What Is Double Taxation and How to Avoid It? (2024)

× Nancy Mann Jackson is an award-winning journalist and content marketing writer who specializes in writing about finance, real estate, healthcare, small business andhuman resources. Her work appears inpublications including CNBC.com, Fortune.com, Entrepreneur, Working Mother, CNNMoney.com, and DailyWorth,and she writes for brands including HSBC Bank, Capital One, Glassdoor, Oracle, ADP, Cintas, Staples,American Express, Acorns, Hospital Corporation of America and a number of others.

The most important decision you make when you start your business — outside of setting the product or service you’ll be selling — might be the corporate business structure you choose. You could form a sole proprietorship, an LLC, an S corporation, or a C corporation. But if you form as a C corp, you’ll have to watch out for double taxation.

So what is double taxation, and how could it affect your business and your bottom line?

What Is Double Taxation?

Double taxation is precisely what it sounds like — being taxed twice on the same source of income. Unlike LLCs, sole proprietors, and S corps, which don’t pay business taxes directly, C corps must pay business taxes. Let’s break it down:

  1. C Corp Taxes: C cop files its income taxes, subtracting expenses and losses. Then, it pays taxes on the remaining profits. The current corporate tax rate is set at 21% by the IRS.
  2. Shareholder Taxes: If a shareholder or owner takes a salary or wages from a C corps’ corporate earnings, they must also pay personal income taxes on those earnings.

So, if you own a C corp, your earnings will be taxed twice—first on the corporate earnings, then on the dividends or wages you earn from the business.

Example

Let’s imagine that your C corp company will make $100,000 in profit this year. The corporate tax rate for 2024 is 21%, according to the Tax Foundation, so your business will have to pay $21,000 in corporate taxes to the IRS. You and your shareholders will receive dividends from the rest of the $79,000, but you’ll each have to pay personal income taxes on those dividends. And because you’re the owner, you’ll pay personal income taxes on the salary you draw.

How to Avoid Double Taxation

C corps can’t escape this tax maze entirely, but they can adjust their strategies:

  • Retaining corporate earnings. You can avoid double taxation by keeping profits in the business rather than distributing it to shareholders as dividends. If shareholders don’t receive dividends, they’re not taxed on them, so the profits are only taxed at the corporate rate. If you and your shareholders rely on company profit for income, retaining corporate earnings probably isn’t a good idea. But if you can afford to reinvest the cash, you could grow your business.
  • Pay salaries instead of dividends. You can distribute profit as salaries or bonuses instead of as dividends. Employees will have to pay personal taxes on any salaries or bonuses they earn, but they’ll be deductible expenses for your business.
  • Split income. Income splitting is a strategy in which a business owner withdraws from the corporate profit what they need to support their lifestyle but leaves the rest of the profits in the corporation. Because progressive tax brackets affect C corps and individuals, income splitting can minimize double taxation. By taking a tax-deductible salary and leaving the rest of the profit for reinvestment, you reduce your personal gross income and the business’s taxable income.

Double taxation can seem like a penalty for C corp owners, but by incorporating these strategies, business owners can take advantage of the C corp structure while minimizing the effects of double taxation.

Despite the possibility of double taxation, some may still choose C corporation for the following advantages:

  • Limited liability and separate legal identity: C corps provides limited liability for their owners. Shareholders are not personally liable for the corporation’s debts. The corporation has a separate legal identity, meaning it exists independently from its owners. This separation shields shareholders from personal financial risks.
  • Tax advantages for smaller business owners: Unlike sole proprietors or partnerships, C corps don’t pay self-employment taxes on profits. C corps have more flexibility with deductions, salaries, and dividend distributions.
  • Attractive for investors: Investors often prefer C corps due to their well-established legal precedents and widespread acceptance by venture capitalists.

The Bottom Line

While double taxation is a big consideration, the C corp structure offers benefits– especially for companies aiming for aggressive growth. One could argue that regardless of double taxation, C corps provides many advantages for large and small business owners.

