The Zero Tax Plan: End Business Taxes
If you followed the 2012 Republican presidential nomination (which seemed like ages ago) you undoubtedly remember Republican Herman Cain’s “9-9-9” tax proposal in which he advocated a nine-percent flat income tax for corporations, a nine-percent flat income tax for individuals, and a nine-percent national sales tax.
Other Republican presidential candidates issued their own tax reform plans. Texas governor Rick Perry had a Steve Forbes inspired plan. Under his plan both corporations and individuals would pay a 20 percent flat tax, and government spending would be capped at 18 percent of GDP.
The 2012 Republican primary was won by Mitt Romney who did not have a flat tax proposal. He proposed instead cutting personal and corporate income tax rates by 20 percent and 29 percent, respectively.
But flat-tax proposals die hard. During the 2016 Republican primary, Senator Ted Cruz proposed a 10 percent flat tax on individuals and a 16 percent “Business Transfer Tax” on corporate income and payroll.
No one, however, proposed anything like me--the zero-percent solution. Under my plan corporations pay no income tax. Nothing!
I haven't lost my senses. In fact, I have given my zero-percent solution careful analysis-- drawing on over thirty-years’ experience in the tax profession. Here’s why I have concluded that corporations should pay no income taxes:
A corporation, like a partnership, is a legal entity, one generally established to conduct one or more business activities. Unlike people, who are natural persons, corporations and partnerships are creatures of law, and owned by others: Corporations are owned by stockholders, and partnerships are owned by partners, both of whom more often than not are natural persons who do pay taxes.
Partnerships, however, do not pay income taxes. Even in tax-happy states like New York, partnerships pay no federal or state income taxes. And a partnership’s profits can be quite substantial-- often in the millions.
Limited Liability Companies (commonly referred to as LLCs) like partnerships pay no income taxes. In fact, there is nothing in the U.S. Tax Code or IRS regulations requiring the taxation of LLCs. In general, LLCs are taxed like partnerships--which means they are not taxed at all. I read recently that PriceWaterhouseCoopers (PWC) is the largest Limited Liability Company in the U.S. PWC is a public accounting firm with more than 150,000 employees worldwide. They pay no U.S. federal income taxes.
One of the simplest (and popular) ways to conduct business is the sole proprietorship. I have conducted my accounting and tax practice as a sole proprietorship for many years. Like partnerships and limited liability companies, there is no income tax on a sole proprietorship's profits. Indeed, the IRS treats the sole proprietorship as a “disregarded entity” and, therefore, is not taxed.
● There is no partnership tax;
● There is no limited liability company tax; and
● There is no sole-proprietorship tax.
But consider the corporate form of doing business. It’s a mix of good and bad news. The good news is that corporations with no more than 100 shareholders can elect not to be taxed. This can be done by the timely filing of a simple document: Form 2553 -- Election by a Small Business Corporation. Once approved (and it generally always is) the S corporation (as it is often called) is on an equal tax footing with partnerships, limited liability companies, and sole proprietorships. No tax!
The bad news (unless you have fallen in with the “corporate greed” crowd) is that once a corporation needs to raise additional capital in order to expand its operations, more often than not it must sell shares to the public--the usual route of most successful corporations.
Private corporations go public via an initial public offering (IPO) of its common stock. Once the corporation crosses the 100 shareholder line, however, it no longer qualifies as an S corporation, so it’s forced to choose between staying private and paying no tax, or going public and having Its profits eaten up by federal, state, and local taxes. Money that could have been used to buy equipment, build factories, and hire workers (heaven forbid) goes instead to support the government and its many friends in places high and low.
Let’s look at Proctor and Gamble (P&G) to illustrate the problem. P&G, the manufacturer of Tide and Bounty, had pre-tax earnings for the fiscal year ending June 30, 2022 of $17,995 million. It paid income taxes of $3,202 million--an effective tax rate of almost 18%. Its net earnings after taxes, therefore, was $14,793 million. During the same fiscal year, it paid dividends of $8,770 million. Dividends are a distribution of after-tax net earnings paid to the owners of the business--the shareholders. Contrary to what many believe, dividends are not a deductible expense. As a result, dividends do not reduce a corporation's taxable earnings. The dividend yield on P&G’s stock is just 2.43%. That represents the investment return to P&G shareholders.
The story, however, does not end there. Let’s say you owned 1,000 shares of P&G stock in 2022, and each share of stock pays a $3.65 dividend. Since you owned 1,000 shares, your total dividends for the year will be $3,650. During January 2023 you will get an important tax document in the mail from P&G--just in time to prepare your income tax returns. It’s called Form 1099-DIV. P&G is required to report to you and the IRS the dividends paid to you. And you must report these dividends on your tax return and pay federal, state, and local taxes on this income.
Those who have been paying attention to what I have been writing should be jumping up right now saying, “Wait a minute. Wasn’t that money already taxed?”
Since dividends are a distribution of after-tax net earnings, the taxation of dividends is in fact a double tax on profits: Once when earned by the corporation, and again when distributed to shareholders.
Partners, LLC members, S-corporation shareholders, and sole proprietors pay tax on their pro-rata share of business profits. The profits are said to “flow through” to the owners--even when undistributed. Any subsequent distributions to the owners are generally tax free because there is one tax (not two) on business profits. Since corporate dividends are taxable, and the dividends are paid from profits that have already been taxed, the only way to level the playing field and bring some semblance of tax fairness to the system is to exempt corporations from income tax.
When corporations are free of the double taxation on profits, an explosion of business activity will surely follow. Investment and production will be set free from the deadweight of government tax confiscation. Equity will replace debt as the favored method of business financing. Projects that are uneconomical on an after-tax basis will now become viable. Investments in property, plant, and equipment will expand, thus creating jobs, new products and services, and real wealth. That’s why I propose a zero-percent solution, but don’t hold your breath. There are too many in the “deep state” that are dead set against this ever happening.