Taxation of Income from Capital
The purpose of this chapter is to introduce the characteristic features of US tax law into the cost of capital.1 We distinguish among assets employed in three different legal forms of organization -- households and non-profit institutions, non- corporate businesses, and corporate businesses. Income from capital employed in corporate business is subject to corporate income tax, while distributions of this income to households are subject to individual income tax. Income from unincorporated businesses -- partnerships and sole proprietorships -- is taxed only at the individual level. Income from equity in household assets is not subject to income tax. Capital utilized in all three forms of organization is subject to property taxation.
Although income from equity in the household sector is not subject to tax, property taxes and interest payments on household debt are deductible from income for tax purposes under the individual income tax. The value of these tax deductions is equivalent to a subsidy to capital employed in the household sector. Interest payments to holders of household debt are taxable to the recipients. Capital gains on household assets are effectively excluded from taxable income at the individual level by generous 'roll-over' provisions for owner-occupied residential housing. Capital gains on owner-occupied housing are not included in income so long as they are 'rolled over' into the same form of investment. We consider the treatment of income from assets employed in the household sector in Section 2.1 below.
Income from capital employed in non-corporate businesses is taxed at the level of the individual. Income from non-corporate____________________