When most people think of corporations and corporate taxes, they think of a company with shareholders, and buying and selling stock. But that’s only one form of corporation, called a C-corporation in tax law. There are also corporations that don’t issue shares of stock to the public. This category includes sole proprietorships, partnerships, and what are called S-corporations. These are “pass-through” corporations, in which the income earned by the corporation goes straight to the owners, and thus is taxed under the personal income tax rather than the corporate income tax. The pass-through sector of the economy is growing, as Aaron Krupkin and Adam Looney review the evidence in “9 facts about pass-through businesses” (Brookings Institution, May 15, 2017).
As they explain, “Of the 26 million businesses in 2014, 95 percent were pass-throughs, while only 5 percent were C-corporations.” But most businesses are very small: for example, 41% of those 26 million businesses were sole proprietorships. Moreover, 99% of all companies and 95% of C-corporations had receipts of less than $10 million.
The share of total business income in C-corporations is falling, and share in partnerships and S-corporations is rising, to the point where pass-through corporations now receive more than half of all business income.
The tax rules are different in a variety of ways across these corporate forms. For example, if you receive a payment from a company for your labor, you owe Social Security and Medicare payroll taxes on that amount, but if you receive a share of profits, then then you don’t owe those payroll taxes. The decision about what is a payment for labor and what is a share of profits contains a large element of discretion. Thus, substantial time and energy goes into finagling the legal structure of the corporation, in part to take advantage of tax differences.
For example, the shares of C-corporations are “closely held” by a small number of investors, which can make them similar in some ways to S-corporations. Krupkin and Looney write:
