Company G, which has a 35 percent marginal tax rate, owns a controlling interest

Question

Company G, which has a 35 percent marginal tax rate, owns a controlling interest in Company J, which has a 15 percent marginal tax rate. Both companies perform engineering services. Company G is negotiating a contract to provide services for a client. Upon satisfactory completion of the services, the client will pay $104,000 cash.

Compute the after-tax cash from the contract assuming that Company G is the party to the contract and provides the services to the client.

Compute the after-tax cash from the contract assuming that Company J is the party to the contract and provides the services to the client.

Compute the after-tax cash from the contract assuming that Company J is the party to the contract, but Company G actually provides the services to the client.

Explanation / Answer

a) Cash Receipt After Tax = Cash Receipt - Tax on Cash Receipt

= $104000 - 35% of $104000

= $104000 - $36400

= $67600

b) Cash Receipt After Tax = Cash Receipt - Tax on Cash Receipt

= $104000 - 15% of $104000

= $104000 - $15600

= $88400

c) The $104000 income generated by the service contract must be taxed to company G

Because company G performed the services.

Therefore

Company G must pay $36400 tax (negative cash flow), even though company J receives the

$104000 Cash.

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