Question

Sandra would like to organize BAL as either an LLC (taxed as a sole proprietorship) or a C corporation. In either form, the entity is expected to generate an 10 percent annual before-tax return on a $630,000 investment. Sandra's marginal income tax rate is 37 percent and her tax rate on dividends and capital gains is 23 8 percent (including the 3.8 percent net investment income tax). If Sandra organizes BAL as an LLC, she will be required to pay an additional 2.9 percent for self- employment tax and an additional 0.9 percent for the additional Medicare tax. BAL's income is not qualified business income (QBI) So Sandra is not allowed to claim the QBI deduction. Assume that BAL will distribute all of its after-tax earnings every year as a dividend if it is formed as a C corporation (Round your intermediate computations to the nearest whole dollar amount.)

Answer 1

Part A

	After tax cash flow
LLC	$25209
C corporation	$11845

Part B

	Overall tax rate
LLC	40.01%
C corporation	39.80%

Explanation

Part A

		LLC	Description	C corp.	Description
1.	Pretax earnings	63000	(630000*10%)	63000	(630000*10%)
2.	Entity level tax rate	0%		21%
3.	Entity level tax	0		13230	(1) × (2)
4.	Earnings after-entity-level tax	63000	(1) – (3)	49770	(1) – (3)
5.	Deduction for 50 percent of SE tax	(843)	(1) × 0.9235 ×0.029 × 0.5		NA
6.	Net income taxable to owner	62157	(4) + (5)	49770	(4) distributed as dividend
7.	Income tax paid by owner	22998	(6) × 0.37	9954	(6) × 0.20
8.	Self-employment tax	1687	(1) × 0.9235 × 0.029
9.	Additional Medicare tax/Net investment income tax	524	(1) × 0.9235 × 0.009 additional Medicare tax	1891	(6) × 0.038 net investment income tax
10.	Owner-level tax	25209	(7) + (8) + (9)	11845	(7) + (9)
	After-tax cash flow	37791	(1) – (10)	37925	(6) – (10)

Part B

10.	Owner-level tax	25209	(7) + (8) + (9)	11845	(7) + (9)
	After-tax cash flow	37791	(1) – (10)	37925	(6) – (10)
	Overall tax rate	40.01%	(10)/(1)	39.80%	[(3) + (10)]/(1)

25209/63000=40.01%

(11845+13230)/63000 = 39.80%