Tags: Small Business Resources, Taxes

What Is Double Taxation and How to Avoid It? (2024)

FAQs

What Is Double Taxation and How to Avoid It? ›

You can avoid double taxation by keeping profits in the business rather than distributing it to shareholders as dividends. If shareholders don't receive dividends, they're not taxed on them, so the profits are only taxed at the corporate rate.

How do you avoid double taxation? ›

Elect S corporation tax status: Once a corporation has been created, the owners can ask the IRS to treat it as an S corporation for tax purposes. S corporations have the same liability-limiting attractions as C corporations, but their profits flow directly to shareholders, avoiding double taxation.

How can a US citizen avoid double taxation? ›

Foreign Tax Credit

If you qualify for the Foreign Tax Credit, the IRS will give you a tax credit equal to at least part of the taxes you paid to a foreign government. In many cases, they will credit you the entire amount you paid in foreign income taxes, removing any possibility of US double taxation.

What is an example of a double tax? ›

For example, when capital gains accrue from stock holdings, they represent a second layer of tax, as corporate earnings are already subject to corporate income taxes. Additionally, the estate tax creates a double tax on an individual's income and the transfer of that income to heirs upon death.

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

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.

Do LLC owners get double taxed? ›

In addition, electing corporate taxation can allow an LLC to offer owners and employees various tax-advantaged fringe benefits, stock options, and stock ownership plans—none of which are subject to double taxation.

Do you get double taxed as a 1099? ›

If you are an independent contractor, however, your tax burden is doubled because you are paying both your own share and the employer's share. In total, the self-employment tax is equivalent to 15.3% of net income from your business.

Do you have to pay US taxes if you live in another country? ›

Yes, if you are a U.S. citizen or a resident alien living outside the United States, your worldwide income is subject to U.S. income tax, regardless of where you live. However, you may qualify for certain foreign earned income exclusions and/or foreign income tax credits.

Do US citizens get taxed twice? ›

The US is one of the few countries that taxes its citizens on their worldwide income, regardless of where they live or earn their income. This means that American expats are potentially subject to double taxation – once by the country where they earn their income, and again by the United States. NOTE!

Do I have to pay taxes if I work in another country? ›

You are subject to tax on worldwide income from all sources and must report all taxable income and pay taxes according to the Internal Revenue Code.

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 ...

Why is social security taxed twice? ›

The rationalization for taxing Social Security benefits was based on how the program was funded. Employees paid in half of the payroll tax from after-tax dollars and employers paid in the other half (but could deduct that as a business expense).

What are the benefits of double taxation? ›

Benefits of the double taxation treaty

For international businesses, a double taxation treaty helps reduce additional tax burdens. Without this type of treaty in place, income could be taxed both in the country of earnings as well as after it's been repatriated to the home country.

Who gets double taxation? ›

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.

Do you get taxed twice if you work remotely? ›

If your employer is outside the state where you live, there may be tax consequences. If your employer is outside the state where you worked remotely in 2023, you could face double taxation. Being a hybrid worker might also mean you get snagged.

How do taxes work if you work remotely in a different state? ›

Where do I pay state taxes if I live in a different state than my employer? As a remote worker, you must pay tax on all your income to the state you live in (if your state has personal income tax). This is true no matter where your employer is located.

What type of business avoids double taxation? ›

On the special type of corporation of interest to small businesses is the Subchapter S corporation. This type of corporation avoids double taxation by having its income taxed to the shareholders as if the corporation were a partnership.

Which type of income is subject to double taxation? ›

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.

Top Articles
Latest Posts
Article information

Author: Msgr. Refugio Daniel

Last Updated:

Views: 5293

Rating: 4.3 / 5 (74 voted)

Reviews: 81% of readers found this page helpful

Author information

Name: Msgr. Refugio Daniel

Birthday: 1999-09-15

Address: 8416 Beatty Center, Derekfort, VA 72092-0500

Phone: +6838967160603

Job: Mining Executive

Hobby: Woodworking, Knitting, Fishing, Coffee roasting, Kayaking, Horseback riding, Kite flying

Introduction: My name is Msgr. Refugio Daniel, I am a fine, precious, encouraging, calm, glamorous, vivacious, friendly person who loves writing and wants to share my knowledge and understanding with you.