Double taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income.
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. 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.
Corporate integration and the removal of the estate tax would address these instances of double taxation.
Businesses and individuals that reside in one country but earn income in other countries could also face double taxation if more than one country taxes their earnings. Credits for foreign taxes, territorial taxation, and tax treaties can minimize the likelihood of double taxation of foreign income.
How Does Double Taxation Occur?
Generally, the income tax attempts to tax the creation of new income once, as it happens. Take the example of a business that produces a good and sells it to a customer, who buys that good with after-tax income. The business then pays tax on the income generated from that sale.
We do not consider the taxation of that business income to be a double-tax of the customer’s income simply because the customer paid taxes on their wages. Rather, this transaction is due to the generation of new income attributable to the business, from a new good or service. This new income should be taxed.
However, a transaction that is the result of a new good or service is distinct from transactions in which no good or service is produced. Money changes hands in the economy all the time without the creation of a new good or service. Alimony is a good example of this. Under current law, the receipt of an alimony payment is considered taxable. However, alimony does not result in new income, because it is simply the transfer of money from one person to another. So, to prevent double taxation, the payer of alimony can deduct it from their taxable income. Transfers like these are generally exempt from additional taxation, in order not to tax the same income twice. The tax code makes a similar adjustment—allowing deduction for payment, but taxing receipt of income—for several other transfers between parties: business interest expenses, payroll expenses, costs of goods sold, and home mortgage interest, to name a few.
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FAQs
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.
What is an example of a double taxed income? ›
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.
How can I avoid double taxation? ›
How to Avoid Double Taxation
- Retaining corporate earnings. You can avoid double taxation by keeping profits in the business rather than distributing it to shareholders as dividends. ...
- Pay salaries instead of dividends. You can distribute profit as salaries or bonuses instead of as dividends. ...
- Split income.
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.
Can you be taxed twice on the same money? ›
Double taxation happens when income tax gets levied twice on the same income. So if you're a shareholder or owner of a corporation, then you may face double taxation because your income will come from corporate earnings that were already taxed, and you will also pay taxes on them.
Do you pay taxes twice if you own a business? ›
Because of the corporate income taxes, C corporations are potentially subject to double taxation. This means that the business is responsible for paying income tax on its earnings, and then the shareholders are responsible for paying a second tax when they receive dividends from the corporation.
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 US citizens get double taxed? ›
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!
Is double taxation a bad thing? ›
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.
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.
Limited Liability Companies ( LLC )
Like a partnership, there is no double taxation and more tax flexibility than a partnership. A primary advantage of an LLC is that its "members" (owners) are not personally liable for the debts and liabilities of the LLC .
Why is social security taxed twice? ›
If you earn above the income thresholds that trigger taxation at the federal level, and you live in one of the 13 states that also tax Social Security benefits to some varying degree, then, and only then, can your Social Security benefits be described as being taxed twice.
What is an example of double taxation in real life? ›
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.
Which of the following is an example of double taxation? ›
When a corporation pays out dividends to shareholders, the dividends also have tax liabilities. Shareholders who receive any dividends must pay taxes on them. Hence, double taxation.
Why is double taxation unfair? ›
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 does LLC avoid double taxation? ›
LLCs avoid double taxation because they are a pass-through entity—there is no tax on profits at the LLC level, only at the individual member level.
