What Does Corporation Double Taxation Mean?

Corporation double taxation refers to profits taxed at the company level and again when distributed to shareholders as dividends. This article explains how it works, why it exists, international issues, and ways businesses reduce exposure through structure or credits.

By Brad Nakase, Attorney

Email | Call (800) 484-4610

Have a quick question? We answered nearly 2000 FAQs.

Table of Contents

1. Introduction

2. The Mechanism of Double Taxation

3. Discussion about Double Taxation

4. Double Taxation Internationally

5. How Can People Prevent Paying Taxes in Two States?

6. Describe a few examples of double taxation

7. Does double taxation apply to all business entities?

8. What is the test for substantial presence?

9. A double taxation treaty: what is it?

10. Double taxation: Can it be prevented/reduced?

11. Is it possible to carry over a foreign tax credit?

12. FAQs

13. Conclusion

Introduction

When taxes are imposed twice on an identical source of income, it is known as double taxation. It can happen when earnings are subject to both personal and company taxes. When the revenue is taxed in two different nations, double taxation may also occur in international commerce or investment. It is important for business owners to first know what double taxation in a corporation means.

The Mechanism of Double Taxation

Because businesses are considered distinct legal entities with respect to their stockholders, double taxation often happens. As a consequence, just like people, corporations contribute taxes on their annual profits. Tax laws may have the incidental consequence of creating double taxation. Authorities try to shun it because it is usually viewed as a negative part of a tax system. Double taxation in a corporation means corporate earnings are again taxed after the first payment.

Even if the earnings that supplied the funds for the payment of dividends had previously been subject to corporate taxation, shareholders who receive dividend payments from corporations are subject to income tax obligations.

Most tax systems aim to have different tax rates & tax credits, as well as an integrated system in which income generated directly by a person is subject to taxes at the same rate as revenue gained by a business and distributed as dividends. In the United States, dividends that satisfy specific requirements can be categorized as “qualifying” and receive favorable tax treatment, with a tax rate of zero percent, fifteen percent, or twenty percent, depending on the income tax bracket of the individual.

Future legislation may alter the federal corporate income tax rate, which is currently fixed at a rate of 21%. States have corporate income tax rates ranging from one percent to twelve percent, and these expenses are deductible.

Discussion about Double Taxation

Some contend that since the funds had previously been subject to corporate taxes, it is unfair to tax shareholders for their dividends. The argument put up by supporters of double taxation is that, in the absence of dividend taxes, wealthy individuals might live comfortably off dividends that they get from holding substantial shares of common stock while paying zero taxes on their own earnings. Supporters say that double taxation in a corporation means preventing dividend income from becoming a tax-free shelter.

In simple terms, stock ownership can become a tax shelter. Additionally, supporters of dividend taxation emphasize that corporations aren’t coerced to have their profits “twice taxed” unless they decide to distribute dividends to stockholders because these payments are choice activities.

Because they prevent the double taxation phenomenon, some assets with a pass-through or flow-through structure, like master limited partnerships, are very popular.

Double Taxation Internationally

Income can be subject to taxation both in the nation where it is generated and upon return to the nation of origin. It might make doing business globally prohibitively costly.

Nations have signed agreements to avoid double taxation with the goal of avoiding these problems; these agreements often depend on models provided by the Organization for Economic Cooperation and Development (OECD). In an effort to improve trade between each of the countries and avoid double taxation, participants in these agreements agree to restrict their taxation of foreign companies.

How Can People Prevent Paying Taxes in Two States?

People might have to file taxes in several states. This happens when people provide services or work in a state other than their home state. Fortunately, the tax statutes of the majority of states have clauses that can assist people in avoiding double taxation. For instance, several jurisdictions have established reciprocal agreements with other states, which simplify employers’ tax withholding regulations. Others might provide taxpayers with credits for paying taxes outside of the state.

When taxes are imposed twice on the same source of income, this is known as double taxation. When dividends get taxed, this usually occurs. Companies pay taxes on their yearly earnings just like people do. Shareholders may be required to shell out income tax on dividends paid by these companies in the future. When people or businesses are subject to taxes by two different countries or states, this is known as double taxation.

Describe a few examples of double taxation

To better understand double taxation, think about the following examples.

1. Corporate double taxation example

This example shows what double taxation in a corporation means.

A corporate income tax rate of 21% applies to corporations. In this case, firm A’s federal taxes came to $210,000 because it had a profit of one million dollars this year. The remaining $790,000 was given as dividends to shareholders by Company A.

Shareholders must pay taxes on these dividends. In addition to a 3.8% taxation on net income from investments, investors are subject to a maximum income tax rate of twenty percent on eligible dividends.

2. International double taxation example

Sally relocates to the Netherlands from the United States. It is a job as a web developer for her company’s Dutch division. She is paid $80,000 a year. Sally will need to report her earnings to the Dutch government because inhabitants of the Netherlands are subject to taxes. Sally must disclose the same amount of $80,000 to the IRS (Internal Revenue Service) on her American Federal Income Tax Return. It’s because she is a citizen of the United States. This is a result of citizen-based taxation in the US.

