Question

Amanda would like to organize BAL as either an LLC (taxed as a sole proprietorship) or a C corporation. In either form, the entity is expected to generate an 8 percent annual before-tax return on a $500,000 investment. Amanda’s marginal income tax rate is 37 percent, and her tax rate on dividends and capital gains is 23.8 percent (including the 3.8 percent net investment income tax). If Amanda organizes BAL as an LLC, she will be required to pay an additional 2.9 percent for self-employment tax and an additional 0.9 percent for the additional Medicare tax. Also, she is eligible to claim a full deduction for qualified business income on BAL’s income. Assume that BAL will distribute half of its after-tax earnings every year as a dividend if it is formed as a C corporation.

a. How much cash after taxes would Amanda receive from her investment in the first year if BAL is organized as either an LLC or a C corporation? (Round intermediate calculations and your final answers to the nearest whole dollar.)

LLC=_____

C corporation= ______

b. What is the overall tax rate on BAL’s income in the first year if BAL is organized as an LLC or as a C corporation? (Round intermediate calculations to the nearest whole dollar. Round your final answers to 2 decimal places.)

LLC= ___%

C corporation= ___%

Answer 1

Sollution:-A)

If Bal is organized as LLC
Annual return before taxes = $500,000 x 8% = $40,000
Marginal Income tax rate =37% Hence tax = $40,000 x 37% = $14,800
Self employment tax rate = 2.9% Hence self employment tax = $40,000 x 2.9% = $1,160
Medicare tax = 0.9% = $40,000 x 0.9% = $360
Total Taxes = $14,800+$1,160+$360 = $16,320
Hence after tax cash , Sandra will receive if business is LLC = $40,000 - $16,320 = $23,680

If BAL is organized as C Corp
C corps are taxed at 21% . Hence tax on income will be $40,000 x 21% = $8,400
In addition tax has to be paid at the individual level on the dividends received
Dividends received will be = $40,000 - $8,400 = $31,600
On the dividend,s tax at the the rate 23.8% has to be paid =$31,600 x 23.8% = $7,520.80
Total taxes paid = $8,400 + $7,520.8 = $15,920.8
Hence after tax cash , Sandra will receive if business if is a C corp = $40,000 - $15,920.8 = $24,079.2

Sollution:-B)

If BAL is LLC overall tax rate = Total taxes / Business Income
= $16,320/$40,000 x 100
= 40.8%
If BAL is a C Corp overall tax rate = Total taxes / Business Income
= $15,920.8/$40,000 x 100
= 39.80%

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