March 26, 2012
Sullivan: Will Rate Changes Transform C Corps Into Tax Shelters?
Martin A. Sullivan (Tax Analysts), Will Rate Changes Transform C Corps Into Tax Shelters?, 134 Tax Notes 1590 (Mar. 26, 2012):
[T]he potential for using C corporations as a tax shelter does not just depend on the values of the corporate and individual rates. The taxation of distributions from C corporations plays a critical role. More precisely, the choice between the passthrough and the corporate form depends on the relative value of the individual rate (on passthrough income) to the sum of the corporate rate plus the effective tax rate on distributions. Professor Daniel Halperin of Harvard Law School emphasized that in a 2010 article: "If the combined tax at the corporate level and on corporate distributions is sufficiently higher than the U.S. individual rate, closely held businesses might continue to prefer passthrough entities." [Mitigating the Potential Inequity of Reducing Corporate Rates.]
The effective tax rate on most dividends is 15%. The effective tax rate on profits realized through capital gains is less than the 15% statutory rate because many gains are deferred. And with the step-up in basis at death, capital gains can have an effective income tax rate of zero.
Table 2 compares passthrough rates with combined individual and corporate tax rates in OECD countries in 2011. Including both state and federal taxes, Table 2 shows that the combined individual and corporate tax rate on corporate income is 54.1% in the United States. That is more than 10 percentage points higher than the estimated corporate rate. The table suggests that if all corporate earnings are distributed as they are earned, the federal statutory rate could be reduced to 25%, and the rate differential that mattered would still tilt in favor of keeping income outside C corporations. [Click on chart to enlarge.]
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