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What Is Double Taxation in Business?

We all have to pay taxes, and depending on states, policies, and how much you earn, some of us pay higher taxes than others. However, double taxation is a little bit different from this; it means you’re paying taxes on the same profit your business earned twice.

How Does Double Taxation Work In Real Life?

With double taxation, you pay taxes on your business’s profit at the corporate level, and when dividends reach you as a shareholder, you pay taxes on them too.

This is what comes with the C Corporation structure. It doesn’t necessarily make it a bad business structure depending on the amount of tax being paid; in some cases, it might even help you reduce some tax burdens. So, in this guide, we’ll be breaking down how double taxation works in businesses, when it makes sense for businesses, and how to avoid it if it’s not the right fit.

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Which Business Entities Are Subject to Double Taxation?

As a business, you’re taxed depending on the particular business structure you choose. Let’s break down how different types of businesses are taxed:

• C corporations: You pay corporate-level income tax, and when the profit is distributed to shareholders as dividends, you still pay taxes as an individual.
• S corporations: This is treated as a pass-through entity. You’re not paying income tax as a business, but as a shareholder, you pay individual taxes on the profit.
• Partnerships: This also works similarly to S corporations; you’re not paying corporate-level tax, but shareholders pay personal income tax.
• Sole proprietorships: This is the simplest pass-through structure. You pay taxes on business profit as an individual, but you’re not paying taxes as a business.
• Limited liability companies (LLCs): This is flexible, depending on your business formation structure and your taxation choice. As a single-member LLC, you’re typically taxed like a sole proprietorship, and multi-member LLCs are taxed like partnerships; both are pass-through entities. However, as an LLC, you can elect to be taxed as an S corporation or a C corporation, depending on what best fits your business growth trajectory.

Summary of Different Types of Corporations and How They Are Taxed ↙️

Business Structure	Taxation Type	Corporate-Level Tax?
C corporation	Double taxation	Yes
S corporation	Pass-through	No
Partnership	Pass-through	No
Sole proprietorship	Pass-through	No
LLC (default)	Pass-through	No

S Corporation vs. C Corporation: How Taxation Works

Both S and C corporations give shareholders limited liability, which means your personal assets are protected from business debts and legal judgments. They both give you shares and hold regular board and shareholder meetings.

The main difference between them is how they are taxed: a C corporation is taxed at both the business and personal levels, while an S corporation uses pass-through taxation and is taxed only at the individual level.

Here’s what that looks like ↙️

How Pass-Through Taxation Works in an S Corporation

Your business profits and losses flow through to individual shareholders proportional to their ownership stake, and shareholders report that income on their personal tax returns at their individual tax rate. So, it operates on a single taxation structure.

Keep in mind that even though your business profits are not taxed at the business level, you still have to file your business income tax return. Also, S corporations come with restrictions; you can’t have more than 100 shareholders, and all shareholders must be U.S. citizens or residents — meaning you can’t raise capital through a global offering.

How Double Taxation Works in a C Corporation

For a C corporation, you pay income tax on its profits at the corporate tax rate, and also personal income tax on your dividends as a shareholder. In case you’re wondering why anyone would go for the double tax burden, C corporations offer way more flexibility.

As a C corporation, there’s no cap on the number of shareholders you can have both within the US and globally. You can also issue multiple classes of stock and pursue a public offering. So, it works for public and venture-backed businesses.

Why Would a Small Business Choose a C Corporation Despite Double Taxation?

Double taxation sounds like an obvious disadvantage, and for many small business owners it is. But some businesses still go for it, and here’s why:

• Venture capital and investor funding: Most venture capital firms and institutional investors require a C corporation structure. If you’re planning to raise significant funding, a C corporation may be the better option.
• Unlimited shareholders and public offerings: C corps can issue shares to an unlimited number of shareholders and pursue an IPO. S corps cannot exceed 100 shareholders and can’t pursue an IPO.
• Multiple stock classes: C corps can issue different classes of stock with different rights, e.g., common and preferred shares. S corporations can only issue one class.
• Retained earnings: As a C corporation, you can reinvest profits at the corporate level, which can lower your corporate income tax rate and legally reduce how much you’re taxed depending on the individual and corporate tax rates of the particular year.
• Foreign investors: S corps require all shareholders to be U.S. citizens or residents. You don’t have that limitation with C corps.

Can I Minimize or Avoid Double Taxation?

Yes, here are several legitimate tax strategies you can use to avoid being taxed twice:

• Elect S corporation status: If your business qualifies, going for S corporation tax treatment eliminates the need for corporate-level tax.
• Structure compensation as salary: Instead of sharing profits as dividends at a go, e.g., quarterly, you can structure your C corp’s profits as a salary, which is deductible at the corporate level. This reduces taxable corporate profit before the first layer of tax applies.
• Retain earnings rather than distributing dividends: If profits stay within the business and are not distributed to shareholders as dividends, shareholders can’t be taxed on dividends that weren’t distributed.
• Form an LLC: Limited liability companies provide the liability protection of a corporation that comes with pass-through taxation by default.
• Qualified Opportunity Zone investments and other strategies: A business attorney or tax advisor can help identify additional strategies based on your specific situation.

Contact MCIS Law About Choosing the Right Business Structure

Both the S corp and a C corp are valid business structures; the best fit depends on your business goals, your investor situation, and your tax exposure. You need to carefully examine these factors before picking one.

If you’re still figuring out which structure fits your business, or need tax strategies that limit your exposure, book a consultation with MCIS Law.

Frequently Asked Questions About Double Taxation

What Is Double Taxation And Why Does It Happen?

Double taxation happens when the same income is taxed at two levels, first as corporate profit, then again as dividend income when distributed to shareholders. It happens because a C corp is treated as a separate taxable entity from its owners.

Which Business Entities Have Double Taxation?

C corps face the double layer of taxation. S corporations, partnerships, sole proprietorships, and most LLCs avoid it through pass-through taxation.

What Business Organization Is Subject To Double Taxation?

Primarily, the C corporation. The business pays corporate tax, and the shareholders also pay personal income tax.

How Does Double Taxation Work Step-by-step?

1. The C corp earns profit.
2. The corporation pays corporate income tax on that profit.
3. The corporation distributes the remaining after-tax profit to shareholders as dividends.
4. Shareholders pay income tax on those dividends on their personal tax returns.

Result: the same profit is taxed twice

What Are The Differences Between Double Taxation And Pass-through Taxation?

Double taxation means your business income and your income as the owner are taxed separately. However, with pass-through taxation, you legally bypass the corporate tax and only get taxed as an individual.

Is Double Taxation Always A Disadvantage For Businesses?

Not always. If you retain the business earnings and reinvest them in the business rather than distribute the dividends, you can defer the second layer of tax. You also have unlimited shareholders, multiple stock classes, and access to venture capital with a C corporation, unlike S corporations or partnerships.

Are There Reasons A Small Business Would Choose A C Corporation Despite Double Taxation?