Unlike the individual taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. code, it’s often easy to view the business tax code impersonally. Who are the workers, consumers, and shareholders who interact with businesses in the U.S.? What forms do these businesses take? How do business taxes impact people’s lives?
It is essential we answer these questions in order to design a business tax system that is simple, efficient, and enables economic progress.
The posts below are designed to provide taxpayers and lawmakers with the facts and data necessary to better understand business taxes in America and have an open and productive debate.
Corporate and Pass-through BusinessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates. Income and Returns Since 1980
Businesses in America broadly fall into two categories: C corporations, which pay the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. , and pass throughs—such as partnerships, S corporationAn S corporation is a business entity which elects to pass business income and losses through to its shareholders. The shareholders are then responsible for paying individual income taxes on this income. Unlike subchapter C corporations, an S corporation (S corp) is not subject to the corporate income tax (CIT). s, LLCs, and sole proprietorships—which “pass” their income “through” to their owner’s income tax returns and pay the ordinary individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. . While C corporations may be fewer in number than pass throughs, they generate larger amounts of revenue and net-income per entity. On the other hand, pass-through businesses make up almost three-fifths of net business income. Read more.
Firm Variation by Employment and Taxes
Businesses shouldn’t be thought of as all identical. While firms with fewer than 20 employees make up 86.8 percent of businesses, they employ only 17.1 percent of all private sector workers. In contrast, while only 0.4 percent of all firms have 500 or more employees, this small group of businesses employs 47.3 percent of the nation’s private sector workforce. The biggest firms play a similarly important role in both earning income and paying taxes on it. Businesses with over $2.5 billion in assets paid the majority of corporate income taxes. These corporations earned 76.1 percent of corporate taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. and paid 69.8 percent of all corporate income taxes. Read more.
2017 GDP and Employment by Industry
In the U.S. economy, there are tens of millions of businesses, including more than 30 million pass-through businesses and more than a million C corporations. Most output and employment come from firms that provide services to consumers—such as education, health care, and social assistance services—though a large share of output and employment still comes from firms in production industries, particularly manufacturing. Read more.
The Lowered Corporate Income Tax Rate Makes the U.S. More Competitive Abroad
The Tax Cuts and Jobs Act lowered the U.S. corporate income tax rate from 35 percent to 21 percent. Previously, America’s combined statutory corporate income tax rate, combining state and federal corporate income taxes, was the highest among all Organisation for Economic Co-operation and Development (OECD) countries. Over time, the lower corporate rate will encourage new investment and lead to additional economic growth. It will make the U.S. more attractive for companies by increasing after-tax returns on investments and will discourage companies from shifting profits to low-tax jurisdictions. Read more.
State Corporate Income Taxes Increase Tax Burden on Corporate Profits
The Tax Cuts and Jobs Act (TCJA)The Tax Cuts and Jobs Act in 2017 overhauled the federal tax code by reforming individual and business taxes. It was pro-growth reform, significantly lowering marginal tax rates and cost of capital. We estimated it reduced federal revenue by .47 trillion over 10 years before accounting for economic growth. reduced the U.S. federal corporate income tax rate from 35 percent to 21 percent. However, most U.S. states also tax corporate income. These state-level taxes mean the average statutory corporate income tax rate in the U.S., which combines the average of state corporate income tax rates with the federal corporate income tax rate, is 25.8 percent in 2019. Read more.
Pass-Through Businesses Q&A
Pass-through businesses are the dominant business structure in America. Pass throughs file more tax returns and report more business income than C corporations. Pass-through businesses are not subject to the corporate income tax, but instead report their income on the individual income tax returns of owners. This blog will address some frequently asked questions about pass-through structure and taxation. Read more.
Marginal Tax RateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. s for Pass-through Businesses Vary by State
Pass-through businesses are now the dominant business form in the U.S., making up more than half of the private sector workforce in every state. Federal taxes on income set a minimum tax rate for pass throughs, but marginal rates for pass throughs vary based on how states tax individual income. Read more.
Taxes on Capital Income Are More Than Just the Corporate Income Tax
Taxes on capital income, or corporate investment, are more than just the corporate income tax. Shareholder-level taxes, such as those on dividends and capital gains, also affect incentives to save and invest. The combined tax rate on corporate profits in the United States is above the average across Organisation for Economic Co-operation and Development (OECD) countries. For example, in 2018, the first tax year after passage of the Tax Cuts and Jobs Act, the U.S. combined rate was 47.25, compared to the OECD average of 41.7 percent. The cost of all taxes, not just the corporate income tax, factors into a business’s decision about whether to make an investment. Thus, it’s important to consider the total burden of taxes that apply to capital income, not just the corporate income tax. Read more.
DepreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. Requires Businesses to Pay Tax on Income That Doesn’t Exist
While tax rates matter to businesses, so too does the measure of income to which those tax rates apply. The corporate income tax is a tax on profits, normally defined as revenue minus costs. However, under the current tax code, businesses are unable to deduct the full cost of certain expenses—their capital investments—meaning the tax code is not neutral and actually increases the cost of investment. Cost recoveryCost recovery is the ability of businesses to recover (deduct) the costs of their investments. It plays an important role in defining a business’ tax base and can impact investment decisions. When businesses cannot fully deduct capital expenditures, they spend less on capital, which reduces worker’s productivity and wages. systems that fall short of full, immediate expensing deny the investor a tax claim for part of the cost of production and increase the cost of making the investment. Ultimately, this means that the corporate income tax is biased against investment in capital assets to the extent that it makes the investor wait years or decades to claim the cost of machines, equipment, or factories on their tax returns. Read more.
Not All Tax ExpenditureTax expenditures are a departure from the “normal” tax code that lower the tax burden of individuals or businesses, through an exemption, deduction, credit, or preferential rate. Expenditures can result in significant revenue losses to the government and include provisions such as the earned income tax credit, child tax credit, deduction for employer health-care contributions, and tax-advantaged savings plans. s Are Equal
Tax expenditures are departures from the normal tax code that lower a taxpayer’s burden, such as exemptions, deductions, and credits. Many tax expenditures provide preferential treatment for particular economic activities, making the tax code less neutral and shrinking the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. . However, some are broad-based changes that play an important role by moving the U.S. toward a different tax system. Simply eliminating expenditures across the board would therefore be misguided. Individuals received 86.3 percent of tax expenditures in 2018, or $1.3 trillion. Corporations received only 13.7 percent of all tax expenditures, or $0.2 trillion ($200 billion). Read more.
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