Office of Tax Analysis

Working Paper 104

October 2015

Business in the United States:

Who Owns It and How Much Tax Do They Pay?

Michael Cooper, John McClelland, James Pearce, Richard Prisinzano, 

Joseph Sullivan, Danny Yagan, Owen Zidar, and Eric Zwick

The OTA Working Papers Series presents original research by the staff of the Office of Tax 

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informing and improving the quality of the analysis conducted by the Office. The papers are 

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Business in the United States:

Who Owns it and How Much Tax Do They Pay?∗

Michael Cooper, US Treasury Department

John McClelland, US Treasury Department

James Pearce, US Treasury Department

Richard Prisinzano, US Treasury Department

Joseph Sullivan, US Treasury Department

Danny Yagan, UC Berkeley and NBER

Owen Zidar, Chicago Booth and NBER

Eric Zwick, Chicago Booth and NBER

October 2015

Abstract

“Pass-through” businesses like partnerships and S-corporations now generate over

half of U.S. business income and account for much of the post-1980 rise in the top1% income share. We use administrative tax data from 2011 to identify pass-through

business owners and estimate how much tax they pay. We present three findings. (1)

Relative to traditional business income, pass-through business income is substantially

more concentrated among high-earners. (2) Partnership ownership is opaque: 20%

of the income goes to unclassifiable partners, and 15% of the income is earned in

circularly owned partnerships. (3) The average federal income tax rate on U.S. passthrough business income is 19%—much lower than the average rate on traditional

corporations. If pass-through activity had remained at 1980’s low level, strong but

straightforward assumptions imply that the 2011 average U.S. tax rate on total U.S.

business income would have been 28% rather than 24%, and tax revenue would have

been approximately $100 billion higher.

∗This work does not necessarily reflect the views of the U.S. Treasury Department. We thank Alan

Auerbach, Curtis Carlson, Martin Feldstein, Austan Goolsbee, Marty Harris, Jim Hines, Joe Koshansky,

Adam Looney, James Mackie, Larry May, Janet McCubbin, Susie Nelson, Jim Poterba, Emmanuel Saez,

Nina Shumofsky, Larry Summers, Alan Viard, George Yin, and Gabriel Zucman, as well as participants

in the National Tax Association Spring Symposium and the Statistics of Income Consultants Panel for

helpful conversations on this topic. We thank Jessica Henderson and Prab Upadrashta for excellent research

assistance. Yagan gratefully acknowledges financial support from the University of California at Berkeley’s

Burch Center for Tax Policy and Public Finance. Zidar gratefully acknowledges support from the Kathryn

and Grant Swick Faculty Research Fund and the University of Chicago Booth School of Business. Zwick

gratefully acknowledges financial support from the Neubauer Family Foundation, the Polsky Center, and the

Hultquist Faculty Research Endowment at the University of Chicago Booth School of Business.

1
The structure of business activity used to be relatively simple, with C-corporations—

traditional corporations subject to the corporate income tax—earning the vast majority of

business income. This is no longer the case. C-corporations now account for less than half

of business income, with “pass-throughs”—businesses whose annual income is taxed at the

owner -level—growing rapidly in importance (Slemrod, 1996; Carroll and Joulfaian, 1997;

Gordon and Slemrod, 2000; Yagan, 2015). Figure 1 shows this dramatic transformation:

54.2% of U.S. business income in 2011 was earned in the pass-through sectors, compared to

only 20.7% in 1980.1

The rise of pass-throughs accounts for much of the rise in income inequality over the last

three decades. Figure 2 uses Piketty and Saez (2003) data (updated through 2013) to plot

two series: the actual share of Form 1040 household income accruing to the top-1% highestincome tax-filing over the last century and the hypothetical share holding pass-through

income fixed at the 1980 level. As is well-known, the top-1% income share doubled (from

10.0% to 20.1%) between 1980 and 2013. Less well-known is that 41% of that increase came

in the form of higher pass-through business income.2

Despite this profound change in the organization of U.S. business activity, we lack clean,

clear facts about the consequences of this change for the distribution and taxation of business

income. This problem is especially severe for partnerships, which constitute the largest, most

opaque, and fastest growing type of pass-through. This paper uses rich administrative data

to identify U.S. business owners and estimate how much tax they pay, with special emphasis

on the partnership sector.

We begin by documenting who owns partnerships and S-corporations, as compared to Ccorporate and sole proprietorship ownership. Partnership ownership is particularly murky:

partnerships can be owned by other partnerships which in turn can be owned by other

partnerships. Partnership owners can also be foreigners, corporations, tax-exempt entities,

and trusts, and partnership income and deductions need not be allocated pro rata to owners.

We address these complications by systematically linking tax-year-2011 partnerships to their

1Pearce (2014) obtains a similar figure for pass-through income as a share of total business income after

accounting for double-counting of partnership income paid to partnership and corporate partners, homogenizing income definitions, and including the other two major pass-through forms (regulated investment

companies and real estate investment trusts) in the computation.

2Saez (2004) presents an earlier decomposition that emphasized the role of rising salary income through

the 1990s which subsequently decelerated. Note that pass-through income reported on 1040 returns is

pre-annual-income-taxes while C-corporate income reported on 1040 returns (i.e., dividends and capital

gains) is post-annual-income-taxes (i.e., the corporate income tax). However, the 1980-2013 rise in top-1%

income shares could have been just as large if pass-through businesses had been organized as C-corporations.

The reason is that owner-managers of C-corporations seeking to avoid payout taxes may report profits as

managerial salary income, which escapes the corporate income tax just like pass-through profits. See Saez

(2014) for evidence that top-earners’ charitable contributions (a type of expenditure) have risen in lock-step

with their rising income shares, consistent with a large real rise in top income shares.

2
owners using Form 1065 K-1 information returns in U.S. tax data, following money through

partnership tiers, and accounting for detailed allocations of various income and deduction

streams to each owner.

We find that pass-through participation and pass-through income are especially concentrated among high-earners. Relative to households in the bottom half of the income

distribution, households in the top-1% of the income distribution are over fifty times as

likely to receive positive partnership income. And the average top-1% household earns over

six-hundred times the amount of partnership income as the average household in the bottom

half. Overall, 69% of pass-through income earned by individuals accrues to the top-1%. Scorporate income is similarly concentrated, but other business income (typically considered

very concentrated) is substantially less concentrated. For instance, only 45% of C-corporate

income (as proxied by dividends) accrues to the top-1%, and top-1% households are only

eight times as likely to receive C-corporate income as households in the bottom half. Furthermore, the majority of partnership income earned by the top-1% derives from partnerships

in finance and professional services. As shown below, income earned by finance partnerships

is on average taxed at preferred rates.

Partnership ownership is not only concentrated, but also opaque. First, twenty percent

of partnership income is earned by partners that we have not been able to classify in administrative data.3 Second, following money through partnership structures—between the

partnership generating the income and the ultimate owners taxed on that income—proves

challenging as well. We develop an algorithm that recursively traces income through partnership structures to ultimate non-partnership owners and attempts to assign that income

back to an originating partnership. This recursive algorithm reaches a fixed point before

all partnership income has been successfully assigned: fifteen percent of income is in circular structures and cannot be uniquely linked to an originating partnership. Together, the

union of income flowing (1) to unclassifiable partners and (2) through circular partnerships

amounts to $200 billion or thirty percent of income earned in the partnership sector overall.4

In the second part of the paper, we estimate the overall average tax rate on business

income. We define the average tax rate in a sector as the difference between the actual U.S.

tax bill and a hypothetical U.S. tax bill that would prevail if all sector income were set to

zero—divided by total sector U.S. income. For our baseline measure, we follow the definition

of U.S. business income used for corporate taxation, so it excludes interest payments and

unrepatriated foreign income. For the partnership sector as an example, this rate answers

3Unclassifiable partners are those for which processed information returns do not report the type of entity

associated with a particular taxpayer identification number.

