Media Missed the Mark on Business Taxes

Media Missed the Mark on Business Taxes

When it comes to attacks on corporate America, history tends to repeat itself. The Government Accountability Office (GAO) recently issued its report on corporate tax liabilities, as it has for many years. And once again, its data are being twisted and misinterpreted by those seeking to demonize the business community.

Perhaps you saw a screaming headline in your local paper or a news story on TV last week claiming that most businesses pay no taxes. These stories were based on a GAO report that appeared to conclude that 60% to 70% of companies in the United States escape the tax man.

What the GAO report actually said was that for the period between 1998 and 2005, corporations—not necessarily the same corporations–had no tax liability for one of the eight years in question. Let’s face it … if two thirds of all corporations paid no taxes for all eight years, we would be reading about a Department of Justice or IRS investigation, not a GAO report!

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When I saw the media report I thought something was fishy.

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A LOT of small business corporations pay no taxes themselves. A lot of them are Subchapter S and the tax burden is passed through to the stockholders. Interestingly, my own bank is a Subchapter S, which is a bit unusual for banks…

Those few small businesses that are C corporations often don’t pay taxes either. That income which is not spent on deductible business investment is paid out in the form of wages to employees and owners, who pay the taxes. If you pay out all of your income on deductible expenses, you pay no taxes.

These stockholders in a subchapter S are usually the owners. The rpofits are essentially tacked on to their paycheck which kicks them into a higher tax bracket.

Perhaps to clarify, the stockholders in either an S corp or a C corp are ALWAYS the owners. The tax on profits passed through to stockholders in an S corp is usually at a lower rate than it would be if the C corp retained earnings and paid taxes on them, because the “first dollar” of a C corp’s profit is taxed at the maximum rate, which is not true of individuals.

For small businesses in which 100% of the stockholders are also 100% of the management, it often does make sense to pay everything to the stockholders as wages or bonuses in a C corp, because they will be taxed at a lower rate, up to the point that the owners are taxed the Alternative Minimum Tax. In an S corp, it doesn’t matter from a tax standpoint whether all the profits are paid to the stockholders or not, because they are taxed for all of it anyway, but at individual rates, not corporate rates.

Occasionally, a corporation in which all the stockholders are not also management, will elect the S form, like the bank I use does. The reason is that if the corporation pays dividends sufficient to pay the taxes on the corporation’s profits, or perhaps a bit more, the stockholders are not hurt by the S corp form, but the corporation itself gets to retain more of its earnings than it would if it was a C corp earning the same amount.

It is important to note that corporations pay no income tax when they have no income. It is the same for individuals. Many auto companies, airlines, and banks are currently not paying federal income tax for the perfectly just and valid reason that they have no income.

It is also true that the US has the second highest corporate tax rate in the world at 40%. Only Japan has a higher rate. We compound that problem by taxing that same income again when some of it is payed out to the owners of the corporation in dividends. The equivalent for individuals would be to withhold tax from the paycheck directly deposited to your checking account and then taxing it again when you took your own money out by ATM. (Of course in many states you are taxed again when you spend the money you withdrew, but at least we don’t currently tax the withdrawal itsef. Try to keep this quiet because politicians are always looking for a new way to raise revenue;) )

The double taxation of dividends is a significant contributor to the American public’s amazingly low savings rate. The personal savings rate recently ROSE to zero. The lack of savings keeps mortgages less available and more expensive than they could be. It makes the mortgage more risky for a bank to lend when the customer has no savings to cover everyday events.

We don’t necessarily need incentives to increase national savings, but we sure do need to remove the disincentives to saving that currently exist.

The same goes for the system of progressive rates that makes it possible for a couple “living in sin” to pay less tax than a married couple with exactly the same income. I would love to hear a Catholic try to defend the marriage penalty.

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