Question

Company G, which has a 30 percent marginal tax rate, owns a controlling interest in Company J, which has a 12 percent marginal tax rate. Both companies perform engineering services. Company G is negotiating a contract to provide services for a client. Upon satisfactory completion of the services, the client will pay $99,000 cash.

1. Compute the after-tax cash from the contract assuming that Company G is the party to the contract and provides the services to the client.
2. Compute the after-tax cash from the contract assuming that Company J is the party to the contract and provides the services to the client.
3. Compute the after-tax cash from the contract assuming that Company J is the party to the contract, but Company G actually provides the services to the client.
   Complete this question by entering your answers in the tabs below. Required A Required B Required C Compute the after-tax cash from the contract assuming that Company G is the party to the contract and provides the services to the client. After-tax cash Required A Required B >
   

Answer 1

Requirement A: Compute after tax cash as follows

According to the assignment of income doctrine, income is taxed to the person who earns it and therefore in this case Company G is the service provider and the income generated from this transaction should be taxed at the marginal tax rate of 30% as follows

Particulars	Total
Cash received under the contract	$99,000
Deduct: Income tax ($99,000 × 30%)	$29,700
After-tax Cash Flows	$69,300

Requirement B: Compute after tax cash as follows

In this case Company J is the service provider and therefore the income under the contract is taxed at the marginal tax rate of 12% as follows

Particulars	Total
Cash received under the contract	$99,000
Deduct: Income tax ($99,000 × 12%)	$11,880
After-tax Cash Flows	$87,120

Requirement C: Compute after tax cash as follows

In this case also actual service to the client is provided by the Company G and therefore the income sthould be taxed at the marginal tax rate of 30% inspite of that the company J signed the contract and received the cash.

Particulars	Total
Cash received under the contract	$99,000
Deduct: Income tax ($99,000 × 30%)	$29,700
After-tax Cash Flows	$69,300