4We use the available information to approximate taxes paid on this income. Section 3.1.1 describes how

we treat unclassifiable income and appendix A describes how we treat circular partnerships.

3
the simple question: holding all other income in the economy constant, how many extra

dollars of tax are owed per dollar of partnership income?

We estimate that the average income tax rate on income earned in the partnership sector

in 2011 was 15.9%. Extending our tax rate definition to other sectors, we estimate the

average tax rate in 2011 in the C-corporate sector to have been 31.6%, in the S-corporate

sector to have been 24.9%, and in the sole proprietorship sector to have been 13.6%. Hence,

partnership income is taxed at the lowest income tax rate in the major formal business sectors

(i.e., non-sole-proprietorships). Weighted by 2011 sector income shares, these estimates

imply an average tax rate on U.S. business income of 24.3%. We believe this estimate to be

the most comprehensive estimate available of the average tax rate on U.S. business income.

Why are partnerships taxed at a relatively low rate, even though they are owned mainly

by high-income Americans who face high statutory ordinary income tax rates? Three mechanisms push the average partnership rate below owners’ statutory ordinary income tax rates.

First, capital gains and dividend income, which are taxed at preferred rates, amount to 45%

of partnership income. This fact is especially clear in our partnership tax rate estimates by

industry, with finance and real estate subject to an average rate of only 14.7%. Second, tax

exempt and foreign entities earn roughly fifteen percent of partnership income and pay tax

rates below 5%. Third, unidentifiable entities and circular partnerships pay an estimated

tax rate (10.6%) that is one-third lower than the average tax rate on partnership income

overall. The relative flexibility in the allocation of income and deductions among partners

can also combine to make the average tax burden on partnerships relatively low.

These tax rates reflect taxes paid to the U.S. Treasury on U.S. business income accruing

to equity owners. To estimate an all-in tax rate on U.S. business income, we combine the

above figures with total foreign tax credits and estimates of total taxes paid on business

interest payments. These additional considerations give rise to an all-in tax rate on U.S.

business income of 23%.

In the final part of the paper, we conduct a counterfactual exercise that asks: how much

higher might the average tax rate on U.S. business income in 2011 have been were it earned

in the traditional C-corporation and sole proprietorship sectors, as in 1980? Specifically and

for each pass-through sector, we reallocate 2011 pass-through income and deductions pro rata

to the C-corporate and sole proprietorship sectors in order to match the 1980 distribution

of sector income shares. We estimate that if 2011 business income had instead been earned

along 1980 sector income shares, the average tax rate on U.S. business income would have

been 28.0%. Total business income in 2011 was $2.6 trillion in income, so an additional 3.8

percentage points would have generated an additional $100 billion in tax revenue.

This work connects to a long literature on U.S. business taxation and economic activity.

4
First, Auerbach (1983), Auerbach and Poterba (1987), and Altshuler et al. (2009) describe

trends in business tax revenue and explore the relative importance of policy and corporate

profits (Feldstein and Summers, 1977) in explaining these trends. We quantify the role

of the rise of pass-throughs in explaining this decline, under strong but straightforward

assumptions.

Second and going back to Harberger (1962), economists have emphasized implications

of heterogeneous business tax rates across sectors (Gordon, Hines and Summers, 1987).

We estimate large differences in average tax rates across sectors, implying potentially large

inefficiency in the U.S. business tax code under the standard assumptions of Gravelle and

Kotlikoff (1989). However, recent evidence from Zwick and Mahon (2014) suggests that

investment at small firms is much more responsive to taxes than investment at large firms,

suggesting some efficiency gain from tilting the business tax burden toward larger firms which

are mostly C-corporations.

Third, recent evidence indicates that business owners bear a substantial share of burden

of business taxation, rather than it being passed on to workers or other capital owners

(Su ́arez-Serrato and Zidar, 2014). We show that pass-through business income accrues much

more disproportionately to high-earners than C-corporate income, suggesting that the rise

of pass-throughs has significantly lowered the business tax burden for high-earners.

Finally, hundreds of economic models require an assumption on the U.S. federal tax rate

paid on U.S. business income. Authors frequently use top statutory rates on C-corporate

income: 35% (considering only annual corporate taxes) or 45% (considering dividend and

capital gains taxation as well). We estimate that this substantially overstates the average

tax rate paid on U.S. business income.

The remainder of this paper is organized as follows. Section 1 details how we match

business income to ultimate taxable owners. Section 2 presents descriptive statistics on who

owns pass-throughs, benchmarked to owners of other business sectors. Section 3 introduces

our average tax rate concept and how we apply it to the matched business-owner data.

Section 4 presents estimates of the average tax rates on business income and conducts the

counterfactual exercise. Section 5 concludes.

1 Data on Businesses and Their Owners

In this section, we detail our data sources. For the analysis of partnerships, we construct

matched firm-owner data, which is crucial for computing industry-level partnership statistics. For the analysis of S-corporations, we use owner-level data. For the analysis of sole

proprietorships, we use data that is by default matched firm-owner data. C-corporations

5
and their owners cannot be comprehensively matched; instead, we use data from annual

C-corporate income tax forms for analyses of the average tax rate and data on household

dividend income as an imperfect proxy for analyses of C-corporate ownership (see caveats

below).

1.1 Matched Partnership-Partner Data

Partnerships are flow-through entities that pay no entity-level tax; instead, partnership income is taxed at the partner-level. Our analysis of partnership tax rates therefore requires

matched partnership-partner data. We first describe data sources used by previous analyses of partnership activity, income, and taxes. We then detail our algorithm for matching

partnerships and partners and constructing our analysis sample covering year 2011, paying

particular attention to partnership tiers (partnerships owned by other partnerships). We

then assess the success of our match algorithm.

Most earlier work on partnerships has used one of two data sources. A first set of

papers relies on partnership-level information derived from the Internal Revenue Service

(IRS) Statistics of Income division’s (SOI) Partnership Study file. Every year, SOI randomly

samples partnership income tax returns (Form 1065), edits numerous variables for accuracy

and consistency, and uses them to publish aggregate statistics. These annual samples contain

no information on the entity’s partners and the taxes those partners may pay. Earlier authors

with access to tax data have used the Partnership Study microdata to analyze partnership

activities and organization (e.g., DeBacker and Prisinzano (2015)). A second set of papers

relies on a subset of partners, individuals who report partnership income on Form 1040

Schedule E, derived from SOI’s Individual and Sole Proprietorship file. Notably, Knittel

and Nelson (2011) link individual partners to their partnerships. We extend this work using

comprehensive data on on all partnerships and all partners.

