The tax reform laws passed at the end of 2017 made massive changes to the way the U.S. government collects taxes. One of the biggest elements of tax reform affected the way that corporations get taxed, with massive tax decreases for companies of nearly all sizes.
Most of the attention that corporate tax reform has gotten has gone to the largest corporations and the billions in savings they might reap. Yet when you look at the actual tax rates, the biggest tax rate decline goes to more modestly sized small business with relatively small profits.
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Why mid-sized businesses got the biggest corporate tax rate drop
The headline numbers on corporate tax reform emphasized the decline from 35% to 21% in the top corporate tax rate. The way that most reports explained the reduction made it seem as though corporations never paid more than 35% of their marginal income in taxes.
Yet when you look at the corporate tax brackets, you'll notice a strange phenomenon. The highest tax rate actually applies to corporations with incomes between $100,000 and $335,000, which are in a special 39% tax bracket.
| Corporate Income | Marginal Corporate Tax Rate |
|---|---|
| $0 to $50,000 | 15% |
| $50,000 to $75,000 | 25% |
| $75,000 to $100,000 | 34% |
| $100,000 to $335,000 | 39% |
| $335,000 to $10 million | 34% |
| $10 million to $15 million | 35% |
| $15 million to $18,333,333 | 38% |
| Above $18,333,333 | 35% |
Data source: IRS.
The reason the two bolded brackets are there has to do with the intent of lawmakers. In general, the legislation setting previous corporate tax rates intended to have two general rates: 34% and 35%. For extremely small businesses, though, lawmakers wanted lower rates to apply in order to encourage start-ups. Still, once those small businesses grew to a large enough level, the brackets were set up to take away the benefit of those lower rates.
Here's how it works. For the first $50,000 in income, corporations pay 15% in tax, a 19-percentage-point savings compared to the higher 34% rate that works out to $9,500. On income between $50,000 and $75,000, the 9-percentage-point difference works out to $2,250, for a total of $11,750.
In order to claw back that $11,750 for larger small business corporations, lawmakers established a 5-percentage-point hike in the tax rate from 34% to 39%. Corporations therefore pay an extra 5% on the $235,000 in income between $100,000 and $335,000. Five percent of $235,000 is $11,750, so once you get to $335,000, you're paying an effective rate of 34%.
A similar effect occurs for larger businesses. After paying 34% on the first $10 million, lawmakers sought to claw back the $100,000 in savings from the 1-percentage-point difference between 34% and 35%. They did so by boosting the tax rate by 3 percentage points to 38% on $3,333,333 worth of income, as 3% of $3,333,333 is $100,000.