How many times to tax business income?

A recent post (8/26/16) on the Tax Justice website was titled - Why we must close the pass-through loophole? That caught my attention as I was trying to think what the "loophole" might be?  A loophole is a provision that can be used beyond its intended purpose because the rule is not written specifically enough. When a rule is being used as intended, it is not a loophole. For example, sometimes the mortgage interest deduction is called a loophole, but it is not. People deducting interest on the mortgages on their primary and vacation homes is using the rule as intended.

The "loophole" that was the subject of the blog post is large businesses operating as partnerships rather than as corporations. Partnerships, S corporations and sole proprietors do not pay corporate income tax. Instead, the income is taxed directly to the owners and only one level of income tax is paid at the federal level (and state level). In contrast, C corporations pay the corporate income tax AND when they distribute earnings (dividends) to shareholders, the shareholders pay income tax. Thus, C corporation income is taxed twice.

That just happens to be the way it works in the US tax system. It doesn't have to work that way and not all countries double tax corporate income. In the US, there is some relief in that qualified dividends received by individuals are subject to the lower capital gains tax rate.

Over the years, there have been numerous studies by the government and various organizations on how to integrate the corporate tax meaning have corporate income taxed only once.  There are numerous ways this can be done.  Two easy ones would be to not have a corporate tax (only tax dividends) or not tax dividends (only tax corporate income at that level when earned).  Neither is ideal because not all corporations pay dividends and not all corporate shareholders are taxable (a lot of corporate stock is owned by tax-exempt organizations).

The Tax Reform Act of 1986 called for Treasury to study corporate taxation. This resulted in two reports issued in 1992 on corporate integration (January 1992 and December 1992).  Most recently, Senator Hatch, chair of the Senate Finance Committee reports he is working on a plan for corporate integration and the SFC held two hearings on an approach called the dividends paid deduction model (5/17 and 5/24; also see Joint Committee on Taxation report prepared for the hearings).

Some of the advantages of corporate integration include:

• Treats all business entities similarly (although this also depends on the corporate versus individual tax rates applicable to business income).
• Removes or lessens a corporation's tax preference for debt over equity.

So, I ask the question differently from the Tax Justice blog post - why not eliminate double taxation of corporate income and find a way to tax all business entities similarly.  And there are many ways of doing that.  More later on that.

What do you think?

Earth Day and Taxes

Today is Earth Day! There is a significant connection to San Jose State University where I teach because the co-founder of Earth Day - Gaylord Nelson, is an alum.

Back to taxes - the Treasury Department announced its green initiative earlier this week (TG-644; 4/19/10). It will be moving more paper transactions to electronic ones. Treasury expects that this will save both money and trees. Specifically, they estimate their new initiatives will reduce costs by over $400 million in five years and save 12 million pounds of paper.

Some details from Treasury:

1. "First, Treasury will require individuals receiving Social Security, Supplemental Security Income, Veterans, Railroad Retirement and Office of Personnel Management benefits to receive payments electronically. Individuals will be able to receive benefits either through direct deposit into a bank account or Treasury's Direct Express debit card."
2. "Second, businesses currently permitted to use paper Federal Tax Deposit coupons will have to make those deposits electronically beginning in 2011 with a few exceptions, primarily businesses with $2,500 or less in quarterly tax liabilities that pay when filing their returns."
3. "Treasury will eliminate the option to purchase paper savings bonds through payroll deductions for federal employees on September 30, 2010 and for the private sector by January 1, 2011. This policy covers only paper savings bonds purchased through payroll sales; individuals will still be able to purchase paper savings bonds at financial institutions for themselves and as gifts. Payroll savers will be encouraged to continue their purchases through Treasury Direct, a web-based system that allows investors to buy and hold electronic savings bonds. Transitioning employees to electronic payroll purchases saves employers administrative costs and allows employees to manage their own bond accounts. This is estimated to save nearly $50 million in the first five years."

Moving tax systems into the 21st century involves both structural changes as well as administrative ones. I think this move by Treasury is a good one as these transactions should be done electronically to make good and appropriate use of today's technology, save money (which should also help reduce the deficit), and electronic can be done more securely than paper transactions. It also helps the growing number of people who keep all of their financial statements electronically.

What do you think?