How to Avoid Double Taxation: Relief, Treaties, Methods, and Agreements

Double taxation is a financial burden that blocks your growth. So, it’s mandatory to know about relief, treaties, and agreements on how to avoid double taxation.
How to avoid double taxation

Table of Content

Are you sick of feeling like you are paying taxes twice on your hard-earned money? Well, you’re not alone! Double taxation can be a real pain but do not worry; we have expert advice to help you.

Today, we will discuss how to avoid double taxation, hence this frustrating financial situation. We’ll uncover relief options, dive into tax treaties, reveal handy methods, and shed light on helpful agreements.

Prepare to bid farewell to those extra tax burdens and keep more money in your pocket.

Let’s go!

What Is Double Taxation?

As the name suggests, double taxation means that the same income or earnings are taxed twice at different levels. This taxation principle can be applied to both corporations and individuals. Also, when there is international trade, this tax is applied in two different countries.

Types of Double Taxation

The two primary types of double taxation are given below. Take a look-

  1. Double Taxation in Corporations

For corporate taxation, when a business makes a profit and an income, the tax is based on the total income it makes as a business unit. After taxes are removed, the rest of the money is given to the shareholders/members. The shareholders are also taxed on the share profits they get on a personal level. This is how double taxation occurs for a corporation.

  1. International Double Taxation

International or legal double taxation occurs when you are considered a resident of two different countries for tax purposes. As a result, you have to pay taxes on your income in both countries, even though it’s the same money.

Double Taxation Example

Let’s look at the following examples to better understand what double taxation is-

Example- 1 (Corporate Or Economic Double Taxation)

In 2022, a company called BG made a profit of $500 million. As a corporation, it was subjected to a 21% tax in the first place. The rest of the money was split among the company’s three shareholders. Then, each individual was taxed at 37% on each share of profit or dividend. This is how corporations are taxed.

Example- 2 (International Or Legal Double Taxation)

Imagine a scenario: Jessica is a successful businesswoman. She earns income in Canada and is also considered a tax resident in Australia. Now, both countries may claim the right to tax Jessica’s income. This can result in her being taxed twice on the same income, leading to financial burden and unfairness.

How to avoid double taxation
Double Taxation Example

To learn more elaborately, check out “An Ultimate Question: How Does Double Taxation Work?

How to Avoid Double Taxation on Foreign Income

We’ve explored some options for you to avoid double taxation on foreign income. Have a look-

Determine if Your Country Has a Tax Treaty

Check if your home country has a tax treaty with the country where you earned the foreign income. It will reduce or maybe remove, your double taxation burden from your foreign income.

Claim Foreign Tax Credits

If you pay taxes in a foreign country, you can often claim a credit for those taxes when filing your home country’s tax return. This credit can help you get a part of your money back.

Use Foreign Earned Income Exclusion (FEIE)

You will not have to scan through tax treaties to avoid US double taxation on certain types of income. Expats who pass the Bona Fide Residence Test or Physical Presence Test can use the Foreign Earned Income Exclusion or FEIE.

Using FEIE, they can deduct roughly up to $100,000 in foreign-earned income from their US tax obligations, regardless of their country.

Consider a Tax Residency Change

You may be able to change your tax residency if you spend a significant amount of time in another country, which can help reduce or eliminate double taxation on your foreign income.

Seek Professional Advice

Consult with a tax advisor or expert specializing in international taxation to ensure you navigate the complexities and maximize your tax benefits. We, Business Globalizer, are always here to help.

Here’s a thing to remember: tax laws vary from country to country or state to state. So, it’s essential to do research and understand the specific rules that apply to your situation.

How to avoid double taxation
How to Avoid Double Taxation on Foreign Income

How to Avoid Double Taxation C Corp

Avoiding double taxation at the corporate level is a bit tricky. But not entirely impossible. Let’s explore a few-

Elect S Corporation Status

By filing Form 2553 with the IRS, a C Corporation can become an S Corporation and avoid double taxation.

Pay Reasonable Salaries

Ensure that owners and shareholders of the C Corporation receive reasonable salaries for their services, reducing the amount of corporate profits subject to double taxation.

Utilize Deductible Expenses

Take advantage of legitimate business expenses and deductions to reduce the corporation’s taxable income.

Use Dividends Strategically

Instead of distributing all profits as dividends, consider retaining some earnings within the corporation to reinvest or use for business expansion.

Employ Tax Credits

Identify and apply for any applicable tax credits that can lower the overall tax liability of the C Corporation.

Consult With a Tax Professional

Seek advice from a qualified tax professional who can provide personalized guidance on minimizing double taxation in your situation.

