As everyone is holding their breath to see if we are going over the "Fiscal Cliff", and the attendant showmanship over taxes, do most folks even know who pays what and why? Probably not.
In my totally unscientific surveys of everyday folks, very few that I have talked with understand the differences between sole proprietorships, partnerships, C corporations, chapter S corporations, LLC's, etc.
For the purposes of simplification, I am only going to address "C" corporations and those that elect Subchapter S.
I have found that the average person assumes that a large company is paying corporate taxes. And I think most folks would be shocked to know that many companies with 100's of millions in revenue, multiple factories, company planes, and the whole ball of wax, may pay no corporate taxes at all.
Most people do understand that corporate income taxes are those that are paid by corporations, and that personal income taxes are paid by individuals, and that the rates are not the same.
Again based upon my unscientific surveys, the average person thinks that any large company, as I described above, first pays a corporate income tax on its profits, and then the individual shareholders pay a personal income tax rate on their dividends, if any. And that is the way it works with a straight "C" Corporation, basically a for profit company that is incorporated, and has shareholders.
However there is a BIG loophole that many companies (over 3 million as of 2002) use to avoid paying any corporate income taxes. That loophole is known as an "S" Corporation, which is a "C" Corporation that has notified the IRS that it is reporting its income under Subchapter S of the IRS Code. Qualifications per the IRS website as follows:
Like Share Print
S corporations are corporations that elect to pass corporate income, losses, deductions and credit through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income.
To qualify for S corporation status, the corporation must meet the following requirements:
- Be a domestic corporation
- Have only allowable shareholders
Here is how the numbers look comparing companies paying corporate income taxes, and S corps, at the present and with the new rates if Obama gets his increase through on the high earners.
Over 100 Investors
$500,000,000 in revenue
Federal corporate income tax rate of 35% with no deductions, they pay $175,000,000. (Note that there is probably not a single corporation of this size that actually pays a 35% rate). I'll leave it to others to discover the actual effective rates they pay, but I believe it is well below 20% on average. This company would also pay a Wisconsin corporate tax of 7.9% or $39,500,000.
In total of federal and state corporate income tax Company One would pay $214,500,000 (again assuming no deductions),
Company One stockholder in the high earner bracket (over $388,350 income) right now would pay a personal tax on dividends from the corporation at a rate of 33%, again assuming no deductions ($100,000 dividends tax of $33,000) — with the Obama increase they would pay a rate of 39.6% or $39,600.
For comparison purposes, just on the FEDERAL level, let us suppose that all dividends are paid to people in the high earner bracket of 33%. The corporate tax paid would be $175,000,000 with an after tax profit of $325,000,000 and if all of that were paid out in dividends to high earners the personal tax would be 325,000,000 x 33% = $107,250,000.
Total federal taxes paid for Company One combination of corporate income and personal income taxes is $282,250,000 — again assuming no deductions for anyone.
Company Two is also a "C" Corporation with annual revenue of $500,000,000, but is only has 35 stockholders, which is well below the 100 limit for an subchapter S tax option.
Corporate income taxes — both federal and state that Company Two pays as an "S" corp. is ZERO. All income flows directly through to the shareholders and they pay taxes on their 1040 form.
Personal income taxes paid — assuming all high earners with no deductions, $500,000,000 x 33% = $165,000,000.
LOSS OF TAX REVENUE FROM COMPANIES USING THE SUBCHAPTER S LOOPHOLE.
Company One income taxes corporate and personal = $282,250,000
Company Two income taxes personal only = $165,000,000
Difference in Tax Revenue between two companies same size = ($117,250,000)
The difference in Wisconsin tax revenue would be Company One with both corporate and personal taxes paying $75,879,500, while Company Two with only personal income tax paying $39,500,000 or $39,500,000 LESS TO WISCONSIN.
Note that not every state relinquishes its corporate income tax for subchapter S corporations — some of them do not recognize that status for state tax purposes, while others have alternate taxes or fees.
In summation: When the politicians start talking about corporate tax rates and high earner tax rates, they never mention that identical 1/2 billion $$ companies could be paying much less, depending upon whether they qualify for the subchapter S loophole.
It is also apparent how private equity firms that buy up corporations can save a lot of money on taxes, if they don't have to pay corporate income taxes.
And this is just one aspect of our tax code — imagine all the various combinations that are possible for when a tax is or isn't paid, and how much.
And by the way — the subchapter S was originally intended to help out small family businesses — not companies making hundreds of millions of dollars.