Double taxation is when a party, organization, or company is required to pay income taxes two times on the income. The two forms of taxation are corporate and personal taxes. Companies and individuals may be subject to double taxation in instances when the money they earn is made in another country. This typically occurs for importers and exporters.
A common example of when double taxation would occur is when a large corporation has multiple shareholders. In this scenario, the double taxation would happen from corporate earnings and then taxed once again as an individual.
The Debate Around Double Taxation
Double taxation is the subject of much debate as opponents claim that corporations are taxed unfairly compared to other business arrangements. Opponents state that in many instances they are taxed at over 50% because they are taxed three times. They claim this to be unjust as they are taxed on the goods they purchase for the corporation, taxed on the profit they make, and taxed as individuals.
Proponents of double taxation claim the tax is just and in fact necessary to maintain the current unfunded liabilities and state that an alteration to the double taxation would affect the government’s ability to pay for debts the government owes.
Corporations and Double Taxation
Corporations can own real property , however they are double taxed unlike LLC’s. The laws regulating corporation ownership of real property are dependent on the laws of the state; however, a corporation in any state is held by a legal entity and not individuals.
Individuals or partners might consider purchasing real estate through a corporation for several major reasons, including reducing liability, minimizing risk, and maximizing potential. Decisions regarding property held by a corporation must be made by all board members, unless the company is a of a larger scale and has different arrangements.
Shareholder liability is reduced or eliminated in a corporation because assets are not held personally; therefore, an individual cannot be held liable for decisions made by the corporation. For this reason, many individuals prefer corporations over other entities. After 2002, however, liability for officers and directors has increased and board members can no longer claim full immunity.
That said, there are still significant drawbacks to corporations owning property. One major disadvantage is the fact that there is double taxation on corporations. The first form of taxation levied is a corporate tax and once the income is distributed to shareholders, the individuals are taxed again.
A hypothetical example of when property held by a corporation may be detrimental is if a corporation makes a profit on an appreciating asset after it is sold. The gain will be taxed using corporate tax rates, which are higher than most rates and then taxed a second time against the individual earning a return. Although individuals and partners form corporations to avoid liability, corporations may actually increase liability because the actions by one or some of the officers may negatively impact other members. If the corporation is sued, property held by the entity may be subject to judgment, liens, and potentially foreclosure, simply due to the actions of one or more board members.
LLC’s, Corporations, and Double Taxation
One of the main reasons individuals choose to form LLCs rather than other ownership forms is to limit personal liability. In the case of corporations or individual holdings, owners of the business are personally at risk for potential lawsuits. For example, imagine an individual owns a property and a guest of one of the tenants injures him or herself on the property. The injured guest will likely bring a lawsuit against the owner. In this situation, the personal assets of the owner must be defended, whereas if the ownership of the property was held in an LLC, the LLC would incur liability rather than the individual. It is then easier to understand why many real estate investors own properties in LLCs.
The second main reason individuals utilize LLCs is to avoid double taxation that is incurred on other forms of real property ownership. Capital gains from property income will go directly to the owner(s) as individuals, thereby mandated only to pay the individual tax rate, rather than the entity tax and individual tax. Under this form of ownership, owners get the protection of the LLC, while paying the tax rate of individuals, an additional invaluable component that serves to maximize the bottom line of businesses.
C Corporations and Double Taxation
When a business is incorporated, it automatically becomes a C Corporation.
A drawback to a C Corporation is “double taxation”. A C Corporation’s income and expenses are taxed at the time they are generated. Owners must also pay a personal income tax on corporate profits when they are distributed as dividends.
S Corporations and Double Taxation
In order to avoid the “double taxation” of a C Corporation, many business entities may instead create an S Corporation. In an S Corporation, the corporation itself is not taxed; rather, shareholders and/or owners are only taxed once when corporate profits are distributed on their personal tax returns.
The following are requirements for creating an S Corporation:
Must be a “domestic” corporation. Domestic means that the business must be headquartered in the state where it primarily conducts business.
Must have fewer than 100 shareholders
Must possess only one class of stocks
