Avoiding Double Taxation

Comments (20)


Many people who buy mutual funds and other stocks often end up paying tax twice when they finally sell the security. This is because they do not keep track of their "average cost base" per share. This problem is very prevalent on investments when the dividends have been reinvested in the same security. Most mutual fund investors reinvest their dividends in more shares of the same fund. Many large corporations offer dividend reinvestment programmes that allow the shareholder to acquire more shares of the corporation directly without any brokerage charges.

While reinvestment of dividends is usually an excellent idea, it does require some record keeping on your part to avoid double taxation. Many financial planning firms provide this tracking as part of their service. In my experience almost every case that I have looked at after a sale, has resulted in the reinvestment of dividends not being accounted for.

For example, let's say you bought units or shares in XYZ mutual fund in 1990 for $ 10,000 when the shares were $5 each. So you got 2000 shares. At the end of the year, the fund will declare a dividend equal to the total of its realized capital gains, dividend and interest income etc. less the fund's expenses. Let's say this dividend worked out to 30 cents per share. On 2000 shares that is a $600 dividend or 120 more shares if the unit value hasn't changed since you bought into the fund.

You will receive a T3 slip in March for that dividend whether you take cash or additional shares for it. If it is a mutual fund corporation you will receive a T5 slip for the dividend declared at its fiscal year end. The tax effect is the same. The point to understand here is that you will be paying taxes that year on that dividend whether you receive it or not. If you reinvest the dividend in more of the same shares, for tax purposes the "average cost per share" has now risen by 30 cents per share. Your total investment is now $10,600 (2120*5.) 00) from an income tax point of view because you will already have been taxed in the current year for the $600.

Now lets assume they pay the same dividend on the same unit value in 1991, 1992, 1993 and then you sell your shares in XYZ mutual in 1994 and receive net proceeds of $14,000. Most people I have found would report a capital gain of $4,000 on their tax return and forget that they already paid tax on four annual dividends. The capital gain is actually $1,600 ($14,000 - $10,000 + 4 x $600), less than half of what is often reported. The good news is that if this has happened to you, you can apply to have an adjustment for at least the last three years of tax returns and sometimes further back than that.

As you may sell a portion of your shares instead of the entire position, it is necessary to keep track of these matters on a price per share basis, rather than the total investment. By adding the dividend per share to the previous cost per share, you now have the new cost per share for future redemptions. This calculation is especially helpful if you are taking a regular monthly income from a mutual fund-often referred to as systematic withdrawal plans. As there are often twelve redemptions per year, a simple record is necessary to come up with the taxable portion for tax time.

If you don not keep track of your cost per share you will be paying more tax than necessary. If you have other losses to offset your gains, you will be using up your losses needlessly. All of these are forms of double taxation, which result from not keeping track of reinvested dividends. If you want a form for keeping track of your cost base there is a free Form for tracking ACB, which you can download, form our web site at www.money-software.com

Copyright 2004 - www.money-software.com

About the Author

Peter F. Baigent CFP, CLU, CHFC, RFP. is a Past President of the Canadian Association of Financial Planners for British Columbia, a former Director of the Canadian Association of Financial Planners. He has spoken across Canada on financial planning matters and has taught courses for the Chartered Financial Consultants & Certified Financial Planners degrees. He is the founder of Money Minders Software which produces financial planning software.

Comments

ladyblues80 28.06.2006. 23:09

How do you avoid double-taxation on income when you establish corporation in Texas? When you establish your business as a corporation in Texas (no state income tax, but there is a franchise tax), what is the best way to distribute earnings to pay the lowest amount of taxes and avoid double-taxation? Should I pay myself a salary, or just pay myself in dividends? I'm not incorporated yet, so I still have the option to form as a LLC.

ladyblues80

Admin 28.06.2006. 23:09

The optimal way to distribute earnings from a TX corporation is to pay yourself a salary. With proper planning during December (or whatever month is your year end), your CPA can estimate your net income from the corporation and then determine if you need to pay yourself a bonus to lower the corporate earnings in order to reduce franchise taxes.

