Question

Tremaine would like to organize UTA as either an S Corporation or a C corporation. In either form, the entity will generate a 9 percent annual before-tax return on a $1,000,000 investment. Tremaine’s marginal income tax rate is 37 percent and his tax rate on dividends and capital gains is 23.8 percent (including the net investment income tax). If Tremaine organizes UTA as an S corporation he will be allowed to claim the deduction for qualified business income. Also, because Tremaine will participate in UTA’s business activities, the income from UTA will not be subject to the net investment income tax. Assume that UTA will pay out 25 percent of its after-tax earnings every year as a dividend if it is formed as a C corporation. (Do not round intermediate calculations and round your final answers to the nearest whole dollar.)

a. How much cash after taxes would Tremaine receive from his investment in the first year if UTA is organized as either an S corporation or a C corporation?

b. What is the overall tax rate on UTA’s income in the first year if UTA is organized as an S corporation or as a C corporation? (Round your final answers to 1 decimal place.)

c. What is the overall tax rate on UTA’s income in the first year if it is organized as an S corporation but UTA’s income is not qualified business income?

d. What is the overall tax rate on UTA’s income if UTA’s income is not qualified business income and Tremaine is a passive investor in UTA? (Round your final answers to 1 decimal place.)

Answer 1

Answer :

(a)

		S crop	Description	C crop	Description
1.	Pretax earnings	90000	(1000000*9%)	90000	(1000000*9%)
2	Entity level tax rate	0%		21%
3	Entity level tax	0		18900	(1) x (2)
4	Earnings after entity level tax	90000	(1) - (3)	71100	(1) - (3)
5	QBI deduction	(18000)	(1) x 0.20		NA
6	Net income taxable to owner	72000	(4) + (5)	71100	(4) distributed as dividend
7	Owner level marginal tax rate	37%		23.8%
8	Owner level tax	26640	(6) x (7)	16922	(6) x(7)
	After tax cash flow	63360	(1) - (8)	54178	(6) - (8)

(b)

8	Owner level tax	26640	(6) x (7)	16922	(6) x (7)
	After tax cash flow	63360	(1) - (8)	54178	(6) - (8)
	Over all tax rate	29.60%	(8)/(1)	39.80%	[(3) + (10)]/(1)

(c).

Over all tax rate

37%

If UTA's income is not qualified business income, then the total income will be taxed at 37%

(d)

Over all tax rate	40.8%
Over all tax rate = 37% + 3.8 net investment income tax =	40.8%

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