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Current time:0:00Total duration:10:18

Is limited liability or double taxation fair?

Video transcript

after watching the last video on corporations and limited liability you might be asking yourself was that fair if bill had owned the the cab himself and got sued the soccer player whose career was ruined would have gotten his actual million dollars but because bill set up this corporation and put the assets of the cab company in this corporation he was able to limit his liability the soccer player was only able to get $180,000 the corporation declared bankruptcy but Bill's liability was limited to what he had contributed to the corporation and he might say my god this guy over here his life was somewhat ruined and he's not able to kind of get compensated for I guess how bad his life was ruined and Bill is so rich Bill is so rich he could probably still make money he should give him the money so you should say you know this is kind of an unfair way that these corporations are a way for well-off people or wealthy people to protect their assets and to some degree that's true but I want to think about in this video is kind of the trade-offs and really this is just a balance that society has to pick that this really was on at least the way I had set it up in the last video it was kind of unfair to the soccer player I mean he was only getting $180,000 for something that might have ruined his career but if you had talked to Bill bill might have said well you know that's right corporations are kind of limiting liability for someone like me but he'd say look I wouldn't have started or you know maybe he wouldn't have started the cab company if he didn't have that limited liability he said look if I had all of these assets maybe maybe he had a million dollars maybe he had up or actually meet here he does have a million dollars maybe had a hundred million dollars he said look if I had a hundred million dollars and I didn't have the option of starting a corporation I would not have started a cab company because just for a little bit of small profit that I could have gotten from an eighty thousand dollar cab I wouldn't have wanted to just jeopardize my the rest of my empire so if I didn't have limited liability I wouldn't have started the business to begin with and that would not have been good for society another argument bill might make and I'm not going to take sides here I'm just saying these are these are the balance these the things that you have to weigh when you set up a legal code in a society is that bill said look whoever starts a cab business this cab business that you know roughly you could start with eighty ninety or a hundred thousand dollars they all have the same upside they're taking a certain amount of risk they're providing a service to the city they'll probably make a similar amount of money and he would argue that it would be unfair that we have different downsides maybe maybe Sal right over here maybe Sal right here maybe my only assets are the cab Plus licenses and I have a TK over there and the insurance and the insurance which is 1k and so what bill would say is look me and Sal could both open the exact same cab business and if there were no corporations if I had to oh if I had to own I want to say I am talking about Bill if Bill had to own the assets of of the cab company or I shouldn't say the cab company I should say bill had to directly own the assets the cab and licenses even though bills and sales up side from the business the profit they could make would be the same bills downside would be more because he has he if he didn't have the corporation he would have all of these other assets at risk and maybe that would make bill get a bigger policy instead of $100,000 policy maybe he would want to get a million dollar policy and then a million dollar policy will probably cost ten times more it would cost ten thousand dollars to have that policy and so if you view it from that way in order to protect his other assets his cost of business would be higher just because he happens to have other things and so bill might argue hey that wouldn't be fair it would again be a reason why someone with assets would be would be less inclined to start another business which may not be great for society and then the other thing that bill might argue is that look in exchange for limited liability he might have to be double taxed and this is an interesting discussion here because you'll probably hear this term a lot double taxation double double taxation it's not it's it's not necessarily going to happen but if the large corporation the type of corporations that are publicly traded this will happen and the idea behind double corporate double taxation it's not true for all corporations and that's a fact let me differentiate it double taxation happens with AC corporation a C Corp it does not happen with things called s corpse and I'm not going to go in detail here and what these are s corpse LLC which stands for limited liability corporation LPS which stands for limited partnerships or limited liability partnerships ll P's it doesn't apply to any of these things but what happens in double taxation is that let's say you have some corporation some C Corp and let's say that it makes let's say it makes $1,000 in profit so it makes $1,000 in profit in a given year that since this is being treated as kind of a legal entity that's kind of like a person by the government it gets taxed like a person so they're going to have to pay some tax maybe it's let's say 30 percent tax so they're going to have to pay 30% or 35% or whatever the corporate tax the marginal corporate tax rate for this corporation is going to be so they're going to have to pay three hundred dollars three hundred dollars in taxes and then let's say this corporation whatever it has left over after taxes so this is let me make it clear this is pre-tax pre-tax profit it pays 30% to the government and so it has $700 and so it has $700 in net net income so this is net of taxes and everything and let's say it then dividends that out to its shareholders so then it gives it to its shareholders to its shareholders and let's just say for simplicity there's one shareholder so one shareholder but this is true even if there were more than one shareholders so that one shareholder he's getting $700 in income based on the fact that he owns this corporation he is going to have to pay taxes again so that $700 so he has to pay taxes so let me do it this way let me draw it he has to pay taxes again maybe his marginal tax rate is another three 80% so he'll have to pay 30% to the government again so this is 30% on the $700 so he'll pay 210 210 dollars in taxes to the government based on this net income from his dividend that he's getting out from the C corporation and actually I want to be very careful here I don't want to get into the details but dividends can sometimes be taxed differently than straight-up income but just for the sake of simplicity let's say it's 30% it might be a lower or higher amount but this is the idea of double taxation the corporation is you'd as a legal entity it pays taxes and then whatever and then after those taxes it's able to give its money back to shareholders and then those shareholders have to pay money on that income again so that's what the double taxation is and regardless you know some people say hey this is horribly unfair you know why should you have to pay taxes twice on the same money and then some of argue well look you're getting all of this limited liability if you don't like paying those double taxes don't set up a corporation and then just accept the full straight-up liability so it's a trade-off you pay the double taxes you get the limited liability and let me be clear here this applies mainly the large corporations if you want the limited liability but you don't want to have to do this double taxation any of these other corporate structures are available and these are usually available to smaller less complicated companies I should say then what's going on with the C Corp and an S corp you have a limited number of shareholders LLC's they can't last forever they they stopped lasting as soon as one of the partners of the corporation one of the owners of the corporation pass away or declare bankruptcy so there are limitations here but these do get the benefits of limited liability limited liability and the profits get passed through to the owners without getting taxed first and so they also have single taxation single taxation so going back to the fairness issue if Bill was smart when he started this company he probably would set this up as a limited liability corporation or as an S corporation or something where he doesn't have to get double taxed and still he would of Wade having to pay the soccer player the full million dollars just what just whatever the company has that's all the soccer player would get but let's say the car service becomes huge and he wants to make it public one day then he would have to make it a c-corporation and then he would have to do the whole double taxation but it's something to think about you know it's an interesting to think about is it fair to have something like this the the the pro corporation side is it encourages entrepreneurship people won't worry about the downside as much people it kind of levels the playing field in terms of regardless of however many side assets you have you have the same liability for a certain amount of business and there's usually certain rules that you have to have a certain amount of money in the corporation a certain amount of insurance in the corporation if you don't then possibly the court can go after the owners assets but as long as you maintain it in a responsible well capitalized way probably won't and then the other trade-off is this double taxation thing that at least for large corporations the type that you know the the general electric's and the and the you know the googles and the Microsoft's of the worlds they are they do pay a fee for this limited liability and that's in and that's in terms of this double taxation all those smaller corporations right when they're getting started out or kind of partnerships they don't have the double taxation but they do get the limited liability