Business Taxation Anderson: The Corporate Income Tax.

Business TaxationAnderson: The Corporate Income Tax

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Introduction

• Organizing a business.

• Rationale for corporate taxation.

• Effects of profit taxation.

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Organizing a Business

• Legal form for business:• Sole proprietorship.• Partnership.• Corporation.

• Issue of incorporation involves limited liability and taxation.• Hybrid forms of business include:• Limited liability partnerships (LLP).• Professional corporations (PC).

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Rationale for Corporate Taxation

• Under a classical system, corporate income taxation is based on a benefits-received justification.• The corporation is a legal entity separate and distinct from any person

or group of persons involved.• It receives benefits afforded by that legal status. • Taxation is justified on that basis.

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Issues Arising

• Tax arbitrage.• Differences between the personal income tax rate, corporate income tax rate,

and the capital gains tax rate provide opportunities to arbitrage.

• Double taxation.• Dividend income is taxed twice, at the corporate level and again at the

individual level.

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Effects of a Profits Tax

• A tax on economic profit would be perfectly efficient, since it would not change firm behavior.

• But, the corporate income tax is not a tax on economic profit.

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Tax Base and Rates

• Net income—the tax base.

• Profits: economic and accounting.

• Corporate income tax rates

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Net Income—the Tax Base

• Gross profit = gross receipts - cost of goods sold.

• Total income = gross profit - dividends - interest - gross rents - gross royalties - capital gain net income + other income.

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Net Income—the Tax Base, [continued]

• Taxable income = Total income - Total deductions.

• Total deductions = compensation of officers + salaries and wages + repairs and maintenance + bad debts + rents + taxes and licenses + interest paid + charitable contributions + depreciation + depletion + advertising + pension and profit-sharing plans + employee benefit programs + other deductions + NOL deduction.

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Figure 14.1: U.S. Corporate Income Tax Return – Form 1120

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Profits: Economic and Accounting

• Accounting profit is the difference between revenue generated by sales and costs incurred for inputs.

• Economic profit is the difference between revenue and cost, including the opportunity cost of capital.

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Figure 14.2: Competitive Firm Profits

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Figure 14.3: Monopolist Profit

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Corporate Income Tax Rates

• Corporate income tax rates in the U.S. are progressive, depending upon the net income of the corporation.

• Most corporations pay a rate of 35%.

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