The Takeaways:
- Double taxation is a tax principle where taxes are collected for the same income, assets or financial transaction at two different time or by different tax authorities.
- There are common cases of double taxation but also legitimate ways to avoid double taxation. Therefore, both double taxation and no double taxation are tax principles followed by tax authorities and/or expected by taxpayers.
- The best example of economic double taxation is corporate profits, which are taxed twice by the same tax authority, first at the corporate level and then at the individual taxpayer level when the profits are distributed to shareholders as dividends.
- The best example of jurisdictional double taxation is in international trade and/or international investment, where the same income or investment gains may be taxed by different countries.
- For insurance related income or investment, it is more likely to observe no double taxation than otherwise in the US.
I have been thinking of writing posts concerning taxation, for no better reason than the fact that insurance deals with two certainties in life: Taxes and deaths. Each is sufficiently complicated alone by itself, but when the two meet, things get outrageous. Since we can’t bypass them, we might as well study them to get smarter.
This post and other similar posts do not provide tax advice for individuals or entities. They are called “golden rules,” but they are really high level personal observations and thoughts from reading tax codes related to life insurance, annuities, property & casualty, and healthcare.
The Rule of (No) Double Taxation
This rule says we should avoid imposing and paying taxes twice on the same source of income, asset and/or transaction, either by the same or different tax authorities.
Here is the observation I have made from studying tax law: Although double taxation commonly exists, the US and local governments have made an effort to avoid charging double taxes, which I believe is a trend likely to be continued in the future.
In other words, both double taxation and efforts to legitimately avoid it exist at the same time. Correspondingly, we have seen discussions on “double taxation” as well as discussions on how to stop or avoid double taxation. This is healthy because we are seeing both sides of the coin.
What Is Double Taxation
Let us begin by defining what double taxation is.
The following definition is from an authoritarian source by Cornell Law School: “Double taxation refers to the imposition of taxes on the same income, assets or financial transaction at two different points of time.” This sounds simple and concise, and is used by Perplexity.AI in its answer to my inquiry.
To ensure multiple sources are considered, I will also cite the following definition by Investopedia.com: “Double taxation is a tax principle referring to income taxes paid twice on the same source of income.”
Neither definition did a complete job. The strength of the Cornell definition is to extend double taxation to cover not just income (like Investopedia did) but assets (e.g., capital taxes) and transactions (e.g., sales taxes). Its weakness is to limit double taxation to “two different points of time.” Finally, the word “imposing” indicates a tax authority perspective.
The truth is that double taxation can happen not necessarily at two different times but by different jurisdictions, sometimes at the same time or by the same due dates. This is the so called “jurisdictional” double taxations.
The strength of the Investopedia definition is to name it as a “tax principle,” while the Cornell definition just lists it as a phenomenon or a process. Its weakness is to limit the principle to “income taxes” only. Finally, the word “paid” signals a taxpayers’ perspective.
It has been frequently stated that double taxation falls into two types of economic and jurisdictional. I argue the former is more fundamental as economic consequences cut through all double taxation cases. On the other hand, some double taxation can be imposed by the same rather than different jurisdictions (e.g., different countries).
How Popular Is Double Taxation?
Perhaps the most famous example of double taxation is corporate profits, which are taxed at the corporate level and then at the individual level when the same profits are distributed as dividends to shareholders. This particular case involves a single jurisdiction or the same tax authority of the federal government, which taxes twice for the same profits.
More specifically, corporations pay taxes on their annual earnings. When a corporation pays out dividends to shareholders, the dividends generate tax liabilities, meaning shareholders who receive any dividends must pay taxes on them, this is when double taxation happens.
It is possible that this particular scenario of double taxation has been going on for too long that we may take it for granted. Let me use an analogue to show this is not always right.
We can consider how wholesalers and retailers pay taxes. It turns out that wholesalers are not required to charge sales tax to retailers because when a wholesaler sells to a retailer, that retailer is not the product’s end user. Therefore, the wholesaler does not have to collect sales tax on the transaction when selling to a retailer.
Using the same logic to corporate profits, it would mean the corporation should not owe any tax because it is not keeping the earnings but distributing them to shareholders, who are the end gainers.
Jurisdictional double taxation is more common. Every year when we file income taxes, every taxpayer must file for the federal and state and local municipal taxes — for the same income we earned in the year. This double filing practice is highly likely to continue in the future, which means we will see both federal and state (or municipalities) income taxes imposed on us.
Jurisdictional double taxation on income taxes can be justified in that each taxpayer presumably receives services provided by both federal and state or local governments. For example, national security is the responsibility of the federal government in the US, while insurance businesses are governed by state government.
At lower levels of government, things are less clear. For example, residents of municipalities pay county and city taxes, even though they receive direct or more perceivable services only from the city, less directly from the county. Because of this issue, sometimes city-county may have agreements for joint financing of services with city residents also financing part of the county share.
The most frequently discussed jurisdictional double taxation is in international trade or investment, where double taxation occurs when the same income is taxed in two different countries.
The Cases for Avoiding Double Taxation
As common as double taxation is, we have also seen the other side of the coin, where double taxation has been avoided legally. This, after all, is why I call “double taxation” and “no double taxation” both legitimate tax rules.
Let’s begin once again with the well-known example of business profits. It turns out that double taxation mainly affects larger corporations (the C corporates) that pay out dividends to shareholders regularly. This is because those corporations are taxed as separate legal entities. As the Motley Fool article points out, “C corporations are the only business structure that is taxed separately as a business,” while other legal structures exist to help you avoid double taxation, such as sole proprietorship, partnership, single member LLC (Limited Liability Company), and S corporation.
The magic words here are “pass through entities” that pay “pass through taxes,” which is a fancy way to say that the profits or losses of a business entity are not taxed at the entity level, but instead “pass through” to the business owner’s personal tax return, without having to owe corporate income tax.
For a hypothetical example, say you and your wife have a small firm that is an S corporation. Last year your firm made a profit of $80,000. In the eyes of IRS, an S corporate is not a separate but a “flow through” legal entity. Therefore, although you are still required to file an annual tax return with the IRS that report the income, gains, losses, deductions, credits, etc., of the corporation each tax year, that $80,000 can “flow through” to your personal tax returns — as long as there are fewer than 100 shareholders — and you owe nothing at the corporate level.
Since your S corporation was incorporated in California, the state also requires you to file an annual return with $800 minimum franchise tax, another example of jurisdictional double tax.
Even the best known jurisdictional double tax can be avoided. International double taxation can be mitigated by formulating trade treaties between nations, such as double taxation agreements (DTAs), with countries they trade with and using relief methods such as the exemption and foreign tax credit methods. I won’t get into details as my focus is not on trade but on insurance.
No Double Taxation in Insurance
Compared with cases of double taxation, there are far more cases of no double taxation in life insurance and retirement taxation. It is safe to assume that once you contributed money to your policy after paying income taxes, you have made a nonqualified contribution as your contribution is not deductible. Based on the rule of no double taxation, you won’t be charged income tax for the second time when you are taking the money out during the so called distribution stage. I will provide more examples later but suffice it to say that when it comes to insurance related incomes and contributions, we have reason to say there are far more cases of no double taxation than otherwise. is one of the fundamental principles that we must keep in mind when we think of tax matters.