What is double taxation?

Double taxation refers to a situation where the same income is taxed twice, typically in the context of corporations. This phenomenon occurs when corporate income is first taxed at the corporate level, and then again at the individual level when profits are distributed to shareholders as dividends.

In this scenario, the corporation pays taxes on its earnings, which is the first level of taxation. Later, when these after-tax profits are distributed to shareholders as dividends, the shareholders are taxed again on that income at their personal tax rates. This results in the same income being taxed both at the entity level and at the individual level, thus exemplifying double taxation.

This concept is most commonly discussed in relation to C corporations in the United States, where the tax structure inherently leads to this type of taxation. In contrast, other business structures, like S corporations or partnerships, generally avoid double taxation, as the income is passed directly to the owners and taxed only once at the individual level. Understanding double taxation is crucial for comprehending corporate tax implications and the incentives driving business entities' structural choices.