Question

Mr. Pauper and Mrs. Queen are the equal shareholders in Corporation PQ. Both shareholders have a 37 percent marginal tax rate. PQ’s financial records show the following.

Gross income from sales of goods $ 1,031,000

Operating expenses (427,000 )

Interest paid on debt to Mr. P and Mrs. Q (79,000 )

Dividend distributions: Mr. Pauper (67,000 ) Mrs. Queen (67,000 )

Compute the combined tax cost for PQ, Mr. Pauper, and Mrs. Queen.

How would your computation change if the interest on the shareholder debt was $213,000 and PQ paid no dividends?

Answer 1

Answer:

Given :

• Marginal tax rate = 37%
• Gross income from sales of goods = $ 1,031,000
• Operating expenses = ( $ 427,000 )
• Interest paid on debt to Mr. P and Mrs. Q = ($ 79,000 )
• Dividend distributions: Mr. Pauper & Mrs. Queen = ($67,000 ) + ($ 67,000) = $ 1,34,000

i)Calculation of the combined tax cost for PQ

Description	Amount	Amount
Gross income from sales of goods		$ 1,031,000
Less: Operating expenses	( $ 427,000 )
Less: Interest paid on debt to Mr. P and Mrs. Q	($ 79,000 )
Corporation PQ's taxable income	$ 1,031,000 - $ 427,000 - $ 79,000 = $ 5,25,000	$ 5,25,000
Tax rate @ 21%	$ 5,25,000 * 21/100 = $ 5,25,000*0.21 = $ 1,10,250	$ 1,10,250
Therefore,Corporate tax		$ 1,10,250

Mr.pauper & mrs Queen's tax on interest = $ 79,000*37% = $ 29,230

Mr.pauper&mrs.Queen's tax on dividends=$1,34,000*20% = $26,800

Therefore, Total income tax cost =$ 1,10,250+$ 29,230+$26,800=$1,66,280

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ii)If the interest on shareholder debt was $213,000 and PQ paid no dividends:

Description	Amount	Amount
Gross income from sales of goods		$ 1,031,000
Less: Operating expenses	( $ 427,000 )
Less: Interest expense	( $ 2,13,000)
Corporation PQ's taxable income	$ 1,031,000-$ 427,000 -$ 2,13,000 =$ 3,91,000	$ 3,91,000
Tax rate @ 21%	$ 3,91,000*21% =$ 3,91,000*0.21 =$ 82,110	$ 82,110
Corporate tax		$ 82,110

Mr.pauper &mrs.Queens tax on interest = $ 2,13,000*37% = $ 78,810

Therefore,Total income tax cost = $ 82,110 + $ 78,810 = $ 1,60,920