Business income taxes in Indiana: who pays?

• Author: Faulk, Dagney

Corporate income tax revenues as a share of total tax revenues at the national level have declined over the past decade, as evidenced by a recent report by the federal General Accounting Office, which found that a majority of corporations reported no federal corporate income tax liability during the 1996-2000 period. (1) The large portion of corporations with no federal income tax liability has raised questions about business income taxes at the state level. A comprehensive analysis of business income taxes includes analyzing not only corporate income tax systems but also business income taxed through the individual income tax system. (2)

The examination of business income taxed through the individual income tax systems is particularly pertinent since new forms of business organization, such as limited liability companies (LLCs), and differential tax rates between corporate and individual tax systems have led an increasing number of businesses to be taxed under the individual rather than corporate tax system. In many states, business income taxes--just one of the taxes that businesses pay--are receiving greater scrutiny.

Under Indiana's current system, which was restructured in 2002, businesses paying taxes through the individual tax system face a 3.4 percent income tax rate while those paying through the corporate tax system face an 8.5 percent tax rate.

The following discussion examines business income from 2001 returns in both the corporate and individual income tax systems. (Bear in mind that the impact of Indiana's 2002 corporate income tax restructuring will first be reflected in the 2003 tax data, but this will not be available for analysis until the fall of 2005.)

The decrease in the corporate share of total tax collections at the state level has been linked to four causes:

1. Cyclical declines in profits

2. Erosion of the federal corporate tax base

3. State policy decisions to decrease corporate tax burdens, including an increased use of deductions and exemptions

4. Aggressive corporate tax planning and increased use of tax shelters (3)

   Corporate Income Taxes in Indiana

   Traditionally, discussions of Indiana corporate income taxes refer to the gross income tax, corporate adjusted gross income tax, and the supplemental net income tax (SNIT). This narrow definition of corporate taxes (collected from C corporations, special corporations, (4) and utilities) shows that the share of corporate tax collections has decreased substantially over the past several years (see Figure 1).

   [FIGURE 1 OMITTED]

   However, when using a broader definition of corporate income that also includes financial institutions and insurance, the decline in the corporate share of total tax collections is less dramatic. Moreover, if one adds in the riverboat taxes that took effect in 1996, the corporate share of state tax collections is relatively stable.

   Distribution of Corporate Tax Liability

   In 2001, approximately 39,450 Indiana corporate income tax returns were filed: about 580 returns from financial institutions, 21,600 returns from C corporations, and 17,250 returns from special corporations. (5)

   Just over 44 percent of these corporations had no income tax liability in 2001 (see Table 1). Almost 88 percent paid $10,000 or less in income tax; meanwhile, approximately 2.5 percent (1,000 corporations) paid almost 80 percent of the total corporate income tax liability (see Figure 2).

   Multistate Corporations

   While multistate corporations (6) represented about 35 percent of tax returns filed, these corporations paid about 83 percent of the total corporate income...