Corporations That Weren't: The Taxation of Firm Profits in Historical Perspective

Richard Winchester, Thomas Jefferson School of Law

Abstract

This article examines federal tax law provisions that disregard a firm’s state law business form to determine the tax on the firm’s profits. The survey reveals that there were three generations of rules. The first generation is represented by the various tax acts adopted in the nineteenth century, when the tax law simply had one set of rules for taxing firm profits, irrespective of a firm’s state law business form. The second generation of rules arose after the passage of the Sixteenth Amendment, when Congress drew a distinction between incorporated and unincorporated firms for tax purposes. However, in certain narrow circumstances, Congress required a corporation to be taxed as if it were a partnership, and vice versa. The third generation of rules gave a narrow range of firms the chance to specify how to be classified for tax purposes. Today, all but a few firms have the freedom to choose their tax classification. Because this flexibility enables a firm to control how much tax must be paid on its profits and when it must be paid, this third generation of rules is unlikely to allow the tax system to operate in the equitable way that Congress hoped it would when it first adopted the income tax.