BOEHM: Tread cautiously through this study

September 29, 2012

Ted BoehmYou may have seen recent news reports discussing a Ball State University study of how the total tax burden in this state varies for different industries and forms of organization. The takeaway is that there are multiple “inequities” in Indiana’s tax structure.

I hope legislators don’t accept this description of Indiana taxation without talking to some tax experts. There are several problems, and some errors in its methodology.

Space in this column does not permit detailed analysis, but in broad strokes, here are some of the issues as I see them.

The study concludes:

1. A business organized as a limited liability company pays 3.4-percent income tax, less than half the income tax that the same business organized as a corporation would pay.

2. Businesses pay a 3.4-percent state tax on their payroll.

3. It is unfair if the total bill for all taxes is a different percentage of gross revenue for different businesses.

4. Retailers pay a 7-percent sales tax and other businesses pay none.

All are fundamentally incorrect.

Limited liability companies are typically smaller businesses with individual owners. Like corporations with fewer than 100 individual shareholders, LLCs select to be taxed as a corporation or have their income taxed to the owners. If taxed as a corporation, an LLC pays the same 8.5-percent rate (scheduled to decline to 6.5 percent ) it would if it were a corporation. If taxed as a partnership, the LLC pays no income tax and its income is taxed to its owners who pay either the individual tax rate of 3.4 percent (plus county tax depending on where they live), or a corporate tax if the owner is a corporation.

The study concludes that big businesses from other states get a break by organizing as LLCs. This is not true in almost all cases. If a corporation organized under another state’s law chooses to do its Indiana business as an LLC, as long as the ownership ultimately ends up in a corporate parent it should be subject to the corporate rate.

Including the sales tax at 7 percent of revenue for a retailer, but zero for other businesses, raises two problems. First, many retailers—perhaps most—can pass the tax on to their customers. The study notes that, depending on the price elasticity of the product, some sellers must absorb some or all of the 7-percent tax. But the study assigns the entire 7-percent sales tax on all revenue of retailers. Moreover, non-retail businesses do pay sales tax on many purchases, not the zero the study assumes.

Next, there is nothing unfair about a tax system that imposes the total bill for all taxes at different percentages of gross revenue for different businesses. We had a gross income tax until 2002 and it was widely condemned as unfair to high-volume, low-margin businesses like grocery stores.

Indiana’s current income tax is an adjusted gross income tax. It rightly attempts to tax profit, not gross revenue, and profit as a percentage of revenue varies widely by type of business.

The study treats the 3.4-percent payroll withholding that employers remit to the state as if it were an expense of the business. In fact, it is the employee’s money, as if you didn’t notice that on your pay stub.

In short, the study may reflect the revenue generated by different businesses for state and local government. But it adds the property and income taxes paid by the business to income taxes withheld from employees and sales taxes collected from customers.

There are major differences in the relative cost of these different taxes to different businesses. Mixing those paid by the business with those collected from others says nothing about the relative fairness of our state’s tax system.•

• Boehm is a retired Indiana Supreme Court justice who previously held senior corporate legal positions and helped launch amateur sports initiatives in Indianapolis. Send comments on this column to ibjedit@ibj.com.


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