How do I avoid corporate double taxation if I am looking to incorporate a business?

Question: What is corporate “double taxation” and how can I avoid it? I am looking to incorporate a small business.

Response: “Double taxation” refers to the fact that a “regular” corporation, called a C-corporation, is a separate entity for tax purposes. If the corporation makes a profit (and remember: a “profit” is when revenue exceeds business expenses), then the corporation is taxed on that profit, the same way an independent contractor or sole proprietor is taxed on their profit when they make it. The C-corporation has just has much independent legal existence, for tax purposes, as any person.

However, if the company then distributes some of its profit to its shareholders (e.g. dividends), they are taxed on that income. That’s “double taxation”—the profit is taxed twice, once when the corporation earns it, once when it’s distributed. (And note: the dividends are not a “business expense” that can be deducted on its taxes by the corporation, so you add insult to injury.)

To avoid this, you might want to set up an S-corporation instead. An S-corp passes its profit or losses directly through to the shareholders, who pay taxes on it (or take tax advantage of the loss) on their personal income tax. That way, the income is only taxed once, not twice. There are limits on S-corps, such as on how many shareholders they may have, that make them not suitable for many larger business; however, they make excellent vehicles for small and often mid-sized businesses.

Answered by Steven Zweig

Additional Resources:

• S-corp structure and taxation
• C-corp taxation

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