It sounds like a nightmare. Double taxation. As if paying taxes isn’t bad enough, under certain circumstances, you could actually end up paying them twice on the same income.
The United States is somewhat infamous in this regard, as citizens have fewer ways out of this, especially when living and working overseas. But it also flows the other way for citizens of other countries working in the US. Depending on your status, you could be subject to double taxation on all earned income. And then there’s double taxation on corporate taxes, too. That’s a lot of tax!
Double Corporate Taxation
A legal corporation in the US is considered a separate entity from the individual or people that founded it, and as such, is taxed separately on any income earned during a tax year. After taxes, the remaining profit is typically distributed to shareholders in the form of dividends. And that’s where the double dip can take place.
Any money received from dividends - which has already been taxed at the corporate level - is considered personal income for the individual shareholders. Personal income, of course, is taxed. And in this case, for the second time.
There are a few ways around this involving legal and transparent techniques to funnel money out of the corporation and to individuals. Salaries, for example, are tax deductible for a corporation, so pay yourself and your employees a fair salary - it moves money from the corporation to an individual before being taxed. But don’t go crazy and figure you’ll double everyone’s annual salary in an effort to funnel even more, as the IRS can and often does negate any salary deduction it considers unreasonable. Another method is to lease personal equipment and property from yourself to your company. The money paid for these assets comes from the corporation to you before being taxed. Obviously, salary and earned income from leased assets will be taxed as your personal income, but it does avoid the double taxation issue. Just tread carefully...and legally.
Double Taxation for Individuals
For the purposes of taxation in the US, individuals are categorized as either US citizens, permanent resident aliens (people with a “green” card), resident aliens, or nonresident aliens. The determination for the last two categories is via a mathematical formula (called the Substantial Presence Test):
Number of Days Present in the US in Current Year + One-third of the Days Present in the US in the Previous Year + One-sixth of the Days Present in the US in the Year Before That.
If this total is equal to 183 or more, you are considered a Resident Alien for tax purposes, and all world income (money earned in the US and elsewhere) is taxable. Less than 183, and ONLY your US-sourced income is taxable.
How much you pay depends on your total income, and whether a tax treaty exists between your home country and the United States.
In order to lessen the burden of double taxation, the US has entered into tax treaties with many countries around the world. If you’re a US citizen living and working overseas, or resident alien working in the US, check to see if a tax treaty exists. The complete list of US Income Tax Treaties is available from the IRS. While each treaty can differ slightly (be sure and read the specific treaty that applies to your situation), they generally recognize a foreign tax credit (FTC) for income tax already paid, and/or foreign earned income exclusion (FEIE).
If, for example, you’re a Canadian living and working in the United States, you might pay $15,000 in income tax on your American salary, but that same salary might be subject to Canadian income tax as well. However, because of the treaty that exists, you would receive a $15,000 tax credit towards any tax owed back in Canada (where the tax rate can be - and often is - higher). Should you owe the Canadian government $18,500 in taxes, you would only be required to pay the difference of $3500. The tax treaty eliminates the double taxation...but only if you take advantage of it and file the appropriate paperwork at the right time. This works both ways, but again, it’s best to use the services of a certified and knowledgeable tax advisor or accountant.
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US Taxes While Living Abroad
Double taxation, despite your best efforts, can happen to anyone. It’s complicated and easy to misunderstand how it all works (third warning - use a good advisor or accountant). But, identifying your tax category and checking out the existing tax treaty between the US and your home country/country where you live and work should be your first port-of-call. That will give you at least a basic understanding of what you’re dealing with, and possible avenues to explore.