Question

Derek would like to organize LFTS as either an LLC or as a corporation (taxed as a C corporation) generating a 12 percent annual before-tax return on a $300,000 investment. Assume the relevant (marginal) individual tax rate is 37% and corporate tax rate is 21%. Derek’s capital gain and dividends tax rate is 20% (ignore the net investment income surtax of 3.8% and the additional Medicare tax of 0.9%. LFTS will pay out its after-tax earnings every year to either its members or its shareholders.

a. Ignoring self-employment taxes, how much would Derek keep after taxes if LFTS is organized as either an LLC or a corporation (taxed as a C corporation)? (10 points)

b. Ignoring self-employment taxes, what are the overall tax rates (combined owner and entity level) if LFTS is organized as either an LLC or a corporation (taxed as a C corporation)? (10 points)

Answer 1

(a)

As C Corporation :

Annual before tax return = $300,000 x 12% = $36,000

Corporate tax @21% = $36,000 x 21% = $7,560

After tax return = $36,000 - $7,560 = $28,440

This amount will be paid as dividend to Derek

This Dividend is taxed at 20% = $28,440 x 20% = $5,688

Net Cashflow = $28,440 - $5,688 = $22,752

Derek would keep after taxes an amount of $22,752

As LLC : (Single person LLC - Pass through)

Nothing will be taxed in the hands of LLC

The total pre tax earnings of $36,000 will be taxed in individual hands = $36,000 x 37%

= $13,320

Derek would keep after taxes = $22,680 ($36,000 - $13,320)

(b)

Overal tax paid (C Corporation type) = $7,560 + $5,688 = $13,248

Overall tax rate (C Corporation type) = ($13,248/$36,000) x 100 = 36.8%

Overal tax paid (LLC type) = $13,320

Overal tax rate (LLC type) = ($13,320/$36,000) x 100 = 37%