US Corporate Income Tax Rate, Its History, and the Effective Rate
How the Tax Act Changes Corporate Taxes
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 taxable income.
It raised the deduction on qualified income to 20% 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 income reaches $157,500 for singles and $315,000 for joint filers.
The Act limits corporations' ability to deduct interest expense 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.
It does not apply to structures. To qualify, the equipment must be purchased after September 27, 2017, and before January 1, 2023.
The Act stiffens the requirements on carried interest profits. Carried interest is taxed at 23.8% instead of the top 39.6% income rate. Firms must hold assets for a year to qualify for the lower rate.
The Act extends that requirement to three years.
The Act eliminates the corporate AMT. The corporate alternative minimum tax had a 20% tax rate that kicked in if tax credits pushed a firm's effective tax rate below 20%. Under the AMT, companies could not deduct research and development spending or investments in a low-income neighborhood.
It installed a "territorial" system for global corporations. Under the territorial system, they aren't taxed on foreign profit. It encourages them to reinvest it in the United States. This benefits pharmaceutical and high tech companies the most.
Under the prior "worldwide" system, multinationals were taxed on foreign income earned. They didn't pay the 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 United States than to bring earnings home. As a result, corporations became debt-heavy in the United States and cash-rich in overseas operations.
The Act 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 employees.
The Effective Tax Rate for Large Corporations Is 18.6%
Before Trump's tax cut, the United States had one of the highest rates in the world. But most corporations don't pay the top rate. The 2017 effective rate was 40%. It included:
- Federal tax rate of 35% for the highest income brackets.
- State and local tax rates ranging from 0% to 12%. It averaged out to 7.5%.
- Companies deducted state and local tax expenses. That averaged out to around 40%.
But most large corporations never paid that much, thanks to tax attorneys who help them avoid paying more. On average, the effective rate was 18.6%, according to a 2017 report by the Congressional Budget Office.
Here's another way to look at it. In 2015, the Treasury Department collected $390 billion.
That's just 18% of U.S. corporate profits of $2.1 trillion, according to Table 1.12 of the National Income and Products Accounts. That's about half the effective rate the government received in 2007, the year before the recession. Corporate taxes were $395 billion on a profit of $1.5 trillion.
How Corporations Avoid Paying Taxes
How do corporations avoid paying taxes? First, almost half of all corporations are "S" Corporations. 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 was a competitive advantage. They made more money in U.S. markets than foreign competitors because of their knowledge of the tax code and how to get around it.
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. The current system is more progressive.
|Year Changed||Max Tax Rate||President|
|1916||2%||Wilson||Reduced tariffs and raised corporate.|
|1917||6%||U .S. entered WWI.|
|1918||12%||Taxes raised to finance WWI.|
|1922||12.5%||Harding||Lowered income tax and raised corporate.|
|1925||13%||Coolidge||Reduced income tax, raised corporate.|
|1929||11%||Hoover||Tax cut triggered stock market crash.|
|1930||12%||Dust Bowl started.|
|1932||13.8%||Tax hikes to stop speculation worsened depression.|
|1936||15%||FDR||Hike revived depression.|
|1938||19%||Dust Bowl ended.|
|1940||24%||Hike to finance WWII.|
|1942||40%||Hikes to pay for WWII.|
|1950||38%||Truman||Cut to fight recession.|
|1951||50.75%||Hike to fund Korean War.|
|1952||52%||Eisenhower||No cuts, despite 1953 and 1957 recessions.|
|1964||50%||LBJ||Implemented JFK's tax cut.|
|1965||48%||Cut boosted economy.|
|1968||52.8%||Hikes paid for Great Society and Vietnam War.|
|1971||48%||Cut to fight recession.|
|1979||46%||Carter||Cut to offset high interest rates.|
|1987||40%||Reagan||Tax Reform Act.|
|1988||34%||Cut to fight recession.|
|1993||35%||Clinton||Omnibus Budget Reconciliation Act.|
|2018||21%||Trump||Tax Act goes into effect.|
The Bottom Line
The corporate tax rate is 21%, the lowest level since the 1930s. Even so, most corporations don't pay that rate. They find tax loopholes so that their effective rate is just 18%.
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.