Question

In the current year, Azure Company has $350,000 of net operating income before deducting any compensation or other payment to its sole owner, Sasha. In addition, Azure has interest on municipal bonds of $25,000. Sasha has significant income from other sources and is in the 37% marginal tax bracket. Based on this information, determine the income tax consequences to Azure Company and to Sasha during the year for each of the following independent situations. (Ignore the deduction for qualified business income and the 3.8% Medicare surtax on net investment income.)The rates on qualified dividends are 0%, 15% and 20%.
a. Azure is a C corporation and pays no dividends or salary to Sasha.

Azure Company has corporate income tax of ($ ) based on taxable income of ($ )

Since Sasha received no dividends or salary from Azure during the year, she (is)(is not) currently taxed on any of the corporation's income.

b. Azure is a C corporation and distributes $75,000 of dividends to Sasha.

Azure Company has corporate income tax of ($ ), and Sasha incurs income tax of ($ ) with respect to the dividends.

c. Azure is a C corporation and pays $75,000 of salary to Sasha.

The salary paid to Sasha (is) (is not) deductible by Azure Company resulting in taxable income of ($ ).

Sasha incurs income tax of ($ ) with respect to the salary she received during the year.

d. Azure is a sole proprietorship, and Sasha withdraws $0.

There (is) (is not) Federal income tax applicable to businesses formed as sole proprietorships.

Sasha incurs income tax of ($ ) with respect to Azure Company.

e. Azure is a sole proprietorship, and Sasha withdraws $75,000.

There (is) (is not) Federal income tax applicable to businesses formed as sole proprietorships.

Sasha (will) (does not) pay tax on the income of Azure Company, (decreased by) (increased by) (regardless) of the amount she withdraws.

Answer 1

Answer:

a. Azure is a C corporation and pays no dividends or salary to Sasha.

Azure Company has corporate income tax of $73,500 based on taxable income of $350,000 and a 21% tax rate. Interests on municipal bonds are not taxed.

Since Sasha received no dividends or salary from Azure during the year, she is not currently taxed on any of the corporation's income.

b. Azure is a C corporation and distributes $75,000 of dividends to Sasha.

Azure Company has corporate income tax of $73,500, and Sasha incurs income tax of $15,000 assuming Azure's dividends are considered qualified dividends and a 20% tax rate with respect to the dividends.

c. Azure is a C corporation and pays $75,000 of salary to Sasha.

The salary paid to Sasha is deductible by Azure Company resulting in taxable income of $275,000.

Sasha incurs income tax of $27,750 (with a 37% tax rate) with respect to the salary she received during the year.

d. Azure is a sole proprietorship, and Sasha withdraws $0.

There is not Federal income tax applicable to businesses formed as sole proprietorships.

Sasha incurs income tax of $129,500 (with a 37% tax rate) with respect to Azure Company.

e. Azure is a sole proprietorship, and Sasha withdraws $75,000.

There is not Federal income tax applicable to businesses formed as sole proprietorships.

Sasha will pay tax on the income of Azure Company, regardless of the amount she withdraws.