In contrast, the income of C corporations is taxed once at the corporate level according to the corporate tax system, and then a second time at the individual-shareholder level. The fact that pass-throughs are responsible for more than half of business income is important because recent tax reform discussions have included the possibility of lowering the tax burden on these businesses. This report uses a nationally representative sample of individual tax returns to analyze who earns pass-through income. Who Earns Pass-Through Business Income? This section analyzes the distribution of pass-through income by adjusted gross income (AGI). Taxpayers with an AGI of $100,000 or greater earned 84% of pass-through income, while accounting for roughly 23% of returns reporting pass-through income. Conversely, taxpayers with AGI less than $100,000 earned about 16% of pass-through income, but accounted for 77% of returns with pass-through income. A significant proportion of pass-through income was concentrated among upper-income earners. Taxpayers with an AGI over $250,000, for example, received 63% of pass-through income, but accounted for just over 6% of returns reporting such income. Those with an AGI in excess of $1 million earned about 32% of pass-through income, while filing roughly 1% of all returns reporting pass-through income. Partnership net income was more concentrated among upper income individuals with nearly all of it accruing to taxpayers with AGI in excess of $100,000, including nearly 48% accruing to those with AGI over $1 million. Nearly all of S corporation income was also earned by taxpayers with an AGI over $100,000, but a greater share of S corporation income than partnership income was earned by those with an AGI over $1 million—about 52%. Sole proprietorship income is not distinguished in the data used in this analysis. Tax Reform Considerations

Recent tax reform discussions have included lowering the tax rates and tax burden on pass-through income. While lowering the tax burden on pass-through income could potentially stimulate the economy, particularly in the short-run, it may also reduce the progressivity of the tax code. As previously stated, 62% of pass-through income was earned by taxpayers with an AGI over $250,000, and 32% was earned by individuals with an AGI in excess of $1 million. The distributions of partnership and S corporation income were more heavily skewed to the upper end of the income distribution. By taxing business income at a lower rate than labor income, employee-owners of pass-throughs may characterize labor income as business income to take advantage of the lower tax rate. Additionally, a rate reduction on pass-through (or corporate) income by itself does little to simplify the tax treatment of businesses. The majority of the complexity in the tax system is the result of special tax incentives such as exclusions, credits, and deductions.
Pass-through businesses—sole proprietorships, partnerships, and S corporations—generate more than half of all business income in the United States. Pass-through income is, in general, taxed only once at the individual income tax rates when it is distributed to its owners. In contrast, the income of C corporations is taxed twice; once at the corporate level according to corporate tax rates, and then a second time at the individual tax rates when shareholders receive dividend payments or realize capital gains. This leads to the so-called "double taxation" of corporate profits.
This report analyzes individual tax return data to determine who earns pass-through business income. The analysis finds that in 2011 over 82% of net pass-through income was earned by individuals with an adjusted gross income (AGI) over $100,000, although these taxpayers accounted for just 23% of individual returns with pass-through income. A significant fraction of pass-through income is concentrated among upper-income earners. Taxpayers with an AGI over $250,000, for example, received 62% of pass-through income, but accounted for just over 6% of returns with pass-through income. Individuals with an AGI in excess of $1 million earned about 32% of pass-through income, while filing roughly 1% of all returns with pass-through income
The findings change slightly when the data for each organizational type are analyzed separately. Nearly half of sole proprietorship income was earned by individuals with an AGI of $100,000 or less. Taxpayers with an AGI between $100,000 and $500,000 earned 39% of sole proprietor income. Individuals with an AGI in excess of $1 million earned 6% of sole proprietor income. Partnership net income was more concentrated among upper-income individuals with nearly all of it accruing to taxpayers with AGI in excess of $100,000, including nearly 48% accruing to those with an AGI over $1 million. Nearly all of S corporation income was also earned by taxpayers with an AGI over $100,000, but a greater share of S corporation income than partnership income was earned by those with an AGI over $1 million—about 52%.
Who earns pass-through income may have important implications for tax reform. Recent tax reform discussions have included taxing pass-through income at a lower rate than the current rate. While lowering the tax burden on pass-through income could potentially stimulate the economy, particularly in the short-run, it could also reduce the progressivity of the tax code given the share of pass-through income that is attributable to the upper end of the income distribution. Tax reform could also result in pass-through income being taxed at lower rates than labor income. This could lead some taxpayers to characterize labor income as business income to minimize taxes. Additionally, a tax rate reduction on pass-through (or corporate) income does little to simplify the tax treatment of businesses. The majority of the complexity in the tax system is the result of special tax incentives such as exclusions, credits, and deductions, formally known as "tax expenditures." Finally, reducing taxes on pass-through businesses could have important budgetary and revenue impacts.