What is Double Taxation and How Does it Affect Your Finances?

No one loves paying taxes, but paying them twice on the same income can be particularly frustrating. Double taxation occurs when business income is taxed twice, once at the corporate level and then again at the shareholder level. 

But there's more to it than just that. Whether a company will pay taxes twice or not will depend on the company's business structure. It can also depend on the company's capital gains, investment income, and more.

In this article, we’ll walk through the basics of double taxation, how it plays out for different business types (including small businesses, C corps, S corps, and sole proprietorships), and how understanding it can help you avoid some unpleasant surprises come tax time.

What is Double Taxation?

Double taxation is when two or more taxes are applied to the same thing by different jurisdictions or levels of government. This situation often arises for businesses, especially C corporations, when their profits are taxed multiple times. Various reasons can contribute to this scenario, but it primarily affects business owners and their profits.

For example, a business earns taxable income, which is taxed on both the business and the business owner's share. That’s double taxation — once at the business level, and once at the personal level.

Of course, not every business is taxed this way. Some business structures, like S corporations or sole proprietorships, often avoid double taxation by passing income straight to the owners.

When Does Double Taxation Happen?

Double tax isn’t just something C corporations deal with. There are a few other situations where double taxation can happen at a personal level, too: 

• International Income: If you’re a U.S. citizen earning income in another country, you’ll have to pay foreign taxes and U.S. taxes. 
• Certain Investment Accounts: Some investment or retirement accounts may be taxed twice — once when you earn income and again when the money is withdrawn. 

Double Taxation for Businesses: C Corporations vs. Pass-Through Entities

While C corporations are taxed at the corporate and individual level, pass-through entities like S corporations generally avoid this extra layer of tax. Let’s take a look at the difference in double taxation for each business type.

C Corp Double Taxation

A C corporation is its entity, so when the business receives profits, those profits are subject to corporate tax. This can even affect self-employed individuals on their self-employment taxes if their business is a separate entity. 

Shareholders also receive portions of this profit, and what they receive is subject to individual income tax.  

For example, if XYZ Corporation earns $100,000 and pays 21% in corporate tax, it keeps $79,000. If it distributes $50,000 of that to shareholders, and a shareholder is in the 24% tax bracket, they’d owe $12,000 in taxes on those dividends. So, the same money is taxed twice — by the corporation and then by the individual.

S Corp Double Taxation

S corporations usually don’t deal with double taxation, and that’s a big reason why many small business owners choose this structure. Instead of the business paying taxes on its profits, the income passes through to the owners, who report it on their tax returns. That means the money is only taxed once, not twice like with a C corp.

However, there are cases where even an S corporation will be subject to double taxation. This can happen when an S vorp has excess net passive income or built-in gains. Excess net passive income occurs when investment asset income is higher than 25% of the S corporation’s gross receipts.  

Built-in gains are when a corporation sells capital assets in a specific period after changing from a regular corporation to an S corporation. In these instances, an S corp will be subject to double taxation as excess net passive income, and built-in gains will be subject to corporate tax and not only the shareholder's income tax.

Double Taxation for Individuals: Investments and Dividends

If you’re an investor, retiree, or employee with stock options, you might face double taxation. For instance, if you own shares in a C corporation, you will be double-taxed in a couple of ways:

• Dividends: When the company earns profits and pays them out to shareholders, you may be taxed on those dividends even though the company already paid taxes on its earnings. 
• Capital Gains: If you sell your shares for more than you paid, you’ll owe capital gains tax on the profit.

It’s important to note that not all dividends are taxed the same. The IRS separates them into two types:

• Qualified Dividends: These are usually taxed at a lower, long-term capital gains rate.
• Ordinary Dividends: These are taxed at your regular income tax rate, which could be higher.

So, whether you're investing for retirement or earning stock options through work, it’s helpful to understand how and when your money might be taxed twice — and how that affects your overall return. 

How to Avoid Double Taxation

Double taxation sounds like a pain, but there are legal ways to work around it. Here are some best practices for how to avoid double taxation:  

For Businesses:

• Elect S Corporation Status: If your company qualifies, this can help you avoid corporate-level taxes altogether.
• Form an LLC With Pass-Through Taxation: LLCs can pass profits directly to the owners, skipping corporate taxes.
• Reinvest Profits: Instead of paying dividends, you can put profits back into the business to delay or reduce shareholder taxes.

For Individuals:

• Use Tax-Advantaged Accounts: IRAs and 401(k)s let you invest without paying taxes on dividends or capital gains right away.
• Choose Tax-Efficient Mutual Funds:  Some funds are structured to minimize taxable payouts.
• Look Into Foreign Tax Credits: If you earn money in another country, you can avoid paying taxes twice on the same income.

Disclaimer: Always seek a professional tax expert regarding your specific situation.

FAQs About Double Taxation

Does Double Taxation Impact Sole Proprietorships?

A sole proprietorship is a type of company that has one individual who owns and operates the business. This type of business is not impacted by double taxation. With other types of corporations, business income is received by multiple entities and people and is thus subject to various tax rates.

But with a sole proprietorship, there is only one individual who owns and operates the business, rather than the company being its separate legal entity.

This means the business income is all allocated to the business owner as their income and is only taxed once with an individual income tax.

How Do I Know If I’m Being Double-Taxed?

If you own stock in a C corporation or earn money from another country, you might be taxed twice — once at the company or foreign level and again on your tax return. 

Can I Avoid Double Taxation as a Business Owner?

Yes. Many small businesses choose S corporation or LLC status to avoid corporate-level tax.

Does Double Taxation Apply to My Side Hustle or Freelance Income?

No. Income from a side hustle is usually taxed once as personal income, not double-taxed. 

Can Check City Help With Taxes on Investment or Business Income?

Yes! We provide simple, affordable tax support for anyone needing help understanding complex income types. We offer federal and state filing, affordable in-person prep, and help with figuring out income from investments, side gigs, and small businesses so you can avoid costly filing mistakes. 

Conclusion

Double taxation can feel like a financial headache, but it doesn’t have to be. Whether you’re a business owner, investor, or just trying to make sense of how your income is taxed, knowing when and how double taxation happens can help you make smarter money decisions. 

Looking for help filing or planning your taxes? Check City’s tax pros are here to help. Contact us today and learn more from the resources shared below.