A robust corporate income ensures that profitable corporations that benefit from public services pay their fair share towards the maintenance of those services, just as working people do. More than forty states currently levy a corporate income tax. This policy brief explains why corporations should be taxed and the basic workings of the corporate tax.
Why Tax Corporations?
Corporations are legally considered “persons,” eligible for many of the same rights and protections as ordinary men and women. And just as working families and individuals benefit from the services that state and local governments provide, so too do corporations. Corporations rely on a state’s education system to provide a trained workforce, use a state’s transportation system to move their products from one place to another, and depend on the state’s court system and police to protect their property and business transactions. While corporations—like individuals—may pay taxes on the purchases they make or on the property they own, they should also pay taxes on the profits they realize, much in the way that people earning a living in the state pay taxes on their income.
Of course, while a corporation may be treated as a single legal person, it exists in reality as a collection of individuals—the shareholders that own it; the executives and staff that work for it; and the consumers that buy its products. As a result, any tax levied on a corporation ultimately falls on one of these groups. Economic research generally indicates that for the most part, it tends to be borne by corporate shareholders. From a fairness perspective, the corporate income tax has three important attributes:
- The corporate income tax is one of the most progressive taxes a state can levy. Since stock ownership is concentrated among the very wealthiest taxpayers, the corporate income tax falls primarily on the most affluent residents of a state.
How Corporate Income Taxes Work
In its simplest form, the corporate income tax is a tax on corporate profits. The corporate tax is based on the “ability to pay” principle: a corporation that does not realize a profit in any one year generally does not owe any corporate income tax that year. Here’s an overview of how the state corporate income tax is calculated:
- Determining who can be taxed. A given company must determine whether it has nexus in a given state—that is, the company must determine whether it engages in a sufficient level of activity in the state to be subject to tax. The
amount of in-state activity in which a company must engage before achieving nexus with a state for corporate income tax purposes is defined by a little-known federal law known as Public Law 86-272, which says that a state cannot apply its corporate income tax to companies whose only connection to the state is the solicitation of orders from, or the shipment of goods to, the residents of the state. Companies are well aware of nexus requirements and may structure their operations so that they avoid “crossing the nexus threshold” —and, by extension, the corporate income tax—in some of the states in which they do business.
The corporate income tax is an important component of many state’s tax structures. Though the revenue generated from the tax has declined in recent years, a robust corporate income tax can- and should – be part of each state’s tax system. Policymakers should work to understand how the corporate tax is calculated to ensure that corporations are paying their fair share. Despite the worrisome recent drop in the yield of these taxes, virtually every state now has available a straightforward set of tax reform policies that could not only end the erosion of their corporate tax base, but could help these taxes regain their former health.