The “double taxation” myth

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The debate over the Tax Cuts and Jobs Act of 2017 resurrected a lot of conflicted thinking about what a corporation is and is not. It has become a common talking point that corporate profits are “double taxed,” first at the corporate level and then as part of the owner’s income. This particular code revision has expanded this theme in several ways, greatly complicating and establishing new rules for “pass-through entities,” most of which were birthed by anonymous lobbyists meeting with influential members of Congress late at night.

I addressed the myth of tax simplification in an earlier post, but it will really take some doing for the IRS to figure out what is now allowable and what is not regarding corporate entities and their declared profits. It will be anything but simple. Tax lawyers are also deep into research and plotting, trying to figure out what kinds of business entities can now stretch the tax-preferred line while still being technically legal.

This new law has gone further to muddy the already-messy definition of when a corporation is a “legal person” and thus separate from its owners. For tax purposes, owners often want to be “not so separate” in order to be taxed as just one entity. In short, they want the income of the business and their personal income stream to be seen as one single “economic event,” and now even taxed lower than conventional personal income. [1] However, in the controversial Citizens United vs. Federal Election Commission Supreme Court decision of 2010, corporations were given expanded rights to interfere in political campaigns because the corporation is a “legal person” in and of itself, and separate from its owners.

“Legal personhood” is essential to an understanding of corporate limited liability, especially during bankruptcy, which I discussed in an earlier post. This legal shield is what protects even the worst abusers of corporate governance from personally feeling any pain past their original investments. By the time most bankruptcies are filed, the local community, the employees, the creditors and the vendors take the bulk of the financial hit with no compensation.

Most countries, including the United States, have a “spiderweb” of taxes of different types, because they are trying to capture an array of “economic events” as close to the “cash exchange point” as possible, in order to extract a small price for “running the country” anywhere cash (in its broadest definition) gets exchanged. In this sense, ordinary employees are “double taxed” as well. They pay income and FICA taxes on their earnings, and also often pay sales taxes and other end-user assessments on their consumption.

The poorer you are, the harder the proportionate hit of the “double whammy” of FICA and sales taxes. While there has been a federal income tax deduction for sales taxes, this is usually not available to the poorest Americans. Capital income, on the other hand, is more often re-invested rather than consumed, and it is typically subject to neither FICA nor sales taxes. Indeed, because so much capital income is filtered through retirement accounts, capital gain deferrals and other tax shelters, a lot of capital income is never taxed for its intended recipient.

So which one is it? If there is truly legal separation between the owners and the corporation, then why should they not be taxed as separate economic entities? If they are taxed one-and-the-same as the owners, then why do they merit limited-liability and other state corporate protections, paid for by taxpayers and other stakeholders when they go astray?

My view is that corporate taxes, in addition to capturing separate financial transactions, help pay for the special protections given to the corporate form of business ownership, particularly bankruptcy protection and the disproportionate level of favors and incentives bestowed on them by federal and state legislators. There is a cost to these corporate protections and favors, most of it usually hidden.

“Persons” pay taxes, even when they are “legal fictions.” When some of these “persons” get a free ride in their economic events, the rest of the populace pays the bill.


Notes:

  1. “How States Should Respond to the Federal Tax Cuts for ‘Pass-Through’ Business Income.” Center on Budget and Policy Priorities, 27 Mar. 2018.

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