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Calculating Income Tax Liability

Sidebar to Business Income Taxes in Indiana: Who Pays?

Corporate Income Tax System

The calculation of corporate income tax liability in most states (including Indiana) begins with federal corporate taxable income and then allows for some additions and subtractions. A decrease in the federal corporate tax base, either as a result of federal policy changes, tax planning by corporations, or increased use of tax shelters will decrease state corporate tax bases and state corporate tax revenue.

Individual Income Tax System

When looking at business income in the individual income tax system, various sources of business income are documented on the federal return (Form 1040) and its various schedules as components of federal adjusted gross income (FAGI). In twenty-six states, including Indiana, the starting point for computing the state individual income tax is FAGI. (7) Components of FAGI reported on Form 1040 include net income and net losses (gross receipts less total expenses) from sole proprietorships, farms, partnerships, S corporations, real estate mortgage investment conduits (REMICs), rental real estate, royalties, capital gains, and dividends.

Taxable income includes not only business income from the sources described above but also wage and salary income, interest income, and Social Security. Indiana taxable income is equal to FAGI plus addbacks of federal deductions not allowed by Indiana, minus Indiana deductions and exemptions. The taxpayer’s gross tax liability is computed on taxable income and then tax credits are applied.

Indiana’s Tax Restructuring of 2002

Sidebar to Business Income Taxes in Indiana: Who Pays?

Corporate income tax data for 2003, which will begin to reflect the changes from tax restructuring, will not be available for analysis until the fall of 2005. With the 2002 tax restructuring, the gross income tax and the supplemental net income tax (SNIT) were repealed, and beginning in 2003, a corporate adjusted gross income tax (AGI) was put in effect with a tax rate of 8.5 percent. The individual AGI tax rate is 3.4 percent, so businesses that pay taxes through the individual income tax system (sole proprietorships, partnerships, and S corporations) pay a lower tax rate than corporations. The following table shows the 2001 and current tax rates for various types of businesses in Indiana:

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