Question

Tawana owns and operates a sole proprietorship and has a 37 percent marginal tax rate. She provides her son, Jonathon, $10,000 a year for college expenses. Jonathon works as a pizza delivery person every fall and has a marginal tax rate of 15 percent.

How much pretax income does it currently take Tawana to generate the $10,000 (after-taxes) given to Jonathon?

If Jonathon worked for his mother’s sole proprietorship, what salary would she have to pay him to generate $10,000 after taxes (ignoring any Social Security, Medicare, or self-employment tax issues)?

How much money would the strategy save?

Answer 1

Solution:

a. The following are the ways in which Tawana can reduce her family tax burden:

Tawana should make her son join sole proprietorship business which she is running. This will shift income taxed rate to 15% to 37%.

b. Calculation of pertax income:

given, Tawana has a 37% marginal tax rate. She spends $10000 a year for her son Jonathon college expenses.

After tax income = Pre tax income(1- Marginal tax rate)

$10000 = Pretax income(1- 0.37)

$10000 = Pretax incom(0.63)

Pretax income = $10000 / 0.63

= $15873

Therefore, the pertax income is $15873.

c. Calculation of Jonathon's salary

given, Jonathon works as a pizza delivery person where marginal tax rate is 15%

After tax income = pretax income(1-marginal tax rate)

$10000 = Pretax income(1-0.15)

$10000 = Pretax income 0.85

Pretax income = $10000/0.85

= $11764.70

Therefore, if Jonathon worked for tawana's sole proprietorship, she would have to pay Jonathon $11764.70 to generate $10000 after taxes.

d. Calculation of amount saved in the strategy:

it is calculated that pretax income is $15873, and Jonathons salary in soleproprietorship is $11764.70

Amount Saved = Pretaxincome - Jonathon salary

= $15873 - $11764.70

= $4108.30

Therefore, the strategy will save $4108.30

Calculation of amount saved in Jonathon salary

Tawana pays her son $11764.70, and Tawana has 37% marginal tax rate

Tax amount saved = Jonathon salaryMarginal tax rate

= $ 11764.7037%

= $11764.700.37

= $4353

Therefore, Tawana can save $4353 in taxes if Jonathon joins her business.

Calculation of Jonathons compensation on the tax:

It is calculated that Jonathon salary in sole proprietorship is $11764.70, and jonathon marginal tax rate is 15%.

Jonathon compensation on tax = SalaryMarginal tax rate

= $11764.7015%

= $11764.700.15

= $1764.70

Therefore, Jonathon compensation on tax is $1764.70.

Calculation of total savings:

Total savings = Amount saved in jonathon's salary - Jonathom's Compensation on tax

= $4353 - $1764.70

= $2588.30

Therefore, the total tax savings is $2588.30

Thank you.