We link partnerships to partners by merging partnership-level Form 1065 returns (hereafter referred to as “1065s”) to partner -level Form 1065 Schedule K-1 returns (hereafter

“K-1s”) by the unique identifier called the Document Locator Number (DLN). When a partnership files its return of partnership income on Form 1065, it is mandated to include in the

same aggregate filing exactly one Form 1065 Schedule K-1 for each of its partners. Similar

to other information returns filed with the IRS by an entity on behalf of a taxpayer (e.g.,

an individual’s Form W-2 filed by her employer), each partner’s K-1 details the amount of

the partnership’s income, deductions, and credits that the partnership is allocating to the

partner. Every dollar of a partnership’s income and deductions is required by law to be

allocated to exactly one partner; hence, the sum of each category across a partnership’s K-1s

6
is mandated to match the corresponding aggregate category listed on the Form 1065.

When a partnership’s aggregate filing is received by the IRS, the IRS assigns it a unique

DLN. Subsequent IRS data processing divides 1065 fields into one database and K-1 fields

into another database, but all retain the same unique DLN. We access unedited data for

2011 for 25,466,066 K-1s and 3,620,924 1065s in the U.S. Treasury’s population tax files,

which represent the near-universe of these returns. We merge these 1065s and K-1s by

merging on DLN and remove K-1s without DLNs and outlier K-1s with amounts exceeding

$1 billion in any K-1 field, yielding our partnership analysis sample. Using population-level

files allows us to analyze the distribution of partnership income across fine income bins and

to comprehensively trace partnership income across partnership ownership tiers.

Partnerships can be owned by individuals, other partnerships, and other types of entities. But partnership income and deductions can never remain in the partnership sector:

since partnerships cannot retain income, every dollar must eventually be distributed to nonpartnership “ultimate” owners. Where possible, we follow income flows through ownership

tiers to ultimate owners along the lines of earlier methods (May, 2012). This exercise allows

us to make statements about the tax rate for particular solved partnerships or for specific

industries within the partnership sector. We refer to partnerships or groups of partnerships

in which all income can be traced to ultimate owners as “solved” partnerships. However,

there are some circular ownership chains, and they are quantitatively important: 14.9% of

income flowing to ultimate owners is associated with circular partnerships. We further describe these circular partnerships in section 4, which presents our tax rate estimates, and in

appendix A, which provides more detail on our aggregation algorithm.

Finally, we match individual partners to the universe of unedited 2011 Form 1040 returns

by linking partners’ masked social security numbers to the masked social security number

of either the primary 1040 filer or the secondary 1040 filer. For the analysis of ownership

across the household income distribution in section 2.2, we top code individual K-1 records

when the absolute value of total partnership income exceeds 100 times the absolute value

of adjusted gross income (AGI) as a simple ad hoc way to account for likely erroneous

or unrepresentative outliers. For these records, we set partnership income equal to 100 ×

sign(partnership income) × |AGI|.

We successfully match 97.7% of 1065s to at least one K-1 by DLN. We believe that match

rates are below 100% because of some combination of DLN manual entry error, taxpayer

non-compliance (the partnership failing to issue K-1s), and potential isolated errors in data

processing. Many partnerships’ K-1 income fields do not sum to the partnership’s total for

those income fields as reported on the partnership’s tax return. However in aggregate, the

matched K-1s allocate to partners the vast majority of partnership income. For example,

7
the sum of ordinary business income across the K-1s equals 98.2% of aggregate ordinary

business income of the 1065s as computed from the 2011 SOI Partnership Study File; for

long-term capital gains, the figure is 98.7%.

We use the following variables, organized here by form.

Form 1065. Industry equals the principal business activity (NAICS) code reported in

Box A.

Form 1065 Schedule K-1. Total partnership income equals the sum of the K-1 fields

available to us from the unedited K-1 population data, across each partnership’s partners’

K-1s: ordinary business income, net rental real estate income, other net rental income,

guaranteed payments, interest income, ordinary dividends, royalties, net short-term capital

gain, and net long-term capital gain, less Section 179 expenses. We lack all other fields, most

notably other deductions and foreign tax credits.

Form 1040. The adjusted gross income (AGI) equals the adjusted gross income on the

individual partner’s Form 1040 filing; it equals zero for non-filing individual partners.

Various business income forms. Partner type equals “Individual” if the K-1 indicates

that the partner is an individual. If not, partner type equals the type of business income

tax return to which we match the partner’s masked taxpayer identificaton number (TIN).5

Partner type equals “Unidentified TIN type” if the partner is neither an individual nor was

matched to a business income tax return; it equals “Unidentified EIN” if the IRS database

classifies the taxpayer identifier as an employer identification number (EIN) but we are unable to match this EIN to a business income tax return. When we refer to partner types

below, we use these groupings:

Partner Type Form Filed

Individual 1040

C- and other corporations 1120, 1120j ∀ j ∈ {F,PC,L,RIC,REIT,H,C,POL,ND,SF,FSC}

S-corporations 1120S

Tax-exempt 990, 990j ∀ j ∈ {T,R,PF,ZR,C}

Estate/trust 1041

Foreign person/entity 1042, 1042S, 8805, 8288A

Partnerships 1065, 1065B, 1066

Unidentified EIN Taxpayer identifier classifiable as EIN, but tax form unknown

Unidentified TIN type Taxpayer identifier not classifiable

5We match non-individual partners to the universe of twenty types of business income tax returns from

complete years available in Treasury’s population business income tax return files (1996-2013). In the few

cases when a single partner matches to multiple business return types, we break such ties by proximity of

the matched business income tax return to 2011.

8
1.2 Matched S-corporation-owner Data

Our approach to matching S-corporations to owners is similar to the one followed above

for matching partnerships to partners. Like partnerships, S-corporations are flow-through

entities that generally pay no entity-level tax; instead, S-corporation income is taxed at the

owner-level. However unlike partnerships, S-corporations are owned only by individuals, so

there is no issue of ownership tiers or other complicated structures, which simplifies the

analysis. Therefore we use the data on the near-universe of 2011 Form 1120S Schedule K-1s

(analogous to the Form 1065 Schedule K-1s with similar fields available as detailed above)

from Treasury’s population tax files and match to the owner’s Form 1040.6

1.3 Sole Proprietorship Data

Sole proprietorships are unincorporated business entities owned by individual taxpapers, and

their income is reported on Form 1040 Schedule C. Thus the distinction between entity-level

and owner-level taxation is moot for sole proprietorships, and sole proprietorships are by

default linked to their owners on 1040’s. For the analysis of sole proprietorship tax rates, we

use the SOI Individual and Sole Proprietorship sample file (see section 1.1 for a description

of SOI study files). For the analysis of the distribution of business ownership and income,

we use information on the near-universe of 2011 1040’s in Treasury’s population tax files.

1.4 C-corporation Data

C-corporation income is taxed at both the entity level and at the owner level: annual income

is taxable at the entity level, and net-of-annual-income-tax earnings are taxable at the owner

level when distributed as a dividend or realized as a capital gain. For the analysis of Ccorporation tax rates, we proceed in two steps. First, we use the near-universe of 2011

Form 1120 returns from Treasury’s population tax files to estimate tax rates on annual

C-corporate income. We then use estimates from the literature as assumed tax rates on

C-corporate distributions. For the analysis of the distribution of business ownership by and

income to individuals, we use (as an imperfect proxy for C-corporate ownership) dividend

income as reported on the near-universe of Form 1040’s in Treasury’s population tax files.7

6Prior work matching S-corporations to their owners includes Bull, Fisher and Nelson (2009) which linked

the SOI 2005 sample of S-corporations to their owners via K-1s.

