Question

Sandra would like to organize LAB as either an LLC (taxed as a sole proprietorship) or a C corporation. In either form, the entity is expected to generate an 9 percent annual before-tax return on a $710,000 investment. Sandraâs marginal income tax rate is 37 percent, and her tax rate on dividends and capital gains is 23.8 percent (including the 3.8 percent net investment income tax). If Sandra organizes LAB as an LLC, she will be required to pay an additional 2.9 percent for self-employment tax and an additional 0.9 percent for the additional Medicare tax. LABâs income is not qualified business income (QBI) so Sandra is not allowed to claim the QBI deduction. Assume that LAB will distribute all of its after-tax earnings every year as a dividend if it is formed as a C corporation. (Round your intermediate computations to the nearest whole dollar amount.)

Required:
a. How much cash after taxes would Sandra receive from her investment in the first year if BAL is organized as either an LLC or a C corporation?
b. What is the overall tax rate on BALâs income in the first year if BAL is organized as an LLC or as a C corporation?

Answer 1

Answer:

Sandra

LAB LLC (taxed as a sole proprietorship)

Annual Income = $63,900

Additional self-employment tax (2.9%) = $1,853 (2.9% * $63,900)

Additional Medicare tax (0.9%) = $575

FICA Tax rate (7.65%) = $4,888

After-tax income $56,584

Tax expense = $7,316 ($63,900 - $56,584)

LAB (taxed as a C corporation)

After-tax income = $40,257 ($63,900 - $23,643)

Dividends and capital gains = $8,051.40 (20% excluding the 3.8%)

Income after dividends and capital gains $32,206

Tax expense = $31,694 ($63,900 - 32,206)

b. Overall tax rate on BAL's income:

1. Organized as an LLC

$7,316/$63,900 * 100

= 11.45%

2. Organized as a C Corporation:

$31,694/$63,900 * 100

= 49.6%

Explanation:

a) Data and Calculations:

Expected annual before-tax return = 9%

Investment = $710,000

The annual return = $63,900 ($710,000 * 9%)

Marginal income tax rate = 37%

Income tax expense = $23,643 ($63,900 * 37%)

After-tax income = $40,257 ($63,900 - $23,643)

Dividends and capital gains = $8,051 (20% excluding the 3.8%)

Income after dividends and capital gains $32,206