The "Corporation" in the Corporate Income Tax : Separate Entity or Shareholder Proxy?

Ever since the first federal corporate income tax was enacted in 1894, corporations have been treated separately for tax purposes. The question is why. In the country's previous experiment with an income tax during the Civil War and Reconstruction, corporations were not subject to special taxation. Individuals were taxed on the undivided profits of a corporation. The traditional explanation for the change in approach was the development of the entity theory of the corporation in the 1890s. Academics suggest that as corporations came to be seen as separate actors with independent abilities to pay, the government sought to tax them on their income. This theory, however, breaks down upon closer analysis. Corporations were viewed as separate entities, capable of being taxed, throughout the nineteenth century and especially during the Civil War and Reconstruction. Discussion of entity theory during the consideration of the 1894 Act merely reflected one of several attempts to justify the tax rather than a legitimate change in the understanding of the corporation. This Article argues that the 1894 Act's corporate income tax, much like the earlier pass-through scheme, was intended to be a method for reaching shareholder income. The rise of intangible wealth and the increasing tax evasion associated with this new wealth led Congress to search for alternative methods of reaching income from wealthy individuals. One such method was to collect taxes using a stoppage-at-the-source provision. The corporation, because of its regular and open distribution of dividends, was an obvious vehicle for this approach. In effect, the corporate income tax was adopted as a substitute, or proxy, for taxing corporate shareholders directly