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Learn how your business can avoid the hassle of double taxation.
If you designate your business as a corporation, you should know about double taxation. Corporations and their shareholders are different than other business structures, which makes them subject to double taxation. Read on to discover precisely what double taxation is, and how you can avoid it.
What Double Taxation Means
The taxation is “double” because you pay income taxes twice on the same source of income. This means that a corporation is taxed at the personal and business levels. Businesses subjected to this are corporations (C Corps) and LLCs that elect to be treated as corporations.
How Double Taxation Works
For corporations, the company will be taxed as a business entity, and then each shareholder’s personal income is taxed as well. Double taxation occurs because corporations are considered separate legal entities from their shareholders. Corporations pay taxes on yearly earnings, and when they pay out dividends to shareholders, those dividends have tax liabilities. Therefore, any shareholder who receives dividends must pay taxes on them. A Corporation will not pay taxes on business income or “retained earnings” until it has paid out dividends to shareholders.
What Qualifies for Pass-Through Taxation
Other types of business structures, such as S Corps, sole proprietorships, partnerships, and LLCs that haven’t elected to be treated as corporations can avoid double tax. What they have instead is pass-through taxation. With this, income is taxed once. Its name comes from the way the taxes “pass-through” the business and onto the owners or individuals.
Avoid Double Taxation
The best thing you can do to avoid double taxation at your business is first not to structure your business as a corporation. If you already have a small corporation, you can have employees be shareholders. If you have a larger corporation, you can add shareholders to payroll as members of the board of directors.
Double taxation can be avoided by structuring your business as any of the structures mentioned above, which qualify for pass-through taxation. You can also avoid double taxation if you make yourself, owners, or other shareholders employees of the corporation because employees pay income tax on their earnings, rather than dividends. Finally, you can avoid this taxation by not distributing dividends but choosing another payment strategy.
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