## In many countries, corporate profits are taxed at a corporate tax rate, and dividends paid to shareholders are taxed at a separate rate -- double taxation.

#### Key Points

• In other systems, dividends are taxed at a lower rate than other income (for example, in the US) or shareholders are taxed directly on the corporation's profits and dividends are not taxed.

• Another disadvantage of corporations is that, as Adam Smith pointed out in the Wealth of Nations, when ownership is separated from management, the latter will inevitably begin to neglect the interests of the former, creating dysfunction within the company.

• The fees and legal costs required to form a corporation may be substantial, especially if the business is just being started and the corporation is low on financial resources.

#### Terms

• Double taxation is the levying of tax by two or more jurisdictions on the same declared income (in the case of income taxes), asset (in the case of capital taxes), or financial transaction (in the case of sales taxes). This double liability is often mitigated by tax treaties between countries.

#### Examples

• You decide to set up a corporation and have a profit of $1,000,000 in the first year. Suppose the government taxes corporate profits at 30%, then the corporation has to pay$300,000 in taxes. It is decided that $500,000 will be distributed as dividends and the dividend tax is 10%, so you will lose a further$50,000 to the government when you file your personal taxes. This is the concept of double taxation: first the company was taxed for its profits, and later shareholders were taxed for their dividends.

#### Figures

1. ##### Leeman Brothers' Collapse

The management of Leeman Brothers was involved in presenting a misleading picture of the company which collapsed in 2008.

In many countries, corporate profits are taxed at a corporate tax rate, and dividends paid to shareholders are taxed at a separate rate. Such a system is sometimes referred to as "double taxation", because any profits distributed to shareholders will eventually be taxed twice.

One solution to this (as in the case of the Australian and UK tax systems) is for the recipient of the dividend to be entitled to a tax credit, which addresses the fact that the profits represented by the dividend have already been taxed. The company profit being passed on is therefore effectively only taxed at the rate of tax paid by the eventual recipient of the dividend.

In other systems, dividends are taxed at a lower rate than other income (for example, in the US) or shareholders are taxed directly on the corporation's profits and dividends are not taxed. For example, S corporations in the US do not pay any federal income taxes. Instead, the corporation's income or losses are divided among and passed through to its shareholders. The shareholders must then report the income or loss on their own individual income tax returns.

Another disadvantage of corporations is that, as Adam Smith pointed out in the Wealth of Nations, when ownership is separated from management (i.e. the actual production process required to obtain the capital), the latter will inevitably begin to neglect the interests of the former, creating dysfunction within the company. Some maintain that recent events in corporate America may serve to reinforce Smith's warnings about the dangers of legally-protected, collectivist hierarchies.

The fees and legal costs required to form a corporation may be substantial, especially if the business is just being started and the corporation is low on financial resources.

#### Key Term Glossary

a specific commercial enterprise or establishment
##### Appears in these related concepts:
capital
Money and wealth. The means to acquire goods and services, especially in a non-barter system.
##### Appears in these related concepts:
concept
An understanding retained in the mind, from experience, reasoning and/or imagination; a generalization (generic, basic form), or abstraction (mental impression), of a particular set of instances or occurrences (specific, though different, recorded manifestations of the concept).
##### Appears in these related concepts:
corporate
An incorporated entity is a separate legal entity that has been incorporated through a legislative or registration process established through legislation.
##### Appears in these related concepts:
corporation
A group of individuals, created by law or under authority of law, having a continuous existence independent of the existences of its members, and powers and liabilities distinct from those of its members.
##### Appears in these related concepts:
credit
A privilege of delayed payment extended to a buyer or borrower on the seller's or lender's belief that what is given will be repaid.
##### Appears in these related concepts:
A weakness or undesirable characteristic; a con.
##### Appears in these related concepts:
dividend
A pro rata payment of money by a company to its shareholders, usually made periodically (e.g., quarterly or annually).
##### Appears in these related concepts:
dividends
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders.
##### Appears in these related concepts:
double taxation
Double taxation is the levying of tax by two or more jurisdictions on the same declared income (in the case of income taxes), asset (in the case of capital taxes), or financial transaction (in the case of sales taxes). This double liability is often mitigated by tax treaties between countries.
##### Appears in these related concepts:
file
To commit official papers to some office
##### Appears in these related concepts:
hierarchy
Any group of objects ranked so that every one but the topmost is subordinate to a specified one above it.
##### Appears in these related concepts:
interest
The price paid for obtaining or price received for providing money or goods in a credit transaction, calculated as a fraction of the amount or value of what was borrowed.
##### Appears in these related concepts:
IT
Information Technology: the use of computers and telecommunications equipment to store, retrieve, transmit, and manipulate data.
loss
the negative difference between revenue and expense
##### Appears in these related concepts:
management
administration; the process or practice of managing
##### Appears in these related concepts:
process
A series of events to produce a result, especially as contrasted to product.
##### Appears in these related concepts:
profit
Total income or cash flow minus expenditures. The money or other benefit a non-governmental organization or individual receives in exchange for products and services sold at an advertised price.
##### Appears in these related concepts:
profits
Collective form of profit.
##### Appears in these related concepts:
resource
Something that one uses to achieve an objective. An examples of a resource could be a raw material or an employee.
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S corporation
a legal designation of companies that elect to pass income, losses, deductions, and credit through to their shareholders for federal tax purposes
##### Appears in these related concepts:
shareholder
One who owns shares of stock.
##### Appears in these related concepts:
system
A whole composed of relationships among the members.