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Corporate Tax Reform versus Business Tax Reform

March 2, 2015 5 minute Read by Christopher Hanna

There is a lot of interest in corporate tax reform, which is understandable given that the top U.S. corporate tax rate of 35 percent is about 10 percentage points higher than the average top corporate tax rate of the other Organization for Economic Cooperation and Development (OECD) countries.  But corporate tax reform should really be viewed as part of business tax reform.

 Unlike many other countries of the world, most U.S. businesses are conducted as partnerships, limited liability companies, S corporations or sole proprietorships.  Such business entities are not subject to the corporate tax and therefore would not be directly affected by any corporate-only tax reform.

The income of such business entities passes through the entity and is taxed to the owners of the entity.  For example, the income of a partnership is not taxed to the partnership, but rather passes through the partnership and is taxed to the partners of the partnership.

Many non-publicly traded companies are taxed as S corporations or partnerships.  The number of S corporations has increased by an average annual rate of 7.42 percent from 1980 until 2008.  By 2008, the number of S corporations had climbed to 4,049,944 from 545,389 in 1980.  The number of partnerships has increased by an average of 2.98 percent annually from 1980 to 2008.  By 2008, the number of partnerships had climbed to 3,146,006 from 1,379,654 in 1980. 

In contrast, the number of traditional or C corporations, which are subject to the corporate tax, declined by an average annual rate of 0.69 percent from 1980 to 2008.  By 2008, there were 1,782,478 C corporations, down from 2,163,458 in 1980.

Shares of Business Returns as a Percentage, 1980-2008

 

1980

1990

2000

2007

2008

S Corporations

4

8

11

12

13

Partnerships

11

8

8

10

10

Sole Proprietorships (Non-farm)

69

74

72

72

72

C Corporations

17

11

9

6

6


As would be expected, with the increasing number of S corporations and partnerships, an increasing amount of business income is being earned by pass-through entities.  In 1980, C corporations earned 75 percent of the net income earned by all businesses, with S corporations, partnerships and sole proprietorships earning a combined 21 percent of all net business income.   By 1990, C corporations earned only 50 percent of the net income earned by all businesses, with S corporations, partnerships and sole proprietorships earning 37 percent.

 In 2000 and 2008, C corporations earned 35 percent and 22 percent, respectively, of the net income earned by all businesses, with S corporations, partnerships and sole proprietorships earning slightly less than half of the net income in 2000 (46 percent) and slightly more in 2008 (59 percent).

Percentage Share of Net Income, 1980-2008

 

1980

1990

2000

2007

2008

All Businesses

100

100

100

100

100

C Corporations

75

50

35

36

22

Regulated Investment Companies (RICs) and Real Estate Investment Trusts (REITs)

5

12

18

17

20

S Corporations

1

8

13

14

18

Partnerships

3

3

18

23

26

Sole Proprietorships

17

26

15

10

15


In 2011, there were 1,648,540 returns of active corporations (not including S corporations, REITs and RICs).  However, the corporate income tax is paid predominantly by a very small number of corporations.

 In 2011, 345 corporations (about two one-hundredths of one percent of all active corporations) had an income tax liability (after credits) of $100 million or more and paid a total of slightly more than $141 billion of corporate income taxes.  This was about 64 percent of the total tax paid by all corporations.  Approximately 8,500 corporations (about one-half of one percent of all active corporations), each with an income tax liability of $1 million or more (after credits) paid almost $209 billion of corporate income taxes, which was 95 percent of the total tax paid by all corporations.

 Corporate tax reform would not directly affect the taxation of pass-through entities, thereby ignoring a large number of U.S. businesses.  If, however, the focus is business tax reform, thereby including the taxation of pass-through entities, then it seems that comprehensive tax reform – meaning the taxation of both individuals and corporations -- would have to be addressed as many of the owners of pass-through entities are individuals.

Christopher Hanna is a Bush Institute fellow and the Alan D. Feld Endowed Professor of Law and Altshuler Distinguished Teaching Professor at SMU’s Dedman School of Law.


Author

Christopher Hanna
Christopher Hanna

Christopher H. Hanna is a professor of law and a University Distinguished Teaching Professor at Southern Methodist University. Professor Hanna has been a visiting professor at the University of Texas School of Law, the University of Florida College of Law, the University of Tokyo School of Law and a visiting scholar at the Harvard Law School and the Japanese Ministry of Finance. In 1998, Professor Hanna served as a consultant in residence to the Organisation for Economic Co-operation and Development (OECD) in Paris. From June 2000 until April 2001, he assisted the U.S. Joint Committee on Taxation in its complexity study of the U.S. tax system and, from May 2002 until February 2003, he assisted the Joint Committee in its study of Enron, and upon completion of the study, continued to serve as a consultant to the Joint Committee on tax legislation.

Prior to coming to SMU, Professor Hanna was a tax attorney with the Washington, D.C. law firm of Steptoe & Johnson. His primary duties included tax planning for partnerships and corporations on both a domestic and international level and also tax controversy. He has received the Dr. Don M. Smart Teaching Award for excellence in teaching at SMU Dedman School of Law on eight separate occasions. In 1995, he was selected and featured in Barrister magazine, a publication of the ABA Young Lawyers' Division, as one of “21 Young Lawyers Leading Us Into the 21st Century” (Special Profile Issue 1995).

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