NCPA - National Center for Policy Analysis

Why the Individual Income Tax Affects Businesses, Not Just People

January 26, 2015

When many people think of "businesses" they think of "corporations," but the majority of businesses in the United States are not traditional corporations: they're sole proprietorships, limited liability companies, partnerships and S corporations -- also known as "pass-through" businesses, because their income "passes through" to their owners and is taxed at the individual level, not the corporate level.

A new report from economist Kyle Pomerleau of the Tax Foundation details how these businesses work. Tax rates on pass-through businesses are the same as on individuals: for single filers, the first $9,075 of income is taxed at 10 percent, rising to a 39.6 percent tax rate on income over $406,750. Additionally, these businesses are subject to other taxes, including self-employment taxes and state and local income taxes.

According to Pomerleau, on average, the top marginal income tax rate on sole proprietorships and partnerships is 47.2 percent, while shareholders of S corporations pay average top rates between 44.5 percent and 48.3 percent. In New York and California, pass-through business tax rates top 50 percent.

Because traditional corporations face two levels of taxation (the entity is taxed on its income, then its shareholders are taxed when profits are distributed as dividends or when they realize capital gains), traditional corporations ultimately face a total tax rate of 56.5 percent, compared to the 47.2 percent partnership tax rate.

Remarkably, 94 percent of all American businesses are pass-through entities, not traditional corporations. They employ 55.2 percent of the private sector workforce and pay wages and salaries of more than $1.6 trillion. This is highly significant, because raising or lowering the individual income tax will have profound consequences for businesses -- it's not just individuals who are paying the individual income tax, but businesses that employ nearly 66 million workers.

Source: Kyle Pomerleau, "An Overview of Pass-through Businesses in the United States," Tax Foundation, January 21, 2015.


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