The effective federal income tax rate—or the actual percent of net income that a firm pays as taxes—varies by its form of organization, according to Effective Federal Income Tax Rates Faced by Small Businesses in the United States. The new report from the Office of Advocacy of the U.S. Small Business Administration shows that overall, small businesses of all types pay an estimated average effective tax rate of 19.8%. Sole proprietorships face a 13.3% rate and small partnerships face 23.6%. In contrast, small Subchapter S corporations face a 26.9% effective tax rate. Although not directly comparable, small C corporations face an effective rate of 17.5%. (For the purpose of this study, the authors, Quantria Strategies, define a small business as a firm with less than $10 million in gross receipts).
Why the discrepancy for S corporations? A recent write-up in the Washington Wire, published by The S Corporation Association, an advocacy group, notes that “the tax treatment of S corporations at the federal level is mirrored on the tax treatment of partnerships. One possibility is that S corporations may tend to be older, more mature companies that were organized before the emergence of the Limited Liability Company.” In addition, they cite Quantria’s explanation that “the effective tax rate for C corporations does not include taxes paid by shareholders on dividends and capital gains.”
The progressivity of the tax code also affects effective rate calculations, as firms with less income face a lower statutory rate. The data reveal that nearly 60% of small sole proprietorships have a net income of less than $10,000, but only 3.1% have a net income of at least $100,000. On the other hand, more than 18% of small S corporations have a net income of at least $100,000. The authors primarily used data from the IRS Individual Statistics of Income Public Use File, 2004, as the basis for the study. A complete copy of the report is available here.
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