations

As the number of pass-through businesses increased, they began to generate more net business income as a group than traditional C corporations. The combined net income of sole proprietorships, partnerships, and S corporations in 1980 was $188 billion compared to total C corporate net income of $697 billion (Figure 4).[16] By 1998, net pass-through income had grown by 340 percent to $829 billion, overtaking C corporate income—$773 billion in 1998—for the first time.

Pass-through business income has been persistently higher than corporate income since 1998, with the exception of 2005, when corporate net income peaked at $1.6 trillion. The most recent data shows that pass-through businesses earned $1.3 trillion in net income, or 63.9 percent of total business net income in 2011.

Most of the Private Sector Workforce Works at, or Is Self-Employed as, a Pass-through Business

Not only do pass-through businesses earn more net income than traditional C corporations, they also account for more employment.

According to 2011 Census data, pass-through businesses account for 55.2 percent of all private sector employment.[17] This represents 65.7 million workers. In contrast, traditional C corporations comprise 44.7 percent of the private sector workforce, or 53.2 million workers.

S corporations account for the most employment of all pass-through business types. In 2011, S corporations employed 24.4 percent of the private sector workforce, or 29 million workers. Sole Proprietorships comprised 19.5 percent of the private sector workforce. Partnerships accounted for the lowest amount of employment with only 11.3 percent of the private sector workforce.

Pass-Through Businesses Are Generally Smaller Than C Corporations, but Pass-Through Businesses Are Not Always Small Businesses

A major reason why C corporations account for a significant amount of employment but so few firms is that they are significantly larger than pass-through businesses on average. Figure 6, below, compares the distribution of pass-through and corporate employment by the size of firm.

Employment at C corporations is heavily concentrated in large firms. In 2011, 72.3 percent (38 million) of C corporate workers were employed at large firms with 500 or more employees with an additional 8.9 percent (4.7 million) working at firms with between 100 and 500 employees.[18] The remaining 18.7 percent (9.9 million) of corporate employment was at firms with fewer than 100 employees.

Pass-through business employment is more heavily distributed among smaller firms. However, it would be a mistake to completely conflate pass-through businesses with small businesses. While most pass-through employment is either self-employment (33.6 percent) or at small firms with between 1 and 100 employees (38.7 percent), a significant number of employees work at large pass-through businesses. According to 2011 Census data, a combined 27.5 percent (18.1 million) of pass-through employment was at firms with more than 100 employees, and 15.9 percent (10.3 million) of pass-through employees work at large firms with 500 or more employees.

Pass-through Businesses Account for Most of the Private Sector Workforce in 48 States

The prevalence of pass-through employment varies among U.S. states. According to Census Bureau data, pass-through businesses accounted more than 60 percent of business employment in eight states: Idaho (64 percent), Maine (62.4 percent), Montana (67.9 percent), North Dakota (60.5 percent), Rhode Island (60.6 percent), South Dakota (64.7 percent), Vermont (63.1 percent), and Wyoming (61.8 percent). [19]  In contrast, Delaware (49.5 percent) and Hawaii (48 percent) had pass-through employment as a share of total private sector employment of less than 50 percent.[20]

Pass-Through Businesses Accounted for Nearly 40 Percent of Private Sector Payroll

Pass-through businesses also account for a significant amount of private sector payroll. Of the $4.48 trillion of salaries and wages paid in 2011, pass-through businesses accounted for approximately $1.65 trillion, or 37 percent (Figure 8).[21] S corporations accounted for most pass-through business payroll with a total of $1 trillion. Partnerships paid $505 billion and sole proprietorships paid $98 billion.[22]

However, given their larger size, C corporations accounted for most of the private sector payroll in the United States. In 2011, 63 percent of private sector payroll was paid by C corporations, or $2.8 trillion.[23]

Pass-through Businesses Employ the Majority of Workers in Service Sector Industries

Pass-through businesses employ workers in every industry. However, service sector industries have larger shares of pass-through employment than corporate employment. In contrast, manufacturing and trade industries are dominated by C corporate employment.

Figure 9 shows the share of corporate versus pass-through employment by industry. According to Census data, pass-through business employment accounts for most employment in most industries. Pass-through employment accounts for 60 percent or more employment in the Arts, Entertainment, and Food Service (72.1 percent); Utilities, Construction, and Transportation (60.8 percent); and Information, Education, and Healthcare (60.3 percent) industries.[24]

C corporations accounted for a majority of employment in only three major industries: manufacturing (63.7 percent); wholesale and retail trade (58 percent); and Finance, Insurance, and Real Estate (50.6 percent).

