STPS

What is Double Taxation and How Can I Avoid it?

Double taxation is a common problem faced by individuals and businesses. The last thing a business owner needs is to pay taxes twice on the same funds. When a corporation pays taxes on earnings while its shareholders pay taxes on dividends or capital gains, both the corporation and the shareholders are taxed twice. This occurs when the same income or assets are taxed by two different jurisdictions, leading to an unfair financial burden. The corporate business structure you choose may be the most crucial choice you’ll make when starting your business, aside from deciding what service or product you’ll sell. You have the option of forming a sole proprietorship, (an LLC), an S corporation, or a C corporation. However, if you incorporate as a C corporation, you must be wary of double taxation. 

What is double taxation?

When a company is formed as a C corporation, it is acknowledged as a separate tax-paying entity. LLCs (sole proprietorships), and S corporations are NOT separate tax-paying entities. The profits from these businesses are reported on the owners’ personal tax returns.

Business taxes must be paid by C corporations and must file a separate income tax return each year. C corporations pay corporate income tax on their profits. They also pay dividends to their shareholders from the after-tax income. Dividends are then taxed personally by shareholders.

As a shareholder or owner of a C corporation, if you receive a salary or wage from the corporate earnings, you are required to pay personal income taxes on that income. When you own a C corporation, you face double taxation: the corporate earnings are taxed and then the dividends or wages earned from the business are taxed again.

Trucking companies frequently face double taxation because their employees work in multiple states and are subject to both state and federal taxes. When an individual or a company is taxed twice on the same income by two different jurisdictions, it creates an unfair financial burden. This is especially difficult for trucking companies because their employees frequently cross state lines, making it difficult to determine where they should be taxed. 

How can double taxation be avoided?

Earnings retention: 

By retaining profits in the business rather than paying them out as dividends to shareholders, you can avoid double taxation. Dividends are not taxed if they are not received by shareholders, so profits are only taxed at the corporate rate. If you and your shareholders rely on company profit for income, retaining corporate earnings is probably not a good idea. However, if you have the financial means to invest, you may be able to expand your business.

Pay salaries instead of dividends: 

Shareholders who work for the corporation may be paid more than dividends. Salaries or bonuses are taxed at individual employee rates but are deductible by the corporation. Salaries must, however, be justified to the IRS.

Create a separate flow-through business: 

You can use this procedure to lease assets to the C-corporation through the second company. A business owner can form a limited liability company (LLC) to purchase equipment and lease it back to the corporation. This results in a  flow-through income for the LLC as well as a tax deduction for the corporation.

Bottom Line:

Tax planning should be a part of your overall business plan. This also applies to pass-through entities and C-corps. Take a strategic plan for your business structure – who you hire, how much equipment or space you lease, and compensation, including dividends. This can lead to a significant increase in your company’s profit. If you are a small trucking business, ATBS will be able to help you with taxation and any other tax or business problems.

Written by Mike Ritzema

With over 20 years of experience in entrepreneurship, management, business planning, financial analysis, software engineering, operations, and decision analysis, Mike has the breadth and depth of experience needed to quickly understand entrepreneurs’ businesses and craft the most suitable solutions.

Before founding Superior Trucking Payroll Service, Mike was the CFO of a trucking company with 80 trucks and a thriving brokerage. This experience gave him the perspective that a payroll solution has to make the lives of the office people better.  All the solutions he has designed are to benefit everyone.  Our company mission is to help trucking families and that includes the company owners, the drivers, and the office.

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