The basic theory behind U.S. income taxation is to tax all income earned one time to the beneficial owners of that income. Under this theory, there is no theoretically valid reason to tax income both when it is earned by the corporation with a corporate tax, and when it is distributed to the shareholder.
One way to do that would be to tax dividends received by shareholders (the beneficial owners of a corporation) as income and to tax liquidation or redemption of stock proceeds as de facto sales of the stock equivalent to a third party sale of stock by the shareholder. And, U.S. tax law does that for publicly held corporations.
But, there is a huge loophole in that plan. If you didn't tax profits when they were earned by the company, they could be deferred indefinitely leading to massive tax losses (and indeed, multinational companies do just that by parking profits in foreign tax havens so they won't be taxed until they are repatriated to the U.S.). Shareholders could simply take out loans to access the value of their shares and dividends would never be paid and the profits would never be taxed.
Corporate taxes prevent the deferral of taxation on corporate profits until they are actually realized by the beneficial owners of the corporation. But, corporate taxes in the U.S. aren't well designed. Because dividends are not tax free (as they are in pass through entities once tax on entity level earning has been paid by the owners - which would look politically ugly in a publicly held company context letting people receive millions in dividends and pay not taxes on it), and there is no deduction for dividends paid to the corporation (in most contexts), and there is no tax credit for taxes paid at the corporate level against income tax liability on dividends, the end result is that there is double taxation of corporate profits both when the profits are earned by the corporation and again when they are distributed to shareholders. This creates a powerful incentive (which corporate management likes but investors do not) to not pay dividends. (Tax experts will note that I am glossing over the accumulated income tax which is mostly toothless, to simplify the analysis.)
Rather than solve this problem honestly, Congress and businesses have come up with a kludge that addresses the problem in an unprincipled way. This has several parts:
Public corporations refrain from paying dividends so double taxation is not incurred (except for utilities and related corporations which can get dividend paid deductions).
Tax rates on capital gains (and for parts of the history of the corporate tax, on dividends) have been preferential on the assumption that they largely reflect gains that are already taxed (and exceptions to favorable tax rates like depreciation recapture impose higher rates in circumstances when double taxation isn't a factor in most cases). Also, tax avoidance or deferral devises like tax favored retirement, education and health savings accounts eliminate capital gain and dividend taxes entirely on stock transaction or defer them until the beneficial owner wants to spend the money for a non-preferred purpose. The step up in basis for capital gains at death provides an end run that can turn deferral of shareholder level taxation by not selling stock and having corporations not pay dividends into tax avoidance rather than mere tax deferral.
Tax breaks at the corporate level, meanwhile reduce the effective tax rate at the corporate level to make up for the portion of double taxation that shareholder level tax breaks don't eliminate. For example, taxing dividends and capital gains on the sale of stock at about 71% of the hypothetically fair tax rate at the shareholder level, and taxing corporate profits at about 71% of the hypothetically fair tax rate at the corporate level, is economically equivalent to not having double taxation.
Equally important, almost all closely held companies are now taxed on a pass through basis in which entity profits are directly taxed to the beneficial owners when they are earned whether the profits are distributed or not. This works in closely held companies because the identity between ownership and management and effective political power of the owners in corporate governance is sufficient to make sure that the entity distributes enough money to allow the owners to pay taxes on profits that are earned. But, in a publicly held company where shareholder power is weak, this can't be counted upon to happen, so shareholders of public companies are taxed when they get the actual benefit and corporate taxes, screwed up as they are, limits the harm of indefinite deferral of income. Tools like private equity funds and increased wealth concentration in the U.S. have made it possible to raise huge amounts of money and take public companies private to avoid corporate taxes by this means, in ways that were simply impossible in earlier days, and this has been fostered by lax regulation of private offerings relative to public offerings by the SEC.