Although C corporations accounted for more employment in these industries, there are consistently more pass-through businesses (firms) in all industries. For example, most employment in manufacturing is at C corporations, but the vast majority of manufacturing firms are pass-through businesses.[25] (See Appendix for complete industry numbers.)

High Income Individuals Report Most Pass-through Business Income

Since pass-through business income is taxed at the individual level, the distribution of pass-through income across individuals is important in understanding the effect of individual marginal tax rates.

If most pass-through business income were earned by low to moderate income individuals, pass-through business income would face relatively low marginal rates. Conversely, if most business income is earned by high-income individuals, pass-through business income would be taxed at potentially high marginal rates.

According to IRS data, 72 percent of returns with business income reported between $1 and $100,000 in business income.[26] However, these returns only accounted for 14 percent of total business income.[27]

The largest concentration of pass-through business income was reported on the 1.3 percent of returns that earned $1 million in net business income or more. This group of taxpayers earned 37 percent of total pass-through business income.

Combined with the 1.8 percent of tax returns with business income between $500,000 and $1 million, 51 percent of business income was earned by the few taxpayers (3.1 percent of returns) with net business income of $500,000 or more.

This means that 51 percent of pass-through business income in 2012 was potentially subject to the federal top marginal tax rate on individual income of 39.6 percent.

Conclusion

In the last thirty years, the number of pass-through businesses has greatly increased while the number of C corporations has declined. As a result, pass-through businesses now account for 94 percent of all businesses, earn more than 64 percent of total business net income, and employ more than half of the private sector workforce in the United States. In addition, they pay more than $1.6 trillion in wages and salaries and operate in every U.S. industry.

One of the main goals of fundamental tax reform is to make U.S. businesses more competitive and to increase economic growth. This requires a reduction in taxes on businesses and investment. Most attention is given to traditional C corporations because they face high tax burdens by international standards and account for a large amount of economic activity. As a result, less attention has been given to pass-through businesses. Since pass-through businesses now account for more than half of the business income and employment in the United States, any business tax reform needs to address the individual income tax code as well as the corporate income tax code.

 

Appendix

Appendix Table 1. Combined Top Marginal Tax Rate on Pass-through Businesses by State, 2014

State

Top Marginal Income Tax Rate (Sole Proprietorships/Partnerships)

Top Marginal Income Tax Rate (S Corporations)

Active Shareholders

Passive Shareholders

Alabama

45.65%

42.67%

46.47%

Alaska

42.58%

39.60%

43.40%

Arizona

46.51%

43.53%

47.33%

Arkansas

48.00%

45.02%

48.82%

California

51.86%

48.88%

52.68%

Colorado

46.56%

43.58%

47.38%

Connecticut

47.81%

44.83%

48.63%

Delaware

47.81%

44.83%

48.63%

Florida

42.58%

39.60%

43.40%

Georgia

47.39%

44.41%

48.21%

Hawaii

50.41%

47.43%

51.23%

Idaho

48.24%

45.26%

49.06%

Illinois

46.79%

43.81%

47.61%

Indiana

46.61%

43.63%

47.43%

Iowa

47.22%

44.25%

48.05%

Kansas

42.58%

39.60%

43.40%

Kentucky

48.30%

45.32%

49.12%

Louisiana

45.96%

42.98%

46.78%

Maine

48.57%

45.59%

49.39%

Maryland

49.05%

46.07%

49.87%

Massachusetts

46.91%

43.93%

47.73%

Michigan

46.52%

43.54%

47.34%

Minnesota

49.72%

46.74%

50.54%

Mississippi

46.79%

43.81%

47.61%

Missouri

47.51%

44.53%

48.33%

Montana

47.93%

44.96%

48.76%

Nebraska

47.90%

44.92%

48.72%

Nevada

42.58%

39.60%

43.40%

New Hampshire

42.58%

39.60%

43.40%

New Jersey

49.18%

46.21%

50.01%

New Mexico

46.73%

43.75%

47.55%

New York

50.24%

47.26%

51.06%

North Carolina

47.27%

44.29%

48.09%

North Dakota

45.71%

42.73%

46.53%

Ohio

48.01%

45.03%

48.83%

Oklahoma

46.94%

43.96%

47.76%

Oregon

49.81%

46.83%

50.63%

Pennsylvania

46.53%

43.55%

47.35%

Rhode Island

47.38%

44.41%

48.21%

South Carolina

48.00%

45.02%

48.82%

South Dakota

42.58%

39.60%

43.40%

Tennessee

42.58%

44.41%

48.21%

Texas

42.58%

39.60%

43.40%

Utah

46.79%

43.81%

47.61%

Vermont

49.17%

46.19%

49.99%

Virginia

47.24%

44.26%

48.06%

Washington

42.58%

39.60%

43.40%

West Virginia

47.69%

44.71%

48.51%

Wisconsin

48.39%

45.41%

49.21%

Wyoming

42.58%

39.60%

43.40%

District of Columbia

49.17%

46.19%

49.99%

U.S. Average

47.25%

44.51%

48.31%

Note: Many states also apply gross receipts, margin, and franchise taxes to pass-through business income. These numbers do not account for those.

