Two weeks ago, the Wall Street Journal ran a front-page piece entitled, “More Firms Enjoy Tax-Free Status.” While you could argue the story itself was less biased than the headline, its overall bent leaves the very strong impression that S corporations and other pass through businesses pay no taxes. The subsequent interview of the author on WSJ Live is even worse:
Author: The vast majority of US businesses essentially don’t have to pay any tax. They are organized as what are called pass-throughs, meaning that there’s no tax paid by the enterprise; instead the tax is paid by the owners of the enterprise.
Interviewer: These figures are just baffling. How does one construct themselves such that they completely avoid the tax exposure? I think anybody seeing these statistics would just want to shake their heads’ and want to be that person.
Author: Yeah, and several million business owners have had that same idea.
This, of course, is highly inaccurate. S corporations and other pass through businesses pay lots of tax on their business income, they just do it at individual rather than corporate rates and they only pay tax once, not twice like C corporations sometimes do.
As leaders in the fight to eliminate the double tax on business income, we responded immediately to the story. The WSJ chose not to post our response, so we’ll post it here instead:
To the Editor:
A significant obstacle for job creation and investment in the United States is the double tax imposed on corporate income. Most of our major trading partners provide explicit relief from the double tax, as did the US from 1913 to 1953 through a dividend exclusion.
Just five years after repealing the dividend exclusion, the Congress created the S corporation in 1958, which eliminated the double tax through a different mechanism. In fact, Congress has engaged in numerous other reforms over the past fifty years to reduce the harmful effects of the double tax, most recently in 2003 when it cut the rate on corporate dividends to 15 percent.
This narrative of a purposeful and beneficial migration away from the double tax might be lost on readers of “More Firms Enjoy Tax-Free Statusb” (WSJ January 10th). Calling these businesses “tax free” is simply inaccurate. They pay roughly 44 percent of all business taxes. The only difference is they pay tax at individual shareholder rates rather than corporate rates.
Pass-through businesses contribute significantly to job creation as well. When the Administration first floated the idea of double taxing pass-through businesses last spring, we asked Ernst & Young to estimate how many Americans they employ. The result? More than half of private sector workers work at a pass-through business, while one in four is employed by an S corporation.
Viewed both historically and internationally, the US practice of double taxing corporate profits is the outlier in this debate, resulting in lower levels of employment and investment here in the US. If Congress wants to make American business more competitive, it should finish its fifty-year effort and eliminate the double tax on corporate income for all businesses.
WSJ Readers Respond
We weren’t the only ones to have a problem with the article. Of the 150+ comments on the WSJ website, all but a handful were highly critical and angry. We went through them and pulled the best ones. The Winner:
There are two issues with the C corp status. One is the higher tax rates for companies generating nearly all their revenues in the US. The other is the double taxation of the dividends when distributed to the owners. This creates an insanely high marginal tax rate on C corporation earnings. This is an obstacle to job creation.
If Income from earnings were taxed once at the same flatter tax rate, the business case of the pass through entities diminishes.
Rather than attack the large number of privately held businesses utilizing pass through tax status to build and grow their business, Congress again should focus on lowering the tax rates, simplifying the deductions and credits, etc.
Amen to that!
- “Did the WSJ hire a writer from OWS? 100% of earnings are paid at the individual income tax level… that’s not enough?”
- “This article is disturbing, because it creates the false impression that no taxes are paid at all. This is false, because the taxes are ultimately paid by the “pass-through” recipient like an individual, who likely will pay a higher tax rate than a corporation. S Corps, LLC’s and Limited Partnerships are all structured this way and there is no nefarious special interest benefiting from such a structure. These types of entities are a time-honored part of the tax code. The main benefit of such a structure that gives a participant a thin shield of liability.”
- “They should simply abolish the corporate income tax altogether and tax all income to the individual shareholder, as they do for partnerships. That would dramatically simplify the tax code, and at the same time eliminate business taxes and place the tax where it belongs, and actually is visited, and that is on the individuals.”
- “The payment of the tax by the business is imputed – to the owner(s) of the business. The business certainly generates a tax liability which is then met with quarterly tax payments and on Form 1120 when the owner(s) file(s) their annual returns. If you don’t believe the businesses pay taxes, raise marginal rates 5 or 10 points, enact millionaire surcharges, etc, and see what happens to hiring and sustained investment at those businesses. I guess these are the unicorns Harry Reid was seeking.”
- “Let’s get it straight. It’s not Tax-free; the tax obligation is passed on to the holder who pays is under their rate. If the holder is a pension, foundation, trust, etc. there is still an obligation, even if it’s under UBTI. The WSJ only damages its credibility by misleading its readers and making it the headline.”
- “Real reform would tax all legal entities uniformly after reducing entity level income by the total of all distributions to the entity’s constituents treating dividends, interest and any other distributions equally.”
- “In an S corp, profits are taxed whether they are distributed or not, this only encourages distributions to the stockholder who is taxed and than generally will need to loan back to corporation for working capital and growth.”
- “The headline on this article and the article itself is terribly misleading. There are taxes paid on these companies. The taxes are paid by the shareholders and not by the companies. It is totally misleading to call them tax-free. Shame on the editors of WSJ.”
“So now S Corps are evil? Give me a break…”
With that one, we’ll conclude.