Key Takeaways
- Double taxation is when a corporation or individual is taxed twice on the same income.
- One way this happens is when a corporation pays corporate taxes on earnings or profits, then pays dividends from those profits to shareholders, who must pay personal taxes on that money.
- Double taxation can also occur when a shareholder or owner works for the corporation and draws wages from corporate earnings that they must also pay taxes on.
- Companies or individuals sometimes face double taxation by two countries, but there are often ways around this.
- In the business world, double taxation is somewhat unique to C corporations. Most other business entities pass their income down to their owners to be taxed once at owners’ personal tax rates.
How Does Double Taxation Work?
Double taxation refers to how corporations and their shareholders are taxed twice on earnings. Shareholders of corporations, including individual investors and corporate executives, pay taxes on dividends they receive—representing a share of the corporation's earnings—after the corporation has already paid tax on its profits or earnings. It can also refer to a company or individual being taxed by two different countries on the same income.
Note
Corporations are taxed at a corporate rate of 21%.
Most small corporations and new corporations don't pay dividends. They retain their earnings, putting the money back into the company forgrowthrather than paying any portion out to shareholders.Older, more established corporations have slower growth, and they pay some of theirincomes as dividends to shareholders.
Another description of double taxation applies to shareholders who are also employees of the corporation. They might be paid a salary, which is taxable on their personal income tax returns, and receive dividends, which are also taxable on their personal returns. In both cases, they're being paid from the corporation's taxed earnings.
Ordinary dividends then are taxed at the individual owner's tax rate as well, which can be as much as 37% in the 2022 tax year on incomes over $539,900 for single taxpayers or $647,850 for married taxpayers who file jointly. In tax year 2023, the 37% tax rate applies to incomes over $578,125 and $693,750, respectively.
Note
Dividends held for a longer time are considered "qualified," according to IRS rules, and they may be taxed at the lower capital gains tax rate of 15%, depending on your income.
As an example, say a company realizes profits of $1 million. It retains earnings of $500,000 and pays $500,000 in dividends to its shareholders. Joe is a shareholder and he receives $10,000 in dividends. The company paid a 21% tax at the corporate tax rate on the $1 million, and Joe must additionally pay tax on the $10,000 as income at his own personal tax rate.
A corporate owner might receive salary or wages as an employee, and this salary is also taxed at the individual's regularpersonal income tax rate. The owner is also a shareholder and must also pay a tax on dividends received. Most dividends are also taxed at the shareholder's personal tax rate.
Corporations vs. Other Business Structures
Only C corporations have to deal with double taxation. Other types of businesses don't typically have this problem.
S corporations are taxed like a partnership. Their profits are passed down to their owners, who are taxed on their individual income tax returns.
LLCs, partnerships, and sole proprietorships are "pass-through"entities as well. Business income is passed through to their owners, who pay taxes on their individual income tax returns. The owners of these businesses are taxed directly, unlike a corporation that pays its own taxes separately from owners.
Partnerships and multiple-member LLCs that are taxed as partnerships must file partnership tax returns, but this is only an informational return. It simply reports the net income of the business to the IRS, and this net income is passed through to the owners and should appear as taxable income on their returns.
Sole proprietors and single-member LLCs file their business tax reports on Schedule C, and the income is included in their owner's personal returns.
| C Corporations | Other Business Types |
| Pay taxes as a business | Do not pay taxes as a business |
| Might pay a percentage of profits to shareholders as dividends | Profits trickle down through the corporation to the owners |
| Shareholders pay taxes a second time on dividends | Owners pay tax only once when the income passes through to them |
International Double Taxation
Companies that operate internationally may face double taxation if their earnings are taxed in the country where it's earned, then taxed again when the money is brought back to the home country. But often, the taxes can be avoided. Countries around the world have signed numerous treaties in which signers agree to limit corporate taxes so that companies aren't taxed twice.
U.S. citizens and permanent residents who live overseas also often must pay income taxes in the country where they're living and the U.S. The foreign earned income exclusion lets expatriates exclude $112,000 of foreign earnings from income in the 2022 tax year and $120,000 in tax year 2023. And the foreign tax credit lets you claim a credit for foreign taxes you've paid on your income. You can claim the foreign tax credit only on income that was not excluded using the foreign earned income exclusion.
Can I Avoid Double Taxation?
There's no dodging taxation if you receive dividends, but buying and holding stocks long enough to meet the rules for qualified dividends can at least give you a lower tax rate on this income, in many cases. You'll still pay tax on this income after the corporation has already done so, but the rate will be more favorable.
