Question

Bob Loblaw and Wayne Jarvis get together to form a new corporation. They each own 50% of the stock. Neither is employed by the corporation. In the first year of operation, the corporation generates $1 million of taxable income and pays $100,000 in dividends ($50,000 each to Bob and Wayne). Assuming a 21% corporate tax rate and a 35% personal tax rate, how much corporate and personal tax will be paid?
Corporate tax:
Bob and Wayne each pay tax:

Same as the above but now assume that instead of a corporation they form a partnership. Instead of receiving dividends, Bob and Wayne each withdraws $50,000 from the partnership (also known as a "draw"). Assume they do not qualify for the Sec. 199A deduction for qualified business income.
Partnership tax:
​​​​​​​Bob and Wayne each pay tax:

Answer 1

Case 1: Bob and Wayne form a corporation

This becomes a case of double taxation, where the corporation pays a corporate tax on the taxable income and the individual pays a personal tax on the dividends received. This is because the taxable income is calculated prior to giving out dividends.

In this case, Taxable Income = 1,000,000$

So, Corporate Tax = 21% x 1,000,000 $ = 210,000 $

Bob and Wayne each pay tax = 35% x 100,000$ = 35,000 $

Case 2: Bob and Wayne form a Partnership

As we all know, The Corporate Tax for a Partnership Firm is not calculated as the owners pay tax on the all income from the entity.

So, Corporate Tax = 0 $

Now, we are considering the case of a partnership so, all the taxable income (profits) goes to the partners. Please note, when we are calculating personal tax on the partner's income we take in to account only the allocated profit i.e. even if Bob & Wayne decide to draw only 10% of their share of profits, their personal tax will be calculated only on their allocated share of profits. Draw is only subtracted from the Owner's equity after adjusting profits for the year.

So, in this case Bob and Wayne each pay tax = 35% x 1,000,000$ = 350,000$