Disadvantages of Corporations

Topics: Corporate tax, Corporation, Tax Pages: 5 (2161 words) Published: April 17, 2013
Double Taxation
Double Taxation: Depending on what special rights and restrictions are attached to the shares, and how the profits of the corporation are paid out to the shareholders, there is the possibility of double taxation: the corporation must pay taxes on its profits and the shareholder may be subject to taxation on the profits paid out. This can result in greater taxation than if a corporation was not used for the business. C corporations pay taxes on profits when corporate income is distributed to owners (shareholders) in the form of dividends. This is the first taxation. The shareholders who receive dividends must also pay taxes for this distribution on their personal returns. This is the second taxation of the same money. The corporation itself does not pay taxes twice, but just the sound of “double taxation” can make potential business owners cringe. However, there is an out. Choose the IRS’ "S Corporation" tax status to avoid double taxation. In other systems, dividends are taxed at a lower rate than other income)(for example, in the US) or shareholders are taxed directly on the corporations profits and dividends are not taxed Double taxation is levying of tax by two or more jurisdictions on the same declared income (in the case of income taxes), asset (in the case of income taxes), or financial transaction (in the case of sales taxes). This double liability is often migrated by tax treaties between countries. Example: You decide to set up a corporation and have a profit of 1,000,000 in the first year. Suppose the government taxes corporate profits at 30%, then the corporation has to pay 300,000 in taxes. It is decided that 500,000 will be distributed as dividends and the dividend tax is 10%, so you will lose a further 50,000 to the government when you file your personal taxes. This is the concept of double taxation: first the company was taxed for its profits, and later shareholders were taxed for their dividends. (https://www.boundless.com/business/types-business-ownership/corporations/disadvantages-corporations/) In many countries, corporate profits are taxed at a corporate tax rate, and dividends paid to shareholders are taxed at a separate rate. Such a system is sometimes referred to as “double taxation”, because any profits distributed to shareholders will eventually be taxed twice. One solution to this (as in the case of Australian and UK tax systems)is for the recipient of the dividend to be entitled to a tax credit, which addresses the fact that the profits represented by the dividend have already been taxed. The company profit being passed on is therefore effectively only taxed at the rate of tax paid by the eventual recipient of the dividend. In other systems, dividends are taxed at a lower rate than other income (for example, in the US) or shareholders are taxed directly on the corporation’s profits and dividends are not taxed. For example, S corporations in the US do not pay any federal income taxes. Instead, the corporation’s income or losses are divided among and passed through to its shareholders. The shareholders must then report the income or loss on their own individual income tax returns. For C corporations, the corporation ends up paying taxes twice. First, when the C corporation turns a profit, it pays a corporate tax rate on the profit amount. The second time the C corporation pays taxes is when it pays dividends to shareholders. Many businesses that incorporate choose to incorporate as an S corporation instead in order to avoid paying taxes twice. The only difference between a C corporation and an S corporation is a tax designation filed with the IRS using Form 2553. According to the IRS, an S corporation can choose to pass the income, losses, deductions and credit for the corporation through to the shareholders of the corporation for federal tax purposes. This avoids the double taxation possibility a C corporation is subject to. Double taxation. A possibility of “double taxation may...
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