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.
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?
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?
Part A
|
S Corp. |
Description |
C corp. |
Description |
||
|
1. |
Pretax earnings |
90000 |
(1000000*9%) |
90000 |
(1000000*9%) |
|
2. |
Entity level tax rate |
0% |
21% |
||
|
3. |
Entity level tax |
0 |
18900 |
(1) × (2) |
|
|
4. |
Earnings after-entity-level tax |
90000 |
(1) – (3) |
71100 |
(1) – (3) |
|
5. |
QBI Deduction |
(18000) |
(1) × 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) × (7) |
16922 |
(6) × (7) |
|
After-tax cash flow |
63360 |
(1) – (8) |
54178 |
(6) – (8) |
Part B
|
8 |
Owner-level tax |
26640 |
(6) × (7) |
16922 |
(6) × (7) |
|
After-tax cash flow |
63360 |
(1) – (8) |
54178 |
(6) – (8) |
|
|
Overall tax rate |
29.60% |
(8)/(1) |
39.80% |
[(3) + (10)]/(1) |
Part C
|
overall tax rate |
37% |
If UTA’s income is not qualified business income, then the total income will be taxed at 37%.
Part D
|
overall tax rate |
40.8% |
Overall tax = 37%+ 3.8% net investment income tax = 40.8%
Tremaine would like to organize UTA as either an S Corporation or a C corporation. In...
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...
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