Question

A corporation or partnership, in 2017, had pre-tax earnings that were half of the previous year earnings of $200,000 and the corporation was subject to a 35% income tax rate and an investor is subject to a 35% personal tax rate and a 10% capital gains tax rate, then what is the advantage to being a partnership (compared to a corporation) if all of the proceeds are paid out to investors in either legal form?

$6,250

$6,300

$6,000

$6,500

Answer 1

Let us first list down the information provided in the question:

Previous year earnings - $ 200,000

Earnings for FY2017 - 50% of previous year earnings i.e. 50% of $ 200,000 = $ 100,000

Tax rate on Corporation - 35%

Personal Tax rate on investor - 35% and Capital gain tax rate - 10%.

Now let us solve the above question:

If its a corporation and 100% profits are distributed, than it will be treated as distribution in the nature of capital gain and will be subject to 10% taxation in the hands of investors/shareholders.

Calculation of Profit after tax in the hands of Corporation:

Earnings for the current year = $ 100,000

Less: Corporate Tax rate @ 35% = $ 35,000

Earnings after Tax for Corporation = $ 65,000

Calculation of Net income in the hands of inventors/shareholders:

Proceeds received from Corporation = $ 65,000

Less: Capital gain tax @ 10% = $ 6,500

Net Income in the hands of investors/shareholders = $ 58,500

If its a partnership firm and 100% profits are distributed, than no taxes will be paid by partnership firm and entire earnings will be subject to 35% taxation in the hands of investors/partners.

Calculation of Profit after tax in the hands of Partnership Firm:

Earnings for the current year = $ 100,000

Earnings distributed to investors/ partners = $ 100,000

Calculation of Net income in the hands of inventors/ Partners:

Proceeds received from Partnership firm = $ 100,000

Less: Personal Tax @ 35% = $ 35,000

Net Income in the hands of investors = $ 65,000

Net advantage to investors if entire earnings are paid in form of partnership firm instead of corporation = Net income in hands of investors in case of partnership firm - Net income in hands of investors in case of Corporation

= $65,000 - $58,500

= $6,500

Conclusion: Hence, the correct answer is $6,500

Trust the same will serve your purpose.

Should you need any clarifications, please feel free to comment.