This week, David Elkins (Netanya; Google Scholar) reviews Edward G. Fox (Michigan; Google Scholar), Zachary D. Liscow (Yale; Google Scholar) & Michael Love (Columbia; Google Scholar), How to Tax Business? Economic Rents, Legibility, and the Corporate-Pass-Through Divide (2026):
The dilemma of whether to tax income earned via an entity at the entity level or to allow the income to flow through to the “owners” of the entity (generally shareholders or partners) is commonly viewed as a conflict between equity and administrability. The flow-through model is considered more in keeping with the progressive rate structure, as an entity-level tax does not take into account the tax rate of the owners. On the other hand, it is difficult to apply the flow-through method in the case of publicly traded entities. Current law attempts to address the dilemma by imposing different tax regimes on different types of entities. For example, partnerships and LLCs are generally taxed using the flow-through model, while publicly traded corporations are taxed at both the entity level (when the income is earned) and at the shareholder level (when the income is distributed as a dividend).
In this week’s feature article, Professors Fox, Liscow, and Love argue that the changing tax and economic landscape requires a reevaluation of these considerations. The first phenomenon that they consider is the fact that business taxation has been moving away from a traditional income tax and toward a cash-flow tax model, both because the TCJA and the OBBBA now permit expensing of investments that previously needed to be capitalized and because businesses are now investing significantly more in creating intangible assets (many of whose development costs are currently deductible, although not uniformly so). As tax theoreticians have long recognized, a cash flow (or consumption) tax effectively exempts from tax both the risk-free return to capital and the risk premium. What it does tax is the economic rent, i.e., income that is beyond what is necessary to induce consumption deferral (compensated for by the risk-free return) or risk taking (compensated for by the risk premium). The reason that this shift is significant is that economic rent is the quintessentially non-distortionary tax base. In theory, tax could be imposed on rent at any tax rate less than 100%, without inducing changes in economic behavior. The authors argue that an entity-level tax model isolates a substantial portion of this rent and permits the imposition of tax on such rent at a rate that is higher than the tax rate imposed on, say, labor income, whereas under a flow-through model, shareholders add their share of the corporation’s income to their personal income and pay tax at the applicable rates on the combination of the two.
The second phenomenon that impacts the entity-level versus flow-through dilemma is the increasing complexity of partnerships. Originally considered to be a “simple” form of conducting business, partnerships have been so entangled that, the authors claim, in 2020 it would be possible to include a mind-boggling 670,000 partnerships within a single cluster, all connected by lines of ownership and representing 60% of total partnership gains and losses. Moreover, over 30% of large partnerships (at least $100 million in assets and at least 100 partners), have at least 20 layers of ownership, and the average large partnership had over 530,000 ultimate owners. Many partnerships even end up with indirect ownership in themselves. Determining how to allocate items of a partnership’s income, deductions, liabilities, and so forth within such a web of interconnectedness—as required under current flow-through rules—presents insurmountable administrative challenges. As a result, audit rates for large partnership are near zero (0.27% versus an audit rate of 87% for large corporations). Even for those large partnerships whose returns are audited, the three years permitted under the statute of limitations is insufficient time to conduct a thorough audit. The authors therefore suggest that for partnerships above a certain level of complexity, entity taxation would be appropriate.
Their argument that the complexity of multi-tiered and entangled partnerships precludes flow-through taxation is difficult to ignore, and their proposal to require entity-level taxation in the case of complex partnership structures appears convincing. It is difficult to imagine an objective argument for the maintenance of the status quo. On the other hand, their analysis regarding the transformation of the income tax into a cash-flow tax and the conclusion that entity taxable gain is effectively rent that can be taxed as such, while provocative and thought-inducing is likely to prove more controversial. One particular point worth noting is that while they do briefly mention the international dimension, they could expand on its implications for the capacity of a country to impose tax on the cash flow of a corporation, given the constraints of tax competition and the inherent difficulty of determining jurisdiction-specific “rent” in a globalized economy.
This article represents a significant contribution to the literature on the taxation of business entities, both in diagnosing administrative limits of flow-through taxation and in reframing the normative case for entity-level taxation in a rent-oriented tax system.
Here’s the rest of this week’s SSRN Tax Roundup:
Harald Amberger (Vienna), Henning Giese (Paderborn), Reinald Koch (Cath. U. of Eichstaett-Ingolstadt) & Lukas Ortner (Cath. U. of Eichstaett-Ingolstadt), Tax Department Design, Tax Planning, and Tax Risk (2026)
Gary Cornell (Scitility PBC), Closing the Gaps: Comprehensive Anti-Abuse Provisions for the Generational Benchmark Inheritance Regime (2026)
Yashika Gupta (Independent), Transfer Pricing Regulations and Dispute Resolution Mechanisms: A Critical Legal Analysis (2026)
Tarun Jain (Supreme Court of India), Imploring Urgent Legislative Reinstatement of “Tax Residency Certificate”: Reflections on Supreme Court of India’s Decision in Tiger Global (2026)
Natalie Kim (IE) & Taejin Jung (Hanyang), Tax Outcome Smoothness and the Cost of Equity Capital (2026)
Leandra Lederman (Indiana) & Sarah B. Lawsky (Illinois), Constructing Deductions (2026)
Lawrence Lokken (Florida), Trump Accounts (2026)
Michael Love (Columbia), Taxing Complexity (2026)
Radek Šauer (Deutsche Bundesbank), Corporate Taxation in Open Economies (2025)
Brent Sullivan & Elliot Rozner, Managing Concentrated Public Stock Positions by Seeding an Exchange-Traded Fund (2026)
Sartono Suwarno (Pancasila), The Role of Cloud Computing in Improving Withholding Tax Compliance and Reducing Transfer Pricing Risk in Sustainable European Multinational Corporations (2026)
