Question

Assuming Orie and Jane’s goal is to minimize their current federal income tax exposure, one can compare the married filing joint and corporate tax rates to achieve this goal. Since Orie and Jane have $200,000 of taxable income not related to their sole proprietorship, they are currently in the 24 percent tax bracket. The task is to allocate the $250,000 between Orie and Jane and their corporation to minimize their current liability. The corporate tax rate is 21 percent and is lower than Orie and Jane’s marginal tax rate of 24 percent. To take advantage of the 21 percent corporate tax rate, all of the expected $250,000 in profits should be retained in the corporation. Any income shifted to Orie and Jane would be taxed at a rate higher than the corporate tax rate of 21 percent.

Answer 1

The tax rate for the married couple is the following:

$0 – $19,050 - 10 %

$19,051 – $77,400 - 12 %

$77,401 – $165,000 - 22 %

$165,001 – $315,000 - 24 %

Corporations have a flat rate of 21% from 2018.

In this case, the best choice is to allocate $75,000 to Orie and June which will be taxed at 12 %, very less than corporations flat 21 % rate. Remaining $175,000 should be allocated to Corporation.

Let's evaluate our options.

1. Allocate all $250,000 to the corporation.

Corporate tax for $250,000 at 21 % would be $52,500

2. Allocate $75,000 to Orie and Jane and remaining $175,000 to the corporation.

Married couple tax on $75,000:- Tax on the first $19,050 at 10 % = $1,905

Tax on the remaining $55,950 at 12 % = $6,714

Total tax on $75,000 = $8,619

Corporate tax on remaining $175,000 at 21 % would be = $36,750

Total tax on $ 250,000 = $45,369

Method avoids a tax liability $7131 ($52,500 - $45,369)