‘Contributions to Capital’ from Nonowners

Abstract

Under current law, a corporation excludes non-shareholder ‘‘contributions to capital’’ from tax. The proposal would end the exclusion because the transfers from non-shareholders are economic income as they improve the net worth of the corporation and its owners. A transfer from a non-owner is not capital to the corporation in any meaningful sense of the word: The corporation does not have any basis recovered by the transfer, and the amount received does not have to be retained by the corporation as a cushion for creditors. The exclusion and related deduction grant a federal subsidy to transactions that do not merit one. Contributions by shareholders in return for stock or pro rata to stock holdings can properly be excluded because they represent a mere pooling by owners of assets previously held apart from the corporate form, in which case the owners recapture the value given up by value or enhanced value of their stock. Transfers by non-owners, by contrast, are an expenditure, even considering value recaptured by shareholdings. The proposal would apply to partnerships, and to shareholder contributions that are not justified by increase in stock.

This proposal is made as a part of the Shelf Project, a collaboration among tax professionals to develop and perfect proposals to serve Congress when it is ready to raise revenue. Shelf Project proposals should become part of a new Treasury study, like the one that preceded the Tax Reform Act of 1986. Congress faces a revenue crisis because government revenue is at 13.4 percent of GDP, and long-term projections for government spending are at 22.4 percent of GDP, which implies an increase in necessary revenue of 168 percent of current yields. Provisions that are politically impossible in ordinary times become political necessities in a revenue crisis. Shelf Project proposals defend the tax base and improve the rationality and efficiency of the tax system. They are designed to raise revenue without raising rates because the best tax systems have the broadest possible base to allow for the lowest feasible tax rates.

Keywords: contributions to capital, tax reform

JEL Classification: H20, K34