The U.S. Corporate Tax System Explained
The U.S. corporate tax system is a subject of frequent debate, with significant implications for the nation’s economy and fiscal outlook. Over the past several years, lawmakers from both parties have pursued major changes to this area of the tax code. Revenues raised by the corporate income tax represent the third-largest category of federal tax revenues, trailing those generated from individual income taxes and payroll taxes. This explainer describes how the U.S. corporate income tax system works, the ways it has evolved in recent years, and the implications for the United States’ fiscal and economic condition.
What Type of Business is Subject to the Corporate Income Tax?
The U.S. corporate income tax applies to C corporations, which are legal entities that are independent of their owners, called shareholders. All C corporations are currently taxed at a statutory rate of 21 percent. When C corporations distribute profits to shareholders as dividends, shareholders must pay individual income taxes on the dividend income they receive.
How Does the U.S. Corporate Income Tax Work?
The corporate income tax is a tax on the net income of corporations — that is, total income minus the costs associated with regular business activities. A corporation’s tax liability can be reduced by certain incentives and deductions in the Internal Revenue Code, such as depreciation, research and development, and employee health care.
The Tax Cuts and Jobs Act (TCJA), enacted in December 2017, reduced the federal tax rate on corporations to 21 percent, a decrease of 14 percentage points from its previous level of 35 percent. The current rate of 21 percent is significantly lower than it has been historically.
In addition to the federal corporate income tax, 44 states and the District of Columbia impose their own taxes on corporate income. Therefore, a C corporation operating in the United States could face a combined tax rate in excess of 21 percent. In 2022, corporations paid an average combined tax rate of 26 percent. For comparison, the average combined corporate income tax rate for central and sub-central governments among other G7 countries was 28 percent, according to the Organisation for Economic Co-operation and Development.
Not all businesses are corporations. Pass-through businesses, such as sole-proprietorships, partnerships, and S corporations, allocate profits to their owners who then pay individual income taxes on those profits. That differs from the federal taxation of C corporations. The profits of C corporations are effectively taxed twice: first through corporate income taxes on profits, then through taxes on the capital gains and dividends of shareholders.
For example, consider the taxation of two businesses with $100 of profits at the top marginal rate. The first is a pass-through business, the profits of which are taxed once via the individual income tax system at the top marginal rate of 37 percent. Pass-through business owners can first deduct 20 percent of their qualified business income, lowering their taxable income to $80. As a result, the after-tax income of the pass-through business owner is $70.40. The second business is a C corporation, and the shareholder is subject to two levels of taxation. The C corporation has $100 of profits for which it is taxed at a rate of 21 percent, leaving $79 after taxes. Those profits are then passed on to the shareholder as a dividend, which is taxed at a rate of 20 percent. The after-tax income of the shareholder would be $63.20.
As business owners consider the relative rates of the corporate income tax and individual income tax, they may migrate between business structures depending on which organizational form is most beneficial for the business. In recent years, pass-through entities have grown to represent an increasingly large percentage of business income in the United States. In 1980, C corporations accounted for 75 percent of all net business income. By 2016, before the enactment of the TCJA, C corporations accounted for just 33 percent of net business income. The share of net business income for C corporations increased in the years following the enactment of the TCJA, reaching 49 percent in 2022, in part due to changes in business incentives from the tax law changes.
How Much Revenue from the Corporate Income Tax Does the Federal Government Collect?
Corporate income taxes are the third-largest source of revenues for the federal government. However, as a share of total federal tax collections, the corporate income tax accounts for a relatively small amount. In 2025, the federal government is projected to collect $524 billion from the corporate income tax, just 10 percent of the total $5.2 trillion in federal tax revenues.
Changes in Corporate Tax Revenues
As the statutory rate has decreased and the prevalence of pass-through businesses has increased, revenues from corporate taxes have declined as a share of GDP. In the 1950s and 1960s, corporate tax revenues represented an average of 4.2 percent of GDP — in 2024, they represented just 1.8 percent.
The share of corporate income tax revenues as a percentage of the economy in the United States is one of the lowest among G7 countries which, on average, collected 2.6 percent of GDP from that source in 2022.
One reason that corporate income tax revenues represent such a small percentage relative to the size of the U.S. economy is the effect of corporate income tax expenditures. Tax expenditures, or tax breaks, are exclusions, exemptions, deductions, and credits that reduce tax liability. In 2024, the United States forfeited $188 billion in revenues due to corporate tax expenditures. The largest corporate tax expenditures were:
- the reduced rate on active income of controlled foreign corporations ($57 billion);
- accelerated depreciation of equipment ($37 billion);
- the credit for increasing research activities ($20 billion).
Conclusion
The federal government collects low levels of revenue from the corporate income tax. As with the individual tax system, tax expenditures reduce revenues from what they would be under the statutory rate. As annual deficits continue to rise and the national debt reaches unprecedented levels, tax reforms designed to increase revenues and support economic growth are one tool to help close the federal fiscal gap.
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Further Reading
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