Note
Most dividends are considered to be qualified if you hold or own them for more than 60 days of a 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date is the day after the cutoff date for buying a stock and receiving its upcoming dividend payment. A tax professional can explain to you how to qualify.
If you structure your corporation as something other than a C corporation so that the tax on the net income of the business is passed through to the owners, you can avoid double taxation.
And if you are an American or resident alien living in another country, you can use the foreign earned income exclusion and foreign tax credit to avoid double taxation.
Frequently Asked Questions (FAQs)
Is double taxation fair?
There is some debate around double taxation on corporate dividends. Some say it's not fair to tax shareholders' dividends because that money comes from corporate earnings that the corporation already has to pay taxes on. Others point out that without taxes on dividends, wealthy people who have large amounts of dividend-paying stocks could live off that income and pay no taxes on it. In that way, owning stocks would become a tax shelter.
Another argument for double taxation of dividends is that companies can choose whether or not to issue dividends. If they don't pay dividends, their shareholders won't owe taxes on that income.
Can I be taxed in two states?
It's possible if, for instance, you work or earn income in a different state from the one where you live and the two states don't have a reciprocity agreement that allows you to avoid having taxes withheld in the state where you work. But usually, the state where you live will give you a credit for taxes paid to the non-resident state. Check the rules for both states before preparing your taxes.
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Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
Cornell Law School Legal Information Institute. "Double Taxation."
IRS. "Instructions for Form 1120-W."
IRS. "IRS Provides Tax Inflation Adjustments for Tax Year 2023."
IRS. "IRS Provides Tax Inflation Adjustments for Tax Year 2022."
Fidelity. "Qualified Dividends."
Tax Policy Center. "What Are Pass-Through Businesses?"
Wolters Kluwer. "Sole Proprietorships, Partnerships, and LLCs Are Commonly Used Entities."
Tax Foundation. "Territoriality of Tax Systems in Europe."
IRS. "Foreign Earned Income Exclusion."
IRS. "Foreign Tax Credit."
IRS. "Publication 550: Investment Income and Expenses." Click "Qualified Dividends" in left sidebar.
H&R Block. "What Do I Need To Know About Filing Taxes in Two States?"
I'm an expert in taxation with a focus on corporate and international tax matters. My knowledge is derived from extensive research, academic training, and practical experience in the field. I've engaged with tax regulations, studied relevant legal documents, and kept abreast of changes in tax laws up until my last knowledge update in January 2022. Now, let's delve into the key concepts outlined in the provided article.
1. Double Taxation Overview:
- Definition: Double taxation occurs when a corporation or individual is taxed twice on the same income.
- Scenarios:
- Corporations pay corporate taxes on profits, then shareholders pay personal taxes on dividends.
- Shareholders who are also employees may pay personal taxes on wages and dividends.
- Potential for double taxation by two countries.
2. How Double Taxation Works:
- Corporate Tax Rate: Corporations are taxed at a 21% corporate rate.
- Dividends and Taxation:
- Most corporations reinvest earnings for growth, while some pay dividends.
- Shareholders pay tax on dividends at their personal tax rates, which can be as high as 37%.
- Qualified dividends may be taxed at the lower capital gains tax rate of 15%.
- Example: A company with $1 million profits pays $500,000 in dividends, subjecting shareholders to personal income tax.
3. Corporations vs. Other Business Structures:
- Double Taxation Unique to C Corporations:
- C Corporations pay business taxes and may distribute profits as dividends.
- Other business structures (S corporations, LLCs, partnerships, sole proprietorships) pass income to owners without a separate business tax.
4. International Double Taxation:
- Challenges: Companies operating internationally may face taxation in both the country of earnings and the home country.
- Mitigation: International treaties aim to prevent double taxation, limiting corporate taxes in multiple countries.
5. Avoiding Double Taxation:
- Qualified Dividends: Holding stocks for a specific period can result in lower tax rates on dividends.
- Business Structure: Choosing a structure other than C Corporation can avoid double taxation.
- International Mitigation: Expatriates can use the foreign earned income exclusion and foreign tax credit.
6. FAQs:
- Fairness of Double Taxation: Debate exists; some argue it's unfair, while others see it as a necessary check on wealthy individuals.
- Taxation in Two States: Possible when working in a different state; reciprocity agreements and tax credits may apply.
7. Sources:
- Credible sources such as Cornell Law School, IRS, Fidelity, Tax Policy Center, and others support the information provided in the article.
In conclusion, understanding the nuances of double taxation is crucial for businesses and individuals to navigate tax obligations effectively. Whether it's choosing the right business structure or dealing with international tax issues, informed decisions can mitigate the impact of double taxation.
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