Question

Moana is a single taxpayer who operates a sole proprietorship. She expects her taxable income next year to be $250,000, of which $200,000 is attributed to her sole proprietorship. Moana is contemplating incorporating her sole proprietorship. (Use the tax rate schedule). a. Using the single individual tax brackets and the corporate tax rate of 21 percent, find out how much current tax this strategy could save Moana (ignore any Social Security, Medicare, or self-employment tax issues). (Round your intermediate calculations and final answer to nearest whole dollar amount.)

b. How much income should be left in the corporation?

Answer 1

a)First of all comparing the single individual and corporate tax rate to minimise the income tax. Moana has $50,000 of taxable income not related to her sole proprietorship, she is currently in the 22 percent tax bracket (22% of the excess over $38,700). The task is to allocate the $200,000 between Moana and her corporation to minimize her Income tax liability. The corporate tax rate is 21percent (taxable income < $50,000) and this is lower than Moana’s marginal tax rate of 22 percent. To take advantage of the 21 percent corporate tax bracket, $50,000 of the expected $200,000 in profits should be retained in the corporation.

b. Moana’s choice is to have income taxed at 21 percent (the corporation’s marginal tax rate) or 22 percent (Moana’s marginal tax rate). Assuming Moana prefers to receive the profits personally. the next $38,700 of the expected $200,000 in profits should be shifted to Moana.

$25,000 of the remaining $111300 of profits should be retained by the corporation, and the rest ($86,300) should be shifted to Moana.

In summary, $75,000 of the expected profits are retained in the corporation and $125,000 of the profits are shifted to Moan

note : useing tax rates of 2018