What Is Double Taxation?

Double taxation means paying taxes twice on the same source of income. There are a couple of scenarios where double taxation may occur — but the main one is when you’ve organized your business as a C corp.

Fortunately, there are ways to avoid it. Here’s everything you need to know about double taxation and how to make sure it doesn’t happen to you.

Double taxation explained

When you start a new business, you have many new factors to consider. From product design to marketing strategy, every detail will influence your bottom line. This is especially true when it comes to how you structure your company.

There are 4 main ways to structure your business: sole proprietorship, LLC, S corporation, or C corporation. Each business structure has different tax implications, but it’s C corps alone that are prone to double taxation.

C corp are distinct legal entities distinct from its owners. C corps maintain many of the same rights that individuals possess. They can enter contracts, sue or be sued, own assets, and more. However, this also means they’re responsible for paying separate taxes.

C corps must pay taxes on the profits they generate as a company. The remaining after-tax sum is then distributed to shareholders and owners. The company’s owners then have to pay personal income taxes on their earnings.

For example, assume you own a C corp that generates $100,000 in income. As of 2022, the corporate tax rate is 21%. In this scenario, your C corp will have to shell out $21,000 before paying out dividends or income.

As the owner, you’ll be entitled to the remaining $79,000. However, you’ll need to claim this income on your personal tax return, and pay taxes accordingly. In this way, your business is taxed twice — once for corporate taxes and once for personal taxes.

Making sure you’re not taxed twice

It’s understandable that you wouldn’t want to pay more taxes than you have to. Fortunately, there are ways to avoid double taxation or reduce your tax burden — even as a C corp. Take a look at some helpful tips.

Retain corporate earnings

As a business owner, you won’t have to pay personal taxes on your company’s earnings if your C corp retains its profits. Instead of issuing dividends or income, your company will retain the funds and only be taxed at the corporate tax rate. This strategy works best if you’re willing to income from your business in order to reinvest the funds.

Pay salaries instead of dividends

Switching up income payments to salaries instead of dividends allows you to claim deduction expenses. This can help reduce your overall tax burden and even avoid double taxation.

Split income

This strategy involves splitting up corporate profit to take advantage of income tax brackets. In theory, you’d only withdraw enough salary to support your lifestyle. The remaining profits would go back into your business. Doing this can help lower your personal taxable income as well as your business’s taxable income.

Establish an LLC

You would establish a separate LLC to purchase equipment, machinery, or even real estate and lease it to your C corp. Cash flow would come through your LLC and your C corp would receive a dedication for making payments.