Source: Author’s calculations.

 

Appendix Table 2. Employment by Business Form and State, 2011

State

C Corporations

Pass-through Total

Sole Proprietorship

Partnership

S Corporations

Share

Employment

Share

Employment

Share

Employment

Share

Employment

Share

Employment

Alabama

44.66%

759,390

55.34%

 941,143

19.86%

 337,810

10.38%

 176,477

25.10%

 426,856

Alaska

40.87%

109,453

59.13%

 158,359

22.64%

 60,631

11.60%

 31,054

24.90%

 66,674

Arizona

47.42%

1,082,867

52.58%

 1,200,610

17.43%

 397,950

12.50%

 285,528

22.65%

 517,132

Arkansas

45.68%

470,789

54.32%

 559,763

19.41%

 200,025

10.43%

 107,464

24.48%

 252,274

California

44.79%

6,281,899

55.21%

 7,743,121

22.55%

 3,162,609

9.67%

 1,356,736

22.99%

 3,223,776

Colorado

43.28%

940,781

56.72%

 1,233,139

18.54%

 402,999

13.04%

 283,389

25.15%

 546,751

Connecticut

46.90%

670,857

53.10%

 759,461

20.03%

 286,557

14.79%

 211,596

18.27%

 261,308

Delaware

50.50%

183,955

49.50%

 180,326

13.57%

 49,425

13.63%

 49,656

22.30%

 81,245

District of Columbia

47.72%

167,067

52.28%

 183,012

15.44%

 54,037

21.26%

 74,435

15.58%

 54,540

Florida

43.30%

3,347,252

56.70%

 4,382,664

19.28%

 1,490,678

9.57%

 739,885

27.84%

 2,152,101

Georgia

46.21%

1,728,269

53.79%

 2,011,755

20.61%

 770,791

9.64%

 360,372

23.55%

 880,592

Hawaii

51.96%

262,206

48.04%

 242,420

20.58%

 103,853

10.32%

 52,053

17.14%

 86,514

Idaho

35.98%

192,506

64.02%

 342,513

21.29%

 113,916

15.06%

 80,578

27.67%

 148,019

Illinois

45.65%

2,381,740

54.35%

 2,836,017

17.50%

 912,902

9.85%

 513,968

27.01%

 1,409,147

Indiana

41.98%

1,036,757

58.02%

 1,433,031

16.49%

 407,276

11.75%

 290,192

29.78%

 735,563

Iowa

46.27%

570,868

53.73%

 662,857

17.63%

 217,458

8.79%

 108,486

27.31%

 336,913

Kansas

46.70%

526,274

53.30%

 600,592

18.27%

 205,836

10.72%

 120,835

24.31%

 273,921

Kentucky

44.34%

677,683

55.66%

 850,549

19.90%

 304,105

11.74%

 179,351

24.02%

 367,093

Louisiana

41.03%

712,283

58.97%

 1,023,924

20.02%

 347,506

15.05%

 261,321

23.91%

 415,097

Maine

37.64%

182,221

62.36%

 301,958

24.41%

 118,201

8.29%

 40,159

29.66%

 143,598

Maryland

43.75%

952,896

56.25%

 1,225,339

20.13%

 438,505

10.55%

 229,728

25.58%

 557,106

Massachusetts

47.52%

1,322,241

52.48%

 1,460,544

18.21%

 506,686

9.62%

 267,801

24.65%

 686,057

Michigan

43.80%

1,553,073

56.20%

 1,992,942

19.41%

 688,336

11.44%

 405,675

25.35%

 898,931

Minnesota

43.94%

1,012,541

56.06%

 1,291,745

17.43%

 401,737

8.43%

 194,226

30.20%

 695,782

Mississippi

44.65%

425,946

55.35%

 528,010

