U.S. Corporate Income Tax: Its Effective Rate and History

How the Tax Cuts and Jobs Act Changes Corporate Taxes

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Corporate income taxes are levied by federal and state governments on business profits. Companies use everything at their disposal within 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 Pass-Through Business Deduction 

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 deduction phases out for service professionals once their incomes reach $170,050 for singles and $340,100 for joint filers as of 2022. 

Deductible Interest Expenses 

The TCJA limits corporations' ability to deduct interest expenses to 30% of income. For the first four years, income is based on earnings before interest, taxes, depreciation, and amortization (EBITDA). Starting in the fifth year (2022), 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.

Deducting Depreciable Assets

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. The equipment must be purchased after Sept. 27, 2017, and before Jan. 1, 2023, to qualify. 

Carried Interest Profits 

The TCJA stiffened the requirements on carried interest profits. Carried interest is income that flows to the general partner in an investment fund. It's now taxed at 23.8% instead of the top income tax rate. The TCJA extended from one to three years the time for which firms must hold assets to qualify for the lower rate. 

The Corporate Alternative Minimum Tax 

The Act eliminates the corporate alternative minimum tax (AMT). Before 2018, the corporate AMT had a 20% tax rate that kicked in if tax credits pushed a firm's effective tax rate below that percentage. The Act repealed the option for companies to deduct certain research and development expenses in the year incurred, beginning in 2022. They must capitalize and amortize those expenses.

Tax Treatment of Global Corporations 

The law installed a quasi-territorial system in which global corporations aren't taxed on foreign profit. 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. Many corporations reinvested profits earned overseas into those markets as a result. It was cheaper for them to borrow at low interest rates in the U.S. than to bring earnings home. Corporations became debt-heavy in the U.S. and cash-rich in overseas operations. 

The TCJA allows companies to repatriate the cash they held in foreign cash stockpiles, estimated at $1 trillion by the end of 2017. 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 Effective Tax Rate for Large Corporations

The U.S. had one of the highest corporate 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
  • A top statutory corporate tax rate of 39.1%, including state corporate taxes

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 Corporations Avoid Paying Taxes

How do corporations avoid paying taxes? First, S corporations are the most common type of corporation. These pass-through firms pay no corporate taxes. They pass corporate income, losses, deductions, and credits through to their shareholders instead. 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. 

Why Changing the Corporate Tax Rate Doesn't Help You

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

They pass it on to consumers or workers to keep share prices high when taxes are raised. It doesn't matter what happens with the corporate tax rate.

Historical Rates

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, meaning that high-earning corporations are taxed at higher rates.

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.

Article Sources

  1. Internal Revenue Service. "U.S. Corporation Income Tax: Tax Brackets and Rates," Download "Historical Table 24." Accessed Jan. 16, 2022.

  2. Congress.gov. "Public Law 115–97 115th Congress," Page 2096. Accessed Jan. 16, 2022.

  3. Internal Revenue Service. "Tax Cuts and Jobs Act, Provision 11011 Section 199A - Qualified Business Income Deduction FAQs." Accessed Jan. 16, 2022.

  4. Internal Revenue Service. "Internal Revenue Bulletin: 2021-48." Accessed Jan. 16, 2022.

  5. Internal Revenue Service. "Basic Questions and Answers About the Limitation on the Deduction for Business Interest Expense." Accessed Jan. 16, 2022.

  6. Internal Revenue Service. "New Rules and Limitations for Depreciation and Expensing Under the Tax Cuts and Jobs Act." Accessed Jan. 16, 2022.

  7. Congressional Research Service. "Taxation of Carried Interest," Pages 2-4. Accessed Jan. 16, 2022.

  8. Internal Revenue Service. "Tax Cuts and Jobs Act: A Comparison for Large Businesses and International Taxpayers." Accessed Jan. 16, 2022.

  9. Congressional Research Service. "Tax Reform: The Alternative Minimum Tax." Accessed Jan. 16, 2022.

  10. Congressional Research Service. "Section 174 and Investment in Research and Development." Accessed Jan. 16, 2022.

  11. Board of Governors of the Federal Reserve System. "U.S. Corporations' Repatriation of Offshore Profits: Evidence From 2018." Accessed Jan. 16, 2022.

  12. Congressional Research Service. "Tax Cuts on Repatriation Earnings as Economic Stimulus: An Economic Analysis," Page 3-4. Accessed Jan. 16, 2022.

  13. Congressional Budget Office. "International Comparisons of Corporate Income Tax Rates," Pages 1-2, 17. Accessed Jan. 16, 2022.

  14. Internal Revenue Service. "S Corporations." Accessed Jan. 16, 2021.

  15. Internal Revenue Service. "Historical Highlights of the IRS." Accessed Jan. 16, 2022.