RELEASE: Big Business and the Financial Industry Avoid Corporate Tax with Pass-Through Loophole, Which Cost the United States Nearly $800 Billion Between 2003 and 2012

Washington, D.C. — Big businesses are avoiding billions of dollars in taxes by using business forms originally designed for smaller, simpler businesses, a new report released today by the Center for American Progress reveals. These business forms—which are primarily partnerships and S corporations—pay very low effective tax rates, even though more than 70 percent of their receipts go to big businesses. CAP’s report also highlights that 70 percent of partnership income goes to the financial industry and holding companies, and 70 percent of partnership and S corporation income goes to the top 1 percent of U.S. households by income. This tax move, while entirely legal, cost the U.S. government nearly $800 billion between 2003 and 2012, which is more than the amount originally authorized for the financial industry bailout of 2008.

Corporations organized under Subchapter C of the U.S. Internal Revenue Code pay the corporate income tax, while other types of businesses—such as S corporations, partnerships, and sole proprietorships—do not pay any income tax at the entity level. In those types of businesses, income is passed through to owners who instead pay the individual income tax on their proportionate share of the pass-through business’ taxable income. CAP’s report reveals that big businesses are not paying corporate taxes because they are structuring in this latter category as pass-through entities. As a result, these big businesses do not pay corporate income taxes. The top 1 percent as well as the financial industry and holding companies are some of the biggest beneficiaries of these tax savings.

Moreover, the rise of pass-throughs is playing a significant role in the rise of income inequality, as nearly 40 percent of the increased share of income going to the top 1 percent of households is explained by pass-through income—that is twice as much as other forms of capital, including corporate stocks and bonds. Pass-throughs also scarcely contributed to middle-class income growth, CAP’s report shows, accounting for just 7 percent of that growth between 1979 and 2011.

“The notion that all pass-throughs are small businesses is simply false. There are a growing number that are big in every sense of the word—size, structure, and savvy,” said Alexandra Thornton, Senior Director for Tax Policy at CAP and coauthor of the report. “The ability of large businesses to organize—completely legally—as pass-through businesses in order to avoid paying corporate income taxes is a major and unaddressed loophole in our tax system that is frankly unfair to truly small businesses and the overwhelming majority of taxpayers who have to make up for the lost tax revenue.”

“The alarming use of pass-through entities by big businesses, and the corresponding decline in corporate income tax revenue, is further evidence that our tax system is tilted heavily in favor of the wealthy and Wall Street,” said Brendan V. Duke, Associate Director of Economic Policy at CAP and coauthor of the report. “Policymakers can and should act to ensure that big financial companies and the wealthy pay their fair share of taxes, including by making large pass-through businesses pay an entity-level tax, and ensuring that the wealthy don’t use pass-throughs to avoid payroll or investment taxes.”

CAP’s report demonstrates how pass-through structures have been used by big business, the financial industry, and the wealthy in order to reduce their tax bills, and offers recommendations for Congress to ensure that businesses pay their fair share of taxes. Those recommendations including making large pass-through businesses pay tax like C corporations; making sure that wealthy taxpayers with business income pay their fair share, just as working families do; and by carefully targeting truly small businesses in tax reform.

Click here to read “Ending the Pass-Through Tax Loophole for Big Business” by Alexandra Thornton and Brendan V. Duke.

For more information or to speak with an expert, contact Chelsea Kiene at ckiene@americanprogress.org or 202.478.5328.

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