U.S. Corporate Income Tax Rate, Its History, and the Effective Rate
The Tax Cuts and Jobs Act Effect on 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 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. Even so, most corporations don't pay that rate.
They find enough tax loopholes that their effective rate is just about 18%.
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 deductions phase out for service professionals once their incomes reach $160,725 for singles and $321,400 for joint filers as of 2019.
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 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.
Deducting Depreciable Assets
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.
Carried Interest Profits
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 Corporate Alternative Minimum Tax
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.
Tax Treatment of Global Corporations
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 Effective Tax Rate for Large Corporations Is 18.6%
The U.S. had one of the highest tax rates in the world Before President Trump's tax reform. 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%, averaging out to 7.5%
- Companies deductible state and local tax expenses averaged out to around 40%
But most large corporations never paid that much. On average, the effective rate was 18.6%, according to a 2017 report by the Congressional Budget Office.
The Treasury Department collected $390 billion in 2015. 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 became a competitive advantage. They made more money in U.S. markets than foreign competitors because of their knowledge of the tax code.
Taxes were levied on the individual owners of businesses but not on the corporations themselves before the 1894 Revenue Act. Although the Act was ruled constitutional, it was replaced by a Tax Act in 1909. This was the first year that corporate taxes were levied. All companies paid the same rate until 1936 regardless of income. The current system is more progressive.
The maximum tax rates below are the rates paid on the highest income levels. Please note that the definition of income changes frequently.
Year / Max Tax Rate / President / Comments
|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 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.