Corporate Income Tax: Definition, History, Effective Rate

3 Legal Ways Corporations Avoid Paying Taxes

corporate tax
The U.S. Robin Hood Tax Campaign protest outside JPMorgan Chase Corporate Headquarters on June 19, 2012 in New York City. Photo by Neilson Barnard/Getty Images for Robin Hood Tax

Definition:Corporate income taxes are levied by the U.S. Federal government and by states on business profits. Understandably, companies try to use everything in the tax code to lower the cost of taxes paid by reducing taxable income.

3 Ways Corporations Avoid Paying Taxes

The U.S. tax rate is around 40%. That includes:

  • Federal tax rate of 35% for the highest income brackets.
  • State and local tax rates ranging from 0% to 12%, which averages out to 7.5%.
  • Companies deduct state and local tax expenses. That averages out to around 40%. 

But corporations don't actually pay that rate. The effective corporate tax rate is around 15%.  As of June 2014, the Treasury Department had collected $303 billion in the previous 12 months. That's just 15% of U.S. corporate profits of $2 trillion.

That's about half the effective rate the government received in June 2007, just before the recession hit. That's when corporate taxes yielded their pre-recession peak of about $383 billion. That's because the U.S. government is receiving a lower share of companies' profitability. Corporate profits exceeded their pre-recession peak two years ago.

How do corporations avoid paying taxes? First, many companies, especially banks, are still writing off losses they incurred during the financial crisis.

Second, almost half of all corporations are "S" Corporations. They pay no corporate taxes.

That's because they pass corporate income, losses, deductions, and credits through to their shareholders. The shareholders are then taxed on these profits or losses at their income tax rates. (Source: IRS, S Corporations)

A third reason is that companies are reinvesting profits earned overseas back into those local markets.

They might prefer to bring the cash home, but are deliberately avoiding U.S. taxes. It's actually cheaper for them to borrow, at current low interest rates, in the U.S. than to bring earnings home. As a result, corporations are debt-heavy in the U.S., and cash-rich in overseas operations. (Source: "An Inverted View of U.S. Corporate Tax BiteThe Wall Street Journal, August 4, 2014.)

In fact, corporations have become so adept at avoiding U.S. taxes that it's become a competitive advantage. They can make more money in U.S. markets than foreign competitors because of their knowledge of the tax code and how to get around it. That's one reason you may never see a tax overhaul. Corporations that are successful in the current tax environment don't want to see the rules, which they've mastered, change. (Source: "Tax Burden Not as Heavy as It Looks," The New York Times, August 18, 2014.)

History of Corporate Taxes

Before the 1894 Revenue Act, taxes were levied on the individual owners of businesses, but not on the corporations themselves. Although the Act was ruled constitutional, it was replaced by a Tax Act in 1909, the first year that corporate taxes were levied.

The maximum tax rates below are the rates paid on the highest income levels.

Please note that the definition of income changes frequently, so keep that in mind when comparing rates. 

Until 1936, all companies paid the same rate, regardless of income. 

Year ChangedMax Tax Rate

Comments

 1909   1%Taft takes office.
 1916   2%President Wilson's term.
 1917   6% 
 1918 12% 
 1919 10%WWI begins.
 1922 12.5%Harding in office. Did they raise taxes to finance WWI?
 1925 13%Coolidge in office.
 1926 13.5% 
 1928 12% 
 1929 11%Hoover took office. Lowering taxes may have hastened the stock market crash.
 1930 12%Hoover raised taxes to stop stock market speculation. 
 1932 13.8%Hoover continued to raise taxes.
 1936 15%FDR raised taxes to balance the budget. That revived the depression.
 1938 19%FDR kept raising taxes in anticipation of World War II.
 1940 24%FDR started raising taxes to gear up for WWII.
 1941 31%Pearl Harbor attack meant higher taxes to go to war.
 1942 40% 
 1950 38%Truman lowered taxes to combat post-WWII recession.
 1951 50.75%Truman raised taxes to fund Korean War.
 1952 52%Taxes remained high despite 1953 and 1957 recessions.
 1964 50%LBJ implemented JFK's tax cut.
 1965 48%Lower taxes kept economy booming.
 1968 52.8%LBJ enacted the Revenue and Expenditure Control Act of 1968 to pay for the Great Society and the Vietnam War.
 1970 49.2%Nixon lowered taxes to fight recession as part of Tax Reform Act of 1969.
 1971 48% 
 1979 46%Carter lowered taxes to fight recession and offset higher interest rates to fight stagflation.
 1987 40%Reagan cut taxes in the Tax Reform Act of 1986 to fight stagflation. It lowered rates while eliminating $30 billion in loopholes.
 1988 34%Taxes remained at this level despite 1990 recession caused by Savings and Loan Crisis
 1993 35%Clinton passed Omnibus Budget Reconciliation Act which lowered the rate for small business while raising it for large ones.

(Sources for Table: IRS, Corporate Tax Rates 1909-2002; ProCon.org, Corporate Tax Rate and Jobs )