22.49%

 214,554

11.23%

 107,121

21.63%

 206,335

Missouri

46.72%

1,076,499

53.28%

 1,227,605

18.39%

 423,710

10.66%

 245,567

24.23%

 558,328

Montana

32.10%

113,952

67.90%

 241,049

23.97%

 85,091

11.13%

 39,516

32.80%

 116,442

Nebraska

44.02%

350,531

55.98%

 445,817

16.58%

 132,034

8.72%

 69,434

30.68%

 244,349

Nevada

46.82%

530,211

53.18%

 602,201

17.00%

 192,474

15.32%

 173,438

20.87%

 236,289

New Hampshire

44.65%

250,754

55.35%

 310,874

20.67%

 116,064

9.60%

 53,901

25.09%

 140,909

New Jersey

45.46%

1,617,960

54.54%

 1,941,400

17.12%

 609,281

13.66%

 486,253

23.76%

 845,866

New Mexico

41.31%

262,688

58.69%

 373,147

20.85%

 132,589

12.97%

 82,499

24.86%

 158,059

New York

40.69%

2,985,817

59.31%

 4,351,881

21.13%

 1,550,289

12.49%

 916,635

25.69%

 1,884,957

North Carolina

45.56%

1,576,409

54.44%

 1,883,894

19.20%

 664,216

9.47%

 327,524

25.78%

 892,154

North Dakota

39.54%

111,283

60.46%

 170,176

18.77%

 52,831

10.37%

 29,201

31.32%

 88,144

Ohio

46.43%

2,071,166

53.57%

 2,389,484

17.68%

 788,483

11.40%

 508,487

24.49%

 1,092,514

Oklahoma

42.23%

573,296

57.77%

 784,340

20.33%

 276,021

13.08%

 177,594

24.36%

 330,725

Oregon

42.03%

577,733

57.97%

 796,751

19.97%

 274,531

11.04%

 151,715

26.96%

 370,505

Pennsylvania

44.64%

2,150,826

55.36%

 2,667,428

18.03%

 868,870

10.54%

 507,738

26.79%

 1,290,820

Rhode Island

39.39%

152,988

60.61%

 235,359

19.30%

 74,945

8.40%

 32,629

32.90%

 127,785

South Carolina

45.77%

751,398

54.23%

 890,332

19.01%

 312,102

10.95%

 179,753

24.27%

 398,477

South Dakota

35.27%

111,142

64.73%

 203,998

20.85%

 65,698

11.28%

 35,561

32.60%

 102,739

Tennessee

48.72%

1,193,808

51.28%

 1,256,432

22.21%

 544,306

14.90%

 364,991

14.17%

 347,135

Texas

46.72%

4,715,695

53.28%

 5,378,460

21.02%

 2,121,668

14.54%

 1,468,145

17.72%

 1,788,647

Utah

42.84%

472,883

57.16%

 630,968

15.39%

 169,915

14.84%

 163,839

26.93%

 297,214

Vermont

36.88%

96,160

63.12%

 164,610

26.69%

 69,589

9.45%

 24,653

26.98%

 70,368

Virginia

48.01%

1,521,565

51.99%

 1,647,972

16.81%

 532,800

10.01%

 317,146

25.18%

 798,026

Washington

45.23%

1,087,939

54.77%

 1,317,293

18.45%

 443,831

10.73%

 258,114

25.58%

 615,348

West Virginia

48.80%

270,479

51.20%

 283,815

19.43%

 107,701

11.77%

 65,268

20.00%

 110,846

Wisconsin

44.03%

1,002,392

55.97%

 1,274,178

16.53%

 376,296

9.90%

 225,355

29.54%

 672,527

Wyoming

38.17%

86,542

61.83%

 140,161

20.13%

 45,631

13.22%

 29,965

28.48%

 64,565

Source: Author’s calculations based on U.S. Census data.

 

