Issues & AdvocacyFederal
Study Shows that S Corps Pay Highest Effective Tax Rate
By Christina Finkenhofer, Manager, Federal Relations
Last week, the National Federation of Independent Business and the S Corporation Association, released a new study showing that S corporations pay the highest effective rates of any business type. The AIA is a member of the S Corporation Association, along with a number of trade associations and small business organizations.
The study, authored by Quantria Strategies, LLC, compares the tax burden different business entities will shoulder in 2013 and finds that S corporations will pay the highest average effective tax rate (31.6 percent of their income), followed by partnerships (29.4 percent), C corporations (17.8 percent) and sole proprietorships (15.1 percent). Moreover, the study shows that the S corporation tax burden is highly progressive, with the smallest S corporations paying 19 percent in tax, while the largest pay 35 percent. In other words, the effective tax rate on successful S corporations is equal to the marginal tax rate paid by the most successful C corporations.
According to the 2012 firm survey, a majority of AIA members are employed by firms organized as S corps and partnerships. This means that architecture firms are taxed at a higher rate on average than businesses organized as corporations and sole proprietorships together.
This is only the second time the tax burden of S corporations and other pass through businesses has been measured. A previous study by the folks at Quantria looked at firms under $10 million in receipts and came up with similar results. Every other attempt to measure effective tax rates, however, has focused exclusively on publicly-traded C corporations. As such, this study sheds important light on their respective tax burdens and policymakers should pay attention.
What does this mean for tax reform?
The results of this study come at a critical time for tax reform. Ways and Means Chairman Dave Camp and Finance Committee Chairman Max Baucus have made clear they intend to spend August crafting their respective tax reform plans. A better understanding of exactly who pays what will help them construct a more thoughtful and successful reform. As the study states:
“While many people think of the statutory tax rate when they consider the effect of federal income taxes, the reality is that the statutory tax rate does not represent the best measure of the effect of taxes on a business. Average effective tax rates are a better measure of whether a particular industry or business form faces greater or lesser federal income taxes relative to other industries or business forms.”
One approach to tax reform would lower rates only for businesses organized as C corporations (i.e. corporate-only reform), which has significant support among lawmakers. The AIA is strongly opposed to corporate-only reform and instead calls on Congress to lower rates for all businesses, regardless of entity choice. Corporate-only tax reform would wipe away existing incentives for S corps and partnerships in order to pay for lower corporate rates, thereby raising the effective tax rates even more on the businesses who can least afford to shoulder that burden.
Supporters of corporate-only reform argue that businesses could simply change from being an S corporation or partnership to a C corporation in order to take advantage of the lowered corporate rates once tax reform passes. But the reality is that many of these businesses are structured in these ways for reasons that go beyond tax planning. Particularly in the architecture industry, firms are structured as S corporations for a variety of reasons, including being genuine small businesses that need to shield liability - precisely the stated reasons for the need of the S chapter of the tax code when it was adopted by Congress in 1958, by the way.
This study serves to underscore AIA’s call for parity among all businesses in any tax reform plan, since it highlights the high rates our firms are legitimately paying today. As the tax committees continue to work on tax reform plans, the AIA remains committed to advancing comprehensive tax reform that would allow our firms to continue designing the innovative buildings of the future, instead of worrying about entity choice and effective tax rates for their businesses.
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