Double taxation is a tax principle referring to instances where taxes are levied twice on the same source of income. It can occur when income is taxed at both the corporate level and the personal level. Double taxation can also occur in an international trade or investment context when the same income is taxed in two different countries.
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.
While critics argue that dividend double taxation is unfair, advocates say that without it, wealthy stockholders could virtually avoid paying any income tax.
Double taxation often occurs because corporations are considered separate legal entities from their shareholders. As such, corporations pay taxes on their annual earnings, just like individuals. When corporations pay out dividends to shareholders, those dividend payments incur income-tax liabilities for the shareholders who receive them, even though the earnings that provided the cash to pay the dividends were already taxed at the corporate level.
Double taxation is often an unintended consequence of tax legislation. It is generally seen as a negative element of a tax system, and tax authorities attempt to avoid it whenever possible.
Most tax systems attempt, through the use of varying tax rates and tax credits, to have an integrated system where income earned by a corporation and paid out as dividends and income earned directly by an individual is, in the end, taxed at the same rate. For example, in the U.S. dividends meeting certain criteria can be classified as "qualified" and as such, subject to advantaged tax treatment: a tax rate of 0%, 15% or 20%, depending on the individual's tax bracket. The corporate tax rate is 21%, as of 2022.
Debate Over Double Taxation
The concept of double taxation on dividends has prompted significant debate. While some argue that taxing shareholders on their dividends is unfair, because these funds were already taxed at the corporate level, others contend this tax structure is just.
Proponents of double taxation point out that without taxes on dividends, wealthy individuals could enjoy a good living off the dividends they receive from owning large amounts of common stock, yet pay essentially zero taxes on their personal income. Stock ownership could become a tax shelter, in other words. Supporters of dividend taxation also point out that dividend payments are voluntary actions by companies and, as such, companies are not required to have their income "double taxed" unless they choose to pay dividends to shareholders.
Certain investments with a flow-through or pass-through structure, such as master limited partnerships, are popular because they avoid the double taxation syndrome.
International Double Taxation
International businesses are often faced with issues of double taxation. Income may be taxed in the country where it is earned, and then taxed again when it is repatriated in the business' home country. In some cases, the total tax rate is so high, it makes international business too expensive to pursue.
To avoid these issues, countries around the world have signed hundreds of treaties for the avoidance of double taxation, often based on models provided by the Organization for Economic Cooperation and Development (IECD). In these treaties, signatory nations agree to limit their taxation of international business in an effort to augment trade between the two countries and avoid double taxation.
How Can I Avoid Double Taxation in Two States?
In some cases, individuals may need to file tax returns in multiple states. This can occur if they work or perform services in a different state from where they reside. Luckily, most states have provisions in their tax codes that can help individuals avoid double taxation. For example, some states have forged reciprocity agreements with others, which streamlines tax withholding rules for employers. Others may provide taxpayers with credits for taxes paid out-of-state, reducing their total obligations and avoiding double taxation. How exactly one can avoid double taxation depends on a wide range of factors, including how income is earned and which states are in question.
What Is the 183-Day Rule?
In the context of state taxes, the 183-day rule refers to a threshold some states use to determine whether or not an individual is a resident for tax purposes. In such cases, a state will consider an individual a full-year resident so long as they spent 183 days or more there.
What States Have No Income Tax?
There are a handful of states that don't levy state income taxes. This includes Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. However, if residents of these states work or perform services in other states, it's possible that income may still be taxed by those other states.
The Bottom Line
Double taxation occurs when taxes are levied twice on a single source of income. Often, this occurs when dividends are taxed. Like individuals, corporations pay taxes on annual earnings. If these corporations later pay out dividends to shareholders, those shareholders may have to pay income tax on them. Double taxation can also occur when income is taxed by two separate countries. In response to increased globalization giving rise to potential double taxation, many countries have forged tax treaties to avoid taxation and augment trade.
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.
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.
The US is one of the only countries in the world that taxes citizens regardless of where they live and work. Because of this, when a US citizen moves to another country with an income tax, they will have to report their income to both governments and face double taxation. This applies to “accidental Americans” as well.
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 ...
Contrary to popular belief, there's nothing in the U.S. Constitution or federal law that prohibits multiple states from collecting tax on the same income. Although many states provide tax credits to prevent double taxation, those credits are sometimes unavailable.
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.
Double taxation occurs when taxes are levied twice on a single source of income. Often, this occurs when dividends are taxed. Like individuals, corporations pay taxes on annual earnings. If these corporations later pay out dividends to shareholders, those shareholders may have to pay income tax on them.
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.
If you permanently moved to another state, you'll need to file two state returns: one for each state you lived in during the tax year (assuming both states charge income tax). You may be able to claim part-year residence, which will allow you to divide your income between the two states instead of paying taxes twice.
U.S. taxes are based on citizenship, not country of residence. That means it doesn't matter where you call home, if you're considered a U.S. citizen, you have a tax obligation this tax year. Your expat tax filing requirement doesn't change even if you're paid by a foreign employer overseas.
Fortunately, LLCs are not double-taxed. Startups structured as C corporations are the only entities paying their taxes twice. S corporations and sole proprietors can also avoid double taxation. Unlike C corporations, LLCs and sole proprietors are legally considered pass-through entities.
However, the double-taxation of Social Security benefits can occur at the state level. A grand total of 38 states don't tax Social Security benefits. But if you live in one of the 12 states that do tax Social Security benefits, and earn above the preset income thresholds in those states, double taxation can occur.
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!
If you want to avoid paying taxes, you'll need to make your tax deductions equal to or greater than your income. For example, using the case where the IRS interactive tax assistant calculated a standard tax deduction of $24,800 if you and your spouse earned $24,000 that tax year, you will pay nothing in taxes.
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.
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.
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