Taxes

Taxing Businesses: Lowest Marginal Rate

Part 3 of a series about Taxing Businesses

Combining the different scenarios from the previous two posts in the series, I highlighted the lowest marginal rate available to US businesses (one version with pass-though business income taxed as earned income the second taxed as unearned income). These graphs, showing how different business structures are taxed a different top rate and that the business structure that offered the lowest marginal rate has changed over a 99-years.


Lowest Marginal Rate: Earned Income Scenario

  • After 1970, pass-through businesses taxed as earned income via the individual tax code offered the lowest marginal rate.
  • 1935-1939; 1952-1970 the lowest option was the effective top rate on C corporate profits & capital gains. 
  • Before 1935; 1940-1951 the lowest option was the effective top rate on C corporate profits & dividends. 

Lowest Marginal Rate: Unearned Income Scenario

  • After 1981, pass-through businesses taxed as earned income via the individual tax code offered the lowest marginal rate.
  • 1935-1939; 1952-1981 the lowest option was the effective top rate on C corporate profits & capital gains. 
  • Before 1935; 1940-1951 the lowest option was the effective top rate on C corporate profits & dividends.

Data Notes available in Part 1 and Part 2 in the series



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Taxing Businesses: C corporations

Part Two of a series about Taxing Businesses

A C corporation is subject to the corporate income tax. While the income from business structures like S corporations, partnerships, LLC's and sole proprietorships are taxed under the individual income tax and therefore not subject to the corporate tax code.  

However, when owners want to extract income from a C corp, they are subject to a second level of taxation, either though taxes on dividends payments or through a capital gains tax on the sale of their share of the business.


Double Taxation: Scenario I

A C corp first pays taxes on their profits through the corporate tax code then distribute dividends to their owners. These dividends are taxed through the owner's individual income tax. 


Double Taxation: Scenario II

C corporation pays taxes on their profits through the corporate tax code then owners pay tax on capital gains from sale of their stock shares (or the business itself)

 

 


Double Taxation: Scenario I and II

A comparison of the two options available to corporate owners to extract income from the corporation (dividends payments vs through sale of shares). During 1950s, 1960s, 1970s and parts of the 30s, 80s, and 90s, the tax code favored the owners who paid taxes on long-term capital gains. Since 2002, the effective rate for these two options mirrored each other.



 To support this project or other future projects  make a monthly Patreon contribution .  Or make  a one time donation here .

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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 

 

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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

10/3/2017 Fixed y-axis label to read % of GDP

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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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