Getting Rid of Double Taxation of Corporate Income

Tax experts often decry the “double taxation” of corporate income. But how exactly is it taxed twice? Corporations are taxed at the corporate level with the regular corporate income tax. The money that the business retains after taxes is then paid out to shareholders in the form of dividends. When shareholders receive those funds, they pay income taxes on those dividends, even though the corporation already paid taxes when it earned that income originally.

Kyle Pomerleau, economist at the Tax Foundation, explains the situation and offers a couple of suggestions for reforming the double-taxation problem.

Pomerleau explains how double taxation raises the total tax rate:

– If a corporation earns $100 and is taxed at the corporate level at a 25 percent rate, the corporation is left with $75 after taxes to distribute as dividends.
– Once those dividends are passed to shareholders, it is taxed again. After a 28.7 percent tax rate, shareholders are left with $54.48, meaning that the effective tax rate on corporate profits was 46.53 percent.

How to integrate the corporate and shareholder taxes? One option would be “credit imputation,” says Pomerleau, meaning that the corporation and the shareholder would both continue to pay taxes, with the shareholder paying a top marginal rate of 39.6 percent. However, the shareholder would receive a credit for the amount of taxes that was already paid by the corporation.

Pomerleau’s other suggestion is “dividend deduction,” which would allow businesses to send dividends to shareholders and deduct that dividend amount from their taxable income. The shareholders would then pay income tax — again, 39.6 percent — on those dividends.

Both options ultimately result in a total tax rate of 39.6 percent, lower than the corporate tax burden would be otherwise. He argues that getting rid of double taxation would boost investment.

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