7This is an imperfect proxy for C-corporate ownership and income by individual tax-filing units because

some C-corporation income is distributed to shareholders as capital gains, because many C-corporations do

not distribute income at all in a given tax year, and because some non-C-corporation income is included in

the dividends Form 1040 field. We do not analyze capital gains because many capital gains do not derive

from C-corporation ownership; dividend income and capital gains exhibit similar ownership patterns. We

9
2 Who Owns Businesses in the Pass-through Sector?

We now use the data detailed in the previous section to describe pass-through (partnership and S-corporation) owners. We first focus on partnerships, documenting the share of

partnership owners (“partners”) that are individuals, C-corporations, S-corporations, and

other partners and also the share of partnership income allocated to these partner types.

We then document the distribution of partnership, S-corporation, sole proprietorship, and

C-corporation income earned across the individual income distribution.

2.1 Partner and Income Shares Across Types and Industries

Figure 3 divides the 25.3 million partner K-1s in the distribution analysis sample into one

of seven partner types: individuals, C- and other corporations, S-corporations, estates and

trusts, tax-exempt organizations, foreign entities, partnerships, and those partners whose

type could not be identified. A large majority of partners (73.9%) are individuals. The

second largest identifiable category is partnerships (5.6%). Another 5.0% are estates or

trusts. Another 2.9% are corporations, with slightly more S-corporate partners than Ccorporate partners. The remainder is divided among the other partner types.

Note that even with administrative data, it is not possible to identify all of the partners.

For 9.5% of partners, we are not able to find a tax return associated with the partner’s

taxpayer identification number. For the majority of these unidentified partners, we cannot

assign an entity type; however, we suspect that most of this income is paid to corporations

(see section 3 below for more detail).

Figure 3 displays a substantially different division of partnership income across partner

types. Though individual partners constitute 73.9% of partners, they receive only 31.5% of

partnership income. Corporate partners on the other hand are allocated a much larger share

of partnership income (7.7% for C- and other corporations and 3.4% for S corporations) than

the share of partners that they constitute (2.9%).

Three additional points are worth noting. First, partnerships themselves receive 26.3%

of partnership income allocations. Thus, any analysis of partnership activity must address

the issue of ownership tiers. Second, a disproportionate share of income accrues to taxexempt and lightly taxed entities (10.9% to tax-exempt and foreign partners). Note that

unlike C-corporate income, which is taxed at the entity level, partnership income earned

include both qualified and unqualified dividends. Unqualified dividends includes dividends from domestic

C-corporations in certain circumstances as well as dividend income paid by foreign corporations, dividend

income earned by pass-throughs, and money market interest. Note that the inclusion of money market

interest likely raises participation rates and income shares outside the top of the income distribution relative

to excluding it.

10
by tax-exempt entities may not be taxed at all. Third, 14.8% of income (including income

paid to other partnerships) accrues to entities that we cannot classify. This fact introduces

a challenge for the estimation of tax rates on partnership income.

Figure 4 shows the distribution of partnership income across partnership industries. The

partnership used to be a niche business form, only of use to groups of people who worked

together and shared general liability. Traditional partnerships, such as law and accounting firms and doctors’ offices, are still present and account for as much as 14.9% of total

partnership income.8 But they are no longer representative of the median partnership in

dollar-weighted terms; 70.0% of allocated income goes to partnerships in finance or those

that classify themselves as holding companies.9 This is consistent with the evidence in

DeBacker and Prisinzano (2015) showing that partnerships with limited liability are now

the most common form of partnership, and that many entities—which may have organized

as corporations in the past to enjoy limited liability protections—now choose this flexible

pass-through form.

2.2 Business Ownership across the Income Distribution

Figure 5 displays participation rates by business income type across the income distribution of U.S. tax filers.10 To create the graph, we divide all 145 million 1040 filing units

(“households”) from year 2011 into percentiles of adjusted gross income (AGI, including

all returns regardless of whether AGI is positive, negative, or zero). We then compute the

share of tax filing units within each percentile bin that earned positive income from each

of the four business sectors we analyze in this paper: sole proprietorship income (defined

as positive 1040 Schedule C income), C-corporation income (defined as positive 1040 dividend income)11, S-corporation income (defined as either the primary earner or the secondary

earner having been issued a Form 1120S Schedule K-1 with positive summed income), and

partnership income (defined as either the primary earner or secondary earner having been

issued a Form 1065 Schedule K-1 with positive summed income).12 Note that these defini8These partnerships are typically organized as general partnerships, in which all partners are jointly

or separately liable for the debts, taxes, or tortious liability of the partnership. This structure is not

attractive for most business organizations, because the owners’ personal assets are not protected (DeBacker

and Prisinzano, 2015).

9This category also includes real estate and insurance industries, which together account for less than

five percentage points of the total.

10We stress that these results are not based on the Treasury distribution model. We use an adjusted gross

income distribution for filing units only, rather than family-size-adjusted cash income for the population.

11See footnote 7 for the caveat that “C-corporation income” here includes some income that does not

derive from C-corporations and excludes non-dividend C-corporation distributions.

12We use positive income rather than all income in order to avoid negative income shares at the very bottom

and because dividend income is never negative. The relative skewness of top-1% pass-through participation

11
tions consider only direct taxable business ownership and thus, for example, do not reflect

indirect business ownership via pension funds or via tax-deferred retirement accounts.

The figure displays striking patterns of participation rates across the income distribution by business type. First, a relatively constant share of households—between 8% and

15%—participate in a sole proprietorship with relatively isolated exceptions. Second, participation rates in C-corporation income is over eight times higher at 80.4% among the top-1%

(households with over $375,738 in AGI) than in the bottom half of the income distribution.

However, many households at every AGI level own publicly traded dividend-paying stocks;

as a result, participation rates in C-corporation income are substantial (no lower than 7.3%)

in every AGI bin. Third and similar to C-corporate participation, partnership participation

rates are also high among top-1% households (71.3%). But unlike C-corporate participation,

partnership participation rates are trivial among bottom-50% households: partnership participation is over fifty-one times higher in the top-1% than in the bottom half of the income

distribution. S-corporation participation exhibits skewness similar to partnership participation. Hence, pass-through participation is very concentrated among high-income households

relative to these other two traditional forms of business activity.

Figure 6A shows that pass-through income is even more concentrated among high-income

households than pass-through participation and other forms of business income. To construct

this figure, we use the same data underlying the previous graph and, for each type of business

income, plot the share of that type of positive business income earned by households in each

AGI percentile. Thus within each series, the values of the one hundred data points sum to

100%. If a given type of business income were equally distributed across households, the series

would be a flat line at 1%. Instead, each type of business income is highly concentrated among

the economy’s highest-earning households. However, the degree of concentration varies by

business income type. Whereas 16.2% of total sole proprietorship income is earned by the

top-1%, 44.7% of total C-corporation income is earned by the top-1%. Pass-through income

is even more highly concentrated, with the top-1% earning 66.9% of total S-corporation

income and 69.0% of total partnership income.

Figure 6A may make it seem that since the top-1% earn most pass-through income, most

pass-through income earned by individuals is taxed at the top ordinary income tax rate

(35% in 2011). One reason this need not be the case is that a large share of partnership

income is portfolio investment income that is taxed at preferred rates. As a preview of the

comprehensive analysis of the character of business income in Section 3, Figure 6B zooms

in on the previous figure 6A’s partnership income series in order to show the distribution

of partnership income from three partnership industries: accommodation and food service

and income shares hold even when using an absolute-value-income concept.

