Effective Federal Income Tax Rates Faced By Small Businesses

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Overall Findings

While they are very widely referred to, the statutory tax rate does not represent the most useful measure of the effect of taxes on businesses. The effective tax rate captures the actual rate paid by businesses. The authors estimated that small businesses pay an average effective federal income tax rate of 19.8 percent.

Highlights

@        Small business sole proprietorships pay an average effective tax rate of 13.3 percent. Sole proprietors make up 84 percent of businesses with gross receipts of less than $25,000 (13.5 million out of 15.9 million).

@        The other kinds of small business entities face higher rates. Small business partnerships have an average effective tax rate of 23.6 percent, small S corporations have a rate of 26.9 percent, and small business C corporations have a rate of 17.5 percent. (The calculations for C corporations are conceptually different from those for other entity types and thus are not directly comparable with the other entities.)

@        Small partnerships, S and C corporations’ higher effective tax rates are also a function of their relative size distribution. Small partnerships constitute 10 percent of small businesses with gross receipts between $100,000 and $250,000; small business S corporations constitute 23 percent of this size range; and small C corporations constitute 13 percent of this group.

@        Effective tax rates by industry group vary little among partnerships and S corporations. Among sole proprietors, the rate ranges from 4.1 percent for utilities (the smallest industry group represented) to 14.2 percent for wholesale and retail trade. Among C corporations, the rate ranges from 12.9 percent for agriculture to 27.1 percent for utilities (again, the smallest industry group represented).

@        The effective federal income tax rate is one element of the overall tax burden, which also includes the Federal Insurance Contributions Act, or FICA, tax (which falls most heavily on the smaller entities), state and local taxes, and fees for permits and licenses.

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