Nutt Corporation projects that it will have taxable income for the year of $537,

ID: 2523575 • Letter: N

Question

Nutt Corporation projects that it will have taxable income for the year of $537,000 before incurring any interest expense. Assume Nutt’s tax rate is 35 percent.

a. What is the amount of the overall tax (corporate level + shareholder level) on the $537,000 of pre-interest expense earnings if Hazel, Nutt’s sole shareholder, lends Nutt Corporation $63,000 at the beginning of the year, Nutt pays Hazel $10,200 of interest on the loan (interest is considered to be reasonable), and Nutt distributes all of its after-tax earnings to Hazel (ignore the net investment income tax)? Assume Hazel's ordinary marginal tax rate is 35 percent and her dividend tax rate is 15 percent.

b. Assume the same facts as in part (a) except that the IRS determines that the fair market value of the interest should be $8,600. What is the amount of the overall tax on Nutt Corporation’s pre-interest expense earnings (ignore the net investment income tax)?

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Alice, the sole shareholder of QLP, decided that she would purchase a building and then lease it to QLP. She leased the building to QLP for $4,500 per month. However, the IRS determined that the fair market value of the lease payment should be only $4,020 per month. How would the lease payment be treated with respect to both Alice and QLP?

Explanation / Answer

a.Reasonable interest

b.Unreasonable interest

Description

(1) Taxable income before interest

$537000

(2)Reasonable interest

10200

8600

(3) Taxable income

526800

528400

(1)-(2)

(4) Entity tax

184380

184940

(3)x35%

(5) After-tax entity earnings

342420

343460

(3)-(4)

(6) Hazel’s tax on dividends

51363

51519

(5)x 15%

(7) Hazel’s tax on interest

3570

3010

(2)x35%

(8) Double tax

239313

239469

(4)+(6)+(7)

Overall tax rate

44.56%

44.59%

(8)/(1)