Taxing Businesses: Pass-through businesses

Part one of my series: Taxing Businesses

In my earlier post on the number of returns and net income by business structure, you can see the share of business returns filed by C corporations has dropped 16.6% to 4.9% 1980-2012 with pass-through businesses filing the majority of business returns. However, sole proprietorships, although the majority of pass-through businesses, are less than 10% of net business income.

So, I have created a series of graphs looking at the top tax rates on C corporations vs pass-throughs, focused on the effective top rates for high incomes businesses. Since pass-through businesses don’t pay the corporate income tax, their profits and investments are taxed through the individual tax code as either earned or unearned income.

The different business structures that "pass-through" business income to the individual include: 

  • Partnership's partner
  • S corporation's owner
  • LLC's member
  • Sole Proprietor's individual owner

The effective tax rate on pass-through businesses has drop dramatically since the 1950s. While rate was the same for earned and unearned income except in ‘70s, ‘90s, early ‘00s.


Earned Income

In this scenario of treating the business income as "earned income" that means top individual tax rate combined with the medicare top rate (since the 1990s) when the cap on max income tax by medicare was removed. To help pay for ACA an additional Medicare surcharge was added for high income earners in 2013.


Unearned Income

“Pass-through” business’s profits and investments taxed as unearned income through individual tax code. 

In this scenario of treating the business income as "unearned income" that means taking the top individual tax rate add combine it with the net investment income tax on high income earners. (to help pay for ACA)



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To support this project or other future projects make a monthly Patreon contribution.

Or make a one time donation here.

 
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Average Combined Federal Taxes on a Family of Four

I am graphing the average combined federal taxes on our single earner family of four with three combinations of tax rates: 

  • Income only

  • Income & Payroll (the employee part of social security and medicare)

  • Income & Payroll (both the employer and employee part of social security and medicare)

For comparison, you can see how the top marginal individual income taxes  rates for the highest earners dropped since the 1950s while the social insurance taxes (i.e. the payroll marginal tax rates) increased. 

Keep in mind the Tax Policy Center calculate these rates for:

  •  4 person family including a married couple with one earner

  •  Itemized deductions are assumed to equal 23 percent of income through 1986 and 18 percent of income thereafter

Data: Historical Combined Income and Employee Tax Rates for a Family of Four; Historical Social Security and FICA Tax Rates for a Family of Four 

 

If you wish to support this project on US taxes and get a first look at the graphs as I make them, make a monthly pledge on Patreon.

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Federal Tax Revenue as a percent of GDP

My last set of graphs shows the decline of C corporations since the 1980s while the share of pass-through businesses increased. Pass-through businesses do not pay taxes through the corporate tax code but through individual tax code. Here are the three main sources of federal revenue (% of GDP) and you can see how corporate income tax receipts were greater in the decades between 1940-1980 but with very little change in the individual income tax receipts.

Data is from the Office of Management and Budget, Historical Tables, Table 2.3

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Number of corporations has dropped since the 1980s

Share of business returns filed by C corporations has dropped 16.6% to 4.9% 1980-2012 with sole proprietorships filing the majority of business returns. At the same time, the net income reported by C corporations has dropped since 1980 from 68.0% to 37.1% in 2012.

A simple matrix of business structures and Pass-Through Businesses: Data and Policy provide more information but one thing you need to know is:

The majority of companies in the United States are pass-through businesses. These businesses are not subject to the corporate income tax; instead, their income is reported on their owners’ tax returns and subject to the individual income tax.

Data Source: IRS https://www.irs.gov/uac/soi-tax-stats-integrated-business-data Table 1: Selected financial data on businesses. 

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Marginal Combined Federal Taxes on a Family of Four

I am graphing the marginal combined federal taxes on our single earner family of four with three different combinations of tax rates: 

  1. Income only

  2. Income & Payroll (the employee part of social security and medicare)

  3. Income & Payroll (both the employer and employee part of social security and medicare)

The marginal payroll tax rate for this family was 0 until 1979 when the taxable maximum income subject to the payroll tax was greater than this family's median income.

Keep in mind the Tax Policy Center calculate these rates for:

  •  4 person family including a married couple with one earner
  •  Itemized deductions are assumed to equal 23 percent of income through 1986 and 18 percent of income thereafter

Data: Historical Combined Income and Employee Tax Rates for a Family of Four; Historical Social Security and FICA Tax Rates for a Family of Four 

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