How to avoid double taxation
How To Avoid Double Taxation C Corp

How to Avoid Double Taxation LLC

We are glad to inform you that LLCs are not subject to double taxation. Only companies organized as C corporations have to pay taxes twice. Both S corporations and sole proprietors can avoid double taxation by default. 

Unlike C corporations, LLCs and sole proprietorships are considered pass-through entities by the law. Because of the structure, their earnings are distributed directly to their owners or members, who pay their taxes through personal income tax. 

You do not need to prevent double taxation if you choose to incorporate your business as an LLC because you won’t be subject to it by default.

Disadvantages of Double Taxation

Double taxation has lots of disadvantages. A few of those are given below:

Reduced Income for Individuals

Double taxation reduces the amount of income individuals receive from their investments or business ventures. This can harm their overall financial well-being.

An Incentive for Tax Avoidance

Double taxation can incentivize individuals and businesses to use tax planning strategies to minimize liabilities. This can result in complicated and potentially abusive tax evasion schemes. 

Reduced Investment and Economic Growth

Double taxation may discourage investment by making it less attractive for individuals to invest in corporations or do business worldwide. This can hinder economic growth and innovation, as individuals may choose alternative investment options with a lower tax burden.

Competitive Disadvantage

Companies operating in countries with double taxation may be at a competitive disadvantage compared to those with a single taxation system. This has the potential to influence international trade and investment decisions.

Administrative Complexity

Double taxation adds complexity to the tax system, requiring individuals and businesses to navigate multiple layers of taxation and comply with different and difficult regulations. This can increase compliance costs and administrative burdens.

Effects of Double Taxation

The effects of double taxation can be burdensome and hurt economic activities and investments. Take a look below-

Lessened Income

Double taxation can reduce the after-tax income of individuals and businesses, making it harder for them to save, invest, and grow.

Reduces Cross-border Trade and Investment  

It can discourage cross-border trade and investment, as the additional tax burden may make international business activities less attractive.

Create Complexities and Administrative Burdens

Double taxation can also create complexities and administrative burdens for taxpayers, as they must comply with the tax laws and reporting requirements of multiple jurisdictions.

Creation of Tax Treaties or Agreements

To prevent double taxation, countries often have tax treaties or agreements to provide relief and avoid or reduce the double taxation of income or assets. So, it can be said that tax treaties or agreements are somehow an effect of double taxation.

Increased Costs

Double taxation imposes additional costs on individuals and businesses, as they must comply with tax laws and regulations in multiple jurisdictions.

Effect on Global Tax Landscape

Double taxation remains an important issue that has an effect on the global tax landscape. And governments and international organizations continue to work on addressing it to foster a favorable environment for international trade and investment.

The Methods Used by the US to Reduce Double Taxation

To avoid double taxation in the US, there are a few methods to utilize. There are relief methods, treaties, and agreements that can lessen the burden of double taxation.

Take a look below-

Double Taxation Relief

If a person has income or gains from one country and is a resident of another, that income or gain may be taxed twice. DTR, or Double Tax Relief, is intended to alleviate double taxation on the same source of income or gain. It is a relief to avoid double taxation. Double taxation relief for companies aims to keep taxes from affecting business decisions about expanding overseas.

To know more, check out our blog titled “Double Taxation Relief: Ultimate Blessing For Global Entrepreneurs.”

Double Tax Treaty

Double Taxation Treaties, or DTTs, are agreements between two countries that keep foreign investors from paying taxes on their income in both countries.

Double Taxation Treaties, or DTTs, are agreements between countries that ensure people don’t get taxed twice on the same income. They make a living, working, and doing business in different countries easier without paying taxes twice.

Double Taxation Avoidance Agreement

The DTAA, or Double Taxation Avoidance Agreement, is an agreement to avoid double taxation. This tax agreement between two countries helps taxpayers avoid paying income tax twice on the same income, asset, or financial transaction in two countries.

DTAA attempts to avoid double taxation by creating a mechanism for allocating taxing authority between the two countries.

To learn more about DTAA, you can check out our detailed blog on it, “DTAA: An Agreement for Double Taxation Relief.

How Does Double Taxation in the UK Work

If you are a resident with income or gains in another country or a non-resident with income or gains in the UK, you may be required to pay taxes in the UK and another country.

You can usually file for tax relief to get some or all of this tax back. Whether or not your foreign income has already been subject to tax affects how you claim.

There are various methods to avoid double taxation in the UK, and in a blog, we elaborately explored the whole thing. We hope “Double Taxation in the UK: A Taxation Roadblock in Old Blighty” can satisfy your curiosity.

