The U.S. Government Accountability Office (GAO) concluded in a recent report that, although the maximum federal corporate tax rate is currently 35%, the average effective tax rates that large corporate filers pay are significantly less. The GAO’s findings were similar to what it found in an earlier report issued in 2013.
The report is interesting in light of the proposals made by President Trump and Republicans in Congress to lower the top federal corporate tax rate from 35% to 15% or 20%, respectively. One reason frequently cited for significantly cutting the top rate is that the maximum U.S. rate is the highest in the developed world. That’s true in terms of the statutory rate, but, as the GAO report shows, most corporations aren’t paying the statutory rate. (Of course, the effective rates paid in other nations may also be lower than their statutory rates.)
Background on the corporate tax rate
Under the tax code, the current income tax rate on an ordinary corporation is generally:
- 15% on the first $50,000 of its taxable income,
- 25% on any amount in excess of $50,000 and up to $75,000,.
- 34% on any amount in excess of $75,000 and up to $10,000,000, and
- 35% on any amount in excess of $10,000,000.
The GAO found that, for tax years 2008 to 2012, profitable large U.S. corporations (generally those with at least $10 million in assets) paid, on average, U.S. federal income tax amounting to about 14% of the pretax net income that they reported in their financial statements. In addition, in each year from 2006 to 2012, at least two-thirds of all active corporations had no federal income tax liability.
The report concluded that, when foreign, state and local income taxes were included, the average effective tax rate for tax years 2008 through 2012 increased to 22.2%.
Corporations that paid no federal income tax
Looking just at 2012, the GAO found that, among large corporations, 42.3% paid no federal income tax, and 19.5% of those large corporations whose financial statements reported a profit paid no federal income tax that year. Corporations that did have a federal corporate income tax liability for the 2012 tax year owed $267.5 billion.
There were a number of reasons why even profitable corporations may have paid no federal tax in a given year, including:
- The use of tax deductions for losses carried forward from prior years and
- Tax incentives (such as depreciation allowances that are more generous in the tax code than allowed for financial reporting purposes).
- These reasons also explain why corporate effective tax rates can differ substantially from statutory tax rates.
In general, effective tax rates attempt to measure taxes paid as a proportion of economic income, while statutory rates indicate the amount of tax liability (before any credits) relative to taxable income, which is defined by tax law and reflects tax benefits built into the law.
Trump administration and congressional Republican proposals
On April 26, the Trump Administration released a draft proposal that would cut the top corporate tax rate from 35% to 15%. In addition, the White House tax plan proposed limiting the tax rate on income from pass-through businesses and sole proprietorships to 15%. That means that owners of S corporations, partnerships and sole proprietorships would pay significantly lower taxes on business income (from 39.6% to 15% in some instances).
Last year, House Republicans announced tax reform proposals that would reduce the maximum corporate income tax rate to 20%. They would also make several other changes, which include creating a new income tax rate for small businesses that are organized as sole proprietorships or pass-though entities instead of taxing them at individual rates.
It’s difficult to predict what the Trump administration and Congress will accomplish this year in terms of new tax laws. The proposals listed above are merely proposals at this time. We don’t know if or when they’ll become law, and you should be aware of potential risks before implementing any strategies to act on them. No matter what happens, we can assist you in planning ahead to minimize your tax bill.