ck is starting a business that he expects to produce $60,000 of income this year
ID: 2354902 • Letter: C
Question
ck is starting a business that he expects to produce $60,000 of income this year before compensating Jack for his services. He has $1,000 of other income and itemized deductions totaling $10,000. He wants to know whether he should incorporate or operate the business as a proprietorship. If a corporation is formed, he wants to know whether he should make an S election. If he incorporates, the corporation will pay Jack a salary of $40,000. He expects to distribute an additional $5,000 of corporate profits to himself each year. Jack is single. Task: Which organizational form, proprietorship, S corporation, or C corporation, will produce the lowest total current income tax liability for Jack and his business? Ignore payroll and other taxes.Explanation / Answer
solo proprietorship
$60,000 of income will be subject of 15.3% self emp.tax - $9180
Jack's AGI will be $60,000(business income) + $1000(other income) - $4590 (half of SE tax) = $56,410
his taxable income- assuming he is single without dependents and without any other credits - $56,410 - $10,000 (itemized deduction) - $3500 = $42910
estimated tax liability is $6915,and total tax liability $6915 + $9180 = $16095
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-- C-corporation
will pay $40,000 salary - that will be taxable income for Jack and deductible expense for C-corporation.
C-corporation will pay 7.65% of fica tax and 6.2%futa tax (up to $7000 of salary.$40,000 * 7.65% + $7000 * 6.2% = $3060 + $434 = $3694
C-corporation net income would be $60,000 - $40,000 (salary) - $3694 (employment taxes) = $16306
C-corporation income tax 15% - $16306 * 15% = $2446
Total corporation taxes $3694 (employment taxes) + $2446 (income tax) = $6140
Additional $5,000 of corporate profits will be distributed after C-corporation will pay taxes on that profit - that will be treated as dividend income for Jack.
There will be not-distributed income in C-corporation $16306 - $2446 - $5000 (dividend distribution) = $8860.
Jack will pay 7.65% of FICA tax (employee's portion) - 40,000 * 7.65% = $3060
his taxable income - assuming he is single without dependents and without any other credits - $40,000 + $5000(dividend distribution) - $10,000 (itemized deduction) - $3500 (personal exemption for 2009) = $31500
estimated income tax liability is $4308
and total tax liability $3060 + $4308 = $7368
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Total taxes to be paid by C-corporation and Jack $6140 + $7368 = $13,508
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-- S-corporation
will be liable for employment taxes the same way as C-corporation - $3694, but there will not be any income tax because S-corporation would pass all tax liability to members.
Remaining income to be passed to Jack $60,000 - $40,000 - $3694 = $16,306
Jack will pay 7.65% of FICA tax (employee's portion) - 40,000 * 7.65% = $3060
his taxable income - assuming he is single without dependents and without any other credits - $40,000 + $16,306(dividend income passed through from S-corporation) - $10,000 (itemized deduction) - $3500 (personal exemption for 2009) = $42,806
estimated income tax liability is $6889
and total tax liability $3060 + $6889 = $9949
Total taxes to be paid by S-corporation and Jack $3694 + $9949 = $13,643
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