Understanding Tax Structures: C Corporations vs. Pass-Throughs
To fully grasp the implications of tax reforms, it’s important to understand the different business tax structures. The two main types are C corporations and pass-through entities.
C corporations, such as large public companies, are taxed at the corporate level. When they earn profits, they must pay corporate income tax. Shareholders then pay personal income tax on any dividends or capital gains from the company’s stock.
In contrast, pass-through entities like S corporations, partnerships, and sole proprietorships do not pay corporate income tax. Instead, their profits “pass through” directly to the owners, who report that income on their personal tax returns and pay individual income tax rates.
This pass-through structure is quite common, with the majority of businesses in the U.S. organized this way. However, the rules around reasonable compensation for owners can create opportunities for tax avoidance.
The Trump Tax Cuts and Jobs Act: Boons for the Wealthy
The 2017 Tax Cuts and Jobs Act, signed into law by former President Trump, made significant changes to the tax code. While proponents claimed it would spur investment and job creation, the reality painted a different picture.
The law slashed corporate tax rates from 35% to 21%, providing an enormous windfall to big businesses. However, evidence shows this did not lead to the promised surge in business investment or trickle-down benefits for workers. Instead, companies largely used the savings to buy back their own stock, enriching executives and shareholders.
The law also created a new deduction for pass-through business income, allowing owners to shield up to 20% of their profits from individual income tax. This provision was meant to aid small businesses, but in reality, it overwhelmingly benefited the wealthy.
Exploiting the Pass-Through Loophole
The pass-through deduction, combined with the existing flexibility around “reasonable compensation” for business owners, created opportunities for tax avoidance. Some savvy business owners began manipulating their salaries to minimize their tax bills.
ProPublica’s “The Secret IRS Files” investigation uncovered numerous instances of business owners dramatically reducing their salaries while their company profits soared. This allowed them to reclassify income as lower-taxed business profits rather than higher-taxed wages.
For example, the CEO of a car accessory manufacturer, David MacNeil, saw his salary plummet from $68 million in 2017 to $47 million in 2018, even as his company’s profits surged. Similarly, the salaries of other executives, such as the CEO of MidFirst Bank and the co-founders of Uline, experienced steep declines despite their businesses thriving.
Experts warn that this strategy, while legally dubious, is difficult for the IRS to challenge. The agency’s definition of “reasonable compensation” is vague, and audits of pass-through businesses are extremely rare.
Closing Loopholes and Ensuring Fair Contributions
In response to these issues, the Biden administration has proposed a series of tax reforms aimed at ensuring the wealthy and large corporations pay their fair share.
The president’s budget plan includes:
Raising Tax Rates on Big Corporations
- Increasing the corporate tax rate from 21% to 28%
- Raising the minimum tax on billion-dollar corporations from 15% to 21%
Cracking Down on Tax Avoidance
- Reforming the international tax system to reduce incentives for shifting profits to low-tax jurisdictions
- Denying corporate tax deductions for executive compensation over $1 million
- Quadrupling the tax on corporate stock buybacks from 1% to 4%
Requiring the Wealthy to Pay Their Fair Share
- Implementing a 25% minimum tax on billionaires’ total income
- Restoring the top marginal income tax rate to 39.6% for high-income individuals
- Ending preferential tax treatment for capital gains and dividends for the wealthy
These measures aim to close loopholes, crack down on tax avoidance, and ensure that the wealthiest Americans and largest corporations contribute their fair share to support critical public services and infrastructure.
Benefits for Working Families and the Middle Class
While targeting the wealthy and corporations, the Biden administration’s tax plan also includes provisions to provide relief and support for middle-class and low-income families.
Key elements include:
Expanding the Child Tax Credit
- Restoring the expanded Child Tax Credit, which helped lift millions of children out of poverty
- Providing an average tax cut of $2,600 for 39 million low- and middle-income families with 66 million children
Strengthening the Earned Income Tax Credit
- Enhancing the Earned Income Tax Credit for 19 million working individuals and couples, providing an average tax cut of $800
Making Health Insurance More Affordable
- Permanently extending the Affordable Care Act’s premium tax credit expansion, saving millions an average of $800 per year on health insurance premiums
These targeted tax cuts and credits are designed to provide much-needed support for working families and the middle class, helping to alleviate financial burdens and promote economic stability.
The Ongoing Debate and the Path Forward
The debate over tax policy remains a contentious and politically charged issue. As the Biden administration pushes for these reforms, they will likely face resistance from those who favor maintaining the status quo or further reducing taxes on the wealthy and corporations.
However, the administration argues that these proposals are essential for creating a fairer tax system, funding critical public services, and ensuring that the nation’s economic growth is broadly shared, rather than concentrated at the top.
Ultimately, the success of these tax reforms will depend on the ability of policymakers to navigate the political landscape and build the necessary support to enact meaningful change. (Link to https://www.stanleyparkhigh.co.uk/)
As the school community, we encourage you to stay informed on these important issues and to engage with your elected representatives to voice your concerns and priorities. Together, we can work towards a tax system that serves the best interests of all citizens, from students to families to businesses.
Conclusion
The tax landscape has undergone significant changes in recent years, with the Trump-era tax cuts primarily benefiting the wealthy and large corporations. However, the Biden administration’s proposed reforms aim to address these imbalances and ensure a fairer system that supports working families and invests in the nation’s future.
By understanding the complexities of business tax structures and the potential for abuse, we can better appreciate the importance of closing loopholes and requiring the wealthiest Americans and most profitable corporations to pay their fair share. At the same time, targeted tax relief for the middle class and low-income households can provide much-needed assistance and promote broader economic prosperity.
As members of the Stanley Park High School community, we have a vested interest in the outcomes of these tax policy debates. By staying informed and engaged, we can contribute to the ongoing dialogue and advocate for solutions that align with our values of equity, opportunity, and a brighter future for all.
