What Is Double Taxation?
Double taxation occurs when taxes are levied twice on the same source of income, often happening when income is taxed at both the corporate and personal levels. It may also arise in international contexts where income is taxed in two different countries.
Key Takeaways
- Double taxation refers to income being taxed twice on the same source.
- It can occur when income is taxed at both the corporate and individual levels, as seen with stock dividends.
- The phenomenon can also happen internationally when the same income is taxed by two countries.
- Despite criticism, double taxation proponents argue that it prevents wealthy shareholders from avoiding income tax completely.
How Double Taxation Works
Because corporations are separate legal entities, they pay taxes on earnings just like individuals. When these corporations pay dividends, shareholders then have to pay income tax on the dividends, even though the earnings were already taxed at the corporate level.
Double taxation often stems from tax legislation and is generally seen as negative. Tax systems usually try to mitigate it through tax rates and tax credits. For instance, in the U.S., dividends meeting specific qualifications can be taxed at advantaged rates of 0%, 15%, or 20%, depending on tax brackets. As of 2022, the corporate tax rate stands at 21%.
Debate Over Double Taxation
The double taxation of dividends is a hot topic as opinions diverge. Detractors feel it is unfair, while supporters argue that it prevents wealthy individuals from using dividends as a tax shelter, thereby avoiding taxes on personal income. They also point out that dividend payments are voluntary actions by companies, thus double taxation isn’t mandatory unless dividends are disbursed.
International Double Taxation
International businesses frequently deal with double taxation where income is taxed in the country of origin and again in the company’s home country. This high cumulative tax scenario can dissuade international business.
To counter this, countries enter into treaties based on models like those from the OECD. These treaties seek to curb double taxation, thereby promoting international trade.
Avoiding Double Taxation Across States
Individuals sometimes need to file tax returns in multiple states. This scenario usually applies when someone works or performs services in a different state from where they reside. Most states provide ways to avoid double taxation through reciprocity agreements or tax credits for taxes paid out-of-state. Determining how to avoid double taxation depends on various factors.
What Is the 183-Day Rule?
In the context of state taxes, the 183-day rule is a threshold for determining residency for tax purposes. If an individual spends over 183 days in a state, they are considered a full-year resident for tax purposes.
States with No Income Tax
Several states in the U.S. do not charge state income taxes, including Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming, although working in multiple states can still subject individuals to taxation.
Conclusion
Double taxation occurs when the same income is taxed twice, typically seen in the context of dividends or when income is earned and taxed in one country and then again in another upon repatriation. Despite being regarded as negative, many countries have policies and treaties in place to mitigate double taxation and foster international trade.
Related Terms: corporate tax, dividend exclusion, tax treaties, income tax, tax credits.
References
- Internal Revenue Service. “Forming a Corporation”.
- Internal Revenue Service. “2022 Form 1041-ES”, Page 1.
- Congress.gov. “H.R.1 - An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018”.
- Organisation for Economic Co-operation and Development. “Model Tax Convention on Income and on Capital: Condensed Version 2017”.
