Question

Problem 17-32 (LO. 3, 7)

Benton Company (BC), a calendar year entity, has one owner, who is in the 37% Federal income tax bracket (any net capital gains or dividends would be taxed at a 20% rate). BC's gross income is $395,000, and its ordinary trade or business deductions are $245,000. Ignore the standard deduction (or itemized deductions) and the deduction for qualified business income.

If required, round computations to the nearest dollar.

a. BC is operated as a proprietorship, and the owner withdraws $100,000 for personal use.

BC's taxable income for the current year is
$, and the tax liability associated with the income from the sole proprietorship is $.

b. BC is operated as a C corporation, pays out $100,000 as salary but no dividends to its shareholder.

BC's taxable income for the current year is $, and BC's tax liability is $. The shareholder's tax liability is $.

c. BC is operated as a C corporation and pays out no salary or dividends to its shareholder. BC's taxable income for the current year is
$, and BC's tax liability is $.

d. BC is operated as a C corporation, pays out $100,000 as salary to its shareholder, and pays out the remainder of its earnings as dividends to its shareholder. BC's taxable income for the current year is $, and BC's tax liability is $. The shareholder's tax liability is $.

e. Assume that Robert Benton of 1121 Monroe Street, Ironton, OH 45638 is the owner of BC, which was operated as a proprietorship. Robert is thinking about incorporating the business for next year and asks your advice. He expects about the same amounts of income and expenses and plans to take $100,000 per year out of the company whether he incorporates or not.

Complete the letter to Robert containing your recommendations. [Based on your analysis in (a), BC is operated as a proprietorship, and the owner withdraws $100,000 for personal use, and in (b), BC is operated as a corporation, pays out $100,000 as salary, and pays no dividends to its shareholder.]

Maloney, Raabe, Young, Nellen, & Hoffman, CPAs 5191 Natorp Boulevard Mason, OH 45040
December 3, 2019
Mr. Robert Benton
1121 Monroe Street
Ironton, OH 45638
Dear Mr. Benton:
This letter is in response to your inquiry as to the tax effects of incorporating your business in 2019. I have analyzed the tax results under both assumptions, proprietorship and corporation. I cannot give you a recommendation until we discuss the matter further and you provide me with some additional information. My analysis based on information you have given me to date is presented below.
Computation 1 Total tax on $150,000 if you continue as a proprietorship $ Total tax if you incorporate: Individual tax on $100,000 salary $ Corporate tax on taxable income $ Total $
Although this analysis appears to favor  , it is important to consider that there   be additional tax on the $ of income left in the corporation if you withdraw that amount as a dividend in the future, as calculated below.
Computation 2 After-tax income left in corporation $ Tax on after-tax income $ Total tax paid if you incorporate $
Comparison of computations 1 and 2 appears   incorporating. If you incorporate and recover the income left in the corporation as long-term capital gain from a sale of stock in the future, the total tax cost of incorporating will be the same, as shown in computation 3 below.
Computation 3 After-tax income left in corporation $ Tax on after-tax income $ Total tax paid if you incorporate $
In summary,   appears to be the more attractive option. However, there are important nontax considerations with respect to this decision. We can discuss those issues at our next meeting.
Thank you for consulting my firm on this important decision. We are pleased to provide analyses that will help you make the right choice.
Sincerely,
Jon Thomas, CPA

Answer 1

Part A

Gross income	395000
Ordinary deductions	(245000)
Taxable income	150000
Tax rate	37%
Tax	$55500

Withdrawal of $100,000 for personal use does not affect the income tax

Part B

Gross income	395000
Ordinary deductions	(245000)
Salary	(100000)
Taxable income	50000
Tax rate	21%
Tax	$10500

Part C

Gross income	395000
Ordinary deductions	(245000)
Taxable income	150000
Tax rate	21%
Tax	$31500

Part D

Gross income	395000
Ordinary deductions	(245000)
Salary	(100000)
Taxable income	50000
Tax rate	21%
Corporate Tax	$10500
Gross income for shareholder
On salary (100000*37%)	37000
On dividend (50000-10500)*20%	7900
Total gross income for shareholder	44900
Total tax	$55400

Part E

Mr. Robert Benton,

1121 Monroe Street

Ironton, OH 45638

Dear Mr. Benton,

The main purpose of writing this letter to offer you recommendations resolving your concern regarding tax effects associated with your business incorporation. The tax effects are presented below in detail for both options, proprietorship and corporation.

If continued as proprietorship

Gross income	395000
Ordinary deductions	(245000)
Taxable income	150000
Tax rate	37%
Tax	$55500

If it is a corporation

Gross income	395000
Ordinary deductions	(245000)
Salary	(100000)
Taxable income	50000
Tax rate	21%
Corporate Tax	$10500
Gross income for shareholder
On salary (100000*37%)	37000
On dividend (50000-10500)*20%	7900
Total gross income for shareholder	44900
Total tax	$55400

The detail calculation and analysis presents that even after considering tax on dividend, the total tax of incorporation is less than the proprietorship.

In case of any further queries or doubts, feel free to contact.

Sincerely,