Appendix Table 3. Payroll by Business Form and State, 2011

State

C Corporate Payroll

Pass-Through Payroll

Sole Proprietorship Payroll

Partnership Payroll

S Corporation Payroll

Share

Amount

Share

Amount

Share

Amount

Share

Amount

Share

Amount

Alabama

60.5%

$32,007,619

39.5%

$20,921,116

2.3%

$1,242,116

9.35%

$4,948,624

27.8%

$14,730,376

Alaska

58.9%

$6,837,634

41.1%

$4,777,962

3.9%

$450,529

10.87%

$1,263,055

26.4%

$3,064,378

Arizona

66.4%

$50,723,125

33.6%

$25,705,549

1.5%

$1,138,622

10.18%

$7,778,764

22.0%

$16,788,163

Arkansas

65.0%

$19,880,118

35.0%

$10,727,277

1.8%

$548,160

9.68%

$2,962,057

23.6%

$7,217,060

California

66.3%

$391,528,884

33.7%

$199,022,094

2.5%

$14,631,666

9.64%

$56,916,574

21.6%

$127,473,854

Colorado

62.2%

$51,740,233

37.8%

$31,422,572

1.5%

$1,285,006

11.89%

$9,889,960

24.3%

$20,247,606

Connecticut

65.0%

$45,463,512

35.0%

$24,480,045

2.6%

$1,806,889

15.18%

$10,618,564

17.2%

$12,054,592

Delaware

63.1%

$9,733,653

36.9%

$5,699,143

1.4%

$221,388

17.36%

$2,679,297

18.1%

$2,798,458

District of Columbia

56.5%

$12,464,549

43.5%

$9,595,380

2.9%

$630,936

27.74%

$6,119,752

12.9%

$2,844,692

Florida

59.9%

$142,247,165

40.1%

$95,084,198

1.3%

$3,105,904

10.41%

$24,716,547

28.3%

$67,261,747

Georgia

66.1%

$83,965,206

33.9%

$43,133,496

1.6%

$1,976,450

9.93%

$12,619,545

22.5%

$28,537,501

Hawaii

68.3%

$10,349,394

31.7%

$4,807,095

3.6%

$549,641

10.35%

$1,568,729

17.7%

$2,688,725

Idaho

52.5%

$7,778,024

47.5%

$7,026,080

2.2%

$320,483

15.97%

$2,364,049

29.3%

$4,341,548

Illinois

62.0%

$132,851,641

38.0%

$81,256,813

2.1%

$4,574,599

11.38%

$24,375,339

24.4%

$52,306,875

Indiana

57.4%

$47,204,435

42.6%

$35,090,766

2.1%

$1,724,555

11.25%

$9,255,257

29.3%

$24,110,954

Iowa

63.3%

$24,808,579

36.7%

$14,408,835

2.2%

$844,610

6.90%

$2,704,843

27.7%

$10,859,382

Kansas

65.0%

$24,718,807

35.0%

$13,321,261

2.2%

$828,865

8.77%

$3,336,798

24.1%

$9,155,598

Kentucky

61.7%

$28,913,905

38.3%

$17,918,397

3.8%

$1,788,935

10.67%

$4,994,966

23.8%

$11,134,496

Louisiana

55.6%

$32,183,055

44.4%

$25,695,038

2.3%

$1,350,352

16.15%

$9,344,547

25.9%

$15,000,139

Maine

56.3%

$7,762,347

43.7%

$6,035,022

3.2%

$438,128

7.41%

$1,021,861

33.2%

$4,575,033

Maryland

59.9%

$51,226,319

40.1%

$34,226,875

2.2%

$1,913,324

9.98%

$8,531,057

27.8%

$23,782,494

Massachusetts

66.7%

$89,890,293

33.3%

$44,910,224

1.7%

$2,327,184

9.78%

$13,178,838

21.8%

$29,404,202

Michigan

62.3%

$78,744,124

37.7%

$47,663,679

1.9%

$2,449,317

10.78%

$13,623,258

25.0%

$31,591,104

Minnesota

63.8%

$59,108,837

36.2%

$33,589,449

1.9%

$1,764,278

7.62%

$7,059,076

26.7%

$24,766,095

Mississippi

62.9%

$15,818,019

37.1%

$9,310,039

2.8%

$698,193

10.93%

$2,747,398

23.3%

