Taxation of Entities: Companies, Partnerships, Trusts, and Look-Through Companies
Core framework
Companies are taxed at the company rate and are separate legal entities; dividends are taxed to shareholders with imputation credits to avoid double taxation. Partnerships and look-through companies (LTCs) are transparent for tax: income and deductions flow through to partners or owners. Trusts are taxed on trustee income, with beneficiary income taxed to beneficiaries.
Key concepts: imputation credits and the imputation credit account; shareholder continuity (49% continuity) for carrying forward losses; the LTC election and eligibility criteria; trustee income vs beneficiary income; the minor beneficiary rule; and the foreign trust disclosure rules.
Traps
- Assuming a company can carry forward losses after a breach of continuity; the 49% shareholder continuity test must be met.
- Treating an LTC as a separate taxpayer; it is transparent and owners apply their own rates.
- Forgetting that beneficiary income is taxed to the beneficiary, not the trust, if vested or paid in the year.
- Ignoring the imputation credit attached to a dividend; shareholders gross up and claim the credit.
Worked example
A company earns $100,000 and pays tax at 28% ($28,000), leaving $72,000. It pays a dividend of $72,000 with $28,000 of imputation credits. A shareholder on a 33% rate grosses up to $100,000, pays $33,000 tax, claims the $28,000 credit, and pays $5,000 further tax.
Rule of thumb
Identify the entity, then ask whether income flows through or is taxed at the entity level.