CBO Releases Report on Taxing Businesses Through the Individual Income Tax

December 6, 2012

Over the past 30 years, the activity of businesses that are subject to the individual income tax has grown compared with that of businesses subject to the corporate income tax. That shift has reduced federal revenues but probably promoted overall investment and a more efficient allocation of resources.

Most business receipts—the revenues that businesses receive from sales of goods and services—come from a relatively small number of firms subject to the corporate income tax, called C corporations. However, other organizational forms allow businesses to avoid the corporate tax by passing their profits through to their owners, where they are subject to the individual income tax. Use of those pass-through structures has grown: In 1980, 83 percent of firms passed profits through to their owners for taxation, and they accounted for 14 percent of business receipts; by 2007, those shares had increased to 94 percent and 38 percent, respectively. Organizational forms that provide owners with the same protection from liability for the debts of the firm that the owners of C corporations receive were almost entirely responsible for that growth.

Today’s CBO report Taxing Businesses Through the Individual Income Tax examines the size and causes of the shift in organizational structure, the effect it has had on federal revenues, and the potential effects on revenues and investment of various alternative approaches to taxing businesses’ profits.

The report examines three potential approaches to the taxation of businesses’ profits:

  • Limiting the use of pass-through taxation,
  • Integrating the individual and corporate income taxes, and
  • Unifying taxes on businesses in a new entity-level tax.

This report was prepared by Paul Burnham of CBO’s Tax Analysis Division.