Question

Amanda would like to organize BAL as either an LLC (taxed as a sole proprietorship) or a C corporation. In either form, the entity is expected to generate an 8 percent annual before-tax return on a $500,000 investment. Amanda’s marginal income tax rate is 37 percent and her tax rate on dividends and capital gains is 23.8 percent (including the 3.8 percent net investment income tax). If Amanda organizes BAL as an LLC, she will be required to pay an additional 2.9 percent for self-employment tax and an additional 0.9 percent for the additional Medicare tax. Also, she is eligible to claim a full deduction for qualified business income on BAL’s income. Assume that BAL will distribute half of its after-tax earnings every year as a dividend if it is formed as a C corporation. (Round your intermediate computations to the nearest whole dollar amount.)

How much cash after taxes would Amanda receive from her investment in the first year if BAL is organised as either an LLC or a C corporation ?

After-tax cash flow for LLC ;

C corporation ?

Answer 1

a)

	LLC	Description	C Corp.	Description
(1) Pretax earnings	$40,000	8% × $500,000	$40,000	8% × $500,000
(2) Entity level tax rate	0%		21%	(1) × 21%
(3) Entity level tax	-0-		8,400	(1) – (2)
(4) Earnings after-entity-level tax	$40,000	(1) – (3)	$31,600	(1) – (3)
(5) QBI deduction	(8,000)	(4) × 20%	NA
(6) Deduction for 50 percent of SE tax	(536)	(1) × .9235 × .029 × .5	NA
(7) Net income taxable to owner	31,464	(4) + (5) + (6)	15,800	(4) × 50% distributed as dividend
(8) Income tax paid by owner	11,642	(7) × .37	3,160	(7) × .20
(9) Self-employment tax	1,071	(1) × .9235 × .029	NA
(10) Additional Medicare tax/Net investment income tax	332	(1) × .9235 × .009 additional Medicare tax	600	(7) × .038 net investment income tax
(11) Owner-level tax	$13,045	(8) + (9) + (10)	$3,760	(8) + (10)
After-tax cash flow	$26,955	(1) – (11)	$12,040	(7) – (11)