$5,864,448

Missouri

64.7%

$50,397,113

35.3%

$27,542,251

1.9%

$1,486,279

9.51%

$7,411,191

23.9%

$18,644,781

Montana

51.2%

$4,632,791

48.8%

$4,423,065

2.9%

$259,706

9.29%

$841,740

36.7%

$3,321,619

Nebraska

58.8%

$15,008,653

41.2%

$10,536,723

1.7%

$443,661

6.90%

$1,763,625

32.6%

$8,329,437

Nevada

59.2%

$21,750,823

40.8%

$14,967,337

4.1%

$1,497,066

14.65%

$5,377,575

22.0%

$8,092,696

New Hampshire

61.6%

$12,618,559

38.4%

$7,856,197

3.0%

$620,889

7.10%

$1,453,691

28.2%

$5,781,617

New Jersey

64.5%

$106,136,669

35.5%

$58,534,325

2.0%

$3,235,618

10.88%

$17,912,850

22.7%

$37,385,857

New Mexico

56.4%

$10,599,304

43.6%

$8,204,404

2.7%

$512,359

15.03%

$2,825,448

25.9%

$4,866,597

New York

59.9%

$218,057,598

40.1%

$146,082,409

2.1%

$7,636,085

16.49%

$60,063,617

21.5%

$78,382,707

North Carolina

65.0%

$73,648,168

35.0%

$39,575,743

1.9%

$2,183,591

8.59%

$9,723,911

24.4%

$27,668,241

North Dakota

57.0%

$5,435,830

43.0%

$4,099,686

2.3%

$217,953

7.94%

$757,496

32.8%

$3,124,237

Ohio

63.7%

$99,012,006

36.3%

$56,340,183

2.1%

$3,266,377

10.12%

$15,722,600

24.0%

$37,351,206

Oklahoma

60.8%

$26,676,707

39.2%

$17,185,828

2.4%

$1,032,740

12.38%

$5,428,372

24.5%

$10,724,716

Oregon

63.0%

$29,763,256

37.0%

$17,498,294

2.3%

$1,072,023

8.37%

$3,955,555

26.4%

$12,470,716

Pennsylvania

61.1%

$111,739,161

38.9%

$71,289,612

2.6%

$4,823,178

9.53%

$17,438,586

26.8%

$49,027,848

Rhode Island

54.1%

$7,406,493

45.9%

$6,294,069

4.6%

$625,134

7.34%

$1,005,234

34.0%

$4,663,701

South Carolina

62.2%

$29,860,505

37.8%

$18,155,968

2.3%

$1,107,622

10.60%

$5,091,516

24.9%

$11,956,830

South Dakota

49.6%

$4,249,432

50.4%

$4,325,195

2.8%

$243,397

10.20%

$874,870

37.4%

$3,206,928

Tennessee

66.6%

$53,449,846

33.4%

$26,780,728

3.1%

$2,481,896

13.86%

$11,118,643

16.4%

$13,180,189

Texas

65.5%

$249,208,105

34.5%

$131,034,636

2.3%

$8,837,959

15.18%

$57,711,580

17.0%

$64,485,097

Utah

60.7%

$21,540,940

39.3%

$13,958,186

1.2%

$419,387

11.21%

$3,979,060

26.9%

$9,559,739

Vermont

56.6%

$4,248,011

43.4%

$3,255,347

3.5%

$265,584

7.24%

$543,079

32.6%

$2,446,684

Virginia

63.5%

$82,006,387

36.5%

$47,083,789

1.9%

$2,401,574

9.68%

$12,501,885

24.9%

$32,180,330

Washington

65.7%

$67,815,134

34.3%

$35,472,191

2.5%

$2,573,819

8.62%

$8,906,822

23.2%

$23,991,550

West Virginia

66.9%

$11,431,956

33.1%

$5,666,790

3.4%

$581,332

10.32%

$1,763,804

19.4%

$3,321,654

Wisconsin

60.4%

$48,179,529

39.6%

$31,615,544

2.3%

$1,854,671

7.78%

$6,204,305

29.5%

$23,556,568

Wyoming

56.1%

$4,545,034

43.9%

$3,559,474

2.3%

$188,161

10.63%

$861,799

31.0%

$2,509,514

Note: Does not include non-employer firms; dollar amounts in thousands.

Source: Author’s calculations based on U.S. Census data.

 

