Double taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income.
Examples of Double Taxation
The United States’ tax code places a double-tax on corporate income with one tax at the corporate level through the corporate income tax and a second tax at the individual level through the individual income tax on dividends and capital gains. For example,when capital gains accrue from stock holdings, they represent a second layer of tax, as corporate earnings are already subject to corporate income taxes.
Additionally, the estate tax creates a double tax on an individual’s income and the transfer of that income to heirs upon death.
Corporate integration and the removal of the estate tax would address these instances of double taxation.
Businesses and individuals that reside in one country but earn income in other countries could also face double taxation if more than one country taxes their earnings. Credits for foreign taxes, territorial taxation, and tax treaties can minimize the likelihood of double taxation of foreign income.
How Does Double Taxation Occur?
Generally, the income tax attempts to tax the creation of new income once, as it happens. Take the example of a business that produces a good and sells it to a customer, who buys that good with after-tax income. The business then pays tax on the income generated from that sale.
We do not consider the taxation of that business income to be a double-tax of the customer’s income simply because the customer paid taxes on their wages. Rather, this transaction is due to the generation of new income attributable to the business, from a new good or service. This new income should be taxed.
However, a transaction that is the result of a new good or service is distinct from transactions in which no good or service is produced. Money changes hands in the economy all the time without the creation of a new good or service. Alimony is a good example of this. Under current law, the receipt of an alimony payment is considered taxable. However, alimony does not result in new income, because it is simply the transfer of money from one person to another. So, to prevent double taxation, the payer of alimony can deduct it from their taxable income. Transfers like these are generally exempt from additional taxation, in order not to tax the same income twice. The tax code makes a similar adjustment—allowing deduction for payment, but taxing receipt of income—for several other transfers between parties: business interest expenses, payroll expenses, costs of goods sold, and home mortgage interest, to name a few.
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FAQs
Key Takeaways. Double taxation refers to income tax being paid twice on the same source of income. This can occur when income is taxed at both the corporate level and the personal level, as in the case of stock dividends. Double taxation also refers to the same income being taxed by two different countries.
What is an example of a double taxed income? ›
For example, when capital gains accrue from stock holdings, they represent a second layer of tax, as corporate earnings are already subject to corporate income taxes. Additionally, the estate tax creates a double tax on an individual's income and the transfer of that income to heirs upon death.
Is double taxation illegal in the US? ›
Fair or not, double taxation is allowed under US law. Some activist groups, such as Americans Against Double Taxation, oppose this and hope to remove double taxation from US tax law. For now, however, double taxation remains a reality for many Americans living overseas.
How can I avoid double taxation? ›
When a business is organized as a pass-through entity, profits flow directly to the owner or owners. In turn, these are not taxed at the corporate level and again at the personal level. Instead, the owners will pay taxes at their personal rate, but double taxation is avoided.
Why is double taxation bad? ›
Opponents of double taxation on corporate earnings contend that the practice is both unfair and inefficient, since it treats corporate income differently than other forms of income and encourages companies to finance themselves with debt, which is tax deductible, and to retain profits rather than pass them on to ...
Can you be taxed twice on the same money? ›
Double taxation refers to the imposition of taxes on the same income, assets or financial transaction at two different points of time. Double taxation can be economic, which refers to the taxing of shareholder dividends after taxation as corporate earnings.
How to avoid double state taxation? ›
Other state tax credit Credit code 187
You may claim this credit if you had income that was taxed by California and another state. The credit will offset the taxes paid to the other state, so you are not paying taxes twice. This credit applies to: Individuals.
What is an example of double taxation in real life? ›
Most commonly, double taxation happens when a company earns a profit in the form of dividends. The company pays the taxes on its annual profits first. Then, after the company pays its dividends to shareholders, shareholders pay a second tax.
Why is social security taxed twice? ›
Yet since Social Security taxes are only 50 percent deductible (the so-called employer share of the tax is paid in pre-tax dollars), it is double taxation to tax more than 50 percent of benefits. Dividend tax – Returns to corporate equity are subject to double-taxation.
Why are Americans taxed twice? ›
The US is one of the few countries that taxes its citizens on their worldwide income, regardless of where they live or earn their income. This means that American expats are potentially subject to double taxation – once by the country where they earn their income, and again by the United States. NOTE!
No U.S. citizen is exempt from paying taxes if they owe them to either the federal government or to their state. Their incomes may be exempt from taxation, however, so they don't owe anything. They may be exempt from filing because they don't owe any tax due to other tax provisions.
Do capital gains get taxed twice? ›
The taxation of capital gains places a double tax on corporate income. Before shareholders face taxes, the business first faces the corporate income tax.
Why are LLCs taxed twice? ›
Does an LLC have double taxation? LLCs avoid double taxation because they are a pass-through entity—there is no tax on profits at the LLC level, only at the individual member level.
How much foreign income is tax free? ›
Limit on excludable amount
The maximum foreign earned income exclusion amount is adjusted annually for inflation. For tax year 2023, the maximum foreign earned income exclusion is the lesser of the foreign income earned or $120,000 per qualifying person. For tax year 2024, the maximum exclusion is $126,500 per person.
Are you taxed twice on dividends? ›
If the company decides to pay out dividends, the government taxes the earnings twice because the money is transferred from the company to the shareholders.
What is an example of a double taxation problem? ›
An example of this is the case where both city and county have code enforcement services, but the county provides code enforcement almost exclusively in the unincorporated area - even though funds to support the county code enforcement come from property taxes which are paid by county residents inside as well as ...
Do you pay taxes twice if you own a business? ›
Fortunately, LLCs are not double-taxed. Startups structured as C corporations are the only entities paying their taxes twice. S corporations and sole proprietors can also avoid double taxation. Unlike C corporations, LLCs and sole proprietors are legally considered pass-through entities.
