Corporate Double Taxation
What is Double Taxation?
From the Latin word “corpus” meaning body of people, based on the words of Stewart Kyd, the author of the first treaties on corporate law, is a body given a charter recognizing the organization as a separate and legal entity with its own rights, privileges, and liabilities that are distinct from those of the members. Even if a corporation is not a “natural” person, they are recognized by the law to have rights similar to that of a citizen. Although conceptually immortal, this “person” dies when they are dissolved by the shareholders, statutory operations or by order of the court.
Since corporations are considered as a separate entity, they are taxed differently, unlike sole proprietorship, or partnership type of business, the profits gained by the businesspersons from these companies are subjected to taxes. With corporations, they are subjected to Dividend taxes and this is a major topic between the corporate world and the government.
Understanding Dividend Tax or Double Taxation
What is a Dividend tax and why corporations thing this is killing the economy. Dividend tax or widely known as double taxation happens when an individual is taxed twice for the same income or asset, much like what happens to corporations. Because they are considered as a separate legal entity, corporate income tax is taken from the corporations’ gains and profits. Then the dividends of the corporation that is being paid or divided to its shareholders are also being taxed from this gain thus the clamor and complains of many who sees it as an unnecessary consequence to people who choose to invest. They argue that if taken out, economy could improve immensely because companies will be able to give higher salaries and more jobs to the citizens of the country.
Those who approve of dividend taxation argue that this system is not overkill to the economy. They say that because the corporation is an entirely different and separate entity from its shareholders and are afforded certain levels of liability protection they should be taxed separately from the shareholders.
How Corporations Eliminate Double Taxation?
Due to a large amount of loss of profits combining that or the corporation and shareholders, corporations resort to a number of processes to reduce this. Zeroing Out is one way that corporations avoid federal tax. This means the net earnings of the corporation is used to pay out salaries or compensation of services rendered to company officers. Example, if a corporation earns $150,000 as profit, that amount can be paid to one or more officer as compensation for service. Meaning, the corporation now will have a tax deduction of $150,000 and since that was the total profit, it zeroes out the taxable income and no federal income tax is due. This now eliminates the problem of double taxation because the recipients of the $150,000 compensation will now pay the tax. The catch to this is that IRS strictly regulates what is an allowable deduction from the declared profit of the corporation. Salaries have to be reasonable and not excessive basing on the service rendered by the officer.
Corporation shareholders also lower the amount for tax filing by leasing their goods and equipments to the company like equipments related to the business, real estate, or employees through outsourcing. This is a great way of moving money from the corporation to an individual legally and avoiding double taxation at the same time.
Putting family members on the payroll of the corporation as long as they are legitimately employed with reasonable salaries is a legal way of income splitting making your income reasonable and keeps your federal tax in lower brackets.
In Conclusion, the IRS is an entity that is designed to keep taxations in check avoiding misuse and evasion among working individuals, business corporations etc. It is their job to check on the company’s financial matters and ensure that appropriate taxable income is declared. Income generating entities on the other hand works on maximizing gains and profits to ensure sustainability and value of the company so they do anything possible to avoid any state tax legally. It has to be taken note though that the IRS has the power to allow or deny any transaction they like depending on their view of the process. Anything questionable and seemingly fraudulent will be declined and you will be required to pay all applicable state tax including penalties and interests. Therefore, it is important that you make sure all your company transactions are legal in all aspects and make sense to make sure that IRS auditors will not be breathing behind your backs.
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