Double Taxation

What is double taxation?

Double taxation occurs when the same income is taxed more than once. The two most common forms are:
– Corporate–personal double taxation: corporate profits are taxed at the company level and again when distributed to shareholders as dividends.
– International or interjurisdictional double taxation: the same income is taxed by two different countries or by more than one U.S. state.

How corporate–personal double taxation works

Corporations are separate legal entities that pay income tax on profits. If a corporation distributes after‑tax profits as dividends, shareholders must report those dividends as personal income and may owe tax on them as well.

Example:
– A corporation earns $1,000 and pays a 21% federal corporate tax = $210. After tax profit = $790.
– If the corporation distributes the $790 as dividends and the shareholder pays a 15% dividend tax, the shareholder’s tax = $118.50.
– Combined tax on the original $1,000 exceeds the single layer that would apply if income were taxed only once.

Tax systems try to reduce this burden by:
– Offering lower rates on “qualified dividends” (0%, 15%, or 20% depending on the taxpayer’s bracket).
– Allowing credits or preferential regimes for certain pass‑through or flow‑through entities (e.g., S corporations, partnerships, LLCs taxed as partnerships) so income is taxed only once at the owner level.

Why it’s debated

Arguments against double taxation:
– It can be viewed as unfair to tax the same economic income twice.
– It may discourage investment and lead to inefficient tax planning.

Arguments for taxing dividends:
– Without a second tax layer, investors could use corporate dividend distributions as a way to avoid personal income taxation.
– Dividend taxation treats payouts to owners as a form of personal income, which many see as appropriate.

International double taxation

Cross‑border income (wages, dividends, interest, royalties) can be taxed in the source country and again in the taxpayer’s country of residence. To prevent this:
– Countries negotiate bilateral tax treaties, often based on OECD model conventions, to allocate taxing rights and reduce or eliminate double taxation.
– Common relief methods include:
– Exemption: income taxed only in one country.
– Foreign tax credit: resident country taxes the income but allows a credit for taxes paid abroad.

Individuals and businesses can also often rely on domestic foreign tax credit rules to avoid being taxed twice on the same foreign income.

Avoiding double taxation

Corporate/ownership strategies
– Pass‑through entities (S corps, partnerships, many LLCs): income is taxed only at the owner level.
– Choosing to retain earnings rather than pay dividends delays shareholder tax (but may have other tax or corporate consequences).

International strategies
– Rely on tax treaties.
– Use foreign tax credits to offset home-country tax.

State and multi‑state issues
– Individuals working in multiple U.S. states may need to file in more than one state.
– Many states provide credits for taxes paid to another state or have reciprocity agreements to prevent double taxation.
– The “183‑day” rule: some states consider someone a resident for tax purposes if they spend 183 days or more in the state (rules vary by state).

States without a personal income tax

As of the latest commonly referenced list, the states that do not levy a personal state income tax are:
– Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming.

(States’ tax rules can change; verify current law for filing requirements.)

Key takeaways

• Double taxation can arise at the corporate and personal level or across jurisdictions.
• Tax policy and treaties provide mechanisms—qualified dividend rates, pass‑through entities, foreign tax credits, and treaties—to reduce or eliminate double taxation.
• Individuals working across state lines or earning foreign income should review residency rules, reciprocity agreements, and available credits to avoid paying tax twice.