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Tax rates are only [x]%. The corporation is a distinct legal and tax entity from its owners. The corporation may use its income for any purpose without ever p

by rprasad 14y ago

Tax rates are only [x]%. The corporation is a distinct legal and tax entity from its owners. The corporation may use its income for any purpose without ever paying the income to its owners as dividends. Most corporate income will not go to its shareholders as dividends (or otherwise). Hence, it is inaccurate to say that the tax cost of limited liability is [x+y]% except in the very limited circumstances where all corporate profits are dividended up to the shareholders. When measuring the true total effective tax rate on a shareholder, you must exclude any corporate income which will not be dividended up from the calculation, so the effective tax rate becomes [x-z+y]%, where z is usually equal to or greater than 95% of x.

yummyfajitas 14y ago
If the money that would have been taxed doesn't go to the shareholders as dividends, then it goes to the shareholders as cap gains when they sell their shares.
- rayiner 14y ago
  That's an even stronger argument to taxing dividends the same as ordinary income. Say 10 people each invest $100 in a business. After 1 year of operation, the business generates $10,000 in profits. The business is taxed as a separate person, and has $6,500 left. With the $1,000 of initial capital, it's worth $7,500. Now, say one investor sells his shares for $7,500 / 10 = $750. How much richer is he? ($750 - $100) = $650. Now, say instead the company pays out all of its profits as a dividend. Each investor receives $6,500 / 10 = $650. The $100 of original investment will of course be recovered when he eventually sells his shares. In each case, the investor is $650 richer than he was previously. What amount should he be taxed on? $650! His net gain is $650. Why should be he taxed any differently on this net gain of $650 for a passive investment than someone who earns $650 in exchange for services?
  - yummyfajitas 14y ago
    I'm all in favor of taxing everything similarly. If a person makes $1000 pre-tax on a $100 investment, we should tax the $900 in a single chunk. The tax rate should probably be the same as the individual income tax rate, and it should be the same regardless of whether it is long or short term capital gains, dividends, interest or royalties. My objection is to breaking the tax up into pieces X+Y, and then acting as if the investor only paid Y. That's just a way of complicating the tax system and pretending investors pay less than they really do.
    - rayiner 14y ago
      Say you have a corporation C, owned by an investor I. When C makes $100 of income, it's not I's money. It's C's money. When C pays $35 of taxes on that $100, I isn't paying it. If C pays out a dividend to I, and I pays $10 on it, he's not being taxed ($35 + $10 = $45). He's paying $10. C and I are separate legal persons. Everything is accounted that way. E.g. when the U.S.'s GDP is calculated, C's income ($100) and I's income ($65) are added up and contribute $165 to the U.S. GDP. Yes, the taxes on C reduce the amount available for C to pay I as dividends. But that's true in any transaction between two people. The taxes on my income reduce the amount available for me to pay my nanny, but you don't add together the taxes I pay and the taxes she pays when computing her tax rate.
rprasad 14y ago
EDIT: This is a reply to yummyfajitas, not to myself. That's not how it works. The only time shareholders will see the corporation's income is if such income is distributed to them. Generally, this happens via: (1) a distribution of the corporation's assets, (2) a dividend, i.e., a distribution of the corporation's earnings and profits but not its assets, (3) a redemption which decreases the shareholder's ownerhsip, or (4) a liquidation which eliminates all shareholder's ownerships. Capital gains reflects the increase in the market value of the corporation. It is entirely possible, and usually is the case, that the market value of corporate stock is based on the "goodwill" value of the corporation (i.e., brand strength) rather than the corporation's cash earnings. For example...every tech company purchased in the past decade, including but not limited to, such notable non-revenue producing companies as Reddit and Instagram.
tomjen3 14y ago
The corporation is also distinct from its employees, but they get taxed once.
- rayiner 14y ago
  You're taxed on net income. Net income is gross income, minus expenditures necessary to produce that income. The labor of employees is necessary to produce income, so expenditures on employee salaries are deducted from gross income. Dividend payments are not necessary to produce income. Thus, they are not dedicated from gross income in computing net income.

by rprasad 14y ago

yummyfajitas 14y ago

If the money that would have been taxed doesn't go to the shareholders as dividends, then it goes to the shareholders as cap gains when they sell their shares.

rayiner 14y ago
That's an even stronger argument to taxing dividends the same as ordinary income. Say 10 people each invest $100 in a business. After 1 year of operation, the business generates $10,000 in profits. The business is taxed as a separate person, and has $6,500 left. With the $1,000 of initial capital, it's worth $7,500. Now, say one investor sells his shares for $7,500 / 10 = $750. How much richer is he? ($750 - $100) = $650. Now, say instead the company pays out all of its profits as a dividend. Each investor receives $6,500 / 10 = $650. The $100 of original investment will of course be recovered when he eventually sells his shares. In each case, the investor is $650 richer than he was previously. What amount should he be taxed on? $650! His net gain is $650. Why should be he taxed any differently on this net gain of $650 for a passive investment than someone who earns $650 in exchange for services?
- yummyfajitas 14y ago
  I'm all in favor of taxing everything similarly. If a person makes $1000 pre-tax on a $100 investment, we should tax the $900 in a single chunk. The tax rate should probably be the same as the individual income tax rate, and it should be the same regardless of whether it is long or short term capital gains, dividends, interest or royalties. My objection is to breaking the tax up into pieces X+Y, and then acting as if the investor only paid Y. That's just a way of complicating the tax system and pretending investors pay less than they really do.
  - rayiner 14y ago
    Say you have a corporation C, owned by an investor I. When C makes $100 of income, it's not I's money. It's C's money. When C pays $35 of taxes on that $100, I isn't paying it. If C pays out a dividend to I, and I pays $10 on it, he's not being taxed ($35 + $10 = $45). He's paying $10. C and I are separate legal persons. Everything is accounted that way. E.g. when the U.S.'s GDP is calculated, C's income ($100) and I's income ($65) are added up and contribute $165 to the U.S. GDP. Yes, the taxes on C reduce the amount available for C to pay I as dividends. But that's true in any transaction between two people. The taxes on my income reduce the amount available for me to pay my nanny, but you don't add together the taxes I pay and the taxes she pays when computing her tax rate.

rprasad 14y ago

EDIT: This is a reply to yummyfajitas, not to myself. That's not how it works. The only time shareholders will see the corporation's income is if such income is distributed to them. Generally, this happens via: (1) a distribution of the corporation's assets, (2) a dividend, i.e., a distribution of the corporation's earnings and profits but not its assets, (3) a redemption which decreases the shareholder's ownerhsip, or (4) a liquidation which eliminates all shareholder's ownerships. Capital gains reflects the increase in the market value of the corporation. It is entirely possible, and usually is the case, that the market value of corporate stock is based on the "goodwill" value of the corporation (i.e., brand strength) rather than the corporation's cash earnings. For example...every tech company purchased in the past decade, including but not limited to, such notable non-revenue producing companies as Reddit and Instagram.

tomjen3 14y ago

The corporation is also distinct from its employees, but they get taxed once.

rayiner 14y ago
You're taxed on net income. Net income is gross income, minus expenditures necessary to produce that income. The labor of employees is necessary to produce income, so expenditures on employee salaries are deducted from gross income. Dividend payments are not necessary to produce income. Thus, they are not dedicated from gross income in computing net income.