A Populist Political Perspective of the Business Tax Entities Universe

This article discloses that double taxation of small and moderate income private C corporations is mostly a myth. For 37% of C corporations (over 750,000 in 1993) accounting for about 5% of C corporation income are small income annually reporting on the average $40,000 taxable at 15%. In sharp contrast, 80% of the owners of these small income, mostly private C corporations are taxable at the 31% bracket or above; 45%, at the 39.6% bracket before exemption and deduction phase outs and wage taxes (which can push the marginal effective rate to 45%). And there is little or no second tax. Dividends are rarely paid by private C corporations. Moreover, about half of private C stock is held until death and any sales are usually long deferred and taxed at 20% or less capital gains rates. Joint Committee reports that inside sheltering results in a $3 billion a year tax expenditure. Similarly 33,500 mostly private, moderate income C corporations accounting for 11% of C corporation income annually report average income of $2 million taxed at 34% while their owners are taxable at the highest bracket, as high as 45% after phase outs and medicare taxes if this income were passed through to them. Confirming populist suspicion of concentrations of wealth, political power and tax preferences, moderate income C corporations garner at least as great a tax subsidy as the small income C corporations. To complete the C corporation reported income picture, consider that 8,000 giant public corporations ($100 million adjusted book basis in assets and mostly larger) report around 80% of C Corporation sector income. In their politically blocked years in the early 1920's and in their tax heyday of the early 1930's, Congressional Populists railed against the income tax rate preference granted corporations as contrasted with the much higher individual rates applicable to proprietorships and partnerships as violating (horizontal) tax equity. In the 1920's, 1930's, 1970's and early 1980's Treasury too criticized the inside shelter as violating ability to pay principles or vertical equity -- the "ultimate tax shelter" for high bracket individuals. Congress in a bi-partisan fashion, however, in the 1960's through the 1980's repeatedly increased the inside rate preference or base for small income C corporations. The triumphant small business political rhetoric (actually benefitting only 750,000 firms out of 25 million small businesses) is largely bunk with the exception of the scarcity of outside financing. This article suggests a Public Choice story of local opnion leaders/small businesses and their lobbyists as behind the preference and cites documentation corroborating this conceit. In 1993 61% of C corporations reported no income or incurred a loss. Many of these dry C corporations have been used for almost 2 decades to deduct health insurance costs for owner employees. As such costs gradually become fully deductible by self-employed and 2% or more S corporation shareholders, such use ought to decline and, in fact, SOI projects 2000-2005 slight declines in the number of smallest C corporation returns and slight increases in the number of larger C corporation returns. The reasons for S corporations' unexpected flourishing (surpassing C corporations in number in 1999 and now accounting for close to 20% of corporate section income) vary from the practical (over 50% have only 1 shareholder so that the capital and income shifting advantages of LLCs are moot), to the mundane (taxpayers and advisers are more familiar with S corporations than LLCs), and especially to the arcane (perceived wage tax advantages to S corporations paying dividends rather than salaries to shareholder-employees). SOI reveals that over half of the undisputed growth in LLCs (including LLPs) is in the real estate and professional services market segments -- the dominant market segments for partnerships in general. In fact, much of the LLC growth is from supplanting limited and especially general partnerships.