What is double taxation: How it works & ways to avoid it

Double taxation is one term that often becomes a cause for concern for those who live or do business abroad.

Double taxation can have significant implications for both individuals and businesses, particularly those operating across international borders.

In this article, we will delve into what double taxation is, how it works, and look into strategies which can help you avoid it altogether — or reduce the taxable amount at least.

Key takeaways

• Double taxation occurs when the same income is taxed twice, at corporate, personal or cross-country level.
• International tax treaties, the Foreign Earned Income Exclusion (FEIE), and Foreign Tax Credits (FTC) can help reduce double taxation.
• US expats must report their worldwide income, but credits and exclusions can bring the taxes down significantly.
• Choosing an S-Corp, partnership, or sole proprietorship can help business owners avoid corporate double taxation.

What is double taxation?

Double taxation is simply what the name implies: income, whether corporate or personal, is taxed in two countries. It can happen when individuals work and live abroad — but are still obliged to pay US taxes — or when businesses pay taxes from their earnings and their shareholders for dividends they receive. We’ll look at both examples in detail anon.

How double taxation works

There are two scenarios when double taxation might kick in.

1. Corporate income being taxed twice. First a corporation pays income tax on its earnings, then its shareholders pay income tax on their dividends, which are paid out of the corporation's after-tax earnings.
2. Personal income being taxed twice. This could happen when a taxpayer is a citizen of one country, but lives and earns his income in another. This is particularly relevant for expats.

International double taxation

International double taxation can happen on a personal level — or on a business level.

Business level covers two aspects:

• Taxes are levied on dividends paid to shareholders (we’ve already detailed this concept above)
• Income received from sales of goods and/or services is taxed both in the country of origin and in the country where these are sold

Personal level is much more straightforward. The dividends situation aside (dividends are considered a type of personal income), there is a more commonplace matter of being a citizen of the US but living and working in another country.

According to US tax law, American citizens are taxed on their worldwide income, regardless of where they live or earn said income.

This leaves American expats exposed to double taxation – once by the country where they earn their income, and again by the United States.

However there are mechanisms in place to prevent this kind of double taxation. Tax treaties between countries, the Foreign Earned Income Exclusion (FEIE), and the Foreign Tax Credit (we’ll cover them all in detail below).

Double taxation examples

To better understand the concept of double taxation, let's take a look at a few examples:

Example 1: Corporate double taxation

A corporation in the United States earns $1 million in profits. It pays a corporate income tax on these profits.

Then, when the after-tax profits are distributed to shareholders as dividends, the shareholders must also pay personal income tax on these dividends.

Example 2. International double taxation

An American expatriate living in Germany earns income from a job in Germany. They pay income tax on this income to the German government.

However, based on US tax law, expats must also report their worldwide income to the IRS, potentially leading to double taxation.

Example 3: Investment income from a foreign source

Consider an American expatriate living in France who receives investment income, such as dividends or interest, from US-based stocks.

The US taxes this investment income because it’s sourced from the US, while France also taxes it since the individual is considered a tax resident in France. Without planning or claiming available credits, this income could be taxed twice, by both the US and France.

To avoid double taxation, the expat can claim the Foreign Tax Credit (FTC) on their US return for the taxes paid to France or apply the US-France tax treaty provisions, if applicable.

Business entities and double taxation

When it comes to business entities, double taxation primarily affects C corporations, often referred to as C-Corps.

This is due to the fact that C corporations are legally considered separate entities from their owners, who are the shareholders.

This separation leads to a two-tier taxation system.

First tier

The first tier of taxation occurs at the corporate level. When a C corporation generates profits, these earnings are taxed according to the prevailing corporate tax rate.

As of the current tax year, this rate stands at 21%, and it applies irrespective of the corporation's annual earnings.

Second tier

The second tier of taxation comes into play when these after-tax profits are distributed to shareholders in the form of dividends.

At this stage, the dividends are subjected to personal income tax, which varies based on the shareholder's federal income tax bracket.

This bracket is determined by several factors, including the shareholder's filing status (single, head of household, married filing jointly, or married filing separately) and the total amount of dividends received.

Exclusions

However, not all business entities are subject to double taxation.

S corporations, partnerships, and sole proprietorships, for example, are classified as "pass-through" entities.

