The Journal of Things We Like (Lots)
Select Page
Steven M. Rosenthal and Lydia S. Austin, The Dwindling Taxable Share Of U.S. Corporate Stock, Tax Notes 923 (May 16, 2016).

The Dwindling Taxable Share Of U.S. Corporate Stock, written by Steven M. Rosenthal and Lydia S. Austin, analyzes the available data regarding the ownership of corporate stock in the United States. Over the history of the income tax, most business capital has been invested in corporations, so an assumption that the income taxation of business meant income taxation of corporations was a reasonable assumption. Similarly, most owners of domestic capital were assumed to be taxable individuals.

One could, therefore, use as a starting point for any reform proposal, the idea that a corporation would be taxed at the stated corporate rates and would make distributions of earnings to individuals who would be taxed at the stated individual rates. Rationalization of business taxation has often aimed at eliminating the incentive to engage in business investment other than through corporate entities. This rationalization (or “integration”) using these standard assumptions about the nature of corporate holdings, involves pushing the corporate tax out to shareholders (by effectively reducing rates when corporate income is distributed), or pushing the individual tax into corporations (by effectively reducing the rate on dividends received).

As many involved in the realpolitik of tax reform in the last decade appreciate, this easy starting point is no longer available. Although corporations continue to be registered in increasing numbers, and start-up enterprises continue to use them, free-standing corporations are now far less likely to either be the direct holders of productive assets or to be directly held by taxable individuals. Corporations are now much more likely to be minority shareholders in noncorporate entities, are more likely to be held by ownership chains that no long involve 80% control (the prerequisite to aggregation of entities into single entities for tax purposes) and, as Rosenthal and Austin demonstrate, more likely to have shareholders that are not taxable individuals.

The authors have set out to unpack the actual nature of the shareholder side of corporate taxation. Although it has been acknowledged for many years that not all shareholders are subject to tax on their corporate holdings, the prevailing assumption has been that most shareholders are, and thus that the earnings on capital invested through US corporations are, absent some sort of sophisticated tax planning, subject to two levels of tax. Reform has meant designing taxes such that the combination of the tax on corporations and the tax on shareholders is no more than the tax on investment made without the use of the corporate form.

Rosenthal and Austin review the work of others and the statistical reports in the Financial Accounts reported by the Federal Reserve. They conclude that a relatively low proportion of corporate holdings are subject to such double taxation. Their conclusion is that something just less than 25% of corporate entities are owned by taxable individuals. The biggest difference in the approach of Rosenthal and Austin involves disaggregating the Federal Reserve classification of “households” into nontaxable and taxable holders. Much of the nontaxable holdings are in pension plans and other preferred tax savings vehicles.

Rosenthal and Austin’s work complicates the task of rationalizing the corporate income tax. The challenge of the tax reformer becomes not simply developing a scheme that equates the taxation of returns to corporate equity with the returns made through other legal entities, but also determining which of the varied patterns of shareholder taxation should be preserved. This, in turn, requires determining whether the inducements intended when these patterns were created should be preserved, even if it means there may be no US tax imposed on some returns.

Rosenthal and Austin presented their work primarily to address the integration debate. Their work provides support for those who would push shareholder taxes in (even if this means eliminated some shareholder preferences) rather than pushing corporate taxation out, and relying on shareholder taxation. But their work has done something equally important, in showing how little we actually know about the taxation of business income. They did not attempt to unpack the corporate side of the historical assumptions. But it prompts a series of questions including the extent of investment made entirely outside of corporate entities, and the amount of investment made nominally through corporate entities but which is in fact under the control of entities in partnership with such corporations. These corporate-side questions present equivalent challenges to old assumptions about the nature of business taxation.

Rosenthal and Austin have made the work of those analyzing the taxation of business income in the US much harder. But that is a good thing, if it results in a disruption of the old approaches to integration and corporate reform more generally.

Download PDF
Cite as: Charlotte Crane,  Who Gets Taxed When a US Corporation Pays Dividends?, JOTWELL (December 5, 2017) (reviewing Steven M. Rosenthal and Lydia S. Austin, The Dwindling Taxable Share Of U.S. Corporate Stock, Tax Notes 923 (May 16, 2016)),