3. Foreign-sourced investment income

John, a citizen of the United States, has relocated to France in this instance. He invests in American stocks and gets dividends and interest from them.

John must pay tax to the Government of France on such investment income since he is regarded as a resident of France. However, because the investment income originates in the United States, the American government also levies taxes on it.

Does double taxation apply to all business entities?

Double taxation does not apply to all business entities. Pass-through businesses like partnerships, S corporations, & sole proprietorships are exempt from corporate taxes on their profits, in contrast to C corporations.

The business owners of pass-through companies are required to record the revenue on their individual tax returns after it is “passed through” to them. This makes it possible for pass-through companies to avoid paying taxes twice.

What is the test for substantial presence?

The United States and certain other nations assess tax residency using the significant presence test. It is known as the 183-day rule. It is determined by how much time a person spends in a specific nation.

Someone can be treated as a tax resident and required to pay taxes on global income if they remain 183 days or longer in one location during a single calendar year period.

It is important for U.S. expats to understand how the 183-day rule may apply in both their home nation and the United States. Separate jurisdictions use varying standards when determining tax residency.

An individual must physically be present in the US for at least one of the following days to be considered a resident of the United States for tax-related purposes:

31 days in the current year
183 days over the course of the three years that comprise the current year & the two years before it, counting:

Every day of this year that you were present
In the first year prior to the current year, one-third of the time you were present
One-sixth of the time you spent in the previous year’s second year

This law does have some exceptions, such as when a person is traveling between two locations outside of the United States or when they’re staying in the country for less than twenty-four hours.

A double taxation treaty: what is it?

An international agreement between two nations to avoid double taxation resulting from transactions occurring across borders. It is also called a DTA (double taxation agreement).

A DTA is “a contract made by two nations (commonly referred to by the term contracting states) to avoid and alleviate (minimize) territorial double taxes of the same earnings by the two jurisdictions.” This is the definition according to the Association of Chartered Certified Accountants (ACCA). “A protocol” refers to any addition/modification to such an agreement.

These agreements are crucial. They can lower tax evasion, promote international trade, & lessen the possibility of double taxation.

Double taxation: Can it be prevented/reduced?

Businesses and individuals can use a number of tactics to reduce or eliminate double taxes. These consist of:

DTT (Double taxation treaty). A DTT creates guidelines for the treatment of income obtained through cross-border transactions with the goal of helping avoid double taxation. For example, under a DTT, the investor may earn a foreign tax credit in their home nation after paying tax where the income originates. As an alternative, it can mandate that taxes be levied in the investor’s home nation while being exempt in the nation where the money is earned.
FTC (Foreign tax credit): The tax burden in one nation is offset by the tax paid in another. People may be able to lower their U.S. tax obligation and prevent double taxation on the same money earned abroad. This is by claiming this credit. Income taxes given to foreign nations or U.S. properties can be offset by this tax benefit for U.S. citizens and resident aliens.
FEIE (Foreign Earned Income Exclusion). Qualified Americans living abroad can use an FEIE as a tax benefit. It is to avoid paying taxes on foreign income in the United States. To put it briefly, its goal is to avoid double taxation. The highest exclusion amount varies annually.
Structure as a pass-through entity. Pass-through entities, including partnerships, S corporations, & sole proprietorships, do not pay corporate income taxes. This is unlike traditional C corporations. Pass-through structures are able to avoid being taxed twice. People planning to launch a business may consider forming it as a pass-through entity rather than choosing a standard corporate structure outright.
Instead of dividends, pay a salary. Salaries are exempt from double taxation since they are regarded as a business expense. This means that by paying out earnings as salaries rather than dividends, firms may be eligible to avoid double taxation.

Is it possible to carry over a foreign tax credit?

It is possible to carry over a foreign tax credit. A client’s foreign tax credit may be carried either forward or back to previous tax years if it surpasses their United States federal income tax obligation for the year in question. The credit may be advantageous since it enables taxpayers to optimize international tax credits and maximize the long-term tax benefit.

It is crucial to remember that there are some restrictions. Excess credits, for example, can be carried backward one year but forward ten years.

FAQs

1. Double taxation: What is it?

Irrespective of whether it’s corporate or individual income, double taxation occurs when the exact same income is subject to two taxes. Corporate double taxation & international double taxation are the primary manifestations of this phenomenon.

2. Corporate Double Taxation: What is it?

The phrase “double taxation” refers to the two distinct periods in which corporate profits may be subject to taxation. These are the times when:

The federal corporate tax rate is applied to corporate profits.
The dividends that shareholders receive from that same income are subject to income tax.

Double taxation results from the shareholders’ individual tax returns taxing these profits as gains on capital. It should be mentioned that C companies are not allowed to deduct earnings that are given to shareholders.

3. International double taxation: What is it?

It is particularly crucial for expatriates & multinational organizations because double taxation may occur internationally. Due to the possibility of income being taxed both domestically and internationally, an American expatriate who earns money abroad may be subject to international double taxation. The current agreements regarding taxes do affect this circumstance.