With an LLC you won't have this option, and LLCs are subject to TX franchise tax. :) PrissyPanda, CPA Dallas

Admin

hitesh b 21.02.2008. 15:44

How to calculate India Tax Credit for employees deputed to US to avoid double taxation? Hi,

I have deputed to US on temporary basis and earning income in India and US. My India income is double taxed (both in India as well as in US). Can you please suggest how to calculate the India tax credit for my income in India to avoid double taxation.

Hitesh

hitesh b

Admin 21.02.2008. 15:44

You need to consult a good C.A. Do not depend on the answers of Yahoo answerers. Actually it is not easy to tell. I am sure no one can answer you. Do not waste your time.

You can try the below web site.:

http://www.thehindubusinessline.com/iw/2008/01/06/stories/2008010650621200.htm

Admin

Tom 14.01.2009. 19:43

What is the difference between the Foreign Earned Income Exclusion and the Foreign Tax Credit? I am a US Citizens living abroad. I am in the process of filing tax return for 2008 for foreign earned income based on IRS' publication 54. Our earned income has already been taxed once by the country we live in.
I see that there are two ways to avoid double taxation on your income -the foreign earned income exclusion and the foreign tax credit.
Can somebody please explain the difference between the two and point out advantages to use one over another?

Tom

Admin 14.01.2009. 19:43

The foreign earned income exclusion allows you to exclude from tax a certain amount ($87,600 in 2008) of your foreign earned income (wages and self-employment earnings). You claim the exclusion on form 2555 and must reside outside the US and meet certain other requirements. If your income is above the exclusion amount you can still take a foreign tax credit for taxes paid on the the income in excess of $87,600, and this calculation is quite complicated.

The foreign tax credit is available to avoid double taxation of foreign income. The credit is claimed on form 1116 and must be calculated separately for certain defined categories of income. That is, one credit for general limitation income (wages, etc.), one credit for passive income (interest, dividends, rents, etc), and so on. In calculating the credit, deductions claimed on your tax return must be allocated to both foreign and non-foreign income.

If you don't want to take the credit, you can instead take any foreign taxes paid as an itemized deduction on Schedule A, if you itemize. Most of the time, this is the least attractive alternative, but not always.

Usually if your foreign earned income is under the exclusion amount and you do not have lots of other income, then the foreign earned income exclusion is the simplest and preferred option, if you qualify to use it. However, if you still owe US taxes after using the exclusion, a detailed calculation of your tax liability using the foreign tax credit is necessary to know which leads to the lower tax.

Advice was prepared based upon understanding of the tax law in effect at the time it was written and the facts and circumstances described. See my profile for more information.

Admin

Lauren Payne 30.08.2012. 11:06

What form do I fill in to avoid double taxation? I'm a UK resident and I am working for a company in the US (not living in the US). What do I do to avoid paying tax in both the UK and the USA? I know I can fill out a form for double taxation making me exempt from paying tax in the US but I can't find a form like this. Also, once I am exempt to paying tax in the US how to I pay my tax to the UK government as it won't me automatically taken out with PAYE. Thanks!

Lauren Payne

Admin 30.08.2012. 11:06

Certificate of residence from HMRC - that goes to US to stop them taxing you. If you are not employed in the UK by this company then you are a free lancer andmust register for Self Assessment (and the UTR is evidence as well).
Phone HMRC - or write - explain situation in loving detail and someone will set up the record and issue the certificate.

Admin

banansanes 19.07.2011. 03:27

Very important question regarding settlement and being kicked out of the house? My boyfriend's mom had a lawsuit, short story, they settle for about a mil. My boyfriend and his sister both would get 150k if they gave it to the mom so avoid double taxation. Otherwise, he would've gotten 60k. She kicked him out of the house yesterday. Is that money legally his or hers?

banansanes

Admin 19.07.2011. 03:27

That would be determined by the terms of the settlement and the original suit, their age is important to the answer because the mother has control of everything until they are 18.}{

Admin

Fred H 17.02.2009. 21:41

I am a USA citizen but live and work in the Netherlands. Income tax advice please? I spent 2008 working in both the USA and Netherlands (different jobs) and the majority of my income has come from my time abroad. What irs forms do I need to fill out to avoid double taxation? How does one file Dutch income taxes? What documents will I need? Thanks in advance for sharing your knowledge.

