Question

ssume that the corporate tax rate is 28% and the personal tax rate is 35%. The founders of a newly formed business are debating between setting up the firm as a partnership versus a corporation. The firm will not need to retain any earnings, so all of its after-tax income will be paid out to its investors, who will have to pay personal taxes on whatever they receive. What is the difference in the percentage of the firm's pre-tax income that investors actually receive and can spend under the corporate and partnership forms of organization? (Enter your answer expressed as a percentage and rounded to one decimal point. E.g., if the calculated solution is 10.53%, enter 10.5 as your answer.)

Answer 1

Solution -

Corporate tax rate - 28%

Personal tax rate -35%

In corporate ,

Corporate net income = Business pre tax income (1-corporate tax)

Investors net income = corporate net income (1- personal tax )

Therefore,

Investors net income =Business pre tax income (1-corporate tax) (1-personal tax)

Investors net income = Business pre tax income (1-0.28)*(1-0.35)

= Business pre tax income *72%*65%= 46.80%

In partnership ,

Investors net income = Business pre tax income *(1-personal tax)

Investors net income = Business pre tax income *(1-0.35)

= Business pre tax income *65%=65%

Difference in the percentage of firm pre tax income = 65%-46.80%= 18.2%