Question

Andrea would like to organize SHO as either an LLC (taxed as a sole proprietorship) or a C corporation. In either form, the entity is expected to generate an 11 percent annual before-tax return on a $350,000 investment. Andrea’s marginal income tax rate is 35 percent, and her tax rate on dividends and capital gains is 15 percent. Andrea will also pay a 3.8 percent net investment income tax on dividends and capital gains she recognizes. If Andrea organizes SHO as an LLC, Andrea will be required to pay an additional 2.9 percent for self-employment tax and an additional 0.9percent for the additional Medicare tax. Further, she is eligible to claim the full deduction for qualified business income. Assume that SHO will pay out all of its after-tax earnings every year as a dividend if it is formed as a C corporation.

a.How much cash after taxes would Andrea receive from her investment in the first year if SHO is organized as either an LLC or a C corporation?

Answer 1

a.

		LLC	Description	C corp.	Description
1.	Pretax earnings	38,500	(350,000*11%)	38,500	(350,000*11%)
2.	Entity level tax rate	0%		21%
3.	Entity level tax	0		8,085	(1) * (2)
4.	Earnings after-entity-level tax	38,500	(1) – (3)	30,415	(1) – (3)
5.	QBI deduction	(7,700)	(4) * 20%		NA
6.	Deduction for 50 percent of SE tax	(516)	(1) * 0.9235 * 0.029 * 0.5		NA
7.	Net income taxable to owner	30,284	(4) + (5) + (6)	30,415	(4) distributed as dividend
8.	Income tax paid by owner	10,599	(7) × 0.35	4,562	(7) × 0.15
9.	Self-employment tax	1,031	(1) × 0.9235 × 0.029		NA
10.	Additional Medicare tax/Net investment income tax	320	(1) × 0.9235 × 0.009 additional Medicare tax	1,156	(7) × 0.038 net investment income tax
11.	Owner-level tax	11,950	(8) + (9) + (10)	5,718	(8) + (10)
	After-tax cash flow	26,550	(1) – (11)	24,697	(7) – (11)