To avoid double taxation, businesses use "pass-through" structures like Sole Proprietorships, Partnerships, S Corporations (S Corps), and Limited Liability Companies (LLCs), where profits are taxed only once at the owner's individual income tax rate, bypassing corporate tax. While a C Corporation faces double taxation (corporate tax + dividend tax), these pass-through entities, including LLCs electing S Corp status, ensure income is taxed just once at the personal level.
Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income.
To avoid double taxation, use "pass-through" business structures like LLCs or S Corporations where profits are taxed only once at the owner's individual rate, instead of C Corporations which are taxed at the corporate level and again on dividends; alternatively, C Corp owners can pay salaries, retain earnings strategically, or use income splitting, while international earners rely on foreign tax credits or treaty provisions.
An LLC can avoid double taxation by electing to be taxed as a pass-through entity. If the LLC has just one member, that owner can be taxed as either a disregarded entity ( and pay business tax on their individual return) or an S Corporation. Either will help them avoid double taxation.
How to Avoid Double Taxation. There are three strategies you can use to avoid double taxation, including retaining corporate earnings, paying salaries instead of dividends, and splitting income.
Double taxation definition
Double taxation means that employees pay income tax in their state of residence and the state where their employer is located. This practice is undesirable for workers and makes payroll more complex for businesses.
The most tax-efficient way for many active LLC owners is to elect S-corporation status, paying yourself a "reasonable" W-2 salary subject to payroll taxes, with remaining profits taken as distributions (dividends) not subject to self-employment tax, saving ~15% on the distribution portion. For single-member LLCs or those with lower profits, owner's draws (flexible withdrawals) are simpler but all profits are subject to self-employment tax, while a salary-only approach (default LLC/sole prop) also taxes all net income at full self-employment rates. Always consult a tax professional, as the best method depends on your specific income and business structure.
What is a C Corporation? A C Corporation is a legal and IRS-recognized business entity that's best for businesses looking to keep their profits in the business. A C Corporation pays tax twice: first as income tax at the corporate rate, and secondly as shareholders when they pay income tax on dividends they receive.
To avoid double taxation, use "pass-through" business structures like LLCs or S Corporations where profits are taxed only once at the owner's individual rate, instead of C Corporations which are taxed at the corporate level and again on dividends; alternatively, C Corp owners can pay salaries, retain earnings strategically, or use income splitting, while international earners rely on foreign tax credits or treaty provisions.
The IRS $600 rule refers to a change in reporting requirements for third-party payment apps (like Venmo, PayPal) for taxable income from goods and services, where platforms must send a Form 1099-K if you receive over $600 in a year, intended to capture gig economy/side hustle income, though delays and phased implementation have adjusted the timeline, with current rules for 2024 using a higher threshold ($5,000) before fully phasing to $600 for future years, but remember all taxable income, regardless of form, must always be reported.
Taxes. While LLCs and S corporations are both pass-through entities, S corporations may have preferable self-employment taxes compared to the LLC because the owner can be treated as an employee and paid a reasonable salary. Taxes, including FICA, are taken out of that salary.
Double taxation can put a strain on your budget, but there are three key strategies you can use to avoid this:
The "2% rule" for S Corporations treats shareholders owning more than 2% of the company's stock (or voting power) differently for fringe benefits, classifying them like partners in a partnership, not regular employees; this means benefits like health insurance premiums paid by the S Corp must be included as taxable wages on their W-2, rather than being tax-free, though the shareholder can often deduct these premiums as an "above-the-line" deduction. This rule prevents them from participating in tax-advantaged Section 125 cafeteria plans, making benefits like Health FSAs unavailable on a pre-tax basis.
Two business structures are often preferred for small businesses since they avoid this double taxation burden. These are an LLC and an S Corporation. With these business structures, the company is taxed more like a Sole Proprietorship or a Partnership than as a separate entity, like the C Corporation.
C corporations, by comparison, are more standardized: They share commonalities like stock to represent ownership, are governance by a board of directors, have day-to-day operations handled by officers, etc.
One of the most popular structures that avoids double taxation is an S Corporation (S Corp). With an S Corp, the business itself doesn't pay federal income tax. Instead, profits “pass through” to your tax return, and you pay taxes just once, at your individual rate.
LLC tax avoidance strategies focus on reducing self-employment tax, maximizing deductions, and deferring income through methods like electing S-Corp status (paying reasonable salary + distributions), funding retirement plans (SEP IRA, Solo 401k), deducting business expenses (home office, vehicles, health insurance), paying family members, and leveraging tax credits. Strategic timing of expenses, like prepaying bills before year-end, also lowers current taxable income.
To avoid double taxation, use "pass-through" business structures like LLCs or S Corporations where profits are taxed only once at the owner's individual rate, instead of C Corporations which are taxed at the corporate level and again on dividends; alternatively, C Corp owners can pay salaries, retain earnings strategically, or use income splitting, while international earners rely on foreign tax credits or treaty provisions.
As mentioned, C corporations are the only business type subject to double taxation. This occurs because the corporation first pays taxes on its profits. Then, when dividends are distributed to shareholders, those dividends are taxed again at the shareholders' individual income tax rates.