Question

Sandra would like to organize LAB as either an LLC (taxed as a sole proprietorship) or a C corporation. In either form, the entity is expected to generate an 8 percent annual before-tax return on a $520,000 investment. Sandra’s marginal income tax rate is 37 percent, and her tax rate on dividends and capital gains is 23.8 percent (including the 3.8 percent net investment income tax). If Sandra organizes LAB as an LLC, she will be required to pay an additional 2.9 percent for self-employment tax and an additional 0.9 percent for the additional Medicare tax. LAB’s income is not qualified business income (QBI) so Sandra is not allowed to claim the QBI deduction. Assume that LAB will distribute all of its after-tax earnings every year as a dividend if it is formed as a C corporation. (Round your intermediate computations to the nearest whole dollar amount.)

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

b. What is the overall tax rate on LAB’s income in the first year if LAB is organized as an LLC or as a C corporation? (Round your final answers to 2 decimal places.)

Answer 1

Answer:

a) Cash after taxes if

BAL is listed as LLC =$24,627.2

BAL is organized as C corporation =$25,042.40

.

b) Overall tax rate if

BAL is listed as LLC = 40.80%

BAL is organized as a C corporation = 39.80%

.

Explanation:

a) If BAL is organized as a LLC

annual pretax earnings = $520,000 x 8% = $41,600

income tax = (41,600 x 37%) + (41,600 x 2.9%) + (41,600 x 0.9%)

= 15,392 + 1,206.40 + 374..4

= $16,972.80

cash after tax = $41,600 - $16,972.80

= $24,627.2

.

If BAL is organized as a C corporation

annual pretax earnings = $500,000 x 8% = $41,600

income tax on company earnings = $41,600 x 21% (corporation tax rate) = $8,736

income after tax = $41,600 - $8,736 = $32,864

dividend received =$32,864

tax on dividends = $32,864 x 23.8% = $7,821.63

cash after tax = $32864 - $7,821.63

=$25,042.40

.

b) Overall tax rate if

BAL is organized as a LLC

= income tax / pretax income x 100%

= $16,972.80 / 41,600 x 100%

= 40.80%

.

BAL if organized as a C corporation

= (corporation tax + dividend tax) / pretax income x 100%

= ($8,736 + $7,821.63) / 41,600 x 100%

= 16,557.63 / 41,600 x 100%

= 39.80%