Appendix Table 4. Pass-through Businesses, Employment, and Payroll by Industry

NAICS Classification

NAICS Code

Total Private Sector

C Corporations

Pass-through Businesses

Firms

Employment

Payroll

Firms

Employment

Payroll

Firms

Employment

Payroll

Agriculture, forestry, fishing and hunting

11

258188

386229

$5,186,733

6767

50678

$1,957,557

251421

335551

$3,229,176

Mining, quarrying, and oil and gas extraction

21

131247

758959

$55,142,854

8863

433115

$39,779,751

122384

325844

$15,363,103

Utilities

22

20703

580534

$52,791,916

2159

537163

$50,520,384

18544

43371

$2,271,532

Construction

23

3032846

7570862

$264,873,890

180636

1862122

$101,836,009

2852210

5708740

$163,037,881

Manufacturing

31-33

585945

11237036

$571,217,485

95521

7160805

$406,976,997

490424

4076231

$164,240,488

Wholesale trade

42

712192

5955180

$353,649,072

129530

3223821

$230,411,033

582662

2731359

$123,238,039

Retail trade

44-45

2498799

16365278

$366,560,872

191122

9735727

$233,317,378

2307677

6629551

$133,243,494

Transportation and warehousing

48-49

1202842

5115544

$174,926,243

62017

2794022

$125,680,588

1140825

2321522

$49,245,655

Information

51

383354

3340315

$229,570,366

29305

2323834

$188,692,027

354049

1016481

$40,878,339

Finance and insurance

52

940019

6214086

$472,183,897

63534

4461143

$376,795,088

876485

1752943

$95,388,809

Real estate and rental and leasing

53

2604917

4209817

$82,333,393

132816

823592

$36,584,148

2472101

3386225

$45,749,245

Professional, scientific, and technical services

54

3924278

10847469

$551,274,359

200958

3681456

$302,677,017

3723320

7166013

$248,597,342

Management of companies and enterprises

55

25009

2605175

$278,703,195

12321

2131746

$240,527,725

12688

473429

$38,175,470

Administrative and support and waste management and remediation services

56

2301092

11257122

$321,620,087

79696

4547393

$176,609,396

2221396

6709729

$145,010,691

Educational services

61

630490

1405289

$25,206,522

13364

400570

$14,262,759

617126

1004719

$10,943,763

Health care and social assistance

62

2534133

10742519

$367,325,270

125854

3421261

$175,269,506

2408279

7321258

$192,055,764

Arts, entertainment, and recreation

71

1277971

2545644

$47,681,968

31199

541619

$16,208,131

1246772

2004025

$31,473,837

Accommodation and food services

72

824512

11744451

$190,190,752

100135

4130380

$77,708,593

724377

7614071

$112,482,159

Other services (except public administration)

81

3905021

6121087

$73,832,944

124134

1000942

$31,498,530

3780887

5120145

$42,334,414

Industries not classified

99

15970

3716

$262,048

2123

2544

$54,870

13847

1172

$207,178

Note: Dollars in thousands of dollars.

Source: Author’s calculations based on U.S. Census data.


[1]       Half of a worker’s payroll taxes are paid by their employer.

[2]       Rental real estate income is exempt from the self-employment tax.

[3]       The IRS sets a limit on how much income an owner can designate as a non-wage distribution to prevent abuse.

[4]       The IRS sets guidelines on what they consider active or passive participation. If shareholders do not satisfy the “material participation” guidelines, the income received from the business is deemed passive and subject to the Net Investment Income Tax. See Michael Kosnitzky & Michael Grisolia, Net Investment Income Tax Regulations Affecting S Corporations, http://www.bsfllp.com/news/in_the_news/001548/_res/id=sa_File1/.

[5]       Regulations require equal distribution among all S corporation shareholders, active or passive. S corporations must distribute enough money to all shareholders, including active shareholders, to cover the 3.8 percent Net Investment Tax, even though active shareholders are not actually required to pay the tax. Although not strictly a tax on S corporations, this limits the amount of money available for reinvestment.

[6]       More than 2 million income tax returns with pass-through business income were subject to the AMT in 2007. U.S. Department of the Treasury, Office of Tax Analysis, Mathew Knittel et al., OTA Technical Paper 4: Methodology to Identify Small Businesses and Their Owners (Aug. 2011), http://www.treasury.gov/resource-center/tax-policy/tax-analysis/Documents/OTA-T2011-04-Small-Business-Methodology-Aug-8-2011.pdf.

[7]       Tax Foundation, State Personal Income Tax Rates and Brackets 2014 Update, http://taxfoundation.org/article/state-personal-income-tax-rates-and-brackets-2014-update.

[8]       Assuming the last dollar earned by an active shareholder is his non-salary income from his business.

[9]       Averages are both weighted by the amount of pass-through income in each state. Assumes no effect of Pease in states with no individual income tax. Pease may apply in states with no income tax, in some cases adding 1.118 percent to the marginal rate. Many states also apply gross receipts, margin, and franchise taxes to pass-through business income. These numbers do not account for those.

[10]     Assuming equity-financed investment.

[11]     Nearly 40 percent of corporate equities are held by tax-exempt organizations and individuals (college endowments, pension funds, and tax preferred retirement accounts). The corporate income passed to these taxpayers is exempt from the second layer of tax. See Congressional Budget Office, Taxing Capital Income: Effective Marginal Tax Rates Under 2014 Law and Selected Policy Options (Dec. 2014), http://www.cbo.gov/sites/default/files/cbofiles/attachments/49817-Taxing_Capital_Income_0.pdf.

