What is double taxation: How it works & ways to avoid it
Dоublе tахаtiоn is one term that often becomes a cause for concern for those who live or do business abroad.
Dоublе tахаtiоn can have significant implications for both individuals and businesses, particularly those operating across international borders.
In this article, we will delve into what dоublе tахаtiоn is, how it works, and look into strategies which can help you avoid it altogether — or reduce the taxable amount at least.
Key takeaways
- Dоublе tахаtiоn occurs when the same income is taxed twice, at corporate, personal or cross-country level.
- International tax treaties, the Foreign Earned Income Exclusion (FEIE), and Foreign Tax Credits (FTC) can help reduce dоublе tахаtiоn.
- US expats must report their worldwide income, but credits and exclusions can bring the taxes down significantly.
- Choosing an S-Corp, partnership, or sole proprietorship can help business owners avoid corporate dоublе tахаtiоn.
What is dоublе tахаtiоn?
Dоublе tахаtiоn is simply what the name implies: income, whether corporate or personal, is taxed in two countries. It can happen when individuals work and live abroad — but are still obliged to pay US taxes — or when businesses pay taxes from their earnings and their shareholders for dividends they receive. We’ll look at both examples in detail anon.
How dоublе tахаtiоn works
There are two scenarios when dоublе tахаtiоn might kick in.
- Corporate income being taxed twice. First a corporation pays income tax on its earnings, then its shareholders pay income tax on their dividends, which are paid out of the corporation's after-tax earnings.
- Personal income being taxed twice. This could happen when a taxpayer is a citizen of one country, but lives and earns his income in another. This is particularly relevant for expats.
International dоublе tахаtiоn
International dоublе tахаtiоn can happen on a personal level — or on a business level.
Business level covers two aspects:
- Taxes are levied on dividends paid to shareholders (we’ve already detailed this concept above)
- Income received from sales of goods and/or services is taxed both in the country of origin and in the country where these are sold
Personal level is much more straightforward. The dividends situation aside (dividends are considered a type of personal income), there is a more commonplace matter of being a citizen of the US but living and working in another country.
According to US tax law, American citizens are taxed on their worldwide income, regardless of where they live or earn said income.
This leaves American expats exposed to dоublе tахаtiоn – once by the country where they earn their income, and again by the United States.
However there are mechanisms in place to prevent this kind of dоublе tахаtiоn. Tax treaties between countries, the Foreign Earned Income Exclusion (FEIE), and the Foreign Tax Credit (we’ll cover them all in detail below).

Dоublе tахаtiоn examples
To better understand the concept of dоublе tахаtiоn, let's take a look at a few examples:
Example 1: Corporate dоublе tахаtiоn
A corporation in the United States earns $1 million in profits. It pays a corporate income tax on these profits.
Then, when the after-tax profits are distributed to shareholders as dividends, the shareholders must also pay personal income tax on these dividends.
Example 2. International dоublе tахаtiоn
An American expatriate living in Germany earns income from a job in Germany. They pay income tax on this income to the German government.
However, based on US tax law, expats must also report their worldwide income to the IRS, potentially leading to dоublе tахаtiоn.
Example 3: Investment income from a foreign source
Consider an American expatriate living in France who receives investment income, such as dividends or interest, from US-based stocks.
The US taxes this investment income because it’s sourced from the US, while France also taxes it since the individual is considered a tax resident in France. Without planning or claiming available credits, this income could be taxed twice, by both the US and France.
To avoid dоublе tахаtiоn, the expat can claim the Foreign Tax Credit (FTC) on their US return for the taxes paid to France or apply the US-France tax treaty provisions, if applicable.
Unseen double tax relief
case success formula: "~$60,000 – ~$3,500 = ~$56,500"
It’s just one of the examples of how, with the help of our CPAs, the client effectively "saved = earned" over $56,000 in net savings while avoiding complex double taxation issues.
background
Alex P. (not their real name) approached us with a challenging tax scenario as a dual taxpayer living in New Zealand while holding US citizenship.
Their income sources included:
- IRA distribution (US-source)
- Royalty income (US-source)
- Wages, rental income, and interest income (New Zealand-source)
New Zealand claimed taxation rights on all income due to residency, while the US asserted rights based on citizenship and source.
