Question

Andrea would like to organize SHO as either an LLC (taxed as a sole proprietorship) or a C corporation. In either form, the entity is expected to generate an 11 percent annual before-tax return on a $200,000 investment. Andrea’s marginal income tax rate is 35 percent and her tax rate on dividends and capital gains is 15 percent. Andrea will also pay a 3.8 percent net investment income tax on dividends and capital gains she recognizes. If Andrea organizes SHO as an LLC, Andrea 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. Further, she is eligible to claim the full deduction for qualified business income. Assume that SHO will pay out all 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 Andrea receive from her investment in the first year if SHO is organized as either an LLC or a C corporation?

b. What is the overall tax rate on SHO’s income in the first year if SHO is organized as an LLC or as a C corporation?

Answer 1

Solution: Net Income before tax= $200,000"11% -$22,000 Now there are two alternatives for Andrea to organize SHO as either an LLC (taxed as sole proprietorship) or a C corporation (i) Ifit is LLC Net income before tax (-) Deduction for qualified business Income (20%) -22,000 (4400) 1 7600 -6160 -510 Taxon income @ 35% Self employment @2.9% Additional Medicare tax @ 0.9% Total tax Therefore cash after tax 158 -6828 = 22000-6828 $15172 Net Income Taxon Income @21% After tax earning This will be distributed as dividends. Tax on dividends @ 15% Net investment tax @ 3.8% -22,000 -4620 -17380 2607 -660 3267 -17380-3267 -$14113 Therefore cash after taxes would be For C corps flat Rate of tax is 21% from 2018.