As a result, U.S. citizens who relocate abroad should be informed that they will probably be subject to double taxation and must report their earnings to the US government and foreign governments. One of the few nations in the world that taxes its inhabitants irrespective of where they live or work is the United States.

Consider an American expatriate who lives abroad and gets dividends from stocks headquartered in the United States. Since the investment income originates in the US, the US will tax it. Since the person is regarded as a taxpayer who lives in a foreign nation, the foreign nation may likewise impose taxes on the investment income. To put it briefly, both the US and the foreign nation may tax the investment income.

Conclusion

Corporate double taxation sounds like a technical tax term, but in real life, it simply means money getting taxed more than once as it moves around. Double taxation in a corporation means one stream of income passing through more than one tax layer.

A corporation pays tax on what it earns. Later, when that same money reaches shareholders as dividends, it gets taxed again. That’s where most of the frustration comes from. People see it as paying twice for the same income, even though the law treats the company and its owners as separate parties.

At the same time, the system wasn’t built randomly. Without dividend taxes, high earners could rely almost entirely on investment income and avoid personal taxes altogether. That’s why double taxation still exists.

The impact also depends on how a business is set up. Pass-through entities avoid it. International rules like tax treaties & credits help reduce the burden for people earning money across borders. Double taxation isn’t always unfair. It does demand planning and awareness.

Have a quick question? We answered nearly 2000 FAQs.

See all blogs: Business | Corporate | Employment

Most recent blogs:

What Does Corporation Double Taxation Mean?

What are the differences between incorporator and corporate promoter?

Incorporators focus on legal tasks like filing articles of incorporation, forming the corporation's legal structure. Corporate promoters, however, initiate the corporation's formation, handling stakeholder engagement and fundraising.

Are Bylaws Legally Binding?

Corporate bylaws are legally binding rules and regulations that govern the company, and corporate directors, officers, and shareholders must adhere to them.

What Are Corporate Bylaws?

Bylaws are internal documents belonging to a corporation that set forth the rules and regulations for how the business is run, governed, and operated.

What Is A Banking Resolution?

A banking resolution is a document showing the formal authorization by a company's board of directors or managing members to open a corporate bank account.

Types of Corporations

There are four general types of corporations: C Corporation, S Corporation. B Corporation, Close Corporation, and non-profit corporation.

Fiduciary Duty California

A principal who owes a beneficiary a fiduciary duty must use reasonable care, the duty of undivided loyalty, confidentiality, good faith, and the best interest of the beneficiary. A breach of fiduciary duty occurs when the person who owes the fiduciary fails to act in the beneficiary's best interest, such as not exercising reasonable care.

Usurping a Corporate Opportunity

When a corporate director or officer is present with a business opportunity related to or the same as the corporation's business, they cannot engage in that business opportunity for their personal benefit.

What does a general counsel do?

A general counsel is a company's chief legal officer who heads a company’s legal department and is the primary attorney and main source of legal advice.

What are the benefits of incorporating a business?

The benefits of a corporation include easy access to raising capital for a new business and personal liability protection. A primary advantage of a corporation is that it protects investors from the liabilities of a company.

What is a Shareholder Derivative Action?

A shareholder derivative action is a lawsuit brought by one or more shareholders on behalf of a corporation against the corporation's officer, director, or third parties who breached their duties to the company. The shareholder derivative actions allege that directors breached their fiduciary duties, either of care or of loyalty to the company.

What is corporate Governance?

Corporate governance is the system of rules, practices, structure, and processes used to direct, manage, and govern a company and its people. Nakase Wade's corporate governance lawyer assist businesses with communication with shareholders, corporate consultation, and guide corporate directors and officers in decision making processes.

S Corp vs C Corp vs LLC

One of the most significant differences between S Corp vs. C Corp is that the profit from the company is taxed at the corporate level, and the dividends to the shareholders are also taxed. For S Corp and LLC, the profits are not taxed at the corporate level, but the dividends to the shareholders are taxed.

Corporate Compliance for Healthcare Board of Directors

This article will discuss the roles of the Chief Compliance Officer and Corporate General Counsel in ensuring that the governing boards of health care organizations comply with corporate laws.

What is corporate compliance?

One of the most common mistakes entrepreneurs make is neglecting to include corporate compliance in the planning stages of a start-up.

Professional Corporation California

A professional corporation in California is a type of corporation for specific professions that offer a service regulated by a state regulatory board or a similar agency. The professional corporation can only provide services from a single profession.

11 Steps on How to Start a Corporation in California

To make forming your corporation easier, we have gathered together a list of the most important tasks you must accomplish over the next period.

See all blogs: Business | Corporate | Employment

1,774

What Does Corporation Double Taxation Mean?

Introduction

The Mechanism of Double Taxation

Discussion about Double Taxation

Double Taxation Internationally

How Can People Prevent Paying Taxes in Two States?

Describe a few examples of double taxation

Does double taxation apply to all business entities?

What is the test for substantial presence?

A double taxation treaty: what is it?

Double taxation: Can it be prevented/reduced?

Is it possible to carry over a foreign tax credit?

FAQs

Conclusion

Free Consultation