Double Taxation: Everything You Need to KnowStartup Law ResourcesIncorporate
Double taxation is when income or profits are taxed twice. It is usually used to reference when income taxes are paid twice at a corporate and personal level.4 min read
2. Why Is Double Taxation Important?
3. Reasons to Consider Avoiding Double Taxation
4. Reason to Permit Double Taxation
6. Common Mistakes
7. Frequently Asked Questions
8. Steps to File
Double Taxation: What Is It?
Double taxation is when income or profits are taxed twice. It is usually used in reference to when income taxes are paid twice. This may happen when profit is taxed on the corporate level and then again as income on the personal level. Although this situation can appear unfair, it arises because a corporation is considered a separate legal entity from its shareholders.
There are some who argue that double taxation is necessary to prevent wealthy individuals from avoiding taxes by paying their salaries via company dividends received from owning stock. Others argue that since the US corporate income rate is 39.1 percent, the highest in the developed world, double taxation stifles investment and provides incentives for corporations to finance investment by borrowing money. Many countries, including Estonia and Australia have integrated their tax code in order to avoid double taxation.
Why Is Double Taxation Important?
Double taxation cuts into a business' profits. You should consider taking steps to avoid having your income double-taxed.
Reasons to Consider Avoiding Double Taxation
Double taxation is often avoided to maximize corporate and personal profits.
Double taxation arguably reduces savings and investment, encourages businesses to avoid corporate structures, and prioritizes debt over equity,
Reason to Permit Double Taxation
One common reason for double taxation is because companies and their shareholders are different. For instance, a company's income is taxed once, but when shareholders receive dividends, this income is taxed again. Although it would seem wise to avoid being taxed twice, corporations and their shareholders are less likely to be audited when the corporation is complying with the double taxation structure.
One way to avoid double taxation is by not paying dividends to your shareholders. This will cut down on the income your shareholders receive from your company, but this income will not be double-taxed.
Many businesses choose to only operate in countries that have signed treaties to avoid double taxation. Countries may do this by not taxing income from another country, if that income has already been taxed. They may also offer tax credits in these situations.
You may also avoid double taxation if you are a resident of another country and living in the U.S. Below a certain threshold, the income you receive will not be taxed.
Many people have suggested significant tax reforms to avoid double taxation. However, none of these have been adopted.
International double taxation is often avoided because the main taxing country may exempt foreign-source income from tax. Many international tax treaties have also been signed to avoid double taxation. The EU has such an agreement with its members. Cyprus has 45 treaties dealing with double taxation. Germany even provides relief for foreign citizens who pay taxes on salary earned in Germany. India has double taxation relief treaties with 88 counties. Australia and the United States have both entered into several double taxation avoidance treaties.
If you have lived and worked in two different states in one year, you may be accidentally subject to double taxation. Keep careful track of how much money you earn in each state during each month of the year. Report these amounts to the different state taxation entities when you are filing your taxes.
Frequently Asked Questions
How Can I Avoid Double Taxation?
There are some simple ways to avoid double taxation:
Do not pay dividends to shareholders. If you pay shares to employees, increase their salary to compensate them for the lack of dividends.
Take a salary. This may expose you to higher personal income, but at least the salary is deductible to the corporation. This will expose you to less taxes overall.
Keep careful track of income earned in different states and countries. Report it accurately and to the appropriate tax agency.
Add family members to the payroll. If you’ve maxed out what you can reasonably take as a salary, you can add family members. This is commonly referred to as income splitting. You can only do this if they are legitimate employees.
Consider which countries you are doing business in and whether they have tax treaties to avoid double taxation.
Leasing equipment you own to the company is a widely accepted practice and a legitimate way to transfer money with limited tax burdens.
If you choose to pay dividends, consider becoming an S corporation with the IRS rather than a C corporation. S corporations do not pay federal taxes. Instead, taxes are only due on the dividends paid. You may also want to consider forming as an LLC.
Steps to File
You either avoid double taxation or are accidentally double-taxed when you file your taxes normally each year. To avoid double taxation, keep careful records of states and countries where your business operates and earns money. You may also consider avoiding paying dividends to your shareholders.
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