Question

Assume that the corporate tax rate is 25% and the personal tax rate is 22%. The founders of a newly formed business are debating between setting up the firm as a partnership versus a corporation. The firm will not need to retain any earnings, so all of its after-tax income will be paid out to its investors, who will have to pay personal taxes on whatever they receive. What is the difference in the percentage of the firm's pre-tax income that investors actually receive and can spend under the corporate and partnership forms of organization?

Answer 1

In case of corporation:

Investors net = Business pre-tax income * (1 - corporate tax rate) * (1 - personal tax rate)

Investors net = Business pre-tax income * (1 - 0.25) * (1 - 0.22)

Investors net = Business pre-tax income * 0.75 * 0.78

Investors net = Business pre-tax income * 58.50%

.

In case of partnership:

Investors net = Business pre-tax income * (1 - personal tax rate)

Investors net = Business pre-tax income * (1 - 0.22)

Investors net = Business pre-tax income * 78%

.

Difference = In case of partnership - In case of corporation

Difference = 78% - 58.50%

Difference = 19.50%