What is the double taxation of dividends?
Answers | 3
Second, any taxable entity that receives these "after-tax" distributions are also subject to potential income tax. Hence, dividends are considered to be taxed twice.
Please note that we are financial advisers and not tax advisers. Please do not construe this explanation as tax advice.
For example, you earn wages that are subject to income tax. You purchase a car and pay sales tax. The car dealer reports the revenue and pays tax on a portion over expenses, and passes some dollars on to the auto manufacturer who would also pay taxes on the net earnings. They would use some of the revenue to pay an auto workers salary, who would have income tax, etc.
Without the constant taxation on dollars circulating within our society, image then how big our budget deficit would be! Investment income to you is investment income to you - how to structure things to minimize YOUR personal tax burden on that income should be the real focus.
Thank you for your question.
If the company decides to pay out dividends, the earnings are taxed twice because of the transfer of the money from the company to the shareholders. The first taxation occurs at the company's year-end when it must pay taxes on its earnings. The second taxation occurs when the shareholders receive the dividends, which come from the company's after-tax earnings. The shareholders pay taxes first as owners of a company that brings in earnings and then again as individuals, who must pay income taxes on their own personal dividend earnings.
This may not seem like a big deal to some people who don't really earn substantial amounts of dividend income, but it does bother those whose dividend earnings are larger. Consider this: you work all week and get a paycheck from which tax is deducted. After arriving home, you give your children their weekly allowances, and then an IRS representative shows up at your front door to take a portion of the money you give to your kids. You would complain since you already paid taxes on the money you earned, but in the context of dividend payouts double taxation of earnings is legal.
Keep in mind that using an IRA, 401(k) or other tax deferred accounts does not decrease the tax. It is only deferred. Contrary to public opinion, Tax advantaged accounts are only tax deferred or as the story goes; a wolf disguised in sheep's clothing.
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