12
(NAICS 72), professional services like law and accounting (NAICS 54), and finance and

holding companies (NAICS 52, 55, and 531). If all industries were shown, the sum of each

percentile bin’s data points in this figure would equal the bin’s corresponding partnership

series data point in figure 6A.

Figure 6B shows that most of the partnership income accruing to the top-1% accrues

from partnerships engaged in finance and company holding. Of the 69.0% of partnership

income that accrues to top-1% households, 36.6 of those percentage points accrue from

partnerships in the finance and holding company industry and another 16.0 accrue from

partnerships in the professional services industry. In contrast, only 0.6 percentage points

accrue from the accommodation and food service industry, a traditional “mom-and-pop”

industry. Taking into account all AGI percentiles, nearly half (48.7%) of partnership income

earned by individuals accrues from partnerships engaged in finance and company holding—

much of which is portfolio income taxed at preferred rates.13

The following two sections take comprehensive account of different types of income

streams being taxed at different rates across the individual partner, corporate partner, and

other partner income distributions in order to provide estimates of tax rates paid on partnership income in the United States.

3 Methodology for Estimating Average Tax Rates

This section describes how we calculate average tax rates on business income from partnerships, sole proprietorships, S-corporations, and C-corporations. These tax rates are important inputs for estimating the average tax rate on business income in the United States. In

addition, C-corporations themselves, for example, can be partners, so we need to be able to

assign a tax rate to partnership income flowing to C-corporation partners.

3.1 Partnership Income

The average tax rate on partnership income depends on the tax liabilities and incomes of

partners. We calculate tax rates on partnership income at three levels. First, we follow

income flows to partners and assign a tax rate to each payment from a partnership. Second,

we calculate tax rates at the partnership level. Third, we calculate tax rates at the level of

the overall partnership sector.

13These findings are consistent with Kaplan and Rauh (2010), who show that partners at top law firms

and Wall Street-related individuals—including hedge fund managers, PE, and VC professionals whose firms

are usually organized as partnerships—earn a large and increasing share of the income at the top of the AGI

distribution.

13
3.1.1 Tax Rates on Income Distributed to Partners

We calculate tax rates for each payment that partners receive from a given partnership.

For these calculations, we use U.S. Treasury’s Office of Tax Analysis (OTA) tax calculators

where possible and directly assign tax rates otherwise. We define a tax rate Tik on income

type i to partner k from all partnerships p,

Tik =

(

T

OTA

ik =

T AXik

Yik

if k files form ∈ {1040, 1120, 1120S}

T

Assigned

ik otherwise

(3.1)

where Yik =

P

p∈P Yikp is the sum of payment of income type i to partner k from all partnerships p in the set of partnerships P, i is an income type in the set I = {dividends, interest,

capital gains, ordinary business income}, and T AXik is the tax liability from the OTA tax

calculator.

For partners who file a tax form for which we have a tax calculator, we recalculate

each partner’s income tax liability in the hypothetical case that they earned no positive (or

negative) income of that income type from all partnerships. For each partner, we consider

income without replacement in the following sequence. We first remove capital gains income,

then dividend income, then schedule E income (ordinary business income), and then interest.

The difference between actual tax liabilities and hypothetical tax liabilities is the numerator

of our average tax rate measure. For example, in the case of capital gains income, the

numerator of our average tax rate measure is:

T AXik ≡Tax Liabilityk|Taxable Income = X

i∈I

X

p∈P

Yipk

− Tax Liabilityk|Taxable Income = X

{i

0∈I:i06=i}

X

p∈P

Yi

0pk (3.2)

where i = capital gains.14 The tax consequences of sequentially zeroing out income of type

i for partner k from all partnerships relative to the size of the payment Yik defines our tax

rate Tik. This measure accurately accounts for the tax situation of each partner and the full

complexity of the tax code imbedded in OTA tax calculators.15

For partners who are C-corporations, we assume an average federal payout tax rate (the

14Due to the sequential treatment of income, the income types included in the sum over income types (when

calculating hypothetical income) is not always i

0 6= i. For dividend income, the hypothetical tax liability is

based on the following taxable income: Taxable Income = P

{i

0∈I:i06=capital gains or dividends}

P

p∈P Yi

0pk since

dividend income is considered in the sequence after capital gains income.

15This approach focuses on allocations of income to partners, but there are important tax implications of

allocations of losses and tax credits that can results in different tax rates. We discuss these considerations

in section 3.1.4.

14
tax rate paid by owners on after-corporate-income-tax income) of 8.25% based on earlier

work.16 For partners who file other tax forms, we assign the following tax rates:

T

Assigned

ik =







T

OTA

i,1040 if form ∈ {1120-RIC,1120-REIT,1066,1041}

T

OTA

i,1120 if form ∈ {1120j}∀ j ∈ {F,PC,L,H,C,POL,ND,SF,FSC}

.025 if form ∈ {8805,1042S,8288A,1042}

0 if form ∈ {990,990j}∀ j ∈ {T,R,PF,ZR,C}

.025+T

OTA

i,1120

2

if k has unidentified EIN or tin type

(3.3)

where form is the tax form partner k files, T

OTA

i,1040 is the tax rate for individuals from the

OTA tax calculator for income type i, and T

OTA

i,1120 is the tax rate for C-corporations. The

2.5% rate is set to match the modest revenues from foreign withholding (Luttrell, 2013). We

assign tax-exempt entities which file Form-990-family forms a rate of 0%. While we observe

a substantial amount of income paid to these entities that could be subject to the Unrelated

Business Income Tax, we know from other sources that in fact little is subject to tax and

little tax is paid given that in aggregate about $350 million in tax is paid by tax exempts

on all sources of their business income (Jackson, 2014). Finally, we set the tax rate for

unidentified entities to the midpoint of two tax rates: the tax rate for C-corporations and

the tax rate for foreign entities. Reconciliations at the end of schedule K on the 1065 in SOI

data suggest that more partnership income is passed to corporate partners than we identify

based on traceable entities. However, the income composition earned by untraceable entities

more closely resembles the income composition of foreign entities. We use the average of

C-corporations and foreign entities to account for both considerations.17 We quantify the

implications of this approach for the average tax rate on partnership income in section 4.2.

16To obtain an average tax rate on C-corporation payouts to shareholders, we make three assumptions.

First, shareholders receive 50% of after-corporate-income-tax income as dividends and the other 50% as

accrued capital gains. Second, the average dividend tax rate is 13.2% (=18.5%—the state-plus-federal

estimate from Poterba (2004) for 2003—minus 5.3%—the OECD’s average state dividend tax estimate).

Third, the accrued capital gains tax rate equals the average dividend tax rate (since the top federal longterm capital gains tax rate equaled the top federal dividend tax rate in 2011) divided by 4 (to account for

tax benefits from deferring realizations). These assumptions yield an average payout tax rate of 50% ×.132+

50% × .132 ×

1

4 = .0825 and thus an average C-corporate partner tax rate of Tik + (1 − Tik) × .0825 where

Tik is the tax rate from the OTA tax calculator for the first layer of income. This methodology follows work

going back to Bailey (1969) and employed recently in Desai and Goolsbee (2004) and Yagan (2015).

17We used subsidiary information from form 851 to determine that the vast majority of untraceable income

is not associated with income from subsidiaries. See section 4.2 for more information on income composition.

