Menu burger Close thin Facebook Twitter Google plus Linked in Reddit Email
Tap on the profile icon to edit
your financial details.

While death and taxes may both be certain, taxation is the only one of the two that can happen twice. If you own a business, the last thing you want is to get taxed on your income twice. Double taxation occurs when a corporation pays taxes on its profits and then its shareholders pay personal taxes on dividends received from the corporation. We explain why double taxation happens and how to avoid it.

The current federal income tax rate on corporate profits is 21 percent. The top marginal individual tax rate is 37 percent. Thus, the combined nominal double taxation rate is 58 percent.

Double taxation clearly can be costly. There are two justifications offered for taxing corporate profits twice. First, the tax on corporate profits is seen as justified because businesses organized as corporations are separate legal entities. Second, levying individual taxes on dividends is seen as necessary to keep wealthy shareholders from paying no income taxes.

The burden of double taxation is a common and significant one for corporations and shareholders, but it’s not inevitable. There are several ways business owners can avoid double taxation or reduce taxation.

Pass-Through Business Entities

One way to ensure that business profits are only taxed once is to organize the business as a flow-through or pass-through entity. When a business is organized as a flow-through entity, profits flow directly to the owner or owners. Profits are not first taxed at the corporate level and again at the personal level. Owners still pay taxes at their personal rate, but double taxation is avoided.

Flow-through business entities include:

Avoiding Corporate Double Taxation

C corporations are the ones that experience double taxation. Again, the corporation pays taxes once. Double taxation occurs when dividends paid to shareholders get taxed at the shareholders’ individual rates.

Corporations, including LLCs as well as S corporations, are considered separate legal entities from their owners. That’s why they pay taxes separately from shareholders. S corporations and LLCs, however, are flow-through entities so they escape double taxation. C corporations are not flow-through entities. That’s why they are subject to double taxation.

Owners of C corporations who wish to reduce or avoid double taxation have several strategies they can follow:

  1. Retain earnings. If the corporation doesn’t distribute earnings as dividends to shareholders, earnings are only taxed once, at the corporate rate.
  2. Pay salaries instead of dividends. Shareholders who work for the corporation may be paid higher salaries instead of dividends. Salaries are taxed at the personal rate but are deductible expenses for the corporation. Salaries have to be justifiable to the IRS, however.
  3. Employ family. Family members can receive salaries for working for the business. This is another way to take money from the corporation without the corporation having to pay taxes on it first. The same restrictions about justification apply to family employee salaries.
  4. Borrow from the business. If a corporation owner takes a loan from the corporation, it’s not treated as a taxable dividend. The IRS may inspect the transaction to ensure that the loan is not a disguised dividend, however. For instance, this may require that the loan is being paid back at a reasonable interest rate.
  5. Set up a separate flow-through business to lease equipment or property to the C corporation. A business owner can create an LLC that purchases equipment and leases it back to the corporation. This creates flow-through income for the LLC and a deduction for the corporation.
  6. Elect S corporation tax status. Once a corporation has been created, the owners can ask the IRS to treat it as an S corporation for tax purposes. S corporations have the same liability-limiting attractions of C corporations, but their profits flow directly to shareholders, avoiding double taxation. S corporations are restricted as to number and type of shareholders and classes of stock, however. So, S corporation election may not be an option for all corporations.

Other Double Taxation

Assess the relative benefits of being a C corporation, S corporation, LLC or sole proprietorship. Businesses that invest internationally may also experience double taxation. This can happen when profits generated in one country are taxed there and then again by their home country. Again, this sort of double taxation isn’t inevitable. Many countries have signed mutual treaties to limit this sort of double taxation in the interest of increasing international investment and trade.

The Bottom Line

Tax planning should be integral to your business strategy. That goes for pass-through entities and C corporations. Taking a strategic approach to your business structure – who you employ, the extent to which you lease equipment or space and compensation, including dividends – can result in a substantial boost to the profit of your business.


  • Consider talking to a financial advisor about double taxation. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
  • SmartAsset has several free tax calculators that can quickly help you figure out how much you will owe the government. This tax guide provides help for several key aspects of paying taxes. In addition, here’s a link to a review of the best online tax software.

Photo credit: ©, ©, ©

Mark Henricks Mark Henricks has reported on personal finance, investing, retirement, entrepreneurship and other topics for more than 30 years. His freelance byline has appeared on and in The Wall Street Journal, The New York Times, The Washington Post, Kiplinger’s Personal Finance and other leading publications. Mark has written books including, “Not Just A Living: The Complete Guide to Creating a Business That Gives You A Life.” His favorite reporting is the kind that helps ordinary people increase their personal wealth and life satisfaction. A graduate of the University of Texas journalism program, he lives in Austin, Texas. In his spare time he enjoys reading, volunteering, performing in an acoustic music duo, whitewater kayaking, wilderness backpacking and competing in triathlons.
Was this content helpful?
Thanks for your input!