Question

Mr. Lion, who is in the 37 percent tax bracket, is the sole shareholder of Toto,Inc., which manufactures greeting cards. Toto's average annual net profit (before deduction of Mr. Lion's salary) is $390,000. For each of the following cases, compute the income tax burden on this profit. (Ignore any payroll tax consequences.) a. Mr. Lion's salary is $100,000, and Toto pays no dividends. b. Mr. Lion's salary is $100,000, and Toto distributes its after-tax income as a dividend. C. Toto is an s corporation. Mr. Lion's salary is $100,000, and Toto makes no cash distributions. Assume Toto's ordinary income qualifies for the 20 percent Section 199A deduction. d. Toto is an S corporation. Mr. Lion draws no salary, and Toto makes no cash distributions. Assume Toto's ordinary income qualifies for the 20 percent Section 199A deduction. e. Toto is an s corporation. Mr. Lion draws no salary, and Toto makes cash distributions of all its income to Mr. Lion. Assume Toto's ordinary income qualifies for the 20 percent Section 199A deduction. a. Income tax burden on this profit b. Income tax burden on this profit c. Income tax burden on this profit d. Income tax burden on this profit e. Income tax burden on this profit

Answer 1

The following are the answers for each of the following options:

a. Average Net Profit Before Mr. Lions Salary : USD 390,000

Less Lions Salary : USD 100,000

Profit after salary before tax   : $290,000

Tax Burden @ 37% $107,300 is the answer to option a.

b. Here it is important to understand that dividend is appropriation of profits after tax but income tax is charge against profits of Toto. Hence the tax burden will still remain the same at $107,300. Balance after tax 182,700 is distributed as dividends.

c.Here Toto is a company: Profit after remuneration of $100,000 is $290,000 (profit before tax).

Corporate tax burden assumed at 37% 107,300

Less 20% deduction under sec 199A on EBITDA (ordinary income of $290,000)= $54,000.

Balance is he actual tax burden that is 107,300-54000=53,300. (answer C)

d. Net profit before tax 390,000

37% corporate tax = 37% on 390,000=144300 less20% of 390000under sec 199A = $78,000.

Hence tax burden on profit is 144,300-78,000= 66,300 (answer D)

e. Dividends is an appropriation of after tax profits, but income tax is charge against profits. Hence ta burden will be the same as in d. There will be a Tax Burden of $ 66,300 and balance distribution to Mr. Lion of 390,000-66,300= 323,700

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Conclusion :

Tax Burden under

a $107,300

b. 107,300

c. 53,300

d. 66,300

e. 66,300

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