There are two things in this life that are definite, death and taxes. Except being taxed can actually happen more than once. It’s called double taxation!
Double taxation happens when an income is taxed at both the company level and personal level.
As a business owner, the last thing you want to happen is to have your income taxed twice.
Double taxation is a major problem for small business owners in the United States.
But it happens. Why?
The US Tax Code is over 70,000 pages long and very complicated. This complexity makes it easy to accidentally pay taxes on income that has already been taxed at the corporate level.
How Does That Even Happen in the First place?
When starting your business, one of the most important decisions to make, (aside from what type of business to have) is the corporate business structure; such as sole proprietorship, LLC, S corporation or C corporation.
Each business structure is set up to pay taxes differently. Sole proprietorship, LLC, or S-corporation do not pay business taxes. Any business profits made are reported on the owner’s personal tax returns and then the taxes are paid on those earnings.
C-corporation is set up as a separate tax paying entity from its owner and its shareholders.
C-corporation pays the income taxes on its profits which then pays the shareholders the dividends from that taxed income. Each shareholder is responsible to pay their own personal income taxes on the profits they received.
This makes C-Corporations a greater risk of being double taxed.
Double taxation can also happen to shareholders who are both owners and employees of a corporation in two ways, if:
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the owner is receiving a salary as an employee, that’s required by the IRS to be taxed at the personal income rate;
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The owner is paid dividends by the corporation which are required to pay those taxes on their personal tax return.
Some Ways to Avoid Being Double Taxed
Double taxation can be very costly. Here’s some ways to help avoid paying more than once:
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Structure your business as a sole proprietorship, partnership, single-member LLC, multi-member LLC, S-corporation and not a C-corporation.
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Retain corporate earnings.
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Make shareholders employees- Although this might not always be an option, by making a shareholder an employee you can pay them a higher salary rather than distributing dividends separately.
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Pay yourself a salary.
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Employ family members.
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Borrow from the business-You have to be careful here. The IRS will check to see if it’s a legitimate loan and not a way to hide dividends.
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Split income-Withdrawing from the corporate profit what you need to support your lifestyle and leave the rest of the profits in the corporation.
Trying to figure out the right steps in setting up your business structure can be a bit confusing. The best thing to do is to reach out to a qualified tax professional to discuss your options.
They will help you create and implement the best tax planning strategy for your corporate business structure.