[marktheknife]

I'm going to quibble a bit, hopefully not in an annoying fashion.

The distinction is that the tax system does not give a deduction to individuals who are spending their money on personal "consumptive" reasons. By and large, the system does give deductions for expenses incurred for business.

In this light, the double taxation of corporations is unusual. Clearly, the dividends are to pay back investors, just as interest is part of paying back lenders. But interest is deductible; why not dividends? Many theories have been advanced to justify this double tax, but none have won wide support among scholars.

(Interestingly, in your example, what probably would happen is that Bob would essentially be the effective managing partner of a general partnership. So we would be under partnership tax rules.)

A last quibble: partnership tax actually taxes partners even while the income is held by the partnership. (Well, generally; there apparently are some odd trust schemes that sort of avoid this.) in general, Partnerships must allocate the income to the partners, who bear the burden of tax. Then, they must later distribute the income in accord with how they've allocated it.

[rayiner]

Payment of dividends isn't either interest or a repayment of principal, since there is no obligation to pay dividends. They're also not expenses, since the company would generate the same revenue with or without paying dividends.

[nickff]

You are assuming that the company could obtain financing while never buying back stock or paying dividends? This seems to be an implicit (and often explicit) part of the fiduciary duty of the corporate officers (maximizing shareholder returns in the short or long term). I would not purchase stock from a corporation that promised never to return money to shareholders.