Double taxation

Double taxation or double taxation of dividends used to be a major concern for business corporations and corporate officers. However, there are ways to avoid double taxation of dividends.

What is double taxation?

Double taxation of double taxation of dividends is when corporate income of a corporation is taxed twice. Most people have heard that corporate income is taxed twice (double taxation). The first corporate income taxation is at the corporate level and the same income is taxed again at the personal level when it is paid out to shareholders in the form of dividends. Double taxation occurs only when dividends are paid.

What are the risks of double taxation of dividends?

In theory, the Internal Revenue Code (IRC) says that most corporations are treated this way (except S corporations, whose profits automatically pass to shareholders each year). In practice, however, double taxation seldom occurs in the context of the small business corporation.

Why is double taxation rare? How to avoid double taxation of dividends

The reason why double taxation does not happen more often is simple. Employee who are the owners of the corporation don’t usually pay themselves dividends. Instead, the shareholders, who usually work for their corporation, pay themselves salaries and bonuses, which are deducted from the profits of the corporate business as ordinary and necessary business expenses.

The result is that corporation profits paid out in salary and other forms of employee compensation to the owner employees of a small business corporation are taxed only once, at the individual level. In other words, as long as you work for your corporation, even in a part time or consulting capacity, you can pay out business profits to yourself as reasonable compensation, and you avoid having your corporation pay taxes on these profits.