How Did Corporations Fare Under This Law?

The recently passed tax law’s most significant and lasting changes are to the corporate tax code. Starting this year, C-corporations will be taxed at a 21 percent rate, down from 35 percent. That represents a 40 percent cut in their tax rate.

The law also created a territorial taxation system, changing how profits earned overseas are taxed. Given the intricacies of that system, it is likely that it will be more financially advantageous for some companies that already have an overseas presence – large, multinational corporations – to expand their presence overseas and shrink their American presence in order to more fully reap the rewards of this change to the system.

• So, what is a C-corp – who gets the benefit of this tax cut?A C-corp is a company whose profits are taxed separately from its owners, or a company that stands as an independent tax entity. C-corps are companies that you think of when you think of major companies: Walmart, AT&T, Amazon. However, most businesses are classified as S-corporations, which is a corporation whose profits are taxed through an individual (an owner). S-corporations are also known as “pass-through entities,” because the profits of an S-corp “pass through” to their owners. The 40 percent rate reduction that was just signed into law applies only to those major corporations – just 5 percent of businesses in the country. However, that small slice of businesses makes 44 percent of business income. So, under this new corporate rate reduction, a small number of very large corporations will get a very large tax break.

Tax rate on corporate income

The centerpiece of the new tax law is a cut in the corporate tax rate from 35 percent to 21 percent; over the next ten years, the tax benefit to corporations from this new much lower rate will total $1.3 trillion. And unlike all of the changes to the individual code, which expire after 2025, this corporate rate cut is permanent.

It is worth noting that, while the previous 35 percent marginal tax rate was relatively high compared to other developed countries, large corporations didn’t typically pay anything near that rate. Even before the new law, United States corporations paid significantly less in taxes than their statutory rate would suggest. The U.S. effective corporate tax rate was in line with countries with comparable economies. Now, with the cuts to the marginal corporate rate, the effective rate will be significantly lower. The reduction largely benefits corporate shareholders: research suggests that about 70 percent of the benefit of a corporate rate cut will flow to the top 20 percent of households, with one-third flowing to the top 1 percent alone.

• Did the new tax law close corporate loopholes?The law increases the gap between the taxation of different industries and the taxation of different types of income, which incentivizes businesses to reclassify their income to fit the most advantageous tax status. For some corporations, that might encourage tax sheltering by turning C-corporations into a device to shield income from the top individual income rate. For example, tax experts have highlighted the likelihood that high-earners will use the new tax law to set up a corporation — and then reclassify their labor income as corporate profits, now taxed at the new preferential 21 percent rate. This sort of opportunity increases the disparity between different types of businesses, since large corporations and wealthy individuals are best equipped to identify and exploit loopholes and other weaknesses in the tax code.

Shift to a “territorial” tax system

The law also shifts the corporate tax code toward a “territorial” system, where profits earned overseas face a tax rate of only 10.5 percent — or half the tax rate for corporate profits earned in the United States. This system has the effect of giving foreign earnings preferential treatment over domestic earnings and may create incentives to offshore business operations and income. This provision will allow large, multinational corporations to funnel their profits to tax shelters and other low-tax foreign jurisdictions — something that small, domestic firms are unable to do.

The Upshot

As a result of the new tax law, large corporations — especially those with international operations — will have access to new tax planning and avoidance opportunities. This will have the effect of providing significant tax advantages over domestic corporations and small businesses.