Question

Orie and Jane, husband and wife, operate a sole proprietorship. They expect their taxable income next year to be $450,000, of which $250,000 is attributed to the sole proprietorship. Orie and Jane are contemplating incorporating their sole proprietorship. (Use the 2018 tax rate schedule). a. Using the married-joint tax brackets and the corporate tax rate of 21 percent, find out how much current tax this strategy could save Orie and Jane. b. How much income should be left in the corporation?

Answer 1

a

Tax payable on $450,000 if they does not incorporate the sole proprietorship and file joint is 108,879.

If they incorporate sole proprietorship and shift $250,000 to it, on balance $200,000 taxable income they pay $36,579 on their individual return and on $250,000 business income at 21% tax payable is $52,500. Thus, total tax payable is $89,079.

By shifting $250,000 income to corporate, they are saving $19,800 in taxes.

b

Their marginal tax rate is 22% once their income crosses $77,400. It is beneficial if they keep $77,400 taxable in their hands and the balance $372,600 in the hands of the corporate at 21%.