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Unformatted text preview: 40. Drew is the sole owner of Morris, Inc., a corporation. Morriss net income for the current year is $150,000 before considering Drews $85,000 salary. Assume Drew is single and has income from other sources that is $30,000 more than his allowable deductions. What is the total income tax liability if Morris is: a. A corporation Drew can be an employee of the corporation, which is a separate taxable entity. He will be taxed on the salary he receives and his taxable income will be $115,000 ($85,000 + $30,000). The corporation deducts his salary in calculating its taxable income of $65,000 ($150,000 - $85,000). The total income tax liability if Morris is organized as a corporation is $37,428: Corporate tax - $ 7,500.00 + [25% x ($ 65,000 - $50,000)] $ 11,250 Drew's tax - $16,056.25 + [28% x ($115,000 - $78,850)] 26,178 Total income tax liability $ 37,428 b. An S corporation An S corporation is a conduit entity. Drew can be an employee of the corporation and is taxed on the salary he receives. As the sole owner, Drew will also include the S corporation's $65,000 ($150,000 - $85,000) income in his taxable income. Drew's taxable income is $180,000 ($65,000 + $85,000 + $30,000) and he will pay a tax of $45,151 if Morris is organized as an S corporation: Drew's tax - $40,052.25 + [33% x ($180,000 - $164,550)] $ 45,151 41. Return to the facts of problem 40. Assume that late in the year, Drew needs extra cash to pay off gambling debts and has the corporation declare a $25,000 dividend to provide the cash. What is the effect of the dividend payment on the total income tax liability if Morris is a. A corporation The dividend will be taxable to Drew and cannot be deducted by Morris. The dividend, while subject to double taxation, is taxed at the long-term capital gains rate. Drew's taxable income increases to $140,000 and the total income tax liability increases to $41,178: Corporate tax - $ 7,500.00 + [25% x ($65,000 - $50,000)] $ 11,250 Drew's tax - Ordinary income - $115,000 (from problem #40) $ 26,178 Dividend income - $ 25,000 x 15% 3,750 29,928 Total income tax liability $ 41,178 b. An S corporation The dividend paid to Drew is not taxable (return of capital investment) and cannot be deducted by Morris. There is no effect on the total tax liability; it remains $45,151. 42. In January of the current year, Josh purchases all the stock of Ballpark Corporation for $100,000. Ballpark's taxable income for the current year is $200,000, and it pays $61,250 in income tax. None of the earnings is distributed as dividends. Josh believes that if he sells his stock two years later for $238,750, he will avoid double taxation. Write a memo to Josh explaining why he is not avoiding double taxation just because he receives no dividends....
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- Fall '08
- Corporation, Taxation in the United States