Question

Tawana owns and operates a sole propritorship and has a 40% marginal tax rate. She provides her son, Johnathon, $16,000 a year for college expenses. Johnathon works as a pizza delivery person every fall and has a marginal tax rate of 15%. If Johnathon worked for his mother's sole proprietorship, what salary would she have to pay him to generate the $16,000 after taxes (ignoring any social security, Medicare, or self-employment tax issues)? The strategy will save tawana how much pre tax and how much for the family after tax?

Answer 1

The best strategy to save Pre Tax and family after tax for Tawana will be:

Tawana marginal tax rate is 40% and 15% marginal tax rate will be applicable on her Son Johanathon 's Income

So, it's beneficial from tax saving prospective to engage as employee to her Son in her Sole proprietorship. So, Income will be shifted to her son and tax saving can be made by paying lower tax rate of 15% despite of paying 40%

If Jonathan works with Tawana then Tawan have to pay $ 18823.53.to generate $16000 after tax in the hand of Jonathan.

Pretax income need to be paid to Jonathan ( $16000/(1-0.15)= $18823.53

Marginal Tax on pre Tax income $18823 payable by Jonathan will be ($18823*15%) = $2823

Marginal Tax on pre Tax income $18823 payable by Tawana , if not following Strategy will be ($18823 *40%) $7529

Tax saving by following strategy will be ($7529-$2823)= $4706