Page 4 of6 Section A: Tax Case Studies Case study (1) (10 Marks) For the current

Question

Page 4 of6 Section A: Tax Case Studies Case study (1) (10 Marks) For the current year, Creative Designs Inc., a C corporation, reports taxable income of paying salary to Ben the sole shareholder of Creative Designs Ii ordinary income is 28 percent and 15 percent on dividend income. Assume CD's tax rate w much total income tax will Creative Designs and Ben pay on the $300,000 taxable income for the year if CD doesn't pay any salary to Ben and instead distributes all of its after-tax income to Ben as a dividend? How much total income CD pays Ben a salary of $100,000 and distributes its remaining after-tax earnings to Ben as a dividend? Compare your answer in part a. with your answer to part b. Explain why these numbers are different a) Ho b) c)

Explanation / Answer

Solution:-

Part a & b:-

Part c:-

The combined taxes are lower under part b because $100,000 of the corporation's earnings is only subject to one level of tax (the individual tax on the salary). Conversely, total taxes paid are greater in part a than in part b because a greater share of corporate pre-tax earnings is subject to the double tax.

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a. without salary Description b. with salary Description (1) Taxable income before salary 300,000 300,000 (2) Salary 0 (100,000) (3) Taxable income 300,000 (1) - (2) 200,000 (1) - (2) (4) Entity tax 117,000 (3) * 39% 78,000 (3) * 39% (5) After-tax entity earnings 183,000 (3) - (4) 122,000 (3) - (4) (6) Ben’s tax on dividends 27,450 (5) * 15% 18,300 (5) * 15% (7) Ben’s tax on salary Not applicable 28,000 (2) * 28% (8) Combined tax 144,450 (4) + (6) 124,300 (4) + (6) + (7) Overall tax rate 48.15% (8) / (1) 41.43% (8) / (1)

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