Question

Andrea would like to organize SHO as either an LLC (taxed as a sole proprietorship) or a C corporation. In either form, the entity is expected to generate an 11 percent annual before-tax return on a $200,000 investment. Andrea's marginal income tax rate is 35 percent and her tax rate on dividends and capital gains is 15 percent. Andrea will also pay a 3.8 percent net investment income tax on dividends and capital gains she recognizes. If Andrea organizes SHO as an LLC, Andrea will be required to pay an additional 2.9 percent for self-employment tax and an addition 0.9 percent for the additional Medicare tax. Further, she is eligible to claim the full deduction for qualified business income. Assume that SHO will pay out all of its after-tax earnings every year as a dividend if it is formed as a C corporation.  

a). How much cash after taxes would Andrea receive from her investment in the first year if SHO is organized as either an LLC or a C corporation?

LLC---after tax cash flow?

C Corporation--after cash flow?

Answer 1

COMPUTATION OF CASH FLOWS AFTER TAX

LLC

PARTICULARS	CALCULATION	$	$
EXPECTED RETURN ON INVESTMENT	($200000 * 11%)		22000
TAXABLE BUSINESS INCOME (AFTER DEDUCTION FOR QUALIFIED BUSINESS INCOME @ 20%)	($22000 * (100 -20)%)	17600
LESS: MARGINAL TAX @ 35%	($17600 * 35%)	6160
SELF-EMPLOYMENT TAX @ 2.9%	($17600 * 2.9%)	510.4
MEDICARE TAX @ 0.9%	($17600 * 0.9%)	158.4	6828.8
CASH FLOWS AFTER TAX			15171.2

WORKING NOTE:

TAXES WILL BE CALCULATED ON THE AMOUNT AFTER ADJUSTING FOR DEDUCTIONS.

QUALIFIED BUSINESS INCOME DEDUCTION IS 20%

COMPUTATION OF CASH FLOWS AFTER TAX

C CORPORATION

PARTICULARS	CALCULATION	$	$
EXPECTED RETURN ON INVESTMENT	($200000 * 11%)		22000
LESS: MARGINAL TAX @ 35%	($22000 * 35%)		7700
DIVIDENDS AND CAPITAL GAINS			14300
LESS: DIVIDEND TAX @ 15%	($14300 * 15%)	2145
ADDITIONAL DIVIDEND TAX @ 3.8%	($14300 * 3.8%)	543.4	2688.4
CASH FLOWS AFTER TAX			11611.6