Double taxation

What is double taxation?

Double taxation is when the same income is taxed twice, regardless of whether it is corporate income or individual income. This event mainly occurs in the form of corporate double taxation and international double taxation.

Corporate double taxation 

There are two different times when corporate profits can face taxation, hence the term “double taxation.” These occasions are when:

1. Corporate profits are taxed at the federal corporate tax rate
2. That same income is distributed to shareholders as a dividend 

Shareholders must pay income tax on the dividends they receive. These profits are taxed as capital gains on the shareholders’ personal tax returns, making it double taxation. It should be noted that earnings distributed to shareholders cannot be deducted by C corps.

International double taxation

Double taxation can also occur at the international level, making it especially important for expatriates and multinational corporations. An American expatriate earning income in a foreign country might face international double taxation, as that income may be taxed both abroad and in the United States. This situation does depend on the tax treaties in place. 

Therefore, U.S. citizens who move to another country must be aware they will have to report their income to both the U.S. and foreign governments and are likely subject to double taxation. The United States is one of the few countries in the world to tax citizens regardless of where they work and live.

Take, for example, an American expatriate living in another country who receives dividends from U.S.-based stocks. The United States will impose taxes on that investment income because it is coming from the United States. Meanwhile, the foreign country may also tax the investment income since the individual is considered a tax resident of the foreign country. In short, the investment income could be taxed by both the United States and the foreign country.

What is the purpose of double taxation?

Double taxation is often an unintended repercussion of tax legislation, and its fairness remains up for debate. According to proponents, the purpose of double taxation is to prevent stock ownership from becoming a tax shelter.

How? Those in favor of double taxation argue it prevents people with large amounts of corporate stocks from living off their dividends while paying no taxes on their personal income. Because corporations are separate legal entities, the taxation of corporate profits is considered fair. 

Proponents also argue that dividend payments are voluntary for corporations, so if a corporation wants to avoid the issue of double taxation, it can elect not to pay out dividends.

What are some examples of double taxation?

Consider the following examples to further explain double taxation.

Example: Corporate double taxation

Corporations are subject to a 21% corporate income tax rate. In this example, company A generated a profit of $1 million this year, so its federal taxes totaled $210,000. Company A distributed the remaining $790,000 to its shareholders in the form of dividends. 

These dividends are taxable to shareholders. For the investors, the qualifying dividends are taxed at a maximum tax rate of 20%, plus a 3.8% tax on net investment income.

Example: International double taxation

In this example, Sally moves from the United States to the Netherlands to work as a web developer for the Dutch branch of her company. Her annual salary is $80,000. Sally will have to report that income to the Dutch government because the Netherlands taxes residents. As a U.S. citizen, Sally will also be required to report that same $80,000 to the Internal Revenue Service (IRS) on a U.S. Federal Income Tax Return. This is because the United States imposes citizen-based taxation.

Example: Investment income from a foreign source 

In this example, John is a U.S. citizen who has moved to France. He is an investor in U.S.-based stocks and receives investment income from them, such as interest and dividends.

Since John is considered a resident of France, he is required to pay taxes to the French government on that investment income. However, the U.S. government also taxes the investment income because it is sourced from the United States. 

Are all business entities subject to double taxation?

Not all business entities are subject to double taxation. While C corporations are subject to corporate taxes, pass-through entities such as partnerships, S corporations, and sole proprietorships are not taxed on their income at the corporate level.

For pass-through entities, it is “passed through” to the business owners, who must then report the income on their personal income tax returns. This enables pass-through entities to avoid double taxation.

What is the substantial presence test?

The substantial presence test, also referred to as the 183-day rule, is how the United States and some other countries determine tax residency. It is based on the amount of time that an individual spends within a particular country.

For instance, an individual may be considered a tax resident and required to pay tax on their worldwide income if they spend 183 days or more in a specific location within a calendar year.

The standards for defining residency vary by jurisdiction, so it is important for U.S. expatriates to understand how the 183-day rule may apply in both their country of residence and the U.S.

In the United States, for instance, to be considered a U.S. resident for tax purposes, the IRS states an individual must be physically present in the United States on at least:

1. 31 days during the current year
2. 183 days during the three-year period that includes the current year and the two years immediately before that, counting:

• All the days you were present in the current year
•  One-third of the days you were present in the first year before the current year
• One-sixth of the days you were present in the second year before the current year

There are some exceptions to this rule, such as days a person is in the United States for less than 24 hours or when they are in transit between two places outside the United States, among other exceptions.

What is a double taxation treaty?

A double taxation treaty (DTT), also known as a double taxation agreement (DTA), is an international agreement signed between two countries to prevent double taxation arising from cross-border transactions.

As explained by the Association of Chartered Certified Accountants (ACCA), a DTA is “a contract signed by two countries (referred to as the contracting states) to avoid or alleviate (minimise) territorial double taxation of the same income by the two countries. Any amendment or addition to such an agreement is known as ‘a protocol.’

Such agreements are important as they not only help mitigate the risk of double taxation but can also facilitate international trade and reduce tax evasion.

Can double taxation be minimized or avoided?

There are several strategies that corporations and individuals can take advantage of to mitigate or avoid double taxation. These include, but are not limited to:

• Double taxation treaty (DTT). To help prevent double taxation, a DTT establishes rules and regulations regarding how income earned through cross-border transactions is treated. For instance, under a DTT, an investor may be levied tax where the income arises and then receive a foreign tax credit in the home country. Alternatively, it may require that tax is charged in the investor’s home country and is exempt in the country where the income is generated.
• Foreign tax credit (FTC). Through an FTC, the tax paid in one country is used to offset the tax liability in another country. By claiming this credit, individuals may be able to reduce their U.S. tax liability and avoid double taxation on the same income earned internationally. This tax benefit enables U.S. citizens or resident aliens to offset income taxes paid to foreign countries or U.S. possessions.
• Foreign Earned Income Exclusion (FEIE). An FEIE is a tax benefit that qualified American expatriates can use to exclude foreign income from U.S. taxation. In short, it aims to prevent double taxation. Each year, the maximum exclusion amount changes. For the tax year 2025, the foreign-earned income exclusion increases to $130,000, up from $126,500 in the tax year 2024.
• Structure as a pass-through entity. Unlike C corporations, pass-through entities such as partnerships, S corporations, and sole proprietorships are not taxed on their income at the corporate level. This enables pass-through entities to avoid double taxation. Therefore, those looking to open a business may want to consider structuring the company as a pass-through entity rather than a corporation to avoid double taxation.
• Pay salaries instead of dividends. Considered a business expense, salaries are not subject to double taxation. This means corporations may be able to avoid double taxation by paying out profits as salaries instead of in the form of dividends.

 Can a foreign tax credit be carried forward?

A foreign tax credit can be carried forward . If a client’s foreign tax credit exceeds their U.S. federal income tax liability for the current tax year, the excess credit can be carried forward or back to other tax years. The credit can be beneficial as it helps taxpayers maximize the foreign tax credits and make the most of the tax benefit over a period of time.

It is important to note that certain limitations do apply. For instance, excess credits can be carried forward 10 years but carried back one year.

We updated this information on 04/30/2025.