Several lawmakers and the Obama Administration have recently expressed interest in taxing large partnerships and S corporations, also known as pass-throughs, as corporations. Pass-throughs may be a source of revenue since they currently comprise over half of all business income but generally pay no corporate tax. Today, two businesses that are otherwise identical other than that one is a corporation and one is a pass-through are taxed differently. This disparity could be viewed as inequitable since the firms are similarly positioned to pay taxes. Additionally, the lack of tax uniformity across business types is believed to result in too much investment in the non-corporate sector where the after-tax return on investment is higher. Taxing large pass-throughs as corporations, when combined with other reform proposals such as eliminating or reducing corporate tax preferences and loopholes, would broaden the corporate tax base and allow for lower tax rates. There are alternative policy prescriptions that can promote business tax uniformity and increase efficiency. For these reasons integration is generally appealing to economists. If, for whatever reason, integration is not possible, then reducing the tax discrepancy between large pass-throughs and corporations may be a viable policy alternative. The impact on businesses is not the only perspective one can take when it comes to changing the tax treatment of pass-throughs. An Analysis of Individual Tax Return Data , by [author name scrubbed] examined the issue of pass-through taxation from the perspective of individual taxpayers. That report concluded that although the corporate tax would be levied on pass-throughs, individuals would bear the full burden of the tax since businesses are legal, not physical entities. In addition, the analysis in that report suggests that higher-income taxpayers would generally bear most of the burden from increased pass-through taxes because they earn the majority of pass-through income and are limited in their ability to shift the burden to lower-income taxpayers. About 30% of S corporation receipts are generated by the largest 0.3% of S corporations, and 41% of partnership receipts are generated by the largest 0.2% of partnerships. For example, 43% of S corporation assets are held by the largest 0.2% of firms, and 78% of partnership assets are held by the largest 1.1% of firms. It is estimated that holding companies would be most affected. Conclusion

This report used aggregate and industry-level individual tax return data to analyze how many partnerships and S corporations could be subject to the corporate tax. The analysis determined that if a receipt-based measure of size is used, then between 0.3% and 1.5% of S corporations and partnerships could be taxed as corporations depending on the definition of a "large" pass-through—either receipts exceeding $50 million or $10 million. Using an asset-based measure of size produces similar estimates. It is estimated that between 0.3% and 1.0% of pass-throughs could pay the corporate tax depending on whether a $100 million or $25 million asset threshold is used to define a "large" firm. Although estimates suggest that only a small percentage of pass-throughs could be considered large for corporate tax purposes, the affected firms are responsible for a significant amount of economic activity, indicating that the proposed policy change could potentially raise substantial revenue. CRS Report R42359, Who Earns Pass-Through Business Income?
Several lawmakers and the Obama Administration have expressed interest in taxing large partnerships and S corporations, also known as pass-throughs, as corporations. Part of this interest appears to be related to deficit and debt concerns. Pass-throughs may be a source of revenue since they currently account for over half of all business income but generally pay no corporate tax. Additionally, there is a growing concern that the current business tax environment may be inequitable and inefficient. Today, two business that are otherwise identical except that one is a corporation and the other is a pass-through are taxed differently. This disparity could be viewed as inequitable since the companies are similarly positioned to pay taxes. Additionally, the lack of tax uniformity across business types may cause an inefficient allocation of resources if business decisions are made for tax reasons and not economic reasons.
This report uses aggregate and industry-level tax data to analyze how many partnerships and S corporations could be subject to the corporate tax. It is estimated that if a receipt-based measure of size is used, then between 0.3% and 1.5% of S corporations and partnerships could be taxed as corporations depending on if a "large" pass-through is defined as one with receipts exceeding $50 million or exceeding $10 million. Using an asset-based measure of size produces similar estimates. It is estimated that between 0.3% and 1.0% of pass-throughs could pay the corporate tax depending on whether a $100 million or $25 million asset threshold is used to define a "large" firm.
Although estimates suggest that only a small percentage of pass-throughs could be considered large for corporate tax purposes, this report also finds that those firms are responsible for a significant amount of economic activity, indicating that the proposed policy change could raise substantial revenue. For example, 30% of S corporation receipts are generated by the largest 0.3% of S corporations, and 41% of partnership receipts are generated by the largest 0.2% of partnerships. Similarly, the largest 0.2% of S corporations hold 43% of S corporation assets, while the largest 1.1% of partnerships hold 78% of partnership assets.
Taxing large pass-throughs as corporations would also allow for lower tax rates as it would broaden the corporate tax base. Lower tax rates combined with a reduction in the tax disparity between the corporate and non-corporate sectors could improve business tax equity and the allocation of resources relative to current policy. At the same time, an alternative policy prescription that is generally more appealing to economists—integration of the corporate and individual tax systems—could also achieve these objectives. If integration is not possible, however, then reducing the tax discrepancy between large pass-throughs and corporations may be another viable alternative, depending on its design.
The focus on businesses is not the only perspective when it comes to changing the tax treatment of pass-throughs. CRS Report R42359, Who Earns Pass-Through Business Income? An Analysis of Individual Tax Return Data, by [author name scrubbed], examined the issue of pass-through taxation from the perspective of individual taxpayers. That report concluded that although the corporate tax would be levied on pass-throughs, individuals would bear the full burden of the tax since businesses are legal, not physical entities. In addition, the analysis in that report suggests that higher-income taxpayers would generally bear most of the burden from increased pass-through taxes because they earn the majority of pass-through income and are limited in their ability to shift the burden to lower-income taxpayers.