[12]     The top marginal individual income tax rates were reduced from 50 percent in 1986 to 28 percent in 1988. This is compared to the corporate income tax rate that was lowered from 46 percent in 1986 to 34 percent in 1988. See Tax Foundation, U.S. Federal Individual Income Tax Rates History, 1862-2013 (Nominal and Inflation-Adjusted Brackets), http://taxfoundation.org/article/us-federal-individual-income-tax-rates-history-1913-2013-nominal-and-inflation-adjusted-brackets; Tax Foundation, U.S. Federal Individual Income Tax Rates History, 1862-2013 (Nominal and Inflation-Adjusted Brackets), http://taxfoundation.org/article/us-federal-individual-income-tax-rates-history-1913-2013-nominal-and-inflation-adjusted-brackets.

[13]     Internal Revenue Service, SOI Tax Stats – Integrated Business Data, 1980–2008, http://www.irs.gov/uac/SOI-Tax-Stats-Integrated-Business-Data; Internal Revenue Service, Business Tax Statistics, 2009–2011, http://www.irs.gov/uac/Tax-Stats-2. IRS data double counts some businesses due to the fact that some private partnerships can be owned by one or more other business entities.

[14]     The number of firms differs from the number of returns. Specifically, an individual firm may own several different businesses that separately file tax returns.

[15]     Census Bureau, County Business Patterns, http://www.census.gov/econ/cbp/; Census Bureau, Nonemployer Statistics, http://www.census.gov/econ/nonemployer/. 2011 is the most up-to-date year for all data sources.

[16]     Internal Revenue Service, SOI Tax Stats – Integrated Business Data, 1980–2008, http://www.irs.gov/uac/SOI-Tax-Stats-Integrated-Business-Data; Internal Revenue Service, Business Tax Statistics, 2009–2011, http://www.irs.gov/uac/Tax-Stats-2.

[17]     Numbers include self-employed individuals in order to get a complete picture of employment by business form. Census Bureau, County Business Patterns, http://www.census.gov/econ/cbp/; Census Bureau, Statistics of U.S. Businesses, http://www.census.gov/econ/susb/; Census Bureau, Nonemployer Statistics 2011, http://www.census.gov/econ/nonemployer/.

[18]     Census Bureau, County Business Patterns, http://www.census.gov/econ/cbp/; Census Bureau, Statistics of U.S. Businesses, http://www.census.gov/econ/susb/; Census Bureau, Nonemployer Statistics 2011, http://www.census.gov/econ/nonemployer/.

[19]     Census Bureau, County Business Patterns, http://www.census.gov/econ/cbp/; Census Bureau, Statistics of U.S. Businesses, http://www.census.gov/econ/susb/; Census Bureau, Nonemployer Statistics 2011, http://www.census.gov/econ/nonemployer/.

[20]     See Appendix for full employment data table.

[21]     Census Bureau, County Business Patterns, http://www.census.gov/econ/cbp/; Census Bureau, Statistics of U.S. Businesses, http://www.census.gov/econ/susb/; Census Bureau, Nonemployer Statistics 2011, http://www.census.gov/econ/nonemployer/.

[22]     These numbers do not account for self-employment income, which is disproportionately earned by pass-through businesses, especially sole proprietorships. Unincorporated self-employed individuals reported approximately $600 billion in gross receipts in 2011. However, gross receipts cannot be directly compared to payroll due to the omission of business expenses. Wages would more accurately be compared to gross receipts minus costs.

[23]     See Appendix for full data table with payroll by state and business form for 2011.

[24]     Census Bureau, County Business Patterns, http://www.census.gov/econ/cbp/; Census Bureau, Statistics of U.S. Businesses, http://www.census.gov/econ/susb/; Census Bureau, Nonemployer Statistics 2011, http://www.census.gov/econ/nonemployer/.

[25]     Robert Carroll & Gerald Prante, The Flow-Through Business Sector and Tax Reform: The economic footprint of the flow-through sector and the potential impact of tax reform (Apr. 2011), http://www.s-corp.org/wp-content/uploads/2011/04/Flow-Through-Report-Final-2011-04-08.pdf.

[26]     Internal Revenue Service, SOI Tax Stats – Individual Statistical Tables by Size of Adjusted Gross Income, Table 1.4, http://www.irs.gov/uac/SOI-Tax-Stats---Individual-Statistical-Tables-by-Size-of-Adjusted-Gross-Income. Business income includes: business and professional income (Schedule C, 1040 Line 12), Rents, Royalties, S Corporation and Partnerships income (Schedule E), and Farm Income (Schedule F).

[27]     It is important to note that individuals can report business income from incidental business activity. For example, an individual can earn rental income from a vacation home.

 

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