Although the tax agreement between the two countries offered double relief, applying it correctly was not straightforward. Missteps could have led to overpayment or penalties.
Business entities and dоublе tахаtiоn
When it comes to business entities, dоublе tахаtiоn primarily affects C corporations, often referred to as C-Corps.
This is due to the fact that C corporations are legally considered separate entities from their owners, who are the shareholders.
This separation leads to a two-tier taxation system.
First tier
The first tier of taxation occurs at the corporate level. When a C corporation generates profits, these earnings are taxed according to the prevailing corporate tax rate.
As of the current tax year, this rate stands at 21%, and it applies irrespective of the corporation's annual earnings.
Second tier
The second tier of taxation comes into play when these after-tax profits are distributed to shareholders in the form of dividends.
At this stage, the dividends are subjected to personal income tax, which varies based on the shareholder's federal income tax bracket.
This bracket is determined by several factors, including the shareholder's filing status (single, head of household, married filing jointly, or married filing separately) and the total amount of dividends received.
Drowning in tax details?
Get your free tax consultation
Exclusions
However, not all business entities are subject to double taxation.
S corporations, partnerships, and sole proprietorships, for example, are classified as "pass-through" entities.
In these business structures, the income earned by the business is not taxed at the corporate level. Instead, it "passes through" to the owners, who then report it on their personal income tax returns.
This pass-through mechanism allows these types of businesses to avoid the dоublе tахаtiоn experienced by C corporations.
Debate on fairness of double taxation
The fairness of dоublе tахаtiоn is a subject of ongoing debate, particularly regarding passive income like dividends. Critics argue that it’s unfair to tax shareholders on dividends since this income was already taxed at the corporate level.
For US expats, this can be especially burdensome, as dividends earned abroad may be taxed in both the foreign country and the US, despite being the result of the same income stream.
On the other hand, proponents of double taxation argue that without taxes on dividends, high-net-worth individuals could potentially avoid taxes altogether by relying primarily on investment income instead of earned income.
For expats, these varying perspectives on double taxation highlight the importance of utilizing available credits and exclusions to reduce the impact of dоublе tахаtiоn, whether on dividends or other income types.
Solve your tax question – ask professionals
Overwhelmed by taxes? With the right information, it gets easier.
Submit your question, and you’ll receive an answer from tax experts within a few business days. While we can’t provide detailed consultations without reviewing your documents, we’ll do our best to assist.
Need help to avoid dоublе tахаtiоn?
Remember that every individual's tax situation is unique, and the information provided here is general in nature.
It's always a good idea to consult with a tax pro who is familiar with the tax rules of both the US and the foreign country where you are living or doing business.
Taxes are complicated
Get peace of mind with TFX
FAQ
Yes, double taxation is legal and often occurs when income is taxed at both the corporate level and personal level. Double taxation also occurs in international business scenarios where income is taxed in two different countries.
An LLC, or Limited Liability Company, avoids double taxation through its unique legal structure. Unlike a C corporation, which is taxed separately from its owners, an LLC is considered a "pass-through" entity for tax purposes. This means that the income earned by the LLC is not taxed at the corporate level. Instead, the income "passes through" to the owners, who report it on their personal income tax returns.
Yes, it is possible to be taxed on the same income in two states, particularly if you earn income in one state but reside in another. However, most states offer tax credits for taxes paid to other states, which can help mitigate the impact of being taxed twice on the same income.
U.S. dual citizens may face the possibility of double taxation, as the US taxes its citizens on worldwide income, regardless of where they reside. However, the US has tax treaties with many countries and offers foreign tax credits and exclusions to help mitigate the impact of double taxation.
The 183-day rule is a guideline used by some countries and US states to determine tax residency based on the amount of time spent within their borders. If an individual spends 183 days or more in a specific location within a calendar year, they may be considered a tax resident for that year and be liable for tax on their worldwide income.
For US expats, it’s crucial to understand how the 183-day rule may apply in both the US and their country of residence, as different jurisdictions have their own standards for defining residency. For instance, in the US, this rule applies to determine state residency for tax purposes in certain states, potentially requiring expats to file state taxes if they meet this threshold during visits back to the US.
This guide is for info purposes, not legal advice.
Always consult a tax pro for your specific case.