Question

Frazzle Inc is a C Corporation owned 50/50 by sisters Jean and Marie. Corporate policy is to distribute all available cash to shareholders. Each shareholder is in the 35% marginal bracket and the corporation also pays a flat 21%. For the current year Frazzle earned $100,000.

a. Calculate the corporate level federal income tax.

b. Frazzle distributed the available cash to the shareholders (earnings less federal taxes) Calculate the shareholder’s federal tax.

c. What is the total tax paid in these earnings (corporate + shareholder)?

d. Assume instead that Frazzle had elected S status. Now what is the total tax paid on the same earnings?

e. Compare the effective tax rates of the two and comment.

f. State taxes were not considered. What would be the effect if the company and shareholders resided in a state with a 7% tax rate with no differentiation for dividend income.

Answer 1

a. corporate level federal income tax= EARNING*CORPORATE TAX RATE

I.E- 100000*21/100=21000

b.shareholder's federal tax= distributed earning* marginal tax rate

here,,

distributed earning=total earning-corporate tax

i.e, 100000-21000=79000

so, 79000*35/100= 27650/per shareholder

total tax= 27650*2=55300

c. Total tax paid= a+b

i.e 21000+55300=76300

d. in case of s corporation only marginal income tax has to be paid as it is small corporation as below:-

distributive earning-10000

share of a shareholder=100000/2=50000

tax=50000*35%=17500

thus total tax=17500*2=35000

e. effective tax rates

1. 76300/100000*100=76.3%

2. 35000/100000*100=35%

comment; s corp. always get benefit in tax as here it get benefit of (76.3-35)=41.3%

f