IRS Data Shows That Businesses Will Bear Brunt of Obama's Tax Hike

July 09, 2012

Today, President Obama renewed his call for allowing the Bush-era tax rates to expire for families earning over $250,000 while extending the lower rates for taxpayers below that threshold. The president and his economic team tend to dismiss the impact that such as tax hike will have on business activity because only 2 or 3 percent of taxpayers with business income are taxed at the highest rates.

While this statistic is true, the more economically meaningful statistic is how much overall business income will be taxed at the highest rates. For example, Treasury data for 2007 indicates that 50 percent of all pass-through income is earned by taxpayers subject to the top two tax brackets of 33 percent and 35 percent.[1]

How this income breaks down by income groups can be seen in the most recent IRS data for 2009. In that year, individual taxpayers reported $896 billion in total business income from all sources – including business and professional income, rents and royalties, partnership and S-corporation income, and farm income. After subtracting net losses, individual taxpayers earned $696 billion in net business income.

As Table 1 indicates, the vast majority (66 percent) of pass-through business income was reported by taxpayers earning more than $250,000. Millionaire tax returns earned 36 percent of this private business income while taxpayers earning between $250,000 and $1 million earned 30 percent. Meanwhile, taxpayers with incomes below $100,000 earned 13 percent of all private business income.

It is also illuminating to look at the distribution of specific types of business income. Table 1 shows the very different distribution of income generated by sole proprietors (business and professional income) versus the income generated by partnerships and S-corporations. Whereas only 25 percent of sole proprietor income is reported by taxpayers earning over $250,000, some 85 percent of partnership and S-corp income is reported by these high-income taxpayers. Indeed, more than half of all partnership and S-corp income is earned by millionaire taxpayers.

 

Table 1. Distribution of Pass-Through Business Income in 2009

 

under $100,000*

$100,000 to
$250,000

$250,000 to
 $1 million

$1 million +

All Pass-Through Income

13%

21%

30%

36%

Net Business & Professional Income

46%

29%

19%

6%

Net Partnership & S-Corp Income

1%

15%

34%

51%

*includes returns with negative income

Source: Tax Foundation calculations based on IRS data

The president and his economic team also tend to overlook how many of these pass-through businesses are employers. A recent Treasury report analyzed IRS data from 2007 and found that roughly 4.2 million pass-through business returns – out of 34.7 million overall – were employers.  As Figure 3 illustrates, 50 percent of the income generated by these employers accrued to taxpayers with incomes above $1 million. Fully 90 percent of this business income was generated by employers with incomes above $200,000.

No matter how you cut the data, the fact is that hiking the top individual income tax rates would amount to one of the largest single tax increases on individually owned businesses in modern history and a threat to the long-term economic health of the nation.



[1] U.S. Department of the Treasury, Office of Tax Analysis, OTA Technical Paper 4: Methodology to Identify Small Businesses and Their Owners, Matthew Knittel, et al., Aug. 2011.

 

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