In these business structures, the income earned by the business is not taxed at the corporate level. Instead, it "passes through" to the owners, who then report it on their personal income tax returns.

This pass-through mechanism allows these types of businesses to avoid the double taxation experienced by C corporations.

Debate on fairness of double taxation

The fairness of double taxation is a subject of ongoing debate, particularly regarding passive income like dividends. Critics argue that it’s unfair to tax shareholders on dividends since this income was already taxed at the corporate level.

For US expats, this can be especially burdensome, as dividends earned abroad may be taxed in both the foreign country and the US, despite being the result of the same income stream.

On the other hand, proponents of double taxation argue that without taxes on dividends, high-net-worth individuals could potentially avoid taxes altogether by relying primarily on investment income instead of earned income.

For expats, these varying perspectives on double taxation highlight the importance of utilizing available credits and exclusions to reduce the impact of double taxation, whether on dividends or other income types.

How to avoid double taxation as an expat or a business

There are several strategies that can be used to avoid or minimize US double taxation.

1. Leverage tax treaties

The US has international treaties in place with 66 countries — precisely to help their citizens living abroad avoid double taxation. However, the simple existence of such a treaty doesn’t mean you’re automatically excused from paying taxes in one of the countries. You have to study the relevant treaty to understand which types of income it covers, and how you can apply the treaty when filing for taxes.

And where there is no treaty in place to ease your tax burden, there are two useful mechanisms which can come to the rescue: the Foreign Earned Income Exclusion and the Foreign Tax Credit.

2. Use the Foreign Earned Income Exclusion (FEIE)

The FEIE allows US taxpayers to exclude a certain amount of their foreign earned income from their US taxable income each year. For the 2025 tax year, the maximum exclusion amount is exactly $130,000, a shade higher than 2024’s $126,500.

To qualify for the Foreign Earned Income, you need to meet three criteria:

• Have a foreign income source
• Have your tax home in a foreign country
• Pass the bona fide or the physical presence test for the year in question

And, like we said above, you can’t exclude more than $130,000 in 2025. The Foreign Earned Income Exclusion also doesn’t apply to passive income, such as dividends or interest.

3. Rely on Foreign Tax Credit

Foreign Tax Credit lowers your taxable US base dollar-for-dollar — based on the taxes you’ve already paid to a foreign country, whether as an individual or a business.
The key difference to the Foreign Earned Income Exclusion is that in the case of Foreign Tax Credit you’ve already paid taxes on your income in a foreign country — and are now trying to avoid paying taxes from that same income the second time. This is not a preventive measure, but rather a post-factum one. Another difference is foreign tax credit applies to passive income and unused credits can be carried over into future tax years.

To qualify for a foreign tax credit, you have to:

• Be a US citizen/resident alien
• Have a foreign-sources income that’s taxable under US rules
• Have accrued/paid income-based taxes to a foreign government

4. Opt for a pass-through entity

Pass-through entities are called this way because owners of such entities are only taxed once — at the individual income rates. In essence, their profits or losses “pass through” to their owners, who then file the usual individual tax return at the end of the year and pay taxes from their income, or claim the net operating loss deduction to lower their tax liability.

Pass-through entities account for more than half of all businesses in the US, precisely because of the taxation benefits they offer. Pass-through entities can come in the form of:

• S-Corporations
• Limited liability companies (LLCs)
• Partnerships
• Sole proprietorships

In the meantime, C-Corporations are taxed both at the federal level for their income (21% tax) and the individual level (shareholder dividends). Curiously, even if a C-Corporations reports a loss, shareholders are still required to pay taxes from their dividends.

5. Pay salaries instead of dividends

Salaries are rightly considered a type of personal income. As such, they are taxed at an individual tax rate. But more pertinently to our discussion, salaries are viewed as business expenses at a company level — unlike dividends paid to shareholders.

So making your shareholders high-earning executives within the company can help you avoid US double taxation because you no longer pay dividends to them. Keep in mind the high salaries have to be justifiable to the IRS though.

Need help to avoid double taxation?

Remember that every individual's tax situation is unique, and the information provided here is general in nature.

It's always a good idea to consult with a tax pro who is familiar with the tax rules of both the US and the foreign country where you are living or doing business.