15
3.1.2 Tax Rates on Partnerships

For a given partnership,18 we use these tax rates Tikp to construct a partnership tax rate:

Tp =

P

i∈I

P

k∈K TikYikp

Yp



(3.4)

where the numerator P

i∈I

P

k∈K TikYikp is the sum of tax liabilities over income types i

and partners k associated with payments from partnership p and the denominator Yp = P

i∈I

P

k∈K Yikp is the total payments from partnership p. Consider the following example.

Suppose partnership A has two partners, 1 and 2. Suppose further that partner 1 receives

both ordinary income and capital gains and partner 2 only receives ordinary income. The

tax rate TA for partnership A is:

TA =



Tordinc,1Yordinc,1,A

YA



+



Tcapgains,1Ycapgains,1,A

YA



+



Tordinc,2Yordinc,2,A

YA



. (3.5)

This example shows that the distribution across income types for each partner and the

distribution across partners are key determinants of tax rates on partnership income.

3.1.3 Tax Rates on Partnership Sector

Finally, we construct a tax rate for the partnership sector:

T =

P

i∈I

P

k∈K

P

p∈P TikYikp

Y



(3.6)

where the numerator is the sum of tax liabilities from payments from partnerships and the

denominator Y =

P

i∈I

P

k∈K

P

p∈P Yikp is the total payments from all partnerships.

3.1.4 Discussion of Assumptions

We could have calculated the tax rate as the ‘last dollar’ average rate, the ‘first dollar’

average rate, or the ‘first dollar of business income rate.’ In evaluating policy changes

(including revenue estimating settings), the ‘last dollar’ rate is often the most appropriate

measure. If one is considering an individual’s decision whether to participate in a partnership

18See appendix A for a discussion of how we calculate tax rates for tiered partnerships for analysis at the

partnership level.

16
the ‘first dollar of business income’ may be preferable. Our measure has the advantage of

being straightforward to calculate and provides a reasonable way to calculate both the total

tax paid for a particular partnership and the average tax rate on the income flows of the

partnership sector overall.

In addition, it is possible that partnerships distribute different types of payments differently. For instance, gains and losses or tax deductions need not be symmetrically allocated to

partners. Different assumptions about asymmetries in distributions could result in different

tax rates.19 In addition, we do not model passive loss limits for individuals.

Furthermore, we focus only on income taxes. A portion of partnership income may be

subject to SECA tax but we do not observe self-employment income on the partner’s K-1 and

the Schedule SE may include income from partnerships, sole proprietorships and other forms

To the extent SECA tax is due on partnership income, a SECA deduction for the partner

will be generated which ideally we would zero out along with the partnership income. As a

result the calculated partnership tax rates for some individual partners are slightly misstated.

Finally, we also assume that all dividends are taxed at preferential rates.

3.2 Sole Proprietorship Income

We calculate tax rates on Sole Proprietorship income using SOI’s sample of individual tax

returns. Specifically, we measure the difference between actual taxes paid and hypothetical

taxes paid when we set income from schedule C and SECA deductions to zero using OTA’s

individual tax model.20

3.3 S-Corporation Income

We calculate tax rates on S-corporation income using OTA tax calculators. First, we measure the difference between actual taxes paid and hypothetical taxes paid when we set Scorporation income from Form 1120S Schedule K-1 to zero. Second, we divide this change

in tax liability by total Form 1120S K-1 income to estimate the tax rate on S-corporation

income.

19Assumptions are required because not all fields (especially certain deductions and credits) are included

in our population-level pass-through income data.

20We ignore payroll taxes except for the loss of the SECA deduction, which is listed as an above-the-linededuction as opposed to being claimed on the schedule C.

17
3.4 C-Corporation Income

There are two layers of taxation on C-corporation income. The first layer relates to the

corporate tax. The second layer relates to dividend taxes paid on distributions to the owners.

We divide actual taxes paid by taxable income to determine the average tax rate on the first

layer of taxation on corporate income.21 We use the estimate from Poterba (2004) on the

average tax rate on the dividend income to determine the second layer.22 We then sum the

tax rates on the first and second layers to obtain an estimate of the average tax rate on

C-corporation income.

4 Average Tax Rates on Business Income

We estimate that the average tax rate on business income in 2011 is 24.3%. This rate is an

income-weighted average of business tax rates. In section 4.1, we compare tax rates across

the business forms and industries that contribute to the overall average. In section 4.2, we

investigate and decompose tax rates on partnerships, which are a key determinant of lower

tax rates on business income. In section 4.3, we calculate the importance of the rise of

pass-throughs on the average tax rate on business income. Finally, we calculate the tax rate

on business income including debt in section 4.4.

4.1 Comparison of Tax Rates Across Business Form and Industry

Figure 7 shows the average tax rates by business form. We estimate that the overall tax rate

in 2011 on partnerships was 15.9%. Tax rates on the partnership sector are comparable to

those on the informal sector and are lower than the tax rates on both S-Corporations by 9.1

percentage points and C-corporations by 15.7 percentage points.

Figure 8A shows the average tax rates by type of partner. S-corporations, individuals, and

C- and other corporations face the highest rates at 22.0%, 21.0%, and 20.1%, respectively.

Estates and trusts pay 16.5% on average. For other partner types, we plot the assumed tax

rates as described in section 3.1.1.

To compute tax rates for each partnership, it is necessary in many cases to follow income

through multiple tiers of ownership until it reaches a taxable end point, and then assign

21Note that taxable income for C-corporations is total income reported for U.S. tax purposes, which

includes income from partnerships.

22We use the same approach that we take for C-corporate partners, i.e., as described in footnote 16, we

compute tax rates for C-corporations as τ + (1 − τ ) ×

5

8 × .132 where τ is the tax rate on the first layer of

income. Note that we use 13.2% instead of 18.5% since we focus on the federal rather than the federal plus

state portions of the estimate in Poterba (2004).

18
that income back to an originating partnership. Figure 3B shows that 26.3% of income

flows from partnerships to other partnerships and thus must be followed through. The

algorithm for implementing this procedure is detailed in appendix A. We follow income

from partnership to partnership through the levels of ownership until the algorithm reaches

a fixed point, which allows us to uniquely assign 85.1% of non-partnership income flows to

a distinct partnership. The remaining 14.9% cannot be assigned this way. Because the K-1

reports the income amounts by income type and the partner type, we can still calculate a

tax rate for this unassigned income. For this unassigned income, we calculate a tax rate of

8.8%, considerably lower than the 15.9% overall rate on partnership income.

Figure 9A shows the average tax rates by partnership industry for the partnerships where

we can allocate all income associated with them. Finance and holding company income,

which accounts for 70.0% of partnership income, is taxed at a 14.7% rate on average. This

is the lowest rate among industries with nontrivial amounts of activity. Manufacturing and

mining, oil, and gas follow at 16.6% and 18.5%, respectively. The traditional partnership

industries, professional services at 22.4% and health care at 22.3%, pay the highest rates.

4.2 Decomposing the Tax Rate on Partnership Income

There are three main reasons why the tax rate on partnership income could be relatively

low: (1) partnership income may be distributed via income types with low tax rates, (2)

partnership income may be earned by partners that face low tax rates, and (3) flexible

allocation rules might allow losses to be passed on to partners with high rates and gains to

those with low rates. Related to the third reason is the possibility that tiering and complex

structures allow losses in one partnership to offset gains in another, or that these structures

create circular income flows that we do not observe leaving the partnership sector.

We find support for the first two explanations. Roughly one quarter of partnership income

is earned by taxpayers facing a zero rate. Nearly half of partnership income allocated to

taxable entities accrues in the form of tax preferred capital gains and dividends. We find

mixed evidence that losses are disproportionately allocated to partners with high tax rates.

