What Is Double Taxation? A Small Business Guide for C Corps (2024)

What is double taxation?

Just as the term implies, double taxation is when taxes are paid twice on the same income. There are three scenarios where the law of double taxation applies:

  1. C corporation, or C corp, profits are taxed at both the shareholder and corporate levels. In this scenario, the business must pay corporate income taxes on profits. All shareholders must then pay individual income taxes on dividends received from those profits.
  2. International trade or investments where the income is both a U.S. tax and foreign tax liability. Many companies conduct business internationally, where profits are earned in one country, but the business’s headquarters are in another. If there is no reciprocal agreement or treaty between the countries, businesses can end up paying taxes in both locations.
  3. Traditional IRAs that include after tax contributions and earnings. With a tax free traditional IRA account that includes after-tax contributions plus earnings, steps can be taken to identify the tax free contributions versus the after-tax contributions versus any subsequent earnings, thus avoiding tax on the original tax free contributions when later making withdrawals.

While the last two tax situations are not uncommon, small business owners like you are probably more concerned with how double taxation affects your corporation and how you can reduce your federal income tax burden.

Double taxation on corporations

Businesses that are registered as C corps (and LLCs that elect to be treated as corporations) are taxed twice on business profits. The corporation first pays taxes on its profits, but then stockholders must pay personal income taxes on the dividends paid from the company’s profits.

For example, if your corporation had $100,000 in profits last year and the corporate tax rate is 21%, your business owes the IRS $21,000 in taxes. But, on top of that, you and your shareholders are required to pay taxes individually on any dividends and wages you received from the remaining $79,000. These are taxed at your personal income tax rate, which can range from 12 to 37 percent.

Other types of business entities such as partnerships, sole proprietors, and non-corporate LLCs only pay income tax one time. These business structures use pass-through taxation since the income “passes through” the business down to the owners or individuals who are then taxed directly.

Suggested resource: C Corp vs. LLC: Which Is Better for Early-Stage Entrepreneurs?

Benefits to operating under a C corp structure

If structuring your small business as a C corporation means paying taxes twice, why is the corporate structure appealing? Despite the double taxation requirement, your business can realize the following benefits as a C corp:

Selling shares

C corps can raise additional capital for their business by selling shares to an unlimited number of shareholders.

For example, Tom and Mike establish a boat dealership together with an investment of $200,000 apiece under the C corp structure. Their friends and family are optimistic the business will do well and become shareholders by investing $1,000 apiece. The business attracts a total of 50 shareholders, infusing the business with another $50,000.

Limited liability

In a C corp, owners and shareholders are not responsible for debts and obligations that surpass the amount of their original investments.

Let’s clarify this benefit by revisiting Tom and Mike’s boat dealership scenario. Unfortunately for their business, the economy has fallen into a major recession, causing boat sales to decrease dramatically. As a result, the dealership goes into debt to the tune of $1 million. However, under the C corp structure, Tom and Mike are each only responsible for their initial $200,000 investment, while their shareholders are only out their original $1,000 investment.

Benefits deductions

C corps can deduct the cost of benefits such as life, health, and disability insurance. The shareholders in the business who are employed don’t have to pay taxes on the benefits they receive from the C corp.

Comparing legal entity taxation benefits and drawbacks

As you consider if a C corp is the right fit for your business, here is a comparison of the advantages and disadvantages of filing taxes under each of the legal entities.

Business entityAdvantagesDisadvantages
C corpNo self-employment tax on profits.

The flat tax rate of 21% may be lower than the individual’s tax bracket rate.

Tax-free benefits such as deductions for retirement plans and insurance.

Double taxation on both the corporate and individual levels.

Owners may have increased tax burden since they can’t take the same credits and deductions (the QBI deduction for example) as individual taxpayers.

Tax filings are more complicated.

S corp*Avoids double taxation by passing income through to owners.

Owners can take deductions for health insurance and retirement plans.

Owners are only subject to payroll taxes on wages and not on corporate profits distributed to them.

Not treated equally by each state. Some States have separate filing requirements in addition to Federal filing requirements.

If an S corp revokes its status, it is automatically taxed as a C corp unless the business applies for a different entity type.

PartnershipPartners can deduct unreimbursed business expenses.

