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INTRODUCTION

This pamphlet1 is prepared by the staff of the Joint Committee on Taxation for the House Committee on Ways and Means and Senate Committee on Finance in connection with the respective committee review of comprehensive tax reform proposals. This pamphlet is one of a series of tax reform proposal pamphlets. It describes and analyzes tax provisions and proposals relating to corporate taxation.

The pamphlet describes present law tax provisions and the tax reform proposal made by President Reagan ("The President's Tax Proposals to the Congress for Fairness, Growth, and Simplicity," May 1985, referred to as the "Administration Proposal"), the 1984 Treasury Department report to the President ("Tax Reform for Fairness, Simplicity, and Economic Growth," November 1984, referred to as the "Treasury Report"), Congressional proposals (identified by the primary sponsors), and other related proposals. Each part of the pamphlet includes an analysis of the tax-related issues. The first part of the pamphlet is a discussion of corporate tax rates. Part two discusses the two-tier tax on distributed income and certain exceptions. Part three discusses distributions and liquidating sales of appreciated assets and the General Utilities doctrine. Part four discusses entity classification, and part five discusses certain other corporate issues.

Additional corporate tax proposals relating to mergers and acquisitions are discussed in two Joint Committee on Taxation staff pamphlets Federal Income Tax Aspects of Mergers and Acquisitions (JCS 6-85), March 29, 1985; and Federal Income Tax Aspects of Hostile Takeovers and Other Corporate Mergers and Acquisitions (and S. 420, S. 476 and S. 632) (JCS 9-85), April 19, 1985. Proposals relating to corporate net operating loss carryovers are discussed in a Joint Committee on Taxation staff pamphlet, Special Limitations on the Use of Net Operating Loss Carryovers and Other Tax Attributes of Corporations (JCS 16-85), May 21, 1985.

1 This pamphlet may be cited as follows: Joint Committee on Taxation, Tax Reform Proposals: Corporate Taxation (JCS-40-85), September 19, 1985.

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I. CORPORATE TAX RATES

Present Law and Background

Corporate taxable income is subject to tax under a five-step graduated tax rate structure. The top corporate tax rate is 46 percent on taxable income over $100,000.

The corporate taxable income brackets and tax rates are presented in the following table:

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This schedule of corporate tax rates, which reduced the previously applicable rates for up to $50,000 of taxable income, was enacted in the Economic Recovery Tax Act of 1981 (ERTA), effective for 1983 and later years. For 1982, the applicable rates were 16 percent for taxable income not over $25,000, and 19 percent for taxable income over $25,000 but not over $50,000. For taxable years after 1979 and before 1982, the rates were 17 percent and 20 percent, respectively.

An additional 5-percent corporate tax is imposed on a corporation's taxable income in excess of $1 million. However, the maximum additional tax is $20,250. Thus, the benefit of the graduated rates is eliminated for corporations with income in excess of $1,405,000. This provision was enacted in the Deficit Reduction Act of 1984, effective for taxable years beginning after 1983.

Rules are provided to prevent the proliferation of the benefits of the graduated rates through the use of commonly controlled multiple corporations (secs. 1551, 1561-1564).

Other statutory provisions attempt to limit the use of corporations to avoid the individual tax rates. These are principally the accumulated earnings tax (secs. 531 et. seq.), the personal holding company tax (secs. 541 et. seq.), and certain personal service corporation provisions (sec. 269A).

An alternative tax rate of 28 percent applies to a corporation's net capital gain (the excess of net long-term capital gain over net short-term capital loss) if the tax computed using that rate is lower than the corporation's regular tax (sec. 1201).

Administration Proposal

Under the Administration proposal, tax would be imposed on corporations under the following schedule:

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The graduated rates would be phased out for corporations with taxable income over $140,000. Corporations with taxable income of $360,000 or more would pay, in effect, a flat tax at the 33 percent rate.

The alternative tax for net capital gains of corporations would remain at 28 percent.

The proposed tax rates would be effective July 1, 1986. Thus, the rate schedule for taxable years including July 1, 1986 would reflect blended rates based on the new rates effective on such date (see sec. 15).

