U.S. Corporate Income Tax Rate, Its History, and the Effective Rate

Corporate income taxes are levied by federal and state governments on business profits. Companies use everything in the tax code to lower the cost of taxes paid by reducing their taxable incomes.

When President Trump signed the Tax Cuts and Jobs Act (TCJA) into law on Dec. 22, 2017, it cut the corporate tax rate from 35% to 21%, the lowest rate since 1939. 

The TCJA also initiated a 20% deduction on qualified business income for pass-through businesses. This deduction ends after 2025. Pass-through businesses include sole proprietorships, partnerships, limited liability companies, and S corporations. They also include real estate companies, hedge funds, and private equity funds. The deductions phase out for service professionals once their incomes reach $160,725 for singles and $321,400 for joint filers as of 2019. 

The TCJA limits corporations' ability to deduct interest expenses to 30% of income. For the first four years, income is based on EBITDA. This acronym refers to earnings before interest, tax, depreciation, and amortization. Starting in the fifth year, it's based on earnings before interest and taxes. That makes it more expensive for financial firms to borrow. Companies would be less likely to issue bonds and buy back their stock.

The tax reform law allows businesses to deduct the cost of depreciable assets in one year instead of having to amortize them over several years. This rule doesn't apply to structures. To qualify, the equipment must be purchased after Sept. 27, 2017, and before Jan. 1, 2023 to qualify. 

The TCJA stiffens the requirements on carried interest profits. Carried interest is taxed at 23.8% instead of the top income tax rate. Firms must hold assets for a year to qualify for the lower rate. The TCJA extends that requirement to three years. 

The Act eliminates the corporate alternative minimum tax (AMT).  The corporate AMT had a 20% tax rate that kicked in if tax credits pushed a firm's effective tax rate below that percentage. Companies could not deduct research and development spending or investments in a low-income neighborhood. 

The law installed a "territorial" system for global corporations. They aren't taxed on foreign profit under this system. The TCJA encourages them to reinvest it in the U.S. This benefits pharmaceutical and high-tech companies the most. 

Multinationals were taxed on foreign income earned under the prior "worldwide" system. They didn't pay tax until they brought the profits home. As a result, many corporations reinvested profits earned overseas into those markets. It was cheaper for them to borrow at low interest rates in the U.S. than to bring earnings home. As a result, corporations became debt-heavy in the U.S. and cash-rich in overseas operations. 

The TCJA allows companies to repatriate the $2.6 trillion they held in foreign cash stockpiles. They pay a one-time tax rate of 15.5% on cash and 8% on equipment. The Congressional Research Service found that a similar 2004 tax holiday didn't do much to boost the economy. Companies distributed repatriated cash to shareholders, not to their employees. 

The U.S. had one of the highest tax rates in the world Before President Trump's tax reform. The 2012 effective rate was 18.6%. It included:

• Federal tax rate of 35% for the highest income brackets
• State and local tax rates ranging from 0% to 12%
• The top statutory corporate tax rate was 39.1%

But most large corporations never paid that much. The average corporate tax rate was 29% in 2012, according to a 2017 report by the Congressional Budget Office.

How do corporations avoid paying taxes? First, S corporations are the most common type of corporation. These pass-through firms pay no corporate taxes. Instead, they pass corporate income, losses, deductions, and credits through to their shareholders. The shareholders are then taxed on these profits or losses at their individual income tax rates. 

Some global corporations don't welcome the tax change. They've become so adept at avoiding U.S. taxes that it became a competitive advantage. They made more money in U.S. markets than foreign competitors because of their knowledge of the tax code. 

Shouldn't corporations pay more? It might not matter. Corporations pass on their tax burden to you. They will either raise prices or reduce wages. They must maintain their profit margins at a certain level to satisfy stockholders.

If taxes are raised, they pass that on to consumers or workers to keep share prices high. It doesn't matter what happens with the corporate tax rate. There is no way around it. U.S. taxpayers will always have to pay taxes.

Taxes were levied on the individual owners of businesses but not on the corporations themselves before the 1894 Tariff Act. Although the Act was ruled unconstitutional, it was replaced by a Tax Act in 1909. This was the first year that corporate taxes were levied. The current system is more progressive.

The Tax Cut and Jobs Act has made many changes to the tax code. It affects small businesses as well as corporations. Your best bet is to consult with a tax expert to see how it applies to your specific situation.