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.
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
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. 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
The U.S. had one of the highest 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
- State and local tax rates ranging from 0% to 12%
- The top statutory corporate tax rate was 39.1%
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. 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.
Why Changing the Corporate Tax Rate Doesn't Help You
Shouldn't corporations pay more? It might not matter. Corporations pass on their tax burden to you. They will either raise prices or reduce wages. They must maintain their profit margins at a certain level to satisfy stockholders.
If taxes are raised, they pass that on to consumers or workers to keep share prices high. It doesn't matter what happens with the corporate tax rate. There is no way around it. U.S. taxpayers will always have to pay taxes.
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.
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.
Tax Policy Center. "Corporate Top Tax Rate and Bracket 1909 to 2020." Accessed June 16, 2020.
Congress.gov. "Public Law 115–97 115th Congress," Page 2096. Accessed June 16, 2020.
Tax Policy Center. "How Did the Tax Cuts and Jobs Act Change Business Taxes?" Accessed June 16, 2020.
Tax Policy Center. "Taxation of Pass-Through Businesses." Accessed June 16, 2020.
IRS. "2019 Instructions for Form 8995-A." Accessed June 16, 2020.
American Bar Association. "Parsing the New Interest Expense Limitation in the Tax Cuts and Jobs Act." Accessed June 16, 2020.
IRS. "New Rules and Limitations for Depreciation and Expensing Under the Tax Cuts and Jobs Act." Accessed June 16, 2020.
Tax Policy Center. "What Is Carried interest, and How Is It Taxed?" Accessed June 16, 2020.
Tax Policy Center. "How the Corporate AMT Affects Different Industries." Accessed June 16, 2020.
Congressional Research Service. "Tax Cuts on Repatriation Earnings as Economic Stimulus: An Economic Analysis," Page 3-4. Accessed June 16, 2020.
Tax Foundation. "State Corporate Income Tax Rates and Brackets for 2020." Accessed June 16, 2020.
CBO. "International Comparisons of Corporate Income Tax Rates," Page 2-3. Accessed June 16, 2020.
CBO. "International Comparisons of Corporate Income Tax Rates," Page 1. Accessed June 16, 2020.
IRS. "SOI Tax Stats - S Corporation Statistics." Accessed June 16, 2020.
Indiana University Bloomington. "The Public Control of Corporate Power: Revisiting the 1909 U.S. Corporate Tax From a Comparative Perspective," Page 502-503. Accessed June 16, 2020.