What is double taxation?

Definition of 'Double Taxation'

A taxation principle referring to income taxes that are paid twice on the same source of earned income.

Double taxation occurs because corporations are considered separate legal entities from their shareholders. As such, corporations pay taxes on their annual earnings, just as individuals do. When corporations pay out dividends to shareholders, those dividend payments incur income-tax liabilities for the shareholders who receive them, even though the earnings that provided the cash to pay the dividends were already taxed at the corporate level.

The concept of double taxation on dividends paid to shareholders has prompted significant debate. While some argue that taxing dividends received by shareholders is an unfair double taxation of income (because it was already taxed at the corporate level), others contend that this tax structure is fair.

Proponents of keeping the "double taxation" on dividends point out that without taxes on dividends, wealthy individuals could enjoy a good living off the dividends they received from owning large amounts of common stock, yet pay essentially zero taxes on their personal income. As well, supporters of dividend taxation point out that dividend payments are voluntary actions by companies and, as such, they are not required to have their income "double taxed" unless they choose to make dividend payments to shareholders.

Many people have heard that corporate income is taxed twice: once to the corporation itself and then a second time when earnings are paid out to the corporation's owners (shareholders). This is true only for earnings paid out to shareholders in the form of dividends -- that is, profits paid by the corporation to its shareholders in return for their investment in the company.

In practice, this sort of double taxation seldom occurs in a small corporation. The reason is simple: Shareholders rarely pay themselves dividends. Instead, they work for the corporation and pay themselves salaries and bonuses. Because the corporation can deduct salaries and bonuses as ordinary and necessary business expenses, it doesn't have to pay corporate tax on them. (Dividends, on the other hand, are not a tax-deductible corporate expense, so both the corporation and the shareholder must pay tax.) As long as you work for your corporation, even in a part-time or consulting capacity, you can avoid double taxation by taking home profits in the form of a salary and bonuses rather than dividends.

Double taxation is the levying of tax by two or more jurisdictions / countries on the same declared income, asset, or financial transaction.

In other words, double taxation occurs when the same transaction or income source is subject to taxation by two or more taxing authorities. This can occur within a single country.

Double tax liability is often mitigated by tax treaties between countries.