8 Ultimate Ways of Avoiding Double Taxation

Avoiding the C-corporation structure is the easiest way to avoid or reduce double taxation. But if the structure is right for your new business, you can use other methods to avoid being legally taxed twice. Here are 8 ultimate ways to avoid double taxation:

  1. Hold Dividends and Keep Income in Retained Earnings

If you are the CEO or a member of the board of directors of a C-corporation, you should put your earnings into retained earnings rather than paying out dividends to shareholders. Instead, let the corporation pay the income tax.

With this method, you can rest assured that your earnings will only be taxed at the corporate level. You can also use the retained earnings from your startup to fund future growth.

However, if the company earns too much money without paying out dividends, you may have to pay a penalty. If you have more than $200,000, consult with an accountant. If the IRS thinks that your business’s profits are a reasonable amount to meet its needs, you are good to go. If not, you may have to face double taxation.

  1. Pay Salaries

Imagine that you and the shareholders of your business depend on its profit. If so, you can only get shares without paying taxes twice if you work for the company. 

Salaries are deductible expenses for a business. They can, however, be taxed personally, eliminating the need for double taxation. So, rather than dividing your profits into shares and distributing them to your shareholders, you can pay them as salaries.

  1. Create a Separate Pass-through Entity

One of the more time-consuming ways to avoid paying taxes twice is to set up a separate pass-through entity, like an LLC. This method is an effective strategy for getting more out of your business structure.  

If you form an LLC, you can use it to acquire properties and equipment to lease to your main company. Apart from assisting your corporation in avoiding double taxation, it creates another source of income and a deduction for your company.

  1. Change Business Structure

You can also change the structure of your corporation to one that is more tax-friendly. But remember that C-corporations do not pay taxes on business income until paid out as dividends. 

Other types of business structures, on the other hand, pay tax on all income earned during the year. Consult an accountant to determine which business structure will save your company the most money in taxes.

  • S Corporation Can Help

    If you decide to form an S-corporation instead, you must follow the rules and regulations of the state where you file. These rules and regulations are available on the Secretary of State’s website. 

    Remember that you are not required to incorporate your company in the state where you live or even in the city where your business is located. However, if you register your corporation in another state, you must register as a foreign corporation in your home state.

    This could lead to more taxes. However, you should first check if you meet all the criteria for an S corporation.

  1. Borrow Money From the Business

If you decide to take loans from your business, the IRS will not consider them taxable shares. This is a great strategy for people who do not have to pay dividends to many shareholders.

Keep in mind that the IRS is likely to check on the loan. They will check to ensure the transaction is not disguised as a dividend and that you repay your loans at a reasonable interest rate.

  1. Splitting Profits

You can reduce your company’s double tax burden by allocating a percentage of its earnings and reinvesting it in your business. You can also hire more people to add to your team and bring in more money.  

This method does not stop your business from being taxed twice, but it can help you pay less.

  1. Look for Double Taxation Agreements or DTA

Another effective approach we suggest is for companies that have to deal with double taxation on an international level. Double taxation agreements or DTAs, are treaties between countries that agree to stop or lower territorial double taxes.

DTAs are implemented to help promote international trade and keep multinational businesses from being taxed twice. Typically, the agreement calls for the tax to be levied in one country while being exempt in another. 

For example, Australian shareholders in an American venture must pay taxes in their home country but are exempt from paying taxes in the United States. 

On the other hand, some shareholders have to pay taxes in the country where the profit is made and will get foreign tax credits in their own country.

  1. Hire Family Members

We are at the end of our list. The funny but much more effective one is—if you may ask—to let the people in your family use nepotism to their advantage. You can hire your spouse or children to work at your business if you are married or have children. 

But, just like you have to pay yourself a salary, you must pay them a fair wage and follow all labor laws. After all, we should comply with the rules. Right?

If you apply this method, you must show that you hired family members who are legally working for your business.

FAQs on How to Avoid Double Taxation 

Q1: What is the best way to avoid double taxation?

Answer: For a corporation: Elect S Corporation tax status.

For International double taxation: Look out for DTAA.

Q2: How can I avoid US double taxation on foreign income?

Answer: The Foreign Earned Income Exclusion (FEIE, accessed via IRS Form 2555) allows you to deduct a portion of your FOREIGN EARNED income from US taxation.

Last Words

So, there you go!

By now, you’ve learned some fantastic tips and tricks to dodge the dreaded double taxation. Remember that it is all about finding relief, using treaties, and finding smart ways to work together. With these powerful tools at your disposal, you can navigate the complicated world of double taxation like a pro.

No more feeling stuck in a financial whirlpool! Stay informed, look into options, and keep your hard-earned money where it belongs: in your pocket. Do not let double taxation rain on your parade! Go forth, and conquer the world of finance with confidence!

Are you still confused? Book an appointment with our experts and let your confusion melt away.

Related Post