Partners pay income tax once and only on their percentage share of profits.

Each partner must set aside enough money to pay quarterly estimated income taxes on their percentage share of annual profits.

Profits are taxed whether partners receive them or not.

Partners must pay self-employment taxes.

Sole proprietorship/LLCCan use net profit instead of wages to meet thresholds for health and retirement plan contributions.

Sole proprietors only pay income tax once.

Business and personal filings are combined on one tax return.

Taxed on all profits of the business on a personal level.

Sole proprietors must pay self employment taxes.

*Note: An S corporation (or S corp) technically isn’t a business type, since your business can’t become an S corporation right from the start—you must first form either an LLC or C corp and then apply for S corp status. Learn more about S corporations.

How you can avoid or minimize double taxation on your business

Now that you are familiar with the concept of double taxation, let’s take a look at how you can avoid this situation for your small business.

The easiest approach is avoiding the C corp structure altogether. While this entity offers the advantages listed above, you may find that the double taxation requirement is just not economically feasible for your business.

However, if you still feel that structuring as a C corp is best for your business, there are ways you can reduce your corporate tax obligations.

  • Put more of your business income into retained earnings. This is a better option for newly formed businesses, since the income should fund company growth. However, keep in mind that you will need to reserve a part of the income to pay dividends to your shareholders. You will also need to justify retained earnings over $250,000 in order to avoid the Accumulated Earnings Tax.
  • Pay salaries instead of dividends. This action reduces the dividend tax for individuals. Instead, they will offset personal income tax through payroll tax withholding. Plus, your business can still deduct the salary, bonus and payroll tax expenses on its tax return.
  • Income splitting. Taking a portion of the profits out for salaries and reinvesting the rest can reduce the owner’s gross income and the corporation’s taxable income. You can also draw a salary in addition to hiring family members and other employees. Even though you still have to pay taxes on your salary, you will reduce your double tax obligation.
  • Take out a loan from the business. Money borrowed from the business is not treated the same as a taxable dividend and is an effective option if you don’t have to pay many shareholders. However, tax authorities may closely scrutinize the transaction, so have a repayment plan with a reasonable interest rate in place.
  • Switch to an S corp structure: Once your corporate structure is in place, it’s easy to ask the IRS to treat it as an S corp for tax purposes. Both types of corporations have limited liability perks, but the profits in the S corp pass through to shareholders, avoiding a double taxation situation. Before requesting S corp treatment, ensure you meet the requirements which includes having less than 100 shareholders with one class of stock.

Should you consider the C corp structure for your business?

While the double taxation requirements of a C corp may have you hesitating to use this structure, there are other benefits and drawbacks to consider.

You should stick to the C corp structure if the following applies:

  • You are seeking investors in the business and want to sell shares of stock to help raise capital.
  • You want the strongest personal liability protection for everyone involved in the business.
  • Your business and personal tax status can handle the double taxation obligations without jeopardizing profits.

On the other hand, the double-taxed C corp structure may not be a good fit for your company for these reasons:

  • It would be a financial hardship for you to pay taxes at both the corporate and individual levels.
  • You don’t plan on having shareholders in your business.
  • You plan on taking profits out of the company rather than reinvesting them.

How Bench can help

After learning about the varying taxation requirements of the above business entities, you may be considering switching your business to a different tax structure. This switch may also require a change in how you do your company’s bookkeeping and tax filings.

With Bench, you can rest assured that your business’s tax structure transition goes smoothly with our expert bookkeeping team. Even after your business has successfully migrated to the new structure, Bench will ensure that your books are kept accurate and up-to-date. Our tax filing solutions can also give you peace of mind that your corporate taxes are filed correctly and on time.

If you need help deciding which entity type is best for your business, download our free business entity guide.

Does double taxation make sense for your bottom line?

Deciding on a structure for your small business is an important decision that affects your bookkeeping and taxes. If you are considering the C corp structure for your business, the double taxation obligation can take a toll on your overall bottom line. However, actions like paying salaries instead of dividends and reinvesting profits can help you minimize the corporate tax burden and keep your business on solid financial ground.

