What Does Double Taxation Mean: Everything You Need to Know
One important question to ask yourself when getting into business is, "What does double taxation mean?" There are a few ways that double taxation is applied.3 min read
What Does Double Taxation Mean?
One important question to ask yourself when getting into business is, "What does double taxation mean?" There are a few ways that double taxation is applied in the business world. First, double taxation can occur when someone has paid taxes twice on income that was obtained from the same origin. This usually happens when the profits of a business are taxed once and then taxes are enforced again on shareholder's dividends. Therefore, the owner of a company has to pay taxes on his or her salary as well as his or her dividends.
Another way that double taxation can occur is in international trade. Income is subject to be taxed in both countries where the trade has taken place. Also, if someone lives in one country but then earns income in another, his or her income can be taxed twice. Some countries have double taxation agreements, which state what country can collect taxes on the income. Since both countries have the right to claim taxes, the agreement states which country has priority.
Most of the time, these types of agreements have different sets of rules for multiple types of income. For example, some income or gains from the tax can be made exempt.
Since there are so many angles of how double taxation can be applied, it is usually seen as a negative. Individuals who have authority in the tax system often try to avoid these cases.
How Does Double Taxation Apply to Corporations and Shareholders?
Businesses and their shareholders are seen as a separate legal entities. The yearly earnings of a company are taxed as it would be for an individual. Then when the company pays its shareholders dividends ,the shareholder has to pay income taxes on those payments.
Many have argued that double taxation on shareholders' dividends are unethical, while others believe it is fair. Those who disagree do not like that shareholders' dividends are taxed both personally and through the company. Those who agree with double taxation state that if taxes were not applied to dividends, then many would live well off of owning common stock, considering that their dividend earnings would be the only type of income that would not be taxed. They also argue that a company's policy on dividends is planned at the corporate level. Therefore, if they do not want to deal with the possibility of double taxation then they should not pay dividends to shareholders.
By using different tax rates and credits, tax systems hope to achieve fairness in having various types of income taxed at the same rate.
Are S Corporations Affected by Double Taxation?
An S Corporation is taxed mostly like a partnership. Therefore, the owner of the company pays taxes on the business profits on his or her personal income tax return.
Is Double Taxation Applied in LLCs, Partnerships, and Sole Proprietors?
These types of businesses are not affected by double taxation. The profits gained from these businesses are reported on the owner's personal income taxes.
How Is Double Taxation Different in Growth and Income Companies?
Small and/or new businesses do not pay dividends. When these companies gain income, they often put it back into the company to improve the companies. Only companies that have established business and have been around for some time use their income to pay shareholders.
How Double Taxation Works in International Business
In companies that conduct business internationally, they are usually at risk for double taxation. Income can be taxed in the place where it is earned. If that place is in a different country than where the business is centrally located, then double taxation can occur. The business' income will be taxed in both locations. This is a problem for many businesses, since the total tax rate in countries differs. Therefore, one country can have a higher tax rate compared to another, which can make international business extremely costly. The result of this makes companies not want to conduct their business internationally.
In an effort to avoid double taxation, many countries have signed treaties agreeing to curb their taxes on international business. This leads to many companies continuing their business internationally.
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