3-A. Marsha is ready to start a business that will generate about 150k of earnin

Question

3-A.

Marsha is ready to start a business that will generate about 150k of earnings each year. Marsha will work full time for the business. Her plan is to withdraw 100k of earnings from the biz each year. She will leave the remaining earnings in the business to retire debt and fund future needs of the business. Marsha wants to minimize the overall tax bite on these earnings. What will be the total entity and personal tax cost under each of the following scenarios, assuming Marsha’s ordinary income tax rate is 25%, her dividend rate is 15%, and the applicable self-employment/payroll tax rate is 15.3%? Ignore all state income tax consequences.

1. Marsha’s business is a C-Corp that distributes Marsha a $100,000 dividend each year.

2. Marsha’s business is a C-Corp that pays Marsha a salary of $100,000 each year for services she renders to the corporation.

3. Marsha’s business is an S-Corp that pays Marsha a $40,000 salary each year and distributes a $60,000 dividend to her each year.

4. Marsha’s business is a LLC that is taxed as a partnership. Marsha owns 90% of the business, and Joe, an investor who does not work in the business, owns the remaining 10%. The LLC distributes $90,000 to Marsha each year and $10,000 to Joe. Assume Joe’s marginal tax rate is also 25%.

Explanation / Answer

computation of total entity and personal tax cost

1) Total gross income= 250,000

less: dividend deduction               85,000

Gross adjusted income=              165,000

Tax paid=                                        41,250

Net income=                                 123,750

2) Total gross income= 250,000

Less: self employment tax=          38,250

Gross adjusted income                211,750

Tax paid=            52,937.5                             

Net income=                                 158,812.5

3) Total gross income= 250,000

less: dividend deduction               51,000

Gross adjusted income=              199,000

Less: self employment tax=          30,447

Gross taxable income=                168,553

Tax paid=                                       42,138.25

Net income=                                 126,414.75

4. Total gross income= 240,000

Less: self employment tax=          36,720

Gross adjusted income=              203,280

Tax paid=                                        50,820

Net income=                                 152,460

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