Question

(3) Calculate the total tax paid by the company and shareholder with and without an imputation system, based on the following facts. (a) the company has one shareholder; (b) the company’s before tax profit is $5,000; (c) all after tax profit is distributed in full at the end of the income year; (d) company tax rate is 27.5%; (e) the shareholder marginal tax rate is 39% including a 2% Medicare levy.

Answer 1

With an imputation system

Income earned by the company = $5000

Tax rate for the company = 27.5%

Tax paid by the company = $5000 *27.5% = $1375

After tax net income = $5000 * $1375

= $3625

Thus $3625 is transferred as dividend to the sole shareholder and he also given a tax credit of $1375 under the imputation system.

Gross Income = $3625 + $1375 = $5000

Gross Tax liability of the shareholder = 39% * $5000

= $1950

Less: tax credit = $1375

Net Tax liability of the shareholder = $575

Thus total tax paid by the company and the shareholder = $1375 + $575 = $1950

Without an imputation system

Income earned by the company = $5000

Tax rate for the company = 27.5%

Tax paid by the company = $5000 *27.5% = $1375

After tax net income = $5000 * $1375

= $3625

Thus $3625 is transferred as dividend to the sole shareholder and no tax credit is allowed to the shareholder.

Thus Gross income of the shareholder = $3625

Tax rate = 39%

Tax liability = $3625*39% = 1413.75

Thus total tax paid by the company and the shareholder = $1375 + $1413.75 = $2788.75

However under the US taxation, qualified dividends are taxed at lower tax rate of 0% / 15% / 20%.

Corresponding to a marginal tax rate of 39%, tax rate on dividend would be 20%

Thus tax liability of the shareholder would be = $3625*20% = $725

Thus total tax paid by the company and the shareholder = $1375 + $725 = $2100.

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