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If All Corporations Are People, Should All People Be Corporations?

Ed. note: We’re happy to welcome tax sage Joe Kristan back to a regular posting spot in these pages. This is his first effort for us but insists that he won’t feel as though he’s truly returned until he’s trolled by Adrienne.

Megan McArdle ponders one of life’s great questions:

One of the main “real world” elements of the case for the corporate income tax, as I understand it, is that failure to impose such a tax would simply create an inviting method for evasion of individual income taxes.

The question I always have about this is: “Well, why don’t more people do this now?”

The biggest reason we don’t all corporations to dodge taxes is that it is unnecessary. People looking to nickel and dime their way to deductions long ago learned that all you need is a Schedule C to have a place to hide a deduction for your dog (“security expense”) or your girlfriend (“theft loss”). This idea is one of the foundations of the multi-level marketing industry, and was carried to spectacular lengths by a recently closed Iowa tax preparer. Megan senses the limits to this approach:

And the reason that it’s mostly pretty minor is that if you are obviously using a corporation to fund your lifestyle, then the IRS will descend upon you like a plague of deranged cicadas.

There’s something to that, even though the cicada analogy implies a nimbleness unlikely in the IRS; a herd of flesh-eating slugs would be more apt.

Still, a corporation does offer some tax-sheltering possibilities. One is that C corporations can normally use any fiscal year. By shuffling income between an individual and a corporation with a November tax year, you can, in theory, get 11 months deferral of income — at least until you are caught. Corporations have a 15% tax rate on their first $50,000 of taxable income, giving higher-bracket individuals possibilities of shifting income to a lower bracket. And C corporation shareholder-employees get some benefits unavailable elsewhere.

Yet these chiseling possibilities have serious limits. The fiscal year games require you to have real live business expenses. A Kansas City attorney who marketed such deals crashed against this requirement. Income of “personal service corporations” like law and accounting firms are taxed at a flat 35%, making them useless as a tax shelter. The personal holding company rules impose a special tax on corporations used to shelter income from investments.

Then there is what I call “friction” — the time and effort required to play the games necessary to juggle income between a corporation and an individual. You have to file a corporation tax return and keep corporate records. You have to compute both personal and corporate income accurately during the year to know how much income to juggle. Unless you have a lot of time on your hands, the effort may well be better spent actually making money.

Finally, C corporations have one overwhelming problem: the double-tax dilemma. Unlike S corporations, which report their income on shareholder tax returns, C corporations have their income taxed twice — first when earned, and again when distributed or recovered on a stock sale. There are games you can play to get it out as a deduction to the corporation, but these have their problems. Take cash out as compensation and you incur payroll taxes; take it out as rent and you actually need something you can lease to the corporation with a straight face. Distribute an appreciated asset to yourself and the corporation is taxed on the gain. The Bittker and Eustice tax treatise has a classic summary of the problem:

Decisions to embrace the corporate form of organization should be carefully considered, since a corporation is like a lobster pot: easy to enter, difficult to live in, and painful to get out of.

These problems could be solved by taxing individuals and corporations at the same rates and allowing a deduction for dividends paid. Unfortunately, the chances of that are as likely as the chances of your brother-in-law making good pre-tax money from his Amway operation.

Analysis: Corporations May Be People But They Are Definitely Not Humans

The Iowa State Fair is going strong and because Election 2012 is in full throttle, the GOP Presidential candidates have been posing for photo-ops and making statements with varying degrees of stupidity.

One of the most logical things uttered, I dare say, was done so by Mitt Romney. By now you’ve probably heard that ol’ Mitt, in between corndogs, got into a bit of a verbal joust with a few of the fair goers. Here’s the soundbite:

The statement has been examined and debated with most intelligent people coming down on the side of Romney. That is, human beings – whether it’s shareholders, employees or customers – eventually bear the cost of the taxes paid by corporations. So while a whole host of humans, including the majority Supreme Court of the United States, are stuck on this “people” thing, it’s worth noting (mostly for the sake of stupid fun) that corporations are definitely not “humans.” Maybe that’s overstating the obvious but English is complicated language and this exercise is not without its merits.

Humans, at their best, are capable of being compassionate, loving, generous and all that crap. Corporations are not. At worst, humans are disgusting, vile creatures capable of ridiculous behavior and we know this to be true mostly because of reality TV. Corporations are certainly capable of deplorable behavior but this behavior is usually at the behest of a human being’s decision.

Accordingly, let’s examine some thing that demonstrate that don’t make corporations “human.”

• Corporations don’t flash women who aren’t the age of consent.

• Corporations don’t use your bathroom and help themselves to the Goldbond Medicated Powder to an extent that you wonder if someone left the window open during a snowstorm.

• Corporations don’t eat corn dogs (humans shouldn’t either).

• Corporations can’t sign a taxpayer protection pledge.

• Corporations don’t “try out” 18 year-old women, take them over state lines and then take money in order to “protect” them.

Feel free to volunteer other examples of “human” versus “people” below but what’s important to note here is that while both humans and corporations may be people, all humans are people and it’s clear that corporations are not humans.

And if that still doesn’t help you understand the difference, just remember this – no matter the situation, for better or worse, humans are the ones who get screwed. Got it?