How Corporations Are Taxed
August 31, 2015
The U.S. has the highest corporate tax rate of the developed world. The reason is corporations are an easy target for raising revenue, thus, corporate income tax stands at about 14% of total federal tax revenue. Moreover, tax liability is determined by the legal form of a business, clearly indicating that tax reform is urgently needed, according to James Angelini and David Tuerck of Beacon Hill Institute.
S-Corporations, partnerships and trusts pass their income through to their owners, on the other hand, C-Corporations (with publicly traded stock) are subject to double taxation: the entity pays tax on its earnings and shareholders pay taxes on the dividends they receive.
The highest corporate income bracket pays a 35% statutory tax rate, along with the state or local tax rate it adds up to 39%. Because of the various legal forms to minimize the tax burden, effective tax rates range from about 13% to 28%, but still among the highest in the world.
Furthermore, the U.S. taxes corporations on their worldwide income when it's repatriated to the United States (at a 35% rate). Therefore, many corporation opt to keep those funds in their foreign subsidiaries, they also use other strategies for tax avoidance:
- Inversion allows a corporation to relocate its headquarters to a foreign domicile with lower taxes.
- Debt financing is used by large and small corporations instead of equity financing because interest payments are tax deductible.
- Compensation to employees in the form of salary instead of dividends because wages are a deductible expense.
It becomes evident that the double taxation of corporate profits affects the well-functioning of a healthy economy and its elimination has been gaining ground.
Source: James P. Angelini and David G. Tuerck, "How Corporations Are Taxed," Beacon Hill Institute/National Center for Policy Analysis, August 2015.
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