Double tax, written more often as double taxation, is the same income, asset or transaction being reached by tax twice. In a US accounting firm’s work it takes two distinct forms. One is the entity form, where a corporation pays tax on its own taxable income and its shareholder is taxed again on what the corporation distributes. The other is the jurisdictional form, where two taxing authorities each assert a claim over the same income. The term names the pattern only, so it says nothing by itself about whether the second charge is lawful or relieved.
The Entity Form: The Corporation, Then the Shareholder
The entity form comes from two provisions that impose tax independently of each other. The first reaches the company itself: a tax is imposed for each taxable year on the taxable income of every corporation (26 U.S.C. 11(a)).
The shareholder’s return then picks up the same profit when it is paid out. That portion of a distribution which is a dividend, as 26 U.S.C. 316 defines that term, is included in gross income (26 U.S.C. 301(c)(1)), and gross income means all income from whatever source derived, with dividends named in the list (26 U.S.C. 61(a)(7)).
The rate that applies at each of those two steps, and a worked comparison of one corporation’s profit under each classification, are in c corp vs s corp. The structure built to avoid the second charge is the pass-through entity, which generally pays no federal income tax of its own and reports its items out to its owners instead.
The Second Layer Is Not Only a C Corporation Problem
A corporation that was a C corporation before it elected S status can meet the same two-charge pattern by a different route. If an S corporation has a net recognized built-in gain for a taxable year beginning in the recognition period, a tax is imposed on the income of that corporation for that year, computed by applying the highest rate of tax specified in section 11(b) to that gain (26 U.S.C. 1374(a) and 1374(b)(1)). The recognition period is the 5-year period beginning with the 1st day of the 1st taxable year for which the corporation was an S corporation, and the gain caught is gain recognized during that period on the disposition of an asset, except to the extent the corporation establishes that it did not hold the asset at the beginning of that 1st S year or that the gain exceeds the asset’s fair market value over its adjusted basis as of that time (26 U.S.C. 1374(d)(3) and 1374(d)(7)(A)). What the charge reaches is appreciation that had already accrued while the company was a C corporation.
That corporate charge does not replace the shareholder’s. The same gain is still taken into account in determining the shareholder’s own tax, as part of the shareholder’s pro rata share of the corporation’s items of income (26 U.S.C. 1366(a)(1)). The statute narrows the overlap rather than closing it: any tax imposed under section 1374 for a taxable year is treated as a loss sustained by the S corporation during that year, which shrinks what passes through without stopping it (26 U.S.C. 1366(f)(2)). Where that corporate charge lands on the return is in federal income tax liability.
The Jurisdictional Form: Two Authorities, One Dollar
The jurisdictional form needs no corporation at all. It arises because taxing authorities claim income on overlapping tests: one taxes its own people on everything they earn anywhere, another taxes anyone on what is earned inside its borders, and one dollar can meet both.
US law runs both of those tests. In general, all citizens of the United States, wherever resident, and all resident alien individuals are liable to the income taxes imposed by the Code whether the income is received from sources within or without the United States (26 CFR 1.1-1(b)). Running the other way, a tax of 30 percent is imposed on fixed or determinable annual or periodical income received from sources within the United States by a nonresident alien individual, but only to the extent that income is not effectively connected with the conduct of a trade or business within the United States (26 U.S.C. 871(a)(1)).
Relief exists, and none of it is automatic. A taxpayer who chooses the benefits of the foreign tax credit subpart has the tax credited with income taxes paid or accrued to a foreign country, subject to the limitation of section 904 (26 U.S.C. 901(a) and 901(b)(1)). Separately, the provisions of the title are applied to any taxpayer with due regard to any treaty obligation of the United States which applies to that taxpayer (26 U.S.C. 894(a)(1)). How those two sit alongside the foreign earned income exclusion, and the information returns that run beside them, is covered in international tax services.
What Double Tax Is Not
A graduated schedule splits taxable income into slices and taxes each slice once, at the rate for the bracket that slice falls in, by one authority on one occasion (26 U.S.C. 1(j)(2)). More than one rate appearing on one return is not more than one tax on the same dollar.
Common Questions
Not at the federal level. The entity form is written into the Code, so corporate profit being taxed at the company and again at the shareholder is the design rather than a defect. A state scheme is a separate question with a separate answer. Maryland allowed its residents a credit for tax paid to another jurisdiction against its state income tax but not against its county income tax, and in 2015 the Supreme Court held that Maryland’s personal income tax scheme violates the dormant Commerce Clause (Legal Information Institute, Comptroller of the Treasury of Maryland v. Wynne).
Accountably places trained offshore tax preparers inside US CPA and EA firms, and a firm can run a block of its own corporate and pass-through return work through a trial task before any client file depends on it.
