Question

Ms. Mills recently started a new business venture and must decide whether to operate as an LLC or incorporate (as a C corporation). She projects that the business will generate $100,000 of cash flow and pretax ordinary business income per year. Ms. Mills’ ordinary income tax rate is 25% and her dividend tax rate is 15%. The corporate tax rate is 21%. Ignore self-employment/payroll tax and the QBI deduction.

a. Compare the combined (business entity + individual) after-tax cash flow between the LLC and C corporation scenarios assuming Ms. Mills plans to distribute all post-tax profits from the business at the end of each year.

b. Compare the combined after-tax cash flow between the LLC and C corporation scenarios assuming Ms. Mills plans to pay herself a $40,000 salary in the C corporation scenario, and then distribute all post-tax profits from the business at the end of each year.

c. Now imagine that Ms. Mills plans to keep all cash flow in the business for reinvestment (i.e., she will make no withdrawals and pay no dividends from the business). Compare the after-tax cash flow available for reinvestment if Ms. Mills operates the business as an LLC compared to a C corporation.

Answer 1

Given, Ms. Mills Started a new business venture, It generates $100,000 of cashflows, pretax ordinary income per year. Mills Ordinary Income Tax rate is 25%. Dividend Tax Rtae is 15%. Corporate Tax rate is 21%.

Limited Liability Company: For Income tax purposes Limited Liability Company (LLC) is treated as a sole proprietory ship or partnership firms under IRS.It mean the LLC does not required to file any tax returns and does not required to pay any taxes.The profits or losses or transferred to the members and the members are liable to pay the taxes.Even if the company does not share the profits and retains the profits to invests in the company, they are liable to pay the taxes on their profit share.

C Corporation: C Corporation has a double taxation effecte.The profits of the C Corporation are taxed first and after tax profit are distributed to the members as dividends which are liable for taxation by the members. If the dividends are not distributed to the members, they need not pay the tax on the dividends which are not distributed thus avoiding double taxation.

a. Compare the combined (business entity + individual) after-tax cash flow between the LLC and C corporation scenarios assuming Ms. Mills plans to distribute all post-tax profits from the business at the end of each year.

Here the LLC is formed by Ms. MIlls and is treated as Single owner LLC where the LLC is not liable for taxation while the owner is liable for taxation.

Particulars	LLC	C Corporation
Cash Flows	$100,000	$100,000
Tax Rate to be paid by LLC / C Corp	0%	21%
Tax amount to be paid by LLC / C Corp	$0	$21,000
Cash Flows after taxed by LLC / C Corp and distributed to member	$100,000	$79,000
Tax rate to be paid by Mills	25%	15% on dividends
Tax Amount to be paid by Mills	$25,000 ($100,000 * 25%)	$11,850 ($79,000 * 15%)
After Tax Cash Flows to Mills	$75,000 ($100,000 - $25,000)	$67,150 ($79,000 - $11,850)

After Tax cash flows for Millls From LLC is $75,000 and from C Corporation is $67,500 after double taxation effect.

b. Compare the combined after-tax cash flow between the LLC and C corporation scenarios assuming Ms. Mills plans to pay herself a $40,000 salary in the C corporation scenario, and then distribute all post-tax profits from the business at the end of each year

Particulars	LLC	C Corporation
Cash Flows	$100,000	$100,000
Salary to Mills	$40,000	$40,000
Cash flows after Salary	$60,000	$60,000
Tax Rate to be paid by LLC / C Corp	0%	21%
Tax amount to be paid by LLC / C Corp	$0	$12,600
Cash Flows after taxed by LLC / C Corp and distributed to member	$60,000	$47,400
Tax rate to be paid by Mills	25%	25% on Salary and 15% on Dividens
Tax Amount to be paid by Mills	$25,000 ([$60,000+$40,000] * 25%)	$17,110 [($47,400 * 15%) + ($40,000 * 25%
After Tax Cash Flows to Mills from business	$75,000 ($100,000 - $25,000)	$70,290 [($47,400 - $7,100) + ($40,000 - $10,000)]

After Tax cash flows to Mills from LLC is $75,000 and from C Corp is $70,290

c. Now imagine that Ms. Mills plans to keep all cash flow in the business for reinvestment (i.e., she will make no withdrawals and pay no dividends from the business). Compare the after-tax cash flow available for reinvestment if Ms. Mills operates the business as an LLC compared to a C corporation.

For limited liability company, even if the company does not share the profits and retains the profits to invests in the company, they are liable to pay the taxes on their profit share.

If the dividends are not distributed to the members, they need not pay the tax on the dividends which are not distributed thus avoiding double taxation.

Particulars	LLC	C Corporation
Cash Flows	$100,000	$100,000
Tax Rate to be paid by LLC / C Corp	0%	21%
Tax amount to be paid by LLC / C Corp	$0	$21,000
Cash Flows after taxed by LLC / C Corp and distributed to member	$100,000	$79,000
Tax rate to be paid by Mills	25%	0%
Tax Amount to be paid by Mills	$25,000 ($100,000 * 25%)	$0
After Tax Cash Flows to Mills	$75,000 ($100,000 - $25,000)	$79,000

After tax cash flows to Mills from LLC is $75,000 less while C Corp is $79,000 is more because the dividend tax need not to be paid by the members of c corp if the dividend is not actually distributed.