Which Corporation Uses a Double Layer of Taxation?

Corporations in the U.S. are taxed differently depending on their structure, and some face “double taxation.” This occurs when a corporation pays taxes on its profits, and then shareholders pay taxes again on dividends. This system primarily applies to C corporations, which are separate legal entities from their owners.

C Corporation Filing Structure

A C corporation must file Articles of Incorporation with the appropriate state agency, typically the Secretary of State. This document establishes the corporation as a legal entity and includes the company’s name, business purpose, registered agent, and stock structure. Filing fees vary by state, ranging from $50 to several hundred dollars.

After incorporation, the corporation must obtain an Employer Identification Number (EIN) from the IRS, which serves as its tax identification number. This is required for opening business bank accounts, hiring employees, and filing tax returns. Corporations must also adopt bylaws that define governance procedures, such as electing directors and conducting meetings. While bylaws are not filed with the state, they are essential for internal management.

Annual compliance includes filing Form 1120, the U.S. Corporation Income Tax Return, which reports income, deductions, and tax liabilities. Many states also require separate corporate tax filings, and some impose franchise taxes based on revenue or net worth. Failure to meet these obligations can lead to penalties, interest charges, or administrative dissolution.

Corporate-Level Taxation

C corporations are taxed as separate legal entities, meaning they pay income taxes on their earnings before distributing profits to shareholders. The corporate tax rate in the U.S. is a flat 21% under the Tax Cuts and Jobs Act (TCJA) of 2017, which remains in effect for 2024. This tax applies to net income after deductions such as business expenses, depreciation, and certain credits. Companies with international operations may also be subject to additional taxes, including the Global Intangible Low-Taxed Income (GILTI) tax, which ensures multinational corporations pay a minimum tax on overseas earnings.

Beyond federal taxation, corporations must account for state and local corporate income taxes, which vary widely. Some states, like Texas and Nevada, do not impose a corporate income tax but may levy a gross receipts or franchise tax instead. Others, such as New Jersey and Pennsylvania, have corporate income tax rates exceeding 9%. Businesses operating in multiple states must navigate complex apportionment rules to determine how much of their income is taxable in each jurisdiction, often using a formula based on sales, payroll, and property distribution.

Tax planning strategies can help reduce corporate tax liabilities. Reinvesting profits into business operations, such as purchasing new equipment or expanding facilities, can qualify for depreciation deductions under Section 179 or bonus depreciation rules. Research and development (R&D) tax credits allow companies engaged in innovation to offset a portion of their tax liability. Additionally, corporations may carry forward net operating losses (NOLs) to offset future taxable income, though the TCJA limits NOL deductions to 80% of taxable income in a given year.

Tax on Shareholder Dividends

When a C corporation distributes profits to shareholders as dividends, those payments are taxed at the individual level. The tax rate depends on whether the dividend is classified as qualified or nonqualified (ordinary). Qualified dividends are taxed at lower rates—0%, 15%, or 20%—depending on the shareholder’s taxable income. To qualify, dividends must be paid by a U.S. corporation or a qualified foreign entity, and the shareholder must meet a required holding period, generally more than 60 days within a 121-day period surrounding the ex-dividend date. Nonqualified dividends are taxed as ordinary income, with rates as high as 37% in 2024.

Taxation of dividends also depends on the shareholder’s residency. U.S. residents report dividends on their tax returns and may offset some liability with tax credits or deductions. Nonresident shareholders are typically subject to a withholding tax of 30%, unless a tax treaty provides for a reduced rate. For example, under the U.S.-U.K. tax treaty, the withholding rate for qualified dividends is reduced to 15%.

Dividend reinvestment plans (DRIPs) present another tax consideration. Although DRIPs automatically reinvest cash dividends to purchase additional shares, the IRS still treats these reinvested amounts as taxable income in the year they are received. This can result in an investor owing taxes on dividends despite not receiving cash, requiring careful planning to avoid liquidity issues.