Corporate Income Tax: Definition, History, Effective Rate

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 Bite" The 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 Changed	Max 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.