Louisiana Taxation of Businesses: Two Alternative Proposals

• Author: James A. Richardson; Susan Kalinka
• Position: The John Rhea Alumni Professor of Economics and Director of Public Administration Institute Louisiana State Univesity

The John Rhea Alumni Professor of Economics and Director of the Public Administration Institute at Louisiana State University.

The Harriet S. Daggett-Frances Leggio Landry Professor of Law at Louisiana State University, Paul M. Hebert Law Center.

Louisiana should reconsider the uneven manner in which it taxes businesses. For both federal and state tax purposes, businesses are taxed differently depending on the form of business organization that the investors choose. There is no justification for the difference in taxation of the various types of business organizations, either at the state or at the federal level.¹ This article addresses only the issue of eliminating the disparity at the state level.

In two respects, corporations are taxed more heavily by the State of Louisiana than other forms of business organization. First, the income of a C corporation is taxed at a higher rate than the income of a pass-through entity, such as an S corporation, a sole proprietorship, or a business entity that is taxed as a partnership. In addition, all corporations, including S corporations, are subject to the corporate franchise tax.

This article explores two alternative proposals for providing uniformity in the manner in which Louisiana taxes businesses. Both proposals would reduce the maximum corporate income tax rate from eight percent to six percent, which is the maximum rate that applies to income flowing through to individual owners of pass- through entities. Both proposals also would eliminate the corporate franchise tax. One proposal also would eliminate the state sales tax on machinery and equipment. Both proposals focus on how businesses should be taxed as opposed to how much tax businesses should pay.

Reducing the maximum corporate income tax rate and eliminating the corporate franchise and the designated sales taxes would create a significant drain on state tax revenues. This article offers two alternatives for replacing the revenue that would be lost if the Louisiana Legislature decided to conform the corporate and individual tax rates and eliminate the corporate franchise tax. The first proposal suggests a value-added tax on all businesses. The second alternative suggests an additional tax on all business profits, regardless of the form of business organization adopted. Because each proposal would broaden the tax base by increasing taxes for all businesses, it would not be necessary to impose a high rate for the supplementary tax if either alternative were adopted.

The differences in business taxation arose many years ago when the three forms of business organization were the corporation, the partnership, and the sole proprietorship. Traditionally, a corporation has been considered an entity separate from its shareholders, whereas a partnership generally has been considered an aggregate of its partners, at least in jurisdictions other than Louisiana.² Like a partnership, a sole proprietorship has never has been treated as a separate entity. Thus, until the adoption of subchapter S, a corporation has been taxed as an entity liable for the tax on its own income.³ In contrast, a partnership is treated as a pass- through entity for tax purposes. A partnership does not pay tax on its income.⁴Instead, each partner pays tax on the partner's distributive share of the partnership's income.⁵ Similarly, the owner of a sole proprietorship pays tax on the income of the business, because the proprietorship is not regarded as an entity separate from its owner for tax purposes.⁶

Under state law, shareholders of a corporation are shielded from liability for corporate debts and obligations.⁷ To ensure that shareholders enjoy limited liability for corporate debts, a corporation is required to register with the secretary of state by filing articles of incorporation.⁸ Registration serves notice on all parties dealing with the corporation that its shareholders have limited liability.

In contrast, all partners in a general partnership are personally liable for partnership debts.⁹ Similarly, the owner of a sole proprietorship, as the direct owner of the business, is personally liable for all of the debts and obligations of the business. Because there is no limitation on the liability of partners or sole proprietors that would necessitate notice to third parties, a general partnership or a sole proprietorship may transact business without registering with the state.¹⁰

Traditionally, the state franchise tax has been justified as a charge due from a corporation for the privilege of exercising its corporate charter and offering investors limited liability. With the rise in popularity of limited liability entities such as partnerships in commendam, limited liability partnerships ("LLPs"), and limited liability companies ("LLCs"), the distinctions between corporations and other forms of business entities have blurred. Like corporations, partnerships in commendam, LLPs, and LLCs offer investors limited liability.¹¹ Like corporations, partnerships in commendam, LLPs, and LLCs are treated as entities separate from their owners.¹² Nevertheless, partnerships in commendam, LLPs, and LLCs generally are treated as partnerships for tax purposes.¹³

Equity considerations call for the equalization of the tax treatment of all businesses, regardless of the form in which the business is conducted. One of the goals of a tax structure is horizontal equity, the concept that similarly situated taxpayers should be taxed similarly.¹⁴

Fiscal considerations also suggest that Louisiana should reconsider its apportionment of the state business tax burden based on the different forms of business organization. The corporate income and franchise tax base has eroded significantly because taxpayers are using business organizations other than corporations. As a result, corporate tax receipts have declined. With the availability of other business entities, such as the LLC, that offer limited liability to all owners of the business, investors have no incentive to form a corporation.

Parity in the taxation of business organizations would not be a novel concept in Louisiana. At one time, there were some business taxes that applied evenly to all forms of business organization. For example, until 1981, Louisiana imposed an occupational license tax on business organizations, other than those engaged in manufacturing, banking, and sawmill operations.¹⁵ The occupational license tax was paid by corporations, partnerships, and sole proprietorships alike. The Louisiana occupational license tax promoted horizontal equity, but it was repealed in 1981.¹⁶

I Current Taxation of Louisiana Businesses

The current business tax structure in Louisiana is summarized in Table 1.

Table 1. Taxation of Business Organizations

(See Table in Pdf File)

The corporate income and franchise taxes create arbitrary differences in the manner in which a business is taxed. As a practical matter, there is little difference between a corporation and any other form of business entity, such as an LLC, LLP, or partnership in commendam, that offers limited liability to its owners. The only significant difference is the manner in which the entity and its income are taxed.

The disparate tax treatment of business entities at the state level is, in part, the result t of Louisiana's decision to classify business organizations for state income tax purposes in the same way as they are classified for federal tax purposes.¹⁷Louisiana's decision to "piggyback" the federal tax laws provides administrative convenience to the Louisiana Department of Revenue (the "Revenue Department") and eases the cost of compliance for taxpayers. Because Louisiana treats business entities for state tax purposes in the same manner as they are treated for federal tax purposes, the Revenue Department can refer to a business entity's federal income tax return to ensure that the entity's income has been reported properly for state income tax purposes.¹⁸ Taxpayers enjoy reduced compliance costs because they may compute their state income in the same manner in which they compute federal income.

It is not necessary for the Louisiana Legislature to repeal Louisiana's piggyback rules in order to eliminate the disparity in taxation of business organizations. This article explores two alternative methods that the Louisiana Legislature should consider for taxing business organizations in a manner that will treat similarly situated businesses similarly, at least for state tax purposes.

All businesses, regardless of the form in which they are organized, use state services in the process of producing the goods and services that they provide to their customers, either within the state or somewhere outside the state.¹⁹ The payment of a tax for the use of state services constitutes the cost of doing business, in the same way that employee compensation, interest payments on business debts, costs of raw materials and utilities, and other business expenses are essential and necessary costs of doing business. State services provided to businesses include maintenance of roads and highways, oversight of the environment, education and training of the workforce, and provision of a court system and a legal environment that ensures that contracts will...