If you’ve heard C Corporations are bad, you’ve probably heard the reason is because of something called double taxation. That’s bad, right? Who wants to pay double tax!
But, do you really know what double taxation is?
Double taxation occurs when a C Corporation pays a dividend to its shareholders. The term comes from the fact that the C Corporation pays tax on the profit of the company and then pays out a dividend which is taxable to the shareholder. The dividend is not a deduction for the C Corporation. So both the shareholder and the C Corporation pay tax.
What if the C Corporation pays a salary to its shareholders? In that case, it would be a deduction for the C Corporation and it would be taxable to the shareholder. So there is tax, but only at one place – the shareholder.
What if the C Corporation pays for employee benefits for the shareholders? In that case, it is a deduction for the C Corporation and there is no tax to the shareholder. It’s the exact opposite of double tax. It’s tax free!
Of the three ways that a shareholder can be paid, only one results in double taxation. The solution, I think, is pretty simple. In the case of a small closely held C Corporation – don’t pay dividends!!
That’s how you avoid double taxation in a C Corporation.