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 14 percent annual before-tax return on a $580,000 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.)

a. How much cash after taxes would Sandra receive from her investment in the first year if BAL is organized as either an LLC or a C corporation?

LLC ?

C Corporation ?

Answer 1

(a)
After Tax cash flow for LLC = $48708
After Tax cash flow for C Corporation = $48880

Computation of After tax Cash flow

Particulars	LLC	Basis	C Corporation	Basis
Pretax Earnings	$81200	$580000 X 14%	$81200	$580000 X 14%
Entity level tax rate	0%		21%
Entity level Tax	(0)	$81200 X 0%	($17052)	$81200 X 21%
Earnings after entity level tax	$81200	-	$64148	$81200-$17052
Deduction for 50% SE tax	($1087)	($81200 X 92.35%) X 2.9% X 50%	0	0
Net income taxable to owner	$80113	$81200- $1087	$64148	-
Income tax paid by owner	($29642)	$80113 X 37%	($12830)	$64148 X 20%
Self employment Tax	($2175)	($81200 X 92.35%) X 2.9%	-	-
Additional Medicare	($675)	($81200 X 92.35%) X 0.9%	-	-
Net investment Income tax	-	-	($2438)	$64148 X 3.8%
Total tax payable	($32492)	$29642 + $2175 + $675	($15268)	$12830 + $2438
After Tax Cash Flow	$48708	$81200 - $32492	$48880	$64148 - $15268

NOTES
1- Corporate tax nominal rate for C Corporation is 21% but it is not applicable to LLC taxed as Sole proprietorship.
2- LLC has to pay SE or self employment tax of 2.9% and additional 0.9% medicare tax on 92.35 % or 0.9235 of it's Pre tax Earnings [Because in case of employment, employer deducts 7.65% of salary for tax purposes. So as per IRS rules, SE tax will also be calculated on (100-7.65)% of 92.35% so that self employed individual get same tax treatment as if they were employed]
3- As per rules, A deduction of 50% is allowable on Self employment tax payments
4- Additional medicare is included along with SE tax on self employed individuals whereas Net investment Income tax is for C corporation charged on Net Taxable income
4- SE and additional medicare tax is not applicable on C Corporation, only on Self employed individuals
5- In case of LLP, we will not consider Deduction for Cash flow purpose as there is no Outflow of cash, so unlike C corporation, Total tax will be deducted from 'Pre tax earnings' and not from 'Net taxable income to owner'