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.

Answer 1

SOLUTION

a)

	S Corp.	Description	C Corp.	Description
(1) Pretax earnings	$90,000	9% × $1,000,000	$90,000	9% × $1,000,000
(2) Entity level tax rate	0%		21%	(1) × 21%
(3) Entity level tax	-0-		18,900	(1) – (2)
(4) Earnings after-entity-level tax	$90,000	(1) – (3)	$71,100	(1) – (3)
(5) QBI deduction	18,000	(4) × 20%	NA
(6) Net income taxable to owner	72,000	(4) - (5)	71,100	(4) distributed as dividend
(7) Owner level marginal tax rate	37%		23.8%	20% div. + 3.8% net investment income tax
(8) Owner-level tax	$26,640	(6) × (7)	$16,922
After-tax cash flow	$63,360	(1) – (8)	$54,178	(6) – (8)

b)

	LLC		Corp.
Overall tax rate	29.6%	(8)/(1)	39.8%	[(3) + (8)]/(1)

c)

37 percent. If the income is not qualified business income, the full amount of income will be taxed at 37%.

d)

40.8 percent (37 percent + 3.8 percent net investment income tax)