Question

Benton Company (BC) has one owner, who is in the 33% Federal income tax bracket. BCâs gross income is $395,000, and its ordinary trade or business deductions are $245,000. Compute the Federal income tax liability on BCâs income for the current year under the following assumptions:
a.BC is operated as a proprietorship, and the owner withdraws $100,000 for personal use.

b.BC is operated as a corporation, pays out $100,000 as salary, and pays no dividends to its shareholder.

c.BC is operated as a corporation and pays out no salary or dividends to its shareholder.

d.BC is operated as a corporation, pays out $100,000 as salary to its shareholder, and pays out the remainder of its earnings as dividends.

e.Assume that Robert Benton of 1121 Monroe Street, Ironton, OH 45638 is the owner of BC, which was operated as a proprietorship. Robert is thinking about incorporating the business for next year and asks your advice. He expects about the same amounts of income and expenses and plans to take $100,000 per year out of the company whether he incorporates or not. Write a letter to Robert [based on your analysis in (a) and (b)] containing your recommendations.

Answer 1

Answer:

BC's net income = $395,000 - $245,000 = $150,000

A) if BC is a sole proprietorship, then the owner will pay income tax for the complete net income = $150,000 x 33% = $49,500

B) if BC is operated as a corporation, then the owner will only pay taxes on the salary earned = $100,000 x 33% = $33,000.

But the corporation will have to pay corporate taxes for its new net income = $150,000 - $100,000 = $50,000 x 21% (current corporate tax rate) = $10,500

Retained earnings = $50,000 - $10,500 = $39,500. When BC distributes its earnings, the owner will have to pay income taxes for the dividends received.

total taxes paid = $33,000 + $10,500 = $43,500, but in the future it will pay an additional $13,035 in taxes (= $39,500 x 33%)

C) if BC is operated as a corporation and no salaries are paid, then it will only pay corporate taxes = $150,000 x 21% = $31,500. When BC distributes its dividends, the owner will have to pay income taxes.

total taxes paid = $31,500 but in the future it will pay an additional $39,105 in taxes [= ($150,000 x 79%) x 33%)]

D) if BC is operated as a corporation, then the owner will only pay taxes on the salary earned = $100,000 x 33% = $33,000.

But the corporation will have to pay corporate taxes for its new net income = $150,000 - $100,000 = $50,000 x 21% (current corporate tax rate) = $10,500

Retained earnings = $50,000 - $10,500 = $39,500. When BC distributes its earnings, the owner will have to pay income taxes = $39,500 x 33% = $13,035

total taxes paid = $33,000 + $10,500 + $13,035 = $56,535

E) If Mr. Benton decides to change his sole proprietorship into a corporation, he will pay more taxes. If he wants to pay less taxes, the best option is to keep the company as a sole proprietorship. If he is worried about unlimited liability, he should change his company into a limited liability partnership or limited liability company, the problem is that he will need to find a partner (maybe his wife or a son/daughter).