What Is Double Taxation? A Small Business Guide for C Corps (2024)


What Is Double Taxation? A Small Business Guide for C Corps? ›

Double taxation

What is double taxation in C corp? ›

Most commonly, double taxation happens when a company earns a profit in the form of dividends. The company pays the taxes on its annual profits first. Then, after the company pays its dividends to shareholders, shareholders pay a second tax.

How to avoid double tax in C corp? ›

Reimburse shareholder expenses: If a C corp directly reimburses business expenses incurred by shareholders, it can deduct these reimbursem*nts and reduce its total earnings, thereby avoiding double taxation.

Do both C corp and S Corp have double taxation structure? ›

One of the primary differences is that C corporations are taxed at the corporate level with double taxation, while S corporations file IRS Form 1120S, and profits, losses, deductions, and credits pass through the entity level without corporate taxes.

How does the use of a subchapter S corporation address the issue of double taxation? ›

Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income.

How does double taxation work for a corporation? ›

Double taxation occurs when a corporation pays taxes on its profits and then its shareholders pay personal taxes on dividends or capital gains received from the corporation. A financial advisor can answer questions about double taxation and help optimize your financial plan to lower your tax liability.

What is considered double taxation? ›

Double taxation is when taxes are paid twice on the same dollar of income, regardless of whether that's corporate or individual income.

How do C corp owners get paid? ›

Officers of C corporations are strictly paid on a salary basis. They may be able to obtain bonuses, but their primary source of income is their salary. In an S corporation, an owner can choose to take regular draws or distributions in addition to their normal salary.

Do I get taxed twice as a business owner? ›

The double taxation policy requires businesses to pay their taxes twice on the same income. This specific policy often applies to startups structured as corporations, international trades or investments, and traditional IRAs.

How to calculate C corp taxes? ›

These corporations compute their tax by multiplying their net income for the year by 8.84% times their net income for the year (see Example 2 below). Important: Newly incorporated or qualified corporations are subject to the minimum franchise requirement on their second return (See Example 3 below).

How to avoid double taxation? ›

By paying out profits in the form of salaries rather than dividends, a corporation can avoid double taxation. Tax treaties: Many countries have tax treaties in place to prevent double taxation. These treaties often provide rules for which country has the right to tax certain types of income.

How much are dividends taxed in C corp? ›

Qualified dividends are taxed at 0%, 15% or 20% depending on taxable income and filing status. Nonqualified dividends are taxed as income at rates up to 37%.

Does C corp pay more taxes than S corp? ›

Single layer of taxation: The main advantage of the S corp over the C corp is that an S corp does not pay a corporate-level income tax. So any distribution of income to the shareholders is only taxed at the individual level.

How do I know if my income is double taxed? ›

Key Takeaways. Double taxation refers to income tax being paid twice on the same source of income. This can occur when income is taxed at both the corporate level and the personal level, as in the case of stock dividends. Double taxation also refers to the same income being taxed by two different countries.

What is a major disadvantage of the corporate form double taxation feature? ›

Answer and Explanation:

One main disadvantage for a corporation form is that the dividends that are distributed by it to the shareholders are taxed twice. They are taxed at the corporate level to be borne by the company and they are taxed for individual shareholders as their income to be borne by them.

Why is double taxation bad? ›

Opponents of double taxation on corporate earnings contend that the practice is both unfair and inefficient, since it treats corporate income differently than other forms of income and encourages companies to finance themselves with debt, which is tax deductible, and to retain profits rather than pass them on to ...

What are the disadvantages of the C corp? ›

Disadvantages of a C Corporation
  • Double taxation. It's inevitable as revenue is taxed at the company level and again as shareholder dividends.
  • Expensive to start. There are a lot of fees that come with filing the Articles of Incorporation. ...
  • Regulations and formalities. ...
  • No deduction of corporate losses.

How are C corp distributions taxed? ›

C corp dividends

The C corporation dividends act differently to the S corporation distributions due to C corp taxation. C corporations pay taxes at the corporate level and any dividends paid from the corporation are taxed again at the shareholder level, which results in double taxation.

Is US corporate income double taxed? ›

C-corporations pay entity-level tax on their income, and their shareholders pay tax again when the income is distributed. But in practice, not all corporate income is taxed at the entity level, and many corporate shareholders are exempt from income tax.

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