Complex structures do coincide with relatively low rates but are not large enough to account

for the low overall rate.

Payments via Low Tax Income Types. Figure 8B presents a decomposition of partnership income by income type for each type of partner. The figure illustrates a key reason

why the partnership rate is low: capital gains and dividend income, both typically taxed at

preferred rates, represent 45% of total income that accrues to non-partnership partners.

19
The share of capital gains and dividend income varies by type of partner, with tax exempts

and foreigners primarily receiving capital gains and dividend income while the S-corporation

and individual capital income shares are significantly lower. Note that the income shares for

the unidentified partner types most closely resemble a mix between the foreign entity and

C-corporation income shares. This fact forms the basis of our tax rate assumptions for these

unknown partners.

Figure 9B presents a decomposition of partnership income by income type based on

partnership industry. This figure shows that finance and holding company firms earn nearly

sixty percent of their income as capital gains and dividends, while other industries earn the

bulk of their income as ordinary income.

Partners with Low Tax Rates. The distribution of income types is an important reason

for the low overall partnership rate, but it is not the only reason. For example, while

manufacturing and oil and gas partnerships earn most of their income as ordinary income,

they pay only somewhat higher rates than finance partnerships.

A second reason why the tax rate on partnership income can be low relates to the level of

tax rates faced by partners. Foreign partners, tax exempt partners, or lower-income partners

face low tax rates Tik on any income type that they earn. Payment shares of total partnership

income to foreign partners is 9.3%, tax-exempt partners is 5.5%. Unidentified partner types

earn another 20.1% of partnership income. Were these partners to be taxed at the average

individual tax rate, the average rate on partnership income would rise by approximately 2

percentage points.

Tiering and Flexible Loss Allocation Rules. Tiering and flexible allocation rules are

a third set of reasons why the average tax rate on partnership income could be low relative

to traditional businesses. If multiple partnerships are connected, it may be possible for losses

in one partnership to offset gains in another, such that gains are mainly realized for low tax

rate partners. Partnership income accruing to other partnerships amounts to 26.3% of total

income flows, so there may be wide scope for across-partnership offsetting to occur. Even

among partnerships without partnership partners, losses may be allocated to partners with

high marginal tax rates and gains may be allocated to partners with low marginal tax rates.

In addition to its role in generating low rates, the extent of partnership tiering presents

major challenges from a tax administration perspective. After our recursive algorithm

reaches a fixed point, there remain 22,417 “circular” partnerships for which we cannot

uniquely link all income to non-partnership owners. These partnerships issue 9.6 million

K-1s. To put this activity’s scale in perspective, our entire K-1 population file includes 25.5

20
million K-1s issued by 3.6 million partnerships. Thus, less than 1% of partnerships issue

nearly 40% of K-1s. Some of these partnerships issue more than 100,000 K-1s.

We divide the $671 billion of income reported on K-1s for non-partnership owners based

on whether the K-1s were issued by a solved or circular partnership. $100 billion remains

within the nexus of the 22,417 circular partnerships. Were we to collapse all of these partnerships into one partnership and estimate the tax rate based on the tax paid on income

received by their non-partnership partners, they would pay a rate of 8.8%. This 8.8% tax

rate is roughly half the tax rate paid on the remaining $571 billion, which amounts to 17.1%.

This evidence suggests that tax planning benefits associated with complex structures may

contribute to the low overall rate.

To explore the importance of flexible loss allocation rules, Figure 10 plots the share of

total losses and the share of total gains claimed by the partnerships grouped by partner

tax rates. Losses tend to be allocated disproportionately to partners with tax rates above

30%. However, payments facing relatively high tax rates between 20 and 30% are more

likely to represent gains than losses. Overall, the patterns in partner payment allocation

provide mixed evidence that flexible allocation rules contribute to the low average tax rate

on partnership income.

4.3 Tax Rate on Business Income without Pass-throughs

This section quantifies the importance of the rise of pass-throughs on the average tax rate

on business income.

In 2011, C-corporations earned 45.4% of business income and sole proprietorships earned

12.5%. We allocate pass-through income from partnerships and S-corporations, which amounted

to 25.6% for partnerships and 16.5% for S-corporations, to C-corporations and sole proprietorships in proportion to 1980 income shares.

We find that allocating partnership income to traditional businesses results in an average tax rate on business income of 28.1%, which exceeds the average tax rate on business

income of 24.3% in 2011 by 3.8 percentage points. Since the pass-through sector earned $1.1

trillion in business income in 2011, an additional 3.8 percentage points on the tax rate would

have generated 97 billion more dollars in business tax revenue, which would amount to an

approximately 15.5% increase in tax revenues from business income on an annual basis.23

We stress that this exercise is not a projection for the likely effects on tax revenue from

business tax reform. It is mechanical and assumes no behavioral responses, but has the

23We compute the aggregate pass-through figure of $1.1 trillion by scaling partnership income of $671

billion by the ratio of the total pass-through income share to the partnership income share (equal to (.165 +

.256)/.256). These shares come from figure 1 of DeBacker and Prisinzano (2015).

21
advantage of being transparent.24

4.4 Overall Tax Rate on Business Income including Debt

This section calculates the overall tax rate on business income including interest income. This

overall tax rate τK is an income-weighted average of business income and interest deductions.

τK =



Ye

Ye + Yd



τe +



Yd

Ye + Yd



τd (4.1)

where Ye is business income, Yd is the sum of interest deductions, τe is the tax rate on

business income and τd is the tax rate on interest income.25

Business income Ye = $2.6 trillion in 2011.26 We compute interest income in the business

sector by summing interest deductions claimed on forms 1120, 1120S, and 1065. Summing

these deductions amounts to Yd = $809 billion.

We use the average tax rate on business income from section 4 for τe = 24.3%. We

compute the tax rate on interest income τd by zeroing out interest income and recomputing

tax liabilities using OTA tax calculators (in a similar fashion to the rates underlying τe).

In particular, we calculate τd as the average income tax rate on interest income and

non-qualified dividend income (which is typically interest). For both types of income, we

calculate the tax consequences of zeroing out that income type. We find that removing

interest income reduces tax liabilities by 20.6% of interest income and removing non-qualified

dividend income reduces tax liabilities by 20.1% of non-qualified dividend income. Weighed

by the shares of income, the average income tax rate on interest income τd equals 20.4%.

We weigh these rates to calculate an overall tax rate on business income that includes

debt:

τK =



2.6

2.6 + 0.8



24.3% + 

0.8

2.6 + 0.8



20.4% = .76 × 24.3% + .24 × 20.4% = 23.3%

24Furthermore, it maintains consistency with the rest of this paper by using the same underlying data, at

the cost of those data’s missing fields and top-coding (see section 1 for a discussion of data limitations that

introduce deviations between our aggregates and official aggregates.)

25Note that τK is for the business sector as opposed to the tax rate on capital income. Our measure does

not include housing income.

26This calculation scales partnership income by its share of overall business income, i.e., $671 billion/.256.

22
5 Conclusion

Most U.S. business income is now earned outside the traditional C-corporate and sole proprietorship sectors and is instead earned in the pass-through sectors. This income is taxed

at the owner-level and often at low rates. We used 2011 tax returns to trace pass-through

income in the two major pass-through sectors—the partnership sector and the S-corporate

sector—to their ultimate owners to document who owns U.S. businesses and how much U.S.

tax do those owners pay.

