Question

ACC312 Federal Taxation

Mrs. Franklin, who is in the 39.6 percent tax bracket, owns a residential apartment building that generates $80,000 annual taxable income. She plans to create a family partnership by giving each of her two children a 20 percent equity interest in the building. (She will retain a 60 percent interest.) Mrs Franklin will manage the building, and value of her services is $15,000 per year. If Mrs. Franklin's children are in the 15 percent tax bracket, compute the tax savings from this income-shifting arrangement. (Ignore any payroll tax consequences.)

Answer 1

Current Situation- Mrs Franklin holding 100%:-

Annual taxable income = $80,000

Mrs Franklin’s Tax Rate = 39.6%

Mrs Franklin’s Share = 100% (thus, total tax is to be borne by Mrs Franklin)

Thus, total tax payable = $80000*39.6/100 = $31,680……………….(A)

Revised Situation – Family Partnership:-

Annual taxable income = $80,000

Mrs Franklin’s Share = 60%

2 Children’s share = 20% each

Thus, Mrs Franklins share in Annual taxable income = $80,000*60/100 = $48,000

Mrs Franklin’s Tax Rate = 39.6%

Thus, tax payable by Mrs Franklin = $48,000*39.6/100 = $19,008……………….(i)

2 Children’s share in annual taxable income = $80,000*20/100 = $16,000 each

Children’s Tax rate = 15%

Thus, Tax payable by each child = $16,000*15/100 = $2,400…………………(ii)

Thus, total tax to be paid by both child = (ii) *2 = $2,400 *2 = $4,800………..(iii)

Thus, total tax to be paid = (i) + (iii) = $19,008 + $4,800 = $23,008………………..(B)

Thus, tax saving as per revised arrangement:-

(A) – (B) = $31,680 - $23,008 = $7,872

(No payroll transactions has been taken into consideration as given in question)