× 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:
- 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.
- 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
FAQs
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.
Is there a way to avoid double taxation? ›
When a business is organized as a pass-through entity, profits flow directly to the owner or owners. In turn, these are not taxed at the corporate level and again at the personal level. Instead, the owners will pay taxes at their personal rate, but double taxation is avoided.
How to avoid double state taxation? ›
Other state tax credit Credit code 187
You may claim this credit if you had income that was taxed by California and another state. The credit will offset the taxes paid to the other state, so you are not paying taxes twice. This credit applies to: Individuals.
How to avoid double taxation US citizen? ›
The IRS requires that taxpayers avoid making double claims by choosing either a credit or a deduction for foreign taxes paid, but not both for the same tax.
How to do 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.
How can a business avoid double taxation? ›
Two business structures are often preferred for small businesses since they avoid this double taxation burden. These are an LLC and an S Corporation. With these business structures, the company is taxed more like a Sole Proprietorship or a Partnership than as a separate entity, like the C Corporation.
What is a double taxation example? ›
Examples of Double Taxation
The United States' tax code places a double-tax on corporate income with one tax at the corporate level through the corporate income tax and a second tax at the individual level through the individual income tax on dividends and capital gains.
How to avoid double taxation LLC? ›
Unlike C corporations, LLCs and sole proprietors are legally considered pass-through entities. The structure means their earnings go directly to their owners, who pay their taxes through their personal income tax. Another way you can avoid double taxation is by adopting the S corporation structure.
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 ...
How do I know if I'm being 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.
Nine states — Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming — do not levy a state income tax. New Hampshire Department of Revenue Administration. Frequently Asked Questions - Interest & Dividend Tax. Accessed Apr 25, 2024.
What state should I withhold taxes for? ›
As a starting point, the default rule of state income tax withholding is to withhold income tax for the state in which services are performed (the work state). Almost all states require employers to withhold tax from employee wages earned for work performed in that state, even for nonresidents.
Can IRS find out about foreign income? ›
One of the main catalysts for the IRS to learn about foreign income which was not reported is through FATCA, which is the Foreign Account Tax Compliance Act.
Do you have to pay taxes if you live in a different country? ›
If you are a U.S. citizen or resident living or traveling outside the United States, you generally are required to file income tax returns, estate tax returns, and gift tax returns and pay estimated tax in the same way as those residing in the United States.
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.
What is the meaning of double taxation? ›
Primary tabs. Double taxation refers to the imposition of taxes on the same income, assets or financial transaction at two different points of time. Double taxation can be economic, which refers to the taxing of shareholder dividends after taxation as corporate earnings.
How to avoid double taxation as an LLC? ›
Unlike C corporations, LLCs and sole proprietors are legally considered pass-through entities. The structure means their earnings go directly to their owners, who pay their taxes through their personal income tax. Another way you can avoid double taxation is by adopting the S corporation structure.
What does it mean to have double taxes? ›
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.