Fred H

Admin 17.02.2009. 21:41

Dutch income tax I can't help you with but you must file a US income tax return then take Dutch income tax as a credit against what you owe. Since Dutch taxes are more than US taxes, you will owe the US nothing.

Admin

Charuchandra 27.05.2011. 05:18

What procedure & document to get credit for TDS and tax paid in India on Income received in India on Investmen? What procedure & document to get credit for TDS and tax paid in India , on Income received in India ,on Investment done in India , to avoid double taxation in Australia.

Charuchandra

Admin 27.05.2011. 05:18

Get Form 16 from the person who is responsible for deduction of tax at source from your Income in India.This form will indicate your gross income with the period of income,rate of tax,amount of tax deducted along with the details of tax paid to the credit of Government of India.This Form will be signed by duly authorised person.

Admin

computelgt 16.08.2007. 18:58

Loop hole to get a Mortgage with a C Corp? Im self employed and live in another country but I am a US Citizen. I recently applied for a home loan and was denied on the basis of not having proof of income. Here is way I think I can get around this

1.File and register a c Corp
2.Business Income is zeroed out with wages etc this avoid double taxation
3.Pay my self a salary of 24,000 per year
4. Do I need to withhold taxes and make quaterly payments to the IRS even though I don't live in the US?
5.Using tax cut even if I with hold income I get a about $200 more than what I pay in taxes
6.This will allow me to file my bussiness taxes and my personal taxes as well over a couple of years I can finally show verifiable proof income and qualify for a home loan.

Can this be done?
I contacted the lender.
Accroding to what I was told income needs to be reported by a US based company and needs to be verifiable. Throgh W2 and tax returns. My previous tax returns show income of $80,000 which don't qualify because there not being reported by a US business. Good thing I don't have to pay income tax on it since I don't live or work in the US. Its Completely exempt.

computelgt

Admin 16.08.2007. 18:58

I would think that that could be done that way. But why is the lender denying you a loan on the basis of not having proof of income? Didn't you give them a US Tax Return? Hopefully you've been filing one, as with you being a US citizen you are taxed on your worldwide income no matter where you live. You need to file a US tax return, but will get foreign income exclusion (I've attached a link to it). And yes, you would need to withhold taxes and make quarterly payments to the IRS even though you don't live in the US, because if you are creating a C-corp, that means you need to file a 1120 return, and will need to get a Tax ID Number (EIN) for the business. You can put yourself on payroll, but will have to pay payroll taxes to the irs for the employee (you). This seems like a big hassle for you to go through though. Why just not contact the lender and ask what would be sufficient proof of income for them?

Admin

justme 10.07.2007. 19:16

How do I get the profit or retained earnings out of my S-Corp? We started our corp with $20,000 and we pay ourselves W2 wages at the end of the year with whatever cash the business has in the checking account. Because of inventory and capital assets there is usually more profit than cash in the bank so we pay taxes on the K-1 reported "profits". How do we get any of that profit out of the company? We already paid "pass through" taxes on the profit, if we have to pay ourselves W2 wages we pay taxes again. I keep hearing S-Corps are supposed to avoid double taxation. Do we have to wait until we sell the business to actually get our profit income? It's not a service business but when my husband dies it won't be worth much any more and I can't run it.

justme

Admin 10.07.2007. 19:16

Pay the profits out as dividends.

As long as you are paying yourselfs a fair salary, your S-corp dividends should not be taxed as wages.

You need to go over this with the IRS as it is complex, and based on your S corp status.

You need a good accountant to do it right.

Admin

Djf 08.07.2012. 20:00

If I start my own corporation? Am I a shareholder? How can I avoid double taxation if I'm running the business myself?

Djf

Admin 08.07.2012. 20:00

DJ,

If you form a for-profit corporation and issue controlling shares to yourself as part of the initial articles of incorporation, then you would be the sole shareholder. Form a sub-chapter S Corp. to avoid the double taxation issues.

Admin

Write a comment

* = required field

:

:

:

:


* Yes No