We found that pass-through owners are even more likely to be high-earners than the

owners of other business types including C-corporations. Holding all other sectors’ income

constant, we estimated an average partnership sector tax rate of 15.9%: for ever dollar

earned by a partnership, U.S. tax revenue rose by $0.159. For the S-corporate sector, we

estimated an average tax rate of 25.0%, yielding an average pass-through (partnership-plusS-corporate) tax rate of 19.5%. Combining these rates with our estimated C-corporate rate

(31.6%) and sole proprietorship rate (13.6%), we estimated an overall U.S. federal tax rate on

U.S. taxable business income of 24.3%—much lower than the top statutory personal (35%)

and C-corporate (35% income plus additional payout) rates.

The migration of business activity out of the C-corporate sector and into the pass-through

sector has likely substantially reduced U.S. tax revenue. If 2011 business income had instead

been earned along 1980 sector income shares, we estimated under strong but straightforward

assumptions that the average tax rate on U.S. business income would have been 28%, yielding

an extra $100 billion in tax revenue.

This paper’s analysis can be extended in at least three important directions. First,

business activity varies considerably across sectors; for example, most hedge funds are partnerships. It would therefore be valuable to estimate average tax rates across organizational

form holding business activity constant. Second, firms’ investment and location decisions

depend on worldwide tax rates on worldwide income, which would likely be substantially

smaller than the the U.S. tax rates on U.S. income estimated here. Broadening tax and

income definitions to encompass non-repatriated income (reported on Forms M-3 and 5471)

is an exercise left to future work. Third, inclusion of missing fields (especially certain deductions and credits) in our population-level pass-through income data would permit more

complete tax rate estimates.

Finally, we note that a long-standing rationale for the entity-level corporate income tax is

that it can serve as a backstop to the personal income tax system (e.g., Bank (2010), Zucman

(2014)). Our inability to unambiguously trace 30% of partnership income to either the

ultimate owner or the originating partnership underscores the concern that the current U.S.

23
tax code encourages firms to organize opaquely in partnership form in order to minimize tax

burdens. Historically, policymakers in the 1930s reduced the prevalence of opaque business

structures (“pyramids”) in the traditional corporate sector by instituting the intercorporate

dividend tax (Morck, 2004). Whether policymakers should pursue a similar approach today

remains an open question.

24
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A Appendix

A.1 Calculating Partnership Tax Rates

Our calculation for the tax rate on the overall partnership sector uses equation 3.6 as described in section 3.1.3. That rate is based only upon the tax liabilities of non-partnership

partners on their partnership incomes. Our partnership-level tax rates are consistent with

this overall tax rate and account for tiering of partnerships. These calculations require that

each partner in the partnership, including other partnerships, be assigned a tax rate for

each type of income (schedule E, capital gains, interest, and dividends). An overall tax

rate for a partnership requires weighting these rates using only the income generated by the

partnership after removing any income received from other partnerships. This insures that

double-counting of dollars does not occur and attributes income to the partnership that generated the income as opposed to the partnership that received it. The implicit assumption

in this method is that the tax rate by partners on a specific source of income applies to

both income generated by the partnership and income received from other partnerships. For

example, assume partnership A disburses $100 in capital gains income to its partners, $50

of which is created by partnership A and $50 of which it receives via a K-1 from partnership

B. If the partners of partnership A pay 15% in tax on this $100 of capital gains, we assume

that the 15% rate applies both to the $50 created by partnership A and the $50 it receives

from partnership B.

The process of assigning tax rates for each type of income to each type of partner is

described in the body of the paper for all partners that are not partnerships. We refer to

partnerships where every partner has a tax rate as “solved“ and all other partnerships as

“unsolved.” For partnerships with no partners that are partnerships, solving its four tax

rates is simple. Each partner is either assigned rates for each income type based solely on

its filing form or rates are calculated using a tax calculator for the form type. These simple

partnerships make up 85% of the 3.4 million partnerships in our sample. Unfortunately they

only account for $381 billion of the total $895 billion of partnership income (which includes

income owing to other partnerships). Thus solving the remaining partnerships is critical for

answering questions about the tax burden on individual partnerships.

Once the simple partnerships have been assigned tax rates for each of the four types of

income, we define a procedure for recursively solving tax rates for partnerships that are part

of dependent partnership structures, meaning that they have partners that are partnerships.

If a partnership has only simple partnerships below it, its various tax rates can be assigned

as described above for simple partnerships. As mentioned above, an overall tax rate for

each partnership requires weighting its four rates using only the income generated by the

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partnership after removing any income received from other partnerships to prevent doublecounting dollars. These one-level partnership structures are then used to calculate tax rates

for two-level dependent structures. These structures include partnerships whose partnership

partners are either simple partnerships or one-level partnerships. This recursive process

is repeated on multi-level structures until each partnership is assigned a tax rate. Each

partnerships tax rates can then be weighted by the income it generates to calculate the

overall partnership sector tax rate calculated via equation 3.6.

The algorithm is implemented as a series of merges. The K-1s list taxpayer identification

numbers (TIN) for the payees and we merge the K-1 file back onto itself by joining where

payer TIN equals payee TIN. We use the partnership return’s DLN to identify the partnership

being solved. Where there are multiple DLNs associated with a single payer TIN, we sort

the data set and use the first DLN for that payer TIN.

The first step reduces the number of unsolved partnerships from 503,943 to 187,197 and

the amount of income in unsolved partnerships from $513 billion to $392 billion. Another

step reduces the count to 93,684 and the income to $329 billion. By the fifth step, the

algorithm begins to slow down and we still have 36,338 unsolved partnerships and $247

billion in unsolved income. By step ten, we still have 23,757 unsolved partnerships and

$207 billion in unsolved income. The algorithm reaches a fixed point at step twenty-two,

at which point we have 22,417 unsolved partnerships and $203 billion in unsolved income

(including income owing to other partnerships. These unsolved partnerships issue 9.6 million

(nearly forty percent) of the 25.2 million K-1s in our population file. Collapsing all of these

partnerships into one and calculating the tax rate based on the tax paid on income received

by their non-partnership partners yields that, as a group, they pay a rate of 8.8% on $100

billion on total income.

A.2 Illustrative Example of Circular Structure

To illustrate further why it is not possible to assign rates to individual partnerships in the

unsolved cases, consider the following simple example. In figure A.1, each triangle represents

a partnership; each line represents the direction of a K-1. In this example, partnerships A,

B and C can each be assigned an effective rate. Partnership A has no partners that are also

partnerships. As such, it is straightforward to assign an effective rate to A using our tax rate

calculators. Since partnership A is a partner in partnerships B and C, their effective rates

can only be assigned after A is assigned an effective rate since the rates are dependent upon

the weighted rates of each partner. It is also the case that since partnership B is a partner

in partnership C, the effective rates for B and C must be assigned sequentially.

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In figure A.2, we present a circular relational structure, which would fall in the unsolved

group our algorithm identifies. Partnership D is a partner in partnership E, partnership

E is a partner in partnership F, and partnership F is a partner in D. These partnerships

cannot be assigned an effective rate. In the case of D, it could be assigned a rate if a rate is

assigned to E. However, E’s rate is dependent upon a rate being assigned to F which is in

turn dependent upon a rate for D.

Figure A.1: Tiered and Solved Partnership Example

Figure A.2: Tiered and Unsolved Partnership Example

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