When American Small Business Hit the Jackpot : Taxes, Politics and the History of Organizational Choice in the 1950s

While many political developments affected American small businesses during the twentieth century, the enactment of Subchapter S of the Internal Revenue Code was of particular significance. For the first time Congress was inclined to, at least partially, eliminate the double tax burden. Following the S Corporation, state legislatures formed other hybrid entities and gradually reduced the barriers to limited liability and other non-tax characteristics of organizational choice. Today, we observe a steady increase in the number of hybrid entities, which indicates that people favor the pass-through approach for taxation. At the same time, it is apparent that the existence of different federal tax regimes still plays a significant role in investors' choice of action. This article begins with the question: How did the American small business community achieve political victory where large organizations had failed? Put differently, how was it that the little fellow accomplished the almost impossible -- the elimination of double taxation and permission to essentially choose his tax treatment -- when, for years, the business community was unsuccessful in its attempts to integrate corporate and individual taxation? By laying out the untold story behind the enactment of Subchapter S, this article argues that three major factors paved the way for the creation of the S Corporation: a genuine economic need to aid small business entrepreneurs in times of recession, strong political pressure from the business sector, and political elite - such as Wilbur Mills, who thought the moment was right to aid small concerns. The story of enacting Subchapter S in 1958 is more than adding another organizational tax choice. It serves as an example of Congress's way of thinking about tax policy as instrumental in implementing social and economic goals. It elucidates a more complex picture of how tax policy evolved in the postwar period. It also reveals one way in which political interest groups affected the process of legislative decision making