1984 Treasury Report

Other Proposals

The 1984 Treasury Report would replace the present graduated corporate rate schedule with a single 33 percent rate on corporate income. The Treasury Report would repeal the current provisions concerning multiple related corporations and domestic personal holding companies.

S. 409 and H.R. 800 (Bradley-Gephardt)

The Bradley-Gephardt bill would replace the present law rate schedule with a single 30 percent rate on corporate income (the same as the top individual rate). This bill would repeal the current provisions concerning multiple related corporations, personal holding companies, personal service corporations, and the accumulated earnings tax. The bill would repeal the preferential rates for net capital gain.

H.R. 2222 and S. 1006 (Kemp-Kasten)

Under the Kemp-Kasten bill, income of large corporations generally would be taxed at a 35 percent rate. However, for corporate income under $100,000, graduated rates would apply. The first $50,000 of corporate income would be taxed at a 15 percent rate, and the second $50,000 would be taxed at a 25 percent rate. This rate reduction would save corporations with $100,000 of taxable income a total of $15,000 of tax (i.e., the difference between $35,000, the tax liability at a 35 percent rate, and $20,000, the tax liability at the proposed graduated rates). The benefit of graduated rates would not be phased out as under present law. For corporations electing capital gains treatment (rather than ordinary income treatment with basis indexed for inflation) the corporate capital gains rate would be 20 percent.

Analysis

The Administration proposal would retain a graduated rate structure for lower income corporations. The proposal states that adoption of a flat corporate rate (as proposed in the 1984 Treasury Report) would result in a substantial tax increase for low income corporations even though large corporations would benefit from a rate cut.la The proposal seeks to retain some rate cut benefit for smaller as well as larger corporations.

The present law graduated rates for lower income corporations are intended to encourage growth in small business by easing the tax burden on such businesses.

Some argue that there is no economic rationale for retaining lower rates for low-income corporations. They contend that the ability-to-pay concept underlying the progressive individual rates is not applicable to corporations because corporate income is used for reinvestment or payment of dividends rather than for direct individual consumption needs. They also argue that the graduated rate structure may discourage mergers of small corporations that potentially could exploit economies of scale and raise productivity. Some also contend that owners of small corporations are in many cases relatively affluent individuals who may be better off having income taxed at lower corporate rates than at their regular individual rates, and that small corporations with 35 shareholders or less may elect to be taxed as an S corporation, in which case there is no corporate-level income tax and corporate income is taxed directly to the shareholders at their tax rates.

The availability of the graduated corporate rates and of a top corporate rate lower than the top individual rate has made it necessary to provide complex rules to prevent the proliferation of low tax brackets through the use of commonly controlled multiple corporations and to maintain certain sets of rules aimed at preventing the use of corporations to avoid the individual tax rates. These latter provisions, especially the personal holding company tax, were originally enacted in large part to prevent individuals from avoiding the individual rates at a time when the top individual rates were substantially higher than the corporate rates. Under present law, the top individual rate is 50 percent and the top corporate rate is 46 percent. Under the Administration proposal, the top individual rate is 35 percent and the top corporate rate is 33 percent. Use of the graduated corporate rates by individuals in the top income tax bracket could produce additional tax savings to the extent of undistributed corporate income. A main function of provisions such as the personal holding company tax under the Administration proposal would be to limit such use of the graduated corporate rates.

The 1984 Treasury Report would have contained the same two point differential in the top individual and corporate rates as does the Administration proposal, but did not provide graduated corpo

la Under the 1984 Treasury proposal, the tax rate applicable to corporations with taxable income below $155,770 would increase, while the tax rate applicable to corporations with income equal to or greater than $155,770 would decrease.

rate rates and would have repealed the personal holding company

tax.

Some have suggested providing a top corporate rate equal to the top individual rate. Others contend that a lower top corporate rate is appropriate to relieve double taxation of corporate income (see Part II, infra). Some suggest that the benefit of favorable corporate rates could be used as an incentive to certain goals. For example, proponents of broader employee ownership of corporations have suggested favorable lower rates for corporations with a specified percentage of employee ownership, or with progressively increasing employee ownership, as one of several possible incentives.2

2 See separate Joint Committee on Taxation staff pamphlet, Tax Reform Proposals: Tax Treat

ment of Employee Stock Ownership Plans (ESOPs) September 1985.

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